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Proposed Exceptions Would Keep Balance Between Bankers and Securities Brokers

Sunday, July 1, 2007

Federal regulatory agencies are proposing broker exemption rules for banks. The rules would define the securities activities that banks may engage in without needing to register with the Securities and Exchange Commission (SEC) as a securities broker.

Explains Tim Koellner of the St. Louis Fed's Banking Supervision & Regulation department: "In short, the rules would let a bank, subject to certain conditions, continue to conduct securities transactions for its customers as part of the bank's trust, fiduciary, custodial and deposit 'sweep' functions, and refer customers to a securities broker-dealer pursuant to a networking arrangement with the broker-dealer."

Before the Gramm-Leach-Bliley Act (GLBA) of 1999, banks had a blanket exception from the definition of "broker" under SEC regulations. The GLBA replaced the blanket exception with 11 activity-based exceptions that let banks continue to provide securities services as part of normal banking functions while also preventing firms from moving a broker-dealer into a bank to avoid SEC regulations. To implement the four most important exceptions, the SEC and Federal Reserve Board jointly issued the proposed Regulation R, which is summarized below.

The first exception lets banks and their employees refer customers to a broker-dealer, subject to certain conditions. Those employees may receive a referral fee that is nominal, non-contingent and paid only in cash. There are special rules on fees for referrals of high net worth and institutional customers. The proposal is not intended to disrupt traditional bonus plans that are: 1) unrelated to securities transactions conducted at a broker-dealer and referrals to a broker-dealer or 2) based on any measure of overall profitability of the bank or any of its affiliates or operating units (other than a broker or dealer). The proposed rules also specify acceptable bonus payment practices.

The second exception lets a bank continue to make securities transactions for its trust and fiduciary customers if the bank receives predominantly "relationship compensation," including administration fees, annual fees, processing fees that do not exceed the bank's cost for executing the transactions and fees based on a percentage of assets under management. The proposed rule prohibits public solicitation of brokerage business other than in conjunction with the bank's advertising of its other trust and fiduciary activities.

The third exception allows banks to conduct a variety of securities activities in connection with customary custody activities. As with the previous two exceptions, the rules limit employee compensation and restrict bank advertisements and marketing practices. Banks may not act as a "carrying broker" for a registered broker-dealer under the proposed rules.

The fourth exception lets banks sweep deposits into a load money market mutual fund if the bank does not characterize the fund as being no-load and provides the fund's prospectus to the customer before sweep transactions are authorized. A bank may transfer any type of customer money into a money market fund if the bank provides the customer with some other banking product or service that does not require broker-dealer registration, such as loan or escrow services.

In sum, the proposed exceptions basically let a bank continue to offer certain security services without registering as a broker. However, if a bank's activities don't qualify for the GLBA's statutory exceptions, including those exceptions outlined above, the bank will be required to either register as a broker with the SEC or transfer the activities to a registered affiliate or third-party brokerage firm.

The comment period ended before this issue of Central Banker went to print; the final rules have not yet been adopted. Once they are, banks will not have to comply with the new broker exceptions until at least June 30, 2008. For more information, see