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The Securities and Exchange Commission and the bank regulatory agencies have proposed new Regulation R that will govern certain bank securities broker activities. It follows several attempts by the SEC to resolve the uncertainty surrounding bank securities activities since the passage of the Gramm-Leach-Bliley Act in 1999.
On December 13 and December 18, 2006, the Securities and Exchange Commission (SEC) and the Board of Governors of the Federal Reserve System (FRB) respectively voted to propose new Regulation R that will govern certain bank securities broker activities. (1) The SEC also voted to propose a companion release adding, among other things, new and amended rules to the already effective bank dealer rules that were issued by the SEC in 2003 (Bank Dealer Rules). (2) In addition, the SEC issued an order extending the temporary exemption for banks from the definition of "broker" under Section 3(a)(4) of the Securities Exchange Act of 1934 (Exchange Act) until July 2, 2007. (3)
Proposed Regulation R and the proposed Bank Dealer Rules are significant developments for banking institutions and should represent the penultimate step in finalizing rules that will resolve the uncertainty surrounding bank securities activities since the passage of the Gramm-Leach-Bliley Act in 1999 (GLB Act). These proposed new and amended rules offer an opportunity for banks and their holding companies to explore new and alternative securities product and service offerings directly within a banking institution.
A Brief History
The passage of the GLB Act in 1999, among other things, drastically altered the landscape of bank securities activities. Sections 201 and 202 of the GLB Act amended the definitions of broker and dealer under Sections 3(a)(4) and 3(a)(5) of the Exchange Act by removing the global bank exception from those definitions and substituting for that exception a list of specific, permissible bank securities activities. Under the Exchange Act, permitted bank securities activities include networking arrangements, trust activities, custody activities and sweep accounts. If a bank's securities activities fall within the definitions of broker or dealer, but do not fall into one or more of the enumerated categories of permissible bank securities activities, the bank must transfer or "push-out" the activity to an affiliated registered broker-dealer. The various categories of permissible bank securities activities listed in the Exchange Act are intended to cover the types of securities activities that banks traditionally have provided.
Since May 2001, the SEC has been wrestling with the task of drafting rules to govern the securities broker and securities dealer activities of banks under the GLB Act. In February 2003, the SEC issued final rules governing certain bank securities dealer activities. (4) Compliance with these rules was required by September 30, 2003. The SEC's bank broker rules have been more controversial and, consequently, have undergone several major revisions. The most recent version of the SEC's bank broker rules, Regulation B, was proposed in June 2004 (5) and, similar to the SEC's prior initiatives in this area, was greeted with significant negative comment from the banking industry, banking regulators, and Capitol Hill. The proposed Regulation R and Bank Dealer Rules are the next and hopefully final round in the SEC's attempt to construct rules to govern bank securities broker activities.
Proposed Regulation R will replace the SEC's prior efforts in the area of bank securities broker activities, including the previously proposed Regulation B. The proposed Bank Dealer Rules will amend and supplement the SEC's existing bank dealer rules.
Unlike prior SEC initiatives directed at bank securities activities (e.g., the original Interim Final Rules released in 1999, the final bank dealer rules issued in 2003, and Regulation B proposed in 2004), proposed Regulation R and the proposed Bank Dealer Rules were drafted jointly by the respective staffs of the SEC and the FRB. (6) The joint rulemaking was mandated by Congress in the recently enacted Financial Services Regulatory Relief Act of 2006 (Reg Relief Act). The Reg Relief Act also required the SEC and FRB to consult with and seek the concurrence of the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Deposit Insurance Corporation.
The direct input of the primary federal bank regulatory agencies in drafting the proposed new and amended rules should result in a set of rules that is more constructive than the SEC's previous efforts in this area. While proposed Regulation R shows some signs of progress from prior SEC efforts in this area, the proposal remains a complex web of inter-related definitions and exemptions. In many respects, proposed Regulation R constitutes micro-management of bank securities activities. (7) It is also interesting to note that many elements of proposed Regulation R clearly are the result of heavy negotiation between the staffs of the SEC and FRB, for example, footnote 38 of the proposed release has an interesting discussion of the meaning of the phrase "including, without limitation." (8)
Several sections of the proposing release show signs of major wins for the banking industry over prior SEC interpretations included in proposed Regulation B. For example, determining whether a department of a bank is a trust department or is examined for compliance with fiduciary principles under the trust and fiduciary activities exception is to be determined by the federal bank regulatory agencies and not the SEC. Further, the federal banking agencies will, in consultation with the SEC, draft record keeping rules that will function as the means to show compliance with the requirements of the push-out rules. Proposed Regulation R also includes "safe-harbor" provisions that permit a bank to continue to offer certain securities services without registering as a broker with the SEC even if the bank is not in technical compliance with one or more of the conditions of proposed Regulation R.
Proposed Regulation R
Section 3(a)(4)(B) of the Exchange Act includes eleven statutory exceptions from the definition of "broker" for certain bank broker activities. These exceptions include, among other things, certain private placement activities, transactions in "identified banking products," and a de minimis number of securities transactions. Proposed Regulation R, however, does not address all of the statutory bank broker exceptions, nor does it address any of the bank dealer exceptions included in Section 3(a)(5) of the Exchange Act. In general, Proposed Regulation R discusses four of the statutory bank broker exceptions:
* Third-Party Brokerage Arrangements (i.e., Networking Arrangements);
* Trust and Fiduciary Activities;
* Sweep Accounts; and
* Safekeeping and Custody Activities. (9)
Proposed Regulation R also includes other rules that address additional bank securities activities outside the statutory "push-out" provisions, including an exemption for mutual fund transactions that are effected through a clearing agency (e.g., NSCC's FundServ) and certain agency transactions effected pursuant to SEC Regulation S. (10)
While proposed Regulation R does not address all possible bank broker activities, the SEC and the FRB are soliciting comments on whether the agencies should issue rules or guidance on additional bank broker activities.
Exchange Act Section 3(a)(4)(B)(i) provides an exception from the definition of broker that permits banks to contract with broker-dealers under certain conditions in order to offer bank customers certain financial services that includes securities brokerage products and services without the bank having to register as a broker (Networking Exception). The Networking Exception includes numerous conditions that a bank must meet to fall within the parameters of the exception. Without the Networking Exception, banks might be required to register as broker-dealers if they enter into networking arrangements with broker-dealers. (11)
Similar to Regulation B, proposed Regulation R defines certain of the key terms included in the Networking Exception. (12)
Proposed definition of "nominal one-time cash fee of a fixed dollar amount." One of the conditions of the Networking Exception relates to compensation arrangements between and among the broker-dealer, bank, and non-registered bank employees participating in a networking arrangement. Generally, under the Networking Exception, there are no limitations on the types …