The adoption of Regulation R by the Securities and Exchange Commission implements the Gramm-Leach-Bliley bank broker exceptions in Section 3(a)(4) of the Securities Exchange Act of 1934, as amended (Exchange Act). The SEC and Federal Reserve Board were mandated with jointly adopting a single set of rules to implement the bank broker exceptions as part of the Financial Services Relief Act of 2006. In this release, the SEC and the Federal Reserve Board adopted an identical set of rules.
The “Networking Exception” in Section 3(a)(4)(B)(i) of the Exchange Act permits a bank to avoid being considered a broker if it enters into a contractual arrangement with a registered broker-dealer under which the broker-dealer offers brokerage services to bank customers, subject to limitations on incentive compensation paid to bank employees for referring bank customers to the broker-dealer. Regulation R defines the different levels of “nominal” incentive compensation bank employees can receive for referring typical bank customers, institutional customers and high net worth customers to the broker-dealer.
The “Trust and Fiduciary Exception” in Section 3(a)(4)(B)(ii) of the Exchange Act permits banks to effect securities transactions in a fiduciary or trustee capacity without being registered as a broker, provided the bank executes the transaction in its trust department or another department regularly examined by bank examiners and the bank is “chiefly compensated” for the transaction by: (i) an administration or annual fee; or (ii) a percentage of assets under management; or (iii) a flat or capped order processing fee; or (iv) any combination thereof. Rule 722 under Regulation R will permit banks to meet the “chiefly compensated’ test if their relationship-based income from the fiduciary or trust account exceeded 50% percent of the total compensation attributable to that account, or if the bank-wide aggregate relationship-based compensation attributable to its trust or fiduciary business exceeded 70% of the total compensation attributable to its trust or fiduciary business.
The “Sweep Exception” in Section 3(a)(4)(B)(v) of the Exchange Act exempts a bank from the definition of a broker for transactions effected as part of a program of investment or reinvestment of deposit funds into a no-load, open-end money market fund registered under the Investment Company Act. Rule 741 of Regulation R will permit banks to utilize this exception so long as the bank provides to the customer in question services such as escrow, trust, fiduciary or custody accounts, deposit accounts, loans or other extensions of credit that would not in and of themselves require broker-dealer registration by the bank.
The “Custody and Safekeeping Exception” in Section 3(a)(4)(B)(viii) of the Exchange Act exempts banks from the definition of broker for services such as safekeeping or custody of securities, facilitating the transfer of funds or securities, effecting securities lending transactions with or on behalf of a customer as part of their custodial services, holding securities pledged by a customer or facilitating pledging transactions, or providing custodial or administrative services to individual or group retirement plans. Rule 760 under Regulation R will continue to permit banks to effect securities transactions for employee benefit, individual retirement and other account types for which the bank acts as custodian, subject to restrictions on employee compensation and advertising imposed to prevent the banks from utilizing their custody operation to run a full-fledged brokerage business.
Regulation R also includes rules which will permit banks to engage in certain securities lending transactions and with a conditional exemption from the definition of broker, to effect transactions involving mutual funds, variable annuities or variable life insurance policies through the National Securities Clearing Corporation or a transfer agent rather than through a registered broker-dealer, and to permit banks to conduct employee benefit transactions in employer securities directly with a transfer agent subject to certain restrictions.