[Federal Register: June 30, 2004 (Volume 69, Number 125)]
[Proposed Rules]
[Page 39681-39739]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr30jn04-22]
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Part III
Securities and Exchange Commission
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17 CFR Parts 240 and 242
Regulation B; Proposed Rule
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240 and 242
[Release No. 34-49879; International Series Release No. 1278; File No.
S7-26-04]
RIN 3235-AJ28
Regulation B
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
publishing Regulation B for public comment. Regulation B proposes a
number of new exemptions for banks from the definition of the term
``broker'' under Section 3(a)(4) of the Securities Exchange Act of 1934
(``Exchange Act''), as amended by the Gramm-Leach-Bliley Act
(``GLBA''). The proposal would broaden a number of exemptions already
available to banks, savings associations, and savings banks that effect
transactions in securities. It also would define certain terms used in
the GLBA. The proposal would exempt credit unions that engage in
limited securities activities that are conducted under the terms
applicable to certain of the bank exceptions from the definitions of
``broker'' and ``dealer.'' The Commission also requests comment on a
proposed conforming amendment to an Exchange Act rule that grants a
limited exemption from the broker-dealer registration requirement for
foreign broker-dealers. The proposal is intended, among other things,
to facilitate banks' compliance with the GLBA.
DATES: Comments should be received on or before August 2, 2004.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml.
); or Send an e-mail to rule-comments@sec.gov. Please include
File Number S7-26-04 on the subject line; or
Use the Federal eRulemaking Portal (http://www.regulations.gov/
). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Jonathan G. Katz,
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW.,
Washington, DC 20549-0609.
All submissions should refer to File Number S7-26-04. This file
number should be included on the subject line if e-mail is used. To
help us process and review your comments more efficiently, please use
only one method. The Commission will post all comments on the
Commission's Internet Web site (http://www.sec.gov/rules/proposed.shtml
). Comments are also available for public inspection and
copying in the Commission's Public Reference Room, 450 Fifth Street,
NW., Washington, DC 20549. All comments received will be posted without
change; we do not edit personal identifying information from
submissions. You should submit only information that you wish to make
available publicly.
FOR FURTHER INFORMATION CONTACT: Catherine McGuire, Chief Counsel;
Lourdes Gonzalez, Assistant Chief Counsel--Sales Practices; Richard C.
Strasser, Attorney Fellow; Linda Stamp Sundberg, Attorney Fellow;
Joseph Corcoran, Special Counsel; Brice Prince, Special Counsel; or
Norman Reed, Special Counsel, at (202) 942-0073, Office of the Chief
Counsel, Division of Market Regulation, Securities and Exchange
Commission, 450 Fifth Street, NW., Washington, DC 20549-1001.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction and Background
A. Statutory Background--The Gramm-Leach-Bliley Act
B. Regulatory and Procedural Background--The Interim Final
Rules, Public Comment, and the Temporary Exemptions
II. Discussion of Proposed Regulation B
III. Discussion of Comments on the ``Broker'' Rules and Proposed
Amendments
A. Networking Exception
1. Comments on Definition of ``Nominal One-Time Cash Fee of a
Fixed Dollar Amount''
2. Proposed Amendments to Definition of ``Nominal One-Time Cash
Fee of a Fixed Dollar Amount''
a. Meaning of ``Nominal''
b. Meaning of ``One-Time''
c. Meaning of ``Cash Fee''
d. Meaning of ``Fixed Dollar Amount''
3. Comments on Definition of ``Referral'' and Proposed
Amendments
4. Proposed New Definition of ``Contingent on Whether the
Referral Results in a Transaction''
5. Interpretations of ``Contractual or Other Written
Arrangement'' and ``Qualified Pursuant to the Rules of a Self-
Regulatory Organization''
B. Trust and Fiduciary Activities Exception
1. Chiefly Compensated
a. Statutory Requirements and Existing Rules
b. Comments on ``Chiefly Compensated'' Requirement
c. Proposed Changes in Response to Comments
d. Proposed Line-of-Business Exemption
i. Description of Existing Rule
ii. Description of Proposed Line-of-Business Exemption
e. Proposed New Living, Testamentary, and Charitable Trust
Account Exemption
f. New Conditional Safe Harbor
g. New Proposed Account-by-Account Exemption
i. Proposed Account-by-Account Exemption
ii. New Safe Harbor for Account-Specific Exemption
h. Other Provisions
i. ``Chiefly Compensated'' and Related Definitions
ii. Formulas to Allocate Sales Compensation to Individual
Accounts
A. 12b-1 Fees
B. Other Fees
iii. Indenture Trustee Exemption
2. Definition of ``Trustee Capacity'' and Indenture Trustees
3. Interpretations of ``Fiduciary Capacity'' and ``Similar
Capacity''
4. Comments on Definition of ``Investment Adviser if the Bank
Receives a Fee for Its Investment Advice'' and Proposed Amendments
5. Comments on ``Other Department That Is Regularly Examined by
Bank Examiners for Compliance With Fiduciary Principles and
Standards''
C. Sweep Accounts Exception
1. Comments on Definition of ``No-Load'' and Proposed Amendments
2. Interpretation of ``Program''
3. Definition of ``Money Market Fund''
D. Affiliate Transactions Exception
E. Safekeeping and Custody Activities Exception
1. Background on Safekeeping and Custody Exception
2. Comments on Commission's Interpretation Regarding Accepting
Customer Orders
3. Comments on Proposed Amendments to the General Bank Custody
Exemption
a. Modifications to General Bank Custody Exemption
1. Bank Compensation
2. Solicitation Restrictions
3. Employee Activities and Compensation
4. Trustee and Fiduciary Activity Accounts
5. Employee Benefit Plans
6. Small Bank Exemption
7. Custody Account Definition
8. Request for Comments
9. Carrying Broker Definition
4. Comments on and Proposed Amendments to the Small Bank Custody
Exemption
a. Bank Asset Size Limit
b. Annual Sales Compensation Limit
c. Other Conditions
1. Solicitation
2. Securities Networking
3. Employee Staffing Restrictions
4. Employee Compensation Restriction
5. Investment Company Shares for Tax-Deferred Accounts
d. Trust and Fiduciary Activity Accounts
e. Availability of Exemption to Non-Depository Trust Companies
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f. Request for Comments
F. General and Special Purpose Exemptions
1. General Exemption
2. Employee Benefit Plan Exemption
3. Regulation S Transactions with Non-U.S. Persons
4. Redesignation and Revision of Exemptions for Savings
Associations and Savings Banks
5. Credit Unions
a. Networking
b. Sweep Accounts
c. Investment, Trustee, and Fiduciary Transactions
d. Scope of Credit Union Exemption
e. Additional Exemptions for Credit Unions
6. Exemption for the Way in Which Banks Effect Transactions in
Investment Company Securities
G. Temporary Exemptions
1. Extension of Time and Transition Period
2. Temporary Exemption for Contracts Entered into by Banks from
Being Considered Void or Voidable
H. Amendment to Exchange Act Rule 15a-6
IV. Administrative Law Matters
A. General Request for Comments
B. Paperwork Reduction Act Analysis
C. Consideration of Benefits and Costs
D. Consideration of Burden on Competition, and on Promotion of
Efficiency, Competition, and Capital Formation
E. Consideration of Impact on the Economy
F. Regulatory Flexibility Analysis
V. Statutory Authority
VI. Text of Proposed Rules and Rule Amendments
I. Introduction and Background
A. Statutory Background--The Gramm-Leach-Bliley Act
The GLBA amended several federal statutes governing the activities
and supervision of banks, bank holding companies, and their
affiliates.\1\ Among other things, it lowered barriers between the
banking and securities industries erected by the Banking Act of 1933
(``Glass-Steagall Act''). \2\ It also altered the way in which the
supervisory responsibilities over the banking, securities, and
insurance industries are allocated among financial regulators. Among
other things, the GLBA repealed the complete separation of investment
and commercial banking imposed by the Glass-Steagall Act, which was
enacted as a response to the perceived abuses and conflicts of interest
in the securities industry during the 1920s. The GLBA also revised the
provisions of the Exchange Act that had completely excluded banks from
broker-dealer registration requirements.\3\
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\1\ Pub. L. 106-102, 113 Stat. 1338 (1999).
\2\ Pub. L. 73-66, ch. 89, 48 Stat. 162 (1933) (as codified in
various sections of 12 U.S.C.).
\3\ Congress originally adopted these complete exclusions in
1934, stipulating that under the Glass-Steagall Act, banks were not
generally permitted to engage in the securities business. The House
Committee on Commerce explained the rationale behind the original
complete bank exclusion from the definitions of ``broker'' and
``dealer'' and Congress' rationale for its subsequent repeal:
The [Committee on Commerce] strongly believes that functional
regulation--regulation of the same functions, or activities, by the
same expert regulator, regardless of the nature of the entity
engaging in those activities--has become essential to a coherent
financial regulatory scheme, as activities and affiliations expand
and change with the financial marketplace.
Subtitle A of title II amends the Exchange Act to eliminate the
blanket exemptions for banks from the definitions of ``broker'' and
``dealer.'' These exceptions, which have been part of the Exchange
Act since its inception, were * * * based on the assumption that the
Glass-Steagall Act, which had become law just one year before the
Exchange Act, had prohibited all but extremely limited specified
bank securities activities. Specifically, at the time of its
enactment, the Glass-Steagall Act included exceptions that permitted
banks to underwrite and deal in obligations of the United States * *
* and their subdivisions. Amendments to the Glass-Steagall Act made
in 1935 permitted banks to provide limited securities brokerage
services as an accommodation to their customers, by permitting banks
to engage in stock purchases and sales in an ``agency'' capacity, at
the request of customers.
Section 20 of the Glass-Steagall Act forbids affiliation of any
Federal Reserve member bank with any business entity ``principally
engaged'' in investment banking activities. For more than fifty
years following the enactment of the Glass-Steagall Act, bank
holding companies could not underwrite securities.
As noted above, however, the limitations on bank securities
activities have eroded as a result of administrative actions by the
Federal banking regulators. The rationale for the exemptions in the
Federal securities laws that apply to banks is, thus, no longer
sound, given the extensive and increasing securities activities in
which banks are engaging.
H.R. 106-74, pt. 3, at 113 (1999).
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Charters for U.S. banks, unlike those for most for-profit
corporations, restrict bank activities to the ``business of banking.''
\4\ For many years, U.S. banking regulators took a narrow view of what
constituted the ``business of banking,'' which did not include
securities activities.\5\ Beginning in the 1980s, commercial businesses
began directly to access the capital markets and banks faced more
competitors in extending credit to commercial customers.\6\ Prior to
passage of the GLBA, many of the regulatory barriers preventing full-
scale integration of commercial bank and securities firms were relaxed.
For example, in 1982, the Federal Deposit Insurance Corporation
(``FDIC'') determined that state banks that were not members of the
Federal Reserve system were not subject to the Glass-Steagall Act's
affiliation restrictions.\7\ In 1987, the Board of Governors of the
Federal Reserve System (``Federal Reserve''), through a series of
administrative actions, began to lower the barrier between banks and
securities firms by allowing bank holding companies to derive a
percentage of their revenue from underwriting and dealing in securities
that were, prior to the Federal Reserve's actions, impermissible for
banks to underwrite and deal in.\8\ Over time, the
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Federal Reserve increased the percentages of revenue that banks could
derive from underwriting and dealing in such securities, repealed most
of the conflict of interest firewalls between banks and securities
firms, and approved the creation of the first U.S. universal bank--
Citigroup.\9\ During the past two decades, the Office of the
Comptroller of the Currency (``OCC''), the Office of Thrift Supervision
(``OTS''), and the FDIC also expanded the types of bank securities
activities that, in the view of these agencies, were within the
permissible ``business of banking.''\10\
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\4\ The ``business of banking'' provision refers to section 24
(seventh) of the National Bank Act. 12 U.S.C. 24 (seventh). Banks
are chartered and regulated under a dual banking system--federal and
state bank charters are available as are federal and state thrift
charters. Unlike broker-dealers, banks may choose whether to be
chartered at the state or federal level. Persons that register as
broker-dealers, however, must be licensed at both the federal and
state levels.
\5\ As one observer has noted: ``In 1975, U.S. banks were
largely barred from entering the securities or insurance businesses.
The Glass-Steagall Act prohibited banks from underwriting or dealing
in securities, except for certain narrowly defined categories of
`bank-eligible' securities such as U.S. government bonds and general
obligation bonds issued by state and local governments.'' Arthur E.
Wilmarth, The Transformation of the U.S. Financial Services
Industry, 1975-2000: Competition, Consolidation, and Increased
Risks, 2002 U. Ill. L. Rev. 215 at 225-6 (2002) [hereinafter
``Wilmarth Article''].
\6\ The development of asset-backed securities, high-yield
securities, and commercial paper has enhanced the ability of banks'
traditional commercial borrowers to access capital markets directly
and forego bank financing. In addition, non-bank competitors have
entered the commercial and consumer lending markets, further putting
pressure on banks' profits. At the same time, investors in search of
higher yields have shifted assets from banks to money market funds
and other securities. To replace the loss of revenue from
traditional lending, large banks have shifted their focus to fee-
based activities, including securities activities. As one industry
observer has noted:
[C]onsolidation is dividing the banking industry into two
distinct sets of institutions. The ten largest banks now hold almost
half of the banking industry's assets, and the fifty largest
institutions control three-quarters of such assets. These large
institutions have shifted away from the traditional, relationship-
based business of lending to long-term customers. Instead, big banks
are pursuing a transaction-based strategy that emphasizes investment
banking, derivatives, syndicated loans, securitized consumer loans,
and other activities tied to the capital markets.
Wilmarth Article, supra note 5, at 251.
\7\ In 1982, the FDIC adopted a policy statement on the
applicability of the Glass-Steagall Act to securities activities of
insured state non-member banks. See 47 FR 38984, (Sept. 3, 1982). In
1984, the FDIC adopted a rule regulating the securities activities
of affiliates and subsidiaries of insured state non-member banks
under the FDI Act. 49 FR 46709 (Nov. 28, 1984) (regulations codified
at 12 CFR 337.4) (1986). Representatives of mutual fund companies
and investment bankers unsuccessfully challenged the FDIC's Policy
Statement (Investment Company Institute v. United States, D.D.C.
Civil Action No. 82-2532, filed September 8, 1982, dismissed without
prejudice) and later its regulations (Investment Company Institute,
v. FDIC, 815 F.2d 1540 (D.C.1987) (regulations were upheld)).
\8\ In 1987, the Federal Reserve began to permit Section 20
subsidiaries to underwrite or deal in commercial paper and other
bank-ineligible securities provided that those activities accounted
for less than five percent of the bank's annual gross revenues. See
Citicorp Order, Approving Applications to Engage in Limited
Underwriting and Dealing in Certain Securities. 73 Fed. Res. Bull.
473 (1987) and Chase Manhattan Corp., Order Approving Application to
Underwrite and Deal in Commercial Paper to a Limited Extent. 73 Fed.
Res. Bull. 369 (1987).
In 1989, the Federal Reserve provided additional guidance on
Section 20 subsidiaries, raising the revenue limit on underwriting
and dealing in bank-ineligible securities from five percent to ten
percent of the subsidiary's total revenues. Order Approving
Modifications to Section 20 Orders, 75 Fed. Res. Bull. 751 (1989).
Subsequently, the Federal Reserve raised the revenue limits from
non-eligible securities to twenty-five percent, eliminated most of
the firewalls between banks and securities firms, and added private
placement services and riskless principal transactions to the list
of approved non-banking activities. See Regulation Y, 12 CFR 225.
\9\ Conditional approval of applications by Travelers Group
Inc., (Sept. 23, 1998). 84 Fed. Res. Bull. 985 (1998). http://www.
federal reserve. gov/ boarddocs/ press/ bhc/ 1998/ 19980923
\10\ See Julie L. Williams and Mark P. Jacobsen, The Business of
Banking: Looking to the Future, 50 Bus. Law. 783 at 814 (May 1995)
and Julie L. Williams and James F.E. Gillespie, The Business of
Banking: Looking to the Future--Part II, 52 Bus. Law. 1279 (Aug.
1997) (``While the nature of the national bank charter is the grant
of a banking franchise, it explicitly does not limit national banks
to banking activities.'').
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By enacting the GLBA, Congress repealed most of the remaining
vestiges of the ownership restrictions that prevented banks,
securities, and insurance firms from combining, thereby allowing them
to adopt the universal banking model through the creation of financial
conglomerates known as ``financial holding companies.'' \11\ Congress
recognized, however, that combined ownership would likely create
conflicts that would need to be addressed through other safeguards.\12\
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\11\ For a general discussion, see, e.g., Wilmarth Article,
supra note 5 at 219-220.
\12\ In eliminating the ownership separations, Congress
understood the need to adopt other safeguards to mitigate the
conflicts of interest that combined ownership could create. One of
the bill's authors highlighted functional regulation as a key
requirement of the GLBA:
The second major feature of the bill is that we promote and
strengthen functional regulation. Under the bill, the general rule
is that if you are a bank and you are in the securities business,
you are regulated by the Securities and Exchange Commission. If you
are a bank and you are in the insurance business, you are regulated
by the state insurance commissioner in the area where you are
engaged in the insurance business. If you are a bank and you are
engaged in banking, you are regulated by bank regulators. By opting
for functional regulation, we preserve consumer protection, we lower
costs.
Statement of Senator Phil Gramm, 145 Cong. Rec. S13783-01.
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The Commission has consistently supported Congress' efforts to
eliminate the few remaining legal barriers among the various types of
financial service providers.\13\ Because eliminating the legal
distinctions or separations between commercial and investment banking
increased the opportunity for conflicts of interest in the purchase and
sale of securities, however, the Commission supported a system of
functional regulation to ensure that investors receive the same high
level of consumer protection no matter where they effect their
securities transactions.\14\ The Commission testified that complete
functional regulation would mean that a bank--just like any other
securities business--would have to obtain a broker-dealer license and
adhere to consumer protections adopted under the federal securities
laws to engage as a broker in securities transactions with investors or
shift those activities to a registered broker-dealer that is obligated
to provide those protections.\15\
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\13\ For a list of Commission testimony and related
correspondence, see Exchange Act Release No. 44291 (May 11, 2001),
66 FR 27760 (May 18, 2001) at n. 8.
\14\ Id. The General Accounting Office recognized that investors
have received unequal levels of investor protection (including
disclosures) and disparate access to remedies depending on the
market professional selling them securities. See U.S. General
Accounting Office, Report to Congressional Requesters: Bank Mutual
Fund Sales Practices and Regulatory Issues GAO/GGD-95-210, at p. 52
(Sept. 1995); U.S. General Accounting Office, Report to
Congressional Requesters: Banks' Securities Activities--Oversight
Differs Depending on Activity and Regulator, GAO/GGD-95-214, at p.
25 (Sept. 1995).
\15\ Testimony of SEC Chairman Arthur Levitt Before the
Committee on Commerce Concerning H.R. 10, ``The Financial Services
Act of 1999'' (May 5, 1999).
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In enacting the GLBA, Congress adopted functional regulation for
bank securities activities, with limited exceptions from Commission
oversight. In particular, the GLBA eliminated the complete bank
exceptions from the definitions of ``broker'' and ``dealer'' in the
Exchange Act and replaced them with narrower transaction-based bank
exceptions. Although it granted a number of exceptions for banks'
securities activities, Congress expressed concerns that banks were
engaging in securities activities for investors who are not protected
by the federal securities laws.\16\
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\16\ See H.R. Rep. No. 106-74, pt. 3, at 114 (1999). In adopting
the GLBA, Congress also intended to level the playing field between
banks and broker-dealers. As the House Committee on Commerce noted
in the legislative history to the GLBA, the complete exception for
banks from broker-dealer registration created a competitive
disparity by permitting banks to engage in securities activities
without being subject to the same regulatory requirements as
registered broker-dealers. See id. In drafting the bank exceptions
from broker-dealer registration, the Committee stated that,
``registration may not be required because the conditions imposed on
the excepted activities are tailored to protect investors and to
ensure competitive fairness among different types of financial
services providers.'' Id. at 162.
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With respect to the definition of ``broker,'' the Exchange Act, as
amended by the GLBA, provides that a bank is not considered a broker to
the extent it meets the requirements of eleven specific exceptions.\17\
Each of these exceptions permits a bank to act as an agent with respect
to specified securities products or in transactions that meet specific
statutory conditions.
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\17\ Exchange Act Section 3(a)(4) [15 U.S.C. 78c(a)(4)].
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In particular, Section 3(a)(4) of the Exchange Act provides
conditional exceptions from the definition of broker for banks that
engage in third-party brokerage arrangements; \18\ trust and fiduciary
activities; \19\ permissible securities transactions; \20\ certain
stock purchase plans; \21\ sweep accounts; \22\ affiliate transactions;
\23\ private securities offerings; \24\ safekeeping and custody
activities; \25\ identified banking
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products; \26\ municipal securities; \27\ and de minimis
transactions.\28\ As part of the Exchange Act, these provisions are
subject to Commission interpretation.\29\ A bank that effects
transactions in securities as agent outside the scope of these
exceptions is required to register as a broker in accordance with
Section 15(a) of the Exchange Act.\30\
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\18\ Exchange Act Section 3(a)(4)(B)(i). This exception permits
banks to enter into third-party brokerage, or ``networking''
arrangements with brokers under nine specific conditions.
\19\ Exchange Act Section 3(a)(4)(B)(ii). This exception permits
banks to effect transactions as trustees or fiduciaries for
securities customers under two specific conditions.
\20\ Exchange Act Section 3(a)(4)(B)(iii). This exception
permits banks to buy and sell commercial paper, bankers'
acceptances, commercial bills, exempted securities, certain Canadian
government obligations, and Brady bonds.
\21\ Exchange Act Section 3(a)(4)(B)(iv). This exception permits
banks, as part of their transfer agency activities, to effect
transactions for certain issuer plans.
\22\ Exchange Act Section 3(a)(4)(B)(v). This exception permits
banks to sweep funds into no-load money market funds.
\23\ Exchange Act Section 3(a)(4)(B)(vi). This exception permits
banks to effect transactions for affiliates, other than broker-
dealers.
\24\ Exchange Act Section 3(a)(4)(B)(vii). This exception
permits certain banks to effect transactions in privately placed
securities.
\25\ Exchange Act Section 3(a)(4)(B)(viii). This exception
permits banks to engage in certain enumerated safekeeping or custody
activities, including stock lending as custodian.
\26\ Exchange Act Section 3(a)(4)(B)(ix). This exception permits
banks to buy and sell certain ``identified banking products,'' as
defined in Section 206 of the GLBA [codified at 15 U.S.C.
78c(a)(4)(B)(ix)].
\27\ Exchange Act Section 3(a)(4)(B)(x). This exception permits
banks to effect transactions in municipal securities.
\28\ Exchange Act Section 3(a)(4)(B)(xi). This exception permits
banks to effect up to 500 transactions in securities in any calendar
year in addition to transactions referred to in the other
exceptions.
\29\ In contrast, the Glass-Steagall Act is interpreted by the
federal banking agencies.
\30\ Exchange Act Section 15(a) generally prohibits broker-
dealers that are not registered with the Commission from effecting
any transactions in, or inducing or attempting to induce the
purchase or sale of, any security.
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B. Regulatory and Procedural Background--The Interim Final Rules,
Public Comment, and the Temporary Exemptions
In 2001, the Commission adopted interim final rules (``the Interim
Rules'') largely in response to interpretive questions and industry
concerns about the way in which the Commission would interpret the
GLBA.\31\ The Interim Rules were designed to provide banks with
guidance regarding the GLBA by defining certain key terms used in the
new statutory exceptions. The Interim Rules also provided banks with
additional targeted exemptions from the definitions of ``broker'' and
``dealer'' for certain types of ongoing securities transactions or
activities. The Commission adopted the Interim Rules in interim final
form to provide the banking industry with immediate guidance and
exemptive relief while also soliciting public comment. In response, the
Commission received over 200 letters commenting on the Interim
Rules.\32\
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\31\ Exchange Act Release No. 44291, supra note 13.
\32\ Nearly all of these letters came from the banking industry
or its representatives. The federal banking agencies (the Federal
Reserve, OCC, and FDIC) (collectively referred to as the ``Banking
Agencies'') also submitted comments. See letter and appendix dated
June 29, 2001 from Alan Greenspan, Chairman, Federal Reserve, John
D. Hawke, Comptroller of the Currency, and Donna Tanoue, Chairman,
FDIC (``Banking Agencies letter'').
Included in the comment letters were 111 comment letters in a
form letter format. Many of the banking organizations that submitted
these form comment letters sent multiple copies of a common form
letter, including 54 letters from one banking organization. The
following banks and persons submitted 116 form letters (``Bank Form
Letters''): Amarillo National Bank (54 letters); American Bank
Holding Co.; American Church Trust Co.; Austin Trust Co.; Bank
Midwest; Bank of West (two letters); Bonham State Bank; Jeff
Scribner, Senior Vice President, Financial Services Division
Manager, Citizens National Bank; Steven M. Dow, Vice President and
Trust Officer, Community Bank &Trust; Extraco Banks; First Command
Bank; First National Bank; First National Bank of Abilene (seven
letters); First National Bank; First National Bank of Mineola; First
State Bank of Texas; First State Bank & Trust Co. (two letters);
Richard Perryman, CPA, Vice President and Trust Officer, Guaranty
Bank; Hibernia National Bank (two letters); Hibernia Trust (two
letters); Murray Pate, Kanaly Trust Company; Legacy Trust Co.;
Longview Bank & Trust; Lubbock National Bank; David Malleck; Charles
Hall Jr., CEO, MaximBank; McAllen National Bank (four letters);
Linda Park; Kimberly Miller, Senior Vice President and Trust
Officer, PNB Financial; Luptis Rosales, VP & Trust Officer of
unnamed bank; Secured Trust Bank; Sentinel Trust Co.; Southside Bank
(two letters); Carol Preston, Senior Vice President and Trust
Officer, Southwest Bank; Texas Bank; Texas Capital Bank; Wayne
Spencer, President, Texas Community Bank and Trust; Texas Gulf Bank;
Texas State Bank (nine letters); Debbie Truman; Willard B. III
Wagner. Three additional form letters were submitted without
identifying information.
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The Commission temporarily suspended the implementation of the
exceptions in light of concerns that banks needed more time to adjust
their operations to comply with the Interim Rules.\33\ The Commission
staff has used this period during the temporary suspension to continue
discussions with banking industry representatives, staff from the
Banking Agencies, and other interested parties to refine further the
guidance and exemptions provided in the Interim Rules.\34\
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\33\ See Exchange Act Release No. 44291, supra note 13, 66 FR
27760 (adopting Interim Rules, including Exchange Act Rule 15a-7,
which gave banks a temporary exemption from the definitions of
``broker'' and ``dealer'' until October 1, 2001, and provided an
additional conditional exemption until January 1, 2002); Exchange
Act Release No. 44570 (July 18, 2001) (providing banks, savings
associations, and savings banks with an additional conditional
exemption from the definitions of ``broker'' and ``dealer'' under
the Exchange Act until May 12, 2002); Exchange Act Release No. 45897
(May 8, 2002) (order extending the exemption from the definition of
``broker'' until May 12, 2003, and from the definition of ``dealer''
until November 12, 2002); Exchange Act Release No. 46751 (Oct. 30,
2002) (extending the exemption from the definition of ``dealer''
until February 10, 2003); Exchange Act Release No. 47366 (Feb. 13,
2003) (extending the exemption from the definition of ``dealer''
until September 30, 2003); Exchange Act Release No. 47649 (April 8,
2003) (extending the exemption from the definition of ``broker''
until November 12, 2004).
\34\ During this period, to facilitate a prompt and efficient
resolution of remaining questions and concerns about the Interim
Rules, the Commission bifurcated the rulemaking process to address
the ``broker'' and ``dealer'' issues separately. For an explanation
of this bifurcation, see Exchange Act Release No. 46745 (Oct. 30,
2002) 67 FR 67496 (Nov. 5, 2002) (``Dealer Proposing Release''). The
dealer provisions, along with the Commission's implementing rules,
became effective September 30, 2003. See Exchange Act Release No.
47364 (Feb. 13, 2003), 68 FR 8686, 8687 (Feb. 24, 2003) (``Dealer
Release'').
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II. Discussion of Proposed Regulation B
After reviewing the comments on the Interim Rules and discussing
the practical application of those Rules with representatives from the
banking industry, banking regulators, and other interested parties, the
Commission is proposing to revise and restructure the Interim Rules and
to codify them in a new regulation, Regulation B. The proposed new rule
series is Exchange Act Rule 710 through Rule 781 (17 CFR 242.710
through 781).
Proposed Regulation B includes rules designed to define and clarify
a number of the statutory exceptions from the definition of ``broker.''
In addition, proposed Regulation B would grant new exemptions from the
``broker'' definition to banks and certain other financial
institutions. These proposed exemptions would supplement the statutory
exceptions to preserve bank securities activities where consistent with
the statutory purpose of investor protection. For example, proposed
Regulation B would provide a broad exemption for certain bank cash
management services. This proposed exemption would allow banks to buy
and sell money market securities for qualified investors and certain
other bank customers who keep funds at banks.
Moreover, in response to banks' concerns about calculating their
compensation as fiduciaries on an account-by-account basis, the
proposal would provide a ``line-of-business'' compensation test that
would permit banks to bypass the account-by-account test in the trust
and fiduciary activities exception. In addition, the proposal would
broaden an exemption for small banks and thrifts, which could greatly
expand the number of smaller financial institutions that are excluded
from broker-dealer registration requirements.
The proposal also would provide a number of specialized exemptions
to accommodate banks' current business practices, balanced with
conditions that are designed to protect investors. These proposed
specialized exemptions include exemptions for banks that effect
transactions for certain custody customers or pension plans, and those
that effect transactions in Regulation S securities with non-U.S.
persons.
The proposed titles and numbering of the rules in proposed
Regulation B, including the proposed new rules, appear below, with
parenthetical explanations added to the titles:
[[Page 39686]]
Regulation B: Securities Activities of Banks and Other Financial
Institutions
Subpart A--Networking Exception: Defined Terms
242.710: Defined terms relating to the networking exception from
the definition of ``broker'' (proposed amendment to provisions in
Exchange Act Rule 3b-17).
Subpart B--Trust and Fiduciary Activities Exception: Exemptions and
Defined Terms
242.720: Exemption from the ``chiefly compensated'' condition for
banks with existing personal trust accounts (proposed new rule).
242.721: Exemption for banks from determining whether they are
``chiefly compensated'' on a line of business (proposed expansion and
redesignation of Exchange Act Rule 3a4-2).
242.722: Exemption for banks from determining whether they are
``chiefly compensated'' on an account-by-account basis (proposed new
rule).
242.723: Exemption from the definition of ``broker'' for banks
effecting transactions as an indenture trustee in a no-load money
market fund (proposed expansion and redesignation of Exchange Act Rule
3a4-3).
242.724: Defined terms relating to the trust and fiduciary
activities exception from the definition of ``broker'' (proposed
amendment to terms in current Exchange Act Rule 3b-17, which would be
repealed).
Subpart C--[Reserved]
Subpart D--Sweep Accounts Exception: Defined Terms
242.740: Defined terms relating to the sweep accounts exception
from the definition of ``broker'' (proposed amendment to terms in
current Exchange Act Rule 3b-17).
Subpart E--Affiliate Transactions Exception: Defined Terms
242.750: Defined terms relating to the affiliate transactions
exception from the definition of ``broker'' (proposed amendment to
terms in current Exchange Act Rule 3b-17).
Subpart F--Safekeeping and Custody Activities Exception: Exemptions
242.760: Exemption from the definition of ``broker'' for banks
effecting transactions in securities in a custody account (proposed
expansion and redesignation of Exchange Act Rule 3a4-5).
242.761: Exemption from the definition of ``broker'' for small
banks effecting securities transactions in a custody account (proposed
expansion and redesignation of Exchange Act Rule 3a4-4).
Subpart G--Special Purpose Exemptions
242.770: Exemption from the definition of ``broker'' for banks
effecting transactions in securities in certain employee benefit plans
(proposed new rule).
242.771: Exemption from the definitions of ``broker'' and
``dealer'' for banks effecting transactions in securities issued
pursuant to Regulation S (proposed new rule).
242.772: [Reserved]\34a\
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\34a\ If the Commission adopts proposed Regulation B, it will
redesignate Exchange Act Rule 15a-11 as Exchange Act Rule 772
without changing the language of the current rule.
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242.773: Exemption from the definitions of ``broker'' and
``dealer'' for savings associations and savings banks (proposed
amendment to and redesignation of Exchange Act Rule 15a-9).
242.774: Exemption from the definitions of ``broker'' and
``dealer'' for credit unions (proposed new rule).
242.775: Exemption from the definition of ``broker'' for the way
banks effect excepted or exempted transactions in investment company
securities (proposed expansion and redesignation of Exchange Act Rule
3a4-6).
Subpart H--Temporary Exemptions
242.780: Exemption for banks from liability under Section 29 of the
Securities Exchange Act of 1934 (proposed amendment to and
redesignation of Exchange Act Rule 15a-8).
242.781: Exemption from the definition of ``broker'' for banks for
a limited period of time (proposed amendment to and redesignation of
Exchange Act Rule 15a-7).
III. Discussion of Comments on the ``Broker'' Rules and Proposed
Amendments
A. Networking Exception
The third-party brokerage (``networking'') exception in Exchange
Act Section 3(a)(4)(B)(i)\35\ allows banks to partner with broker-
dealers in offering their customers a wide range of financial services,
including securities brokerage. Specifically, the exception provides
that a bank will not be considered a broker if, under certain
conditions, the bank enters into a contractual or other written
arrangement with a registered broker-dealer under which the broker-
dealer offers brokerage services to bank customers (``networking
arrangement''). If the bank's networking activities meet the conditions
of the exception, it may, without itself being registered as a broker-
dealer, receive compensation related to brokerage transactions the
broker-dealer effects as a result of the networking arrangement. The
exception also allows unregistered bank employees \36\ to engage in
limited securities-related activities and to receive incentive
compensation in the form of a ``nominal one-time cash fee of a fixed
dollar amount'' for referring bank customers to the broker-dealer.\37\
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\35\ 15 U.S.C. 78c(a)(4)(B)(i).
\36\ ``Unregistered'' bank employees are bank employees who are
not also employed as registered representatives of a registered
broker-dealer that supervises their securities activities.
\37\ The statutory conditions under which banks may rely on the
networking exception stem from a line of no-action letters in which
the Commission staff indicated enforcement action would not be
recommended against thrifts that entered into highly circumscribed
networking arrangements. H.R. Rep. No. 106-74, pt. 3, at 163 (1999).
The first of these letters was issued in response to a request from
Chubb Securities Corp. See Letter re: Chubb Securities Corp. (Nov.
24, 1993) (``Chubb letter''). Because they are not banks, thrifts
could not rely on the then-existing general exemption from the
definition of ``broker'' enjoyed by banks, and these letters
provided thrifts with a means to compete with banks in making
securities brokerage services available to their customers. For the
relief the Commission is proposing to extend to thrifts, see Section
III.F.4 infra. Although the networking exception in Exchange Act
Section 3(a)(4)(B)(i) allows banks to continue many of the
networking activities in which they engaged before the GLBA was
enacted, it also limits the scope of those activities.
Various aspects of bank networking activities are also subject
to limitations and requirements in self-regulatory organization
(``SRO'') rules, including NASD Rule 2350 (``Broker/Dealer Conduct
on the Premises of Financial Institutions'') and NASD Rule 3040
(``Private Securities Transactions of an Associated Person''). See
also Federal Reserve, FDIC, OCC, and OTS, Interagency Statement on
Retail Sales of Nondeposit Investment Products (Feb. 15, 1994)
(``Interagency Statement'').
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To clarify the way in which bank employees may be compensated
consistent with the networking exception, the Interim Rules defined
certain terms used in the exception, such as ``nominal one-time cash
fee of a fixed dollar amount'' and ``referral.''\38\ These definitions
establish objective standards for determining whether a referral fee
would be nominal and the manner in which the fee must be
structured.\39\ For example, the fee may
[[Page 39687]]
not exceed one hour of wages of the employee making the referral. The
definition also anticipates that banks may pay referral fees in cash as
well as through a points-based compensation system so long as the
number of points the referring employee receives for a securities
referral does not exceed the number of points the employee receives for
non-securities related activities. These definitions also specify that
payment of a referral fee may not be related to certain factors such as
the value or successful completion of a securities transaction, or the
financial stature of the customer being referred.
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\38\ See Exchange Act Rule 3b-17 (g)(1) and (h).
\39\ Exchange Act Rule 3b-17(g) states:
(g)(1) The term nominal one-time cash fee of a fixed dollar
amount means a payment in either of the following forms that meets
the requirements of subparagraph (2):
(i) A payment that does not exceed one hour of the gross cash
wages of the unregistered bank employee making a referral; or
(ii) Points in a system or program that covers a range of bank
products and non-securities related services where the points count
toward a bonus that is cash or non-cash if the points (and their
value) awarded for referrals involving securities are not greater
than the points (and their value) awarded for activities not
involving securities.
(2) Regardless of the form of payment, the payment may not be
related to:
(i) The size, value, or completion of any securities
transaction;
(ii) The amount of securities-related assets gathered;
(iii) The size or value of any customer's bank or securities
account; or
(iv) The customer's financial status.
Exchange Act Section 3b-17(h) states: ``The term referral means
a bank employee arranging a first securities-related contact between
a registered broker-dealer and a bank customer, but does not include
any activity (including any part of the account opening process)
related to effecting transactions in securities beyond arranging
that first contact.''
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1. Comments on Definition of ``Nominal One-Time Cash Fee of a Fixed
Dollar Amount''
We received numerous comments regarding the Interim Rules'
definition of ``nominal one-time cash fee of a fixed dollar
amount.''\40\ The commenters generally opposed the definition, arguing,
among other things, that it was unnecessary, unworkable, or overly
restrictive. Some commenters contended that defining the term
``nominal'' unnecessarily limits referral fees. They maintained that
the term should be left undefined or interpreted to allow market-rate
referral fees up to a set amount, such as $25, $100, or $250.\41\ Other
commenters opined that Congress did not intend for the limitations on
incentive compensation included in the networking exception to affect
year-end bank bonus programs even if those programs were in part based
on the number of referrals made.\42\ Commenters also asserted that the
definition imposed limits on networking compensation beyond those
contained in the Exchange Act.\43\ Some commenters contended that the
definition would unduly limit the fees banks could pay based on points
for activities involving non-securities products and services.\44\
Several commenters stated that tying referral fees to hourly wages is
impractical or unworkable because it does not permit a single, flat fee
that would be high enough to provide a meaningful incentive for tellers
and platform personnel to make referrals to the broker-dealers.\45\
Others indicated that
[[Page 39688]]
the definition should not list categories of factors on which referral
fees could not be made contingent.\46\
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\40\ See, e.g., letter dated June 4, 2001 from James D.
McLaughlin, Director, Regulatory and Trust Affairs, American Bankers
Association (``ABA'') and Beth L. Climo, Executive Director,
American Bankers Securities Association (``ABASA'') and the letter
dated July 17, 2001 from Edward L. Yingling, Deputy Executive Vice
President and Executive Director, ABA, and Beth L. Climo, Executive
Director, ABASA (``ABA/ABASA letters''); letter dated July 17, 2001
from John Duncan, the Banking Law Committee of the Business Law
Section of the American Bar Association (``ABA Banking Law Committee
letter''); letter dated July 17, 2001 from Robert M. Kurucza,
General Counsel, Bank Securities Association (``BSA letter'');
letter dated July 17, 2001 from Charlotte M. Bahin, Director of
Regulatory Affairs, Senior Regulatory Counsel, America's Community
Bankers (``ACB letter''); the Banking Agencies letter; letter dated
July 17, 2001 from John H. Huffstutler, Associate General Counsel,
Bank of America Corporation (``Bank of America letter''); letter
dated July 17, 2001 from J. Michael Shepherd, Executive Vice
President and General Counsel, Bank of New York (``BONY letter'');
letter dated July 16, 2001 from John M. Kramer, Deputy General
Counsel, Bank One Corporation (``Bank One letter''); letter dated
July 16, 2001 from Roger D. Wiegley, Chair, Committee on Banking
Law, The Association of The Bar of the City of New York (``Bar of NY
letter''); letter dated July 13, 2001 from Jim Goudge, President and
CEO, Broadway National Bank (``Broadway letter''); letter dated July
12, 2001 from Terry Jones Cox, Vice President, HR/Compliance,
Central National Bank (``Central letter''); letter dated August 22,
2001 from Andrew Trainor, President and CEO of Community Banks of
Southern Colorado (``Community Banks of Southern Colorado letter'');
letter dated July 17, 2001 from Gerald M. Noonan, President, the
Connecticut Bankers Association (``Connecticut Bankers letter'');
letter dated July 16, 2001 from William C. Mutterperl, Executive
Vice President, General Counsel and Secretary, FleetBoston Financial
Corporation (``Fleet letter''); the Frost letter; letter dated
August 30, 2001 from Edward J. Eason, Vice President, Granite Bank
(``Granite bank letter''); letter dated July 16, 2001 from Paul V.
Reagan, Senior Vice President and U.S. General Counsel, Bank of
Montreal Group on behalf of Harris Trust and Savings Bank (``Harris
Trust letter''); letter dated July 17, 2001 from Robert I Gulledge,
Chairman, Independent Community Bankers of America (``ICBA
letter''); letter dated July 17, 2001 from Lawrence R. Uhlick,
Executive Director and General Counsel, Institute of International
Bankers (``IIB letter''); letter dated July 16, 2001 from Michael E.
Bleier, General Counsel, Mellon Financial Corporation (``Mellon
letter''); letter dated July 16, 2001 from David A. Daberko,
Chairman and Chief Executive Officer, National City Corporation
(``National City letter''); letter dated July 17, 2001 from Guy
Messick, General Counsel to the National Association of Credit Union
Service Organizations (``NACUSO letter''); letter dated August 1,
2001 from Jeffrey P. Neubert, President and Chief Executive Officer,
New York Clearing House (``NYCH letter''); letter dated July 16,
2001 from Deborah R. Bortner, President, the North American
Securities Administrators Association (``NASAA letter''); letter
dated July 17, 2001 from James S. Keller, Chief Regulatory Counsel,
PNC Financial Services Group (``PNC letter''); letter dated July 17,
2001 from Samuel E. Upchurch, Jr., Executive Vice President, General
Counsel and Secretary, Regions Financial Corporation (``Regions
letter''); letter dated July 17, 2001 from Richard M. Whiting,
Executive Director and General Counsel, Financial Services
Roundtable (``Roundtable letter''); letter dated July 17, 2001 from
Barry P. Harris, Chair, Bank Retail Broker-Dealer Committee,
Securities Industry Association (``SIA letter''); letter dated July
17, 2001 from A. Michelle Roberts, Executive Director, The Trust
Financial Services Division of the Texas Bankers Association
(``Texas Bankers Trust Division letter''); letter dated July 17,
2001 from Lawrence A. Knecht, Senior Vice President and Legal
Counsel, UMB Bank (``UMB Bank letter''); letter dated July 17, 2001
from Norimichi Kanari, President and CEO, Union Bank of California
(``Union Bank letter''); letter dated July 12, 2001 from W. Steve
Meacham, Senior Vice President and Senior Trust Officer, letter
dated August 31, 2001 from David S. Hickman, Chairman and CEO,
United Bank & Trust ([ldqu]o;United Bank letter''); letter dated
July 12, 2001 from W. Steve Meacham, Senior Vice President and
Senior Trust Officer, First Victoria National Bank (``Victoria
letter''); and letter dated July 13, 2001 from Bruce Moland, Vice
President and Assistant General Counsel, Wells Fargo & Company
(``Wells Fargo letter''). The Bank Form Letters criticized the
Interim Rules'' limitations on the value of referral fees and
expressed the view that those limitations are unfair, but did not
comment specifically on the definition of ``nominal one-time cash
fee of a fixed dollar amount.''
\41\ See, e.g., Central letter; ABA Banking Law Committee
letter; and Wells Fargo letter. Similarly, in a September 23, 2003
meeting, banking agency staff told the Commission staff that some
banks pay fees of as much as $100 for referrals of high net-worth
customers and that members of the banking agencies staff believe
such fees should be considered nominal, although currently referral
fees typically range from $5 to $50, with $50 representing the top
of the range at large banks in coastal metropolitan areas. One
commenter asserted that because the Commission has considered $250 a
``de minimis'' amount in the context of Municipal Securities
Rulemaking Board Rule G-37, the term ``nominal'' should be
interpreted to allow referral fees of the same amount in this
context. See Wells Fargo letter. MSRB Rule G-37 relates to political
contributions that might improperly influence municipal officials in
awarding underwriting business. The fact that some may look to
wholly unrelated contexts to argue that a particular amount should
be considered ``nominal'' in this context underscores the importance
of giving quantitative meaning to the term in the proposed amended
definition of ``nominal one-time cash fee of a fixed dollar
amount.''
\42\ See,e.g., Bank of America letter; Harris Trust letter; and
Mellon letter.
\43\ See, e.g., Bank of America letter; Fleet letter; Harris
Trust letter; IIB letter; Mellon letter; PNC letter; Regions letter;
and Wells Fargo letter.
\44\ See, e.g., Bank of America letter; Harris Trust letter; and
Mellon letter.
\45\ See, e.g., SIA letter; Bank One letter; Regions letter;
Harris Trust letter; PNC letter; and Wells Fargo letter (criticizing
the definition's methodology for determining nominal value as
impractical and unworkable); and Bank of America letter; Fleet
letter; Harris Trust letter; IIB letter; letter dated July 16, 2001
from Carol L. Klimas, Executive Vice President and Chief Fiduciary
Officer, KeyBank National Association (``KeyBank letter''); Mellon
letter; and Roundtable letter (arguing that requiring banks
regularly to adjust payment of referral fees based on salary levels
would create an unnecessary administrative burden). See also Bank
Form Letters, which suggested that the Interim Rules' limitations on
referral fees would result in banks being charged with calculating
and tracking referral fee compensation.
\46\ See ABA/ABASA letters; Banking Agencies letter; Bank of
America letter; NYCH letter; and SIA letter.
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The Commission continues to believe that the term ``nominal'' as
used in the GLBA should be defined as that term is commonly understood.
Nominal means inconsequential or trifling.\47\ In the context of
compensation, and in common legal usage, a ``nominal'' fee is a small
one of no concern to the payor and little value to the payee.\48\
---------------------------------------------------------------------------
\47\ See, e.g., Webster's New Collegiate Dictionary at 786
(2002) (indicating that one common meaning of ``nominal'' is
``existing or being something in name or form only,'' and that
``nominal'' is synonymous with the terms ``trifling'' and
``insignificant'').
\48\ Black's Law Dictionary (7th ed. 1999) defines ``nominal
consideration'' as, ``Consideration that is so insignificant as to
bear no relationship to the value of what is being exchanged (e.g.,
$10 for a piece of real estate.'').
---------------------------------------------------------------------------
Some published data suggests that banks' referral fees have
increased in recent years and sometimes exceed levels that a reasonable
person would deem to be ``nominal.''\49\ Thus, leaving ``nominal''
undefined could lead some to read the term as meaning ``market rate.''
The Commission believes that such an interpretation could lead to
unregistered bank employees being given an incentive not just to make
referrals, but actually to sell securities brokerage services to bank
customers. The Commission and courts have long interpreted the broker-
dealer registration provisions in the federal securities laws to
require persons with this kind of incentive to register as broker-
dealers or be registered representatives of broker-dealers.\50\
---------------------------------------------------------------------------
\49\ The Consumer Bankers Association's 2000 Consumer
Investments Study indicates that in 1998, the latest year for which
figures were available when the GLBA was being drafted, 79 percent
of referral fees were $10 or less (approximately $12 or less in 2004
dollars). However, according to the same study, in 1999 the
percentage of fees over $10 jumped from 21 percent to 31 percent.
This recent trend of sharp increases in referral fees is evidenced
by other data as well. For example, according to an October 17, 1996
American Banker story, in an effort to compete with larger banks,
Placer Savings Bank, a Northern California thrift, began paying its
employees investment referral fees for the first time in August
1995. The fee initially was $5 per referral (approximately $6 in
2004 dollars), and then, in September 1996, it was increased to $10
(approximately $12 in 2004 dollars).
At some banks, it appears that referral fees may already exceed
nominal levels. The Consumer Bankers Association's 2001 Consumer
Investments Study indicates that in 2001, the percentage of banks
paying cash referral fees of $10 or less was 45 percent. However,
this figure fell by 4 percent in only one year, from 49 percent in
2000, and the percentage of banks paying fees between $11 and $25
rose by 2 percent in this period, from 31 percent in 2000 to 33
percent in 2001. The report also indicates that no bank included in
the study paid fees of more than $25 in 2000, but that in 2001, a
small proportion of banks (2 percent) had begun paying fees of more
than $25. The available data on referral fee amounts suggests that
just before the GLBA was enacted in 1999, the great majority of
referral fees were $10 or less (approximately $12 or less in 2004
dollars), but that without a definition of nominal value, the
average amount of a referral fee has been increasing, and in some
cases clearly has exceeded a nominal value. The Commission staff
recently learned from staff of the federal banking agencies that
some large banks pay referrals fees of as much as $100 for
particularly valuable referrals. Unless they are paid to highly
compensated bank employees, fees of such amounts clearly are not
nominal.
\50\ See Exchange Act Section 15(a)(1). See also SEC v. Hansen,
Fed. Sec. L. Rep. ] 91,426 (S.D.N.Y. 1984) (receipt of commissions
instead of salary was factor in identifying broker activity); SEC v.
Margolin, Fed. Sec. L. Rep. ] 97,025 (S.D.N.Y. 1992) (same). The
Commission similarly has noted the importance of transaction-based
compensation in identifying broker activity. See Exchange Act
Release No. 22172 (June 27, 1985) (adopting release for Exchange Act
Rule 3a4-1; ``[T]he receipt of transaction-based compensation often
indicates that [a] person is engaged in the business of effecting
transactions in securities. Compensation based on transactions in
securities can induce high pressure sales tactics and other problems
of investor protection which require application of broker-dealer
regulation under the Act.''); Litigation Release No. 15654 (Feb. 26,
1998) (receipt of transaction-based compensation was factor in
finding violation of broker-dealer registration requirement and
violation of order barring individual from associating with broker).
---------------------------------------------------------------------------
Accordingly, in response to many of these comments, we propose only
to amend the definition of ``nominal one-time cash fee of a fixed
dollar amount'' to clarify further the application of the statutory
limitations to banks' existing practices, to give meaning to the
investor protections embodied in this provision of the Exchange
Act.\51\
---------------------------------------------------------------------------
\51\ As indicated above, SRO rules and banking agency guidance
may also limit networking activities. See supra note 37.
---------------------------------------------------------------------------
2. Proposed Amendments to Definition of ``Nominal One-Time Cash Fee of
a Fixed Dollar Amount''
We propose to amend the definition of ``nominal one-time cash fee
of a fixed dollar amount'' to mean that a referral payment must have a
value that does not exceed the greater of three alternative measures:
the employee's base hourly rate of pay, a dollar amount equal to $15 in
1999 plus an adjustment for inflation, or $25.\52\ The fee could be
paid to a bank employee no more than one time per customer referred by
that employee. If the referral is not paid entirely in cash, the value
of the non-cash payment must be ``readily ascertainable'' (i.e., its
value or potential value must have been known by the bank and the
employee at the time of the referral). Also, any non-cash portion of
the payment would have to have a value such that the value of the
entire payment is nominal, and the non-cash portion would have to be
paid under an incentive program that covers a broad range of products
and that is designed primarily to reward activities unrelated to
securities. Finally, the fee would have to be the same for any
securities referral made by that particular employee, with a flat value
that does not vary based on factors such as the financial status of a
customer the employee refers, the identity of the broker-dealer to
which the customer is referred, the number of referrals the employee
makes, or whether the customer expresses an interest in a particular
type of securities product.
---------------------------------------------------------------------------
\52\ See proposed Exchange Act Rule 710(b).
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a. Meaning of ``Nominal''
We propose to amend the definition of ``nominal'' to replace the
standard of ``one hour of gross cash wages'' used in the Interim Rules
with ``base hourly rate of pay'' to clarify that this alternative
measure could be used with respect to salaried as well as unsalaried
employees. As amended, the Commission believes this option would permit
highly compensated bank employees to receive scaled referral fees
without giving them an inappropriate promotional interest in the
brokerage services a broker-dealer offers under a networking
arrangement. We request comment on this proposed alternative and, in
particular, on whether it might lead to some highly compensated bank
employees being given a salesman's stake in the securities activities
of the bank's customers.
Second, the proposed amended definition of ``nominal one-time cash
fee of a fixed dollar amount'' would include a new, specific dollar-
amount measure of nominal value that should simplify compliance with
the networking exception in Exchange Act Section 3(a)(4)(B)(i). In
particular, we are proposing a dollar amount of $15 with annual
adjustments to account for inflation, based on 1999 dollars.\53\ In
[[Page 39689]]
addition, the definition would specify $25 (without an adjustment for
inflation) as an alternative measure of nominal value.\54\
---------------------------------------------------------------------------
\53\ We propose that the definition specify 1999 as the
reference year because that is the year in which the GLBA was
enacted. The definition also would provide that the $15 amount could
be adjusted for inflation on an annual basis by order of the
Commission. $15 in 1999 dollars after adjustment for inflation
equals approximately $17 in 2004 dollars.
The $15 inflation-adjusted amount is consistent with the range
of referral fees in thrift networking arrangements that were the
subject of no-action relief that the Commission staff has granted.
See, e.g., letter re: Coast Federal Bank, Federal Savings Bank (May
13, 1993) ($7 in 1993 dollars is equivalent to approximately $8 in
1999 dollars). See also letter re: First Piedmont Federal Savings
and Loan Association (July 22, 1991) (the fee specified was $15
(approximately $18 in 1999 dollars)). This amount also is consistent
with the $5 to $15 fee range most banks were understood to pay their
employees for securities brokerage referrals when the GLBA was
drafted in 1998. FDIC, Nondeposit Investment Products and
Recordkeeping Requirements--Questions and Answers at 10 (July 16,
1998) (citing results of a 1996 survey on bank retail investment
services conducted by American Brokerage Consultants, Inc., which
``indicated that most banks pay referral fees in a range between $5
and $15.'').
Estimates of inflation-adjusted dollar amounts in this footnote
and elsewhere in this release were calculated with the online
inflation calculator available on the U.S. Department of Labor
Bureau of Labor Statistics' website, which uses the average Consumer
Price Index for a given calendar year, available at http://data.
bls. gov/ cgi- bin/ cpicalc. pl.
\54\ Twenty-five dollars approximates the value of the larger
fees some banks have begun to pay their employees for brokerage
referrals in the past few years, although it appears that at such
levels the fees may be contingent on factors inconsistent with the
conditions of the networking exception. See infra note 55.
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The proposed inflation-adjusted $15 and non-adjusted $25
alternative measures of nominal value should address concerns some
commenters raised that administering an hourly, wage-based standard
might be burdensome or unworkable. As proposed, the amended definition
of ``nominal one-time cash fee of a fixed dollar amount'' should permit
many banks to continue paying referral fees with values comparable to
fees they pay under their existing referral incentive programs, but
others may be required to reduce the amount paid for referrals of
customers meeting certain financial criteria.\55\
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\55\ We anticipate that the most significant changes that may be
required at some banks could involve steps such as discontinuing
certain types of brokerage-related conditions on referral fees.
Information on existing incentive programs provided through the
ABASA, the Bank Insurance Securities Association (``BISA''), and the
Independent Community Bankers Association (``ICBA'') suggests that
the proposed amendments would accommodate levels of referral fees
consistent with the existing referral incentive programs of most
banks that provided information to the Commission staff, to the
extent such programs do not create inappropriate sales incentives
for unregistered bank employees. A representative of the ICBA told
the Commission staff that $8 is the average referral fee paid by
community banks. Information from BISA on fees for brokerage
referrals paid by ten banks that provided a dollar amount in
response to a survey indicates a range from zero to $30: one bank
pays $5; one bank pays $7 per qualified referral, which is paid into
a branch-wide pool of funds that the branch will receive if it meets
certain goals that include investment and insurance production;
three banks pay $10; one bank pays a range between zero and $14.84,
depending on whether employees meet or exceed a threshold number of
qualified referrals; one bank pays $20; one bank pays $10 for a
discount brokerage referral and $20 for a full-service brokerage
referral; one bank pays either $18.75 or $25, depending on whether
an employee has already made referrals that have resulted in twelve
meetings with a registered representative; and one bank pays points
with a value of $25, $25 in cash, or a cash award of between $25 and
$30 for referrals exceeding quarterly target levels. One sample plan
from ABASA provides for payments in points having a value of $10 for
referrals that result in a kept appointment with a registered
representative. Another, apparently used by multiple banks, provides
for referral fees of either $25 or $35 in cash, depending on whether
a bank utilizing the incentive plan selects a minimum investable
assets amount of $10,000 or $25,000 for ``qualified'' customers--
i.e., those to whom the referring bank employee has spoken
personally, meet the $10,000 or $25,000 minimum investable assets
level, and keep an appointment with a registered representative of
the broker-dealer within 60 days.
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As discussed above, some commenters criticized the definition of
``nominal one-time cash fee of a fixed dollar amount'' in the Interim
Rules \56\ for listing conditions on referral fees that are
inconsistent with the networking exception.\57\ As amended, the
definition would not list impermissible referral fee conditions.
Instead, such conditions would be addressed by the meaning given to the
phrase ``fixed dollar amount'' in the definition, and the proposed new
definition of ``contingent on whether the referral results in a
transaction,'' as described below.
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\56\ See 17 CFR 240.3b-17(g)(2).
\57\ See, e.g., Harris Trust letter and QMellon letter (arguing
that the Interim Rules should not identify impermissible conditions
on referral fees that are not explicitly identified in the statute).
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We request comment on the proposed dollar-amount and hourly
compensation standards for measuring nominal value in the proposed
amended definition of ``nominal one-time cash fee of a fixed dollar
amount.'' In particular, are the $15-inflation adjusted and $25 amounts
the most appropriate levels?
The Commission also solicits comments on the merits of providing
another alternative standard for determining whether a referral fee is
nominal that would be based on the incentive a bank would pay its
employee for the sale or renewal of a certificate of deposit (``CD'').
To avoid such a standard leading to referral fees with non-nominal
values equivalent to what a bank might pay for the sale of a large,
long-term CD, the measure would refer to a CD with a term and value
equal to the term and value of the CDs banks most frequently issue. The
Commission solicits comments on whether such a standard would provide a
useful means for measuring a nominal value in this context. In
particular, we request comment on what compensation, if any, banks pay
for the sale or renewal of a CD. Does the compensation for the sale or
renewal of a CD vary based on economic factors such as the bank's level
of interest in gathering deposits? Does the incentive vary depending on
whether the transaction is a new purchase or a renewal? Does the
incentive vary depending on the value of the CD or based on the term of
the CD? For example, would the average incentive that a bank pays for
the sale of a one-year, $5,000 CD be nominal? The Commission also
solicits comments on other possible objective measures banks could use
to gauge whether the referral fees they pay are nominal.
b. Meaning of ``One-Time''
Exchange Act Section 3(a)(4)(B)(i)(VI)\58\ permits unregistered
bank employees to receive a ``one-time'' fee for the referral of a
customer. Commenters expressed the view that banks should be able to
pay fees more often than contemplated by the statute.\59\ This could
include, for example, making a payment at the time of a referral and
then a second one later if the employee makes a particular number of
referrals in a period of time covering the referral for which the
employee was already paid. Such an approach would be inconsistent with
the plain language of the networking exception, which limits banks to
paying unregistered employees only ``one-time'' referral fees.
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\58\ 15 U.S.C. 78c(a)(4)(B)(i)(VI).
\59\ See, e.g., NYCH letter.
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We therefore propose to include in the amended definition of ``one-
time nominal cash fee of a fixed dollar amount'' an interpretation of
the term ``one-time'' to clarify that a referral fee may be paid to a
bank employee no more than one time per customer referred by that
employee. This proposed amendment should help clarify the issue, raised
by some commenters, of the circumstances under which compensation paid
in the form of bonuses falls within the networking exception's
prohibition on the payment of brokerage-related incentive compensation
to unregistered bank employees.\60\
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\60\ The proposed provision would not require a bank to
determine whether a customer had ever been referred by any of the
bank's unregistered employees to pay the referring employee a
referral fee. A bank could not, however, pay additional fees to the
same unregistered employee based on additional referrals of the same
customer, including additional referrals for different types of
brokerage products. In other words, a bank could not pay a
particular employee more than one referral fee based on multiple
referrals of the same customer, and an unregistered bank employee
who referred a customer more than once could receive only one fee
related to that customer.
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Some commenters argued that only bonus plans used as a conduit to
pay
[[Page 39690]]
brokerage-related compensation to unregistered employees under the
exception are prohibited.\61\ We do not agree. Any bonus or other
incentive compensation that is payable based in part, directly or
indirectly, on a referral for which the employee has already received a
referral fee, would violate the exception's requirement that brokerage-
related incentive compensation paid to unregistered employees under the
exception be limited to ``one-time'' referral fees. However, consistent
with the meaning we propose to give ``cash fee'' (described below) in
the definition of ``nominal one-time cash fee of a fixed dollar
amount,'' a referral fee could be paid partially in cash at the time of
the referral and partially in points to be paid to the employee as a
bonus at a later time, if the total value of the cash and points in
which the fee is paid has a nominal value under the definition.
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\61\ See, e.g., July 17, 2001, ABA/ABASA letter; Banking
Agencies letter; and PNC letter. The Bank One letter, Mellon letter,
and SIA letter also sought clarification regarding the circumstances
under which bonuses would not be impermissible incentive
compensation under the networking exception.
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Other types of bonuses that do not give unregistered bank employees
a promotional interest in securities brokerage would not be prohibited
by the exception's ``one-time'' requirement. As we explained in
adopting the Interim Rules, while the exception does not permit
unregistered bank employees to receive bonuses based on brokerage
referrals, it does not prohibit bonuses based on the overall
profitability of a bank that are determined and paid regardless of the
brokerage-related activities of an employee receiving such a bonus.\62\
This is true even though the financial performance of the bank as a
whole would in part depend on the bank's securities networking
activities, because such activities are unlikely to represent a
significant source of the bank's overall profits and such bonuses are
not likely to give unregistered employees a promotional interest in the
brokerage services offered by the broker-dealers with which the bank
networks.
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\62\ See Exchange Act Release No. 44291, supra note 13, 66 FR at
27766. The explanation continued with the caveat that a bank could
not rely on the networking exception and use bonuses as a means of
indirectly paying their unregistered employees brokerage-related
incentive compensation based on the performance of a branch,
department or line of business of the bank. This is also true for
bonuses based on points paid under the proposed interpretation of
``cash fee.'' Such bonuses also must not be contingent on factors on
which the payment of a referral fee, or the value of a referral fee,
may not be conditioned. See discussions regarding ``fixed-dollar
amount'' and ``contingent on whether the referral results in a
transaction,'' infra. Of course, whether an unregistered employee
receives a bonus based in part on brokerage referrals could be
contingent on factors unrelated to securities brokerage, such as
whether the employee opens a certain number of deposit accounts or
consistently follows the bank's risk management policies. However,
as explained below, the exception's ``fixed dollar amount''
condition means that the value of any points paid for brokerage
referrals that might count toward the bonus would need to have a
set, nominal value at the time the referrals were made.
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In addition, some commenters stated that a bonus program applicable
to all employees of a bank holding company, or based on the
profitability of a bank holding company as a whole, should not be
limited by the networking exception's restrictions on brokerage-related
compensation.\63\ The Commission believes that a bonus based on the
profitability of a bank's ultimate parent company should be analyzed in
the same way as a bonus based on the bank's profitability. We believe
that bonuses based on measures more closely related to securities
brokerage, however, would be inconsistent with the statutory
limitations on referral fees.
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\63\ See e.g., letter dated July 12, 2001 from Michael P. Smith,
President, New York Bankers Association (``NYBA letter''); Harris
Trust letter; Mellon letter; and SIA letter.
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We request comment on the interpretation of the term ``one-time''
in the proposed amended definition of ``nominal one-time cash fee of a
fixed dollar amount.'' We are also soliciting comment on what
additional guidance, if any, commenters would find useful with respect
to bonus programs.
c. Meaning of ``Cash Fee''
In addition to cash payments, the definition of ``nominal one-time
cash fee of a fixed dollar amount'' in the Interim Rules provided for
payments in points in a system or program covering a range of bank
products and non-securities related services in which points count
toward a bonus, so long as the value of the points awarded for
referrals involving securities are not greater than the value of the
points awarded for activities not involving securities.\64\ While
Exchange Act Section 3(a)(4)(B)(i) does not contemplate the payment of
referral fees in points instead of cash, the Commission included this
provision in recognition of banks' existing practices to give them
additional flexibility. While some commenters supported the provision,
others expressed concern or raised questions about it. For example,
some asserted that it should not be limited to points awarded for
securities referrals as part of a broader program or argued that it
unfairly limited the value of fees paid in points.\65\
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\64\ See 17 CFR 240.3b-17(g)(1)(ii).
\65\ See Banking Agencies letter; BSA letter; Harris letter;
Mellon letter; NYCH letter; Regions letter; and letter dated July
17, 2001 from Ted T. Cecala, Chairman & CEO, Wilmington Trust
Company (``Wilmington Trust letter''). Moreover, in meetings with
the Commission staff, bank representatives explained they were
uncertain regarding the scope of services a program would need to
cover to qualify for the exception.
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In response to questions and concerns expressed about this
provision, the Commission is proposing to modify it. The amended
definition of ``nominal one-time cash fee of a fixed dollar amount''
\66\ would allow the payment of referral fees or portions of referral
fees other than in cash to the extent that: (1) Such payments are in
units of value with a readily ascertainable cash equivalent;\67\ (2)
the total value of the referral fee meets the nominal value conditions
of the proposed amended definition; and (3) the payment is made under
an incentive program that covers a broad range of products and that is
designed primarily to reward activities unrelated to securities.\68\ As
noted above, this interpretation of the networking exception's ``cash
fee'' requirement would permit banks to continue using certain types of
point-based incentive programs under which points are accumulated
toward a cash bonus or other incentive. These provisions are intended
to maintain the flexibility provided in the Interim Rules for banks to
continue using such programs, while providing greater certainty as to
the conditions under which such programs may be used to reward
securities brokerage referrals. Of course, a referral fee paid in part
or entirely in points must not only have a nominal value, but it must
also meet the other conditions of the networking exception.
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\66\ See proposed Exchange Act Rule 710(b)(1).
\67\ The ``readily ascertainable cash equivalent'' condition
would limit the value of a referral fee paid in points to an amount
that is determined by a bank and known to an employee before the
employee makes a brokerage referral. This requirement would not
permit the value of a ``point'' to be based on the number of points
an employee earns from brokerage referrals. For example, the size of
a points-based bonus could not be based on the number of brokerage
referrals an employee makes over a target number of brokerage
referrals. Similarly, the value of a points-based bonus could not be
increased by the percentage of an employee's total points earned
from securities brokerage referrals.
\68\ See proposed Exchange Act Rule 710(b)(3). The condition
that the incentive program cover a broad range of products and be
designed primarily to reward activities unrelated to securities
means the program provides incentives for activities such as selling
bank products or services not involving securities or for making
referrals for non-securities products such as insurance, and that
the program is not focused on brokerage referrals.
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We request comment on the proposed interpretation of the
exception's``cash fee'' requirement. In particular, commenters are
invited to discuss whether the limitations in this provision
[[Page 39691]]
would be sufficient to assure that unregistered bank employees are not
given incentives to promote a broker-dealer's brokerage business by
engaging in more than the limited activities permitted under the
exception. We are also soliciting comment on what additional guidance,
if any, commenters would find useful with respect to such programs.
d. Meaning of ``Fixed Dollar Amount''
We also propose to amend the definition of ``nominal one-time cash
fee of a fixed dollar amount'' to specify that a fee of a ``fixed
dollar amount'' means a flat fee.\69\ The proposed definition would
state that fees paid for brokerage referrals made by a particular
employee must have a set value and may not vary based on factors such
as the financial status of a customer the employee refers, the identity
of the broker-dealer to which the customer is referred, the number of
referrals the employee makes, or whether the customer expresses an
interest in a particular type of securities product.
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\69\ The proposed definition would clarify that rewarding
referrals with non-flat fees that vary in amount based on
``success'' factors would be inconsistent with the ``fixed dollar''
amount requirement in the statute.
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3. Comments on Definition of ``Referral'' and Proposed Amendments
The Interim Rules define the term ``referral'' to exclude any
activity beyond arranging a first securities-related contact between a
registered broker-dealer and a bank customer. We received over a dozen
comments on the definition of ``referral.''\70\ Commenters
characterized the definition as excessively narrow,\71\ and generally
took the position that it was more restrictive than required by the
Exchange Act, the Banking Agencies, and the Interagency Statement.\72\
Several commenters indicated that they saw no need to restrict referral
payments at all.\73\ A few objected to the use of the phrase ``first
securities-related contact,'' or suggested that the phrase be
defined.\74\
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\70\ See, e.g., Banking Agencies letter; Bank of America letter;
BONY letter; Connecticut Bankers letter; NYCH letter; Regions
letter; Roundtable letter; UMB Bank letter; and Wells Fargo letter.
\71\ Id.
\72\ See Interagency Statement, supra note 37.
\73\ See Banking Agencies letter; Connecticut Bankers letter;
and UMB Bank letter.
\74\ See, e.g., NYCH letter and Wells Fargo letter.
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In response to these comments and to address concerns commenters
expressed about difficulties they might have in meeting the definition
in the Interim Rules, we propose to eliminate the first securities-
related contact limitation from the definition of ``referral.'' We also
propose to simplify the definition in a manner consistent with pre-GLBA
networking arrangements. Under the amended definition, a ``referral''
would mean the action taken by a bank employee to direct a customer of
the bank to a registered broker or dealer for the purchase or sale of
securities for the customer's account.\75\
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\75\ See proposed Exchange Act Rule 710(c). Representatives of
banks have expressed an interest in paying their unregistered
employees for broker-related activities other than referrals, such
as screening potential brokerage customers. The Commission believes
that such activities constitute brokerage activities beyond those
intended to be covered by the networking exception. The Commission
believes it would be inconsistent with the networking exception for
banks to pay fees to unregistered bank employees to perform
functions--other than those expressly permitted by the GLBA or an
applicable exemption--that are traditionally performed by a
registered representative of a broker-dealer. A broker-dealer has a
duty to know its customers, which involves obtaining financial
information from them through its registered representatives.
Moreover, whether investing in securities through a broker-dealer is
appropriate for a particular individual must be determined by that
broker-dealer's registered representative, not unregistered bank
employees that are not subject to suitability obligations.
---------------------------------------------------------------------------
The proposed amendment also would specify that a bank may pay a fee
for a brokerage referral only to the employee who made the referral and
not to other employees, such as a branch manager or other supervisor.
This interpretation of the statute is consistent with existing
networking practices and banking agency guidance. We request comment on
these proposed changes and clarifications to the definition of
``referral.'' Commenters are invited to discuss whether banks need
additional guidance on what constitutes a referral.
4. Proposed New Definition of ``Contingent on Whether the Referral
Results in a Transaction''
The Interim Rules stated that the payment of a ``nominal one-time
cash fee of a fixed dollar amount'' for a referral cannot be related to
certain enumerated factors, including the value of any securities
transaction or a customer's financial status.\76\ Although some
commenters indicated that limitations on the conditions under which
referral fees may be paid are unnecessary,\77\ the networking exception
is clear that the payment of referral fees in reliance on this
exception may not be contingent on whether the referral results in a
transaction.\78\
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\76\ See 17 CFR 240.3b-17(g)(2). Proposed Regulation B uses the
word ``including'' as expanding or illustrative, not as exclusive or
limiting. The use of the term ``including, but not limited to'' in
Exchange Act Rules 10b-10 and 15b7-1 is not intended to create a
negative implication regarding the use of ``including'' without the
term ``but not limited to'' in Regulation B or other Exchange Act
rules.
\77\ See Bank of America letter and SIA letter.
\78\ Exchange Act Section 3(a)(4)(B)(i)(VI).
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Thus, to provide guidance on those contingencies on which incentive
compensation may not be based under the exception, we propose to define
the term ``contingent on whether the referral results in a
transaction'' to mean, with two exceptions, contingent on any factor
related to whether the referral results in a transaction, including
whether it is likely to result in a transaction, whether it results in
a particular type of transaction, or whether it results in multiple
transactions.\79\
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\79\ See proposed Exchange Act Rule 710(a).
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For example, under the proposed definition, a bank could not make
referral fees contingent on whether a customer opens a brokerage
account because such a contingency would make it more likely that the
referral would result in a securities transaction.\80\ Referral fees
also may not be contingent on whether the customer invests more than a
specified amount in securities or maintains a brokerage account for a
specified time.
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\80\ Opening a brokerage account is the first step in a
securities transaction. Typically, opening a brokerage account
results in the purchase or sale of securities.
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In response to commenters' requests,\81\ however, the proposed
definition specifically would permit referral fees to be contingent on
two factors. First, the term would permit referral fees to be
contingent on whether a customer contacts or keeps an appointment with
a broker-dealer as a result of a referral.\82\ Second, referral fees
may be contingent on whether a bank customer has assets meeting any
minimum requirement that the registered broker-dealer, or the bank, may
have established generally for referrals for securities brokerage
accounts.\83\ Both of these factors give broker-dealers the flexibility
to avoid paying fees for worthless referrals without inappropriately
aligning the financial interests of the bank's employee with those of
the broker-dealer. A customer could fail to keep an appointment
scheduled at the time of a referral but still contact a broker-dealer
as a result of the referral. Banks may wish to pay referral fees in
those contexts. These contingencies appear to be commonly used in
existing networking arrangements. In contrast, contingencies based on
whether a referral results in a customer opening or funding a brokerage
account, on
[[Page 39692]]
whether the customer keeps the account open for a certain period of
time, or on whether the referral results in brokerage-related fees
above a certain amount or assets invested above a certain amount are
the type of success-based factors that are close measures of whether a
referral results in a transaction.
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\81\ See Bank of America letter and SIA letter.
\82\ See proposed Exchange Act Rule 710(a)(1).
\83\ See proposed Exchange Act Rule 710(a)(2).
---------------------------------------------------------------------------
We request comment on the proposed definition of ``contingent on
whether the referral results in a transaction.'' In particular, we seek
comment on whether there are additional contingencies that banks
currently place on referral fees that should be permissible under the
proposed definition of ``contingent on whether the referral results in
a transaction.'' In addition, we encourage commenters to discuss other
areas where they believe the Commission should grant exemptive relief
related to networking arrangements. For example, in addition to the
asset, net worth, and income contingencies excluded from the proposed
definition, we seek comment on whether banks should be able to
condition the payment of referral fees on other criteria relating to
other aspects of a customer's financial profile, such as tax bracket.
Banks also are invited to discuss whether they would be able to
continue their existing networking activities if the current rules were
amended as described above. If not, banks should explain what proposed
rule provisions would prevent them from doing so. Banks should also
explain what changes, if any, they would need to make to their existing
networking programs to comply with the amended rules.
5. Interpretations of ``Contractual or Other Written Arrangement'' and
``Qualified Pursuant to the Rules of a Self-Regulatory Organization''
The Commission has received requests to provide further guidance on
certain terms used in the Interim Rules in connection with the
networking exception that were not defined in the Interim Rules.
Therefore, it may be useful to clarify the meaning of some of these
terms. First, one commenter proposed that the Commission interpret the
networking exception requirements expansively to ``apply to any bank
subsidiary expressly formed for the purpose of engaging in securities
transactions.'' \84\ We decline to expand the scope of the networking
exception in this manner. The Exchange Act's functional exceptions for
banks from the definitions of ``broker'' and ``dealer'' apply only to
banks, and only under limited circumstances. Non-bank affiliates of
banks are not subject to the same level of regulation as banks, and
such entities were not exempted from the Exchange Act's broker-dealer
registration requirements by the general exemption that the GLBA
replaced with limited, functional exceptions for banks. Non-bank
subsidiaries or affiliates of a bank may not rely on a bank exception
or exemption from broker-dealer registration.\85\ This interpretation
is consistent with the plain language of the GLBA. Non-bank entities
that refer customers, including bank customers, to broker-dealers would
generally have to register as broker-dealers.\86\
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\84\ See letter dated July 17, 2001 from Neil Milner, President
and CEO, Conference of State Bank Supervisors (``CSBS letter'').
Similarly, the Commission staff has received informal requests for
guidance on whether the networking exception would permit a bank to
avoid being considered a broker based on a networking arrangement
entered into by an affiliate or a subsidiary of the bank, and
whether a bank could participate in networking activities under
arrangements entered into by an affiliated insurance agency.
\85\ See Exchange Act Section 3(a)(6) which defines ``bank.''
\86\ In general, absent an exception or exemption, a person who
regularly refers securities business prospects for compensation to a
broker-dealer would be a broker required to be registered with the
Commission. See Exchange Act Release No. 27017 (July 11, 1989), 54
FR 30013, 30017-18 (July 18, 1989).
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Second, the Commission has received informal requests to clarify
the term ``qualified pursuant to the rules of a self-regulatory
organization.'' This term means to be qualified to effect a securities
transaction as a natural person associated with a registered broker or
dealer under Exchange Act Rule 15b7-1, which requires broker-dealers to
comply with SRO qualification standards.\87\
---------------------------------------------------------------------------
\87\ See 17 CFR 240.15b7-1.
---------------------------------------------------------------------------
We request comment on these interpretations, and on whether banks
require additional clarification of these terms or explanations of
other terms used in the networking exception. We also seek comment on
whether these interpretations or any other suggested interpretations
related to the networking exception should be included as amendments to
the Interim Rules.
The Commission staff also has received informal requests for
guidance on whether particular activities are clerical or ministerial,
and thus can be performed by unregistered bank employees within the
scope of the networking exception. Clerical and ministerial functions
are those such as scheduling appointments with a broker-dealer that do
not require specific qualifications or licensing when performed by an
employee of a broker-dealer. These functions do not require familiarity
with the securities industry, or the exercise of judgment concerning
securities. Detailing all of the activities that would constitute
clerical and ministerial functions is beyond the scope of this release.
Nevertheless, the Commission would welcome requests for exemptive or
no-action relief or interpretive guidance with respect to specific
activities that interested parties believe are clerical or ministerial
in the banking context.
B. Trust and Fiduciary Activities Exception
Section 3(a)(4)(B)(ii) of the Exchange Act \88\ permits a bank,
under certain conditions, to effect transactions in a trustee or
fiduciary capacity without registering as a broker. Under this
exception, a bank must effect such transactions in its trust
department, or other department that is regularly examined by bank
examiners for compliance with fiduciary principles and standards.\89\
The bank also must be ``chiefly compensated'' for such transactions,
consistent with fiduciary principles and standards, 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 that does not
exceed the cost the bank incurs in executing such securities
transactions, or, (4) any combination of such fees.\90\ The term
``chiefly compensated'' is not defined in the GLBA. Therefore, in the
Interim Rules, the Commission provided a definition for the term to
establish clear standards for complying with the ``chiefly
compensated'' requirement under the GLBA.\91\
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\88\ 15 U.S.C. 78c(a)(4)(B)(ii).
\89\ Id.
\90\ 15 U.S.C. 78c(a)(4)(B)(ii)(I). Banks relying on this
exception may not publicly solicit brokerage business, other than by
advertising that they effect transactions in securities in
conjunction with advertising their other trust activities. 15 U.S.C.
78c(a)(4)(B)(ii)(II). The exception also provides that a bank's
trust and fiduciary activities that result in a transaction in the
United States of any security that is publicly traded must meet the
conditions set out in Section 3(a)(4)(C) of the Exchange Act. 15
U.S.C. 78c(a)(4)(C). These conditions require a bank to direct a
trade to a registered broker or dealer for execution, to effect the
trade through a cross trade or substantially similar trade either
within the bank or between the bank and an affiliated fiduciary that
is not in contravention of fiduciary principles established under
applicable federal or state law, or to effect the trade in some
other manner permitted by the Commission. 15 U.S.C. 78c(a)(4)(C)(i)-
(iii). The term ``assets under management'' is not defined in the
Exchange Act or in the proposed rules.
\91\ Exchange Act Rule 3b-17(a) defines the term ``chiefly
compensated'' to mean that ``the `relationship compensation'
received by a bank from a trust or fiduciary account exceeds the
`sales compensation' received by the bank from such account during
the immediately preceding year. * * *''
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[[Page 39693]]
Provisions of the Interim Rules relating to the ``chiefly
compensated'' requirement engendered a great deal of public comment and
have been a primary focus of the discussions the Commission staff has
had with banking industry representatives and bank regulators since the
Interim Rules were adopted. As a result of these comments and
discussions, the Commission is proposing to modify substantially the
``chiefly compensated'' provisions in the Interim Rules. In the
Commission's view, these proposed improvements should facilitate their
compliance with the ``chiefly compensated'' requirement while
permitting banks to continue many of their current practices. This, in
turn, should ease their costs of transition to the new statutory scheme
without compromising investor protection.
1. Chiefly Compensated
a. Statutory Requirements and Existing Rules
To qualify for the trust and fiduciary activities exception,
Exchange Act Section 3(a)(4)(B)(ii) requires a bank to be ``chiefly
compensated'' for transactions effected in its trustee or fiduciary
capacity, consistent with fiduciary principles and standards. This
condition reflects Congress' goals to implement the functional
regulation of securities activities and to permit banks to continue to
conduct limited securities activities while acting as, and being paid
as, fiduciaries.\92\ The statutory conditions that a bank must meet to
qualify for this exception are designed to ensure that bank trustees
and fiduciaries conducting securities activities outside of the
protections of the securities laws are compensated as traditional
trustees and fiduciaries.\93\
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\92\ By enacting a trust and fiduciary activities exception in
the Exchange Act, Congress acknowledged that banks held securities
in trust accounts. In the GLBA's legislative history, the conference
committee stated that ``[t]he Conferees expect that the SEC will not
disturb traditional bank trust activities under this provision.''
H.R. Conf. Rep. No. 106-434, 164 (1999).
The House Committee on Commerce further stated that it expected
the Commission ``to interpret this exception, and, in particular the
references to ``chiefly'' and ``fiduciary principles and standards''
contained in this exception, so as to limit a bank's ability to
receive incentive compensation or similar compensation that could
foster a salesman's stake in promoting securities transactions.''
That Committee also stated that it did not intend for a bank to
conduct a full-scale securities brokerage operation in the trust
department that would be exempt from Commission regulation and the
imposition of appropriate investor protections under the Federal
securities laws. H.R. Rep. No. 106-74, pt. 3, at 164 (1999).
\93\ The question of when a bank may be acting in a fiduciary
capacity is separate and distinct from the question of whether a
specific account is established for a fiduciary purpose. For
example, a bank may be acting in a fiduciary capacity when it
provides investment advice to a common investment fund. Such a fund,
however, will be excluded from the definition of investment company
under the Investment Company Act of 1940 (``Investment Company
Act'') only if it is employed solely as an aid to the administration
of accounts maintained for a traditional fiduciary purpose. See
Section 3(c)(3) of the Investment Company Act.
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By its terms, the ``chiefly compensated'' condition divides a
bank's compensation into qualifying (traditional fees received by
trustees and fiduciaries) and non-qualifying types (traditional fees
received by broker-dealers), and limits the amount of non-qualifying
compensation a bank may receive and still rely on the exception. In
other words, Section 3(a)(4)(B)(ii) contemplates that a bank relying on
the trust and fiduciary activities exception will need to limit its
non-qualifying compensation and will need to have a mechanism in place
to determine whether it has succeeded in doing so.
While defining the types of compensation to compare is essential to
making the test meaningful, the statutory limitations require many
banks to categorize and compare their compensation in a manner that is
new to them. Current Exchange Act Rule 3b-17 was intended to facilitate
that categorization and comparison. The Rule defines ``chiefly
compensated'' to mean that more of a bank's payments for securities
transactions must come from qualifying, or ``relationship
compensation,'' \94\ than from non-qualifying, or ``sales
compensation.'' \95\
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\94\ See Exchange Act Rule 3b-17(i). The term ``relationship
compensation,'' an amended version of which the Commission is
proposing to codify in Exchange Act Rule 724, includes
administrative or annual fees (payable on a monthly, quarterly, or
other basis), fees based on a percentage of assets under management,
a flat or capped per order processing fee limited by the bank's cost
in effecting the transaction, or any combination of such fees.
\95\ See Exchange Act Rule 3b-17(j). The ``sales compensation''
definition, an amended version of which the Commission is proposing
to codify in Exchange Act Rule 724, includes compensation that a
bank receives for a securities offering that the bank does not
receive directly from a customer, beneficiary, or the assets of the
trust or fiduciary account. ``Sales compensation'' also includes
Rule 12b-1 fees. ``Rule 12b-1 fees'' or ``12b-1 fees'' are fees paid
out of fund assets pursuant to a distribution plan adopted under
Rule 12b-1 under the Investment Company Act. 17 CFR 270.12b-1. The
``sales compensation'' definition reflects the fact that bank trust
departments, like broker-dealers, receive payments for securities
transactions from third parties. Many of the sales practice
provisions of the federal securities laws, including a number of
NASD rules, are designed to address such conflicts of interest.
``Sales compensation'' also includes revenue sharing payments that
bank trust departments receive from mutual fund companies.
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To determine compliance with the ``chiefly compensated'' condition,
current Exchange Act Rule 3b-17 requires banks to compare their
``relationship compensation'' to their ``sales compensation'' annually,
on an account-by-account basis. Unrelated compensation is not included
in the ``chiefly compensated'' calculation because it is not relevant
to whether a bank is acting as a broker.\96\
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\96\ Any fee a bank receives that is not related to effecting
securities transactions is considered ``unrelated compensation''
and, except as discussed below, is not included in the definition of
``relationship compensation.'' Unrelated compensation includes fees
charged separately for activities, including taking deposits,
lending funds (including margin lending), preparing taxes, or
providing other services that are not related to managing securities
accounts pursuant to the trust and fiduciary activities exception.
Unrelated compensation also includes compensation received as
permitted under the terms of another bank exception from the
definitions of ``broker'' and ``dealer.'' This exclusion includes
any payment made to the bank or one of its employees pursuant to the
networking exception. See Exchange Act Section 3(a)(4)(B)(i)(VI).
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The Interim Rules also provided two exemptions from the general
requirements of the ``chiefly compensated'' condition. First, current
Exchange Act Rule 3a4-2 exempts banks that receive less than ten
percent sales compensation from making calculations on an account-by-
account basis. Second, Exchange Act Rule 3a4-3 exempts banks from the
definition of broker when they act in the narrow role of indenture
trustees investing in no-load money market funds. These exemptions are
explained in more detail below.
b. Comments on ``Chiefly Compensated'' Requirement
We received multiple comments addressing the ``chiefly
compensated'' condition.\97\ Many commenters agreed
[[Page 39694]]
that the term ``chiefly compensated'' should not be interpreted to
require a higher percentage threshold than the fifty percent standard
in the Interim Rules.\98\ Many commenters disagreed with the
Commission's interpretation, however, that the ``chiefly compensated''
calculation should be made on an account-by-account basis.\99\
Commenters opposing an account-by-account calculation argued that the
GLBA does not expressly require such a calculation and that determining
compliance in this manner would be unduly costly and complicated. Some
commenters expressed the view that the ``chiefly compensated''
condition should instead be interpreted to allow banks to determine
compliance on a line-of-business basis because they believe that
Congress intended a line-of-business approach.\100\
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\97\ See, e.g., ABA/ABASA letters; ACB letter; Bank of America
letter; ABA Banking Law Committee letter; Bank One letter; Banking
Agencies letter; BONY letter; Broadway letter; CSBS letter; letter
dated July 17, 2001 from Jerry W. Powell, General Counsel, Compass
Bancshares (``Compass letter''); Connecticut Bankers letter; letter
dated July 2, 2001 from Melanie L. Fein, Attorney at Law, on behalf
of Federated Investors, Inc. and letter dated June 18, 2001 from
Eugene F. Maloney, Executive Vice President and Corporate Counsel,
Federated Investors, Inc. (``Federated letters''); letter dated July
10, 2001 from William Nappi, CTCP, Trust Compliance Officer,
FirstMerit Corp., N.A. (``FirstMerit letter''); letter dated July
13, 2001 from Michael Watkins, Senior Vice President and Deputy
General Counsel, First Union Corporation (``First Union letter'');
Fleet letter; Harris Trust letter; IIB letter; Mellon letter;
National City letter; Bar of NY letter; NYCH letter; PNC letter;
Regions letter; Roundtable letter; letter dated July 17, 2001 from
Stewart P. Greene, Chief Counsel, Securities Law, Teacher Insurance
and Annuity Association (``TIAA-CREF letter''); Texas Bankers Trust
Division letter; UMB Bank letter; Victoria letter; Virginia Bankers
letter; Wells Fargo letter; letter on behalf of an unnamed client,
dated July 17, 2001 from Satish M. Kini of Wilmer, Cutler &
Pickering (``Wilmer, Cutler letter''); and letter dated July 16,
2001 from W. David Hemingway, Chief Financial Officer, Zions Bank
Capital Markets, Zions First National Bank, letter dated July 17,
2001 from Rick D. Burtenshaw, Senior Vice President, Investment
Division, Zions National Bank (``Zions Bancorporation letters'').
\98\ See, e.g., Banking Agencies letter.
\99\ See, e.g., ABA/ABASA letters; ACB letter; Banking Agencies
letter; BONY letter; Compass letter; Connecticut Bankers letter;
Mellon letter; NYCH letter; PNC letter; Regions letter; UMB Bank
letter; Wells Fargo letter; and Wilmer, Cutler letter.
But see Statement of the ABASA Before the Committee on Banking
and Financial Services, U.S. House of Representatives, on The
Financial Services Act of 1999, H.R. 10, February 16, 1999:
[H.R. 10's] fee provisions . . . will force every trust bank to
analyze each fiduciary account to ensure that the account satisfies
the exemption's fee requirements. . .. Despite the regulatory
burdens associated with complying with the fee aspect of the
exemption, the overall exemption is, ABASA believes, workable. . . .
The Commission notes that H.R. 10 contained language regarding
bank securities activities within a trust and fiduciary exception to
the definition of broker that was virtually identical to the version
that Congress ultimately adopted.
\100\ See, e.g., ABA/ABASA letters.
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Some commenters also raised concerns about the way in which the
Commission proposed to categorize certain types of compensation. For
example, under the Interim Rules, Rule 12b-1 fees are considered
``sales compensation'' rather than ``relationship compensation.'' Some
commenters believed that 12b-1 fees should be categorized as
``relationship compensation.''\101\ In addition, one commenter asserted
that banks should be able to treat fees based on a percentage of assets
under management, such as separately charged fees for managing real
property, as ``relationship compensation.''\102\
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\101\ See NYCH letter and PNC Bank letter.
\102\ See Texas Bankers Trust Division letter.
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One commenter recommended that the Commission ``grandfather'' trust
and fiduciary arrangements that were entered into prior to the
establishment of the parameters for categorizing compensation.\103\
Others emphasized the need for a cure period or ``safe harbor'' for
banks that inadvertently failed to meet the ``chiefly compensated''
condition during a particular time period.\104\
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\103\ See NYCH letter.
\104\ See ABA/ABASA letters; Banking Agencies letter; Roundtable
letter; Bar of NY letter; and Wilmer, Cutler letter. The Commission
also received a number of comments regarding the exemptions from the
``chiefly compensated'' requirement in current Exchange Act Rules
3a4-2 and 3a4-3. These comments are discussed below in connection
with proposed amendments to those exemptions.
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c. Proposed Changes in Response to Comments
In response to comments on provisions of the Interim Rules dealing
with the ``chiefly compensated'' condition, the Commission is proposing
new exemptions and expanding the existing exemptions. To simplify
compliance, the Commission also is proposing to expand the definition
of ``relationship compensation'' to expand the types of assets that
could qualify for assets under management fees paid directly by the
customer, beneficiary, or account.\105\ The Commission believes that
the proposed amendments to the provisions of the Interim Rules that
address the ``chiefly compensated'' condition should significantly
simplify compliance with the condition, alleviate concerns about
inadvertent noncompliance, and reduce the costs banks were likely to
have incurred in making the ``chiefly compensated'' calculation under
the Interim Rules.
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\105\ Although the term ``assets under management'' is defined
in Section 203A(a)(2) of the Advisers Act, it is not defined in the
Exchange Act or in these proposed rules and would include non-
securities assets. See section III.B.1.h infra.
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For example, the Commission is proposing a ``line-of-business''
alternative to the account-by-account methodology in response to
requests by representatives from the banking industry. Moreover, the
Commission is proposing to exempt existing living, testamentary, and
charitable trust accounts from the ``chiefly compensated'' calculation.
Finally, the Commission is proposing to establish a multi-tiered ``safe
harbor'' for banks determining compliance on an account-by-account
basis that find themselves out of compliance with respect to particular
accounts. The proposed safe harbors would provide banks with legal
certainty during those periods in which they were not compliant and
would provide them opportunities to come into compliance with the
``chiefly compensated'' condition. These proposed changes to the
Interim Rules, as well as Commission guidance on other aspects of the
Interim Rules, are discussed below.\106\
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\106\ Despite commenters' suggestions, an annual account-by-
account calculation is consistent with implementing functional
regulation to protect investors. It also is consistent with the way
in which both broker-dealers and banks establish their obligations
and duties to their customers which, in turn, defines the capacity
in which they will act. It is also consistent with accounting
requirements and other fundamental determinations that trustees must
make under state trust law. Moreover, bank trust departments
primarily charge fees at the same level at which securities
transaction fees are assessed--the account level.
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d. Proposed Line-of-Business Exemption
i. Description of Existing Rule
Exchange Act Rule 3a4-2 permits a bank to rely on the trust and
fiduciary activities exception from broker registration under the GLBA
if the bank's total ``sales compensation'' during the previous year was
less than ten percent of its total ``relationship compensation'' for
that period, provided the bank meets other conditions in the
exception.\107\ The rule was intended to provide banks with an
alternative to the account-by-account calculation of the ``chiefly
compensated'' requirement.
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\107\ A bank relying on the Exchange Act Rule 3a4-2 exemption
must comply with all other terms of the trust and fiduciary
activities exception and must maintain procedures reasonably
designed to ensure compliance with the ``chiefly compensated''
requirement with respect to a trust or fiduciary account. Exchange
Act Rule 3a4-2 currently requires those procedures to provide that
an account will be reviewed when it is opened, when the compensation
arrangement for the account is changed, and when sales compensation
received from the account is reviewed by the bank for purposes of
determining an employee's compensation. Exchange Act Section
3(a)(4)(C) requires that a bank must also execute any securities
orders through a broker-dealer (or in a cross trade or other means
that the Commission may prescribe).
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Commenters generally agreed that an alternative to the account-by-
account ``chiefly compensated'' calculation was desirable. \108\ Some
argued, however, that the alternative that the Commission adopted in
Exchange Act Rule 3a4-2 was unduly restrictive and in practice would
not provide meaningful relief from the account-by-account calculation.
In particular, several commenters stated that the procedural conditions
in the exemption essentially require an account-by-account calculation,
thereby defeating the purpose of the exemption.\109\
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\108\ See, e.g., Banking Agencies letter and BSA letter.
\109\ See, e.g., Banking Agencies letter; BONY letter; Bank One
letter; Federated letters; Fleet letter; ICBA letter; Mellon letter;
PNC letter; Regions letter; and UMB Bank letter. Commenters
expressed concern about the costs and burdens associated with these
requirements. See, e.g., Mellon letter. One commenter suggested
eliminating one of the procedural conditions so that banks could
adopt an across-the-board fee increase without triggering an
account-by-account compliance review. See Federated letters.
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[[Page 39695]]
ii. Description of Proposed Line-of-Business Exemption
In response to comments, we propose to adopt a ``line-of-business''
approach in proposed Exchange Act Rule 721.\110\ The proposal would
define a ``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 type of fiduciary capacity as listed in Exchange Act
Section 3(a)(4)(D).\111\ Under the proposal, a bank could use an
alternative calculation for ``chiefly compensated'' during one year if
it could demonstrate that during the preceding year its ratio of
``sales compensation'' to ``relationship compensation'' was no more
than one to nine either on a line-of-business or bank-wide basis (i.e.,
``one to nine ratio'').\112\
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\110\ See proposed Exchange Act Rule 721(c). We do not expect
banks to be in compliance with the ``chiefly compensated'' condition
during the delayed compliance period for the Interim Rules.
Moreover, given that the exemption we are proposing under Exchange
Act Rule 721 depends on compliance during the preceding year, this
condition would not apply during the first year that the broker
exceptions apply to banks. Of course, banks would be expected to
demonstrate compliance at the end of the first year after the
delayed compliance period. Then, by demonstrating year-end
compliance, a bank would have legal certainty for the following year
under the terms of the proposed exemption.
\111\ See proposed Exchange Act Rule 724(e).
\112\ We are proposing a one to nine ratio, which is similar to
the test in the Interim Rules, because we understand that many banks
would fit within this proposed exemption using this threshold. See
Exchange Act Release No. 44291, supra note 13. A one to nine ratio
allows banks to receive slightly more than ten percent in sales
compensation and not run afoul of the proposed exemption. The
proposal would require that the comparison be made based on
compensation from accounts within the scope of Exchange Act Section
3(a)(4)(D). For this exception and all of the proposed related
exemptions, year continues to be defined as a calendar year or other
fiscal year consistently used by a bank for recordkeeping and
reporting purposes.
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A bank could use this proposed alternative on a line-of-business
basis provided that the ``sales compensation'' and ``relationship
compensation'' from all trust and fiduciary activity accounts within a
particular line of business (or all such accounts within a particular
line of business established before a single date certain) is used to
determine whether the bank meets this condition.
For example, the bank could limit the accounts in a personal trust
line of business that would be used in the line-of-business
compensation comparison to all of the accounts established before a
single date certain. The enhanced flexibility in this part of the
proposal would permit a bank to phase in the use of account-by-account
exemptions for qualifying fiduciary activities as long as the bank
establishes a specific cut-off date for older accounts within a line of
business. This flexibility also should allow them to use this proposal
consistent with their changing business practices.
Banks relying on the proposed line-of-business alternative would be
required to meet the other conditions in the trust and fiduciary
activities exception and would be required 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.\113\ In addition, in
contrast to the requirement in current Exchange Act Rule 3a4-2 that the
bank review an existing account whenever the compensation arrangement
for the account changes, the proposal would only require the bank to
maintain procedures reasonably designed to ensure that, after opening
or establishing an account, at such time as the bank individually
negotiates with the accountholder or beneficiary of that account to
increase the proportion of ``sales compensation'' as compared to
``relationship compensation,'' 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.\114\ In other
words, only when the bank is revising the fees of a particular account
with the accountholder or beneficiary in a way that would increase the
proportion of ``sales compensation,'' would it also have to review the
account to ensure that it is likely to receive more ``relationship
compensation'' than ``sales compensation.'' \115\
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\113\ See proposed Exchange Act Rule 721(a)(3).
\114\ See proposed Exchange Act Rule 721(a)(4). This proposed
requirement would not be triggered, for example, when the fees
received by the bank change due to changes in assets or asset
allocation, or if the bank makes across-the-board changes in fees to
address inflation.
\115\ We also propose to eliminate the requirement in current
Exchange Act Rule 3a4-2 that a bank review an account when sales
compensation is reviewed for purposes of determining an employee's
compensation. See Exchange Act Rule 3a4-2(a)(2)(iii).
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The proposed line-of-business alternative is intended to give banks
legal certainty for each year based on their demonstrated compliance
for the previous year.
We request comment on the line-of-business alternative in proposed
Exchange Act Rule 721. Generally, would the proposed line-of-business
alternative make it easier for banks to comply with the ``chiefly
compensated'' condition? If so, please provide quantitative information
regarding the cost savings banks that choose the line-of-business
alternative could expect versus the account-by-account calculation. In
this regard, we request comment on how banks are generally compensated
with respect to their existing trust and fiduciary activity accounts.
The one to nine ratio is essentially the same comparison used in the
Interim Rules, but expressed as a ratio rather than as a percentage to
align the comparison in the proposed rules more closely with the
``chiefly compensated'' condition in the statute. We request comment on
whether the use of a ratio makes the comparison more clear, or whether
the comparison should be expressed as a percentage. We also request
comment on whether a one to nine ratio (or, if expressed as a
percentage, 11 percent) is the most appropriate comparison, if a one to
ten ratio would be sufficient to accommodate banks' current business,
or if another ratio would be more practicable. Commenters should
include specific information on each particular bank's ``sales
compensation'' compared to its ``relationship compensation.''
In addition, we request comment on what impact the expanded
definition of ``relationship compensation,'' which would now include
separately charged assets under management fees for managing other
assets (such as real property, oil and gas, etc.), would have on banks'
ability to meet the proposed line-of-business alternative.\116\
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\116\ See proposed Exchange Act Rule 724(h) and section
III.B.1.h infra.
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Further, we solicit comment on the procedural requirement that a
bank review an account when the proportion of ``sales compensation'' is
increased, and the impact of this condition on waiving ``relationship
compensation'' for a particular account.\117\ Is there an alternative
that would allow for fee waivers without allowing the bank to be
continually compensated by a significant number of accounts entirely
through ``sales compensation''?
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\117\ See proposed Exchange Act Rule 721(a)(4).
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We also request comment on what impact the requirement that the
bank use the compensation from all trust and fiduciary activity
accounts within a particular line of business would have on the bank's
ability to use the other exemptions proposed in this release,
[[Page 39696]]
such as the exemptions in proposed Exchange Act Rules 720 and 776. In
particular, we solicit comment on whether living, testamentary, and
charitable trust accounts are grouped with other non-exempt accounts in
a line of business. We also request comment on whether banks place
employee benefit plan accounts and other accounts not subject to a
special purpose exemption within a particular line of business. Banks
that believe they will need additional flexibility for their personal
trust and retirement business should provide a detailed explanation of
the type of relief they believe would be useful and discuss the sources
of their compensation in connection with that business. In addition, we
request comment on whether the definition of line of business is
practicable. Is this definition subject to manipulation by banks that
may have difficulty meeting the line-of-business test in a particular
year, and if so, how should it be modified to prevent this?
We also request comment on whether it is appropriate that banks be
permitted to use the proposed line-of-business alternative for some
lines of businesses, and use an account-by-account calculation or other
proposed exemptions for its other lines of business if available. In
addition, we request comment on whether it is appropriate for banks to
choose whether to use this proposed exemption for particular accounts
based on a cut-off date that the bank determines.
Bank representatives informed Commission staff that it would be
simpler and more cost effective if banks were permitted to compare
``sales compensation'' to a bank's total trust and fiduciary activities
compensation rather than to ``relationship compensation.'' Presumably,
total trust and fiduciary activities compensation would include
``relationship compensation,'' ``sales compensation,'' and any
compensation that a bank receives for the sale of other products and
services. We are soliciting comment on the feasibility and desirability
of amending the ``one to nine ratio'' in the line-of-business
calculation to require banks to compare their ``sales compensation'' to
their total compensation from qualifying fiduciary activities, as
opposed to the current comparison of ``sales compensation'' to
``relationship compensation.'' What ratio would be appropriate if the
basis were expanded?
In particular, we solicit comment on what compensation items, in
addition to ``sales compensation'' and ``relationship compensation,''
would be included in a bank's total compensation for qualifying
fiduciary activities and the quantitative impact of including these
compensation items on the line-of-business proposal. In addition, what
impact, if any, would such a change in the calculation have on the
number of banks that could meet the trust and fiduciary activities
exception? Moreover, what would be the cost savings to banks in
complying with the ``chiefly compensated'' condition if we were to
permit banks to compare ``sales compensation'' to total compensation
rather than to ``relationship compensation?'' We would like to know the
types of compensation that banks would include in total compensation
from qualifying fiduciary activities. To evaluate the recommendation
that we permit banks to compare ``sales compensation'' to total
compensation for trust and fiduciary activities, we are soliciting
quantitative information from banks that would illustrate how such a
bank would fare under each of the tests.\118\ What other changes, if
any, do commenters believe should be made to the ``chiefly
compensated'' calculation?
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\118\ To the extent that such information would be deemed
proprietary, banks could request confidential treatment for that
information.
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Finally, we are seeking comment on the way in which banks are
likely to use the proposed calculation alternatives to determine
whether additional flexibility is needed in this particular exemption
and how best to provide it. For example, do banks have lines of
business containing both accounts covered by the special purpose
exemptions (e.g., for Regulation S or employee benefit plan accounts)
and accounts that are not? If so, which lines of business contain both
types of accounts?
e. Proposed New Living, Testamentary, and Charitable Trust Account
Exemption
Commenters indicated that banks need flexibility with respect to
established personal trust accounts that have terms that cannot readily
be changed without consequences to both the bank and the trust
beneficiaries. These commenters explained that fees received in
connection with these accounts were negotiated in the past and may be
difficult to change to meet the ``chiefly compensated'' condition based
on, for example, the age or type of the trust.\119\ Banks may
administer trusts that were created by settlors who have died or who
may have become incompetent. In addition, we understand that state law
may make it impracticable to change the compensation structure of
existing trusts.
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\119\ See, e.g., Banking Agencies Letter and NYCH letter.
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In response to these concerns, we are proposing new Exchange Act
Rule 720. This proposed rule would exempt a bank from meeting the
``chiefly compensated'' condition to the extent that it effects
transactions for a living, testamentary, or charitable trust account
opened, or established before July 30, 2004, in a trustee or fiduciary
capacity if the bank does not individually negotiate with the
accountholder or beneficiary of the account to increase the proportion
of ``sales compensation'' as compared to ``relationship compensation''
after July 30, 2004.\120\ For purposes of this proposed rule, a
testamentary trust may be deemed to be established as of the date of
the will that directed that the trust be established. Banks making an
account-by-account calculation that rely on a particular exemption must
comply with all of the requirements in that exemption, but have the
option of choosing the exemption or exemptions they need to match their
business.
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\120\ This date was chosen for administrative simplicity.
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We invite comment on the proposed exemption for existing personal
trust accounts. Banks are particularly invited to explain the ways in
which they are compensated for administering existing personal trust
accounts.
f. New Conditional Safe Harbor
We also propose to adopt a one-year conditional safe harbor for a
bank that exceeds the one to nine ratio that it would need to meet to
rely on the line-of-business alternative in proposed Exchange Act Rule
721.\121\ Under this safe harbor, a bank that exceeds the one to nine
ratio in any given year may continue to rely on the proposed line-of-
business alternative for the following year if it meets three
requirements.\122\ First, it must meet the other requirements of the
rule and the other requirements of the trust and fiduciary activities
exception. Second, the bank's ratio of ``sales compensation'' to
``relationship compensation'' the bank received from its qualifying
fiduciary business must have been no more than one to seven.\123\
Third, it may not have relied on this safe harbor during any of the
five preceding years.
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\121\ See proposed Exchange Act Rule 721(b).
\122\ See supra note 112 for a discussion of the term ``year.''
\123\ The one to seven ratio is intended to provide legal
certainty to banks that are working in good faith to comply with the
terms of the proposed exemption.
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Used in conjunction with the line-of-business alternative,
discussed above,
[[Page 39697]]
this proposed new safe harbor should provide banks with time to adjust
their ``sales compensation,'' when necessary, to ensure that it does
not exceed the exemption's limit. For example, a bank that finds its
``sales compensation'' is likely to exceed the one to nine compensation
ratio could begin to adjust its compensation immediately. The legal
assurance that it would have time to make this adjustment without
consequence should permit banks to refine their compensation
sufficiently to assure that they will remain in compliance.
This new safe harbor should supplement the rule's general exemption
in addressing banks' concerns that if they inadvertently exceed the
exemption's ``sales compensation'' percentage in one year, they would
immediately need to conduct an account-by-account analysis to determine
whether they are in compliance with the ``chiefly compensated''
condition. We understand that banks relying on proposed Exchange Act
Rule 721 may not have compliance procedures in place to do account-by-
account monitoring. Banks could rely on the proposed new safe harbor
for one year while taking steps to ensure that they will meet the terms
of the general exemption before the end of that year.\124\
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\124\ These steps could include employing brokers to execute
transactions for trust and fiduciary activity accounts, or charging
those accounts only a flat or capped per order processing fee equal
to not more than the cost incurred by the bank in connection with
executing securities transactions for trustee and fiduciary
customers. A bank could also rebate 12b-1 fees to the account.
Alternatively, the bank could restructure the compensation from some
or all of its trust and fiduciary activity accounts to change the
proportion of ``relationship compensation'' by reducing the price it
charges for executing transactions, executing transactions at cost
so the reimbursement would be characterized as ``relationship
compensation,'' or raising the bank's annual fee and offering
unlimited securities transactions at no additional cost to the
account.
A bank could implement any, or several, of these alternatives at
any time during the year. For example, a bank might identify a
problem in November of a calendar year that it finds is caused by a
large account with high ``sales compensation'' that would likely
cause the bank to fail its compensation comparison. The bank could
waive securities transaction fees, or refund fees already charged to
the account. The bank could also restructure the compensation in the
account by not charging for additional securities transactions, or
by converting to an annual fee that includes unlimited transactions.
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We invite comment on the proposed one-year safe harbor in proposed
Exchange Act Rule 721, including whether an additional year is a
sufficient amount of time and whether one to seven is the appropriate
ratio.
g. New Proposed Account-by-Account Exemption
Proposed Exchange Act Rule 722 would provide banks with a new
exemption designed to give additional flexibility and legal certainty
to banks that determine their compliance with the ``chiefly
compensated'' requirement on an account-by-account basis.
i. Proposed Account-by-Account Exemption
Proposed Exchange Act Rule 722 is intended to provide banks that
determine compliance with the ``chiefly compensated'' condition through
an account-by-account calculation with legal certainty for one year
based on their demonstrated compliance for the previous year. Under
proposed paragraph (a) of Rule 722, a bank would be exempt from the
``chiefly compensated'' condition with respect to a particular account
during any year if it meets four conditions. First, the bank would be
required to meet the other conditions of the trust and fiduciary
activities exception. Second, the bank must have met the ``chiefly
compensated'' condition with respect to that particular account during
the preceding year.\125\ Third, a bank would be required 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. Fourth, a bank
would 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 accountholder or beneficiary of
that account to increase the proportion of ``sales compensation'' as
compared to ``relationship compensation,'' 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.
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\125\ This condition would not apply during the first year that
the broker exceptions apply to banks. During that first year, banks
will be expected to demonstrate compliance at the end of the year.
By demonstrating compliance during the first year that the broker
exceptions are implemented for banks, a bank will have legal
certainty for the following year under the terms of the exemption.
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We request comment on the proposed exemption. Banks are
particularly invited to discuss the extent to which the proposed
exemption would provide them with legal certainty. In addition, we are
seeking comment from those who believe that the account-by-account
calculation should be eliminated. In particular, we invite comment on
how banks would satisfy the ``chiefly compensated'' requirement of the
trust and fiduciary exception in the absence of an account-by-account
calculation requirement.
ii. New Safe Harbor for Account-Specific Exemption
Commenters expressed concern that banks that determine their
compliance with the ``chiefly compensated'' condition on an account-by-
account basis would need flexibility if they discovered that their
``sales compensation'' for a particular account had exceeded their
``relationship compensation'' in a particular year.\126\ To mitigate
banks' compliance concerns, we are proposing a one-year conditional
safe harbor for a bank that does not meet the ``chiefly compensated''
requirement with respect to a particular account.\127\ This new safe
harbor would provide a bank the time to bring its compensation
arrangements for that account into compliance with the ``chiefly
compensated'' condition.
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\126\ Some commenters indicated that occasionally, prudent
financial management of an individual customer account, such as a
position concentration, could result in a particular account
exceeding the chiefly compensated requirement in a particular year.
For example, a bank could need to lessen a customer's concentration
in a particular investment. See, e.g., Banking Agencies Letter.
In addition, the Banking Agencies, bank trade associations and a
law firm stated that banks would be at risk of unintentionally
violating the securities laws because a bank can fall out of
compliance with the exception for the preceding year based on one
account without any type of cure period. See Roundtable letter and
Wilmer, Cutler letter.
We note that there are many ways that a concentrated portfolio
may be diversified without incurring high transaction payments to
the bank.
\127\ See proposed Exchange Act Rule 722(b) and (c). This
alternative safe-harbor is not necessary until after the first year
that the bank broker exceptions apply.
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Under the proposed safe harbor, a bank with one or more accounts
that exceed the ``chiefly compensated'' requirement could continue to
rely on the trust and fiduciary activities exemption in the next year
for these ``sales compensation'' accounts so long as these accounts
represent ten percent or less of the total number of accounts for which
the bank acts in a trustee or fiduciary capacity.\128\ A bank relying
on this exemption would need to meet two requirements. First, it must
meet the other requirements of the rule, as well as the other
requirements of the trust and fiduciary activities exception. Second,
the bank may not have relied
[[Page 39698]]
on this safe harbor with respect to the particular ``sales
compensation'' account during any of the five preceding years.
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\128\ The ten percent limitation is intended to provide legal
certainty to banks that are working in good faith to comply with the
terms of the proposed exemption.
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This safe harbor is intended to provide banks with time to
restructure the compensation arrangement with respect to a particular
account or accounts. It would not require banks to expand or otherwise
modify their overall compliance procedures. Rather, it would permit
them to target particular accounts and adjust their compensation
accordingly.
We would expect banks to use the safe harbor period to ensure that
their new compensation arrangement with respect to the ``sales
compensation'' account will allow them to meet the ``chiefly
compensated'' condition in the future for that account. While this
should theoretically mean that an account that exceeds the ``chiefly
compensated'' threshold would not exceed that threshold again, the
character of an account can change over time. Therefore, the safe
harbor would be available for a bank to use for the same account once
every five years.
Banks that choose to calculate their compliance with the ``chiefly
compensated'' condition on an account-by-account basis will need to
have systems in place to monitor their own compliance. We would expect
banks' systems to ensure that few accounts actually exceed the
``chiefly compensated'' threshold. While the proposed safe harbor would
permit up to ten percent of a bank's trust and fiduciary activities
accounts to exceed the compensation threshold in a given year, we would
expect banks to monitor their compliance closely enough that their
percentage of non-complying accounts remains small. We request comment
on the ten percent limit. Banks that believe the limit should be higher
are encouraged to discuss what limit would be consistent with the
compliance systems they plan to put in place.
In addition to the general one-year safe harbor, we are proposing
to give additional flexibility to banks when a small number of accounts
do not meet the ``chiefly compensated'' condition more frequently than
once in a five-year period. Under this proposal, a bank can continue to
be exempt even though the lesser of 500 accounts or 1 percent of the
total number of its qualifying fiduciary activity accounts continued
not to meet the ``chiefly compensated'' condition, provided the bank
has documented the reason that each such account continued not to meet
the condition and linked that reason to the bank's exercise of
fiduciary responsibility.\129\
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\129\ See proposed Exchange Act Rule 722(c)(4). For example,
during a particular year, an accountholder may have unexpectedly
inherited a large number of shares of stock that a trust instrument
required to be deposited into an account for which the bank was
acting in a trust or fiduciary capacity. This proposed threshold is
intended to provide banks that are working in good faith to comply
with the provisions of the proposed exemption with an additional
safety valve.
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Commenters are invited to discuss the utility of the proposed safe
harbors and whether they would provide banks with sufficient legal
certainty. We also request comment on whether the general limit on
using the exemption once every five years for a particular account
together with the additional flexibility for a few accounts that
exceeded the ``chiefly compensated'' condition more than once in a
five-year period would provide banks with sufficient flexibility while
remaining consistent with the statutory purpose. We also solicit
comment on the additional safe harbor for a small number of accounts
that fail the ``chiefly compensated'' test more than once in a five-
year period and on whether the lesser of 500 or one percent of the
total number of a bank's qualifying accounts is the appropriate
threshold. Banks likely to need additional flexibility are invited to
include a discussion of their planned compliance systems.
h. Other Provisions
i. ``Chiefly Compensated'' and Related Definitions
In addition to expanding the exemptions to facilitate banks'
compliance and eliminate unnecessary burdens, we are proposing several
technical changes to the definitions and proposing to expand the
definition of ``relationship compensation.'' Otherwise, we are not
proposing to change substantially the definition of ``chiefly
compensated'' or related definitions. The technical changes to these
rules are intended to simplify and clarify the definitions. Moreover,
we believe the proposed exemptions discussed above should address many
of the practical problems commenters noted in discussing these
definitions.\130\
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\130\ For example, we address commenters' concerns about
defining Rule 12b-1 fees as ``sales compensation'' by proposing
amendments to simplify the exemption in Exchange Act Rule 3a4-2 to
allow banks to compare ``sales compensation'' to ``relationship
compensation'' derived from its trust and qualifying fiduciary
activity accounts on a line-of-business basis and proposing a
separate exemption in proposed Exchange Act Rule 770. We also note
that an investment company may restructure its fee arrangement to
pay shareholder servicing fees that are not being paid for sales or
distribution outside of a Rule 12b-1 plan. This type of fee
arrangement is unrelated compensation under the Interim Rules rather
than ``sales compensation.'' We also propose to replace the term
``trust or fiduciary account'' with the term ``an account for which
the bank acts in a trustee or fiduciary capacity.'' Because this
language more closely matches the statutory language in the trust
and fiduciary activities exception, it should reduce confusion.
We also note that the definition of ``sales compensation''
includes revenue sharing payments. As we discussed in proposing
targeted disclosure requirements for broker-dealers selling mutual
funds, revenue sharing arrangements not only pose potential
conflicts of interest for the recipient, but also may have the
indirect effect of reducing investors' returns by increasing the
distribution-related costs incurred by funds. See Exchange Act
Release No. 49148 (Jan. 29, 2004), 69 FR 6437 (Feb. 10, 2004).
Revenue sharing arrangements may give broker-dealers heightened
incentives to market the shares of particular mutual funds, or
particular classes of fund shares. These incentives may be reflected
in the use of ``preferred lists'' that explicitly favor the
distribution of certain funds, or they may be reflected in other
ways, including incentives or instructions to employees of a bank or
broker-dealer. The magnitude of revenue sharing payments--estimated
in 2001 at $2 billion annually--suggests that those arrangements
influence the mutual fund choices presented to investors. See ``How
high can costs go?,'' Institutional Investor, May 2001 at 56.
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The expansion of the definition of ``relationship compensation''
that we are proposing would add types of assets that could qualify for
assets under management fees paid directly by the customer,
beneficiary, or account. This amended definition would include, for
example, separately charged assets under management fees for managing
real property, and would affect the ratio in the line-of-business
exemption in proposed Exchange Act Rule 721 discussed above.\131\ While
the original definition of ``relationship compensation'' required the
bank to be engaged in securities management activities for these fees
to be included in the definition, we propose this change to address
banks' accounting and systems concerns that it would be difficult to
treat assets under management fees differently for managing different
types of assets.
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\131\ Banks determining compliance on an account-by-account
basis would not need to consider accounts that did not contain
securities, such as an account that only contained real estate,
since broker-dealer registration is not necessary for these
accounts.
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One commenter urged the Commission to amend the definition of
``flat or capped per order processing fee equal to not more than the
cost incurred by the bank in connection with executing securities
transactions for trustee and fiduciary customers;'' in current Exchange
Act Rule 3b-17(b) to allow banks to include the cost of shared
resources as opposed to the ``exclusively dedicated'' standard in the
Interim Rules.\132\ In response, we propose to amend the definition to
[[Page 39699]]
include the direct marginal cost of any resources of the bank that are
used for transaction execution, comparison, or settlement for trust and
fiduciary activity accounts if the bank makes a precise and verifiable
allocation of these resources according to their use. We believe this
proposed change is consistent with the statutory requirement of cost
recovery. We also propose to amend the definition to clarify that the
account, rather than the bank, pays the fee. We request comment on the
proposed amendments to the definition of ``flat or capped per order
processing fee equal to not more than the cost incurred by the bank in
connection with executing securities transactions for trustee and
fiduciary customers;'' in proposed Exchange Act Rule 724(b).
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\132\ See ABA/ABASA letters.
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We request comment on these proposed amendments to the definitions.
Commenters are invited to discuss whether the ``sales compensation''
definition should include additional sales-related arrangements that
may create conflicts of interest, such as sales or distribution-related
payments to affiliates or employees of banks. We also invite banks to
provide us with any specific information on their compensation
arrangements that might help us to further simplify the ``chiefly
compensated'' calculation while implementing the statutory provisions.
ii. Formulas to Allocate Sales Compensation to Individual Accounts
A. 12b-1 Fees
Rule 12b-1 under the Investment Company Act permits investment
companies to use their assets to finance sales-related expenses.\133\
Unlike fees for assets under management by the bank, which do not
differ depending on the investment that the bank selects, Rule 12b-1
fees paid to banks and other distributors often vary from investment
company to investment company. Rule 12b-1 fees create incentives to
distribute particular investment company securities and create
conflicts between the bank and investors. Such conflicts of interest
drive much of broker-dealer regulation. Accordingly, Rule 12b-1 fees
are included in the ``sales compensation'' definition.\134\
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\133\ See Investment Company Act Release No. 11414, 45 FR 73898
(Nov. 7, 1980).
\134\ See Exchange Act Release No. 44291, supra note 13, 66 FR
at 27775.
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Commenters pointed out that because Rule 12b-1 fees are paid based
on the amount of assets in an omnibus account, it would be difficult to
allocate such fees on an account-by-account basis.\135\ We therefore
propose to add a formula to the definition of ``sales compensation'' in
proposed Exchange Act Rule 724 to allow banks to estimate the amount an
individual account pays annually in Rule 12b-1 fees that are paid on an
entity basis. The proposed formula would allow a bank to calculate the
Rule 12b-1 fees for each account using one of two methods. First, a
bank could calculate the 12b-1 fees 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 Rule 12b-1 fee rate applicable
to that class of securities. Alternatively, a bank could use another
allocation method if it fairly and consistently measures the amount of
``sales compensation'' attributable to each account during the
preceding year.\136\
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\135\ See NYCH letter and PNC Bank letter. We note, however,
that in connection with E*Trade's Rule 12b-1 fee rebate program,
E*Trade explains its fifty percent rebate formula as follows: ``For
example, if the average daily value of your eligible mutual fund
holdings for the year is $200,000 and we receive 12b-1 fees at the
annual rate of 0.25% (25 basis points) from the funds you selected,
you would receive an annual rebate of $250 (0.0025 x $200,000/2).''
See (https://us.etrade.com/e/t/home?SC=LBH4249).
\136\ We chose the year-end formula to allow banks performing
the ``chiefly compensated'' calculation on an account-by-account
basis to make a reasonable estimate, consistent with the chiefly
timeframe, of the amount of 12b-1 fees paid by an account during the
preceding year. The proposed formula also is intended to provide
banks with the additional flexibility to measure the changing value
of an account during the year to determine the amount of 12b-1 fees
paid by that account, provided that the bank uses the same fair
method for each account.
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We request comment on whether the proposed formula would facilitate
banks' allocation of the 12b-1 fees to individual accounts. We also
invite commenters to discuss any alternative allocation methods they
believe would more accurately measure the amount of ``sales
compensation'' attributable to each account. In addition, commenters
are invited to suggest other allocation methods that they believe would
be simpler, while providing a reasonably accurate allocation of these
fees to individual accounts. Commenters should explain how the results
from any alternative method would compare to the results from the
proposed allocation method.
B. Other Fees
We also propose to amend the definition of ``sales compensation''
in proposed Exchange Act Rule 724(i)(4) and (6) to allow a bank to
estimate the amount that it receives annually that is attributable to
an individual account, but that is not paid directly from the account.
This formula would allow a bank to calculate these fees for each
account by using one of two methods. First, a bank could divide the
number of shares of each class of each type of investment company held
in each account on the last business day of the preceding year by the
total number of the same type of investment company shares that the
bank held in a trustee or fiduciary capacity on the same day, and
multiply the resulting number by the total dollar amount of these fees
the bank received in connection with that class during the preceding
year. Second, a bank could use its own method of allocation if it
fairly and consistently measures the amount of ``sales compensation''
attributable to each account during the preceding year. \137\
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\137\ See id. for a discussion of the reasons why we are
proposing this formula.
---------------------------------------------------------------------------
We request comment on the proposed formula. Commenters are invited
to discuss whether it will facilitate banks' allocation of these fees
to individual accounts. We also invite comment on whether there would
be a simpler method that would provide a reasonably accurate allocation
of these fees to individual accounts. We also invite comment on how to
address the problem of the sale of shares at the end of the year. For
example, an account that held a substantial proportion of a bank's
total holdings in a given fund for most of a year, but whose shares
were sold just before year-end, may be allocated none of the bank's
fees earned from that fund. At the same time, an account with
relatively small holdings in the same fund that did not sell at the end
of the year might be allocated a disproportionately large amount of the
bank's fees earned from that fund. In addition, we invite comment on
whether this formula should be revised to make it more consistent with
other proposals on which the Commission is currently seeking comment
regarding revenue sharing payments that occur at the fund complex
level, as opposed to the fund level.\138\ Commenters are specifically
requested to consider whether the formula should compare the value of
the account with the value of all assets held by the bank in a fund
complex if revenue sharing is paid on a fund complex basis.
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\138\ See infra note 405.
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iii. Indenture Trustee Exemption
Exchange Act Rule 3a4-3 currently provides a limited exemption from
broker registration for a bank that serves
[[Page 39700]]
as an indenture trustee in a no-load money market fund, provided that
it meets certain conditions. Comments we received on this rule
criticized its utility in part based on the definition of ``indenture
trustee,'' which is currently codified in Exchange Act Rule 3b-17.\139\
For example, two commenters recommended that we expand the ``indenture
trustee'' definition to include trustees appointed pursuant to pooling
and servicing agreements, trust agreements, bond resolutions, and
mortgages, given that, according to these commenters, documents
appointing trustees generally are not limited to indentures.\140\
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\139\ 17 CFR 240.3b-17(c). Current Exchange Act Rule 3a4-3
permits banks to effect transactions as indenture trustees in no-
load money market funds without meeting the ``chiefly compensated''
condition in the trust and fiduciary activities exception.
\140\ See ABA/ABASA letters and Bank One letter.
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In lieu of modifying the ``indenture trustee'' definition (which we
are proposing to move to Exchange Act Rule 724), as discussed
previously, the Commission is proposing a broad general exemption
(proposed Exchange Act Rule 776) that would permit banks to effect
transactions for qualified investors and certain other investors in
money market funds.\141\ As discussed below, we propose to eliminate
the definition of ``trustee capacity,'' which defined the term to
include the capacity of a trust indenture trustee. As a result, banks
acting in an indenture trustee capacity would not need to look to the
definition of ``indenture trustee'' to determine whether they qualify
for the trust and fiduciary activities exception.
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\141\ See Section III.F.1 supra for discussion of proposed
Exchange Act Rule 776, under which banks not acting in an indenture
trustee capacity could effect transactions for customers who are
``qualified investors'' and customers for whom they act in a trustee
or fiduciary capacity or in certain escrow capacities in money
market funds, including those that charge a ``load.''
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We propose to move the definition of ``indenture trustee'' to
proposed Exchange Act Rule 724(c), where the term would be defined for
purposes of the exemption in proposed Exchange Act Rule 723, which
would provide an exemption from the ``chiefly compensated'' calculation
for banks to effect transactions as an indenture trustee in no-load
money market funds. While the exemption would still be available on the
same terms as before, we believe that banks acting as indenture
trustees may opt for the exemption in proposed Exchange Act Rule 776.
We request comment on proposed Exchange Act Rule 723. Commenters
are specifically invited to discuss whether the exemption would be
necessary if we adopt proposed Exchange Act Rule 776.
2. Definition of ``Trustee Capacity'' and Indenture Trustees
We received numerous comments on the definition of ``trustee
capacity,'' which was included in the Interim Rules to clarify that for
purposes of the trust and fiduciary activities exception, the term
includes indenture trustees and trustees for tax-deferred account
described in sections 401(a), 408, and 408A under subchapter D and in
section 457 under subchapter E of the Internal Revenue Code of 1986 (26
U.S.C. 1, et seq.) \142\ Some commenters supported the definition's
provision of legal certainty for indenture trustees and trustees for
certain tax-deferred accounts.\143\ However, some commenters urged the
Commission to expand the definition to cover banks acting as custodial
trustees for Individual Retirement Accounts (``IRAs'').\144\ Commenters
also indicated that the definition should cover both indenture trustees
operating under appointive documents other than indentures, and
indenture trustees serving on issues or transactions outside those
delineated in the Interim Rules.\145\ Some commenters urged the
Commission to withdraw the definition of ``trustee capacity'' and
instead interpret the trust and fiduciary activities exception to cover
all types of ``trustees.'' \146\ Several commenters indicated that
defining ``trustee capacity'' as including an indenture trustee or a
trustee for certain tax-deferred accounts may create ambiguity by
suggesting that other ``trustees'' may not be able to rely on the trust
and fiduciary activities exception.\147\ One commenter took issue with
the analysis of trustee relationships because, in the commenter's view,
it focused on whether a bank exercises investment discretion.\148\ This
commenter asserted that there are numerous trustee relationships in
which a bank may not exercise investment discretion, but would still be
subject to fiduciary duties, such as personal trusts, charitable
foundation trusts, insurance trusts, rabbi trusts, secular trusts,
conservatorships and guardianships.\149\ Two commenters stated that the
governing trust instrument under state and federal fiduciary law, and
not the Commission, should determine the nature of a trust or fiduciary
relationship.\150\ One commenter maintained that it is unclear how
banks could ``push out'' trust accounts to broker-dealers.\151\
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\142\ See Exchange Act Release No. 44291, supra note 13, 66 FR
27767-69. See, e.g., ABA/ABASA letters; Bank One letter; Banking
Agencies letter; BONY letter; Bar of NY letter; Fleet letter;
KeyBank letter; Mellon letter; NASAA letter; NYCH letter; PNC
letter; Regions letter; letter dated August 31, 2001 from Andrew
Cecere, Vice Chairman, Private Client and Trust Services, U.S.
Bancorp (``U.S. Bancorp letter''); Wells Fargo letter; and Zions
Bancorporation letters.
\143\ See, e.g., ABA/ABASA letters and Federated letters.
\144\ See ABA/ABASA letters; Federated letters; and Wells Fargo
letter.
\145\ See ABA/ABASA letters.
\146\ See, e.g., Banking Agencies letter; BONY letter; Federated
letters; PNC letter; Roundtable letter; and Wells Fargo letter.
\147\ See, e.g., Banking Agencies letter; BONY letter; Federated
letters; Frost letter; Harris Trust letter; NYCH letter; PNC letter;
Roundtable letter; UMB Bank letter; and Wells Fargo letter.
\148\ See Roundtable letter.
\149\ Id.
\150\ See ICBA letter and National City letter.
\151\ See NYCH letter.
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After considering these comments, we propose to withdraw the
definition of ``trustee capacity'' and not specifically identify the
types of trustee capacities in which banks may act in reliance on the
trust and fiduciary activities exception. This should simplify
compliance and allow banks that effect transactions in a trustee
capacity to continue doing so even if they do not assume significant
fiduciary responsibilities as trustee. As discussed in more detail
below, however, we do not propose to broaden the meaning of the term
``trustee capacity'' to include banks acting in non-trustee capacities,
such as IRA bank custodians, for purposes of Exchange Act Section
3(a)(4)(B)(ii).\152\ We request comment on our proposal to eliminate
the definition of ``trustee capacity'' and not specifically identify
trustee capacities that would provide a basis for relying on the trust
and fiduciary activities exception. We also request comment on whether
additional clarification regarding the meaning of ``trustee capacity''
would be helpful.
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\152\ As discussed above and below, however, we propose other
exemptions that may address some of the business needs of banks that
are not trustees but act in capacities that commenters suggest
should be recognized as such--e.g., IRA custodians, escrow agents,
and paying agents.
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3. Interpretations of ``Fiduciary Capacity'' and ``Similar Capacity''
The definition of ``fiduciary capacity'' in Exchange Act Section
3(a)(4)(D) provides that a bank may qualify for the trust and fiduciary
activities exception if it acts in certain specified fiduciary
capacities or ``in any other similar capacity.'' In adopting the
Interim Rules, the Commission identified several capacities from state
uniform acts and codes that were not expressly listed in the statutory
definition of
[[Page 39701]]
``fiduciary capacity.'' \153\ The Commission also noted that in some
cases, state authorities used different nomenclature to refer to the
same fiduciary capacity.\154\ The Commission did not expand the term
``similar capacity'' to include agency activities that are not subject
to the standards applicable under trust and fiduciary law to banks
acting as fiduciaries.
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\153\ For example, the Uniform Probate Code uses the term
``Personal Representative'' and similar successor titles in place of
executor or administrator as the representative of a decedent.
Similarly, under the Uniform Custodial Trust Act, the terms that are
used for fiduciaries who act for persons who have become
incapacitated include ``conservator'' and ``custodial trustee.''
\154\ For example, Exchange Act Section 3(a)(4)(D)(i) refers
only to the capacity of a ``custodian under a uniform gift to minor
act,'' while the Uniform Transfers to Minors Act uses both the terms
``conservator'' and ``custodian'' for fiduciaries that act for
minors.
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Some commenters indicated that, because the definition of
``fiduciary capacity'' in Exchange Act Section 3(a)(4)(D) \155\ is
similar to the definition of the same term in regulations issued by the
OCC,\156\ the Commission should interpret the term to include the same
range of activities.\157\ Some commenters suggested, for example, that
the Commission should treat banks that act as IRA custodians as if they
were IRA trustees for purposes of the trust and fiduciary activities
exception.\158\ Other commenters urged us to define a bank that
performs escrow services to be acting in a similar capacity to an
indenture trustee.\159\ Similarly, commenters have suggested that the
Commission consider various other capacities as ``similar'' to the
fiduciary capacities listed in the statute. Examples of such other
capacities include escrow agent, commercial paper listing and paying
agent, debt securities paying agent, collateral agent, custodian for
mortgage loan files, and titleholder or qualified intermediary in like-
kind exchange transactions. As discussed above in connection with
indenture trustees, some of these capacities would be within the scope
of proposed Exchange Act Rule 776.
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\155\ 15 U.S.C. 78c(a)(4)(D).
\156\ See 12 CFR 92(e). Notably, the range of permitted banks
activities under the OCC's regulations is significantly broader than
activities in which banks could engage in reliance on the trust and
fiduciary activities exception under our definition. In particular,
the OCC's regulations provide that a national bank may act in any
fiduciary capacity in which national banks' competitors may act
under the law of the state where the national bank is located. See
66 FR 34792 (July 2, 2001). In addition to the enumerated fiduciary
capacities, OCC staff has identified escrow agent and personal
investment management (other than in the capacity of an investment
adviser for a fee) as functions they believe should be added to
those a bank may perform in reliance on the exception.
\157\ See, e.g., July 17, 2001 ABA/ABASA letter; Banking
Agencies letter; PNC letter; and NYCH letter. Commenters suggested
adding to the list of permissible fiduciary capacities certain non-
fiduciary capacities such as escrow agent, commercial paper issuer,
distribution agent, collateral agent, exchange accommodation,
titleholder, and qualified intermediary. To the extent that any of
these capacities do not involve effecting transactions in
securities, a bank would not need to rely on any exception or
exemption to engage in that activity.
\158\ See ABA/ABASA letters; Federated letter; and Wells Fargo
letter.
\159\ See, e.g., ABA/ABASA letters; Compass letter; and
Federated letters.
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We do not propose to identify additional capacities as similar to
those specified in the statute because such capacities, for example the
capacity of IRA custodian, do not involve fiduciary duties similar to
those exercised by banks acting in true fiduciary capacities; nor are
they trustees, which are separately identified in the statute as well
as included within the definition of fiduciary.\160\ In addition, the
Commission understands from discussions with bank representatives that
many of the capacities some commenters suggest should be considered as
``similar to fiduciary capacities'' typically do not involve investing
in securities, but rather involve financial record keeping. While we
recognize that some state laws may use nomenclature different from that
used in the Exchange Act to refer to certain fiduciary capacities,\161\
we do not consider additional capacities that are merely the functional
or economic equivalent of capacities listed in Exchange Act Section
3(a)(4)(D) \162\ to be ``similar'' capacities for purposes of the
definition of ``fiduciary capacity.'' These capacities do not
necessarily involve fiduciary obligations or carry the same legal
obligations as those assumed by the types of fiduciaries identified in
the statute. Banks acting in some of these types of agency capacities,
however, would be able to rely on the general exemption contained in
proposed Exchange Act Rule 776.\163\
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\160\ For example, we would not consider a bank, if effecting
transactions in securities as an IRA custodian which may act in a
capacity that is the functional equivalent of a directed trustee, to
be acting in a capacity that is similar to one of the capacities
listed in Exchange Act Section 3(a)(4)(D). In guidance to trust
examiners, the OCC states, ``Agency service arrangements that do not
involve the exercise of discretion or other similar
responsibilities, such as escrow, safekeeping and custody, may be
performed by a bank under the incidental powers of banking, without
having trust powers.'' OCC, Handbook for Trust Examiners at 9.2600.
\161\ See discussion of ``other similar capacity'' in Exchange
Act Release No. 44291, supra note 13, 66 FR at 27772.
\162\ 15 U.S.C. 78c(a)(4)(D).
\163\ See Section III.F.1 supra.
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In contrast to a bank's ability under banking law to engage in a
wide variety of activities not implicating the broker-dealer
registration requirements, a bank cannot rely on the trust and
fiduciary activities exception to avoid being considered a broker
merely because it is performing any function under state law that is
permitted for a competitor of that national bank. A term does not
necessarily have the same meaning under different statutes enacted for
different purposes.\164\ Moreover, the purpose of the functional
regulation approach taken in the GLBA's bank exceptions from ``broker''
and ``dealer'' was to ensure that broker-dealer functions outside the
scope of certain narrow bank activities specifically identified in the
statute will be performed by registered broker-dealers.
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\164\ Just as the meaning of the term ``security'' under the
securities law does not determine the term's meaning under the
Glass-Steagall Act, the meaning of the terms ``fiduciary capacity''
and ``similar capacity'' under Exchange Act Section 3(a)(4)(D) is
not determined by meanings these terms may have been given by the
OCC's regulations and interpretations for purposes of the federal
banking laws. See Investment Co. Institute v. Conover, 790 F. 2d
925, 933 n.7 (D.C. Cir. 1986) (citing Securities Industry Ass'n v.
Board of Governors of Fed. Reserve Sys., 468 U.S. 137, 175, 104 S.
Ct. 2979, 2999-3000, 82 L. Ed. 2d 107 (1984) (O'Connor, J.,
dissenting) as support for the proposition that the definition of
the term ``security'' under the securities laws should be different
than the definition under the Glass-Steagall Act because ``the
purposes of the banking and securities laws are quite different'')
cert. denied, Investment Co. Inst. v. Clarke, 479 U.S. 939, 107 S.
Ct. 421, 93 L. Ed. 2d 372 (1986).
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We request comment on this approach. We specifically invite comment
on any capacities similar to the fiduciary capacities listed in the
statute in which banks assume fiduciary obligations equivalent to those
assumed by banks acting in the listed capacities.
4. Comments on Definition of ``Investment Adviser if the Bank Receives
a Fee for its Investment Advice'' and Proposed Amendments
Exchange Act Section 3(a)(4)(D) defines the term ``fiduciary
capacity'' to include acting as an ``investment adviser if the bank
receives a fee for its investment advice.'' \165\ The Interim Rules
defined ``investment adviser if the bank receives a fee for its
investment advice'' to mean that a bank investment adviser provides, in
return for a fee, continuous and regular investment advice to a
customer's account that is based upon the individual needs of the
customer, and that under state law, federal law, contract, or customer
agreement, the bank owes the customer a duty of loyalty, including an
affirmative duty to make full and fair
[[Page 39702]]
disclosure to the customer of all material facts relating to conflicts
of interest.\166\
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\165\ See 15 U.S.C. 78c(a)(4)(D).
\166\ See current Exchange Act Rule 3b-17(d).
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We received multiple comments on the definition of ``investment
adviser if the bank receives a fee for its investment advice.'' \167\
One commenter stated that this definition is appropriate because it is
consistent with current law regarding investment advisers.\168\ Another
stated that the ``continuous and regular'' requirement is consistent
with its understanding of how such activities are performed by bank
trust departments.\169\ This commenter suggested that the Commission
provide banks with a safe harbor if they review customers' accounts at
least annually.\170\ In addition, this commenter also urged the
Commission to take the position that periodic rebalancing of asset
allocation models by banks would be viewed as providing ``continuous
and regular'' investment advice.\171\
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\167\ See, e.g., ABA/ABASA letters; Banking Agencies letter;
Frost letter; Harris Trust letter; NASAA letter; Regions letter;
Roundtable letter; TIAA-CREF letter; UMB Bank letter; and Wilmer,
Cutler letter.
\168\ See NASAA letter.
\169\ See Federated letters.
\170\ Id.
\171\ Id.
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In contrast, several commenters viewed the definition as contrary
to their understanding of the statute, inconsistent with their
interpretation of congressional intent, or too restrictive.\172\ One
commenter stated that some customers may only want or need a one-time
portfolio review.\173\ Another commenter indicated that a ``continuous
and regular'' requirement could create undesirable pressure on banks to
recommend inappropriately frequent transactions in a customer's
investment account.\174\ One commenter expressed the view that banks
should be able to provide advice that is based principally on market
events.\175\
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\172\ See ABA/ABASA letters; ABA Banking Law Committee letter;
ACB letter; Banking Agencies letter; Bank One letter; BSA letter;
Fleet letter; Frost National letter; Harris Trust letter; ICBA
letter; IIB letter; KeyBank letter; Mellon letter; NationalCity
letter; NYCH letter; Regions letter; Roundtable letter; TIAA-CREF
letter; UMB Bank letter; Wells Fargo letter; and Wilmer, Cutler
letter.
\173\ See ICBA letter.
\174\ See Federated letters. We note, however, that the Interim
Rules do not require banks relying on this exception to provide
continuous and regular advice to trade.
\175\ See Wilmer, Cutler letter.
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Three commenters urged the Commission to eliminate the condition
that a bank must have a duty of loyalty to its customer.\176\ The
Banking Agencies expressed a similar opinion.\177\ In their view, a
duty of loyalty may arise as a consequence of a bank or other person
acting as an investment adviser, but is not a precondition to acting as
an investment adviser.\178\ While the Banking Agencies agreed that
banks providing investment advice for a fee have fiduciary obligations
to their customers, including the duty to disclose potential conflicts
of interests, they asserted that the bank regulation and examination
process provides the most appropriate method for ensuring banks'
compliance with these important duties.\179\ Another commenter stated
that a duty of loyalty is not determinative of whether an entity or an
individual is functioning as an investment adviser.\180\ This commenter
indicated that the duty of loyalty is derived from bank regulation,
ERISA, federal tax law, state statutes, common law, and case law.\181\
Other commenters remarked that there is no need to place another duty
of loyalty on banks under the federal securities laws.\182\ Another
commenter stated that because disclosure of material facts relating to
fiduciary conflicts of interest is an area that has historically been
regulated by state fiduciary laws, it would not be appropriate for the
Commission to scrutinize the fiduciary disclosure obligations of
banks.\183\
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\176\ See ACB letter and Regions letter.
\177\ See Banking Agencies letter.
\178\ Id.
\179\ Id.
\180\ See ABA/ABASA letters.
\181\ Id. National banks, however, are not subject to uniform
disclosure obligations with respect to their material conflicts. The
source of fiduciary law governing national banks' fiduciary
relationships may include federal law, state laws, the terms of the
instrument governing a fiduciary relationship, and any court order
pertaining to the relationship. See OCC, Fiduciary Activities of
National Banks, 61 FR 68543, 68544 (Dec. 30, 1996).
\182\ See ABA/ABASA letters; ABA Banking Law Committee letter;
and NYCH letter.
\183\ See TIAA-CREF letter.
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While it appears that most banks conduct continuous and regular
reviews of the accounts of customers to whom they provide investment
advice for a fee, we understand that they may not necessarily
communicate with each customer on a continuous and regular basis.
Accordingly, we propose to revise the definition of ``acting as an
investment adviser if the bank receives a fee for the investment
advice'' to eliminate the implication that a bank must communicate
continuously and regularly with customers.\184\ The revised definition
would omit the phrase ``continuous and regular.'' Instead, the amended
definition would provide that to rely on the exception a bank must have
an ongoing responsibility to review, select, or recommend specific
securities for its customers.\185\
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\184\ See proposed Exchange Act Rule 724(d).
\185\ This interpretation is consistent with the view expressed
by staff of the Banking Agencies, who indicated that a bank may not
fairly be considered to be acting as an ``investment adviser if the
bank receives a fee for its investment advice'' unless the bank
provides investment advice based on the particular needs of a
customer and the bank's advice or recommendations to the customer
concern the purchase or sale of specific securities. See appendix to
the Banking Agencies letter at 14 (citing 12 CFR 9.101(a), and 12
CFR 9.101(b)(2)(i) (``[a] bank does not provide `investment advice'
merely by providing market information to customers in general.'')).
Similarly, instructions to the Commission's Form ADV Uniform
Application for Investment Adviser Registration explain that an
investment adviser without discretionary authority over an account
provides continuous and regular supervisory or management services
with respect to the account if the adviser has ``ongoing
responsibility to select or make recommendations, based upon the
needs of the client, as to specific securities or other investments
the account may purchase or sell and, if such recommendations are
accepted by the client, [the adviser is] responsible for arranging
or effecting the purchase or sale.'' See Form ADV: Instructions for
Part 1A, at 4 (available at http://www.sec.gov/about/forms/formadv.pdf
) (emphasis added).
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The proposed amendment recognizes that a bank's advice must relate
to specific securities or other investments the customer may purchase
or sell, and is intended to ensure that the securities transactions the
bank effects in an investment advisory capacity are effected subject to
the bank's fiduciary obligations that attach when it is acting as an
investment adviser for a fee.\186\ Under the amended definition, a bank
would be able to rely on the trust and fiduciary activities exception
to continue to effect transactions for advisory customers such as
mutual fund wrap account customers, provided the investment advice the
bank provides to its wrap account customers includes the review,
selection or recommendation of specific securities, and the
transactions result from customers acting on the bank's advice. A bank
providing only general asset allocation advice not relating to specific
securities, however, could not rely on the exception to effect
transactions resulting from that advice.
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\186\ See proposed Exchange Act Rule 724(d). This proposal is
consistent with the definition in the Interim Rules. See Exchange
Act Rule 3b-17(d).
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The amended definition would also retain the concept that a bank
acting as an investment adviser for a fee has a duty of loyalty to the
customer and must make full and fair disclosure of all conflicts. This
duty, in part, differentiates a bank acting as an investment adviser
from one acting as a broker.\187\ As we recently explained, an
[[Page 39703]]
investment adviser must act for the benefit of its clients and not use
its clients' assets for its own benefit.\188\ This duty of loyalty is
implicit in the role of an investment adviser.\189\
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\187\ As explained by the Supreme Court in 1963 in SEC v.
Capital Gains Research Bureau, Inc.,
Nor is it necessary in a suit against a fiduciary, which
Congress recognized the investment adviser to be, to establish all
the elements required in a suit against a party to an arm's-length
transaction. Courts have imposed on a fiduciary an affirmative duty
of ``utmost good faith, and full and fair disclosure of all material
facts,'' as well as an affirmative obligation ``to employ reasonable
care to avoid misleading'' his clients.
SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194
(1963) (footnotes omitted) (citing Prosser, Law of Torts (1955),
534-535; Keeton, Fraud--Concealment and Non-Disclosure, 15 Texas L.
Rev. 1 (1936); 1 Harper and James, The Law of Torts 541 (1956)). In
contrast, although a broker may have disclosure obligations with
respect to matters entrusted to it by a client with whom it has a
relationship of trust and confidence, absent such a relationship
``there `is no general fiduciary duty inherent in an ordinary
broker/customer relationship.' '' See United States v. Szur, 289
F.3d 200 (2d Cir. 2002) (quoting Independent Order of Foresters v.
Donaldson, Lufkin & Jenrette, Inc., 157 F.3d 933, 940 (2d Cir.
1998)).
\188\ See In re Alliance Capital Management, L.P., Investment
Advisers Act Release No. 2205, Order Instituting Administrative and
Cease-and-Desist Proceedings Pursuant to Sections 203(e) and 203(k)
of the Investment Advisers Act of 1940 and Sections 9(b) and 9(f) of
the Investment Company Act, Making Findings, and Imposing Remedial
Sanctions and a Cease-and-Desist Order (Dec. 18, 2003), available at
http://www.sec.gov/litigation/admin/ia-2205.htm (adviser's
activities permitting inappropriate market timing were found to have
constituted breaches of the investment adviser's fiduciary duty).
\189\ See Investment Advisers Act Release No. 2209, Investment
Company Act Release No. 26337, Investment Adviser Codes of Ethics
(Jan. 20, 2004), 69 FR 4039, 4040 (Jan. 27, 2004) (proposing new
rule and related rule amendments under the Investment Advisers Act
of 1940 (``Investment Advisers Act'') that would require registered
advisers to adopt codes of ethics, and citing Capital Gains Research
Bureau at 375 U.S. 181, 181-82 for the proposition that ``[a]dvisers
are fiduciaries that owe their clients a duty of undivided
loyalty.'').
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We propose to clarify that the trust and fiduciary activities
exception is available to a bank providing investment advice for a fee
only if the bank does so in a fiduciary capacity in which the bank owes
its advisory customer a duty of loyalty. In other words, a bank may
only rely on the exception if it takes on fiduciary obligations,
including obligations to disclose conflicts of interest and other
material facts. This duty of loyalty requirement is inherent in the
fiduciary obligations of a bank that is in a position to rely on the
exception based on the bank's acting in an investment advisory
capacity--which include a duty of loyalty to the customer for whom the
bank is effecting securities transactions under the exception. Because
this duty is implicit in the role of an investment adviser, the amended
definition would not specify any particular source of such a duty, such
as contract or state law.\190\ We request comment on the proposed
amendments to the definition of ``investment adviser if the bank
receives a fee for its investment advice.'' We are particularly
interested in receiving information about activities commenters believe
the proposed definition would, but, in the commenter's view, should
not, preclude. We also would appreciate descriptions of any fiduciary
obligations that banks acting in such capacities owe their customers.
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\190\ The duty is not established by the definition, but rather
an element of the relationship between an investment adviser and its
fee-paying client that must exist if the bank is to satisfy the
definition of ``fiduciary capacity'' on that basis--that is, it is
acting as an investment adviser for a fee.
Of course, a fiduciary has a duty to disclose fully all material
conflicts of interest. For guidance on the fiduciary disclosure
obligations that characterize the status of a bank acting as an
investment adviser for a fee, a bank seeking to rely on the
exception may look to the disclosure obligations applicable to an
investment adviser under the Investment Advisers Act. See 15 U.S.C.
80b et seq. See also Rule 204-3 under the Investment Advisers Act
and Form ADV, Part II.
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5. Comments on ``Other Department That Is Regularly Examined by Bank
Examiners for Compliance With Fiduciary Principles and Standards''
Exchange Act Section 3(a)(4)(B)(ii) requires a bank to effect
transactions in a trustee or fiduciary capacity in a trust department
or other department that is ``regularly examined by bank examiners for
compliance with fiduciary principles and standards.'' In adopting the
Interim Rules, we explained that this statutory requirement means that
``all aspects'' of effecting securities transactions in compliance with
the trust and fiduciary activities exception must be conducted in the
part of a bank that is regularly examined by bank examiners for
compliance with fiduciary principles and standards.\191\ Moreover, at
that time we clarified that effecting transactions in securities
includes more than just executing trades or forwarding securities
orders to a broker-dealer for execution.\192\
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\191\ See Exchange Act Release No. 44291, supra note 13, 66 FR
at 27772.
\192\ Id. at 27772-73.
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Some commenters expressed the view that requiring ``all aspects''
of securities transactions conducted by a bank for its trust and
fiduciary customers to be conducted in a part of the bank regularly
examined by bank examiners for compliance with fiduciary principles and
standards is overly broad and could unduly restrict new business and
cross-selling efforts.\193\ Other commenters noted that banks
conducting fiduciary activities often delegate securities processing
and settlement activities for cost or operational efficiencies to
either a separate department, an affiliate or a third-party service
provider, and that those entities may not be regularly examined for
compliance with fiduciary principles and standards.\194\ Some banks and
bank trade groups also explained that banks may use the trading desk of
a registered investment adviser to process trades in fiduciary activity
accounts, or bank fiduciaries may find it more economical to outsource
certain trust back office functions.\195\ One commenter maintained that
the examination requirement set forth in the Interim Rules would
require banks to set up parallel back offices and other facilities
solely for the purpose of relying on the trust and fiduciary activities
exception and asked the Commission to clarify that this requirement
would only apply to the part of the bank managing fiduciary activity
accounts.\196\ Another commenter stated that because certain activities
are not typically examined for compliance with fiduciary standards and
principles, the Interim Rules' interpretation would constrain a bank's
normal business operations.\197\ One commenter noted that small banks
often conduct trust activities outside of their trust departments and
urged us to clarify that it is the activity that qualifies for the
exception, and not where the activity is conducted.\198\
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\193\ See, e.g., UMB Bank letter.
\194\ See, e.g., Bank Agencies letter; letter dated July 17,
2001, from Maureen W. Sullivan, Associate General Counsel,
Manufacturers and Traders Trust Company (``M&T letter''); IIB
letter; Bankers Trust (Iowa) letter; and Harris Bank letter.
\195\ See, e.g., ABA/ABASA letters; KeyBank letter; and M&T
letter.
\196\ See NYCH letter.
\197\ See Harris Bank letter.
\198\ See ICBA letter.
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In light of these comments, we propose to recast the examination
requirement to more closely correlate with how bank trust and fiduciary
activities are currently examined. We propose to interpret this
requirement to mean that ``all aspects'' of effecting securities
transactions in compliance with the trust and fiduciary activities
exception must be regularly examined by bank examiners for compliance
with fiduciary principles and standards. In other words, we would view
this requirement to mean that the activities, rather than the
department in which they are conducted, would need to be regularly
examined. For example, a bank could meet the terms of the exception if
bank examiners regularly examined a trading desk located outside of the
trust department for compliance with fiduciary principles and standards
in executing the trades for the bank's trust and fiduciary customers.
Similarly, advertising for the trust department activities could be
examined without
[[Page 39704]]
reviewing the other advertising of the bank. As noted in the Interim
Rules, we rely primarily on the Banking Agencies to ensure that banks
meet the examination requirements of this condition.\199\
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\199\ See Exchange Act Release No. 44291, supra note 13, 66 FR
at 27772. We note the use by the federal financial institutions'
regulators of the Uniform Interagency Trust Rating System in
evaluating financial institutions' fiduciary activities. In 2000,
there were 2,886 banks and trust companies (both insured and
uninsured) that were subject to reporting requirements of the
Federal Financial Institutions Examinations Council regarding their
trust assets. See http://www2.fdic.gov/structur/trust/00trustdata.asp.
Any institution that intends to rely on a bank
exception from broker-dealer regulation must determine whether it
falls within the definition of ``bank'' in Exchange Act Section
3(a)(6).
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This interpretation does not extend to bank affiliates and third-
party service providers that carry out brokerage activities. Bank
affiliates and third-party service providers cannot rely on any bank
exception from registration, unless these affiliates and third-party
service providers are themselves banks.\200\ This means that if some
aspect of a securities transaction occurs outside of a bank, unless the
securities-related activity in question is located within a registered
broker-dealer,\201\ the bank would be unable to rely upon the trust and
fiduciary activities exception for that transaction. Moreover, an
affiliate participating in key points of securities transactions would
be required to register as a broker-dealer, absent an exemption or no-
action relief.
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\200\ See also Division of Market Regulation, Staff Compliance
Guide to Banks on Dealer Statutory Exceptions and Rules (Sept.
2003), which clarified the exceptions found in the GLBA and that the
additional exemptions granted by the Commission apply only to bank
activities. Available at http://www.sec.gov/divisions/marketreg/bankdealerguide.htm
.
``Question 1: May a bank holding company, subsidiary of
a bank, or affiliate of a bank use the bank exceptions in the
Exchange Act?
Answer 1: No. The exceptions in the Exchange Act only
exclude banks' securities activities from broker-dealer regulation,
and then only in certain specified circumstances. Only the bank
itself may claim an exception or exemption. The exceptions and
exemptions are not available to a subsidiary or affiliate of a bank
(unless the subsidiary or affiliate is itself a bank).'' (emphasis
omitted)
\201\ Certain securities related activities may occur in a
registered investment adviser. Trustees routinely turn to registered
investment advisers for professional asset management of a trust's
portfolio. The adviser is hired as an agent, usually pursuant to a
limited power of attorney, and the trustee is able to receive client
disclosure and, when necessary, provide client consent.
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We note that the Banking Agencies distinguish between core and
ancillary bank fiduciary activities.\202\ The Banking Agencies'
analysis and our analysis serve two different purposes.\203\ A bank
intending to qualify for the exception would need to rely on its
banking regulator to ensure that all of its activities that constitute
effecting securities transactions are regularly examined for compliance
with fiduciary principles and standards.
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\202\ Activities that are considered to be ancillary to a bank's
or savings association's business include many activities that
constitute key points of a securities transaction, such as
advertising, marketing, or soliciting fiduciary business. See, e.g.,
12 CFR 9.2(k) (OCC) (``Examples of ancillary activities include
advertising, marketing, and soliciting for fiduciary business;
contacting existing or potential customers, answering questions, and
providing information about matters related to their accounts;
acting as liaison between the trust office and the customer (e.g.,
forwarding requests for distribution or changes in investment
objectives, or forwarding forms and funds received from the
customer); inspecting or maintaining custody of fiduciary assets or
holding title to real property.''); See also 12 CFR 550.60 (OTS).
\203\ The Banking Agencies focus on providing guidance to
national banks regarding their multi-state fiduciary activities. For
example, the OCC explains at the Supplementary Information section
of its release on this topic that ``[t]he purpose of the rulemaking
was to provide clarity and certainty for national banks' multi-state
fiduciary activities.'' See 66 FR 34792 (July 2, 2001); See also 67
FR 76293 (Dec. 12, 2002) (OTS) (amending 12 CFR 550.60 to include a
definition of the term ``activities ancillary to your fiduciary
business.'' The amendment codified OTS legal opinions that concluded
that a Federal savings association is not ``located'' in a state for
purposes of Section 5(n) of the Home Owners'' Loan Act when the
association conducts in that state activities that are ancillary to
the association's fiduciary business.).
In contrast, our interpretation is intended to provide guidance
to banks on the requirements necessary to qualify for the trust and
fiduciary activities exception from registering as a broker pursuant
to Section 15 of the Exchange Act.
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The proposed amendments should give banks increased flexibility in
satisfying this statutory requirement, while ensuring that investors
receive all of the protections contemplated by this exception to the
definition of broker. We also expect it to accommodate the needs of the
Banking Agencies in fulfilling their supervisory functions by
permitting them to target their examination resources more precisely.
We solicit comment on the proposed amendments to this interpretation of
the ``other department that is regularly examined by bank examiners for
compliance with fiduciary principles and standards'' requirement of
trust and fiduciary activities exception. Do commenters believe that
this proposed approach would make it easier for banks to comply with
this statutory requirement?
C. Sweep Accounts Exception
In general, any person that induces transactions in securities for
the account of others by selling securities products or services
together with other, non-securities products or services sold by that
person would be a broker required to register with the Commission.\204\
The sweep accounts exception set out in Exchange Act Section
3(a)(4)(B)(v), however, permits a bank to participate in mixed product
arrangements in which the bank offers a mutual fund ``sweep'' service
linked to deposit accounts under certain conditions. Specifically, this
section excepts a bank from the definition of ``broker'' to the extent
it ``effects transactions as part of a program for the investment or
re-investment of deposit funds into any no-load, open-end management
investment company registered under the Investment Company Act that
holds itself out as a money market fund.'' \205\
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\204\ See Exchange Act Release No. 27017, supra note 86, 54 FR
at 30017-18 (explaining, in the context of the broker-dealer
registration requirements as applied to foreign broker-dealers, that
the Commission generally views solicitation requiring broker-dealer
registration ``as including any affirmative effort by a broker or
dealer intended to induce transactional business for the broker-
dealer or its affiliates,'' and stating, ``[s]olicitation includes
efforts to induce a single transaction or to develop an ongoing
securities business relationship.'').
\205\ See Exchange Act Section 3(a)(4)(B)(v).
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To provide guidance to banks seeking to rely on the sweep accounts
exception, the Interim Rules defined the terms ``money market fund''
and ``no-load.'' We propose to retain the definition of ``no-load''
substantially as in the Interim Rules, with a minor adjustment to
recognize that some investment companies offer both load and no-load
shares. We are also proposing to provide a new exemption for banks
effecting transactions for certain customers in money market funds,
including, with certain disclosures, money market funds that would not
qualify as ``no-load'' funds.\206\
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\206\ See proposed Exchange Act Rule 776.
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1. Comments on Definition of ``No-Load'' and Proposed Amendments
Exchange Act Rule 3b-17(f)\207\ provides that an investment company
is ``no-load'' for purposes of the sweep accounts exception if: (1) it
does not have a sales load \208\ or a deferred sales load; and (2) its
total charges against net assets to provide for sales-related expenses
and service fees (including
[[Page 39705]]
12b-1 fees)\209\ do not exceed 0.25 of one percent of average net
assets annually and are disclosed in the mutual fund's prospectus. This
definition is consistent with the way in which the term ``no-load'' is
used under the federal securities laws. In particular, it is consistent
with the NASD's definition of ``no-load'\210\ and the interpretative
position taken by Commission staff,\211\ under which NASD member firms
and others may not describe a fund as being ``no-load,'' or as having
``no sales charge,'' if it is subject to Rule 12b-1 fees exceeding a
minimal amount.
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\207\ 17 CFR 240.3b-17(f).
\208\ For purposes of determining whether a fund is a ``no-
load'' fund, ``sales load'' includes any charges related to the
offering price of a fund, such as contingent deferred sales charges.
See Order Approving Proposed Rule Change Relating to the Limitation
of Asset-Based Sales Charges as Imposed by Investment Companies,
Exchange Act Release No. 30897 (July 13, 1992), 57 FR 30985 n.8
(citing interpretation of definition of ``sales load'' in Section
2(a)(35) of the Investment Company Act [15 U.S.C. 80a-2(a)(35)] in
NASD Notice to Members 89-35, Apr. 1989).
\209\ As we noted in adopting the Interim Rules, 12b-1 fees,
which funds are permitted to impose under Investment Company Act
Rule 12b-1, are asset-based charges whose purpose may be entirely
for the distribution of fund shares. See Exchange Act Release No.
44291, supra note 13, 66 FR at 27775 and 27779 n.167.
\210\ See NASD Rule 2830(d)(4).
\211\ See letter dated August 22, 1994 from Barry P. Barbash,
Director, Division of Investment Management, to Paul Schott Stevens,
General Counsel, Investment Company Institute, regarding use of
``no-load'' terminology (observing that investors ``have a
reasonable expectation that terminology will be used uniformly for
all funds with similar fees,'' and that using a description such as
``no-load'' or ``no sales charge'' in connection with a fund having
a Rule 12b-1 fee or service fee of more than 0.25% of average net
assets per year, ``may be misleading and may constitute a violation
of the antifraud provisions of the federal securities laws,''
whether or not the description is attributable to an NASD member
firm).
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We received numerous comments on the definition of ``no-
load.''\212\ One commenter expressed the view that defining the term to
be consistent with the NASD definition of ``no-load'' was a ``logical
and appropriate'' approach.\213\ Most commenters asserted that the term
should be interpreted to mean only that a fund is not subject to front-
end or back-end sales charges. In their view, this approach would be
consistent with Congressional intent.\214\ Some claimed that the
definition of ``no-load'' in the Interim Rules would require revisions
to banks'' existing sweeps programs that would involve significant
administrative expense for banks, as well as inconvenience for bank
customers.\215\
Commission staff consulted with banks and bank representatives to
gather more information about sweep account practices. Industry groups
confirmed that mutual fund transactions in sweep programs are effected
regularly, typically on a daily or overnight basis.\216\ One group
indicated that banks often charge account-level fees for sweep
services, typically on a monthly basis.\217\ In addition to possibly
receiving Rule 12b-1 fees that exceed 25 basis points, this group
indicated that banks might directly charge customers ``rate spread
fees''\218\ as well as direct servicing fees.
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\212\ See, e.g.,, ABA/ABASA letters; Bank of America letter;
Bank One letter; Banking Agencies letter; BONY letter; Compass
letter; Fleet letter; Frost letter; Harris Trust letter; KeyBank
letter; Mellon letter; NASAA letter; National City letter; NYCH
letter; PNC letter; Regions letter; Roundtable letter; Shaw Pittman
letter; Texas Bankers Trust Division letter; and Wells Fargo letter.
\213\ See NASAA letter.
\214\ See, e.g., ABA/ABASA letters; Compass letter; and NYCH
letter.
\215\ See, e.g., Banking Agencies letter; PNC letter; and
Regions letter.
\216\ See Letter dated January 22, 2004 from America's Community
Bankers, the American Bankers Association, the Bank Insurance and
Securities Association, the Financial Services Roundtable, the
Independent Community Bankers of America, the Institute of
International Bankers, and the New York Clearing House Association
(``ACB/ABA letter''). The letter does not comment on the definition
of ``no-load'' in the Interim Rules.
\217\ See ACB/ABA letter.
\218\ We understand a rate spread fee to be the difference
between the return that the money market fund pays the bank's
customer whose deposit funds are swept into the fund and the fee the
bank charges the customer for the sweep service.
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We understand that banks generally offer sweep account services to
customers seeking higher interest rates than the rates that banks pay
on deposits. The most common types of sweep account fee structures
appear to involve a minimum balance requirement, and some banks also
charge a monthly fee of between $25 and $100. Banks also receive Rule
12b-1 fees from funds into which deposit balances are swept, which we
understand range from 25 to 55 basis points.\219\
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\219\ In addition, some banks may retain a portion of the yield
on a money market account, but this does not appear to be a common
practice. In the rare cases in which a bank and its customer agree
that the bank will retain a portion of the yield from a fund in a
sweep arrangement, it appears that the retained yield would likely
be between 25 and 50 basis points. For example, the bank might
reduce a 2 percent yield on a fund to 1.5 percent and keep the 0.5
percent difference. This type of fee appears to be the same as the
``rate spread fee'' discussed above.
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After considering comments, we continue to believe that ``no-load''
as used in the statute should be given its customary meaning under the
securities laws. We believe customers have come to rely on this term
no-load as denoting not more than minimal Rule 12b-1 fees and no front-
end or deferred sales charge. Thus, consistent with common industry and
investor understanding, Commission staff guidance, and NASD rules, a
bank may not use the sweep accounts exception, which covers only
transactions in no-load money market fund securities, to effect
transactions in securities that are subject to more than 25 basis
points in charges against net assets for distribution. Although
payments by investment companies of asset-based fees to distributors of
their securities create conflicts of interest for the distributors, the
sweep accounts exception mitigates these conflicts by restricting the
funds eligible to be used under the exception to no-load money market
funds that are subject to only certain types of minimal distribution
fees. In addition, limiting the type of funds that may be used in sweep
arrangements offered under the exception to no-load money market funds
regulated under Rule 2a-7 under the Investment Company Act \220\ limits
the risks to investors. The customary emphasis of such funds on
maintaining a constant net asset value, the absence of a sales load,
and the minimal distribution fees that funds could pay to their bank
distributors under the Interim Rules are also important conditions of
the exception that could reduce the risks to investors who choose to
invest in mutual funds through sweep accounts without using a broker.
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\220\ 17 CFR 270.2a-7.
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Allowing banks that rely on the sweep accounts exception to use
mutual fund shares subject to asset-based sales fees exceeding a level
that sweep account holders might expect to pay for a ``no-load'' fund
would effectively strike the term ``no-load'' from the exception.
Indeed, interpreting the term to mean only that a fund does not charge
a front-end or deferred sales load could mislead investors, who would
end up with accounts paying distribution fees they reasonably did not
expect to pay. As understood by the investing public and the securities
industry when the GLBA was being drafted and after it was enacted, the
term ``no-load'' meant having Rule 12b-1 fees of not more than 25 basis
points.\221\
We considered the comment that the definition of ``no-load'' in
Exchange Act Rule 3b-17 would create significant administrative
expenses for banks and
[[Page 39706]]
inconvenience bank customers. We understand that the conditions of the
statutory exception may require banks to modify some sweep arrangements
involving funds that impose more than minimal charges against fund
assets. In particular, some banks that wish to rely on the exception
may need to begin charging customers directly for sweep services if
they wish to continue receiving fees for the services equivalent to
what they currently may receive from funds in the form of sales loads,
deferred sales loads, Rule 12b-1 fees, and shareholder service fees. As
we explained in adopting the Interim Rules, banks are not prohibited by
the statute's ``no-load'' condition or our interpretation of it from
directly charging their customers for sweep services, because those
direct charges would not be charges against fund assets.\222\ While
some banks may need to restructure some of their sweep arrangements to
comply with the statute's ``no-load'' condition, and such restructuring
may entail some expense to banks or inconvenience to bank customers,
these considerations do not justify changing our interpretation of
``no-load'' in ways that could subject bank customers to unexpected
fees. Identifying funds that meet the definition of ``no-load'' should
not be burdensome because the Commission's definition is the industry
standard.\223\
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\221\ For example, the Glossary of Mutual Fund Terms in the 1997
edition of the Investment Company Institute's publication A Guide to
Understanding Mutual Funds defines a ``no-load fund'' as, ``[a]
mutual fund whose shares are sold at net asset value,'' and the
1998, 2000 and 2002 editions of the same publication define a ``no-
load fund'' as, ``[a] mutual fund whose shares are sold without a
sales commission and without a 12b-1 fee of more than .25 percent
per year.'' A banking trade group also communicated this commonly
understood meaning of the term to Congress as it considered the bill
that became the Gramm-Leach-Bliley Act. See The Financial Services
Modernization Act of 1999: Hearings on H.R. 10 Before the House
Comm. on Banking and Fin. Services, 106th Cong., 1st Sess. 354
(1999) (``Statement for the Record of the ABA Securities Association
(``ABASA'')'' citing NASD Rule 2830 as support for the statement,
``Mutual funds that assess service fees that do not exceed .25 of 1%
of average net assets per annum are generally understood to be no-
load.'').
\222\ Therefore, direct charges by banks of sweep fees would not
affect the fund's status as a ``no-load'' fund. See Exchange Act
Release No. 44291, supra note 13, 66 FR at 27779.
\223\ As we explained in adopting the Interim Rules, a bank
could satisfy its obligation to assure that any money market fund
included in the bank's sweep program is in fact a no-load fund by
using only money market funds that hold themselves out as no-load
funds or by obtaining written confirmation from the money market
fund that it is a no-load fund before including the fund in its
sweep program. See Exchange Act Release No. 44291, supra note 13, 66
FR at 27779 n.169.
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Some commenters indicated that our definition of ``no-load'' should
be changed because limitations on asset-based sales charges might cause
some banks to increase their account fees to offset losses of fees from
money market funds or cause them to stop offering sweep accounts. If a
bank can only offer sweep services by charging its customers additional
fees above the built-in fees of true no-load funds, however, we believe
investors should understand that and make their investment decisions
accordingly.\224\ Fees charged directly to the account of a sweep
account customer would permit the customer to evaluate the worth of the
sweep services provided by the bank.
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\224\ As mentioned above, according to the ACB/ABA letter, banks
often charge their sweep customers monthly, account-level fees.
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Moreover, banks offering sweep account services have incentives
other than earning fees to sweep balances out of deposit accounts.
Notably, sweeping allows banks to reduce the amount of assets they are
required to hold in vault cash or Federal Reserve accounts, neither of
which earns interest. Sweep accounts, therefore, inherently allow banks
to use more of their assets to generate income.\225\ They also provide
a means by which a bank may direct investments into proprietary funds
from which the bank or an affiliate of the bank may receive advisory
fees and other revenue.
---------------------------------------------------------------------------
\225\ See Paul Bennett and Stavros Peristiani, Are U.S. Reserve
Requirements Still Binding?, 8 Economic Policy Review of the Federal
Reserve Bank of New York 53 (May 2002) (available at http://www.ny.frb.org/research/epr/02v08n1/0205benn.pdf
); Remarks of
Treasury Under Secretary Gary Gensler Before the House Banking and
Financial Services Committee, May 3, 2000 (available at http://www.ustreas.gov/press/releases/ls600.htm
).
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One mutual fund company \226\ suggested amending the definition to
reflect the fact that different classes or series of shares issued by a
particular fund may be subject to different distribution-related
charges. This commenter noted that many investment companies offer
multiple classes or series of shares, and some, but not others, may be
subject to sales loads or deferred sales loads. In response to this
comment, we propose to amend the definition of ``no-load'' to refer to
loads applicable to a class or series of investment company security,
rather than to the securities of an investment company in general.\227\
We request comment on the proposed amendment to the definition of ``no-
load,'' and specifically on the provision that ``no-load'' means not
subject to Rule 12b-1 fees and certain other charges of more than 25
basis points. We also invite comment on whether rate spread or retained
yield fees should be counted as sales charges in determining whether
money market funds in a sweep account program involving such fees
should be considered ``no-load'' for purposes of the exception.
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\226\ See letter dated October 2, 2002 from Steve Keen, General
Counsel, Federated Investors, Inc.
\227\ See proposed Exchange Act Rule 740(c).
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2. Interpretation of ``Program''
Counsel for banks and investment companies asked the Commission
staff whether the sweep accounts exception would permit a bank to sweep
deposit balances into mutual funds less frequently than daily. They
also asked whether a bank could rely on the exception to effect sweep
transactions only at the direction of a customer rather than
automatically. In addition, one commenter asked the Commission staff
whether the exception would permit a bank to effect money market mutual
fund transactions for a customer of another bank.\228\
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\228\ See Federated letters.
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In light of the legislative history, we do not believe that the
sweep accounts exception permits other than regular, automatic
sweeps.\229\ Moreover, we do not believe, and there is nothing in the
legislative history to suggest, that this exception permits a bank to
effect money market mutual fund transactions for another bank using
deposits held at the other bank. Therefore, to limit potential
confusion, we are clarifying that the term ``program'' in Exchange Act
Section 3(a)(4)(B)(v)\230\ refers to arrangements for the automatic
transfer of funds on a regular basis. We also interpret the term
``program'' as referring to a bank's investment and reinvestment of
deposit balances held at the bank by the bank's own customers. We
request comment on our interpretation of the term ``program,'' and on
whether the term should be defined by a rule.
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\229\ Legislative history suggests the scope of the sweep
accounts exception could be limited to overnight sweeps. See H.R.
Rep. No. 106-74, pt. 3, at 167 (1999) (``Section 201 [of the GLBA]
contains a limited exception for banks that `sweep' depositors`
funds on an overnight basis into a no-load money market account. The
exception has the effect of permitting banks to continue investing
depositors' funds from depository accounts into no-load money market
accounts.'') (emphasis added). However, we interpret the term
``program'' to include programs that involve regular, automatic
sweeps of deposit balances meeting preset levels, even if the
transactions are effected on a periodic basis less frequently than
daily.
\230\ 15 U.S.C. 78c(a)(4)(B)(v).
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3. Definition of ``Money Market Fund''
The Interim Rules defined the term ``money market fund'' as an
open-end management investment company registered and regulated as a
money market fund pursuant to Rule 2a-7 under the Investment Company
Act.\231\ We did not receive any comments on this definition, and we
propose to leave it unchanged.\232\ We request comment on whether the
definition should remain unchanged.
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\231\ 17 CFR 270.2a-7.
\232\ See proposed Exchange Act Rule 740(b).
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D. 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
affiliate of the bank.''\233\
[[Page 39707]]
The affiliate transactions exception applies to a bank effecting trades
for the accounts of its affiliates, other than those affiliates that
are registered broker-dealers or engaged in merchant banking.
Affiliates, including operating subsidiaries and other subsidiaries of
the bank, may not use the bank exceptions and exemptions from the
definitions of broker and dealer. While none of the Interim Rules
addressed the affiliate transactions exception, in the release adopting
the Interim Rules, the Commission interpreted the exception as not
covering a bank effecting trades with non-affiliated customers, even
when the customer transaction also is effected as part of a trade
involving an affiliate.\234\
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\233\ 15 U.S.C. 78c(a)(4)(B)(vi). Bank Holding Company Act
Section 2(k) [12 U.S.C. 1841(k)] defines affiliate to mean ``any
company that controls, is controlled by or that is under common
control with another company.''
\234\ See Exchange Act Release No. 44291, supra note 13, 66 FR
at 27783.
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We received two comments relating to the Commission's
interpretation of this exception.\235\ One of these commenters stated
that the Commission's interpretation, if construed literally, would
effectively negate the statutory exception by prohibiting a bank from
completing a brokerage transaction with non-affiliated customers under
the affiliate transactions exception.\236\ The other commenter said
that this exception should cover transactions with non-affiliates if
one of the parties to the transaction is an affiliate of the bank.\237\
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\235\ See Banking Agencies letter and ICBA letter.
\236\ See Banking Agencies letter.
\237\ See ICBA letter.
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Under the interpretation of the exception that these commenters
have proffered, a bank could avoid broker-dealer registration for a
securities brokerage transaction if an affiliate is involved in the
transaction. The Commission believes that this interpretation is
contrary to the plain meaning of the GLBA. As a result, we are
proposing to clarify the Commission's interpretation of this exception
by defining the term ``effects transactions for the account of any
affiliate.''\238\ Under this proposed definition, the affiliate must be
acting as a principal or as a trustee or fiduciary purchasing or
selling securities for investment purposes.\239\ Moreover, the
affiliate may not act as a riskless principal for another person, as a
registered broker-dealer, or be engaged in merchant banking.\240\
Finally, the bank would be required to obtain the securities to
complete the subject transaction from a registered broker-dealer, from
a person acting in that capacity that is not required to register, or
pursuant to another exception or exemption from Exchange Act Section
3(a)(4)(B).
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\238\ See proposed Exchange Act Rule 750.
\239\ The securities laws and rules, however, distinguish
``dealers'' (which buy and sell securities as part of a regular
business) from ``traders'' (which buy and sell securities for
investment and not as part of a regualr business). For additional
information on distinguishing ``dealers'' from ``traders,'' see
Exchange Act Release Nos. 46745 (Oct. 31, 2002), 67 FR 67496, 67498
(Nov. 5, 2002) and 47364, (Feb. 14, 2003), 68 FR 8686, 8688 (Feb.
24, 2003).
\240\ The affiliate may not be a registered broker-dealer or be
engaged in merchange banking because the statute contains these
conditions. Exchange Act Section 3(a)(4)(B)(vi). The affiliate may
not act as a riskless principal because that would effectively be
acting for another person who would be a customer of the affilaite.
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We request comment on this proposed definition. In particular,
commenters are invited to discuss whether this definition would enhance
the clarity of the affiliate transactions exception.
E. Safekeeping and Custody Activities Exception
1. Background on Safekeeping and Custody Exception
Exchange Act Section 3(a)(4)(B)(viii) provides an exception from
broker-dealer registration with respect to certain securities-related
safekeeping and custody services that banks may perform for their
customers.\241\ The exception explicitly allows a bank that holds funds
and securities for its customers as part of ``customary banking''
activities to perform specified securities-related functions with
respect to those securities without registering as a broker.\242\ In
particular, a bank may, among other things, exercise warrants or other
rights, facilitate the transfer of funds or securities in connection
with clearing and settling customers' securities transactions, effect
securities lending or borrowing transactions and invest cash collateral
pledged in connection with such transactions, and hold securities
pledged by a customer or facilitate the pledging or transfer of
securities that involve the sale of those securities. In addition, the
exception expressly permits a bank to ``serve as a custodian or
provider of other related administrative services'' to IRAs, pension,
retirement, profit sharing, bonus, thrift savings, incentive, or other
similar benefit plans without being considered a broker. The exception
does not apply, however, to a bank that acts as a carrying broker or
clearing broker in connection with securities transactions (other than
with respect to government securities).\243\
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\241\ 15 U.S.C. 78c(a)(4)(B)(viii).
\242\ In the absence of an exception or exemption, holding
customer funds and securities in connection with securities
transactions typically would require broker registration. See, e.g.,
SEC v. Margolin, [1992 Transfer Binder] Fed. Sec. L. Rep. (CCH) ]
97,025 (S.D.N.Y. 1992) (noting that evidence of brokerage activity
included receiving transaction-based compensation, advertising for
clients, and possessing client funds and securities). See letter re:
Financial Surveys, Inc. (July 30, 1973) (persons in the business of
effecting transactions in securities include persons who hold
customer funds or securities in connection with securities
transactions). See also 15 David A. Lipton, at 1.04[3] (having
custody or control over funds and securities of others is a badge of
being a broker).
\243\ Exchange Act Section 3(a)(4)(B)(viii)(II).
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In the release adopting the Interim Rules, the Commission provided
interpretive guidance with respect to the exception. In particular, the
Commission stated:
``custody'' or ``related administrative services'' do not include
accepting orders from investors to purchase or sell securities. In
particular, we do not believe that by its terms the safekeeping and
custody exception covers a bank that accepts orders from investors
to purchase or sell securities other than those specifically
permitted in the exception, such as with respect to securities
lending and borrowing or investing collateral.\244\
\244\ 66 FR at 27781.
---------------------------------------------------------------------------
To mitigate unnecessary disruptions in banks' existing safekeeping
and custody practices that the GLBA might have caused, the Interim
Rules provided conditional exemptions to permit banks to effect
transactions in securities over which they have custody. In particular,
current Exchange Act Rule 3a4-5 permits all banks to effect
transactions in any security for custody accounts under narrow
conditions.\245\ In addition, current Exchange Act Rule 3a4-4 permits
small banks to effect transactions in mutual funds for tax-deferred
custody accounts.\246\
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\245\ See 17 CFR 240.3a4-5.
\246\ See 17 CFR 240.3a4-4. Both exemptions are subject to
limits on solicitation activities, compensation, and use of bank
employees. The exemptions also require banks to execute the
resulting transactions pursuant to Exchange Act Section 3(a)(4)(C),
which requires banks that accept orders to the extent they engage in
transactions under a specified safekeeping and custody function
either to transmit orders to be executed to a registered broker-
dealer or internally cross those orders.
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We received numerous comments on the safekeeping and custody
exception.\247\ These comments focused
[[Page 39708]]
primarily on the Commission's interpretation with respect to accepting
orders, the general custody exemption, and the small bank custody
exemption.
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\247\ See ABA/ABASA letters; Banking Agencies letter; BONY
letter; Bank One letter; BSA letter; CSBS letter; FirstMerit letter;
FirstUnion letter; Fleet letter; Frost letter; Harris Trust letter;
ICBA letter; KeyBank letter; letter dated August 30, 2001 from D.
Rodman Thomas, Senior Vice President and Senior Trust Officer, The
Ledyard National Bank (``Ledyard letter''); Mellon letter; letter
dated August 29, 2001 from Bill Beyer, President and CEO, Meredith
Village Savings Bank (``Meredith Village Savings Bank''); National
City letter; NYCH letter; PNC letter; Shaw Pittman letter;
Roundtable letter; UMB Bank letter; Wells Fargo letter; State Street
letter; M&T Bank letter; Fulton Street Financial letter; Union Bank
of California letter; ICBA letter; IIB letter; Wilmer, Cutler
letter; Wilmington Trust letter; Regions Financial letter; TIAA-CREF
letter; Virginia Bankers Association letter; and Compass Bank
letter.
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2. Comments on Commission's Interpretation Regarding Accepting Customer
Orders
A number of commenters criticized the Commission's interpretation
that the safekeeping and custody exception generally does not permit
banks to accept their customers' securities orders. These commenters
argued that the interpretation was contrary to the GLBA and its
legislative history.\248\ In particular, they contended that order
taking is a customary banking activity in custody accounts and that in
adopting the GLBA Congress did not intend to disturb such activities. A
few commenters also opined that with respect to retirement and other
benefit plans, the plain meaning of the exception and Congressional
intent should expressly permit a bank to handle orders because the
exception permits banks to engage in ``related administrative
services'' for investors through retirement and benefit plans.\249\
Moreover, two commenters stated that, whether under the trust and
fiduciary exception or the safekeeping and custody exception, Congress
clearly intended to allow banks to continue effecting transactions in
securities for custodial IRAs.\250\ Some commenters also asserted that
the Commission staff has recognized that entities offering a bundle of
custodial and administrative services may accept and process orders for
retirement plans.\251\
---------------------------------------------------------------------------
\248\ See, e.g., ABA Banking Law Committee letter; ABA/ABASA
letters; Banking Agencies letter; Financial Services Roundtable
letter; and IIB letter.
\249\ See, e.g., ABA/ABASA letters; Banking Agencies letter; and
NYCH letter.
\250\ See, e.g., Federated letters and Mellon letter.
\251\ See, e.g., Banking Agencies letter; PNC letter; and TIAA-
CREF letter. Commenters cited Letter re: Universal Pensions, Inc.
(Jan. 30, 1998). Pursuant to that staff no-action letter, a third-
party pension plan administrator acted in a mechanical order-taking
role subject to independent supervision, could not influence the
purchase of securities by plan participants, did not receive
transaction-based compensation related to those purchases, was not
permitted to handle funds or securities, recommend any mutual funds,
or provide any other investment advice. Broker-dealers worked
directly with plan sponsors and advised the sponsors in which mutual
funds to invest. While the administrator could receive and invest
new participant contributions for each plan according to directions
from the plan fiduciary, it could not net or match orders. An
independent trust company independently calculated net orders and
forwarded them along with cash to settle trades. We note that banks
relying on the safekeeping and custody exception could not meet the
terms of the Universal Pensions letter because they handle funds and
securities.
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Although we understand the concerns of the commenters discussed
above, the Commission continues to believe that accepting orders to
purchase or sell securities is a core broker-dealer function and was
not intended to be permitted under the safekeeping and custody
exception.\252\ Therefore, we continue to believe that the combination
of handling funds and securities with order taking, absent a specific
exemption, requires broker-dealer registration. Although the
safekeeping and custody exception generally does not provide for banks
to take orders for securities, the Commission has proposed several
exemptions to allow banks to accept orders from a custody account,
subject to certain conditions.
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\252\ See H.R. Rep. No. 106-74, pt. 3, at 169 (1999) (``This
exception is not intended to allow banks to engage in broader
securities activities.'').
Although the term ``related administrative services'' is not
defined in the securities laws, in the broker-dealer industry,
administrative services generally are considered to be those that
are ``clerical and ministerial.'' Clerical and ministerial
activities include, for example, mechanical tasks such as
bookkeeping and record keeping, performing calculations, and data
processing functions. Accepting general orders to buy and sell
securities, however, is not a ``clerical and ministerial'' activity.
See Exchange Services, Inc. v. S.E.C., 797 F.2d 188, 189-190 (4th
Cir. 1986) (court determined that the Commission was not being
arbitrary and capricious when it relied, as a reason to deny an
exemption, on NASD's policy that anyone taking orders from the
public must register as a broker-dealer).
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3. Comments on and Proposed Amendments to the General Bank Custody
Exemption
Current Exchange Act Rule 3a4-5 provides a limited exemption from
the definition of ``broker'' for banks seeking to operate in the
broader role of order takers for all types of securities while holding
clients' funds or securities. To qualify for the exemption, however, a
bank may not receive any compensation for effecting such transactions.
In addition, the exemption would limit the ways in which banks: (1)
Solicit orders; (2) use their employees to engage in brokerage
activities; and (3) compensate their employees for the sale of
securities.\253\
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\253\ See Exchange Act Rule 3a4-5(a). For example, the rule
restricts banks that wish to rely on the exemption from soliciting
securities transactions except through one of four means specified
in the rule. See Exchange Act Rule 3a4-5(a)(5)(i)-(iv). A bank
relying on the exemption also must comply with the order execution
condition in Exchange Act Section 3(a)(4)(C). See Exchange Act Rule
3(a)(3).
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We received multiple comments regarding the general bank custody
exemption.\254\ One commenter argued that the safekeeping and custody
exception is clear and unequivocal, and therefore an exemptive rule in
this area is unnecessary.\255\ Another explained that taking orders to
execute securities transactions for its custody clients historically
has been an important aspect of its custody business that it provides
as an accommodation and convenience for clients rather than as a
substitute for the brokerage business.\256\
---------------------------------------------------------------------------
\254\ See, e.g., ABA/ABASA letters; Banking Agencies letter;
BONY letter; Bank One letter; BSA letter; CSBS letter; FirstMerit
letter; Fleet letter; Frost letter; Harris Trust letter; ICBA
letter; KeyBank letter; Ledyard letter; Mellon letter; National City
letter; NYCH letter; PNC letter; Shaw Pittman letter; Roundtable
letter; UMB Bank letter; and Wells Fargo letter.
\255\ See IIB letter.
\256\ See BONY letter.
---------------------------------------------------------------------------
Another commenter expressed concerns that a bank may not receive
transaction-based compensation for placing orders for its customers and
still rely on this exemption.\257\ It viewed this condition as
requiring banks to provide certain custodial services at a loss.
---------------------------------------------------------------------------
\257\ See Mellon letter.
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Other commenters indicated that Exchange Act Rule 3a4-5 could be
misinterpreted to prohibit a bank from receiving certain fees that
these commenters believed should be permissible under the exemption
(e.g., settlement fees, securities movement fees, or similar processing
fees that do not depend on whether the bank placed an order for its
customer).\258\
---------------------------------------------------------------------------
\258\ See, e.g., NYCH letter and BONY letter.
---------------------------------------------------------------------------
One commenter urged the Commission to expand the exemption so that
banks may continue to be compensated for effecting securities
transactions in custodial accounts where the compensation consists of
Rule 12b-1 fees, shareholder servicing fees, mutual fund advisory fees,
or other revenue sharing arrangements.\259\
---------------------------------------------------------------------------
\259\ See NYCH letter.
---------------------------------------------------------------------------
Some commenters complained about the solicitation restrictions in
Exchange Act Rule 3a4-5(a)(5), arguing, among other things, that they
would prohibit banks from engaging in advertising activities that are
expressly permitted by the Exchange Act.\260\
---------------------------------------------------------------------------
\260\ See, e.g., Banking Agencies letter and UMB Bank letter.
---------------------------------------------------------------------------
Some commenters stated that banks offering proprietary funds should
not (as the rule requires) be required also to offer competitors' funds
because their operational costs would increase as the number of
investment options offered increased.\261\
---------------------------------------------------------------------------
\261\ See, e.g., BONY letter; Frost letter; Harris Trust letter;
Mellon letter; NYCH letter; PNC letter; and Roundtable letter.
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[[Page 39709]]
Several commenters objected to the employee compensation provisions
in the rule because they believe that banks should be able to reward
their employees for securing new custody business.\262\ Some commenters
asserted that the rule's prohibition on using dually licensed employees
to accept orders is contrary to the Commission's view that registration
provides important investor protections.\263\
---------------------------------------------------------------------------
\262\ See, e.g., ABA/ABASA letters; Harris Trust letter; Mellon
letter; and NYCH letter.
\263\ See, e.g., Fleet letter; BONY letter; Meredith Village
Savings Bank letter; National City letter; NYCH letter; PNC letter;
and Roundtable letter.
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One commenter complained about a provision in the rule requiring
that a bank employee taking customers' securities orders primarily
perform duties for the bank other than effecting transactions in
securities for customers.\264\ This commenter contended that this
provision restricts a bank's ability to staff custody accounts in a
manner that it deems most appropriate without enhancing customer
protection.
---------------------------------------------------------------------------
\264\ See PNC letter referencing Exchange Act Rule 3a4-
5(a)(2)(ii).
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a. Modifications to General Bank Custody Exemption
1. Bank Compensation
In response to comments, and based on the Commission staff's
discussions with representatives of banks, bank trade groups, and staff
of the Banking Agencies, we propose to amend the general custody
exemption to clarify that a bank that accepts orders for securities
could be compensated for effecting a securities transaction for a
person with an existing custody account or for a ``qualified investor''
so long as the compensation that the bank receives for its custody
services (e.g., securities movement fees, annual fees, asset based
fees, and processing fees) does not directly or indirectly vary based
on whether the bank accepts an order to purchase or sell a
security.\265\
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\265\ See proposed Exchange Act Rule 760. The term ``qualified
investor'' is defined in Exchange Act Section 3(a)(54). Banks
advised the Commission that banks provide custody services to a
broad range of institutional customers, including corporations,
endowments, market professionals (such as mutual funds, hedge funds,
and investment advisers), employer pension plans, state, local, and
foreign governmental entities, other not-for-profit organizations,
welfare benefit plans, union plans, Indian Tribal Nations, and
partnerships and limited liability companies. Bank custodians also
act as custodians for individuals, such as private banking clients,
trust clients, or IRA owners. Most of these customers did not use
bank custodians to execute securities transactions.
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Accordingly, the proposed amendment would conditionally permit a
custodian bank to be compensated for the movement of funds and
securities for ``grandfathered'' custody accounts or accounts of
``qualified investors'' when that movement results from the bank's
acceptance of a securities order. We propose to limit this exemption on
a going forward basis to ``qualified investors'' because their custody
accounts have not typically been used extensively for execution
purposes.\266\ Customers that do not already have a custody
relationship, other than ``qualified investors,'' would not obtain
securities (other than securities covered by other exceptions or
exemptions) through their bank custodian. We solicit comment on
limiting this exemption to ``qualified investors'' on a going-forward
basis. In particular, we solicit comment on whether there are other
institutional entities that have custodial, rather than trust accounts,
with banks and that have a special need for banks to take their
securities orders. We request that commenters, particularly those that
are custody customers, set forth the specific reasons why banks would
need to have other entities included within the terms of this
exemption. Please include the special circumstances that apply to these
entities and why these entities do not require the comprehensive
protections of the federal securities laws.
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\266\ See Banking Agencies letter (``Based on our supervisory
experience, banks customarily conduct accommodation trades for
custodial accounts only upon the order of the customer and on an
incidental and infrequent basis.'').
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The proposed amendment articulates more clearly the accommodative
and historical nature of the limited securities business that banks
have customarily performed through their custody departments. The
proposed amendment also would remove limitations in the Interim Final
Rules that prohibited custody department employees from being
compensated for securities-related custody activities, including
gathering assets and moving funds and securities, if the bank accepts
customer orders. While we see no difference between a bank that effects
transactions in securities as a custodian and a broker-dealer,\267\ we
believe an exemption would be appropriate where a bank's sales efforts
and sales incentives are limited. While the proposal would be more
accommodative than the current exemption, it would not permit a bank to
operate as an ``introducing broker'' in the custody department, which
we do not believe would be consistent with Exchange Act investor
protection principles.\268\
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\267\ When brokerage is conducted through a custody account, the
investor protections associated with order entry through a
registered broker-dealer are not available. However, the protections
associated with order execution are available because orders are
forwarded to a registered broker-dealer for execution.
\268\ An ``introducing broker'' arranges securities transactions
for a customer but uses a ``clearing broker'' to execute the
transactions and maintain securities and funds on that customer's
behalf.
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Under the proposal, banks that accept securities orders would not
be permitted to adjust their compensation to reflect the additional
cost of forwarding orders on behalf of customers. These costs could not
be recouped in any other aspect of their customer relationships to
account for the acceptance of customers' orders pursuant to this
exemption.\269\ To give legal certainty to banks regarding the
compensation condition, the proposed amendment would specify 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 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.
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\269\ One bank trade group informed the staff that custody fee
arrangements may reflect other products or services for which the
customer uses the bank. Similarly, to ensure that the whole
relationship with a customer is profitable, clearing brokers do not
necessarily charge uniform fees to securities customers. For
example, clearing firms may charge low custody fees and split
securities lending income with the customer to offset other charges.
In this example, a bank could engage in securities lending pursuant
to the safekeeping and custody exception or the exemption for
securities lending transactions in Exchange Act Rule 15a-11. A
bank's compensation from securities lending transactions involving a
custody customer's securities could not, however, be used to offset
or credit fees for that custody customer's securities transactions
pursuant to this exemption.
A non-exhaustive list of examples of indirect compensation for
order-taking may include:
(1) The bank custody department varies the fees received based
on securities transaction volume;
(2) The bank custody department only charges certain custody
customers for purchasing securities;
(3) The bank varies the order acceptance fee for customers who
purchase another product or service, such as by giving high net
worth bank customers a certain number of free trades annually or by
requiring a custody customer to purchase another product or service
to qualify for a particular custody fee that includes order-taking
services; and
(4) The bank receives payments of sales compensation from other
persons related to the sale of mutual funds to custody customers,
other than payments expressly permitted pursuant to this exemption.
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In addition, we propose to amend the general custody exemption to
permit banks to be compensated for accepting securities orders through
Rule 12b-1 or shareholder servicing fees for accounts that were opened
before the date of this proposing release or for ``qualified
investors.'' While Rule 12b-1 fees create the types of conflicts of
interest that broker-dealer regulation is designed to address, we
propose to grandfather
[[Page 39710]]
existing custody accounts to avoid any unnecessary disruption of this
business.
In keeping with the accommodative nature of banks' custody business
and partially to address the conflicts associated with Rule 12b-1 fees,
we propose to condition the receipt of Rule 12b-1 and shareholder
servicing fees on the bank making 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. This condition
is designed to ensure that investors have a full range of choices
available when they consider whether to pay custody costs directly or
to offset some of these custody costs with Rule 12b-1 fees. By making
different classes of shares available, including classes that do not
pay 12b-1 fees (e.g., institutional class), banks will not effectively
require a customer to pay Rule 12b-1 fees to obtain execution services.
We believe that the additional conditions that we propose, however,
will limit banks to the type of accommodation role that commenters
represent banks act in when effecting transactions in securities as
custodians. We do not propose to amend the exemption to permit banks to
be compensated for accepting securities orders through revenue sharing
arrangements because of the conflicts that these payments create.\270\
We solicit comment on these proposed amendments, including specific
comments on whether we have adequately protected the interests of these
current bank customers through the conditions we propose. We request
comment on whether it is appropriate to grandfather existing custody
customers by allowing banks to take securities orders from these
customers and collect 12b-1 fees from their accounts. We request
comment on whether this proposed exemption creates an unreasonable
level of competitive issues for other banks or broker-dealers that
should be considered by us further. If commenters think that these
customers should have additional investor protections that we have not
provided through these proposed conditions, please tell us what
additional investor protections we should require.
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\270\ The NYCH advised the Commission staff that banks acting as
custodians may enter into revenue sharing arrangements with
investment advisers. As the Commission noted, the development of
fund ``supermarkets'' sponsored by broker-dealers has led to related
arrangements in which a fund or its affiliates compensates broker-
dealers in ways that are not generally disclosed to investors. See
69 FR 6438 at 6443.
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2. Solicitation Restrictions
In general, we propose to tighten the solicitation conditions in
the proposed amendments. Consistent with commenters' assertions that
banks effect transactions purely as an accommodation to their
customers, we propose to remove a provision from the current custody
exemption that permits banks to solicit investors through investment
company advertising and other sales material. We propose to modify the
current custody exemption to permit banks to respond to investor
inquiries by delivering sales literature that is prepared by an
investment company that is not an affiliated person.\271\ We propose to
remove the condition in the current exemption that permits banks to
solicit their existing customers for securities transactions in
connection with solicitation of their other custody activities.
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\271\ See proposed Exchange Act Rule 760(a)(3)(B).
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In response to a request from one commenter to limit the
solicitation condition to custodian accounts,\272\ we propose to
clarify that the solicitation restrictions in the general bank custody
exemption apply only to solicitations of securities transactions
pursuant to the proposed amended exemption covering accounts for which
the bank acts as a custodian. Therefore, a bank could solicit a custody
business, including securities transactions that are permissible under
the safekeeping and custody exception in Exchange Act Section
3(a)(4)(B)(viii) and the stock lending exemption in Exchange Act Rule
15a-11. A bank could not, however, directly or indirectly solicit
securities transactions in reliance on this proposed exemption, except
as permitted pursuant to the terms of this exemption. For example, a
bank making referral payments to another person for the solicitation of
securities transactions for the bank operating pursuant to this
proposed exemption would exceed the solicitation limits in this
proposed exemption.
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\272\ See NYCH letter.
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Banks advised the Commission staff that departments of a bank other
than the custody department may provide lists of recommended
securities, watch lists, research reports, or other publications
highlighting particular securities or groups of securities, and may
provide investment advice. These activities exceed the securities
solicitation limits of Exchange Act Rule 3a4-5 and the proposed
exemption.\273\ Except as expressly permitted, the solicitation
conditions would not permit a bank to solicit through another bank
department securities activities in its custody department. We solicit
comment on each of these proposed changes to the solicitation
restrictions. We specifically invite comment on whether these
restrictions are too lax or too strict. We also invite comment on
whether we should impose any other or different restrictions.
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\273\ As we explained in Exchange Act Release No. 27017, supra
note 86, 54 FR at 30017-18:
[T]he Commission generally views ``solicitation,'' in the
context of broker-dealer regulation, as including any affirmative
effort by a broker or dealer intended to induce transactional
business for the broker-dealer or its affiliates. Solicitation
includes efforts to induce a single transaction or to develop an
ongoing securities business relationship. Conduct deemed to be
solicitation includes telephone calls from a broker-dealer to a
customer encouraging use of the broker-dealer to effect
transactions, as well as advertising one's function as a broker or a
market maker in newspapers or periodicals of general circulation in
the United States or on any radio or television station whose
broadcasting is directed into the United States. Similarly,
conducting investment seminars for U.S. investors, whether or not
the seminars are hosted by a registered U.S. broker-dealer, would
constitute solicitation. A broker-dealer also would solicit
customers by, among other things, recommending the purchase or sale
of particular securities, with the anticipation that the customer
will execute the recommended trade through the broker-dealer.
This release explains that providing research reports may be a
form of solicitation. Providing an asset allocation model to a
custody customer is another example of an affirmative effort to
induce transactional business.
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3. Employee Activities and Compensation
As suggested by commenters, we propose to eliminate a provision in
current Exchange Act Rule 3a4-5(a)(2)(i) that prohibits the use of
dually licensed employees to effect transactions pursuant to the
general custody exemption. We also propose to eliminate the requirement
that a bank employee must primarily perform duties for the bank other
than effecting transactions in securities.\274\ Commenters explained
that eliminating these prohibitions would enhance operational
efficiencies and would allow them to use the most skilled persons for
processing securities transactions.
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\274\ See Exchange Act Rule 3a4-5(a)(2)(ii).
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We also propose to eliminate the restriction in current Exchange
Act Rule 3a4-5 (a)(2)(iii)(B) that custody employees may not receive
incentive compensation for the amount of securities-related assets
gathered or the size or value of any customer's securities account.
This will permit compensation for a custody employee that brings assets
into the bank.
We request comment on the elimination of both of these
restrictions. We invite commenters to tell us if other or more tailored
conditions would be
[[Page 39711]]
more likely to enhance investor protections.
4. Trustee and Fiduciary Activity Accounts
We propose to add a new provision to the general custody exemption
designed to ensure that a bank would use that exemption only for those
custody accounts in which it does not act in a trustee or fiduciary
capacity.\275\ Transactions for trust and fiduciary activity accounts
would need to be effected in compliance with the trust and fiduciary
exception in Exchange Act Section 3(a)(4)(B)(ii). Congress enacted the
conditions that apply to that exception in recognition of certain
fiduciary obligations that banks have to their trust customers. In
contrast, a custody account is created through a contractual
relationship that does not provide the customer with any fiduciary
protections. We solicit comment on the appropriateness of this proposed
new provision of the general custody exemption. We also request comment
on whether activities covered by any other exceptions or exemptions
should be specifically carved out of this custody exemption. We also
invite comment on whether any other restrictions would offer better
protection to investors.
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\275\ See proposed Exchange Act Rule 760(a)(4).
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5. Employee Benefit Plans
In light of the proposed new exemption for banks effecting
transactions for employee benefit plans, we propose to add a new
provision to the general bank custody exemption to clarify that the
custody exemption would not be available for banks to effect
transactions in securities for an employee benefit plan account
described in proposed Rule 770. We invite comment on this proposed
provision and whether any other restrictions should be imposed for the
protection of investors.
6. Small Bank Exemption
In light of the expanded availability of the small bank custody
exemption, we propose to add a new provision to the general custody
exemption that would limit the availability of the general bank custody
exemption to banks that do not simultaneously use the small bank
custody exemption. Banks that qualify for both exemptions could choose
which custody exemption to use. We invite comment on whether it is
appropriate to limit the use of these exemptions in this way.
7. Custody Account Definition
We propose to define an ``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 of income, processing
of corporate actions, pricing securities positions, and providing of
recordkeeping and reporting services.\276\ We based this definition on
our understanding of what custodians do. In addition, to provide legal
certainty to bank custodians accepting orders for IRAs, we specifically
added such accounts to this definition of custody account. We invite
comment on the extent to which custodians provide the services outlined
in the proposed definition and whether there are additional services
that custodians perform that should be included in this definition. We
also invite comment on whether there are any other conditions or
disclosure requirements that we should consider to protect investors.
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\276\ Proposed Exchange Act Rule 762(a).
---------------------------------------------------------------------------
8. Request for Comments
We request comment on these proposed modifications to the general
custody exemption. In responding to this request for comments, please
describe whether this exemption would cover most categories of custody
customers from whom banks accept orders for the purchase or sale of
securities. For bank commenters, with respect to each type of custody
customer, please list: (1) The percentage of any type of order for the
movement of funds or securities that includes an order for the purchase
or sale of a security; (2) the types of securities the bank purchases
or sells for these customers; (3) how the bank offers particular
classes or series of mutual funds to these custody customers; (4) all
of the types of compensation the bank receives in connection with its
custody activities related to different types of custody customers; and
(5) how the bank solicits these custody customers. We solicit comment
regarding whether we should adopt disclosure requirements similar to
the proposed general disclosure requirements in proposed Exchange Act
Rule 776.
We request comment on whether the proposed definition of ``account
for which the bank acts as a custodian'' in Rule 762(a) reflects the
types of services that bank custodians typically provide. If not,
please explain which of these services bank custodians typically
provide. In addition, does the custody definition reflect the services
that banks typically provide for investors who purchase or sell
securities within individual retirement accounts?
9. Carrying Broker Definition
The Exchange Act generally \277\ disqualifies banks that act as
carrying brokers from utilizing the safekeeping and custody exception
and the networking exception.\278\ The applicable statutory condition
defines the term ``carrying broker'' by reference to Exchange Act
Section 15(c)(3) and the rules thereunder.\279\ In adopting the Interim
Rules, the Commission explained:
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\277\ Exchange Act Section 3(a)(4)(B)(viii)(II) does not
prohibit a bank from using the safekeeping and custody exception if
the bank only acts as a carrying broker for government securities.
\278\ Exchange Act Sections 3(a)(4)(B)(i)(VIII) and
3(a)(4)(B)(viii)(II). 15 U.S.C. 78c(a)(4)(B)(i)(VIII) and 15 U.S.C.
78c(a)(4)(B)(viii)(II).
\279\ The legislative history indicates that the GLBA uses the
terms ``carrying broker'' and ``clearing broker'' synonymously. See
H.R. Rep. No. 106-74, pt. 3, at 169 (1999). (``The exception also
will not apply to a bank that acts as a clearing broker in
connection with securities transactions, except if the bank is
acting in the U.S. as a clearing broker with respect to government
securities.''). As the legislative history indicates:
``To ensure that an investor has SIPC protection for the
securities that he or she purchases--protection that applies to the
broker-dealer but not a bank--the broker-dealer that is part of a
networking arrangement must carry the investor's account.'' H.R.
Rep. No. 106-74, pt. 3, at 164.
There is a technical difference between a ``carrying broker''
and a ``clearing broker.'' A carrying firm knows the customer and is
responsible for the underlying customer assets. A customer may clear
elsewhere. As the Commission has explained, an introducing broker-
dealer is one that has a contractual arrangement with another firm,
known as the carrying or clearing firm, under which the carrying
firm agrees to perform certain services for the introducing firm.
Usually, the introducing firm submits its customer accounts and
customer orders to the carrying firm, which executes the orders and
carries the account. The carrying firm's duties include the proper
disposition of the customer funds and securities after trade date,
the custody of customer securities and funds, and the recordkeeping
associated with carrying customer accounts. Exchange Act Release No.
31511 (Nov. 24, 1992), 57 FR 56973, 56978 (Dec. 2, 1992). See also
NASD Rule 3230 regarding clearing arrangements (discussing the
contractual requirements for all ``clearing or carrying agreements
entered into by a member''); NYSE Rule 382 and American Stock
Exchange Rule 400. As noted above, however, Congress used these
terms interchangeably.
A bank acting as a carrying broker facilitates the transfer of
funds and securities associated with the clearance and settlement of
securities and related margin lending on behalf of a broker-dealer
and executes trades for itself and its customers. A carrying broker
relationship is distinguished from a custody relationship by the
fact that the bank is
[[Page 39712]]
selected and its systems are utilized primarily by the broker-dealer
rather than primarily by the customer. In a situation where the
broker-dealer arranges for a substantial majority of its customers
to use bank custody or deposit services of a bank, a carrying broker
relationship may be established particularly if the bank performs
clearance and settlement functions that the broker-dealer cannot
perform economically or efficiently. In contrast, a bank would not
be a carrying broker when it acts as custodian for a customer of a
broker-dealer and responds to customer directions to deliver
securities against payment or cash against receipt of
---------------------------------------------------------------------------
securities.\280\
\280\ Exchange Act Release No. 44291, supra note 13, 66 FR at
27780, n. 174.
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One commenter stated that the distinction between permissible
clearing and settlement functions within the custody and safekeeping
exception and impermissible ``carrying broker'' activities was not
clear.\281\ This commenter expressed concern about a bank's status when
multiple customers may have bank accounts for which the bank provides
investment management and custody services, as well as accounts with
the bank's affiliated broker-dealer for which the bank is a custodian.
In this commenter's view, a bank in this situation may inadvertently
act as a carrying broker merely by having a large number of accounts,
even if the accounts were originated primarily because of the bank's
relationship with customers.\282\
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\281\ See PNC letter.
\282\ Id.
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A brokerage relationship can involve an introducing broker-dealer
that accepts customer orders, a clearing or carrying broker-dealer that
settles the customer orders,\283\ and a custodian that holds the funds
and securities on behalf of the carrying or clearing broker-dealer. The
prohibition on banks acting as carrying brokers for registered broker-
dealers predates the GLBA.\284\ Only registered broker-dealers have
been permitted to act as carrying or clearing brokers.\285\ The
statutes and rules governing securities transactions generally use the
terms, ``carrying broker'' and ``clearing broker''
interchangeably.\286\ Under these earlier provisions, and consistent
with the Exchange Act condition on the networking and safekeeping and
custody exceptions, banks are only permitted to act as carrying brokers
with respect to government securities.\287\ Thus the question arises as
to what a carrying broker is and when would a bank be engaged in
prohibited conduct.
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\283\ If a broker-dealer effects securities transactions for a
customer, Exchange Act Rule 15c3-1(a)(2)(i) requires a broker-dealer
to hold the customer assets and settle the securities transactions.
See also 15 U.S.C. 78o(c)(3)(A).
\284\ See Decision of the Comptroller of the Currency on the
Application by Zions First National Bank, to Commence New Activities
in an Operating Subsidiary, December 11, 1997, at n. 74. The
Comptroller references a Commission comment letter on the Zions'
application in this footnote, and states that the subsidiary has
committed to comply with all applicable federal securities laws and
regulations, including the Commission's financial responsibility
regulations. In more detail than was repeated in the OCC's order,
the Commission's letter stated,''[b]ecause the bank is not a broker-
dealer, the Operating Subsidiary would be required to introduce to a
registered broker-dealer its customers' transactions in Revenue
Bonds, or to carry and clear those accounts itself in compliance
with the Commission's financial responsibility regulations,
including Rules 15c3-1 and 15c3-3 under the Securities Exchange Act
of 1934.'' See letter from Jonathan G. Katz, Secretary, Commission,
to Office of the Comptroller of the Currency at page 2 (Nov. 21,
1997).
\285\ See 15 U.S.C. 78o(c)(3)(A), Exchange Act Rule 15c3-
1(a)(2)(i), NASD Rule 3230, Clearing Agreements and NYSE Rule 382.
\286\ Id.
\287\ 15 U.S.C. 78c(a)(4)(B)(viii)(II).
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Under the securities laws and rules, a carrying or clearing broker
has higher minimum net capital requirements than a broker-dealer that
does not handle customer funds and securities.\288\ In addition, a
carrying or clearing broker often provides securities recordkeeping,
trade execution, and settlement services. A carrying or clearing broker
relationship must be documented and, at a minimum, must specify the
responsibilities of the introducing broker and the carrying or clearing
broker.\289\ Because the responsibilities of the carrying or clearing
broker and the introducing broker are clearly set forth, securities
customers are protected and the legal obligations of the parties can be
determined in the event of a dispute.\290\
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\288\ See Exchange Act Rule 15c3-1(a)(2)(i).
\289\ See NASD Rule 3230, Clearing Agreements and NYSE Rule 382,
which set forth the following requirements to specify the
responsibility of the introducing broker and the carrying or
clearing broker: (1) opening, approving and monitoring customer
accounts; (2) extension of credit; (3) maintenance of books and
records; (4) receipt and delivery of funds and securities; (5)
safeguarding of funds and securities; (6) confirmations and
statements; and (7) acceptance of orders and execution of
transactions. For purposes of the financial responsibility rules and
SIPC, customers are customers of the clearing broker. Furthermore,
each customer whose account is introduced on a fully disclosed basis
must be notified in writing upon the opening of the account or the
existence of the agreement and the relationship between the
introducing and the carrying broker.
One way to divide the responsibilities of an introducing and a
clearing broker-dealer is to list the front office activities
conducted by an introducing broker-dealer (items one and seven
above) as compared to the back office activities conducted by a
clearing broker-dealer (items two through six above).
\290\ For example, if either party were to become insolvent, the
rights and obligations of the solvent party, the Securities Investor
Protection Corporation, and the customers could be determined under
the terms of the written agreement. Without this kind of clear
documentation, a carrying or clearing broker relationship could
result in chaos if one of the parties were to become insolvent, or
in the event of any dispute over their respective responsibilities
and obligations. This kind of dispute or insolvency may
unnecessarily harm customers, or the Securities Protection Investors
Corporation.
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When a bank performs the back office functions of a broker-dealer,
the bank is often acting as a carrying broker for the broker-dealer. A
bank may be acting as a carrying broker if it also executes customers'
securities transactions through a broker-dealer whose primary purpose
is to support the bank, and whose back office functions reside in the
bank.\291\ For example, a bank could be a carrying broker by acting as
a custodian, performing many back office functions for a broker-dealer,
and entering into a networking arrangement on an omnibus basis with the
broker-dealer.\292\ In this situation, the business of the two entities
would be so inextricably intertwined, and the bank would be providing
so many different functions to the broker-dealer, that the bank could
be said to be ``carrying'' the broker-dealer's accounts.
---------------------------------------------------------------------------
\291\ See supra note 289 for an explanation of ``front office''
versus ``back office'' functions.
\292\ This would be especially true if that broker-dealer does
not engage in business other than executing securities transactions
for the bank. Exchange Act Section 3(a)(4)(B)(vii) permits banks to
enter into networking arrangements with broker-dealers on the basis
that all customers that receive the services are fully disclosed to
the broker-dealer. A bank relying on the networking exception may
not, however, act as a carrying broker.
Broker-dealers could, of course, continue to use banks to
fulfill their customer segregation requirements as provided in
Exchange Act Rules 15c3-3(c)(5), 15c3-3(e)(1), and 15c3-3(k)(2)(i).
---------------------------------------------------------------------------
One bank trade group advised the Commission staff that bank custody
departments typically do not open accounts with large numbers of
broker-dealers. Instead, when a large bank opens an account with a
broker-dealer, the broker-dealer frequently is a bank affiliate. A bank
could be acting as a carrying broker if it uses an affiliated broker-
dealer whose main purpose is to execute the securities transactions of
the bank and the bank assumes other functions, such as clearing
transactions with a clearing agency, that properly belong within the
broker-dealer. The carrying broker question arises when a bank assumes
more broker-dealer functions, and the broker-dealer is dependent upon
the specific relationship established between the bank and the broker-
dealer. Of course, a bank would not be acting as a carrying broker when
a customer chooses the bank to act as custodian and the bank then uses
a variety of broker-dealers to execute and clear the subsequent
[[Page 39713]]
securities transactions as permitted by the safekeeping and custody
exception.\293\
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\293\ This interpretation does not affect the ability of a bank
to act as a good ``control location'' of fully-paid and excess
margin securities of customers pursuant to Exchange Act Rule 15c3-
3(c). A broker-dealer is deemed to have control of securities under
Rule 15c3-3(c)(5), if the securities:
are in the custody or control of a bank as defined in Section
3(a)(6) of the Act, the delivery of which securities to the broker
or dealer does not require the payment of money or value and the
bank having acknowledged in writing that the securities in its
custody or control are not subject to any right, charge, security
interest, lien or claim of any kind in favor of a bank or any person
claiming through the bank * * * .
Under Exchange Act Rule 15c3-3(c), only a broker-dealer may have
access to the securities held at a bank that is a good ``control
location.''
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We solicit comment on whether we should adopt a rule setting forth
specific factors to clarify the distinction between a bank acting as a
carrying broker and a bank acting as a custodian. Some of the factors
we would consider including in a rule as indications of whether a bank
is acting as a carrying broker are: (1) A bank having opening,
approving and monitoring control over the broker-dealer's customer
accounts; (2) a bank extending credit to the broker-dealer's customers;
(3) a bank maintaining the broker-dealer's books and records; (4) the
bank receiving and delivering the broker-dealer's funds and securities;
(5) the bank safeguarding the funds and securities of the broker-
dealer's customers; (6) the bank preparing and issuing the broker-
dealer's confirmations and statements; (7) the bank accepting the
customer's orders; and (8) the bank arranging for the execution of the
customer's transactions. We invite comment on whether there are any
other factors that should be considered in determining whether a bank
is acting as a carrying broker.
4. Comments on and Proposed Amendments to the Small Bank Custody
Exemption
The Exchange Act exceptions from the definition of ``broker'' apply
equally to all banks. To help alleviate possible administrative burdens
imposed on small banks by the GLBA, current Exchange Act Rule 3a4-4
provides a limited exemption from the definition of ``broker'' under
Exchange Act Section 3(a)(4) to permit small banks to receive
transaction-based compensation for effecting transactions in investment
company securities held in tax-deferred custodial securities accounts,
such as custody IRAs.\294\
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\294\ 17 CFR 240.3a4-4.
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Exchange Act Rule 3a4-4 is available to banks with less than $100
million in assets and that are not part of bank holding companies with
consolidated assets of more than $1 billion.\295\ Compensation from
securities transactions effected under this exemption may constitute up
to three percent of a small bank's annual revenue. The exemption is
only available to small banks offering custody accounts that do not
have affiliated broker-dealers or networking arrangements with
registered broker-dealers. The exemption is also subject to
restrictions on solicitation, staffing, and employee incentive
compensation.
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\295\ The Interim Rules use the $1 billion limit for small bank
holding companies because the Federal Reserve Board has categorized
these companies as ``small, noncomplex bank holding companies'' for
the purposes of determining the type of supervisory review that they
receive. See Exchange Act Release No. 44291, supra note 13, 66 FR at
27782 (citing the 1999 Federal Reserve Annual Report at 122). See
also 2003 Federal Reserve Annual Report at 87.
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We received several comments regarding the small bank custody
exemption. Commenters criticized many aspects of the exemption
asserting, among other things, that its conditions limit the
exemption's usefulness.\296\ In particular, commenters contended that
the $100 million asset limit is too low. Some commenters recommended
increasing the asset limit to $250 million, noting that the Banking
Agencies, for purposes of the Community Reinvestment Act, define a
small bank as one with less than $250 million in assets.\297\ In later
discussions with Commission staff, the ICBA recommended increasing the
asset limit to $500 million. Some commenters asserted that the three
percent limit on annual revenue would severely constrain small banks
from receiving compensation for order taking services.\298\ Commenters
also objected to the restriction on utilizing networking arrangements
with registered broker-dealers to effect securities transactions for a
bank's customers in conjunction with the exemption.\299\
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\296\ See ABA/ABASA letters; ICBA letter; IIB letter, Compass
letter; and Trust Financial Services Division of the Texas Bankers
Association letter.
\297\ See ICBA letter and ABA/ABASA letters. See also Virginia
Bankers Association letter (asserting the $100 million dollar asset
limit is ``too narrow'').
\298\ See ABA/ABASA letters; Banking Agencies letter; and ICBA
letter.
\299\ See, e.g., Banking Agencies letter and ICBA letter.
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In response to comments, we propose to amend Exchange Act Rule 3a4-
4, which would be redesignated as Exchange Act Rule 761, to expand the
exemption's usefulness to small banks while minimizing their potential
compliance costs. In particular, as discussed in detail below, we
propose to raise the eligibility limit from banks with $100 million in
assets to banks with $500 million in assets. In addition, we propose to
eliminate the exemption's staffing restrictions. We propose to retain,
however, the requirement that a bank may not be affiliated with a bank
holding company that has more than $1 billion in assets. We also
propose to limit the availability of the exemption to banks that have
less than $100,000 in annual ``sales compensation'' and that do not
have affiliated broker-dealers. This proposed exemption would be
available for transactions in any type of security held in an account
for which the bank acts as a custodian.
The small bank exemption, with the proposal modifications, reflects
a balance between making it available to more banks while also assuring
that these banks' securities activities are largely effected through
registered broker-dealers, consistent with the functional regulation
mandate in the GLBA. The conditions are designed to permit small banks
to use a limited securities sales channel without meeting the
licensing, sales practices, and other requirements that apply to
registered broker-dealers.
In proposing these amendments, we have evaluated the benefits to
small banks against the risk to investors of not receiving protections
under the Exchange Act and SRO rules. We have also considered whether
the proposed conditions could tilt the level playing field between
securities market participants that Congress sought to establish with
functional regulation. In particular, we have considered the
competitive effect the scope of this proposed exemption may have on
small broker-dealers. Commenters are invited to discuss whether this
proposal strikes the right balance.
a. Bank Asset Size Limit
We propose to increase significantly the number of banks that
potentially could utilize the small bank custody exemption by amending
the definition of ``small bank'' to mean a bank with less than $500
million in assets.\300\ We
[[Page 39714]]
propose, however, to retain the requirement that such a bank may not be
an affiliate of a bank holding company or a savings and loan holding
company with more than $1 billion in consolidated assets in the two
prior calendar years.\301\
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\300\ The Banking Agencies have recently proposed to raise the
small institution asset limit of the Community Reinvestment Act from
$250 million to $500 million, without reference to holding company
assets. See 69 FR 5729 (Feb. 6, 2004). We do not consider this
proposal relevant for purposes of setting the asset limit for this
exemption because of the very different legislative purposes of the
Community Reinvestment Act and the Exchange Act. The asset limit
increase recently proposed by the Banking Agencies addresses a
bank's responsibilities under the Community Reinvestment Act, while
the asset limit increase we propose addresses whether a small bank
must register as a broker-dealer to effect securities transactions
for its custody customers.
The Interim Rules incorporate the definition of ``small bank''
used by the Small Business Administration (``SBA'') because it was a
definition determined by an independent third agency. One option
would be to raise the asset limit for this exemption to $150 million
because the SBA raised its size standards for small banks from $100
million to $150 million since the Interim Rules were adopted. See 13
CFR 121.201. See also Small Business Size Standards, Inflation
Adjustments to Size Standards, 67 FR 3041 (Jan. 23, 2002).
Increasing the asset threshold to $150 million would expand the
availability of this exemption to approximately 63 percent of all
banks and thrifts insured by the FDIC.
However, the ABA and the ICBA have advised the Commission staff
that few banks with assets of less than $150 million actually hold
custody of customers' securities. They have indicated that a $500
million standard would be more useful. Because we believe that this
exemption should be one that small banks having custody of
securities can use, we have adopted the suggestion of the ABA and
the ICBA and propose to increase the asset threshold for the
proposed Exchange Act Rule 761 to $500 million.
\301\ The requirement of two prior calendar years is a condition
of current Exchange Act Rule 3a4-4. We received no comments on this
requirement. It is intended to preclude short-term business changes
from affecting a bank's reliance on this provision.
We propose a technical amendment to add savings and loan holding
companies to bank holding companies. Because a new bank, bank
holding company, or a savings and loan holding company would have no
assets in either one or both of the two prior calendar years, a bank
would qualify for the exemption for at least the period of time in
which it had no assets.
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A $500 million asset limit would greatly expand the availability of
this exemption, increasing the number of potentially eligible banks and
thrifts from 4,359 (or approximately 48 percent of all banks and
thrifts insured by the FDIC) to 8,021 (or approximately 88 percent of
all FDIC insured banks and thrifts).\302\ We solicit comment on the
proposed amendment to the definition of small bank. We also solicit
comment regarding whether an eligibility test based on deposits rather
than assets would be better suited for an exemption targeted to small
banks. Should the $500 million asset limit be adjusted for inflation?
If so, what measure of inflation should be used?
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\302\ A smaller percentage than 88 percent of banks and thrifts
would be able to use this proposed exemption because other
conditions of this proposed exemption require that these banks
cannot be affiliated with a bank holding company or a savings and
loan holding company with consolidated assets of more than $1
billion and cannot be affiliated with a registered broker-dealer.
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b. Annual Sales Compensation Limit
We propose to replace the current three percent annual revenue
limit with an annual ``sales compensation'' limit of $100,000 for
effecting securities transactions in reliance on this exemption. Sales
compensation would include compensation that a bank receives for a
securities offering that the bank does not receive directly from a
customer, beneficiary, or the assets of the trust or fiduciary account,
such as Rule 12b-1 fees.\303\ We anticipate that most sales
compensation would be composed of Rule 12b-1 fees. Sales compensation
could also include revenue sharing arrangements with mutual funds or
commissions for securities trades that include a profit. Sales
compensation, however, 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. In addition, the
proposed rule provides that this $100,000 annual limit on ``sales
compensation'' that the bank receives pursuant to this exemption would
be adjusted for inflation so that this exemption remains useful to
small banks in years to come.\304\
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\303\ See section III.B. supra.
\304\ As of December 1, 2003, three percent of the annual
revenue of an average bank with $500 million in assets was $183,570;
for an average bank with $250 million in assets it was $131,010; and
for an average bank with $150 million in assets it was $97,770. The
proposed revenue limitation is necessary because some banks that
would qualify for the proposed exemption have extremely high
revenues in relation to total assets. For example, the Commission
staff reviewed Schedule RC (``Consolidated Report of Condition'')
and Schedule RC-I (``Consolidated Report of Income'') (Form FFIEC
041) of a bank that has assets of approximately $354 million but
revenue of approximately $493 million. Some banks with $500 million
or less in assets appear to be almost exclusively in the securities
business, and these banks could potentially operate a large
introducing broker-dealer within the bank without an overall revenue
limitation such as the one we are proposing.
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The $100,000 annual ``sales compensation'' limit should provide
those banks that occasionally effect transactions in securities as an
accommodation in their custody relationships with sufficient
flexibility to continue to serve the needs of their customers without
requiring the banks to register as brokers.\305\ We solicit comment on
the proposed $100,000 ``sales compensation'' limitation.
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\305\ The $100,000 limit was selected based on information the
Commission staff received from a bank trade association. This
information indicated that the proposed limit should accommodate
small banks' existing business.
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Commenters are invited to share information about how small banks
assess custody fees. With respect to each type of customer with a
custody relationship with a small bank, small banks are invited to
discuss: (1) The types of securities that the bank purchases or sells
for these customers; (2) all of the types of compensation that the bank
receives in connection with its custody activities related to different
types of such customers; (3) whether custody fees vary depending on
whether small banks sell non-custody products and services to
customers; and (4) whether small banks are compensated in other ways
for custody accounts or relationships.
In particular, we seek comment regarding the amount of ``sales
compensation'' that small banks receive for effecting transactions in
securities for customers with whom they have a custody relationship. We
seek comment regarding the percentage of custody revenue that small
banks obtain from Rule 12b-1 fees. Commenters are invited to discuss
whether small banks receive significant sales compensation outside of
Rule 12b-1 fees, such as from revenue sharing arrangements for mutual
funds held for custody customers or through commissions for securities
trades that include a profit. Commenters should note if their answer
varies depending on whether the custody accounts are for: (1)
Companies; (2) market professionals; (3) individual private banking
clients; or (4) clients holding IRAs. We seek comment on whether small
banks would find it difficult to calculate the total amount of Rule
12b-1 fees they would receive on an annual basis in connection with
this exemption.
We invite comment on whether the sales compensation limit should be
set at a different level. Would a different limit on sales compensation
such as $50,000 be more appropriate for an exemption designed to be
used only by small banks? Should the limit be higher? Commenters that
believe that this limit on sales compensation should be more than
$100,000 should provide empirical data supporting this assertion. We
request comment about the inflation-adjusted aspect of this condition.
Is linking it to the Consumer Price Index All Urban Consumers published
by the Department of Labor appropriate or should another measure of
inflation be used? \306\ The Commission is also interested in
information regarding the types of securities transactions that a bank
likely would effect at these different revenue levels.
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\306\ See proposed Exchange Act Rule 761(c).
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We invite comment on whether particular types or sources of
revenues should be excluded, temporarily or permanently, from the
$100,000 sales compensation limit. For example, should Rule 12b-1 fees
that small banks
[[Page 39715]]
receive as a result of mutual fund sales that took place before the
date of this proposal be excluded from the $100,000 sales compensation
limit? If yes, please explain why. Should there be any limitations on
such excluded revenue? Should revenues received from the sale of other
types of securities be excluded from the $100,000 limit? If so, why?
c. Other Conditions
1. Solicitation
We propose to simplify the solicitation restrictions in current
Exchange Act Rule 3a4-4 to permit small banks effecting securities
transactions pursuant to this exemption to publicly solicit brokerage
business as permitted by the trust and fiduciary activities
exception.\307\ The trust and fiduciary exception permits small banks
to solicit brokerage business by advertising that they effect
transactions in securities in conjunction with advertising their other
trust activities.\308\ This restriction on solicitation of securities
transactions for custody accounts would not apply to securities
transactions that are not effected pursuant to this proposed exemption.
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\307\ The Commission interprets solicitation broadly in the
context of securities transactions. See Exchange Act Release No.
27017, supra note 86, 54 FR 30013.
\308\ See Exchange Act Section 3(a)(4)(B)(ii)(II).
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We request comment on this proposed amendment to the small bank
custody exemption. We are particularly interested in comments regarding
how small banks market custody services to potential clients. We also
request comment on the extent to which small banks inform those
customers with whom they have custody relationship about securities.
For example, do small banks provide these customers with recommended
lists, watch lists, research reports, or other publications
highlighting securities or groups of securities? Do small banks offer
asset allocation advice, and, if so, do they suggest possible
investments to achieve asset allocation goals? Do small banks recommend
specific securities--or classes of securities--to such customers? Do
small banks recommend specific trading strategies to these customers?
Do small banks provide investment advice to such customers? How do
small banks offer particular classes or series of mutual funds to their
customers with whom they maintain a custody relationship? Finally, we
solicit comment regarding whether we should adopt disclosure
requirements similar to the proposed general disclosure requirements in
proposed Exchange Act Rule 776.
2. Securities Networking
Commenters criticized the provision in Exchange Act Rule 3a4-4 that
excluded banks that had a networking relationship with a broker. They
argued that permitting small banks to have networking arrangements with
third-party broker-dealers would allow banks to offer the services of a
broker to their customers (the networking arrangement), while still
allowing banks to conduct some transactions in-house.\309\ We propose
to replace that restriction with one that restricts a small bank from
affiliating with a broker-dealer. Permitting banks to have networking
arrangements with registered broker-dealers will greatly increase the
utility of this exemption to small banks. Banks with a registered
broker-dealer affiliate, however, have demonstrated their ability to
put in place the infrastructure of a regulated broker-dealer to serve
their customers, which can be used for other securities activities of
bank customers. Small banks that have networking arrangements with
broker-dealers are particularly invited to discuss whether this
provision would be workable for them, and to suggest alternative
provisions that might be more workable. We request comment on the
proposal to replace the networking restriction in current Exchange Act
Rule 3a4-4 with a restriction on having an affiliated broker-dealer. We
also solicit comment on the number of small banks that have an
affiliated broker-dealer.
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\309\ See, e.g., ICBA letter and Banking Agencies letter.
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3. Employee Staffing Restrictions
Commenters criticized the provision in the Interim Rules that
prohibits bank employees from also being employees of a broker-dealer,
asserting that having such dual employees allows banks to better serve
the investment needs of retail customers with whom bank employees come
into contact while performing their banking custodial
responsibilities.\310\ In response to this comment, we propose to
permit small banks to use dual employees with broker-dealers.
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\310\ See ABA/ABASA letters.
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Commenters also criticized the requirement that any bank employee
must primarily have duties other than conducting securities
transactions, arguing that this requirement is contrary to proper
internal controls.\311\ This requirement was designed to prevent banks
from developing dedicated securities sales forces outside of the
safeguards of the sales practice rules applicable to broker-dealers. We
understand, however, that it would ease small banks' compliance burdens
if specialized employees could be used to effect securities
transactions for bank customers in the context of this exemption. We
also understand that specialized employees may improve operational
economies. Therefore, we propose to permit banks to use a dedicated
bank sales force to effect transactions in securities under this
exemption. This dedicated sales force may consist of either
unregistered personnel or registered representatives employed by both a
broker-dealer and the small bank seeking to qualify for the exemption.
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\311\ See ICBA letter and Frost letter.
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We solicit comment with regard to these proposed amendments to the
employee staffing restrictions for the small bank custody exemption.
Commenters are particularly invited to discuss how small banks utilize
personnel to effect securities transactions.
4. Employee Compensation Restriction
Some commenters expressed concern regarding the rule's restriction
on payment of incentive compensation to bank employees for the sale of
securities.\312\ We propose to retain this restriction but to clarify
that small banks may pay their employees incentive compensation
pursuant to a networking arrangement that meets the conditions of
Exchange Act Section 3(a)(4)(B)(i).\313\ This condition encompasses
payment of incentive compensation both to unregistered employees and to
employees who are registered representatives.\314\
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\312\ See ICBA letter and BSA letter.
\313\ See proposed Exchange Act Rule 761(e).
\314\ See section III.B. supra.
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We request comment on this proposed amendment to the small bank
custody exemption. Commenters are invited to discuss how small bank
employees are compensated. For example, how much incentive compensation
would a typical small bank employee receive in a year from making
referrals to a broker-dealer via a networking arrangement? How much
could a small bank employee earn in a year from this activity if he or
she made so many referrals as to be in the top one percent of employees
referring customers to broker-dealers?
5. Investment Company Shares for Tax-Deferred Accounts
Commenters also criticized the small bank custody exemption because
it only applies to transactions in investment company shares for the
benefit of tax-
[[Page 39716]]
deferred accounts.\315\ One commenter suggested that the exemption
should not be limited to providing order taking services for clients
seeking to purchase mutual funds, but should be expanded to include
tax-deferred accounts holding corporate debt and equity
securities.\316\ Other commenters suggested that the Commission
eliminate the requirement that banks offering proprietary mutual funds
also offer nonproprietary mutual funds.\317\ To provide small banks and
their customers more flexibility, we propose to expand the scope of
this exemption to allow small banks to effect transactions in all
securities, not just shares of investment companies. In addition, we
are proposing to expand this exemption to apply to custodial accounts
in general by eliminating the requirement that transactions pursuant to
this exemption must be for tax-deferred accounts. Finally, we propose
to permit small banks to offer proprietary mutual funds without the
requirement that banks also offer nonproprietary mutual funds.
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\315\ See ICBA letter and ABA/ABASA letters.
\316\ See ABA/ABASA letters.
\317\ See Compass letter and Frost letters.
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We solicit comment regarding how small banks select the mutual
funds they offer to their custody customers, and the extent to which
they limit offerings to proprietary funds. We also invite comment
regarding the effect on investor protections of this proposed expansion
of the securities transactions permitted under the exemption. Moreover,
we are also interested in receiving comment on this exemption for small
banks in light of the proposed ERISA exemption available to all banks.
Do commenters believe that exempting bank trustees and non-fiduciary
administrators that effect transactions in securities of open-end
companies for participants in employee benefit plans from the
definition of broker eliminates the need for the amendments being
proposed to the small bank custody exemption? \318\ In other words, do
commenters believe that the small bank custody exemption will be used
for securities transactions in securities other than investment company
securities or for accounts other than IRA custody accounts?
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\318\ See section III.F.2 supra (proposed ERISA exemption).
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d. Trustee and Fiduciary Activity Accounts
A small bank that has trust and fiduciary activity accounts may use
the small bank custody exemption provided that it does not rely on any
other of the trust and fiduciary exemptions in the Rules.\319\ In other
words, banks could elect to effect transactions for trust and fiduciary
activity accounts under this exemption. The sales compensation that a
bank would receive from these transactions would count towards the
$100,000 annual limit. If small banks elect to utilize this exemption
to effect securities transactions for trust and fiduciary activity
accounts, they would avoid all calculation and other requirements of
the trust and fiduciary exemptions--except in particular accounts where
they elect to rely on the statutory test without utilizing any safe
harbors. We understand that up to 85 percent of small banks may be able
to avoid any other ``chiefly compensated'' comparison by using this
proposed exemption.
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\319\ See proposed Exchange Act Rule 761(d).
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e. Availability of Exemption to Non-Depository Trust Companies
An industry group representing non-depository trust companies
complained that the small bank custody exemption is not workable for
its members.\320\ According to this commenter, because trust companies
do not earn revenue from loan payments, the three percent annual
revenue limit would not permit them to continue to effect transactions
in securities.\321\ While we do not propose specific amendments to
address non-depository trust companies, the proposal to amend Exchange
Act Rule 3a4-4 to replace the three percent limit on ``annual
compensation'' with an annual sales compensation limit of $100,000
should address this comment. We seek comment on whether replacing the
three percent annual revenue limit with the $100,000 annual limit on
sales compensation addresses any competitive disadvantages that non-
depository trusts might have with regard to small banks as a result of
the small bank custody exemption.\322\
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\320\ See Association of Independent Trust Companies letter.
\321\ This commenter stated that its trust company members
typically have assets under management of between $50 million and
$500 million and may, in some cases, have in excess of $1 billion in
assets under management. See id.
\322\ One commenter asked that we extend current Exchange Act
Rule 3a4-4 to include small insurance agencies and insurance
brokerage, arguing that these entities will be at a competitive
disadvantage in the financial services marketplace if they do not
also receive an exemption. See letter dated September 4, 2001 from
Scott Sinder and Douglas S. Kantor, Counsel to the Council of
Insurance Agents & Brokers. We are not proposing to extend this
exemption to include these entities because, in contrast to banks,
insurance agencies and insurance brokerages historically have not
held customer assets, in connection with securities transactions or
accepted customer orders as an accommodation to custer without using
registered broker-dealers.
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f. Request for Comments
We solicit comment on the small bank exemption in proposed Exchange
Act Rule 761. In particular, we are soliciting comments on the
Commission's proposal to raise the eligibility limit from $100 million
to $500 million in assets. What would the impact of such a change have
on the percentage of banks that could qualify for the exception? Should
the threshold be higher or lower than $500 million? Commenters should
provide a detailed discussion, including data, if available, to support
a higher or lower standard. We also solicit comment on whether banks
anticipate effecting transactions in securities as custodians for
health savings accounts and whether this proposed exemption would
accommodate this business.
In addition, we are soliciting comment on whether the proposed
exemption would place small broker-dealers at a competitive
disadvantage vis-a-vis small banks.
F. General and Special Purpose Exemptions
1. General Exemption
In response to requests by some commenters that the Commission
provide banks with greater flexibility to provide cash management
services to their customers, we are proposing a general exemption, not
tied to any of the GLBA exceptions, that would, subject to certain
conditions, allow banks to buy and sell money market securities for
bank customers who are ``qualified investors,'' \323\ a person who
directs the purchase of securities from any cash flows that relate to
an asset-backed security that has a minimum original asset amount of
$25,000,000, and for 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.
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\323\ ``Qualified investor'' is defined in Exchange Act Section
3(a)(54). 15 U.S.C. 78c(a)(54).
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The new exemption, which would be contained in proposed Exchange
Act Rule 776, is based in part on requests from some commenters on the
Interim Rules that the Commission provide more flexibility with respect
to the services banks could offer to their customers for whom they act
in capacities such as indenture trustee, escrow agent, or paying
agent.\324\ Similarly, commenters and other industry representatives
have indicated to Commission staff that banks desire
[[Page 39717]]
more flexibility to offer clients with particular cash management needs
shares in money market funds that may pay more than 25 basis points in
12b-1 fees.
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\324\ See, e.g., ABA/ABASA letters and Federated letters.
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The Commission is sensitive to commenters' requests that banks be
given greater flexibility in offering some of their customers a wider
range of cash management services that include investing in money
market funds that may include investing in money market fund shares
that do not qualify as ``no-load.'' We believe that this enhanced
flexibility could be granted to banks and would also be consistent with
the Exchange Act investor protection principles with respect to these
limited securities transactions that this proposed exemption
contemplates.
Accordingly, the exemption in proposed Exchange Act Rule 776 would
permit banks to make available money market funds for cash management
purposes to customers that have particular cash management needs and
that prefer to compensate banks for these or other services through
Rule 12b-1 fees, or through a combination of Rule 12b-1 fees and other
fees. For example, banks would be able to continue to provide these
cash management services when the bank is acting as an indenture
trustee for a municipality that needs to invest bond proceeds on a
short-term basis or as escrow agent for corporations that need to
invest funds pending the consummation of a corporate transaction.
We would limit the availability of the proposed exemption to
certain investors. For purposes of the proposed exemption, a
``qualified investor'' would be identified as a qualified investor
within the meaning of Exchange Act Section 3(a)(54). We include
qualified investors because Congress already determined that investors
in this category were able to engage in some transactions directly with
banks that would not generally be available to other investors.\325\ We
would also permit a bank to use the exemption with respect to a person
who directs the purchase of securities from any cash flows that relate
to an asset-backed security that has a minimum original asset amount of
$25,000,000. We selected a minimum $25,000,000 in original asset amount
for qualifying for this exemption because we believe that it is
consistent with minimum of $25,000,000 in investments found in many of
the categories of qualified investor. We elected to make this
$25,000,000 requirement applicable only to the original asset amount,
so that the bank would not have to monitor the size of the remaining
asset pool every time it entered into a sweep transaction with a person
who directs the purchase of securities from any cash flows that relate
to an asset-backed security. We believe that this description of the
second category of persons should be broad enough to accommodate asset-
backed securities issuers, such as certain small state and local
governmental entities that use these kinds of sweep investments. Bank
representatives suggested to Commission staff that these types of
issuers of asset-backed securities be included under an exemption, such
as the one found in proposed Exchange Act Rule 776, although many of
these issuers may not meet the definition of qualified investors under
Exchange Act Section 3(a)(54). We request comment on whether the
proposed exemption is appropriate in its coverage, including the
selected minimum $25,000,000 in original asset amount. If commenters
believe that minimum qualifying amount should be changed, we request
that commenters provide us with specific information on what the amount
should be and why. We also request comment on whether the proposed
exemption should be expanded to cover additional types of investors,
such as commercial depositors that may not be qualified investors under
Exchange Act Section 3(a)(54).
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\325\ For example, the asset-backed transactions exception from
the definition of dealer only permits a bank to issue and sell
securities through a grantor trust or other separate entity to
qualified investors. See Exchange Act Section 3(a)(5)(C)(iii). 15
U.S.C. 78c(a)(5)(C)(iii).
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The exemption would be limited to certain, specified securities.
The money market fund shares in which a bank could effect transactions
in reliance on the exemption would have to belong to a ``no-load''
class or series of the fund's shares, or, alternatively, the bank would
not be permitted to characterize or refer to the shares as ``no-load.''
A bank relying on the exemption to effect transactions in money market
fund shares that do not qualify as ``no-load'' for customers (other
than ``qualified investors'' and persons who direct the purchase of
securities from any cash flows that relate to an asset-backed security
that has a minimum original asset amount of $25,000,000) also would
have to provide to these customers a fund prospectus and a clear and
conspicuous notice disclosing payments the bank may receive in
connection with the transactions from the fund's fund complex.\326\
This notice would also be required to refer the customers to the fund
prospectus for additional information regarding expenses. These
conditions are designed to assure that a customer of a bank relying on
the exemption would have sufficient information upon which to make an
informed decision. We request comment on whether the proposed exemption
should be conditioned on additional disclosures, and invite any
commenters who believe the exemption should be expanded to cover
transactions for additional types of investors to comment on whether
such transactions should be conditioned on enhanced disclosures. In
particular, we invite comment on whether the conditions under which
banks may rely on the exemption should include disclosure obligations
with respect to fees banks charge directly to their customers, such as
rate spreads or retained yield fees. We also request comment on whether
it is appropriate not to require that the additional disclosures for
``qualified investors'' and persons who direct the purchase of
securities from any cash flows that relate to an asset-backed security
that has a minimum original asset amount of $25,000,000.
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\326\ The term ``no-load'' is defined in proposed Exchange Act
Rule 740(c), which amends the definition of the term in current
Exchange Act Rule 3b-17(f). Under the proposed definition, with
certain exceptions, a class or series of a fund's securities would
be considered no-load if it is not subject to a sales load or a
deferred sales load and charges against net assets for sales or
sales promotion expenses, for personal service, or for the
maintenance of shareholder accounts do not exceed 25 basis points.
The notice that would have to be provided to investors, other than
qualified investors, in load money market fund shares under the
proposed exemption would have to identify separately any payments to
the bank that are a ``sales load'' or a ``deferred sales load,'' as
those terms are defined in proposed Exchange Act Rule 740, or a fee
paid pursuant to a plan under Rule 12b-1 under the Investment
Company Act (17 CFR 270.12b-1).
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We considered whether to extend the proposed exemption to cover
transactions for additional types of bank customers. Most such
customers, however, do not have the same specific cash management needs
as the customers that we have identified. Moreover, we remain concerned
that additional types of customers may be more vulnerable than the
types of customers identified in the proposed exemption to being misled
regarding the costs of their investments.\327\ As a
[[Page 39718]]
result, the proposed exemption would apply only to ``qualified
investors'' and certain other customers who already use a bank for
trust or fiduciary services, or for the agency services identified in
proposed Exchange Act Rule 776.
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\327\ The services covered by the proposed exemption would
involve fee-related issues similar to those raised by sweep accounts
offered to retail investors. Sweep account fees can represent
significant costs for retail investors, and sweep account customers
have sued banks over excessive fees. However, cases in which
investors unsuccessfully sued banks over excessive sweep fees
indicate that retail investors do not have a private right of action
for excessive sweep account fees under the federal banking laws.
See, e.g., In re Fidelity Bank Trust Fee Litigation, 839 F. Supp.
318 (E.D. Penn. 1993). In addition, some courts have considered the
anti-fraud protections of the federal securities laws inapplicable
to excessive sweep account fees due to the extensive regulation of
deposit accounts under the federal banking laws. See, e.g., Simpson
v. Mellon Bank, 1993 U.S. Dist. LEXIS 17994 (E.D. Penn. Dec. 17,
1993).
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Bank representatives have told Commission staff that some banks
have existing business practices that include investments in a broader
range of securities. We request comment on whether the proposed
exemption should be extended to cover funds that are not money market
funds and whether extending the exemption to these other funds would
accommodate existing bank practices that would not otherwise be covered
by one of the proposed exemptions or exceptions. It would be
particularly helpful if any such comments identified and described
mutual funds, other than money market funds, that banks would be unable
to continue using for customers under the other exceptions or
exemptions, as well as how much the banks currently invest in these
other funds on behalf of customers that would qualify for this
exemption. We also ask commenters to provide us with information on
whether the 12b-1 fees generated by those funds are currently offset
against bank fees. Would a custodial exemption that required that fees
be offset, such as that proposed for ERISA activities, be appropriate?
Finally, we request comment generally on the exemption contained in
proposed Exchange Act Rule 776. Commenters are specifically invited to
discuss whether the proposed exemption should be limited to particular
types of money market funds or to specific types of investors within
the categories described in the proposed exemption, and, if so, under
what conditions. Commenters that believe the proposed exemption should
be expanded should also explain why any proposed expansion of the
proposed exemption would be consistent with the protection of
investors.
2. Employee Benefit Plan Exemption
The Exchange Act does not specifically exclude from broker-dealer
registration banks that administer employer-sponsored retirement
plans.\328\ While banks do not typically charge plan participants
directly for the cost of plan administration, banks may be compensated
through Rule 12b-1 fees and other fees that meet the ``sales
compensation'' definition in current Exchange Act Rule 3b-17. Because
of this compensation arrangement, banks that administer these
retirement accounts often cannot meet the requirement in the trust and
fiduciary activities exception to be ``chiefly compensated'' through
relationship fees.\329\
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\328\ As of 2003, these plans accounted for $2.1 trillion in
mutual fund assets. They, therefore, are an important vehicle
through which ordinary Americans invest in securities. Investment
Company Institute, 2003 Mutual Fund Fact Book at 47.
\329\ For example, banks administering small plans advised the
Commission staff that they often bundle their fees by offering Class
C shares with one percent Rule 12b-1 fees. Banks that offer Class C
shares to smaller plans do so in part to compete with insurance
companies that are more prevalent in the small plan market and
bundle their fees. Class B shares often carry relatively high 12b-1
fees, but may automatically convert into Class A shares (which
generally carry lower 12b-1 fees) several years after purchase.
Class C shares also generally carry relatively high 12b-1 fees, and
usually do not automatically convert to a class of shares with lower
12b-1 fees. Because Class C shares do not automatically convert to a
share class associated with lower 12b-1 fees, post-first year
compensation for selling Class C shares may be particularly
significant. See, e.g., Release Nos. 33-8358, 34-49148, IC-26341
(Jan. 29, 2004) supra note 130, 69 FR 6438 at 6453, n. 97 and 101
(Feb. 10, 2004).
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We propose conditionally to exempt from the definition of broker
bank trustees and non-fiduciary administrators that effect transactions
in securities of open-end companies for participants in employee
benefit plans. A bank relying on this proposed exemption would be
required to offset or credit any compensation it received from a fund
complex related to securities in which plan assets are invested against
fees and expenses that the plan owes to the bank. While ERISA permits
banks to receive Rule 12b-1 compensation from mutual funds that they
offer to plan sponsors, banks have advised the Commission staff that
they offset or credit any compensation received from mutual funds
against plan expenses.\330\ A dollar-for-dollar offset or credit would
address the conflict of interest that banks would otherwise have when
choosing particular funds to offer to plan sponsors.
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\330\ Banks advised the Commission staff that they do a dollar-
for-dollar offset, or credit, of the compensation they receive from
the funds that they offer to plans against the fees imposed on the
plans themselves. In this way, the bank avoids having a conflict of
interest in selecting the funds in which plan participants invest.
This dollar-for-dollar offset practice is consistent with
guidance issued by the Department of Labor (``DOL''). See ERISA
Advisory Opinion 97-15A (available at: http://www.dol.gov/ebsa/programs/ori/advisory97/97-15a.htm
). In that opinion, a bank acting
as a directed trustee that reserved the right to add, delete, or
substitute individual mutual funds or fund families within the
investment menu that it made available to plans and applied the
mutual fund fees received for the benefit of the plans. Because this
bank applied the mutual fund fees for the benefit of the plans,
either as a dollar-for-dollar offset against the fees that the plans
paid for trustee and recordkeeping services, or as amounts credited
to the plans, the DOL viewed the bank as not engaging in self
dealing under 29 U.S.C. 406(b)(1) or (b)(3). At all times, the terms
of the bank's fee arrangements with the mutual fund companies was
fully disclosed to the plans. Although DOL also issued ERISA
advisory opinion 97-16A (available at: http://www.dol.gov/ebsa/programs/ori/advisory97/97-16a.htm
), no bank has advised the
Commission staff that it does not apply mutual fund fees for the
benefit of the plans.
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In addition, the exemption in proposed Exchange Act Rule 770 would
require the bank to disclose clearly and conspicuously to the plan
sponsor or its designated 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.\331\ The disclosures
would need 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 related to securities
in which plan assets are invested against the fees and expenses that
the plan owes to the bank.
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\331\ The term ``fund complex'' would be defined in proposed
Exchange Act Rule 770(b)(1).
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These disclosure requirements are intended to ensure that banks
relying on the exemption provide their customers with information on
their compensation and offsets that makes the disclosure of fees
charged more transparent and easier to compare for plan sponsors or
their designated fiduciaries.\332\ As we have discussed before,
investors need to know about the fees associated with these investments
because these fees directly affect the amount of their returns.\333\
This information should be transparent to purchasers of ERISA plans so
that they can make ``apples to apples'' comparisons.\334\
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\332\ This requirement is consistent with our proposal to
increase transparency regarding mutual fund fees and expenses. See,
e.g., Exchange Act Release No. 49148, supra note 130.
\333\ Id.
\334\ It is very difficult for a plan sponsor to compare fees
across plans because plan vendors have 80 different ways of charging
plan fees. See Economic Systems, Inc, Study of 401(k) Plan Fees and
Expenses (April 13, 1998) (study sponsored by the Office of Policy
and Research of the Department of Labor's Pension and Welfare
Benefits Administration). This may lead to fee disparities of up to
100 basis points for similar plans. A 100 basis point charge reduces
the return to investors by 18 percent over 20 years. See, e.g.,
Exchange Act Release No. 47023 (Dec.18, 2002), 68 FR 160 (Jan. 2,
2003).
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[[Page 39719]]
Some plans allow plan participants to invest through their
retirement plans in securities and funds beyond those offered in the
plan menu. This is often referred to as a participant-directed
brokerage account or a ``brokerage window.''\335\ Bank representatives
advised the Commission staff that when they offer brokerage windows to
plan participants, they establish separate brokerage accounts for each
participant with a broker-dealer. The proposed rule would codify this
practice by requiring banks that offer brokerage windows to plan
participants to continue to do so through a registered broker-dealer.
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\335\ See description of ``participant-directed brokerage
account'' in Schedule H of the 2003 Instructions for Form 5500
(combined Internal Revenue Service, Department of Labor and Pension
Benefit Guaranty Corporation Annual Report of Employee Benefit
Plan).
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Finally, proposed Exchange Act Rule 770 would prohibit a bank that
administers employee benefit plans 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. The
payment of incentive compensation for securities transactions creates
the type of salesman's stake the federal securities laws are designed
to regulate. Banks could, of course, pay these employees nominal
referral fees consistent with the terms of the networking exception for
referring accounts to a broker-dealer. Banks could also register these
employees as associated persons of broker-dealers for the purpose of
receiving incentive compensation from the broker-dealers.
We solicit comment on all aspects of this exemption. In responding
to comments, please specify the typical size of the employee benefit
plan. We solicit comment regarding whether we have adequately captured
the types of employee benefit plans for which banks act as pension plan
administrators. If we have not listed all the types of employee benefit
plans that a bank administers, please list the additional types of
employee benefit plans that are not included in the proposed rule.
Please answer the following questions for employee benefit plans
that are listed in the proposed rule, as well as for any additional
types of employee benefit plans that a commenter believes should be
added to the list. We seek bank-specific empirical data with respect to
each question. In other words, a bank should answer these questions
with respect to its own business and customers.
Does a bank typically act as a trustee or as a non-fiduciary
recordkeeper? How does a bank determine in which capacity to act? What
services does a bank provide in each different capacity in which it
acts?
How does a bank's compensation differ depending on the capacity in
which it acts? How does a bank's compensation differ depending on the
type of compensation that it offers to plan participants? What
transactional or asset-based charges does a bank earn when it acts in
each different capacity? If a bank offers unaffiliated mutual funds,
how is the bank compensated by these funds? If a bank is acting in a
trustee or fiduciary capacity, can the bank meet the ``chiefly
compensated'' comparison requirement, including the related exemptions?
Does a bank offset or credit any compensation that it receives from
a fund complex related to securities in which plan assets are invested
against fees and expenses that the plan owes to the bank? How does a
bank disclose the total compensation that it receives for acting as
trustee or non-fiduciary recordkeeper? How does it disclose any offsets
or credits?
3. Regulation S Transactions with Non-U.S. Persons
Persons that conduct a broker or dealer business while located in
the United States must register as broker-dealers (absent an
exemption), even if they direct all of their selling efforts
offshore.\336\ A bank industry group has requested an exemption from
the broker-dealer registration requirements to permit banks to continue
to sell securities that are covered by the safe harbor from U.S.
registration pursuant to Regulation S to non-U.S. persons, both as
agent and on a riskless principal basis.\337\ The group also requested
that the exemption extend to resale of Regulation S securities held by
non-U.S. persons to other non-U.S. persons in transactions pursuant to
Regulation S. While the group indicated that banks need this exemption
primarily to sell proprietary products, such as mutual funds, to non-
U.S. persons,\338\ they would like the flexibility to sell other
Regulation S securities to non-U.S. persons as well.\339\
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\336\ As the Commission stated when it adopted Exchange Act Rule
15a-6:
As a policy matter, the Commission now uses a territorial
approach in applying the broker-dealer registration requirements to
the international operations of broker-dealers.
Under this approach, all broker-dealers physically operating
within the United States that effect, induce, or attempt to induce
any securities transactions would be required to register as broker-
dealers with the Commission, even if these activities were directed
only to foreign investors outside the United States.
Exchange Act Release No. 27017, supra note 86, 54 FR at 30016
(footnotes omitted).
\337\ See letter dated May 27, 2004, from Lawrence R. Uhlick,
Executive Director & General Counsel, Institute of International
Bankers to Catherine McGuire, Chief Counsel, Division of Market
Regulation, Commission. Regulation S [17 CFR 230.901, et seq.]
specifies the requirements for an offer or sale of securities to be
deemed to occur outside the United States and therefore not subject
to the registration requirements of Section 5 of the Securities Act.
Regulation S permits the sale of newly issued off-shore securities
and re-sales of off-shore securities from a non-U.S. person to a
non-U.S. person.
\338\ These mutual funds are usually specifically designed for
sale offshore to avoid implicating U.S. tax laws for nonresident
non-U.S. persons.
\339\ Banks indicated to the Commission staff that although
these products will vary depending on customer preferences and
needs, among the most important products for banks are proprietary
and non-proprietary offshore mutual funds structured (particularly
for tax purposes) for non-U.S. investors, Euro bonds, and emerging
market debt (especially debt sold to customers in the local
jurisdiction--e.g., Argentine debt sold to Argentine investors). To
a lesser extent, banks indicated they may also sell European equity
securities and emerging market equity securities (again, especially
for investors in the local jurisdiction) to investors. Banks also
noted they may sell tailored investment products, such as structured
notes or deposits (e.g., equity-or credit-linked notes), which often
are customized to the individual needs of an investor and may be
issued by a bank affiliate or an entity (e.g., a special purpose
vehicle) controlled by a bank affiliate. Banks may sell other
products as well, such as offshore ``hedge funds,'' to certain
investors.
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In explaining the need for an exemption, the industry group
expressed the view to the Commission staff that non-U.S. persons expect
to deal with one private banker and that these customers would not
choose to deal with a registered broker-dealer to conduct securities
transactions in Regulation S securities, but would instead look to
foreign banks to effect these transactions.
In response to this request, we are proposing Exchange Act Rule
771, which would provide banks with a conditional exemption to effect
transactions pursuant to Regulation S with non-U.S. persons.\340\ This
exemption would not permit banks to effect transactions involving U.S.
persons, other than U.S. registered broker-dealers. This exemption
would permit banks to effect transactions involving offshore, non-U.S.
persons on an agency or riskless principal basis. The exemption defines
riskless principal for the purposes of the exemption. 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
[[Page 39720]]
comply with the requirements of Regulation S.\341\ After the
requirements of Regulation S cease to apply to an issuance, then the
bank could resell the securities to another non-U.S. person or a
broker-dealer without meeting the terms of Regulation S.
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\340\ 17 CFR 242.771. Nothing in this proposed rule would affect
the necessity of complying with Regulation S or any other
requirements of or exemptions from the Securities Act of 1933.
\341\ Rule 904 of Regulation S (17 CFR 230.904).
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We are proposing this exemption with these limited conditions
because we believe that non-U.S. persons will not be relying on the
protections of the U.S. securities laws when purchasing Regulation S
securities from U.S. banks.\342\ While generally we believe that U.S.
broker-dealers should be subject to the broker-dealer standards of
conduct when dealing with non-U.S. persons, we feel that this principle
is less compelling when the foreign person has chosen to deal with a
U.S. bank with respect to Regulation S securities. We also understand
that non-U.S. persons can purchase the same securities from banks
located outside of the U.S. and would not have the protections of the
U.S. law when purchasing these securities offshore. We invite comment
on whether U.S. broker-dealer registration should be required with
respect to transactions with these non-U.S. persons who are purchasing
new offering securities offshore, or may be selling or purchasing
seasoned securities.
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\342\ While no rules have been adopted, the exemption provided
by Exchange Act Section 30(b), pertaining to foreign securities, has
been held unavailable if the United States is used as a base for
securities fraud perpetrated on foreigners, Arthur Lipper Corp. v.
SEC, 547 F.2d 171 (2d Cir. 1976), reh. denied, 551 F.2d 915 (2d Cir.
1977), cert. denied 434 U.S. 1009. See also Exchange Act Release No.
27017, supra note 86, 54 FR at 30016.
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We propose to define two other terms used in the exemption. We
propose to define the term ``eligible security'' to include a
requirement that the security is not being sold from the inventory of
the bank or an affiliate of the bank. We request comment on whether
this condition would be an appropriate safeguard against banks'
financial conflicts that may disadvantage foreign investors. Within the
definition of eligible security, we are also proposing to exclude from
the exemption situations when the bank or an affiliate of the bank is
underwriting a new issue security on a firm-commitment basis. In that
instance, the bank could still sell the security using the exemption if
the security is acquired from an unaffiliated ``distributor,'' that has
not purchased the securities from the bank or a bank affiliate.\343\
This condition is intended to prevent banks from soliciting investors,
who do not have the protections of the U.S. securities laws, to
purchase securities in which banks or their affiliates have an
overriding financial interest as underwriters or selling group members.
We understand, however, that there may be instances when a customer
wants to purchase a security that is being underwritten by a bank or
its affiliate. To facilitate these customer requests, a bank could sell
the securities in reliance on this exemption if it obtained the
securities from another distribution participant, other than an
affiliate of the bank, as long as the other distribution participant
did not directly or indirectly obtain the securities from the bank or
its affiliate. We request comment on whether this condition would be an
appropriate safeguard against banks' financial conflicts that may
disadvantage foreign investors.
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\343\ The term ``distributor'' is defined in 17 CFR 230.902(d).
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We also propose to define the term ``purchaser'' to mean a person
that purchases a security and that is a non-U.S. person under Rule
902(k) of Regulation S.\344\
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\344\ 17 CFR 230.902(k).
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We request comment on this proposed exemption, as well as the other
proposed definitions, including the definition of riskless principal
that is consistent with the definition we have used previously in the
bank dealer rules. We particularly request comment from non-U.S.
investors on whether this exemption is necessary to serve their needs,
or whether they would prefer to purchase Regulation S securities
subject to the full investor protections of the U.S. federal securities
laws. We also invite comment on the possible competitive effects this
proposed exemption may have.
4. Redesignation and Revision of Exemptions for Savings Associations
and Savings Banks
We propose to redesignate the current exemption for savings
associations and savings banks found in Exchange Act Rule 15a-9 \345\
as Exchange Act Rule 773.\346\ As is true under the current rule, the
savings associations and savings banks would be subject to all of the
same conditions and definitions as are applicable to banks that utilize
the exceptions from the definitions of ``broker'' and ``dealer.'' \347\
We propose to extend to savings associations and savings banks the
proposed money market exemption in Exchange Act Rule 776,\348\ the
proposed exemptions in Exchange Act Rules 720-723 \349\ relating to the
bank trust and fiduciary activities exception, the proposed small bank
custody exemption in Exchange Act Rule 761,\350\ the proposed expanded
exemption for the way in which banks effect transactions in investment
company securities in Exchange Act Rule 775,\351\ and the current
exemption for securities lending transactions in Exchange Act Rule 15a-
11,\352\ which we are proposing to redesignate as Exchange Act Rule
772.\353\
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\345\ 17 CFR 240.15a-9.
\346\ 17 CFR 242.773.
\347\ Nevertheless, savings associations and savings banks that
are municipal securities dealers must register and be regulated as
municipal securities dealers pursuant to Exchange Act Section 15B.
Banks must also register pursuant to Exchange Act Section 15B.
Exchange Act Section 3(a)(34)(A) provides that the ``appropriate
regulatory agency'' of a municipal securities dealer that is a bank
regulated by the OCC, the Federal Reserve, or the FDIC is the agency
that already regulates the bank. Exchange Act Section
3(a)(34)(A)(iv) designates the Commission as the appropriate
regulatory agency in the case of all other municipal securities
dealers, which includes savings associations and savings banks that
are municipal securities dealers.
\348\ 17 CFR 242.776.
\349\ 17 CFR 242.720 through 723.
\350\ 17 CFR 242.761.
\351\ 17 CFR 242.775.
\352\ 17 CFR 15a-11.
\353\ 17 CFR 242.772.
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We are not proposing to extend to thrifts the proposed general
custody exemption in Exchange Act Rule 760,\354\ the proposed new ERISA
exemption in Exchange Act Rule 770,\355\ or the proposed Regulation S
exemption in Exchange Act Rule 771, however, because we were unable to
obtain sufficient information to determine whether thrifts directly
engage in the types of securities activities covered by these proposed
exemptions.\356\ We solicit comment on whether thrifts engage in
securities activities or transactions that would be covered by the
excluded exemptions. We invite commenters to provide specific
information about their current business models that would require them
to utilize these proposed exemptions. For example, do thrifts have
income that does not qualify as ``relationship compensation'' for
employee benefit plan accounts and that cannot be accommodated by the
small bank custody exemption? With respect to those securities
activities or transactions that are not covered by the excluded
exemptions, we seek empirical data from individual thrifts regarding
the type and amount of compensation received for each of these
securities activities. Thrift commenters are invited to answer the
specific request for comments in each of the exemptions.
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\354\ 17 CFR 242.760.
\355\ 17 CFR 242.770.
\356\ 17 CFR 242.771.
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[[Page 39721]]
5. Credit Unions
Because credit unions are not ``banks'' under the Exchange
Act,\357\ they cannot utilize the bank exceptions from the definitions
of broker and dealer. While nine commenters indicated that some, or
all, of the exceptions should be extended to credit unions, the
commenters generally conceded that credit unions do not currently
engage in many of the securities activities authorized for banks under
the Exchange Act exceptions from the definitions of ``broker'' and
``dealer.'' \358\
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\357\ The term ``bank'' is defined in Exchange Act Section
3(a)(6).
\358\ See ACCU letter; CUNA letter; NACUSO letter; NASCUS
letter; NCUA letter; NAFCU letter; Navy Federal letter; Ohio Credit
Union League letter; and U.S. Central Credit Union letter.
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Based on the Commission staff's discussions with credit union
representatives, we understand that credit unions are engaged in a very
limited securities business today.\359\ We do not propose extending all
of the transaction-based bank exceptions in Exchange Act Section
3(a)(4) to credit unions for their potential future securities
activities. We do, however, propose to extend three of the bank
exceptions to provide a limited accommodation for credit unions. As is
true under the rule for the savings associations and savings banks,
credit unions utilizing this proposed exemption would be subject to all
of the same conditions and definitions as are applicable to banks that
utilize the exceptions from the definitions of ``broker'' and
``dealer.''
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\359\ This reflects the fact that credit unions, unlike banks,
never had a blanket exception from broker-dealer registration.
Therefore, credit unions that wanted to conduct a securities
business always had to do so through a registered broker-dealer.
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a. Networking
Credit unions currently may enter into networking arrangements with
broker-dealers under the conditions set forth in the Chubb letter.\360\
However, banks, savings banks, and savings and loan associations can
network with broker-dealers under the terms of the Exchange Act Section
3(a)(4)(B)(i) exception for third-party brokerage arrangements.\361\
This bifurcated system makes compliance more complicated for broker-
dealers that have networking arrangements with a variety of financial
institutions. It also creates an unequal playing field among financial
institutions offering the same services.
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\360\ See Chubb Letter, a staff no-action letter, supra note 37.
The staff no-action letter sets forth the terms under which
financial institutions (federal and state chartered banks, savings
and loan associations, savings banks, and credit unions) may
participate in the networking arrangement.
\361\ As discussed throughout this release, banks, savings banks
and savings associations continue to have a temporary exemption from
the Exchange Act definition of ``broker.'' The networking exception
in Exchange Act Section 3(a)(4)(B)(i) and proposed Exchange Act Rule
710 set forth the terms that banks and savings associations will
follow when the Exchange Act's bank broker exceptions and rules are
fully implemented.
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We, therefore, propose Exchange Act Rule 774 \362\ to address these
issues by simplifying the terms under which credit unions may enter
into networking arrangements by exempting them from the definition of
broker under the terms of the bank networking exception in Exchange Act
Section 3(a)(4)(B)(i),\363\ including any related interpretive and
exemptive rules for banks' networking activities that the Commission
may adopt. The proposed rule would subject credit unions to the same
uniform networking rules that apply to banks and savings associations.
This should simplify compliance for credit unions as well as for the
broker-dealers that enter into networking arrangements with different
types of retail depository institutions. If the Commission adopts this
proposal as a final rule, the rule would supercede the staff no-action
letter. We request comment on whether this is appropriate. We also
request comment on whether any additional conditions or limitations
should be imposed on credit unions that enter into networking
arrangements with broker-dealers.
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\362\ 17 CFR 242.774.
\363\ 15 U.S.C. 78c(a)(4)(B)(i).
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b. Sweep Accounts
The sweep accounts exception is a limited transactional exception
that permits banks to sweep deposit funds into no-load, open-end money
market funds.\364\ One credit union requested a Commission exemption to
engage in this activity. The Commission published this request along
with a request for comment in June 2002.\365\ After reviewing the
credit unions' comments, we are proposing Exchange Act Rule 774 to
provide an exemption for credit unions to provide sweep account
services. In particular, proposed Exchange Act Rule 774 would permit
credit unions to sweep deposit accounts into no-load money market funds
under the terms of the bank exception in Exchange Act Section
3(a)(4)(B)(v).\366\ Because the statutory exception is limited, any
incentives for abuse are also limited. Thus, we believe extending this
exception to credit unions would not raise investor protection
concerns. Moreover, it should place financial institutions offering
similar services on a more level playing field.
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\364\ Exchange Act Section 3(a)(4)(B)(v). 15 U.S.C.
78c(a)(4)(B)(v).
\365\ See Notice of Application of Evangelical Christian Credit
Union for Exemptive Relief Under Sections 15 and 36 of the Exchange
Act and Request for Comment, Exchange Act Release No. 46069 (June
12, 2002), 67 FR 41545 (June 18, 2002) (available at http://www.sec.gov/rules/other/
).
\366\ 15 U.S.C. 78c(a)(4)(B)(v).
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c. Investment, Trustee, and Fiduciary Transactions
The investment transactions exception in Exchange Act Section
3(a)(5)(ii) permits a bank to buy or sell securities ``for investment
purposes'' for its own account or for the accounts for which it acts as
a trustee or fiduciary.\367\ We propose to include in Exchange Act Rule
774 an exemption for credit unions from the definition of dealer to
permit credit unions to buy and sell securities for investment purposes
for themselves, or for accounts for which they act as trustee or
fiduciary under the terms of the bank exception in Exchange Act Section
3(a)(5)(C)(ii).\368\ While credit unions may rely on the dealer-trader
distinction \369\ for their proprietary trading, extending this
exemption to credit unions should provide them with legal certainty.
With respect to transactions for trust and fiduciary account customers,
we would expect credit unions' fiduciary obligations to provide these
customers with sufficient protections.
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\367\ As we noted in footnote 83 of the release in which we
adopted final ``dealer'' rules for banks, [Exchange Act Release No.
47364, 68 FR 8686 (Feb. 24, 2003)], the ``dealer'' exception for
trustee and fiduciary transactions only applies when the bank buys
or sells securities for investment purposes for the bank, or for
accounts for which the bank acts as a trustee or fiduciary.
Furthermore, in giving meaning to the term ``fiduciary'' in Exchange
Act Section 3(a)(5)(C)(ii), we look to the legislative history. The
legislative history states that Exchange Act Section 3(a)(5)
``excepts a bank from the definition of `dealer' when it buys and
sells securities for investment purposes for the bank, or for
accounts for which the bank acts as trustee or fiduciary. This
mirrors existing law distinguishing between investors and dealers,
and is limited to the portfolio trading of the bank and the accounts
for which it makes investment decisions.'' H.R. Rep. No. 106-74, pt.
3, at 170-171 (1999).
\368\ 15 U.S.C. 78c(a)(5)(C)(ii).
\369\ See Section IV of the Dealer Release for a discussion of
the Dealer/Trader distinction. Exchange Act Release. No. 47364 (Feb.
14, 2003).
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d. Scope of Credit Union Exemption
We propose to permit all credit unions to utilize the proposed
Exchange Act Rule 774 exemptions. This would include federal- and
state-chartered credit unions, as well as federally insured and
privately insured credit unions. We are preliminarily of the view that
these transactions should be handled in the same way under one uniform
set of rules for all credit unions, as well as for all banks and
savings
[[Page 39722]]
associations. The proposed exemption would grant credit unions these
three statutory exceptions but this exemption would not automatically
give them any associated exemptions we may grant to banks in the
future.
The Commission requests comment on proposed Exchange Act Rule
774.\370\ In addition, the Commission specifically requests comment on
whether state-charted, privately insured credit unions (which do not
have a federal regulator) should be included within the scope of the
exemption.\371\ Commenters are requested to discuss the scope of the
supervision of state-chartered, privately insured credit unions and the
legal framework applicable to these entities.
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\370\ We also request comment on whether there are other issues
or restrictions that we should consider in connection with this
exemption for these three securities activities.
\371\ In contrast to credit unions, all banks and savings
associations have a federal regulator.
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e. Additional Exemptions for Credit Unions
Exchange Act Section 3(a)(4)(B)(viii) provides banks with an
exception from the definition of broker for certain safekeeping and
custody activities.\372\ Under this exception, a bank is not considered
a ``broker'' if, as part of its customary bank activities, it engages
in certain specified types of safekeeping and custody services with
respect to securities on behalf of its customers. The exception
generally permits banks to hold securities, pledge securities, lend
securities held in custody, and reinvest collateral.\373\
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\372\ 15 U.S.C. 78c(a)(4)(B)(viii).
\373\ Exchange Act Section 3(a)(4)(B)(viii)(aa-ee). This
exception is discussed in greater detail in Section III.E. supra.
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The National Credit Union Administration (``NCUA'') has indicated
to the Commission staff that credit unions are authorized to hold
custody of customer funds and securities in connection with securities
transactions. However, the Commission staff has no evidence that credit
unions engage in the activities included in the safekeeping and custody
activities exception. For this reason, we are not proposing to give
credit unions a custody exemption.
We invite comment on the extent to which credit unions utilize
their authority to hold custody of customer funds and securities, and
whether credit unions engage in any of the types of transactions
enumerated in the bank safekeeping and custody exception. Do credit
unions hold custody of customer funds and securities in connection with
transactions other than the networking, sweep accounts, or investment
transactions described above? Credit union commenters are invited to
discuss any legal authority on which they currently rely to engage in
any of these additional activities.\374\
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\374\ As part of transactions covered by the proposed exemptions
for networking, sweep accounts, and investment, trustee and
fiduciary transactions, a credit union would be permitted to hold
customer funds and securities in connection with the securities
transactions that fall within the exemptions.
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Because we have no evidence that credit unions require additional
exemptions for the safekeeping and custody of customer funds and
securities in connection with securities transactions, we are not
proposing additional exemptions at this time. Commenters that believe
additional exemptions are warranted should explain why an exemption is
needed and discuss how such an exemption would be in the public
interest, and whether any additional conditions should be added to
protect investors. In addition, we specifically invite comment on how
any credit unions that need additional exemptions are regulated, both
under state and federal law.
6. Exemption for the Way in Which Banks Effect Transactions in
Investment Company Securities
Exchange Act Section 3(a)(4)(C) requires a bank to execute through
a registered broker-dealer (or internally cross) transactions executed
in the United States in securities that are publicly traded in the
United States that are effected pursuant to either the trust and
fiduciary activities exception, the safekeeping and custody exception,
or certain stock purchase plans exception.\375\ Current Exchange Act
Rule 3a4-6, however, exempts from this requirement banks that process
transactions in shares of investment company securities through the
National Securities Clearing Corporation's (``NSCC'') Mutual Fund
Services,\376\ including Fund/SERV.\377\
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\375\ 15 U.S.C. 78c(a)(4)(B)(ii), (iv), and (viii).
\376\ NSCC is a clearing agency registered pursuant to Exchange
Act Section 17A. 15 U.S.C. 78q-1. A ``clearing agency'' is a person
that acts as an intermediary in making payments or deliveries (or
both) in connection with transactions in securities, or that
provides facilities for comparing data with respect to the terms of
securities transactions to reduce the number of settlements or the
allocation of securities settlement responsibilities. See 15 U.S.C.
78c(a)(23)(A). A clearing agency is an SRO, and its rules of
operation are subject to approval by the appropriate federal
regulatory agency. See 15 U.S.C. 78c(a)(26), 78s(b). See also
Investment Company Act Release No. 26288 (Dec. 11, 2003), 68 FR
70388, 70395 at n. 11 (Dec. 17, 2003).
\377\ NSCC's Mutual Fund Services provide an automated system to
participants to process transactions in investment company
securities. Fund/SERV centralizes order entry, confirmation,
registration, and settlement of purchases and redemptions of
investment company securities. NSCC's Mutual Fund Services are
available to investment companies, broker-dealers, banks, trust
companies, and other financial institutions that have been accepted
for membership in the NSCC.
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Banks that use NSCC's Mutual Fund Services to execute transactions
in investment company securities advised us that they may not use a
registered broker-dealer to execute these transactions, depending on
whether NSCC's arrangement is with the principal underwriter or a
transfer agent that acts as agent for the investment company.
Therefore, some industry representatives indicated informally to the
staff that banks needed an exemption from the trade execution
requirements of Exchange Act Section 3(a)(4)(C) to continue to use the
NSCC's Mutual Fund Services, while complying with exceptions and
exemptions from the definition of broker. Exchange Act Rule 3a4-6 was
designed to allow banks to continue to execute transactions in shares
of open-end investment companies through NSCC's Mutual Fund Services
because NSCC's Mutual Fund Services simplify and automate the process
for purchasing and redeeming investment company securities.\378\ This
exemption is a limited one and is only available to banks that process
orders through a service of a registered clearing agency subject to the
supervision and regulation of the Commission.
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\378\ In light of the recent scandals involving the market
timing of shares issued by certain registered open-end investment
companies, this exemption could potentially allow further abuses to
go undetected. Current Exchange Act Rule 3a4-6 is not an exemption
from other provisions of the federal securities laws such as
sections 206(1) and 206(2) of the Investment Advisers Act (15 U.S.C.
80b-6(1) and (2)) or Section 34(b) of the Investment Company Act (15
U.S.C. 80a-33(b)).
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Commenters generally supported this exemption. However, some urged
the Commission to expand the exemption to include mutual fund purchases
and redemptions directed to the fund's transfer agent.\379\ These
commenters indicated that such an exemption would reflect banks'
current practices.\380\
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\379\ See ABA/ABASA letters; Mellon Bank letter; BONY letter;
Wilmington Trust letter; NYCH letter; PNC Bank letter; Northern
Trust letter; Shaw Pittman letter; and Wells Fargo letter.
\380\ In 2002, Fund/SERV processed approximately 83 million fund
transactions, half of all such transactions processed that year.
Transfer agents processed the others. See Investment Company Act
Release No. 26288, supra note 376 at n. 64.
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We, therefore, propose to expand this exemption to permit banks to
process purchases and redemptions of shares of open-end investment
companies directly with transfer agents that act as agents for these
investment companies, provided that the transfer agents do not
[[Page 39723]]
accept compensation paid for the distribution of the securities,
including any compensation paid pursuant to any revenue-sharing
arrangement or pursuant to Rule 12b-1 of the Investment Company
Act.\381\ The proposed exemption would only be available for securities
that are distributed by registered broker-dealers or otherwise sold for
sales loads that do not exceed the NASD limits for broker-distributed
funds. This condition is intended to ensure that mutual fund investors
will not incur higher loads for the same funds if they choose to
purchase through banks, rather than through registered broker-dealers.
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\381\ See 17 CFR 270.12b-1. Transfer agents that are not
registered as broker-dealers need to consider whether the securities
activities that they are undertaking are brokerage activities that
require them to register as broker-dealers. Exchange Act Section
3(a)(4) defines a ``broker'' as a person engaged in the business of
effecting transactions in securities for the account of others. It
includes several exceptions for certain bank activities. See 15
U.S.C. 78c(a)(4). Exchange Act Section 15 essentially makes it
unlawful for a broker or dealer ``to effect any transactions in, or
induce or attempt to induce the purchase or sale of, any security
(other than an exempted security or commercial paper, bankers'
acceptances, or commercial bills)'' unless the broker or dealer is
registered with the Commission. See 15 U.S.C. 78o(a)(1). See also
Investment Company Act Release No. 26288, supra note 376 at n. 7.
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We propose to limit this exemption to transactions in securities of
open-end investment companies that are not traded on a national
securities exchange, through the facilities of a national securities
association, or through an interdealer quotation system.\382\ This
exemption would not be necessary with regard to these securities
because investors purchase or sell such shares through broker-dealers
at market prices throughout the day.
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\382\ For example, this exemption from executing trades through
a registered broker-dealer would not be available for exchange-
traded funds, which are investment companies that are registered
under the Investment Company Act as open-end funds or unit
investment trusts. Section 5(a)(1) of that Act defines an open-end
fund as an investment company that is a management company, which
offers, or has outstanding, any redeemable security of which it is
the issuer. 15 U.S.C. 80a-5(a)(1). Section 4(2) of the Investment
Company Act defines a unit investment trust as an investment company
that is organized under a trust indenture or similar instrument,
that does not have a board of directors, and that issues only
redeemable securities, each of which represents an undivided
interest in a unit of specified securities. 15 U.S.C. 80a-4(2). See
Investment Company Act Release No. 25258 (Nov. 8, 2001).
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We solicit comment on the proposed amendments to this exemption. We
invite comment with regard to the use of omnibus accounts in the
context of this proposal. In particular, we request comment about the
issues raised, especially those arising from conflicts of interest
associated with 12b-1 fees, and how they are disclosed by banks to
custody account customers. We also seek comment regarding the number
and percentage of fund share orders submitted directly to designated
transfer agents.
While not specifically addressing Exchange Act Rule 3a4-6, one
commenter requested guidance on the meaning of the term ``publicly
traded security [in the United States]'' within the context of Exchange
Act Section 3(a)(4)(C).\383\ Exchange Act Section 3(a)(4)(C)(i)
requires a bank to direct trades in publicly traded securities in the
United States to a registered broker-dealer for execution. However, a
U.S. registered broker-dealer would not necessarily provide the most
liquid markets and the best prices for foreign securities, because the
primary trading markets for foreign securities are located outside of
the United States. Thus, if a bank customer requests a security listed
or traded primarily outside of the United States, Exchange Act Section
3(a)(4)(C) gives banks the flexibility to seek the best markets for
that security. In other words, Exchange Act Section 3(a)(4)(C)
encourages banks to obtain best execution for securities by directing
them to registered broker-dealers for U.S. transactions, but not for
foreign transactions.
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\383\ See Compass letter. In that letter, the commenter asked
the Commission to clarify that shares of open-end investment
companies are not ``publicly traded securities'' within the meaning
of Exchange Act Section 3(a)(4)(C) unless the shares are, in fact,
traded on a recognized exchange.
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Publicly traded securities \384\ include all securities in which at
least two registered broker-dealers have indicated a willingness to
quote a price, securities that are registered under Exchange Act
Section 12,\385\ or those from an investment company that is required
to file reports under Exchange Act Section 15(d).\386\ The term
includes equity securities, regardless of whether they are traded
through a national securities exchange, an automated quotation system
sponsored by a registered national securities association, an
alternative trading system, an electronic communications network,
Nasdaq's Over-the Counter Bulletin Board service, or an interdealer
quotation system such as the one operated by Pink Sheets LLC.\387\ The
term also includes debt securities and hybrid securities.\388\ We
solicit comment about whether the term ``publicly traded securities''
should be defined by rule.
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\384\ While the term ``publicly traded security'' is used in
other sections of the Exchange Act for specific purposes, see, e.g,
15 U.S.C. 78m(h) and 78u-3(c)(3)(A)(i), the term is commonly
understood to encompass a broader range of securities than these
other particular uses would indicate.
\385\ 15 U.S.C. 78l.
\386\ 15 U.S.C. 78o(d).
\387\ Pink Sheets LLC is a privately owned company that provides
pricing and financial information for equity securities that are not
listed on a national securities exchange or quoted on Nasdaq.
\388\ Hybrid securities are securities with features common to
both equity and debt securities.
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G. Temporary Exemptions
1. Extension of Time and Transition Period
Commenters have indicated that banks may need as much as a year to
develop compliance systems to adapt to the more limited Exchange Act
bank exceptions from the definition of broker. The Commission has also
stated that it does not expect banks to develop compliance systems for
the broker exceptions until the Commission has adopted any amendments
to the Interim Rules.
We recognize that when the bank broker exceptions are fully
effective, some banks may need a transition period as they move toward
statutory compliance.\389\ Exchange Act Rule 15a-7 provides such a
transition period, and we propose to amend that rule, which would be
redesignated as Exchange Act Rule 781, to extend the transition period
to one year after any amended rules are adopted. We expect banks to use
this time to develop compliance systems.\390\
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\389\ 17 CFR 240.15a-7.
\390\ For example, if the bank broker rules were adopted by
year-end 2004, then the bank broker exceptions would apply one year
later, beginning January 1, 2006. Thus, banks would not have to be
in compliance with the terms of the exception or exemption during
2005, but should develop compliance systems to be used beginning in
2006.
With respect to the ``chiefly compensated'' requirements, 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 risk of
noncompliance with these requirements during 2007. See proposed
Exchange Act Rule 722(a)(2).
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We request comment on the proposed amendment to this temporary
exemption, and, in particular, on whether banks would need a full year
to develop compliance systems. We also request comment on whether the
transition period should cease at the end of a calendar year.
2. Temporary Exemption for Contracts Entered Into by Banks From Being
Considered Void or Voidable
Current Exchange Act Rule 15a-8 recognizes that banks may have
inadvertent, technical violations as they become accustomed to any new
regulatory requirements. This exemption mitigates the unique compliance
problems that banks may
[[Page 39724]]
have by eliminating the possibility that any inadvertent failures by
banks could trigger rescission under Exchange Act Section 29 during
this transitional period.\391\ The Commission amended this exemption in
the rules addressing the exceptions from the definition of ``dealer''
under the Exchange Act to provide a transitional period from rescission
liability under Exchange Act Section 29 on contracts entered into by
banks in a dealer capacity for a finite period until March 31,
2005.\392\
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\391\ Exchange Act Section 29(b) provides, in pertinent part,
that every contract made in violation of the Exchange Act or of any
rule or regulation thereunder shall be void.
\392\ See Exchange Act Release No. 47364, supra note 34, 68 FR
8686.
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We received a few comments on Exchange Act Rule 15a-8.\393\ All of
these commenters supported this temporary exemption for banks. One
commenter said that liability for any violation of the broker-dealer
registration requirements should be limited to customers or groups of
customers that received the services or were parties to the
transactions.\394\
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\393\ See ABA/ABASA letters; Banking Agencies letter; NYCH
letter; NASAA letter; and Regions letter.
\394\ See NYCH letter.
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Once we adopt any final rules, or amendments to the bank broker
rules, we anticipate extending the compliance date for the broker
statutory exceptions and rules to provide banks with an appropriate
transition period. We therefore propose to extend the exemption from
rescission liability under Exchange Act Section 29 to contracts entered
into by banks acting in a broker capacity until 18 months after the
delayed effective date of the broker rules.
This proposed exemption, which would be codified in proposed
Exchange Act Rule 780, would be limited to bank contracts being
considered void or voidable by reason of Exchange Act Section 29
because a bank that is a party to the contract violated the
registration requirements of Section 15(a) of the Exchange Act or any
applicable provision of this Act and the rules and regulations
thereunder, based solely on a bank's status as a broker or dealer when
the contract was created.
We note that this proposed exemption would not relieve banks of the
obligation to register as a broker or dealer if their securities
activities do not fit within a specific functional exception or
exemption. We also note that banks' securities activities continue to
be subject to the antifraud provisions of the federal securities laws,
irrespective of the bank's lack of registration or failure to comply
with the provisions of the Exchange Act and the related rules that
otherwise apply to banks based on their status as broker-dealers. We
request comment on extending the temporary exemption from Exchange Act
Section 29(b).
H. Amendment to Exchange Act Rule 15a-6
Exchange Act Rule 15a-6 provides a conditional exemption from U.S.
broker-dealer registration for certain foreign broker-dealers.\395\
Exchange Act Rule 15a-6 (a)(4)(i) allows a foreign broker-dealer,
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.'' \396\ Thus,
in transactions between a U.S. bank and its foreign broker-dealer
affiliate, acting as principal, the U.S. bank could rely on the
affiliate transactions exception in the GLBA,\397\ and the foreign
affiliate could rely on Rule 15a-6(a)(4)(i). As discussed in the
release adopting the Interim Rules, Exchange Act Rule 15a-6(a)(4)(i),
however, does not permit a foreign broker-dealer or bank to have direct
contact with customers of the U.S. bank.\398\ Moreover, the affiliate
transactions exception would not permit the U.S. bank to effect
transactions with its foreign affiliate's customers.\399\ We received
no comments on our discussion of the interplay between Exchange Act
Rule 15a-6 and the affiliate transactions exemption and we are not
proposing to change that analysis in the current proposal.
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\395\ 17 CFR 240.15a-6. Even when the GLBA permits a bank to
engage in securities-related activities without itself registering
as a broker-dealer, a broker-dealer engaged in the business of
effecting transactions for such bank still must register--absent an
exemption or other exclusion from the broker-dealer registration
requirements of the Exchange Act. For instance, a foreign broker-
dealer that executes trades for a bank under Exchange Act Section
3(a)(4)(C) would need to register as a U.S. broker-dealer if it does
not meet the conditions of Exchange Act Rule 15a-6, or it does not
otherwise qualify for an exemption from registration. Foreign banks
cannot rely on the GLBA bank exceptions because they do not fall
within the definition of ``bank'' in Exchange Act Section 3(a)(6).
Cf. U.S. branches and agencies of foreign banks can rely on the bank
exceptions to the extent described in 54 FR 30013 at 30015, n. 16.
\396\ 17 CFR 240.15a-6(a)(4)(i).
\397\ Exchange Act Section 3(a)(4)(B)(vi).
\398\ 66 FR at 27783.
\399\ Id. A bank would, however, be permitted to sell Regulation
S securities to non-U.S. persons, including customers of a foreign
affiliate, as provided in the Regulation S exemption discussed at
section III.F.3, supra.
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We do, however, propose a technical amendment to Exchange Act Rule
15a-6 in light of the amended definitions of ``broker'' and ``dealer.''
Currently, Exchange Act Rule 15a-6(a)(4)(i) refers to ``a bank acting
in a broker or dealer capacity as permitted by U.S. law.'' As amended,
however, the definitions of ``broker'' and ``dealer'' in Exchange Act
Section 3(a)(4) and 3(a)(5) respectively, provide that banks engaging
in the conditional exceptions in those definitions ``shall not be
considered to be'' brokers or dealers. To reflect this change, we
propose to amend Exchange Act Rule 15a-6(a)(4)(i) by replacing the
phrase ``in a broker or dealer capacity as permitted by U.S. law'' with
the phrase ``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.'' \400\ We request comment on this proposed amendment to Exchange
Act Rule 15a-6(a)(4)(i).
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\400\ Nothing in this release should be construed as modifying
the Exchange Act Section 3(a)(6) definition of ``bank'' as it
applies to foreign banks. Currently, foreign banks generally would
not meet this definition and would be considered broker-dealers
under the U.S. securities laws. As such, foreign banks generally
would be required to register as U.S. broker-dealers unless they
qualify for an exemption from registration under Exchange Act Rule
15a-6.
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IV. Administrative Law Matters
A. General Request for Comments
We are soliciting comments on all aspects of these proposed new
rules and rule amendments. We also request comment on the portions of
the Interim Rules pertaining to banks' broker activities that we are
not proposing to amend, including Exchange Act Rule15a-9,\401\ which
provides an exemption from the definitions of ``broker'' and ``dealer''
for savings associations and savings banks. In addition, we encourage
comment on the other provisions of Exchange Act Section 3(a)(4)(B) that
we did not discuss in connection with these proposals. We plan to
address issues regarding issuer plans separately.\402\
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\401\ 17 CFR 240.15a-9.
\402\ Exchange Act Section 3(a)(4)(B)(iv)(III).
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Commenters should, when possible, provide us with empirical data to
support their views. Commenters suggesting alternative approaches
should provide comprehensive proposals, including any conditions or
limitations they believe should apply. We also specifically request
comment on when any final rules should become effective. Should
particular rules be implemented on a more delayed schedule? If so, why?
With respect to proposed exemptions that contain a grandfather clause,
have we proposed the most appropriate date for such purposes? If not,
why not? Commenters suggesting an alternative date should
[[Page 39725]]
provide reasons why they believe the alternative date would be more
appropriate.
Finally, individual banks that anticipate the need for additional
time to implement compliance systems for particular rules or statutory
provisions are encouraged to explain their specific needs.
B. Paperwork Reduction Act Analysis
Certain provisions of proposed Exchange Act Rules 776, 722, and 770
contain ``collection of information'' requirements within the meaning
of the Paperwork Reduction Act of 1995.\403\ The Commission has
submitted them to the Office of Management and Budget (``OMB'') for
review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The
collections of information under proposed Exchange Act Rules 776, 722,
and 770 are new. The title for the new collection of information under
proposed Exchange Act Rule 776 is ``Rule 776: Exemption for banks
effecting transactions for certain investors in money market funds.''
The title for the new collection of information under proposed Exchange
Act Rule 722 is ``Rule 722: Exemption for banks from determining
whether they are `chiefly compensated' on an account-by-account
basis.'' The title for the new collection of information under proposed
Exchange Act Rule 770 is ``Rule 770: Exemption from the definition of
`broker' for banks that effect transactions in securities in certain
employee benefit plans.'' OMB has not yet assigned a control number to
the new collections of information contained in proposed Exchange Act
Rules 776, 722, and 770. An agency may not conduct or sponsor, and a
person is not required to respond to, a collection of information
unless it displays a currently valid control number.\404\
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\403\ 44 U.S.C. 3501, et seq.
\404\ 44 U.S.C. 3512.
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1. Proposed Exchange Act Rule 776
a. Collection of Information
Proposed Exchange Act Rule 776(a)(2)(ii)(B) would require a bank
relying on this proposed exemption to provide customers that are not
qualified investors or persons that direct the purchase of securities
from any cash flows relating to asset-backed issues of at least
$25,000,000 with a prospectus for the securities bought or sold
pursuant to the proposed exemption and a clear and conspicuous notice
containing the information required by this proposed rule.\405\
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\405\ See proposed Exchange Act Rule 776(a)(2)(ii)(B) which
would require, among other things, that a bank would have to
disclose any payments it may receive in connection with transactions
effected pursuant to the proposed rule from the fund complex to
which the issuer of the securities belongs.
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b. Proposed Use of Information
The purpose of the collection of information in proposed Exchange
Act Rule 776 is to assure that a customer of a bank relying on the
exemption would have sufficient information upon which to make an
informed investment decision and to learn of any potential conflicts of
interest that the bank may have.
c. Respondents
The proposed collection of information in Exchange Act Rule 776
would apply to banks relying on the exemption provided in the proposed
rule.
d. Reporting and Recordkeeping Burden
The Commission estimates that approximately 500 banks annually
would use the exemption in proposed Exchange Act Rule 776 and each bank
would deliver the prospectus and notice required by the proposed rule
to approximately 1,000 customers annually. Therefore, the Commission
estimates that proposed Exchange Act Rule 776 would result in
approximately 500,000 responses per year. The Commission estimates
further that a bank would spend approximately .10 hour per response to
comply with the delivery requirement of proposed Exchange Act Rule 776.
Thus, the estimated total annual reporting and recordkeeping burden for
proposed Exchange Act Rule 776 is 50,000 hours. The Commission
estimates that the initial reporting and recordkeeping burden for this
proposed rule would be insubstantial, but we solicit comment on this
point.
e. Collection of Information Is Mandatory
This collection of information would be mandatory.
f. Confidentiality
The collection of information delivered pursuant to proposed
Exchange Act Rule 776 would be provided by banks relying on the
exemption in this rule to customers that are not ``qualified
investors,'' as defined in proposed Exchange Act Rule 776(b)(6).
g. Record Retention Period
Proposed Exchange Act Rule 776 would not include a record retention
requirement. Banks are subject to record retention requirements
promulgated by banking regulators.
2. Proposed Exchange Act Rule 722
a. Collection of Information
Proposed Exchange Act Rule 722(c)(2) would require banks relying on
the exemption in this rule to document the reason that an account has
continued not to meet the ``chiefly compensated'' condition and link
the reason to its exercise of fiduciary responsibility.
b. Proposed Use of Information
Proposed Exchange Act Rule 722 is intended to provide banks that
determine compliance with the ``chiefly compensated'' condition through
an account-by-account calculation with legal certainty for one year
based on their demonstrated compliance for the previous year. The
purpose of the collection of information in proposed Exchange Act Rule
722 is to document the reason a bank has not met the ``chiefly
compensated'' condition while still being able to rely on the exemption
provided in paragraph (c) of the rule.
c. Respondents
The proposed collection of information in proposed Exchange Act
Rule 722 would apply to banks that wish to utilize the exemption
provided in this proposed rule.
d. Reporting and Recordkeeping Burden
Based on information available to the Commission at this time, the
Commission estimates that approximately ten banks per year would use
the exemption provided by proposed Exchange Act Rule 722(c) for
approximately ten accounts per bank for a total of 100 responses
annually. The Commission estimates that it will take each bank
approximately .25 hour per response. Thus, the Commission estimates the
annual reporting and recordkeeping burden for proposed Exchange Act
Rule 722 to be 25 hours.
e. Collection of Information Is Mandatory
This collection of information would be mandatory.
f. Confidentiality
Banks relying on the exemption provided in proposed Exchange Act
Rule 722(c) would not be required to provide the documentation required
by the proposed rule to the Commission. Rather, banks would be required
to make the proper documentation and maintain such documentation in
compliance with existing recordkeeping requirements of banking
regulators.
[[Page 39726]]
g. Record Retention Period
Proposed Exchange Act Rule 722 would not include a record retention
requirement. Banks are subject to the record retention requirements
promulgated by banking regulators.
3. Proposed Exchange Act Rule 770
a. Collection of Information
Proposed Exchange Act Rule 770(a)(2)(ii) would require banks that
wish to utilize the exemption provided in this proposed rule to
disclose clearly and conspicuously to plan sponsors or their designated
fiduciaries all fees and expenses assessed for services provided to the
plan and all compensation received or to be received from a fund
complex.
b. Proposed Use of Information
The purpose of the collection of information in proposed Exchange
Act Rule 770 is to provide information to plan sponsors or their
designated fiduciaries to enable them to determine that a bank has
offset or credited any fees or expenses received from a fund complex
related to securities in which plan assets are invested against the
fees and expenses that the plan owes to the bank.
c. Respondents
The collection of information in proposed Exchange Act Rule 770
would apply to banks that administer employer-sponsored retirement
plans that wish to utilize the exemption provided in the proposed rule.
d. Reporting and Recordkeeping Burden
Based on the information available to the Commission at this time
regarding which banks might utilize the exemption in proposed Exchange
Act Rule 770, the Commission estimates that approximately 100 banks
would rely on proposed Exchange Act Rule 770 annually, and each bank
would provide the notice required by the proposed rule to approximately
100 plan sponsors. Thus, the Commission estimates that there would be
approximately 10,000 annual responses for proposed Exchange Act Rule
770. Based on discussions between Commission staff and industry
participants, the Commission believes that disclosure requirements of
proposed Exchange Act Rule 770 reflect current business practices of
banks, and as such, banks utilizing the exemption provided in proposed
Exchange Act Rule 770 would already have in place the systems and
procedures to make the disclosure required by the proposed Rule.
Therefore, the Commission believes that the time required for a bank to
comply with the clear and conspicuous notice requirement of the
proposed rule would require .10 hour per response. Thus, the Commission
estimates the total annual reporting and recordkeeping burden imposed
by proposed Exchange Act Rule 770 would be 1,000 hours.
e. Collection of Information Is Mandatory
This collection of information would be mandatory.
f. Confidentiality
The collection of information delivered pursuant to proposed
Exchange Act Rule 770 would be provided by banks to plan sponsors or
their designated fiduciaries.
g. Record Retention Period
Proposed Exchange Act Rule 770 would not include a record retention
requirement. Banks are subject to the record retention requirements
promulgated by banking regulators.
4. Request For Comment
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comments to:
(i) Evaluate whether the proposed collections of information are
necessary for the proper performance of the functions of the
Commission, including whether the information would have practical
utility;
(ii) Evaluate the accuracy of the Commission's estimates of the
burden of the proposed collections of information and provide the
Commission with data on proposed Exchange Act Rules 770, 772, and 776;
(iii) Enhance the quality, utility, and clarity of the information
to be collected; and
(iv) Minimize the burden of the collections of information on those
required to respond, including through the use of automated collection
techniques or other forms of information technology.
In addition to the general solicitation of comments above regarding
the collections of information contained in the proposed rules, the
Commission also solicits comments regarding how many banks would rely
on the exemptions provided in proposed Exchange Act Rules 776, 722, and
770, and whether banks relying on such exemptions would be able to use
existing systems, programs, and procedures to comply with the
collections of information requirements contained in the proposed
rules. Persons desiring to submit comments on the collection of
information requirements should direct them to the Office of Management
and Budget, Attention: Desk Officer for the Securities and Exchange
Commission, Office of Information and Regulatory Affairs, Washington,
DC 20503, and should send a copy of their comments to Jonathan G. Katz,
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW,
Washington, DC 20549-0609, and refer to File No. S7-26-04. OMB is
required to make a decision concerning the collection of information
between 30 and 60 days after publication of this release in the Federal
Register. Therefore, comments to OMB are best assured of having full
effect if OMB receives them within 30 days of this publication.
Requests for materials submitted to OMB by the Commission with regard
to this collection of information should be in writing, refer to File
No. S7-26-04, and be submitted to the Securities and Exchange
Commission, Records Management, Office of Filings and Information
Services, 450 Fifth Street, NW, Washington, DC 20549.
C. Consideration of Benefits and Costs
1. Introduction
Prior to enactment of the GLBA, banks were exempted from the
definitions of ``broker'' and ``dealer'' in Sections 3(a)(4) and
3(a)(5) of the Exchange Act, respectively. As a result, notwithstanding
the fact that banks may have conducted activities that would have
brought them within the scope of the broker or dealer definitions, they
were not required by the Exchange Act to register as such.\406\ The
GLBA replaced banks' historic exemption from the definitions of
``broker'' and ``dealer'' with fifteen functional exceptions. Eleven of
these exceptions apply to broker activities and are the subject of this
release.\407\
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\406\ Exchange Act Release No. 44291, supra note 13, 66 FR at
27761.
\407\ See Exchange Act Section 3(a)(4)(B)(i) `` (xi).
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In May 2001, when the Commission adopted the Interim Rules, it
analyzed their costs and benefits and noted:
[w]hile these rules may affect how the banks' restructuring occurs,
we believe that most of the restructuring will stem from the statute
and not from the rules themselves. Moreover, the extent to which
banks need to restructure may be limited by the way they already do
business. The majority of banks conduct most of their securities
activities through registered broker-dealers that are already
regulated by the Commission.\408\
\408\ 66 FR at 27790.
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Given that the costs and benefits of the Interim Rules were
discussed at the time they were adopted, this discussion will focus on
the costs and benefits that could result from the changes the
[[Page 39727]]
Commission is proposing to make through Regulation B.
2. Discussion of Proposed Regulation B
Proposed Regulation B responds to commenters' concerns that the
Interim Rules are overly complex, do not provide banks with sufficient
flexibility, and would be too costly to implement. The potential
benefits and costs of the principal amendments the Commission is
proposing are discussed below.
a. Networking Exception
Exchange Act Section 3(a)(4)(B)(i) excepts banks from the
definition of ``broker'' if they enter into a contractual or other
written arrangement with a registered broker-dealer to share revenue
when the broker-dealer offers brokerage services to bank customers.
This ``networking'' exception is subject to several conditions.
The section also permits banks to motivate unregistered bank
employees--such as tellers, loan officers, and private bankers--to
refer bank customers to their broker-dealer networking partners,
through the payment of nominal referral fees.\409\
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\409\ Exchange Act Section 3(a)(4)(B)(i)(VI) limits such
referral fees to a ``nominal one-time cash fee of a fixed dollar
amount'' and requires that the payment of the fees not be contingent
on whether the referral results in a transaction.
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Commenters complained that provisions of the Interim Rules defining
how these referral fees could be paid would impose unnecessary limits
on bank networking arrangements and administrative burdens on
banks.\410\ As a result, the Commission is proposing to amend these
provisions to allow banks to pay referral fees that do not exceed: (1)
the referring employee's base hourly rate of pay; (2) $15 plus an
adjustment for inflation; or (3) $25 without adjustment for inflation.
Moreover, the Commission is proposing to permit banks to pay their
employees non-cash referral fees under certain conditions.\411\
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\410\ Exchange Act Rule 3b-17(g)(1) defines the term ``nominal
one-time cash fee of a fixed dollar amount.''
\411\ See proposed Exchange Act Rule 710(b).
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The Commission believes that banks will benefit in a number of ways
from the proposed amendments. For example, establishing a flat fee or
inflation-adjusted fee could benefit the over 8,000 smaller banks--the
entities that the Commission anticipates will be most likely to take
advantage of this exemption--by permitting them to pay their employees
for referrals in a manner that is easy to understand and requires no
complicated calculations. In addition, permitting banks to pay referral
fees based on an employee's base hourly rate of pay will give banks
objective and easily calculable approaches to paying their employees
referrals while remaining consistent with the requirements of the GLBA
that such fees be ``nominal'' in relation to the overall compensation
of the referring employees.
The Commission does not anticipate that the proposed changes to the
networking exception rules will impose any material additional costs to
banks other than those costs that banks already would incur as a result
of the GLBA and the Interim Rules. The proposed amendments discussed
above are designed to provide banks flexibility while being consistent
with the statutory requirements. We believe that any cost of compliance
would not be significant.
We request comments generally on the costs and benefits associated
with the proposed changes to the networking exception rules. We also
invite banks to provide us with additional information, including data,
to assist us in further evaluating the costs and benefits associated
with the proposed change to the networking exception. We invite banks
to include estimates of their start-up costs for updating their
systems, and their annual ongoing costs for complying with the proposed
changes discussed above. We invite commenters to provide us with data
to assist the Commission in further evaluating these proposed rules. We
specifically invite comment regarding the costs associated with
proposed Exchange Act Rule 710's alternative measures of nominal
referral fee value based on $15 adjusted for inflation, $25 without an
adjustment for inflation, and an unregistered employee's hourly rate of
pay. We also request comment on any other costs banks would likely need
to incur as a result of the proposal, and ask that commenters provide
us with data to support their views.
b. Trust and Fiduciary Activities Exception
Exchange Act Section 3(a)(4)(B)(ii) permits a bank, under certain
conditions, to effect transactions in a trustee or fiduciary capacity
in its trust department or other department that is regularly examined
by bank examiners for fiduciary principles and standards without
registering as a broker. To qualify for the trust and fiduciary
activities exception, Exchange Act Section 3(a)(4)(B)(ii) requires that
the bank be ``chiefly compensated'' for such transactions on the basis
of the types of fees specified in the GLBA.
The Commission believes that the proposed amendments to the Interim
Rules dealing with the trust and fiduciary activities exception should
provide a number of benefits to banks and their customers without
imposing significant costs on either group.\412\ Indeed, virtually all
of the proposed amendments, discussed above, are in response to
commenters' concerns that certain aspects of the Interim Rules are
overly costly or burdensome to banks.
---------------------------------------------------------------------------
\412\ The trust and fiduciary exception is addressed in proposed
Exchange Act Rules 720-724.
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The proposed amendments to the ``chiefly compensated'' test and
related exemptions should reduce banks' compliance costs and make the
trust and fiduciary activities exception more useful. For example, the
proposed line-of-business test should provide banks with a less costly
approach for determining compliance with the trust and fiduciary
activities exception. Similarly, the Commission's proposal to
grandfather living, testamentary, and charitable trust accounts opened
prior to a certain date should reduce banks' compliance costs by
allowing them not to analyze these older accounts. In addition, the
proposed exemptions for money market accounts, employee benefit plan
accounts, and Regulation S accounts for non-U.S. persons, the benefits
and costs of which are discussed below, should provide banks with the
option of excluding from the ``chiefly compensated'' analysis
compensation a bank receives from these accounts provided the accounts
are in lines of business that do not contain other accounts not subject
to an exemption. The proposed safe harbors should provide banks with
legal certainty with respect to their compliance with the trust and
fiduciary activities exception. The Commission also is proposing to
amend the small bank custody exemption so that it can be used by
qualifying small banks in lieu of complying with the ``chiefly
compensated'' condition and the other requirements of the trust and
fiduciary activities exception.
Moreover, the Commission is proposing to remove a current
requirement in the Interim Rules that banks provide ``continuous and
regular'' investment advice to their customers' accounts.\413\ This
proposed amendment to the definition of ``investment adviser if the
bank receives a fee for its investment advice'' could make it easier
for banks to determine that they are acting in a fiduciary capacity
with respect to those accounts and thereby make it easier for banks to
rely on the trust and fiduciary activities exception
[[Page 39728]]
in Exchange Act Section 3(a)(4)(B)(ii).\414\ In particular, in the
absence of the ``continuous and regular'' requirement, banks would not
be required to monitor the frequency with which their employees provide
advice to determine whether they are meeting a certain continuity
standard. In addition, banks would not be required to impose on their
employees arbitrary requirements that they take steps to demonstrate
continuity of advice, such as contacting customers, merely to satisfy
the ``continuous and regular'' standard.\415\
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\413\ Compare Exchange Act Rule 3b-17(d)(1) with proposed
Exchange Act Rule 724(d)(2).
\414\ See Exchange Act Section 3(a)(4)(D) which defines
``fiduciary capacity'' for purposes of the trust and fiduciary
exception to mean, among other things, ``as an investment adviser if
the bank receives a fee for its investment advice.''
\415\ From the perspective of the banks' customers, the removal
of the ``continuous and regular'' requirement could reduce the
number of unwanted contacts they receive from their banks. The
removal could also decrease the likelihood that bank employees would
make confusing or unnecessary securities recommendations to the
banks' customers merely to ensure that the employees are providing
``continuous and regular'' investment advice.
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As the Commission noted in the release adopting the Interim Rules,
banks are likely to incur costs to comply with the GLBA, but ``almost
all of these costs will be necessary because of the statutory change
and not because of the interim final rules.'' \416\ The same is true
with respect to the proposed amendments to the Interim Rules. None of
the amendments discussed above with respect to the trust and fiduciary
activities exception imposes additional requirements on banks. Indeed,
for the most part, the proposed rules would increase the number of
available exemptions.
---------------------------------------------------------------------------
\416\ 66 FR at 27793.
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Although the proposed exemptions to the ``chiefly compensated''
test should reduce banks' costs to comply with the trust and fiduciary
activities exception, banks will incur costs in complying with the
statutory ``chiefly compensated'' condition. The costs of compliance
with the ``chiefly compensated'' condition, however, are already
established by the GLBA and, to the extent they are not, they are
established by current Exchange Act Rule 3a4-2. As a result, the
Commission does not believe that banks would incur additional marginal
costs to comply with the liberalized exemptions proposed in Exchange
Act Rules 720 through 724.
We solicit comment on the costs and benefits banks expect to incur
in complying with the ``chiefly compensated'' condition in the statute.
We anticipate that most banks that are subject to the ``chiefly
compensated'' condition will utilize the proposed line-of-business
exemption, and other exemptions, such as the proposed money market
account exemption, if available. To the extent that this is true, we
ask that commenters attempt to provide us with data associated with
complying with the ``chiefly compensated'' condition after excluding
lines of business that are covered by an exemption.
In determining the costs associated with the ``chiefly
compensated'' condition, we also seek comment on how banks track
revenue from their trust and fiduciary business (e.g., on a line-of-
business basis or by type, such as assets under management fees), and
whether their systems are able to distinguish revenue from various
lines of business, including lines of business covered by an exemption.
In addition, we seek comment on how banks track revenue they earn from
mutual funds, and whether banks can separate 12b-1 fees between
fiduciary and custody accounts and along lines of business in the
fiduciary activity accounts.
We also seek comment on whether the ``chiefly compensated''
condition will require banks to track compensation in a manner that
they have not done before, and if so, we would like information on the
start-up and annual ongoing costs to update systems to track
compensation in this manner. We have received preliminary estimates
indicating that the costs associated with complying with the ``chiefly
compensated'' condition would range from minimal to $100,000. Those
banks that estimate the costs to be minimal have indicated that their
systems currently are able to track compensation consistent with this
condition. Other banks intend to stop receiving Rule 12b-1 fees. Those
banks whose cost estimates on the high end of the range contend that
their current systems would need to be reprogrammed to track
compensation consistent with this condition. We solicit comment on
these estimates.
c. Safekeeping and Custody Exception
The Interim Rules include two exemptions that permit banks to
accept orders from investors for the purchase and sale of securities
under limited circumstances in which the bank is acting in a
safekeeping or custody capacity. These exemptions, which are in current
Exchange Act Rules 3a4-4 and 3a4-5, supplement the ``safekeeping and
custody activities'' exception in Exchange Act Section
3(a)(4)(B)(viii).
Current Exchange Act Rule 3a4-4 provides that small banks may
effect transactions in investment company securities in customers' tax-
deferred custody accounts, provided that the bank meets certain
conditions. Current Exchange Act Rule 3a4-5 provides that banks may
effect transactions in securities in an account for which the bank acts
as custodian under Exchange Act Section 3(a)(4)(B)(viii), if, among
other conditions, the bank does not receive any compensation for
effecting such transactions.\417\
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\417\ Exchange Act Rule 3a4-5(a)(1).
---------------------------------------------------------------------------
Commenters criticized both of these exemptions, arguing that the
exemptions provide banks with less flexibility to effect securities
transactions in a safekeeping or custody capacity than is provided
under the GLBA.\418\ In response, the Commission has decided both to
simplify and expand the exemption in current Exchange Act Rule 3a4-4
(proposed to be redesignated as Exchange Act Rule 761) and to clarify
and simplify current Exchange Act Rule 3a4-5 (proposed to be
redesignated as Exchange Act Rule 760).
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\418\ See, e.g., Banking Agencies letter.
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In proposed Exchange Act Rule 761, the Commission is proposing to
expand the definition of ``small bank'' from the current $100 million
asset limit to a $500 million asset limit, and replace the current
three percent annual revenue limit with an annual sales compensation
limit of $100,000. The proposed rule would also simplify the
solicitation restrictions to permit small banks effecting securities
transactions pursuant to this exemption to publicly solicit brokerage
business as permitted by the trust and fiduciary activities exception.
In addition, it would replace the broad restriction on networking with
broker-dealers with a narrower restriction that only prohibits
affiliation with broker-dealers. The rule would also permit dual
employees and allow small banks to maintain a dedicated sales force.
Moreover, the exemption would expand to include all custodial accounts
not just tax-deferred accounts, and to permit transactions in all
securities rather than just mutual funds. Finally, the proposed
amendments would simplify the rule's restriction on payment of
incentive compensation to permit banks to pay their employees incentive
compensation pursuant to a networking arrangement that meets the
conditions of Exchange Act Section 3(a)(4)(B)(i).
The Commission believes that the proposed amendments to the
safekeeping and custody exemptions--in particular, the broadening of
the exemption in current Exchange Act Rule 3a4-4--would benefit
approximately 4,000 additional small banks and thrifts
[[Page 39729]]
by raising the asset limit for this exemption from $100 million to $500
million. As a result, many more banks would be able to rely on this
exemption.
To help the Commission better assess the costs and benefits of
these proposed amendments to current Exchange Act Rule 3a4-4, we invite
comment from small banks. Banks should indicate their the asset size,
the approximate number of their custody relationships, and the annual
dollar amount of revenue that the bank receives from effecting
securities transactions for custodial accounts. Small banks are also
invited to estimate their start-up costs and annual ongoing costs to
update their systems to track revenue that the bank receives from
effecting securities transactions for its custodial accounts.
The other proposed amendments to this exemption, including
permitting small banks to enter into networking arrangements with
broker-dealers, have dual employees, and to expand the types of
accounts and the types of securities that are covered by the
exemption--will permit smaller banks to continue to perform many of the
same securities activities that they perform today. As a result, up to
85 percent of small banks may not need to make material changes to
their current operations, which should lower their overall costs of
compliance with the GLBA. We believe that costs of compliance for
qualifying small banks will not be significant. We request comment on
the costs that will be incurred by qualifying small banks to comply
with this proposed amended rule.
The Commission believes that the small bank exemption should
provide a very useful exemption to small banks that is not also
available to small broker-dealers. This may give small banks a
competitive advantage over broker-dealers that might compete with those
banks. That being said, the Commission believes that small banks
currently provide the services that would be encompassed by proposed
Exchange Act Rule 761 and, given its limited scope, should not
materially impact the competitive environment between small banks and
broker-dealers. Nevertheless, the Commission seeks comment on whether
the proposed amendments to the small bank custody exemption as set
forth in proposed Exchange Act Rule 761 place small broker-dealers at a
competitive disadvantage vis-[agrave]-vis small banks. We note,
however, that, according to the NASD, there are 5,304 active registered
broker-dealers and that 1,284 firms, or 24.21 percent, have annual
revenue of $100,000 or less. The Commission requests comment on whether
the proposed amendments to the small bank custody exemption would have
a cost to small broker-dealers. The Commission is particularly
interested in hearing from those active registered broker-dealers that
have annual revenue of $100,000 or less and whether the existence of
any of the proposed bank exemptions will have a negative impact on
competition. Please provide detailed information on exactly how banks
and broker-dealers compete and how the particular exemptions would
impact broker-dealers' business. We are also interested in the relative
cost structure of these small broker-dealers as compared to banks that
qualify as ``small'' under the proposed amendments to the small bank
custody exemption. In these comments, please provide us with specific
information on any differences in costs between banks that could use
this exemption and small registered broker-dealers that could have a
hidden cost that we should consider in our analysis.
We also request comment from small banks about whether they have
affiliated broker-dealers or if they are affiliated with a bank holding
company. Those affiliated with a bank holding company should indicate
the holding company's approximate consolidated assets. Small banks are
also invited to discuss whether they have a networking relationship
with a registered broker-dealer, and if so, whether they have dual
employees. Those with dual employees should indicate how many.
The Commission also is proposing to amend the general custody
exemption, which would be codified in Exchange Act Rule 760, to permit
a bank to be compensated for effecting a securities transaction for a
person with an existing custody account or for a ``qualified investor''
so long as the compensation that the bank receives for its custody
services (e.g., securities movement fees, annual fees, asset based
fees, and processing fees) does not directly or indirectly vary based
on whether the bank accepts an order to purchase or sell a security. In
other words, the proposed amendment would conditionally permit a
custodian bank to be compensated for the movement of funds and
securities for ``grandfathered'' custody accounts or accounts of
``qualified investors'' when that movement results from the bank's
acceptance of a securities order. The proposed exemption also would
remove limitations in the Interim Rules that prohibited custody
department employees from being compensated for securities-related
custody activities, including gathering assets and moving funds and
securities, if the bank accepts customer orders.
We solicit comment about the costs and benefits that would be
imposed by proposed Exchange Act Rule 760. In particular, we invite
commenters to discuss whether banks charge their custody customers when
they accept an order to purchase or sell securities, and if so, how.
Banks should note whether that charge varies when they accept an order
to move funds or securities without purchasing or selling securities.
If the charge varies depending on the type of customer, banks should
also explain the range of charges and the proportion of customers
within each range.
We expect these proposed changes to ease the compliance burden on
those banks that qualify for the exemption because they would permit a
bank to continue to receive Rule 12b-1 shareholder servicing fees for
existing custody accounts as well as for new accounts with qualified
investors. While the proposed amendment to the general custody
exemption could impose some limited marginal costs on banks to ensure
that the compensation they receive is consistent with the exemption, we
believe that, on balance, the benefits of the exemption should justify
the costs of complying with it. We believe that the costs of compliance
for individual banks with respect to individual accounts will not be
significant. We solicit comment on the costs that individual banks will
incur to comply with this proposed rule on an account basis and we ask
that banks tell us how many accounts will be affected by these proposed
amendments to the rule.
We solicit comment on the percentage of a bank's customers' orders
to move funds and securities that also include orders to purchase or
sell a security. We also solicit comment about which segment or type of
customers' account for these orders, such as custody IRAs. Banks are
also invited to discuss the percentage of the securities transactions
they effect for custody accounts that involve the purchase or sale of
mutual fund shares. In addition, we request comment on whether banks
wanting to use the modified general bank custody exemption would need
to code their new accounts (other than those for qualified investors)
to distinguish them from old accounts and to identify qualified
investors. If so, we also invite estimates of the costs associated with
coding new accounts.
d. Other Proposed Changes
In addition to those exemptions discussed above, the Commission is
[[Page 39730]]
proposing a number of special purpose exemptions. For example, in
response to commenters' recommendations that the Commission provide
more flexibility with respect to the services banks could offer to
customers that utilize money market funds for cash management purposes,
we are proposing a new exemption that would, subject to certain
conditions, allow a bank (without registering as a broker-dealer) to
effect transactions for ``qualified investors,'' trust and fiduciary
activity accounts and certain agency accounts. These transactions in
money market funds would not be limited to no-load funds or to
transactions that are part of a sweeps program.
The proposal should benefit banks by permitting them to offer a
cash management service to these customers under an exemption that has
few conditions. This proposed exemption should give banks additional
flexibility in structuring their business models and in accommodating
the needs of their customers when the bank acts as an indenture trustee
or escrow agent. Moreover, the proposed exemption should benefit the
customers within the scope of the exemption by allowing them to use
more financial instruments to meet their cash management needs,
including money market funds, which are diversified, highly liquid, and
have low transactions costs.
We do not expect banks or investors to incur any costs related to
this proposed exemption. We request comment from banks on whether they
will incur any costs related to this proposed exemption.
The Commission also is proposing to permit banks that are relying
on the trust and fiduciary activities, safekeeping and custody, or
certain stock purchase plans exceptions under the GLBA to process
transactions in investment company shares through a mutual fund's
transfer agent, (in addition to using a broker-dealer or Fund/SERV,
which the Interim Rules currently permit), provided the banks meet
certain conditions.\419\ We do not expect banks to incur any costs from
complying with this proposed exemption. We invite comment from banks on
whether they will incur any costs related to the proposed amendments to
this exemption.
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\419\ Exchange Act Section 3(a)(4)(C) requires a bank to execute
through a registered broker-dealer (or internally cross)
transactions executed in the United States in securities that are
publicly traded in the United States that are effected pursuant to
either the trust and fiduciary activities exception, the safekeeping
and custody exception, or certain stock purchase plans exception. 15
U.S.C. 78c(a)(4)(B)(ii), (iv), and (viii). Current Exchange Act Rule
3a4-6 exempts from this requirement banks that process transactions
in investment company securities through NSCC's Mutual Fund
Services, including Fund/SERV.
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The Commission is proposing a new exemption for bank trustees and
non-fiduciary administrators that effect transactions in securities of
open-end investment companies for participants in employee benefit
plans. This proposed exemption would allow a bank to accept
compensation from a fund complex as long as the bank offsets or credits
any such compensation against fees and expenses that the plan owes to
the bank. Since banks have advised the Commission staff that they
offset or credit any compensation received from mutual funds against
plan expenses, there should be no cost to banks from utilizing this
proposed new exemption. We request comment on whether any banks will
incur any costs as a result of this exemption. We invite any bank that
believes it will incur costs as a result of this proposed exemption
specifically to delineate the nature of the costs that the bank will
incur.
The Commission also is proposing a new exemption that would permit
banks to effect transactions pursuant to Regulation S with non-U.S.
persons. We do not expect banks to incur any significant costs in
connection with utilizing this proposed exemption. We request comment
on whether banks will incur any costs related to this proposed
exemption. The Commission is proposing to extend the cash management
exemption and the exemptions from the definition of ``chiefly
compensated'' relating to trust and fiduciary activity accounts to
savings banks and savings and loan associations, and to extend certain
GLBA bank exceptions to credit unions.\420\ We do not expect savings
associations, savings banks, or credit unions to incur any costs as a
result of the proposed amendments to the exemptions and proposed new
exemptions. We invite comment on any costs that these entities may
incur related to these proposed changes. The Commission also is
proposing to extend the exemption from rescission liability under
Exchange Act Section 29 to contracts entered into by banks acting in a
broker capacity until a date that would be 18 months after the
effective date of the proposed amendments to the Interim Rules.\421\ We
do not expect banks to incur any costs due to the proposed amendments
to this exemption. We request comment on any costs banks may incur.
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\420\ See proposed Exchange Act Rules 771 and 774, respectively.
\421\ See proposed Exchange Act Rule 780.
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The Commission believes these proposed changes could offer a number
of benefits to banks, credit unions, and to their respective customers.
In particular, extending the Fund/SERV exemption to mutual fund
purchases and redemptions directed to the fund's transfer agent would
give banks more flexibility in processing their customers' mutual fund
transactions without losing a broker registration exemption.
Moreover, the proposed Regulation S exemption could help to ensure
that U.S. banks that effect transactions in Regulation S securities
with non-U.S. customers will be more competitive with foreign banks
that offer those services. In addition, the proposed credit union
exemptions should help to level the competitive playing field between
banks, savings banks, savings and loan associations, and credit unions
while remaining consistent with the principles of the Exchange Act.
Finally, the proposed extension of the exemption from rescission
liability under Exchange Act Section 29 should provide banks some legal
certainty for a reasonable period of time while they become accustomed
to the proposed amendments to the Interim Rules.
We estimate that the costs of the proposed exemptions would be
minimal and would be justified by the benefits. For example, the
Regulation S exemption could impose certain costs on banks to ensure
that they remain in compliance with the conditions under the exemption.
In particular, the proposed exemption would require banks to expend
certain administrative costs to ensure that the proposed exemption is
used only for ``eligible securities'' and for a purchaser who is
outside of the U.S. within the meaning of section 903 of Regulation S.
Nevertheless, the proposed exemption is an accommodation to banks that
wish to effect transactions in Regulation S securities and, as a
result, the compliance costs will only be imposed on those banks that
believe that it is in their best business interests to take advantage
of the proposed exemption. The same is true with respect to the
proposed cash management exemption and the proposed exemption for
credit unions. Given that Exchange Act Section 29 is rarely used as a
remedy, the Commission does not anticipate that this proposed exemption
will impose any costs on the industry or on investors. We request
comment on whether any bank will incur any costs or will benefit as a
result of this proposed exemption. Please provide any
[[Page 39731]]
supporting data with respect to such costs or benefits.
D. Consideration of Burden on Competition, and on Promotion of
Efficiency, Competition, and Capital Formation
Exchange Act Section 3(f) requires the Commission, whenever it
engages in rulemaking, to consider or determine if an action is
necessary or appropriate in the public interest, and to consider
whether the action will promote efficiency, competition, and capital
formation.\422\ Exchange Act Section 23(a)(2) requires the Commission,
in adopting rules under that Act, to consider the impact that any such
rule would have on competition. This section also prohibits the
Commission from adopting any rule that would impose a burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act.\423\
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\422\ 15 U.S.C. 78c(f).
\423\ 15 U.S.C. 78w(a)(2).
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The Commission has considered the proposed amendments to the
Interim Rules in light of these standards and preliminarily believes
that they will not impose a burden on competition not necessary or
appropriate in furtherance of the purposes of the Exchange Act. Indeed,
the Commission believes that by providing legal certainty to banks that
conduct securities activities, by clarifying the GLBA requirements, and
by exempting a number of activities from those requirements, the
proposed amendments should allow banks to continue to conduct many of
the securities activities they already conduct consistent with the
GLBA. As a result, the Commission believes that the proposed amendments
will permit banks to continue to compete with broker-dealers in
providing a wide range of securities activities, which should preserve
competition and help to keep transaction costs low for investors and
for companies. We note, however, that, according to the NASD, there are
5,304 active registered broker-dealers and that 1,284 firms, or 24.21
percent, have annual revenue of $100,000 or less. The Commission
requests comment on whether the proposed amendments would promote
efficiency, competition, and capital formation. The Commission is
particularly interested in hearing from those active registered broker-
dealers that have annual revenue of $100,000 or less and whether the
existence of any of the proposed bank exemptions will have a negative
impact on competition. Please provide detailed information and data on
exactly how banks and broker-dealers compete and how the particular
exemptions would impact broker-dealers' business.
E. Consideration of Impact on the Economy
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996, or ``SBREFA,'' \424\ the Commission must advise the Office
of Management and Budget as to whether the proposed amendments to the
Interim Rules constitute a ``major'' rule. Under SBREFA, a rule is
considered ``major'' where, if adopted, it results or is likely to
result in:
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\424\ Pub. L. 104-121, Title II, 110 Stat. 857 (1996) (codified
in various sections of 5 U.S.C., 15 U.S.C. and as a note to 5 U.S.C.
601).
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An annual effect on the economy of $100 million or more (either in
the form of an increase or a decrease);
A major increase in costs or prices for consumers or individual
industries; or
A significant adverse effect on competition, investment, or
innovation.
If a rule is ``major,'' its effectiveness will generally be delayed
for 60 days pending Congressional review. We request comment on the
potential impact of the proposed amendments on the economy on an annual
basis. Commenters are requested to provide empirical data and other
factual support for their views to the extent possible.
F. Initial Regulatory Flexibility Analysis
The Commission has prepared an Initial Regulatory Flexibility
Analysis (``IRFA''), in accordance with the provisions of the
Regulatory Flexibility Act (``RFA''),\425\ regarding the proposed
amendments to the Interim Rules.
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\425\ 5 U.S.C. 603.
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1. Reasons for the Proposed Action
The Commission is proposing the amendments to the Interim Rules to
respond to a number of concerns commenters raised about the Interim
Rules and generally to make the guidance and exemptions provided in
those rules more useful to the industry while preserving the investor
protection principles of the GLBA.
2. Objectives
The proposed amendments are intended to improve the usefulness and
clarity of the principles addressed by the Interim Rules. The
Commission intends for the proposed amendments to the Interim Rules to
provide legal certainty to the industry with respect to the GLBA
requirements. The Commission also seeks to make the restrictions
imposed by the GLBA more accommodating of current securities activities
carried out by banks while preserving investor protection principles.
3. Legal Basis
Pursuant to the Exchange Act and, particularly, Sections 3, 23(a),
and 36 thereof, the Commission proposes to adopt amendments to the
Interim Rules.
4. Small Entities Subject to the Rule
Congress did not exempt small entity banks from the application of
the GLBA. Moreover, because the Interim Rules are intended to provide
guidance to all banks that are subject to the GBLA, the Commission
determined that it would not be appropriate to exempt small entity
banks from the operation of those Rules. Therefore, the Interim Rules
generally applied to banks that would be considered small entities.
Nevertheless, in adopting the Interim Rules, the Commission
recognized that small banks' customers often use banks to effect
transactions in IRAs. To allow small banks to continue to offer this
service, the Commission adopted Exchange Act Rule 3a4-4 (which we are
proposing to amend and redesignate as Exchange Act Rule 761), which
provides a limited exemption from broker-dealer registration for small
banks that effect transactions in investment company securities in tax-
deferred accounts.\426\
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\426\ 66 FR at 27781.
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In response to comments that the scope of this exemption is too
limited to be useful to small banks and their customers, as discussed
above, the Commission is proposing to expand the small bank exemption.
A proposed amendment to this rule would raise the limit on this
exemption from $100 million to $500 million in assets. The proposed
amount could greatly expand the number of banks that qualify for the
exemption.\427\ The Commission seeks comment on the number of banks
that would qualify for the small bank custody exemption.
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\427\ A $500 million asset limit could greatly expand the
availability of this exemption from broker registration, increasing
the number of eligible entities from over 4,000 FDIC-insured banks
and thrifts, or approximately 48 percent of all such entities, to
over 8,000 FDIC-insured banks and thrifts, or almost 88 percent of
all such entities. Given that some of these entities may be
affiliated with larger holding companies or may be affiliated with
registered broker-dealers, however, some of these entities
presumably would not meet the proposed definition of small bank. See
proposed Exchange Act Rules 761(a) and 762(h).
---------------------------------------------------------------------------
Moreover, the proposed amendment would expand the scope of the
exemption to increase the types of securities that could be bought or
sold under the exemption and the types of accounts. It would also
permit a small bank to use a dedicated bank sales force
[[Page 39732]]
to effect transactions in securities that may consist of either
unregistered personnel or registered representatives employed by both a
broker-dealer and the small bank seeking to qualify for the exemption.
5. Reporting, Recordkeeping and Other Compliance Requirements
The proposed amendments would not impose any new reporting,
recordkeeping, or other compliance requirements on banks that are small
entities.
6. Duplicative, Overlapping, or Conflicting Federal Rules
The Commission believes that there are no rules that duplicate,
overlap, or conflict with the proposed amendments.
7. Significant Alternatives
Pursuant to Section 3(a) of the RFA,\428\ the Commission must
consider the following types of alternatives: (a) The establishment of
differing compliance or reporting requirements or timetables that take
into account the resources available to small entities; (b) the
clarification, consolidation, or simplification of compliance and
reporting requirements under the proposed rule for small entities; (c)
the use of performance rather than design standards; and (d) an
exemption from coverage of the proposed rule, or any part thereof, for
small entities.
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\428\ 5 U.S.C. 603(c).
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As discussed above, the GLBA does not exempt small banks from the
Exchange Act broker-dealer registration requirements, and the
Commission does not believe that an unconditional exemption would be
consistent with the investor protection principles of the GLBA.
Moreover, such an exemption could place broker-dealers at a competitive
disadvantage versus small banks.
The proposed amendments to the Interim Rules (which would be
codified in Regulation B) are intended to clarify and simplify
compliance with the GLBA by expanding exemptions in the Interim Rules
and by adding additional exemptions. As such, the proposed amendments
should ease compliance on banks of all sizes, including smaller
entities.
The Commission does not believe that it is necessary to consider
whether small entities should be permitted to use performance rather
than design standards to comply with the proposed amendments because
they already propose performance standards and do not dictate for
entities of any size any particular design standards (e.g., technology)
that must be employed to achieve the objectives of the proposed
amendments.
Nevertheless, as discussed above, the Commission is proposing to
expand the exemption for small banks in current Exchange Act Rule 3a4-4
(which we are proposing to redesignate as Exchange Act Rule 761) by
increasing the asset limit from $100 million to $500 million, as well
as expanding the types of securities included under the exemption.
These proposed changes should further ease the compliance burden on
those small banks that qualify for the exemption.
8. Request for Comments
The Commission encourages written comments on matters discussed in
the IRFA. In particular, the Commission requests comments on (a) the
number of small entities that would be affected by the proposed
amendments; (b) the nature of any impact the proposed amendments would
have on small entities and empirical data supporting the extent of the
impact; and (c) how to quantify the number of small entities that would
be affected by and/or how to quantify the impact of the proposed
amendments. Such comments will be considered in the preparation of the
Final Regulatory Flexibility Analysis, if the proposed rule is adopted,
and will be placed in the same public file as comments on the proposed
rule itself. Persons wishing to submit written comments should refer to
the instructions for submitting comments in the front of this release.
V. Statutory Authority
Pursuant to authority set forth in the Exchange Act and
particularly Sections 3(b), 15, 23(a), and 36 thereof (15 U.S.C.
78c(b), 78o, 78w(a), and 78mm, respectively) the Commission proposes to
(1) amend current Rules 3a4-2, 3a4-3, 3a4-4, 3a4-5, 3a4-6, 15a-8, and
15a-9 (Sec. Sec. 240.3a4-2, 240.3a4-3, 240.3a4-4, 240.3a4-5, 240.3a4-
6, 240.15a-8, and 240.15a-9, respectively) and redesignate them as
Rules 721, 723, 761, 760, 775, 780, and 773 (Sec. Sec. 242.721,
242.723, 242.761, 242.760, 242.775, 242.780, and 242.773, respectively)
(2) amend Exchange Act Rule 15a-6 (Sec. 240.15a-6); (3) repeal Rule
3b-17 (Sec. 240.3b-17); and redesignate Exchange Act Rules 15a-10, and
15a-11 as 15a-7 (Sec. 240.15a-7), and 772 (Sec. 242.772).
VI. Text of Proposed Rules and Rule Amendments
List of Subjects
17 CFR Part 240
Broker-dealers, Reporting and recordkeeping requirements,
Securities.
17 CFR Part 242
Banks, banking, Brokers, Broker-dealers, Credit unions, Savings
associations, Securities.
For the reasons set forth in the preamble, Title 17, Chapter II of
the Code of Federal Regulations is proposed to be amended as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
1. The authority citation for Part 240 continues to read, in part,
as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i,
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5,
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless
otherwise noted.
* * * * *
Sec. Sec. 240.3a4-2 through 240.3a4-6 [Removed]
2. Sections 240.3a4-2 through 240.3a4-6 are removed.
* * * * *
Sec. 240.3b-17 [Removed and Reserved]
3. Section 240.3b-17 is removed and reserved.
* * * * *
4. Section 240.15a-6 is amended by revising paragraph (a)(4)(i) to
read as follows:
Sec. 240.15a-6 Exemption of certain foreign brokers or dealers.
(a) * * *
(4) * * *
(i) A registered broker or dealer, whether the registered broker or
dealer is acting as principal for its own account or as agent for
others, or a bank acting 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 (15 U.S.C. 78c(a)(4)(B) or 15 U.S.C.
78c(a)(5)(C)).
* * * * *
Sec. Sec. 240.15a-7 through 240.15a-9 [Removed]
5. Sections 240.15a-7 through 240.15a-9 are removed.
Sec. 240.15a-10 [Redesignated]
6-7. Section 240.15a-10 is redesignated as Sec. 240.15a-7.
[[Page 39733]]
PART 242--REGULATIONS M, ATS, AC AND B AND CUSTOMER MARGIN
REQUIREMENTS FOR SECURITY FUTURES
8. The part heading for part 242 is revised as set forth above.
9. The authority citation for Part 242 is revised to read as
follows:
Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2),
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g),
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and
80a-37.
10. Part 242 is amended by adding Regulation B, Sec. Sec. 242.710
through 242.781, to read as follows:
Regulation B--Securities Activities of Banks and Other Financial
Institutions
Subpart A--Networking Exception: Defined Terms
Sec.
242.710 Defined terms relating to the networking exception from the
definition of ``broker.''
Subpart B--Trust and Fiduciary Activities Exception: Exemptions and
Defined Terms
242.720 Exemption from the ``chiefly compensated'' condition for
banks with existing personal trust accounts.
242.721 Exemption for banks from determining whether they are
``chiefly compensated'' on a line of business.
242.722 Exemption for banks from determining whether they are
``chiefly compensated'' on an account-by-account basis.
242.723 Exemption from the definition of ``broker'' for banks
effecting transactions as an indenture trustee in a no-load money
market fund.
242.724 Defined terms relating to the trust and fiduciary activities
exception from the definition of ``broker.''
Subpart C--[Reserved]
Subpart D--Sweep Accounts Exception: Defined Terms
242.740 Defined terms relating to the sweep accounts exception from
the definition of ``broker.''
Subpart E--Affiliate Transactions Exception: Defined Terms
242.750 Defined terms relating to the affiliate transactions
exception from the definition of ``broker.''
Subpart F--Safekeeping and Custody Activities Exception: Exemptions
242.760 Exemption from the definition of ``broker'' for banks
effecting transactions in securities in a custody account.
242.761 Exemption from the definition of ``broker'' for small banks
effecting securities transactions in a custody account.
242.762 Defined terms relating to the safekeeping and custody
activities exception from the definition of ``broker.''
Subpart G--Special Purpose Exemptions
242.770 Exemption from the definition of ``broker'' for banks
effecting transactions in securities in certain employee benefit
plans.
242.771 Exemption from the definitions of ``broker'' and ``dealer''
for banks effecting transactions in securities issued pursuant to
Regulation S.
242.772 [Reserved]
242.773 Exemption from the definitions of ``broker'' and ``dealer''
for savings associations and savings banks.
242.774 Exemption from the definitions of ``broker'' and ``dealer''
for credit unions.
242.775 Exemption from the definition of ``broker'' for the way
banks effect excepted or exempted transactions in investment company
securities.
242.776 Exemption for banks effecting transactions for certain
investors in money market funds.
Subpart H--Temporary Exemptions
242.780 Exemption for banks from liability under section 29 of the
Securities Exchange Act of 1934.
242.781 Exemption from the definition of ``broker'' for banks for a
limited period of time.
Regulation B--Securities Activities of Banks and Other Financial
Institutions
Subpart A--Networking Exception: Defined Terms
Sec. 242.710 Defined terms relating to the networking exception from
the definition of ``broker.''
When used with respect to the Third Party Brokerage Arrangements
(``Networking'') Exception from the definition of the term ``broker''
in section 3(a)(4)(B)(i) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(4)(B)(i)), the following terms shall have the meaning
provided:
(a) Contingent on whether the referral results in a transaction
means contingent on any factor related to whether the referral results
in a securities transaction, including whether it is likely to result
in a transaction, whether it results in a particular type of
transaction, or whether it results in multiple transactions, provided,
however, that a referral fee may be contingent on whether a customer:
(1) Contacts or keeps an appointment with a registered broker or
dealer as a result of the referral; or
(2) Has assets, a net worth, or income meeting any minimum
requirement that the registered broker or dealer, or the bank, may have
established generally for referrals for securities brokerage accounts.
(b) Nominal one-time cash fee of a fixed dollar amount means a
payment:
(1) Having a value that does not exceed the greater of:
(i) The employee's base hourly rate of pay;
(ii) Twenty five dollars; or
(iii) A dollar amount that does not exceed the whole dollar amount
nearest to fifteen dollars in 1999 dollars adjusted by the cumulative
annual percentage change in the Consumer Price Index All Urban
Consumers--(CPI-U) published by the Department of Labor that was
reported on June 1 of the preceding year;
(2) Paid to a bank employee no more than one time for each customer
referred by that employee;
(3) That, to the extent any portion of the fee is paid other than
in cash:
(i) Is paid in units of value with a readily ascertainable cash
equivalent;
(ii) Has, together with any portion of the fee paid in cash, a
total cash value that meets the conditions of paragraph (b)(1) of this
section; and
(iii) Is paid under an incentive program that covers a broad range
of products and that is designed primarily to reward activities
unrelated to securities; and
(4) Having a set value that a particular employee making a referral
would receive for any referral to a registered broker or dealer, and
that does not vary based on factors such as the financial status of a
customer the employee refers, the identity of the registered broker or
dealer to which the customer is referred, the number of referrals the
employee makes, or whether the customer expresses an interest in a
particular type of securities product.
(c) Referral means the action taken by a bank employee to direct a
customer of the bank to a registered broker or dealer for the purchase
or sale of securities for the customer's account.
Subpart B--Trust and Fiduciary Activities Exception: Exemptions and
Defined Terms
Sec. 242.720 Exemption from the ``chiefly compensated'' condition for
banks with existing living, testamentary, or charitable trust accounts.
(a) A bank relying on the exception from the definition of the term
``broker'' under section 3(a)(4)(B)(ii) of the Securities Exchange Act
of 1934 (15 U.S.C. 78c(a)(4)(B)(ii)) is exempt from meeting the
``chiefly compensated'' condition in section 3(a)(4)(B)(ii)(I) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(4)(B)(ii)(I)) to the
extent that it effects transactions in securities for a living,
testamentary, or charitable trust account opened, or established before
July 30, 2004, in a trustee or fiduciary capacity within the scope of
section 3(a)(4)(D) of the Securities
[[Page 39734]]
Exchange Act of 1934 (15 U.S.C. 78c(a)(4)(D)), if the bank:
(1) Meets the other conditions for the exception from the
definition of the term ``broker'' under sections 3(a)(4)(B)(ii) and
3(a)(4)(C) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)(B)(ii) and 15 U.S.C. 78c(a)(4)(C)); and
(2) Does not individually negotiate with the accountholder or
beneficiary of such account to increase the proportion of sales
compensation as compared to relationship compensation after July 30,
2004.
(b) For purposes of this section, a testamentary trust may be
deemed to be established as of the date of the will that directed that
the trust be established.
Sec. 242.721 Exemption for banks from determining whether they are
``chiefly compensated'' on a line of business basis.
(a) A bank relying on the exception from the definition of the term
``broker'' under section 3(a)(4)(B)(ii) of the Securities Exchange Act
of 1934 (15 U.S.C. 78c(a)(4)(B)(ii)) is exempt from meeting the
``chiefly compensated'' condition in section 3(a)(4)(B)(ii)(I) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(4)(B)(ii)(I)) to the
extent that it effects transactions in securities for any account in a
trustee or fiduciary capacity within the scope of section 3(a)(4)(D) of
the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(4)(D)) in any
year in which the bank:
(1) Meets the other conditions for the exception from the
definition of the term ``broker'' under sections 3(a)(4)(B)(ii) and
3(a)(4)(C) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)(B)(ii) and 15 U.S.C. 78c(a)(4)(C));
(2) Can demonstrate that during the preceding year its ratio of
sales compensation to relationship compensation was no more than one to
nine;
(3) Maintains procedures reasonably designed to ensure that, before
opening or establishing an account for which it will act in a trustee
or fiduciary capacity, 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; and
(4) Maintains procedures reasonably designed to ensure that, after
opening or establishing an account for which it will act in a trustee
or fiduciary capacity, at such time as the bank individually negotiates
with the accountholder or beneficiary of that account to increase the
proportion of sales compensation as compared to relationship
compensation, 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.
(b) A bank that fails to meet the ratio requirement in paragraph
(a)(2) of this section may nonetheless continue to rely on the
exemption in paragraph (a) of this section for one year if it:
(1) Meets the other requirements in paragraph (a) of this section;
(2) Can demonstrate that during the preceding year its ratio of
sales compensation to relationship compensation was no more than one to
seven; and
(3) Did not rely on the safe harbor in paragraph (b) of this
section during any of the five preceding years.
(c) A bank may use this section for all accounts for which the bank
acts in a trustee or fiduciary capacity on a bank-wide basis, or a bank
may use this section for one or more individual lines of business
provided that the sales compensation and relationship compensation from
all accounts for which the bank acts in a trustee or fiduciary
capacity, or all accounts established before a single date certain for
which the bank acts in a trustee or fiduciary capacity, within a
particular line of business is used to determine whether the bank meets
the requirement in paragraph (a)(2) or (b)(2) of this section.
Sec. 242.722 Exemption for banks from determining whether they are
``chiefly compensated'' on an account-by-account basis.
(a) A bank relying on the exception from the definition of the term
``broker'' under section 3(a)(4)(B)(ii) of the Securities Exchange Act
of 1934 (15 U.S.C. 78c(a)(4)(B)(ii)) is exempt from meeting the
``chiefly compensated'' condition in section 3(a)(4)(B)(ii)(I) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(4)(B)(ii)(I)) to the
extent that it effects transactions in securities for an account in a
trustee or fiduciary capacity within the scope of section 3(a)(4)(D) of
the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(4)(D)) in any
year in which the bank:
(1) Meets the other conditions for the exception from the
definition of the term ``broker'' under sections 3(a)(4)(B)(ii) and
3(a)(4)(C) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)(B)(ii) and 15 U.S.C. 78c(a)(4)(C));
(2) Can demonstrate that it met the ``chiefly compensated''
condition with respect to such account during the preceding year;
(3) Maintains procedures reasonably designed to ensure that, before
opening or establishing an account for which it will act in a trustee
or fiduciary capacity, 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; and
(4) Maintains procedures reasonably designed to ensure that, after
opening or establishing an account for which it will act in a trustee
or fiduciary capacity, at such time as the bank individually negotiates
with the accountholder or beneficiary of that account to increase the
proportion of sales compensation as compared to relationship
compensation, 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.
(b) Except as provided in paragraph (d) of this section, a bank
that fails to meet the requirement in paragraph (a)(2) of this section
with respect to an account may nonetheless continue to rely on the
exemption in paragraph (a) of this section with respect to such account
for one year if it:
(1) Meets the other requirements in paragraph (a) of this section;
and
(2) Did not rely on the safe harbor in paragraph (b) of this
section with respect to such account during any of the five preceding
years.
(c) Except as provided in paragraph (d) of this section, a bank
that fails to meet the requirements in paragraphs (a)(2) and (b)(2) of
this section with respect to an account may nonetheless continue to
rely on the exemption in paragraph (b) of this section with respect to
such account if it:
(1) Meets the other requirements in paragraph (a) of this section;
(2) Has documented the reason that such account continued not to
meet the ``chiefly compensated'' condition and linked that reason to
its exercise of fiduciary responsibility; and
(3) Has no more than the lesser of 500 or one percent of the total
number of accounts for which it acts in a trustee or fiduciary capacity
that did not meet the requirement in paragraph (b)(2) of this section.
(d) A bank may not rely on the safe harbors in paragraphs (b) and
(c) of this section if more than ten percent of the total number of
accounts for which it acts in a trustee or fiduciary capacity did not
meet the ``chiefly compensated'' condition.
Sec. 242.723 Exemption from the definition of ``broker'' for banks
effecting transactions as an indenture trustee in a no-load money
market fund.
A bank that meets the conditions for the exception from the
definition of the
[[Page 39735]]
term ``broker'' under section 3(a)(4)(B)(ii) of the Securities Exchange
Act of 1934 (15 U.S.C. 78c(a)(4)(B)(ii)), except for the ``chiefly
compensated'' condition in section 3(a)(4)(B)(ii)(I) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(4)(B)(ii)(I)), is exempt from
the definition of the term ``broker'' under section 3(a)(4) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(4)) to the extent
that it effects transactions as an indenture trustee in a no-load money
market fund.
Sec. 242.724 Defined terms relating to the trust and fiduciary
activities exception from the definition of ``broker.''
For purposes of this subpart and sections 3(a)(4)(B)(ii) and
3(a)(4)(D) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)(B)(ii) and 15 U.S.C. 78c(a)(4)(D)), the following terms shall
have the meaning provided:
(a) Chiefly compensated means that during the preceding year, the
bank received more relationship compensation than sales compensation
from an account for which the bank acts in a trustee or fiduciary
capacity within the scope of section 3(a)(4)(D) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(4)(D)).
(b) Flat or capped per order processing fee equal to not more than
the cost incurred by the bank in connection with executing securities
transactions for trustee and fiduciary customers means a fee that is no
more than the amount a broker-dealer charged an account for which the
bank acts in a trustee or fiduciary capacity within the scope of
section 3(a)(4)(D) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)(D)) for executing the transaction, plus the direct marginal
cost of any resources of the bank that are used for transaction
execution, comparison, or settlement for accounts for which the bank
acts in a trustee or fiduciary capacity if the bank makes a precise and
verifiable allocation of these resources according to their use.
(c) Indenture trustee means any trustee for an indenture to which
the definition in section 303 of the Trust Indenture Act of 1939 (15
U.S.C. 77ccc) applies, and any trustee for an indenture to which the
definition in section 303 of that Act would apply but for an exemption
from qualification pursuant to section 304 of that Act.
(d) Investment adviser if the bank receives a fee for its
investment advice in section 3(a)(4)(D) of the Securities Exchange Act
of 1934 (15 U.S.C. 78c(a)(4)(D)) means a bank that has a fiduciary
relationship with the advised customer in which the bank:
(1) Owes the customer duty of loyalty, including an affirmative
duty to make full and fair disclosure of all material facts and
conflicts of interest; and
(2) Has an ongoing responsibility to provide investment advice
based upon the customer's individual needs that includes selecting or
making recommendations regarding specific securities and, if the
customer accepts such selections or recommendations, a responsibility
to direct the purchases or sales to a registered broker or dealer for
execution.
(e) Line of business means 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 type of fiduciary capacity as listed in section
3(a)(4)(D) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)(D)).
(f) Money market fund has the same meaning as in Sec. 242.740.
(g) No-load has the same meaning as in Sec. 242.740.
(h) Relationship compensation means any compensation a bank
receives directly from a customer or beneficiary, or directly from the
assets of an account for which the bank acts in a trustee or fiduciary
capacity within the scope of section 3(a)(4)(D) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(4)(D)), that consists solely of:
(1) An administration or annual fee (payable on a monthly,
quarterly, or other basis);
(2) A fee based on a percentage of assets under management;
(3) A flat or capped per order processing fee equal to not more
than the cost incurred by the bank in connection with executing
securities transactions for trustee and fiduciary customers; or
(4) Any combination of such fees.
(i) Sales compensation means any compensation a bank receives in
connection with activities for which it relies on an exception under
section 3(a)(4)(B)(ii) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(4)(B)(ii)) that is:
(1) A fee for effecting a securities transaction that exceeds the
fee defined in paragraph (b) of this section;
(2) Compensation that if paid to a broker or dealer would be
payment for order flow, as defined in 17 CFR 240.10b-10;
(3) A finders' fee received in connection with a securities
transaction or account, except a fee received pursuant to section
3(a)(4)(B)(i) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)(B)(i));
(4) A fee paid for an offering of securities that the bank does not
receive directly from a customer or beneficiary, or directly from the
assets of an account for which the bank acts in a trustee or fiduciary
capacity, which fee may be allocated to each account by dividing the
number of shares of each class of an investment company's securities
(or class of a series of an investment company's securities) held in
each account on the last business day of the preceding year by the
aggregate number of shares of the same class held by the bank in a
trustee or fiduciary capacity on the same day, and multiplying the
resulting number by the aggregate dollar amount of these fees the bank
received in connection with that class during the preceding year, or by
using another method of allocation that fairly and consistently
measures the amount of sales compensation attributable to each account
during the preceding year;
(5) A fee paid pursuant to a plan under 17 CFR 270.12b-1, which fee
may be calculated for each account by multiplying the number of shares
of each class of a registered investment company's securities (or class
of a series of an investment company's securities) held in each account
on the last business day of the preceding year by the net asset value
per share for that class of securities for such day by the annual Rule
12b-1 fee rate applicable to that class of securities, or by using
another method of allocation that fairly and consistently measures the
amount of sales compensation attributable to each account during the
preceding year; or
(6) A fee paid by an investment company, other than pursuant to a
plan under 17 CFR 270.12b-1, for personal service or the maintenance of
shareholder accounts, which fee may be allocated to each account by
dividing the number of shares of each class of an investment company's
securities (or class of a series of an investment company's securities)
held in each account on the last business day of the preceding year by
the aggregate number of shares of the same class held by the bank in a
trustee or fiduciary capacity on the same day, and multiplying the
resulting number by the aggregate dollar amount of these fees the bank
received in connection with that class during the preceding year, or by
using another method of allocation that fairly and consistently
measures the amount of sales compensation attributable to each account
during the preceding year. For purposes of this section, charges for
the following will not be considered charges for personal service or
for the maintenance of shareholder accounts:
[[Page 39736]]
(i) Providing transfer agent or sub-transfer agent services for
beneficial owners of investment company shares;
(ii) Aggregating and processing purchase and redemption orders for
investment company shares;
(iii) Providing beneficial owners with account statements showing
their purchases, sales, and positions in the investment company;
(iv) Processing dividend payments for the investment company;
(v) Providing sub-accounting services to the investment company for
shares held beneficially;
(vi) Forwarding communications from the investment company to the
beneficial owners, including proxies, shareholder reports, dividend and
tax notices, and updated prospectuses; or
(vii) Receiving, tabulating, and transmitting proxies executed by
beneficial owners of investment company shares.
(j) Year means a calendar year or other fiscal year consistently
used by the bank for recordkeeping and reporting purposes.
Subpart C--[Reserved]
Subpart D--Sweep Accounts Exception: Defined Terms
Sec. 242.740 Defined terms relating to the sweep accounts exception
from the definition of ``broker.''
For purposes of section 3(a)(4)(B)(v) of the Securities Exchange
Act of 1934 (15 U.S.C. 78c(a)(4)(B)(v)), the following terms shall have
the meaning provided:
(a) Deferred sales load has the same meaning as in 17 CFR 270.6c-
10.
(b) Money market fund means an open-end company registered under
the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) that is
regulated as a money market fund pursuant to 17 CFR 270.2a-7.
(c)(1) No-load, in the context of an investment company or the
securities issued by an investment company, means, for securities of
the class or series in which a bank effects transactions, that:
(i) That class or series is not subject to a sales load or a
deferred sales load; and
(ii) Total charges against net assets of that class or series of
the investment company's securities for sales or sales promotion
expenses, for personal service, or for the maintenance of shareholder
accounts do not exceed 0.25 of 1% of average net assets annually and
are disclosed in the investment company's prospectus.
(2) For purposes of this definition, charges for the following will
not be considered charges against net assets of a class or series of an
investment company's securities for sales or sales promotion expenses,
for personal service, or for the maintenance of shareholder accounts:
(i) Providing transfer agent or sub-transfer agent services for
beneficial owners of investment company shares;
(ii) Aggregating and processing purchase and redemption orders for
investment company shares;
(iii) Providing beneficial owners with account statements showing
their purchases, sales, and positions in the investment company;
(iv) Processing dividend payments for the investment company;
(v) Providing sub-accounting services to the investment company for
shares held beneficially;
(vi) Forwarding communications from the investment company to the
beneficial owners, including proxies, shareholder reports, dividend and
tax notices, and updated prospectuses; or
(vii) Receiving, tabulating, and transmitting proxies executed by
beneficial owners of investment company shares.
(d) Open-end company has the same meaning as in section 5(a)(1) of
the Investment Company Act of 1940 (15 U.S.C. 80a-5(a)(1)).
(e) Sales load has the same meaning as in section 2(a)(35) of the
Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(35)).
Subpart E--Affiliate Transactions Exception: Defined Terms
Sec. 242.750 Defined terms relating to the affiliate transactions
exception from the definition of ``broker.''
For purposes of section 3(a)(4)(B)(vi) of the Securities Exchange
Act of 1934 (15 U.S.C. 78c(a)(4)(B)(vi)), the term effects transactions
for the account of any affiliate means effecting a securities
transaction as agent for an affiliate of the bank as defined in section
2 of the Bank Holding Company Act of 1956 (12 U.S.C. 1841(k)), provided
that:
(a) The affiliate is:
(1) Acting as a principal; or
(2) Acting as a trustee or fiduciary purchasing or selling for
investment purposes; and
(b) The affiliate is not:
(1) Acting as a riskless principal for another person;
(2) Registered as a broker or dealer; or
(3) Engaged in merchant banking as described in section 4(k)(4)(H)
of the Bank Holding Company Act of 1956 (12 U.S.C. 1843(k)(4)(H)); and
(c) The bank obtains the security or securities to complete the
transaction from a registered broker or dealer, from a person that is
acting in the capacity of a broker or dealer that is not required to
register as such, or pursuant to another exception or exemption from
section 3(a)(4)(B) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)(B)).
Subpart F--Safekeeping and Custody Activities Exception: Exemptions
Sec. 242.760 Exemption from the definition of ``broker'' for banks
effecting transactions in securities in a custody account.
(a) A bank is exempt from the definition of the term ``broker''
under section 3(a)(4) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)) to the extent that it accepts orders to effect transactions
in securities in an account for which the bank acts as a custodian
under section 3(a)(4)(B)(viii) of the Securities Exchange Act of 1934
(15 U.S.C. 78c(a)(4)(B)(viii) for a person with an account that was
opened before July 30, 2004, or for a qualified investor if:
(1) The bank can demonstrate that it does not charge for or receive
any compensation for effecting such transactions that directly or
indirectly varies based on whether the bank accepts an order to
purchase or sell a security other than:
(i) A fee paid pursuant to a plan under 17 CFR 270.12b-1; or
(ii) A fee paid by a registered investment company, other than
pursuant to a plan under 17 CFR 270.12b-1, for personal service or the
maintenance of shareholder accounts;
(2) Any bank employee effecting such transactions does not receive
compensation from the bank, the executing broker or dealer, or any
other person related to the size, value, or completion of any
securities transaction effected pursuant to this exemption;
(3) The bank does not directly or indirectly solicit such
securities transactions except through responding to inquiries of a
potential purchaser in a communication initiated by the potential
purchaser of the security; provided, however, that the content of such
responses is limited to:
(A) Information contained in a registration statement for the
security filed under the Securities Act of 1933 (15 U.S.C. 77a et
seq.); and
(B) Sales literature prepared by the principal underwriter that is
a registered broker or dealer or prepared by a registered investment
company that is not an affiliated person of the bank;
(4) The bank does not effect securities transactions in reliance on
this section for an account for which the bank acts in a trustee or
fiduciary capacity within
[[Page 39737]]
the scope of section 3(a)(4)(D) of the Securities Exchange Act of 1934
(15 U.S.C. 78c(a)(4)(D));
(5) The bank does not effect securities transactions in reliance on
this section for an account described in Sec. 242.770(a)(1);
(6) The bank does not effect transactions in reliance on Sec.
242.761;
(7) The bank complies with section 3(a)(4)(C) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(4)(C)); and
(8) If the bank accepts an order to effect transactions in
securities of a registered investment company for compensation as
described in paragraph (a)(1)(i) or (a)(1)(ii) of this section, the
bank does so on the same terms for any class or series of securities of
such registered investment company that can reasonably be obtained by
the bank for purchase or sale by bank customers.
(b) A bank may demonstrate that it does not receive compensation
for effecting securities transactions that varies based on whether the
bank accepts an order to purchase or sell a security by:
(1) Utilizing fee schedules that specify charges for the movement
of funds and securities; and
(2) 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.
(c) For purposes of this section, the term qualified investor has
the same meaning as in section 3(a)(54)(A) of the Securities Exchange
Act of 1934 (15 U.S.C. 78c(a)(54)(A)).
Sec. 242.761 Exemption from the definition of ``broker'' for small
banks effecting securities transactions in a custody account.
A small bank is exempt from the definition of the term ``broker''
under section 3(a)(4) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)) to the extent that it accepts orders to effect transactions
in securities in an account for which the bank acts as custodian under
section 3(a)(4)(B)(viii) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(4)(B)(viii)) if:
(a) The bank is not a person associated with a broker or dealer;
(b) The bank does not publicly solicit such securities transactions
except by soliciting brokerage business as permitted under section
3(a)(4)(B)(ii)(II) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)(B)(ii)(II));
(c) The annual sales compensation the bank receives for effecting
transactions in securities pursuant to this exemption does not exceed
$100,000 in 2004 dollars adjusted by the cumulative annual percentage
change in the Consumer Price Index All Urban Consumers--(CPI-U)
published by the Department of Labor that was reported on June 1 of the
preceding year;
(d) The bank does not effect securities transactions in reliance on
this section for an account for which the bank acts in a capacity
described in section 3(a)(4)(D) of the Securities Exchange Act of 1934
(15 U.S.C. 78c(a)(4)(D)) unless it does not rely on any exemption under
Sec. 242.720, Sec. 242.721, or Sec. 242.722 in the year following
the year in which this exemption is utilized in connection with such an
account;
(e) The bank does not pay its employees any incentive compensation
related to any brokerage transaction effected under this section except
pursuant to a networking arrangement that meets the conditions of
section 3(a)(4)(B)(i) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)(B)(i)); and
(f) The bank complies with section 3(a)(4)(C) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(4)(C)).
Sec. 242.762 Defined terms relating to the safekeeping and custody
activities exception from the definition of ``broker.''
For purposes of this subpart, the following terms shall have the
meaning provided:
(a) Account for which the bank acts as a custodian means 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:
(1)(i) Safekeeping of securities;
(ii) Settling trades;
(iii) Investing cash balances as directed;
(iv) Collecting income;
(v) Processing corporate actions;
(vi) Pricing securities positions; and
(vii) Providing recordkeeping and reporting services; or
(2) An individual retirement account for which the bank acts as a
custodian.
(b) Affiliate has the same meaning as in the Bank Holding Company
Act of 1956 (12 U.S.C. 1841 et seq.).
(c) Affiliated person has the same meaning as in section 2(a)(3) of
the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(3)).
(d) Bank holding company has the same meaning as in the Bank
Holding Company Act of 1956 (12 U.S.C. 1841 et seq.).
(e) Principal underwriter has the same meaning as in section
2(a)(29) of the Investment Company Act of 1940 (15 U.S.C. 80a-
2(a)(29)).
(f) Sales compensation has the same meaning as in Sec. 242.724.
(g) Savings and loan holding company has the same meaning as in
section 10(a)(1)(D) of the Home Owners' Loan Act (12 U.S.C.
1467(a)(1)(D)).
(h) Small bank means a bank that:
(1) Had less than $500 million in assets as of December 31 of both
of the prior two calendar years; and
(2) Is not, and since December 31 of the third prior calendar year
has not been, an affiliate of a bank holding company or a savings and
loan holding company that as of December 31 of both of the prior two
calendar years had consolidated assets of more than $1 billion.
Subpart G--Special Purpose Exemptions
Sec. 242.770 Exemption from the definition of ``broker'' for banks
effecting transactions in securities in certain employee benefit plans.
(a) A bank is exempt from the definition of the term ``broker''
under section 3(a)(4) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)) to the extent that it effects transactions in securities of
an open-end company in an account for a plan that is qualified under
section 401(a) of the Internal Revenue Code of 1986 (26 U.S.C. 401(a))
or a plan described in sections 403(b) or 457 of the Internal Revenue
Code of 1986 (26 U.S.C. 403(b) or 26 U.S.C. 457) for which the bank
acts as a trustee or a custodian; or offers participants a participant-
directed brokerage account, if:
(1) The bank offsets or credits any compensation that it receives
from a fund complex related to securities in which plan assets are
invested against fees and expenses that the plan owes to the bank;
(2) The bank provides a clear and conspicuous disclosure to the
plan sponsor or its designated fiduciary, if any, that includes all
fees and expenses assessed for services provided to the plan and all
compensation received or to be received from a fund complex in a manner
that permits the plan sponsor or its designated fiduciary, if any, to
determine that the bank has offset or credited any compensation
received from a fund complex related to securities in which plan assets
are invested or to be invested against the fees and expenses that the
plan owes to the bank;
(3) The bank offers the participant-directed brokerage account
through a registered broker or dealer;
(4) The bank does not pay any incentive compensation to a natural
person that is not qualified pursuant to
[[Page 39738]]
the rules of a self-regulatory organization that differs based on the
value of a security or the type of security purchased or sold by an
account or a person who exercises control over the assets of such
account; and
(5) The bank complies with section 3(a)(4)(C) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(4)(C)).
(b) Definitions. For purposes of this section:
(1) Fund complex means the issuer of the security (including the
sponsor, depositor or trustee), the issuer of any other security that
holds itself out to investors as a related company for purposes of
investment or investor services, any agent of such issuer, any
investment adviser of such issuer, and any affiliated person (as
defined in section 2(a)(3) of the Investment Company Act of 1940 (15
U.S.C. 80a-2(a)(3)) of such issuer or any such investment adviser.
(2) Open-end company has the same meaning as in Sec. 242.740.
(3) Participant-directed brokerage account means an account that is
carried by a broker or dealer on a basis in which each participant that
receives any brokerage services is fully disclosed to the broker or
dealer.
Sec. 242.771 Exemption from the definitions of ``broker'' and
``dealer'' for banks effecting transactions in securities issued
pursuant to Regulation S.
(a) A bank is exempt from the definitions of the terms ``broker''
and ``dealer'' under sections 3(a)(4) and 3(a)(5) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(4) and 15 U.S.C. 78c(a)(5)), to
the extent that, as agent or as a riskless principal, the bank:
(1) Effects a sale of an eligible security to a purchaser who is
outside of the United States within the meaning of and in compliance
with the requirements of 17 CFR 230.903;
(2) Effects a resale of an eligible security after its initial sale
within the meaning of and in compliance with the requirements of 17 CFR
230.903, by or on behalf of a person who is not a U.S. person under 17
CFR 230.902(k) to a purchaser or a registered broker or dealer,
provided that if the sale is made prior to the expiration of the
distribution compliance period specified in 17 CFR 230.903(b)(2) or
(b)(3), the sale is made in compliance with the requirements of 17 CFR
230.904; or
(3) Effects a resale of an eligible security after its initial sale
within the meaning of and in compliance with the requirements of 17 CFR
230.903, by or on behalf of a registered broker or dealer to a
purchaser, provided that if the sale is made prior to the expiration of
the distribution compliance period specified in 17 CFR 230.903(b)(2) or
(b)(3), the sale is made in compliance with the requirements of 17 CFR
230.904.
(b) Definitions. For purposes of this section:
(1) Distributor has the same meaning as in 17 CFR 230.902(d).
(2) Eligible security means a security that:
(i) Is not being sold from the inventory of the bank or an
affiliate of the bank; and
(ii) Is not being underwritten by the bank or an affiliate of the
bank on a firm-commitment basis, unless the bank acquired the security
from an unaffiliated distributor that did not purchase the security
from the bank or an affiliate of the bank.
(3) Purchaser means a person who purchases an eligible security and
who is not a U.S. person under 17 CFR 230.902(k).
(4) Riskless principal transaction means a transaction in which,
after having received an order to buy from a customer, the bank
purchased the security from another person to offset a contemporaneous
sale to such customer or, after having received an order to sell from a
customer, the bank sold the security to another person to offset a
contemporaneous purchase from such customer.
Sec. 242.772 [Reserved]
Sec. 242.773 Exemption from the definitions of ``broker'' and
``dealer'' for savings associations and savings banks.
(a) Any savings association or savings bank that has deposits
insured by the Federal Deposit Insurance Corporation under the Federal
Deposit Insurance Act (12 U.S.C. 1811 et. seq.), and is not operated
for the purpose of evading the provisions of the Securities Exchange
Act of 1934 (15 U.S.C. 78a et seq.), is exempt from the definitions of
the terms ``broker'' and ``dealer'' under sections 3(a)(4) and 3(a)(5)
of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(4) and 15
U.S.C. 78c(a)(5)), to the extent that the savings association or
savings bank acts as a broker or dealer on the same terms and under the
same conditions that banks are excepted, provided that if a savings
association or savings bank acts as a municipal securities dealer, it
shall be considered a bank municipal securities dealer for purposes of
the Securities Exchange Act of 1934 and the rules thereunder, including
the rules of the Municipal Securities Rulemaking Board.
(b) Any savings association or savings bank that has deposits
insured by the Federal Deposit Insurance Corporation under the Federal
Deposit Insurance Act (12 U.S.C. 1811 et seq.), and is not operated for
the purpose of evading the provisions of the Securities Exchange Act of
1934 (15 U.S.C. 78a et seq.), is exempt from the definitions of the
terms ``broker'' and ``dealer'' under sections 3(a)(4) and 3(a)(5) of
the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(4) and 15 U.S.C.
78c(a)(5)) to the extent that the savings association or savings bank
acts as a broker or dealer on the same terms and under the same
conditions that banks are exempted pursuant to Sec. Sec. 242.720
through 242.723, Sec. 242.761, Sec. 242.772, Sec. 242.775, Sec.
242.776, Sec. 242.780 and Sec. 242.781.
Sec. 242.774 Exemption from the definitions of ``broker'' and
``dealer'' for credit unions.
Any federal or state-chartered credit union that is not operated
for the purpose of evading the provisions of the Securities Exchange
Act of 1934 (15 U.S.C. 78a et seq.) is exempt from the definitions of
the terms ``broker'' and ``dealer'' under sections 3(a)(4)(B)(i) and
(v) and 3(a)(5)(C)(ii) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(4)(B)(i) and (v) and 15 U.S.C. 78c(a)(5)(C)(ii)), to the
extent that the credit union acts as a broker or dealer on the same
terms and under the same conditions that banks are excepted under those
sections of the Securities Exchange Act of 1934.
Sec. 242.775 Exemption from the definition of ``broker'' for the way
banks effect excepted or exempted transactions in investment company
securities.
(a) A bank that meets the conditions for an exception or exemption
from the definition of the term ``broker'' except for the condition in
section 3(a)(4)(C)(i) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)(C)(i)), is exempt from such condition to the extent that it
effects transactions in securities issued by an open-end company that
is neither traded on a national securities exchange nor through the
facilities of a national securities association or an interdealer
quotation system, provided that:
(1) Such transactions are effected through the National Securities
Clearing Corporation's Mutual Fund Services or directly with a transfer
agent acting for the open-end company; and
(2) With respect to such transactions:
(i) The transfer agent, if any, does not accept compensation paid
for the distribution of the securities, including any compensation paid
pursuant to any revenue-sharing arrangement and
[[Page 39739]]
compensation paid pursuant to a plan under 17 CFR 270.12b-1; and
(ii)(A) The securities are distributed by a registered broker or
dealer; or
(B) The sales charge is no more than the amount a registered broker
or dealer may charge pursuant to the rules of a securities association
registered under section 15A of the Securities Exchange Act of 1934 (15
U.S.C. 78o-3) adopted pursuant to section 22(b)(1) of the Investment
Company Act of 1940 (15 U.S.C. 80a-22(b)(1)).
(b) Definitions. For purposes of this section:
(1) Interdealer quotation system has the same meaning as in 17 CFR
240.15c2-11.
(2) Open-end company has the same meaning as in Sec. 242.740.
Sec. 242.776 Exemption for banks effecting transactions for certain
investors in money market funds.
(a) A bank is exempt from the definition of the term ``broker''
under section 3(a)(4) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)) to the extent that it effects transactions on behalf of a
customer in securities issued by a money market fund, provided that:
(1)(i) The customer has obtained from the bank a financial product
or service not involving securities and is a qualified investor as
defined in section 3(a)(54)(A) of the Securities Exchange Act of 1934
(15 U.S.C. 78c(a)(54)(A)), or a person that directs the purchase of
securities from any cash flows that relate to an asset-backed security
as defined in proposed 17 CFR 229.1101(c)(1) of Regulation AB, which
has a minimum original asset amount of $25,000,000;
(ii) The bank effects the transactions in a trustee or fiduciary
capacity within the scope of section 3(a)(4)(D) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(4)(D)); or
(iii) The bank effects the transactions as escrow agent, collateral
agent, depository agent, or paying agent; and
(2)(i) The class or series of securities is no-load; or
(ii)(A) The class or series of securities is not no-load, and the
bank does not characterize or refer to the class or series of
securities as no-load; and
(B) If the customer is not a person described in paragraph
(a)(1)(i) of this section, the bank provides the customer, not later
than at the time the customer authorizes the bank to effect the
transactions, a prospectus for the securities and a clear and
conspicuous notice that:
(1) Discloses any payments the bank may receive in connection with
the transactions from the fund complex to which the issuer of the
securities belongs;
(2) Separately identifies any such payments that are sales loads,
deferred sales loads, or fees paid pursuant to a plan under 17 CFR
270.12b-1; and
(3) Indicates that the customer should carefully review the
prospectus for the securities for additional information regarding
expenses.
(b) Definitions. For purposes of this section:
(1) Deferred sales load has the same meaning as in Sec. 242.740.
(2) Fund complex has the same meaning as in Sec. 242.770.
(3) Money market fund has the same meaning as in Sec. 242.740.
(4) No-load has the same meaning as in Sec. 242.740.
(5) Open-end company has the same meaning as in Sec. 242.740.
(6) Sales load has the same meaning as in Sec. 242.740.
Subpart H--Temporary Exemptions
Sec. 242.780 Exemption for banks from liability under section 29 of
the Securities Exchange Act of 1934.
(a) No contract entered into before January 1, 2003, shall be void
or considered voidable by reason of section 29 of the Securities
Exchange Act of 1934 (15 U.S.C. 78cc) because any bank that is a party
to the contract violated the registration requirements of section 15(a)
of the Securities Exchange Act of 1934 (15 U.S.C. 78o(a)), any other
applicable provision of that Act, or the rules and regulations
thereunder based solely on the bank's status as a broker or dealer when
the contract was created.
(b) No contract entered into before March 31, 2005, shall be void
or considered voidable by reason of section 29 of the Securities
Exchange Act of 1934 (15 U.S.C. 78cc) because any bank that is a party
to the contract violated the registration requirements of section 15(a)
of the Securities Exchange Act of 1934 (15 U.S.C. 78o(a)), any other
applicable provision of that Act, or the rules and regulations
thereunder based solely on the bank's status as a dealer when the
contract was created.
(c) No contract entered into before [insert date 18 months after
effective date of the final rule], shall be void or considered voidable
by reason of section 29 of the Securities Exchange Act of 1934 (15
U.S.C. 78cc) because any bank that is a party to the contract violated
the registration requirements of section 15(a) of the Securities
Exchange Act of 1934 (15 U.S.C. 78o(a)), any other applicable provision
of that Act, or the rules and regulations thereunder based solely on
the bank's status as a broker when the contract was created.
Sec. 242.781 Exemption from the definition of ``broker'' for banks
for a limited period of time.
A bank is exempt from the definition of the term ``broker'' under
Section 3(a)(4) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(4)) until January 1, 2006.
Dated: June 17, 2004.
By the Commission.
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 04-14138 Filed 6-29-04; 8:45 am]
BILLING CODE 8010-01-P