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Kieran J. Fallon Assistant General Counsel Federal Reserve Board

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Presentation on theme: "Kieran J. Fallon Assistant General Counsel Federal Reserve Board"— Presentation transcript:

1 Reg R – Here and Now FIRMA 23rd National Risk Management Conference New Orleans, LA April 28, 2009
Kieran J. Fallon Assistant General Counsel Federal Reserve Board Sarah A. Miller Executive Director and General Counsel ABA Securities Association

2 A Brief History of Reg. R GLB Act replaced blanket “broker” exception for banks with 11 exceptions covering a wide array of bank activities. Final rules were adopted in September 2007. 12 CFR Part 218 for the Board 17 CFR Part 247 for the SEC Release and regulation are available at

3 Overview Regulation R implements only certain exceptions in the statute and includes a number of regulatory exemptions but all statutory exceptions remain available to a bank. Bank may choose exception or exemption it relies on for a particular transaction. Exceptions and exemptions apply to a bank only regardless of the entity where securities-related activities take place today. Compliance date First day of a bank’s first fiscal year after September 30, 2008. For most banks, the compliance date will be January 1, 2009.

4 Ongoing Matters Recordkeeping Rules Interagency Guidance on NDIPs
Status General Approach Not a compliance guide to the statute and Regulation R. Rules should provide some flexibility in the type of records a bank may use to demonstrate compliance. Interagency Guidance on NDIPs Interpretations Procedure Current requests

5 Trust and Fiduciary - Overview
GLB Act allows a bank to continue to effect securities transactions for its trust and fiduciary customers subject to two principal conditions: Compliance with “chiefly compensated” test; and No public solicitation of brokerage business other than in conjunction with advertising its other trust and fiduciary activities.

6 Trust and Fiduciary – Chiefly Compensated
Bank must be chiefly compensated for the securities transactions it effects for trust or fiduciary customers from “relationship compensation,” which includes: Administration fees; Annual fees; Fees based on a percentage of assets under management (“AUM fees”); Flat or capped per order securities processing fees that do not exceed the bank’s cost for executing the transactions; and Any combination of these fees.

7 Trust and Fiduciary – Chiefly Compensated
“Relationship compensation” includes the following to the extent attributable to a trust or fiduciary account: Rule 12b-1 fees, service fees, and sub-transfer and sub- accounting fees received from mutual funds or their service providers (e.g. distributor, administrator, advisor); Fees for custody services; Fees received in connection with securities lending or borrowing transactions; Fees paid for personal services, tax preparation, or real estate settlement services; and Other administration, annual fees and AUM fees regardless of the type of asset involved (e.g., securities, real estate, etc.).

8 Trust and Fiduciary – Chiefly Compensated
Compliance monitored using either Account-by- Account Approach (Rule 721) or Bank-Wide Approach (Rule 722) Bank-wide (most common): Bank meets “chiefly compensated” test if aggregate relationship compensation attributable to its trust and fiduciary business as a whole during each of the preceding 2 years equals or exceeds 70 percent of the total compensation attributable to the bank’s trust and fiduciary business as a whole during those years after annual ratios for each year are averaged together. Certain accounts and revenue may be excluded from the calculation (Rule 721(b), Rule 722(d) and Rule 723).

9 Trust and Fiduciary: Advertising Restrictions
A bank: May not advertise its securities brokerage services for T&F accounts except as part of advertising its broader T&F services; and May not advertise its securities brokerage services for T&F accounts more prominently than other aspects of the T&F services provided to these accounts. “Advertisements”: Any material distributed through public media, such as newspapers, radio, television and websites.

10 Trust and Fiduciary: Other Conditions
Activities must be conducted in the trust department or another area subject to fiduciary examination. Bank may use other areas of the bank or third-parties (such as an investment adviser or service provider) to handle aspects of transactions subject to fiduciary principles and oversight. Trades generally must be sent to a broker-dealer for execution, or effected through a cross-trade within the bank or between the bank and an affiliated fiduciary (in accordance with fiduciary principles). • Exceptions to this requirement provided in Rule 775 and Rule 776.

11 Custody – Overview Statute allows banks to conduct a variety of securities activities in connection with customary custody and safekeeping activities. Examples include: Facilitating the movement of cash and securities associated with clearing and settling customer securities transactions; and Acting as agent for a customer in securities lending and borrowing transactions where the bank has custody of the securities being borrowed or lent.

12 Custody – Overview Custody Exemption (Rule 760): Designed to address securities order-taking. The rule allows banks to continue to accept orders for all types of custody accounts subject to certain conditions. Conditions, which were designed to comport with bank practices, differ based on whether the account is an EBP/IRA account. If a bank does not accept orders for securities transactions from a custody account, then it does not need to adhere to the conditions in the rule with respect to that account.

13 Custody Exemption: EBPs and IRAs
Bank Compensation: No restriction. Employee Compensation: Bank employees may not receive compensation, including 12b-1 fees, from the bank or any other person that varies based on: Whether a security transaction is executed for the account; or The quantity, price or identity of the securities purchased or sold for the EBP or IRA account. Bank employees may, however, receive compensation under a bonus or similar plan if the plan meets the criteria established under the Networking Rules. (See Networking slides).

14 Custody Exemption: EBPs and IRAs
Advertising. Bank may not: Advertise that it accepts securities orders for these accounts except as part of advertising its other custodial services; or Advertise that such EBP or IRA accounts are “securities brokerage accounts” or that the bank’s safekeeping and custody services are a substitute for a securities brokerage account. Additional Marketing Restriction for IRAs (due to the retail nature of these accounts). Advertisements and sales literature may not describe the bank’s securities order-taking services more prominently than other aspects of the bank’s custodial services. Compliance Tip: Ensure processes are in place for advertising and sales literature to be reviewed by trained compliance personnel.

15 Custody Exemption: Key Definitions
“Employee Benefit Plan” and “IRA” broadly defined to include qualified and non-qualified plans and HSAs, Roth IRAs, and education IRAs (Rule 760(h)(4) and (5)). “Advertisements” include any material published or used in any electronic or other public media, including Web site, newspaper, magazine or other periodical, radio, TV, telephone/tape recording, videotape display, signs or billboards, motion pictures, or telephone directories (Rule 760(h)(2)). “Sales literature” defined as material distributed or made available to customers or the public generally, whether or not distributed through public media. (E.g., marketing brochures or form letters.) (Rule 760(h)(6)).

16 Custody Exemption: Accommodation Trades
Banks may accept securities orders for other custodial accounts only as an accommodation for the customer. Accommodation conditions: Compensation: Bank: May not receive fees that vary based on – Whether the bank accepted a securities order for the account, or The price or quantity of the securities bought or sold by the account. Bank employees: Same restriction that applies to EBP and IRA accounts. Compliance Tip: Review fee schedules and payment arrangements.

17 Custody Exemption: Accommodation Trades
Conditions (continued): Advertisements and sales literature: No advertising order-taking for these types of custodial accounts in public media. Sales literature – May not state that the bank accepts orders from these accounts except as part of describing the bank’s custody and safekeeping services; and May not describe order-taking services more prominently than other custodial services. Sales literature” is defined as material distributed or made available to customers or the public generally, whether or not distributed through public media. (E.g., marketing brochures or form letters.) (Rule 760(h)(6)).

18 Custody Exemption: Accommodation Trades
Conditions (continued): Advice/Solicitation restrictions: Bank employees generally prohibited from providing investment advice or soliciting orders from the account. Prohibitions do not prevent a bank from cross-marketing its trust, fiduciary, or other services to custody customers. For example, A bank may provide customers non-account specific research and advice provided to customers generally through in media such as newsletters and web sites; and May provide customers samples of stock-specific research provided to other persons for marketing purposes. Bank, however, may not provide personalized investment advice, research or recommendations regarding particular securities to a custodial account from which it accepts “accommodation” orders. Compliance Tip: Ensure custody personnel receive adequate training. Review and update (as necessary) policies governing distribution of research and advisory materials to accommodation customers.

19 Custody Exemption: Carrying Broker
Banks operating under the statutory Custody Exception or the Custody Exemption may not act as a “carrying broker” for a registered broker-dealer. In general, broker-dealers establish carrying arrangements with another broker-dealer to permit the non-carrying broker-dealer to be subject to lesser financial responsibility requirements under the Exchange Act. In analyzing whether a “carrying broker” relationship exists, the focus is primarily on the broker-dealer, which may not: Structure its operations or have arrangements with a bank to cause the broker-dealer’s customers generally to use the bank’s custody accounts instead of maintaining their funds or securities at the broker-dealer; or Delegate to the bank core functions not permitted by SRO rules; or Fail to maintain possession or control of the cash or securities of the firm or its clients (even if held in custody by a bank).

20 Custody Exemption: Carrying Broker
The following factors alone, however, generally would not indicate that the bank acts as a “carrying broker”: Existence of a substantial number of common customers between a broker-dealer and a bank’s custody department. Performance by the bank of limited back-office functions on behalf of a broker-dealer. Shared risk management systems, such as BSA/AML compliance systems. Compliance Tip: Conduct due diligence with broker-dealer clients; request representations and warranties as appropriate.

21 Custody Exemption: Administrators and Recordkeepers
A bank acting as a non-fiduciary and non-custodial administrator or recordkeeper for an EBP may accept orders for the plan if: The bank and the custodian bank both comply with the conditions discussed above applicable to EBP accounts; and The bank does not execute cross-trades or net securities orders for the EBP other than – For mutual fund shares not traded on an exchange; and Crossing orders among accounts of the custodian bank that hired the bank to provide administrative or recordkeeping services.

22 Networking Exception: Overview
Allows banks and their employees to refer customers to a broker-dealer, subject to certain conditions. Exception and its conditions are based on a series of SEC no-action letters and the Banking Agencies’ Statement on the Retail Sale of Nondeposit Investment Products.

23 Networking Exception: Nominal Referral Fees
Statute permits bank employees that refer customers to a broker-dealer to receive a one-time fee for each referral that is: Nominal; Not contingent on a securities transaction; and Paid only in cash (non-cash payments for securities referrals prohibited).

24 Networking Exception: Nominal Referral Fees
Rule 700(b)(1) provides banks five alternatives for establishing that a referral fee is “nominal.” Two are based on the average of the high and low hourly wage or base salary established by the bank for the “job family” that includes the employee. Examples of job families may include tellers, loan officers, etc. Job family must be used in the ordinary course of the bank’s business for hiring, promotion and compensation. Two options are based on the referring employee’s actual base hourly wage or annual base salary; and One option is a simple dollar amount ($25), adjusted periodically for inflation.

25 Networking Exception: Nominal Referral Fees
Payment of the referral fee may not depend on whether: The referral results in a purchase or sale of one or more securities at the broker-dealer; or An account is opened with the broker-dealer. Payment may depend on whether: The customer contacts or keeps an appointment with the broker- dealer; or The customer meets objective base-line qualification criteria (e.g., minimum assets, net worth, income, tax bracket) generally established by the bank or the broker-dealer for referrals to the broker-dealer.

26 Networking: Bonus Plans
Key issue in developing the rules was whether payments by a bank with a networking arrangement to its employees under a general bonus plan might constitute impermissible ”incentive compensation.” Rule 700(b) includes several provisions designed to ensure that the rules do not disrupt traditional bank bonus plans. Rules essentially establish a 3-step process for analyzing bonus plans.

27 Networking: Bonus Plans
FIRST: Consider whether payments under the bonus plan are based in any way on the success (including revenues) of securities transactions conducted at a broker-dealer or referrals to a broker-dealer. SECOND: If the plan includes inputs from the broker-dealer or that are related to referrals to the broker-dealer, consider whether payments under the bonus plan are based on any measure of overall profitability or revenue of the bank or any of its affiliates or operating units other than a broker or dealer, or an affiliate or operating unit that over time is predominately engaged in the business of making referrals to a broker-dealer.

28 Networking: Bonus Plans
THIRD: If a plan does not meet these standards, payments under the plan are still OK if they: Are made on a discretionary basis; Are based on multiple factors or variables, including significant factors or variables that are not related to securities transactions by the broker-dealer; and Are not based on the number of securities referrals made by the employee or another person.

29 Networking: High Net Worth and Institutional Customers
Rule 701 permits banks to pay higher-than-nominal and contingent referral fees for referrals of High Net Worth and Institutional Customers. Key Conditions of Rule 701 : Written agreement between bank and broker-dealer Bank employee eligibility Customer eligibility Disclosures Suitability or sophistication analysis

30 Dual Employees – FINRA Rule 3040 Revision
FINRA Rule 3040/Proposed FINRA Rule 3110 In general We support FINRA’s effort to eliminate Rule 3040 As proposed, the new rule should allow banks to continue to provide their customers securities services in connection with their banking activities under the supervision of the Banking Agencies Open questions Meaning of “comprehensive view” of an employee’s securities activities at the bank and broker-dealer. How broadly should “antifraud provisions” be read. Proposed rule would require notification of all violations of policies and procedures, not just material violations. Status Banking Agencies have had informal discussions with FINRA. The final package has not yet been sent to the SEC so we do not know how these issues may be addressed in the final rule.


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