Securities Activities of Banks Exceptions and Exemptions for Banks from the Definition of "Broker"
FederalAgency guidance
Ask Donna
How this section applies to your facts.
FDIC Financial Institution Letters › Securities Activities of Banks Exceptions and Exemptions for Banks from the Definition of "Broker"
Text
Wednesday,
October 3, 2007
Part III
Federal Reserve
System
Securities and
Exchange
Commission
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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00001
Fmt 4717
Sfmt 4717
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56514
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
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.
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
e
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
nald, 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
ion
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
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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00002
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56515
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
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.).
3 15 U.S.C. 78c(a)(4).
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
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.
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.
17 See 71 FR 77522, December 26, 2006.
18 See, e.g., Citigroup Letter, Independent
Community Bankers Ass’n (‘‘ICBA’’) Letter,
American Bankers Ass’n (‘‘ABA’’) Letter, JPMorgan
Chase & Co
ddition to transactions referred to in the other
exceptions.
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.
17 See 71 FR 77522, December 26, 2006.
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.
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.
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
lation 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.
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
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)
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).
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.
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
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
200120 or 2004.21
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
004.21
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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00003
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56516
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
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.
23 See Rule 723(c).
24 See Rule 776.
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.
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
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).
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 § ___.100 to § ___.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, § 101(a)(3), 120 Stat. 1966,
1968 (2006).
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))
ional 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.
30 See 12 U.S.C. 1828(t)(1).
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’’).
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.
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
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
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
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
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
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
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
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
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
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.
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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00004
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00004
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56517
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
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.
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).
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).
38 See, e.g
3d 212, 216–217 (D.C. Cir. 1995), cert. denied 116
S.Ct. 775 (1996).
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).
38 See, e.g. ABA Letter, Roundtable Letter,
Citigroup Letter, Union Bank of California (‘‘Union
Bank’’) Letter.
39 See, e.g., Pace Project Letter.
40 Proposed Rule 700(c).
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.
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
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
ns 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.
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
er 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.
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
‘‘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
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
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
est
ted 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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00005
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56518
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
45 See Exchange Act Section 3(a)(4)(B)(i)(V).
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).
49 Rule 700(c)(1) and (2).
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 × $25) would be $24.04, based on
a 40 hour per week (or 1080 hours per year) work
schedule
il
Sales of Nondeposit Investment Products (Feb. 15,
1994).
49 Rule 700(c)(1) and (2).
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 × $25) would be $24.04, based on
a 40 hour per week (or 1080 hours per year) work
schedule.
52 Rule 700(c)(2).
53 See Pace Project Letter.
54 Proposed Rule 700(d).
55 See 15 U.S.C. 78c(a)(4)(B)(i)(V).
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
es 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.
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
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
In developing these alternatives to t
urly 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
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.
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
hat may be received
by bank tellers under the flat dollar
option.
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.
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
mpensation.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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00006
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00006
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56519
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
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.
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.
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).
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.
63 Rule 700(e)
hicles
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.
63 Rule 700(e).
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.
securities recommendations to the
customer.56
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
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.
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.
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
on-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
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
e 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
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.
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
3
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
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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00007
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56520
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
65 Rule 700(a).
66 Rule 700(a).
67 See, e.g., BISA Letter, Clearing House Ass’n
Letter, and U.S. Trust Letter.
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.
69 See NASAA Letter.
70 See, e.g., U.S. Trust Letter and Union Bank
Letter.
71 See TD Banknorth, N.A. (‘‘TD Banknorth’’)
Letter
65 Rule 700(a).
66 Rule 700(a).
67 See, e.g., BISA Letter, Clearing House Ass’n
Letter, and U.S. Trust Letter.
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.
69 See NASAA Letter.
70 See, e.g., U.S. Trust Letter and Union Bank
Letter.
71 See TD Banknorth, N.A. (‘‘TD Banknorth’’)
Letter.
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.
Commenters generally supported
these permissible contingencies
nerally 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.
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.
In addition, the ‘‘broker’’ exceptions
in Sections 3(a)(4)(B) of the Exchange
Act are available only to banks
stomer
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.
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
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
er 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
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.
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
r broker-dealer by that
employee. Other commenters asked that
the Agencies provide that all
‘‘traditional’’ bank bonus programs are
protected under the rule.
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
Several commenters also asserted that
the safe harbor in paragraph (b)(2)
should be clarified or expanded to cover
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00008
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56521
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
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.
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)
ral’’ 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).
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
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
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
ave 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.
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
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
lly 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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00009
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
e 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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00009
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56522
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
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.
78 Proposed Rule 701.
79 See Proposed Rule 701(a)(1) and (d)(4).
80 See id. at 701(a)(2)(i).
81 See id. at 701(a)(3)(ii).
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:
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
als 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
nit 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
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.
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
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—
• 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
• Required the bank to provide
certain disclosures to the customer
regarding the referral arrangement; 80
and
• 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
Many commenters supported
providing an exemption for referrals
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00010
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
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
Many commenters supported
providing an exemption for referrals
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00010
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56523
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
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.
85 See Exchange Act Section 3(a)(4)(B)(i)(V) and
(IX).
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.
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
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 sop
ealer.84
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
teria 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.
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
oker-
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
imited
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
els 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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00011
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56524
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
88 See, e.g., ABA Letter, Clearing House Ass’n
Letter, State Street Corp. Letter.
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
d 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.
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.
93 See ABA Letter, PNC Letter, Roundtable Letter.
94 Rule 701(d)(1)(i)(B).
95 See, e.g., 15 U.S.C. 80a–2(a)(51), 78c(a)(54); 17
CFR 230.501(a).
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
e Letter.
94 Rule 701(d)(1)(i)(B).
95 See, e.g., 15 U.S.C. 80a–2(a)(51), 78c(a)(54); 17
CFR 230.501(a).
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).
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.
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
ent
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.
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
saction, 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
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.
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
r 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
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.
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
er to understand and
promote compliance.
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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00012
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56525
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
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).
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.
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).
105 Rule 701(a)(2)(ii).
106 Proposed Rule 701(a)(2)(i)
tter.
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).
105 Rule 701(a)(2)(ii).
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).
111 Rule 701(b).
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) d
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
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
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 employe
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.
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.
3
) 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.
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
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
fore 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
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.
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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00013
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
s 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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00013
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56526
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
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.
115 Proposed Rule 701(a)(3)(ii).
116 Proposed Rule 701(a)(3)(iii)(C).
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.
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
perform the
analysis.
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.
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).
121 Rule 701(a)(3)(iii)(B).
122 Rule 701(a)(3)(ii)(B)(1).
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
nvestors).
121 Rule 701(a)(3)(iii)(B).
122 Rule 701(a)(3)(ii)(B)(1).
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.
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
designed to call
attention to the nature and significance
of the information.
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
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
tion 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.
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
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.
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.
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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00014
Fmt 4701
d 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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00014
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56527
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
123 Rule 701(a)(3)(iv).
124 See Proposed Rule 701(a)(1).
125 Proposed Rule 701(a)(3)(i)(A).
126 Proposed Rule 701(a)(2)(iii).
127 Proposed Rule 701(a)(3)(iii)(B).
128 See Rule 701(a)(1), (a)(2)(iii), (a)(3)(ii)(A), and
(a)(3)(v)(B).
129 See Business Law Section Letter.
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.
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).
133 Rule 700(a)(2)(iii).
elements of FINRA IM–2310–3
(Suitability Obligations to Institutional
Customers).
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.
5
o
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.
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
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
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
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.
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
loyee’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.
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
ee
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.
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).
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
nsidered 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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00015
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56528
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
134 Rule 701(a)(2)(iv).
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.
136 Proposed Rule 701(d)(4).
137 See, e.g., Clearing House Ass’n Letter and
JPMorgan Letter.
138 See NASAA Letter.
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
to
Rule 701.
136 Proposed Rule 701(d)(4).
137 See, e.g., Clearing House Ass’n Letter and
JPMorgan Letter.
138 See NASAA Letter.
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.
141 Rule 701(c).
142 15 U.S.C. 78c(a)(4)(B)(ii).
143 Id.
144 15 U.S.C. 78c(a)(4)(B)(ii)(I).
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.
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
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
7
exceeds the amount the bank
otherwise would be permitted to pay
under the statutory networking
exception and Rule 700.134
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
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
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
aler, the rule
would provide an incentive for bank
employees to provide ongoing
investment advice to customers.138
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.
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
aid 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.
III. Trust and Fiduciary Activities
A
ar 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.
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
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 un
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
VerDate Aug<31>2005
19:08 Oct 02, 2007
Jkt 214001
PO 00000
Frm 00016
Fmt 4701
Sfmt 4700
E:\FR\FM\03OCR2.SGM
03OCR2
mstockstill on PROD1PC66 with RULES2
56529
Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
148 Proposed Rule 721.
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.
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).
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).
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
emption 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).
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.
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, an
This text is long and has been trimmed here. Open the source document for the complete record.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.