Independent Community Bankers of America

December 5, 2002

Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 5th Street, NW
Washington, DC 20549-0609

    Re: File No. S7-41-02; 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

Dear Mr. Katz:

The Independent Community Bankers of America (ICBA)1 appreciates the opportunity to comment on the proposed rule that would further define the dealer exceptions under the Gramm-Leach-Bliley Act (GLBA) for banks, savings associations and savings banks.


Prior to GLBA, banks were subject to a blanket exemption from registration as brokers or dealers under the 1934 Securities and Exchange Act. GLBA removed the blanket exemption, but recognizing that banks have long offered customers certain securities services without problem, instituted a series of exceptions from the broker-dealer registration requirement for certain traditional banking activities, such as trust and fiduciary activities. The proposed rule is designed to address those activities that would otherwise require a bank to register with the Securities and Exchange Commission (SEC) as a dealer.

According to the SEC, assessing whether or not a bank must register as a dealer is a two-step analysis. The first stage assesses whether a bank is buying or selling securities for its own account and whether the bank is engaged in the business of that activity as a part of a regular business. As a general rule, the SEC has determined that a bank would be classified as a dealer by conducting activities such as underwriting, acting as a market maker or specialist on an organized exchange or trading system, or buying and selling directly to securities customers. If a bank would otherwise qualify as a dealer subject to SEC registration and reporting requirements under this first stage of the analysis, the second step considers whether statutory exceptions are available.2

If a bank qualifies as a dealer under the first stage of analysis, GLBA offers four specific exceptions from the definition. GLBA allows banks to engage in the following without becoming a securities dealer: (1) investment transactions where the bank buys and sells securities for investment purposes for the bank or for its own customers; (2) transactions in exempted securities (primarily government obligations); (3) transactions in banking products as identified under GLBA; and (4) asset-backed transactions where the bank pools and sells securities representing interests in underlying obligations, such as mortgages, provided the bank, its affiliates or a syndicate in which the bank is a member have predominately originated the obligations underlying by the security.

The proposal would clarify several terms for transactions that qualify as asset-backed transactions, address how "riskless principal" transactions are counted, and clarify when securities lending activities are exempt from the definition of dealer. In addition, the proposal would address the definition of "qualified investor" for securities lending activities.

Summary of ICBA Position

We commend the SEC for taking steps to make the rules more flexible since the interim final rule was issued in 2001. However, we also recommend additional changes to make the final rule even more flexible, both to take into account traditional banking activities and to ensure that banks can easily adapt to changing market conditions. In summary:

  • it is appropriate to extend the exceptions to savings institutions

  • requiring a bank to originate at least 85% of the loans under an asset-backed transaction is likely to be a barrier to community banks' ability to sell loans on the secondary market - rather, a simple majority, e.g., 51%, would meet Congress' intent

  • the ICBA applauds the SEC proposal to match the buy and sell components of a "riskless principal" transaction as one transaction for purposes of the de minimis exception

  • since "riskless principal" transactions are essentially agency arrangements, the ICBA strongly encourages the SEC to reconsider its approach to bring the SEC rule into accord with long-held banking practice

  • the ICBA commends the SEC for clarifying that non-custodial securities lending activities are within the ambit of the GLBA exception

  • it is not necessary to require banks to verify and document that securities lending involves qualified participants and proper purposes

  • while it may be appropriate to institute a single definition of a "qualified investor" as a means to simplify compliance, the application should be limited to securities lending activities pending more careful and thorough analysis

Applicability to Savings Banks

Before GLBA was enacted, the exemption from broker-dealer requirements applied only to banks and not savings associations or savings banks. The interim final rule and the proposal extend these exceptions to savings associations and savings banks, placing them on the same footing as banks. The ICBA finds this appropriate and commends the SEC for taking this step.

Asset Backed Transactions

Under this exception, a bank is not considered a dealer if it pools and sells interests in underlying obligations to "qualified investors," provided the underlying obligations are predominately originated by bank, its affiliates or a syndicate in which the bank is a member. In the 2001 interim final rule, the SEC proposed a rather narrow definition for this exception.

Under the proposal, the SEC would expand the definition of "originated" to allow additional flexibility based on banks' business practices. As proposed, a loan would be considered originated by the bank as long as it meets two conditions: (1) the obligation must conform to the bank's underwriting standards or be documented on bank documents, and (2) the bank must fund the obligation within six months after it was created. According to the SEC, this revision will allow banks to engage in transactions with a variety of loan origination channels, such as automobile dealers, mortgage brokers and other banks.

The other requirement under the statutory exception is that the bank must have "predominately" originated the loans underlying security in order to qualify. At the time the SEC issued the interim rule, it was suggested that the bank must have originated at least 85% of the underlying obligations in order to qualify. The current proposal maintains that percentage level without change.

The ICBA reiterates our concerns that the requirement that a bank originate at least 85% of the loans is too high a percentage. While smaller community banks are unlikely to take the lead in putting together the pool of assets that are securitized, the ability of small banks to sell loans into the market is critical for liquidity and to be able to meet credit needs in their communities by funding new loans. Sales of loans to institutions that securitize them are one way that smaller banks obtain new funding. Not all community banks are able, for a variety of reasons, to use government sponsored enterprises such as Fannie Mae and Freddie Mac for this purpose, and so the SEC proposal will cut many of them off from the secondary market. Therefore, the ICBA again strongly urges the SEC to drop this high percentage. In fact, as we noted in our earlier comments, we believe that a simple majority - 51 percent - would be sufficient to carry out Congress' intent.

Although the current proposal makes the definition of "originated" much more flexible than initially proposed, the ICBA believes that the definition will still have a serious chilling effect on the ability of smaller banks to sell loans. By requiring the lead bank to either fund the loan or have the loan documented on its documents or under its underwriting standards, the lead bank will have to have arrangements with potential selling banks before the loans are made. For the typical arrangement a bank may have with an automobile dealership, this is not likely to present a problem. However, for smaller banks that may be originating and then seeking to sell mortgage loans to ensure adequate funding, this may not be a workable requirement. By making it difficult for larger banks to incorporate loans in a securitization that they themselves do not originate, the SEC erects a barrier to small banks selling these loans into the market.

We recognize and appreciate that the proposal provides an exemption for a bank acting as a dealer in selling the pooled securities. While we commend the SEC for making efforts to make this rule more flexible than was originally proposed, we are also very concerned that the inability of larger banks to purchase loans that do not qualify for the SEC definition of "originated" and that restrict loans that meet the syndication test, smaller banks will have difficulty selling loans. To enable these kinds of sales in the future, the rule should be as flexible and expansive as possible, especially to allow the market to adapt to changing economic conditions. The SEC has suggested it has drafted the proposal to address current market arrangements, but the ICBA believes that the rule needs to be sufficiently flexible to allow the market to adapt to changing conditions.

Riskless Principal Transactions

The second element of the proposal addresses "riskless principal" transactions. Under a so-called "riskless principal" transaction, a bank matches buy and sell orders from different customers. While banking law treats this appropriately as an agency transaction, the SEC continues to maintain that these are essentially dealer transactions. However, in the interest of coordinating with banking law, the SEC has proposed to treat the match order as one transaction instead of two separate transactions. The transaction would then be counted as one for purposes of determining whether or not a bank has reached the limits of the de minimis exception.3

There would, however, be one exception. The proposal would treat the matching transaction as one if the bank matches buy and sell orders from one buyer and one seller. However, if there are more parties on either side of the equation, the SEC would then look to the side of the transaction with the greatest number of counterparties to determine the number of transactions under the de minimis calculation. For example, a single buyer matched by the bank to five sellers would count as five transactions under the de minimis calculation, while two sellers and three buyers would count as three transactions.

The SEC correctly notes that its interpretation of these riskless principal transactions is different from that taken by the banking agencies, which treat these transactions as agency transactions. While the ICBA commends the SEC for taking a more flexible approach than originally planned, the ICBA is also concerned that differing treatment between securities regulators and banking regulators may engender confusion. While there may be instances when it is appropriate for differences between banking regulation and securities regulation, the ICBA does not believe that this is one of those instances. Since these transactions are essentially agency arrangements, the ICBA strongly encourages the SEC to revise its treatment of these arrangements to bring the SEC rule into accord with long-held banking practice.

Securities Lending Activities

Institutional investors often place securities in custody with banks, and the banks then carry out and administer securities lending activities on behalf of the customer. However, banks also engage in securities lending activities when the bank does not have actual custody of the securities. GLBA only provides an exception from the dealer definition for securities lending activities in general, without specifying whether the exception applies to custodial or non-custodial lending activities. To provide legal certainty for banks, the SEC proposes to clarify that the exemption under GLBA applies both when the bank is acting as custodian and when it is conducting securities lending activities but is not the actual custodian.

The proposal would require a written securities lending agreement between the bank carrying out the lending activities and the investor owning the securities. The proposal would also require that the transaction be limited to "qualified investors" as lenders and borrowers (it would not apply when the bank is acting on its own behalf).

The ICBA applauds the SEC for taking this step to clarify that non-custodial securities lending activities are within the ambit of the GLBA exception, and we agree that these transactions should be conducted under a written securities agreement. The SEC has asked whether banks should be required to verify that the participants are borrowing securities for a proper purpose and whether the participants in the transaction have been evaluated for their suitability to participate. In addition, the SEC has asked whether this exemption should include a condition that it not be used to avoid U. S. margin requirements that apply to securities financing transactions or other restrictions on the alienability of securities. The ICBA does not believe that these steps are necessary, since it would add to documentation requirements and expense as an added compliance step without a demonstrated commensurate benefit.

Definition of Qualified Investor

The term "qualified investor" is relevant to several of the GLBA broker-dealer exceptions. The proposal would define a "qualified investor" for securities lending purposes using the definition found at section 3(a)(54) of the Securities and Exchange Act. For purposes of the term "company," the SEC would use a broad definition that encompasses any type of entity not otherwise listed in the definition. In addition, the SEC has asked for comment on whether this definition should be applied in other instances where GLBA uses the term, such as equity swap agreements.

All other things being equal, the ICBA believes that it would be appropriate to have one universally recognized definition of "qualified investor," since to do so would simplify compliance and reduce confusion. However, that being said, we have not had an opportunity to analyze the impact that a single definition might have in other instances. At this time, we believe that the application should be limited to securities lending activities, but as the SEC moves forward with regulatory proposals under GLBA, the agency should make efforts to reconcile the definition of "qualified investor" as appropriate and move toward one single definition.

Thank you for the opportunity to comment. Should you have any questions or need additional information, please contact ICBA's regulatory counsel, Robert Rowe, at 202-659-8111 or


/s/ Joanne F. Shephard
Chairman, ICBA Regulation Review Committee

1 ICBA is the nation's leading voice for community banks and the only national trade association dedicated exclusively to protecting the interests of the community banking industry. ICBA has 5,000 members with branches in 17,000 locations nationwide. Our members hold nearly $511 billion in insured deposits, $624 billion in assets and more than $391 billion in loans for consumers, small businesses, and farms. They employ more than 231,000 citizens in the communities they serve.
2 The SEC stresses that this analysis must be conducted under the securities laws and regulations, not banking law. However, banks must separately consider whether an activity is permissible under banking law.
3 Under the de minimis exception, a bank generally may conduct up to 500 transactions annually without being classified as a dealer.