July 17, 2001
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549-0609
Re: File No. S7-12-01
Dear Mr. Katz:
The Institute of International Bankers is an association that represents the interests of internationally headquartered financial institutions that conduct banking, securities and/or insurance activities in the United States. On behalf of our member institutions, we appreciate this opportunity to comment on the interim final rules adopted by the Commission under the Securities Exchange Act of 1934 (the "Exchange Act") addressing the functional exceptions for banks from the "push-out" provisions of Title II, Subtitle A of the Gramm-Leach-Bliley (GLB) Act. The Institute's members conduct banking operations in the United States through federal and state-licensed branches and agencies as well as incorporated bank subsidiaries and as such are directly affected by the interim final rules.
We appreciate the opportunity to have met with Commission staff prior to issuance of the interim final rules to discuss questions regarding the scope of the exceptions to the push-out provisions. While the Commission's release in certain respects favorably addresses these questions, we continue to have several fundamental concerns with respect to the Commission's overall approach to the push-out provisions. These include (i) the issuance of guidance as interim final rules rather than as proposed rules that would be finalized and effective only after consideration of comments received; (ii) the provision in Rule 15a-7 of temporary exemptive relief that, as a practical matter, fails to provide banks sufficient time to conform their activities to the applicable legal requirements; (iii) the failure to address the situation in which a bank inadvertently or in an unforeseeable manner violates one of the requirements of an exception and therefore faces potential liability under the securities laws for failure to register as a broker-dealer; and (iv) the imposition of conditions on certain statutory exceptions to the push-out provisions that in critical respects are inconsistent with the plain meaning of the GLB Act's push-out provisions and Congressional intent , unnecessarily complex, unduly burdensome and so restrictive in their requirements as to render nugatory the exceptions.
To address these concerns, we strongly urge the Commission to (i) convert the interim final rules, other than Rule 15a-7 and Rule 15a-8, into proposed rules that would be finalized and effective only after addressing the issues raised during the comment period; (ii) as soon as possible, and in any event prior to October 1, 2001, revise Rule 15a-7 to provide banks a blanket exemption from the push-out requirements that would expire one year after the Commission adopts final rules in this area; (iii) adopt a rule permitting banks to "cure" inadvertent or unforeseeable violations of the push-out provisions without incurring any potential liability under the failure securities laws for failure to register as a broker-dealer; and (iv) modify the interim final rules to reduce their burden and reflect the intent of Congress in providing the exceptions to the push-out provisions.
The Need for Revised Rulemaking Procedures and Extension of the Temporary Relief from the Push-Out Provisions Provided under Rule 15a-7
We are troubled by the Commission's decision to adopt interim final rules rather than issue proposed rules that would be finalized only after consideration of the comments received. As discussed below, the interim final rules establish requirements that we believe are contrary to Congressional intent and unduly impinge on the conduct of well established banking practices. The question of whether or not banks will be required to "push out" certain securities activities to registered broker-dealers is of fundamental importance to the banking industry and also has significant implications for implementing the functional regulation regime contemplated by Congress in the GLB Act.
With all due respect, we believe that the magnitude of these considerations warrants more deliberate rulemaking procedures that permit adequate opportunity for industry comment and facilitate the formulation of a regulatory scheme that effectuates Congress' clear intent not to disrupt these activities. Accordingly, we strongly urge the Commission to revise the approach it has adopted by converting the interim final rules (other than Rule 15a-7 and Rule 15a-8) into proposed rules that would be finalized and effective only after addressing the issues raised during the comment period.
While the Commission in Rule 15a-7 has provided temporary exemptive relief from the push-out provisions, we believe that the exemption period is too brief and does not provide banks sufficient opportunity to conform their activities to the requirements of the rules. Moreover, as the interim final rules remain subject to revision based on the comments received, banks remain uncertain of what the applicable requirements ultimately will be. Banks thus confront the very real prospect of undertaking significant modifications to their existing practices and operations without the certainty that such actions will be either necessary or sufficient under the rules as ultimately finalized. These actions include revising customer documentation, developing and implementing new management information systems and oversight procedures, training personnel and, where necessary, either establishing a de novo broker-dealer affiliate or transferring existing customers to an existing (affiliated) broker-dealer. In the case of our member institutions, implementation of these tasks is further complicated by the need to communicate with customers located outside the United States and the prospect of having to explain to them the necessity of reconfiguring their longstanding banking relationships.
In these circumstances, we believe it is unrealistic and unfair to expect banks to undertake such extensive actions without the certainty that no further action will be necessary to ensure compliance with the rules' final requirements. It is likewise unrealistic and unfair to expect that such actions, even were they sufficient to ensure compliance, will be accomplished within the limited timeframes contemplated by Rule 15a-7. Accordingly, we strongly urge the Commission to revise Rule 15a-7 by providing banks a blanket exemption from the push-out provisions for a period of time sufficient to enable them to conform their activities to whatever final requirements ultimately are mandated under the Commission's rules. We believe a period of one year from the Commission's adoption of final rules under the push-out provisions would be sufficient for these purposes.1
Our very serious concerns regarding these matters are intensified by the highly restrictive conditions imposed by the interim final rules on banks that seek to qualify for certain exceptions to the push-out provisions. As discussed below, the interim final rules create strong incentives for banks to "push-out" activities that Congress otherwise intended should not be disturbed in order to avoid the legal and reputational risks of violating the broker-dealer registration requirements of the federal securities laws.
Comments on the Interim Final Rules' Guidance Relating To the Trust and Fiduciary Capacity Exception to the Push-Out Provisions
With respect to the trust and fiduciary capacity exception set forth in Section 3(a)(4)(B)(ii) of the Exchange Act, the interim final rules impose restrictions that are not required by the GLB Act and, indeed, in important aspects are contrary to the Congressional intent that the Commission "not disturb" the conduct of traditional bank trust and fiduciary activities.2 For decades prior to the GLB Act, banks have conducted these activities in accordance with applicable trust and fiduciary standards and subject to the oversight of the bank supervisory authorities. Congress' inclusion of this exception to the GLB Act's push-out provisions reflects its determination that the existing legal and supervisory framework within which these activities are conducted provides sufficient protection to investors without their transfer to registered broker-dealers.
We are especially concerned regarding the following aspects of the interim final rules' requirements for the trust and fiduciary capacity exception:
Monitoring Compliance with the "Chiefly Compensated" Requirement. We strongly support the Commission's determinations that (i) compliance with the chiefly compensated standard be calculated on an annual basis and (ii) the standard is satisfied so long as more than 50% of a bank's compensation for activities it conducts pursuant to the trust and fiduciary capacity exception is attributable to the types of revenues listed in the statute.
However, we have very grave concerns regarding the interim final rules' requirement that such determinations be performed on an account-by-account basis. Specifically, we are concerned that:
In light of the foregoing considerations, we strongly urge the Commission to permit banks to determine compliance with the chiefly compensated standard based on the aggregate compensation that a bank receives during a year from the trust and fiduciary accounts for which the bank has effected securities transactions on the basis of the trust and fiduciary exception. As a corollary to thus recharacterizing the manner in which the chiefly compensated standard is applied, Rule 3a4-2 should be withdrawn.
Enabling Banks to Cure Inadvertent or Unforeseeable Violations of the Push-Out Provisions. Determining compliance with the chiefly compensated standard on an account-by-account basis raises the prospect that a bank could inadvertently or in an unforeseeable manner violate the statutory requirement, notwithstanding its good faith efforts to ensure compliance. For example, unexpected market developments could result in a bank, in its trust or fiduciary capacity, effecting an unusually large number of securities transactions on behalf of a customer that results in the receipt during the year of sales compensation in an amount that exceeds relationship compensation with respect to the account. The bank's awareness of such a violation of the chiefly compensated requirement necessarily would arise only after the fact of the violation (the difficulty of the bank's situation would be especially severe if such developments occurred near the end of the period during which compliance with the standard is measured), but under the interim final rules its inability to take preventive action would in no way diminish the severity of the bank's resulting potential liability under the federal securities laws for failing to register as a broker-dealer. Absent an opportunity to cure such violations, a bank well might determine to avoid such risks entirely by pushing out to a registered broker-dealer those of its activities that otherwise would qualify for the trust and fiduciary exception.
We believe that such a result is particularly inappropriate where banks have implemented policies and procedures reasonably designed to comply with the requirements of the trust and fiduciary capacity exception. While our comments regarding the lack of a cure mechanism under the interim final rules focus on this particular exception, the same considerations apply to the exceptions to the push-out provisions generally. Accordingly, we strongly urge the Commission to adopt a rule permitting banks a reasonable opportunity to cure inadvertent or unforeseeable violations of the push-out provisions.
Components of "Relationship" and "Sales" Compensation. Apart from the level within a bank at which compliance with the chiefly compensated standard is determined and the lack of any cure procedures for inadvertent or unforeseeable violations of the standard, we have serious concerns regarding the interim final rules' restrictions on the components of compensation that make up the standard itself.
With regard to relationship compensation, Rule 3b-17(b) requires that to qualify under the statute as 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" a bank can only recover costs of resources that are "exclusively dedicated" to transaction execution, comparison, and settlement for trust and fiduciary customers. Simply stated, the plain language of the GLB Act does not call for any such restriction, nor is there even a suggestion in the statute or its legislative history that such a requirement is intended. For the many banks that operate centralized trading desks and back office operations, the exclusivity requirement will have the effect of prohibiting them from including in the calculation of the chiefly compensated standard income that is expressly provided for by the statute. Excluding costs of shared resources, general overhead allocations and return on capital from qualifying relationship compensation would have a particularly harsh impact and is contrary to sound banking practices. We therefore most strongly urge the Commission to eliminate this requirement.
The Commission has also taken the position that a bank's receipt of per order processing fees in any amount in excess of its costs disqualifies the entirety of the fee from inclusion in the calculation of the chiefly compensated standard.4 This result also is directly contrary to the specific language of the statute, which unambiguously provides that per order processing fees not in excess of costs are eligible under the standard. We therefore also most strongly urge the Commission to withdraw its position on this matter.
With regard to sales compensation, we believe that the interim final rules are over-inclusive, resulting in diminished opportunities for banks to qualify under the trust and fiduciary capacity exception. For example, Rule 3b-17(j)(6) includes fees paid by an investment company for personal service or the maintenance of shareholder accounts, but there is no reason to believe that such fees create on the part of a bank any salesman's stake or other potential conflict of the type sought to be regulated by broker-dealer registration. Likewise, the rationale for including as sales compensation "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" (quoting Rule 3b-17(j)(4)) is by no means self-evident from the statute and does not appear to be required by its provisions (as discussed in note 4, the same concerns apply with regard to the definition of "relationship compensation" in Rule 3b-17(i)).
Providing Investment Advice for a Fee. The GLB Act expressly provides that for purposes of the trust and fiduciary capacity exception, the term "fiduciary capacity" includes "in the capacity . . . as an investment adviser if the bank receives a fee for its investment advice." There is nothing ambiguous about this language, which is derived from longstanding regulations promulgated by the Office of the Comptroller of the Currency (OCC) with respect to the fiduciary activities of national banks and federally licensed branches and agencies.5 Nevertheless, the interim final rules qualify and limit the statutory language by requiring that such advice be "continuous and regular" and that the bank rendering the advice "[u]nder 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."
Neither the text nor the legislative history of the GLB Act provides any evidence of a Congressional intent that such requirements attach to the trust and fiduciary exception or that the Commission be given the prerogative to assess the fiduciary responsibilities of a bank to its customers. In addition, the "continuous and regular" requirement incorporates into the trust and fiduciary capacity exception standards developed by the Commission under the Investment Advisers Act of 1940, notwithstanding the clear Congressional intent that these activities should remain outside the regulatory purview of the federal securities laws.
We have very serious concerns that the limitations imposed by the interim final rules on rendering investment advice for a fee will strongly discourage banks from continuing these Congressionally sanctioned activities pursuant to the trust and fiduciary capacity exception. Accordingly, we urge the Commission to withdraw these requirements.
Reliance on Examination by the Federal Banking Agencies. We strongly support reliance on the bank regulatory agencies in determining whether the activities that a bank conducts pursuant to the trust and fiduciary capacity exception are conducted in an area of the bank that is regularly examined by bank examiners for compliance with fiduciary principles and standards. However, we believe that neither the language of the GLB Act nor any policy consideration supports the Commission's additional requirement that all aspects of the securities transactions conducted by a bank pursuant to the exception are in a part of the bank that meets the examination conditions of the exception. Further, such a requirement does not comport with banks' longstanding practices in this area (for example, the centralization within a bank, or outsourcing to third parties, of back office functions relating to processing and settlement of securities transactions effected on behalf of trust/fiduciary customers).
We find no suggestion in the GLB Act that Congress intended for banks to alter their operations in the manner contemplated by the interim final rules in order to qualify for the trust and fiduciary capacity exception. We have serious concerns that as a practical matter such a requirement will so limit the availability of the exception as to exclude banks that Congress properly intended should be covered.
Comments on the Interim Final Rules' Guidance Relating to the Safekeeping and Custody Exception to the Push-Out Provisions
As added by the GLB Act, Section 3(a)(4)(B)(viii)(I)(aa) of the Exchange Act provides that where banks "as part of customary banking activities" provide safekeeping or custody services with respect to securities, "including the exercise of warrants and other rights on behalf of customers", these activities may be retained in the bank and need not be pushed out to a registered broker-dealer. Like the other exceptions to the push-out provisions, the safekeeping and custody exception is intended to "facilitate certain activities in which banks have traditionally engaged."6 The Commission, however, has adopted an extremely narrow interpretation of this exception that effectively precludes such activities.
In the Commission's view, "custody . . . does not include accepting orders from investors to purchase or sell securities."7 The exception instead is interpreted to permit the acceptance of orders from customers only with respect to those types of securities "specifically permitted in the exception."8 Thus, whereas Section 3(a)(4)(B)(viii)(I)(aa) of the Exchange Act lists the exercise of warrants and other rights on behalf of customers as among the type of securities that are included in the exception, the interim final rules restricts this part of the exception to only these types of securities, with the result that other types of securities are excluded.
With respect to other types of securities, the Commission instead has created two exemptions, both of which are extremely narrow in their applicability. The exemption in Rule 3a4-4 applies only to "small banks" and is limited to effecting transactions in securities of registered open-end investment companies held in customers' tax-deferred custody accounts. The exemption in Rule 3a4-5 permits order taking with respect to any type of security, but prohibits the receipt, directly or indirectly, of any compensation and imposes other restrictions so limiting in their requirements as to make the exemption practically a nullity.
Most troubling is the Commission's rejection of substantial evidence that banks, as part of their customary banking activities, for many years have effected securities trades as an accommodation to their custodial customers. Such activities are subject to the supervisory oversight of the banking agencies in connection with their examination of banks' safekeeping and custody operations, and there has been no evidence that these practices have raised any investor protection concerns on the part of customers on whose behalf such trades are effected. In this regard, it is especially noteworthy that the GLB Act requires that where trades effected under the safekeeping and custody exception involve securities publicly traded in the United States, they must be executed through a registered broker-dealer or effected by the bank as a cross trade.
We believe the Congressional purpose in this area, as reflected in the provisions of Section 3(a)(4)(B)(viii) of the Exchange Act added by the GLB Act, is clear and unequivocal: banks historically have been permitted to effect trades for their custodial customers on an accommodation basis and there is no reason to prohibit them from continuing to do so. Because exemptive relief in this area therefore is unnecessary, we strongly urge the Commission to withdraw both Rule 3a4-4 and Rule 3a4-5.
Comments on the Interim Final Rules' Guidance Relating To Compensation Arrangements Permissible under the Networking Exception to the Push-Out Provisions
The "networking" exception set forth in Section 3(a)(4)(B)(i) of the Exchange Act limits the referral fees payable to bank employees involved in these arrangements to "a nominal one-time cash fee of a fixed dollar amount", provided that "the payment of the fee is not contingent on whether the referral results in a transaction." As the Commission acknowledges, the networking exception codifies a series of staff no-action letters in this area. While these letters limit referral fees to payments that are nominal in amount, and must be unrelated to the volume of securities traded by the referred customers, banks have been permitted considerable flexibility in structuring these payments. Rule 3b-17(g), however, prescribes very detailed criteria that severely restrict the types of arrangements that banks may enter into to compensate their employees for referrals, including the prohibition of bonus payments unless made on the basis of the overall profitability of the bank regardless of the contribution of the employee.
There is nothing in the push-out provisions of the GLB Act or their legislative history indicating that enforcement of the broker-dealer registration requirements of the Exchange Act warrants such specific restrictions and such extensive intrusion on the prerogatives of a bank's management to compensate its employees in connection with the mere referral of a bank's customer to a registered broker-dealer. The requirements of Rule 3b-17(g) are not necessary to enhance investor protection and will only discourage banks from utilizing the networking exception. We therefore strongly urge the Commission to withdraw the provisions of Rule 3b-17(g) in favor of an approach that permits the continuation of the types of practices developed by banks in connection with permissible networking arrangements established prior to the GLB Act.
* * *
Please contact the Institute if we can provide any further assistance.
Very truly yours,
Lawrence R. Uhlick
Executive Director and
|1||As is the case under the interim final rules, banks also would be able to seek further exemptive relief from the Commission on a case-by-case basis where warranted by their individual circumstances. For example, we believe such further relief would be appropriate where a bank, having decided to push out certain securities activities to a de novo broker-dealer affiliate, requires additional time to complete the broker-dealer registration process, notwithstanding its good faith efforts to do so within the time allotted by Rule 15a-7.|
|2||H.R. Rep. No. 106-434, 106th Cong., 1st Sess. at 164 (1999).|
|3||In this connection, the definition of "relationship compensation" in Rule 3b-17(i) requires that such compensation be received "directly from a customer or beneficiary, or directly from the assets of the trust or fiduciary account." Nothing in the GLB Act or its legislative history suggests that such a limitation is contemplated by the trust and fiduciary capacity exception.|
|4||Moreover, the provisions of Rule 3b-17(j)(1) suggest that such fees should be counted in their entirety as "sales compensation". Such treatment significantly overreaches any reasonable reading of the statute.|
|5||See 12 C.F.R. § 9.2(e). As a matter of practice, many states also look to the OCC's regulations for guidance on banks' fiduciary activities.|
|6||H.R. Rep. 106-434 at 163 (emphasis added).|
|7||66 Fed. Reg. at 27781 (May 18, 2001).|