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SEC PROPOSES REGULATION B, WHICH WOULD IMPLEMENT THE GRAMM-LEACH-BLILEY "PUSH-OUT" PROVISIONS

On June 17, 2004, the Securities and Exchange Commission ("SEC") proposed for comment new Regulation B, which would govern the securities activities of banks and other depository institutions effecting securities transactions as agent.¹ Proposed Regulation B, which would implement the "push-out" provisions of the Gramm-Leach-Bliley Act of 1999 ("GLBA"), contains a series of bank exemptions from the definition of "broker" under Section 3(a)(4) of the Securities Exchange Act of 1934 ("Exchange Act"), permitting banks to continue providing specified securities activities without registering as brokers with the SEC. It proposes to apply the GLBA statutory exceptions, and certain of the proposed exemptions to savings banks and savings associations under the same conditions as they apply to banks, and to apply a small number of the statutory exceptions to credit unions as well. Comments on proposed Regulation B are requested by the SEC on or before August 2, 2004.² It is expected that banks will be given a one year grace period to conform to these regulations, once they are finally adopted.³

BISA has participated extensively in meetings with the SEC over the past year, assisting the agency in the development of Regulation B. One of Regulation B’s primary authors, Linda Sundberg, spoke at BISA’s Legal, Regulatory and Compliance Conference on June 10, 2004. BISA intends to prepare a comment letter addressing areas of concern, and the comment letter will be shared with members.

I.  Background

GLBA amended federal law governing the activities and supervision of banks, bank holding companies and their affiliates, including the elimination of the complete separation between commercial and investment banking. Under prior law, a bank was excluded from the Exchange Act definition of "broker," so the SEC had limited authority over bank securities activities. GLBA eliminated that general exclusion, and replaced it with eleven enumerated exceptions.⁴ For example, a bank’s "networking" arrangement with a registered broker-dealer will be governed by the SEC under the Exchange Act. Banks (and their employees) effecting transactions in a way that is inconsistent with the SEC’s interpretation of GLBA, will be required to register with the SEC as broker-dealers.

GLBA was intended to realign the regulation of banking, securities and insurance activities, placing each of those areas under the jurisdiction of one expert regulator. With respect to bank securities activities, GLBA therefore permits banks to continue to engage in specified securities activities traditionally provided by banks, while generally requiring banks to push-out other securities activities, not specifically excepted, to their broker-dealer affiliates.

In May 2001, the SEC adopted "interim final rules" ("Interim Final Rules") to implement GLBA’s treatment of bank securities activities.⁵ Because of negative comment from the banking industry, as well as fellow regulators, the Interim Final Rules never became effective, and banks have been doing business under a general exemption from the Exchange Act definition of "broker" ever since. In September 2003, SEC rules governing bank securities activities as dealer went into effect, causing banks to limit their securities activities conducted as principal.⁶ The current bank exemption from the Exchange Act definition of "broker" expires on November 12, 2004.⁷

II.  Proposed Regulation B

Proposed Regulation B consists of seven subparts, five of which discuss the implementation of specific statutory exceptions; a sixth subpart contains additional specified exemptions; and a seventh subpart contains temporary exemptions for bank securities activities. The subparts in order, are: Subpart A — Networking; Subpart B — Trust and Fiduciary Activities; Subpart D — Sweep Accounts;⁸ Subpart E — Affiliate Transactions; Subpart F — Safekeeping and Custody; Subpart G - Special Purpose Exemptions; and Subpart H — Temporary Exemptions.

Subpart A.   Networking Exception

The "Networking" Exception in Exchange Act Section 3(a)(4)(B)(i) provides that a bank will not be considered a broker if, under certain circumstances, the bank enters into a contractual or other written arrangement with a broker-dealer under which the broker-dealer provides brokerage services to customers. The exception permits banks to receive transaction-related compensation from the broker-dealer, and it permits unlicensed bank employees to receive a "nominal one-time cash fee of a fixed dollar amount" for referring bank customers to the broker-dealer. Bank concerns with the Interim Final Rules were largely related to the SEC’s interpretation of the amount of, and circumstances under which unlicensed persons may receive, referral fees, as well as a lack of flexibility which would permit compensation arrangements typically utilized by banks.

1. "Nominal One-Time Cash Fee of a Fixed Dollar Amount." The SEC has proposed to permit unregistered bank employees to receive a nominal referral fee of the greater of: (1) $25; (2) an amount equal to $15 in 1999 plus an adjustment for inflation; or (3) the employee’s base hourly rate of pay.⁹ If the referral fee is not paid entirely in cash, it may be paid in points or units having a readily ascertainable nominal value, as part of an incentive program that covers a broad range of products that is designed primarily to reward activities unrelated to securities. The fee would have to be the same for any securities referral made by a particular employee, with a flat value that may not vary based on factors such as the financial status of the customer, the broker-dealer to which the customer is referred, the number of referrals an employee makes or whether the customer expresses an interest in a particular type of securities product. The SEC also stated that an unlicensed employee’s annual bonus may not be closely tied to the employee’s brokerage-related activities during the prior year. The SEC made clear, however, that a bank employee’s bonus may be tied to the overall profitability of the bank, or its holding company parent, provided that it is determined and paid regardless of the brokerage-related activities of the employee.
2. Definition of Referral. The SEC defined the term "referral" in proposed Regulation B to mean an action taken by a bank employee to direct a customer of the bank to a registered broker-dealer for the purchase or sale of securities for the customer’s account. It clarified that receipt of a referral fee may be contingent on two specified factors, and that it may not be directly or indirectly related to other specified factors.
1. Receipt of a referral fee may be contingent on whether a customer contacts or keeps an appointment to meet with a registered representative of a broker-dealer or on the amount of assets or net worth of the customer.
2. Receipt of a referral fee may not be contingent on whether the customer opens an account with the broker-dealer or keeps it open for a specified period, whether a customer account results in brokerage-related fees above a certain amount or assets invested above a certain amount, or whether a securities transaction results from the referral.

Subpart B.   Trust and Fiduciary Activities Exception

Exchange Act Section 3(a)(4)(B)(ii) permits a bank, under certain conditions, to effect securities transactions in a trustee or fiduciary capacity without registering as a broker-dealer with the SEC. Under the exception, a bank may effect securities transactions in its trust department or other department regularly examined for compliance with fiduciary principles and standards,¹⁰ provided it is "chiefly compensated" on the basis of: (1) an administration or annual fee; (2) a percentage of assets under management; (3) a flat or capped per order processing fee not exceeding the bank’s costs; or (4) any combination of these types of fees. In order to meet the "chiefly compensated" test, a bank’s compensation of the three types listed above ("Relationship Compensation")¹¹ must exceed its receipt of transaction-related compensation ("Sales Compensation")¹² in each account for which it provides trust and fiduciary services.

1. Definition of "Chiefly Compensated."
1. The SEC interprets the Trust and Fiduciary Activities Exception, as requiring a bank to be chiefly compensated by Relationship Compensation, as compared with Sales Compensation, with respect to each account for which it provides trust and fiduciary services. Under the standard test, the ratio of Relationship Compensation to Sales Compensation must exceed 1 to 1 (or 50%) for each account./li>
2. The SEC has proposed alternative exemptions in Regulation B, under which a bank may compare its Relationship Compensation to its Sales Compensation bank-wide, or through a "line of business" test,¹³ in which case the bank, or each applicable line of business, may not receive Sales Compensation to Relationship Compensation in a ratio exceeding 1 to 9 (or 11%)¹⁴. Banks relying on the "line of business" test may determine to subject only accounts from specified lines of business (or accounts within specified lines of business established prior to a certain date) to the 1 to 9 ratio test. Remaining accounts, not within those specified lines of business (or within specified lines of business but established after a specified date) would be examined on an account by account basis.
2. Proposed Safe Harbors and Exemptions from the Chiefly Compensated Test.
1. A bank relying on the account-by-account test for "chiefly compensated" in one year would be granted a safe harbor, deeming it in compliance with the "chiefly compensated" test for the following year, provided it meets four conditions: (i) meet all of the other conditions of the Trust and Fiduciary Activities Exception; (ii) have met the "chiefly compensated" test with respect to the particular account during the prior year; (iii) maintain procedures reasonably designed to ensure that, before opening or establishing an account, the bank reviews the account to ensure that the bank is likely to receive more Relationship Compensation than Sales Compensation for that account; and (iv) maintain procedures to reasonably ensure that after opening or establishing an account, at such time as the bank individually negotiates with the account holder or beneficiary of that account to increase the proportion of Sales Compensation to Relationship Compensation, that the bank is likely to receive more Relationship Compensation than Sales Compensation with respect to that account. Toward the end of each year, the bank could test for compliance on an account-by-account basis in order to qualify for a safe harbor in the following year.
2. Proposed Regulation B would provide a safe harbor, enabling a bank that meets the 1 to 9 ratio required for the line of business or bank-wide exemptions in a given year to be deemed in compliance with that exemption for the following year, provided three requirements are met. To rely on the safe harbor: (i) the bank would have to meet all other requirements of the Trust and Fiduciary Activities Exception; (ii) the bank’s ratio of Sales Compensation to Relationship Compensation from its qualifying fiduciary business may not exceed a 1 to 7 ratio; and (iii) the bank must not have relied on this safe harbor in any of the five preceding years. Toward the end of each year, the bank could test for compliance with the line of business or bank-wide exemption in order to qualify for a safe harbor in the following year.
3. A bank that does not meet the "chiefly compensated" test with respect to particular accounts in a given year would be permitted to continue to rely on the Trust and Fiduciary Activities Exception for the following year so long as those accounts represent ten percent or less of the total accounts for which the bank acts in a trustee or fiduciary capacity. A bank relying on this exemption would be required to: (i) meet all of the other requirements of the Trust and Fiduciary Activities Exception; and (ii) not have relied on this exemption with respect to those specified accounts in the preceding five years.
4. Banks also would be exempted if the lesser of 500 accounts or 1 percent of the total number of qualifying fiduciary activity accounts continued not to meet the "chiefly compensated" test in the following year, provided the bank has documented the reasons that each such account continued not to meet the condition and linked that reason to the bank’s exercise of fiduciary responsibility.
3. Other Trust and Fiduciary Activities Exemptions.
1. Proposed Regulation B would provide a general exemption for banks from the definition of broker with respect to established personal trust accounts that have terms that cannot be readily changed without consequences to both the bank and the trust beneficiaries. This exemption would apply, for example, to certain living, testamentary and charitable trust accounts that were established before July 30.
2. Proposed Regulation B provides an exemption from the Exchange Act definition of "broker" for a bank that serves as an indenture trustee in a no-load money market fund, without meeting the "chiefly compensated" test.
4. Definition of "Trustee Capacity," Interpretation of "Fiduciary Capacity" The SEC did not define the term ""trustee capacity" under proposed Regulation B, as it had in the Interim Final Rules. Instead, banks acting under the title of trustee could generally rely on the Trust and Fiduciary Activities Exception, regardless of the amount of fiduciary responsibilities they incur. The SEC noted, however, that banks acting in a non-trustee capacity, such as IRA custodians, may not rely on the Trust and Fiduciary Activities Exception in that capacity. The SEC also has not proposed to add additional bank capacities to those stated in Exchange Act Section 3(a)(4)(D) to be included in the term "fiduciary capacity" for purposes of the Trust and Fiduciary Activities Exception.¹⁵

Subpart C.   (Reserved)

Subpart D.   Sweep Account Exception¹⁶

Exchange Act Section 3(a)(4)(B)(v) provides an exemption from the definition of broker to banks effecting transactions as part of a program for the investment or reinvestment of deposit funds into any "no-load, open-end management investment company registered under the Investment Company Act of 1940 that holds itself out as a money market fund." Rule 3b-17 under the Interim Final Rules provides that an investment company is "no-load" for purposes of the sweep accounts exception if: (1) it does not have a sales load or a deferred sales load; and (2) its total charges against net assets to provide for sales-related expenses and service fees (including 12b-1 fees) do not exceed 0.25 of one percent (0.0025) of average net assets annually and are disclosed in the mutual fund’s prospectus.¹⁷ The SEC is proposing to retain the current Rule 3b-17 definition of "no-load" for purposes of the Sweep Account Exception¹⁸. The SEC also clarified that the exception applies separately to each series or class or a mutual fund’s securities, to allow for the fact that investment companies may charge different fees for different securities they issue. The exception applies only to sweep programs that require the automatic investment of customer funds on a regular basis, not requiring the direction of the customer for each transaction. It applies solely to transactions effected on behalf of a bank’s own deposit customers, not to transactions effected on behalf of another bank or its customers.

Subpart E.   Affiliate Transactions Exception

Exchange Act Section 3(a)(4)(B)(vi) excepts from the definition of broker a bank that effects transactions for the account of any of its affiliates (other than an affiliated registered broker-dealer or affiliate engaged in merchant banking). For a bank to avail itself of this exception, the affiliate must be acting as a principal or as a trustee or fiduciary purchasing or selling securities for investment purposes.¹⁹ The affiliate may not act as riskless principal for another person, as a registered broker-dealer or be engaged in merchant banking. The bank would be required to obtain the securities to complete the transaction on behalf of an affiliate from a registered broker-dealer, a person not required to register as a broker-dealer, or by means of another exception or exemption under Exchange Act Section 3(a)(4)(B).

Subpart F.   Safekeeping and Custody Exception

Exchange Act Section 3(a)(4)(B)(viii) permits a bank to perform securities safekeeping and custody services as part of customary banking activities. Under the SEC’s interpretation, a bank relying on this exception may facilitate the transfer of funds and securities as part of the clearance and settlement of transactions, effect securities lending or borrowing transactions, and hold securities pledged by a customer or facilitate the pledging or transfer of securities that involve the sale of those securities. The exception permits banks to "serve as custodian or provider of other related administrative services" to IRAs, pension, retirement, profit sharing, bonus, thrift savings, incentive or similar benefit plans without being considered a broker. The exception does not permit a bank to act as clearing broker or carrying broker with respect to securities transactions (other than with respect to government securities).²⁰ The SEC similarly interprets the exception as not permitting banks to accept customer orders for securities transactions. In administering the Safekeeping and Custody Exception, the SEC proposes two sets of exemptions, one for existing accounts and qualified investors, and the other for small banks, as discussed below.

1. General Safekeeping and Custody Exemption for Existing Accounts²¹ and Accounts of Qualified Investors ("Eligible Accounts")²². In order to mitigate the disruption that the implementation of GLBA is expected have on banks and their customers, the SEC has proposed "grandfathering" existing custody accounts,²³ and exempting accounts of qualified investors, as described below.
1. The SEC proposes to permit banks to accept orders for customer securities transactions for Eligible Accounts investors, provided that any compensation that the bank receives for its custody services does not vary directly or indirectly based on whether the bank accepts an order to purchase or sell a security.²⁴
2. Banks would be permitted to receive 12b-1 fees and shareholder servicing fees for Eligible Accounts, provided that the bank makes available any class or series of a registered investment company’s securities that can be reasonably obtained by the bank for purchase or sale by customers. Banks, however, may not be compensated for revenue sharing arrangements under this exception.
3. Solicitation of Transactions. Under the general safekeeping and custody exemption, a bank would be permitted to solicit transactions for Eligible Accounts in response to customer requests by providing information contained in the registration materials for a security filed under the Securities Act of 1933; or sales materials prepared by the principal underwriter that is a registered broker-dealer or an investment company that is not an affiliated person of the bank. Banks would not be permitted, however, to solicit securities transactions for those accounts when advertising for their custody business generally.²⁵
4. Dually Licensed Employees; Unlicensed Bank Employees. Proposed Regulation B would permit banks to rely on dually-licensed bank employees, whose duties are not primarily for the bank, to effect securities transactions for Eligible Accounts. It also would permit bank custody employees to receive incentive compensation for the amount of securities-related assets gathered or the size or value of a customer’s securities account.
5. Trustees, Fiduciaries May Not Rely on General Exemption. Proposed Regulation B would not permit a bank acting in its trustee or fiduciary capacity to rely on the general safekeeping and custody exemption. Banks acting in that capacity would instead have to meet the conditions of the Trust and Fiduciary Activities Exception. Similarly, the general safekeeping and custody exemption would not be available to banks effecting transactions on behalf of an employee benefit plan or to banks relying on the small bank safekeeping and custody exemption.²⁶
2. Small Bank Safekeeping and Custody Exemption. In addition to the general exemptions proposed for Eligible Accounts, the SEC has proposed a safekeeping and custody exemption for small banks. That exemption would apply to banks with less than $500 million in assets that are not part of a holding company with consolidated assets of more than $1 billion and that are not affiliated with a broker-dealer. Banks relying on this exemption may earn up to $100,000 annually from securities "sales compensation,"²⁷ regardless of the types of securities purchased or sold.²⁸ Small banks relying on this exemption also may solicit brokerage business by advertising that they effect transactions as part of their safekeeping and custody activities.²⁹ They may rely on the small bank safekeeping and custody exemption while entering into networking relationships with unaffiliated broker-dealers, effectively permitting the bank to effect securities transactions pursuant to their safekeeping and custody activities in addition to the networking arrangement.³⁰ Small banks relying on this exemption also may rely on dual bank/broker-dealer employees to work with bank customers while performing bank custodial activities.

Subpart G.   Special Purpose Exemptions

Regulation B proposes a number of other exemptions for banks effecting securities as agent, which are discussed below.

1. General Cash Management Exemption. Proposed Regulation B would provide a general exemption permitting banks to provide cash management services to their customers under specified circumstances. This exemption would allow banks to purchase and redeem money market securities for: (a) qualified investors; (b) persons who direct the purchase of securities from any cash flows that relate to an asset-backed security that has a minimum original asset value of $25 million or more; and (c) other customers for whom banks act in a trustee or fiduciary capacity, or in an escrow agent, collateral agent, depository agent, or paying agent capacity.³¹ The SEC is specifically seeking comment on whether this exemption should also extend to investments by the bank in other securities products.
2. Employee Benefit Plan Exemption. Proposed Regulation B would exempt from the definition of "broker" bank trustees and non-fiduciary administrators that effect transactions in securities of open-end investment companies for participants in employee benefit plans.³² A bank relying on this exemption would have to offset or credit any compensation it receives from a fund complex related to securities transactions in which plan assets are invested against fees and expenses that the plan owes to the bank. The proposal would require the bank to disclose clearly and conspicuously to the plan sponsor or fiduciary, if any, all fees and expenses assessed for services provided to the plan and all compensation received or to be received from a fund complex. The disclosures would have to be made in a manner that permits the plan sponsor or its designated fiduciary to determine that the bank has offset or credited any fees or expenses received from a fund complex relating to securities in which plan assets are invested against the fees and expenses that the plan owes to the bank. The bank also would be prohibited from paying unregistered employees incentive compensation that differs based on the value of a security or the type of security purchased or sold by a plan participant.³³
3. Regulation S Transactions with Non-U.S. Persons. Proposed Regulation B would provide banks with an exemption from the Exchange Act definition of "broker" to effect transactions pursuant to Regulation S with non-U.S. persons offshore in an agency or riskless principal capacity.³⁴ A bank could also resell any eligible Regulation S securities after their initial issuance by or on behalf of a non-U.S. person or to a non-U.S. person as long as the bank continues to comply with the requirements of Regulation S. After the requirements of Regulation S cease to apply to an issuance, the bank could resell the securities to another non-U.S. person or a broker-dealer without meeting the terms of Regulation S.³⁵ For purposes of this exemption, an eligible security does not include a security sold from the bank’s inventory or the inventory of its affiliate. The SEC also proposes to exclude from the exemption situations where the bank or its affiliate is underwriting a new issue on a firm-commitment basis.³⁶
4. Exemptions for Savings Associations and Savings Banks. Proposed Regulation B would extend to savings banks and savings associations the same conditions and definitions as are applicable to banks that utilize the statutory exceptions from the definitions of "broker" and "dealer." Proposed Regulation B also would exempt savings associations and savings banks from the definition of "broker" for effecting transactions for certain customers in money market funds; for effecting transactions in reliance on the Trust and Fiduciary Activities Exception and the small bank Safekeeping and Custody Exception, for effecting transactions in investment company securities through Fund/SERV or directly with a fund transfer agent (as described below); and for securities lending transactions. Proposed Regulation B, however, would not extend the general safekeeping and custody exemption to savings banks and savings associations. It also would not provide the exemption for savings banks and savings associations effecting transactions in ERISA plans that is provided to banks, or for effecting Regulation S transactions, because the SEC had insufficient information to determine whether thrifts directly engage in the types of securities activities covered by those proposed exemptions. The SEC is therefore soliciting comment on whether thrifts participate in securities activities covered by these exemptions, including empirical data supporting those comments.
5. Credit Unions. Based on discussions the SEC staff has had with credit union representatives, they do not believe credit unions engage in extensive securities activities. The SEC therefore proposed to extend only three of the bank exceptions in proposed Regulation B to credit unions.³⁷ Under the proposal, credit unions may engage in networking relationships with broker-dealers under the same conditions and definition as banks may. Credit unions may sweep deposit funds into no-load money market funds under the same conditions and definitions as for banks. The proposal also would permit credit unions to rely on the Trust and Fiduciary Activities Exception under the same conditions and definitions as would apply to banks. Credit unions also would be exempted from the Exchange Act definition of "dealer" to permit them to purchase securities for their own account or for accounts over which they act as trustee or fiduciary under the trust and fiduciaries activities exception. These exemptions would apply to all credit unions, whether state or federally chartered, and whether federally insured or privately insured. The SEC is soliciting comment on whether credit unions currently engage in securities safekeeping and custody activities to the extent that they should be able to rely on that bank exception also.
6. Effecting Transactions in Investment Company Securities Through Fund/SERV or a Transfer Agent. Under Exchange Act Section 3(a)(4)(C), banks must effect securities transactions pursuant to the Trust and Fiduciary Activities Exception, the Safekeeping and Custody Exception, and the stock purchase plan exception through a broker-dealer (or internally cross the securities).³⁸ The Interim Final Rules provided an exemption from this requirement for banks effecting transactions in investment company securities through the facilities of a registered clearing agency, without the intermediation of a registered broker-dealer. The SEC has proposed keeping that exemption, and expanding it to banks processing the purchase and redemption of investment company shares directly with a fund’s transfer agent, provided that the bank does not receive compensation for the distribution of the securities, including any revenue sharing arrangement.³⁹

Subpart H.   Temporary Exemptions

1. Transition Period. The SEC proposes to provide banks and other depository institutions with a transition period of one year after the adoption of any amended rules to come into compliance with those rules.⁴⁰ The SEC is seeking comment on whether that is a sufficient amount of time, and whether banks would need that much time to come into compliance.
2. Relief From Exchange Act Section 29. Exchange Act Section 29 permits a party to void a transaction that was entered into in violation of the Exchange Act. In the release adopting the exemptions from the Exchange Act definition of "dealer," the SEC amended Rule 15a-8, to prevent banks from having transactions voided for inadvertent compliance problems resulting from the implementation of the GLBA provisions, until March 31, 2005.⁴¹ Proposed Regulation B would similarly provide an exemption until 18 months after the effective date of any rules the SEC adopts implementing the GLBA definition of broker. The exemption would be limited to bank contracts being considered void because the bank that is a party to the contract violated the registration requirements of Exchange Act Section 15(a), or any applicable provision of the Exchange Act and the rules and regulations thereunder, based solely on the bank’s status as a broker when the contract was created.

III.  Amendment to Exchange Act Rule 15a-6

Exchange Act Rule 15a-6 allows foreign broker-dealers, without registering in the United States, to effect transactions in securities with or for a U.S. registered broker-dealer or bank acting "in a broker-dealer capacity as permitted by U.S. law."⁴² Because GLBA amended the Exchange Act to provide that banks engaged in certain activities would not be considered to be brokers or dealers, the SEC proposed replacing the phrase, "in a broker or dealer capacity as permitted by U.S. law," with "pursuant to an exception or exemption from the definition of ‘broker’ or ‘dealer’ in Sections 3(a)(4)(B) or 3(a)(5)(C) of the Act."

IV.  Request For Comments

The SEC has requested comment on proposed Regulation B on or before August 2, 2004. BISA is in the process of collecting comments from members on the SEC proposal, which we intend to incorporate into the association’s comment letter. Please provide any comments on proposed Regulation B to John F. Hartigan, 213.612.2630; Kathleen W. Collins, 202.739.5642; or Jack P. Drogin, 202.739.5380. Comments from members are request as soon as possible, but not later than July 7, 2004.

¹See Securities Exchange Act Release No. 49879 (June 17, 2004); www.sec.gov/rules/proposed/34-49879.htm
²Comments may be filed electronically at www.sec.gov/cgi-bin/ruling-comments?ruling=s72604&rule_path=/rules/proposed/s72604&file_num=S7-26-04&action=Show_Form
³Regulation B, once implemented, will apply solely to a bank’s securities activities as agent. Other banking activities, such as insurance, would be governed by separate laws and regulations.
⁴The eleven GLBA statutory exceptions for banks from the Exchange Act definition of "broker" are for: (a) networking; (b) trust and fiduciary activities; (c) transactions in commercial paper, bankers’ acceptances, commercial bills and other exempted securities; (d) transactions incidental to transfer agent activity; (e) no-load sweeps; (f) transactions for affiliates; (g) private placements; (h) safekeeping and custody; (i) transactions in "identified banking products;" (j) municipal securities; and (k) 500 annual transactions de minimis exception.
⁵SeeSecurities Exchange Act Release No. 44291 (May 11, 2001). www.sec.gov/rules/final/34-44291.htm
⁶SeeSecurities Exchange Act Release No. 47364 (February 13, 2003)(adopting rules governing bank activities as dealer). www.sec.gov/rules/final/34-47364.htm
⁷SeeSecurities Exchange Act Release No. 47649 (April 8, 2003)(extending the bank exemption from the Exchange Act definition of broker until November 12, 2004). www.sec.gov/rules/other/34-47649.htm
⁸Subpart C is reserved.
⁹The referral fee may be received not more than one time per customer. The SEC is seeking comment on whether to add another category to the amount of referral fee, to include the amount an employee would be paid for the sale or renewal of a certificate of deposit.
¹⁰Proposed Regulation B would permit a bank to rely on the Trust and Fiduciary Activities Exception, for activities regularly examined by bank examiners for compliance with fiduciary principles and standards, regardless of whether the activity was conducted within the trust department of the bank or another department.
¹¹Under the proposed amendments to Rule 3b-17, Relationship Compensation includes compensation from all bank trust and fiduciary activities, including managing real estate or other assets, as well as from securities activities.
¹²The definition of Sales Compensation would include 12b-1 fees paid to the bank for distribution of fund shares, but it would not include fees that the bank receives for shareholder servicing activities. Proposed Regulation B would permit banks to allocate on an account-by-account basis the 12b-1 fees they receive from funds on an entity basis: (1) based on the number of each class of an investment company’s shares held in each account on the last business day of the preceding year multiplied by the net asset value per share on that day and by the annual 12b-1 fee rate applicable to that class of securities; or (2) another allocation method, provided that it fairly and consistently measures the amount of Sales Compensation attributable to each account during the preceding year. A similar allocation method was proposed for banks receiving other fees it receive annually attributable to an account that is not received from that account.
¹³Proposed Rule 724(e) would define "line of business" as an identifiable department, unit, or division of a bank organized and operated on an ongoing basis for business reasons with similar types of accounts and for which the bank acts in a similar fiduciary capacity to those listed in Exchange Act Section 3(a)(4)(D).
¹⁴Banks relying on the bank-wide or line of business test would be required to meet all of the other requirements of the trust and fiduciary exception and to maintain procedures reasonably designed to ensure that, before opening or establishing an account, the bank reviews the account to ensure that the bank is likely to receive more Relationship Compensation than Sales Compensation with respect to that account. Banks would also be required to maintain procedures reasonably designed to ensure that, after opening or establishing an account, at such time as the bank individually negotiates with the account holder or beneficiary of the account to increase the proportion of Sales Compensation to Relationship Compensation, with respect to that account, the bank reviews the account to ensure that the bank is likely to receive more Relationship Compensation than Sales Compensation with respect to the account.
¹⁵Exchange Act Section 3(a)(4)(D) states that the term "fiduciary capacity" for purposes of the Trust and Fiduciary Activities Exception includes a bank acting in the capacity of: trustee, executor, administrator, registrar of stocks and bonds, transfer agent, guardian, assignee, receiver, or custodian under uniform gift to minor act, or as investment adviser if the bank receives a fee for its investment advice. Proposed Regulation B would permit banks with an ongoing responsibility to review, select, or recommend specific securities for its customers, in a fiduciary capacity imposing a duty of loyalty, to be considered an investment adviser receiving fees for its investment advice, under the Trust and Fiduciary Activities Exception. That would include banks effecting transactions for wrap account customers, but it would not include banks merely providing asset allocation advice.
¹⁶The SEC also has proposed a general exception for investments in money market funds that do not have be no-load funds on behalf of qualified investors, trust and fiduciary accounts, and specified agency accounts, , provided certain disclosures are made. See Section F.1., infra.
¹⁷This definition is consistent with the NASD’s definition of "no-load" and the interpretations of SEC staff under which broker-dealers may describe a fund as being "no-load" or as having "no sales charge." See NASD Rule 2830(d)(4); and letter re: Investment Company Institute (August 22, 1994).
¹⁸Banks relying on the Sweep Account Exception may impose additional charges in addition to the 0.25 of one percent of assets in the account on customers, provided those charges are not against assets in the account.
¹⁹The SEC distinguishes purchasing and selling securities for investment purposes, which unregistered persons (i.e., traders) may do, from buying and selling as part of a regular business, which only registered dealers may do.
²⁰The SEC discussed the differences between a "carrying broker" and a "custodian," in it s proposal. One of the major differences is that a carrying broker performs back-office functions on behalf of an introducing broker-dealer, whereas a bank custodian, under this exception, typically acts on behalf of a bank customer.
²¹The general safekeeping and custody exemption would apply to accounts existing on July 30.
²²Exchange Act Section 3(a)(54) defines the term "qualified investor" to include a bank, a broker-dealer and its associated persons (other than natural persons), an investment company, an employee sponsored retirement plan, a company or natural person with $25 million or more in investments, foreign government or a government or political subdivision, agency or instrumentality with $50 million or more in investments.
²³Proposed Regulation B would define the phrase "account for which the bank acts as a custodian" to mean an account established by a written agreement between the bank and the customer, which, at a minimum, provides for the terms that will govern the fees payable, rights, and obligations of the bank regarding the safekeeping of securities, settling of trades, investing cash balances as directed, collecting income, processing corporate actions, pricing securities positions, and providing of recordkeeping and reporting services.
²⁴The SEC stated that a bank could demonstrate that it does not receive additional compensation for effecting securities transactions by utilizing fee schedules that specify charges for the movement of funds or securities and identifying similarly situated customers who pay the same price for such movements and who do not utilize the bank or its affiliates to effect securities transactions.
²⁵Banks would, however, be permitted to solicit securities activities permitted under the statutory Safekeeping and Custody Exception (e.g., for government securities) or other exemptions, such as securities lending pursuant to Exchange Act Rule 15a-11. They could not, however, solicit transactions with respect to their safekeeping and custody activities generally. The SEC also noted that the current bank practice of providing lists of recommended securities, watch lists, research reports, or other publications highlighting particular securities or groups of securities is not within the Safekeeping and Custody Exception.
²⁶Banks meeting the requirements of the small bank exemption would have to choose whether to rely on the general bank safekeeping and custody exemption or the exemption granted to small banks.
²⁷The SEC stated that sales compensation would include compensation that a bank receives for a securities offering that the bank does not received directly from a customer, beneficiary, or the assets of the trust or fiduciary account, such as 12b-1 fees or revenue sharing arrangements with mutual funds. Sales compensation would not include fees for holding custody of a customer’s funds and securities that do not vary based on whether orders for securities are accepted by the broker. This $100,000 annual limit would be adjusted for inflation. Banks relying on this exception may not also rely on another exception for certain accounts. For example, compensation received for effecting transactions for its trust and fiduciary activities accounts would be counted toward the banks annual sales compensation limit.
²⁸The Interim Final Rules limited the small bank’s securities revenues to investments in investment company securities in tax-deferred accounts. The current proposal opens it up to any security, and does not limit its application to tax-deferred accounts.
²⁹This solicitation proposal corresponds to banks being able to advertise that they effect transactions for customers as part of their trust and fiduciary activities under that exception.
³⁰Small banks relying on this exemption may pay incentive compensation to bank employees only pursuant to, and as permitted under, the Networking Exception.
³¹This exemption would apply to purchases and redemptions of money market securities regardless of whether they meet the definition of "no-load." Banks providing these services with respect to money market funds not meeting the definition of no-load, would be prohibited from characterizing or referring to the securities as "no-load," and they must provide the customer with a fund prospectus and clear and conspicuous notice disclosing payments the bank may receive in connection with the transactions from the fund’s fund complex. The notice would also be required to refer the customers to the fund prospectus for additional information regarding expenses.
³²Investments in securities other than those provided through the plan, such as through a "brokerage window" would have to be effected through a registered broker-dealer under this exemption.
³³Banks could, however, pay unregistered employees a referral fee pursuant to a networking arrangement.
³⁴The proposed exemption would not affect the necessity of complying with Regulation S or any other requirements of the Securities Act of 1933.
³⁵See Rule 904 of Regulation S, 17 CFR 230.904.
³⁶In that instance, the bank could still rely on the exemption if the security is obtained from an unaffiliated "distributor" that has not obtained the security from the bank or its affiliate, so long as the other distribution participant did not receive the securities directly or indirectly from the bank or its affiliate. See 17 CFR 230.902.
³⁷The SEC also made clear that although they are providing these three exceptions to credit unions, that is no guarantee they will provide future bank exemptions to credit unions also.
³⁸Exchange Act Section 3(a)(4)(B)(viii) provides a bank exception from the definition of "broker" for banks participating in stock purchase plans.
³⁹The exemption would only be available for open-end investment company securities distributed by registered broker-dealers or otherwise sold for sales loads that do not exceed NASD limits for broker-dealer distributed funds. It would not be available for purchases and sales of exchange-traded funds.
⁴⁰For example, if Regulation B were adopted prior to the end of 2004, banks would have until January 1, 2006 to come into compliance. With respect to the "chiefly compensated" requirements in the Trust and Fiduciary Activities Exception, banks would need to be in compliance with the terms of the account-by- account calculation, or one of the exemptions, by the end of 2006. Demonstrated compliance during 2006 would exempt a bank from the risk of non-compliance with those requirements during 2007.
⁴¹See Securities Exchange Act Release No. 47364 (February 13, 2003)(adopting rules governing bank activities as dealer).
⁴²See 17 CFR 240.15a-6(a)(4)(i).