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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks Before the Bank Insurance Securities Association


Catherine McGuire

Chief Counsel, Division of Market Regulation
U.S. Securities and Exchange Commission

Washington, D.C.
October 8, 2003

This group is very familiar with the Commission's attempts to implement the functional regulation exceptions in Gramm-Leach-Bliley. Still, it is useful to discuss the process. But before I begin my comments, I must remind you that my remarks represent my own views, and not necessarily those of the Commission or my colleagues on the staff.1

As many of you know, the Commission adopted interpretations to the bank broker-dealer exceptions in May 2001 and solicited comment on these interpretations and related exemptions. These rules were not well received by bank regulators and the banking industry. The Commission received over 200 letters commenting on the rules. Nearly all of the letters came from the banking industry. In response to concerns that banks needed more time, and recognizing the likelihood that the Rules would be amended in light of the continuing dialogue between the Commission and industry participants, the Commission temporarily suspended implementation of the exceptions, bifurcated the rulemaking process — adopting rules governing the "dealer" exceptions first and then committing to amend the rules governing the "broker" exceptions.

The Commission adopted rules amending dealer exceptions in February, and they became effective on September 30th. The rules amending the dealer exceptions and exemptions cover stock lending, banks' issuance of asset-backed securities, and the method for counting riskless principal transactions for purposes of the 500 de minimis limit in the "broker" exception. The staff also recently issued a plain English guide to the dealer exceptions with some frequently asked questions. You can find the guide on the Commission's website at http://www.sec.gov/divisions/marketreg/bankdealerguide.htm.

In proposing amendments and adopting the final bank dealer rules, the Commission tried to be very sensitive to the issues that banks brought to their attention. For example, the Commission amended some of the definitions of terms relating to asset-backed securities to accommodate the business of the banks that actually sell asset-backed securities. The Commission also amended the exemption for banks from the definition of dealer for certain de minimis riskless principal transactions to count those transactions as one transaction whether they are with customers or market professionals. In response to a bank industry group request, the Commission added a new exemption from broker-dealer registration for bank securities lending transactions with qualified investors. In order to make the transition easier for banks the Commission also extended the exemption from rescission liability for contracts entered into by banks in a dealer capacity until March 31, 2005.

The Commission followed several principles in drafting the dealer exceptions. First, the Commission strove to give legal certainty wherever possible. Second, the Commission granted exemptions such as stock lending when they became aware that many banks engaged in noncustodial securities lending activities that benefited the marketplace by providing liquidity, while at the same time raising few investor protection concerns. For example, because the stock lending exemption is limited to an institutional market, the Commission could include a minimal number of other conditions. Third, the Commission tried to identify those areas where securities and banking law treated the same activities differently, such as, for example, when banks act as riskless principal. Such activity is deemed dealer activity under securities laws but agency activity under banking law. Thus, the Commission tried to grant simple exemptions, consistent with investor protection, to allow those activities to continue in certain situations, albeit in a limited form. Finally, the Commission made the exemptions flexible when it could do so consistent with the goals of functional regulation in GLBA.

The Commission and the staff used an inclusive rulemaking process leading up to adoption of the dealer exceptions. In developing these proposals, we considered the views of the banking agencies, bank trade groups, banks, end users of these services, and other interested parties. The Commission and the staff held multiple extensive meetings in person and by telephone in an attempt to fully understand the practical business problems banks believed they would have in complying with the new definition of dealer under the GLBA. It took considerable time and effort to learn what different banks do, to assess their transactions under the statutory framework, and to develop proposals that accommodate appropriate bank securities transactions.

After crafting proposals that the staff believed addressed these problems, the staff met with the banking agencies and industry groups before the Commission issued proposed rules. The staff used those meetings to describe the new proposals and gauge whether they met the needs of the banking industry, and make adjustments to accommodate legitimate concerns, before recommending that the Commission publish them for formal notice and comment.

After the proposal was outlined, the bank representatives gave very positive feedback and generated few substantive comments. Indeed, most of the bank representatives said that the proposed rule amendments and new rules would be quite workable for them. In preparing to finalize our recommendations to the Commission regarding the dealer rules, the staff remained open to further comments and once again broadened and simplified rules that were proposed.

The banking agencies, admittedly, were somewhat less satisfied. But the staff continues to believe that our best hope of reaching consensus is through this interactive process.

"Broker" process

The next rulemaking will involve defining terms in the "broker" exceptions. The general exception expires in November 2004. The existence of more exceptions and more banks involved in brokerage, rather than dealing, will make this process significantly more complicated. More banks will likely have to change something about the way they currently conduct their brokerage operations by either "pushing out" certain brokerage activities or changing their compensation so that they are not compensated like securities firms.

The staff is well along in the process to develop amendments to the "broker" exceptions. We have met with the bank trade groups, including this one, to develop a process for reaching out to representative groups of bankers in different areas in which we have questions. We have asked persons on the business side of the bank to provide us with factual information about their business practices so that we may develop amendments to the exceptions that do not inadvertently affect business practices that do not raise any investor protection concerns.

For example, the staff has spoken separately to the major banks that act as corporate trustees in order to understand what securities activities they engage in that may affect their ability to calculate whether they are "chiefly compensated" from the enumerated fees, as is required by the trust and fiduciary activities exception from broker. Banks were understandably reluctant to speak to us at first because of concerns over potential leaks of business sensitive information. I think they were quite pleased that we assured them that we would of course keep bank-specific information confidential.

The staff sent questions to banks through their trade groups regarding their networking compensation arrangements with unregistered bank employees and their sweep arrangements.2 We also sent questions about banks' investment advisory activities. The staff intends to ask banks about their custody and ERISA plan administration business practices. We have not been successful in getting banks to tell us about their practices, even when we have pointed out the success of our discussions with banks that act as corporate trustees. This has been discouraging. It will be very difficult to arrive at solutions that work for banks if we cannot have these frank discussions.

On a parallel track with this process with banks, the staff also asked the bank regulators to help us gather factual information in specific areas. We find that their industry-wide perspective puts them in the best position in certain instances to develop this factual information.

The next step in the process, like in the dealer process, is to develop a term sheet to discuss with bank regulators and the banking industry. The Commission will then propose rules, and seek formal comment on the rules.

I cannot expect the issues to be as narrow as in the dealer context. There are 11 exceptions in broker versus 4 in dealer. There are also many more banks acting as brokers than as dealers in the industry. However, if the staff can have a frank dialogue with banks about their business practices, the Commission can expect to develop a rule proposal that minimizes burdens to banks to the fullest extent that they can.


The staff intends to continue to work with the banking industry to learn, analyze, and develop workable solutions. This process has been lengthy because it takes time to develop the information necessary to understand the transactions involved in many different business models. Once the staff completes this process, we will discuss proposed rules before their formal proposal and then solicit formal comment. The staff hopes to amend the current rules to implement GLBA with a minimum regulatory burden while addressing the Commission's investor protection concerns.

The process that the Commission and the staff have followed has allowed us to achieve more workable exemptions. The Commission depends on banks to communicate completely and candidly about their current business problems. The Commission is wholeheartedly interested in engaging in a constructive dialogue with the banking industry and regulators to understand their concerns about the functional exceptions to the definitions of broker and dealer. While I cannot commit that we will have consensus on each and every point, the Commission is committed to a constructive and transparent process and to reducing regulatory burdens wherever possible, consistent with the protection of investors and the statutory amendments made under the GLBA.

Questions Regarding Networking Plans

  1. How does your bank typically pay unregistered employees for referring a bank customer to a broker-dealer under a networking arrangement? How much per referral?
  2. What is the average annual base compensation for unregistered bank employees at your bank, and what is their average total incentive compensation? How much of the incentive compensation is based on securities brokerage referrals, and how much is based on referrals other than securities brokerage referrals? Also, how much of their total incentive compensation is paid in the form of bonuses, and how much is paid in the form of referral fees? Please describe how these amounts vary across different types of employees.
  3. What are the three main types of employees who receive incentive compensation based on securities brokerage referrals, and, for each of these three types of employee, what on average is their total annual compensation, annual compensation based on securities brokerage referrals, and, on an annual basis, other incentive compensation including bonuses and fees for referrals not involving securities?
  4. Are managerial or supervisory employees paid incentive compensation based on referrals they do not make themselves? Please describe any such compensation.
  5. Does your bank pay more for some types of brokerage referrals than other types of brokerage referrals? For example, are referrals involving proprietary mutual funds or variable annuities worth more than referrals involving other types of products, or are referrals of some kinds of customers worth more than referrals of other types of customers?
  6. How much does your bank typically pay an unregistered employee for selling a renewal of a certificate of deposit? Is there a range based on the value or term of the CD? Where do CD renewals fall in the range of activities for which the bank makes such payments?
  7. How do your bank's networking activities compare to those of other banks, and if other banks have networking models that differ from the one used by your bank, what are the differences?

Questions Regarding Sample Networking Referral Fee Plans

  1. The Commission staff assumes that the three sample plans enclosed with your letter represent the most common types of bank referral fee plans. Please describe in general terms the banks that provided the sample plans and the bank employees that participate in the plans.
  2. How do fees paid under the plans relate to the total compensation packages paid to bank employees? For example, do participating employees receive bonuses or other incentive compensation for referrals in addition to fees paid under the plans, and are managerial or supervisory employees paid incentive compensation based on referrals they do not make themselves?
  3. What is the average annual base compensation for the different categories of employees participating in these plans, what is their average total incentive compensation including bonuses, how much of their total incentive compensation is based on referrals, and how much of their referral compensation is based on referrals to investment representatives?
  4. Plan A refers to a "Sales Tracking System." Please provide a description of or documentation for this system, and an explanation of how referrals, including each employee's referral fee or point total, are tracked under plans B and C.
  5. Under each plan, what determines the value of a point? Are points adjusted? If so, how and what factors are used to adjust them?
  6. Under each plan, what is the ratio of kept appointments to appointments not kept, or qualified referrals to referrals determined to be not qualified? How does a registered representative determine whether a referral is "qualified," if at all?
  7. How often are the plans revised? Under Plan B, how often does the bank's CEO adjust an award earned under the terms of the plan, and what is the basis for such adjustment? Also, what "specified local options" does the Plan Administrator use to recommend modifications to Plan B?
  8. In plan C, why are the acquisition points for a referral resulting in the opening of an asset management checking account 1.50 for a nonregistered associate and 1.00 for a registered representative?
  9. Please provide a copy of the "[Name Redacted] Trust Referral Plan (TIP)" referred to in section 8 of Plan B. Under any of the three sample plans, are unlicensed bank custody, trust, or fiduciary employees eligible to receive incentive compensation for securities-related referrals? If so, how do these plans work?
  10. The staff read in a recent study of the bank brokerage business that over half of all platform reps are Series 6 licensed and thus could share in commissions, but that about two thirds all platform reps, both licensed and unlicensed, are paid flat referral fees. This study also indicated that over half of these flat referral fees are in the range of ten to twenty dollars. For licensed and unlicensed platform reps separately, what are the percentages of flat referral fees (a) under ten dollars, (b) between ten and twenty dollars, and (c) over twenty dollars?

Questions Regarding Investment Advice for a Fee

  1. The Commission staff understands that banks have concerns about the definition of "investment adviser if a bank offers investment advice for a fee." The Commission used this term to describe a bank that does not have investment discretion on behalf of another, and is not a trustee, executor, administrator, registrar of stock and bonds, transfer agent, guardian, assignee, receiver, or custodian under a uniform gift to minor act. From reports on the investment advice industry, the staff understands that investment programs are typically categorized by the degree to which the advice provided through them is personalized. These categories involve advice that is, in order of increasing personalization,
    1. not customized for particular investors;
    2. typically based on limited investor information to meet the needs of a person in an investor's situation;
    3. customized, but limited to nonrecurring recommendations concerning a limited range of products;
    4. provided according to preset asset-allocation models determined by committee and monitored on an ongoing basis;
    5. provided as needed on a recurring basis; or
    6. provided as part of a long-term and recurring client relationship, based on a highly detailed investor profile and interview that takes into account factors such as estate planning considerations.
    If your bank provides investment advice for a fee, which of the above categories best describe the program or programs your bank offers, and how much of your bank's advice falls into each category?
    For each type of investment program listed above that your bank offers, please describe the bank's responsibility to review, select, or recommend specific securities for an account, or to monitor assets held in the account for risk and suitability.
    For each type of program your bank offers, how frequently does the bank review or monitor its advised accounts, how does it determine whether an advised account requires rebalancing or other action, and how frequently and in what format does it communicate with the owners or beneficiaries of the accounts?
    For each type of program your bank offers, what is the fee for the advice, and are there separate fees for brokerage transactions? What are the brokerage fees?
    If your bank provides investment advice for a fee that does not match any of the above categories, how would you characterize it, and how much of the advice your bank provides for a fee does it represent?
  1. What obligations to disclose conflicts does your bank have to customers for whom the bank acts as an investment adviser for a fee? Are there any material conflicts that the bank is not required to disclose? Do these obligations differ based on the personalization of the investment program? If not, what determines the difference -- recall that trust accounts and discretionary accounts are not included in this discussion.

  2. When your bank acts as an investment adviser for a fee, does it always provide advice regarding specific securities? If not, how is the bank paid for advice not regarding specific securities?
  3. Does your bank ever provide one-time investment advice in connection with a single brokerage transaction? If so, how frequently does it provide such advice, what is the fee for the advice, and is there a separate fee for the brokerage transaction? What is the fee for the brokerage?

Questions Regarding ERISA Plans

With respect to these questions, please indicate if answers differ depending on whether you are servicing a large, medium, or small plan:

  1. Does your bank typically act as a trustee or as a non-fiduciary recordkeeper with respect to ERISA plans? How does your bank determine in what capacity to act? How do the banks' services and compensation differ depending on capacity? What transactional or asset-based charges does the bank earn when it services ERISA plans?
  2. What investment options does the bank typically offer to ERISA plans? If it offers unaffiliated mutual funds, how is compensated by these funds? What other revenue sharing arrangements, if any, does the bank have for ERISA plans?
  3. Does your bank ever give investment advice to 401(k) plan participants? Does it offer an advice option directly, through a registered broker-dealer or investment adviser, or an unaffiliated company such as Financial Engines?
  4. How does your bank compensate its employees working in 401(k) plan administration (including education)? Are they compensated in any way based on the product sold? Please explain regular compensation as well as bonus potential.
  5. Are any employees working in 401(k) plan administration (including education) dual employees of broker-dealers? If they are, what is their reason for registering?
  6. Does your bank offer a brokerage window options to plan sponsors? Does the bank contract with a broker-dealer to offer that option? If so, does the broker-dealer know the identity of the participants?
  7. Some commenters cited Universal Pension Services in their comment letter for the proposition that the SEC has recognized that banks offering a bundle of custodial and administrative services may accept and process orders for the plan's participants for the investment of new contributions or the reallocation of existing contributions. This no-action letter involves a third-party recordkeeper that is paid shareholder servicing fees for receiving participants' investment instructions and maintaining records for participant accounts. An independent trustee submits purchases and sales for the plan as a whole. The recordkeeper does not provide investment advice, offer mutual funds, or otherwise engage in any activity other than act as a mechanical order gatherer for very limited compensation and is not affiliated with any other entity that does so. If affiliation were not an issue, is this a model that the bank could use for its 401(k) plan business?

Questions Regarding Bank Custody Practices


  1. The staff understands that certain types of customers are more likely than others to establish custody relationships with banks. These types of customers include corporations, endowments, market professionals (such as mutual funds, hedge funds, and investment advisers), employer pension plans (both defined benefit plans and defined contribution plans), and certain individuals (such as private banking clients, trust clients, or owners of IRAs). Are there other types of investors with which your bank has a custody relationship? If so, could you describe those types of customers and estimate what percentage of your custody business they account for?
  2. What is the approximate market value of the securities that your bank holds in custody for customers?
  3. What is the approximate market value of the securities that your bank arranged to purchase for its customers by forwarding orders to a mutual fund, trading desk, or affiliated broker-dealer [in the last month] [in an average month] [in the past fiscal year] [in the past calendar year]?
  4. The staff would like to better understand the types of transactions that banks are called upon to effect for their custody customers. Please estimate the percentage of transactions that your bank effects for custody customers in (a) mutual funds, (b) equity securities, (c) government securities, and (d) debt securities other than government securities. Please also estimate the number of transactions that the bank effects in each of these categories.
  5. With respect to the types of customers identified in question 1, above, which customers generate the most securities transactions? Please rank these customer types from highest to lowest.
  6. To what extent is your bank's custody department involved in the bank's proprietary trading? For example, does the bank ever borrow securities from custody clients?


  1. To the extent that your bank purchases mutual funds for custody customers, how does it select which funds to offer? Does it offer proprietary funds? How does it execute orders for mutual funds?
  2. Does your bank have a relationship with one or more broker-dealers through which it provides securities services to custody customers? If your bank has a relationship with multiple broker-dealers, how do you decide which orders to send to which broker-dealer?
  3. The staff would expect that some custody customers just use the bank for custody — and not for execution services. What percentage of your custody customers do you estimate are custody-only clients? Do custody-only customers tend to be of particular types? (See question 1 in "General" section, above). If so, which types?
  4. Do some custody customers use the bank for execution sometimes but not all the time? If so, what percentage of their average [daily] [monthly] [yearly] processing volume for custody orders involves orders to trade?


  1. How does your bank market its custody services to potential custody clients? If you have written marketing materials, we would appreciate receiving copies.
  2. What percentage of your custody clients are also clients of your bank for other services?
  3. What information — if any — does your bank provide to custody customers regarding securities? For example, does the bank provide recommended lists, watch lists, research reports, or other publications highlighting particular securities or groups of securities?
  4. Does the bank recommend specific securities — or classes of securities — to custody customers? Does it recommend specific trading strategies?
  5. Does the bank provide investment advice to custody customers? Which ones?


  1. How are custody fees assessed? Do custody fees vary depending on other products or services that the custody customer may also use the bank for?
  2. Is the bank compensated in other ways for custody accounts or relationships? For example, does the bank have revenue sharing arrangements with mutual fund companies?
  3. What percentage of custody revenue comes from 12b-1 and other distribution fees? How, if at all, does this percentage vary in the contexts of custody accounts for (a) institutional (non-401k) plans, (b) market professionals, (c) individual private banking clients, and (d) IRAs?
  4. How are custody bank employees compensated? Please explain regular compensation as well as bonus potential.

Comparison with Industry Practice

  1. With respect to all the issues outlined above, how does your bank compare with other banks? Please identify significant differences. If your bank differs from other banks, which business model do you believe is closest to the industry norm?

Questions Regarding Corporate Trustees

Customers and Services

  1. What services does your bank perform as corporate trustee, in percentage terms from greatest to smallest? For example, temporary cash management by investing in money market funds; longer term cash management by investing in other types of securities such as government bond funds? Who are your customers, from largest to smallest?


The Commission staff would like to see fee schedules or contracts reflecting fees.

  1. How is your bank compensated when it acts as corporate trustee? Do clients have the choice of one all-inclusive (bundled) fee or unbundled fees? If it is an unbundled fee, what do clients pay for?
  2. How does the compensation differ if your bank acts as trustee or agent? What are the compensation restrictions when your bank acts as a corporate trustee versus when it acts as a custodian or agent?
  3. What kind of revenue sharing arrangements does your bank acting as corporate trustee typically enter into with broker-dealers? Mutual funds? Are there any other arrangements?

Bank Employees

  1. How are your corporate trust bank employees compensated?

Order Processing

  1. What percentage of the average daily securities processing volume for corporate trust or fiduciary orders involve orders to trade? In other words does e.g., 5% or less of the total number of corporate shares processed on average involve shares for which the bank has also taken an order to trade?
  2. How are orders to trade handled? Does the same trading desk handle them as other personal trust orders? Are they handled using the same protocols? What execution rules apply to your bank acting as corporate trustee?

Industry Practice

  1. How does your bank's corporate trustee activities compare to those of other banks, and if other banks have models that differ from the one used by your bank, what are the differences?


1 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publications or statements by any of its employees. The views expressed herein are mine and do not necessarily reflect the views of the Commission or of my colleagues on the staff of the Commission.

2 Attached to these remarks are the questions that the Commission staff forwarded to bank trade groups or to banks directly.



Modified: 11/17/2003