[Federal Register Volume 66, Number 97 (Friday, May 18, 2001)]
[Rules and Regulations]
[Pages 27760-27800]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-12388]



[[Page 27759]]

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Part II





Securities and Exchange Commission





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17 CFR Parts 200 and 240



Definition of Terms in and Specific Exemptions for Banks, Savings 
Associations, and Savings Banks Under Sections 3(a)(4) and 3(a)(5) of 
the Securities Exchange Act of 1934; Interim Final Rule

Federal Register / Vol. 66, No. 97 / Friday, May 18, 2001 / Rules and 
Regulations

[[Page 27760]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 200 and 240

[Release No. 34-44291; File No. S7-12-01]
RIN 3235-AI19


Definition of Terms in and Specific Exemptions for Banks, Savings 
Associations, and Savings Banks Under Sections 3(a)(4) and 3(a)(5) of 
the Securities Exchange Act of 1934

AGENCY: Securities and Exchange Commission.

ACTION: Interim final rules with request for comments.

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SUMMARY: The Securities and Exchange Commission is adopting, as interim 
final rules, new Rules 3a4-2, 3a4-3, 3a4-4, 3a4-5, 3a4-6, 3a5-1, 3b-17, 
3b-18, 15a-7, 15a-8, and 15a-9 under the Securities Exchange Act of 
1934 (``Exchange Act''), and amending Rule 30-3 of our Rules of 
Organization and Program Management. These new rules address the 
functional exceptions for banks from the definitions of ``broker'' and 
``dealer'' that were added to the Exchange Act by the Gramm-Leach-
Bliley Act and will become effective May 12, 2001.
    We are promulgating these rules on an interim final basis, 
effective May 11, 2001, to clarify the terms of the functional 
exceptions from the definitions of broker and dealer as well as to 
provide additional exemptions, which will aid banks in complying with 
the provisions of the Gramm-Leach-Bliley Act when they become 
effective. We are soliciting comments on all aspects of the interim 
final rules and will amend these rules as appropriate in response to 
comments received.

DATES: Effective Date: May 11, 2001.
    Comment Date: Comments on the interim final rules should be 
submitted by July 17, 2001.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G. 
Katz, Secretary, Securities and Exchange Commission, 450 5th Street, 
N.W., Washington, D.C. 20549-0609. Comments also may be submitted 
electronically at the following E-mail address: <a href="/cdn-cgi/l/email-protection#2c5e594049014f4341414942585f6c5f494f024b435a"><span class="__cf_email__" data-cfemail="d1a3a4bdb4fcb2bebcbcb4bfa5a291a2b4b2ffb6bea7">[email protected]</span></a>. 
All comment letters should refer to File No. S7-12-01; this file number 
should be included on the subject line if E-mail is used. All comments 
received will be available for public inspection and copying in the 
Commission's Public Reference Room, 450 5th Street, N.W., Washington, 
D.C. 20549-0102. Electronically submitted comment letters will be 
posted on the Commission's Internet site (http://www.sec.gov).\1\
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    \1\ We do not edit personal, identifying information, such as 
names or e-mail addresses, from electronic submissions. Submit only 
information you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: Catherine McGuire, Chief Counsel; 
Lourdes Gonzalez, Assistant Chief Counsel; Linda Stamp Sundberg, 
Banking Fellow; Patricia Albrecht, Special Counsel; or Joseph P. 
Corcoran, Attorney, (202) 942-0073, Office of the Chief Counsel, 
Division of Market Regulation, Securities and Exchange Commission, 450 
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5th Street, NW., Washington, DC 20549-1001.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is adopting Rules 3a4-2 [17 CFR 240.3a4-2], 3a4-3 [17 
CFR 240.3a4-3], 3a4-4 [17 CFR 240.3a4-4], 3a4-5 [17 CFR 240.3a4-5], 
3a4-6 [17 CFR 240.3a4-6], 3a5-1 [17 CFR 240.3a5-1], 3b-17 [17 CFR 
240.3b-17], 3b-18 [17 CFR 240.3b-18], 15a-7 [17 CFR 240.15a-7], 15a-8 
[17 CFR 240.15a-8], and 15a-9 [17 CFR 240.15a-9] under the Exchange Act 
as interim final rules clarifying certain terms in Sections 3(a)(4) and 
3(a)(5) of the Exchange Act [15 U.S.C. 78c(a)(4) and 78c(a)(5)] and 
providing exemptions for banks from broker-dealer registration. The 
Commission is delegating authority to the Division of Market Regulation 
through an amendment to Rule 30-3 of its Rules of Organization and 
Program Management [17 CFR 200.30-3] to issue to banks, savings 
associations, and savings banks additional exemptions from registration 
and regulation.

Table of Contents

I. Introduction

A. Background
    1. Exceptions From Both ``Broker'' And ``Dealer'' Definitions
    2. Other Exceptions From ``Broker'' Definition
    3. Other Exception From ``Dealer'' Definition
B. The Gramm-Leach-Bliley Act

II. Rule 3b-17--Definitions Related to Exception From ``Broker''

A. Networking Exception
B. Trust And Fiduciary Activities Exception
    1. Trustee Capacity
    a. Indenture Trustees
    b. ERISA And Other Similar Trustees
    c. IRA Trustees
    d. Definitional Exemption Alleviates Uncertainty
    2. Fiduciary Capacity
    a. Transfer Agent
    b. Investment Adviser If The Bank Receives A Fee For Its 
Investment Advice
    i. Continuous And Regular Investment Advice
    ii. Full And Fair Disclosure
    3. Other Similar Capacity
    4. Other Department That Is Regularly Examined By Bank Examiners 
For Compliance With Fiduciary Principles And Standards
    5. Chiefly Compensated
    a. Account-By-Account Calculations
    b. Annual Computation
    c. A Flat Or Capped Per Order Processing Fee
    d. ``Relationship Compensation,'' ``Sales Compensation,'' And 
``Unrelated Compensation''
    i. Relationship Compensation
    ii. Sales Compensation
    iii. Unrelated Compensation
    e. ``Chiefly Compensated'' Computation
    f. RULE 3a4-2--Exemption For Banks That Are Compensated By 
Relationship Compensation
    g. RULE 3a4-3--Exemption From ``Chiefly Computation'' For 
Indenture Trustees
    h. Solicitation Of Comment
C. Sweep Accounts Exception
D. Safekeeping And Custody Activities Exception
    1. RULE 3a4-4--Exemption For Small Bank Custodians Effecting 
Transactions In Investment Company Securities For Tax-Deferred 
Custody Accounts
    2. RULE 3a4-5--Exemption For Bank Custodians Placing Orders As 
An Accommodation To Customers

III. Discussion of Other Exceptions From Broker

A. Affiliate Transactions Exception
B. De Minimis Exception And RULE 3a5-1

IV. Rule 3b-18--Definitions of Terms Used In Asset-Backed Exception to 
Dealer

V. Rule 3a4-6--Exemption To Permit Execution of Investment Company 
Securities Through NSCC's Mutual Fund Services

VI. Rule 15a-7--Extensions of Time

VII. Rule 15a-8--Exemption for Contracts Entered Into by Banks Before 
2003 From Being Considered Void or Voidable

VIII.Rule 15a-9--Exemption for Savings Associations and Savings Banks

IX. Rule 30-3--Delegation of Authority

X. Procedural Matters

A. Administrative Procedures Act And Request For Comments
B. Paperwork Reduction Act
C. Consideration Of Costs And Benefits
    1. Introduction
    2. Banks' Securities Activities Before The GLBA
    3. Options For Compliance With The GLBA Under The Statute In 
Light Of These Interim Final Rules
    a. Benefits
    b. Costs
D. Consideration Of Burden On Competition, and On Promotion of 
Efficiency, Competition, And Capital Formation
E. Summary Of Regulatory Flexibility Analysis

[[Page 27761]]

XI. Statutory Authority

XII. Text of Rules and Rule Amendments

I. Introduction

A. Background

    On November 12, 1999, the President signed the Gramm-Leach-Bliley 
Act (``GLBA'') into law.\2\ The GLBA represents the culmination of more 
than 30 years of Congressional efforts aimed at reforming the 
regulation of financial services.\3\ The GLBA changed federal statutes 
governing the scope of permissible activities and the supervision of 
banks, bank holding companies, and their affiliates. The GLBA lowers 
(although does not altogether eliminate) barriers between the banking 
and securities industries erected by the Banking Act of 1933 (popularly 
known as the ``Glass-Steagall Act'') \4\ and between the banking and 
the insurance industries erected by the 1982 amendments to the Bank 
Holding Company Act of 1956 (the ``Bank Holding Company Act'').\5\ Some 
have described the GLBA as the most important piece of federal banking 
legislation since the Depression.\6\
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    \2\ Pub. L. No. 106-102, 113 Stat. 1338 (1999).
    \3\ Jaworski, Robert M., ``Financial Modernization: The Federal 
Government Plays Catch-up,'' 54 Consumer Fin. L.Q. Rep. 2 (Winter, 
2000).
    \4\ Pub. L. No. 73-66, ch. 89, 48 Stat. 162 (1933) (as codified 
in various sections of 12 U.S.C.).
    \5\ The Garn-St. Germain Depository Institutions Act of 1982, 
Pub. L. No. 97-320, 96 Stat. 1469 (1982) (as codified in various 
sections of 12 U.S.C.), amending section 4(c)(8) of the Bank Holding 
Company Act, 12 U.S.C. 1841-1850 (1994).
    \6\ See Jaworski, Robert M., supra note 3.
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    When Congress enacted the Exchange Act in l934, it completely 
exempted banks from the regulatory scheme provided for brokers and 
dealers. Over the past 60 years, however, evolution of the financial 
markets driven by competition and technology eroded the separation that 
previously existed between banks, insurance companies, and securities 
firms. Regulators responded to these changes with interpretations that 
increasingly sought to accommodate the market changes. The Board of 
Governors of the Federal Reserve System (``Federal Reserve''), the 
Office of the Comptroller of the Currency (``OCC''), and the Federal 
Deposit Insurance Corporation (``FDIC'') have long permitted banks and 
bank holding companies to engage in retail and institutional securities 
brokerage and private placement activities.
    Beginning in the 1980s, these developments, coupled with arguments 
for competitive equality both domestically and internationally, spurred 
Congressional action. Congress considered major restructuring of legal 
restrictions preventing financial services firms from offering a full 
array of products, while at the same time maintaining the successful 
system of functional regulation of securities, insurance, and banking 
that existed under that framework.\7\
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    \7\ During recent years, the Senate, the House, and 
Congressional committees acted on several versions of Glass-Steagall 
reform bills. In 1988, the Senate passed S. 1886, the ``Financial 
Modernization Act of 1988,'' which would have repealed the 
provisions of the Glass-Steagall Act that prohibit affiliations 
between commercial banks and investment banks. That same year the 
House Banking Committee reported H.R. 5094, the ``Depository 
Institutions Act of 1988.'' This legislation never reached the House 
floor. In 1991, in response to the Administration's call for 
financial services reform, the Senate passed S. 543, the 
``Comprehensive Deposit Insurance Reform and Taxpayer Protection Act 
of 1991.'' The House Banking Committee voted to report favorably 
H.R. 6, the ``Financial Institutions Safety and Consumer Choice Act 
of 1991,'' which would have allowed banks to affiliate with 
securities firms, insurance companies, and commercial entities under 
a diversified holding company structure. The Glass-Steagall 
provisions of those bills were dropped, however. In 1995, the House 
Banking Committee approved H.R. 1062, the ``Financial Services 
Competitiveness Act of 1995,'' which would have allowed banks to 
affiliate with securities firms and engage in activities that were 
financial in nature. Later that same year, the House Banking 
Committee ordered reported another version as part of H.R. 1858, the 
``Financial Institutions Regulatory Relief Act of 1995.'' 
Significantly, in 1997, the Administration supported, through the 
Treasury Department, a different version of financial services 
modernization legislation. The House Banking Committee also approved 
financial services modernization legislation in the form of H.R. 10, 
the ``Financial Services Competitiveness Act of 1997.'' 
Administration support for some version of financial services 
legislation, together with strong lobbying and negotiating efforts 
involving the affected industries, led to the passage by the House 
of H.R. 10 on May 13, 1998, by a one-vote margin of 214 to 213. On 
September 11, 1998, the Senate Banking Committee also approved its 
version of H.R. 10. That legislation did not reach the Senate floor.
    Five comprehensive financial services reform bills were 
introduced in the first session of the 106th Congress in 1999. Two 
bills, H.R. 10 and S. 900, were reported out of committee, passed by 
the House and Senate, and resulted in a compromise version of S. 900 
that was enacted. There was no activity on the other three bills, S. 
753, H.R. 665, and H.R. 823; however, some policies in those bills, 
for example, in the areas of financial privacy and treatment of bank 
subsidiaries, were reflected to some extent in the legislation that 
eventually passed.
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    The Commission long supported modernizing the legal framework 
governing financial services, so long as it was consistent with a 
system of functional regulation to ensure that investors purchasing 
securities through banks received the same protections as those when 
they purchased securities from registered broker-dealers.\8\ The GLBA 
is the product of many years of Congressional deliberation and reflects 
a careful balance between providing investors with the same protections 
wherever they purchase securities, while not unnecessarily disturbing 
certain bank securities activities.
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    \8\ See Letter from Arthur Levitt, Chairman, U.S. Securities and 
Exchange Commission, to Senator Phil Gram, Chairman, Committee on 
Banking, Housing and Urban Affairs, U.S. Senate (Oct. 14, 1999) 
(stating that ``the Securities and Exchange Commission has long 
supported financial modernization legislation that provides the 
protections of the securities laws to all investors.''); see, also 
Testimony of Arthur Levitt, Chairman, U.S. Securities and Exchange 
Commission, Concerning H.R. 10, the ``Financial Services Act of 
1999,'' Before the Subcomm. On Finance and Hazardous Materials of 
the House Comm. On Commerce (May 5, 1999); Testimony of Arthur 
Levitt, Chairman, U.S. Securities and Exchange Commission, 
Concerning Financial Modernization Legislation Before the Senate 
Comm. On Banking, Housing, and Urban Affairs (Feb. 24, 1999); 
Testimony of Harvey J. Goldschmid, General Counsel, U.S. Securities 
and Exchange Commission, Concerning H.R. 10, the ``Financial 
Services Act of 1999,'' Before the House Comm. On Banking and 
Financial Services, U.S. House of Representatives (Feb. 12, 1999); 
Testimony of Arthur Levitt, Chairman, U.S. Securities and Exchange 
Commission, Concerning H.R. 10, The ``Financial Services Act of 
1998,'' Before the Senate Comm. On Banking, Housing, and Urban 
Affairs (June 25, 1998); Testimony of Arthur Levitt, Chairman, U.S. 
Securities and Exchange Commission, Concerning Financial 
Modernization and H.R. 10, the ``Financial Services Competition Act 
of 1997,'' Before the Subcomm. On Finance and Hazardous Materials of 
the House Comm. On Commerce (July 17, 1997); Testimony of Arthur 
Levitt, Chairman, U.S. Securities and Exchange Commission, 
Concerning Financial Modernization, Before House Comm. On Banking 
and Financial Services (May 22, 1997); Testimony of Arthur Levitt, 
Chairman, U.S. Securities and Exchange Commission, Regarding H.R. 
1062, the ``Financial Services Competitiveness Act of 1995,'' Before 
the Subcomm. On Telecommunications and Finance and the Subcomm. On 
Commerce, Trade and Hazardous Materials of the House Comm. On 
Commerce (June 6, 1995); Testimony of Arthur Levitt, Chairman, U.S. 
Securities and Exchange Commission, Concerning the ``Financial 
Services Competitiveness Act of 1995'' and Related Issues, Before 
the House Comm. On Banking and Financial Services (Mar. 15, 1995); 
Testimony of Arthur Levitt, Chairman, U.S. Securities and Exchange 
Commission, Concerning H.R. 3447 and Related Functional Regulation 
Issues, Before the Subcomm. On Telecommunications and Finance of the 
House Comm. On Energy and Commerce (Apr. 14, 1994); Testimony of 
Richard C. Breeden, Chairman, U.S. Securities and Exchange 
Commission, Concerning Financial Modernization, Before the Subcomm. 
On Telecommunications and Finance of the House Comm. On Energy and 
Commerce (July 11, 1990); Memorandum of the Securities and Exchange 
Commission (under Chairman David Ruder) to the Subcomm. On 
Telecommunications and Finance of the House Comm. On Energy and 
Commerce, Concerning Financial Services Deregulation and Repeal of 
the Glass-Steagall Act (Apr. 11, 1988); Testimony of David S. Ruder, 
Chairman, U.S. Securities and Exchange Commission, Concerning the 
Structure and Regulation of the Financial Services Industry, Before 
the Subcomm. On Telecommunications and Finance of the House Comm. On 
Energy and Commerce (Oct. 5, 1987).
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    Sections 201 and 202 of the GLBA substantially amended the Exchange 
Act's definitions of ``broker'' and ``dealer,'' respectively.\9\ The 
amended definitions become effective on May 12,

[[Page 27762]]

2001. Before the amendment, Sections 3(a)(4) and 3(a)(5) of the 
Exchange Act provided that the terms ``broker'' and ``dealer'' did not 
include a ``bank.''\10\ Accordingly, banks \11\ that engaged in 
securities activities were excepted from the requirement to register as 
broker-dealers under the Exchange Act.\12\ The amended definitions 
replace this general exception for banks with specific functional 
exceptions from broker-dealer registration for certain bank securities 
activities.
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    \9\ Exchange Act Sections 3(a)(4) and 3(a)(5) [15 U.S.C. 
78c(a)(4) and 78c(a)(5)].
    \10\ Current Exchange Act Section 3(a)(4) defines the term 
``broker'' as ``any person engaged in the business of effecting 
transactions in securities for the account of others, but does not 
include a bank.'' Current Exchange Act Section 3(a)(5) defines the 
term ``dealer'' as ``any person engaged in the business of buying 
and selling securities for his own account, through a broker or 
otherwise, but does not include a bank * * * .''
    \11\ Exchange Act Section 3(a)(6) [15 U.S.C. 78c(a)(6)] defines 
the term ``bank'' as:
    (A) a banking institution organized under the laws of the United 
States, (B) a member bank of the Federal Reserve System, (C) any 
other banking institution, whether incorporated or not, doing 
business under the laws of any State or of the United States, a 
substantial portion of the business of which consists of receiving 
deposits or exercising fiduciary powers similar to those permitted 
to national banks under the authority of the Comptroller of the 
Currency * * * and which is supervised and examined by State or 
Federal authority having supervision over banks, and which is not 
operated for the purpose of evading the provisions of this title, 
and (D) a receiver, conservator, or other liquidating agent of any 
institution or firm included in clauses (A), (B), or (C) of this 
paragraph.
    \12\ Exchange Act Section 15(a) [15 U.S.C. 78o(a)] generally 
provides that:
    [i]t shall be unlawful for any broker or dealer which is either 
a person other than a natural person or a natural person not 
associated with a broker or dealer which is a person other than a 
natural person (other than such a broker or dealer whose business is 
exclusively intrastate and who does not make use of any facility of 
a national securities exchange) to make use of the mails or any 
means or instrumentality of interstate commerce to effect any 
transactions in, or to induce or attempt to induce the purchase or 
sale of, any security (other than an exempted security or commercial 
paper, bankers' acceptances, or commercial bills) unless such broker 
or dealer is registered in accordance with [the provisions] of this 
section.
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    In particular, the amended definitions create 11 ``broker'' and 4 
``dealer'' exceptions for banks. Three of these exceptions are similar 
for both ``broker'' and ``dealer.'' The exceptions are outlined briefly 
below:\13\
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    \13\ This outline is a summary. It does not describe the 
exceptions in full.
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1. Exceptions From Both ``Broker'' And ``Dealer'' Definitions
    <bullet> Trust and fiduciary activities: permits banks to act as 
brokers and dealers in securities so long as they act as ``trustees'' 
or ``fiduciaries'' and meet other conditions.
    <bullet> Permissible securities transactions: permits banks to act 
as brokers and dealers with respect to exempted securities, Canadian 
government obligations, and Brady bonds.
    <bullet> Identified banking products: permits banks to act as 
brokers and dealers for certain ``identified banking products,'' as 
defined in Section 206 of the GLBA.
2. Other Exceptions From ``Broker'' Definition
    <bullet> Third party brokerage arrangements: permits banks to enter 
into contractual arrangements with registered broker-dealers to sell 
securities to bank customers under specified conditions.
    <bullet> Certain stock purchase plans: permits banks, as a part of 
their transfer agent activities, to effect certain securities 
transactions in employee benefit plans, dividend reinvestment plans, 
and issuer plans under specified conditions.
    <bullet> Sweep accounts: permits banks to sweep customer funds into 
no-load money market funds.
    <bullet> Affiliate transactions: permits banks to effect 
transactions for affiliates, other than affiliates that are registered 
broker-dealers or affiliates engaged in merchant banking.
    <bullet> Private securities offerings: permits banks that are not 
affiliated with broker-dealers to privately place securities under 
specified conditions.
    <bullet> Safekeeping and custody activities: permits banks to hold 
securities, pledge securities, lend securities held in custody, and 
reinvest collateral.
    <bullet> Municipal securities: permits banks to act as brokers in 
municipal securities.
    <bullet> De minimis exception: permits banks to engage in 500 
securities transactions annually without registering as brokers.
3. Other Exception From ``Dealer'' Definition
    <bullet> Asset-backed products: permits banks to underwrite and 
sell asset-backed securities representing obligations predominantly 
originated by a bank, an affiliate of the bank other than a broker-
dealer, or a syndicate in which the bank is a member, for some types of 
products.
    In recent weeks, we have received an increasing number of inquiries 
regarding how we will interpret some of the terms in the new specific 
functional exceptions.\14\ Because the exceptions from the definitions 
of broker and dealer are exceptions to the Exchange Act, we are 
statutorily charged with interpreting these exceptions. In response to 
interpretive questions that have arisen, we are adopting, as interim 
final rules,\15\ new Exchange Act Rules 3b-17 and 3b-18.\16\
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    \14\ Letter from Melanie L. Fein to Robert L. D. Colby, Deputy 
Director, and Catherine McGuire, Associate Director and Chief 
Counsel, Division of Market Regulation, Commission (Mar. 30, 2001); 
Letter from Scott M. Albinson, Managing Director, OTS, to Annette L. 
Nazareth, Director, Division of Market Regulation, Commission, and 
Paul F. Roye, Director, Division of Investment Management, 
Commission (Mar. 20, 2001); Letter from Lawrence R. Uhlick, 
Executive Director and General Counsel, Institute of International 
Bankers, to Robert L. D. Colby, Deputy Director, and Catherine 
McGuire, Associate Director and Chief Counsel, Division of Market 
Regulation, Commission (Mar. 15, 2001); Letter from Barry Harris, 
Chair, Bank Retail Broker-Dealer Committee, Securities Industry 
Association, to Laura Unger, Acting Chairman, Commission (Mar. 13, 
2001); Letter from Melanie L. Fein to Robert L. D. Colby, Deputy 
Director, and Catherine McGuire, Associate Director and Chief 
Counsel, Division of Market Regulation, Commission (Mar. 13, 2001); 
Letter from Melanie L. Fein to Robert L. D. Colby, Deputy Director, 
and Catherine McGuire, Associate Director and Chief Counsel, 
Division of Market Regulation, Commission (Mar. 7, 2001); Letter 
from Sarah A. Miller, Director, Center for Securities, Trust and 
Investments, American Bankers Association, to Laura Unger, Acting 
Chairman, Commission (Feb. 28, 2001).
    \15\ Several of the banking agencies promulgated interim final 
rules implementing various provisions of the GLBA and solicited 
comments to implement the bank activity sections of the GLBA. See 
Interim Final Rule with Request for Comments, Repurchases of Stock 
by Recently Converted Savings Associations, Mutual Holding Company 
Dividend Waivers, 65 Fed Reg. 43088 (July 12, 2000), comment period 
extended, 65 FR 60095 (Oct. 10, 2000) (Office of Thrift Supervision 
(``OTS'')); Joint Interim Final Rule with Request for Comments, Bank 
Holding Companies and Changes in Bank Control, 65 FR 16460 (Mar. 28, 
2000) (Board of Governors of the Federal Reserve System (``Federal 
Reserve'') and Department of Treasury (``Treasury'')); Interim Final 
Rules with Request for Comment, Activities and Investments of 
Insured State Banks, 65 FR 15526 (Mar. 23, 2000), Final Rule, 66 FR 
1018 (Jan. 5, 2001) (Federal Deposit Insurance Corporation 
(``FDIC'')); Interim Final Rule with Request for Comments, Financial 
Subsidiaries, 65 FR 14819 (Mar. 20, 2000) (Federal Reserve); Joint 
Interim Final Rule with Request for Comments, Financial 
Subsidiaries, 65 FR 15050 (Mar. 20, 2000) (Treasury and Federal 
Reserve); Interim Final Rule with Request for Comments, Application 
of Sections 23A and 23B of the Federal Reserve Act to Derivative 
Transactions with Affiliates and Intraday Extensions of Credit to 
Affiliates, 66 FR 24229 (May 11, 2001) (Federal Reserve).
    \16\ Exchange Act Section 3(b) [15 U.S.C. 78c(b)] authorizes us 
to define terms in the Exchange Act.
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    New Rule 3b-17 defines terms applicable to three exceptions from 
the definition of broker: (1) Networking arrangements; (2) trust and 
fiduciary activities; and (3) sweep accounts. Rule 3b-17 also provides 
legal certainty to banks regarding the availability of the fiduciary 
activities exception when they act as indenture trustees or as trustees 
for tax-deferred accounts. New Rule 3b-18 defines terms for the 
exception from the definition of dealer for banks that sell asset-
backed securities.
    To alleviate concerns that have been expressed to us in recent 
months, we also grant five exemptions under which banks may effect 
transactions in

[[Page 27763]]

securities without being registered as broker-dealers. New Rule 3a4-2 
responds to concerns banks have expressed about calculating the 
compensation condition in the trust and fiduciary activities exception. 
This rule permits banks to compute their compensation, for purposes of 
the compensation condition, based on their total amount of trust and 
fiduciary activities, subject to a 10% limit and internal maintenance 
procedures. New Rule 3a4-3 allows banks to effect transactions as 
indenture trustees in no-load money market funds without meeting the 
``chiefly compensated'' condition in the trust and fiduciary activities 
exception.
    New Rule 3a4-4 provides a conditional exemption to allow small 
banks to effect transactions in investment company securities held in 
tax-deferred custody accounts and to be compensated for this brokerage 
activity. We define small banks as banks that had less than $100 
million in assets as of December 31 in both of the prior two calendar 
years, and have not been, since December 31 of the third prior calendar 
year, an affiliate of a bank holding company or financial holding 
company that, as of December 31 of both of the prior two calendar 
years, had total assets of $1 billion or more. Small banks may not rely 
this exemption if they are affiliated with, or have networking 
arrangements with, registered broker-dealers. New Rule 3a4-5 
conditionally exempts all banks that effect transactions in securities 
for custody accounts without, directly or indirectly, receiving 
compensation for providing this service. A bank relying on this 
exemption may pass on to the customer the broker-dealer's charge for 
executing the transactions. Like Rule 3a4-4, this exemption imposes 
conditions on banks' solicitation of transactions.
    New Rule 3a4-6 provides a conditional exemption that allows banks 
to continue to execute transactions in investment company securities 
through the National Securities Clearing Corporation's (``NSCC'') 
Mutual Fund Services, including Fund/SERV, instead of through a 
registered broker-dealer as required by Exchange Act Section 
3(a)(4)(C). This exemption is available only to banks that otherwise 
meet the conditions of another exception or exemption.
    New Rule 3a5-1 conditionally exempts from the definition of 
``dealer'' banks engaged in riskless principal transactions if they do 
not exceed the de minimis transactions exception limit in Exchange Act 
Section 3(a)(4)(B)(xi).
    We understand that banks will need time to determine whether any 
securities activities must be conducted through registered broker-
dealers after May 11, 2001. In addition, some banks may not have 
completed the process of ensuring that securities transactions are 
conducted through registered broker-dealers, where required. 
Accordingly, new Rule 15a-7 exempts banks that are engaging in 
securities activities from the definitions of broker and dealer until 
October 1, 2001.\17\ In addition, Rule 15a-7 exempts banks whose 
compensation arrangements do not meet the compensation conditions of a 
particular exception or exemption from the definition of broker until 
January 1, 2002, if they meet the other conditions for an exception or 
exemption.
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    \17\ Exchange Act Section 36 [15 U.S.C. 78mm] authorizes us to 
exempt any person, security, or transaction from the provisions of 
the Exchange Act, to the extent that such exemption is necessary or 
appropriate in the public interest, and consistent with the 
protection of investors.
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    New Rule 15a-8 exempts banks from the potential voiding under 
Exchange Act Section 29(b) of contracts entered into before January 1, 
2003, because the bank violated the broker-dealer registration 
requirements or any applicable provision of the Exchange Act and rules 
thereunder based solely on the bank's status as a broker or dealer at 
the time the bank entered into the contract. Finally, new Rule 15a-9 
exempts savings associations and savings banks \18\ from the 
definitions of ``broker'' and ``dealer'' under Exchange Act Sections 
3(a)(4) and 3(a)(5) on the same terms and conditions that apply to 
banks.
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    \18\ This exemption is limited to savings associations and 
savings banks that have deposits insured by the FDIC under the 
Federal Deposit Insurance Act (``FDIA''). 12 U.S.C. 1811 et seq.
---------------------------------------------------------------------------

    We recognize that banks have developed their particular securities 
activities under the general exception from broker-dealer registration 
that existed prior to the passage of the GLBA. Because particular banks 
may have individual considerations that may be appropriate for 
additional relief, we are authorizing the Director of the Division of 
Market Regulation to consider, on a case-by-case basis, individual 
requests for exemptive relief from banks. We also are directing the 
staff to consider requests from savings associations and savings banks 
for additional exemptive relief.\19\ To facilitate the processing of 
these requests, we have delegated exemptive authority to the staff of 
the Division of Market Regulation through an amendment to Rule 30-3 of 
our Rules of Organization and Program Management. We expect the staff 
to submit novel and complex requests for exemption to us.
---------------------------------------------------------------------------

    \19\ See id. The same limitation applies to this delegation.
---------------------------------------------------------------------------

    As a general matter, under the federal securities laws, parties 
relying on an exception or exemption have the burden of demonstrating 
that they qualify for such exception or exemption. We would therefore 
expect banks, as a matter of good business practice, to be able to 
demonstrate that they meet the terms of a particular exemption. We 
solicit comment regarding whether the requirements that the bank 
regulators are required to adopt under Section 18(t) of the FDIA \20\ 
will be sufficient for this purpose or whether the Commission itself 
should adopt record keeping rules relating to these exemptions. We 
solicit comment on what records banks have or can develop to 
demonstrate to the Commission that they meet the terms of a particular 
exemption. We also solicit comment on whether it is necessary for 
savings association and savings bank regulators to adopt record keeping 
requirements for savings associations and savings banks analogous to 
those adopted for banks.
---------------------------------------------------------------------------

    \20\ 12 U.S.C. 1828(t).
---------------------------------------------------------------------------

    We request comment on all aspects of the interim final rules as 
well as comment on the specific provisions and issues highlighted 
below.

B. The Gramm-Leach-Bliley Act

    As highlighted above, the GLBA repealed certain provisions of the 
Glass-Steagall Act \21\ and other restrictions applicable to banks and 
bank holding companies. As a result, banks are able to affiliate with 
securities firms and insurance companies within the same financial 
holding company.
---------------------------------------------------------------------------

    \21\ Supra note 4.
---------------------------------------------------------------------------

    The GLBA codified the concept of functional regulation--that is, 
regulation of the same functions, or activities, by the same expert 
regulator, regardless of the type of entity engaging in those 
activities. Congress believed that, given the expansion of the 
activities and affiliations in the financial marketplace, functional 
regulation was important to building a coherent financial regulatory 
scheme.\22\ Accordingly, Title II of the GLBA amended the federal 
securities laws to provide for functional regulation of securities 
activities by eliminating the complete exception for banks from the 
definitions of ``broker'' and ``dealer.'' As the legislative history 
noted, prior to the passage of the GLBA, the exception for banks from 
broker-dealer registration

[[Page 27764]]

created a competitive disparity by permitting banks to engage in 
securities activities without being subject to the same regulatory 
requirements as broker-dealers. In the legislative history, Congress 
specifically expressed concern that the complete exception had 
permitted banks to engage in securities activities without being 
subject to the provisions of the federal securities laws that were 
designed to protect investors.\23\
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    \22\ H.R. Rep. No. 106-74, pt. 3, at 106th Cong., 1st Sess. at 
113 (1999).
    \23\ Id. at 113-14.
---------------------------------------------------------------------------

    The federal securities laws provide a comprehensive and coordinated 
system of regulation of securities activities. They are specifically 
and uniquely designed to assure the protection of investors through 
full disclosure concerning securities and the prevention of unfair and 
inequitable practices in the securities markets. The securities laws 
also have as a goal fair competition among all participants in the 
securities markets. Broker-dealer registration is an important element 
of this regulatory system. Absent broker-dealer registration, bank 
securities activities generally are regulated only under banking law, 
which has as its primary purposes the protection of depositors and the 
preservation of the financial soundness of banks.\24\ Thus, bank 
securities activities take place outside of the coordinated system of 
securities regulation that is designed to protect investors, leading to 
regulatory disparities.
---------------------------------------------------------------------------

    \24\ See Board of Governors of Federal Reserve System v. 
Investment Co. Institute, 450 U.S. 46, 61, 101 S. Ct. 973, 984, 67 
L. Ed. 2d 36 (1981); 75 Cong. Rec. 9913-9914 (1932) (remarks of Sen. 
Bulkley). Employees that perform purely cerical and ministerial 
duties are not required to pass a qualifications test.
---------------------------------------------------------------------------

    For example, to become licensed to sell securities, all persons 
associated with a broker-dealer are required to pass a qualifications 
test covering substantive aspects of the securities business.\25\ 
Commission and self-regulatory organization (``SRO'') rules also assure 
that those persons associated with broker-dealers who have committed 
abuses that would make them subject to a statutory disqualification are 
prohibited from working in the securities industry or are subject to 
conditions such as enhanced supervision.\26\ The SROs also require that 
persons involved in the management of the broker-dealer pass additional 
examinations relating to supervisory procedures and requirements.\27\ 
These qualification requirements are supplemented by continuing 
education requirements, the broker-dealer's duty to supervise its 
employees to prevent violations of the federal securities laws, and the 
specific supervisory procedures imposed by the SROs.\28\ In addition, 
our rules and those of the SROs specifically address sales practice 
abuses.\29\ By contrast, bank personnel generally are not subject to 
licensing or other regulations designed to test their knowledge of the 
securities business.
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    \25\ See, e.g., NASD Rules 1031 and 1032, relating to the 
registration of representatives of member firms; and New York Stock 
Exchange (``NYSE'') Rule 345, relating to employee registration, 
approval, and records.
    \26\ See, e.g., Exchange Act Section 19(h)(3) [15 U.S.C. 
78s(h)(3)].
    \27\ See, e.g., NASD Rules 1021 and 1022, relating to the 
registration of principals of member firms.
    \28\ See, e.g., Exchange Act Section 15(b)(7) [15 U.S.C. 
78o(b)(7)]; NASD Rules 1120 (``Continuing Education Requirements'') 
and 3010 (``Supervision''); NYSE Rules 345A (``Continuing Education 
for Registered Persons'') and 405(b) (``Supervision of Accounts'').
    \29\ See, e.g., Exchange Act Rule 15g-9 [17 CFR 240.15g-9] 
(``Sales Practice Requirements for Certain Low-Priced Securities''); 
NASD Rule 2310 (``Recommendations to Customers (Suitability)''); 
NASD Rule 2440 (``Fair Prices and Commissions'').
---------------------------------------------------------------------------

    Another area in which banking and securities regulation differ is 
communications with the public, including advertising. Broker-dealers 
must comply with specific guidelines concerning the content and review 
of communications with the public, including advertisements.\30\ With 
certain limited exceptions, there are no equivalent rules governing the 
advertisement of bank securities activities.\31\
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    \30\ See NASD Rule 2210 (``Communications with the Public''); 
NYSE Rule 472 (``Communications with the Public''). These rules 
include standards for communications with the public, approval, 
record keeping, and filing requirements. The NASD and the NYSE also 
require supervisory review of communication with the public. NASD 
Conduct Rule 3010 (``Supervision''); NYSE Rule 342 (``Offices-
Approval, Supervision, and Control'').
    \31\ See, e.g., The Interagency Statement on Retail Sales of 
Nondeposit Investment Products (February 15, 1994), 7 Fed. Banking 
L. Rep. (CCH) para. 70-101 (joint statement by the Federal Reserve, 
OTS, FDIC, and the OCC).
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    Broker-dealers are subject to inspections and examinations not only 
by our staff but also by the SROs with our supervision. SRO 
examinations are designed to assure compliance with the federal 
securities laws, in particular sales practices and financial 
responsibility regulations. Banks, on the other hand, are not members 
of SROs. While bank examiners may review for violations of the banking 
agencies' securities guidelines, the primary focus is on ensuring the 
safety and soundness of the bank rather than the protection of 
investors.
    Congress considered the different purposes of bank and securities 
regulation when it eliminated the blanket exception from broker-dealer 
registration for banks' securities activities.\32\ The GLBA replaced 
the general exception with eleven specific functional exceptions to the 
definition of broker and four specific functional exceptions to the 
definition of dealer. In replacing the general exception with more 
narrowly tailored exceptions, the GLBA sought to apply broker-dealer 
regulation to bank securities activities where appropriate to 
strengthen investor protection, taking into account the nature of the 
securities activities being conducted. This approach resulted in the 
specific exceptions enumerated in the amended definitions of broker and 
dealer in the Exchange Act that will continue to allow banks to engage 
directly in many securities activities without conducting those 
activities through a registered broker or dealer. The new exceptions go 
into effect on May 12, 2001.
---------------------------------------------------------------------------

    \32\ H.R. Rep. No. 106-74, pt. 3, at 113-14, 161-62 (1999).
---------------------------------------------------------------------------

II. Rule 3b-17--Definitions Related to Exception From ``Broker''

    Exchange Act Section 3(a)(4) generally defines a ``broker'' to be 
``any person engaged in the business of effecting transactions in 
securities for the account of others.'' \33\ Prior to the passage of 
the GLBA, this definition was modified by the words ``but does not 
include a bank'' (emphasis added).\34\ The GLBA repealed this exception 
and replaced it with eleven specific exceptions for certain securities 
activities that a bank may engage in without being considered a 
broker.\35\
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    \33\ Exchange Act Section 3(a)(4) [15 U.S.C. 78c(a)(4)].
    \34\ Former Exchange Act Section 3(a)(4).
    \35\ Exchange Act Section 3(a)(4)(B) [15 U.S.C. 78c(a)(4)(B)].
---------------------------------------------------------------------------

    We are adopting Rule 3b-17 \36\ to clarify some of the exceptions 
enumerated in amended Exchange Act Section 3(a)(4).\37\ Rule 3b-17 
defines certain terms that are used in the exceptions regarding third-
party brokerage arrangements, trust and fiduciary activities, and sweep 
accounts. In addition, both in this Part and in Part III of this 
Release below, we discuss exceptions in Exchange Act Section 3(a)(4) 
related to safekeeping and custody activities, affiliate transactions, 
and a de minimis number of securities transactions.
---------------------------------------------------------------------------

    \36\ 17 CFR 240.3b-17.
    \37\ Exchange Act Section 3(b) [15 U.S.C. 78c(b)] authorizes us 
to define terms used in the Exchange Act, consistent with the 
provisions and purposes of the Exchange Act.
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A. Networking Exception

    Section 3(a)(4)(B)(i) of the Exchange Act provides an exception 
from the

[[Page 27765]]

definition of broker for banks that enter into third-party brokerage 
(``networking'') arrangements.\38\ Under this exception, and subject to 
certain conditions, a bank will not be considered a broker if it 
``enters into a contractual or other written arrangement'' with a 
registered broker-dealer through which the broker-dealer ``offers 
brokerage services on or off the premises of the bank.'' \39\ 
Statutorily imposed conditions to the exception address separation of 
brokerage and banking services, compliance with advertising conditions, 
functions and compensation of bank employees, conditions to fully 
disclose the customers' accounts to broker-dealers, and conditions on 
banks acting as carrying brokers.
---------------------------------------------------------------------------

    \38\ This exception follows a long line of letters issued by the 
Commission staff regarding these types of arrangements. H.R. Rep. 
No. 106-74, pt. 3, at 163 (1999); see, e.g., Letter re: Chubb 
Securities Corp. (Nov. 24, 1993) (``Chubb Letter''). The Chubb 
Letter superseded prior staff positions regarding these 
arrangements. See also NASD Rule 2350 (Broker-Dealer conduct on the 
Premises of Financial Institutions). The Chubb Letter will remain in 
effect for required service corporations of savings associations and 
savings banks; however, the Chubb Letter is available only to 
service corporations so long as a savings association or savings 
bank is required to use one. A savings association or savings bank 
that complies with the terms of the networking exception will 
automatically comply with the terms of the Chubb Letter.
    \39\ Exchange Act Section 3(a)(4)(B)(i) [15 U.S.C. 
78c(a)(4)(B)(i)].
---------------------------------------------------------------------------

    One particular condition prohibits unregistered bank employees from 
receiving:

incentive compensation for any brokerage transaction unless such 
employees are associated persons of a broker or dealer and are 
qualified pursuant to the rules of a self-regulatory organization, 
except that the bank employees may receive compensation for the 
referral of any customer if the compensation is a nominal one-time 
cash fee of a fixed dollar amount and the payment of the fee is not 
contingent on whether the referral results in a transaction.\40\
---------------------------------------------------------------------------

    \40\ Exchange Act Section 3(a)(4)(B)(i)(VI) [15 U.S.C. 
78c(a)(4)(B)(i)(VI)].

    Legislative history indicates that this condition, like the other 
conditions in the networking exception, was designed to promote 
investor protection.\41\ Specifically, Congress included the limitation 
on incentive compensation to unregistered bank employees to ensure that 
those people who have a ``salesman's stake'' in securities transactions 
are subject to the sales practice standards and other requirements of 
the federal securities laws.\42\
---------------------------------------------------------------------------

    \41\ See H.R. Rep. No. 106-74, pt. 3, at 163 (1999) (``The 
[third-party brokerage arrangements] exception is * * * limited by a 
variety of conditions designed to promote investor protection.'').
    \42\ See id. (``[T]he conditions contained in the networking 
exception * * * restrict the securities activities of unregistered 
bank personnel to reduce sales practice concerns.'').
---------------------------------------------------------------------------

    We have kept Congress' limit in mind in interpreting two terms in 
the provision. First, Rule 3b-17(h) defines the term ``referral'' to 
mean a bank employee arranging a first securities-related contact 
between a registered broker-dealer and a bank customer. The term 
``referral'' does not include any activity (including any part of the 
account opening process) related to effecting transactions in 
securities beyond arranging that first securities-related contact.\43\
---------------------------------------------------------------------------

    \43\ The ``account opening process'' commences at the point of 
first contact between a broker-dealer and a customer. See NASD 
Notice to Members 97-89 (1997), at Question 7.
---------------------------------------------------------------------------

    Second, Rule 3b-17(g) provides two alternative definitions of the 
term ``nominal one-time cash fee of a fixed dollar amount.'' First, the 
rule provides that a nominal one-time cash fee of a fixed dollar amount 
may be a payment that does not exceed one hour of the gross cash wages 
of the unregistered bank employee making the referral. Second, the rule 
also provides that a nominal one-time cash fee of a fixed dollar amount 
may be a payment in the form of points in a system or program that 
covers a range of bank products and non-securities related services, 
where the points count toward a bonus that is cash or non-cash, if the 
points awarded for referrals involving securities are not greater than 
the points awarded for products or services not involving securities. 
Banks may use either alternative in setting nominal payments if they 
meet the requirements discussed below, including the requirement that 
any payment not be designed as an incentive to a bank employee to 
solicit particular investors to open accounts or to engage in 
securities transactions.
    We provided two alternative ways to measure cash compensation to 
give banks the flexibility of compensating their employees for 
securities referrals based either on their current wages or on what the 
banks pay for referrals of other products and services. By creating two 
alternative standards, we allow banks to develop a market-based 
approach to employee compensation that is consistent with the 
compensation limitation in the networking exception. In either case, as 
discussed below, we require that any payment not be designed as an 
incentive to a bank employee to solicit particular investors to open 
accounts or to solicit investors to engage in securities transactions.
    We considered choosing a set dollar amount as the measure for a 
nominal cash payment. We decided against this approach after 
considering that we would likely have to adjust periodically any set 
dollar amount to reflect changes in the economy that would affect its 
real value. We also determined that, given the economic differences 
across the country, an across-the-board dollar amount may not have a 
nominal value everywhere or in every part of the bank. For example, 
what is considered a nominal dollar amount in San Francisco, California 
may be considered generous in Wichita, Kansas. Similarly, one system 
may be used for teller referrals and another system for private banker 
referrals. Using one hour of the cash wages of the unregistered bank 
employee making a referral should alleviate these concerns. Hourly 
wages are generally adjusted, not just to reflect the current state of 
the economy, but also to reflect the economic climate of a particular 
location and the duties of a particular employee. Also, using one hour 
of cash wages as the measure for a nominal cash payment, we ensured 
that the referral fee is proportionate to an employee's overall wages.
    We understand that bank employees making referrals typically are 
paid a yearly salary rather than an hourly wage. In these cases, 
translating the yearly salaries into hourly wages should still be a 
simple task. We request comment on whether an hour's wages, subject to 
the limits described below, is a proper measure of a ``nominal'' fee.
    Use of a point system under the second alternative reflects our 
understanding that banks do not always reward employees with a set cash 
referral fee. Payment of bonuses as part of a point system or program 
offered to bank employees is not necessarily inconsistent with the 
networking exception. A point system may do nothing more than translate 
a nominal one-time cash referral fee into nominal one-time referral 
points. If the point system is part of an overall system that includes 
products other than securities and lines of business other than 
brokerage, and the securities-related referral points have a value that 
is no greater than the points received under the system for any other 
product or service, it should have only a nominal value in the system. 
Accordingly, we have provided this alternative definition in an effort 
to accommodate existing bank practices. Of course, the program may not 
be structured in any way that allows unregistered bank employees to be 
compensated either directly or indirectly for meeting sales targets

[[Page 27766]]

related to securities products or services.
    We understand that banks may choose to provide prizes, rather than 
cash bonuses, to bank employees that meet a certain point goal.\44\ As 
long as the point system meets the conditions described above, 
including the requirement that any payment not be designed as an 
incentive to a bank employee to solicit particular investors to open 
accounts or to solicit investors to engage in securities transactions, 
we would view the system as consistent with the statutory 
exception.\45\
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    \44\ Non-cash compensation can include, but is not necessarily 
limited to, merchandise, gifts, prizes, travel expenses, meals, and 
lodging. See NASD Rule 2830(b)(1)(D) (providing essentially the same 
definition of non-cash compensation for NASD rule limiting cash and 
non-cash compensation to members in connection with investment 
company securities activities).
    \45\ This condition does not necessarily dictate equal weighting 
for referrals to different business lines. Rather, it means that, to 
the extent there are differential referral payouts, points for 
referrals to broker-dealers should not have greater weight than 
points for any other type of referral.
---------------------------------------------------------------------------

    Regardless of the form of payment banks decide to use, Rule 3b-
17(g) also provides that any payment may not be designed to provide, 
either directly or indirectly,\46\ an incentive to a bank employee to 
solicit investors to open accounts or to solicit investors to engage in 
securities transactions. Therefore, Rule 3b-17(g) also specifies that 
payments may not be based on: (1) The size, value, or completion of any 
securities transaction; (2) the amount of securities-related assets 
gathered; (3) the size or value of any customer's bank or securities 
account; or (4) the customer's financial status.
---------------------------------------------------------------------------

    \46\ We look behind the terms of a compensation arrangement to 
determine its economic substance, that is, to determine whether it 
is transaction-related. Thus, a fee arrangement designed to 
compensate a person for what that person would have received if the 
person directly received transaction-related compensation (for 
example, a flat fee that is recalculated periodically to reflect an 
increase or decrease in the number of transactions) would be the 
equivalent of transaction-related compensation. In this regard, a 
flat fee representing a percentage of expected future commissions 
could be considered transaction-related.
---------------------------------------------------------------------------

    This interpretation is consistent with the Commission staff's 
historical position on networking activities.\47\ Also, while nominal 
referral payments that are not based on the success of any securities 
transactions may provide a limited salesman's stake, we believe these 
parameters will help ensure that the effect of the stake will be 
small.\48\
---------------------------------------------------------------------------

    \47\ See Chubb Letter, supra note 38.
    \48\ This is important, in our view, because referral 
compensation may create an improper salesman's incentive. For 
example, in 1998 NationsSecurities and NationsBank, N.A., without 
admitting or denying the matters set forth in the settlement order, 
settled administrative proceedings brought by us for alleged 
misleading sales practices relating to two high-risk sales of 
closed-end bond funds. In the Matters of NationsSecurities and 
NationsBank, N.A., Securities Act Rel. No. 7532; Exchange Act Rel. 
No. 39947; File No. 3-9596 (May 4, 1998). The bank also adopted a 
referral fee system that created heightened incentives for bank 
employees to make customer referrals to the broker-dealer. Under 
this program, the broker-dealer paid the bank 5% of the broker-
dealer's gross commission for making referrals to the broker-dealer 
and the bank then paid the referring bank employee. The payment was 
conditioned on closing a sale of securities and was proportional to 
the size of the sale. In some instances, bank employees 
substantially increased their monthly compensation during this 
period by making referrals to the broker-dealer. The statutory 
limitations on the networking exception are designed to prevent 
precisely these types of incentives to unregistered bank personnel.
---------------------------------------------------------------------------

    We are concerned that referral payments, while ``nominal'' when 
considered independently, may not be ``nominal'' when considered in the 
aggregate. For example, one referral payment to a teller for one 
referral in one day of work may be ``nominal,'' but twenty referral 
payments to a teller for twenty referrals in one day may not be 
``nominal'' when considered in the aggregate. ``Nominal'' payments are 
to be paid to employees for whom referrals to the broker-dealer 
constitute an insubstantial part of an employee's duties. If a referral 
fee system were structured in such a manner that referral fees 
constituted a substantial portion of an employee's total compensation, 
it would raise serious questions about whether the payments were 
designed to encourage the bank employee to solicit securities 
activities. We solicit comment on whether we need to establish gross 
compensation standards so that referral payments that are ``nominal'' 
do not become incentive compensation when aggregated, and if so, what 
those limits should be.
    Banks also have questioned whether bonuses paid in addition to a 
point system, either in the form of cash or non-cash compensation, are 
acceptable under the exception. We do not believe that bonuses based on 
brokerage referrals fall within the compensation limits of the 
exception.\49\ While bonuses sometimes fall within the category of a 
one-time payment, by their very nature they are incentive compensation. 
The networking exception prohibits unregistered bank employees from 
receiving incentive compensation for any brokerage-related activity 
except for nominal one-time cash payments of a fixed dollar amount for 
a referral.
---------------------------------------------------------------------------

    \49\ The statute also does not contemplate deferred compensation 
on a sliding scale, a grid, or breakpoints for referrals. See H.R. 
Rep., No. 106-74, pt. 3, at 163 (``[B]ank employees who are not 
registered representatives may not receive incentive compensation in 
connection with securities transactions.''). In the securities 
industry, variable commission payments are designed to be incentive 
compensation. See generally Report of the Committee on Compensation 
Practices (April 10, 1995) (``Tully Report'').
---------------------------------------------------------------------------

    Banks, however, may give bonuses, either in the form of cash or 
non-cash compensation, to unregistered bank employees based on the 
overall profitability of the bank regardless of the contribution of 
employee or employees receiving the bonus. To rely on the third-party 
brokerage exception, however, banks cannot indirectly pay their 
unregistered bank employees incentive compensation for securities 
transactions through a branch, department, or line of business or 
through a bonus program related to the securities transactions of a 
branch, department, or line of business.
    In addition, the language and legislative history of the networking 
exception indicate that brokerage referral fees can only be paid to 
natural persons who are bank employees.\50\ The compensation limit, 
however, does not interfere with any incentive-based compensation 
arrangements between the broker-dealer and the bank as a whole. 
Therefore, a broker-dealer in a third-party brokerage arrangement with 
a bank may make transaction-related payments to the bank for brokerage 
transactions conducted by the broker-dealer with the bank's 
customers.\51\
---------------------------------------------------------------------------

    \50\ See generally Exchange Act Section 3(a)(4)(B)(i) [15 U.S.C. 
78c(a)(4)(B)(i)]; H.R. Rep. No. 106-74, at 163 (1999) (both the 
language of the statute and the legislative history of the exception 
refer only to bank employees in the context of individual natural 
persons, especially when comparing their status to registered 
representatives; registered representatives are always individual 
natural persons).
    \51\ Banks cannot structure arrangements with networking broker-
dealers or affiliated broker-dealers in which the bank becomes the 
carrying broker for the affiliates or networking broker-dealers. See 
Exchange Act Section 3(a)(4)(B)(viii)(II) [15 U.S.C. 
78c(a)(4)(B)(viii)(II)].
---------------------------------------------------------------------------

    We find that the definitions in Rule 3b-17 related to the 
networking exception are consistent with the provisions and purposes of 
the Exchange Act.\52\ We request comment on the interpretation of the 
limits on incentive compensation in the networking exception. 
Commenters are specifically requested to identify other issues related 
to the payment of various types of incentive compensation.
---------------------------------------------------------------------------

    \52\ Exchange Act Section 3(b) [15 U.S.C. 78c(b)].
---------------------------------------------------------------------------

B. Trust And Fiduciary Activities Exception

    Exchange Act Section 3(a)(4)(B)(ii)\53\ excepts banks that act as 
trustees or fiduciaries from the definition of ``broker,'' subject to 
certain conditions. Under the terms of this exception, a bank will not 
be considered a ``broker'' if it meets the following conditions in 
conducting brokerage activities: (1)

[[Page 27767]]

Effects transactions in a trustee or fiduciary capacity; (2) effects 
such transactions in its trust department or other department that is 
regularly examined by bank examiners for compliance with fiduciary 
principles and standards; (3) is chiefly compensated for such 
transactions, consistent with fiduciary principles and standards, on 
the basis of an administration or annual fee (payable on a monthly, 
quarterly, or other basis), a percentage of assets under management, or 
a flat or capped per order processing fee equal to not more than the 
cost incurred by the bank in connection with executing such securities 
transactions or any combination of such fees; and (4) does not publicly 
solicit brokerage business, other than by advertising that it effects 
transactions in securities in conjunction with advertising its other 
trust activities.\54\ A bank also must execute such transactions 
through a registered broker-dealer or in a cross trade.\55\
---------------------------------------------------------------------------

    \53\ 15 U.S.C. 78c(a)(4)(B)(ii).
    \54\ Exchange Act Sections 3(a)(4)(B)(ii)(I) and (II); [15 
U.S.C. 78c(a)(4)(B)(ii)(I) and (II)].
    \55\ Exchange Act Section 3(a)(4)(C) [15 U.S.C. 78c(a)(4)(C)].
---------------------------------------------------------------------------

    This exception recognizes the traditional role banks have played in 
effecting securities transactions for trust customers. These activities 
generally were inherent in a bank's trust operation itself, or arose as 
an accommodation to bank customers or through a traditional trust 
arrangement, rather than through promotion and public solicitation of 
bank brokerage services.\56\ Congress expressed the expectation that we 
would not disturb traditional bank trust activities under this 
exception.\57\ Congress, however, did not intend the trust exception to 
be used to conduct a securities brokerage operation in the bank trust 
department without the appropriate investor protections provided under 
the federal securities laws.\58\ We believe that this legislative 
history indicates that the trust and fiduciary activities exception was 
designed not only to preserve these traditional securities-related bank 
trust activities but also to apply broker-dealer protections to 
securities activities outside those traditional lines. We have kept 
that intent in mind in interpreting this exception.
---------------------------------------------------------------------------

    \56\ H.R. Rep. No. 106-74, pt. 3, at 164. (1999).
    \57\ H.R. Conf. Rep. No. 106-434, pt. 3, 164 (1999).
    \58\ H.R. Rep. No. 106-74, pt. 3, at 164 (1999).
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1. Trustee Capacity
    The trust and fiduciary activities exception excepts banks that act 
in a ``trustee capacity'' or in a ``fiduciary capacity'' from the 
definition of broker.\59\ Trustees typically are subject to the 
strongest of fiduciary duties to trust beneficiaries.
---------------------------------------------------------------------------

    \59\ Exchange Act Section 3(a)(4)(B)(ii) [15 U.S.C. 
3(a)(4)(B)(ii) excepts any bank * * * ``that effects transactions in 
a trustee capacity, or effects transactions in a fiduciary capacity. 
* * *'' Exchange Act Section 3(a)(4)(D)(i) [15 U.S.C. 
78c(a)(4)(D)(i)] defines the term ``fiduciary capacity'' to mean ''* 
* * in the capacity as trustee.''
---------------------------------------------------------------------------

    We have been asked, however, whether a bank that acts as a 
``trustee'' in three specific situations involving securities accounts 
directed by others qualify for trust and fiduciary activities 
exception. This question arises because banks in these situations may 
not be subject to significant fiduciary responsibilities. These three 
situations are indenture trustees, Employee Retirement Security Act 
(``ERISA'') and other pension plan trustees, and Individual Retirement 
Account (``IRA'') trustees. In each of these situations, the person who 
assumes certain ministerial duties for tax, employee benefit, or trust 
indenture purposes is labeled a trustee, often under a federal statute, 
but does not actually assume a comprehensive set of fiduciary duties 
under either state or federal law.
    a. Indenture Trustees. Under certain forms of trust indenture,\60\ 
a bank acting as an indenture trustee may invest idle cash in shares of 
money market mutual funds or other securities.\61\ Sometimes, the 
issuer of the bonds actually directs the investments. In this case, an 
indenture trustee might act as an order-taker at the direction of the 
bond issuer, within the investment parameters set forth in the 
indenture. However, an indenture trustee acts in a constrained order-
taking capacity, because the indenture trustee is responsible for 
making sure that any investments it undertakes fall within the 
investment parameters of the trust indenture.
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    \60\ The difficulties of issuing secured corporate debt to 
numerous bondholders gave rise to the need for indenture trustees. 
Since it would be wholly impractical to have the security run to the 
group of bondholders directly or to have a separate security 
instrument for each bondholder, a trustee exercises its powers and 
duties on behalf of the bondholders. See G. Bogert, TRUSTS AND 
TRUSTEES 250, pp. 254-55 (West 1977); E.F. Hutton v. Union Planters 
National Bank, 953 F.2d 963, 968 (5th Cir. 1992).
    The need for an indenture trustee for issues of modern day 
unsecured corporate debentures also continues because the debt 
represented by the debenture is typically not secured by specific 
assets of the issuer and is frequently subordinated to senior 
indebtedness of the issuer. Thus, the corporate trustee is needed to 
protect the rights of the many holders of the debentures and to 
perform certain ministerial tasks connected with the normal 
operation of the debentures. Although the debts created by 
debentures run directly from the issuer to the holders, the 
contractual rights conferred by the indenture run from the issuer to 
the trustee for the benefit of the holders of the debentures. E.F. 
Hutton, 953 F.2d at 968.
    \61\ See, e.g., Investment Company Act Rel. No. 15900, Community 
Program Loan Trust No. 1987 A; Application, 52 FR 28628 (Applicant 
represented that trust indenture agreement permitted indenture 
trustee to invest funds of indenture trust in certain eligible 
investments as described in the agreement).
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    Indenture trustees are subject to the Trust Indenture Act of 1939 
(``TIA'') when the corporate securities that underlie the indenture are 
sold to the public by use of the mails or in interstate commerce.\62\ 
State law also may provide additional duties in circumstances where the 
TIA and federal common law are not controlling.\63\ However, the 
courts, in expounding and construing the law regarding indenture 
trustees, have not always agreed on the type and nature of the duties 
of indenture trustees.\64\
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    \62\ 15 U.S.C. 77aaa et seq. (1988).
    \63\ Martin D. Sklar, The Corporate Indenture Trustee: Genuine 
Fiduciary or Mere Stakeholder?, 106 Banking L.J. 42, 49 (1989).
    \64\ See Meckel v. Continental Resources Co., 758 F.2d 811, 816 
(2d Cir. 1985) and Elliott Associates v. J. Henry Schroder Bank and 
Trust Co., 838 F. 2d 66, 71 (2d Cir. 1988), both of which held that 
indenture trustees have no duties above the specific obligations 
imposed in the indenture. But see Dabney v. Chase National Bank, 196 
F.2d 668 (2d Cir. 1952), appeal dismissed, 346 U.S. 863, 74 S. Ct. 
102, 103, 98 L. Ed. 374 (1953), where Judge Learned Hand, writing 
for the Second Circuit, reached a somewhat different conclusion when 
the indenture trustee was a creditor of the obligor, and the court 
found the indenture trustee liable for prematurely collecting a debt 
from the obligor. The bondholders sued the indenture trustee, 
alleging that it had forced the obligor into bankruptcy. Judge Hand 
stated that the duty of a trustee not to profit at the possible 
expense of his beneficiary is the most fundamental of the duties, 
which he accepts when he becomes a trustee. It is a part of his 
obligation to give his beneficiary his undivided loyalty, free from 
any conflicting personal interest; an obligation that has been 
nowhere more jealously and rigidly enforced than in New York where 
these indentures were executed. Judge Hand indicated that indenture 
trustees are not fiduciaries by saying: ``We can find no warrant for 
so supposing; and, indeed, a trust for the benefit of a numerous and 
changing body of bondholders appears to us to be preeminently an 
occasion for a scruple even greater than ordinary; for such 
beneficiaries often have too small a stake to follow the fate of 
their investment and protect their rights.'' Id. at 671.
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    b. ERISA And Other Similar Trustees. ERISA \65\ Section 403(a) 
generally requires that ``all assets of an employee benefit plan shall 
be held in trust by one or more trustees,'' who are to be named in the 
trust instrument or appointed by a named fiduciary of the plan. \66\ 
The term ``fiduciary,'' as defined under ERISA Section 3(21)(A),\67\ 
provides that:
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    \65\ 29 U.S.C. 1001 et seq.
    \66\ 29 U.S.C. 1103(a).
    \67\ 29 U.S.C. 1105(c)(1)(A).

    Except as otherwise provided in subparagraph (B),\68\ a person 
is a fiduciary

[[Page 27768]]

with respect to a plan to the extent (i) he exercises any 
discretionary authority or discretionary control respecting 
management of such plan or exercises any authority or control 
respecting management or disposition of its assets, (ii) he renders 
investment advice for a fee or other compensation, direct or 
indirect, with respect to any moneys or other property of such plan, 
or has any authority or responsibility to do so, or (iii) he has any 
discretionary authority or discretionary responsibility in the 
administration of such plan. Such term includes any person 
designated under section 405(c)(1)(B).\69\
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    \68\ Subparagraph (B) states that an investment company 
registered under the Investment Company Act of 1940, and the 
company's investment adviser or principal underwriter, are not 
deemed to be fiduciaries or parties in interest to plans investing 
in the company's securities (except for in-house plans of such 
persons). ERISA Section 3(21)(B) [29 U.S.C. 1002(21)(B)].
    \69\ ERISA Section 405(c)(1)(B) [29 U.S.C. 1105(c)(1)(B)] 
describes the designation by named fiduciaries of other persons to 
carry out fiduciary responsibilities.

    Under ERISA, a person performing any of the duties described in the 
definition of ``fiduciary'' would be considered a fiduciary.\70\ A 
person is a fiduciary, however, only to the extent that he performs 
``fiduciary'' functions.\71\ For example, a person may be a fiduciary 
with respect to some plan assets but not others.\72\
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    \70\ See, e.g., Olson v. E.F. Hutton and Co., 957 F.2d 622 (8th 
Cir. 1992) (ERISA applied to a broker-dealer).
    \71\ See, e.g., Chicago Board Options Exchange v. Connecticut 
General Life, 713 F.2d 254 (7th Cir. 1983).
    \72\ See Class Exemption for Plan Asset Transactions Determined 
by Independent Qualified Professional Asset Managers, 49 F.R. 9494, 
9496 (1984).
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    While a trustee can be considered a plan fiduciary if the trustee 
has discretionary authority over the plan and its assets, depending on 
the structure of the particular retirement plan, the trustee may be 
subject to investment direction from the ``named fiduciary'' of the 
plan, investment managers, or plan participants.\73\ Thus, the issue 
becomes whether an ERISA plan trustee who is subject to another 
person's investment direction is a fiduciary. Similar issues may arise 
regarding state and local government plans permitted under Section 457 
of the Internal Revenue Code (``IRC'').\74\ Although courts have 
disagreed regarding whether a trustee subject to investment direction 
is a fiduciary under ERISA,\75\ the Department of Labor takes the 
position that a trustee of an ERISA plan is a fiduciary by the very 
nature of its position.\76\
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    \73\ See Sections 403(a) and 404(c) of ERISA, 29 U.S.C. 1103(a) 
and 1104(c).
    \74\ 26 U.S.C. 457(b). Assets and deferred amounts of Section 
457(b) plans can be held in trust, custodial accounts, or annuity 
contracts. 26 U.S.C. 457(g). However, custodial accounts and annuity 
contracts are treated as trusts, and regardless of how the assets 
and deferred amounts are held, they must be held for the exclusive 
benefit of participants and their beneficiaries for the plan. 26 
U.S.C. 457(g)(1) and (3).
    \75\ See, e.g, Bedall v. State Street Bank and Trust Co., 137 
F.3d 12 (1st Cir. 1998) (bank, which held plan assets ``in trust'' 
but did not manage, administer, or conduct valuations of the assets, 
was not a fiduciary); Maniace v. Commerce Bank of Kansas City, N.A., 
40 F.3d 264 (8th Cir. 1994), cert. denied, 514 U.S. 1111 (1995) 
(bank trustee of an employee stock ownership plan was not a 
fiduciary under ERISA because it did not have real discretion over 
the plan's assets, and because the trust document explicitly limited 
the bank's discretion with respect to employer stock); Donovan v. 
Cunningham, 541 F. Supp. 276, 290 (S.D. Tex 1982), modified on other 
grounds, 716 F.2d 1455 (5th Cir. 1983), cert. denied, 476 U.S. 1251 
(1984) (trustee, who was a ``directed trustee'' under ERISA Section 
403(a)(1), was not liable for breach of fiduciary duties where its 
activities were confined to the ``limited role of directed 
trustee''); Robbins v. First American Bank, 514 F. Supp. 1183 (1981 
N.D. Ill.) (bank was not a fiduciary when acting as directed trustee 
following instructions of a plan fiduciary, or is custodian of plan 
assets); Bradshaw v. Jenkins, 1984 WL 2405, Fed. Sec. L. Rep. P 
99,719 (W.D.Wash. Mar. 9, 1984) (bank, which was a ``directed 
trustee,'' was a ``mere custodian of plan assets who follows the 
instructions of another fiduciary'').
    \76\ See 29 CFR 2509.75-8, D-3 (trustee is a fiduciary by the 
very nature of its position). If a bank trustee does not make any 
recommendations concerning the selection of particular investment 
company securities, but another plan fiduciary independently 
selects, from mutual fund families made available to the bank, 
particular funds to be made available for investment by plan 
participants, these duties will not arise if the bank gives notice 
to the plan sponsor before modifying the list of funds available for 
investment by plan participants. See Department of Labor (``DOL'') 
Advisory Opinion 97-16A (May 22, 1997) regarding Frost National Bank 
(``The Department points out that the act of limiting designative 
investment options which are intended to constitute all or part of 
the investment universe of an ERISA 404(c) plan is a fiduciary 
function, which, whether achieved through fiduciary designation or 
express plan language, is not a direct or necessary result of any 
particular direction of such plan.''); DOL Information Letter to 
Mark H. Sokolsky, WSB File No. DL0523 (Sept. 5, 1996) (a trustee 
subject to direction from a named fiduciary has ``residual'' 
fiduciary authority for determining whether the direction is proper 
and consistent with ERISA); see also 29 CFR 2550.404c-1(f)(8).
---------------------------------------------------------------------------

    c. IRA Trustees. An IRA \77\ account can be created through a trust 
or custody agreement with a bank under the IRC.\78\ Whichever type of 
agreement is used, an IRA account must be maintained at all times as a 
domestic trust in the United States. \79\ The trustee's duties with 
respect to an account are generally ministerial in nature. \80\ IRA 
trustees do not have discretion regarding the management of the IRA 
assets. \81\
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    \77\ See Section 408 of the Internal Revenue Code of 1986 [26 
U.S.C. 408] and the regulations promulgated thereunder. 26 CFR 
1.408-2.
    \78\ The IRC permits an IRA to be denominated as a ``trust'' or 
a ``custodial account.'' See 26 CFR 1.408-2(b) and (d). Other 
entities also may become the holder of custodial or trustee accounts 
for IRAs if they meet the requirements established by the Internal 
Revenue Service under the Department of the Treasury. 26 U.S.C. 
408(h) and 26 CFR 408-2(e). For our purposes, this alternative 
qualification procedure is not relevant because banks, which are the 
focus of our analysis, are automatically qualified to undertake this 
role under the statute.
    \79\ See 26 CFR 1.408-2(b).
    \80\ The bank must file form ``5498 IRA Contribution 
Information'' on an annual basis. The bank also must file 
appropriate form ``1099-R Distributions from Pensions, Annuities, 
Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, 
etc.'' to reflect distributions from any IRA account.
    \81\ ERISA Section 403(a) establishes the general requirement 
that a plan trustee ``shall have exclusive authority and discretion 
to manage and control the assets of a plan.'' An exception to the 
general rule is when a trustee receives directions from a named plan 
fiduciary, that is, when it acts as a ``directed trustee.'' See 
ERISA Section 403(a)(1) for basis of ``directed trustee'' exception.
---------------------------------------------------------------------------

    Courts that have considered IRA trustees in other contexts 
generally, but not uniformly, have reached the conclusion that an IRA 
trust does not establish a fiduciary relationship and that an IRA 
should not be treated as a trust is treated under other law.\82\ An IRA 
trustee does not actually assume a comprehensive set of fiduciary 
duties towards investors under either state or federal law.
---------------------------------------------------------------------------

    \82\ For example, Texas courts have likened IRAs to safe deposit 
boxes where the bank administers the IRA, keeping records and 
compiling reports, and the IRA depositor decides what assets the IRA 
will contain. See Colvin v. Alta Mesa Resources, Inc., 920 S.W. 2d 
688 (Tex.App.''Houston 1996); Lee v. Gutierrez, 876 S.W. 2d 382 
(Tex.App.''Austin 1994, writ denied). Other courts have reached 
similar conclusions. See In re Houck, Eisenberg v. Houck, 181 B.R. 
187 (Bankr. E.D. Pa. April 19, 1995) (court found that an IRA was 
not a trust as that term was commonly used); Estate of Davis v. 
Davis, 171 Cal.App.3d 854, 217 Cal. Rptr. 734 (1985) (court found 
that an IRA was not an express trust because there was no intent to 
establish a trust; an IRA was a trust for the purpose of tax 
deferment only). But see In re Gillett, Tavormina v. Merchants Bank 
of Miami, 55 B.R. 675, 13 Bankr.Ct.Dec. 1101 (Bankr. S.D. Fla., Dec. 
19, 1985).
---------------------------------------------------------------------------

    d. Definitional Exemption Alleviates Uncertainty. The law is 
unclear as to whether banks acting in these three capacities should be 
covered by the trust and fiduciary activities exception because they 
are acting, at most, in a limited fiduciary capacity with regard to 
investors who direct their investments, despite their ``trustee'' 
label. To alleviate this legal uncertainty, we are providing an 
exemption for these trustees if they conduct their securities 
activities in accordance with all of the other terms of the exception 
for trustee activities, including being within a ``trust department or 
other department that is regularly examined by bank examiners for 
compliance with fiduciary principles and standards.''\83\

[[Page 27769]]

Specifically, Rule 3b-17(k) defines the term ``trustee capacity'' in 
the trust and fiduciary activities exception to include trust indenture 
trustees and trustees for certain tax-deferred accounts.\84\ By 
clarifying that ``trustee capacity,''\85\ as set forth in the trustee 
and fiduciary activities exception, includes these types of trustees, 
banks will be able to continue to effect securities transactions for 
investors free from doubt regarding their broker-dealer status under 
the trust and fiduciary activities exception.\86\
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    \83\ Because banks may act as trustees or custodians for IRAs, 
it is important to note that this exemption is available only when 
the bank acts as a trustee and meets all of the other conditions of 
the trustee exception. The trust and fiduciary activities exception 
does not apply to IRA custodians. However, as described below, we 
are using our exemptive authority to grant two conditional 
exemptions under the safekeeping and custody exception to permit 
banks to effect securities transactions as IRA custodians. 
Furthermore, the small bank custody exemption is available to 
trustees and fiduciaries that are acting as custodians. For example, 
the small bank custody exemption is available to small bank trustees 
that have custody of assets and are effecting transactions in 
investment company securities consistent with the terms of that 
exemption.
    \84\ We are providing this definitional exemption under our 
exemptive authority under Exchange Act Section 36(a)(1) [15 U.S.C. 
78mm(a)(1)]. Exchange Act Section 36(a)(1) allows us to grant 
exemptions from any provision of the Exchange Act or the Exchange 
Act's Rules, if an exemption is necessary or appropriate in the 
public interest, and is consistent with the protection of investors. 
See also Exchange Act Section 15(a)(2) [15 U.S.C. 78o(a)(2)], 
Exchange Act Section 15(a)(2) [15 U.S.C. 78o(a)(2)] allows us to 
grant exemptions from Exchange Act 15(a)(1) [15 U.S.C. 78o(a)(1)], 
which generally requires brokers and dealers to be registered if 
effecting transactions in securities, if the exemption is consistent 
with the public interest and the protection of investors.
    \85\ It is important to note that our definitional exemption 
regarding the term ``trustee capacity'' in Section 3(a)(4)(B)(ii) of 
the Act does not alter our view that Section 3(c)(3) of the 
Investment Company Act of 1940 [15 U.S.C. 80a-3(c)(3)] is 
unavailable to common trust funds holding IRA assets.
    As amended by the GLBA, Section 3(c)(3) excludes from the 
definition of investment company:
    ``any common trust fund or similar trust fund maintained by a 
bank exclusively for the collective investment and reinvestment of 
moneys contributed thereto by the bank in its capacity as a trustee, 
executor, administrator, or guardian, if--
    ``(A) such fund is employed by the bank solely as an aid to the 
administration of trusts, estates, or other accounts created and 
maintained for a fiduciary purpose;
    ``(B) except in connection with the ordinary advertising of the 
bank's fiduciary services, interests in such fund are not--
    ``(i) advertised; or
    ``(ii) offered for sale to the general public; and
    ``(C) fees and expenses charged by such fund are not in 
contravention of fiduciary principles established under applicable 
Federal or State law.''
    The GLBA added paragraphs (A) through (C). These changes, among 
other things, codify our longstanding interpretation that the common 
trust fund exception is unavailable to common trust funds holding 
IRA assets because such assets are not held ``for a fiduciary 
purpose.'' See In re Commercial Bank and Marvin C. Abeene, 
Securities Act Rel. No. 7116, Investment Company Act Rel. No. 20757, 
Admin. Proc. File No. 3-8567, 58 SEC Dkt. 0487, 0491 (Dec. 6, 1994) 
(Order Instituting Public Proceedings Pursuant to Section 8A of the 
Securities Act of 1933 and Sections 9(b) and 9(f) of the Investment 
Company Act of 1940, Making Findings, Imposing Remedial Sanctions 
and Ordering Respondents to Cease and Desist). See also Santa 
Barbara Bank and Trust, SEC No-Action Letter (Nov. 1, 1991) (citing 
Testimony of Richard C. Breeden, Chairman, U.S. Securities and 
Exchange Commission, Before the Subcommittee On Telecommunications 
and Finance of the House Committee on Energy and Commerce (Oct. 4, 
1990)); United Missouri Bank of Kansas City, N.A., SEC No-Action 
Letter (Dec. 31, 1981).
    \86\ This exception should not, however, be considered by banks 
in analyzing whether they are acting in a ``similar capacity'' as 
that term is used in the definition of ``fiduciary capacity.'' 
Exchange Act Section 3(a)(4)(D). See also discussion of ``similar 
capacity,'' infra at Part 3 of this section.
---------------------------------------------------------------------------

    We invite comment on the scope of the fiduciary responsibilities of 
indenture trustees, ERISA trustees, IRA trustees, and trustees for 
other pension plans. We also invite comment on the scope of the 
fiduciary responsibilities of indenture trustees that are not subject 
to the TIA. In addition, we invite comment on the circumstances under 
which, if any, indenture trustees, ERISA trustees, IRA trustees and 
trustees for other pension plans may disclaim fiduciary 
responsibilities, which fiduciary responsibilities they may or may not 
disclaim, and whether, in such circumstances, this definitional 
exemption is appropriate.
2. Fiduciary Capacity
    The trust and fiduciary activities exception applies to banks 
acting in a trustee or fiduciary capacity to investors. The term 
fiduciary capacity is defined in Exchange Act Section 3(a)(4)(D), which 
identifies several alternative forms of fiduciary capacity. Banks may 
qualify as acting in a fiduciary capacity if they act as a ``trustee, 
executor, administrator, registrar of stocks and bonds, transfer agent, 
guardian, assignee, receiver, or custodian under a uniform gift to 
minor act * * *''\87\ Banks also may qualify as acting in a fiduciary 
capacity if they act as an investment adviser if the bank ``receives a 
fee for its investment advice'' or ``possess[es] investment discretion 
on behalf of another.''\88\ Finally, banks may act in a fiduciary 
capacity if they act ``in any other similar capacity.''\89\
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    \87\ Exchange Act Section 3(a)(4)(D)(i) [15 U.S.C. 
78c(a)(4)(D)(i)].
    \88\ Exchange Act Sections 3(a)(4)(D)(i) and (ii) [15 U.S.C. 
78c(a)(4)(D)(i) and (ii)].
    \89\ Exchange Act Section 3(a)(4)(D)(iii) [15 U.S.C. 
78c(a)(4)(D)(iii)].
---------------------------------------------------------------------------

    In general, we analyze the activities that a person is engaged in, 
as well as the label used, to determine whether a person is acting in a 
particular capacity. We take the same approach in considering whether a 
bank is acting as a fiduciary under the trust and fiduciary activities 
exception. As Justice Frankfurter stated in another context, ``to say 
that a man is a fiduciary only begins the analysis; it gives direction 
to further inquiry. To whom is he a fiduciary? What obligations does he 
owe as a fiduciary?''\90\ We understand that the exact nature of the 
fiduciary obligations differ depending on the type and nature of the 
fiduciary relationship between the customer and the bank.\91\
---------------------------------------------------------------------------

    \90\ SEC v. Chenery Corp., 318 U.S. 80, 85-86, 87 L. Ed. 626, 63 
S. Ct. 454 (1943).
    \91\ See 1 Austin Wakeman Scott and William Franklin Fratcher, 
The Law of Trusts 8.1 (4th ed. 1987) (``When a bank * * * receives 
the position of securities or other property from a customer, its 
duties depend on what it undertakes to do.'').
---------------------------------------------------------------------------

    Congress intended that banks act in a ``strict trustee or fiduciary 
capacity''\92\ that provides investors the protection of strong 
fiduciary principles if conducting securities activities without 
broker-dealer regulation under the trust and fiduciary activities 
exception. We address specific situations with respect to the term 
``fiduciary capacity.''
---------------------------------------------------------------------------

    \92\ See H.R. Rep. No. 106-74, pt. 3, at 165 (1999) note 9 
above, at 165 (``Because these activities will be conducted by banks 
acting in a strict trustee or fiduciary capacity, subject to Federal 
and State trust law, and rigorously and regularly examined by bank 
examiners, bank trust customers will be afforded some basic 
protections. This mitigates concerns that would otherwise exist 
because of the lack of Federal securities law protections for these 
customers. Absent this protection, the exemption may be 
inappropriate.'') (emphasis added).
---------------------------------------------------------------------------

    a. Transfer Agent. One category included in the statutory 
definition of fiduciary capacity that requires special explanation is 
``transfer agent.''\93\ In considering the fiduciary capacity role of 
transfer agents for purposes of the trust and fiduciary activities 
exception, we must take into account the Exchange Act definition of 
transfer agent.\94\ Under the Exchange Act, a transfer agent is 
generally any person who engages in certain activities ``on behalf of 
an issuer of securities or on behalf of itself as an issuer of 
securities. * * *'' This definition makes clear that the fiduciary 
relationship of acting as a transfer agent runs primarily to the 
issuer, and any

[[Page 27770]]

fiduciary duties that a transfer agent may have to shareholders when 
carrying out transfer agent activities are the same as the issuer's 
duty to the shareholder.\95\
---------------------------------------------------------------------------

    \93\ Exchange Act Section 3(a)(4)(B)(iv) [15 U.S.C. 
78c(a)(4)(B)(iv)] also provides a separate exception for banks that 
effect transactions, as part of their transfer agent activities, in 
certain stock purchase plans.
    \94\ Exchange Act Section 3(a)(25) [15 U.S.C. 78c(a)(25)] 
provides that a transfer agent is:
    ``any person who engages on behalf of an issuer of securities or 
on behalf of itself as an issuer of securities in (A) countersigning 
such securities upon issuance; (B) monitoring the issuance of such 
securities with a view to preventing unauthorized issuance, a 
function commonly performed by a person called a registrar; (C) 
registering the transfer of such securities; (D) exchanging or 
converting such securities; or (E) transferring record ownership of 
securities by bookkeeping entry without physical issuance of 
securities certificates. The term ``transfer agency'' does not 
include any insurance company or separate account which performs 
such functions solely with respect to variable annuity contracts or 
variable life policies which it issues or any registered clearing 
agency which performs such functions solely with respect to options 
contracts which it issues.''
    \95\ See generally Uniform Commercial Code Section 8-407 
(transfer agent performing transfer agent functions has the same 
obligation, with regard to those functions, as the issuer has with 
those functions). See also Caleb and Co. v. E.I. DuPont de Nemours 
and Co., 599 F. Supp. 1468, 1475 (S.D.N.Y. 1984) (transfer agent 
acting within scope of agency, if found to have acted detrimentally 
to alter the rights of shareholders, would be held to fiduciary 
standards with respect to shareholders).
---------------------------------------------------------------------------

    Taken together, the definitions of ``fiduciary capacity'' and 
``transfer agent'' in the Exchange Act indicate that the trust and 
fiduciary activities exception in Exchange Act Section 3(a)(4)(B)(ii) 
does not extend to securities activities that a bank transfer agent 
conducts with the shareholders of an issuer that resemble those of a 
broker-dealer. If a bank that is registered as a transfer agent engages 
in transfer agent activities for shareholders on behalf of the issuer 
of the type that are specified in the Exchange Act's definition of 
transfer agent and other similar activities, the bank may rely on the 
trust and fiduciary activities exception for those particular 
activities. Other securities activities would not be covered by the 
fiduciary responsibilities owed to the shareholder that are 
contemplated under the exception.\96\ Accordingly, unless another 
exemption was available,\97\ broker-dealer registration would be 
required for bank transfer agents that also effected securities 
transactions for investors.
---------------------------------------------------------------------------

    \96\ Legal authorities have generally found that transfer agents 
who have acted outside the scope of usual transfer agent activities 
are more than transfer agents and therefore, owe shareholders more 
extensive fiduciary duties under the federal securities laws. See 
Affiliated Ute Citizens v. United States, 406 U.S. 128, 151-52 
(1972) (if bank employees claiming to be acting as transfer agents 
had performed purely transfer agent functions, instead of acting as 
market makers for stock, they would not have expanded their 
liability under the federal securities laws); see also Goldman v. 
McMahan, Brafman, Morgan and Co., 1987 WL 12820, *22 (S.D.N.Y. June 
18, 1987) (citing Affiliated Ute Citizens to support holding that 
defendant acted as more than a transfer agent by actively engaging 
in activity to create fraudulent trading losses, thereby expanding 
its fiduciary duties beyond the scope of the transfer agency to 
plaintiff).
    \97\ Banks have a separate exception for transactions effected 
``as part of [their] transfer agency activities'' in the securities 
of an issuer as part of certain stock purchase plans of the issuer. 
Exchange Act Section 3(a)(4)(B)(iv) [15 U.S.C. 78c(a)(4)(B)(iv)].
---------------------------------------------------------------------------

    We request comment on any fiduciary role of transfer agents. We 
also request comment on any fiduciary responsibilities owed directly to 
the shareholders.
    b. Investment Adviser If The Bank Receives A Fee For Its Investment 
Advice. As further described below, if a bank provides its customer 
with investment advice for a fee for an account, even though the 
customer is free to accept or reject the bank's advice, the bank may 
rely on the trust and fiduciary activities exception. In this 
situation, the bank would be acting as ``an investment adviser if the 
bank receives a fee for its investment advice,'' as described in the 
definition of fiduciary capacity.\98\ For the reasons stated below, 
Rule 3b-17(d) defines the term ``investment adviser if the bank 
receives a fee for its investment advice'' to mean a relationship 
between the bank and a customer in which the bank: (1) provides, in 
return for a fee, continuous and regular investment advice to a 
customer's account that is based upon the individual needs of the 
customer; and (2) under state law, federal law, contract, or customer 
agreement owes a duty of loyalty, including an affirmative duty to make 
full and fair disclosure to the customer of all material facts relating 
to conflicts.
---------------------------------------------------------------------------

    \98\ Exchange Act Section 3(a)(4)(D)(i).
---------------------------------------------------------------------------

    i. Continuous And Regular Investment Advice. Banks act in an 
advisory capacity to varying degrees in non-discretionary accounts. It 
may be difficult to determine whether a bank that provides some 
investment advice to a non-discretionary account falls within the 
fiduciary capacity category of an investment adviser that receives a 
fee for its advice. Accordingly, we are providing guidance to aid banks 
in determining which advisory relationships to non-discretionary 
accounts are covered by the fiduciary category of ``investment adviser 
if the bank receives a fee for its investment advice.''
    Congress did not intend the trust and fiduciary activities 
exception to allow a bank to administer an account offering primarily 
brokerage without the investor protections of the federal securities 
laws.\99\ At its narrowest, a brokerage relationship comes into 
existence when ``the order has been placed and the broker has consented 
to execute it'' and ``ends when the transaction is complete.''\100\ 
Accordingly, where the responsibilities of a bank to its customer arise 
only when the customer places an order for his account, and terminate 
once the transaction is complete,\101\ that account has the indicia of 
a brokerage account that the federal securities laws are designed to 
regulate. The bank's activities, therefore, would not fall within the 
trust and fiduciary activities exception. We reach the same conclusion 
even if the bank provides incidental, ancillary investment advice to 
the account. Because full-service broker-dealers frequently also give 
incidental, ancillary investment advice,\102\ such an account would 
still have the indicia of a brokerage account, and thus, the fees paid 
would be primarily for brokerage services, not for advice.
---------------------------------------------------------------------------

    \99\ See H.R. Rep. No. 106-74, pt. 3, at 164 (1999).
    \100\ Robinson v. Merrill Lynch, Pierce, Fenner and Smith, Inc., 
337 F. Supp. 107, 111 (N.D. Ala. 11971), aff'd, 453 F.2d 417 (5th 
Cir.1972); see also E.F. Hutton and Company, Inc., 49 S.E.C. 829, 
832 n.9 (1988) (citing Robinson v. Merrill Lynch, Pierce, Fenner and 
Smith, Inc. as support for conclusion that broker-dealer became 
customer's agent for the purpose of executing a limit order). The 
decision in E.F. Hutton and Company, Inc., also known as the Manning 
Decision after the name of the customer, became the genesis for the 
NASD's Limit Order Protection Rule, IM-2110-2, which prohibits any 
member from trading at the same price as, or at a better price than, 
a customer limit order that it holds.
    \101\ See Certain Broker-Dealers Deemed Not To Be Investment 
Advisers, Exchange Act Rel. No. 42099, Investment Advisers Act Rel. 
No. 1845 (Nov. 4, 1999) (notice of proposed rulemaking); see also 
Merrill Lynch, Pierce, Fenner and Smith, Inc. v. Cheng, 697 F. Supp. 
1224, 1226-27 (D.D.C. 1988) (finding that fiduciary relationship 
between stockbroker and customer holding a non-discretionary account 
limited to time between placement of order and subsequent purchase).
    \102\ See Certain Broker-Dealers Deemed Not To Be Investment 
Advisers, Exchange Act Rel. No. 42099, Investment Advisers Act Rel. 
No. 1845 (Nov. 4, 1999) (proposing to codify the position that the 
Advisers Act applies only to those customers to whom the broker-
dealer provides advice that is not incidental to brokerage 
services); see also De Kwiatkowski v. Bear Stearns and Co., Inc., 
126 F. Supp. 2d 672 (S.D.N.Y. 2000) (finding that broker-dealer 
acted as investment adviser when broker-dealer gave continuous 
investment advice that went beyond ancillary matters).
---------------------------------------------------------------------------

    Accordingly, Rule 3b-17(c) provides that a bank providing only non-
discretionary investment advice must provide the customer's account 
with ``continuous and regular investment advice * * * that is based on 
the individual needs of the customer'' in order for the bank to fall 
within the definition of an ``investment adviser if the bank receives a 
fee for its investment advice.'' Rule 3b-17(e) neither purports nor 
attempts to provide a comprehensive definition of ``investment advice'' 
or of the types of investment advice banks may offer their customers. 
The rule identifies the circumstances where the bank's non-
discretionary advisory services to a customer's account for a fee are 
sufficiently substantial that any brokerage services provided for that 
fee are merely ancillary to the advice. To state it another way, the 
rule identifies the circumstances where the fees paid by the account 
may be viewed properly as for investment advice, rather than for 
brokerage, when the bank provides both investment advice and brokerage 
to the account. The rule thus gives effect to Congress' intent, as 
discussed earlier,

[[Page 27771]]

that a bank not be permitted to offer what is essentially a brokerage 
account absent the investor protections of the federal securities 
laws.\103\
---------------------------------------------------------------------------

    \103\ H.R. Rep. No. 106-74, pt. 3, at 164 (1999).
---------------------------------------------------------------------------

    A bank will provide ``continuous and regular'' investment advice 
under Rule 3b-17(e) if the bank has ongoing (as opposed to episodic or 
periodic) responsibility to select or make recommendations, based upon 
the needs of the client, as to specific securities or other investments 
the customer may purchase or sell. We adopted this same standard under 
Section 203A(a)(2) of the Investment Advisers Act (``Advisers Act''), 
which uses ``continuous and regular'' to determine which advisers have 
$25 million or more of ``assets under management'' and thus are 
eligible for Commission registration.\104\ Congress added this 
provision to the Advisers Act in 1996, as part of the National 
Securities Markets Improvement Act (``NSMIA'').\105\
---------------------------------------------------------------------------

    \104\ Investment Advisers Act Release No. 1633, Rules 
Implementing Amendments to the Investment Advisers Act of 1940 (May 
15, 1997) [62 FR 33008 (May 22, 1997)] (adopting release).
    \105\ The amendment was part of the Investment Advisers 
Supervision Coordination Act, which was Title III of NSMIA. Pub. L. 
104-290, 110 Stat. 3416 (1996). The Coordination Act effected 
several amendments to the Advisers Act, and the most significant of 
these was to divide responsibility for regulating investment 
advisers between the Commission and the securities administrators of 
the several states. Following NSMIA, the Commission regulates 
advisers that have at least $25 million in ``assets under 
management'' and the states regulate advisers with assets under 
management under $25 million. Congress defined ``assets under 
management'' to mean the ``securities portfolios with respect to 
which an investment adviser provides continuous and regular 
supervisory or management services.'' [15 U.S.C. 80b-3a].
---------------------------------------------------------------------------

    In developing the Commission's rules to implement NSMIA, we faced 
the question of when are non-discretionary advisory services 
significant and ongoing enough to constitute ``assets under 
management.'' Albeit with different import, we face a similar question 
here `` namely, when are the bank's non-discretionary advisory services 
significant enough that the fee paid ``for advice'' is for an ongoing 
advisory relationship with the customer account rather than a brokerage 
relationship. In both cases, we look to the actual nature of the 
underlying advisory services that the adviser, or bank, provides and to 
the duties and responsibilities that the adviser, or bank, 
accepts.\106\
---------------------------------------------------------------------------

    \106\ See Investment Advisers Act Rel. No. 1601, Rules 
Implementing Amendments to the Investment Advisers Act of 1940 
(December 20, 1996) (proposing release) (``Whether an adviser that 
does not have discretionary authority will be considered to provide 
continuous and regular management or supervisory services with 
respect to an account would depend upon the nature of the adviser's 
responsibilities. The greater the amount of day-to-day 
responsibility an adviser has, the more likely the adviser would be 
providing continuous and regular supervisory or management 
service.''); see also Item 2 of Part 1A of Form ADV.
---------------------------------------------------------------------------

    If a bank provides continuous and regular guidance for a fee to a 
non-discretionary account based on the individual needs of that 
account, the bank would fit the definition of ``investment adviser if 
the bank receives a fee for its investment advice,'' even if a customer 
makes self-directed trades in the account independent of the bank's 
advice. Accordingly, we would consider the bank to be acting in a 
fiduciary capacity for purposes of the trust and fiduciary activities 
exception.\107\
---------------------------------------------------------------------------

    \107\ This approach is consistent with the OCC's view on a bank 
receiving a fee for providing investment advice. In describing its 
definition of ``fiduciary capacity,'' upon which the GLBA's 
definition of fiduciary capacity is based, the OCC indicated that, 
if the bank received a fee from the customer for investment advisory 
activities (regardless of whether or not the customer followed the 
advice) the account would be brought under the fiduciary umbrella 
because ``the customer has a reasonable expectation of receiving 
advice that is free of conflicts of interest.'' Final Rule; 
Fiduciary Activities of National Banks; Rules of Practice and 
Procedure, 61 FR 68543, 68545 (Dec. 30, 1996) (codified at 12 CFR 
9.2(e)). However, if a customer is paying a minimal fee for 
ancillary investment advice, there is very little, if anything, the 
fiduciary umbrella is covering that can be protected by the 
fiduciary principles that are replacing the investor protection 
provided under the federal securities laws.
---------------------------------------------------------------------------

    If, however, the bank provides brokerage and ancillary, incidental 
advice in return for a fee to a self-directed non-discretionary 
account, such advice would not meet the continuous and regular 
standard, and the fee would be viewed as payment for brokerage, rather 
than payment for the advice. For instance, if the bank provides only 
impersonal advice, such as market newsletters, or provides advice only 
on an intermittent or periodic basis upon the request of the client or 
in response to some market event, the bank would not be giving 
continuous and regular investment advice.\108\ Also, if a bank offers a 
certain number of trades for a set fee for an ``advisory'' account 
without providing continuous and regular advisory services, we would 
not consider the account to fall within the trust and fiduciary 
activities exception. Such an account is more similar to a brokerage 
account described above than the type of fiduciary account covered 
under the trust and fiduciary activities exception.
---------------------------------------------------------------------------

    \108\ These examples are taken, in part, from examples we have 
previously given to provide guidance on what accounts receive 
continuous and regular supervisory or management services and what 
accounts do not. See Item 2 of Part 1A of Form ADV. We have included 
only those examples that involve the giving of advice and do not 
involve providing management services.
---------------------------------------------------------------------------

    Customer agreements outlining an account holder's relationship with 
a bank will be instructive in distinguishing those non-discretionary 
accounts for which banks provide continuous and regular investment 
advice from those for which they provide little investment advice. The 
nature of the bank's advice and the nature of the trading in the 
account also will be relevant to the analysis.
    ii. Full And Fair Disclosure. Investment advisers historically have 
been considered to be fiduciaries with corresponding duties.\109\ If a 
bank acts in the capacity of an investment adviser and receives a fee 
for its advice, the bank will perforce be subject to an investment 
adviser's duties. The Supreme Court has stated that the most important 
duty an investment adviser has is a duty of loyalty.\110\ This includes 
an affirmative duty to make full and fair disclosure of material facts, 
thereby eliminating, or at least exposing, conflicts of interest.\111\ 
Therefore, the investment adviser must act with ``utmost good faith'' 
and ``solely'' in the best interests of the client.\112\ By disclosing 
all of its potential conflicts of interest to a client, the investment 
adviser enables the client to make an informed decision of whether to 
enter into or continue in an advisory relationship with the adviser or 
whether to take some action to protect himself against the specific 
conflict of interest involved.\113\ The definition of ``investment 
adviser if the bank receives a fee for its investment advice'' in Rule 
3b-17(c) acknowledges the importance of this duty by providing that 
banks giving investment advice for a fee must owe a duty of loyalty 
that includes making full and fair disclosure to their clients. We find 
that this definition is

[[Page 27772]]

consistent with the provisions of the Exchange Act.\114\
---------------------------------------------------------------------------

    \109\ SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 
187 (1963) (recognizing that investment advisers have historically 
been considered fiduciaries).
    \110\ Id. at 191-92, 194.
    \111\ Id. at 192-92, 194.
    \112\ Id. at 191-92, 194; see also Laird v. Integrated 
Resources, Inc., 897 F.2d 826, 834 (5th Cir. 1990) (citing Capital 
Gains for proposition that an investment adviser has a fiduciary 
duty of utmost good faith and full and fair disclosure of all 
material facts, as well as an affirmative obligation to employ 
reasonable care to avoid misleading his clients); SEC v. Blavin, 760 
F.2d 706, 711-12 (6th Cir. 1985) (same).
    \113\ Applicability of the Investment Advisers Act to Financial 
Planners, Pension Consultants, and Other Persons Who Provide 
Investment Advisory Services as a Component of Other Financial 
Services, Investment Advisers Act Rel. No. 1092 (Oct. 8, 1987), 52 
FR 38400 (Oct. 16, 1987).
    \114\ Exchange Act Section 3(b) [15 U.S.C. 78c(b)].
---------------------------------------------------------------------------

    We invite comments on all aspects of this definition. Commenters 
also are encouraged to suggest alternative ways to evaluate whether a 
bank meets the definition of ``investment adviser if the bank receives 
a fee for its investment advice.''
3. Other Similar Capacity
    The definition of fiduciary capacity also provides that a bank may 
qualify for the trust and fiduciary activities exception if it acts 
``in any other similar capacity'' to the fiduciary relationships 
already described in the definition.\115\ We have identified from 
uniform acts and codes several capacities that are not expressly set 
forth in the definition of fiduciary capacity that we believe are 
similar to the fiduciary capacities that are covered by the trust and 
fiduciary activities exception.\116\
---------------------------------------------------------------------------

    \115\ Exchange Act Section 3(a)(4)(D)(iii) [15 U.S.C. 
78c(a)(4)(D)(iii)].
    \116\ The National Conference of Commissioners of Uniform State 
Laws has worked for the uniformity of state laws since 1892. Today 
the Conference is recognized primarily for its work in securities 
law, commercial law, family law, probate and estates, law of 
business organizations, health law, and conflicts of law. See The 
National Conference of Commissioners of Uniform State Laws website 
at http://www.nccusl.org/uniformact_factsheets/uniformacts-fs-upc.htm.
---------------------------------------------------------------------------

    For example, the Uniform Probate Code, which has been adopted in 18 
states,\117\ uses the term ``Personal Representative'' and similar 
successor titles in place of executor or administrator as the 
representative of a decedent. Under the Uniform Custodial Trust Act, 
which has been adopted in 14 states,\118\ the terms that are used for 
fiduciaries who act for persons who have become incapacitated include 
``Conservator'' and ``Custodial trustee.'' A bank would be eligible to 
act in any of these capacities under these uniform acts.
---------------------------------------------------------------------------

    \117\ Id.
    \118\ Id.
---------------------------------------------------------------------------

    Exchange Act Section 3(a)(4)(D)(i) references only the capacity of 
a ``custodian under a uniform gift to minor act.'' In contrast, the 
Uniform Transfers to Minors Act, which has been adopted in 49 States 
and the District of Columbia,\119\ uses both the terms ``Conservator'' 
and ``Custodian'' for fiduciaries that act for minors.\120\ A bank 
would be eligible to act in either or both of these capacities for a 
minor under this uniform act.
---------------------------------------------------------------------------

    \119\ Id.
    \120\ The Uniform Transfers to Minors Act was developed in 1983, 
amended in 1986 and supersedes the Uniform Gifts to Minor Act (1956, 
amended 1965 and 1966), which was perceived to be inadequate to 
address all of the issues inherent in this area of the law. See The 
National Conference of Commissioners of Uniform State Laws, Summary, 
Uniform Transfer to Minors Act, available at http://www.nccusl.org/uniformact_summaries/uniformacts-s-uttma.htm.
---------------------------------------------------------------------------

    We consider banks that act as fiduciaries in these representative 
capacities are acting in similar fiduciary capacities for purposes of 
the trust and fiduciary activities exception, provided that the other 
requirements of that exception are met. We invite comment on whether 
there are additional roles, functions, or relationships of banks that 
should be considered as being an ``other similar capacity'' for 
purposes of this exception.
    As noted above, courts have raised serious questions regarding 
whether indenture trustees and trustees for tax-deferred accounts are 
fiduciaries. Thus, although we have provided legal certainty to permit 
them to operate within the exception, we do not believe that banks 
operating in a similar capacity to such exempted entities are 
necessarily acting in a fiduciary capacity. For example, an IRA 
custodian is virtually indistinguishable from an IRA trustee, but does 
not take on the ``trustee'' label. Thus, it is not eligible for the 
definitional exemption in Rule 3b-17(k).
4. Other Department That Is Regularly Examined By Bank Examiners For 
Compliance With Fiduciary Principles And Standards
    To protect investors, Congress specifically required that the 
activities conducted by banks under the trust and fiduciary activities 
exception be ``rigorously and regularly examined by bank examiners.'' 
\121\ Because Congress believed that the ``examinations of bank trust 
departments are today rigorous in nature,'' these examinations would 
provide customers with ``some basic protections'' to mitigate the lack 
of federal securities law protections.\122\
---------------------------------------------------------------------------

    \121\ H.R. Rep. No. 106-74, pt. 3, at 165 (1999).
    \122\ Id. at 164-65.
---------------------------------------------------------------------------

    While the bank trust department is the traditional center of bank 
fiduciary services, the trust and fiduciary activities exception 
recognizes that banks may effect transactions in a fiduciary capacity 
in bank departments other than the trust department, as long as those 
departments are ``regularly examined by bank examiners for compliance 
with fiduciary principles and standards.'' This condition is key in 
affording investors some protection when banks conduct activities under 
this exception.
    Some banks place all of their fiduciary activities in the trust 
department, while others conduct them in different bank departments 
depending on the nature of the fiduciary service. As a result, the 
number and type of banking departments that are regularly examined by 
bank examiners for compliance with fiduciary principles and standards 
could easily vary from bank to bank. Because of this variance, we 
intend to rely primarily on the bank regulatory agencies in determining 
whether the activities are conducted in an area subject to examination 
by fiduciary examiners and examined on a regular basis.\123\
---------------------------------------------------------------------------

    \123\ We note the use by the federal financial institutions' 
regulators of the Uniform Interagency Trust Rating System 
(``UITRS'') in evaluating financial institutions' fiduciary 
activities. In 1999, there were 3,034 banks and trust companies 
(both insured and uninsured) that were subject to reporting 
requirements of the Federal Financial Institutions Examinations 
Council regarding their trust assets. See http://www2.fdic.gov/structur/trust/99trustdata.html.
---------------------------------------------------------------------------

    We also note that for a bank to be effecting securities 
transactions in compliance with the trust and fiduciary activities 
exception, the bank needs to ensure that all aspects of its role in 
effecting those transactions are conducted in a part of the bank that 
is regularly examined by bank examiners for compliance with fiduciary 
principles and standards. Effecting transactions in securities includes 
more than just executing trades or forwarding securities orders to a 
broker-dealer for execution. Generally, effecting securities 
transactions can include participating in the transactions through the 
following activities: (1) Identifying potential purchasers of 
securities; (2) screening potential participants in a transaction for 
creditworthiness; (3) soliciting securities transactions;\124\ (4) 
routing or

[[Page 27773]]

matching orders, or facilitating the execution of a securities 
transaction; (5) handling customer funds and securities;\125\ and (6) 
preparing and sending transaction confirmations (other than on behalf 
of a broker-dealer that executes the trades).\126\ In other words, for 
purposes of qualifying for the trust and fiduciary activities 
exception, the bank must make sure that all of the key points in a 
transaction that it participates in are in a part of the bank that 
meets the examination conditions of the exception.
---------------------------------------------------------------------------

    \124\ Solicitation is one of the most relevant factors in 
determining whether a person is effecting transactions. See, e.g., 
SEC v. Century Investment Transfer Corp., [1971-72 Transfer Binder] 
Fed.Sec.L.Rep. (CCH) para. 93,232 (S.D.N.Y. 1971) at 91,441-3 
(entity acted as a broker by soliciting customers for securities 
transactions, among other things); SEC v. National Executive 
Planners, 503 F. Supp. 1066, 1073 (M.D.N.C. 1980) (where entity 
solicited clients actively and sold $4.3 million worth of 
securities, ``[c]learly, [the entity] was a broker-dealer as defined 
in the 1934 Act''); see also 15 David A. Lipton, Broker-Dealer 
Regulation, at 1.04[3][a] (1998) (``Solicitation is considered a 
badge of securities activity that would bring a person within the 
definition of broker''). As we have previously stated, ``no amount 
of disclosure in a prospectus can be effective to protect investors 
unless the securities are sold by a salesman who understands and 
appreciates both the nature of the securities he sells and his 
responsibilities to the investor to whom he sells.'' See Persons Not 
Deemed To Be Brokers, Exchange Act Rel. No. 20943, 49 FR 20512 (May 
15, 1984). Solicitation includes any affirmative effort intended to 
induce transactional business for a broker-dealer and encompasses 
such activities as advertising and providing investment advice or 
recommendations intended to induce transactions that benefit or 
involve the solicitor. See SEC v. Margolin, [1992 Transfer Binder] 
Fed. Sec. L. Rep. (CCH) para. 97,025 (S.D.N.Y. 1992) at 94,517 
(person acted as a broker by, among other things, advertising for 
clients); see also Letters re: Attkisson, Carter and Akers (June 17, 
1998) (among other things, the person seeking relief from Section 
15(a) of the Exchange Act would neither recommend nor endorse 
specific investments); Charles Schwab and Co., Inc. (Nov. 27, 1996) 
(same).
    \125\ See, e.g., 15 David A. Lipton, Id. at 1.04[3] (having 
custody or control over the funds and securities of others is a 
badge of being a broker-dealer); SEC v. Margolin, [1992 Transfer 
Binder] Fed. Sec. L. Rep. (CCH) para. 97,025 (S.D.N.Y. 1992) 
(defendant was ``engaged in the business'' because he provided 
clearing services for the securities trading of his clients; other 
evidence of brokerage activity included receiving transaction-based 
compensation, advertising for clients, and possessing client funds 
and securities). However, where banks customarily hold securities 
for customers in accounts in other parts of the bank, these funds 
and securities may be accessed as part of a transaction covered by 
the trust and fiduciary exception.
    \126\ See 15 David A. Lipton, Broker-Dealer Regulation, supra 
note 124 at 1.04[3].
---------------------------------------------------------------------------

    We invite comment on this discussion of this prong of the trust and 
fiduciary activities exception. We particularly invite commenters to 
provide information on the location within banks of activities related 
to effecting securities transactions in a trust or fiduciary capacity.
5. Chiefly Compensated
    To qualify for the trust and fiduciary activities exception from 
the definition of broker, banks must meet certain compensation limits 
for transactions effected in a fiduciary capacity. First, banks must be 
``chiefly compensated * * * on the basis of an administration or annual 
fee (payable on a monthly, quarterly, or other basis), a percentage of 
assets under management, or a flat or capped per order processing fee 
equal to not more than the cost incurred by the bank in connection with 
executing securities transactions for trustee and fiduciary customers, 
or any combination of such fees.''\127\ Second, this revenue must be 
consistent with fiduciary principles and standards.\128\
---------------------------------------------------------------------------

    \127\ Exchange Act Section 3(a)(4)(B)(ii) [15 U.S.C. 
78c(a)(4)(B)(ii)].
    \128\ Id.
---------------------------------------------------------------------------

    The first question that must be addressed, then, is how to 
determine when a bank is ``chiefly'' compensated. The term ``chiefly'' 
has not been previously defined in the federal securities or banking 
laws. In choosing the term, Congress not only expected us to interpret 
it, Congress also expected that our interpretation would limit a bank's 
ability to receive incentive compensation or similar compensation that 
could foster a ``salesman's stake'' in promoting a securities 
transaction.\129\ In framing our definition of the term ``chiefly 
compensated,'' we have sought to apply the purposes of the GLBA so that 
the broker-dealer requirements of the federal securities laws apply to 
situations that could foster a salesman's stake in promoting securities 
transactions.\130\ This definition is discussed below.
---------------------------------------------------------------------------

    \129\ H.R. Rep. No. 106-74, pt. 3, at 164 (1999) (``The 
Commission is expected to interpret * * * the reference[ ] to 
`chiefly' * * * so as to limit a bank's ability to receive incentive 
compensation or similar compensation that could foster a `salesman's 
stake' in promoting a securities transaction.'').
    \130\ H.R. Rep. No. 106-74, pt. 3, at 164 (1999).
---------------------------------------------------------------------------

    a. Account-By-Account Calculations. Determining when a bank is 
``chiefly compensated'' requires, ultimately, a comparison of the 
different types of compensation that a bank receives. We considered 
several alternatives, but believe that the calculation to determine 
whether a bank is chiefly compensated by the statutorily enumerated 
fees should be done on an account-by-account basis. In our view, this 
calculation is consistent with assuring the protection of each investor 
and with determinations that trustees must make under state trust 
law.\131\ Moreover, fiduciaries often use fee schedules, which should 
provide a basis to make an account level calculation of compensation.
---------------------------------------------------------------------------

    \131\ Generally, trust instruments and state trust laws allow 
trustee compensation on an account basis that is ``reasonable'' and 
``not excessive.'' 1 Scott, supra note 91, Section 242 at 275. 
Moreover, we note that courts consider the cost of performing 
trustee services in determining the reasonableness of trustee 
compensation. See, e.g., In re Powell, 411 P.2d 162 (Wash. 1966) 
(stating that the ``universal'' standards needed to determine 
trustee compensation are: (1) The amount of risk and responsibility 
involved, (2) the time actually required of the trustee in the 
performance of the trust, (3) the size of the estate, (4) the amount 
of income received, and (5) the manual and overall services 
performed).
---------------------------------------------------------------------------

    We considered, alternatively, whether this calculation should be 
made on a transaction-by-transaction or customer-by-customer basis. We 
concluded, however, that these methods would be unnecessarily 
burdensome for banks, without providing significantly more protection 
for investors. We also considered whether the ``chiefly compensated'' 
calculation should be made across a bank's entire fiduciary department 
or on a business line basis. While a department or business line 
approach would provide administrative convenience to banks, we believe 
that adopting this approach as a guiding principle is inconsistent with 
the wording of the statute, which reads ``chiefly compensated for such 
transactions.'' (emphasis added). In referring to ``such 
transactions,'' the statute focuses on the compensation at the level at 
which the transactions occurred, which is the account level, and 
focuses on protection of investors making such transactions. Making the 
``chiefly compensated'' calculation at the department or business line 
level would potentially allow a bank to primarily engage in a brokerage 
relationship, without investor protection, with a large number of 
customers if the compensation from the statutorily enumerated fees 
across the department or business line exceeded that from brokerage. 
Moreover, a department or line of business is difficult to define 
because lines of business vary from institution to institution.
    Nonetheless, as discussed below, for administrative simplicity, we 
are adopting Rule 3a4-2, which provides an exemption to permit banks to 
compute compensation on the basis of their total fiduciary activities 
if sales compensation is less than 10% of relationship compensation for 
these total fiduciary activities.\132\ To rely on this exemption, 
however, banks must have in place procedures that are reasonably 
designed to ensure compliance at certain key times in the life of the 
account with the condition that they be ``chiefly compensated'' by 
relationship compensation.
---------------------------------------------------------------------------

    \132\ We chose 10% as a threshold because we understand that 
many banks would fit within this exemption using that threshold.
---------------------------------------------------------------------------

    We believe this exemption reduces costs for many banks by avoiding 
account level calculations where most accounts are likely to satisfy 
the ``chiefly'' standard. This exemption also balances Congress's 
intent that brokerage relationships be administered in a broker-dealer 
with its desire that we not disturb traditional trust activities. 
Accordingly, we find that this exemption is necessary or appropriate in 
the public interest and is consistent with the protection of 
investors.\133\
---------------------------------------------------------------------------

    \133\ Exchange Act Sections 15(a)(2), 23(a)(1), and 36(a)(1) [15 
U.S.C. 78o(a)(2), 78w(a)(1), and 78mm(a)(1)].
---------------------------------------------------------------------------

    b. Annual Computation. The account-by-account ``chiefly'' 
calculation should be conducted on a yearly basis. We

[[Page 27774]]

considered calculations on a more frequent basis, such as quarterly, 
but concluded that annual calculations would achieve the purposes of 
the provision with lower burdens for banks. The definition of ``chiefly 
compensated'' incorporates this concept by allowing banks to use a 
calendar year or other fiscal year consistently used by the bank for 
recordkeeping and reporting purposes.
    c. A Flat Or Capped Per Order Processing Fee. A bank may count as 
one of its statutorily enumerated sources of compensation ``a flat or 
capped per order processing fee equal to not more than the cost 
incurred by the bank in connection with executing securities 
transactions for trustee and fiduciary customers.'' \134\ New Rule 3b-
17(b) defines this term as a fee that is no more than the amount a 
broker-dealer charged the bank for executing the transaction, plus the 
costs of any resources of the bank that are solely dedicated to 
transaction execution, comparison, and settlement for trust and 
fiduciary customers. Per transaction charges are a hallmark of a 
brokerage relationship, and Congress explicitly limited a bank trust 
department to cost recovery for these charges.\135\
---------------------------------------------------------------------------

    \134\ Exchange Act Section 3(a)(4)(B)(ii)(I) [15 U.S.C. 
78c(a)(4)(B)(ii)(I)].
    \135\ We find that this definition is consistent with the 
provisions and purposes of the Exchange Act. See Exchange Act 
Section 3(b) [15 U.S.C. 78c(b)]; see also Exchange Act Section 
23(a)(1) [15 U.S.C. 78w(a)(1)].
---------------------------------------------------------------------------

    These dedicated resources would include the salary of a bank trust 
department employee whose sole responsibility is working on a trading 
desk that is exclusively dedicated to executing and comparing trades 
for trust or fiduciary customers. These dedicated resources would also 
include information technology resources exclusively related to trade 
execution, comparison, and settlement for trust or fiduciary customers, 
such as trade execution and comparison software that links a bank trust 
department trading desk with broker-dealers.
    In contrast, these dedicated resources would not include the cost 
of an employee's incentive based compensation related to the number, 
size, or value of trades executed. Such incentive payments typically do 
not reflect costs incurred to execute trades, but rather are 
inducements to encourage trades. These dedicated resources also would 
not include the cost of shared resources, general overhead allocation, 
or a return on capital.
    If a per order processing fee exceeds the broker-dealer charges and 
the costs of dedicated resources, that entire fee would be excluded 
from the ``per order processing fee'' source of revenue. We also 
believe that brokerage commissions paid to execute trust and fiduciary 
transactions would not fall within the ``flat or capped per order 
processing fee'' definition if they result in cash rebates or soft 
dollar benefits to the bank other than for brokerage, research, or 
expenses covered by this definition.\136\ Soft dollar benefits are, on 
their face, more than the cost of executing a trade.\137\ However, 
commissions resulting in payments for general research and brokerage 
expenses of the trust department that are strictly within the safe 
harbor of Exchange Act Section 28(e) would not need to be deducted from 
the costs that are permitted to be passed through to customers.\138\
---------------------------------------------------------------------------

    \136\ The soft dollar safe harbor only applies to persons who 
exercise ``investment discretion with respect to an account.'' 
Exchange Act Section 28(e)(1) [15 U.S.C. 78bb(e)(1)]. The term 
``investment discretion'' is defined in Exchange Act Section 
3(a)(35) [15 U.S.C. 78c(a)(35)].
    \137\ Soft dollar arrangements are understood generally as 
arrangements under which products, services, or other economic 
benefits, other than the execution of securities transactions, are 
obtained by a money manager in exchange for the direction by the 
money manager of client brokerage transactions to a broker-dealer. 
Investment Advisers Act Rel. No. 1469, 60 FR 9750 (Feb. 21, 1995).
    \138\ We also note that bank trust departments that accept soft 
dollar payments for expenses other than brokerage and research do 
not fit within the Section 28(e) safe harbor. ``Brokerage and 
research services'' are defined in Section 28(e)(3) of the Exchange 
Act as: (1) Furnishing advice, either directly or through 
publications or writings, as to the value of securities, the 
advisability of investing in, purchasing, or selling securities, and 
the availability of securities or purchasers or sellers of 
securities; (2) furnishing analyses and reports concerning issuers, 
industries, securities, economic factors and trends, portfolio 
strategy, and the performance of accounts; or (3) effecting 
securities transactions and performing functions incidental thereto 
(such as clearance, settlement, and custody) or required in 
connection therewith by rules of the Commission or a self-regulatory 
organization of which such person is a member or person associated 
with a member or in which such person is a participant. Exchange Act 
Section 28(e)(3) [15 U.S.C. 78bb(e)(3)].
---------------------------------------------------------------------------

    We note that, consistent with fiduciary principles and standards, 
banks may send trades to be executed by affiliated broker-dealers under 
the trust and fiduciary activities exception. However, banking 
regulators have recognized that sending trust customer trades to an 
affiliated broker-dealer raises issues regarding the bank's fiduciary 
obligation to its trust customers.\139\ In addition, we note that fees 
charged to fiduciary accounts, including brokerage commissions, must be 
consistent with fiduciary principles. We intend to rely primarily on 
the banking regulators' supervision of whether these fees are in fact 
consistent with fiduciary principles.
---------------------------------------------------------------------------

    \139\ The OCC has stated, for example, that the general rule 
followed by it is that national banks could only effect securities 
transactions through an affiliated discount broker-dealer if the 
transactions are performed on a non-profit basis. See OCC Trust 
Banking Circular 23 (Oct. 4, 1983). The OCC subsequently stated that 
``[t]o the extent that TBC-23, ``Policy of the OCC with Respect to 
Trust Department Purchase of Securities Through Affiliated Discount 
Brokerage Companies,'' (Oct. 4, 1983) permitted affiliated brokerage 
transactions on a nonprofit basis, that policy is no longer in 
effect.'' See OCC Trust Interpretive Letter No. 273 (Sept. 23, 
1992).
---------------------------------------------------------------------------

    d. ``Relationship Compensation,'' ``Sales Compensation,'' And 
``Unrelated Compensation''. To calculate whether banks are ``chiefly 
compensated'' for effecting transactions in a manner consistent with 
the terms of the trust and fiduciary activities exception, we compare 
two categories of bank compensation related to transactions, which we 
call ``sales'' compensation and ``relationship'' compensation. 
``Relationship'' compensation, which is based on the statutorily 
enumerated sources of compensation, must exceed ``sales'' compensation 
for the account to be ``chiefly compensated.'' We exclude other 
compensation not related to transactions in making the ``chiefly 
compensated'' calculation.\140\
---------------------------------------------------------------------------

    \140\ We find that this definition is consistent with the 
provisions and purposes of the Exchange Act. See Exchange Act 
Section 3(b) [15 U.S.C. 78c(b)]; see also Exchange Act Section 
23(a)(1) [15 U.S.C. 78w(a)(1)].
---------------------------------------------------------------------------

    i. Relationship Compensation. We have defined the term 
``relationship compensation'' in Rule 3b-17(i) to include the eligible 
statutory fees, which are generally charged based on an account 
relationship. As defined in the rule, relationship compensation must be 
received directly from the customer or beneficiary, or directly from 
the assets of the trust or fiduciary account. An annual or 
administrative account fee, or an account fee that is based on a 
percentage of assets under management, received from these sources 
would be relationship compensation. We interpret a percentage of assets 
under management fee as a fee for the bank's managing or otherwise 
caring for the assets of a trust or fiduciary account. Assets under 
management fees would not include payments from other persons, such as 
investment companies, that are based on the amount of assets maintained 
by the bank's trust and fiduciary accounts with those other persons. We 
believe this interpretation is consistent with the intent of the trust 
and fiduciary activities exception.\141\ In addition, relationship 
compensation would include a flat or capped per order processing fee 
equal to not more than the cost incurred by the bank in connection with 
executing securities

[[Page 27775]]

transactions for trustee and fiduciary customers.
---------------------------------------------------------------------------

    \141\ H.R. Rep. No. 106-74, pt. 3, at 164 (1999).
---------------------------------------------------------------------------

    ii. Sales Compensation. We also define the term ``sales 
compensation'' in Rule 3b-17(j) for purposes of determining whether a 
bank is ``chiefly compensated.''\142\ Sales compensation includes: (1) 
A fee for effecting a transaction in securities that is not a flat or 
capped per order processing fee equal to not more than the cost 
incurred by the bank in connection with executing securities 
transactions for trustee and fiduciary customers; (2) compensation that 
if paid to a broker or dealer would be payment for order flow;\143\ (3) 
a fee received in connection with a securities transaction or account, 
except for those finders' fees received pursuant to the networking 
exception in Exchange Act Section 3(a)(4)(B)(i);\144\ (4) fees paid for 
an offering of securities that are not received directly from a 
customer or beneficiary, or directly from the assets of the trust or 
fiduciary account; (5) fees paid pursuant to a Rule 12b-1 plan under 
the Investment Company Act of 1940 (``Investment Company Act'');\145\ 
and (6) ``service fees'' paid by an investment company for personal 
service or the maintenance of shareholder accounts.\146\
---------------------------------------------------------------------------

    \142\ We find that this definition is consistent with the 
provisions and purposes of the Exchange Act. See Exchange Act 
Section 3(b) [15 U.S.C. 78c(b)]; see also Exchange Act Section 
23(a)(1) [15 U.S.C. 78w(a)(1)].
    \143\ 17 CFR 240.10b-10(d)(9).
    \144\ Exchange Act Section 3(a)(4)(B)(i) [15 U.S.C. 
78c(a)(4)(B)(i)]. See, e.g., NASD Rule 2420; NYSE Rule 345. See also 
NASD Guide to Rule Interpretations, III. Questions and Answers, A. 
Frequently Asked Interpretive Questions About NASD Rules and 
Regulations With Responses From Its Office of General Counsel, 
Question 1. (as of 9/12/2000) (NASD's Office of General Counsel 
stated that ``it is improper for a member or person to [pay finders' 
or referral fees to third parties that introduce or refer 
prospective customers to the member] unless the recipient is 
registered as a representative of an NASD member firm. * * *'' The 
NASD has consistently maintained that persons who introduce or refer 
prospective customers and receive compensation for such activities 
are engaged in the securities business for the member in the form of 
solicitation''); IV NYSE Interpretation Handbook, Rule 345, 
Employees--Registration, Approval, Records, at (a)(i)/02 
(Compensation to non-registered persons) (``Rule 345(a) precludes 
members and member organizations from paying to non-registered 
persons compensation based upon the business of customers they 
direct to members or members organization if (a) the compensation is 
formulated as a direct percentage of the commissions or income 
generated, or * * * (d) such person regularly engages in activity 
which may be reasonably expected to result in the procurement of new 
customers or orders. * * *'').
    \145\ Rule 12b-1 under the Investment Company Act of 1940 [17 
CFR 270.12b-1] allows investment companies to use their assets to 
finance sales related expenses. See Investment Company Act Rel. No. 
11414, 45 FR 73898 (Nov. 7, 1980).
    \146\ Our definition is based on the NASD's definition of 
``service fees.'' ``Service fees'' are distinguished from other fees 
because they relate to personal services provided to the customer, 
such as a registered representative providing information on 
investments. The NASD excludes from the term ``service fees'' fees 
paid to a transfer agent for performing shareholder services 
pursuant to its transfer agent agreement. The term ``service fees'' 
also does not include record keeping charges, accounting expenses, 
transfer costs, or custodian fees. Specific services not covered by 
the term ``services fees'' include: (1) Transfer agent and 
subtransfer agent services for beneficial owners of the funds' 
shares; (2) aggregating and processing purchase and redemption 
orders; (3) providing beneficial owners with statements showing 
their positions in the investment companies; (4) processing dividend 
payments; (5) providing subaccounting services for fund shares held 
beneficially; (6) forwarding shareholder communications, such as 
proxies, shareholder reports, dividend tax notices; and updating 
prospectuses to beneficial owners; and (7) receiving, tabulating, 
and transmitting proxies executed by beneficial owners. Unlike 
``service fees,'' these other fees would be unrelated compensation 
rather than sales compensation. See NASD Rule 2830(b)(9); NASD 
Notice to Members 93-12 (1993) at Question 17 (explanation of term 
``service fees'').
---------------------------------------------------------------------------

    We understand that some banks acting as trustees or fiduciaries may 
charge customers an annual or asset-based fee that includes a specified 
number of securities transactions, or even unlimited trading on an 
irregular and occasional basis. If a bank charges an annual fee for 
effecting a certain number of securities transactions, this fee should 
be scrutinized to determine whether the fee is for transactions or 
fiduciary services. We believe that this approach is consistent with 
the statutory intent to separate compensation giving rise to sales 
incentives from non-sales oriented compensation. For example, if the 
bank effects transactions in a trustee or other fiduciary capacity 
where the bank is exercising investment discretion, in addition to 
offering trades for the annual fee, we believe the entire annual fee 
should be counted as relationship revenue. If a bank offers continuous 
and regular investment advice and a specified number of trades for a 
fee but separately charges for additional trades, we believe that the 
fees for combined advice/trading would be relationship revenues. The 
separate charges for trades, however, must be evaluated under the ``per 
order processing fee'' definition to determine their status. If the 
bank acts as an IRA trustee and offers a specified number of trades for 
a fee, this fee should be evaluated under the ``per order processing 
fee'' definition unless the fee permits an unlimited number of trades. 
If a fiduciary provides an unlimited number of transactions for an 
annual or assets under management fee, this fee would be considered 
relationship compensation.
    Paying banks to distribute securities, such as when an investment 
company pays a bank to distribute its shares through Rule 12b-1 fees, 
creates a conflict of interest between the bank distributor and 
investors. Rule 12b-1 fees are fees for distributing investment company 
securities and not for managing investors' assets.\147\ We view Rule 
12b-1 fees as commissions, and in fact, these fees are often described 
as trail commissions.\148\ Unlike fees for assets under management by 
the bank, which do not differ depending on the investment selected by 
the bank but are paid for the management role of the bank, the Rule 
12b-1 fees differ based on the particular investment company securities 
in which the assets are invested and maintained. These differing fees 
create incentives to distribute particular investment company 
securities and raise conflicts between the bank and investors. 
Similarly, finders' fees create incentives for bank trust departments 
to solicit trust customers to engage in securities transactions with 
other entities.\149\ It is precisely these divided loyalties or 
conflicts of interest faced by securities salesmen that drive much of 
broker-dealer regulation, and particularly rules governing securities 
practice standards.\150\ Therefore, these fees are defined as sales 
compensation.
---------------------------------------------------------------------------

    \147\ Id. See also Investment Company Act Rel. No. 16244, 53 FR 
3192 (Feb. 4, 1988); Exchange Act Rel. No. 30897, 57 FR 30985-02 
(July 13, 1992).
    \148\ See supra note 146, regarding Rule 12b-1 fees.
    \149\ See supra note 144, regarding finders' fees.
    \150\ By way of contrast, such conflicts of interest are managed 
differently under the fiduciary principles that take the place of 
the protections of broker-dealer regulations for activities covered 
by the trust and fiduciary activities exception. For example, in 
1983, the FDIC issued an opinion, which generally addressed the use 
of unaffiliated discount brokers, stating that bank trust 
departments ``should not share in any commission associated with the 
transactions'' for a trust customer. See FDIC General Counsel's 
Opinion No. 6, 48 FR 22989 (May 23, 1983). The FDIC subsequently 
stated that, in the absence of a statutory prohibition, and assuming 
no unusual facts, the sharing of commissions would not itself give 
rise to a breach of fiduciary obligations if ``(1) a trust 
instrument expressly authorizes the bank trustee to share in 
commissions generated by securities transactions effected on behalf 
of the account, and (2) the settlor of the trust entered into the 
authorization after full disclosure of the facts.'' See FDIC-84-10 
(Apr. 3, 1984).
---------------------------------------------------------------------------

    iii. Unrelated Compensation. Compensation that does not fall within 
the definitions of ``sales compensation'' or ``relationship 
compensation,'' we call ``unrelated compensation.'' Unrelated 
compensation should not be used to determine whether banks are 
``chiefly compensated'' in a manner consistent with the terms of the 
trust and fiduciary activities exception. For example, unrelated 
compensation includes fees charged separately for any activity of the 
bank that is not related to securities

[[Page 27776]]

transactions, such as taking deposits, lending funds (including margin 
lending), managing non-securities assets, or providing other services 
that are not related to managing securities accounts pursuant to the 
trust and fiduciary activities exception. Unrelated compensation also 
includes compensation received pursuant to another exception under the 
GLBA, such as a fee received pursuant to the networking exception, 
except for a referral fee listed in that exception.\151\
---------------------------------------------------------------------------

    \151\ See Exchange Act Section 3(a)(4)(B)(i)(VI) [15 U.S.C. 
78c(a)(4)(B)(i)(VI)].
---------------------------------------------------------------------------

    In addition, unrelated compensation includes other compensation 
received by the bank, such as when the bank acts as an investment 
adviser, transfer agent, or custodian to an investment company, or 
receives administrative fees from an investment company, including 
payments for providing subtransfer agent, subaccounting, or 
administrative services for securities accounts.\152\ As stated 
previously, where the customer is charged an annual or assets under 
management fee by a bank that meets the conditions of acting in a 
trustee or fiduciary capacity or as an investment adviser for a fee, 
the entire annual or assets under management fee would be relationship 
compensation. This would also be the case if the fee included 
compensation for an unlimited number of transactions, even though the 
investor may only effect a few transactions.
---------------------------------------------------------------------------

    \152\ For a complete list of payments included in this category, 
see NASD Notice to Members 93-12 (1993) at Question 17 (what does 
the term ``service fees'' include or exclude?). See supra note 146, 
regarding service fees.
---------------------------------------------------------------------------

    e. ``Chiefly Compensated'' Computation. To calculate whether it is 
``chiefly compensated,'' Rule 3b-17(a) requires that a bank must first 
set aside any compensation received from an account that does not fall 
within the definitions of ``relationship compensation'' or ``sales 
compensation,'' in Rules 3b-17(i) and (j), respectively. In other 
words, the bank must set aside ``unrelated compensation.'' The bank 
then must identify the remaining compensation received from the account 
either as ``relationship compensation'' or ``sales compensation,'' 
again based on the definitions of those terms in Rule 3b-17. To meet 
the definition of ``chiefly compensated'' in Rule 3b-17(a) for this 
account, the bank's relationship compensation from the account must 
exceed its sales compensation for that account in the immediately 
preceding year, which can be either a calendar year or other fiscal 
year consistently used by the bank for recordkeeping and reporting 
purposes.\153\
---------------------------------------------------------------------------

    \153\ We find that this definition is consistent with the 
provisions and purposes of the Exchange Act. See Exchange Act 
Section 3(b) [15 U.S.C. 78c(b)]; see also Exchange Act Section 
23(a)(1) [15 U.S.C. 78w(a)(1)].
---------------------------------------------------------------------------

    A simple chart providing an example of the ``chiefly'' calculation 
is set forth below. This chart is based on a trust customer with 
$1,000,000 in trust assets, all of which are invested in investment 
company securities. In this chart, the bank trust department charges a 
$1,000 annual base fee plus 1.235% of the first $1,000,000 under 
management. For the $1,000 annual base fee, the bank provides 
continuous and regular investment advice and allows the customer to 
effect securities transactions on an occasional and irregular basis. 
Because the bank also provides fiduciary services in addition to trades 
for this fee, this fee would be relationship compensation. The 1.235% 
of assets under management fee is not related to the customer's self-
directed trades, and therefore would be relationship compensation.\154\ 
The bank also receives 41 basis points as sales compensation in the 
form of Rule 12b-1 fees from the investment company.
---------------------------------------------------------------------------

    \154\ Even if this fee is related to the customer's self-
directed trades, it would be relationship compensation if the 
customer effected the trades as part of the bank's fiduciary 
relationship.

------------------------------------------------------------------------
                                              Relationship      Sales
                                              compensation  compensation
                                                   for           for
              Bank A receives:                 $1,000,000    $1,000,000
                                                in trust      in trust
                                                 assets        assets
------------------------------------------------------------------------
Base fee $1,000.............................       1,000    ............
Assets under management fee of 1.235%.......      12,350    ............
Rule 12b-1 fees.............................                    $4,100
                                             ---------------------------
  Total.....................................      13,350         4,100
------------------------------------------------------------------------

The account meets the ``chiefly compensated'' definition because the 
$13,350 in relationship compensation exceeds the $4,100 in sales 
compensation.
    In defining ``chiefly compensated,'' we have taken a conservative 
approach by adopting a definition that requires that the ``relationship 
compensation'' simply exceed the ``sales compensation'' on an annual 
basis. This definition depends upon all of the imbedded definitions and 
interpretations, including our definitions of the terms ``relationship 
compensation,'' ``sales compensation,'' and ``flat or capped per order 
processing fee equal to not more than the cost incurred by the bank in 
connection with executing securities transactions for trustee and 
fiduciary customers.'' In addition, the items included within each of 
the categories of compensation were carefully chosen in consideration 
of the test that simply requires that the ``relationship compensation'' 
exceed the ``sales compensation.'' We considered requiring a higher 
level of relationship compensation in interpreting this phrase as we 
did in interpreting ``predominantly'' with respect to the origination 
of asset-backed transactions in Rule 3b-18.\155\ Requiring a higher 
level of relationship compensation, at least initially, also would have 
been consistent with the approach taken by the Federal Reserve as the 
revenue test for so-called section 20 subsidiaries developed.\156\ We 
chose the more than 50% approach for the purposes of this interim final 
rule. We solicit comment on whether the chiefly test should be higher, 
such as 75% or 90%.
---------------------------------------------------------------------------

    \155\ The word ``chiefly'' is defined as: (1) in chief, in 
particular; preeminently; especially, particularly; above all, most 
of all; and (2) (relative to others) principally, mainly, for the 
most part (usually with the force of ``mainly but not 
exclusively''). 3 J.A. Simpson & E.S.C. Weiner, The Oxford English 
Dictionary (2d ed. 1989).
    \156\ See infra at notes 276-78 (Section 20).
---------------------------------------------------------------------------

    f. Rule 3a4-2--Exemption For Banks That Are Compensated By 
Relationship Compensation. We are particularly sensitive to the 
concerns expressed by banks regarding the compensation computations 
required under the trust and fiduciary activities exception. Therefore, 
we are adopting Rule 3a4-2 \157\ to permit banks that are compensated 
almost entirely by relationship compensation to avoid making 
calculations on an account-by-account basis. We find that this 
exception is necessary or appropriate in the public interest and is 
consistent with the protection of investors.\158\ It should minimize 
the costs and regulatory burdens on banks arising from the GLBA 
requirements relating to the trust and fiduciary compensation 
computations discussed above.
---------------------------------------------------------------------------

    \157\ 17 CFR 240.3a4-2.
    \158\ Exchange Act Section 36(a)(1) [15 U.S.C. 78mm(a)(1). See 
Exchange Act Section 3(b) [15 U.S.C. 78c(b)]; see also Exchange Act 
Section 23(a)(1) [15 U.S.C. 78w(a)(1)].
---------------------------------------------------------------------------

    New Rule 3a4-2 exempts a bank from the definition of ``broker'' if 
it: (1) Complies with the trust and fiduciary activities exception, 
except for the ``chiefly compensated'' condition; (2) can demonstrate 
that sales compensation, as that term is defined in Rule 3b-17, 
received during the immediately preceding year for its total fiduciary 
activities is less than 10% of the total amount of relationship 
compensation, as that term is defined in

[[Page 27777]]

Rule 3b-17, received for its total fiduciary activities during the same 
year; (3) maintains procedures reasonably designed to ensure compliance 
with the definition of ``chiefly compensated'' with respect to a trust 
or fiduciary account: (i) When the account is opened, (ii) when the 
compensation arrangement for the account is changed, and (iii) when 
sales compensation received from the account is reviewed by the bank 
for purposes of determining an employee's compensation; and (4) 
complies with the requirement that resulting orders be executed through 
a broker-dealer (or in a cross trade).
    A bank must first determine whether a trust or fiduciary account 
involves activities for which the bank relies on the trust and 
fiduciary activities exception. Compensation from accounts that do not 
hold securities would not be included in the 10% calculation because 
the definitions of relationship compensation and sales compensation are 
based on securities activities conducted under the trust and fiduciary 
activities exception. Similarly, compensation received by the bank for 
activities covered by another exception or exemption would not be 
included in the 10% calculation. Once a bank determines which accounts 
contain securities, which should be done at the same time as the 10% 
calculation, the bank can use the total compensation received from 
these accounts for the 10% calculation.
    A simple chart providing an example of the 10% calculation is set 
forth below. The bank's total revenue is $1,000,000 from its trust and 
fiduciary accounts that contain securities. The bank acts as a personal 
trustee, and as an ERISA trustee. Asset under management and annual 
fees from its personal trusts and ERISA trusts are the bank's main 
source of revenue. The bank also receives sales compensation in the 
form of Rule 12b-1 fees and fees for executing trades that are not flat 
or capped per order processing fees.

------------------------------------------------------------------------
                                              Relationship      Sales
              Bank A receives:                compensation  compensation
------------------------------------------------------------------------
Personal trustee:
  a. Total annual and assets under               $500,000   ............
   management fees..........................
  b. Total 12b-1 fees.......................  ............      $4,000
ERISA trustee:
  a. Total annual and assets under                480,000   ............
   management fees..........................
  b. Total non-flat or capped per order fees  ............      16,000
                                             ---------------------------
    Total...................................      980,000       20,000
------------------------------------------------------------------------

    The bank would meet the 10% calculation because its sales 
compensation, $20,000, is less than 10% of its relationship 
compensation, $980,000 ($20,000/$980,000 = 2%).
    A second chart using the example of a bank acting as an indenture 
trustee illustrates the interaction of this exemption with other 
exemptions, statutory exceptions, and non-securities income. An 
indenture trustee receives income from five sources: annual fees, fees 
for effecting transactions in government securities that are not flat 
or capped per order fees, fees for non-securities related services, 
Rule 12b-1 fees for investing in no-load money market funds, and non-
flat or capped per order fees for effecting transactions in securities 
that are not covered by another exception. Even though the bank is 
charging the indenture trusts transaction fees for government 
securities that are not flat or capped per order processing fees, these 
fees would count as unrelated compensation for purposes of the 10% 
calculation because the transactions are covered by the permissible 
securities transactions exception.\159\ Similarly, the Rule 12b-1 fees 
for no-load money funds (which are sales compensation) would count as 
unrelated compensation for purposes of the 10% calculation because the 
bank is exempt for effecting transactions in no-load money funds when 
acting as an indenture trustee under Rule 3a4-3. Fees for non-
securities related services would also be excluded from the 10% 
calculation as unrelated compensation.
---------------------------------------------------------------------------

    \159\ Section 3(a)(4)(B)(iii) of the Exchange Act [15 U.S.C. 
78c(a)(4)(B)(iii)].

------------------------------------------------------------------------
                                Relationship      Sales       Unrelated
       Bank A receives:         compensation  compensation  compensation
------------------------------------------------------------------------
Indenture trustee:
  a. Annual fees..............    $5,000,000  ............  ............
  b. Non-flat or capped per     ............  ............        $5,000
   order fees for gov't
   securities transactions....
  c. Non-securities related     ............  ............         5,000
   fees.......................
  d. 12b-1 fees for no-load     ............  ............       150,000
   money funds................
  e. Non-flat or capped per     ............        50,000  ............
   order fees for other
   securities transactions....
                               -----------------------------------------
    Total.....................     5,000,000        50,000       160,000
------------------------------------------------------------------------

    The bank would meet the 10% calculation because its sales 
compensation, $50,000, is less than 10% of its relationship 
compensation, $5,000,000 ($50,000/$5,000,000 = 1%).
    As discussed above, the bank must maintain procedures reasonably 
designed to ensure compliance with the chiefly compensated condition 
with respect to a trust or fiduciary account: (1) When the account is 
opened; (2) when the compensation arrangement for the account is 
changed; (3) and when sales compensation received from the account is 
reviewed by the bank for purposes of determining an employee's 
compensation. We do not believe that these procedures will be unduly 
burdensome to banks. Rather, the procedures need to be reasonably 
designed to ensure compliance with the definition of ``chiefly 
compensated'' with respect to a trust or fiduciary account in the three 
described situations. For new accounts, bank employees could project on 
a prospective basis whether an account, depending on the type and 
activity of the account, is likely to generate more of its revenue from 
relationship compensation than sales compensation. For existing 
accounts, bank employees could review whether an account, depending on 
the type and activity of the account, generated more of its revenue 
from relationship compensation than sales compensation.
    In addition, under the compensation element of the requirement, the 
bank

[[Page 27778]]

needs to maintain procedures for situations in which the bank uses 
sales compensation received from accounts in determining the 
compensation of an employee. The bank does not need these procedures if 
it only uses relationship compensation received from accounts in 
determining an employee's compensation.
    If, after reviewing an account, a bank determines that the account 
either is likely to exceed the compensation limits or has done so in 
the past, the bank must follow its procedures to bring the account into 
compliance with the ``chiefly compensated'' definition. For example, a 
bank can do this by revising the compensation schedule or shifting the 
securities trades into the client's brokerage account.
    We believe this exemption, which permits banks to avoid 
calculations on a continuous basis in much of their traditional trust 
business, is consistent with Congress' dual intents of not disturbing 
traditional trust activities and requiring securities business that has 
been conducted in the trust department to be administered in the future 
by a broker-dealer that is subject to the investor protections 
available under the federal securities laws.
    g. Rule 3a4-3--Exemption From ``Chiefly Computation'' For Indenture 
Trustees. We are adopting Rule 3a4-3 \160\ to provide an exemption to 
address the use of the trust and fiduciary activities exception from 
the broker registration for banks that serve as indenture trustees. As 
discussed previously, banks may serve as indenture trustees in 
accordance with the requirements of the TIA. The issuer of a bond 
indenture may be a state, a municipality, a quasi-public authority, a 
school, a church, or any organization that needs to raise cash through 
the sale of bonds. Bonds may be sold to the general public, to a 
limited investor group, or to a single investor such as an insurance 
company or governmental agency.
---------------------------------------------------------------------------

    \160\ 17 CFR 240.3a4-3.
---------------------------------------------------------------------------

    As a part of its duties as an indenture trustee, a bank also may 
invest otherwise idle cash in shares of money market investment 
companies or other securities, solely at the direction of the issuer of 
the bonds. Commonly, compensation that may be received from an 
investment company or its distributor for investments of mutual funds 
is considered when the terms of the trust indenture, including the 
bank's compensation, are negotiated.
    The trust and fiduciary activities exception requires banks to 
compute for each trustee or fiduciary account whether the bank meets 
the ``chiefly compensated'' condition. A bank acting as a trustee under 
an indenture may not meet the condition that it receive more of its 
compensation from relationship compensation than from sales 
compensation because of fee structures individually negotiated with the 
issuers. Therefore, we are adopting, in Rule 3a4-3, an exemption from 
the definition of broker for banks acting in the narrow role of 
indenture trustees investing in no-load money market funds.
    Rule 3a4-3 provides that, if a bank, acting in its capacity as a 
bond indenture trustee, complies with all of the conditions of the 
trust and fiduciary activities exception, other than the compensation 
condition, the bank is exempt from the definition of the term 
``broker'' solely for effecting transactions as an indenture trustee in 
no-load money market funds.\161\ Granting banks acting as indenture 
trustees an exemption to directly place idle cash in a no-load money 
market fund, an investment vehicle with a constant net asset value per 
shares and without a sales load, does not create any serious risk of 
abuse. In addition, the limit in the exemption to no-load, money market 
funds is consistent with the sweep accounts exception, which provides 
that a bank may invest depositors' funds through a sweep program 
without being considered a broker as long as the bank limits its sweep 
program to no-load, money market funds. Also, granting such an 
exemption relieves banks acting as indenture trustees of the task of 
continually watching the maturity of an instrument with the draw 
schedule of a project financed by bond proceeds. Therefore, we find 
that this exception is necessary or appropriate in the public interest 
and is consistent with the protection of investors.\162\
---------------------------------------------------------------------------

    \161\ The term ``money market fund'' is defined in Rule 3b-
17(e).
    \162\ Exchange Act Section 36(a)(1) [15 U.S.C. 78mm(a)(1). See 
Exchange Act Section 3(b) [15 U.S.C. 78c(b)]; see also Exchange Act 
Section 23(a)(1) [15 U.S.C. 78w(a)(1)].
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    h. Solicitation of Comment. We invite comment on the definition of 
``chiefly compensated,'' including whether other methods of calculation 
would accurately assess whether a bank is meeting the ``chiefly 
compensated'' condition, consistent with the investor protection 
concerns that we have expressed. We also request comment on whether we 
set the threshold test for being ``chiefly compensated'' too low and 
whether we should consider raising that test to a higher level, such as 
75% or 90%. In addition, we request comment on whether the definition 
of ``chiefly compensated'' also should be changed to require a higher 
relative amount of ``relationship compensation'' in the event that any 
of the underlying definitions were to be changed.
    Further, we seek comment on the definition of ``a flat or capped 
per order processing fee equal to not more than the cost incurred by 
the bank in connection with executing securities transactions for 
trustee and fiduciary customers.'' In particular, we are interested in 
whether we have struck an appropriate balance between accuracy and 
simplicity by permitting banks to pass on costs of resources 
exclusively dedicated to trustee and fiduciary transactions, but not 
pass on the proportional allocations of costs of shared resources. If 
proportional allocations of costs were permitted, would the record 
keeping costs exceed the benefits of permitting the allocations? We 
also solicit comment on both exemptions, and are especially interested 
other ways to exempt banks that receive small amounts of sales 
compensation and whether a line of business calculation is feasible.
    In addition, some banking industry representatives have told us 
that banks may charge one comprehensive fee for several accounts of an 
individual or members of one family. We seek comment on how to treat 
clusters of accounts for which a bank may charge a single fee 
attributable to all of the accounts in that cluster. We also seek 
comment on how to determine a nexus among such accounts to consider the 
scope of any additional relief that may be necessary.

C. Sweep Accounts Exception

    Section 3(a)(4)(B)(v) of the Exchange Act\163\ provides an 
exception from the definition of broker for sweep account activities. 
Under the exception, a bank will not be considered a broker if it 
``effects transactions as part of a program for the investment or 
reinvestment of deposit funds into any no-load, open-end management 
investment company registered under the Investment Company Act that 
holds itself out as a money market fund.'' The sweep accounts exception 
is intended to continue to allow banks to sweep funds into no-load 
money market funds without having to register as broker-dealers.
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    \163\ 15 U.S.C. 78c(a)(4)(B)(v).
---------------------------------------------------------------------------

    Payments by investment companies of asset-based fees to 
distributors of their securities create a conflict of interest for the 
brokers and banks that are distributing these shares. The sweep account 
exception protects sweep customers from conflicts of interest

[[Page 27779]]

created by compensation arrangements by limiting banks that are not 
registered as broker-dealers to sweeping deposit accounts into no-load, 
money market funds that pay minimal distribution fees. In addition, the 
sweep accounts exception's limitation to no-load money market funds 
results in limited risks to bank customers because of the constant net 
asset value of the funds, the absence of a sales load, and the minimal 
distribution fees that funds may pay to the banks.
    The term ``no-load'' is not defined in the GLBA or in the federal 
securities laws. Historically, the term ``no-load'' was viewed as 
meaning that neither investors in the fund, nor the fund itself, bore 
the costs of distributing the fund's shares, including making payments 
to broker-dealers.\164\ The Commission's adoption in 1980 of Investment 
Company Act Rule 12b-1, which for the first time permitted funds to use 
their assets to finance distribution expenses, created some confusion 
as to the meaning of the term.\165\ To address this confusion, the 
National Association of Securities Dealers, Inc. (``NASD'') adopted 
Rule 2830(d)(4), which describes what a ``no-load'' investment company 
is. Rule 2830(d)(4) allows an NASD member broker-dealer to describe an 
investment company as being ``no-load'' or as having ``no sales 
charge'' if the investment company does not have a front-end or 
deferred sales charge, and if its total charges against net assets to 
provide for sales related expenses and/or service fees do not exceed 
0.25 of 1% of average net assets per annum.\166\
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    \164\ See Investment Company Act Release No. 15431 (June 13, 
1988), 53 FR 23258.
    \165\ Investment Company Act Release No. 11414 (Oct. 28, 1980), 
45 FR 73898 (Nov. 7, 1980).
    \166\ NASD Rule 2830(d)(4) specifically states that a member 
broker-dealer may not ``describe an investment company as being 
``no-load'' or as having ``no sales charge'' if the investment 
company has a front-end or deferred sales charge or its total 
charges against net assets to provide for sales related expenses 
and/or service fees exceed .25 of 1% of average net assets per 
annum.'' (emphasis added). See Exchange Act Release No. 30897 (July 
7, 199), 57 FR 30985-02 (July 13, 1992). NASD Rule 2830(d)(4) was 
formerly classified as Article III, Section 26(d)(3) of the NASD 
Rules of Fair Practice. See Exchange Act Release No. 36698 (Jan. 11, 
1996), 61 FR 1419 (Jan. 19, 1996).
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    Although the rules of the NASD expressly apply only to the conduct 
of NASD member broker-dealers and their associated persons, our 
Division of Investment Management has endorsed the NASD's definition of 
``no load'' regardless of whether an investment company is associated 
with an NASD member. We believe that the NASD's definition of ``no load 
in NASD Rule 2830(d)(4) is reasonable, and we have adopted this 
definition in Rule 3b-17(f). This definition should help clarify the 
sweep accounts exception.
    We also are adopting a definition of ``money market fund.'' 
Specifically, Rule 3b-17(e) defines that term as an open-end management 
investment company registered under the Investment Company Act that is 
regulated as a money market fund pursuant to Rule 2a-7 under the 
Investment Company Act. Rule 3b-17(f) provides that an investment 
company registered under the Investment Company Act is ``no-load'' if: 
(1) Purchases of the investment company's securities are not subject 
either to a sales load (as that term is defined in Section 2(a)(35) of 
the Investment Company Act) or a deferred sales load (as that term is 
defined in Rule 6c-10 under the Investment Company Act); and (2) its 
total charges against net assets that provide for sales or sales 
promotion expenses \167\ and for personal services or the maintenance 
of shareholder accounts do not exceed 0.25 of 1% of average net assets 
annually and are disclosed in the mutual fund's prospectus.\168\
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    \167\ Rule 12b-1 under the Investment Company Act [17 CFR 
270.12b-1] provides that an investment company may make payments 
with respect to the distribution of shares of the investment company 
securities as long as, among other things, those payments are made 
pursuant to a written plan. Payments made by a fund pursuant to Rule 
12b-1 must be disclosed in the fund's prospectus. See Item 8(b) of 
Form N-1A. In practice, however, fees paid pursuant to a Rule 12b-1 
plan sometimes also may relate to types of services other than 
distribution-related services.
    \168\ Interim Final Rule 3b-17(f) provides, however, that 
certain charges a money market fund makes against fund assets will 
not be considered charges for personal service or the maintenance of 
shareholder accounts. In particular, charges against a money market 
fund's assets for transfer agent and subtransfer agent services for 
beneficial owners of the fund shares; aggregating and processing 
purchase and redemption orders; providing beneficial owners with 
statements showing their positions in the investment companies; 
processing dividend payments; providing subaccounting services for 
fund shares held beneficially; and forwarding shareholder 
communications, such as proxies, shareholder reports, dividend and 
tax notices, updating prospectuses to beneficial owners; and 
receiving, tabulating, and transmitting proxies executed by 
beneficial owners will not count toward the 0.25 of 1% limit in Rule 
3b-17(f)(2).
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    A bank can meet the conditions of the sweep accounts exception 
contained in Exchange Act Section 3(a)(4)(B)(v) if it invests customer 
assets through its sweep program in money market funds that meet the 
definition contained in new Rule 3b-17(e). All charges against fund 
assets that fall within the definition count toward the 0.25 of 1% 
limit, whether they are disclosed as an item in the fund's fee table or 
as part of the fund's miscellaneous or aggregate expenses.
    Rule 3b-17(f) gives effect to the ``no-load money market fund'' 
condition of the sweep account exception by reflecting current industry 
and public understanding of what ``no-load'' means. The rule would not 
prevent a bank from directly charging its customers for the bank's 
sweep services, because such direct charges would have no effect on 
whether the fund is a ``no-load'' fund. The rule also would not prevent 
a bank from sweeping accounts into a money market fund that charges 
more than 0.25 of 1% of net assets under its Rule 12b-1 plan, provided 
that it charges a total of no more than 0.25 of 1% of the fund's net 
assets for sales or sales-related expenses and fees for personal 
service or the maintenance of the shareholder accounts.\169\
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    \169\ Accordingly, banks relying on the sweep accounts exception 
should ensure that any money market fund included in the bank's 
sweep program that discloses Rule 12b-1 fees in its prospectus that 
exceed 0.25 of 1% of the fund's net assets does not use more than 
0.25 of 1% of the fund's net assets to pay for sales or sales 
promotion expenses and personal services or the maintenance of 
shareholder accounts. A bank could satisfy this obligation by using 
only money market funds that hold themselves out as no-load funds or 
by obtaining written confirmation from the money market fund that it 
is a no-load fund before including the fund in its sweep program.
---------------------------------------------------------------------------

    We find that our definitions of the terms ``no-load'' and ``money 
market fund'' used in the sweep accounts exception are consistent with 
the provisions and puroses of the Exchange Act.\170\
---------------------------------------------------------------------------

    \170\ Exchange Act Section 3(b) [15 U.S.C. 78c(b)].
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D. Safekeeping And Custody Activities Exception

    Exchange Act Section 3(a)(4)(B)(viii) provides an exception from 
the definition of broker for certain safekeeping and custody 
activities.\171\ Under the exception, a bank will not be considered a 
``broker'' because, as part of customary bank activities, it engages in 
certain specified types of safekeeping and custody services with 
respect to securities on behalf of its customers.\172\
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    \171\ 15 U.S.C. 78c(a)(4)(B)(viii).
    \172\ Exchange Act Section 3(a)(4)(B)(viii)(aa-ee).
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    Traditionally, activities that have been identified as the type of 
activity requiring broker-dealer registration include, among other 
things, executing securities transactions and holding customer funds 
and securities.\173\ The

[[Page 27780]]

safekeeping and custody exception makes clear that banks, as part of 
customary banking activities, may hold customer funds and securities 
without being considered a broker if, except with respect to government 
securities, they do not act as a carrying broker.\174\
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    \173\ See, e.g., 15 David A. Lipton, supra note 124, at 1.04[3] 
(having custody or control over the funds and securities of others 
is a badge of being a broker-dealer); SEC v. Margolin, [1992 
Transfer Binder] Fed. Sec. L. Rep. (CCH) para.97,025 (S.D.N.Y. 1992) 
(defendant was ``engaged in the business'' because he provided 
clearing services for the securities trading of his clients; other 
evidence of brokerage activity included receiving transaction-based 
compensation, advertising for clients, and possessing client funds 
and securities).
    \174\ 15 U.S.C. 78c(a)(4)(B)(viii)(II). A bank acting as a 
carrying broker facilitates the transfer of funds and securities 
associated with the clearance and settlement of securities and 
related margin lending on behalf of a broker-dealer and executes 
trades for itself and its customers. A carrying broker relationship 
is distinguished from a custody relationship by the fact that the 
bank is selected and its systems are utilized primarily by the 
broker-dealer rather than primarily by the customer. In a situation 
where the broker-dealer arranges for a substantial majority of its 
customers to use bank custody or deposit services of a bank, a 
carrying broker relationship may be established particularly if the 
bank performs clearance and settlement functions that the broker-
dealer cannot perform economically or efficiently. In contrast, a 
bank would not be a carrying broker when it acts as custodian for a 
customer of a broker-dealer and responds to customer directions to 
deliver securities against payment or cash against receipt of 
securities.
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    In addition, the safekeeping and custody exception explicitly 
allows banks that hold securities for their customers, on behalf of 
their customers, to exercise warrants or other rights, facilitate the 
transfer of funds or securities in connection with the clearance and 
settlement of the customers' transactions, effect securities lending or 
borrowing transactions when the securities are in the custody of the 
bank, invest cash collateral pledged in connection with securities 
lending or borrowing transactions, and facilitate the pledging or 
transfer of securities that involve the sale of those securities.\175\ 
Moreover, banks may provide custody and related administrative services 
to IRAs, pension, retirement, profit sharing, bonus, thrift savings, 
incentive, or other similar benefit plans without being considered a 
broker.\176\
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    \175\ Exchange Act Section 3(a)(14) provides, ``[t]he terms 
``sale'' and ``sell'' each include any contract to sell or otherwise 
dispose of.'' Similarly, Exchange Act Section 3(a)(13) provides, 
``[t]he terms ``buy'' and ``purchase'' each include any contract to 
buy, purchase, or otherwise acquire.'' Courts have read this 
language broadly. For example, the Supreme Court has stated that a 
transaction does not need to involve cash to constitute a sale of 
securities for purposes of the anti-fraud provisions of the Exchange 
Act. Gelles v. TDA Industries, 44 F.3d 102, 104 (2d Cir. 1994) 
(citing SEC v. National Securities, Inc., 393 U.S. 453 (1969)). 
Moreover, neither delivery nor the passing of title is required for 
the transaction to be considered a ``sale'' for these purposes. The 
pledge of stock is a ``sale'' within the meaning of Section 2(3) of 
the Securities Act. Rubin v. United States, 449 U.S. 424 (1981). The 
Court stated that although full title to the pledged securities were 
not transferred, the transaction nonetheless could be a sale. In the 
Court's view, the ``inchoate but valuable interest'' transferred by 
a pledge (i.e., the right to absolute title and ownership in the 
event of a default) was an ``interest in a security'' within the 
meaning of Section 2(3) of the Securities Act. 449 U.S. at 429-30.
    \176\ 15 U.S.C. 78c(a)(4)(B)(viii)(ee). See H.R. Rep. No. 106-
74, pt. 3, note 9 above, at 169 (1999) (``Many of the activities 
permitted under the safekeeping and custody exception are incidental 
to activities that banks perform today.'').
---------------------------------------------------------------------------

    Securities trades conducted under the safekeeping and custody 
exception must still be executed in compliance with Exchange Act 
Section 3(a)(4)(C). Exchange Act Section 3(a)(4)(C) requires banks that 
accept orders to the extent they engage in transactions under a 
specified safekeeping and custody function either to transmit orders to 
be executed to a registered broker-dealer or to internally cross those 
orders. Exchange Act Section 3(a)(4)(C) ensures that when investors 
purchase or sell securities through banks under the trust and fiduciary 
activities exception, safekeeping and custody exception, and certain 
stock purchase plans exception, registered broker-dealers, rather than 
unregulated market intermediaries, ultimately execute those 
transactions.
    Exchange Act Section 3(a)(4)(C) does not require all orders to 
purchase and sell a security to be sent to a registered broker-dealer. 
To read the section otherwise would mean that a bank would always be 
required to purchase or sell the underlying securities through a 
registered broker-dealer in connection with, for example, an investor's 
exercise of rights or warrants. This would preclude a bank from filling 
an investors' exercise of rights or warrants by delivery of shares from 
the issuer--a commonly used method. However, if a bank does purchase or 
sell the underlying securities in the open market, Exchange Act Section 
3(a)(4)(C) requires banks either to execute the transactions through a 
registered broker-dealer or internally to cross the trade. Furthermore, 
Exchange Act Section 3(a)(4)(C) should not be read to permit a bank to 
accept orders for the purchase or sale of securities in situations not 
specifically provided for under the safekeeping and custody exception. 
In this regard, it does not expand a bank's ability to accept orders 
for the purchase or sale of securities without registering as a broker-
dealer.
    Congress also did not intend the safekeeping and custody activities 
exception to allow banks to engage in broader securities 
activities.\177\ For example, although the safekeeping and custody 
exception permits banks to provide custody and related administrative 
services to IRAs and various benefit plans,\178\ as one of the limited 
securities-related activities that can be conducted under the 
safekeeping and custody activities exception, the exception does not 
allow banks, under the rubric of providing these ``related 
administrative services'' \179\ to accept orders to purchase and sell 
securities.
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    \177\ See H.R. Rep. No. 106-74, pt. 3, at 169 (1999) (``This 
exception is not intended to allow banks to engage in broader 
securities activities.'').
    \178\ We note that securities in retirement plans, including 
IRAs, are not immune to the sales practice abuses and fraudulent 
conduct that the rules of the SROs and securities laws are designed 
to address. The NASD has brought several enforcement actions for 
unsuitable recommendations and unauthorized trading in IRA accounts. 
See, e.g., In re Frederick C. Heller, 1991 NASD Discip. LEXIS 115 
(Aug. 26, 1991) (registered representative engaged in excessive and 
unauthorized trading in an IRA account); In re Paul D. Baune, 1994 
NASD Discip. LEXIS 17 (Aug. 4, 1994) (registered representative 
violated the NASD's suitability rule by recommending illiquid 
limited partnerships for the IRA account and non-IRA account of an 
elderly widow); In re William J. Lucadamo et al., 1997 NASD Discip. 
LEXIS 35 (May 20, 1997) (registered representative made unsuitable 
recommendations and engaged in unauthorized trading in IRA 
accounts). In addition, a pension plan administrator was permanently 
enjoined from, among other things, violating Sections 10(b), 15(a), 
and 17(a) of the Exchange Act for acting as an unregistered broker-
dealer and misappropriating customer funds, some of which were held 
at a custodial bank. See Securities and Exchange Commission v. 
Qualified Pensions Inc. et al., Civil Action No. 95-1746 (LFO) 
(D.D.C. July 2, 1997), Litigation Releases No. 15403, 64 S.E.C. 
Docket 2280 (July 2, 1997) and No. 14680, 60 S.E.C. Docket 1086 
(Oct. 5, 1995). See also In re Bankers Pension Services, Inc., 
Exchange Act Rel. No. 37567 (Aug. 14, 1996) (order instituting a 
public administrative proceeding, making findings, and imposing a 
cease-and-desist order); In re Transcorp Pension Services, Inc., 
Exchange Act Rel. No. 37278 (June 4, 1996) (order instituting a 
public administrative proceeding, making findings, and imposing a 
cease-and-desist order); First Philadelphia Corp., 50 SEC 360 (1990) 
(allocation of shares in a ``hot issue'' to a custodial account for 
the benefit of securities firm's president's son).
    \179\ Although the term ``related administrative services'' is 
not defined in the securities laws, in the broker-dealer industry, 
administrative services generally are considered to be those 
services that are labeled as ``clerical and ministerial.'' Clerical 
and ministerial activities include, for example, mechanical tasks 
such as bookkeeping and record keeping, performing calculations, and 
data processing functions. Accepting general orders to buy and sell 
securities, however, is not a ``clerical and ministerial'' activity. 
Cf. Exchange Services, Inc. v. S.E.C., 797 F.2d 188, 190 (4th Cir. 
1986) (The court determined that the SEC was not being arbitrary and 
capricious when it relied, as a reason to deny an exemption, on 
NASD's policy that anyone taking orders from the public must 
register.). A person accepting general securities orders must, at a 
minimum, register as an assistant representative for order 
processing with the NASD. See generally NASD Rules 1041 and 1042 
(listing registration requirements, and limits on the activities of, 
assistant representatives).
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    The point at which orders are accepted from customers and routed 
for execution represents a critical juncture for an investment decision 
and results in the consummation of the sale. Therefore, it is important 
that the customer protections, such as employee sales practice and 
training requirements,

[[Page 27781]]

that flow from broker-dealer registration and application of the 
federal securities laws apply at this juncture.\180\ Accepting orders 
necessarily involves communication with customers. The risks inherent 
in communication with customers relating to securities transactions--
sales practice abuses and customer confusion--as well as related order 
taking risks, are risks that the securities laws are uniquely designed 
to address. Accepting orders to buy and sell securities also implicates 
concerns traditionally covered by the federal securities laws and the 
requirement of best execution.\181\ For these reasons and the others 
discussed above, we have determined that ``custody'' or ``related 
administrative services'' do not include accepting orders from 
investors to purchase or sell securities. In particular, we do not 
believe that by its terms the safekeeping and custody exception covers 
a bank that accepts orders from investors to purchase or sell 
securities other than those specifically permitted in the exception, 
such as with respect to securities lending and borrowing or investing 
collateral.
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    \180\ A critical aspect of the federal securities laws is the 
protection of investors that is accomplished not only through our 
rules, but also through investor protection conditions imposed by 
SROs on registered entities and their personnel.
    \181\ The duty of best execution requires a broker-dealer to 
seek the most advantageous terms reasonably available under the 
circumstances for a customer's transaction. The duty of best 
execution derives from the common law duty of loyalty, which 
obligates an agent to act exclusively in the principal's best 
interest. When a broker-dealer acts as agent on behalf of a customer 
in a transaction, the agent is under a duty to exercise reasonable 
care to obtain the most advantageous terms for a customer. 
Restatement 2d Agency Sec. 424 (1958). Traditionally price has been 
the predominant factor in determining whether a broker-dealer has 
satisfied its best execution obligations. Exchange Act Release No. 
34902, 59 FR 55006 (1994). We also have stated that broker-dealers 
should consider at least six additional factors: (1) The size of the 
order; (2) the speed of execution available on competing markets; 
(3) the trading characteristics of the security; (4) the 
availability of accurate information comparing markets and the 
technology to process such data; (5) the availability of access to 
competing markets; and (6) the cost of such access. See, e.g., 
Second Report on Bank Securities Activities, at 97-98, n.233, as 
reprinted in H.R. Rep. No. 145, 95 Cong., 1st Sess. 233 (Comm. Print 
1977).
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    We are supported in our conclusion by a comprehensive reading of 
the GLBA broker exceptions. An interpretation that banks engaged in 
safekeeping and custody services may accept orders without being 
required to register as broker-dealers would contradict the 
comprehensive statutory scheme of limited brokerage exceptions with the 
attendant conditions that Congress established for banks to be able to 
effect securities transactions without any of the investor protections 
available under the federal securities laws.\182\
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    \182\ If banks were allowed to effect transactions for 
compensation as custodians, they would be subject to fewer 
requirements than banks effecting transactions for investors under 
other exceptions contained in the GLBA amendments to Exchange Act 
Section 3(a)(4). Congress created at least three specific exceptions 
to permit banks to effect securities transactions with retail 
investors--as part of networking arrangements with broker-dealers; 
pursuant to the trust and fiduciary exception; and as registered 
transfer agents for issuer plans. To read the term ``administrative 
services'' to include accepting orders for the purchase and sale of 
securities would mean that banks acting as custodians would be 
subject to significantly fewer limits than banks that effect 
transactions with investors in these three situations. In short, an 
expansive reading of the word ``administrative services'' would 
circumvent the conditions of all of the other exceptions that 
restrict banks' ability to become active brokerage distribution 
channels outside of the investor protections of the federal 
securities laws.
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    Bankers have asserted that the custody exception was intended to 
preserve all ``customary'' activities involving custody accounts. This 
exception, however, just like the other exceptions from broker-dealer 
registration, was not designed to protect from the federal securities 
laws every existing bank brokerage activity. Prior to the passage of 
the GLBA, banks could operate a brokerage business without any 
conditions and still be excepted from broker-dealer registration. By 
replacing the blanket exception with specific exceptions, the GLBA 
limited the range of excluded bank securities activities. Therefore, 
the terms of a specific exception and the purpose of the exceptions 
must be examined to determine what bank securities activities were, in 
fact, excepted. This determination cannot be made merely based on an 
assumption that all ``customary'' bank securities activities were 
excepted.
    Although we conclude that the safekeeping and custody activities 
exception allows banks to accept only those orders specifically 
permitted in the exception, we are creating two exemptions to permit 
banks to accept orders from investors for the purchase and sale of 
securities under limited circumstances in a safekeeping and custody 
capacity. Rule 3a4-4 provides that small banks may effect transactions 
in investment company securities in customers' tax-deferred custody 
accounts. In addition, Rule 3a4-5 provides that banks may accept orders 
for securities for safekeeping and custody accounts where the bank is 
not compensated for these transactions. The bank, however, may pass on 
the broker-dealer's charge for executing the transactions. As discussed 
below, we find that these exceptions are consistent with the public 
interest and the protection of investors.\183\
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    \183\ Exchange Act Section 36(a)(1) [15 U.S.C. 78mm(a)(1)]; see 
also Exchange Act Sections 15(a)(2) and 23(a)(1) [15 U.S.C. 
78o(b)(2) and 78w(a)(1)].
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1. Rule 3a4-4--Exemption For Small Bank Custodians Effecting 
Transactions In Investment Company Securities For Tax-Deferred Custody 
Accounts
    To permit small banks to continue assisting IRA customers to invest 
in investment company securities under conditions designed to foster a 
passive sales environment, new Rule 3a4-4 \184\ provides that, under 
certain conditions, a small bank \185\ is exempt from the definition of 
the term ``broker'' under Section 3(a)(4) of the Exchange Act solely 
for effecting transactions in securities of an investment company in a 
tax-deferred account \186\ for which the bank acts as custodian under 
the safekeeping and custody activities exception, or as trustee under 
the trust and fiduciary activities exception.
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    \184\ 17 CFR 240.3a4-4. Of course small bank trustees for tax-
deferred accounts that are effecting transactions in investment 
company securities and that are acting as custodian may 
alternatively rely on this exemption.
    \185\ We define the term ``small bank'' as a bank with less than 
$100 million in assets as of December 31 of both of the prior two 
calendar years, and since December 31 of the third prior calendar 
year has not been, an affiliate of a bank holding company or a 
financial holding company that as of December 31 of both of the 
prior two calendar years had consolidated assets of more than $1 
billion. The $100 million in assets cut-off was derived from The 
Small Business Administration, Small Business Size Regulations. 13 
CFR 121.201; see also 66 FR 10212 (citing 13 CFR 121.201).
    \186\ A ``tax deferred account'' is defined as those accounts 
described in Sections 401(a), 403, 408, and 408A under Subchapter D 
and in Section 457 under Subchapter E of the Internal Revenue Code 
of 1986.
---------------------------------------------------------------------------

    We have been advised that small banks offering tax-deferred custody 
accounts may not have an affiliated broker-dealer or networking 
arrangements with registered broker-dealers. In 1996--the last year for 
which data was available--over 90% of banks used registered broker-
dealers to effect securities transactions as brokers.\187\

[[Page 27782]]

Nevertheless, small banks without broker-dealers might occasionally 
accept unsolicited orders for investment company securities from 
customers in these tax-deferred accounts.
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    \187\ See Testimony of Andrew C. Hove, Jr., Acting Chairman 
Federal Deposit Insurance Corporation, on Financial Modernization 
before the Subcommittee on Finance and Hazardous Materials, 
Committee on Commerce, United States House of Representatives, July 
17, 1997, where he said:
    Second, the vast majority of insured institutions already use 
registered broker/dealers for sales of nondeposit investment 
products. Recent surveys, including the FDIC's 1996 survey of 
nondeposit investment product sales practices, have found that very 
few banks--less than 300 out of 10,000--sell such products using 
their own employees under the present exemption from registration as 
a broker/dealer. Thus, most of those selling nondeposit investment 
products at banks and thrifts already are registered representatives 
of broker/dealers subject to the regulatory oversight of the 
Securities and Exchange Commission and securities industry self-
regulatory organizations, such as the National Association of 
Securities Dealers (NASD).
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    Because the IRC requires tax-deferred accounts to be held by a 
custodian or trustee, investors often hold these accounts with banks. 
To avoid unnecessarily disrupting this service in small banks that do 
not have an affiliate or networking arrangement with a broker-dealer, 
we provide an exemption from the definition of broker for small banks 
with under $100 million in assets as of December 31 of both of the two 
prior years.\188\ Such a bank may also not be an affiliate of a bank 
holding company or financial holding company with more than $1 billion 
in consolidated assets in the two prior calendar years.\189\ Under this 
exemption, small banks may effect transactions in investment company 
securities for customers' tax-deferred custody accounts and receive 
compensation for these securities transactions, subject to a revenue 
limit. This exemption does not apply to banks that do not meet the 
definition of ``small banks'' because these banks can more easily 
affiliate with a broker-dealer or develop a networking arrangement with 
a registered broker-dealer.\190\
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    \188\ Because a new bank, bank holding company, or financial 
holding company would have no assets in either one or both of the 
two prior years, it would qualify for the exemption for at least the 
period of time in which had no assets.
    \189\ We chose $1 billion to indicate small bank holding 
companies or financial holding companies because the Federal Reserve 
Board has previously categorized these companies as ``small, 
noncomplex bank holding companies'' for the purpose of determining 
the type of supervisory review that they receive. See 1999 Federal 
Reserve Annual Report at 122.
    \190\ Banks cannot structure arrangements with networking 
broker-dealers or affiliated broker-dealers in which the custody 
department becomes the carrying broker for the affiliates or 
networking broker-dealers. See Section 3(a)(4)(B)(viii)(II) of the 
Act [15 U.S.C. 78c(a)(4)(B)(viii)(II)].
---------------------------------------------------------------------------

    Because this exemption is designed to allow the bank to effect 
transactions in securities as an accommodation to its customers, the 
bank must not be affiliated with a broker or dealer or have a 
networking arrangement with a broker or dealer to effect transactions 
in securities for the bank's customers. Similarly, a bank employee 
effecting transactions under this exemption must not be an associated 
person of a broker or dealer, must primarily perform duties for the 
bank other than effecting transactions in securities for customers, and 
must not receive incentive compensation for such transactions. In 
effecting transactions under this exemption, the bank also must execute 
the order through a broker-dealer (or in a cross transaction).\191\
---------------------------------------------------------------------------

    \191\ Section 3(a)(4)(C) of the Exchange Act [15 U.S.C. 
78c(a)(4)(C)]. The bank also may use the NSCC's Mutual Fund 
Services, including Fund/SERV to execute the order, pursuant to Rule 
3a4-6.
---------------------------------------------------------------------------

    In addition, the bank may solicit transactions only through certain 
limited activities. First, a bank may deliver only advertising and 
sales literature about an investment company's securities that is 
prepared by the registered broker-dealer that is the principal 
underwriter of the investment company, or prepared by the investment 
company that is not an affiliated person of the bank, as defined in 
Section 2(a)(3) of the Investment Company Act.\192\ The requirement to 
use sales literature prepared by a broker-dealer that complies with the 
NASD's advertising rules is designed to protect investors from 
representations about investments that could not be made by a 
registered broker-dealer. Second, banks may respond to questions from 
potential purchasers of securities, but the bank must limit its answers 
to information contained in the registration statement for the 
investment company security or sales literature prepared by the 
investment company security's principal underwriter that is a 
registered broker-dealer. Third, a bank may advertise its trust 
activities, but only as permitted under the advertising conditions of 
the trust and fiduciary activities exception.\193\ Finally, banks may 
notify their existing customers that they accept orders for investment 
company securities in conjunction with solicitations related to their 
other activities concerning tax-deferred accounts.
---------------------------------------------------------------------------

    \192\ Id.
    \193\ Exchange Act Section 3(a)(4)(B)(ii)(II) [15 U.S.C. 
78c(a)(4)(B)(ii)(II)].
---------------------------------------------------------------------------

    We are concerned that this exemption could be used primarily as a 
means to market proprietary investment company securities without the 
protections available under the federal securities laws. Thus, to meet 
the conditions of the exemption in Rule 3a4-4, a bank that sells 
investment company securities of affiliated persons must make available 
to the tax-deferred account the securities of similar investment 
companies that are not affiliated persons of the bank.\194\ Investment 
companies with similar characteristics would be investment companies 
with similar investment objectives and strategies, such as two global 
equity funds. We solicit comment on whether we need to define further 
the term ``similar characteristics.''
---------------------------------------------------------------------------

    \194\ Investment Company Act Section 2(a)(3) [15 U.S.C. 80a-
2(a)(3)].
---------------------------------------------------------------------------

    Finally, the bank's compensation related to effecting transactions 
in securities pursuant to this exemption \195\ must be less than 3% of 
its annual revenue.\196\ This exemption is provided to permit small 
banks to accept the occasional investor order to purchase and sell 
investment company securities for tax-deferred accounts. We have chosen 
the 3% revenue limit consistent with this intent.
---------------------------------------------------------------------------

    \195\ The term ``compensation related to effecting transactions 
in securities pursuant to this exemption'' means the total annual 
compensation received for effecting transactions in securities 
pursuant to this exemption, including fees received from investment 
companies for distribution.
    \196\ Revenue is defined as the annual total net interest income 
and noninterest income from the bank's four most recent Reports of 
Condition and Income or any successor reports required to be filed 
by the bank's appropriate federal banking agency.
---------------------------------------------------------------------------

    We expect small banks effecting transactions in securities under 
the terms of this exemption to be offering brokerage services solely as 
an accommodation to their customers. We do not intend for this 
exemption to be used to allow an unregistered sales force to market 
widely securities without complying with the requirements of the 
federal securities laws, such as licensing, advertising, and other 
sales practice standards, and continuing education requirements. The 
conditions a bank must meet to qualify for this exemption reflect this 
purpose.
    In adopting this exemption, we have carefully balanced the 
administrative convenience to investors of submitting orders to small 
bank custodians that do not have arrangements with broker-dealers to 
interact with these customers, with the loss of the protections 
afforded to those investors under the federal securities laws. We also 
have considered that small broker-dealers do not have a similar 
exemption from the application of the federal securities laws. 
Nonetheless, in this limited situation, we believe that the exemption 
for small banks is appropriate.
    We have imposed a 3% annual revenue limit under this exemption and 
imposed conditions to limit banks' solicitation of investors to ensure 
a passive securities distribution channel because none of the 
protections available to investors under the federal securities laws 
are available in this situation. We solicit comment on whether this 
exemption poses a burden on competition for broker-dealers that do not 
have a similar exemption. We also solicit comment on whether this 
exemption is necessary and consistent

[[Page 27783]]

with the protection of investors under the federal securities laws.
2. Rule 3a4-5--Exemption for Bank Custodians Placing Orders as an 
Accommodation to Customers
    New Rule 3a4-5 \197\ is broader than Rule 3a4-4 in that it is 
available to all banks for the full range of securities. However, the 
exemption builds upon the passive sales conditions developed in Rule 
3a4-4 by also prohibiting receipt by the bank of any transaction-
related compensation.
---------------------------------------------------------------------------

    \197\ 17 CFR 240.3a4-5.
---------------------------------------------------------------------------

    Rule 3a4-5 exempts a bank from the definition of the term 
``broker'' solely for effecting transactions in securities in an 
account for which the bank acts as custodian under the safekeeping and 
custody activities exception if the bank meets certain conditions. 
Specifically, the bank may not directly or indirectly receive any 
compensation for effecting such transactions. We also impose the same 
limitations on soliciting orders, and other conditions, as apply to 
small banks effecting transactions for investors under Rule 3a4-4. The 
bank also must comply with the order execution condition in Exchange 
Act Section 3(a)(4)(C).\198\
---------------------------------------------------------------------------

    \198\ 15 U.S.C. 78c(a)(4)(C). The bank also may use the Fund/
SERV system to execute orders in investment company securities, 
pursuant to Rule 3a4-6.
---------------------------------------------------------------------------

    We believe that the exemption balances the intent of not 
unnecessarily disrupting bank securities activities with the intent to 
require active and compensated securities sales operations to be 
subject to the federal securities laws as required by the GLBA. It will 
allow existing custody customers to maintain their relationships with 
their banks to the extent the service of effecting securities 
transactions is provided as a true accommodation. However, because the 
protection of the securities laws will not be available, nor will 
fiduciary standards be applicable, the exemption contains strict 
compensation limits on the bank and its employees. For example, the 
bank may not receive sales compensation, as that term is defined in 
Rule 3b-17. The bank, however, may pass on the broker-dealer's charge 
for executing the transaction. Thus, under the exemption, if a bank 
charges an annual or assets under management custodial fee, it must 
charge the same custody fee to an investor who engaged in many 
securities transactions as it would to one who engaged in only a few 
securities transactions or none at all. A bank must also charge the 
same custody fees regardless of whether the investor invested in 
proprietary investment company securities or investment company 
securities sponsored by unaffiliated broker-dealers. These conditions 
are consistent with our intent to permit banks in their custody 
capacity to accept investors' orders for the purchase or sale of 
securities, while limiting to a passive securities distribution channel 
brokerage that does not carry the investor protections found in the 
federal securities laws.
    We solicit comment on whether this exemption is necessary, and 
consistent with the protection of investors under the federal 
securities laws. We also request comments on the exemptions that we 
have provided for banks that engage in certain securities activities. 
Are there other areas or lines of business of the banks where an 
exemption may be appropriate if there are sufficient investor 
protection obligations? Are there conditions that may be imposed in 
those circumstances to limit solicitation of securities brokerage and 
compensation that could address our investor protection concerns?

III. Discussion of Other Exceptions From Broker

A. Affiliate Transactions Exception

    Exchange Act Section 3(a)(4)(B)(vi) excepts from the definition of 
broker a bank that ``effects transactions for the account of any 
affiliate (as defined in section 2 of the Bank Holding Company Act) 
\199\ of the bank.'' \200\ Questions have arisen regarding this 
exception, particularly in light of one of the exemptions from broker-
dealer registration found in Exchange Act Rule 15a-6.\201\
---------------------------------------------------------------------------

    \199\ Bank Holding Company Act Section 2(k) [12 U.S.C. 1841(k)] 
defines affiliate to mean ``any company that controls, is controlled 
by or that is under common control with another company.''
    \200\ 15 U.S.C. 78c(a)(4)(B)(vi).
    \201\ 17 CFR 240.15a-6.
---------------------------------------------------------------------------

    The affiliate exception applies to banks effecting trades for the 
accounts of affiliates of the bank, excluding registered broker-dealers 
or affiliates engaged in merchant banking. The exception was provided 
because affiliates were not deemed to need the protections of broker-
dealer registration. The exception does not cover a bank effecting 
trades with non-affiliated customers, even when the customer 
transaction also is effected as part of a trade involving an affiliate. 
A separate exception is necessary for the customer side of the trade.
    Exchange Act Rule 15a-6 provides an exemption from U.S. broker-
dealer registration for certain foreign broker-dealers.\202\ Subsection 
(a)(4)(i) of Rule 15a-6 \203\ allows a foreign broker-dealer to effect 
transactions in securities with or for a U.S. registered broker-dealer 
or bank acting in a broker-dealer capacity as permitted by U.S. law. If 
a foreign broker-dealer or bank is an affiliate of a U.S. bank acting 
in a broker-dealer capacity permitted by U.S. law, the foreign broker-
dealer or bank can rely on Rule 15a-6(a)(4)(i) to effect transactions 
in securities with or for such U.S. bank without registering in the 
United States as a broker-dealer. Moreover, in these transactions with 
its foreign affiliate, the U.S. bank could rely on the affiliate 
transactions exception.\204\ However, if the foreign broker-dealer or 
bank seeks to have direct contact with customers of the U.S. bank, the 
foreign entity may not avail itself of the exemption in Rule 15a-
6(a)(4)(i). Similarly, the U.S. bank could not rely on the affiliate 
transactions exception to avoid any registration requirements arising 
out of its role in the foreign broker-dealer's or bank's dealings with 
its customers.
---------------------------------------------------------------------------

    \202\ 17 CFR 240.15a-6. Rule 15a-6 and other exemptions from 
registration remain viable after the passage of the GLBA to the 
extent that the conditions of such exemptions can be met. Even when 
the GLBA permits a bank to engage in securities-related activities 
without itself registering as a broker-dealer, a broker-dealer 
engaged in the business of effecting transactions for such bank 
still must register absent an exemption or other exclusion from the 
requirements of the Exchange Act. For instance, this would be the 
case for a foreign broker-dealer that handles trades for a bank 
under Exchange Act Section 3(a)(4)(C). Moreover, foreign banks do 
not enjoy the bank exemptions because they do not fall within the 
definition of bank in Exchange Act Section 3(a)(6).
    \203\ 17 CFR 240.15a-6(a)(4)(i).
    \204\ Exchange Act Section 3(a)(4)(B)(vi) [15 U.S.C. 
78c(a)(4)(B)(vi)].
---------------------------------------------------------------------------

B. De Minimis Exception and RULE 3a5-1

    Exchange Act Section 3(a)(4)(B)(xi) \205\ excepts from the 
definition of broker banks that effect no more than 500 securities 
transactions, other than transactions that qualify for one of the other 
statutory exceptions. A transaction in which the bank is acting as an 
agent for a customer would count as one transaction toward the 500-
transaction limit. Questions have arisen, however, as to whether banks 
can rely on this exception if they engage in ``riskless'' principal 
transactions.\206\
---------------------------------------------------------------------------

    \205\ 15 U.S.C. 78c(a)(4)(B)(xi) [15 U.S.C. 78c(a)(4)(B)(xi)].
    \206\ ``Riskless'' principal transactions are generally 
described as trades in which, after receiving an order to buy (or 
sell) from a customer, the broker-dealer purchases (or sells) the 
security from (or to) another person in a contemporaneous offsetting 
transaction. See Exchange Act Rule 10b-10(a)(2)(ii)(A) [17 CFR 240. 
10b-10(a)(2)(ii)(A)]; Exchange Act Rel. No. 33743 (Mar. 9, 1994) at 
n.11.
---------------------------------------------------------------------------

    In the context of permissible bank activity under the Glass-
Steagall Act, the OCC has interpreted ``riskless''

[[Page 27784]]

principal activity as equivalent to agency activity.\207\ Nevertheless, 
under the securities laws, ``riskless'' principal transactions involve 
dealer activity because entities that engage in ``riskless'' principal 
transactions as a matter of course would be involved in the business of 
buying and selling securities for their own accounts, even if the risk 
associated with the transactions is minimal or non-existent.\208\ In 
light of the differing interpretations regarding ``riskless'' principal 
transactions, we have determined to adopt Rule 3a5-1 to exempt banks 
from the definition of dealer provided that the number of ``riskless'' 
principal transactions and agency transactions engaged in by a bank 
does not exceed 500 transactions per year.\209\ We believe that this 
exemption provides relief to banks in an area that may have been 
understood to have been covered by the de minimis exception because of 
the differing legal interpretations under the banking and securities 
laws. This exemption, however, does not expand the number of 
transactions permitted under the statutory exception. Rather, this is a 
technical exemption to clarify that banks may act as a riskless 
principal, as well as an agent, and meet the terms of the de minimis 
exception.
---------------------------------------------------------------------------

    \207\ The OCC stated that, ``riskless principal activities are 
the legal and economic equivalent of permissible brokerage 
activities inasmuch as riskless principal brokerage is conducted in 
a manner consistent with the express terms of section 16,'' of the 
Glass-Steagall Act. See OCC Interpretive Letter No. 371 (June 13, 
1986).
    \208\ See Securities Exchange Act Section 3(a)(5). In connection 
with amendments to Rule 10b-10, however, the Commission stated that 
``riskless'' principal transactions are in many respects equivalent 
to transactions effected on an agency basis. See Securities 
Confirmations, Exchange Act Rel. No. 15219 (Oct. 6, 1978), 43 FR 
47495 (Oct. 6, 1978).
    \209\ We find that this exception is necessary and appropriate 
in the public interest and consistent with the protection of 
investors. See Exchange Act Sections 15(a)(2), 23(a)(1), and 
36(a)(1) [15 U.S.C. 78o(a)(2), 78w(a)(1), and 78mm(a)(1)].
---------------------------------------------------------------------------

    Rule 3a5-1 provides that a bank is exempt from the definition of 
the term ``dealer'' solely for engaging in riskless principal 
transactions if the number of such riskless principal transactions 
combined with transactions in which the bank is acting as an agent for 
a customer under the de minimis exception do not exceed 500 
transactions. A ``riskless principal transactions'' is defined as a 
transaction in which, after having received an order to buy from a 
customer, the bank purchased the security from another person to offset 
a contemporaneous sale to such customer or, after having received an 
order to sell from a customer, the bank sold the security to another 
person to offset a contemporaneous purchase from such customer.
    For purposes of Rule 3a5-1 and the de minimis exception, riskless 
principal transactions should be counted toward the 500-transaction 
limit in the following manner. First, a transaction in which the dealer 
bank is acting as a riskless principal intermediary between a broker-
dealer and a non-broker-dealer customer would count as one trade toward 
the 500-transaction limit. Second, a transaction in which the dealer 
bank is acting as a riskless principal intermediary between two non-
broker-dealer customers would count as two trades toward the 500-
transaction limit. We have included this methodology in Rule 3a5-1(b), 
which explicitly provides that for purposes of the 500-transaction 
limit ``a riskless principal transaction counts as: (1) Two 
transactions if neither transaction comprising the riskless principal 
transaction is with a broker or dealer; or (2) one transaction if 
either transaction comprising the riskless principal transaction is 
with a broker or dealer.''
    We believe this methodology is consistent with the de minimis 
exception to the definition of ``broker.'' Specifically, a broker acts 
as an agent for a customer in executing securities transactions. 
Because riskless principal transactions are in many respects equivalent 
to transactions effected on agency basis for customers, we determined 
to focus on transactions between banks and customers that are similar 
to agency transactions. Transactions between banks and broker-dealers 
appear in many respects to be transactions between principals. We 
therefore determined not to count transactions with broker-dealers for 
purpose of this exemption.
    We request comment on whether riskless principal transactions 
should be counted as provided in Rule 3a5-1 for purposes of the de 
minimis exception. Should this exception be limited to instances where 
a broker or dealer is the counterparty to a particular transaction? Are 
there other specific types of transactions that should be specially 
accounted for in determining the de minimis exception?

IV. Rule 3b-18--Definitions of Terms Used in Asset-Backed Exception 
to Dealer

    Exchange Act Section 3(a)(5)(A) defines the term ``dealer'' 
generally as ``any person engaged in the business of buying and selling 
securities for such person's own account through a broker or otherwise 
* * *'' Exchange Act Section 3(a)(5)(B) \210\ provides an exception for 
any ``person that buys or sells securities for such person's own 
account, either individually or in a fiduciary capacity, but not as a 
part of a regular business.'' Prior to the passage of the GLBA, the 
Exchange Act completely excepted banks from the definition. However, 
the Glass-Steagall Act generally prohibited banks from acting as 
underwriters or dealers of corporate securities and certain other types 
of securities. The GLBA retained the general prohibition on bank 
underwriting and dealing in corporate securities and certain other 
types of securities but repealed the Exchange Act's blanket exception 
for banks acting as dealers. The GLBA replaced the blanket exception 
with four specific exceptions for certain securities activities that a 
bank may engage in without being considered a dealer.\211\ The four 
exceptions are for: (1) Permissible securities transactions; \212\ (2) 
investment, trustee, and fiduciary transactions; \213\ (3) asset-backed 
transactions; \214\ and (4) transactions in identified banking 
products.\215\ The permissible securities transactions exception allows 
banks to buy and sell permissible securities, which include commercial 
paper and exempted securities. The second exception permits banks to 
buy and sell securities for investment purposes for the bank or for the 
accounts for which the bank acts as a trustee or fiduciary. The third 
exception is discussed below. The fourth exception permits the bank to 
buy and sell identified banking products, which include deposit 
accounts, letters of credit issued by a bank, and loans made by a bank. 
We view the first, second, and fourth exceptions as not needing 
additional clarification by rule at this time. However, we do solicit 
comment on whether there are any issues surrounding the interpretation 
of these three exceptions of which we should be aware and as to which 
we should provide guidance.
---------------------------------------------------------------------------

    \210\ 15 U.S.C. 78c(a)(5)(B) [15 U.S.C. 78c(a)(5)(B)].
    \211\ Exchange Act Section 3(a)(5)(C) [15 U.S.C. 78c(a)(5)(C)].
    \212\ Exchange Act Section 3(a)(5)(C)(i) [15 U.S.C. 
78c(a)(C)(i)].
    \213\ Exchange Act Section 3(a)(5)(C)(ii) [15 U.S.C. 
78c(a)(C)(ii)].
    \214\ Exchange Act Section 3(a)(5)(C)(iii) [15 U.S.C. 
78c(a)(C)(iii)].
    \215\ Exchange Act Section 3(a)(5)(C)(iv) [15 U.S.C. 
78c(a)(C)(iv)].
---------------------------------------------------------------------------

    The third exception allows banks to issue and sell certain asset-
backed securities.\216\ Under this exception banks are permitted to 
issue or sell

[[Page 27785]]

specified securities to qualified investors through a grantor trust or 
other separate entity without being considered a dealer. The specified 
securities generally must be originated by the bank and backed by the 
obligations of the bank's customers. We have identified several issues 
under this exception that require clarification. We are adopting Rule 
3b-18 to assist banks in structuring their activities in accordance 
with the new asset-backed transaction exception.\217\
---------------------------------------------------------------------------

    \216\ Exchange Act Section 3(a)(5)(C)(iii) [15 U.S.C. 
78c(a)(5)(c)(iii)].
    \217\ Id.
---------------------------------------------------------------------------

    The exception to the definition of dealer registration for banks 
engaging in asset-backed issuance and sale transactions specifically 
provides that a bank may ``engage in the issuance or sale to qualified 
investors, through a grantor trust or other separate entity, of 
securities backed by or representing an interest in notes, drafts, 
acceptances, loans, leases, receivables, other obligations (other than 
securities of which the bank is not the issuer), or pools of any such 
obligations predominantly originated by: (1) The bank; (2) an affiliate 
of any such bank other than a broker or dealer; or (3) a syndicate of 
banks of which the bank is a member, if the obligations or pool of 
obligations consist of mortgage obligations or consumer-related 
receivables.'' \218\
---------------------------------------------------------------------------

    \218\ Exchange Act Sections 3(a)(5)(C)(iii)(I), (II), and (III) 
[15 U.S.C. 78c(a)(C)(iii)(I), (II), and (III)].
---------------------------------------------------------------------------

    This language makes it clear that Congress intended to create a 
narrow dealer exception for banks that engage in the issuance and sale 
of securities based on assets created by the bank itself and sold only 
to qualified investors. Congress' intent to limit this exception to 
bank-generated underlying assets is shown by the language found at the 
conclusion of the section that requires any of the obligations to be 
``predominantly originated'' by the group consisting of the bank and 
its affiliates. In the case of mortgage obligations and consumer-
related receivables, the limitation is expanded to permit a syndicate 
of banks that includes the issuing bank to originate the obligations or 
pool of obligations.
    Moreover, the legislative history indicates that this exception 
should be limited to syndicates in which the bank is more than an 
insignificant member. It states that, ``[t]he Committee expects this 
provision shall be interpreted so that the bank will [have] not less 
than ten percent of the assets in the syndicate or pool of 
obligations.'' \219\ This interpretation generally limits the 
availability of the underwriting exception to asset-backed transactions 
predominantly originated by the bank that is underwriting the 
transaction, or involving syndicates where that bank is not an 
insignificant member. In addition, the exception requires the asset-
backed securities to be placed into a grantor trust or other separate 
entity.
---------------------------------------------------------------------------

    \219\ See H.R. Rep. No. 106-74, pt. 3, at 171 (1999).
---------------------------------------------------------------------------

    The exception by its terms does not cover repurchases by the bank 
of the asset-backed securities after they have been originated and 
issued; rather, the terms of the exception cover the issuance or sale 
of asset-backed securities. Thus, the exception permits a bank to 
create, underwrite, and issue asset-backed securities predominantly 
originated by the bank and its affiliates. This exception does not 
permit the bank to be a dealer by regularly repurchasing and reselling 
the asset-backed securities that it issues. A bank may purchase these 
securities for investment purposes, so long as the bank is not acting 
as a dealer.\220\
---------------------------------------------------------------------------

    \220\ Exchange Act Section 3(a)(5)(C)(ii) [15 U.S.C. 
78c(a)(C)(ii)]. In contrast, a bank also may deal in government 
securities, such as securities of the Federal National Mortgage 
Association (``Fannie Mae'') and the Federal Home Loan Mortgage 
Corporation (``Freddie Mac''). Exchange Act Sections 3(a)(5)(C)(II) 
(exception from ``dealer'' for exempted securities) [15 U.S.C. 
78c(a)(5)(C)(II)], 3(a)(12)(A) (exempted security defined) [15 
U.S.C. 78c(a)(12)(A)], and 3(a)(42)(B) and (C) (government 
securities defined) [15 U.S.C. 78c(a)(42)(B) and (C)].
---------------------------------------------------------------------------

    We note that this is the only exception that permits this type of 
securitized transaction. The exception to the definition of dealer for 
banks buying or selling identified banking products \221\ does not 
permit the packaging of securities for sale in an asset-backed 
transaction.\222\
---------------------------------------------------------------------------

    \221\ Section 206 of the GLBA defines the term ``identified 
banking product'' as:
    ``(1) a deposit account, savings account, certificate of 
deposit, or other deposit instrument issued by a bank;
    ``(2) a banker's acceptance;
    ``(3) a letter of credit issued or loan made by a bank;
    ``(4) a debit account at a bank arising from a credit card or 
similar arrangement;
    ``(5) a participation in a loan which the bank or an affiliate 
of the bank (other than a broker or dealer) funds, participates in, 
or owns that is sold--
    ``(A) to qualified investors; or
    ``(B) to other persons that--
    ``(i) have the opportunity to review and assess any material 
information, including information regarding the borrower's 
creditworthiness; and
    ``(ii) based on such factors as financial sophistication, net 
worth, and knowledge and experience in financial matters, have the 
capability to evaluate the information available, as determined 
under generally applicable banking standards or guidelines; or
    ``(6) any swap agreement, including credit and equity swaps, 
except that an equity swap that is sold directly to any person, 
other than a qualified investor (as defined in section 3(a)(54) of 
the Securities Act of 1934) shall not be treated as an identified 
banking product.'' 15 U.S.C. 78c note.
    \222\ Exchange Act Section 3(a)(5)(C)(iv) [15 U.S.C. 
78c(a)(5)(C)(iv)].
---------------------------------------------------------------------------

    We are clarifying several terms in the asset-backed securities 
exception to assist banks in understanding how this section applies to 
their asset-backed securities activities. Specifically, Rule 3b-18 
defines the terms ``affiliate,'' ``consumer-related receivable,'' 
``member of a syndicate of banks,'' ``obligation,'' ``originated,'' 
``pool,'' ``predominantly originated,'' and ``syndicate of banks'' as 
used in this exception. We find that these definitions are consistent 
with the provisions and purposes of the Exchange Act.\223\
---------------------------------------------------------------------------

    \223\ Exchange Act Section 3(b) [15 U.S.C. 78c(b)].
---------------------------------------------------------------------------

    First, in defining the term ``predominantly,'' which modifies the 
term ``originated,'' we looked to other sections of the GLBA in which 
the term is used. Section 103(n) of the GLBA uses the term 
``predominantly'' to modify ``financial'' and to allow analysis of 
whether nonfinancial activities and affiliations may be retained.\224\ 
Section 103(n)(2) of the GLBA expressly provides that a firm is 
predominantly engaged in financial activities when at least 85% of the 
annual gross revenues of the consolidated company derive from financial 
activities, excluding any revenue from banks. To be consistent, we are 
applying the same numerical test found in Section 103(n)(2) of GLBA for 
loan product originations for the purpose of the asset-backed 
securities exception from the definition of dealer.
---------------------------------------------------------------------------

    \224\ Bank Holding Company Act Section 4(n)(2) [12 U.S.C. 
1843(n)(2)].
---------------------------------------------------------------------------

    Therefore, for the purpose of the asset-backed transaction 
exception, Rule 3b-18(g) defines ``predominantly originated'' so that a 
bank may engage in the issuance or sale of asset-backed securities 
without registration as a dealer if at least 85% of the obligations 
underlying the securities were originated by the bank or its 
affiliates, other than its broker-dealer affiliates, or any permitted 
syndicate of which the bank is more than an insignificant member. 
Specifically, the bank, its affiliates, or any such syndicate must have 
originated 85% of the obligations in any pool as measured by the value 
of the obligations. We considered and

[[Page 27786]]

rejected also having banks apply the predominantly originated test to 
the number and dollar amount owing on the obligations as well as the 
value in an asset-backed transaction pool. We rejected this more 
extensive test as too burdensome for any increased reliability that it 
might offer. We invite comment on this definition.
    Many of the definitions we are adopting are intended to shed light 
on the financial terms used in the exception and avoid ambiguities 
without delving into complex financial issues that may not be relevant 
to the analysis of whether a bank would be considered a dealer. Thus, 
the definitions should be relatively straightforward and uncomplicated. 
In defining the terms, we have looked to generally understood meanings 
and the interpretations of the other financial participants, including 
regulators.
    For instance, Rule 3b-18(e) provides that ``originated'' means 
initially making and funding an obligation.\225\ Thus, to count as an 
obligation originated by the bank or its affiliates, the bank and its 
affiliates must be the initial lender as shown both by creating and 
supplying the money for a loan. Rule 3b-18(d) provides that 
``obligation'' means any note, draft, acceptance, loan, lease, 
receivable, or other evidence of indebtedness that is not a security 
issued by a person other than the bank.\226\
---------------------------------------------------------------------------

    \225\ See, e.g., John Downes and Jordan Elliot Goodman, 
Dictionary of Finance and Investment Terms 422 (5th ed. 1998); Glenn 
G. Munn, updated by F.L. Garcia, Encyclopedia of Banking and Finance 
743 (8th ed 1983); and Yahoo! Financial Glossary at http://dir.yahoo.com/Business_and_Economy/Finance_and_Investment/Reference_and_Guides/Glossaries.
    \226\ See, e.g., Dictionary of Finance and Investment Terms, 
Id., at 405; John F. Marshall, Dictionary of Financial Engineering, 
122 (2000); and Encyclopedia of Banking and Finance, Id. at 728.
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    Rule 3b-18(a) defines the term ``affiliate'' by using the same 
definition found in Section 509 of the GLBA and Section 2 of the Bank 
Holding Company Act.\227\ This definition states that affiliate means 
``any company that controls, is controlled by, or is under common 
control with another company.'' Rule 3b-18(h) defines the term 
``syndicate of banks'' to mean a group of banks that acts jointly, on a 
temporary basis, to loan money in one or more bank credit 
obligations.\228\
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    \227\ Exchange Act Section 3(a)(4)(B)(vi) adopts the definition 
of ``affiliate'' found in Bank Holding Company Act Section 2(k) [12 
U.S.C. 1841(k)]. Both definitions are the same.
    \228\ See, e.g., Dictionary of Finance and Investment Terms, 
supra note 225 at 555; Encyclopedia of Banking and Finance, supra 
note 225, at 907; Yahoo! Financial Glossary, supra note 225; see 
also Federal Deposit Insurance Corporation Regional Outlook, First 
Quarter 1999, at 19, citing American Bankers Association, Banking 
Terminology, 3rd ed., 1989, p. 435.
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    The asset-backed transaction exception allows ``consumer-related 
receivables'' to be originated by a syndicate of banks of which a bank 
is a member, as well as being originated by the bank itself or an 
affiliate of the bank, other than a broker-dealer.\229\ Rule 3b-18(b) 
defines ``consumer-related receivable,'' as any obligation incurred by 
any natural person to pay money arising out of a transaction in which 
the money, property, insurance, or services (being purchased) are 
primarily for personal, family, or household purposes.\230\
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    \229\ Exchange Act Section 3(a)(5)(C)(iii)(I-III) [15 U.S.C. 
78c(a)(5)(C)(iii)(I-III)].
    \230\ Adapted from 1989 Fed. Res. Interp. Ltr. Lexis 283 (Aug. 
1, 1989).
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    Rule 3b-18(g) defines a ``pool'' as more than one obligation or 
type of obligation grouped together to provide collateral for a 
securities offering.\231\ Finally, we note that the term ``qualified 
investor'' is defined in Section 3(a)(54) of the Exchange Act, as 
amended by Section 207 of the GLBA. This definition limits the universe 
of purchasers of asset-backed securities to a more sophisticated group 
when there is not a registered broker-dealer underwriting the 
securities offering.
---------------------------------------------------------------------------

    \231\ See e.g., Dictionary of Financial Engineering, supra note 
226, at 117; Yahoo! Financial Glossary supra note 225.
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    We invite comment on these definitions, including whether there are 
any alternate definitions of these terms that would be more appropriate 
for the purposes of this specific functional exception to the 
definition of dealer. We also invite comment on whether the 85% test 
for ``predominantly originated'' and whether calculating the 
``predominantly originated by'' test based on the value of the 
obligations is a workable approach, or whether other means of 
determining ``predominantly'' should be considered. Commenters also are 
requested to give their views on whether there are any other 
definitions or interpretations that should be added, or issues that 
should be considered to enhance the clarity of this exception.

V. Rule 3a4-6--Exemption To Permit Execution of Investment Company 
Securities Through NSCC'S Mutual Fund Services

    We have been asked whether banks may purchase and redeem shares of 
open-end investment companies through NSCC's Mutual Fund Services,\232\ 
including Fund/SERV, and still comply with Exchange Act Section 
3(a)(4)(C). NSCC's Mutual Fund Services provide an automated system to 
participants to process transactions in investment company securities. 
Fund/SERV centralizes order entry, confirmation, registration, and 
settlement of purchases and redemptions of investment company 
securities. NSCC's Mutual Fund Services are available to investment 
companies, broker-dealers, banks, trust companies, and other financial 
institutions that have been accepted for membership in NSCC.
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    \232\ NSCC is a clearing agency registered pursuant to Section 
17A of the Exchange Act [15 U.S.C. 78q-1].
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    Exchange Act Section 3(a)(4)(C) requires banks to execute through a 
registered broker-dealer (or internally cross) securities transactions 
effected pursuant to the trust and fiduciary activities exception, 
safekeeping and custody exception, or certain stock purchase plans 
exception.\233\ Banks that use NSCC's Mutual Fund Services to execute 
transactions in investment company securities may not use a registered 
broker-dealer to execute these transactions, depending on whether the 
NSCC arrangement is with the principal underwriter or the transfer 
agent of the investment company. Therefore, some banks require an 
exemption from the trade execution requirements of Exchange Act Section 
3(a)(4)(C) to continue to use NSCC's Mutual Fund Services while 
complying with exceptions and exemptions from the definition of broker. 
We are adopting this exemption to allow banks to continue to execute 
transactions in shares of open-end investment companies through NSCC's 
Mutual Fund Services because NSCC's Mutual Fund Services simplify and 
automate the process for purchasing and redeeming investment company 
securities without raising investor protection concerns. This exemption 
is available only to banks that process orders through a service of a 
registered clearing agency subject to our supervision and regulation. 
We find that this exception is necessary or appropriate in the public 
interest and consistent with the protection of investors.\234\
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    \233\ 15 U.S.C. 78c(a)(4)(B)(ii), (iv), and (viii).
    \234\ Exchange Act Section 36(a)(1) [15 U.S.C. 78mm(a)(1); see 
also Exchange Act Sections 15(a)(2) and 23(a)(1) [15 U.S.C. 
78o(a)(2) and 78w(a)(1)].
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VI. Rule 15a-7--Extentions of Time

    We have received a number of requests from representatives of banks 
for an extension of time to comply with

[[Page 27787]]

the broker-dealer provisions of the GLBA.\235\ These requests indicate 
that a number of banks will not have completed the process of shifting 
certain necessary securities activities to a registered broker-dealer 
by May 12, 2001, to avoid being considered a broker or dealer subject 
to registration requirements. They also request time to adapt to the 
guidance provided by the Commission regarding these provisions. We 
recognize the time concerns that banks have raised. Because banks have 
historically enjoyed an exception from broker-dealer regulation, we 
believe they may need additional time to more fully comply with the 
GLBA amendments and these rules. Accordingly, we are adopting Rule 15a-
7, which provides two conditional exemptions from broker-dealer 
registration to allow additional time for banks to make the necessary 
arrangements either to register or to comply with a specific functional 
exception to the definitions of broker or dealer. We find that these 
exemptions are necessary or appropriate in the public interest and 
consistent with the protection of investors.\236\
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    \235\ Letter from Lawrence R. Uhlick, Executive Director and 
General Counsel, Institute of International Bankers, to Robert L. D. 
Colby, Deputy Director, and Catherine McGuire, Associate Director 
and Chief Counsel, Division of Market Regulation, Commission (Mar. 
15, 2001); Letter from Barry Harris, Chair, Bank Retail Broker-
Dealer Committee, Securities Industry Association, to Laura Unger, 
Acting Chairman, Commission (Mar. 13, 2001); Letter from Sarah A. 
Miller, Director, Center for Securities, Trust and Investments, 
American Bankers Association, to Laura Unger, Acting Chairman, 
Commission (February 28, 2001).
    \236\ Exchange Act Section 36(a)(1) [15 U.S.C. 78mm(a)(1); see 
also, Exchange Act Sections 15(a)(2) and 23(a)(1) [15 U.S.C. 
78o(a)(2) and 78w(a)(1)].
---------------------------------------------------------------------------

    First, Rule 15a-7(a) exempts until October 1, 2001 banks that would 
otherwise be required to register as a broker or dealer because the 
bank's securities activities do not fit within the exceptions to the 
definitions of broker or dealer. Second, Rule 15a-7(b) exempts until 
January 1, 2002, banks that would be a broker solely because their 
compensation arrangements--either for the bank or for its employees--do 
not meet the compensation conditions of a particular exception or 
exemption.\237\ This would include effecting transactions in a money 
market fund that does not qualify as no-load under the sweeps 
exception.
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    \237\ Banks should be aware that the definitions of broker and 
dealer do not include any exceptions for banks acting as municipal 
securities dealers. Banks acting as municipal securities dealers are 
still required to be registered under Exchange Act Section 15B [15 
U.S.C. 78o-4] and to comply with requirements of the Exchange Act 
applicable to municipal securities dealers.
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VII. Rule 15a-8--Exemption for Contracts Entered Into by Banks 
Before 2003 From Being Considered Void or Voidable

    We recognize that banks may need to adjust their procedures to 
shift their securities activities to registered broker-dealers or to 
comply with the conditions of the specific functional exceptions or 
exemptions to the definitions of broker and dealer. We also are aware 
that there may be instances where, despite having reasonable procedures 
in place, a bank may inadvertently fail to meet the terms and 
conditions of the specific functional exceptions upon which it is 
relying. This could result in the bank engaging in securities 
activities in violation of the registration requirements of Exchange 
Act Section 15 and the rules promulgated under that section.
    Exchange Act Section 29(b) \238\ provides that any contract made in 
violation of the Exchange Act or Exchange Act rules shall be void as 
regards the rights of any person who made or engaged in the performance 
of any such contract.\239\ Occasionally, private parties have invoked 
this remedy, which is purely equitable in nature,\240\ in instances 
involving broker-dealer registration violations by the opposite 
party.\241\
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    \238\ 15 U.S.C. 78cc(b).
    \239\ Exchange Act Section 29(b) does not make the contract 
automatically a nullity. Rather, the contract is voidable at the 
option of the innocent party. Mills v. Electric Auto-Lite Co., 396 
U.S. 375, 387 (1970). In this manner, ``interests of the victim are 
sufficiently protected by giving him the right to rescind; to regard 
the contract as void where he has not invoked the right would only 
create the possibility of hardships to him or others without 
necessarily advancing the statutory policy of disclosure.'' Id. at 
388.
    \240\ Id. at 388; see also Occidental Life Ins. Co. v. Pat Ryan 
and Assoc., 496 F.2d 1255, 1267 (4th Cir.), cert. denied, 419 U.S. 
1023 (1974) (principles of equity, like estoppel and waiver, apply 
to actions brought under Exchange Act Section 29(b)).
    \241\ See Boguslavsky v. Kaplan, 159 F.3d 715, 722 (2nd Cir. 
1998) (under the liberal pleading standard accorded pro se 
litigants, an investor properly presented an identifiable claim for 
rescission under Exchange Act Section 29(b) in asserting that the 
firm opeated without director of compliance and thus was not 
properly registered as securities broker-dealer); Regional 
Properties, Inc. v. Financial and Real Estate Consulting Co., 752 
F.2d 178, 182 (5th Cir. 1985) (subject to equitable defenses, real 
estate developers were entitled to rescind agreement with broker to 
structure and market limited partnership interest where broker had 
failed to register as required by the Exchange Act); Regional 
Properties v. Financial and Real Estate Consulting Co., 678 F.2d 
552, 557, 566-67 (5th Cir. 1982) (recognizing that Exchange Act 
Section 29(b) provides for a private, equitable cause of action for 
the rescission of a contract where the securities broker was 
unlicensed); Eastside Church of Christ v. National Plan, Inc., 391 
F.2d 357, 362 (5th Cir.)., cert. denied, 393 U.S. 913 (1968) 
(churches could void a transaction with broker under Exchange Act 
Section 29(b) because the broker was unregistered); Couldock and 
Bohan, Inc. v. Societe Generale Securities, Corp., 93 F. Supp. 2d 
220, 233 (D. Conn. 2000) (a contract violating broker registration 
requirements of the Exchange Act is voidable at the option of the 
innocent party under Exchange Act Section 29(b)).
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    As explained above, the amended Exchange Act contains numerous 
broker-dealer definitional provisions that apply only to banks, which 
were previously excepted from broker-dealer regulation. Because of this 
history, we believe that banks may have unique issues in complying with 
these definitional provisions. It is, therefore, appropriate to provide 
a transitional period before these provisions fully apply. Therefore, 
to provide certainty to banks while they become fully familiar with the 
operation of the exceptions, we are adopting Rule 15a-8.\242\ This rule 
provides an exemption for contracts entered into by banks before 
January 1, 2003 from being considered void or voidable by reason of 
Exchange Act Section 29 because a bank that is a party to the contract 
violated the registration requirements of Section 15(a) of the Exchange 
Act or any applicable provision of this Act and the rules and 
regulations thereunder based solely on a bank's status as a broker or 
dealer when the contract was created. We expect the banks are already 
working to come into full compliance with the functional regulation 
provisions of the GLBA. Banks may, however, have inadvertent, technical 
violations as they become accustomed to the new regulatory 
requirements. This exemption is designed to recognize the unique 
compliance problems that many banks have by preventing any inadvertent 
failures by banks to meet the conditions of the functional exceptions 
from triggering potential rescission under Exchange Act Section 29 
during this transitional period.
---------------------------------------------------------------------------

    \242\ 17 CFR 240.15a-8.
---------------------------------------------------------------------------

    We note that this provision does not relieve banks of the 
obligation to register as a broker or dealer if their securities 
activities do not fit within a specific functional exception or 
exemption. We also note that banks' securities activities continue to 
be subject to the antifraud provisions of the federal securities laws, 
irrespective of the bank's lack of registration or failure to comply 
with the provisions of the Exchange Act and the rules thereunder that 
otherwise apply to banks based on their status as broker-dealers. We, 
therefore, find that this exemption is consistent with the

[[Page 27788]]

public interest and the protection of investors.\243\
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    \243\ Exchange Act Section 36(a)(1) [15 U.S.C. 78mm(a)(1)].
---------------------------------------------------------------------------

    We request comment on the appropriateness of this temporary 
exemption from Exchange Act Section 29(b).

VIII. Rule 15a-9--Exemption for Savings Associations and Savings 
Banks

    We are granting an exemption from the definitions of ``broker'' and 
``dealer'' for savings associations and savings banks \244\ on the same 
terms and conditions that banks are excepted or exempted from broker-
dealer registration.\245\ Savings associations and savings banks are 
not ``banks'' as defined in Exchange Act Section 3(a)(6).\246\ 
Accordingly, they have not had the same general exception from broker-
dealer registration for securities transactions as banks have had. 
Savings associations and savings banks have typically established 
networking arrangements with broker-dealers.\247\
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    \244\ This exemption requires savings associations and savings 
banks to have deposits insured by the FDIC under the FDIA and to not 
be operated for the purpose of evading the provisions of the 
Exchange Act. 12 U.S.C. 1811 et seq.
    \245\ Nevertheless, savings associations and savings banks that 
are municipal securities dealers must register and be regulated as 
municipal securities dealers pursuant to Exchange Act Section 15B 
[15 U.S.C. 78o-4]. Banks must also register pursuant to Exchange Act 
Section 15B. Exchange Act Section 3(a)(34)(A) [15 U.S.C. 
78c(a)(34)(A) provides that the ``appropriate regulatory agency'' of 
a municipal securities dealer that is a bank regulated by the OCC, 
the Federal Reserve, or the FDIC is the agency that already 
regulates the bank. Exchange Act Section 3(a)(34)(A)(iv) [15 U.S.C. 
78c(a)(34)(A)(iv)] designates the Commission as the appropriate 
regulatory agency in the case of all other municipal securities 
dealers, which includes savings associations and savings banks that 
are municipal securities dealers.
    \246\ See Letter re: AmeriFed Federal Savings Bank (Jan. 18, 
1990). The OTS is the appropriate federal regulator for savings 
associations, which include federally chartered savings banks, and 
the FDIC is the appropriate federal regulator for state-chartered 
savings banks as it is for all state-chartered banks that are not 
members of the Federal Reserve System. 12 U.S.C. 1813(q); see also, 
Investment Company Act Rel. No. 13666, Status of Savings and Loan 
Associations Under the Federal Securities Laws; Advance Notice of 
Possible Commission Action, 49 FR 6383 (December 19, 1983).
    \247\ See, e.g., Chubb Letter, supra note 38.
---------------------------------------------------------------------------

    Now that the general exception for banks has been replaced, and the 
differences between banks and savings associations have narrowed;\248\ 
it seems reasonable to afford savings associations and savings banks 
the same type of exemptions. Moreover, insured savings associations are 
subject to a similar regulatory structure and examination standards as 
banks.\249\ We find that extending the exemption for banks to savings 
associations and savings banks is necessary or appropriate in the 
public interest and is consistent with the protection of 
investors.\250\
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    \248\ See FDIC Banking Review, Volume 10, No., 1 pp. 3-18 (June 
1997).
    \249\ See e.g., 12 U.S.C. 1828(c), dealing with the regulatory 
responsibilities of the banking agencies regarding mergers of 
insured depository institutions; 12 U.S.C. 1828(i), governing the 
statutory requirements for a reduction in stock capital; 12 U.S.C. 
1828(m), governing activities of savings associations and their 
subsidiaries; 12 U.S.C. 1818(e), governing insured depository 
institutions removal and prohibition authority; 12 U.S.C. 1831m, 
governing early identification of needed improvements in financial 
condition; and 12 U.S.C. 1831o, governing prompt corrective action. 
In each of these instances, the OTS has exactly the same regulatory 
authority as do the federal banking agencies with regard to the 
banks under their jurisdiction.
    The FDIC also must approve the applications of savings 
associations and savings banks for deposit insurance. 12 U.S.C. 
1815. The FDIC receives a notice every time a savings association or 
savings bank establishes or acquires a new subsidiary or commences a 
new activity. 12 U.S.C. 1828(m). The FDIC also has additional 
regulatory and examination authority over these insured depository 
institutions in its role as the insurer of their deposits, just like 
it does over state and national banks. 12 U.S.C. 1820. The FDIC also 
reviews the activities of state chartered savings associations and 
state chartered banks, including savings banks, whenever they engage 
in activities that are not permissible for federally chartered 
savings associations or national banks, respectively. 12 U.S.C. 
1831e and 1831a, respectively.
    \250\ Exchange Act Section 36(a)(1) [15 U.S.C. 78mm(a)(1).
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    In addition, the existence of some of the bank exceptions from 
broker-dealer registration, such as the trust and fiduciary activities 
exception, the safekeeping and custody exception, and the sweep 
accounts exception, that may suggest registration is necessary for 
certain limited conduct, create legal uncertainty for savings 
associations and savings banks engaging in such activities. The 
exemption will allow savings associations and savings banks that are 
governed by a similar regulatory structure to operate under the same 
terms and conditions as banks. We emphasize, however, that consistent 
with functional regulation, savings associations and savings banks, as 
well as banks, using the trust and fiduciary activities, safekeeping 
and custody, or stock purchase plan exceptions, must execute securities 
transactions through registered broker-dealers or internally cross 
their trades. We note that the OTS, the FDIC, or the Federal Financial 
Institutions Examinations Council may adopt recordkeeping 
requirements.\251\ We solicit comment on whether there is a need for us 
to propose regulations to assure parallel recordkeeping requirements. 
We also request comment on all aspects of this exemption as well as 
whether it should be extended to any other entities.
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    \251\ See 12 U.S.C. 1828(t).
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IX. Rule 30-3--Delegation of Authority

    We are amending Rule 30-3 of our Rules of Organization and Program 
Management \252\ by adding new paragraph (a)(72) to Rule 30-3 to 
delegate to the Director of the Division of Market Regulation authority 
to review and, either unconditionally or on specified terms and 
conditions, to grant or deny to banks, savings associations, and 
savings banks exemptions from the broker-dealer registration 
requirements,\253\ pursuant to the authority provided in Section 15 and 
Section 36 of the Exchange Act.\254\ The delegation of authority to the 
Division is designed to conserve our resources by permitting Division 
staff to grant or deny exemptions where appropriate and in a timely 
manner. We expect the staff to submit to us novel and complex requests 
for exemption.
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    \252\ See 17 CFR 200.30-3(a), which is entitled ``Delegation of 
authority to Director of Division of Market Regulation.''
    \253\ Section 15(a) generally requires a broker or dealer to 
register with us prior to effecting, inducing, or attempting to 
induce securities transactions.
    \254\ This delegation of authority does not apply to banks 
seeking exemptions from registration as a municipal securities 
dealer under Exchange Act Section 15B [15 U.S.C. 78o-4], which 
regulates the activities of municipal securities dealers. Banks that 
act as municipal securities dealers are still required to comply 
with the requirements of the Exchange Act applicable to non-bank 
municipal securities dealers. Savings associations and savings banks 
are required to comply with the requirements applicable to bank 
municipal securities dealers but by the terms of the exemption in 
Rule 15a-9 are exempted from complying with those requirements if 
they comply with rules applicable to bank municipal securities 
dealers.
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X. Procedural Matters

A. Administrative Procedures Act And Request For Comments

    The Administrative Procedures Act (``APA'') permits an agency to 
issue a rule without prior notice and comment upon a finding of good 
cause, or if the rule is interpretive, a general statement of policy, 
or a rule of agency organization, procedure, or practice.\255\ The APA 
also permits an agency to issue a rule without delaying its effective 
date for 30 days from the date of publication if the agency finds good

[[Page 27789]]

cause and publishes its finding with the rule, or if the rule is not 
substantive.\256\
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    \255\ The APA provides that prior notice and comment is not 
required: ``(A) [for] interpretive rules, general statements of 
policy, or rules of agency organization, procedure, or practice; or 
(B) when the agency for good cause finds (and incorporates the 
finding and a brief statement of reasons therefore in the rules 
issued) that notice and public procedure thereon are impracticable, 
unnecessary, or contrary to the public interest.'' 5 U.S.C. 
553(b)(A) and (B).
    \256\ The APA provides that publication of a substantive rule 
must be made not less than 30 days prior to its effective date, 
except ``(1) a substantive rule which grants or recognizes an 
exemption or relieves a restriction; (2) interpretive rules and 
statements of policy; or (3) otherwise provided by the agency for 
good cause found and published with the rule.'' 5 U.S.C. 553(d).
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    For the reasons discussed below, we find that there is good cause 
for issuing Rules 3a4-2, 3a4-3, 3a4-4, 3a4-5, 3a4-6, 3a5-1, 3b-17, 3b-
18, 15a-7, 15a-8 and 15a-9 under the Exchange Act without prior notice 
and comment and without a delayed effective date. We also find that the 
amendment to Rule 30-3 of our Rules of Organization and Program 
Management relates solely to agency organization, procedure, or 
practice, and is not a substantive rule. Accordingly, we are issuing 
the amendment without prior notice and comment and without a delayed 
effective date.
    As the banking regulators found with respect to certain of their 
regulations under the GLBA,\257\ we find good cause for issuing Rules 
3a4-2, 3a4-3, 3a4-4, 3a4-5, 3a4-6, 3a5-1, 3b-17, 3b-18, 15a-7, 15a-8 
and 15a-9 without notice and comment or a delayed effective date. We 
make this finding for the following reasons: (1) The short time 
available between the time members of the banking community requested 
specific guidance as to the meaning of certain provisions of the GLBA 
and the date on which those provisions become effective; (2) the amount 
of input we already have received from the industry on the issues 
addressed by the rules; (3) the fact that the rules do not impose any 
new obligations in addition to those created by the GLBA, but rather 
provide guidance as to the meaning of certain provisions of that 
statute or provide exemptive relief consistent with the intent of those 
provisions; and (4) the interim nature of the rules, which come after 
discussions with the industry, and which invite further comment, with 
possible revision of the rules in light of those comments.
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    \257\ See Interim Final Rule with Request for Comments, 
Repurchases of Stock by Recently Converted Savings Associations, 
Mutual Holding Company Dividend Waivers, 65 FR 43088 (July 12, 
2000), comment period extended, 65 FR 60095 (Oct. 10, 2000) (OTS); 
Joint Interim Final Rule with Request for Comments, Bank Holding 
Companies and Changes in Bank Control, 65 FR 16460 (Mar. 28, 2000) 
(Board of Governors of the Federal Reserve System (Federal Reserve 
and Treasury); Interim Final Rules with Request for Comment, 
Activities and Investments of Insured State Banks, 65 FR 15526 (Mar. 
23, 2000), Final Rule, 66 FR 1018 (Jan. 5, 2001) (FDIC); Interim 
Final Rule with Request for Comments, Financial Subsidiaries, 65 FR 
14819 (Mar. 20, 2000) (Federal Reserve); Joint Interim Final Rule 
with Request for Comments, Financial Subsidiaries, 65 FR 15050 (Mar. 
20, 2000) (Treasury and Federal Reserve); Interim Final Rule with 
Request for Comments, Application of Sections 23A and 23B of the 
Federal Reserve Act to Derivative Transactions with Affiliates and 
Intraday Extensions of Credit to Affiliates, 66 FR 24229 (May 11, 
2001) (Federal Reserve).
---------------------------------------------------------------------------

    Although Congress enacted the GLBA in November 1999, members of the 
banking community more recently requested specific guidance as to the 
meaning of certain key terms used in the GLBA amendments to the 
definitions of ``broker'' and ``dealer'' and as to the application of 
those terms to certain activities. The GLBA does not require us to 
engage in rulemaking in this area, and we initially anticipated that we 
could work with banks on an individual basis to address their 
particular concerns. In recent weeks, however, we have received a 
significant number of inquiries regarding how we interpret some of the 
key terms in the new definitions. Based on these inquiries, we now 
believe that it is necessary to provide guidance in the form of 
rulemaking before the effective date of May 12, 2001.
    We recently received many requests for guidance and certain relief 
by letter. Several of the letters asked us to delay implementing the 
GLBA amendments to the definitions of ``broker'' and ``dealer.'' \258\ 
One of the letters expressed the writer's view on how the trust and 
fiduciary activities exception applied to conduct by indenture trustees 
and requested an exemption for this conduct from the statute.\259\ A 
different letter from the same writer asked how the trust and fiduciary 
activities exception applied to banks acting as trustees for certain 
benefit plans and self-directed IRAs.\260\ A separate letter by the 
same writer asked whether certain investment management services 
offered by bank trust departments.\261\ Another letter asked that we 
extend the exceptions to the definitions of ``broker'' and ``dealer'' 
to thrifts.\262\ Still other letters noted that the term ``no-load'' 
was not defined in the GLBA and inquired if we interpreted the term in 
the same manner as the NASD's definition of that term.\263\ In 
addition, Commission staff has had numerous discussions with industry 
members during the past few weeks concerning the GLBA amendments. These 
requests and discussions persuaded us that immediate guidance 
concerning the scope of the functional exceptions to the definitions of 
``broker'' and ``dealer'' added by the GLBA is imperative.
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    \258\ See, e.g., Letter from Lawrence R. Uhlick, Executive 
Director and General Counsel, Institute of International Bankers, to 
Robert L. D. Colby, Deputy Director, and Catherine McGuire, 
Associate Director and Chief Counsel, Division of Market Regulation, 
Commission (Mar. 15, 2001); Letter from Barry Harris, Chair, Bank 
Retail Broker-Dealer Committee, Securities Industry Association, to 
Laura S. Unger, Acting Chairman, Commission (Mar. 13, 2001); Letter 
from Robert M. Kurucza, General Counsel, Bank Securities 
Association, to Laura S. Unger, Acting Chairman, Commission (Mar. 
12, 2001); Letter from Sarah A. Miller, Director, Center for 
Securities, Trusts, and Investments, American Bankers Association, 
to Laura S. Unger, Acting Chairman, Commission (Feb. 28, 2001).
    \259\ Letter from Melanie L. Fein, Counsel, Federated Investors, 
Inc., to Robert L. D. Colby, Deputy Director, and Catherine McGuire, 
Associate Director and Chief Counsel, Division of Market Regulation, 
Commission (Mar. 30, 2001).
    \260\ Letter from Melanie L. Fein to Robert L. D. Colby, Deputy 
Director, and Catherine McGuire, Associate Director and Chief 
Counsel, Division of Market Regulation, Commission (Mar. 13, 2001).
    \261\ Letter from Melanie L. Fein to Robert L. D. Colby, Deputy 
Director, and Catherine McGuire, Associate Director and Chief 
Counsel, Division of Market Regulation, Commission (Mar. 7, 2001).
    \262\ Letter from Scott M. Albinson, Managing Director, OTS, to 
Annette L. Nazareth, Director, Division of Market Regulation, 
Commission and Paul F. Roye, Director, Division of Investment 
Management, Commission (Mar. 20, 2001).
    \263\ Letter from Barry Harris, Chair, Bank Retail Broker-Dealer 
Committee, Securities Industry Association, to Laura S. Unger, 
Acting Chairman, Commission (Mar. 13, 2001); Letter from Senator 
Phil Gramm, U.S. Senate Committee on Banking, Housing, and Urban 
Affairs, to Arthur Levitt, Chairman, Commission (Feb. 6, 2001).
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    The industry requests not only clarified the need for immediate 
rulemaking, but also provided us with valuable information in drafting 
the rules. In this regard, Commission staff has received critical input 
from the banking industry through frequent discussions with staff from 
banks and industry associations, as well as banking regulators. Our 
staff has traveled throughout the country to determine what, if any, 
regulatory issues are of concern to industry members in light of the 
GLBA amendments. In addition, we initiated a dialogue with the affected 
industries by soliciting inquiries, participating in industry 
conferences, and conducting question and answer sessions. Finally, we 
reviewed information provided to Congress by industry sources, 
including the American Bankers Association, at the time the GLBA was 
enacted. As a result, we have received much of the input and 
information that we would expect to receive from commenters during a 
pre-effective comment period.
    The rules we have adopted in response to industry concerns do not 
impose any new obligations beyond those created by the statute. Rules 
3b-17 and 3b-18 are primarily definitional and are designed to clarify 
certain terms used in the functional exceptions to the definitions of 
``broker'' and ``dealer'' added by the GLBA although the definitions of 
trustee in Rule 3b-17 is also exemptive in nature. Six of the rules, 
Rules 3a4-2, 3a4-3, 3a4-4, 3a4-

[[Page 27790]]

5, 3a4-6, 3a5-1, and the definition of trustee in Rule 3b-17, provide 
exemptive relief for certain practices or activities where we have 
determined that an exemption is consistent with the intent of a 
functional exception. Rules 15a-7 and 15a-8 provide additional 
exemptive relief to banks to give them sufficient time to adjust their 
securities activities to comply with the new regulatory scheme of the 
GLBA. Finally, Rule 15a-9, extends the banks' exceptions and exemptions 
from the definitions of ``broker'' and ``dealer'' to savings 
associations and savings banks.
    Accordingly, these rules do not expand the obligations of banks 
under the new statutory definitions of ``broker'' and ``dealer.'' 
Rather, they provide guidance and relief to banks that have not 
previously been subject to our jurisdiction. They either clarify the 
Commission's interpretation of certain statutory definitions or provide 
exemptive relief from those definitions. In our view, the limited scope 
of the rules reduces the need for pre-issuance comment.
    Finally, we note that these are interim rules. While the rules will 
become effective on May 11, 2001, we are interested in receiving 
written comments on the rules within 60 days after the date they are 
published in the Federal Register. We will carefully examine the 
comments that we receive, and we will revise or amend the rules as 
necessary in light of those comments.
    Because of the immediate need for guidance on the GLBA amendments 
to the definitions of ``broker'' and ``dealer'' prior to the May 12, 
2001 statutory effective date, the input we have received from the 
industry, the limited scope of the rules, and the fact that the rules 
are interim in nature, we find, consistent with the APA, that good 
cause exists to issue these interim final rules without notice and 
comment and without a delayed effective date.
    Although we have dispensed with notice of proposed rulemaking for 
the reasons set out above, we are soliciting written comments on the 
rules within 60 days after their publication in the Federal Register. 
We will consider carefully those comments and make changes to the rules 
as necessary.
    We seek comments on the interpretations and the exemptions set 
forth in this release. In addition to the requests for comments 
throughout the release, we seek comment on the following: (1) Whether 
these rules operate to regulate the banks' broker-dealer operations in 
the same manner as broker-dealers subject to our jurisdiction prior to 
the exclusion of a bank from the definition of a broker or dealer; and 
(2) whether the fiduciary principles triggered by these interim final 
rules create a standard of conduct or disclosure by banks to which 
other registered broker-dealers may not be subject. Commenters should 
also address whether there are any legal or policy reasons why the we 
should consider different approaches or exemptions, including but not 
limited to: (1) A description of the issue to be addressed; (2) a 
description of the necessity of any alternate approach suggested; and 
(3) a recommendation as to how to remedy the problem identified, if 
any, as well as the feasibility of adopting and enforcing such remedy. 
Commenters should, where possible, provide us with empirical data and/
or describe specific actions the commenter would suggest we take.

B. Paperwork Reduction Act

    These interim final rules do not impose recordkeeping or 
information collection requirements, or other collections of 
information that require approval of the Office of Management and 
Budget under 44 U.S.C. 3501, et seq. Accordingly, the Paperwork 
Reduction Act does not apply.\264\
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    \264\ We would expect banks, as a matter of good business 
practice, to be able to demonstrate that they meet the terms of a 
particular exemption. We also note that Section 203 of the GLBA 
specifically requires the bank regulators to promulgate 
recordkeeping requirements. Banks affected by the GLBA should 
already be aware of these specific GLBA requirements. See, e.g., 
``Gramm-Leach-Bliley Deadlines Draw Near: Be Aware, Prepared'', 
Information Access Company, Mar. 1, 2001 (noting that to comply with 
GLBA ``push-out'' provisions, or to fall within an exemption in the 
GLBA, banks must ``maintain records that will clearly indicate that 
the trust department securities activities fall within the 
exemptions. * * * While banking regulators will provide guidance on 
the nature any types of records they will ask banks to maintain, 
there are a few steps banks can take immediately to ensure 
compliance with the new rules.'').
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C. Consideration of Costs and Benefits

1. Introduction
    When the broker-dealer registration provisions of the GLBA become 
effective, many banks will need to restructure aspects of their 
securities-related business to comply with the new statutory 
requirements.\265\ The interim final rules, which will become effective 
May 11, 2001, define statutory terms and provide banks with conditional 
exemptions. While these rules may affect how the banks' restructuring 
occurs, we believe that most of the restructuring will stem from the 
statute and not from the rules themselves.
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    \265\ Banks had been excepted from the definitions of ``broker'' 
and ``dealer'' under the Exchange Act since 1934. Until recent 
years, banks' ability to engage in securities activities had been 
constrained by federal banking laws. As these constraints lessened, 
banks have engaged in a broader range of securities activities.
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    Moreover, the extent to which banks need to restructure may be 
limited by the way they already do business.\266\ The majority of banks 
conduct most of their securities activities through registered broker-
dealers that are already regulated by the Commission.\267\ Indeed, in 
1995, the General Accounting Office ``estimated that approximately 87 
percent of all sales of securities on bank premises are effected by 
SEC-regulated broker-dealers.'' \268\ The FDIC confirmed the findings 
of the GAO in 1997, explaining that very few banks sold securities 
directly using unregistered bank employees.\269\
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    \266\ Banks have had varying reasons for choosing to conduct 
securities activities through a separate entity. For example, some 
banks believed that their securities activities had greater 
marketing credibility with a registered securities sales force. 
Separation of these activities also permitted banks to pay bank and 
securities sales teams differential compensation. See John L. 
Douglas, Banking Organizations: Structural and Other Considerations 
Involving Non-Banking Activities, 1 N.C. Banking Inst. 59, March 
1997 (giving reasons why certain activities may be moved outside of 
the bank, including ``compensation concerns may result in shifting 
highly commissioned salespeople out of the bank in order to avoid 
jealousies or salary complaints''); see also Michael G. Capatides, A 
Guide to the Capital Markets Activities of Banks and Bank Holding 
Companies (Mar. 1, 1993) at 154 (although banks may act as private 
placement agents directly, banks establish separate entities for 
``operational convenience as well as the desire to develop an 
investment bank environment with a stand alone compensation plan'').
    \267\ Reform Law Leaves Some Doubters, Am. Banker, November 8, 
2000 (noting that ``many banks and securities firms had already 
merged via regulatory loopholes.'')
    \268\ See U.S. General Accounting Office, Report to 
Congressional Requesters: Bank Mutual Sales Practices and Regulatory 
Issues GAO/GGD-95-210, at p. 52 (Sept. 1995); U.S. General 
Accounting Office, Report to Congressional Requesters: Banks' 
Securities Activities--Oversight Differs Depending on Activity and 
Regulator, GAO/GGD-95-214, at p. 25 (Sept. 1995).
    \269\ See Testimony of Andrew C. Hove, Jr., Acting Chairman, 
Federal Deposit Insurance Corporation on Financial Modernization 
Before the Subcommittee on Finance and Hazardous Materials, 
Committee on Commerce, United States House of Representatives, July 
17, 1997, supra at note 187.
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    In considering the potential costs and benefits of these interim 
final rules, we have considered the historical securities activities of 
banks, and how those activities have expanded in recent years. We also 
have considered the decisions many banks will face in determining how 
to best restructure their businesses to comply with the new 
requirements of the GLBA. Finally, we have identified specific costs 
and benefits, and requested comment on additional costs or benefits 
that may stem from these interim final rules.

[[Page 27791]]

2. Banks' Securities Activities Before the GLBA
    The Glass-Steagall Act, the Bank Holding Company Act and its 1970 
amendment \270\ restricted banks' ability to engage in many businesses, 
including the securities business.\271\ As a result, commercial and 
investment banking \272\ in the U.S. were separated for over 60 years.
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    \270\ The Bank Holding Company Act is codified at 12 U.S.C. 1841 
et seq.
    \271\ Congress placed a large amount of blame for the Great 
Depression on commercial banks' securities activities conducted 
through ``so-called bank securities `affiliates.' '' As a result, 
Congress enacted the Glass-Steagall Act in an attempt to achieve the 
complete separation of commercial and investment banking. Jonathan 
R. Macey, Special Interest Groups Legislation and the Judicial 
Function: The Dilemma of Glass-Steagall, 33 Emory L.J. 1, 3 (Winter 
1984).
    \272\ Section 16 is codified at 12 U.S.C. 24 (Seventh); Section 
20 is codified at 12 U.S.C. 377; Section 21 is codified at 12 U.S.C. 
378; and Section 32 is codified at 12 U.S.C. 78.
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    The GLBA repealed Sections 20 and 32 of the Banking Act of 
1933.\273\ Section 20 forbade affiliations between commercial banks and 
securities firms that were ``engaged principally'' in the investment 
banking business.\274\ Section 32 prohibited persons involved ``in any 
aspect of the investment banking business'' from serving as an officer, 
director, or employee of a bank that was a member of the Federal 
Reserve System.\275\
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    \273\ Public Law 106-102, Section 101 repealing Section 20 (12 
U.S.C. 377) and Section 32 (12 U.S.C. 78) of the Banking Act of 
1933. The GLBA retains Sections 16 and 21 of the Banking Act of 
1933. 12 U.S.C. 24 (Seventh); 12 U.S.C. 377. Section 16 prohibits 
national banks from underwriting, selling, or dealing in securities, 
except for certain bank-eligible securities such as U.S. government 
securities. See, 12 U.S.C. 24 (Seventh); see also 12 U.S.C. 335 at 
5(c) (applying Glass-Steagall Act Section 16 restrictions to state-
chartered banks in the Federal Reserve System). However, Section 16 
excludes from its prohibitions securities transactions in which the 
bank acts as agent for its customers, considered agency activity. 
Under state law, insured state banks generally may act as agent for 
their customers although insured state banks are prohibited from 
engaging as principal in any activities that are not permissible for 
national banks unless the state banks comply with applicable capital 
standards and the FDIC has determined that the activity will not 
pose a significant risk to the appropriate insurance fund. Federal 
Deposition Insurance Corporation Improvement Act of 1991, Pub. L. 
102-242, Title III, Section 303, 12 U.S.C. 1831a. Section 21, also 
still in effect, prohibits investment banks from offering checking 
or savings accounts. 12 U.S.C. 378a.
    \274\ 12 U.S.C. 377. The Supreme Court interpreted the term 
``engaged principally'' to mean that bank affiliates could engage in 
some ineligible activities so long as they were not the primary 
activities. Board of Governors v. Agnew, 329 U.S. 441, 447-49 
(1947). The FDIC's interpretation that section 21 did not apply to 
subsidiaries of state nonmember banks and thus that these 
subsidiaries could engage in underwriting securities was upheld by 
the U. S. Court of Appeals for the D.C. Circuit in 1987. Investment 
Company Institute v. FDIC, 815 F.2d 1540 (D.C. Cir. 1987).
    \275\ 12 U.S.C. 78.
---------------------------------------------------------------------------

    Prior to their repeal, however, these prohibitions had already 
eroded over time. In 1987, Section 20 of the Glass-Steagall Act was 
significantly liberalized, with the regulatory expansion of bank 
holding companies' abilities to underwrite corporate debt and equity 
through their registered broker-dealer affiliates (known as ``Section 
20'' affiliates).\276\ The Federal Reserve established a revenue test 
to determine if a Section 20 affiliate was ``engaged principally'' in 
underwriting and dealing.\277\ That revenue test created an incentive 
for banks to shift permissible securities activities into affiliated 
broker-dealers.\278\
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    \276\ The Federal Reserve initially approved bank holding 
company subsidiaries to underwrite municipal revenue bonds, mortgage 
related securities of investment quality on 1-4 family residential 
and large denomination commercial paper as long as the underwriting 
revenue from these activities did not exceed five percent of the 
subsidiary's gross revenue of average calculated on a two year 
period. See Orders Issued Under Section 4 of the Bank Holding 
Company Act, Citicorp, J.P. Morgan and Co. Inc., Bankers Trust New 
York Corp., Order Approving Applications to Engage in Limited 
Underwriting and Dealing in Certain Securities, 73 Fed. Res. Bull. 
473, 485 (1987).
    \277\ As noted above, Section 20 prohibited a member bank from 
affiliating with a securities firm if the securities firm was 
``principally engaged'' in underwriting and dealing.
    \278\ The revenue test distinguished between ``bank eligible'' 
securities (that is, securities that a bank itself would be allowed 
to underwrite or deal in) and ``bank ineligible'' securities. ``Bank 
eligible'' securities included government securities, as well as any 
securities issued in private placements. ``Bank ineligible'' 
securities were any securities that were not ``bank eligible.'' 
Under the test, a bank was permitted to affiliate with a securities 
firm as long as the securities firm did not derive more than 5% of 
its gross revenues from bank-ineligible securities. In 1989, the 
Federal Reserve raised this restriction to 10 percent of total 
revenues (and later increased it again, effective in 1997 to 25 
percent), and increased the types of securities allowed to include 
debt securities, including sovereign debt securities, corporate 
debt, convertible debt securities, securities issued by a trust or 
other vehicle secured by or representing interests in debt 
obligations and equity securities. See Review of Restrictions on 
Director, Officer and Employee Interlocks, Cross-Marketing 
Activities, and the Purchase and Sale of Financial Assets Between a 
Section 20 Subsidiary and an Affiliated Bank or Thrift, 61 FR 57679, 
57683 (Nov. 7, 1996); see also 75 Fed. Res. Bull. 192 (1989). 
Investment banking income derived from ``bank eligible securities,'' 
such as U.S. government securities and general obligation municipal 
bonds that banks were expressly allowed to deal in under section 16 
of Glass-Steagall, were not counted as securities for the purpose of 
calculating the revenue limit. Riskless principal and private 
placement securities activities also were not deemed to be 
``ineligible'' securities for these purposes. Bankers Trust New York 
Corporation, 75 Fed. Res. Bull. 829 (1989). Thus, under the test, 
the more gross revenue the Section 20 subsidiary derived from bank 
eligible securities, the more income they could also derive from 
bank ineligible securities. In other words, bank holding companies 
had an incentive to ensure that bank eligible securities activities 
were handled in a Section 20 broker-dealer subsidiary, rather than 
in the bank itself. See generally Revenue Limit on Bank-Ineligible 
Activities of Subsidiaries of Bank Holding Companies Engaged in 
Underwriting and Dealing in Securities, 61 FR 68750, 68752 (Dec. 30, 
1996).
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    Commercial banks also benefited from using broker-dealers to effect 
securities transactions. Commercial banks entered the brokerage 
business by licensing operating subsidiaries as registered broker-
dealers. In 1996, the OCC permitted national banks to own majority 
interests in certain operating subsidiaries that engaged in activities 
that were impermissible for national banks.\279\ In the case of 
securities activities, these operating subsidiaries were required to 
register as broker-dealers.\280\ Subsequent national bank operating 
subsidiary approvals included underwriting and dealing in municipal 
revenue bonds and corporate debt securities.\281\
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    \279\ 12 CFR 5.34, 61 FR 60342 (Nov. 27, 1996); Comptroller News 
Releases NR 96-129 (Nov. 20, 1996) (``Questions and Answers on Part 
5''); NR 96-128 (Nov. 20, 1996) (``Part 5 Fact Sheet'').
    \280\ The exceptions from the Exchange Act definitions of 
``broker'' and ``dealer'' are only available to the bank itself. See 
supra note 10, regarding current definitions of ``broker'' and 
``dealer.''
    \281\ Comptroller Conditional Approval No. 262 (Dec. 11, 1997) 
(approval to Zion's First National Bank to engage through an 
operating subsidiary in underwriting and dealing in municipal 
revenue bonds); Comptroller Conditional Approval No. 331 (November 
3, 1999) (approval to National Bank of Commerce to engage through an 
operating subsidiary in underwriting and dealing in corporate bonds, 
dealing in and privately placing trust preferred securities and 
buying and selling collateralized mortgage obligations).
---------------------------------------------------------------------------

    We have studied aggregate data showing that, while banks' 
traditional activities (described as the financing of loans with 
deposits) have been declining, banks' non-traditional activities 
(described as fee-generating activities, including underwriting, cash 
management, and custody services) have been rising.\282\ In addition to 
the bank securities activities described above, these non-traditional 
activities would include the provision of trust and investment services 
to high net worth individuals.\283\
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    \282\ Economists describe the common characteristic of 
nontraditional activities as being that they produce fee income 
rather than interest income. Kevin Rogers and Joseph F. Sinkey, Jr., 
An Analysis of Nontraditional Activities at U.S. Commercial Banks, 1 
Review of Financial Economics, Jan. 1, 1999, at 25. Commercial 
banks' non-interest income has risen from 30% in 1988 to 43% in 
2000. FDIC, Trends in Commercial Bank Income and Expense 1988-2000 
available at 
http://www2.fdic.gov/qbp/2000dec/ctrends.html.
    \283\ Id.
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    In sum, banks today may engage in a wide range of securities 
activities arising from their roles as custodians of fiduciaries, as 
well as separately for a fee. Banks engage in these activities either 
directly or through affiliated broker-dealers. These activities include 
brokerage and dealing, as well as

[[Page 27792]]

effecting private placements and riskless principal transactions.
    Once the broker-dealer registration provisions of the GLBA become 
effective, banks that engage in the securities activities described 
above will need to determine whether they can continue to engage in 
those activities in the same way, or whether they will need to 
restructure their businesses to comply with the new statutory 
requirements. The interim final rules adopted today are designed to 
provide banks with guidance in this process. The new definitions should 
clarify the parameters of the new statutory exemptions from the 
definitions of broker and dealer. In addition, the interim final rules 
provide banks with additional specific exemptive relief.
    As always, we are mindful of the costs imposed by our rules. We 
believe the rules are consistent with Congress's intent in enacting the 
GLBA. Congress determined that all securities activities should be 
functionally regulated to ensure investor protection, regardless of the 
entity in which the activities occur. Thus, the majority of regulatory 
costs arise from Congress's determination that amendment of the 
Exchange Act was necessary in light of the liberalization of banking 
laws, such as Glass-Steagall. Otherwise banks that engaged in 
underwriting corporate securities would be subject to a fragmented 
securities regulatory scheme.
    Banks that fall outside the scope of one of the exceptions 
enumerated by Congress in amended Exchange Act Sections 3(a)(4) and 
3(a)(5), as further refined through these interim final rules, may 
incur costs from the GLBA. Even banks that have existing relationships 
with registered broker-dealers may incur costs in connection with 
discrete lines of securities business that have nonetheless been 
conducted directly by those banks. These costs could relate to 
restructuring their business operations, to transferring their non-
excepted securities business to registered broker-dealers, or to 
entering into networking arrangements with registered broker-dealers. 
As noted earlier, most of banks' securities activities are currently 
effected by SEC regulated broker-dealers. In the following section, we 
outline some of the choices banks may have in determining how they can 
best comply with the new requirements of the GLBA as well as the 
interim final rules.
3. Options for Compliance With the GLBA Under the Statute in Light of 
These Interim Final Rules
    Banks will have a number of preliminary decisions \284\ in 
determining how to comply with these interim final rules and the 
amended definitions of broker and dealer under the Exchange Act.\285\ 
While most banks already conduct their securities activities through 
registered broker-dealers, the GLBA may require some banks to shift 
some securities activities formerly conducted internally to registered 
broker-dealers.
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    \284\ Banking and Financial Services Policy Report, Volume 19 
(Oct. 2000), ``Banks as Securities Lending Agents: To Register or 
Not as a Broker'' (discussing decisions to be made by bank upon 
determination of GLBA to banks' own securities activities).
    \285\ Barbara A. Rehm, No Merger Wave, But Money Saved, The 
American Banker, Nov. 7, 2000, at 1, noted that most banks would 
continue to do business as usual, except that the bank, would no 
longer require specific ``loopholes to sell insurance or underwrite 
securities.'' The article further noted that the biggest change for 
the banking industry was ``it put an end to 20 years of battling 
over who could do what.''
---------------------------------------------------------------------------

    A bank that engages in securities activities that are not covered 
by an exception in the GLBA definitions of broker and dealer may choose 
to shift those activities to a registered broker-dealer. The registered 
broker-dealer could be a broker-dealer with which the bank already has 
a relationship. Alternatively, the bank could enter into a new 
relationship. One form of relationship could be contractual--that is, a 
bank could enter into a third-party brokerage arrangement with a 
registered broker-dealer. Alternatively, a bank could choose to 
register an affiliate as a broker-dealer.
    If a bank registers a broker-dealer affiliate, the bank has 
additional choices. A banking group may register a broker-dealer 
affiliate that is a subsidiary of the bank holding company or a 
financial holding company. Alternatively, a bank may register a broker-
dealer that is an operating or financial subsidiary of the bank. In all 
cases when a bank uses a registered broker-dealer, a bank may effect 
securities transactions using bank employees who also are associated 
persons of the registered broker-dealer.\286\ Most non-bank registered 
broker-dealers must also become members of the Securities Investor 
Protection Corporation.\287\
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    \286\ Broker-dealers may also have to register with the states 
in which they do business.
    \287\ The Securities Investor Protection Act of 1970 created the 
Securities Investor Protection Corporation (SIPC). 15 U.S.C. 78aaa, 
et seq. SIPC is a nonprofit membership corporation funded by its 
member securities broker-dealers. Most broker-dealers (excluding 
broker-dealers whose business is limited to the following: 
Distributing shares of mutual funds, selling variable annuities, 
providing investment advice, or selling United States Government 
securities) registered with the Commission are automatically members 
of SIPC. SIPC provide investors with certain protections in the 
event of a bankruptcy or loss of securities by a broker-dealer.
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    As a final option, a bank that wishes to act as a broker-dealer may 
register with the Commission and with at least one SRO. To begin the 
registration process, a broker-dealer completes the uniform form for 
broker-dealer registration, Form BD. The completed Form BD is submitted 
to the Central Registration Depository (CRD), which is operated by the 
NASD. Broker-dealers seeking to become members of the NASD must also 
provide certain information. This includes a detailed business plan, as 
well as descriptions of their financial controls, their communications 
and operational systems, their supervisory systems and written 
procedures, their recordkeeping systems, and their continuing education 
plans. The NASD conducts in-person membership interviews with all 
applicants. Approval for membership with the NASD is contingent upon 
the submission of a written membership agreement. Broker-dealers also 
must register their personnel. Registration of personnel is 
accomplished by submitting a Form U-4 and a fingerprint card. 
Registered personnel also need to successfully complete qualification 
examinations. We believe, however, that most banks will not utilize 
this final alternative, finding it impracticable due to the disparate 
capital and customer protection regulatory requirements \288\ 
applicable to banks and securities firms, including employment 
prohibitions.\289\

[[Page 27793]]

We, therefore, expect that most banks will either enter into networking 
arrangements or create broker-dealer affiliates.
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    \288\ For unsecured receivables, such as a commercial loan, a 
bank is generally required to reserve an amount of capital equal to 
as much as 8% of the loan amount. In contrast, a broker-dealer would 
be required to reserve an amount of capital equal to 100% of 
unsecured loan. For certain fully secured loans, such as a margin 
loan, a bank would be required to reserve as capital up to 8% of the 
loan. A broker-dealer, however, would not be required to reserve 
capital for the loan, provided the account meets regulatory margin 
requirements. To remain in capital compliance, a bank registered as 
a broker-dealer would need to meet the greater of the banking or 
securities regulatory capital requirements for credit risk. Also, 
the customer protection rule applicable to broker-dealers that 
requires customer assets to be held separately from proprietary 
assets would be virtually impossible for a bank to comply with it if 
it accepts customer deposits (the core business of commercial 
banking). Therefore, in most cases, it would be prohibitively 
expensive for a bank to engage in traditional banking activity, such 
as unsecured lending, and for a broker-dealer to conduct traditional 
securities activities, such as extending margin loans.
    \289\ Dual employees who are registered representatives for a 
bank have certain obligations created by SRO rules. For example, 
transactions for bank customers must comply with NASD Rule 3040 that 
restricts the ability of any person associated with a member to 
participate in a ``private securities transaction,'' which is 
defined as ``any securities transactions outside the regular course 
or scope of an associated person's employment with a member,'' 
subject to limited exceptions. NASD Rule 3040 requires broker-
dealers to review all transactions in which a registered 
representative participates, including transactions where the 
registered representative acts as an investment adviser. The 
registered broker-dealer must develop and maintain a record keeping 
system ``to enable the member to properly supervise the RR/IA by 
aiding the member's understanding of the nature of the service 
provided by an RR/IA, the scope of the RR/IA's authority, and the 
suitability of the transactions. NASD Notice to Members 96-33.
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    We are setting forth below additional benefits and costs that we 
believe arise from the promulgation of these interim final rules. We 
note, however, that due to the multitude of banking charters that 
distinguish a ``trust bank'' from a ``commercial bank'' from a 
``savings and loan,'' we have delegated authority to the Division of 
Market Regulation to consider and to process a bank's or savings and 
loan's request for additional relief not encompassed within either 
these interim final rules or the GLBA.
    a. Benefits. We believe that these interim final rules will provide 
legal certainty for banks in connection with their determination of 
whether they meet the terms and conditions for an exception to the 
definitions of broker and dealer under the Exchange Act. By adopting 
specific objective criteria, with particular dollar limitations, 
business activities, and time conditions, we have provided banks with a 
basis to assess accurately if and when they may need to register as 
broker-dealers.
    As discussed earlier, the GLBA replaced the general exception for 
banks from the definitions of broker and dealer with specific 
functional exceptions for certain bank securities activities. These 
interim final rules clarify exceptions to these amended definitions by 
defining key terms used in the new functional exceptions.
    Moreover, Rules 3a4-2, 3a4-3, 3a4-4, 3a4-5, 3a4-6, and the 
definition of trustee in Rule 3b-17 provide targeted exemptions for 
certain banks from these new definitions of broker and dealer. Banks 
that meet the provisions of those exemptions need not transfer their 
non-excepted securities business to registered broker-dealers.
    Rule 15a-7 extends the date for banks to comply with the 
requirements of the exceptions. This alleviates the need for banks to 
apply individually to us for specific relief. To promote certainty in 
commercial markets as to the legal validity of contracts, Rule 15a-8 
conditionally exempts banks temporarily from risk of rescission rights 
under Exchange Act Section 29. Finally, new Rule 15a-9 exempts savings 
associations and savings banks from the terms ``broker'' and ``dealer'' 
under Exchange Act Sections 3(a)(4) and 3(a)(5) on the same terms and 
conditions that apply to banks.
    These interim final rules were written in response to requests from 
the banking industry for guidance. By clarifying terms in the GLBA, 
these interim final rules provide legal certainty to banks seeking to 
conform their business activities to the exceptions from the 
definitions of broker and dealer. This, in turn, will assist banks in 
planning their ongoing business operations. In the event they need 
additional time, we have provided temporary exemptions from compliance 
with the new terms.
    These interim final rules, including the temporary exemptions from 
registration as a broker-dealer and the temporary exemption from 
liability under Section 29 for banks that would have been required to 
register as a broker-dealer, will enable banks to plan and structure 
their business operations to fully comply with the statute. This latter 
exemption, in particular, will eliminate costs that banks might have 
otherwise incurred from actions to rescind securities transactions 
during the transition to compliance with the new GLBA requirements.
    In addition, Rules 3a4-2, 3a4-3, 3a4-4, 3a4-5, 3a4-6, 3a5-1, and 
the definition of trustee capacity in Rule 3b-17 exclude certain bank 
activities from the scope of the GLBA's amended definition of broker-
dealer. They, therefore, provide relief to banks from potential costs 
they might incur in registering as a broker-dealer, registering an 
affiliate as a broker-dealer, or entering into a third-party brokerage 
arrangement with a broker-dealer. These costs could include engaging 
securities counsel, registering as a broker-dealer, paying personnel to 
study for and pass applicable securities examinations, and joining a 
SRO. Indeed, Rules 3b-17 and 3b-18, and the four limited exemptions, 
clarify the permissible activities in which banks may engage without 
triggering the statutory requirement to register as a broker or dealer 
under the Exchange Act after May 12, 2001. As noted earlier, most of 
banks' securities business is currently effected through SEC-registered 
broker-dealers. Consequently, we do not anticipate that banks will 
derive a large benefit from this rulemaking in relation to their 
current securities business.
    However, failure to adopt these interim final rules could result in 
additional costs. Without the certainty and uniformity these interim 
final rules provide, banks would have more difficulty planning and 
operating their existing businesses in compliance with the GLBA. This, 
in turn, could result in disruption of their securities business. In 
addition, banks could be subject to regulatory costs if their 
activities were later determined to fall outside of the scope of the 
GLBA's exceptions.
    In addition, the extension of time in Rule 15a-7, and exemptions in 
Rules 3a4-2, 3a4-3, 3a4-4, 3a4-5, 3a4-6, 3a5-1, and the definition of 
trustee capacity in Rule 3b-17 benefit banks that may not otherwise be 
able to comply with the statutory deadline of GLBA. Most banks that 
need additional time to restructure their operations may rely on these 
temporary exemptions and not need to seek individual relief from our 
staff. Banks seeking individual relief may request a specific exemption 
from us.
    b. Costs. We believe that, regardless of how a bank chooses to 
comply with the GLBA in light of these interim final rules, it will 
likely incur certain costs. We believe, however, that almost all of 
these costs will be necessary because of the statutory change and not 
because of the interim final rules.
    Interim final Rules 3b-17 and 3b-18 are intended to clarify the 
meanings of certain terms in the exceptions to the definitions of 
broker and dealer, as amended by the GLBA. Although they are not 
intended to impose costs on any market participant, we expect that some 
banks may experience some de minimis costs from the determination of 
how to best comply with the GLBA. In ascertaining this de minimis 
impact, we reviewed the number of banks that are already heavily 
involved in securities-related activities.
    Some banks seeking to meet the exceptions to broker-dealer 
registration could incur de minimis administrative costs. For instance, 
Rule 3b-17 provides an objective test for determining whether a bank is 
``chiefly compensated'' through securities activities as excepted by 
Exchange Act Section 3(a)(4)(B)(ii). Banks seeking to qualify for this 
particular exception will need to undertake a financial accounting 
review to determine their compliance with this objective compensation 
test. Some banks may already keep and analyze the data required to 
perform this analysis in accordance with their customary audit and 
reporting procedures under applicable banking regulations. It is 
possible, however, that some banks may

[[Page 27794]]

need to supplement their existing accounting or financial procedures 
and activities to perform this calculation on an annual basis. 
Moreover, some banks may incur similar costs in calculating 
compensation on an account-by-account basis.
    Banks also may need to make limited software changes to make the 
``chiefly compensated'' calculation.\290\ Because of the differences in 
banks' existing computer systems, the types of account information 
resident in those systems, and the range of ways in which they may 
choose to alter those systems, we cannot estimate this cost with 
specificity. We believe, however, that the costs of computer 
alterations could include the cost of purchasing new computer hardware, 
as well as new computer software. Banks also could incur the costs of 
personnel time to re-program software. As noted previously, almost all 
of these costs arise from the functional regulation mandated by the 
GLBA and not from these interim final rules.
---------------------------------------------------------------------------

    \290\ Depending on the number of accounts in the bank, the 
accounts affected by the definition of ``chiefly compensated,'' and 
the number of accounts resident, a bank may need to customize its 
computer software to match the bank's specific accounts and data.
---------------------------------------------------------------------------

    We also expect that many banks may incur costs for legal and other 
professional accounting review. Many banks will utilize their in-house 
counsel, accountants, and compliance officers. Banks that have provided 
cost information have estimated their in-house legal resources to range 
from $75.00 to $125.00 an hour as a composite rate based upon the 
yearly salary of in-house counsel. Estimates of legal counsel review 
time include the hours spent by in-house counsel on review and 
compliance with the GLBA. Discussions with banks offering services 
impacted by the GLBA indicate that some banks have estimated the review 
time of attorneys to fall within the range of 30 to 60 hours. We expect 
that most banks affected by the functional regulation provisions of the 
GLBA will either use in-house counsel or bank officers for this review. 
We believe that most of these costs arise from the requirements of GLBA 
rather than from our interim final rules.
    Some banks may choose to utilize outside counsel, either 
exclusively or as a supplement to in-house resources. We estimate these 
costs as the high end of the in-house range.
    If a bank affiliates with a registered broker-dealer or enters into 
a third-party brokerage arrangement, it may also incur certain other 
costs. In making these changes, the costs arise from the statutory 
language of the GLBA, which removed the exception banks had for certain 
securities operations. These costs could include, for example, the cost 
of training, examining, and licensing associated persons of the bank as 
registered representatives of the broker-dealer. In addition, banks may 
incur additional expenses to establish a relationship with a broker-
dealer or to inform their customers of their changes in operating 
procedures. Since most banks operate their securities related business 
through broker-dealers registered with us, we believe that these costs, 
if any, would be quite small.
    We request comments on the costs and benefits of the interim final 
rules, and ask commenters to provide supporting empirical data for any 
positions advanced. Commenters should address in particular whether any 
of the new rules will generate the anticipated benefits or impose any 
costs on investors, banks, registered broker-dealers or other market 
participants. As always, commenters are specifically invited to share 
quantifiable costs and benefits.

D. Consideration of Burden on Competition, and on Promotion of 
Efficiency, Competition, and Capital Formation

    In accordance with our responsibilities under Section 3(f) of the 
Exchange Act, we have considered both the protection of investors and 
whether the interim final rules will promote efficiency, competition, 
and capital formation in determining whether they are consistent with 
the public interest.\291\ In addition, Section 23(a)(2) of the Exchange 
Act \292\ requires us, in adopting rules under the Exchange Act, to 
consider the anticompetitive effects of such rules, if any, and to 
refrain from adopting a rule that will impose a burden on competition 
not necessary or appropriate in furthering the purpose of the Exchange 
Act.
---------------------------------------------------------------------------

    \291\ 15 U.S.C. 78c(f).
    \292\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    We do not believe that the interpretations, definitions, and 
exemptions will result in any burden on competition that is not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act or Congress's intent to impose functional regulation upon banks 
that conduct a brokerage business outside a statutory exception in the 
GLBA. These interim final rules define terms in the statutory 
exceptions to the definitions of broker and dealer added to the 
Exchange Act by Congress in the GLBA, and provide guidance to banks as 
to the appropriate scope of those exceptions. These interim final 
rules, therefore, do not impose any additional competitive burdens on 
banks engaging in a securities business, other than those imposed 
through by Congress through functional regulation in the GLBA.
    The conditional exemptions from broker-dealer registration granted 
through these interim final rules permit banks more time to fully 
comply with the statutory requirements of GLBA and therefore do not 
impose any burden on banks seeking to avail themselves of those limited 
exemptions.
    We do not believe that the new definitional rules will adversely 
affect capital formation. Nothing in the interim final rules is 
intended to adversely affect banks' compliance with the GLBA. Banks 
that alter their securities-related activities in accordance with the 
GLBA will continue to be able to provide securities services to their 
customers. In enacting the GLBA, Congress determined that functional 
regulation was appropriate--that is, when a bank was conducting a 
securities business outside of the enumerated exceptions, that bank 
should be registered as a broker-dealer. In the interest of protecting 
the public and ensuring orderly markets, Congress determined that 
banks, with a broad securities business, should be subject to the same 
regulatory oversight as broker-dealers conducting the same types of 
activities. These interim final rules promote Congress' intent.
    Since these interim final rules define statutory exceptions 
mandated by Congress and provide temporary exemptive relief for banks 
unable to comply with certain of the exceptions by the effective date 
of GLBA, we do not believe that the rules impose any extra-statutory 
adverse effects on efficiency, competition, or capital formation.\293\ 
Once Congress passed the GLBA, Congress determined that regulation of 
banks conducting a securities operation outside of certain exceptions 
was necessary and appropriate and in the public interest.
---------------------------------------------------------------------------

    \293\ Indeed, these rules actually enhance competition by 
providing relief to savings associations and savings banks as well 
as ``commercial banks.'' Letter from Scott M. Albinson, Managing 
Director, OTS, to Annette L. Nazareth, Director, Division of Market 
Regulation, Commission and Paul F. Roye, Director, Division of 
Investment Management, Commission (Mar. 20, 2001).
---------------------------------------------------------------------------

    We are, however, interested in receiving comments regarding the 
effect of these interim final rules on efficiency, competition, and 
capital formation. We will consider those comments in making

[[Page 27795]]

any changes to the interim final rules as necessary.
    We also solicit comment on the potential effect of these interim 
final rules on the U.S. economy on an annual basis. Commenters are 
requested to provide empirical data to support their views.

E. Summary of Regulatory Flexibility Analysis

    We have prepared an Initial Regulatory Flexibility Analysis 
(``IRFA'') in accordance with the Regulatory Flexibility Act (``RFA'') 
\294\ regarding the interim final rules under the Exchange Act that 
define certain terms in the GLBA's amendments to Sections 3(a)(4) and 
3(a)(5) of the Exchange Act and provide exemptions from broker-dealer 
registration for certain banks and savings and loan associations.\295\ 
The following summarizes the IRFA:
---------------------------------------------------------------------------

    \294\ 5 U.S.C. 601 et seq. See also 5 U.S.C. 603 (requiring the 
preparation of an IRFA).
    \295\ Although the requirements of the RFA are not applicable to 
rules adopted under the Administrative Procedures Act's good cause 
exception, see 5 U.S.C. 601(2) (defining ``rule'' and notice 
requirements under the APA), we nevertheless prepared an Initial 
Regulatory Flexibility Analysis because we may supplant the interim 
final rules with final rules.
---------------------------------------------------------------------------

    Rules 3b-17 and 3b-18 are intended to provide banks with guidance 
on how to interpret the exceptions to the definitions of broker and 
dealer in Sections 3(a)(4) and 3(a)(5) of the Exchange Act. This 
guidance is intended to assist banks in structuring their securities 
activities so as to continue to fit within the exceptions for their 
securities activities, as well as to provide more certainty as to when 
broker-dealer registration would be required if they choose to engage 
in more extensive securities activities. Rule 15a-7 provides certain 
limited time periods for banks to determine whether they should 
register as broker-dealers or restructure certain of their securities 
activities so as to continue to be exempted from registration. Rule 
15a-8 temporarily exempts banks from liability under Exchange Act 
Section 29 by providing that no contract into which a bank enters 
before January 1, 2003 will be void or considered voidable because the 
bank violates the registration requirements of Exchange Act Section 
15(a) or any rule under the Exchange Act based solely on the bank's 
status as a broker-dealer. New Rules 3a4-2, 3a4-3, 3a4-4, 3a4-5, 3a4-6, 
3a5-1, and the definition of trustee capacity in Rule 3b-17 provide 
exemptive relief that permits banks that meet the conditions in the 
exemptions to continue to effect brokerage transactions for customers 
in specified circumstances without registering as broker-dealers under 
the Exchange Act.
    Specifically, Rules 3a4-2 and 3a4-3 provide that, under certain 
conditions, banks will not be deemed to be brokers under the trust and 
fiduciary activities exception if the bank fails to satisfy the 
compensation requirement, as long as the bank complies with the other 
requirements of the exception. Rule 3a4-4 conditionally exempts small 
banks effecting transactions in investment company securities for tax-
deferred custody accounts. Rule 3a4-5 conditionally exempts banks 
effecting transactions in securities for tax-deferred custody accounts. 
Rule 3a4-6 permits banks to process transactions in investment company 
securities through the NSCC's Mutual Fund Services, including Fund/
SERV. Rule 3a5-1 provides that a bank will not be considered a dealer 
if it engages in riskless principal transactions as long as the number 
of those transactions, combined with any agency transactions effected 
by the bank, is less than 500. The definition of trustee capacity makes 
clear that banks acting as indenture trustees and trustees for tax-
deferred ERISA and IRA accounts will be eligible for the trustee 
exception if they meet its requirements.
    Some banks affected by these interim final rules would fall under 
the definition of small entities for purposes of the Regulatory 
Flexibility Act (``RFA''). As discussed more fully in the IRFA, unlike 
for broker-dealers and other entities that historically have been 
subject to our jurisdiction, we do not have a definition of ``small 
entity bank'' for purposes of the RFA. The banking regulators have 
defined small entities for purposes of the RFA to include banks with 
less than $100 million in assets.\296\ For purposes of this analysis, 
we have used the banking regulators' definition of small entity. 
According to information from the FDIC, there are approximately 8,375 
FDIC-insured commercial banks; of these, 4,922 are small entity banks 
with less than $100 million in assets.\297\ As explained more fully 
below, one of the interim final rules provides only small entity banks 
with an exception from the definition of broker. All of the other rules 
apply equally to all banks. Thus, all banks could be affected by the 
interim final rules.
---------------------------------------------------------------------------

    \296\ See Joint Release of the Board of Governors of the Federal 
Reserve System, the Federal Deposit Insurance Corporation, Office of 
the Comptroller of the Currency and Office of Thrift Supervision, 
``Interagency Guidelines Establishing Standards for Safeguarding 
Customer Information and Rescission of Year 2000 Standards for 
Safety and Soundness,'' 65 FR 39471 (June 26, 2000).
    \297\ See FDIC, Statistics on Banking, available at http://www.fdic/gov/bank/statistical/statistics/0009/cbrc01a.html. There 
may be additional banks that fall within the Exchange Act's 
definition of ``bank'' under Section 3(a)(6) that may be subject to 
GLBA that are not reflected in these figures. For example, U.S.-
licensed branches and agencies of foreign banks may not be included 
in the FDIC's tally because they typically are not insured. 
Nevertheless, we do not believe that any such omissions are material 
to the analysis set forth in the IRFA.
---------------------------------------------------------------------------

    The clarification of statutory terms set out in Rules 3b-17 and 3b-
18 provide additional guidance to all banks in connection with their 
determination of whether they fall within the terms and conditions for 
the exceptions to the definitions of broker and dealer under the 
Exchange Act as amended by the GLBA. These interim final rules provide 
uniform definitions that will enable banks to accurately assess whether 
they are subject to our jurisdiction. The extensions of time in Rule 
15a-7 give limited relief to certain banks that cannot comply with the 
GLBA provisions by the statutory effective date of May 12, 2001.
    In addition, Rules 3a4-2, 3a4-3, 3a4-4, 3a4-5, 3a5-1, and the 
definition of trustee capacity in Rule 3b-17 provide exemptions from 
the definitions of broker and dealer under the amended Exchange Act. 
Rule 3a4-4 benefits small entity banks that may not readily have access 
(through affiliation or otherwise) to a registered broker or dealer to 
establish a networking arrangement meeting the criteria of the GLBA, 
and that maintain custody accounts for the convenience of their 
customers. Under this interim final rule, small banks may engage in 
minor securities transaction activities as an accommodation to their 
customers in limited circumstances and still fall outside of the 
definition of broker under the Exchange Act.
    Rules 3a4-2, 3a4-3, 3a4-4, 3a4-6, 3a5-1 and the definition of 
trustee capacity in Rule 3b-17 are not limited to small entity banks, 
but rather exempt all banks. Rules 3a4-2 and 3a4-3 are discussed above. 
The definition of trustee capacity makes clear that banks acting as 
indenture trustees and trustees for tax-deferred ERISA and IRA accounts 
will be eligible for the trustee exception if they meet the other 
requirements of the trust and fiduciary activities exception.
    As definitional and exemptive rules, the interim final rules should 
not have a significant regulatory impact on banks, including small 
entity banks. Moreover, we do not anticipate that the rules will impose 
any additional recordkeeping requirements on banks other than 
recordkeeping currently required under

[[Page 27796]]

applicable banking statutes and regulations.
    As described in the IRFA, we have considered and will continue to 
consider alternatives to the interim final rules that would accomplish 
our stated objectives. These objectives are to implement the 
Congressional requirement to provide for functional regulation of 
securities activities, to provide banks with clear guidance on whether 
they are subject to broker-dealer registration, and to provide 
exemptive relief to banks that require additional time to restructure 
their business operations to comply with the GLBA.
    Congress did not exempt small entity banks from the application of 
the GLBA. Because the interim final rules are intended to provide 
guidance to all banks that are subject to the GBLA, it would not be 
appropriate to exempt small entity banks from operation of these 
interim final rules. Nevertheless, because we recognize that small 
banks may not have established networking relationships with broker-
dealers for purposes of the GLBA amendments, we have provided an 
exemption for small entities that maintain custody accounts through 
Rule 3a4-4.
    Because Rules 3b-17 and 3b-18 are definitional and clarify the 
securities-related activities in which banks may engage without 
registering as broker-dealers, these interim final rules must apply to 
all banks engaged in securities brokerage activities. Accordingly, 
providing different compliance and reporting requirements under, or 
exemptions from any of the requirements pursuant to, these rules for 
small entities would not be practicable or promote the purposes of 
functional regulation adopted by Congress.
    The new interim final rules and exemptions provide banks with more 
legal certainty and additional flexibility in determining how to 
structure their operations to comply with the provisions of the GLBA. 
This flexibility benefits all banks, including small entity banks, that 
wish to continue to provide securities activities without being 
required to shift those securities activities to registered broker-
dealers.
    As noted in the IRFA, we encourage the submission of written 
comments with respect to any aspect of the IRFA. Comment is 
specifically is requested on the costs of compliance with these rules 
and suggested alternatives that would accomplish the objectives of 
these rules. Comments received will be considered in the preparation, 
if required, of a Final Regulatory Flexibility Analysis.
    A copy of the IRFA may be obtained from Nancy Appel, Attorney, 
Office of Chief Counsel, Division of Market Regulation, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-1001; 
(202) 942-0073.

XI. Statutory Authority

    The Commission is amending Title 17, Chapter II of the Code of 
Federal Regulations by amending Section 200.30-3, and by adding, as 
interim final rules, Rules 3a4-2, 3a4-3, 3a4-4, 3a4-5, 3a4-6, 3a5-1, 
3b-17, 3b-18, 15a-7, 15a-8, and 15a-9 [Sections 240.3a4-2, 240.3a4-3, 
240.3a4-4, 240.3a4-5, 240.3a4-6, 240.3a5-1, 240.3b-17, 240.3b-18, 
240.15a-7, 240.15a-8, and 240.15a-9, respectively] pursuant to 
authority set forth in Sections 3(b), 15, 23(a), and 36 of the Exchange 
Act (15 U.S.C. 78c(b), 78o, 78w(a), and 78mm, respectively).

XII. Text of Rules and Rule Amendments

List of Subjects

17 CFR Part 200

    Administrative practice and procedure, Authority delegations 
(Government agencies), Organization and functions (Government 
agencies).

17 CFR Part 240

    Broker-dealers, Reporting and recordkeeping requirements, 
Securities.

Text of Amendment

    For the reasons set forth in the preamble, Title 17, Chapter II of 
the Code of Federal Regulations is amended as follows:

PART 200--ORGANIZATION; CONDUCT AND ETHICS; AND INFORMATION AND 
REQUESTS

Subpart A--Organization and Program Management

    1. The authority citation for Part 200, subpart A, continues to 
read, in part, as follows:

    Authority: 15 U.S.C. 77s, 78d-1, 78d-2, 78w, 78ll(d), 78mm, 79t, 
77sss, 80a-37, 80b-11, unless otherwise noted.
* * * * *

    2. Section 200.30-3 is amended by adding paragraph (a)(72) to read 
as follows:


Sec. 200.30-3  Delegation of authority to Director of Division of 
Market Regulation.

* * * * *
    (a) * * *
    (72) Pursuant to Sections 15(a)(2) and 36 of the Act (15 U.S.C. 
78o(a)(2) and 78mm), to review and, either unconditionally or on 
specified terms and conditions, to grant or deny exemptions to any 
bank, savings association, or savings bank from the broker-dealer 
registration requirements of Section 15(a)(1) of the Act (15 U.S.C. 
78o(a)(1)) or any applicable provision of this Act (15 U.S.C. 78c et 
seq.) and the rules and regulations thereunder based solely on such 
bank's, savings association's, or savings bank's status as a broker or 
dealer.
* * * * *

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    3. The authority citation for Part 240 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78j-1, 
78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 
78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 
and 80b-11, unless otherwise noted.
* * * * *

    4. Sections 240.3a4-2, 240.3a4-3, 240.3a4-4, 240.3a4-5, and 
240.3a4-6 are added to read as follows:


Sec. 240.3a4-2  Exemption from the definition of ``broker'' for bank 
calculating compensation for effecting transactions in fiduciary 
accounts.

    (a) A bank that meets the conditions for exception from the 
definition of the term ``broker'' under Section 3(a)(4)(B)(ii) of the 
Act (15 U.S.C. 78c(a)(4)(B)(ii)), except for the ``chiefly 
compensated'' condition in Section 3(a)(4)(B)(ii)(I) of the Act (15 
U.S.C. 78c(a)(4)(B)(ii)(I)), is exempt from the definition of the term 
``broker'' under Section 3(a)(4) of the Act (15 U.S.C. 78c(a)(4)) 
solely for effecting transactions in securities pursuant to Section 
3(a)(4)(B)(ii) of the Act (15 U.S.C. 78c(a)(4)(B)(ii)) if:
    (1) The bank can demonstrate that sales compensation, as defined in 
Sec. 240.3b-17(j), received during the immediately preceding year is 
less than 10% of the total amount of relationship compensation, as 
defined in Sec. 240.3b-17(i), received during that year;
    (2) The bank maintains procedures reasonably designed to ensure 
compliance with the ``chiefly compensated'' condition in Section 
3(a)(4)(B)(ii)(I) of the Act (15 U.S.C. 78c(a)(4)(B)(ii)(I)) with 
respect to a trust or fiduciary account:
    (i) When the account is opened;
    (ii) When the compensation arrangement for the account is changed; 
and
    (iii) When sales compensation, as defined in Sec. 240.3b-17, 
received from the account is reviewed by the bank for

[[Page 27797]]

purposes of determining an employee's compensation; and
    (3) The bank complies with Section 3(a)(4)(C) of the Act (15 U.S.C. 
78c(a)(4)(C)).
    (b) For purposes of this section, the term year means either a 
calendar year or other fiscal year consistently used by the bank for 
recordkeeping and reporting purposes.


Sec. 240.3a4-3  Exemption from the definition of ``broker'' for bank 
effecting transactions as an indenture trustee in a no-load money 
market fund.

    A bank that meets the conditions for exception from the definition 
of the term ``broker'' under Section 3(a)(4)(B)(ii) of the Act (15 
U.S.C. 78c(a)(4)(B)(ii)), except for the ``chiefly compensated'' 
condition in Section 3(a)(4)(B)(ii)(I) of the Act (15 U.S.C. 
78c(a)(4)(B)(ii)(I)), is exempt from the definition of the term 
``broker'' under Section 3(a)(4) of the Act (15 U.S.C. 78c(a)(4)) 
solely for effecting transactions as an indenture trustee in a no-load 
money market fund, as defined in Sec. 240.3b-17(f) and Sec. 240.3b-
17(e), respectively.


Sec. 240.3a4-4  Exemption from the definition of ``broker'' for small 
bank effecting transactions in investment company securities in a tax-
deferred custody account.

    (a) A small bank is exempt from the definition of the term 
``broker'' under Section 3(a)(4) of the Act (15 U.S.C. 78c(a)(4)) 
solely for effecting transactions in securities of an open-end 
management investment company registered under the Investment Company 
Act of 1940 (15 U.S.C. 80a-1 et seq.) in a tax-deferred account for 
which the bank acts as custodian under Section 3(a)(4)(B)(viii) of the 
Act (15 U.S.C. 78c(a)(4)(B)(viii)) if:
    (1) The bank is not associated with a broker or dealer and does not 
have an arrangement with a broker or dealer to effect transactions in 
securities for the bank's customers;
    (2) Any bank employee effecting such transactions:
    (i) Is not an associated person of a broker or dealer;
    (ii) Primarily performs duties for the bank other than effecting 
transactions in securities for customers; and
    (iii) Does not receive compensation for such transactions from the 
bank, the executing broker or dealer, or any other person related to:
    (A) The size, value, or completion of any securities transaction;
    (B) The amount of securities-related assets gathered; or
    (C) The size or value of any customer's securities account;
    (3) The bank complies with Section 3(a)(4)(C) of the Act (15 U.S.C. 
78c(a)(4)(C));
    (4) The bank makes available to the tax-deferred account the 
securities of investment companies that are not affiliated persons, as 
defined in Section 2(a)(3) of the Investment Company Act of 1940 (15 
U.S.C. 80a-2(a)(3)), of the bank and that have similar characteristics 
to the securities of investment companies made available that are 
affiliated persons;
    (5) The bank does not solicit securities transactions except 
through the following activities:
    (i) Delivering advertising and sales literature for the security 
that is prepared by the registered broker-dealer that is the principal 
underwriter of an open-end management investment company registered 
under the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.), or 
prepared by an open-end management investment company registered under 
the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) that is 
not an affiliated person, as defined in Section 2(a)(3) of the 
Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(3)), of the bank;
    (ii) Responding to inquiries of a potential purchaser in a 
communication initiated by the potential purchaser; provided, however, 
that the content of such responses is limited to information contained 
in a registration statement for the security of an investment company 
filed under the Securities Act of 1933 (15 U.S.C. 77a et seq.) or sales 
literature prepared by the investment company security's principal 
underwriter that is a registered broker-dealer;
    (iii) Advertising of trust activities, if any, permitted under 
Section 3(a)(4)(B)(ii)(II) of the Act (15 U.S.C. 78c(a)(4)(B)(ii)(II)); 
or
    (iv) Notifying its existing customers that it accepts orders for 
investment company securities in conjunction with solicitations related 
to its other activities concerning tax-deferred accounts; and
    (6) The bank's annual compensation related to effecting 
transactions in securities pursuant to this exemption is less than 3% 
of its annual revenue.
    (b) Definitions. For purposes of this section:
    (1) The phrase compensation related to effecting transactions in 
securities pursuant to this exemption means the total annual 
compensation received for effecting transactions in securities pursuant 
to this exemption, including fees received from investment companies 
for distribution.
    (2) The term networking arrangement means a contractual or other 
written arrangement with a broker or dealer to effect transactions in 
securities for the bank's customers.
    (3) The term principal underwriter has the meaning given in Section 
2(a)(29) of the Investment Company Act of 1940 (15 U.S.C. 80a-
2(a)(29)).
    (4) The term revenue means the total annual net interest income and 
noninterest income from the bank's most recent Consolidated Reports of 
Condition and Income (Call Reports) or any successor forms the bank is 
required to file by its appropriate Federal banking agency (as defined 
in Section 3 of the FDIA (12 U.S.C. 1813).
    (5) (i) The term small bank means a bank that:
    (A) Had less than $100 million in assets as of December 31 of both 
of the prior two calendar years; and
    (B) Is not, and since December 31 of the third prior calendar year 
has not been, an affiliate of a bank holding company or a financial 
holding company that as of December 31 of both of the prior two 
calendar years had consolidated assets of more than $1 billion.
    (ii) For purposes of this paragraph (b)(5) the terms affiliate, 
bank holding company, and financial holding company have the same 
meanings as given in the Bank Holding Company Act of 1956 (12 U.S.C. 
1841 et seq.).
    (6) The term tax-deferred account means those accounts described in 
Sections 401(a), 403, 408, and 408A under Subchapter D and in Section 
457 under Subchapter E of the Internal Revenue Code of 1986 (26 U.S.C. 
1 et seq.).


Sec. 240.3a4-5  Exemption from the definition of ``broker'' for banks 
effecting transactions in securities in a custody account.

    (a) A bank is exempt from the definition of the term ``broker'' 
under Section 3(a)(4) of the Act (15 U.S.C. 78c(a)(4)) solely for 
effecting transactions in securities in an account for which the bank 
acts as custodian under Section 3(a)(4)(B)(viii) of the Act (15 U.S.C. 
78c(a)(4)(B)(viii)) if:
    (1) The bank does not directly or indirectly receive any 
compensation for effecting such transactions;
    (2) Any bank employee effecting such transactions:
    (i) Is not an associated person of a broker or dealer;
    (ii) Primarily performs duties for the bank other than effecting 
transactions in securities for customers;
    (iii) Does not receive compensation for such transactions related 
to:
    (A) The size, value, or completion of any securities transaction;

[[Page 27798]]

    (B) The amount of securities-related assets gathered; or
    (C) The size or value of any customer's securities account; and
    (iv) Does not receive compensation for the referral of any customer 
to the broker or dealer;
    (3) The bank complies with Section 3(a)(4)(C) of the Act (15 U.S.C. 
78c(a)(4)(C));
    (4) The bank makes available to the account the securities of 
investment companies with similar characteristics that are not 
affiliated persons, as defined in Section 2(a)(3) of the Investment 
Company Act of 1940 (15 U.S.C. 80a-2(a)(3)), of the bank, if the bank 
makes available the securities of investment companies that are 
affiliated persons, as defined in Section 2(a)(3) of the Investment 
Company Act of 1940 (15 U.S.C. 80a-2(a)(3)); and
    (5) The bank does not solicit securities transactions except 
through the following activities:
    (i) Delivering advertising and sales literature for the security 
that is prepared by the registered broker-dealer that is the principal 
underwriter of an investment company, or prepared by an investment 
company that is not an affiliated person, as defined in Section 2(a)(3) 
of the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(3)), of the 
bank;
    (ii) Responding to inquiries of a potential purchaser in a 
communication initiated by the potential purchaser of the security; 
provided, however, that the content of such responses is limited to 
information contained in a registration statement for the security 
filed under the Securities Act of 1933 (15 U.S.C. 77a et seq.) or sales 
literature prepared by the principal underwriter that is a registered 
broker-dealer;
    (iii) Advertising of trust activities, if any, permitted under 
Section 3(a)(4)(B)(ii)(II) of the Act (15 U.S.C. 78c(a)(4)(B)(ii)(II)); 
and
    (iv) Notifying its existing customers that it accepts orders for 
securities in conjunction with solicitations related to its other 
custody activities.
    (b) For purposes of this section, the term principal underwriter 
has the meaning given in Section 2(a)(29) of the Investment Company Act 
of 1940 (15 U.S.C. 80a-2(a)(29)).


Sec. 240.3a4-6  Exemption from the definition of ``broker'' for banks 
that execute transactions in investment company securities through NSCC 
Mutual Fund Services.

    A bank that meets the conditions for an exception or exemption from 
the definition of the term ``broker,'' except for the condition in 
Section 3(a)(4)(C)(i) of the Act (15 U.S.C. 78c(a)(4)(C)(i)), is exempt 
from such condition solely for transactions in investment company 
securities effected through the National Securities Clearing 
Corporation's Mutual Fund Services.

    5. Section 240.3a5-1 is added to read as follows:


Sec. 240.3a5-1  Exemption from the definition of ``dealer'' for bank 
engaged in riskless principal transactions.

    (a) A bank is exempt from the definition of the term ``dealer'' 
solely for engaging in riskless principal transactions if the number of 
such riskless principal transactions during a calendar year combined 
with transactions in which the bank is acting as an agent for a 
customer pursuant to Section 3(a)(4)(B)(xi) of the Act (15 U.S.C. 
78c(a)(4)(B)(xi)) during that same year do not exceed 500 transactions.
    (b) For purposes of the 500-transaction limit in paragraph (a) of 
this section, a riskless principal transaction counts as:
    (1) Two transactions if neither transaction comprising the riskless 
principal transaction is with a broker or dealer; or
    (2) One transaction if either transaction comprising the riskless 
principal transaction is with a broker or dealer.
    (c) For purposes of this section, the term riskless principal 
transaction means a transaction in which, after having received an 
order to buy from a customer, the bank purchased the security from 
another person to offset a contemporaneous sale to such customer or, 
after having received an order to sell from a customer, the bank sold 
the security to another person to offset a contemporaneous purchase 
from such customer.

    6. Sections 240.3b-17 and 240.3b-18 are added to read as follows:


Sec. 240.3b-17  Definitions of terms used in Section 3(a)(4) of the 
Act.

    For purposes of Section 3(a)(4) of the Act (15 U.S.C. 78c(a)(4)):
    (a) The term chiefly compensated means that the ``relationship 
compensation'' received by a bank from a trust or fiduciary account 
exceeds the ``sales compensation'' received by the bank from such 
account during the immediately preceding year, which is either a 
calendar year or other fiscal year consistently used by the bank for 
recordkeeping and reporting purposes.
    (b) The term flat or capped per order processing fee equal to not 
more than the cost incurred by the bank in connection with executing 
securities transactions for trustee and fiduciary customers means a fee 
that is no more than the amount a broker-dealer charged the bank for 
executing the transaction, plus the costs of any resources of the bank 
that are exclusively dedicated to transaction execution, comparison, 
and settlement for trust and fiduciary customers.
    (c) The term indenture trustee means any trustee for an indenture 
to which the definition given in Section 303 of the Trust Indenture Act 
of 1939 (15 U.S.C. 77ccc) applies, and any trustee for an indenture to 
which the definition in Section 303 of the Trust Indenture Act of 1939 
(15 U.S.C. 77ccc) would apply but for an exemption from qualification 
pursuant to Section 304 of the Trust Indenture Act of 1939 (15 U.S.C. 
77ddd).
    (d) The term investment adviser if the bank receives a fee for its 
investment advice means a bank that has a relationship with the 
customer paying the fee in which the bank:
    (1) Provides, in return for the fee, continuous and regular 
investment advice to the customer's account that is based upon the 
individual needs of the customer; and
    (2) Under state law, federal law, contract, or customer agreement 
owes a duty of loyalty, including an affirmative duty to make full and 
fair disclosure to the customer of all material facts relating to 
conflicts.
    (e) The term money market fund means an open-end management 
investment company registered under the Investment Company Act of 1940 
(15 U.S.C. 80a-1 et seq.) that is regulated as a money market fund 
pursuant to Sec. 270.2a-7 of this chapter.
    (f)(1) The term no-load in the context of an investment company 
registered under the Investment Company Act of 1940 (15 U.S.C. 80a-1 et 
seq.) means:
    (i) Purchases of the investment company's securities are not 
subject to a sales load, as that term is defined in Section 2(a)(35) of 
the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(35)), or a 
deferred sales load, as that term is defined in Sec. 270.6c-10 of this 
chapter; and
    (ii) The investment company's total charges against net assets for 
sales or sales promotion expenses and personal service or the 
maintenance of shareholder accounts do not exceed 0.25 of 1% of average 
net assets annually and are disclosed in the money market fund's 
prospectus.
    (2) For purposes of paragraph (f)(1) of this section, charges for 
the following will not be considered charges for personal service or 
for the maintenance of shareholder accounts:

[[Page 27799]]

    (i) Transfer agent and subtransfer agent services for beneficial 
owners of the investment company shares;
    (ii) Aggregating and processing purchase and redemption orders;
    (iii) Providing beneficial owners with statements showing their 
positions in the investment companies;
    (iv) Processing dividend payments;
    (v) Providing subaccounting services for investment company shares 
held beneficially;
    (vi) Forwarding shareholder communications, such as proxies, 
shareholder reports, dividend and tax notices, and updating 
prospectuses to beneficial owners; or (vii) Receiving, tabulating, and 
transmitting proxies executed by beneficial owners.
    (g)(1) The term nominal one-time cash fee of a fixed dollar amount 
means a payment in either of the following forms that meets the 
requirements of subparagraph (2):
    (i) A payment that does not exceed one hour of the gross cash wages 
of the unregistered bank employee making a referral; or
    (ii) Points in a system or program that covers a range of bank 
products and non-securities related services where the points count 
toward a bonus that is cash or non-cash if the points (and their value) 
awarded for referrals involving securities are not greater than the 
points (and their value) awarded for activities not involving 
securities.
    (2) Regardless of the form of payment, the payment may not be 
related to:
    (i) The size, value, or completion of any securities transaction;
    (ii) The amount of securities-related assets gathered;
    (iii) The size or value of any customer's bank or securities 
account; or
    (iv) The customer's financial status.
    (h) The term referral means a bank employee arranging a first 
securities-related contact between a registered broker-dealer and a 
bank customer, but does not include any activity (including any part of 
the account opening process) related to effecting transactions in 
securities beyond arranging that first contact.
    (i) The term relationship compensation means any compensation 
received by a bank in connection with activities for which the bank 
relies on an exception under Section 3(a)(4)(B)(ii) of the Act (15 
U.S.C. 78c(a)(4)(B)(ii)) that is received directly from a customer or 
beneficiary, or directly from the assets of the trust or fiduciary 
account, and consists solely of an administration or annual fee 
(payable on a monthly, quarterly, or other basis), a percentage of 
assets under management fee, or a flat or capped per order processing 
fee equal to not more than the cost incurred by the bank in connection 
with executing securities transactions for trust and fiduciary 
accounts, or any combination of such fees.
    (j) The term sales compensation means any compensation received by 
a bank in connection with activities for which the bank relies on an 
exception under Section 3(a)(4)(B)(ii) of the Act (15 U.S.C. 
78c(a)(4)(B)(ii)) that:
    (1) Is a fee for effecting a transaction in securities that is not 
a flat or capped per order processing fee equal to not more than the 
cost incurred by the bank in connection with executing securities 
transactions for trustee and fiduciary customers;
    (2) Is compensation that if paid to a broker or dealer would be 
payment for order flow, as defined in Sec. 240.10b-10;
    (3) Is a finders' fee received in connection with a securities 
transaction or account, except a fee received pursuant to Section 
3(a)(4)(B)(i) of the Act (15 U.S.C. 78c(a)(4)(B)(i));
    (4) Is a fee paid for an offering of securities that is not 
received directly from a customer or beneficiary, or directly from the 
assets of the trust or fiduciary account;
    (5) Is a fee paid pursuant to a Rule 12b-1 plan under the 
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.); or
    (6) Is a fee paid by an investment company for personal service or 
the maintenance of shareholder accounts, except a fee that is not part 
of a Rule 12b-1 plan under the Investment Company Act of 1940 (15 
U.S.C. 80a-1 et seq.) for:
    (i) Transfer agent and subtransfer agent services for beneficial 
owners of shares in the investment company;
    (ii) Aggregating and processing purchase and redemption orders;
    (iii) Providing beneficial owners with statements showing their 
positions in the investment companies;
    (iv) Processing dividend payments;
    (v) Providing subaccounting services for shares in the investment 
company held beneficially;
    (vi) Forwarding shareholder communications, such as proxies, 
shareholder reports, dividend and tax notices, and updating 
prospectuses to beneficial owners; or
    (vii) Receiving, tabulating, and transmitting proxies executed by 
beneficial owners.
    (k) The term trustee capacity in Section 3(a)(4)(B)(ii) of the Act 
(15 U.S.C. 78c(a)(4)(B)(ii)) includes an indenture trustee or a trustee 
for a tax-deferred account described in Sections 401(a), 408, and 408A 
under subchapter D and in Section 457 under subchapter E of the 
Internal Revenue Code of 1986 (26 U.S.C. 1 et seq.).


Sec. 240.3b-18  Definitions of terms used in Section 3(a)(5) of the 
Act.

    For purposes of Section 3(a)(5)(C) of the Act (15 U.S.C. 
78c(a)(5)(C):
    (a) The term affiliate means any company that controls, is 
controlled by, or is under common control with another company.
    (b) The term consumer-related receivable means any obligation 
incurred by any natural person to pay money arising out of a 
transaction in which the money, property, insurance, or services (being 
purchased) are primarily for personal, family, or household purposes.
    (c) The term member of a syndicate of banks means a bank that is a 
participant in a syndicate of banks and contributes no less than 10% of 
the money loaned by the syndicate.
    (d) The term obligation means any note, draft, acceptance, loan, 
lease, receivable, or other evidence of indebtedness that is not a 
security issued by a person other than the bank.
    (e) The term originated means initially making and funding an 
obligation.
    (f) The term pool means more than one obligation or type of 
obligation grouped together to provide collateral for a securities 
offering.
    (g) The term predominantly originated means that the bank or its 
affiliates, not including any broker or dealer affiliates, originated 
no less than 85% of the value of the obligations in any pool. For this 
purpose, the bank and its affiliates include any financial institution 
with which the bank or its affiliates have merged but does not include 
the purchase of a pool of obligations or the purchase of a line of 
business.
    (h) The term syndicate of banks means a group of banks that acts 
jointly, on a temporary basis, to loan money in one or more bank credit 
obligations.

    7. Section 240.15a-7, 240.15a-8, 240.15a-9 are added to read as 
follows:


Sec. 240.15a-7  Exemption from the definitions of ``broker'' or 
``dealer'' for banks for limited period of time.

    (a) A bank is exempt from the definitions of the term ``broker'' 
under Section 3(a)(4) of the Act (15 U.S.C. 78c(a)(4)) and the term 
``dealer'' under Section 3(a)(5) of the Act (15 U.S.C. 78c(a)(5) until 
October 1, 2001; and
    (b) A bank is exempt from the definition of the term ``broker'' 
under Section 3(a)(4) of the Act (15 U.S.C. 78c(a)(4)) until January 1, 
2002, for activities that meet the conditions of an

[[Page 27800]]

exception or exemption for banks from the definition of the term 
``broker'' except for those conditions of Section 3(a)(4) of the Act 
(15 U.S.C. 78c(a)(4)) and the rules thereunder relating to compensation 
of the bank or its employees.


Sec. 240.15a-8  Exemption for banks from Section 29 liability.

    No contract entered into before January 1, 2003 shall be void or 
considered voidable by reason of Section 29 of the Act (15 U.S.C. 78cc) 
because any bank that is a party to the contract violated the 
registration requirements of Section 15(a) of the Act (15 U.S.C. 
78o(a)) or any applicable provision of the Act (15 U.S.C. 78a et seq.) 
and the rules and regulations thereunder based solely on the bank's 
status as a broker or dealer when the contract was created.


Sec. 240.15a-9  Exemption from the definitions of ``broker'' and 
``dealer'' for savings associations and savings banks.

    Any savings association or savings bank that has deposits insured 
by the Federal Deposit Insurance Corporation under the FDIA (12 U.S.C. 
1811 et seq.), and is not operated for the purpose of evading the 
provisions of the Act (15 U.S.C. 78a et seq.), is exempt from the 
definitions of the terms ``broker'' and ``dealer'' under Sections 
3(a)(4) and 3(a)(5) of the Act (15 U.S.C. 78c(a)(4) and 15 U.S.C. 
78c(a)(5)), based solely on the savings association's or savings bank's 
status as a broker or dealer on the same terms and under the same 
conditions that banks are excepted or exempted, provided that if a 
savings association or savings bank acts as a municipal securities 
dealer, it shall be considered a bank municipal securities dealer for 
purposes of the Act (15 U.S.C. 78a et seq.) and the rules thereunder, 
including the rules of the Municipal Securities Rulemaking Board.

    By the Commission.

    Dated: May 11, 2001.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-12388 Filed 5-11-01; 4:21 pm]
BILLING CODE 8010-01-P


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