[Federal Register Volume 72, Number 191 (Wednesday, October 3, 2007)]
[Rules and Regulations]
[Pages 56514-56562]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 07-4769]
[[Page 56513]]
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Part III
Federal Reserve System
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Securities and Exchange Commission
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12 CFR Part 218 and 17 CFR Parts 240 and 247
Definitions of Terms and Exemptions Relating to the ``Broker''
Exceptions for Banks and Exemptions for Banks Under Section 3(a)(5) of
the Securities Exchange Act of 1934 and Related Rules; Final Rules
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 /
Rules and Regulations
[[Page 56514]]
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FEDERAL RESERVE SYSTEM
12 CFR Part 218
[Regulation R; Docket No. R-1274]
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240 and 247
[Release No. 34-56501; File No. S7-22-06]
RIN 3235-AJ74
Definitions of Terms and Exemptions Relating to the ``Broker''
Exceptions for Banks
AGENCIES: Board of Governors of the Federal Reserve System (``Board'')
and Securities and Exchange Commission (``SEC'' or ``Commission'')
(collectively, the Agencies).
ACTION: Final rule.
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SUMMARY: The Board and the Commission jointly are adopting a single set
of final rules that implement certain of the exceptions 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 rules define terms used in these
statutory exceptions and include certain related exemptions. In
developing these rules, the Agencies have consulted with, and sought
the concurrence of, the Office of the Comptroller of the Currency
(``OCC''), the Federal Deposit Insurance Corporation (``FDIC'') and the
Office of Thrift Supervision (``OTS''), and have taken into
consideration all comments received on the proposed rules issued in
December 2006. The rules are intended, among other things, to
facilitate banks' compliance with the Exchange Act and the GLBA.
DATES: Effective dates: The addition of parts 12 CFR 218 and 17 CFR 247
is effective September 28, 2007. Regulations at 12 CFR 218.781 and 17
CFR 247.781 (collectively ``Rule 781'') are effective on September 28,
2007. Regulations at 12 CFR 218.100 through 218.780 and 17 CFR 247.100
through 247.780 are effective December 3, 2007. Amendments affecting
Part 240 of Title 17 are effective December 3, 2007.
Compliance date: Banks are exempt from complying with the rules and
the ``broker'' exceptions in Section 3(a)(4)(B) of the Exchange Act
until the first day of their first fiscal year that commences after
September 30, 2008.
FOR FURTHER INFORMATION CONTACT:
BOARD: Kieran J. Fallon, Assistant General Counsel, (202) 452-5270,
Andrea Tokheim, Counsel, (202) 452-2300, or Brian Knestout, Attorney,
(202) 452-2249, Legal Division, Board of Governors of the Federal
Reserve System, 20th Street and Constitution Avenue, NW., Washington,
DC 20551. Users of Telecommunication Device for Deaf (TDD) only, call
(202) 263-4869.
SEC: Catherine McGuire, Chief Counsel, Linda Stamp Sundberg, Senior
Special Counsel, Joshua Kans, Senior Special Counsel, John J. Fahey,
Branch Chief, or Elizabeth MacDonald, Special Counsel, at (202) 551-
5550, Office of the Chief Counsel, Division of Market Regulation,
Securities and Exchange Commission, 100 F Street, NE., Washington, DC
20549.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Background
B. Overview of Comments
C. Final Rules and Related Matters
II. Networking Arrangements
A. Overview of Proposed Rules and Comments
B. Rule 700: Definition of Terms Used in Networking Exception
1. Definition of ``Nominal One-Time Cash Fee of a Fixed Dollar
Amount''
2. Definition of ``Referral''
3. Definition of ``Contingent on Whether the Referral Results in
a Transaction''
4. Definition of ``Incentive Compensation''
a. Exception for Discretionary, Multi-Factor Bonus Plans
b. Safe Harbor for Plans Based on Overall Profitability or
Revenue
C. Rule 701: Exemption for Referrals Involving Institutional
Customers and High Net Worth Customers
1. Definitions of ``Institutional Customer'' and ``High Net
Worth Customer''
2. Determining that a Customer Meets the Relevant Thresholds
3. Conditions Relating to Disclosures
4. Suitability or Sophistication Analysis by Broker-Dealer
5. Conditions Relating to Bank Employees
6. Good Faith Compliance and Corrections by Banks
7. Referral Fees Permitted Under the Exemption
8. Permissible Bonus Compensation Not Restricted
III. Trust and Fiduciary Activities
A. Trust and Fiduciary Exception and Proposed Rules
B. Joint Final Rules
1. ``Chiefly Compensated'' Test and Bank-Wide Exemption Based on
Two-Year Rolling Averages
2. ``Relationship Compensation''
3. Excluded Compensation
4. Trust or Fiduciary Accounts
5. Exemptions for Special Accounts, Foreign Branches,
Transferred Accounts, and a De Minimis Number of Accounts
6. Advertising Restrictions
IV. Sweep Accounts and Transactions in Money Market Funds
A. Rule 740: Definition of Terms Used in Sweep Exception
B. Exemption Regarding Money Market Fund Transactions
V. Safekeeping and Custody
A. Background
B. Rule 760: Custody Exemption
1. Order-Taking for Employee Benefit Plan Accounts and
Individual Retirement or Similar Accounts
a. Employee Compensation Restrictions
b. Advertisements and Sales Literature
c. Other Conditions
2. Order-Taking as an Accommodation for Other Types of Accounts
a. Accommodation Basis
b. Employee Compensation Restrictions
c. Limitations on Bank Fees
d. Advertising and Sales Literature Restrictions
e. Investment Advice or Recommendations
3. Other Conditions Applicable to Order-Taking for All Custody
Accounts
a. Directed Trustees
b. Broker Execution Requirement
c. Carrying Broker Provisions
4. Custodians, Subcustodians, and Administrators/Recordkeepers
a. ``Account for Which a Bank Acts as a Custodian''
b. Administrators/Recordkeepers and Subcustodians
5. Evasions
VI. Other Exemptions
A. Exemption for Regulation S Transactions With Non-U.S. Persons
and Broker-Dealers
B. Exemption for Non-Custodial Securities Lending Transactions
C. Exemption for Banks Effecting Certain Excepted or Exempted
Transactions in Investment Company Securities and Variable Insurance
Products
D. Exemption for Certain Transactions involving a Company's
Securities for Its Employee Benefit Plans and Participants
E. Temporary and Permanent Exemption for Contracts Entered Into
by Banks From Being Considered Void or Voidable
F. Extension of Time and Transition Period
VII. Finding That the Exemptions Are Appropriate and in the Public
Interest and Consistent With the Protection of Investors
VIII. Withdrawal of Proposed Regulation B and Removal of Exchange
Act Rules 3a4-2-3a4-6, and 3b-17
IX. Administrative Law Matters
A. Paperwork Reduction Act Analysis
B. Consideration of Benefits and Costs
C. Consideration of Burden on Competition, and on Promotion of
Efficiency, Competition, and Capital Formation
D. Consideration of Impact on the Economy
E. Regulatory Flexibility Analysis
F. Plain Language
X. Statutory Authority
XI. Text of Rules and Rule Amendment
I. Introduction
A. Background
The GLBA amended several federal statutes governing the activities
and supervision of banks, bank holding
[[Page 56515]]
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 most of the
separation of investment and commercial banking imposed by the Glass-
Steagall Act. The GLBA also revised the provisions of the Exchange Act
that had completely excluded banks from broker-dealer registration
requirements.
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\1\ Pub. L. No. 106-102, 113 Stat. 1338 (1999).
\2\ Pub. L. No. 73-66, ch. 89, 48 Stat. 162 (1933) (as codified
in various Sections of 12 U.S.C.).
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In enacting the GLBA, Congress adopted functional regulation for
bank securities activities, with certain exceptions from Commission
oversight for specified securities activities. With respect to the
definition of ``broker,'' the GLBA amended the Exchange Act to provide
eleven specific exceptions for banks.\3\ Each of these exceptions
permits a bank to act as a broker or agent in securities transactions
that meet specific statutory conditions.
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\3\ 15 U.S.C. 78c(a)(4).
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In particular, Section 3(a)(4)(B) of the Exchange Act as amended by
the GLBA provides conditional exceptions from the definition of broker
for banks that engage in certain securities activities in connection
with third-party brokerage arrangements; \4\ trust and fiduciary
activities; \5\ permissible securities transactions; \6\ certain stock
purchase plans; \7\ sweep accounts; \8\ affiliate transactions; \9\
private securities offerings; \10\ safekeeping and custody activities;
\11\ identified banking products; \12\ municipal securities; \13\ and a
de minimis number of other securities transactions.\14\
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\4\ Exchange Act Section 3(a)(4)(B)(i). This exception permits
banks to enter into third-party brokerage, or ``networking''
arrangements with brokers under specific conditions.
\5\ Exchange Act Section 3(a)(4)(B)(ii). This exception permits
banks to effect transactions as trustees or fiduciaries for
securities customers under specific conditions.
\6\ 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.
\7\ 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.
\8\ Exchange Act Section 3(a)(4)(B)(v). This exception permits
banks to sweep funds into no-load money market funds.
\9\ Exchange Act Section 3(a)(4)(B)(vi). This exception permits
banks to effect transactions for affiliates, other than broker-
dealers.
\10\ Exchange Act Section 3(a)(4)(B)(vii). This exception
permits certain banks to effect transactions in certain privately
placed securities, under certain conditions.
\11\ 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.
\12\ 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.
\13\ Exchange Act Section 3(a)(4)(B)(x). This exception permits
banks to effect transactions in municipal securities.
\14\ 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.
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In October 2006, the Financial Services Regulatory Relief Act of
2006 (``Regulatory Relief Act'') became effective.\15\ Among other
things, the Regulatory Relief Act requires that the SEC and the Board
jointly adopt a single set of rules to implement the bank broker
exceptions in Section 3(a)(4) of the Exchange Act.\16\ In addition, it
required that the Agencies issue a single set of proposed rules to
implement these exceptions not later than 180 days after enactment of
the Regulatory Relief Act (April 11, 2007).
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\15\ Public Law No. 109-351, 120 Stat. 1966 (2006).
\16\ See Exchange Act Section 3(a)(4)(F), as added by Section
101 of the Regulatory Relief Act.
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In December 2006, the Agencies jointly issued, and requested public
comment on, a single set of proposed rules to implement the broker
exceptions for banks relating to third-party networking arrangements,
trust and fiduciary activities, sweep activities, and safekeeping and
custody activities.\17\ The proposed rules included certain exemptions
related to these activities, as well as exemptions related to foreign
securities transactions, securities lending transactions conducted in
an agency capacity, the execution of transactions involving mutual fund
shares, and the potential liability of banks under Section 29 of the
Exchange Act. In developing the proposed rules, the Agencies
considered, among other things, the language and legislative history of
the ``broker'' exceptions for banks adopted in the GLBA, the rules
previously issued or proposed by the Commission relating to these
exceptions, and the comments received in connection with those prior
rulemakings.
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\17\ See 71 FR 77522, December 26, 2006.
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The Agencies requested comment on all aspects of the proposed
rules. In addition, the Agencies requested comment on whether it would
be useful or appropriate for the Agencies to adopt rules implementing
the other bank ``broker'' exceptions in Section 3(a)(4)(B) of the
Exchange Act that were not addressed in the proposal.
B. Overview of Comments
The Agencies received comments from 58 organizations and
individuals on the proposed rules. Commenters included 22 trade
associations, 20 banking organizations, 7 other organizations in the
financial services industry, 3 community and nonprofit groups, two
credit unions, one state government, one self-regulatory organization,
one association of state securities administrators, and one individual.
Many commenters supported the proposed rules as a general matter. For
example, commenters asserted that the proposed rules would provide
banks considerable flexibility in providing securities services to
their customers, would avoid disrupting bank activities and customer
relationships, or were a significant improvement over earlier
proposals.\18\ In addition, many commenters supported the general
approaches (including related exemptions) taken by the proposed rules
to implement the networking, trust and fiduciary, sweep, and
safekeeping and custody exceptions. Several commenters, however,
contended that the proposed rules did not adequately protect investors,
and particularly retail investors.\19\ Some of these commenters argued
that that the Agencies should withdraw the proposed rules and issue new
rules based on those issued in 2001\20\ or 2004.\21\
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\18\ See, e.g., Citigroup Letter, Independent Community Bankers
Ass'n (``ICBA'') Letter, American Bankers Ass'n (``ABA'') Letter,
JPMorgan Chase & Co. (``JP Morgan'') Letter, Financial Services
Roundtable (``Roundtable'') Letter.
\19\ See, e.g., Massachusetts Securities Division Letter, Pace
Investors Rights Project (``Pace Project'') Letter, Boyd Financial
Letter.
\20\ Exchange Act Release No. 44291 (May 11, 2001), 66 FR 27760
(May 18, 2001).
\21\ Exchange Act Release No. 49879 (June 17, 2004), 69 FR 39682
(June 30, 2004). See, e.g., North American Securities Administrators
Association (``NASAA'') Letter.
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Most commenters also recommended that the Agencies modify specific
provisions of the proposed rules to, among other things, reduce
administrative burden, better protect bank customers or investors, or
clarify the scope or effect of the rules. The comments received on the
proposed rules are discussed in greater detail in the following
sections of this SUPPLEMENTARY INFORMATION.
C. Final Rules and Related Matters
After carefully considering the comments, the Agencies have adopted
[[Page 56516]]
final rules to implement the broker exceptions for banks relating to
third-party networking arrangements, trust and fiduciary activities,
sweep activities, and custody and safekeeping activities.\22\ The Board
and SEC have consulted extensively with, and sought the concurrence of,
the OCC, FDIC and OTS in developing these final rules.
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\22\ Commenters generally did not request that the Agencies
adopt rules to implement the other broker exceptions for banks at
this time or stated that no additional guidance was needed at this
time with respect to these exceptions. See ABA Letter.
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Like the proposal, the final rules include certain exemptions
related to these activities, as well as exemptions related to foreign
securities transactions, securities lending transactions conducted in
an agency capacity, the execution of transactions other than through a
broker-dealer, the potential liability of banks under Section 29 of the
Exchange Act, and the date on which the GLB Act's ``broker'' exceptions
for banks will go into effect.
As discussed in the following sections, the Agencies have modified
the rules in numerous respects in light of the comments received. These
changes include, among other things, modifications to the examples of
``relationship compensation'' in Rule 721 to clarify the scope of the
term for purposes of the rules relating to trust and fiduciary
activities; the custody exemption in Rule 760 to permit banks acting as
a directed trustee to accept orders under the exemption; and Rule 781
to extend the compliance date for a bank until the first day of its
first fiscal year commencing after September 30, 2008. The Agencies
also have adopted new exemptions relating to trust or fiduciary
accounts held in a foreign branch of a bank,\23\ and to permit a bank
to effect, under certain conditions and without using a broker-dealer,
transactions in a fiduciary or custodial capacity for an employee
benefit plan in the stock of the plan's sponsor.\24\
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\23\ See Rule 723(c).
\24\ See Rule 776.
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The final rules are designed to accommodate the business practices
of banks and protect investors. If more than one broker exception or
exemption is available to a bank under the statute or rules for a
securities transaction, the bank may choose the exception or exemption
on which it relies to effect the transaction without registering as a
broker-dealer. For example, if the bank effects a transaction in a
security sold in an offshore transaction for a custody account that is
permissible under either the Regulation S exemption in Rule 771 or the
custody exemption in Rule 760, the bank may choose which exemption to
rely on and comply with in effecting the transaction. Similarly, if a
bank effects no more than 500 securities transactions as agent for its
customers in a calendar year, the bank may rely on the de minimis
exception in Section 3(a)(4)(B)(xi) of the Exchange Act in lieu of any
other available exception or exemption for such transactions. The bank,
of course, must comply with all of the requirements contained in the
exception or exemption on which it relies.\25\
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\25\ An employee of a bank that operates in accordance with the
exceptions in Section 3(a)(4)(B) of the Exchange Act and, where
applicable, the rules is not required to register as a ``broker'' to
the extent that the employee's activities are covered by the
relevant exception or rule.
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Section 401 of the Regulatory Relief Act amended the definition of
``bank'' in Section 3(a)(6) of the Exchange Act to include any Federal
savings association or other savings association the deposits of which
are insured by the FDIC. Accordingly, as used in the final rules, the
term ``bank'' includes any savings association that qualifies as a
``bank'' under Section 3(a)(6) of the Exchange Act, as amended.\26\
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\26\ Several commenters asked the Agencies, or the Commission
independently, to adopt rules that would extend to federal or state-
chartered credit unions some or all of the ``broker'' exceptions or
exemptions provided banks under Section 3(a)(4)(B) of the Exchange
Act or the final rules. See, e.g., Credit Union Nat'l Ass'n Letter,
Nat'l Ass'n of Credit Union Service Organizations Letter, Nat'l
Ass'n of Fed. Credit Unions Letter, Navy Fed. Credit Union Letter,
and XCU Corp. Letter. While the GLBA's ``bank'' exceptions do not by
their terms apply to credit unions, these requests are under
consideration by the Commission, which is the agency with authority
to address these matters. The Commission notes the existence of SEC
staff positions with regard to networking relationships between a
credit union and a broker-dealer and is not addressing this issue at
this time. See, e.g., Chubb Securities Corp., 1993 SEC No-Act. LEXIS
1204 (Nov. 24, 1993).
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Identical sets of the final rules are being adopted by the Board
and SEC and will be published by the Board in Title 12 of the Code of
Federal Regulations and by the SEC in Title 17 of the Code of Federal
Regulations.\27\ Pursuant to the Regulatory Relief Act, this single set
of final rules supersedes any and all other proposed or final rules
issued by the Commission on or after the date of enactment of the GLBA
with regard to the definition of ``broker'' under Section 3(a)(4) of
the Exchange Act.\28\
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\27\ The final rules adopted by the Board and the SEC within
their respective titles of the Code of Federal Regulation (12 CFR
part 218 for the Board and 17 CFR part 247 for the SEC) are
identically numbered from Sec. ------.100 to Sec. ------.781. For
ease of reference, the single set of final rules adopted by each
Agency are referred to in this release as Rule ------, excluding
title and part designations. A similar format is used to refer to
the single set of proposed rules issued by the Agencies.
\28\ Pub. L. No. 109-351, Sec. 101(a)(3), 120 Stat. 1966, 1968
(2006).
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Any additions or changes to these rules that may be appropriate to
implement Section 3(a)(4)(B) of the Exchange Act will be adopted
jointly by the SEC and Board in accordance with the consultation
provisions in Section 101(b) of the Regulatory Relief Act. In addition,
if any rules (including exemptions) are proposed or adopted in the
future related to the other bank ``broker'' exceptions in Section
3(a)(4)(B) of the Exchange Act that are not addressed in the final
rules now being adopted by the SEC and the Board, they would be
proposed and adopted jointly by the SEC and Board.\29\
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\29\ A few commenters requested that the Commission delegate
authority to act on future exemptive requests from banks to the
Director of its Division of Market Regulation. See America Community
Bankers Ass'n (``ACB'') Letter, Roma Bank Letter. Because particular
banks may have individual situations that may be appropriate for
additional relief, the Commission delegated authority to the
Director of the Division of Market Regulation to consider, on a
case-by-case basis, individual requests for exemptive relief from
banks. To facilitate the processing of these requests, the
Commission delegated this exemptive authority within its Rules of
Organization and Program Management in Rule 30-3(a)(70) (17 CFR
200.30-3(a)(70)). The Commission continues to expect the staff to
submit novel and complex requests for exemptions to the Commission.
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As required by the GLBA, the Board, OCC, FDIC, and OTS
(collectively, the Banking Agencies) will develop, and request public
comment on, recordkeeping rules for banks that operate under the
``broker'' exceptions in Section 3(a)(4) of the Exchange Act.\30\ These
rules, which will be developed in consultation with the SEC, will
establish recordkeeping requirements to enable banks to demonstrate
compliance with the terms of the statutory exceptions and the final
rules and will be designed to facilitate compliance with the statutory
exceptions and the rules.
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\30\ See 12 U.S.C. 1828(t)(1).
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Several commenters urged the Agencies also to cooperate in
providing interpretations or guidance (such as staff no-action letters)
concerning the final rules or the broker exceptions for banks in
Section 3(a)(4)(B) of the Exchange Act or in taking enforcement action
to enforce compliance with these rules or exceptions.\31\ In addition,
a number of commenters urged the Agencies to work
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with the Financial Industry Regulatory Authority (``FINRA'') \32\ to
modify promptly its Rule 3040 as it applies to persons that are
employees of both a bank and a broker-dealer (so-called ``dual
employees'').\33\
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\31\ See, e.g., ABA Letter, Clearing House Ass'n Letter,
Citigroup Letter, The PNC Financial Services Group, Inc. (``PNC'')
Letter. One commenter, however, expressed concern that coordination
among the Agencies might result in slower responses to requests for
guidance. See American Bar Ass'n Section of Business Law Letter
(``Business Law Section Letter'').
\32\ On July 26, 2007, the Commission approved a proposed rule
change filed by NASD to amend NASD's Certificate of Incorporation to
reflect its name change to Financial Industry Regulatory Authority
Inc., or FINRA, in connection with the consolidation of member firm
regulatory functions of NASD and NYSE Regulation, Inc. See
Securities Exchange Act Release No. 56146 (July 26, 2007). FINRA's
Rules currently consist of the rules adopted by the NASD and
effective on the date of the consolidation (which include NASD Rule
3040), as well as certain rules of the NYSE that FINRA has
incorporated into its own rules.
\33\ See, e.g., ABA Letter, Clearing House Ass'n Letter, Harris
Bank Letter, HSBC Bank, N.A. (``HSBC Bank'') Letter, HSBC Securities
(USA) Inc. (``HSBC Securities'') Letter, Roundtable Letter. These
commenters asserted that it was important for the requested
modifications to FINRA's Rule 3040 to be made prior to the date on
which banks would first have to comply with the new ``broker''
exceptions in the GLBA.
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In light of the joint nature of the final rules and the Agencies'
joint rule-writing authority for the bank broker exceptions in Section
3(a)(4)(B),\34\ the Agencies will jointly issue any interpretations and
responses to requests for no-action letters or other interpretive
guidance concerning the scope or terms of the exceptions and rules, and
will consult and, to the extent appropriate, coordinate with each other
and the appropriate federal banking agency for a bank concerning any
formal enforcement actions proposed to be taken against a bank for
violations of the exceptions or rules.
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\34\ Rapaport v. U.S. Department of Treasury, 59 F. 3d 212, 216-
217 (D.C. Cir. 1995), cert. denied 116 S.Ct. 775 (1996).
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The Agencies already consult with and coordinate with each other
and the other federal banking agencies in a variety of areas, and the
Agencies and the other federal banking agencies are in the process of
supplementing their existing policies and procedures to facilitate
coordination with respect to the broker exceptions and rules. Banks or
others that seek an interpretation of, or a no-action letter or other
staff guidance concerning, the rules or the exceptions should submit
their request to both Agencies. The Agencies also expect to continue
their dialogue with FINRA concerning potential modifications to that
authority's Rule 3040.
II. Networking Arrangements
The third-party brokerage exception (``networking exception'') in
Section 3(a)(4)(B)(i) of the Exchange Act permits a bank to avoid being
considered a broker if, under certain conditions, it enters into a
contractual or other written arrangement with a registered broker-
dealer under which the broker-dealer offers brokerage services to bank
customers.\35\ The networking exception does not address the type or
amount of compensation that a bank may receive from its broker-dealer
partner under a networking arrangement. However, the networking
exception provides that a bank may not pay its unregistered employees
\36\ incentive compensation for brokerage transactions. Nevertheless,
the statutory exception does permit a bank employee to receive a
``nominal one-time cash fee of a fixed dollar amount'' for referring
bank customers to the broker-dealer if payment of the referral fee is
not ``contingent on whether the referral results in a transaction.''
\37\ Congress included this general prohibition on, and limited
exception to, incentive compensation to reduce concerns regarding the
securities sales practice of unregistered bank employees.
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\35\ 15 U.S.C. 78c(a)(4)(B)(i).
\36\ An unregistered bank employee is an employee that is not
registered or approved, or otherwise required to be registered or
approved, in accordance with the qualification standards established
by the rules of any self-regulatory organization.
\37\ 15 U.S.C. 78c(a)(4)(B)(i)(VI).
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A. Overview of Proposed Rules and Comments
Proposed Rule 700 defined certain key terms related to referral
fees and incentive compensation used in the networking exception. For
example, the proposed rule provided that a referral fee would be
considered ``nominal'' if it met any of four standards included in the
rule. The proposed rule also defined when a referral fee would be
``contingent on whether a referral results in a transaction,'' what
constitutes ``incentive compensation,'' and what types of bank bonus
plans would not be considered incentive compensation under the
networking exception. Proposed Rule 701 included an exemption that
permitted bank employees, subject to certain conditions, to receive
higher-than-nominal, contingent referral fees for referring
institutional customers and high net worth customers to a broker-
dealer.
Many commenters supported the general approach of Proposed Rules
700 and 701, including the range of alternatives provided for
determining if a referral fee is nominal and the adoption of an
exemption for referrals involving high net worth or institutional
customers.\38\ Some commenters, however. suggested that the proposed
rules would harm investors by giving bank employees undue incentives to
direct unsophisticated customers into potentially unsuitable investment
products.\39\
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\38\ See, e.g. ABA Letter, Roundtable Letter, Citigroup Letter,
Union Bank of California (``Union Bank'') Letter.
\39\ See, e.g., Pace Project Letter.
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B. Rule 700: Definition of Terms Used in Networking Exception
1. Definition of ``Nominal One-Time Cash Fee of a Fixed Dollar Amount''
Proposed Rule 700 defined the term ``nominal one-time cash fee of a
fixed dollar amount'' to mean a cash payment for a referral in an
amount that meets any one of four alternative standards: the first
based on twice the average hourly base wage established by the bank for
the employee's job family; the second based on 1/1000th of the average
annual base salary established by the bank for the employee's job
family; the third based on twice the employee's actual base hourly
wage; and the fourth based on a specified dollar amount ($25), indexed
for inflation.\40\
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\40\ Proposed Rule 700(c).
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Many commenters generally supported the flexibility that this range
of alternatives would afford in determining whether a referral fee is
``nominal.'' \41\ Some commenters expressed concern that the proposed
rule placed greater limits on permissible payments under networking
arrangements than exist currently under applicable federal banking
agency guidance or questioned the need for a definition of ``nominal''
to be established by rule at all.\42\ A few commenters contended that
the specific dollar amount in the proposed rule ($25) was too low.\43\
A number of commenters, however, believed that the alternatives would
result in the payment of fees that are higher than nominal and would
create incentives for bank employees to make securities referrals even
when not appropriate for the customer. These commenters questioned, for
example, whether twice an employee's hourly wage was truly nominal and
whether the Agencies had sufficient basis for selecting that measure of
``nominal.'' \44\
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\41\ See, e.g., Roundtable Letter, ACB Letter.
\42\ See, e.g., Bank Insurance & Securities Ass'n (``BISA'')
Letter, Wisconsin Bankers Ass'n (``WBA'') Letter.
\43\ See, e.g., Clearing House Ass'n Letter and ICBA Letter.
\44\ See, e.g., Boyd Financial Letter, NASAA Letter, Pace
Project Letter, and University of Cincinnati Corp. Law Ctr. Letter.
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[[Page 56518]]
After carefully reviewing the comments, the Agencies have
determined to adopt the ``nominal'' definition substantially as
proposed. Including a definition of ``nominal'' in the rule will
provide banks with certainty as to the Agencies'' interpretation of
that standard and should facilitate compliance. The Agencies believe
that each of the alternatives for defining ``nominal'' is consistent
with the statutory networking exception, which provides that a bank
employee may receive compensation for each referral if the compensation
for that referral is ``nominal'' and meets the other requirements of
the statute. Under each of the alternatives established, the amount of
compensation a bank employee may receive for each referral will be
small in relation to the employee's overall compensation and therefore
unlikely to create undue incentives for the bank employee to engage in
activities, such as ``pre-selling'' specific securities to the customer
involved in violation of the networking exception,\45\ which would
raise sales practice concerns. As discussed below, the multiple
alternatives are designed to provide flexibility for banks of all sizes
and locations to use different business models and to take into account
economic differences around the country and among their employees in
assessing how best to structure their program(s) for paying ``nominal''
cash referral fees under the networking exception. The alternatives
also were designed to allow for roughly equivalent treatment of bank
employees at different base or hourly compensation levels within a
bank.
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\45\ See Exchange Act Section 3(a)(4)(B)(i)(V).
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Rule 700(c) provides that a referral fee paid to any bank employee
will be considered ``nominal'' if it does not exceed $25.\46\ This
dollar amount will be adjusted for inflation on April 1, 2012, and
every five years thereafter, to reflect any changes in the value of the
Employment Cost Index For Wages and Salaries, Private Industry Workers
(or any successor index thereto), as published by the Bureau of Labor
Statistics, from December 31, 2006.\47\ The Agencies selected this
index because it is a widely used and broad indicator of increases in
the wages of private industry workers, which includes bank employees.
Available data indicate that the $25 amount is consistent with the
level of referral fees generally paid to tellers and other bank
employees engaged in making referrals of retail customers under
existing Banking Agency guidance, which also includes a ``nominal''
standard.\48\
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\46\ Rule 700(c)(3).
\47\ Each adjustment would be rounded to the nearest multiple of
$1. Rule 700(f).
\48\ See ABA Securities Ass'n., 2003/2004 National Survey of
Bank Retail Investment Services, Vol. I, at 60 (survey data
demonstrate that 20 percent of banks pay retail referral fees of $20
or more); Banking Agencies' Interagency Statement on Retail Sales of
Nondeposit Investment Products (Feb. 15, 1994).
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As under the proposal, a referral fee also will be considered
``nominal'' under Rule 700(c) if the payment does not exceed (1) twice
the employee's actual base hourly wage; (2) twice the average of the
minimum and maximum hourly wage established by the bank for the current
or prior year for the job family that includes the employee; or (3) 1/
1000th of the average of the minimum and maximum annual base salary
established by the bank for the current or prior year for the job
family that includes the employee.\49\
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\49\ Rule 700(c)(1) and (2).
---------------------------------------------------------------------------
In developing these alternatives to the fixed $25 fee, the Agencies
considered data on the average hourly wages of bank tellers, which are
the class of bank employees most typically engaged in making referrals
of retail customers. These data indicate that the national mean hourly
wage in 2005 for tellers was $10.59.\50\ Accordingly, the $25 amount is
slightly more than twice the national mean hourly wage for tellers in
2005, and slightly more than 1/1000th of the annualized salary of an
employee that makes $12.50 per hour (or $25 every two hours) based on a
40 hour work week.\51\ Thus, the alternatives based on twice the
employee's hourly base wage or 1/1000th of the employee's base annual
salary, at current pay rates, are designed to allow bank employees to
receive referral fees that are roughly equivalent to those that may be
received by bank tellers under the flat dollar option.
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\50\ Occupational Employment and Wages, May 2005, (Tellers),
U.S. Department of Labor, Bureau of Statistics.
\51\ Specifically, twice the hourly wage for an employee who
earns an annual base salary of $25,000 (1,000 x $25) would be
$24.04, based on a 40 hour per week (or 1080 hours per year) work
schedule.
---------------------------------------------------------------------------
The options based on the employee's job family use these same
measurements but allow comparisons to the average of the minimum and
maximum hourly base wage or base salary of the employee's job family.
These options are designed to reduce administrative burden while also
ensuring that referral fees remain nominal in amount. To provide
comparability between the alternative based on an employee's actual
compensation and those based on the compensation established for the
employee's job family, the Agencies have modified the final rule to
provide that a referral fee also will be considered nominal if it does
not exceed 1/1000th of the employee's actual base annual salary.\52\
Under the final rules, a bank may use a different ``nominal''
methodology in its different business lines or operating units and may
alter the methodology it uses within a given year.
---------------------------------------------------------------------------
\52\ Rule 700(c)(2).
---------------------------------------------------------------------------
One commenter suggested that the term ``job family'' was ambiguous
and could allow banks to include all employees in a single job family,
which would result in payments to employees with salaries at the lower
end of the job family that may be well in excess of twice their hourly
wage.\53\ Rule 700 defines a ``job family'' as a group of jobs or
positions involving similar responsibilities, or requiring similar
skills, education or training, that a bank, or a separate unit, branch
or department of a bank, has established and uses in the ordinary
course of its business to distinguish among its employees for purposes
of hiring, promotion, and compensation.\54\ The requirements that a job
family include jobs or positions with similar responsibilities, or that
require similar skills, education and training, and be used by the bank
in the ordinary course of its business for hiring, promotion and
compensation purposes are designed to prevent a bank from establishing
special job family classifications to evade the ``nominal'' standard. A
bank may not deviate from its ordinary classification of jobs for
purposes of determining whether a referral fee is nominal under this
standard, and the Banking Agencies will monitor the job family
classifications used by banks for ``nominal'' determination as part of
the risk-focused examination process. Depending on a bank's internal
employee classification system, examples of a job family may include
tellers, loan officers, or branch managers. The Agencies note,
moreover, that other provisions of the networking exception also
provide significant protection to customers. For example, the
networking exception provides that unregistered bank employees may
perform only clerical or ministerial functions in connection with
brokerage transactions.\55\ Accordingly, bank employees referring a
customer to a broker-dealer under the exception may not provide
investment advice concerning securities or make specific
[[Page 56519]]
securities recommendations to the customer.\56\
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\53\ See Pace Project Letter.
\54\ Proposed Rule 700(d).
\55\ See 15 U.S.C. 78c(a)(4)(B)(i)(V).
\56\ A bank employee, however, may describe in general terms the
types of investment vehicles available from the bank and the broker-
dealer under the arrangement. See id.
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A few commenters suggested that, by defining ``nominal'' by
reference to hourly wages and annual base salary, the rule treats
unfairly employees who receive a considerable portion of their
compensation through bonuses tied to sales of non-securities
products.\57\ Because the five alternatives included in the final rule
are based on a set dollar amount or the hourly wage or annual base
salary established by a bank for the employee or the employee's job
family, the alternatives help ensure that a referral fee will be
nominal in relation to the employee's compensation in the year it is
paid. Bonuses, however, typically are discretionary, vary significantly
from year-to-year and, as noted by commenters, may constitute a
significant portion of the compensation of certain types of bank
employees in particular years. Permitting referral fees to be based in
part on the size of a bonus paid in a previous year (or projected to be
paid in the current year) could allow bank employees to receive a
referral fee that is not nominal in relation to the employee's
compensation, or the average compensation paid to employees within the
relevant job family, in the year in which the fee is paid and, thus,
could increase the potential for sales practice concerns.
---------------------------------------------------------------------------
\57\ See, e.g., ABA Letter, BISA Letter, Clearing House Ass'n
Letter, Harris Bank Letter, Roundtable Letter, PNC Letter, U.S.
Trust Company, N.A. (``U.S. Trust'') Letter, and WBA Letter.
---------------------------------------------------------------------------
Commenters also asserted that more than one employee should be able
to receive a fee for a single referral and also requested clarification
as to whether officers and directors of a bank may receive referral
fees under the exception.\58\ The Agencies believe that the networking
exception permits a bank employee who personally participated in a
referral to receive a referral fee for the referral.\59\ Accordingly,
the Agencies have modified Rule 700(c) to clarify this position. Thus,
for example, a supervisory employee may receive a separate, nominal
one-time cash fee for a referral made by another individual supervised
by the employee only if the supervisory employee personally
participated in the referral. A supervisory employee may not, however,
receive a referral fee merely for supervising the employee making the
referral or administering the referral process. An officer or director
of a bank who makes or personally participates in making a referral may
receive a nominal fee for the referral as a bank employee.
---------------------------------------------------------------------------
\58\ See, e.g., Consumer Bankers Ass'n (``CBA'') Letter, BISA
Letter.
\59\ See Section 3(a)(4)(B)(i)(VI) of the Exchange Act
(permitting ``the bank employee [to] receive compensation for the
referral of any customer'' in accordance with the exception).
---------------------------------------------------------------------------
The proposed rule permitted a nominal referral fee to be paid only
in cash. Many commenters requested that banks be given the flexibility
to pay referral fees in non-cash forms.\60\ The terms of the networking
exception, however, provide for a ``nominal, one-time cash fee of a
fixed dollar amount'' \61\ and, accordingly, the final rule continues
to require that referral fees paid under the exception be paid in cash.
A bank, therefore, may not pay referral fees in non-cash forms, such as
vacation packages, stock grants, annual leave, or consumer goods. The
final rules do not, however, prevent a bank from paying an employee on
a quarterly or more frequent periodic basis the total amount of
nominal, fixed cash fees the employee earned during the period. For
example, if a bank employee is entitled to receive a $25 referral fee
for each securities referral and the employee makes three qualifying
referrals in a given quarter, the bank may pay the employee $75 at the
end of the quarter instead of three individual payments of $25. A bank
also may use a ``points'' system to keep track of the number of
qualifying securities referrals made by the employee during a quarterly
or more frequent period and the total amount of nominal, fixed cash
fees that the employee is entitled to receive at the end of the period.
In all cases, however, points must translate into cash payments on a
uniform basis and the cash amount that an employee will receive for a
qualifying securities referral (e.g., twice the employee's actual base
hourly wage) must be fixed before the referral is made and may not be
contingent or vary based on whether an employee makes a specified
number or type of securities referrals during a quarterly or more
frequent period.\62\
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\60\ See, e.g., ABA Letter, BISA Letter, Clearing House Ass'n
Letter, and JP Morgan Letter.
\61\ See Exchange Act Section 3(a)(4)(B)(i)(VI).
\62\ The exception and the final rules also do not prohibit a
bank from providing its employees non-cash items, such as pizza or
coffee mugs, in connection with programs to familiarize bank
employees with new types of investment vehicles offered by the bank
or the broker-dealer through the arrangement, provided that the
programs or items given to employees do not reward or compensate an
employee for making a referral to a broker-dealer. Thus, for
example, a ``pizza party'' that is made available only to those
employees that have made one or more referrals to a broker-dealer
would not be permissible.
---------------------------------------------------------------------------
2. Definition of ``Referral''
The statutory networking exception permits bank employees to
receive a nominal one-time cash fee of a fixed dollar amount for the
``referral'' of a customer to a broker-dealer. Rule 700(e) defines a
referral as an action taken by one or more bank employees to direct a
customer of the bank to a broker-dealer for the purchase or sale of
securities for the customer's account.\63\ For purposes of the
networking exception and Rules 700 and 701, the term ``customer''
includes both existing and potential customers of the bank.
---------------------------------------------------------------------------
\63\ Rule 700(e).
---------------------------------------------------------------------------
As proposed, a bank employee may receive a referral fee under the
networking exception and Rule 700 for each referral made to a broker-
dealer, including separate referrals of the same individual or entity.
In addition, nothing in the statutory networking exception or the final
rules limits or restricts the ability of a bank employee to refer
customers to other departments or divisions of the bank itself,
including, for example, the bank's trust, fiduciary or custodial
department. Likewise, the networking exception and the rules do not
apply to referrals of retail, institutional or high net worth customers
to a broker-dealer or other third party solely for transactions not
involving securities, such as loans, futures contracts (other than a
security future), foreign currency, or over-the-counter commodities, or
solely for transactions in securities (such as U.S. Government
obligations) that would not require the other party to register under
section 15 of the Exchange Act.\64\
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\64\ A bank that acts as a government securities broker (as
defined in Section 3(a)(43) of the Exchange Act) is not exempt from
and must comply with the notification and other applicable
requirements of section 15C of the Exchange Act.
---------------------------------------------------------------------------
3. Definition of ``Contingent on Whether the Referral Results in a
Transaction''
Under the statutory networking exception, a nominal fee paid to an
unregistered bank employee for referring a customer to a broker-dealer
may not be contingent on whether the referral results in a transaction.
This limitation is designed to allow banks to reward bank employees for
introducing customers to a broker-dealer without giving unregistered
bank employees a direct financial interest in any resulting securities
transaction at the broker-dealer.
The final rule, like the proposed rule, provides that a referral
fee will be considered ``contingent on whether the referral results in
a transaction'' if payment of the fee is dependent on
[[Page 56520]]
whether the referral results in a purchase or sale of a security;
whether an account is opened with a broker-dealer; whether the referral
results in a transaction involving a particular type of security; or
whether the referral results in multiple securities transactions.\65\
The final rule expressly provides that a referral fee may be contingent
on whether a customer (1) contacts or keeps an appointment with a
broker-dealer as a result of the referral; or (2) meets any objective,
base-line qualification criteria established by the bank or broker-
dealer for customer referrals, including such criteria as minimum
assets, net worth, income, or marginal federal or state income tax
rate, or any requirement for citizenship or residency that the broker-
dealer, or the bank, may have established generally for referrals for
securities brokerage accounts.\66\ A bank or broker-dealer may
establish and use different objective, base-line qualification criteria
(including citizenship or residency requirements) for different classes
of customers or for different business lines, divisions or units of the
bank or broker-dealer.
---------------------------------------------------------------------------
\65\ Rule 700(a).
\66\ Rule 700(a).
---------------------------------------------------------------------------
Commenters generally supported these permissible contingencies.
Some commenters contended that the rule also should allow payment of a
nominal referral fee to be contingent on other events, such as the
opening of an account at the broker-dealer or on the opening of an
account that may be used to conduct only securities transactions that
the bank itself could effect without registering as a broker under the
exceptions for banks in Sections 3(a)(4)(B) of the Exchange Act.\67\
Opening a securities account at the broker-dealer, however, is a
necessary first step to executing securities transactions and one that
a customer is unlikely to take unless the customer anticipates engaging
in securities transactions with the broker-dealer. In light of this
close link between opening an account and executing securities
transactions, the Agencies have not modified the rule as requested and
the final rule continues to provide that payment of a referral fee may
not be contingent on whether the customer opens an account (other than
the types of accounts described in Part B.2 supra.) at the broker-
dealer. Other contingencies not specified in the rule may be
permissible if they are not based on whether the referral results in a
securities transaction at the broker-dealer.
---------------------------------------------------------------------------
\67\ See, e.g., BISA Letter, Clearing House Ass'n Letter, and
U.S. Trust Letter.
---------------------------------------------------------------------------
In addition, the ``broker'' exceptions in Sections 3(a)(4)(B) of
the Exchange Act are available only to banks. Accordingly, a referral
to a broker-dealer for a securities transaction within the scope of
section 15 of the Exchange Act still involves a ``broker'' transaction
at the broker-dealer even if a bank could conduct the transaction
itself without registering as a broker, and a referral fee may not be
contingent on the occurrence of such a transaction (or the opening of
an account to engage in such transactions).\68\
---------------------------------------------------------------------------
\68\ For similar reasons, a referral to a broker-dealer for such
a transaction is a ``referral'' for purposes of the networking
exception and Rule 700.
---------------------------------------------------------------------------
4. Definition of ``Incentive Compensation''
The networking exception prohibits an unregistered employee of a
bank that refers a customer to a broker-dealer under the exception from
receiving ``incentive compensation'' for the referral or any securities
transaction conducted by the customer at the broker-dealer other than a
nominal, non-contingent referral fee. To provide banks and their
employees additional guidance in this area, Proposed Rule 700(b)
defined ``incentive compensation'' as compensation that is intended to
encourage a bank employee to refer potential customers to a broker-
dealer or give a bank employee an interest in the success of a
securities transaction at a broker-dealer.
The proposed rule also excluded certain types of bonus compensation
from the definition of ``incentive compensation.'' Proposed Rule
700(b)(1) excluded compensation paid by a bank under a bonus or similar
plan if such compensation is paid on a discretionary basis; based on
multiple factors or variables; such factors or variables include
significant factors or variables that are not related to securities
transactions at the broker-dealer; and a referral made by the employee
or any other person is not a factor or variable in determining the
employee's compensation under the plan.
In addition, Proposed Rule 700(b)(2) provided that the definition
of incentive compensation did not prevent a bank from compensating its
employees on the basis of any measure of the overall profitability of
(1) the bank, either on a stand-alone or consolidated basis; (2) any of
the bank's affiliates (other than a broker-dealer) or operating units;
or (3) a broker-dealer if such profitability is only one of multiple
factors or variables used to determine the compensation of the officer,
director, or employee and those factors or variables include
significant factors or variables that are not related to the
profitability of the broker-dealer. The Agencies specifically requested
comment on whether existing bank bonus programs would fit, or could
easily be adjusted to fit, within these proposed exclusions.
Many commenters indicated that the proposed bonus provisions worked
well and would not interfere with bank bonus plans generally. One
commenter, however, opposed the proposed bonus provisions arguing that
permitting bonuses to be based even in part on revenues generated by
activity conducted at a broker-dealer would encourage bank employees to
make referrals regardless of the appropriateness of the referral in
order to increase their compensation under the bonus plan.\69\ In
addition, a number of commenters requested that the Agencies either
confirm that bonus programs structured in particular ways identified by
the commenter would not fall within the definition of ``incentive
compensation'' or modify the terms of the exclusions to encompass plans
with these features. For example, several commenters asked the Agencies
to confirm that the rules would not prohibit a bank from basing an
employee's bonus on the assets, revenues or profits brought to the bank
and its partner broker-dealer by that employee. Other commenters asked
that the Agencies provide that all ``traditional'' bank bonus programs
are protected under the rule.
---------------------------------------------------------------------------
\69\ See NASAA Letter.
---------------------------------------------------------------------------
A number of commenters also raised specific issues with one or more
aspects of the exception in Rule 700(b)(1) for discretionary, multi-
factor bonus plans or the safe harbor in Rule 700(b)(2) for plans based
on overall profitability. For example, some commenters requested
clarification of the ``discretionary'' requirement in paragraph (b)(1)
and asserted that a bonus plan should be considered ``discretionary''
if employees do not have an enforceable right to compensation under the
plan until it is paid.\70\ One commenter also argued that Proposed Rule
700(b)(1) should not prohibit the number of referrals made by an
employee from playing a role in the employee's compensation under a
bonus plan.\71\
---------------------------------------------------------------------------
\70\ See, e.g., U.S. Trust Letter and Union Bank Letter.
\71\ See TD Banknorth, N.A. (``TD Banknorth'') Letter.
---------------------------------------------------------------------------
Several commenters also asserted that the safe harbor in paragraph
(b)(2) should be clarified or expanded to cover
[[Page 56521]]
bonus programs based on any measure of the financial performance, and
not just the ``overall profitability,'' of a bank, affiliate, operating
unit or broker-dealer.\72\ Commenters indicated that bank bonus
programs may be based on a wide variety of measures or metrics related
to the operations or performance of the bank, an affiliate or operating
unit.\73\ Some commenters also requested that the safe harbor be
revised to clarify that a bonus program may be based on the overall
profitability of an operating unit of an affiliate of a bank (other
than a broker-dealer), or be expanded to allow bonus programs to be
based on the financial performance of a branch, division, or
geographical or operational unit of a broker-dealer.\74\
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\72\ See, e.g., ABA Letter, Clearing House Ass'n Letter.
\73\ See, e.g., Clearing House Ass'n Letter, Harris Bank Letter,
U.S. Trust Letter.
\74\ See, e.g., ABA Letter, Clearing House Ass'n Letter, HSBC
Bank Letter, PNC Letter, and Union Bank Letter.
---------------------------------------------------------------------------
The purpose of the exception and exclusion in paragraph (b) is to
recognize that certain types of bonus plans are not likely to give
unregistered bank employees a promotional interest in the brokerage
services offered by the broker-dealers with which the bank networks and
to avoid affecting bonus plans of banks generally. As described below,
the Agencies have made several revisions to the exception and exclusion
to help clarify the types of bonus plans that fall outside of the scope
of ``incentive compensation'' and to ensure that excepted or excluded
plans are not likely to give bank employees an impermissible
promotional interest in the broker-dealer's activities. These
exceptions and exclusions are crafted to accommodate existing types of
bank bonus programs in general. Nevertheless, a plan's longevity or the
number of banks that utilize similar plans are not factors in
determining whether a plan constitutes ``incentive compensation'' under
this definition. Accordingly, banks that have networking arrangements
with a broker-dealer should review their existing bonus programs in
light of the standards set forth in the rule to evaluate whether they
may constitute impermissible incentive compensation.
a. Exception for Discretionary, Multi-Factor Bonus Plans
Under Rule 700(b)(1) of the final rules, compensation paid by a
bank under a bonus or similar plan is specifically excepted from
``incentive compensation'' if it is paid on a discretionary basis and
based on multiple factors or variables, provided that (1) those factors
or variables include multiple, significant factors or variables that
are not related to securities transactions at the broker-dealer; (2) a
referral made by the employee is not a factor or variable in
determining the employee's compensation under the plan; and (3) the
employee's compensation under the plan is not determined by reference
to referrals made by any other person.\75\ The Agencies have modified
the rule to make clear that, to be excluded under Rule 700(b)(1), a
multi-factor plan must include multiple, significant factors or
variables that are not related to securities transactions at the
broker-dealer.\76\ The proposed rule already required that there be
``significant factors or variables'' and the addition of ``multiple''
highlights the plural nature of these terms.
---------------------------------------------------------------------------
\75\ Rule 700(b)(1). The requirement that an employee's
compensation not be based on a ``referral'' made by the employee or
another person means that the employee's compensation under the
bonus or similar plan may not vary based on the fact that the
employee or other person made a referral to a broker-dealer or the
number of securities referrals made by the employee or other person
to a broker-dealer.
\76\ A similar change has been made to the corresponding
language in Rule 700(b)(2).
---------------------------------------------------------------------------
Each factor or variable unrelated to securities transactions at the
broker-dealer will be considered ``significant'' for purpose of Rule
700(b) if it plays a material role in determining an employee's
compensation under the bonus or similar plan, i.e., the amount of the
employee's bonus could be reduced or increased by a material amount
based on the non-securities factor or variable. This clarification will
give banks greater certainty and will allow them to more readily
identify the types of factors or variables not related to securities
transactions that must be included within a discretionary, multi-factor
bonus plan under paragraph (b)(1) of the Rule. Thus, under paragraph
(b)(1), a bank's bonus program may take account of the full range of
banking, securities or other business of one or more customers brought
to the bank and its partner broker-dealer by an employee so long as the
bonus is paid on a discretionary basis, the banking and other factors
or variables not related to securities transactions at the broker-
dealer are significant factors or variables under the bonus program,
and a referral or number of referrals made by the employee or others is
not a factor or variable under the program. In this way, the rule is
designed to accommodate discretionary bank bonus programs that are
based on general measures of the business or performance of a bank or a
particular customer, branch or other unit of the bank, that are not
based on referrals made by one or more bank employees and that include
some inputs based on securities transactions at a broker-dealer as well
as multiple significant factors or variables that are unrelated to
securities transactions at the broker-dealer.
A bank may not establish or maintain one or more ``sham'' non-
securities factors or variables in its bonus or similar plan for the
purpose of evading the restrictions in Rule 700(b) and the Banking
Agencies will continue to review the bonus and similar plans of banks
participating in networking arrangements as part of the risk-focused
supervisory process. In considering if a bonus program at a bank
contains sufficient banking or other factors unrelated to securities
transactions at a broker-dealer, the agencies will consider, among
other things, whether such factors or variables relate to banking or
other non-broker-dealer business(es) actually being conducted by the
bank or its employees, the resources devoted by the bank to such
business(es), and whether such business(es) materially contributes to
the payments made under the plan over time. It is not expected that the
actual payments made under a bank's bonus or similar plan would, over
time, be based predominantly on securities transactions conducted at a
broker-dealer. If such a situation were to occur, the bank would be
expected to make appropriate modifications to its bonus or similar plan
going forward.
A bonus or similar plan will be considered ``discretionary'' under
the final rule if the amount an employee may receive under the plan is
not fixed in advance and the employee does not have an enforceable
right to payments under the plan until the amount of any payments are
established and declared by the bank. A plan may, however, include
targets or metrics that must be met in order for any bonus to be paid,
provided the plan is otherwise a ``discretionary'' plan.
The Agencies have not modified the rule to allow a bonus plan to be
based on the fact of a referral or the number of referrals made by one
or more bank employees. The Agencies believe that doing so would allow
a direct linkage between a referral and an employee's bonus
compensation and be contrary to the purposes of the exception.
b. Safe Harbor for Plans Based on Overall Profitability or Revenue
The safe harbor provisions of Rule 700(b)(2) are designed to allow
banks to avoid having to analyze whether a particular bonus program
meets the
[[Page 56522]]
requirements of the exception in paragraph (b)(1) in circumstances
where the general structure of the program clearly reduces the
potential for sales practice concerns in connection with a referral to
a broker-dealer. The Agencies have made several changes to the safe
harbor to address the issues raised by commenters and to ensure that
the safe harbor achieves its purpose. In particular, the Agencies have
modified paragraph (b)(2) of the rule to cover any bonus or similar
plan that is based on the overall profitability or revenue of:
(i) The bank, either on a stand-alone or consolidated basis;
(ii) Any affiliate of the bank (other than a broker-dealer), or any
operating unit of the bank or an affiliate (other than a broker-
dealer), if the affiliate or operating unit does not over time
predominately engage in the business of making referrals to a broker-
dealer; or
(iii) A broker-dealer if:
(A) Such measure of overall profitability or revenue is only one of
multiple factors or variables used to determine the compensation of the
officer, director or employee;
(B) The factors or variables used to determine the compensation of
the officer, director or employee include multiple significant factors
or variables that are not related to the profitability or revenue of
the broker-dealer;
(C) A referral made by the employee is not a factor or variable in
determining the employee's compensation under the plan; and
(D) The employee's compensation under the plan is not determined by
reference to referrals made by any other person.
When a bonus program is based on the overall profitability of a
bank, an affiliate of a bank (other than a broker-dealer), or an
operating unit of the bank or an affiliate (other than a broker-
dealer), any relationship between a referral made by an employee and
the amount of payments that the employee may receive under the plan are
likely to be attenuated. In these circumstances, for example, any
potential connection between the revenue received by a bank from its
partner broker-dealer as a result of a referral and the payments made
to the referring bank employee under the plan likely would be tenuous
and largely speculative given the number of other employees, business
and actions that contribute to the overall profitability of the bank,
affiliate or most operating units. The Agencies believe this
attenuation effectively addresses any potential that payments under the
plan would give an employee an undue promotional interest in any
securities transactions that may occur at the broker-dealer as a result
of a referral. A bonus plan based on the overall revenue of a bank or
qualifying affiliate or operating unit would be similarly attenuated
and, for this reason, the Agencies have modified the safe harbor to
cover plans based on either the ``overall profitability or revenue'' of
a bank or a qualifying affiliate or operating unit. This would include
plans based on an entity's earnings per share or stock price, both of
which are directly related to the entity's overall profitability or
revenue. Because other, more granular measures of the financial
performance of a bank, affiliate or operating unit could create an
unduly close connection between the employee's expected payment under
the bonus plan and referrals made to the broker-dealer or the
securities transactions that result from those referrals, the rules
provide for plans structured in more granular ways to be analyzed under
the multi-factor, discretionary criteria in Rule 700(b)(1).
The potential connection between a referral made by a bank employee
and the payments made to the employee under a bonus plan may be
particularly strong if payments under the plan are based on the
profitability or revenue of (i) the partner broker-dealer itself or a
specific branch or operating unit of the broker-dealer (such as the
branch or operating unit responsible for handling customers referred by
the bank), or (ii) an operating unit of the bank or a non-broker-dealer
affiliate that is predominantly engaged over time in referring
customers to the broker-dealer. To address the potential for improper
incentives in these situations, the Agencies have modified Rule
700(b)(2)(iii) to allow a bonus program to be based on the overall
profitability or revenue of a broker-dealer only if the program meets
the conditions specified in (A)-(D) above. These conditions are similar
to those that would apply to a discretionary bonus or similar plan
under paragraph (b)(1) and are designed to ensure that the
profitability or revenue of the broker-dealer is only one of multiple
significant factors or variables in determining the employee's
compensation and that a referral or number of referrals made by the
employee is not a factor or variable under the program.\77\ Like the
proposal, the safe harbor in paragraph (b)(2) is not available to bonus
plans based on the profitability or revenue of a particular branch,
division or operating unit of the partner broker-dealer.
---------------------------------------------------------------------------
\77\ As with a multi-factor bonus plan under paragraph (b)(1) of
the Rule, a non-securities factor or variable will be considered
``significant'' under paragraph (b)(2)(iii) if it plays a material
role in determining an employee's compensation under the bonus or
similar plan.
---------------------------------------------------------------------------
In addition, the Agencies have modified paragraph (b)(2)(ii) of the
rule to exclude bonus plans based on the profitability or revenue of an
operating unit of a bank or non-broker-dealer affiliate that over time
predominantly engages in the business of making referrals to a broker-
dealer. This exclusion is intended to prevent a bank from basing a
bonus plan on the overall profitability or revenue of a bank unit that
is focused solely or predominately on making referrals to a broker-
dealer. This restriction, however, is not intended to prevent a bonus
plan from being based on the overall profitability or revenue of a bank
unit, such as a call center, that in fact markets, sells or supports a
range of bank products in addition to making referrals to a broker-
dealer and which is not, over time, predominantly engaged in the
business of making referrals to a broker-dealer.
C. Rule 701: Exemption for Referrals Involving Institutional Customers
and High Net Worth Customers
The proposed rules included an exemption that would permit a bank,
subject to certain conditions, to pay an employee a contingent referral
fee of more than a nominal amount for referring an ``institutional
customer'' or ``high net worth customer'' to a broker-dealer with which
the bank has a contractual or other written networking arrangement.\78\
Among the conditions included in the proposed rule were conditions
that--
---------------------------------------------------------------------------
\78\ Proposed Rule 701.
---------------------------------------------------------------------------
Established the financial thresholds at which a customer
would be considered an ``institutional customer'' or ``high net worth
customer'';
Limited the types of bank employees that may receive a
higher-than-nominal referral fee under the exemption and the manner in
which these fees may be structured; \79\
---------------------------------------------------------------------------
\79\ See Proposed Rule 701(a)(1) and (d)(4).
---------------------------------------------------------------------------
Required the bank to provide certain disclosures to the
customer regarding the referral arrangement; \80\ and
---------------------------------------------------------------------------
\80\ See id. at 701(a)(2)(i).
---------------------------------------------------------------------------
Required that the agreement between the bank and the
broker-dealer include certain provisions, including a provision
obligating the broker-dealer to perform a suitability analysis of
certain securities transactions that may result from the referral or a
sophistication analysis of the customer referred.\81\
---------------------------------------------------------------------------
\81\ See id. at 701(a)(3)(ii).
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Many commenters supported providing an exemption for referrals
[[Page 56523]]
involving sophisticated individuals and entities.\82\ These commenters,
for example, asserted that the exemption was appropriate in light of
the required sophistication of the customer involved.\83\ Other
commenters, however, argued that providing an exemption to the
``nominal'' requirement would not be in the interest of investors or
the public. These commenters asserted that the exemption as proposed
would allow bank employees to have a significant salesman's stake in
securities transactions and encourage bank employees to act as finders
or salespeople for a broker-dealer.\84\
---------------------------------------------------------------------------
\82\ See, e.g., BISA Letter, CBA Letter, Citigroup Letter, ICBA
Letter, Roundtable Letter, Securities Industry and Futures Markets
Ass'n (``SIFMA'') Letter, State Street Corp. Letter, U.S. Trust
Letter, Union Bank Letter.
\83\ See CBA Letter.
\84\ See, e.g., Massachusetts Securities Division Letter, NASAA
Letter.
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Many commenters, including a number that supported the exemption,
also asked that the Agencies modify the exemption to, among other
things, lower or alter the thresholds at which a person would be
considered an ``institutional customer'' or ``high net worth customer''
under the rule; eliminate the provisions of the rule requiring the
broker-dealer to perform a suitability or sophistication analysis in
connection with a referral; or eliminate the limitations on the manner
in which a higher-than-nominal referral fee may be structured. In
addition, many commenters requested that the Agencies modify the rule
in several respects to reduce administrative burden and complexity. For
example, several commenters asked that the Agencies provide a bank and
its partner broker-dealer greater flexibility to assign between
themselves the responsibility for fulfilling the disclosure and other
obligations included in the rule.
After carefully considering the comments, the Agencies have decided
to retain the exemption. The Agencies continue to believe that it is
appropriate to provide an exemption from the nominal and contingency
limitations in the networking exception for referrals that both involve
institutions and individuals that meet certain financial criteria and
that occur under other conditions designed for investor protection.
When provided appropriate information, such institutions and
individuals are more likely to be able to understand and evaluate the
relationship between a bank and its employees and the bank's broker-
dealer partner and the impact of that relationship on any resulting
securities transaction with the broker-dealer. The conditions in the
final exemption are designed to help ensure that, among other things,
institutional and high net worth customers, as defined in the rule,
receive appropriate investor protections and information that enables
the customer to understand the financial interest of the bank employee
so the customer can make informed choices. Moreover, as the exemption
itself provides, a bank operating under the exemption also must comply
with the terms and conditions in the statutory networking exception
(other than the compensation restrictions in Section 3(a)(4)(B)(i)(VI)
of the Exchange Act's networking exception), including the terms and
conditions that require the disclosure of the uninsured nature of
securities and that limit the role that a bank employee may have in a
brokerage transaction.\85\ These conditions provide additional
protections to institutional and high net worth customers that may be
referred to a broker-dealer under Rule 701.
---------------------------------------------------------------------------
\85\ See Exchange Act Section 3(a)(4)(B)(i)(V) and (IX).
---------------------------------------------------------------------------
The Agencies have modified the final rule in several respects to,
among other things, provide banks and broker-dealers greater
flexibility in complying with the rule's disclosure requirements and to
make the exemption more workable in practice. In light of the
protections retained in the rule, the Agencies also have modified the
thresholds at which a non-natural person will be considered an
``institutional customer'' for purposes of the rule. These
modifications are discussed further below.
Banks that pay their employees only nominal, non-contingent fees in
accordance with Rule 700 for referring customers--including
institutional or high net worth customers--to a broker-dealer do not
need to rely on, or comply with, the exemption provided in Rule 701. As
under the proposal, the final rule requires that the written agreement
between a bank operating under the exemption and its partner broker-
dealer include terms that obligate the broker-dealer to take certain
actions. Banks and broker-dealers are expected to comply with the terms
of their written networking arrangements. If a bank or broker-dealer
does not comply with the terms of the agreement, however, the bank
would not become a ``broker'' under Section 3(a)(4) of the Exchange Act
or lose its ability to operate under the proposed exemption.
1. Definitions of ``Institutional Customer'' and ``High Net Worth
Customer''
Proposed Rule 701(d)(2) defined an ``institutional customer'' to
mean any corporation, partnership, limited liability company, trust, or
other non-natural person that has at least $10 million in investments
or $40 million in assets. Under the proposal, a non-natural person also
would qualify as an ``institutional customer'' with respect to a
referral if the customer has $25 million in assets and the bank
employee refers the customer to the broker-dealer for investment
banking services. Proposed Rule 701(d)(1) defined a ``high net worth
customer'' to mean any natural person who, either individually or
jointly with his or her spouse, has at least $5 million in net worth
excluding the primary residence and associated liabilities of the
person and, if applicable, his or her spouse. Proposed Rule 701 also
included provisions governing the allocation of assets held by a
natural person jointly with his or her spouse and provided for the
dollar thresholds in the rule to be adjusted for inflation every five
years.
A number of commenters argued that the proposed dollar thresholds
for both types of customers were too high in light of the nature of the
transactions involved and the other requirements of the exemption.\86\
Commenters asserted that customers with lower levels of net worth,
assets or investments are sophisticated enough to understand and
evaluate the implications of a higher-than-nominal or contingent
referral fee. Commenters suggested a wide variety of alternative
thresholds, with many recommending that the Agencies use an existing
standard established under the federal securities laws for assessing a
customer's investment sophistication. For example, commenters
recommended that the Agencies use the ``accredited investor''
definition in the Commission's Regulation D, or the definition of that
term proposed for use in connection with investments in certain private
investment vehicles, for purposes of defining an institutional or high
net worth customer; \87\ treat all corporate and non-natural persons as
an institutional customer; consider all persons advised by a bank or a
registered investment adviser to be sophisticated; or lower the asset
threshold for municipalities or
[[Page 56524]]
charitable organizations.\88\ Several commenters also asked that the
Agencies allow banks to use a business customer's revenues for purposes
of determining if the customer is an institutional customer.
---------------------------------------------------------------------------
\86\ See, e.g., HSBC Bank Letter, U.S. Trust Letter, SIFMA
Letter, Roundtable Letter.
\87\ See 17 CFR 230.501(a)(3), (5) and (6); Securities Act Rel.
No. 33-8766, 72 FR 400, Jan. 4, 2007.
\88\ See, e.g., ABA Letter, Clearing House Ass'n Letter, State
Street Corp. Letter.
---------------------------------------------------------------------------
After carefully reviewing the comments, the Agencies have modified
the definition of an ``institutional customer'' in the final rule to
mean any corporation, partnership, limited liability company, trust, or
other non-natural person that has, or is controlled by a non-natural
person that has, at least: (i) $10 million in investments; or (ii) $20
million in revenues; or (iii) $15 million in revenues if the bank
employee refers the customer to the broker-dealer for investment
banking services.\89\ When converted to an equivalent asset number, the
$20 million and $15 million revenue thresholds in the final rule are
somewhat lower than $40 million and $25 million asset thresholds in the
proposed rule.\90\ The Agencies believe that these lower thresholds are
appropriate for corporate and other non-natural customers in light of
the other protections retained in the final rule, including the
provisions requiring a suitability or sophistication determination, and
the greater internal and external resources that business entities
typically have as compared to individuals. The Agencies have modified
the thresholds to be based on revenues (rather than assets) to
eliminate the potential for borrowings to influence the status of a
corporate customer and to promote the equivalent treatment of non-
financial companies and financial companies. In addition, the Agencies
have amended the rule to provide that a company controlled by an
institutional customer will itself be considered an institutional
customer. A company controlled by another company should generally have
access to the resources and sophistication of the controlling company.
---------------------------------------------------------------------------
\89\ Rule 701(d)(2).
\90\ To develop comparable asset and revenue thresholds for an
institutional customer, the Agencies used a dataset composed of all
publicly traded, U.S.-incorporated, non-financial companies with a
market capitalization of greater than $0 and for which asset and
sales data were available in the 2005 CompuStat Universe of North
American companies published by Standard & Poor's Corporation. For
more information on the CompuStat Universe, see http://www2.standardandpoors.com/spf/pdf/products/Compustat2006.pdf. A
company with $40 million in assets and a company with $25 million in
assets would rank at approximately the 27.5th percentile and the
21.9th percentile, respectively, of all companies within this
dataset when ranked according to assets. When the companies within
this dataset are ranked according to sales, the companies at
approximately the 27.5th percentile and the 21.9th percentile have
approximately $27.7 million and $15.7 million in sales.
---------------------------------------------------------------------------
The lower revenue threshold for referrals involving investment
banking services is designed to facilitate access to the capital
markets by smaller companies. Like the proposal, the final rule defines
``investment banking services'' to include, without limitation, acting
as an underwriter in an offering for an issuer, acting as a financial
adviser in a merger, acquisition, tender-offer or similar transaction,
providing venture capital, equity lines of credit, private investment-
private equity transactions or similar investments, serving as
placement agent for an issuer, and engaging in similar activities.\91\
The phrase ``other similar services'' would include, for example,
acting as an underwriter in a secondary offering of securities and
acting as a financial adviser in a divestiture. These examples are not
exhaustive and are provided solely for illustrative purposes.\92\
---------------------------------------------------------------------------
\91\ See Rule 701(d)(3).
\92\ When used in this rule, the term ``include, without
limitation'' means a non-exhaustive list. This usage is not intended
to suggest that the term ``including'' as used in the Exchange Act
and the rules under that Act means an exhaustive list. The use of
the term ``including, but not limited to'' in Exchange Act Rules
10b-10 and 15b7-1 is also not intended to create a negative
implication regarding the use of ``including'' without the term
``but not limited to'' in other Exchange Act rules. See Exchange Act
Release No. 49879, 69 FR 39682 (June 30, 2004), at footnote 76.
---------------------------------------------------------------------------
The final rule continues to define a ``high net worth customer'' as
a natural person who, either individually or with his or her spouse,
has at least $5 million in net worth excluding the primary residence
and associated liabilities of the person and, if applicable, his or her
spouse. In response to comments,\93\ the Agencies have modified this
definition to include any revocable, inter vivos or living trust the
settlor of which is a natural person who, either individually or
jointly with his or her spouse, meets the $5 million in net worth
test.\94\ This change is designed to reflect the fact that otherwise
sophisticated individuals may hold assets through such trusts for
estate planning or other purposes.
---------------------------------------------------------------------------
\93\ See ABA Letter, PNC Letter, Roundtable Letter.
\94\ Rule 701(d)(1)(i)(B).
---------------------------------------------------------------------------
The Agencies believe that customers that meet the net worth,
investment and revenue thresholds included in the final rule should
have the ability to understand and evaluate the financial interest of
the bank employee making a referral to a broker-dealer under the
exemption. In developing these thresholds, the Agencies took into
account the limited nature of activities covered by the exemption
(i.e., a referral by a bank employee to a broker-dealer). The Agencies
have not modified the rule, as requested by some commenters, to treat
any person advised by a bank or a registered investment adviser as an
institutional or high net worth customer. The existence of such an
advisory relationship generally is not, by itself, sufficient to
establish the financial sophistication of an individual or corporate
entity for purposes of the other similar standards in or developed
under the federal securities laws.\95\
---------------------------------------------------------------------------
\95\ See, e.g., 15 U.S.C. 80a-2(a)(51), 78c(a)(54); 17 CFR
230.501(a).
---------------------------------------------------------------------------
For purposes of determining whether a natural person meets the $5
million net worth test, the assets of a person include: (1) Any assets
held individually; (2) if the person is acting jointly with his or her
spouse, any assets of the person's spouse (whether or not such assets
are held jointly); and (3) if the person is not acting jointly with his
or her spouse, fifty percent of any assets held jointly with such
person's spouse and any assets in which such person shares with such
person's spouse a community property or similar shared ownership
interest. These rules are designed to ensure that the full amount of
jointly owned assets are not considered in cases where one spouse acts
independently of the other in contacting a broker-dealer.\96\ The
Agencies have re-formatted these allocation provisions in the final
rule to make them easier to understand and promote compliance.
---------------------------------------------------------------------------
\96\ One commenter asserted that the Agencies should allow a
person to include assets that the person holds jointly with someone
other than a spouse, such as a relative or domestic partner, for
purposes of calculating whether the person meets the net worth
threshold. See Roundtable Letter. The Agencies have not modified the
rule in this manner to keep the scope of individuals whose assets
may be considered in determining whether a natural person has the
appropriate level of financial sophistication consistent with the
standards used in determining whether a natural person is an
accredited investor under the Commission's Regulation D. See 17 CFR
230.501(a).
---------------------------------------------------------------------------
As in the proposal, the dollar threshold for both institutional
customers and high net worth customers will be adjusted for inflation
on April 1, 2012, and every five years thereafter, to reflect changes
in the value of the Personal Consumption Expenditures Chain-Type Price
Index, as published by the Department of Commerce, from December 21,
2006. The Agencies selected this index because it is a widely used and
broad indicator of inflation in the U.S. economy.
2. Determining That a Customer Meets the Relevant Thresholds
The proposal required the bank to determine that the customer being
[[Page 56525]]
referred met the standards to be a high net worth or institutional
customer either (i) before the referral fee was paid to the bank
employee, in the case of a non-natural person, or (ii) prior to or at
the time of the referral, in the case of a natural person.\97\ In
making these determinations for a natural person, the proposed rule
allowed the bank to rely on a signed acknowledgment from the person
that he or she met the standards to be a high net worth customer.\98\
The proposed rule also required that the written agreement between the
bank and the broker-dealer provide for the broker-dealer to (i)
determine that the customer being referred met the standards to be a
high net worth customer or institutional customer before the referral
fee was paid,\99\ and (ii) promptly inform the bank if the broker-
dealer determined that a customer referred under the exemption did not
meet the applicable standard.\100\
---------------------------------------------------------------------------
\97\ Proposed Rule 701(a)(2)(ii).
\98\ Proposed Rule 701(a)(2)(ii)(B)(2).
\99\ Proposed Rule 701(a)(3)(i).
\100\ Proposed Rule 701(a)(3)(iii)(A).
---------------------------------------------------------------------------
Commenters argued that either the bank or the broker-dealer, but
not both, should be required to make these customer eligibility
determinations and that the bank and the broker-dealer should be
permitted to allocate responsibility for these determinations between
themselves.\101\ In addition, several commenters contended that a bank
should be allowed to make the eligibility determinations for both high
net worth customers and institutional customers before the referral fee
is paid or before a securities transaction is effected at the broker-
dealer.\102\ A few commenters also asserted that banks and broker-
dealers should be permitted to rely on a signed acknowledgement from
either an institutional or high net worth customer.\103\
---------------------------------------------------------------------------
\101\ See, e.g., BISA Letter, Clearing House Ass'n Letter,
Citigroup Letter, and SIFMA Letter. Some commenters, for example,
suggested that requiring bank employees to make these determinations
might require the employee to go beyond the limited role a bank
employee is permitted to play in a brokerage transaction under the
statute. See, e.g., BISA Letter, ABA Letter.
\102\ See, e.g., ABA Letter, BISA Letter, Clearing House Ass'n
Letter, HSBC Bank Letter, and PNC Letter.
\103\ See, e.g., Citigroup Letter, SIFMA Letter.
---------------------------------------------------------------------------
The status of the referred customer as a high net worth or
institutional customer is a fundamental aspect of the exemption and the
final rule continues to provide for both the bank and the broker-dealer
to determine that the customer meets the necessary qualification
criteria to provide added assurance that these criteria are met.\104\
In addition, less information typically is in the public domain
concerning the financial resources of an individual than of a
corporation or other business entity and, accordingly, there is a
greater likelihood that a bank employee--without further
investigation--will be able to preliminarily identify corporate or
other business customers that are likely to satisfy the rule's
eligibility criteria than in the case of individuals. For these
reasons, the final rule continues to provide for the bank to determine
that a natural person is a high net worth customer before a referral is
made and before the employee potentially develops an expectation of a
higher-than-nominal fee.
---------------------------------------------------------------------------
\104\ See Rule 701(a)(2)(ii) and (3)(ii)(B). The final rule also
continues to provide for the written agreement between the bank and
the broker-dealer to require the broker-dealer to inform the bank if
the broker-dealer determines that a referred customer does not meet
the relevant eligibility thresholds. See Rule 701(a)(3)(v)(A).
---------------------------------------------------------------------------
The Agencies, however, have modified the final rule to make it more
flexible while retaining its underlying purpose by providing that a
bank or a broker-dealer satisfies its customer eligibility requirements
if the bank or broker-dealer ``has a reasonable basis to believe that
the customer'' is an institutional customer or high net worth customer
before the time specified in the rule.\105\ A bank or broker-dealer
would have a ``reasonable basis to believe'' that a customer is a high
net worth customer or institutional customer if, for example, the bank
or broker-dealer obtains a signed acknowledgment from the customer (or,
in the case of an institutional customer, from an appropriate
representative of the customer) that the customer meets the applicable
standards to be considered a high net worth customer or an
institutional customer, respectively, and the bank employee making the
referral or the broker-dealer employee dealing with the referred
customer does not have information that would cause the employee to
believe that the information provided by the customer (or
representative) is false.
---------------------------------------------------------------------------
\105\ Rule 701(a)(2)(ii).
---------------------------------------------------------------------------
3. Conditions Relating to Disclosures
The proposed exemption required that the bank provide a high net
worth customer or institutional customer being referred to the bank's
broker-dealer partner certain written disclosures about the bank
employee's potential interest in the referral prior to or at the time
of the referral.\106\ Commenters generally believed that providing
these types of disclosures to a high net worth or institutional
customer would help ensure that the customer received appropriate
information concerning the relationship between the bank and the
broker-dealer,\107\ although a few questioned whether sophisticated
customers required any disclosures at all or suggested that more
simplified disclosures be permitted.\108\ A number of commenters also
asserted that the requirement that the bank provide these disclosures
``prior to or at the time of the referral'' was impractical or
burdensome.\109\ Commenters instead asserted that the rule should allow
the disclosures to be provided before the referral fee is paid or
before a securities transaction is effected at the broker-dealer, or
allow the bank and the broker-dealer to determine which entity would
make the disclosures.\110\
---------------------------------------------------------------------------
\106\ Proposed Rule 701(a)(2)(i).
\107\ See, e.g., ABA Letter, JP Morgan Letter, Roundtable
Letter, BISA Letter.
\108\ See, e.g., Bank of America Corp. (``BofA'') Letter and WBA
Letter.
\109\ For example, some commenters noted that some referrals may
occur only by telephone or asserted that it may be unclear to an
employee when a referral actually occurs.
\110\ See, e.g., ABA Letter, BISA Letter, Clearing House Ass'n
Letter, HSBC Bank Letter, and WBA Letter. In addition, some
commenters contended that banks should be required to provide
similar conflict-of-interest disclosures to customers referred to a
broker-dealer under the statutory networking exception. See, e.g.,
Boyd Financial Letter, Pace Project Letter, University of Cincinnati
Corp. Law Center Letter. The statutory networking exception itself
sets certain disclosures that the bank or broker-dealer must provide
a customer in situations where the bank employee making the referral
may receive only a ``nominal'' referral fee. 15 U.S.C.
78c(a)(4)(i)(IX).
---------------------------------------------------------------------------
The final rule continues to require that a high net worth or
institutional customer referred to a broker-dealer under the exception
receive disclosures that clearly and conspicuously disclose (i) the
name of the broker-dealer; and (ii) that the bank employee participates
in an incentive compensation program under which the bank employee may
receive a fee of more than a nominal amount for referring the customer
to the broker-dealer and that payment of this fee may be contingent on
whether the referral results in a transaction with the broker-
dealer.\111\ This requirement ensures that high net worth or
institutional customers receive notice of the financial interest the
referring employee may have in the transaction so they can make
informed choices.
---------------------------------------------------------------------------
\111\ Rule 701(b).
---------------------------------------------------------------------------
In light of the comments, the Agencies have modified the provisions
of the rule governing how and when these disclosures must be provided
to make the rule more workable and less burdensome while also requiring
that customers receive the information in time to make informed
choices. Specifically, the final rule provides two options for
providing the required
[[Page 56526]]
disclosures. Under the first option, as under the proposal, the bank
must provide the high net worth or institutional customer the
disclosures in writing prior to or at the time of the referral.\112\
The second option allows the bank to provide the disclosure to the
customer orally prior to or at the time of the referral. However, if
the bank provides the customer the required disclosures only orally,
then either (i) the bank must provide the disclosure to the customer in
writing within 3 business days of the date of the referral; or (ii) the
broker-dealer must be obligated, under the terms of its written
agreement with the bank, to provide the disclosures in writing to the
customer.\113\ If the broker-dealer is responsible for providing the
written disclosures, then it must provide the disclosures to the
customer prior to or at the time the customer begins the process of
opening an account at the broker-dealer (if the customer does not
already have an account with the broker-dealer) or prior to the time
the customer places an order for a securities transaction with the
broker-dealer as a result of the referral (if the customer already has
an account at the broker-dealer).\114\ In this way, the rule provides a
mechanism for customers to receive the disclosures in writing when they
initially are provided only orally. Whether provided orally or in
writing, the required disclosures will be considered to have been made
in a clear and conspicuous manner if they are provided in a manner
designed to call attention to the nature and significance of the
information.
---------------------------------------------------------------------------
\112\ Rule 700(a)(2)(i).
\113\ Rule 701(a)(2)(i) and (a)(3)(i).
\114\ Rule 701(a)(3)(i). As a general matter, a customer begins
the account-opening process when the customer fills out the
appropriate forms provided by the broker-dealer to establish an
account.
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4. Suitability or Sophistication Analysis by Broker-Dealer
The proposed exemption required that the written agreement between
the bank and the broker-dealer provide for the broker-dealer to perform
a suitability or sophistication analysis of a securities transaction or
the customer being referred, respectively. The type and timing of the
analysis needed to be conducted by the broker-dealer depended on
whether the referral fee was contingent on the completion of a
securities transaction at the broker-dealer.\115\ The proposed rule
also required that the written agreement between the bank and its
partner broker-dealer obligate the broker-dealer to inform the bank if
it determined that a customer referred under the exemption, or a
transaction to be conducted by the customer, did not meet the relevant
suitability or sophistication standard.\116\
---------------------------------------------------------------------------
\115\ Proposed Rule 701(a)(3)(ii).
\116\ Proposed Rule 701(a)(3)(iii)(C).
---------------------------------------------------------------------------
Several commenters objected to this suitability/sophistication
requirement arguing that the broker-dealer should be required to
conduct a suitability/sophistication analysis only when such an
analysis would otherwise be required under the rules of the broker-
dealer's self-regulatory organization (``SRO'') (i.e., in those cases
where the broker-dealer makes a recommendation to the customer
concerning securities).\117\ Commenters also argued that the
suitability/sophistication requirement was unworkable or unnecessary
given that the transaction may involve only a referral (without a
securities transaction occurring) of a sophisticated customer.\118\ In
addition, some commenters expressed concern that the proposed standards
would increase the potential liability of broker-dealers or delay the
ability of a broker-dealer to respond to a customer's instructions.
---------------------------------------------------------------------------
\117\ See, e.g., ABA Letter, Clearing House Ass'n Letter,
Citigroup Letter, and PNC Letter. See also FINRA Rule 2310 and FINRA
IM-2310-3 (discussing suitability obligations of member broker-
dealers). One commenter also asserted that any expansion of a
broker-dealer's suitability obligations should be processed and
approved through the normal market regulation and SRO process. See
SIFMA Letter.
\118\ See, e.g., Clearing House Ass'n Letter, SIFMA Letter.
Commenters also asserted that a broker-dealer may not be able to
perform the proposed ``sophistication'' analysis if the customer
does not open an account or refuses to provide the broker-dealer the
information necessary to perform the analysis.
---------------------------------------------------------------------------
After carefully considering the comments, the Agencies have
retained the requirement that the parties' written agreement provide
for the broker-dealer to perform a suitability analysis when a referral
fee is contingent on a transaction and a suitability or sophistication
analysis for other referrals. These requirements provide additional
investor protections in those circumstances where the bank employee
making the referral may receive a higher-than-nominal referral fee. The
suitability and sophistication standards included in the final rule are
based on the standards that broker-dealers currently must apply and use
under applicable SRO rules and, thus, should be familiar to those
broker-dealers that partner with banks operating under the
exemption.\119\ In addition, the exemption gives a broker-dealer the
flexibility to perform a suitability analysis, if one is otherwise
required by the rule, in connection with all referrals made under the
exemption if the broker-dealer determines that such an approach is
appropriate for business, compliance or other reasons.
---------------------------------------------------------------------------
\119\ One commenter expressed concern that the suitability/
sophistication requirements of the rule may discourage low-cost,
execution-only brokers from establishing relationships with banks
under the exemption. See Business Law Section Letter. The Agencies
are mindful of the need to keep appropriate investment options,
including low-cost options, available to investors. However, given
the cost structure of low-cost brokers, the Agencies expect that few
such brokers would participate in referral arrangements under the
exemption that provides for higher-than-nominal referral fees.
Broker-dealers that do not wish to become obligated to perform the
suitability/sophistication analyses required by the rule also may
continue to establish and maintain networking arrangements pursuant
to the statutory networking exception.
---------------------------------------------------------------------------
Specifically, for contingent referral fees payable under the
exemption, the written agreement between the bank and the broker-dealer
must provide for the broker-dealer to conduct a suitability analysis of
each securities transaction that triggers any portion of the
contingency fee in accordance with the rules of the broker-dealer's
applicable SRO as if the broker-dealer had recommended the securities
transaction.\120\ This analysis must be performed by the broker-dealer
before each securities transaction on which the referral fee is
contingent is conducted.
---------------------------------------------------------------------------
\120\ Rule 701(a)(3)(ii)(A). Because the exemption provides for
a broker-dealer to conduct its suitability analysis in accordance
with the rules of its applicable SRO, the broker-dealer may follow
and take advantage of any applicable SRO rules or interpretations
that allow the broker-dealer to make an alternative suitability
evaluation. See, e.g., FINRA IM-2310-3 (discussing a member's
suitability obligations with respect to certain institutional
investors).
---------------------------------------------------------------------------
For non-contingent referral fees payable under the exemption, the
written agreement must provide for the broker-dealer to conduct, before
the referral fee is paid, either (1) a sophistication analysis of the
customer being referred; or (2) a suitability analysis with respect to
all securities transactions requested by the customer contemporaneously
with the referral in accordance with the rules of the broker-dealer's
applicable SRO as if the broker-dealer had recommended the securities
transaction.\121\ Under the sophistication analysis option, the broker-
dealer must determine that the customer has the capability to evaluate
investment risk and make independent decisions, and determine that the
customer is exercising independent judgment based on the customer's own
independent assessment of the opportunities and risks presented by a
potential investment, market factors, and other investment
considerations.\122\ This sophistication analysis is based on
[[Page 56527]]
elements of FINRA IM-2310-3 (Suitability Obligations to Institutional
Customers).
---------------------------------------------------------------------------
\121\ Rule 701(a)(3)(iii)(B).
\122\ Rule 701(a)(3)(ii)(B)(1).
---------------------------------------------------------------------------
The Agencies have modified the final rule to provide for the
broker-dealer to notify the customer, rather than the bank, if the
broker-dealer determines that a high net worth or institutional
customer, or a securities transaction to be conducted by such a
customer, does not meet the applicable sophistication or suitability
standard.\123\ Providing such notification to the customer should
assist the customer in deciding whether or not to conduct the
transaction.
---------------------------------------------------------------------------
\123\ Rule 701(a)(3)(iv).
---------------------------------------------------------------------------
5. Conditions Relating to Bank Employees
Paragraph (b)(1) of the Proposed Rule included certain limitations
on the types of bank employees that may receive a higher-than-nominal
referral fee under the rule. In particular, the Proposed Rule provided
that the bank employee: be predominantly engaged in banking activities,
other than making referrals to a broker-dealer; encounter the high net
worth or institutional customer in the ordinary course of the
employee's assigned business for the bank; not be qualified or required
to be qualified under the rules of a SRO; and not be subject to
statutory disqualification under Section 3(a)(39) of the Exchange Act
(other than subparagraph (E) of that Section) (``statutory
disqualification'').\124\
---------------------------------------------------------------------------
\124\ See Proposed Rule 701(a)(1).
---------------------------------------------------------------------------
The proposed exemption also included other provisions related to
the SRO and statutory disqualification conditions. First, it required
that the written agreement between the bank and the broker-dealer must
provide for the bank and the broker-dealer to affirmatively determine,
before a referral fee is paid to a bank employee under the exemption,
that the employee is not subject to statutory disqualification.\125\
Second, it required that the bank provide the broker-dealer the name of
the employee and such other identifying information that may be
necessary for the broker-dealer to determine whether the bank employee
is subject to statutory disqualification or associated with a broker-
dealer.\126\ And third, it required that the parties' written agreement
obligate the broker-dealer to promptly inform the bank if it determined
the bank employee was subject to statutory disqualification.\127\
---------------------------------------------------------------------------
\125\ Proposed Rule 701(a)(3)(i)(A).
\126\ Proposed Rule 701(a)(2)(iii).
\127\ Proposed Rule 701(a)(3)(iii)(B).
---------------------------------------------------------------------------
The final rule retains these provisions with the following
modifications.\128\ In response to comments,\129\ the Agencies have
modified the SRO condition in paragraph (a)(1)(A) of the Rule to
provide that the employee receiving the referral fee must not be
``registered or approved, or otherwise required to be registered or
approved, in accordance with the qualification standards established by
the rules of any self-regulatory organization.'' The Agencies have
modified the related language in paragraph (a)(2)(iii) of the rule in a
similar manner.
---------------------------------------------------------------------------
\128\ See Rule 701(a)(1), (a)(2)(iii), (a)(3)(ii)(A), and
(a)(3)(v)(B).
\129\ See Business Law Section Letter.
---------------------------------------------------------------------------
Several commenters argued that the requirement that a bank employee
encounter the high net worth or institutional customer ``in the
ordinary course of the bank employee's assigned duties'' was
unnecessary and ambiguous.\130\ The Agencies have retained the
requirement to help ensure that a bank employee making a referral under
the rule does so as part of the employee's duties as a bank employee
and not as a sales representative of the broker-dealer. However, the
Agencies recognize that in the ordinary course of his or her assigned
duties for the bank, a bank employee may encounter customers or
potential customers outside the employee's regular business hours or at
locations outside of the bank, such as at social or civic functions or
gatherings.
---------------------------------------------------------------------------
\130\ See, e.g., ABA Letter, BISA Letter, Clearing House Ass'n
Letter, Comerica Bank Letter, and U.S. Trust Letter. For example,
some asserted that bank employees may be expected to identify and
develop client relationships at social or other events and expressed
concern that the language might prevent a bank employee from
receiving a referral fee for institutional or high net worth
customers encountered in these ways.
---------------------------------------------------------------------------
A number of commenters contended that the bank and the broker-
dealer should not both be required to verify that the bank employee is
not subject to statutory disqualification and suggested that the bank
and broker-dealer be permitted to allocate this responsibility between
themselves.\131\ The Agencies have modified the rule to provide for
these determinations to be made by the broker-dealer under the terms of
the parties' written agreement.\132\ The Agencies believe that broker-
dealers are better suited to make this determination given their
familiarity with the Exchange Act's statutory disqualification
standards, provided that they receive the necessary information
concerning the employee from the bank. A broker-dealer fulfills its
responsibilities under paragraph (a)(3)(ii)(A) of Rule 701 if the
broker-dealer determines that a bank employee is not subject to
statutory disqualification before the employee first receives a
referral fee under Rule 701 and at least once each year thereafter as
long as the employee remains eligible to receive referral fees under
the rule.
---------------------------------------------------------------------------
\131\ See, e.g., ABA Letter, BISA Letter, Clearing House Ass'n
Letter, Citigroup Letter, PNC Letter, and SIFMA Letter.
\132\ Rule 701(a)(3)(ii)(A).
---------------------------------------------------------------------------
As a means designed to ensure that the broker-dealer has the
appropriate information to make these determinations, the rule
continues to require that, before a higher-than-nominal referral fee is
paid to a bank employee under the exemption, the bank provide the
broker-dealer the name of the employee and such other identifying
information that the broker-dealer may need to determine whether the
employee is subject to statutory disqualification.\133\ Once the
information for a particular employee is conveyed to the broker-dealer,
the bank should provide at least annually its broker-dealer partner any
changes to the identifying information initially provided under
paragraph (a)(2)(iii) of Rule 701 for an employee who continues to make
referrals and receive referral fees under the exemption so that the
broker-dealer may perform its periodic review of the employee's
qualifications under paragraph (a)(3)(ii)(A).
---------------------------------------------------------------------------
\133\ Rule 700(a)(2)(iii).
---------------------------------------------------------------------------
6. Good Faith Compliance and Corrections by Banks
As in the proposal, the final exemption provides that a bank that
acts in good faith and that has reasonable policies and procedures in
place to comply with the requirements of the exemption will not be
considered a ``broker'' under Section 3(a)(4) of the Exchange Act
solely because the bank fails, in a particular instance, to determine
that a customer is an institutional or high net worth customer, provide
the customer the required disclosures, or provide the broker-dealer the
required information concerning the bank employee receiving the
referral fee within the time periods prescribed. If the bank is seeking
to comply and takes reasonable and prompt steps to remedy the error,
such as by promptly making the required determination or promptly
providing the broker-dealer the required information, the bank will not
lose the exemption from registration in these circumstances. Similarly,
to promote compliance with the terms of the
[[Page 56528]]
exemption, the bank must make reasonable efforts to reclaim the portion
of the referral fee paid to the bank employee for a referral that does
not, following any required remedial actions, meet the requirements of
the exemption and that exceeds the amount the bank otherwise would be
permitted to pay under the statutory networking exception and Rule
700.\134\
---------------------------------------------------------------------------
\134\ Rule 701(a)(2)(iv).
---------------------------------------------------------------------------
A few commenters suggested that the Agencies strike the requirement
that the bank seek to reclaim the higher-than-nominal portion of a
referral fee. The Agencies have retained this requirement as it helps
provide employees an incentive to comply with the rule.\135\
---------------------------------------------------------------------------
\135\ One commenter requested that the rule provide a similar
safe harbor for broker-dealers. See SIFMA Letter. Any obligations of
a broker-dealer that arise by reason of Rule 701 run only to its
bank partner under the terms of their agreement and the Agencies
believe the issue of contractual liability between the parties is
best addressed by the parties themselves. As stated in the proposal,
the Commission anticipates that it may be necessary for either FINRA
or the Commission to propose a rule that would require broker-
dealers to comply with the written agreements entered into pursuant
to Rule 701.
---------------------------------------------------------------------------
7. Referral Fees Permitted Under the Exemption
Proposed Rule 701 placed certain limits on how a higher-than-
nominal referral fee paid under the exemption may be structured.\136\
Some commenters argued that these restrictions are unnecessary in light
of the other protections included in the exemption, or that the rule
should allow a higher-than-nominal referral fee to be based on a
percentage of any type of securities transaction conducted at a broker-
dealer (rather than just investment banking transactions).\137\ On the
other hand, one commenter asserted that, by allowing a referral fee to
be based on the total amount of assets maintained in an account with
the broker-dealer, the rule would provide an incentive for bank
employees to provide ongoing investment advice to customers.\138\
---------------------------------------------------------------------------
\136\ Proposed Rule 701(d)(4).
\137\ See, e.g., Clearing House Ass'n Letter and JPMorgan
Letter.
\138\ See NASAA Letter.
---------------------------------------------------------------------------
The final rule continues to place limits on the types of referral
fees a bank employee may receive under the exemption. These limitations
are designed to reduce the potential ``salesman's stake'' of the bank
employee in securities transactions conducted at the broker-dealer.
Specifically, the exemption provides that a referral fee paid under the
exemption may be a dollar amount based on a fixed percentage of the
revenues received by the broker-dealer for investment banking services
provided to the customer.\139\ Alternatively, the referral fee may be a
predetermined dollar amount, or a dollar amount determined in
accordance with a predetermined formula, so long as the amount does not
vary based on (1) the revenue generated by, or the profitability of,
securities transactions conducted by the customer with the broker-
dealer; (2) the quantity, price, or identity of securities purchased or
sold over time by the customer with the broker-dealer; or (3) the
number of customer referrals made.\140\ For these purposes,
``predetermined'' means established or fixed before the referral is
made. The requirement that the amount of the referral fee not vary
based on the number of customer referrals made does not prohibit an
employee from receiving a referral fee for each referral made by the
employee under the exemption.
---------------------------------------------------------------------------
\139\ Rule 701(d)(4)(ii).
\140\ Rule 701(d)(4)(i). A referral fee paid under the exemption
may be contingent on whether the customer opens an account with the
broker-dealer or executes one or more transactions in the account
during the initial phases of the account.
---------------------------------------------------------------------------
As the exemption provides, these restrictions do not prevent a
referral fee from being paid in multiple installments or from being
based on a fixed percentage of the total dollar amount of assets placed
in an account with the broker-dealer. Additionally, these restrictions
do not prevent a referral fee from being based on a fixed percentage of
the total dollar amount of assets (including securities and non-
securities assets) maintained by the customer with the broker-dealer.
Fees structured in this manner and consistent with the limitations in
paragraph (d)(4)(i) of the Rule do not provide a bank employee an
incentive to recommend the purchase or sale of particular securities.
In fact, the bank employee would have no special incentive to recommend
the purchase of any security, as the addition of cash or other non-
security instruments to the account would count equally towards the
employee's compensation as any addition of securities to the account.
8. Permissible Bonus Compensation Not Restricted
The exemption for high net worth and institutional customers
expressly provides that nothing in the exemption prevents or prohibits
a bank from paying, or a bank employee from receiving, any type of
compensation under a bonus or similar plan that would not be considered
incentive compensation under paragraph (b)(1), or that is described in
paragraph (b)(2), of Rule 700 (implementing the networking
exception).\141\ As explained above, these types of bonus arrangements
do not tend to create the kind of financial incentives for bank
employees that the statute was designed to address.
---------------------------------------------------------------------------
\141\ Rule 701(c).
---------------------------------------------------------------------------
III. Trust and Fiduciary Activities
A. Trust and Fiduciary Exception and Proposed Rules
Section 3(a)(4)(B)(ii) of the Exchange Act (the ``trust and
fiduciary exception'') permits a bank, under certain conditions, to
effect securities transactions in a trustee or fiduciary capacity
without being registered as a broker.\142\ 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.\143\ In addition the bank 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.\144\
---------------------------------------------------------------------------
\142\ 15 U.S.C. 78c(a)(4)(B)(ii).
\143\ Id.
\144\ 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.\145\ In addition, a bank that effects a transaction in the
United States of a publicly traded security under the exception must
execute the transaction in accordance with Exchange Act Section
3(a)(4)(C).\146\ This Section requires that the bank direct the trade
to a registered broker-dealer for execution, effect the trade through a
cross trade or substantially similar trade either within the bank or
between the bank and an affiliated fiduciary in a manner that is not in
contravention of fiduciary principles established under applicable
federal or state law, or effect the trade in some other manner that the
Commission permits.\147\ The trust and fiduciary exception recognizes
the
[[Page 56529]]
traditional securities role banks have performed for trust and
fiduciary customers and includes conditions to help ensure that a bank
does not operate a securities broker in the trust department.
---------------------------------------------------------------------------
\145\ 15 U.S.C. 78c(a)(4)(B)(ii)(II).
\146\ 15 U.S.C. 78c(a)(4)(C).
\147\ 15 U.S.C. 78c(a)(4)(C)(i)-(iii). As discussed infra at
Part VI.C, the Agencies have adopted Rule 775 that permits banks,
subject to certain conditions, to effect trades in securities issued
by an open-end company and certain variable insurance contracts
without sending the trade to a registered broker-dealer. Trades
effected by a bank in accordance with Rule 775 are conducted in
accordance with Section 3(a)(4)(C) of the Exchange Act.
---------------------------------------------------------------------------
The proposed rules provided that a bank would meet the ``chiefly
compensated'' condition in the trust and fiduciary exception if the
bank's relationship compensation attributable to each trust or
fiduciary account exceeded 50 percent of the total compensation
attributable to the relevant account.\148\ The proposed rules also
included an exemption that would permit a bank to use a bank-wide
approach to the ``chiefly compensated'' condition as an alternative to
the account-by-account approach. A bank using this proposed alternative
would be able to use the aggregate relationship and total compensation
that the bank received from its trust and fiduciary business as a whole
to monitor its compliance with the chiefly compensated test. The
proposed rule allowed a bank to use this bank-wide alternative if,
among other things, the bank's aggregate relationship compensation
attributable to its trust or fiduciary business as a whole equaled or
exceeded 70 percent of the total compensation attributable to its trust
or fiduciary business. This bank-wide alternative was designed to
simplify compliance, alleviate concerns about inadvertent
noncompliance, and reduce the costs and disruptions banks likely would
incur under the account-by-account approach.
---------------------------------------------------------------------------
\148\ Proposed Rule 721.
---------------------------------------------------------------------------
The proposal defined the term ``relationship compensation'' to mean
the types of trust and fiduciary compensation specifically identified
in the trust and fiduciary exception. The proposed rules also provided
examples of fees that would be considered an administration fee or a
fee based on a percentage of assets under management for these
purposes. For example, the proposed rules provided that fees paid by an
investment company pursuant to a plan under 17 CFR 270.12b-1 (``12b-1
fees'') or for personal service or the maintenance of shareholder
accounts (``service fees'') would be considered relationship
compensation under the rules. The proposed rules also implemented the
statute's advertising restriction and provided certain other
conditional exemptions.
B. Joint Final Rules
1. ``Chiefly Compensated'' Test and Bank-Wide Exemption Based on Two-
Year Rolling Averages
A majority of commenters supported the general approach taken in
the proposed rules implementing the trust and fiduciary exception,
including the proposed bank-wide alternative for the chiefly
compensated test. For example, a number of commenters stated that the
proposed bank-wide approach would provide banks an improved, workable
and flexible method of complying with the statutory exception.\149\
Some commenters, however, opposed either the account-by-account or
bank-wide alternative to the ``chiefly compensated'' requirement. For
example, some commenters argued that the account-by-account approach
was inconsistent with the terms and purposes of the trust and fiduciary
exception.\150\ Another commenter argued that an account-by-account
approach to the chiefly compensated test is the only way to help ensure
that a bank does not operate a brokerage business out of its trust or
fiduciary departments and, for this reason, recommended that the
Agencies eliminate the bank-wide alternative.\151\ Some commenters also
requested that the Agencies lower the 70 percent relationship
compensation/total compensation percentage required by the bank-wide
exemption to 60 percent or 50 percent to make it more consistent with
the percentage required by the account-by-account approach.\152\
---------------------------------------------------------------------------
\149\ See, e.g., ABA Letter, Roundtable Letter, U.S. Trust
Letter, WBA Letter.
\150\ See, e.g., Clearing House Ass'n Letter.
\151\ See NASAA Letter.
\152\ See ACB Letter, CBA Letter.
---------------------------------------------------------------------------
After carefully considering the comments, the Agencies have
retained the two alternative approaches in substantially the same form
as proposed. Specifically, Rule 721 provides that a bank meets the
``chiefly compensated'' condition in the trust and fiduciary exception
if the ``relationship-total compensation percentage'' for each trust or
fiduciary account of the bank is greater than 50 percent.\153\ The
``relationship-total compensation percentage'' for a trust or fiduciary
account is calculated by (1) Dividing the relationship compensation
attributable to the account during each of the immediately preceding
two years by the total compensation attributable to the account during
the relevant year; (2) translating the quotient obtained for each of
the two years into a percentage; and (3) then averaging the percentages
obtained for each of the two immediately preceding years.\154\
---------------------------------------------------------------------------
\153\ Rule 721(a)(1).
\154\ The rule provides for this process to be accomplished by
calculating the ``yearly compensation percentage'' and the
``relationship-total compensation percentage'' for the account. See
Rule 721(a)(2) and (3).
---------------------------------------------------------------------------
The final rules (Rule 722) also allow a bank to use a bank-wide
approach to the ``chiefly compensated'' condition as an alternative to
the account-by-account approach. To use this bank-wide methodology, the
bank must meet two conditions. First, the ``aggregate relationship-
total compensation percentage'' for the bank's trust and fiduciary
business as a whole must be at least 70 percent.\155\ The ``aggregate
relationship-total compensation percentage'' of a bank operating under
the bank-wide approach is calculated in a similar manner as the
``relationship-total compensation percentage'' of an account under the
account-by-account, except that the calculations would be based on the
aggregate relationship compensation and total compensation received by
the bank from its trust and fiduciary business as a whole during each
of the two immediately preceding years. In other words, the percentage
would be determined by (1) Dividing the relationship compensation
attributable to the bank's trust and fiduciary business as a whole
during each of the immediately preceding two years by the total
compensation attributable to the bank's trust and fiduciary business as
a whole during the relevant year; (2) translating the quotient obtained
for each of the two years into a percentage; and (3) then averaging the
percentages obtained for each of the two immediately preceding
years.\156\ Second, the bank must comply with the conditions in the
trust and fiduciary exception (other than the compensation test in
Section 3(a)(4)(B)(ii)(I)) \157\ and comply with Section 3(a)(4)(C)
(relating to trade execution) of the Exchange Act.\158\
---------------------------------------------------------------------------
\155\ Rule 722(a)(2).
\156\ The rule provides for this process to be accomplished by
calculating the ``yearly bank-wide compensation percentage'' and the
``aggregate relationship-total compensation percentage'' for the
bank's trust and fiduciary business as a whole. See Rule 722(b) and
(c).
\157\ The Agencies have modified the bank-wide exemption to
clarify that these conditions include the advertising restrictions
contained in the trust and fiduciary exception as implemented by
Rule 721(b). See Rule 722(a)(1).
\158\ Rule 722(a)(1).
---------------------------------------------------------------------------
The Agencies believe that providing banks these two alternatives is
consistent with the purposes of the trust and fiduciary exception. In
this regard, the availability of these two alternatives is designed to
avoid disrupting the trust and fiduciary operations of banks. The
[[Page 56530]]
compensation tests in both the account-by-account and bank-wide
approaches are designed to ensure that a bank's trust department is not
unduly dependent on the types of securities-related compensation not
permitted by the statute. The 70 percent compensation threshold in the
bank-wide exemption is higher than that required under the account-by-
account approach in order to compensate for the loss of particularity
when the chiefly compensated test is implemented and monitored on a
bank-wide basis, rather than on an account-by-account basis. The
Agencies note that several commenters also asserted that the proposed
aggregate relationship compensation-total compensation percentage
required by the bank-wide alternative (70 percent) would not disrupt
the trust and fiduciary operations or customer relationships of banks
in light of the proposal's definition of ``relationship compensation.''
Some commenters asked that the Agencies modify how the bank-wide
exemption could be applied in several ways. For example, some asserted
that a bank should be allowed to apply the 70 percent compensation
threshold separately to each individual fiduciary business line,
operating unit or geographic region of the bank, rather than only on an
aggregate bank-wide basis. Others asked that the Agencies allow a bank
to use an aggregate compensation approach only for some trust or
fiduciary business lines and use the account-by-account approach for
the bank's trust or fiduciary accounts in its remaining business
lines.\159\ In addition, some asked that a bank be permitted to monitor
compliance with the 70 percent compensation test on a combined basis
with its affiliated entities engaged in trust or fiduciary activities
(such as an affiliated bank or a subsidiary or affiliate registered as
an investment adviser).\160\ Some commenters also asked the Agencies to
modify the bank-wide approach to provide for a bank's relationship
compensation-total compensation percentage to be calculated based on
the compensation attributable to all of the bank's trust and fiduciary
accounts rather than the compensation from the bank's ``trust and
fiduciary business.'' \161\
---------------------------------------------------------------------------
\159\ See Clearing House Ass'n Letter.
\160\ See Citigroup Letter, Clearing House Ass'n Letter, Mellon
Bank, N.A. (``Mellon'') Letter, PNC Letter, ABA Letter.
\161\ See, e.g., ABA Letter, Joint ABA/ABASA/Clearing House
Ass'n Letter of July 16, 2007, BISA Letter, Clearing House Ass'n
Letter, Comerica Bank Letter.
---------------------------------------------------------------------------
The Agencies believe that the bank-wide alternative as structured
provides banks appropriate and adequate flexibility in conducting their
trust and fiduciary operations while meeting the statute's goals. The
bank-wide approach is designed to reflect both the relationship
compensation and total compensation received by a bank through the
conduct of its full range of trust or fiduciary services, and, thus,
allow banks to avoid tracking their trust or fiduciary revenue back to
one or more specific accounts. At the same time, the use of two uniform
methodologies (account-by-account or bank-wide) should facilitate the
review of bank compliance during the bank supervisory process and aid
the development of software and related systems by banks and their
service providers for compliance purposes. Furthermore, because the
broker exceptions for a bank in Section 3(a)(4)(B), including the trust
and fiduciary exception, apply to each bank individually and are not
available to a nonbank entity, including a nonbank subsidiary or
affiliate of a bank, the Agencies have not modified the rules to allow
a bank to monitor its compliance with the compensation limit in Rule
721 on a combined basis with one or more affiliated banks, subsidiaries
or affiliates. The Agencies also do not believe that requiring banks to
monitor their compliance with the 70 percent compensation test on a
bank-wide basis, rather than on an individual business line or
operating unit basis, will impose significant additional burdens on
banks.\162\
---------------------------------------------------------------------------
\162\ The Agencies note, for example, that a bank that operates
under the bank-wide approach may use different systems across its
trust or fiduciary business lines, units or regions to monitor its
compensation within those business lines, units or regions, provided
that such information is then aggregated on a bank-wide basis as
provided in Rule 722.
---------------------------------------------------------------------------
A bank has the flexibility to elect to use a calendar year or the
bank's fiscal year for purposes of complying with the compensation
provisions of either the account-by-account or bank-wide approach.\163\
In addition, whether a bank decides to use the account-by-account
approach or the bank-wide approach, the bank's compliance with the
relevant compensation restriction is based on a two-year rolling
average of the compensation attributable to the trust or fiduciary
account or the bank's trust or fiduciary business, respectively. This
two-year averaging is designed to allow for short-term fluctuations
that otherwise could lead a bank to fall out of compliance with the
exception or exemption from year-to-year.
---------------------------------------------------------------------------
\163\ Proposed Rule 721(a)(6).
---------------------------------------------------------------------------
Some commenters asked that the Agencies clarify when a bank must
commence monitoring its compliance with the two-year rolling
compensation test. As discussed infra in Part VI.F, a bank must comply
with the exceptions in Section 3(a)(4)(B) of the Exchange Act and the
final rules starting the first day of the bank's first fiscal year
commencing after September 30, 2008. Thus, a bank that operates on a
calendar-year basis must start monitoring its compliance with the
compensation requirements on either an account-by-account or bank-wide
basis beginning January 1, 2009, and would first have to meet the
applicable compensation restriction after the conclusion of 2010 (based
on the average of the bank's year-end compensation ratios for 2009 and
2010).\164\ To allow banks sufficient time to obtain and verify the
relevant compensation data, the Agencies have modified both the
account-by-account approach and the bank-wide approach to provide banks
up to 60 days after the end of a year to calculate their compliance
with the relevant compensation restriction.\165\ While the rules
provide for a bank's compliance with the compensation tests to be
determined based solely on calculations as of year-end, banks are
encouraged to monitor their trust and fiduciary compensation on a
regular basis as appropriate to identify and address potential
compliance issues before the end of the relevant two-year period.
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\164\ This same schedule also would apply to a bank that
operates on an October 1st to September 30th fiscal year, but that
elects to use the calendar year for purposes of monitoring its
compliance with the chiefly compensated test. The Agencies believe
the delay and phased-in nature of the compensation tests should
provide banks as a general matter sufficient notice and time to
address potential compensation issues across the full range of their
trust and fiduciary accounts, including personal and charitable
accounts and estates. See Business Law Section Letter.
\165\ See Rule 721(a)(3)(ii) and Rule 722(c)(2).
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2. ``Relationship Compensation''
Both the account-by-account and bank-wide approaches are based on
the ratio of the relationship compensation attributable to a trust or
fiduciary account or a bank's trust and fiduciary business to the total
compensation attributable to the account or business. The proposal
defined the term ``relationship compensation'' to mean the types of
trust and fiduciary compensation identified in the statute: an
administration fee; an annual fee (payable on a monthly, quarterly or
other basis); a fee based on a percentage
[[Page 56531]]
of assets under management; a flat or capped per order processing fee
that is equal to not more than the cost incurred by the bank in
connection with executing securities transactions for trust or
fiduciary accounts; or any combination of these fees.\166\ The proposed
rules also provided examples of fees that would be considered an
administration fee or a fee based on a percentage of assets under
management for these purposes. For example, the proposed rules provided
that 12b-1 fees,\167\ service fees,\168\ and fees for certain sub-
transfer agent, sub-accounting or related services \169\ paid by an
investment company on the basis of assets under management would be
considered relationship compensation under the rules.
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\166\ Proposed Rule 721(a)(4).
\167\ Proposed Rule 721(a)(4)(iii)(A).
\168\ Proposed Rule 721(a)(4)(iii)(B).
\169\ See Proposed Rule 721(a)(4)(i) and (iii)(C). Specifically,
these fees, which are hereinafter referred to as ``sub-transfer
agent and related fees'' are paid for (1) providing transfer agent
or sub-transfer agent services for the beneficial owners of
investment company shares; (2) aggregating and processing purchase
and redemption orders for investment company shares; (3) providing
the beneficial owners with account statements showing their
purchases, sales, and positions in the investment company; (4)
processing dividend payments to the account for the investment
company; (5) providing sub-accounting services to the investment
company for shares held beneficially in the account; (6) forwarding
communications from the investment company to the beneficial owners,
including proxies, shareholder reports, dividend and tax notices,
and updated prospectuses; or (7) receiving, tabulating, and
transmitting proxies executed by the beneficial owners of investment
company shares in the account.
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The Agencies received numerous comments on the definition of
relationship compensation. A number of commenters supported the
definition including, in particular, the examples recognizing 12b-1 and
service fees as relationship compensation. For example, some commenters
stated that treating these fees as relationship compensation is
consistent with the terms and purposes of the trust and fiduciary
exception and ``critical'' to ensuring that the rules do not disrupt
the trust and fiduciary operations and customer relationships of
banks.\170\ Other commenters, however, argued that all 12b-1 fees, or
the portion of such fees paid for distribution expenses, should be
excluded from relationship compensation.\171\ These commenters asserted
that treating 12b-1 fees as relationship compensation would allow banks
to have a ``salesman's stake'' in their customers'' securities
transactions in contravention of the purposes of the statute, result in
the disparate treatment of banks and registered investment advisers,
and create confusion as to how 12b-1 fees should be treated under other
aspects of the federal securities laws and rules of the NASD (now
FINRA).
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\170\ See Joint ABA/ABASA/Clearing House Ass'n Letter of June 7,
2007.
\171\ See NASD Letter, NASAA Letter.
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In addition, many commenters asked that the Agencies clarify
whether additional types of fees not mentioned in the proposed rules
would qualify as relationship compensation. For example, commenters
asked the Agencies to confirm that fees separately charged a trust or
fiduciary customer for custodial services and fees charged or earned in
connection with securities lending and borrowing transactions conducted
for a trust or fiduciary customer are relationship compensation.
After carefully considering the comments, the Agencies have
retained, consistent with the statute, the definition of relationship
compensation as any compensation that a bank receives that is
attributable to a trust or fiduciary account and that consists of (1)
an administration fee, (2) an annual fee (payable on a monthly,
quarterly or other basis), (3) a fee based on a percentage of assets
under management (an ``AUM fee''), (4) a flat or capped per order
processing fee, paid by or on behalf of a customer or beneficiary, that
is equal to not more than the cost incurred by the bank in connection
with executing securities transactions for trust or fiduciary accounts;
or (5) any combination of these fees.\172\
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\172\ Rule 721(a)(4). For banks operating under the bank-wide
alternative, fees of these types are relationship compensation if
they are attributable to the bank's trust or fiduciary business as a
whole. See Rule 722(c)(1).
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The final rules also continue to list all 12b-1 fees that are paid
on the basis of assets under management and attributable to a trust or
fiduciary account (under the account-by-account test) or the bank's
trust and fiduciary business as a whole (under the bank-wide test) as
examples of AUM fees that are relationship compensation. The Agencies
believe that treating 12b-1 fees in this manner is consistent with both
the language and purposes of the trust and fiduciary exception. When
paid on the basis of a percentage of assets under management these fees
fall within the types of fees expressly permitted by the trust and
fiduciary exception. 12b-1 fees that are paid on the basis of assets
under management also are distinguishable from the types of non-
relationship compensation, such as front-end or back-end sales loads
\173\ or per-order transaction fees that exceed a bank's costs, that
are limited by the statute's chiefly compensated test.
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\173\ A front-end sales charge is a charge that is used to
finance sales or sales promotion expenses and that is included in
the public offering price of the shares of an investment company. A
deferred sales charge is an amount properly chargeable to sales or
promotional expenses that is paid by a shareholder of an investment
company after purchase of the company's shares but before or upon
redemption. See FINRA Rule 2830(b)(8)(B) and (c); 17 CFR 270.6c-10.
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Treating 12b-1 fees in this manner also will avoid significant
disruptions to the trust and fiduciary operations of banks and, when
viewed in light of other provisions and protections, is consistent with
investor protection. Many bank trust and fiduciary departments,
particularly those that act as a corporate trustee or as a trustee or
fiduciary for employee benefit plans, receive a significant portion of
their trust and fiduciary compensation through payments made under a
12b-1 plan.
Importantly, as provided in the trust and fiduciary exception, all
12b-1 fees received by a bank must be consistent with the fiduciary
principles and standards governing the bank-customer relationship,\174\
and the bank's compliance with these principles and standards will
continue to be regularly examined by bank examiners during the bank
supervisory and examination process. In addition, the treatment of 12b-
1 fees that are paid on the basis of assets under management and
service fees as ``relationship compensation'' for purposes of the trust
and fiduciary exception and related rules does not affect the treatment
of such fees under other provisions of the federal securities laws, the
federal banking laws, applicable trust or fiduciary principles and
standards, or the rules of an SRO. Thus, for example, the treatment of
12b-1 fees that are paid on the basis of assets under management and
service fees as relationship compensation for purposes of these rules
does not alter or affect the
[[Page 56532]]
treatment of, or limitations imposed on, these fees under FINRA Rule
2830.\175\
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\174\ Section 802(f) of the Uniform Trust Code, for example,
provides that a trustee may receive compensation from an investment
company in which the trustee has invested trust funds and receipt of
such compensation will not be presumed to represent a conflict of
interest if the investment otherwise complies with the
jurisdiction's prudent investor rule. See Uniform Trust Code, Sec.
902(f) and related comment (2005). In addition, a bank's receipt of
12b-1 fees from an employee benefit plan for which the bank acts as
a fiduciary is governed by the Employee Retirement Income Security
Act (``ERISA'') and the regulations and guidance issued by the
Department of Labor thereunder. See 29 U.S.C. 1001 et seq.; DOL
Advisory Opinion 2003-09A (June 25, 2003) (discussing conditions
under which a directed trustee may receive 12b-1 fees under ERISA).
\175\ The rules also do not alter or affect the ability of a
nonbank registered investment adviser to receive 12b-1 fees under
the federal securities laws or the rules of an SRO. The ``broker''
exceptions for banks in Section 3(a)(4)(B) of the Exchange Act,
including the trust and fiduciary exception, are not available to
nonbank entities such as nonbank investment advisers.
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In light of the comments received, the Agencies have modified Rule
721 to provide additional examples of the types of fees that qualify as
relationship compensation under the statute and the rules. For example,
the Agencies have modified the rule to include, as additional examples
of an administration fee, compensation received by a bank (1) for
disbursing funds from, or for recording payments to, a trust or
fiduciary account; (2) in connection with securities lending and
borrowing transactions conducted for a trust or fiduciary account; and
(3) for custody services provided to a trust or fiduciary account
(whether or not separately charged).\176\ In addition, the Agencies
have included (1) as an example of an annual fee, an annual fee paid
for assessing the investment performance of a trust or fiduciary
account or for reviewing such an account's compliance with applicable
investment guidelines or restrictions, and (2) as an example of an
assets under management fee, a fee based on the financial performance,
such as capital gains or capital appreciation, of trust or fiduciary
assets under management. The Agencies believe the characterization of
these fees comports with the manner in which banks generally receive
compensation for these services. Several commenters noted that banks
currently may receive 12b-1 fees, service fees or sub-transfer agent
and related fees either directly from a mutual fund or from the fund's
distributor, transfer agent, administrator or adviser.\177\ In light of
these comments, the Agencies have eliminated the language in the
proposed rules that required that these types of fees be ``paid by an
investment company.''
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\176\ Rule 721(a)(4)(i)(B), (C) and (D). Because securities
lending/borrowing fees and custody fees may be charged on an assets
under management basis, the rule also provides that these fees are
relationship compensation when charged in this manner. Rule
721(a)(4)(iii)(E). As with other types of relationship compensation,
the fees that a bank receives for effecting securities lending/
borrowing transactions for a trust or fiduciary account must be
consistent with applicable fiduciary principles and standards.
\177\ See Investment Company Institute (``ICI'') Letter,
Federated Investors, Inc. (``Federated Investors'') Letter.
---------------------------------------------------------------------------
The examples of an administration fee, annual fee and an asset
under management fee included in Rule 721(b) are provided only for
illustrative purposes. Other types of fees or fees for other types of
services could be an administration fee, annual fee or an AUM fee. In
addition, an administration fee, annual fee or assets under management
fee attributable to a trust or fiduciary account or a bank's trust or
fiduciary business is considered relationship compensation regardless
of what entity or person pays the fee, and regardless of whether the
fee is related to only securities assets, to a combination of
securities and non-securities assets, or to only non-securities assets.
These fees are part of the compensation for acting as a trustee or
fiduciary.
Some commenters asserted that a bank should be permitted to include
within its relationship compensation any per-transaction securities
processing fee it charges as a directed trustee or in another fiduciary
capacity even if the fee exceeds the bank's costs in processing the
transaction.\178\ The statute, however, expressly provides that a per-
order securities processing fee may be counted towards the statute's
chiefly compensated requirement only if the fee is ``equal to not more
than the cost incurred by the bank in connection with executing
securities transactions'' for its trust or fiduciary customers. For
this reason, the Agencies have not modified the rule in the manner
requested.
---------------------------------------------------------------------------
\178\ See, e.g., Wells Fargo & Company (``Wells Fargo'') Letter,
State Street Corp. Letter, Mellon Letter.
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However, as discussed further in Part V, the Agencies have modified
the custody exemption (Rule 760) to permit banks that accept securities
orders as a directed trustee to do so under that exemption in lieu of
the trust and fiduciary exception and related rules. In addition, as
the Agencies explained in the proposal, a per order processing fee
included in relationship compensation may include the fee charged by
the executing broker-dealer as well as any additional fixed or variable
costs incurred by the bank in processing the transaction. If a bank
includes any such additional fixed or variable costs in the per order
processing fees it includes in its relationship compensation, the bank
should maintain appropriate policies and procedures governing the
allocation of these costs to the orders processed for trust or
fiduciary customers. This should help ensure that profits derived from
per trade charges are not masked as costs of processing the trades and
thereby included in relationship compensation.
3. Excluded Compensation
A number of commenters asserted that the revenues derived from
securities transactions conducted by a bank for a trust or fiduciary
customer under a different exception or exemption (such as the
exemption provided in Rule 771 for transactions in Regulation S
securities) should be excluded from the account-by-account or bank-wide
compensation test completely.\179\ Others asked that certain other
types of fees, such as internal credits from other areas of the bank,
credits received from broker-dealers for brokerage or research services
in accordance with Section 28(e) of the Exchange Act, or revenues
earned from providing trust or fiduciary services to mutual funds, be
excluded from the chiefly compensated calculation as well.
---------------------------------------------------------------------------
\179\ See, e.g., Institute of Int'l Bankers (``IIB'') Letter,
Clearing House Ass'n Letter.
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As discussed in Part I.C supra, if more than one ``broker''
exception or exemption is available for a securities transaction
effected by a bank for a customer, the bank may choose the exception or
exemption on which it relies in effecting the transaction. In light of
the comments received, the Agencies have modified Rules 721 and 722 to
explicitly provide that, if a bank effects a securities transaction for
a trust or fiduciary customer in accordance with the terms of an
exception or exemption other than Rule 721 or Rule 722, the bank may,
at its election, exclude the revenues associated with those
transactions from the applicable relationship-total compensation
calculation in Rule 721 or Rule 722.\180\ As the rules provide, if a
bank elects to exclude the revenues associated with transactions
conducted under another exception or exemption, the bank must exclude
such revenue from both the bank's relationship compensation (if the
compensation would otherwise qualify as relationship compensation) and
total compensation. Of course, the bank also must comply with the
conditions applicable to the other available exception or exemption on
which the bank chooses to rely.\181\
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\180\ Rule 721(b) and Rule 722(d).
\181\ Some commenters asserted that a bank should be allowed to
include in its relationship compensation all of the revenue from
securities transactions conducted for a trust or fiduciary account
under another exception or exemption, regardless of whether that
revenue otherwise qualifies as relationship compensation. The
Agencies have not amended the rule in this manner as it is
inconsistent with the terms of the trust and fiduciary exception
which sets forth the types of fees that are included in relationship
compensation.
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In addition, compensation that is not derived from the provision of
trust or fiduciary services should not be
[[Page 56533]]
included in a bank's relationship or total compensation under either
the account-by-account or bank-wide alternative. Such compensation
includes, for example, (1) revenue earned by a trust or fiduciary
department from providing back-office services to an affiliated or
unaffiliated party,\182\ (2) revenue from the sale of an office or
assets of the trust department, or from the provision on a stand-alone
basis of other services (such as custody services or the sale of
portfolio management software to a third party that independently
operates and uses the software in connection with its own business)
that do not involve trust or fiduciary services as defined in section
3(a)(4)(D) of the Act; and (3) internal payments or credits allocated
to a bank's trust or fiduciary department or unit from another
department or unit of the bank for deposits and other similar services
not involving a security. Credits received by a bank from a broker-
dealer for brokerage and research services provided by a broker-dealer
in accordance with section 28(e) of the Act (15 U.S.C. 78bb(e)) and the
regulations issued thereunder also should be excluded from the
compensation tests. The Agencies do not believe these credits
constitute compensation to the bank for purposes of the exception and
rules because these credits must be reasonable in relation to the value
of the brokerage and research provided by the broker-dealer in
connection with the bank's exercise of investment discretion for its
fiduciary accounts.
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\182\ On the other hand, the revenue derived from providing
fiduciary services to investment companies or companies affiliated
with the bank should be included in the relevant chiefly compensated
calculation.
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4. Trust or Fiduciary Accounts
The final rules, like the proposal, define a trust or fiduciary
account as an account for which the bank acts in a trustee or
``fiduciary capacity'' as that term is defined in Section 3(a)(4)(D) of
the Exchange Act.\183\ This definition is based on the definition of
``fiduciary capacity'' in part 9 of the OCC's regulations, which
relates to the trust and fiduciary activities of national banks, in
effect at the time of enactment of the GLB Act.
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\183\ Rule 721(a)(5).
---------------------------------------------------------------------------
Section 3(a)(4)(D) identifies a number of particular situations
where a bank serves in a fiduciary capacity.\184\ The definition also
provides that a bank acts in a ``fiduciary capacity'' if it acts ``in
any other similar capacity'' to those specifically identified.
Accordingly, the scope of the term ``fiduciary capacity'' is not fixed
in time.
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\184\ Section 3(a)(4)(D) of the Exchange Act provides that a
bank acts in a ``fiduciary capacity'' if, among other situations,
the bank has investment discretion on behalf of another. Thus, for
example, if a bank has investment discretion over an escrow account
on behalf of another, the bank would be acting in a ``fiduciary
capacity'' with respect to the account.
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The Agencies recognize, moreover, that different nomenclature may
be used to identify a fiduciary capacity in the relevant governing
documents or state laws. For example, the Uniform Probate Code uses the
term ``Personal representative'' and similar successor titles in place
of the terms ``executor'' or ``administrator'' to identify the
representative of a decedent; the Uniform Custodial Trust Act uses the
terms ``Conservator'' and ``Custodial trustee'' to refer to persons
that act as a fiduciary for another person who has become
incapacitated; and the Uniform Transfers to Minors Act uses both the
terms ``Conservator'' and ``Custodian'' to refer to fiduciaries that
act on behalf of a minor.\185\
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\185\ The text of and additional information on these Uniform
Codes and Acts, which are developed under the auspices of the
National Conference of Commissioners of Uniform State Laws
(``NCCUSL''), may be found on NCCUSL's Web site at http://www.nccusl.org.
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Some commenters asked whether a bank that engages in trust or
fiduciary activities may conduct securities transactions under the
trust and fiduciary exception and related rules even if the bank does
not maintain a separate trust department or has not had to obtain
formal trust powers from its appropriate federal banking agency.\186\
The trust and fiduciary exception and related rules do not require that
a bank effecting securities transactions for a customer in a trust or
fiduciary capacity do so through a separate trust department or have
obtained formal trust powers from its appropriate federal banking
agency. However, securities transactions conducted for a trust or
fiduciary customer under the exception and related rules must be
effected in a department of the bank ``that is regularly examined for
compliance with fiduciary principles and standards'' by the bank's
appropriate federal or state banking supervisor.\187\ As stated in the
proposal, the Agencies will rely on the appropriate federal banking
agency for a bank to determine whether the bank's activities are
conducted in the bank's trust department or other department regularly
examined by the agency's examiners for compliance with fiduciary
principles and standards.\188\
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\186\ See, e.g., ACB Letter, Roundtable Letter. Federal savings
associations, for example, are not required to obtain approval from
their appropriate federal banking agency to act as a trustee for an
individual retirement account under section 408(a) of the Internal
Revenue Code. See 12 CFR 550.580.
\187\ 15 U.S.C. 78c(a)(4)(B)(ii); Rule 722(a)(1). A bank
effecting transactions for trust or fiduciary customers through a
department examined for compliance with trust or fiduciary
principles may use other divisions or departments of the bank, or
other affiliated or unaffiliated third parties, to handle aspects of
these transactions. The bank must continue to act in a trustee or
fiduciary capacity with respect to the account and, accordingly,
should exercise appropriate diligence in selecting persons to
provide services to the bank's trust or fiduciary customers and in
overseeing the services provided in accordance with the bank's
fiduciary obligations. No party, other than the bank (including,
without limitation, a transfer agent or investment adviser), working
in conjunction with the bank may rely on the bank's exception or
exemption from ``broker'' status. To the extent that any such third
party performs activities that would make that entity a broker under
Section 3(a)(4) of the Exchange Act that entity would be required to
register as a broker (in the absence of an applicable exemption or
regulatory relief) notwithstanding any written or unwritten
agreement the third party may have with the bank.
\188\ The OTS, for example, is in the process of revising its
examination procedures to provide for the regular examination of
individual retirement accounts held by a federal savings association
as trustee for compliance with fiduciary principles and standards.
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5. Exemptions for Special Accounts, Foreign Branches, Transferred
Accounts, and a De Minimis Number of Accounts
The Agencies also proposed a rule (Proposed Rule 723) that would
permit a bank to exclude certain types of accounts for purposes of
determining its compliance with the account-by-account or bank-wide
compensation tests. As proposed, Rule 723 allowed a bank, in
calculating its compensation under either approach, to exclude
compensation received from any trust or fiduciary account open only for
a short period of time (less than 3 months) or acquired within the past
12 months as part of a merger or similar transaction. In addition, the
Proposed Rule allowed a bank using the account-by-account approach,
subject to certain conditions, to (1) exclude the lesser of 1 percent
or 500 of its trust or fiduciary accounts in a year from the chiefly
compensated test, and (2) transfer any trust or fiduciary account
ultimately determined to be non-conforming to a registered broker-
dealer or an unaffiliated entity exempt from registration within 3
months of the end of the relevant year.
Commenters generally favored these exemptions. One commenter,
however, argued that these exemptions should be eliminated because they
would allow banks to manipulate the chiefly compensated test.\189\
Several commenters also requested that the Agencies adopt an additional
exemption
[[Page 56534]]
permitting banks to exclude trust and fiduciary accounts held at a
foreign branch of a bank from the chiefly compensated tests.\190\ These
commenters contended that few, if any, of the trust and fiduciary
accounts of a foreign branch (other than an offshore ``shell'' branch
servicing U.S. branches of the bank) likely are to be held by or on
behalf of a U.S. person and, accordingly, the costs of applying the
chiefly compensated test to the foreign branches of a U.S. bank would
significantly outweigh any potential benefits to U.S. persons. After
carefully considering these comments, the Agencies have adopted,
without change, the exemptions included in Proposed Rule 723. In
addition, the Agencies have adopted a new conditional exemption (Rule
723(c)) for trust and fiduciary accounts held at a foreign branch of a
bank.
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\189\ NASAA Letter.
\190\ See ABA Letter, Clearing House Ass'n Letter, Joint ABA/
ABASA/Clearing House Ass'n Letter of July 16, 2007.
---------------------------------------------------------------------------
Rule 723(a) permits a bank that uses either the account-by-account
or bank-wide compensation test to exclude any trust or fiduciary
account that was open for a period of less than 3 months during the
relevant year.\191\ Rule 723(b) permits a bank to exclude, for purposes
of determining its compliance with either compensation test, any trust
or fiduciary account that the bank acquired from another person as part
of a merger, consolidation, acquisition, purchase of assets or similar
transaction by the bank for 12 months after the date the bank acquired
the account from the other person.\192\ A bank that elects to use Rule
723(a) or (b) for one or more accounts must exclude both the
relationship compensation and total compensation attributable to such
accounts for purposes of the applicable compensation test.
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\191\ Rule 723(a).
\192\ Rule 723(b).
---------------------------------------------------------------------------
Rule 723(c) provides a new exemption under which a bank using the
bank-wide approach may exclude for purposes of the chiefly compensated
test the trust or fiduciary accounts held at a ``non-shell'' foreign
branch of the bank, provided that the bank has reasonable cause to
believe that the trust or fiduciary accounts of the foreign branch held
by or for the benefit of a U.S. person constitute less than 10 percent
of the total trust or fiduciary accounts of the foreign branch.\193\
The rule provides that a bank will be deemed to have reasonable cause
to believe that less than 10 percent of the total number of trust or
fiduciary accounts of the foreign branch are held by or for the benefit
of a U.S. person if the principal mailing address for the
accountholder(s) and beneficiary(ies) of the account is not in the
United States, or the records of the foreign branch indicate that the
accountholder(s) and beneficiary(ies) of the account is not a U.S.
person as defined in 17 CFR 230.902(k).
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\193\ The Agencies expect that few, if any banks, that use the
account-by-account approach to the chiefly compensated test will
have foreign branches engaged in trust or fiduciary services and,
accordingly, have limited the exemption to banks that use the bank-
wide approach.
---------------------------------------------------------------------------
The rule defines a ``non-shell foreign branch'' of a bank to mean a
branch of the bank that is located outside the United States and
provides banking services to residents of the foreign jurisdiction in
which the branch is located, and for which the decisions relating to
day-to-day operations and business of the branch are not made by an
office of the bank located in the United States.\194\ The Agencies
believe this exemption provides appropriate relief to banks with
respect to foreign branches where the records of the bank indicate that
it is not significantly engaged in providing trust or fiduciary
services to U.S. customers.
---------------------------------------------------------------------------
\194\ This definition is designed to exclude branches that are
established in certain offshore jurisdictions primarily to provide
services to U.S. customers and, for this reason, are managed on a
day-to-day basis from the United States.
---------------------------------------------------------------------------
Rule 723(e) permits a bank using the account-by-account approach to
exclude, for purposes of the chiefly compensated test, the lesser of
(1) 1 percent of the total number of trust or fiduciary accounts held
by the bank; or (2) 500 accounts.\195\ To rely on this exemption with
respect to an account, the bank must not have relied on this exemption
for such account during the immediately preceding year.\196\ In
addition, the bank must maintain records demonstrating that the
securities transactions conducted by or on behalf of the excluded
account were undertaken by the bank in the exercise of its trust or
fiduciary responsibilities with respect to the account.\197\
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\195\ Rule 723(d). Under the rule, if a bank has less than 100
trust or fiduciary accounts in the aggregate, the bank may exclude 1
account under the exemption in any given year.
\196\ Rule 723(d)(3).
\197\ Rule 723(d)(1).
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The Agencies believe these exclusions reduce administrative burdens
and facilitate compliance. A bank, consistent with its fiduciary
duties, may need to conduct a higher level of securities transactions
for a trust or fiduciary account at certain times, such as shortly
after the account is established or acquired from another person or
shortly before the account is closed.\198\ The exclusions in Rule
723(a), (b) and (d) are designed to help prevent such short-term
fluctuations in the amount of securities transactions conducted for a
trust or fiduciary account from distorting, or causing a bank to fail,
the relevant compensation test. At the same time, these exclusions
promote compliance by requiring that the bank bring the relevant
accounts into compliance within a short and prescribed period of time.
For this reason, the Agencies do not believe it would be appropriate to
expand the Rule 723(d) to allow a bank to exclude an account from the
chiefly compensated test in consecutive years as requested by some
commenters. Some commenters also asked the Agencies to raise the 500
account maximum in Rule 723(d) to avoid discriminating against large
banks.\199\ The Agencies expect that most banks that have more than
50,000 trust and fiduciary accounts, and thus would be subject to the
500 account cap in Rule 723(d), will operate under the bank-wide test
and for this reason have not made the requested change.
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\198\ For example, after a trust or fiduciary account is
acquired or established, the bank may need to conduct a number of
securities transactions to invest or rebalance the account's
holdings in accordance with the terms of the agreement establishing
the account or, in cases where the bank has investment discretion,
to implement the bank's investment strategy for the account.
\199\ See, e.g., ACB Letter; Clearing House Ass'n Letter.
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Rule 723(c) also provides that a bank that uses the account-by-
account approach will not be considered a broker for purposes of
Section 3(a)(4) of the Exchange Act solely because a particular trust
or fiduciary account does not meet the ``chiefly compensated'' test if,
within 3 months of the end of the year in which the account fails to
meet such standard, the bank transfers the account or the securities
held by or on behalf of the account to a registered broker-dealer or
another unaffiliated entity (such as an unaffiliated bank) that is not
required to be registered as a broker-dealer.\200\
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\200\ Rule 723(c).
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6. Advertising Restrictions
Proposed Rule 721(b) implemented the advertising restrictions in
Section 3(a)(4)(B)(ii)(II) of the Act applicable to banks conducting
securities transactions under the trust and fiduciary exception. No
commenters opposed the advertising restrictions of the rule and the
Agencies have adopted these restrictions as proposed. The final rules
provide that a bank complies with the advertising restriction
applicable under either Rule
[[Page 56535]]
721 or 722 if advertisements by or on behalf of the bank do not
advertise that the bank provides securities brokerage services for
trust or fiduciary accounts except as part of advertising the bank's
broader trust or fiduciary services, and do not advertise the
securities brokerage services provided by the bank to trust or
fiduciary accounts more prominently than the other aspects of the trust
or fiduciary services provided to such accounts.\201\
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\201\ Rule 721(b).
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An ``advertisement'' for these purposes means any material that is
published or used in any electronic or other public media, including
any Web site, newspaper, magazine or other periodical, radio,
television, telephone or tape recording, videotape display, signs or
billboards, motion pictures, blast e-mail, or telephone directories
(other than routine listings).\202\ Other types of material or
information that is not distributed through public media, such as
mailings or e-mails to a bank's own customers, are not considered an
advertisement. In addition, in considering whether an advertisement
advertises the securities brokerage services provided to trust or
fiduciary customers more prominently than the bank's other trust or
fiduciary services, the nature, context and prominence of the
information presented--and not simply the length of text or information
devoted to a particular subject--should be considered.
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\202\ Rule 721(b)(2) (referencing Rule 760(g)(2)).
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IV. Sweep Accounts and Transactions in Money Market Funds
Exchange Act Section 3(a)(4)(B)(v) (``sweep exception'') 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.'' \203\ To provide banks with guidance on
the sweep exception, Proposed Rule 740 defined several terms used in
the exception, including the terms ``money market fund'' and ``no-
load.'' \204\ The Agencies also requested comment on a separate
exemption (Proposed Rule 741) that would permit banks, without
registering as a broker, to effect transactions in securities issued by
a money market fund on behalf of a customer in a broader set of
circumstances, subject to certain conditions.\205\
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\203\ See Exchange Act Section 3(a)(4)(B)(v) (15 U.S.C.
78c(a)(4)(B)(v)).
\204\ Proposed Rule 740(b) and (c).
\205\ Proposed Rule 741.
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Most commenters that addressed Proposed Rules 740 and 741 supported
the rules and Rule 741 in particular.\206\ One commenter objected to
the exemption in Rule 741 on the basis that it would permit banks to
effect transactions in money market funds that did not meet the ``no-
load'' requirements of the sweep exception.\207\ Another commenter
asked that the Agencies clarify whether a bank may effect transactions
under the rules for deposits held by another bank.
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\206\ See, e.g., Federated Investors Letter, ICBA Letter,
Clearing House Ass'n Letter, ABA Letter.
\207\ See, e.g., NASAA Letter.
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A. Rule 740: Definition of Terms Used in Sweep Exception
As under the proposal, the final rule defines a ``money market
fund'' for purposes of the sweep exception to mean an open-end
investment 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.\208\ In addition, consistent with FINRA
rules, the final rule provides that a class or series of securities of
an investment company will be considered ``no-load'' if (1) the class
or series is not subject to a sales charge or a deferred sales charge;
and (2) total charges against net assets of the class or series of
securities for sales or sales promotion expenses, personal service, or
the maintenance of shareholder accounts do not exceed 0.0025 of average
net assets annually.\209\ A bank may effect transactions under the
sweep exception and Rule 740 as part of a program to sweep deposit
funds of, or collected by, another bank into a no-load money market
fund in accordance with the exception and the Rule.
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\208\ Rule 740(b). One commenter requested that Rule 740(b) be
modified to allow banks to sweep deposits into an unregistered
investment company that operates pursuant to Rule 12d1-1 under the
Investment Company Act (17 CFR 270.12d1-1). See State Street Corp.
Letter. The statutory sweep exception, however, provides only for
deposit funds to be swept into an investment company ``registered
under the Investment Company Act of 1940.'' Exchange Act Section
3(a)(4)(B)(v).
\209\ See Rule 740(c); FINRA Rule 2830. Consistent with FINRA
Rule 2830, charges for the following are not be considered charges
against net assets of a class or series of an investment company's
securities for sales or sales promotion expenses, personal service,
or the maintenance of shareholder accounts: (1) Providing transfer
agent or sub-transfer agent services for beneficial owners of
investment company shares; (2) Aggregating and processing purchase
and redemption orders for Investment company shares; (3) Providing
beneficial owners with account statements showing their purchases,
sales, and positions in the investment company; (4) Processing
dividend payments for the investment company; (5) Providing sub-
accounting services to the investment company for shares held
beneficially; (6) Forwarding communications from the investment
company to the beneficial owners, including proxies, shareholder
reports, dividend and tax notices, and updated prospectuses; or (7)
Receiving, tabulating, and transmitting proxies executed by
beneficial owners of investment company shares.
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B. Exemption Regarding Money Market Fund Transactions
After carefully considering the comments, the Agencies have adopted
Rule 741, which permits banks, without registering as a broker, to
effect transactions on behalf of a customer in securities issued by a
money market fund under certain conditions.\210\ To qualify for this
exemption, the bank must provide the customer, directly or indirectly,
some other product or service, the provision of which would not, in and
of itself, require the bank to register as a broker-dealer under
Section 15(a) of the Exchange Act.\211\ Examples of other products or
services that may be a qualifying ``other'' product or service include
an escrow, trust, fiduciary or custody account, a deposit account or a
loan or other extension of credit. The Agencies have modified the rule
to also permit a bank to effect transactions under the exemption on
behalf of another bank as part of a program for the investment or
reinvestment of the deposit funds of, or collected by, the other
bank.\212\ This change is designed to allow banks to provide sweep
services to other banks under the exemption, as they may do under the
sweep exception itself.
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\210\ Rule 741.
\211\ Rule 741(a)(1)(A).
\212\ Rule 741(a)(1)(B).
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The final exemption continues to allow banks to effect transactions
only in securities of a registered money market fund. In addition, the
rule continues to provide that, if the class or series of money market
fund securities is not no-load (as defined in Rule 740), the bank may
not characterize or refer to the class or series of securities as no-
load and the bank must provide the customer, not later than at the time
the customer authorizes the bank to effect the transactions, a
prospectus for the securities.\213\ The Agencies believe these
conditions and limitations provide bank customers adequate protections
in light of the limited nature of the transactions
[[Page 56536]]
permitted under the exemption.\214\ In addition, the exemption
recognizes that banks have long offered sweeps and other services that
invest customer funds in money market funds that do not qualify as
``no-load'' funds under Commission and FINRA rules.
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\213\ Rule 741(a)(2)(ii). If a bank relies on the exemption to
sweep the deposits of another bank into a money market fund that is
not ``no-load,'' then neither the deposit-holding bank nor the
sweeping bank may characterize the fund as a ``no-load'' fund, and
either the deposit-taking bank or the sweeping bank must provide the
customer with a prospectus for the fund within the time prescribed
by the rule. See Rule 741(a)(2)(ii)(A) and (B).
\214\ Some commenters requested that the prospectus-delivery
requirement be eliminated or modified so that delivery is required
before a transaction is effected rather than before the customer
authorizes the transaction. See, e.g., ABA Letter, Clearing House
Ass'n Letter, and HSBC Bank Letter. The final rule retains this
requirement to ensure that a customer receives notice that its funds
are to be invested in a fund that is not ``no-load'' before the
customer authorizes the transaction(s). If a customer's funds are
invested in a no-load fund and the bank is authorized, under the
terms of its agreement with the customer to alter the specific fund
into which the customer's balances are invested, the bank should
provide the customer a prospectus for any money market fund that is
not a ``no-load'' fund prior to the date on which the bank first
invests the customer's balances in the fund.
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V. Safekeeping and Custody
A. Background
Section 3(a)(4)(B)(viii) of the Exchange Act provides banks with an
exception from the ``broker'' definition for certain bank custody and
safekeeping activities (``custody and safekeeping exception''). In
particular, this exception allows a bank to perform the following
activities as part of its customary banking activities without
registering as a ``broker':
Providing safekeeping or custody services with respect to
securities, including the exercise of warrants and other rights on
behalf of customers;
Facilitating the transfer of funds or securities, as a
custodian or a clearing agency, in connection with the clearance and
settlement of its customers' transactions in securities;
Effecting securities lending or borrowing transactions
with or on behalf of customers as part of the above described custodial
services or investing cash collateral pledged in connection with such
transactions;
Holding securities pledged by a customer to another person
or securities subject to purchase or resale agreements involving a
customer, or facilitating the pledging or transfer of such securities
by book entry or as otherwise provided under applicable law, if the
bank maintains records separately identifying the securities and the
customer; and
Serving as a custodian or provider of other related
administrative services to any individual retirement account, pension,
retirement, profit sharing, bonus, thrift savings, incentive, or other
similar benefit plan.\215\
---------------------------------------------------------------------------
\215\ 15 U.S.C. 78c(a)(4)(B)(viii).
---------------------------------------------------------------------------
The proposed rules included an exemption to allow banks, subject to
certain conditions, to accept orders for securities transactions from
employee benefit plan accounts and individual retirement and similar
accounts for which the bank acts as custodian.\216\ In addition, the
proposed exemption allowed banks, subject to certain conditions, to
accept orders for securities transactions on an accommodation basis
from other types of custody accounts.\217\
---------------------------------------------------------------------------
\216\ Proposed Rule 760(a).
\217\ Proposed Rule 760(b).
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Some commenters contended that an exemption for custodial order-
taking activity is unnecessary because, they argued, order-taking
activity is permitted directly under the statutory exception.\218\
Other commenters stated that the exemption was important because it
would allow banks to continue to provide order-taking services to
employee benefit plans and individual retirement accounts and similar
accounts, or that the restrictions in the exemption were
reasonable.\219\ Another commenter, however, objected to the proposed
exemption arguing that permitting custodial banks to take orders for
securities is inconsistent with functional regulation.\220\
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\218\ See, e.g., Union Bank Letter, Harris Bank Letter, Clearing
House Ass'n Letter, ABA Letter.
\219\ See, e.g., The Charles Schwab Corp. (``Schwab'') Letter,
ICBA Letter.
\220\ See NASAA Letter.
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B. Rule 760: Custody Exemption
After carefully considering the comments, the Agencies have adopted
Rule 760. The Agencies have crafted the exemption to allow banks to
continue to accept securities orders in a custodial capacity and to
permit bank customers to take advantage of those order-taking services
subject to important conditions designed to limit the scope of the
activity and provide appropriate investor protections. In this way, the
Agencies believe the exemption is consistent with functional regulation
and the purposes of the GLBA.
Rule 760 and the other final rules do not implement the statutory
custody and safekeeping exception.\221\ A bank does not need to rely on
the custody exemption in Rule 760 to the extent the bank conducts other
custodial activities permitted by Section 3(a)(4)(B)(viii)(I)(aa)-(ee)
(e.g., exercising warrants or other rights with respect to securities
or effecting securities lending or borrowing transactions on behalf of
custodial customers) or another of the final rules (e.g., Rule 772,
which permits banks to effect securities lending or borrowing
transactions on behalf of certain non-custodial customers).\222\ In
addition, a bank would not have to rely on Rule 760 to the extent the
bank holds securities in custody for a customer and provides clearance
and settlement services to the account in connection with such
securities, but the bank does not accept orders for securities
transactions for the account or engage in other activities with respect
to the account that would require the bank to be registered as a
broker.
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\221\ The Agencies asked for comment on whether the Agencies
should adopt rules to implement the statutory custody and
safekeeping exception. No commenters requested that the Agencies do
so at this time.
\222\ One commenter asserted that a bank would not ``accept'' a
securities order if it received the order from a custodial customer
and at the customer's request transmitted the order to a broker-
dealer selected by the customer. See Union Bank Letter. Such
activities, however, constitute ``accepting'' a securities order for
purposes of Rule 760 and a bank engaged in such activities for a
custodial customer must comply with Rule 760 unless some other
exception or exemption is available for the transaction (e.g.,
Section 3(a)(4)(B)(x) of the Act if the transaction involves
municipal securities).
---------------------------------------------------------------------------
The following discusses the scope and terms of the custody
exemption.
1. Order-Taking for Employee Benefit Plan Accounts and Individual
Retirement or Similar Accounts
We are adopting, largely as proposed, the sections of Rule 760
providing that a bank will not be considered a broker to the extent
that, as part of its customary banking activities, the bank accepts
orders to effect transactions in securities in an ``employee benefit
plan account'' or an ``individual retirement account or similar
account'' for which the bank acts as a custodian.\223\ The rule defines
an ``employee benefit plan account'' as a pension plan, retirement
plan, profit sharing plan, bonus plan, thrift savings plan, incentive
plan, or other similar plan, and provides a number of non-exclusive
examples of plans that meet this definition.\224\ The rule defines an
``individual retirement account or similar account'' to mean an
[[Page 56537]]
individual retirement account as defined in Section 408 of the Internal
Revenue Code (26 U.S.C. 408), a Roth IRA as defined in Section 408A of
the Internal Revenue Code (26 U.S.C. 408A), a health savings account as
defined in Section 223(d) of the Internal Revenue Code (26 U.S.C.
223(d)), an Archer medical savings account as defined in Section 220(d)
of the Internal Revenue Code (26 U.S.C. 220(d)), a Coverdell education
savings account as defined in Section 530 of the Internal Revenue Code
(26 U.S.C. 530), or other similar account.\225\
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\223\ See Rule 760(a).
\224\ Rule 760(h)(4). The rule provides that the term ``employee
benefit plan account'' includes, without limitation, an employer-
sponsored plan qualified under Section 401(a) of the Internal
Revenue Code (26 U.S.C. 401(a)), a governmental or other plan
described in Section 457 of the Internal Revenue Code (26 U.S.C.
457), a tax-deferred plan described in Section 403(b) of the
Internal Revenue Code (26 U.S.C. 403(b)), a church plan,
governmental, multi-employer or other plan described in Section
414(d), (e) or (f) of the Internal Revenue Code (26 U.S.C. 414(d),
(e) or (f)), an incentive stock option plan described in Section 422
of the Internal Revenue Code (26 U.S.C. 422); a Voluntary Employee
Beneficiary Association Plan described in Section 501(c)(9) of the
Internal Revenue Code (26 U.S.C. 501(c)(9)), a non-qualified
deferred compensation plan (including a rabbi or secular trust), a
supplemental or mirror plan, and a supplemental unemployment benefit
plan.
\225\ Rule 760(h)(5).
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A number of commenters supported these definitions of ``employee
benefit plan account'' and ``individual retirement account or similar
account.'' \226\ The Agencies note that both definitions, by their
terms, encompass ``other similar'' plans or accounts. So, for example,
similar plans or accounts, such as ``lifetime savings accounts,'' that
are established under the Internal Revenue Code in the future would be
employee benefit plan accounts or individual retirement accounts or
similar accounts for purposes of the rule. In addition, the term
``employee benefit plan account'' includes a non-U.S. plan that meets
the definition of an employee benefit plan account.
---------------------------------------------------------------------------
\226\ See, e.g., ABA Letter, Clearing House Assn. Letter, WBA
Letter.
---------------------------------------------------------------------------
Under the final rules, a bank relying on the employee benefit plan
and individual retirement and similar account provisions must comply
with the advertising and sales literature limitations in paragraphs
(a)(2) and (3), the employee compensation limitations in paragraph (c),
and the other conditions in the paragraph (d) of the rule. These
conditions are discussed below.
Some commenters asked that the Agencies permit a bank to accept
securities orders for other types of accounts that may involve custody
of securities, such as accounts for which the bank acts as escrow
agent, issuing and paying agent, tender agent, or disbursement agent,
subject to the conditions applicable to employee benefit plan accounts
and individual retirement and similar accounts, rather than the
expanded set of conditions applicable to accommodation orders accepted
for other types of custody accounts. The provisions in Rule 760(a) for
employee benefit plan accounts and individual retirement and similar
accounts are designed to reflect the extent and manner in which banks
provide order-taking services for these types of accounts. In addition,
these provisions take account of the special mention of these accounts
in the custody and safekeeping exception \227\ and the additional
protections to which these accounts typically are subject under the
ERISA, the Internal Revenue Code, and other applicable law. For these
reasons, the Agencies have not expanded Rule 760(a) to cover accounts
other than employee benefit plan accounts and individual retirement and
other similar accounts. Banks may continue to accept orders from other
types of accounts for which the bank acts as a custodian under the
accommodation provisions of the rule.
---------------------------------------------------------------------------
\227\ See Section 3(a)(4)(B)(viii)(I)(ee) of the Exchange Act.
---------------------------------------------------------------------------
a. Employee Compensation Restrictions
We are adopting the employee compensation restrictions in Rule
760(c) as proposed. These restrictions apply when a bank, acting in a
custodial capacity, accepts a securities order for an employee benefit
plan account or an individual retirement account or similar account
under paragraph (a) of the rule, and when a bank accepts a securities
order for another type of custodial account under paragraph (b) of the
rule. Under these restrictions, if a bank accepts securities orders
pursuant to Rule 760, then no employee of the bank may receive
compensation (including a fee paid pursuant to a 12b-1 plan) from the
bank, the executing broker-dealer, or any other person that is based
on: (1) Whether a securities transaction is executed for the account;
or (2) the quantity, price, or identity of the securities purchased or
sold by the account. These restrictions are designed to be consistent
with banking practices and reduce the financial incentives a bank
employee might have to encourage a customer to submit securities orders
to the bank and use a custody account as the functional equivalent of a
securities brokerage account.
Only a few commenters addressed the employee compensation
restrictions of the rule. For example, one commenter asserted that the
rule should permit a bank to compensate its employees based on the
potential revenues associated with a custodial account, including
revenues received from processing securities transactions or from a
mutual fund in which the account is invested.\228\ In addition, a
commenter expressed concern that the restrictions would prohibit
employees from receiving bonuses based on the total revenues derived
from the custodial accounts for which the employee is responsible.
---------------------------------------------------------------------------
\228\ See, e.g., Wells Fargo Letter.
---------------------------------------------------------------------------
As the Agencies noted in the proposal, the employee compensation
restrictions in Rule 760(c) do not prohibit a bank employee from
receiving compensation that is based on whether a customer establishes
a custodial account with the bank, or that is based on the total amount
of assets in a custodial account at account opening or at any other
time. Moreover the rule expressly provides that the employee
compensation restrictions do not prevent a bank employee from receiving
payments under a bonus or similar plan that are permissible under the
exception in Rule 700(b)(1) as if a referral had been made by the bank
employee, or from receiving any compensation described in Rule
700(b)(2) of the networking rules.\229\
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\229\ Because the employee compensation restrictions relate to
securities transactions conducted in the relevant custody account,
they would not prevent a bank employee from receiving a referral fee
for referring the customer to a broker-dealer to engage in
securities transactions at the broker-dealer that are unrelated to
the custody account in accordance with the networking exception or
the institutional customer and high net worth customer exemption
(Rule 701) for networking arrangements.
---------------------------------------------------------------------------
Thus, for example, the rule does prohibit a bank from directly
passing on to an employee a portion or percentage of the 12b-1 fees
received by the bank from a custody account's investment in a mutual
fund, or a portion of a fee that is charged only when, or that varies
based on whether, a securities transaction is executed for the account.
A bank employee may receive payments under a bonus or similar plan rule
that includes within its allocation pool the revenues generated by one
or more custodial accounts if the plan meets the criteria for a
discretionary, multi-factor bonus program in Rule 700(b)(1), or the
bonus program is based on the overall profitability or revenues of the
bank, an affiliate, or operating unit and the program complies with the
requirements of the safe harbor in Rule 700(b)(2). If a bank's
compensation practices are inconsistent with these limitations, the
bank may not rely on the exemption to take securities orders in a
custodial capacity.
b. Advertisements and Sales Literature
As under the proposed rule, final Rule 760(a)(2) provides that a
bank relying on the exemption may not advertise that it accepts orders
for securities transactions for employee benefit plan accounts or
individual retirement accounts or similar accounts for which the bank
acts as custodian, except as part of advertising the other custodial or
[[Page 56538]]
safekeeping services the bank provides to these accounts.\230\ The bank
also may not advertise that such accounts are securities brokerage
accounts or that the bank's safekeeping and custody services substitute
for a securities brokerage account.\231\ Moreover, advertisements and
sales literature for individual retirement or similar accounts that are
issued by or on behalf of the bank may not describe the securities
order-taking services provided by the bank to these accounts more
prominently than the other aspects of the custody or safekeeping
services the bank provides.\232\
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\230\ Rule 760(h)(2) defines an ``advertisement'' to mean
material that is published or used in any electronic or other public
media, including any Web site, newspaper, magazine or other
periodical, radio, television, telephone or tape recording,
videotape display, signs or billboards, motion pictures, or
telephone directories (other than routine listings).
\231\ Rule 760(a)(2)(i) and (ii).
\232\ Rule 760(a)(3). Rule 760(h)(6) defines ``sales
literature'' to mean any written or electronic communication, other
than an advertisement, that is generally distributed or made
generally available to customers of the bank or the public,
including circulars, form letters, brochures, telemarketing scripts,
seminar texts, published articles, and press releases concerning the
bank's products or services.
---------------------------------------------------------------------------
One commenter indicated that these advertising restrictions were
reasonable.\233\ Another commenter suggested that these advertising
limitations should not apply to certain advertisements for which a
broker-dealer takes compliance responsibility.\234\ The advertising and
sales literature restrictions are designed to help prevent a bank from
operating a brokerage business out of its custody department and, for
this reason, apply to all advertisements and sales literature issued by
or on behalf of a bank, whether or not a broker-dealer has some
compliance responsibility with respect to the advertisement or sales
literature. These limitations would not, however, apply to the
advertisements or sales literature that a registered broker-dealer may
make to inform the public or others about the availability of brokerage
services from the broker-dealer.
---------------------------------------------------------------------------
\233\ See ICBA Letter.
\234\ See UMB Bank, N.A. Letter.
---------------------------------------------------------------------------
c. Other Conditions
A bank that accepts orders for a securities transaction for an
employee benefit plan account or individual retirement account or
similar account also must comply with the conditions set forth in
paragraph (d) of the Rule.\235\ These conditions are discussed below in
Part V.B.3.\236\
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\235\ Rule 760(a)(1).
\236\ The Agencies have made a technical change from the
proposal to make clear that a bank operating under Rule 760(a) must
comply with the conditions set forth in paragraph (d) as well as
with the employee compensation limitations of paragraph (c). See
Rule 760(a)(1). This should better clarify banks' responsibilities
under these provisions, and the Agencies have made a conforming
change to the text of Rule 760(b) relating to accommodation trades.
---------------------------------------------------------------------------
2. Order-Taking as an Accommodation for Other Types of Accounts
The proposed rule also permitted banks to continue to accept
securities orders for custodial accounts other than employee benefit
plan and individual retirement and similar accounts as an accommodation
to the customer, subject to certain conditions designed to help ensure
that these services continue to be provided only as an accommodation to
customers and that a bank does not operate as a securities broker out
of its custody department. While commenters generally supported
permitting banks to accept securities orders for other custodial
accounts on an accommodation basis, several commenters asked the
Agencies to modify or clarify the scope or terms of the exemption,
including the meaning of ``accommodation'' and the prohibition on
providing investment advice, research, and recommendations.
The Agencies are adopting, largely as proposed, the provisions of
the rule permitting banks to accept orders as an accommodation for
these other custodial accounts.\237\ A bank relying on this part of the
exemption must comply with the conditions discussed below.
---------------------------------------------------------------------------
\237\ Rule 760(b).
---------------------------------------------------------------------------
a. Accommodation Basis
For the reasons stated in the proposing release, the final rule,
like the proposal, permits a bank to accept securities orders for other
types of custodial accounts only as an accommodation to the
customer.\238\ Some commenters suggested that the Agencies define the
term ``accommodation'' in the rule to mean any trade that is effected
solely on the request of the customer or on an unsolicited basis.\239\
As noted in the proposal, the Banking Agencies will develop guidance to
assist Banking Agency examiners in reviewing, as part of the agencies'
ongoing risk-focused supervisory and examination process, the order-
taking services provided to these custodial accounts. The guidance will
describe the types of policies, procedures and systems that a bank
should have in place to help ensure that the bank accepts securities
orders for these custodial accounts only as an accommodation to the
customer and in a manner consistent with the custody exemption.\240\ As
part of these reviews, Banking Agency examiners also will, consistent
with the rule, consider the form and substance of the relevant
accounts, transactions, and activities to prevent evasions of the
requirements of the rule.\241\ The Agencies believe this approach,
rather than adopting by rule a definition of ``accommodation,'' is
appropriate given the disparity in the types, characteristics and uses
of other custody accounts, the size and operations of banks that
provide these services and the manner in which they do so.
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\238\ Rule 760(b)(1).
\239\ See Fiserv Trust Company Letter; Ass'n of Colorado Trust
Companies Letter.
\240\ See 71 FR at 77532-33.
\241\ See Rule 760(f).
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b. Employee Compensation Restrictions
For the reasons stated in the proposing release, final Rule
760(b)(2) continues to provide that a bank that accepts orders for
other custody accounts must comply with the employee compensation
limitations in paragraph (c) of the rule. These limitations were
previously discussed in Part V.B.I.a., supra. \242\
---------------------------------------------------------------------------
\242\ Rule 760(b)(2).
---------------------------------------------------------------------------
c. Limitations on Bank Fees
The rule prohibits a bank that accepts accommodation orders for a
custody account from charging or receiving any fee that varies based on
(1) whether the bank accepted the order for the transaction or (2) the
quantity or price of the securities to be bought or sold.\243\ These
restrictions do not prevent a bank from charging or receiving a fee
that is based on the type of security purchased or sold by the account
(e.g., a foreign security), provided the fee complies with the
conditions set forth in Rule 760(b)(3). Commenters did not raise
concerns with these restrictions.
---------------------------------------------------------------------------
\243\ Rule 760(b)(3).
---------------------------------------------------------------------------
d. Advertising and Sales Literature Restrictions
Under the final rule, the bank's advertisements may not state that
the bank accepts orders for securities transactions for a custodial
account (other than an employee benefit plan or individual retirement
account or similar account). In addition, the bank's sales literature:
(1) May state that the bank accepts securities orders for such an
account only as part of describing the other custodial or safekeeping
services the bank provides to the account, and (2) may not describe the
securities order-taking services provided to such an account more
prominently than the other aspects of the custody or
[[Page 56539]]
safekeeping services provided by the bank to the account.\244\
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\244\ Rule 760(b)(5). One commenter urged the Agencies to
abandon the prohibitions on advertising order-taking as an
accommodation to other custodial accounts, arguing that the
prohibition violates a bank's constitutional free speech rights. See
CBA Letter. The Agencies believe these restrictions are appropriate
to effectuate the purposes of the exemption and have tailored the
restrictions to comply with the customary practices of banks and
minimize potential disruptions. The Agencies specifically requested
comments on the conditions of the rule, and no commenter indicated
that the advertising restrictions on accommodation trade would
materially disrupt their business or operations.
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e. Investment Advice or Recommendations
The proposed rule imposed certain restrictions on the ability of a
bank to provide investment advice or research concerning securities to
an account for which it accepts accommodations orders, make
recommendations concerning securities to the account, or otherwise
solicit securities transactions from the account.\245\
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\245\ Rule 760(b)(6).
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Several commenters, expressed concerns with the proposed
limitations on investment advice, research and recommendations. For
example, commenters expressed concern that the restrictions would
negatively affect a bank's ability to cross-market its trust, fiduciary
or other services to custody customers.\246\ Some expressed concern
that the limitations would interfere with a bank's ability to share
research with custody customers or make the bank's views concerning
securities or markets available to the public through Web sites,
mailings, interviews or other means.\247\
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\246\ See, e.g., Harris Bank Letter; U.S. Trust Letter.
\247\ See, e.g., PNC Letter; National City Corp. Letter.
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After carefully considering the comments received, the Agencies
believe that no change is necessary to accommodate the cross-marketing
of other bank services. Accordingly, we are adopting the provisions
related to investment advice, research and recommendations without
change. The Agencies note that the prohibitions do not prevent a bank
from cross-marketing its trust, fiduciary or other services to its
custody customers. A bank's marketing to custody account customers
may--without violating the rule's general prohibition against providing
advice, research or recommendations--include non-account specific
information provided in media such as newsletters and websites. In
addition, the advice, research, recommendation and solicitation
prohibition does not prohibit a bank from providing samples of
research, including stock-specific research, to custody customers that
the bank provides to other persons for marketing purposes. Thus, the
Agencies believe that banks will continue to be able to cross-market
their products and services to their custody customers. A custody
account, however, is not a fiduciary account, and a bank operating
under Rule 760(b) with respect to a custodial account may not provide
such samples in such a way or with such a frequency as to provide the
custody account securities services that only are permissible for a
trust or fiduciary customer. The bank, moreover, may not provide
personalized investment advice, research or recommendations regarding
particular securities to the custodial account for any reason.\248\
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\248\ This would include providing personalized advice, research
or recommendations concerning securities to the account in an effort
to convert the account to another type of account, for goodwill or
to obtain referrals.
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Some commenters questioned whether providing custody customers with
a choice of investments from which to select would constitute providing
investment advice.\249\ Banks may use menus or other lists to make
custodial customers aware of the securities available to them through
the custodial account. For example, the restrictions in paragraph
(b)(6) of the rule do not prevent a bank from providing its customers
with an online menu of the mutual funds that the customer is able to
purchase through the custody account.
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\249\ See Harris Bank Letter; PNC Letter.
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The limitations and restrictions in Rule 760(b), including those
relating to investment advice and recommendations, relate only to those
custodial accounts for which the bank accepts securities orders on an
accommodation basis. Thus, for example, these limitations would not
apply to (1) an employee benefit plan account or an individual
retirement account or similar account; or (2) a trust or fiduciary
account maintained by a customer with a bank even if that customer also
maintains a custodial account with the bank.
Commenters asked how the limitations on investment advice and
research would apply when a customer has both a custody account and a
separate trust or fiduciary account with a bank, and asked the Agencies
to clarify that a bank would not violate the restrictions if the bank
provides a trust or fiduciary customer with research or advice that the
customer then uses to make orders through its custody accounts.\250\
Rule 760(b)(6) prohibits banks from providing investment advice,
research or recommendations concerning securities to, or soliciting
securities transactions from, a custody account for which the bank
accepts orders under the accommodation trade authority. The rule does
not limit the types of research or other services a bank may provide to
a customer's trust or fiduciary account, and the Agencies recognize
that a bank may have no control over which account the customer uses to
place any orders that result from such research or other services.
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\250\ See ABA Letter; Harris Bank Letter.
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The final rule, like the proposal, continues to provide that, in
order to prevent evasions of the custody exemption, the Agencies will
consider both the form and substance of the relevant account(s),
transaction(s) and activities (including advertising activities) in
considering whether a bank meets the terms of the exemption.\251\ For
example, the Agencies will consider the content, format and frequency
of any investment research provided to an accommodation custodial
account in considering if such research in purpose or effect evades the
restrictions in the rule or provides a custody account securities
services that only are permissible for a trust or fiduciary customer.
Similarly, a bank may not evade the rule's restrictions by providing an
accommodation customer that has both a custody account and a trust or
fiduciary account with investment advice, recommendations or research
that is targeted to the securities held in the customer's custody
account. For example, if a customer's custody account has a large
position in a particular security and that security is not held in the
customer's trust or fiduciary account, a bank may not routinely provide
the customer with research focused on that security. Banks should have
and maintain policies and procedures to abide by these limitations and
bank examiners will review bank compliance with these limits in
accordance with the risk-based supervisory and examination process,
considering both the form and substance of the cross-marketing
activities in applying the anti-evasion provisions of the rule.
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\251\ Rule 760(e).
---------------------------------------------------------------------------
The restrictions in Rule 760(b)(6) do not prohibit the bank from
advertising its custodial services and disseminating sales literature
that meets the conditions in the exemption.\252\ These restrictions
also will not prevent a bank employee from responding to customer
inquiries regarding the bank's safekeeping and
[[Page 56540]]
custody services by providing advertisements or sales literature
describing the safekeeping, custody and related services the bank
offers (provided those advertisements and sales literature comply with
the restrictions in the proposed exemption), a prospectus prepared by a
registered investment company, sales literature prepared by a
registered investment company or by the broker-dealer that is the
principal underwriter of the registered investment company pertaining
to the registered investment company's products, or information based
on any of those materials.\253\ The exemption allows a bank's employees
to respond to customer inquiries concerning the bank's safekeeping,
custodial or other services, such as inquiries concerning the
customer's account or the availability of sweep or other services, so
long as the bank does not provide investment advice or research
concerning securities to the account or make a recommendation to the
account concerning securities.\254\
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\252\ Rule 760(b)(6)(i).
\253\ Rule 760(b)(6)(ii). ``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)). Rule 760(h)(7).
\254\ Rule 760(b)(6)(iii).
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3. Other Conditions Applicable to Order-Taking for All Custody Accounts
The proposed exemption provided that a bank may accept orders for a
securities transaction for a custody account under the exemption only
if the bank (1) does not act in a trustee or fiduciary capacity (as
defined in section 3(a)(4)(D) of the Exchange Act) with respect to the
account; (2) complies with section 3(a)(4)(C) of the Act in handling
any order for a securities transaction for the account; and (3)
complies with section 3(a)(4)(B)(viii)(II) of the Act regarding
carrying broker activities.
a. Directed Trustees
Some commenters requested that the Agencies modify the exemption to
allow a bank that acts as a directed trustee for an account to accept
orders and effect transactions for the account under the custody
exemption in Rule 760 in lieu of relying on the trust and fiduciary
rules (Rule 721 to 723) for the transaction.\255\ In light of the
comments and the protections included in Rule 760, the Agencies have
modified the final rule to provide that a bank that acts as a directed
trustee for an account may rely on the custody exception to accept
orders for, and effect transactions in, securities for the
account.\256\ If a bank acting as directed trustee relies on the rule
to effect transactions for an employee benefit plan account or an
individual retirement account or similar account, the bank must comply
with the conditions in Rule 760(a). If a bank acting as directed
trustee relies on the rule to effect transactions for another type of
account, the bank must comply with the conditions governing
accommodation accounts in Rule 760(b).
---------------------------------------------------------------------------
\255\ See Teachers Insurance and Annuity Association of America
and College Retirement Equities Fund (``TIAA-CREF'') Letter; ACB
Letter; Roma Bank Letter. Commenters asserted, for example, that a
bank acting as a directed trustee provides services that are
functionally similar to those provided as a custodian and in either
case does not have investment discretion with respect to the
account.
\256\ See Rule 760(d)(1). Alternatively, the bank may continue
to effect transactions for the account under the rules relating to
trust or fiduciary accounts.
---------------------------------------------------------------------------
The rule defines a directed trustee as ``a trustee that does not
exercise investment discretion with respect to the account.'' \257\ The
Agencies also have modified the definition of ``an account for which
the bank acts as a custodian'' to include an account for which a bank
acts as a directed trustee.\258\ Although a bank acting as directed
trustee for an account may effect transactions under the custody
exemption, the bank's trustee relationship with the account remains a
trust and fiduciary relationship and, as such, the bank must continue
to comply with applicable fiduciary principles and standards in its
relationships with the account.
---------------------------------------------------------------------------
\257\ Rule 760(h)(3).
\258\ See Rule 760(h)(1).
---------------------------------------------------------------------------
b. Broker Execution Requirement
Consistent with the requirements of the custody and safekeeping
exception, Rule 760(d)(2) requires a bank that accepts orders for a
custody account under the rule to comply with Section 3(a)(4)(C) of the
Exchange Act \259\ in handling any order for a securities transaction
for the account.\260\ Under this provision, (i) the bank must direct
the trade to a registered broker-dealer for execution, or (ii) the
trade must be a cross trade or other substantially similar trade of a
security that is made by the bank or between the bank and an affiliated
fiduciary and is not in contravention of fiduciary principles
established under applicable Federal or State law, or (iii) the trade
must be conducted in some other manner permitted under rules,
regulations, or orders as the Commission may prescribe or issue.
---------------------------------------------------------------------------
\259\ 15 U.S.C. 78c(a)(4)(C).
\260\ See Rule 760(d)(2).
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c. Carrying Broker Provisions
A number of commenters addressed the proposed provision limiting
the availability of the custody exemption to banks that comply with
Section 3(a)(4)(B)(viii)(II) of the Exchange Act \261\ relating to
carrying broker activities.\262\ Some stated that the Agencies should
define the term ``carrying broker'' by rule rather than by
interpretation.\263\ One commenter requested that we interpret the term
based on the view that the essence of a carrying broker relationship is
``complete dependence'' of a broker-dealer on another entity for back
office functions and execution.\264\ Another commenter took the
position that a custodian bank should not be deemed a carrying broker
so long as ``it is not enabling'' broker-dealers to avoid the net
capital requirements applicable to carrying brokers.\265\ One commenter
generally suggested that we either eliminate the carrying broker
limitation from the proposed rules, or amend it to avoid affecting the
ability of banks to undertake traditional banking activities.\266\
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\261\ 15 U.S.C. 78c(a)(4)(B)(viii)(II). This provision prohibits
a custodian bank from acting as a carrying broker (as such term, and
different formulations thereof, are used in Exchange Act Section
15(c)(3) and the rules and regulations under that Section) for any
broker-dealer, unless such carrying broker activities are engaged in
with respect to government securities.
\262\ Rule 760(d)(3).
\263\ See ABA Letter; State Street Corp. Letter; PNC Letter.
\264\ See Clearing House Ass'n Letter.
\265\ See U.S. Trust Letter.
\266\ See HSBC Bank Letter. In addition, a few commenters
asserted that the description of potential carrying broker activity
in prior rulemakings under the GLB Act would, if adopted, be highly
problematic and disruptive for banks and broker-dealers. See
Clearing House Ass'n Letter; ABA Letter.
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Section 3(a)(4)(B)(viii)(II) of the Exchange Act provides that a
bank relying on the custody exception may not act as a ``carrying
broker,'' as that term and different formulations of the term are used
in Section 15(c)(3) of the Act and the underlying rules and
regulations, for a broker-dealer other than with respect to government
securities. Section 15(c)(3) of the Act in relevant part requires
broker-dealers to comply with the Commission's regulations with respect
to financial responsibility and related customer protection practices
of broker-dealers.\267\ The Commission's financial responsibility and
customer protection rules expand on what it means to carry
[[Page 56541]]
customer securities.\268\ In general, broker-dealers establish carrying
arrangements in which other broker-dealers carry their accounts to
permit the non-carrying broker-dealer to be subject to lesser financial
responsibility requirements under the Exchange Act. A broker-dealer
entering into such an agreement with a carrying entity that is not a
registered broker-dealer, however, may not take advantage of those
lesser requirements.\269\
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\267\ Exchange Act Section 15(c)(3)(A), 15 U.S.C. 78o(c)(3)(A).
\268\ The Commission's net capital rule specifies that a broker-
dealer shall be deemed to carry customer or broker-dealer accounts
``if, in connection with its activities as a broker or dealer, it
receives checks, drafts, or other evidences of indebtedness made
payable to itself or persons other than the requisite registered
broker or dealer carrying the account of a customer, escrow agent,
issuer, underwriter, sponsor, or other distributor of securities''
or ``if it does not promptly forward or promptly deliver all of the
securities of customers or of other brokers or dealers received by
the firm in connection with its activities as a broker or dealer.''
Exchange Act Rule 15c3-1(a)(2)(i)
The Commission's customer protection rule governing reserves and
custody of securities defines the term ``securities carried for the
account of a customer'' to mean ``securities received by or on
behalf of a broker or dealer for the account of any customer and
securities carried long by a broker or dealer for the account of any
customer,'' as well as securities sold to, or bought for, a customer
by a broker-dealer. Exchange Act Rule 15c3-3(a)(2).
\269\ Within common securities industry usage, the terms
``carrying broker'' and ``clearing broker'' are virtually identical
and often are used interchangeably. In certain instances, the terms
mean a broker that, as part of an arrangement with a second broker
(an ``introducing'' or ``corresponding'' broker), allows the second
broker to be subject to lesser regulatory requirements (e.g., under
the net capital provisions of Exchange Act Rule 15c3-1 and the
customer protection provisions of Exchange Act Rule 15c3-3).
Technically, however, a ``carrying broker'' is a broker that holds
funds and securities on behalf of customers, whether its own
customers or customers introduced by another broker-dealer, and a
``clearing broker'' is a member of a registered clearing agency.
---------------------------------------------------------------------------
After carefully considering the comments, the Agencies have
retained this limitation as a condition of the custody exemption
without change as it is a term of the statutory custody exception.
Banks may look to certain key factors to help distinguish permissible
custodial activity from impermissible carrying broker activity. In
particular, key factors in considering whether the existence of shared
customers between a broker-dealer and a bank may entail impermissible
carrying broker activity by the bank are the broker-dealer's own
regulatory obligations and whether the broker-dealer either makes
formal or informal arrangements with the bank or structures its
operations or offerings to cause the broker-dealer's customers
generally (or one or more broad segments of the broker-dealer's
customers) to use the bank's custody accounts instead of maintaining
funds and securities in accounts at the broker-dealer (thereby avoiding
the broker-dealer's financial and related responsibilities). The
existence of a substantial number of common customers between a broker-
dealer and a bank's custody department in the absence of such an
arrangement or structure would not cause the bank to act as a carrying
broker for the broker-dealer.
Similarly, a bank may perform or share systems that perform limited
back-office functions on behalf of a broker-dealer without becoming a
carrying broker for the broker-dealer. A broker-dealer, for example,
may contract with an unregistered party such as a bank to send out
transaction confirmations on behalf of the broker-dealer or have an
arrangement with an affiliated bank to provide customers with combined
statements, with the broker-dealer remaining responsible for the
accuracy and completeness of those confirmations and the broker-dealer
aspects of the statements. A bank and an affiliated broker-dealer also
may share or coordinate risk management systems such as, for example,
those relating to Bank Secrecy Act and anti-money laundering
compliance.\270\ A broker-dealer, however, may not delegate core
functions to a bank or other unregistered entity or functions that
would require an individual to pass a qualification examination or
register with an SRO.\271\ A broker-dealer also must maintain
possession or control over the broker-dealer's proprietary cash or
securities and its customers' cash or securities in accordance with the
Commission's financial responsibility rules.\272\ Of course, a bank may
serve as custodian for proprietary or customer cash or securities of
the broker-dealer and may accept and use in the ordinary course of its
banking business cash deposited with the bank by the broker-dealer or
its customers.\273\
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\270\ Other examples of current permissible coordination
arrangements between banks and broker-dealers include legal and
compliance functions, accounting and finance functions (such as
payroll and expense account reporting), information technology,
operations functions (such as disaster recovery services), and
administration functions (such as human resources and internal
audits). See NASD Notice to Members 05-48 (July 2005) at 2.
\271\ NASD Notice to Members 05-48 (July 2005), ``Outsourcing,''
provides guidance to member firms regarding the outsourcing
activities and functions that, if performed directly by members,
would be required to be the subject of a supervisory system and
written supervisory procedures pursuant to NASD Rule 3010.
\272\ See e.g., Rules 15c3-1 and 15c3-3 [17 CFR 240.15c3-1,
15c3-3]. This is true even if the broker-dealer is not ``completely
dependent'' on the bank for all back office functions and execution.
\273\ See Rule 15c3-3(c)(5).
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4. Custodians, Subcustodians and Administrators/Recordkeepers
a. ``Account for which a bank acts as a custodian''
As a general matter, the exemption in Rule 760 is available only
for an ``account for which the bank acts as a custodian.'' The proposed
rule defined this term to mean an account that is: (i) An employee
benefit plan account for which the bank acts as a custodian; (ii) an
individual retirement account or similar account for which the bank
acts as a custodian; or (iii) an account established by a written
agreement between the bank and the customer that sets forth the terms
that will govern the fees payable to, and rights and obligations of,
the bank regarding the safekeeping or custody of securities.\274\ As
discussed in Part V.B.3.a supra, the Agencies have amended this
definition in the final rule also to include an account for which a
bank acts as a directed trustee.
---------------------------------------------------------------------------
\274\ Proposed Rule 760(g)(1).
---------------------------------------------------------------------------
A few commenters asked whether a bank performing custodial
functions in a non-trustee and non-fiduciary capacity (such as escrow
agent, fiscal agent or paying agent) may use the custody exemption even
if it is not formally designated as ``custodian'' by the bank-customer
agreement.\275\ Whether a bank serves as custodian for the securities
or other assets of an account depends on the services the bank provides
to the account with respect to such securities or assets, not the label
used to identify the account or the bank's services in the agreement
between the bank and the customer. Thus, for example, a bank that acts
as an escrow agent, fiscal agent or paying agent with respect to an
account, and that provides safekeeping or custody services for the
securities or other assets in the account, is considered to be a
custodian for the account for purpose of the rule regardless of whether
the account agreement uses the term ``custodian'' or any other
particular language.
---------------------------------------------------------------------------
\275\ See Union Bank Letter, Wells Fargo Letter.
---------------------------------------------------------------------------
b. Administrators/Recordkeepers and Subcustodians
The proposed exemption permitted a bank acting as a non-fiduciary
and non-custodial administrator or recordkeeper for an employee benefit
plan to accept securities orders for the plan on behalf of a custodian
bank.\276\ Under the proposed exemption, both the administrator/
recordkeeper bank and the custodial bank had to comply with the
requirements relating to employee
[[Page 56542]]
benefit plan accounts.\277\ In addition, the proposed rule prohibited
an administrator/recordkeeper bank from executing a cross-trade with or
for the employee benefit plan or from netting orders for securities for
the plan, other than orders for shares of open-end investment companies
not traded on an exchange.\278\
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\276\ Proposed Rule 760(e).
\277\ Proposed Rule 760(e)(1).
\278\ Proposed Rule 760(e)(2).
---------------------------------------------------------------------------
A few commenters supported these provisions, but opposed the
restrictions on cross-trading and netting.\279\ One commenter
maintained that the administrator/recordkeeper provisions should also
be available to banks providing administrative services to individual
retirement accounts.\280\
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\279\ See ABA Letter; Clearing House Ass'n Letter; CBA Letter.
The commenters asserted that the cross-trading and netting
restrictions were too restrictive and noted that section 3(a)(4)(C)
of the Exchange Act permits bank custodians to engage in a broader
range of cross-trade and netting activities.
\280\ See CBA Letter.
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Some commenters also questioned whether or how the proposed
exemption would apply to a bank that acts as a subcustodian for the
trust or fiduciary or custody accounts of another bank. For example,
some commenters asserted that a bank acting as a subcustodian for
another bank's trust or fiduciary accounts should be permitted to
accept orders for those accounts under the less restrictive conditions
in Rule 760(a) regardless of the type of accounts actually
involved.\281\ Other commenters suggested that a subcustodian bank be
permitted to effect trades for the accounts of the other bank with a
direct custodial relationship with the customer under the same rules
(e.g., trust and fiduciary or custody), and subject to the same
conditions, that would apply to the other bank if it conducted the
transactions directly.\282\ Commenters also noted that banks, and
particularly smaller banks, at times use subcustodian arrangements with
other banks to provide their customers custodial services more
efficiently and at lower cost than they may be able to do on their own.
---------------------------------------------------------------------------
\281\ See, e.g., ABA Letter, CBA Letter, PNC Letter, Schwab
Letter.
\282\ See TIAA-CREF Letter.
---------------------------------------------------------------------------
After carefully considering the comments, the Agencies have adopted
Rule 760(e), which permits a bank that acts as a non-fiduciary and non-
custodial administrator or recordkeeper for an employee benefit plan
for which another bank acts as a custodian to accept orders for the
account under Rule 760.\283\ In addition, the Agencies have adopted a
new paragraph (f) of the rule that permits a bank that acts as a
subcustodian for any type of account for which another bank acts as
custodian to accept orders for the account under Rule 760. This change
was made in response to comments that greater flexibility and clarity
was needed for banks that use, and banks that provide, subcustodial
services. Under these provisions of the final rule, the administrator/
recordkeeper bank or subcustodian bank, as well as the initial
custodian bank for the account, must comply with the provisions of Rule
760 applicable to the type of account involved (i.e. employee benefit
plan account, individual retirement account or similar account, or
other types of accounts).\284\
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\283\ The Agencies understand that the type of administrator/
recordkeeper arrangements described in Rule 760(e) are not typically
used with respect to accounts other than employee benefit plan
accounts and, for this reason, have not expanded the paragraph to
cover other types of accounts.
\284\ See Rule 760(e)(1) and (f)(1) and (2). The Agencies made a
technical change to Rule 760(e) to clarify that the administrator/
recordkeeper bank and the custodial bank for employee benefit
accounts need to comply only with the requirements in the rule
applicable to employee benefit plan accounts and do not need to
comply with the conditions applicable to accommodation trades.
---------------------------------------------------------------------------
The final rule generally prohibits a recordkeeper/administrator
bank or subcustodian bank relying on the exemption from executing a
cross-trade or netting orders with or for the relevant account.\285\
However, the Agencies have expanded the exceptions to this general
prohibition in light of the comments received. In particular, the final
rule permits the administrator/recordkeeper bank or subcustodian bank
to cross or net orders for shares of open-end investment companies not
traded on an exchange.\286\ In addition, the final rule permits the
administrator/recordkeeper bank or subcustodian bank to cross orders
between or net orders for accounts of the custodian bank that
contracted with the administrator/recordkeeper bank or subcustodian
bank for services.\287\ Permitting this additional type of cross-trade
and netting activity is consistent with the exceptions to broker
execution requirement in section 3(a)(4)(C) of the Exchange Act and
should allow cost-savings for the customer by eliminating the need for
a broker intermediary. At the same time, by prohibiting an
administrator/recordkeeper bank or subcustodian bank operating under
the rule from executing cross-trades or netting orders among the
accounts of different custodian banks to which it provides services
will help prevent banks from establishing a market for securities under
the exemption.
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\285\ Rule 760(e)(2) and (f)(3).
\286\ See Rule 760(e)(2)(i) and (f)(3)(i).
\287\ See Rule 760(e)(2)(ii) and (f)(3)(ii).
---------------------------------------------------------------------------
The Agencies note that these provisions do not apply to a bank that
provides custody and order-taking services to the trust or fiduciary
accounts of another bank. In these circumstances, the bank providing
custodial services is treated as a custodian, and not a subcustodian,
for purposes of the rule and may provide order-taking services to the
account in accordance with the provisions of Rule 760(a) or (b)
applicable to the type of account involved.
5. Evasions
The Agencies are adopting, as proposed, the provision that states
the Agencies will consider both the form and substance of the relevant
accounts, transactions and activities (including advertising
activities) in considering whether a bank meets the terms of the
exemption, to prevent evasions of the exemption.\288\ We received no
comments on this anti-evasion provision. As part of the regular risk-
focused examination process, the Banking Agencies will monitor the
securities transactions in custodial accounts. If the appropriate
Banking Agency were to find that a bank is evading the terms of the
custody exemption to run a brokerage business out of its custody
department, the agency would take appropriate action to address the
problem.
---------------------------------------------------------------------------
\288\ Rule 760(g).
---------------------------------------------------------------------------
VI. Other Exemptions
The Agencies also are adopting certain other exemptions relating to
the securities ``broker'' activities of banks. These are discussed
below.
A. Exemption for Regulation S Transactions With Non-U.S. Persons and
Broker-Dealers
We are adopting Rule 771 of Regulation R to exempt banks from the
definition of ``broker'' under the Exchange Act for certain agency
transactions involving Regulation S securities.\289\ As with Rule 3a5-2
under
[[Page 56543]]
the Exchange Act, which the Commission separately is adopting to permit
banks to engage in certain Regulation S transactions on a riskless
principal basis without being ``dealers,'' Rule 771 recognizes that
non-U.S. persons located outside the United States generally will not
rely on the protections of the U.S. securities laws when purchasing
Regulation S securities from U.S. banks, and that those persons may
purchase the same securities from foreign banks located outside the
U.S. without subjecting the foreign bank to U.S. broker-dealer
registration.
---------------------------------------------------------------------------
\289\ The Commission's Regulation S (17 CFR 230.901 et seq.)
provides that offers and sales of securities conducted in accordance
with the terms of the regulation will not be deemed to constitute an
offer, offer to sell, sale or offer to buy within the United States
for purposes of the securities registration requirements of Section
5 of the Securities Act. See 17 CFR 230.901. Specifically, Rule 903
of Regulation S provides that an offer or sale of securities by the
issuer, a distributor, or an affiliate or a person acting on their
behalf shall be deemed to occur outside the U.S. within the meaning
of Rule 901 if the offer or sale is made in an offshore transaction
(as defined in Rule 901), and no directed selling efforts are made
in the U.S. by the issuer, a distributor, affiliate, or person
acting on their behalf. Other conditions may also apply depending on
the place of incorporation and reporting status of the issuer, and
the amount of U.S. market interest in the securities.
Rule 904 of Regulation S provides that an offer or sale of
securities by any person other than the issuer, a distributor, an
affiliate (except an officer or director who is an affiliate solely
by virtue of that position) or person acting on their behalf will be
deemed to occur outside the U.S. within the meaning of Rule 901 if
the offer or sale is made in an offshore transaction (as defined in
Rule 901), and no directed selling efforts are made in the U.S. by
the seller, an affiliate or person acting on their behalf.
Additional conditions apply in the case of resales of certain types
of securities by dealers and persons receiving selling concessions,
and in the case of resales by certain affiliates of the issuer or a
distributor.
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Commenters generally supported the proposal while suggesting
certain modifications and clarifications.\290\ For example, commenters
requested that the Agencies clarify that the exemption is available to
banks both during and after any applicable distribution compliance
period for the securities required by Regulation S, and allow banks to
conduct resales of eligible securities for either non-U.S. persons or
registered broker-dealers if the bank has a reasonable belief that the
securities were initially sold in compliance with Regulation S.\291\ In
addition, some commenters argued that the exemption should not require
a bank to comply with the resale restrictions in Rule 904 of Regulation
S if the bank effects a resale of an eligible security in accordance
with Rule 903 of Regulation S prior to the end of any applicable
distribution compliance period for the security.\292\ Commenters also
urged the Agencies to make the proposed ``broker'' exemption in
Regulation R and the ``dealer'' exemption proposed by the Commission as
consistent as possible and to make both exemptions as consistent as
possible with Regulation S.
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\290\ See IIB Letter; ABA Letter; Clearing House Ass'n Letter.
\291\ See IIB Letter; Clearing House Ass'n Letter. Rules
903(b)(2) and (b)(3) of Regulation S subject Category 2 securities
and Category 3 debt securities to a 40-day distribution compliance
period, and subject Category 3 equity securities to a one-year
distribution compliance period, during which certain restrictions
apply to offers or sales of the securities in order to preserve the
foreign nature of the transactions. Under Rule 903 of Regulation S,
Category 1 encompasses certain securities: (i) Issued by a foreign
issuer, for which there is no substantial U.S. market interest, (ii)
that are offered and sold in an overseas directed offering, (iii)
that are backed by the full faith and credit of a foreign
government, or (iv) that are offered and sold to employees of the
issuer or its affiliates pursuant to certain foreign employee
benefit plans. Category 2 encompasses securities, not eligible for
Category 1, that are equity securities of a reporting foreign
issuer, or debt securities of a reporting issuer or of a non-
reporting foreign issuer. Category 3 applies to all offerings of
securities that do not fall within Category 1 or 2.
\292\ See IIB Letter.
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The Agencies have modified the rule in several respects in light of
the comments, to enhance its clarity and to better conform it to
Regulation S. The final rule, like the proposed rule, continues to have
three parts. The first part permits a bank to effect a sale of an
eligible security in compliance with the requirements of Rule 903 of
Regulation S to a purchaser who is not in the United States.\293\ The
term ``purchaser'' is defined to mean a person who purchases an
eligible security and who is not a U.S. person under Rule 902(k) of
Regulation S.\294\
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\293\ Rule 771(a)(1).
\294\ Rule 771(b)(3). Rule 902(k) of Regulation S defines the
term ``U.S. person'' to mean: (i) Any natural person resident in the
U.S.; (ii) any partnership or corporation organized or incorporated
under the laws of the U.S.; (iii) any estate of which any executor
or administrator is a U.S. person; (iv) any trust of which any
trustee is a U.S. person; (v) any agency or branch of a foreign
entity located in the U.S.; (vi) any non-discretionary account or
similar account (other than an estate or trust) held by a dealer or
other fiduciary for the benefit or account of a U.S. person; and
(vii) any discretionary account or similar account (other than an
estate or trust) held by a dealer or other fiduciary organized,
incorporated, or (if an individual) resident in the U.S., and (viii)
any partnership or corporation if (A) organized or incorporated
under the laws of any foreign jurisdiction, and (B) formed by a U.S.
person principally for the purpose of investing in securities not
registered under the Act, unless it is organized or incorporated,
and owned, by accredited investors (as defined in Rule 501(a) under
the Securities Act) who are not natural persons, estates or trusts.
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The second part permits a bank to effect, by or on behalf of a
person who is not a U.S. person under Rule 902(k) of Regulation S, a
resale of an eligible security after its initial sale to a purchaser
who is not in the United States or to a registered broker-dealer.\295\
To take advantage of this second exemption, the bank (1) must have a
reasonable belief that the eligible security was initially sold outside
of the United States within the meaning of and in compliance with Rule
903 of Regulation S, and (2) if the resale is made prior to any
applicable distribution compliance period specified in Rules 903(b)(2)
or (b)(3) of Regulation S, the resale must be made in compliance with
the requirements of Rule 904 of Regulation S.\296\
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\295\ Rule 771(a)(2).
\296\ Rule 771(a)(2).
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The third part of the exemption permits a bank to effect, by or on
behalf of a registered broker-dealer, a resale of an eligible security
after its initial sale to a purchaser who is not in the United
States.\297\ As under the second part, the bank must have a reasonable
belief that the eligible security was initially sold outside of the
United States within the meaning of and in compliance with Rule 903 of
Regulation S and, if the resale is made prior to the expiration of any
applicable distribution compliance period in Rules 903(b)(2) or (b)(3)
of Regulation S, the bank must effect the resale in compliance with the
requirements of Rule 904 of Regulation S. The proposed rule would have
allowed a bank to rely on a reasonable belief that the security was
sold in compliance with Regulation S only when it purchases a security
from a non-U.S. person but not when it purchases a security from a
broker-dealer. In light of comments received, the reasonable belief
standard is also available under the final rule for a bank's
transactions with a broker-dealer because the process of determining
whether a security initially was issued in compliance with Regulation S
should be similar whether the purchase is from a broker-dealer or a
non-U.S. person.\298\ As the rule makes clear, a bank effecting a
resale of an eligible security under the exemption must effect the
transaction in accordance with the conditions of Rule 904 if the
transaction occurs during, but not after, any applicable distribution
compliance period for the security under Rule 903(b)(2) or (b)(3) of
Regulation S.
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\297\ Rule 771(a)(3).
\298\ See IIB Letter and Clearing House Ass'n Letter.
---------------------------------------------------------------------------
The final rule continues to require, however, that any sale
effected under paragraph (b)(1) of the Rule, or resale effected under
paragraphs (b)(2) or (b)(3) of the Rule (other than one to a registered
broker-dealer), be to a ``purchaser who is not in the United States.''
This is true even if the applicable distribution compliance period for
the overseas offering of the security under Regulation S has expired.
Consistent with Regulation S, which permits the offshore resale of
securities, the purpose of the exemption in Rule 771 is to permit U.S.
banks to sell Regulation S securities to customers outside the United
States. It does not permit banks to sell those securities domestically
(other than to a registered
[[Page 56544]]
broker-dealer).\299\ For purposes of the exemption, an ``eligible
security'' means any security other than a security that is being sold
from the inventory of the bank or an affiliate of the bank or that is
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.\300\ Commenters requested that the
Agencies clarify that the definition of ``eligible security'' would not
prohibit a bank from effecting transactions under the exemption in
securities that have been issued by the bank or an affiliate.\301\ A
security that is issued by a bank or an affiliate of a bank, such as a
structured note or share in a pooled investment vehicle, may be an
eligible security if it otherwise meets the terms of paragraph (b)(2)
of Rule 771.
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\299\ The Agencies recognize that the ``offshore transaction''
condition in Rules 903 and 904 of Regulation S also require that the
offer not be made to a person in the United States. See 17 CFR
230.902(h), 230.903(a)(1) and 230.904(a)(1). For this reason, one
commenter stated that the rule simply should refer to sales to a
``purchaser,'' rather than to a purchaser who is outside the United
States. See IIB Letter. The Agencies have retained the ``purchaser
who is not in the United States'' language in the final rule, even
for those transactions that must be conducted in accordance with
Rule 903 or 904 of Regulation S, to highlight and reaffirm that
these transactions must be with persons outside the United States.
\300\ Rule 771(b)(1). For purposes of the rule, the term
``distributor'' has the same meaning as in Rule 902(k) of Regulation
S (17 CFR 230.902(k)).
\301\ See IIB Letter, ABA Letter.
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B. Exemption for Non-Custodial Securities Lending Transactions
The Agencies are adopting, as proposed, Rule 772 of Regulation R to
provide banks engaged in certain securities lending transactions with a
conditional exemption from the definition of ``broker.'' The exemption
allows a bank to engage in securities lending transactions as agent in
circumstances where the bank does not have custody of the securities or
has custody of such securities for less than the entire period of the
transaction. This exemption reinstates, without modification, an
exemption that the Commission adopted previously.\302\
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\302\ See Exchange Act Release No. 47364 (Feb. 13, 2003), 68 FR
8686 (Feb. 24, 2003) (adopting Exchange Act Rule 15a-11 to provide
an exemption from the definitions of both ``broker'' and ``dealer''
for banks engaging in securities lending transactions). The broker
provisions of the Rule 15a-11 exemption, which never became operable
due to the temporary exemption applicable to all bank broker
activities, will become void under the Regulatory Relief Act with
the Agencies' adoption of a single set of final ``broker'' rules.
See Pub. L. No. 109-351, Sec. 101(a)(3), 120 Stat. 1968 (1999). In
light of this, the Commission separately has amended Rule 15a-11 to
remove the ``broker'' aspects of that rule. As discussed in the
accompanying release, the Commission is re-adopting, without
modification, the ``dealer'' portions of Rule 15a-11, as Exchange
Act Rule 3a5-3. See Exchange Act Release No. 56502 (Sept. 24, 2007).
---------------------------------------------------------------------------
Most commenters that addressed the exemption supported its
adoption.\303\ One commenter opposed the exemption, arguing that
securities lending and borrowing transactions should be conducted only
by broker-dealers or, alternatively, banks providing such services
should be subject to additional disclosure and customer approval
requirements.\304\ The Agencies continue to believe that the exemption
is appropriate and necessary. The exemption enables sizable and
sophisticated customers to divide custody and securities lending
management between two expert entities when the customer decides such
actions are in the customer's interest, and permits banks to continue
to provide the types of non-custodial securities lending services that
they currently provide without disruption. The Agencies note, moreover,
that the statutory custody and safekeeping exception permits banks to
effect securities lending transactions (and provide related securities
lending services) when the bank has custody of the securities. A bank
need not rely on the exemption in Rule 772 to engage in securities
lending transactions when acting in this capacity.
---------------------------------------------------------------------------
\303\ See, e.g., State Street Corp. Letter, PNC Letter, Mellon
Letter, and ABA Letter.
\304\ See NASAA Letter.
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Rule 772 provides that a bank is exempt from the broker definition
to the extent that, as agent, it engages in or effects certain
``securities lending transactions'' \305\ and ``securities lending
services'' \306\ in connection with such transactions.\307\ The
exemption applies only to securities lending activities with or on
behalf of a person that the bank reasonably believes to be: (1) A
qualified investor as defined in Section 3(a)(54)(A) of the Exchange
Act;\308\ or (2) any employee benefit plan that owns and invests, on a
discretionary basis, not less than $25 million in investments. One
commenter requested that the Agencies modify the rule to allow banks to
engage in securities lending transactions under the exemption as agent
for institutional customers that have less than $25 million in
investments.\309\ We have not amended the investment requirements,
however, as we believe they are consistent with the nature of customers
that utilize banks for non-custodial securities lending
transactions.\310\
Another commenter suggested that the Agencies exempt banks
involved, as agent, in securities repurchase and reverse repurchase
transactions in non-exempt securities from the ``broker'' definition,
stating that repurchase and reverse repurchase activities are
functionally equivalent to securities lending.\311\ As discussed in the
accompanying release, moreover, a number of commenters also requested
that banks be exempted from the ``dealer'' definition for repurchase
and reverse repurchase agreement activities involving non-exempt
securities they undertake in a principal capacity.\312\ The Agencies
have not acted on these requests at this time because we believe
additional information from banks and other interested parties would be
helpful in understanding the issues raised by these requests. For this
reason, we invite comment on the following matters, as well as any
other matters that interested parties believe may be relevant to the
Agencies' consideration of the issues posed by the requests: (1) The
nature, structure (including term and type of security involved), and
purpose of repurchase and reverse repurchase agreements currently
conducted with respect to non-exempt securities; (2) the types of
customers
[[Page 56545]]
and financial institutions currently involved in repurchase and reverse
repurchase agreements with respect to non-exempt securities; (3) the
extent to and manner in which banks currently engage, as agent or
principal, in repurchase and reverse repurchase agreements with respect
to non-exempt securities; (4) recent developments or trends in the
market for repurchase and reverse repurchase agreements with respect to
non-exempt securities; (5) any material similarities or differences in
the use, structure, customer base, or legal, regulatory, tax or
accounting treatment of repurchase and reverse repurchase agreements
with respect to non-exempt securities, on the one hand, and repurchase
or reverse repurchase agreements with respect to exempt securities or
securities lending transactions involving exempt or non-exempt
securities. The information we receive through this process should help
inform any future actions the Agencies may take in this area.
---------------------------------------------------------------------------
\305\ Rule 772(b) defines the term ``securities lending
transaction'' to mean a transaction in which the owner of a security
lends the security temporarily to another party pursuant to a
written securities lending agreement under which the lender retains
the economic interests of an owner of such securities, and has the
right to terminate the transaction and to recall the loaned
securities on terms agreed by the parties.
\306\ Rule 772(c) defines the term ``securities lending
services'' to mean: (1) Selecting and negotiating with a borrower
and executing, or directing the execution of the loan with the
borrower; (2) receiving, delivering, or directing the receipt or
delivery of loaned securities; (3) receiving, delivering, or
directing the receipt or delivery of collateral; (4) providing mark-
to-market, corporate action, recordkeeping or other services
incidental to the administration of the securities lending
transaction; (5) investing, or directing the investment of, cash
collateral; or (6) indemnifying the lender of securities with
respect to various matters.
\307\ Rule 772(a).
\308\ 15 U.S.C. 78c(a)(54)(A). In part, this definition
encompasses corporations and partnerships with at least $25 million
in investments.
\309\ See Union Bank Letter.
\310\ See, e.g. Letter from Edward J. Rosen, Cleary, Gottlieb,
Stein & Hamilton, to Annette Nazareth, Director, Division of Market
Regulation, Commission, dated Oct. 9, 2002 (requesting that the
exemption encompass banks' securities lending activity involving any
entity that owns and invests on a discretionary basis at least $25
million in investments).
\311\ See Clearing House Ass'n Letter. Banks are permitted by
statutory exception to engage in repurchase and reverse repurchase
activities with respect to exempt securities such as government
securities. Exchange Act Section 3(a)(5)(C)(i)(II).
\312\ See Exchange Act Release No. [--------] (Sept. ----,
2007).
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C. Exemption for Banks Effecting Certain Excepted or Exempted
Transactions in Investment Company Securities and Variable Insurance
Products
The Agencies are adopting Rule 775 of Regulation R to allow banks
to take advantage of certain exceptions and exemptions to the broker
definition for transactions involving mutual funds, variable annuity
contracts and variable life insurance policies without having to comply
with the broker-execution requirement of Exchange Act Section
3(a)(4)(C)(i).\313\ The rule as proposed permitted banks to effect
transactions in open-end mutual funds through the National Securities
Clearing Corporation (``NSCC'') or the fund's transfer agent, rather
than through a broker-dealer.
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\313\ As discussed above, Section 3(a)(4)(C) generally provides
that a bank effecting a transaction in any ``publicly traded
security'' in the United States under the trust and fiduciary, stock
purchase plan, or custody and safekeeping exception must direct the
resulting trade to a broker-dealer for execution unless the trade is
a cross trade or similar trade or the trade otherwise is permitted
by Commission rule, regulation or order. 15 U.S.C. 78c(a)(4)(C).
Rule 760, the exemption for order-taking by banks acting as
custodians, also requires banks to comply with Section 3(a)(4)(C).
See Rule 760(d)(2).
---------------------------------------------------------------------------
A number of commenters stated, however, that the exemption should
be broadened to also encompass variable annuities and variable life
insurance, with some commenters noting that only variable annuities and
mutual funds are permissible investments for 403(b) plans.\314\
Commenters noted that transactions in variable annuity and variable
life products typically are effected directly with the relevant
insurance company.\315\
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\314\ See ABA Letter; TIAA-CREF Letter; American Council of Life
Insurers Letters of March 26 (``ACLI March 26 Letter'') and August
2, 2007, Roundtable Letter, Business Law Section Letter, The
Depository Trust & Clearing Corp. (``DTCC'') Letter.
\315\ See ACLI March 26 Letter, DTCC Letter.
---------------------------------------------------------------------------
In light of these comments, the Agencies have expanded the rule to
cover transactions involving variable annuities and variable life
insurance policies, as well as transactions involving mutual funds.
Applying the exemption to transactions in variable insurance products,
as well as to transactions involving mutual funds, will avoid needless
disruptions and costs with respect to banks' transactions with
customers in which interposing an executing broker-dealer would be
inefficient, inconsistent with market practice and unnecessary for
investor protection.
Specifically, Rule 775 as modified is available for transactions
involving securities issued by an open-end company, as defined by
Section 5(a)(1) of the Investment Company Act,\316\ that is registered
under that Act,\317\ as well as variable insurance contracts funded by
any separate account, as defined by Section 2(a)(37) of the Investment
Company Act, that is registered under that Act. To take advantage of
the exemption, the security must not be traded on a national securities
exchange or traded through the facilities of a national securities
association or an interdealer quotation system.\318\ In addition, the
securities must be distributed by a registered broker-dealer, or the
sales charge must be no more than the amount permissible for a security
sold by a registered broker-dealer pursuant to any applicable rules of
a registered securities association.\319\ Finally, the transaction must
be effected through the NSCC, or directly with a transfer agent or with
an insurance company or a separate account that is excluded from the
definition of transfer agent in Section 3(a)(25) of the Exchange
Act.\320\
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\316\ Rule 775(b)(1). We note that banks may effect transactions
in securities that meet the conditions to be an ``exempted
security'' under Exchange Act Section 3(a)(12)(A)(iv) without
complying with the exemption provided by Rule 775. Exchange Act
Section 3(a)(4)(B)(iii)(II) permits banks to effect transactions
involving ``exempted securities'' without registering as a broker
and without effecting the transaction through a registered broker-
dealer.
\317\ Rule 775(b)(2).
\318\ Rule 775(a)(1).
\319\ Rule 775(a)(2). FINRA currently is the only registered
securities association. FINRA Rule 2830 limits the sales charges
associated with open-end mutual funds. Currently, there are no FINRA
rules limiting the sales charges associated with the insurance
securities subject to Rule 775. Therefore currently, in all cases,
these insurance securities would satisfy the condition under Rule
775(a)(2) that the sales charge be no more than the amount
permissible under applicable registered securities association
rules.
\320\ Rule 775(a)(3).
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D. Exemption for Certain Transactions involving a Company's Securities
for its Employee Benefit Plans and Participants
In response to issues raised by a commenter, the Agencies are
adopting an additional exemption (Rule 776) to permit banks that rely
on certain exceptions and exemptions to effect certain transactions
involving the securities of a company for the company's employee
benefit plans and participants without complying with the broker-
execution requirements of Exchange Act Section 3(a)(4)(C)(i).\321\ The
commenter stated that banks that act as trustee or custodian for the
defined benefit or defined contribution plans of a company at times
effect in-kind contributions, purchases and sales, and distribution
transactions for the plan involving the securities of the company
without the involvement of a broker-dealer. The commenter indicated
that these transactions are effected through the company's transfer
agent and that no commission is charged in connection with the
transaction.\322\
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\321\ See note 313 supra for a listing of the relevant
exceptions and exemptions.
\322\ See The Northern Trust Company Letter. The commenter
further stated that ERISA effectively prohibits a commission from
being charged in connection with in-kind contributions by a company
of its stock to the company's benefit plans and direct purchases and
sales by the company of its stock with the company's plans.
---------------------------------------------------------------------------
In light of these comments, Rule 776 permits a bank utilizing
particular exceptions and exemptions to effect a transaction in the
securities of a company to do so directly with a transfer agent acting
for the company, subject to four conditions. First, no commission may
be charged with respect to the transaction.\323\ Second, the
transaction must be conducted solely for the benefit of an employee
benefit plan.\324\ Third, the security must be obtained directly from
the company or an employee benefit plan of the company.\325\ And
fourth, the security must be transferred only to the company or an
employee benefit plan of the company.\326\ Securities obtained from, or
transferred to, a participant in an employee benefit plan on behalf of
the
[[Page 56546]]
plan are considered to be obtained from, or transferred to, the plan.
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\323\ Rule 776(a)(1).
\324\ Rule 776(a)(2). For these purposes, an ``employee benefit
plan'' is defined to mean any pension plan, retirement plan, profit
sharing plan, bonus plan, thrift savings plan, incentive plan, or
other similar plan. Rule 776(b).
\325\ Rule 776(a)(3).
\326\ Rule 776(d).
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We are adopting this rule because we believe that requiring banks
to send these types of transactions to a broker-dealer for execution--
as would be required to comply with Section 3(a)(4)(C)(i) of the
Exchange Act--at times would preclude plans from engaging in these
transactions, would disrupt existing practices and otherwise would
introduce cost and complexity to those transactions without materially
promoting functional regulation and investor protection.\327\
---------------------------------------------------------------------------
\327\ The commenter also stated that banks acting as trustees
and custodians at times directly effect transactions with and for
different employee benefit plans involved in a corporate spin-off
transaction with respect to company stock of both companies involved
in the spin-off transaction. See Northern Trust letter. We
understand that the same bank typically is the trustee or custodian
for the different plans in such transactions and conducts such
transactions through cross-trades within the bank. Accordingly, no
additional exemption is required for these transactions.
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E. Temporary and Permanent Exemption for Contracts Entered Into by
Banks From Being Considered Void or Voidable
The Agencies are adopting as proposed Rule 780, which grants one
temporary and one permanent exemption from section 29(b) of the
Exchange Act, which addresses inadvertent failures by banks that could
trigger rescission of contracts between a bank and a customer.\328\
Under the temporary exemption, no contract entered into before 18
months after the effective date of the exemption would be void or
considered voidable by reason of Section 29 of the Exchange Act because
any bank that is a party to the contract violated the registration
requirements of Section 15(a) of the Exchange Act, any other applicable
provision of that Act, or the rules and regulations adopted under the
Exchange Act based solely on the bank's status as a broker when the
contract was created.\329\
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\328\ 15 U.S.C. 78cc(b). 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 adopted under the Exchange
Act (with certain exceptions) shall be void.
\329\ Rule 780(a).
---------------------------------------------------------------------------
Under the permanent exemption, no contract entered into is void or
considered voidable by reason of Section 29(b) of the Exchange Act
because any bank that is a party to the contract violated the
registration requirements of Section 15(a) of the Exchange Act or the
rules and regulations adopted thereunder based solely on the bank's
status as a broker when the contract was created if two conditions are
met. First, at the time the contract was created, the bank must have
acted in good faith and had reasonable policies and procedures in place
to comply with Section 3(a)(4)(B) of the Exchange Act, and the rules
and regulations, thereunder. Second, any violation of the registration
requirements by the bank must not have resulted in any significant
harm, financial loss or cost to the person seeking to void the
contract. This exemption is provided because a bank that is acting in
good faith and has reasonable policies and procedures in effect at the
time a securities contract is created should not be subject to
rescission claims as a result of an inadvertent failure to comply with
the requirements under Section 3(c)(4) of the Exchange Act if customers
are not significantly harmed. One commenter supported the
exemptions,\330\ and no commenters objected to their adoption.
---------------------------------------------------------------------------
\330\ ICBA Letter.
---------------------------------------------------------------------------
F. Extension of Time and Transition Period
The Agencies are further extending the time that banks have to come
into compliance with the Exchange Act provisions relating to the
definition of ``broker.'' Under the final rule, a bank is exempt from
the definition of ``broker'' under Section 3(a)(4) of the Exchange Act
until the first day of its first fiscal year commencing after September
30, 2008. This is an additional calendar quarter beyond the date (June
30, 2008) provided in the proposed rule. A bank that has a fiscal year
based on the calendar year, for example, must comply with the new
exceptions for banks and these rules beginning on January 1, 2009. Some
commenters noted that banks and broker-dealers would need sufficient
time to make the changes necessary to come into compliance with the
statute and these rules.\331\ The Agencies believe that the extension
granted by the rule, which is a minimum of one year, should provide
banks a reasonable period of time to come into compliance with these
provisions.
---------------------------------------------------------------------------
\331\ See, e.g., HSBC Securities Letter.
---------------------------------------------------------------------------
The Administrative Procedure Act (``APA'') permits an agency to
issue a rule without delaying its effective date for 30 days from the
date of publication if, among other reasons, the rule is a substantive
rule which grants or recognizes an exemption or relieves a restriction,
or if the agency finds good cause and publishes its finding with the
rule.\332\ The Agencies find that this Rule 781 grants or recognizes an
exemption or relieves a restriction and also that there is good cause
for adopting Rule 781 without a delayed effective date because it is in
the public interest that banks not unnecessarily incur costs to comply
with the statutory exceptions and related rules before such exceptions
and rules would become effective in accordance with Rule 781.\333\
---------------------------------------------------------------------------
\332\ The APA provides that publication of a substantive rule
must be made not less than 30 days prior to its effective date,
except ``(1) a substantive rule which grants or recognizes an
exemption or relieves a restriction; (2) interpretive rules and
statements of policy; or (3) otherwise provided by the agency for
good cause found and published with the rule.'' 5 U.S.C. 553(d).
\333\ This finding also satisfies the requirements of 5 U.S.C.
Section 808(2), which allows a rule to become effective immediately
notwithstanding the requirements of 5 U.S.C. Section 801 if an
agency ``for good cause finds that notice and public procedure
thereon are impracticable, unnecessary, or contrary to the public
interest.''
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VII. Finding That the Exemptions are Appropriate in the Public Interest
and Consistent With the Protection of Investors
Section 36(a)(1) of the Exchange Act generally provides that the
Commission may conditionally or unconditionally exempt any person or
class of persons from any provision of the Exchange Act to the extent
that an exemption is necessary or appropriate in the public interest
and consistent with the protection of investors.\334\ Taken as a whole,
the exemptions will implement the bank broker provisions of the GLBA
while providing banks with flexibility to structure their business
models under conditions designed to preserve key investor protections,
and therefore, as discussed above more fully, are appropriate in the
public interest and consistent with the protection of investors.
---------------------------------------------------------------------------
\334\ 15 U.S.C. 78mm(a)(1).
---------------------------------------------------------------------------
VIII. Withdrawal of Proposed Regulation B and Removal of Exchange Act
Rules 3a4-2 Through 3a4-6, and 3b-17
Under the Regulatory Relief Act, a final single set of rules or
regulations jointly adopted by the Board and Commission in accordance
with that Act shall supersede any other proposed or final rule issued
by the Commission on or after the date of enactment of Section 201 of
the GLBA with regard to the definition of ``broker'' under Exchange Act
Section 3(a)(4).\335\ Moreover, the law states that ``[n]o such other
rule, whether or not issued in final form, shall have any force or
effect on or after that date of enactment.''
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\335\ President Clinton signed the GLBA into law on November 12,
1999.
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In 2001, the Commission adopted Interim Rules discussing the way in
[[Page 56547]]
which the Commission would interpret the GLBA.\336\ The rules that
address the definition of ``broker'' under Section 3(a)(4) of the
Exchange Act (and applicable exemptions) are Exchange Act Rules 3a4-2
through 3a4-6 and Rule 3b-17.\337\ In 2004, the Commission proposed to
revise and restructure the ``broker'' provisions of the Interim Rules
and codify them in a new regulation, proposed Regulation B, which would
consist of proposed new Exchange Act Rules 710 through 781.\338\ By
operation of the Regulatory Relief Act, the joint adoption of these
final rules by the Board and the Commission supersedes Exchange Act
Rules 3a4-2 through 3a4-6, 3b-17, and proposed Rules 710 through 781.
Any discussion or interpretation of these prior rules in their
accompanying releases does not apply to this single set of rules
adopted by the Agencies.
---------------------------------------------------------------------------
\336\ Exchange Act Release No. 44291 (May 11, 2001), 66 FR 27760
(May 18, 2001).
\337\ 17 CFR 240.3a4-2 through 3a4-6 and 17 CFR 240.3b-17.
\338\ 17 CFR 242.710 through 781. See Exchange Act Release No.
49879 (June 17, 2004), 69 FR 39682 (June 30, 2004).
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IX. Administrative Law Matters
A. Paperwork Reduction Act Analysis
Certain provisions of Rules 701, 723, and 741, contain ``collection
of information'' requirements within the meaning of the Paperwork
Reduction Act of 1995.\339\ The Commission has submitted these
information collections 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 Board has reviewed the rules under authority delegated by
OMB.\340\
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\339\ 44 U.S.C. 3501, et seq.
\340\ 5 CFR 1320.16; Appendix A.1.
---------------------------------------------------------------------------
The collections of information under Rules 701, 723, and 741 are
new. The Commission's title for the new collection of information under
Rule 701 is ``Rule 701: Exemption from the definition of `broker' for
certain institutional referrals.'' The Commission's title for the new
collection of information under Rule 723 is ``Rule 723: Exemptions for
special accounts, foreign branches, transferred accounts, and a de
minimis number of accounts.'' The Commission's title for the new
collection of information under Rule 741 is ``Rule 741: Exemption for
banks effecting transactions in money market funds.'' The Commission's
OMB control number for the three rules is 3235-0624. The Board's title
for the new collection of information under Rules 701, 723, and 741 is
``Recordkeeping and Disclosure Requirements Associated with Regulation
R'' (FR 4025). The Board's OMB control number will be 7100-0316. 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.\341\ We received no comments on the paperwork
reduction analysis in the proposal.
---------------------------------------------------------------------------
\341\ 44 U.S.C. 3512.
---------------------------------------------------------------------------
1. Rule 701
Rule 701 provides a conditional exemption from the requirements
under the networking exception under the Exchange Act. This exemption
permits bank employees to receive payment of more than a nominal amount
for referring institutional customers and high net worth customers to a
broker-dealer and permits such payments to be contingent on whether the
customer effects a securities transaction with the broker-dealer.
a. Collection of Information
Rules 701(a)(2)(i), (a)(3)(i) and (b) require banks or their
broker-dealer partners that utilize the exemption provided in this rule
to make certain disclosures to high net worth or institutional
customers. Specifically, these disclosures must clearly and
conspicuously disclose (1) the name of the broker-dealer; and (2) that
the bank employee participates in an incentive compensation program
under which the bank employee may receive a fee of more than a nominal
amount for referring the customer to the broker-dealer and payment of
this fee may be contingent on whether the referral results in a
transaction with the broker-dealer.\342\ These requirements were
modified from the proposal to permit timely oral disclosure of this
information, followed by written disclosure, to better accommodate the
variety of circumstances in which referrals may occur.
---------------------------------------------------------------------------
\342\ See Rules 701(a)(2)(i), (a)(3)(i) and (b).
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In addition, one of the conditions of the exemption is that the
broker-dealer and the bank need to have a contractual or other written
arrangement containing certain elements, including notification and
information requirements.\343\ Rule 701(a)(3)(v) requires the written
agreement to obligate a broker-dealer to notify its bank partner if the
broker-dealer determines that (1) the customer referred under the
exemption is not a high net worth or institutional customer, as
applicable; or (2) the bank employee making the referral is subject to
statutory disqualification (as defined in Section 3(a)(39) of the
Exchange Act).\344\ In addition, Rule 701(a)(3)(iv) requires the
written agreement to obligate the broker-dealer to notify the customer
if the securities transaction(s) to be conducted by the customer or the
customer do not meet the applicable suitability or sophistication
determination standards set forth in the rule.\345\ Similarly, the bank
is required to provide its broker-dealer partner with the name of the
bank employee receiving the referral fee and certain other identifying
information.\346\
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\343\ See Rule 701(a) and (a)(3).
\344\ See Rule 701(a)(3)(v). The latter requirement does not
apply to subparagraph (E) of Section 3(a)(39) of the Exchange Act
((15 U.S.C. 78c(a)(39)).
\345\ See Rule 701(a)(3)(iv).
\346\ See Rule 701(a)(2)(iii).
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b. Use of Information
The purpose of the collection of information in Rules 701(a)(2)(i),
(a)(3)(i) and (b) is to provide a customer of a bank relying on the
exemption with information to assist the customer in identifying and
assessing any conflict of interest on the part of the bank employee
making a referral to a broker-dealer and for which the bank employee
may receive a higher-than-nominal and/or contingent referral fee. The
collection of information in Rule 701(a)(2)(iii) and (a)(3)(v) is
designed to help a bank determine whether it is acting in compliance
with the exemption. The collection of information in Rule 701(a)(3)(iv)
is designed to provide the customer with information that may be
helpful to the customer in deciding whether to engage in a securities
transaction with the broker-dealer.
c. Respondents
The collections of information in Rule 701 will apply to banks that
wish to utilize the exemption provided in this rule and broker-dealers
with which those banks enter into networking arrangements.
d. Disclosure Burden
The Agencies estimate that approximately 1,000 banks annually will
use the exemption in Rule 701 and that each bank, individually or
working with its partner broker-dealer, will on average make the
required referral fee disclosures to 200 customers annually. In
addition, we estimate that each bank will provide one notice annually
to its broker-dealer partner regarding names and other identifying
information about bank employees. The Agencies also estimate that
broker-dealers will, on average, notify each of the 1,000 banks
approximately twice a year about a determination regarding a customer's
high net worth or institutional status as well as a bank employee's
statutory
[[Page 56548]]
disqualification status. The Agencies further estimate that each
broker-dealer will notify three customers of each partner bank per year
concerning transaction suitability or the customer's financial
sophistication.
Based on these estimates, the Agencies anticipate that Rule 701
will result in approximately 200,000 disclosures to customers, 1,000
notices to broker-dealers about bank employees, 2,000 notices to banks
about customer status, and 3,000 notices to customers per year about
suitability or sophistication. The Agencies further estimate (based on
the level of difficulty and complexity of the applicable activities)
that a bank or broker-dealer will spend approximately 5 minutes per
customer to comply with the disclosure requirement, and that a bank
will spend approximately 15 minutes per notice to a broker-dealer. The
Agencies also estimate that a broker-dealer will spend approximately 15
minutes per notice to a bank or customer. Thus, the estimated total
annual disclosure burden for these requirements in Rule 701 is
approximately 8,583 hours for banks and approximately 9,583 hours for
broker-dealers.\347\
---------------------------------------------------------------------------
\347\ Because banks and broker-dealers will share the disclosure
obligation under the final rule, these estimates attribute 50
percent of that disclosure burden to banks and 50 percent to broker-
dealers.
---------------------------------------------------------------------------
e. Collection of Information Is Mandatory
This collection of information is mandatory for banks relying on
Rule 701 and their broker-dealer partners.
f. Confidentiality
A bank relying on the exemption provided in Rule 701 or its partner
broker-dealer is required to provide certain referral fee disclosures
to the customers referred by the bank under this rule. Banks relying on
the exemption provided in Rule 701 are required also to enter into
agreements with a broker-dealer obligating the broker-dealer to notify
the bank upon becoming aware of certain information with respect to the
customer or the bank employee, and to notify the customer upon becoming
aware of certain information concerning the customer or the nature of a
securities transaction.\348\ Similarly, a bank is required to notify a
broker-dealer about the name of the bank employee receiving a referral
fee and certain other identifying information.
---------------------------------------------------------------------------
\348\ These requirements are discussed in more detail in section
1.d (Rule 701, Disclosure Burden), supra.
---------------------------------------------------------------------------
g. Record Retention Period
Rule 701 does not include a specific record retention requirement.
Banks, however, are required to retain the records in compliance with
any existing or future recordkeeping or disclosure requirements
established by the Banking Agencies. Broker-dealers are also required
to retain records in compliance with existing or future recordkeeping
or disclosure requirements established by the Commission or any self-
regulatory organization.
2. Rule 723
a. Collection of Information
Rule 723(e)(1) requires a bank that desires to exclude a trust or
fiduciary account in determining its compliance with the chiefly
compensated test, pursuant to a de minimis exclusion,\349\ to maintain
records demonstrating that the securities transactions conducted by or
on behalf of the account were undertaken by the bank in the exercise of
its trust or fiduciary responsibilities with respect to the
account.\350\
---------------------------------------------------------------------------
\349\ See Rule 723(e)(2), which requires that the total number
of accounts excluded by the bank, under the exclusion from the
chiefly compensated test in Rule 721(a)(1), do not exceed the lesser
of 1 percent of the total number of trust or fiduciary accounts held
by the bank (if the number so obtained is less than 1, the amount
will be rounded up to 1) or 500.
\350\ See Rule 723(e)(1).
---------------------------------------------------------------------------
b. Use of Information
The collection of information in Rule 723 is designed to help
ensure that a bank relying on the de minimis exclusion is able to
demonstrate that it was acting in a trust or fiduciary capacity with
respect to an account excluded from the chiefly compensated test in
Rule 721(a)(1).
c. Respondents
The collection of information in Rule 723 will apply to banks
relying on the de minimis exclusion from the chiefly compensated test.
d. Recordkeeping Burden
Because the Agencies expect a small number of banks may use the
account-by-account approach in monitoring their compliance with the
chiefly compensated test, the Agencies estimate that approximately 50
banks annually will use the de minimis exclusion in Rule 723 and each
such bank will, on average, need to maintain records with respect to 10
trust or fiduciary accounts annually conducted in the exercise of the
banks' trust or fiduciary responsibilities. Therefore, the Agencies
estimate that Rule 723 will result in approximately 500 accounts
annually for which records are required to be maintained. The Agencies
anticipate that these records will consist of records that are
generally created as part of the securities transaction and the account
relationship and minimal additional time will be required in
maintaining these records. Based on this analysis, the Agencies
estimate that a bank will spend approximately 15 minutes per account to
comply with the record maintenance requirement of Rule 723. Thus, the
estimated total annual recordkeeping burden for Rule 723 is 125 hours.
e. Collection of Information Is Mandatory
This collection of information is mandatory for banks desiring to
rely on de minimis exclusion contained in Rule 723.
f. Confidentiality
Rule 723 does not address or restrict the confidentiality of the
documentation prepared by banks under the rule. Accordingly, banks will
have to make the information available to regulatory authorities or
other persons to the extent otherwise provided by law.
g. Record Retention Period
Rule 723 will include a requirement to maintain records related to
certain securities transactions. Banks will be required to retain these
records in compliance with any existing or future recordkeeping
requirements established by the Banking Agencies.
3. Rule 741
a. Collection of Information
Rule 741(a)(2)(ii)(A) requires a bank relying on this exemption
(i.e., the exemption from the definition of the term ``broker'' under
Section 3(a)(4) of the Exchange Act for effecting transactions on
behalf of a customer in securities issued by a money market fund) to
provide customers with a prospectus of the money market fund
securities, not later than the time the customer authorizes the bank to
effect the transaction in such securities, if they are not no-load. In
situations where a bank effects transactions under the exemption as
part of a program for the investment or reinvestment of deposits funds
of, or collected by, another bank, the rule permits either the
effecting bank or deposit-taking bank to provide the customer a
prospectus for the money market fund securities.
b. Use of Information
The purpose of the collection of information in Rule 741 is to help
ensure that a customer of a bank whose
[[Page 56549]]
funds or deposits are invested into a money market fund that is not a
no-load fund under the exemption will have sufficient information upon
which to make an informed investment decision, in particular, regarding
the fees the customer will pay with respect to the securities.
c. Respondents
The collection of information in Rule 741 applies to banks that
directly or indirectly rely on the exemption provided in the rule in
the manner described above.
d. Disclosure Burden
The Agencies believe that banks generally sweep or invest their
customer funds into no-load money market funds. Accordingly, the
Agencies estimate that approximately 500 banks annually will use the
exemption in Rule 741 and each bank (or its partner bank), on average,
will deliver the prospectus required by the rule to approximately 1,000
customers annually. Therefore, the Agencies estimate that Rule 741 will
result in approximately 500,000 disclosures per year. The Agencies
estimate further that a bank will spend approximately 5 minutes per
response to comply with the delivery requirement of Rule 741. Thus, the
estimated total annual disclosure burden for Rule 741 is 41,667 hours.
e. Collection of Information Is Mandatory
This collection of information is mandatory for banks relying on
the exemption.
f. Confidentiality
The collection of information delivered pursuant to Rule 741 must
be provided by banks relying on the exemption in this rule (or in the
case of programs involving deposits of another bank, the other bank) to
customers that are engaging in transactions in securities issued by a
money market fund that is not a no-load fund.
g. Record Retention Period
Rule 741 does not include a record retention requirement.
B. Consideration of Benefits and Costs
1. Introduction
Prior to enactment of the GLBA, banks were exempted from the
definition of ``broker'' in Section 3(a)(4) of the Exchange Act.
Therefore, notwithstanding the fact that banks may have conducted
activities that will have brought them within the scope of the broker
definition, they were not required by the Exchange Act to register as
such. The GLBA replaced banks' historic exemption from the definition
of ``broker'' with eleven exceptions.\351\
---------------------------------------------------------------------------
\351\ See Exchange Act Section 3(a)(4)(B)(i)-(xi).
---------------------------------------------------------------------------
While banks' efforts to comply with the GLBA and the exemptions
will result in certain costs, the Agencies have sought to minimize
these burdens to the extent possible consistent with the language and
purposes of the GLBA. For example, the Agencies are adopting exemptions
and interpretations that are expected to provide banks with increased
options and flexibility and help to reduce overall costs. Some
commenters noted that the rules as proposed will give banks flexibility
in structuring their operations, and one bank trade association stated
that small banks will be able to comply with the proposed rules without
significantly altering their activities.\352\ Two commenters stated
that the Agencies had underestimated the costs associated with coming
into compliance with Regulation R and also provided estimates of
ongoing compliance costs.\353\
---------------------------------------------------------------------------
\352\ See Citigroup Letter, ACB Letter, ICBA Letter.
\353\ See Fiserv Letter, Colorado Trust Letter.
---------------------------------------------------------------------------
2. Discussion of Rule Interpretations and Exemptions
The benefits and costs of the principal exemptions and
interpretations in the rules 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 under which the
broker-dealer offers brokerage services to bank customers. This
networking exception is subject to several conditions. The Section also
prohibits banks from paying unregistered bank employees--such as
tellers, loan officers, and private bankers--``incentive compensation''
for any brokerage transaction, except that bank employees may receive a
``nominal'' referral fee for referring bank customers to their broker-
dealer networking partners.\354\
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\354\ 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.
---------------------------------------------------------------------------
Under the rule, a ``nominal'' referral fee is defined as a fee that
does not exceed any of the following standards: (1) Twice the average
of the minimum and maximum hourly wage established by the bank for the
current or prior year for the job family that includes the employee or
1/1000th of the average of the minimum and maximum annual base salary
established by the bank for the current or prior year for the job
family that includes the employee; (2) twice the employee's actual base
hourly wage or 1/1000th of the employee's actual annual base salary; or
(3) twenty-five dollars ($25), as adjusted for inflation pursuant to
Rule 700(f).
The Agencies believe these alternatives likely will provide banks
appropriate flexibility while being consistent with the statute. For
example, some banks, and particularly small banks, may find it most
useful to establish a flat fee or inflation-adjusted fee for securities
referrals as this method is easy to understand and requires no
complicated calculations. In addition, permitting banks to pay referral
fees based on either an employee's base hourly or annual rate of pay or
the average hourly or annual rate of pay for a job family gives 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. While some start-up costs may be incurred
by banks in the process of developing a fee structure in line with the
requirements of the GLBA, the ability to choose among alternative
methods (as reflected in the rules) is expected to enable banks to
minimize their overall costs based on their individual referral
programs and cost structures. Several commenters supported these
alternatives, or stated that the rules implementing the networking
exception as a whole struck an appropriate balance.\355\
---------------------------------------------------------------------------
\355\ See ABA Letter, Roundtable Letter, ACB Letter.
---------------------------------------------------------------------------
In light of the statutory provision allowing banks to pay a
``nominal one-time cash fee,'' the rule requires that all referral fees
paid under the exception be paid in cash. At the same time, the
Agencies have clarified that banks have the flexibility to use cash-
equivalent points, paid no less often than quarterly, in paying nominal
referral fees under the exception.
Rule 700(b) also contains a definition of ``incentive
compensation'' and excludes from this definition compensation paid by a
bank under a bonus or similar plan that meets certain criteria. The
bonus or similar program must be paid on a discretionary basis and
based on multiple factors or variables. These factors or variables must
include multiple, significant factors or variables that are not related
to securities transactions at the broker-
[[Page 56550]]
dealer. Moreover, a referral made by the employee may not be a factor
or variable in determining the employee's compensation under the plan
and the employee's compensation under the plan may not be determined by
reference to referrals made by any other person. Rule 700(b) also
provides a conditional safe harbor from the definition of ``incentive
compensation'' for certain bonus or similar plans that are based on any
measure of the overall profitability of a bank; an affiliate of a bank
(other than a broker-dealer); an operating unit of a bank or of an
affiliate of a bank (other than a broker-dealer); or a broker-dealer
(if the bonus plan meets certain criteria designed to ensure, among
other things, that the plan includes other factors or variables). The
final definition has been revised from the proposal to give banks more
flexibility in using their existing bonus plans within the framework
required by the GLBA.
The rules also include a conditional exemption to permit a bank to
pay an employee a contingent referral fee of more than a nominal amount
for referring an institutional customer or high net worth customer to a
broker-dealer with which the bank has a contractual or other written
networking arrangement. This exemption provides a benefit to banks by
expanding the types of referral fees that banks may utilize with
respect to institutional customers and high net worth customers. A
number of commenters supported granting an exemption for such
referrals.\356\ There likely will be costs associated with complying
with the conditions in the exemption (such as the requirement for banks
to make certain disclosures to high net worth or institutional
customers and the requirement for broker-dealers to make certain
determinations and provide certain notifications to banks or a
customer) \357\ as well as the other terms and conditions in the
statutory networking exception. These costs, however, will be either a
result of the statutory requirements or costs voluntarily incurred by
banks because they want to take advantage of the exemption.
---------------------------------------------------------------------------
\356\ See State Street Letter, SIMFA Letter, U.S. Trust Letter,
BISA Letter.
\357\ Rule 701(a)(2)(i), (a)(3)(iii)-(v), and 701(b).
---------------------------------------------------------------------------
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 compliance with 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 and comply with
certain advertising restrictions set forth in the statute.
The Agencies believe that the rules dealing with the trust and
fiduciary activities exception will provide a number of benefits to
banks and their customers without imposing significant costs on either
group.\358\ The provisions regarding the ``chiefly compensated''
condition and related exemptions, while imposing some costs related to
systems necessary to perform the calculations and track compensation,
are expected to reduce banks' compliance costs and make the trust and
fiduciary activities exception more useful. For example, the rules
permit a bank to follow an alternate test to the account-by-account
approach to the ``chiefly compensated'' condition. Under this
exemption, a bank may calculate the compensation it receives from its
trust and fiduciary business as a whole on a bank-wide basis, subject
to certain conditions.\359\ This alternative is designed to provide
banks with a potentially less costly approach for determining
compliance with the trust and fiduciary activities exception. Some
commenters noted that this alternative approach was workable.\360\
Similarly, the Agencies' exemptions from the ``chiefly compensated''
condition for certain short-term accounts, accounts acquired as part of
a business combination or asset acquisition, accounts held at a non-
shell foreign branch, accounts transferred to a broker-dealer or other
unaffiliated entity, and a de minimis number of accounts are expected
also to reduce banks' compliance costs by facilitating banks' ability
to comply with the ``chiefly compensated'' condition.\361\ While
compliance with the conditions in these exemptions likely will result
in some costs, such as the recordkeeping requirement associated with
the de minimis exclusion, these costs are likely more than justified by
the benefits associated with the exemptions given that banks could
individually determine whether they wish to utilize the exemptions.
---------------------------------------------------------------------------
\358\ The trust and fiduciary exception is addressed in Rules
721-723.
\359\ See Rule 722.
\360\ See, e.g., ABA Letter, WBA Letter, U.S. Trust Letter, PNC
Letter.
\361\ See Rule 723.
---------------------------------------------------------------------------
As previously noted, banks are likely to incur some costs to comply
with the GLBA. The rules, however, include a number of exemptions which
are intended to help to reduce overall costs. As a result, the Agencies
do not believe that banks will incur significant additional costs to
comply with the liberalized exemptions of Rules 722 through 723 or the
definitional guidance of Rule 721.
c. Sweep Accounts and Transactions in Money Market Funds
Section 3(a)(4)(B)(v) of the Exchange Act provides a bank with an
exception 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 for a customer or on behalf of another bank into any
no-load, open-end management investment company registered under the
Investment Company Act that holds itself out as a money market fund.
The rules provide guidance, consistent with FINRA rules,\362\ regarding
the definition of ``no-load'' as used in the exception. This guidance
likely will benefit banks by clarifying the types of charges that are
permissible and by providing greater legal certainty.
---------------------------------------------------------------------------
\362\ See FINRA Rule 2830.
---------------------------------------------------------------------------
The rules also contain an exemption that permits banks to effect
transactions on behalf of a customer, or for the deposit funds of
another bank, in securities issued by a money market fund, subject to
certain conditions.\363\ While compliance with the conditions
associated with this exemption, such as the prospectus delivery
requirement in certain circumstances, may require banks to incur some
costs, these costs are likely to be more than justified by the investor
protection benefits enjoyed by the banks' customers and the enhanced
flexibility granted banks by the exemption. Furthermore, because banks
are free to determine whether to incur these costs, the exemption is
expected to provide a net benefit for banks that wish to utilize the
exemption.
---------------------------------------------------------------------------
\363\ See Rule 741.
---------------------------------------------------------------------------
d. Safekeeping and Custody Exception
Section 3(a)(4)(B)(viii) of the Exchange Act provides banks with an
exception from the definition of ``broker'' for certain bank custody
and safekeeping activities. The rules contain an exemption that permits
a bank, subject to certain conditions, to accept orders to effect
transactions in securities for accounts for which the bank acts as a
custodian (including an account for which a bank acts as directed
trustee),
[[Page 56551]]
or, in some cases, for which the bank acts as a subcustodian or a non-
fiduciary administrator or recordkeeper. Specifically, this custody
exemption (Rule 760) allows banks, subject to certain conditions, to
accept orders for securities transactions from employee benefit plan
accounts and individual retirement and similar accounts for which the
bank acts as a custodian. In addition, the exemption allows banks,
subject to certain conditions, to accept orders for securities
transactions on an accommodation basis from other types of custodial
accounts. This exemption allows banks to accept orders from custody
accounts while imposing conditions designed to prevent a bank from
operating a brokerage business out of its custody department.
The exemption is designed to benefit banks by permitting certain
order-taking activities for securities transactions. While banks may
incur some costs in complying with the conditions contained in the
exemption, such as developing systems for making determinations
regarding compliance with advertising and compensation restrictions,
the Agencies believe the conditions contained in the rules are
consistent with the practices of banks and any costs will only be
imposed on banks that choose to utilize the exemption.
e. Other Rules
The Agencies are also adopting certain special purpose exemptions.
Specifically, we are adopting an exemption that permits banks to effect
transactions in Regulation S securities with non-U.S. persons or
registered broker-dealers.\364\ Another exemption also allows, under
certain conditions, a bank to effect transactions in investment company
securities and variable life insurance and variable annuities through
the National Securities Clearing Corporation or directly with a
transfer agent or insurance company or separate account that is
excluded from the definition of transfer agent, instead of through a
broker-dealer.\365\ In addition, an exemption permits banks that rely
on certain exceptions and exemptions to effect certain transactions
involving the securities of a company for the company's employee
benefit plans and participants through the National Securities Clearing
Corporation or directly with a transfer agent or insurance company or
separate account that is excluded from the definition of transfer
agent, instead of through a broker-dealer. An additional exemption
permits a bank, as agent, to effect securities lending transactions
(and engage in related securities lending services) for securities that
they do not hold in custody with or on behalf of a person the bank
reasonably believes is a qualified investor (as defined in Section
3(a)(54)(A) of the Exchange Act) or any employee benefit plan that owns
and invests on a discretionary basis at least $25 million in
investments.\366\ We also are extending 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 is 18 months after
the effective date of the final rule.\367\ This exemption also
provides, under certain circumstances, protections from rescission
liability under Exchange Act Section 29 resulting solely from a bank's
status as a broker, if the bank has acted in good faith, adopted
reasonable policies and procedures, and any violation of broker
registration requirements did not result in significant harm or
financial loss to the person seeking to void the contract.\368\
Finally, we are issuing a temporary general exemption from the
definition of ``broker'' under Section 3(a)(4) of the Exchange Act
until the first day of a bank's first fiscal year commencing after
September 30, 2008.\369\
---------------------------------------------------------------------------
\364\ See Rule 771.
\365\ See Rule 775.
\366\ See Rule 772.
\367\ See Rule 780.
\368\ Id.
\369\ See Rule 781.
---------------------------------------------------------------------------
The Agencies believe these provisions offer a number of benefits to
banks and their customers. In particular, the Regulation S exemption
helps ensure that U.S. banks that effect transactions in Regulation S
securities with non-U.S. customers will be more competitive with
foreign banks or other entities that offer those services without being
registered as broker-dealers. The exemption from rescission liability
under Exchange Act Section 29 also provides banks some legal certainty,
both temporarily and on a permanent basis, as they conduct their
securities activities. The exemption related to securities lending
services enables banks to engage in the types of services in which they
currently engage thereby minimizing compliance costs, while providing
the banks' customers with continuity of service. The temporary general
exemption from the definition of ``broker'' also benefits banks by
providing them with an adequate period of time to transition to the
requirements under the statute and the rules.
The Agencies estimate that the costs of these exemptions will be
minimal and are justified by the benefits the exemptions offer. For
example, the Regulation S exemption may impose certain costs on banks
that are designed to ensure that they remain in compliance with the
conditions under the exemption. In particular, the exemption permits
banks to rely on the exemption only for transactions in ``eligible
securities'' and with either broker-dealers or purchasers who are not
U.S. persons within the meaning of Section 903 of Regulation S. Banks
may incur certain administrative costs to ensure that a transaction
meets these requirements. Nevertheless, the exemption is an
accommodation to banks that wish to effect transactions in Regulation S
securities and, as a result, the compliance costs will be imposed only
on those banks that believe that it is in their best business interests
to take advantage of the exemption.
Given that Exchange Act Section 29 is rarely used as a remedy, we
do not anticipate that this exemption will impose significant costs on
the industry or on investors.
3. General Costs and Benefits
Based on the burden hours discussed in the Paperwork Reduction Act
Analysis section, supra, the Agencies expect the ongoing requirements
of the rules to result in a total of 50,375 annual burden hours for
banks and 9583 annual burden hours for broker-dealers, for a grand
total of 59,958 annual burden hours.\370\ The Agencies estimate that
the hourly costs for these burden hours will be approximately $68 per
hour.\371\ Therefore, the annual total costs will be approximately
$4,077,144.
---------------------------------------------------------------------------
\370\ See infra at VIII.A.1.d., VIII.A.2.d., and VIII.A.3.d.
\371\ $68/hour figure for a clerk (e.g. compliance clerk) is
from the Securities Industry Association (now SIFMA) Report on
Office Salaries in the Securities Industry 2005, modified to account
for an 1800-hour work-year and multiplied by 2.93 to account for
bonuses, firm size, employee benefits and overhead.
---------------------------------------------------------------------------
In addition to the costs associated with burden hours discussed in
the Paperwork Reduction Act Analysis section, supra, the Agencies
expect that many banks also could incur start-up costs for legal and
other professional services.\372\ Many banks will utilize their in-
house counsel, accountants, compliance officers, and programmers in an
effort to achieve compliance with the rules. Industry sources indicate
the
[[Page 56552]]
following hourly labor costs: Attorneys--$324 per hour, intermediate
accountants--$162 per hour, compliance manager--$205 per hour, and
senior programmer--$268.\373\ Taking an average of these professional
costs, the Agencies estimate a general hourly in-house labor cost of
$240 per hour for professional services.
---------------------------------------------------------------------------
\372\ For example, banks may incur start-up costs in the process
of reviewing or developing their networking arrangements in line
with the requirements of the rules. See supra at VIII.B.2.a. In
addition, there likely will be costs for developing systems for
making determinations regarding compliance with advertising and
compensation restrictions pursuant to the rules regarding
safekeeping and custody. See supra at VIII.B.2.d.
\373\ The hourly figures for an attorney, intermediate account,
and compliance manager is from the SIA Report on Management &
Professional Earnings in the Securities Industry 2005, modified to
account for an 1800-hour work-year and multiplied by 5.35 to account
for bonuses, firm size, employee benefits and overhead.
---------------------------------------------------------------------------
Based on our expectation that most start-up costs will involve
bringing systems into compliance and that many banks will be able to do
so either using existing systems or by slightly modifying existing
systems, the Agencies estimate that the rules will require banks to
utilize an average of 30 hours of professional services. The Agencies
expect that most banks affected by the rules will either use in-house
counsel or employees resulting in an average total cost of $7,200 per
affected bank.\374\ The Agencies estimate that the rules will apply to
approximately 9,475 banks and approximately 25 percent of these banks
will incur more than a de minimis cost. Using these values, the
Agencies estimate total start-up costs of $17,055,000 (9,475 x .25 x
$7,200). As previously discussed, the Agencies have sought to minimize
these costs to the extent possible consistent with the language and
purposes of the GLBA.
---------------------------------------------------------------------------
\374\ Some banks may choose to utilize outside counsel, either
exclusively or as a supplement to in-house resources. The Agencies
estimate these costs as being similar to the in-house costs
(Industry sources indicate the following hourly costs for hiring
external workers: Attorneys--$400, accountant--$250, auditor--$250,
and programmer--$160.).
---------------------------------------------------------------------------
Two commenters stated that the Agencies' estimates of hourly rates
in the proposal were fair, but that the estimates of the time
requirements were too low. These commenters estimated startup costs of
between $43,000 and $55,000.\375\ In addition, these commenters
estimated ongoing costs to be between $60,000 and $95,000 per year.
Based on these commenters' estimates, startup costs would range from
$101.9 million (9475 banks x 0.25 affected x $43,000) to $130.3 million
(9475 x 0.25 x $55,000), and a range of annual ongoing costs of $142.1
million (9475 x 0.25 x $60,000) to $225 million (9475 x 0.25 x
$95,000). The Agencies, however, believe that these cost estimates are
not representative of the costs for the majority of banks affected by
Regulation R. The Agencies received approximately 60 comments,
primarily from banks and banking industry groups, and the comments
generally were favorable. Only these two commenters stated that the
Agencies had underestimated start-up and continuing compliance costs.
The Agencies therefore believe that the estimates in the proposal
reflect the costs that the majority of the banks affected by the rules
are likely, on average, to incur, and are appropriately used to
estimate the overall compliance costs of Regulation R.
---------------------------------------------------------------------------
\375\ See Fiserv Letter, Colorado Trust Letter.
---------------------------------------------------------------------------
The Agencies believe that the rules will provide greater legal
certainty for banks in connection with their determination of whether
they meet the terms and conditions for an exception to the definition
of broker under the Exchange Act as well as provide additional relief
through the exemptions. Without the rules, banks may have difficulty
planning their businesses and determining whether their operations are
in compliance with the GLBA. This, in turn, could hamper their
business. The Agencies anticipate these benefits will be useful to
banks in a number of ways.
The Agencies expect that one component of the benefits to banks
will be savings in legal fees, given that difficulties in interpreting
the GLBA absent any regulatory guidance could result in the need for
greater input from outside counsel. Based on the number of interpretive
issues raised by the GLBA, the Agencies estimate that, absent any
regulatory guidance, banks on average will use the services of outside
counsel for approximately 25 more hours for the initial year and 5 more
hours per year thereafter, than with the existence of the rules.
Industry sources indicate that the hourly costs for hiring outside
counsel are approximately $400 per hour. The rules will therefore
result in an average total cost savings of approximately $10,000 per
affected bank per year during the initial year and $2,000 per affected
bank per year thereafter. The Agencies estimate that the rules will
apply to approximately 9,475 banks and approximately 25 percent of
these banks will enjoy more than a de minimis cost savings benefit.
Using these values, the Agencies estimate a cost savings related to
reduced legal fees of $23,687,500 (9,475 x 0.25 x $10,000) for the
initial year and $4,737,500 (9,475 x 0.25 x $2,000) per year
thereafter.
The Agencies believe that the benefits of Regulation R justify the
costs.
C. 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 and is required to consider or determine if an
action is necessary or appropriate in the public interest, to consider
whether the action will promote efficiency, competition, and capital
formation.\376\ Exchange Act Section 23(a)(2) requires the Commission,
in adopting rules under that Act, to consider the impact that any such
rule will have on competition. This Section also prohibits the
Commission from adopting any rule that will impose a burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act.\377\
---------------------------------------------------------------------------
\376\ 15 U.S.C. 78c(f).
\377\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
The Agencies have designed the interpretations, definitions, and
exemptions to minimize any burden on competition. Indeed, the Agencies
believe 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 rules
allow banks to continue to conduct securities activities consistent
with the GLBA.
The rules define terms in the statutory exceptions to the
definition of broker added to the Exchange Act by Congress in the GLBA,
and provide guidance to banks as to the appropriate scope of those
exceptions. In addition, the rules contain a number of exemptions that
provide banks flexibility in conducting their securities activities,
which will promote competition and reduce costs.
D. Final Regulatory Flexibility Analysis
The Agencies have prepared a Final Regulatory Flexibility Analysis
(``FRFA''), in accordance with the provisions of the Regulatory
Flexibility Act (``RFA''),\378\ regarding the rules.
---------------------------------------------------------------------------
\378\ 5 U.S.C. 604.
---------------------------------------------------------------------------
1. Reasons for the Action
Section 201 of the GLBA amended the definition of ``broker'' in
Section 3(a)(4) of the Exchange Act to replace a blanket exemption from
that term for ``banks,'' as defined in Section 3(a)(6) of the Exchange
Act. Congress replaced this blanket exemption with eleven specific
exceptions for securities activities conducted by banks.\379\ On
October 13, 2006, President Bush signed into law
[[Page 56553]]
the Regulatory Relief Act.\380\ Section 101 of that Act, among other
things, requires the Agencies jointly to issue a single set of rules
implementing the bank broker exceptions in Section 3(a)(4) of the
Exchange Act.\381\ These rules are being adopted by the Agencies to
fulfill this requirement. The rules are designed generally to provide
guidance on the GLBA's bank exceptions from the definition of broker in
Exchange Act Section 3(a)(4) and to provide conditional exemptions from
the broker definition consistent with the purposes of the Exchange Act
and the GLBA.
---------------------------------------------------------------------------
\379\ 15 U.S.C. 78c(a)(4).
\380\ Pub. L. No. 109-351, 120 Stat. 1966 (2006).
\381\ See Exchange Act Section 3(a)(4)(F), as added by Section
101 of the Regulatory Relief Act. The Regulatory Relief Act also
requires that the Board and SEC consult with, and seek the
concurrence of, the OCC, FDIC and OTS prior to jointly adopting
final rules. As noted above, the Board and the SEC also have
consulted extensively with the OCC, FDIC and OTS in developing these
joint rules.
---------------------------------------------------------------------------
2. Objectives
The rules provide guidance to the industry with respect to the GLBA
requirements. The rules also provide certain conditional exemptions
from the broker definition to allow banks to perform certain securities
activities. The Supplementary Information section, supra, contains more
detailed information on the objectives of the rules.
3. Legal Basis
Pursuant to Section 101 of the Regulatory Relief Act, the Agencies
are issuing the rules.
4. Small Entities Subject to the Rule
The rules apply to ``banks,'' which is defined in Section 3(a)(6)
of the Exchange Act to include banking institutions organized in the
United States, including members of the Federal Reserve System, Federal
savings associations, as defined in Section 2(5) of the Home Owners'
Loan Act, and other commercial banks, savings associations, and
nondepository trust companies that are organized under the laws of a
state or the United States and subject to supervision and examination
by state or federal authorities having supervision over banks and
savings associations.\382\ Congress did not exempt small entity banks
from the application of the GLBA. Moreover, because the rules are
intended to provide guidance to, and exemptions for, all banks that are
subject to the GBLA, the Agencies determined that it would not be
appropriate or necessary to exempt small entity banks from the
operation of the rules. The rules generally apply to all banks,
including banks that would be considered small entities (i.e., banks
with total assets of $165 million or less) for purposes of the
RFA.\383\ The Agencies, however, have adopted several interpretations
or exceptions that likely will be particularly useful for small banks
such as, for example, the fixed inflation-adjusted dollar alternative
to the ``nominal'' requirement in the networking exception and the
exception in Rule 723 from the chiefly compensated test for a de
minimis number of trust or fiduciary accounts.
---------------------------------------------------------------------------
\382\ See 15 U.S.C. 78c(a)(6); Pub. L. No. 109-351, 120 Stat.
1966 (2006).
\383\ Small Business Administration regulations define ``small
entities'' to include banks and savings associations with total
assets of $165 million or less. 13 CFR 121.201.
---------------------------------------------------------------------------
The Agencies estimate that the rules will apply to approximately
9,475 banks, approximately 5,816 of which could be considered small
banks with assets of $165 million or less. Moreover, we do not
anticipate any significant costs to small entity banks as a result of
the rules. We note that a trade association whose membership consists
primarily of small banking organizations indicated that small banks
would be able to comply with the rules as proposed without
significantly altering their activities.\384\
---------------------------------------------------------------------------
\384\ See ICBA Letter.
---------------------------------------------------------------------------
5. Reporting, Recordkeeping and Other Compliance Requirements
The rules will not impose any significant reporting, recordkeeping,
or other compliance requirements on banks that are small entities.\385\
---------------------------------------------------------------------------
\385\ The Agencies' estimates related to recordkeeping and
disclosure are detailed in the ``Paperwork Reduction Act Analysis''
Section of this Release.
---------------------------------------------------------------------------
6. Duplicative, Overlapping, or Conflicting Federal Rules
The Agencies believe that no other rules duplicate, overlap, or
conflict with the final rules.
7. Significant Alternatives
Pursuant to Section 3(a) of the RFA,\386\ the Agencies must
consider the following types of alternatives: (1) The establishment of
differing compliance or reporting requirements or timetables that take
into account the resources available to small entities; (2) the
clarification, consolidation, or simplification of compliance and
reporting requirements under the rule for small entities; (3) the use
of performance rather than design standards; and (4) an exemption from
coverage of the rules, or any part thereof, for small entities.
---------------------------------------------------------------------------
\386\ 5 U.S.C. 604(a).
---------------------------------------------------------------------------
As discussed above, the GLBA does not exempt small entity banks
from the Exchange Act broker registration requirements and because the
rules are intended to provide guidance to, and exemptions for, all
banks that are subject to the GLBA and are designed to accommodate the
business practices of all banks (including small entity banks), the
Agencies determined that it would not be appropriate or necessary to
exempt small entity banks from the operation of the rules. Moreover,
providing one or more special exemptions for small banks could place
broker-dealers, including small broker-dealers, or larger banks at a
competitive disadvantage versus small banks.
The rules are intended to clarify and simplify compliance with the
GLBA by providing guidance with respect to exceptions and by providing
additional exemptions. As such, the rules are expected to facilitate
compliance by banks of all sizes, including small entity banks.
The Agencies do not believe that it is necessary to consider
whether small entity banks should be permitted to use performance
rather than design standards to comply with the rules because the rules
already use performance standards. Moreover, the rules 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
rules.
E. Plain Language
Section 722 of the GLBA (12 U.S.C. 4809) requires the Board to use
plain language in all proposed and final rules published by the Board
after January 1, 2000. The Board believes the rules, to the maximum
extent possible, are presented in a simple and straightforward manner.
X. Statutory Authority
Pursuant to authority set forth in the Exchange Act and
particularly Sections 3(a)(4), 3(b), 15, 17, 23(a), and 36 thereof (15
U.S.C. 78c(a)(4), 78c(b), 78o, 78q, 78w(a), and 78mm, respectively) the
Commission is repealing by operation of statute current Rules 3a4-2,
3a4-3, 3a4-4, 3a4-5, 3a4-6, and 3b-17 (Sec. Sec. 240.3a4-2, 240.3a4-3,
240.3a4-4, 240.3a4-5, 240.3a4-6, and 240.3b-17, respectively). The
Commission is repealing Exchange Act Rules 15a-7 and 15a-8 (Sec.
240.15a-7 and Sec. 240.15a-8, respectively). The Commission, jointly
with the Board of Governors of the Federal Reserve System, is also
adopting new Rules 700, 701, 721, 722, 723, 740, 741, 760, 771, 772,
775, 776, 780, and 781 under the Exchange Act (Sec. Sec. 247.700,
247.701, 247.721, 247.722, 247.723, 247.740,
[[Page 56554]]
247.741, 247.760, 247.771, 247.772, 247.775, 247.776, 247.780, and
247.881, respectively).
XI. Text of Rules and Rule Amendment
List of Subjects
12 CFR Part 218
Banks, Brokers, Securities.
17 CFR Part 240
Broker-dealers, Reporting and recordkeeping requirements,
Securities.
17 CFR Part 247
Banks, Brokers, Securities.
Federal Reserve System
Authority and Issuance
0
For the reasons set forth in the preamble, the Board amends Title 12,
Chapter II of the Code of Federal Regulations by adding a new Part 218
as set forth under Common Rules at the end of this document:
PART 218--EXCEPTIONS FOR BANKS FROM THE DEFINITION OF BROKER IN THE
SECURITIES EXCHANGE ACT OF 1934 (REGULATION R)
Sec.
218.100 Definition.
218.700 Defined terms relating to the networking exception from the
definition of ``broker.''
218.701 Exemption from the definition of ``broker'' for certain
institutional referrals.
218.721 Defined terms relating to the trust and fiduciary activities
exception from the definition of ``broker.''
218.722 Exemption allowing banks to calculate trust and fiduciary
compensation on a bank-wide basis.
218.723 Exemptions for special accounts, transferred accounts, and a
de minimis number of accounts.
218.740 Defined terms relating to the sweep accounts exception from
the definition of ``broker.''
218.741 Exemption for banks effecting transactions in money market
funds.
218.760 Exemption from definition of ``broker'' for banks accepting
orders to effect transactions in securities from or on behalf of
custody accounts.
218.771 Exemption from the definition of ``broker'' for banks
effecting transactions in securities issued pursuant to Regulation
S.
218.772 Exemption from the definition of ``broker'' for banks
engaging in securities lending transactions.
218.775 Exemption from the definition of ``broker'' for banks
effecting certain excepted or exempted transactions in investment
company securities.
218.776 Exemption from the definition of ``broker'' for banks
effecting certain excepted or exempted transactions in a company's
securities for its employee benefit plans.
218.780 Exemption for banks from liability under section 29 of the
Securities Exchange Act of 1934.
218.781 Exemption from the definition of ``broker'' for banks for a
limited period of time.
Authority: 15 U.S.C. 78c(a)(4)(F).
Securities and Exchange Commission
Authority and Issuance
0
For the reasons set forth in the preamble, the Commission amends Title
17, Chapter II of the Code of Federal Regulations as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
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, 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, 240.3b-17, 240.15a-7, and
240.15a-8 [Removed and Reserved]
0
2. Sections 240.3a4-2 through 240.3a4-6, 240.3b-17, 240.15a-7, and
240.15a-8 are removed and reserved.
0
3. Part 247 is added as set forth under Common Rules at the end of this
document:
PART 247--REGULATION R--EXEMPTIONS AND DEFINITIONS RELATED TO THE
EXCEPTIONS FOR BANKS FROM THE DEFINITION OF BROKER
Sec.
247.100 Definition.
247.700 Defined terms relating to the networking exception from the
definition of ``broker.''
247.701 Exemption from the definition of ``broker'' for certain
institutional referrals.
247.721 Defined terms relating to the trust and fiduciary activities
exception from the definition of ``broker.''
247.722 Exemption allowing banks to calculate trust and fiduciary
compensation on a bank-wide basis.
247.723 Exemptions for special accounts, transferred accounts, and a
de minimis number of accounts.
247.740 Defined terms relating to the sweep accounts exception from
the definition of ``broker.''
247.741 Exemption for banks effecting transactions in money market
funds.
247.760 Exemption from definition of ``broker'' for banks accepting
orders to effect transactions in securities from or on behalf of
custody accounts.
247.771 Exemption from the definition of ``broker'' for banks
effecting transactions in securities issued pursuant to Regulation
S.
247.772 Exemption from the definition of ``broker'' for banks
engaging in securities lending transactions.
247.775 Exemption from the definition of ``broker'' for banks
effecting certain excepted or exempted transactions in investment
company securities.
247.776 Exemption from the definition of ``broker'' for banks
effecting certain excepted or exempted transactions in a company's
securities for its employee benefit plans.
247.780 Exemption for banks from liability under section 29 of the
Securities Exchange Act of 1934.
247.781 Exemption from the definition of ``broker'' for banks for a
limited period of time.
Authority: 15 U.S.C. 78c, 78o, 78q, 78w, and 78mm.
Common Rules
The common rules that are adopted by the Commission as Part 247 of
Title 17, Chapter II of the Code of Federal Regulations and by the
Board as Part 218 of Title 12, Chapter II of the Code of Federal
Regulations follow:
Sec. ----.100 Definition.
For purposes of this part the following definition shall apply: Act
means the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.).
Sec. ----.700 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 Act (15 U.S.C. 78c(a)(4)(B)(i)) in the
context of transactions with a customer, the following terms shall have
the meaning provided:
(a) Contingent on whether the referral results in a transaction
means dependent on whether the referral results in a purchase or sale
of a security; whether an account is opened with a broker or dealer;
whether the referral results in a transaction involving a particular
type of security; or whether it results in multiple securities
transactions; provided, however, that a referral fee may be contingent
on whether a customer:
(1) Contacts or keeps an appointment with a broker or dealer as a
result of the referral; or
(2) Meets any objective, base-line qualification criteria
established by the bank or broker or dealer for customer referrals,
including such criteria as minimum assets, net worth, income, or
[[Page 56555]]
marginal federal or state income tax rate, or any requirement for
citizenship or residency that the broker or dealer, or the bank, may
have established generally for referrals for securities brokerage
accounts.
(b)(1) Incentive compensation means compensation that is intended
to encourage a bank employee to refer customers to a broker or dealer
or give a bank employee an interest in the success of a securities
transaction at a broker or dealer. The term does not include
compensation paid by a bank under a bonus or similar plan that is:
(i) Paid on a discretionary basis; and
(ii) Based on multiple factors or variables and:
(A) Those factors or variables include multiple significant factors
or variables that are not related to securities transactions at the
broker or dealer;
(B) A referral made by the employee is not a factor or variable in
determining the employee's compensation under the plan; and
(C) The employee's compensation under the plan is not determined by
reference to referrals made by any other person.
(2) Nothing in this paragraph (b) shall be construed to prevent a
bank from compensating an officer, director or employee under a bonus
or similar plan on the basis of any measure of the overall
profitability or revenue of:
(i) The bank, either on a stand-alone or consolidated basis;
(ii) Any affiliate of the bank (other than a broker or dealer), or
any operating unit of the bank or an affiliate (other than a broker or
dealer), if the affiliate or operating unit does not over time
predominately engage in the business of making referrals to a broker or
dealer; or
(iii) A broker or dealer if:
(A) Such measure of overall profitability or revenue is only one of
multiple factors or variables used to determine the compensation of the
officer, director or employee;
(B) The factors or variables used to determine the compensation of
the officer, director or employee include multiple significant factors
or variables that are not related to the profitability or revenue of
the broker or dealer;
(C) A referral made by the employee is not a factor or variable in
determining the employee's compensation under the plan; and
(D) The employee's compensation under the plan is not determined by
reference to referrals made by any other person.
(c) Nominal one-time cash fee of a fixed dollar amount means a cash
payment for a referral, to a bank employee who was personally involved
in referring the customer to the broker or dealer, in an amount that
meets any of the following standards:
(1) The payment does not exceed:
(i) Twice the average of the minimum and maximum hourly wage
established by the bank for the current or prior year for the job
family that includes the employee; or
(ii) 1/1000th of the average of the minimum and maximum annual base
salary established by the bank for the current or prior year for the
job family that includes the employee; or
(2) The payment does not exceed twice the employee's actual base
hourly wage or 1/1000th of the employee's actual annual base salary; or
(3) The payment does not exceed twenty-five dollars ($25), as
adjusted in accordance with paragraph (f) of this section.
(d) Job family means a group of jobs or positions involving similar
responsibilities, or requiring similar skills, education or training,
that a bank, or a separate unit, branch or department of a bank, has
established and uses in the ordinary course of its business to
distinguish among its employees for purposes of hiring, promotion, and
compensation.
(e) Referral means the action taken by one or more bank employees
to direct a customer of the bank to a broker or dealer for the purchase
or sale of securities for the customer's account.
(f) Inflation adjustment--(1) In general. On April 1, 2012, and on
the 1st day of each subsequent 5-year period, the dollar amount
referred to in paragraph (c)(3) of this section shall be adjusted by:
(i) Dividing the annual value of the Employment Cost Index For
Wages and Salaries, Private Industry Workers (or any successor index
thereto), as published by the Bureau of Labor Statistics, for the
calendar year preceding the calendar year in which the adjustment is
being made by the annual value of such index (or successor) for the
calendar year ending December 31, 2006; and
(ii) Multiplying the dollar amount by the quotient obtained in
paragraph (f)(1)(i) of this section.
(2) Rounding. If the adjusted dollar amount determined under
paragraph (f)(1) of this section for any period is not a multiple of
$1, the amount so determined shall be rounded to the nearest multiple
of $1.
Sec. ----.701 Exemption from the definition of ``broker'' for certain
institutional referrals.
(a) General. A bank that meets the requirements for the exception
from the definition of ``broker'' under section 3(a)(4)(B)(i) of the
Act (15 U.S.C. 78c(a)(4)(B)(i)), other than section 3(a)(4)(B)(i)(VI)
of the Act (15 U.S.C. 78c(a)(4)(B)(i)(VI)), is exempt from the
conditions of section 3(a)(4)(B)(i)(VI) of the Act solely to the extent
that a bank employee receives a referral fee for referring a high net
worth customer or institutional customer to a broker or dealer with
which the bank has a contractual or other written arrangement of the
type specified in section 3(a)(4)(B)(i) of the Act, if:
(1) Bank employee. (i) The bank employee is:
(A) Not registered or approved, or otherwise required to be
registered or approved, in accordance with the qualification standards
established by the rules of any self-regulatory organization;
(B) Predominantly engaged in banking activities other than making
referrals to a broker or dealer; and
(C) Not subject to statutory disqualification, as that term is
defined in section 3(a)(39) of the Act (15 U.S.C. 78c(a)(39)), except
subparagraph (E) of that section; and
(ii) The high net worth customer or institutional customer is
encountered by the bank employee in the ordinary course of the
employee's assigned duties for the bank.
(2) Bank determinations and obligations--(i) Disclosures. The bank
provides the high net worth customer or institutional customer the
information set forth in paragraph (b) of this section
(A) In writing prior to or at the time of the referral; or
(B) Orally prior to or at the time of the referral and
(1) The bank provides such information to the customer in writing
within 3 business days of the date on which the bank employee refers
the customer to the broker or dealer; or
(2) The written agreement between the bank and the broker or dealer
provides for the broker or dealer to provide such information to the
customer in writing in accordance with paragraph (a)(3)(i) of this
section.
(ii) Customer qualification. (A) In the case of a customer that is
a not a natural person, the bank has a reasonable basis to believe that
the customer is an institutional customer before the referral fee is
paid to the bank employee.
(B) In the case of a customer that is a natural person, the bank
has a reasonable basis to believe that the customer is a high net worth
customer prior to or at the time of the referral.
(iii) Employee qualification information. Before a referral fee is
paid to a bank employee under this section,
[[Page 56556]]
the bank provides the broker or dealer the name of the employee and
such other identifying information that may be necessary for the broker
or dealer to determine whether the bank employee is registered or
approved, or otherwise required to be registered or approved, in
accordance with the qualification standards established by the rules of
any self-regulatory organization or is subject to statutory
disqualification, as that term is defined in section 3(a)(39) of the
Act (15 U.S.C. 78c(a)(39)), except subparagraph (E) of that section.
(iv) Good faith compliance and corrections. A bank that acts in
good faith and that has reasonable policies and procedures in place to
comply with the requirements of this section shall not be considered a
``broker'' under section 3(a)(4) of the Act (15 U.S.C. 78c(a)(4))
solely because the bank fails to comply with the provisions of this
paragraph (a)(2) with respect to a particular customer if the bank:
(A) Takes reasonable and prompt steps to remedy the error (such as,
for example, by promptly making the required determination or promptly
providing the broker or dealer the required information); and
(B) Makes reasonable efforts to reclaim the portion of the referral
fee paid to the bank employee for the referral that does not, following
any required remedial action, meet the requirements of this section and
that exceeds the amount otherwise permitted under section
3(a)(4)(B)(i)(VI) of the Act (15 U.S.C. 78c(a)(4)(B)(i)(VI)) and Sec.
----.700.
(3) Provisions of written agreement. The written agreement between
the bank and the broker or dealer shall require that:
(i) Broker-dealer written disclosures. If, pursuant to paragraph
(a)(2)(i)(B)(2) of this section, the broker or dealer is to provide the
customer in writing the disclosures set forth in paragraph (b) of this
section, the broker or dealer provides such information to the customer
in writing:
(A) Prior to or at the time the customer begins the process of
opening an account at the broker or dealer, if the customer does not
have an account with the broker or dealer; or
(B) Prior to the time the customer places an order for a securities
transaction with the broker or dealer as a result of the referral, if
the customer already has an account at the broker or dealer.
(ii) Customer and employee qualifications. Before the referral fee
is paid to the bank employee:
(A) The broker or dealer determine that the bank employee is not
subject to statutory disqualification, as that term is defined in
section 3(a)(39) of the Act (15 U.S.C. 78c(a)(39)), except subparagraph
(E) of that section; and
(B) The broker or dealer has a reasonable basis to believe that the
customer is a high net worth customer or an institutional customer.
(iii) Suitability or sophistication determination by broker or
dealer--(A) Contingent referral fees. In any case in which payment of
the referral fee is contingent on completion of a securities
transaction at the broker or dealer, the broker or dealer, before such
securities transaction is conducted, perform a suitability analysis of
the securities transaction in accordance with the rules of the broker
or dealer's applicable self-regulatory organization as if the broker or
dealer had recommended the securities transaction.
(B) Non-contingent referral fees. In any case in which payment of
the referral fee is not contingent on the completion of a securities
transaction at the broker or dealer, the broker or dealer, before the
referral fee is paid, either:
(1) Determine that the customer:
(i) Has the capability to evaluate investment risk and make
independent decisions; and
(ii) Is exercising independent judgment based on the customer's own
independent assessment of the opportunities and risks presented by a
potential investment, market factors and other investment
considerations; or
(2) Perform a suitability analysis of all securities transactions
requested by the customer contemporaneously with the referral in
accordance with the rules of the broker or dealer's applicable self-
regulatory organization as if the broker or dealer had recommended the
securities transaction.
(iv) Notice to the customer. The broker or dealer inform the
customer if the broker or dealer determines that the customer or the
securities transaction(s) to be conducted by the customer does not meet
the applicable standard set forth in paragraph (a)(3)(iii) of this
section.
(v) Notice to the bank. The broker or dealer promptly inform the
bank if the broker or dealer determines that:
(A) The customer is not a high net worth customer or institutional
customer, as applicable; or
(B) The bank employee is subject to statutory disqualification, as
that term is defined in section 3(a)(39) of the Act (15 U.S.C.
78c(a)(39)), except subparagraph (E) of that section.
(b) Required disclosures. The disclosures provided to the high net
worth customer or institutional customer pursuant to paragraphs
(a)(2)(i) or (a)(3)(i) of this section shall clearly and conspicuously
disclose
(1) The name of the broker or dealer; and
(2) That the bank employee participates in an incentive
compensation program under which the bank employee may receive a fee of
more than a nominal amount for referring the customer to the broker or
dealer and payment of this fee may be contingent on whether the
referral results in a transaction with the broker or dealer.
(c) Receipt of other compensation. Nothing in this section prevents
or prohibits a bank from paying or a bank employee from receiving any
type of compensation that would not be considered incentive
compensation under Sec. ----.700(b)(1) or that is described in Sec.
----.700(b)(2).
(d) Definitions. When used in this section:
(1) High net worth customer--(i) General. High net worth customer
means:
(A) Any natural person who, either individually or jointly with his
or her spouse, has at least $5 million in net worth excluding the
primary residence and associated liabilities of the person and, if
applicable, his or her spouse; and
(B) Any revocable, inter vivos or living trust the settlor of which
is a natural person who, either individually or jointly with his or her
spouse, meets the net worth standard set forth in paragraph
(d)(1)(i)(A) of this section.
(ii) Individual and spousal assets. In determining whether any
person is a high net worth customer, there may be included in the
assets of such person
(A) Any assets held individually;
(B) If the person is acting jointly with his or her spouse, any
assets of the person's spouse (whether or not such assets are held
jointly); and
(C) If the person is not acting jointly with his or her spouse,
fifty percent of any assets held jointly with such person's spouse and
any assets in which such person shares with such person's spouse a
community property or similar shared ownership interest.
(2) Institutional customer means any corporation, partnership,
limited liability company, trust or other non-natural person that has,
or is controlled by a non-natural person that has, at least:
(i) $10 million in investments; or
(ii) $20 million in revenues; or
(iii) $15 million in revenues if the bank employee refers the
customer to the broker or dealer for investment banking services.
(3) Investment banking services includes, without limitation,
acting as
[[Page 56557]]
an underwriter in an offering for an issuer; acting as a financial
adviser in a merger, acquisition, tender offer or similar transaction;
providing venture capital, equity lines of credit, private investment-
private equity transactions or similar investments; serving as
placement agent for an issuer; and engaging in similar activities.
(4) Referral fee means a fee (paid in one or more installments) for
the referral of a customer to a broker or dealer that is:
(i) A predetermined dollar amount, or a dollar amount determined in
accordance with a predetermined formula (such as a fixed percentage of
the dollar amount of total assets placed in an account with the broker
or dealer), that does not vary based on:
(A) The revenue generated by or the profitability of securities
transactions conducted by the customer with the broker or dealer; or
(B) The quantity, price, or identity of securities transactions
conducted over time by the customer with the broker or dealer; or
(C) The number of customer referrals made; or
(ii) A dollar amount based on a fixed percentage of the revenues
received by the broker or dealer for investment banking services
provided to the customer.
(e) Inflation adjustments--(1) In general. On April 1, 2012, and on
the 1st day of each subsequent 5-year period, each dollar amount in
paragraphs (d)(1) and (d)(2) of this section shall be adjusted by:
(i) Dividing the annual value of the Personal Consumption
Expenditures Chain-Type Price Index (or any successor index thereto),
as published by the Department of Commerce, for the calendar year
preceding the calendar year in which the adjustment is being made by
the annual value of such index (or successor) for the calendar year
ending December 31, 2006; and
(ii) Multiplying the dollar amount by the quotient obtained in
paragraph (e)(1)(i) of this section.
(2) Rounding. If the adjusted dollar amount determined under
paragraph (e)(1) of this section for any period is not a multiple of
$100,000, the amount so determined shall be rounded to the nearest
multiple of $100,000.
Sec. ----.721 Defined terms relating to the trust and fiduciary
activities exception from the definition of ``broker.''
(a) Defined terms for chiefly compensated test. For purposes of
this part and section 3(a)(4)(B)(ii) of the Act (15 U.S.C.
78c(a)(4)(B)(ii)), the following terms shall have the meaning provided:
(1) Chiefly compensated--account-by-account test. Chiefly
compensated shall mean the relationship-total compensation percentage
for each trust or fiduciary account of the bank is greater than 50
percent.
(2) The relationship-total compensation percentage for a trust or
fiduciary account shall be the mean of the yearly compensation
percentage for the account for the immediately preceding year and the
yearly compensation percentage for the account for the year immediately
preceding that year.
(3) The yearly compensation percentage for a trust or fiduciary
account shall be
(i) Equal to the relationship compensation attributable to the
trust or fiduciary account during the year divided by the total
compensation attributable to the trust or fiduciary account during that
year, with the quotient expressed as a percentage; and
(ii) Calculated within 60 days of the end of the year.
(4) Relationship compensation means any compensation a bank
receives attributable to a trust or fiduciary account that consists of:
(i) An administration fee, including, without limitation, a fee
paid--
(A) For personal services, tax preparation, or real estate
settlement services;
(B) For disbursing funds from, or for recording receipt of payments
to, a trust or fiduciary account;
(C) In connection with securities lending or borrowing
transactions;
(D) For custody services; or
(E) In connection with an investment in shares of an investment
company for personal service, the maintenance of shareholder accounts
or any service described in paragraph (a)(4)(iii)(C) of this section;
(ii) An annual fee (payable on a monthly, quarterly or other
basis), including, without limitation, a fee paid for assessing
investment performance or for reviewing compliance with applicable
investment guidelines or restrictions;
(iii) A fee based on a percentage of assets under management,
including, without limitation, a fee paid
(A) Pursuant to a plan under Sec. 270.12b-1;
(B) In connection with an investment in shares of an investment
company for personal service or the maintenance of shareholder
accounts;
(C) Based on a percentage of assets under management for any of the
following services--
(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) Based on the financial performance of the assets in an account;
or
(E) For the types of services described in paragraph (a)(4)(i)(C)
or (D) of this section if paid based on a percentage of assets under
management;
(iv) A flat or capped per order processing fee, paid by or on
behalf of a customer or beneficiary, that is equal to not more than the
cost incurred by the bank in connection with executing securities
transactions for trust or fiduciary accounts; or
(v) Any combination of such fees.
(6) Trust or fiduciary account means an account for which the bank
acts in a trustee or fiduciary capacity as defined in section
3(a)(4)(D) of the Act (15 U.S.C. 78c(a)(4)(D)).
(7) Year means a calendar year, or fiscal year consistently used by
the bank for recordkeeping and reporting purposes.
(b) Revenues derived from transactions conducted under other
exceptions or exemptions. For purposes of calculating the yearly
compensation percentage for a trust or fiduciary account, a bank may at
its election exclude the compensation associated with any securities
transaction conducted in accordance with the exceptions in section
3(a)(4)(B)(i) or sections 3(a)(4)(B)(iii)-(xi) of the Act (15 U.S.C.
78c(a)(4)(B)(i) or 78c(a)(4)(B)(iii)-(xi)) and the rules issued
thereunder, including any exemption related to such exceptions jointly
adopted by the Commission and the Board, provided that if the bank
elects to exclude such compensation, the bank must exclude the
compensation from both the relationship compensation (if applicable)
and total compensation for the account.
(c) Advertising restrictions--
[[Page 56558]]
(1) In general. A bank complies with the advertising restriction in
section 3(a)(4)(B)(ii)(II) of the Act (15 U.S.C. 78c(a)(4)(B)(ii)(II))
if advertisements by or on behalf of the bank do not advertise--
(i) That the bank provides securities brokerage services for trust
or fiduciary accounts except as part of advertising the bank's broader
trust or fiduciary services; and
(ii) The securities brokerage services provided by the bank to
trust or fiduciary accounts more prominently than the other aspects of
the trust or fiduciary services provided to such accounts.
(2) Advertisement. For purposes of this section, the term
advertisement has the same meaning as in Sec. ----.760(g)(2).
Sec. ----.722 Exemption allowing banks to calculate trust and
fiduciary compensation on a bank-wide basis.
(a) General. A bank is exempt from meeting the ``chiefly
compensated'' condition in section 3(a)(4)(B)(ii)(I) of the Act (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 Act (15 U.S.C. 78c(a)(4)(D)) if:
(1) The bank 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 Act (15 U.S.C. 78c(a)(4)(B)(ii) and 15 U.S.C.
78c(a)(4)(C)), including the advertising restrictions in section
3(a)(4)(B)(ii)(II) of the Act (15 U.S.C. 78c(a)(4)(B)(ii)(II) as
implemented by Sec. --.721(c); and
(2) The aggregate relationship-total compensation percentage for
the bank's trust and fiduciary business is at least 70 percent.
(b) Aggregate relationship-total compensation percentage. For
purposes of this section, the aggregate relationship-total compensation
percentage for a bank's trust and fiduciary business shall be the mean
of the bank's yearly bank-wide compensation percentage for the
immediately preceding year and the bank's yearly bank-wide compensation
percentage for the year immediately preceding that year.
(c) Yearly bank-wide compensation percentage. For purposes of this
section, a bank's yearly bank-wide compensation percentage for a year
shall be
(1) Equal to the relationship compensation attributable to the
bank's trust and fiduciary business as a whole during the year divided
by the total compensation attributable to the bank's trust and
fiduciary business as a whole during that year, with the quotient
expressed as a percentage; and
(2) Calculated within 60 days of the end of the year.
(d) Revenues derived from transactions conducted under other
exceptions or exemptions. For purposes of calculating the yearly
compensation percentage for a trust or fiduciary account, a bank may at
its election exclude the compensation associated with any securities
transaction conducted in accordance with the exceptions in section
3(a)(4)(B)(i) or sections 3(a)(4)(B)(iii)-(xi) of the Act (15 U.S.C.
78c(a)(4)(B)(i) or 78c(a)(4)(B)(iii)-(xi)) and the rules issued
thereunder, including any exemption related to such sections jointly
adopted by the Commission and the Board, provided that if the bank
elects to exclude such compensation, the bank must exclude the
compensation from both the relationship compensation (if applicable)
and total compensation of the bank.
Sec. ----.723 Exemptions for special accounts, transferred accounts,
foreign branches and a de minimis number of accounts.
(a) Short-term accounts. A bank may, in determining its compliance
with the chiefly compensated test in Sec. ----.721(a)(1) or Sec. --
--.722(a)(2), exclude any trust or fiduciary account that had been open
for a period of less than 3 months during the relevant year.
(b) Accounts acquired as part of a business combination or asset
acquisition. For purposes of determining compliance with the chiefly
compensated test in Sec. ----.721(a)(1) or Sec. ----.722(a)(2), any
trust or fiduciary account that a bank acquired from another person as
part of a merger, consolidation, acquisition, purchase of assets or
similar transaction may be excluded by the bank for 12 months after the
date the bank acquired the account from the other person.
(c) Non-shell foreign branches--(1) Exemption. For purposes of
determining compliance with the chiefly compensated test in Sec. --
--.722(a)(2), a bank may exclude the trust or fiduciary accounts held
at a non-shell foreign branch of the bank if the bank has reasonable
cause to believe that trust or fiduciary accounts of the foreign branch
held by or for the benefit of a U.S. person as defined in 17 CFR
230.902(k) constitute less than 10 percent of the total number of trust
or fiduciary accounts of the foreign branch.
(2) Rules of construction. Solely for purposes of this paragraph
(c), a bank will be deemed to have reasonable cause to believe that a
trust or fiduciary account of a foreign branch of the bank is not held
by or for the benefit of a U.S. person if
(i) The principal mailing address maintained and used by the
foreign branch for the accountholder(s) and beneficiary(ies) of the
account is not in the United States; or
(ii) The records of the foreign branch indicate that the
accountholder(s) and beneficiary(ies) of the account is not a U.S.
person as defined in 17 CFR 230.902(k).
(3) Non-shell foreign branch. Solely for purposes of this paragraph
(c), a non-shell foreign branch of a bank means a branch of the bank
(i) That is located outside the United States and provides banking
services to residents of the foreign jurisdiction in which the branch
is located; and
(ii) For which the decisions relating to day-to-day operations and
business of the branch are made at that branch and are not made by an
office of the bank located in the United States.
(d) Accounts transferred to a broker or dealer or other
unaffiliated entity. Notwithstanding section 3(a)(4)(B)(ii)(I) of the
Act (15 U.S.C. 78c(a)(4)(B)(ii)(I)) and Sec. ----.721(a)(1) of this
part, a bank operating under Sec. ----.721(a)(1) shall not be
considered a broker for purposes of section 3(a)(4) of the Act (15
U.S.C. 78c(a)(4)) solely because a trust or fiduciary account does not
meet the chiefly compensated standard in Sec. ----.721(a)(1) if,
within 3 months of the end of the year in which the account fails to
meet such standard, the bank transfers the account or the securities
held by or on behalf of the account to a broker or dealer registered
under section 15 of the Act (15 U.S.C. 78o) or another entity that is
not an affiliate of the bank and is not required to be registered as a
broker or dealer.
(e) De minimis exclusion. A bank may, in determining its compliance
with the chiefly compensated test in Sec. ----.721(a)(1), exclude a
trust or fiduciary account if:
(1) The bank maintains records demonstrating that the securities
transactions conducted by or on behalf of the account were undertaken
by the bank in the exercise of its trust or fiduciary responsibilities
with respect to the account;
(2) The total number of accounts excluded by the bank under this
paragraph (d) does not exceed the lesser of--
(i) 1 percent of the total number of trust or fiduciary accounts
held by the bank, provided that if the number so obtained is less than
1 the amount shall be rounded up to 1; or
(ii) 500; and
[[Page 56559]]
(3) The bank did not rely on this paragraph (d) with respect to
such account during the immediately preceding year.
Sec. ----.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 Act (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.
(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)).
Sec. ----.741 Exemption for banks effecting transactions in money
market funds.
(a) A bank is exempt from the definition of the term ``broker''
under section 3(a)(4) of the Act (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) The bank either
(A) Provides the customer, directly or indirectly, any other
product or service, the provision of which would not, in and of itself,
require the bank to register as a broker or dealer under section 15(a)
of the Act (15 U.S.C. 78o(a)); or
(B) Effects the transactions on behalf of another bank as part of a
program for the investment or reinvestment of deposit funds of, or
collected by, the other bank; and
(2)(i) The class or series of securities is no-load; or
(ii) If the class or series of securities is not no-load
(A) The bank or, if applicable, the other bank described in
paragraph (a)(1)(B) of this section provides the customer, not later
than at the time the customer authorizes the securities transactions, a
prospectus for the securities; and
(B) The bank and, if applicable, the other bank described in
paragraph (a)(1)(B) of this section do not characterize or refer to the
class or series of securities as no-load.
(b) Definitions. For purposes of this section:
(1) Money market fund has the same meaning as in Sec. ----.740(b).
(2) No-load has the same meaning as in Sec. ----.740(c).
Sec. ----.760 Exemption from definition of ``broker'' for banks
accepting orders to effect transactions in securities from or on behalf
of custody accounts.
(a) Employee benefit plan accounts and individual retirement
accounts or similar accounts. A bank is exempt from the definition of
the term ``broker'' under section 3(a)(4) of the Act (15 U.S.C.
78c(a)(4)) to the extent that, as part of its customary banking
activities, the bank accepts orders to effect transactions in
securities for an employee benefit plan account or an individual
retirement account or similar account for which the bank acts as a
custodian if:
(1) Employee compensation restriction and additional conditions.
The bank complies with the employee compensation restrictions in
paragraph (c) of this section and the other conditions in paragraph (d)
of this section;
(2) Advertisements. Advertisements by or on behalf of the bank do
not:
(i) Advertise that the bank accepts orders for securities
transactions for employee benefit plan accounts or individual
retirement accounts or similar accounts, except as part of advertising
the other custodial or safekeeping services the bank provides to these
accounts; or
(ii) Advertise that such accounts are securities brokerage accounts
or that the bank's safekeeping and custody services substitute for a
securities brokerage account; and
(3) Advertisements and sales literature for individual retirement
or similar accounts. Advertisements and sales literature issued by or
on behalf of the bank do not describe the securities order-taking
services provided by the bank to individual retirement accounts or
similar accounts more prominently than the other aspects of the custody
or safekeeping services provided by the bank to these accounts.
(b) Accommodation trades for other custodial accounts. A bank is
exempt from the definition of the term ``broker'' under section 3(a)(4)
of the Act (15 U.S.C. 78c(a)(4)) to the extent that, as part of its
customary banking activities, the bank accepts orders to effect
transactions in securities for an account for which the bank acts as
custodian other than an employee benefit plan account or an individual
retirement account or similar account if:
(1) Accommodation. The bank accepts orders to effect transactions
in securities for the account only as an accommodation to the customer;
(2) Employee compensation restriction and additional conditions.
The bank complies with the employee compensation restrictions in
paragraph (c) of this section and the other conditions in paragraph (d)
of this section;
(3) Bank fees. Any fee charged or received by the bank for
effecting a securities transaction for the account does not vary based
on:
(i) Whether the bank accepted the order for the transaction; or
(ii) The quantity or price of the securities to be bought or sold;
(4) Advertisements. Advertisements by or on behalf of the bank do
not state that the bank accepts orders for securities transactions for
the account;
(5) Sales literature. Sales literature issued by or on behalf of
the bank:
[[Page 56560]]
(i) Does not state that the bank accepts orders for securities
transactions for the account except as part of describing the other
custodial or safekeeping services the bank provides to the account; and
(ii) Does not describe the securities order-taking services
provided to the account more prominently than the other aspects of the
custody or safekeeping services provided by the bank to the account;
and
(6) Investment advice and recommendations. The bank does not
provide investment advice or research concerning securities to the
account, make recommendations to the account concerning securities or
otherwise solicit securities transactions from the account; provided,
however, that nothing in this paragraph (b)(6) shall prevent a bank
from:
(i) Publishing, using or disseminating advertisements and sales
literature in accordance with paragraphs (b)(4) and (b)(5) of this
section; and
(ii) Responding to customer inquiries regarding the bank's
safekeeping and custody services by providing:
(A) Advertisements or sales literature consistent with the
provisions of paragraphs (b)(4) and (b)(5) of this section describing
the safekeeping, custody and related services that the bank offers;
(B) A prospectus prepared by a registered investment company, or
sales literature prepared by a registered investment company or by the
broker or dealer that is the principal underwriter of the registered
investment company pertaining to the registered investment company's
products;
(C) Information based on the materials described in paragraphs
(b)(6)(ii)(A) and (B) of this section; or
(iii) Responding to inquiries regarding the bank's safekeeping,
custody or other services, such as inquiries concerning the customer's
account or the availability of sweep or other services, so long as the
bank does not provide investment advice or research concerning
securities to the account or make a recommendation to the account
concerning securities.
(c) Employee compensation restriction. A bank may accept orders
pursuant to this section for a securities transaction for an account
described in paragraph (a) or (b) of this section only if no bank
employee receives compensation, including a fee paid pursuant to a plan
under 17 CFR 270.12b-1, from the bank, the executing broker or dealer,
or any other person that is based on whether a securities transaction
is executed for the account or that is based on the quantity, price, or
identity of securities purchased or sold by such account, provided that
nothing in this paragraph shall prohibit a bank employee from receiving
compensation that would not be considered incentive compensation under
Sec. ----.700(b)(1) as if a referral had been made by the bank
employee, or any compensation described in Sec. ----.700(b)(2).
(d) Other conditions. A bank may accept orders for a securities
transaction for an account for which the bank acts as a custodian under
this section only if the bank:
(1) Does not act in a trustee or fiduciary capacity (as defined in
section 3(a)(4)(D) of the Act (15 U.S.C. 78c(a)(4)(D)) with respect to
the account, other than as a directed trustee;
(2) Complies with section 3(a)(4)(C) of the Act (15 U.S.C.
78c(a)(4)(C)) in handling any order for a securities transaction for
the account; and
(3) Complies with section 3(a)(4)(B)(viii)(II) of the Act (15
U.S.C. 78c(a)(4)(B)(viii)(II)) regarding carrying broker activities.
(e) Non-fiduciary administrators and recordkeepers. A bank that
acts as a non-fiduciary and non-custodial administrator or recordkeeper
for an employee benefit plan account for which another bank acts as
custodian may rely on the exemption provided in this section if:
(1) Both the custodian bank and the administrator or recordkeeper
bank comply with paragraphs (a), (c) and (d) of this section; and
(2) The administrator or recordkeeper bank does not execute a
cross-trade with or for the employee benefit plan account or net orders
for securities for the employee benefit plan account, other than:
(i) Crossing or netting orders for shares of open-end investment
companies not traded on an exchange, or
(ii) Crossing orders between or netting orders for accounts of the
custodian bank that contracted with the administrator or recordkeeper
bank for services.
(f) Subcustodians. A bank that acts as a subcustodian for an
account for which another bank acts as custodian may rely on the
exemptions provided in this section if:
(1) For employee benefit plan accounts and individual retirement
accounts or similar accounts, both the custodian bank and the
subcustodian bank meet the requirements of paragraphs (a), (c) and (d)
of this section;
(2) For other custodial accounts, both the custodian bank and the
subcustodian bank meet the requirements of paragraphs (b), (c) and (d)
of this section; and
(3) The subcustodian bank does not execute a cross-trade with or
for the account or net orders for securities for the account, other
than:
(i) Crossing or netting orders for shares of open-end investment
companies not traded on an exchange, or
(ii) Crossing orders between or netting orders for accounts of the
custodian bank.
(g) Evasions. In considering whether a bank meets the terms of this
section, both the form and substance of the relevant account(s),
transaction(s) and activities (including advertising activities) of the
bank will be considered in order to prevent evasions of the
requirements of this section.
(h) Definitions. When used in this section:
(1) Account for which the bank acts as a custodian means an account
that is:
(i) An employee benefit plan account for which the bank acts as a
custodian;
(ii) An individual retirement account or similar account for which
the bank acts as a custodian;
(iii) An account established by a written agreement between the
bank and the customer that sets forth the terms that will govern the
fees payable to, and rights and obligations of, the bank regarding the
safekeeping or custody of securities; or
(iv) An account for which the bank acts as a directed trustee.
(2) Advertisement means any material that is published or used in
any electronic or other public media, including any Web site,
newspaper, magazine or other periodical, radio, television, telephone
or tape recording, videotape display, signs or billboards, motion
pictures, or telephone directories (other than routine listings).
(3) Directed trustee means a trustee that does not exercise
investment discretion with respect to the account.
(4) Employee benefit plan account means a pension plan, retirement
plan, profit sharing plan, bonus plan, thrift savings plan, incentive
plan, or other similar plan, including, without limitation, an
employer-sponsored plan qualified under section 401(a) of the Internal
Revenue Code (26 U.S.C. 401(a)), a governmental or other plan described
in section 457 of the Internal Revenue Code (26 U.S.C. 457), a tax-
deferred plan described in section 403(b) of the Internal Revenue Code
(26 U.S.C. 403(b)), a church plan, governmental, multiemployer or other
plan described in section 414(d), (e) or (f) of the Internal Revenue
Code (26 U.S.C. 414(d), (e) or (f)), an incentive
[[Page 56561]]
stock option plan described in section 422 of the Internal Revenue Code
(26 U.S.C. 422); a Voluntary Employee Beneficiary Association Plan
described in section 501(c)(9) of the Internal Revenue Code (26 U.S.C.
501(c)(9)), a non-qualified deferred compensation plan (including a
rabbi or secular trust), a supplemental or mirror plan, and a
supplemental unemployment benefit plan.
(5) Individual retirement account or similar account means an
individual retirement account as defined in section 408 of the Internal
Revenue Code (26 U.S.C. 408), Roth IRA as defined in section 408A of
the Internal Revenue Code (26 U.S.C. 408A), health savings account as
defined in section 223(d) of the Internal Revenue Code (26 U.S.C.
223(d)), Archer medical savings account as defined in section 220(d) of
the Internal Revenue Code (26 U.S.C. 220(d)), Coverdell education
savings account as defined in section 530 of the Internal Revenue Code
(26 U.S.C. 530), or other similar account.
(6) Sales literature means any written or electronic communication,
other than an advertisement, that is generally distributed or made
generally available to customers of the bank or the public, including
circulars, form letters, brochures, telemarketing scripts, seminar
texts, published articles, and press releases concerning the bank's
products or services.
(7) 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)).
Sec. --.771 Exemption from the definition of ``broker'' for banks
effecting transactions in securities issued pursuant to Regulation S.
(a) A bank is exempt from the definition of the term ``broker''
under section 3(a)(4) of the Act (15 U.S.C. 78c(a)(4)), to the extent
that, as agent, the bank:
(1) Effects a sale in compliance with the requirements of 17 CFR
230.903 of an eligible security to a purchaser who is not in the United
States;
(2) Effects, by or on behalf of a person who is not a U.S. person
under 17 CFR 230.902(k), a resale of an eligible security after its
initial sale with a reasonable belief that the eligible security was
initially sold outside of the United States within the meaning of and
in compliance with the requirements of 17 CFR 230.903 to a purchaser
who is not in the United States or a registered broker or dealer,
provided that if the resale is made prior to the expiration of any
applicable distribution compliance period specified in 17 CFR
230.903(b)(2) or (b)(3), the resale is made in compliance with the
requirements of 17 CFR 230.904; or
(3) Effects, by or on behalf of a registered broker or dealer, a
resale of an eligible security after its initial sale with a reasonable
belief that the eligible security was initially sold outside of the
United States within the meaning of and in compliance with the
requirements of 17 CFR 230.903 to a purchaser who is not in the United
States, provided that if the resale is made prior to the expiration of
any applicable distribution compliance period specified in 17 CFR
230.903(b)(2) or (b)(3), the resale 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).
Sec. ----.772 Exemption from the definition of ``broker'' for banks
engaging in securities lending transactions.
(a) A bank is exempt from the definition of the term ``broker''
under section 3(a)(4) of the Act (15 U.S.C. 78c(a)(4)), to the extent
that, as an agent, it engages in or effects securities lending
transactions, and any securities lending services in connection with
such transactions, with or on behalf of a person the bank reasonably
believes to be:
(1) A qualified investor as defined in section 3(a)(54)(A) of the
Act (15 U.S.C. 78c(a)(54)(A)); or
(2) Any employee benefit plan that owns and invests on a
discretionary basis, not less than $ 25,000,000 in investments.
(b) Securities lending transaction means a transaction in which the
owner of a security lends the security temporarily to another party
pursuant to a written securities lending agreement under which the
lender retains the economic interests of an owner of such securities,
and has the right to terminate the transaction and to recall the loaned
securities on terms agreed by the parties.
(c) Securities lending services means:
(1) Selecting and negotiating with a borrower and executing, or
directing the execution of the loan with the borrower;
(2) Receiving, delivering, or directing the receipt or delivery of
loaned securities;
(3) Receiving, delivering, or directing the receipt or delivery of
collateral;
(4) Providing mark-to-market, corporate action, recordkeeping or
other services incidental to the administration of the securities
lending transaction;
(5) Investing, or directing the investment of, cash collateral; or
(6) Indemnifying the lender of securities with respect to various
matters.
Sec. ----.775 Exemption from the definition of ``broker'' for banks
effecting certain 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 Act (15 U.S.C. 78c(a)(4)(C)(i)), is exempt
from such condition to the extent that it effects a transaction in a
covered security, if:
(1) Any such security is neither traded on a national securities
exchange nor through the facilities of a national securities
association or an interdealer quotation system;
(2) The security is distributed by a registered broker or dealer,
or the sales charge is no more than the amount permissible for a
security sold by a registered broker or dealer pursuant to any
applicable rules adopted pursuant to section 22(b)(1) of the Investment
Company Act of 1940 (15 U.S.C. 80a-22(b)(1)) by a securities
association registered under section 15A of the Act (15 U.S.C. 78o-3);
and
(3) Any such transaction is effected:
(i) Through the National Securities Clearing Corporation; or
(ii) Directly with a transfer agent or with an insurance company or
separate account that is excluded from the definition of transfer agent
in Section 3(a)(25) of the Act.
(b) Definitions. For purposes of this section:
(1) Covered security means:
(i) Any security issued by an open-end company, as defined by
section 5(a)(1) of the Investment Company Act (15 U.S.C. 80a5(a)(1)),
that is registered under that Act; and
(ii) Any variable insurance contract funded by a separate account,
as defined by section 2(a)(37) of the Investment Company Act (15 U.S.C.
80a-2(a)(37)), that is registered under that Act.
[[Page 56562]]
(2) Interdealer quotation system has the same meaning as in 17 CFR
240.15c2-11.
(3) Insurance company has the same meaning as in 15 U.S.C.
77b(a)(13).
Sec. ----.776 Exemption from the definition of ``broker'' for banks
effecting certain excepted or exempted transactions in a company's
securities for its employee benefit plans.
(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 Act (15 U.S.C. 78c(a)(4)(C)(i)), is exempt
from such condition to the extent that it effects a transaction in the
securities of a company directly with a transfer agent acting for the
company that issued the security, if:
(1) No commission is charged with respect to the transaction;
(2) The transaction is conducted by the bank solely for the benefit
of an employee benefit plan account;
(3) Any such security is obtained directly from:
(i) The company; or
(ii) An employee benefit plan of the company; and
(4) Any such security is transferred only to:
(i) The company; or
(ii) An employee benefit plan of the company.
(b) For purposes of this section, the term employee benefit plan
account has the same meaning as in Sec. ----.760(h)(4).
Sec. ----.780 Exemption for banks from liability under section 29 of
the Securities Exchange Act of 1934.
(a) No contract entered into before March 31, 2009, shall be void
or considered voidable by reason of section 29(b) of the Act (15 U.S.C.
78cc(b)) because any bank that is a party to the contract violated the
registration requirements of section 15(a) of the Act (15 U.S.C.
78o(a)), any other applicable provision of the Act, or the rules and
regulations thereunder based solely on the bank's status as a broker
when the contract was created.
(b) No contract shall be void or considered voidable by reason of
section 29(b) of the Act (15 U.S.C. 78cc(b)) because any bank that is a
party to the contract violated the registration requirements of section
15(a) of the Act (15 U.S.C. 78o(a)) or the rules and regulations
thereunder based solely on the bank's status as a broker when the
contract was created, if:
(1) At the time the contract was created, the bank acted in good
faith and had reasonable policies and procedures in place to comply
with section 3(a)(4)(B) of the Act (15 U.S.C. 78c(a)(4)(B)) and the
rules and regulations thereunder; and
(2) At the time the contract was created, any violation of the
registration requirements of section 15(a) of the Act by the bank did
not result in any significant harm or financial loss or cost to the
person seeking to void the contract.
Sec. ----.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 Act (15 U.S.C. 78c(a)(4)) until the first day of
its first fiscal year commencing after September 30, 2008.
By order of the Board of Governors of the Federal Reserve
System, September 24, 2007.
Jennifer J. Johnson,
Secretary of the Board.
Dated: September 24, 2007.
By the Securities and Exchange Commission.
Nancy M. Morris,
Secretary.
[FR Doc. 07-4769 Filed 9-28-07; 8:45 am]
BILLING CODE 8011-01-P; 6210-01-P