July 17, 2001
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: Interim Final Rules for Banks, Savings Associations, and Savings Banks Under Sections 3(a)(4) and 3(a)(5) of the Securities Exchange Act of 1934 (the "Exchange Act"), Release File No. S7-12-01 ("Interim Final Rules" or "Rules")
Dear Mr. Katz:
The undersigned members of the Banking Law Committee of the Business Law Section of the American Bar Association appreciate this opportunity to provide comments on the Interim Final Rules issued by the Securities and Exchange Commission (the "Commission" or "SEC") on May 18, 2001, under Title II of the Gramm-Leach-Bliley Act of 1999 (the "GLBA"). Each of the undersigned is an experienced banking lawyer and most are also experienced securities lawyers. We are in private practice (affiliations noted where applicable), and the concerns expressed in these comments are shared by many of our clients, state- and federally-chartered large and small banks and trust companies and their affiliated securities firms, located throughout the United States. All of us are in leadership positions with the Banking Law Committee.
We wish further to preface our comments by stating that we have been privileged since the enactment of Gramm-Leach-Bliley to have participated in ongoing, informal dialogues, through the Banking Law Committee's meetings, programs and other activities, with attorneys and other staff of the Commission with respect to these matters, and we have appreciated and benefited from the willingness of Commission staff to spend time meeting with members of the banking bar and to participate in seminars relating to this topic. Such dialogues have facilitated our understanding of the concerns of the staff concerning bank securities activities and, we hope, have also allowed us to acquaint further the staff participants with how securities activities have been historically conducted in banks and the investor protections afforded by fiduciary and other state laws governing such activities as well as by the comprehensive federal and state bank regulatory schemes.
Concerns Regarding the Rules' Rationale and General Approach. The Interim Final Rules implement the provisions of Title II of the Gramm-Leach-Bliley Act ("Title II") that eliminated the blanket exemptions for banks from the definitions of "broker" and "dealer" under the Exchange Act (as amended, the "Definitions") and replaced those exemptions with more specific, activity-focused exemptions. However, the clear intent of Congress in designing the new Definitions was to permit banks to continue providing trust, fiduciary, custodial, and other traditional banking services to meet customers' financial needs. With very clear and unambiguous language, Congress has accomplished this in Title II by drawing a distinct line between those securities activities that do not require the bank to register as a broker-dealer and those that do.
Activities that do not subject banks to SEC registration also do not subject them to SEC regulation. In other words, the regulatory scheme of the Exchange Act does not authorize the SEC to regulate those securities-related activities of a bank that do not bring it within the statutory definition of "broker" or "dealer": there is no "SEC-lite" authorized by the Definitions, whereby activities that do not require licensing nevertheless may be regulated by the SEC.1 We believe that in many respects, though, the Interim Final Rules do not conform to this fundamental delineation by Congress in the GLBA of regulatory authority and in effect constitute a new comprehensive regulatory regime governing and constraining traditional bank securities activities.
The work devoted by the staff to developing the Interim Final Rules is apparent. As a treatise on historic broker-dealer law, it is a valuable addition to the available source material on Commission and staff positions concerning the Exchange Act. However, we believe that in many cases the staff looked to historic Commission and staff precedents and interpretations of the Exchange Act for its inspiration for provisions of the Rules rather than to the clear, dispositive language of that Act as amended by the GLBA. These historic positions of the staff and the Commission regarding which activities were within or without the pre-amendment definitions of "broker" and "dealer" in the Exchange Act were in some cases adopted by Congress in Title II. However, in many significant instances they were not adopted (despite the strong urgings by articulate proponents of the Commission's historic positions) or were adopted in a significantly varied form. In these instances, where the express language of Title II amended the Definitions in a manner inconsistent with Commission and staff positions on the pre-GLBA Exchange Act definitions of "broker" and "dealer," those prior interpretations have effectively been superseded.
Basing parts of the Interim Final Rules on superseded interpretations of the Exchange Act has resulted in provisions in those Rules that conflict with and undermine a clear and conspicuous Congressional intent not to disturb traditional bank trust and fiduciary, custody and safekeeping, asset-backed securities and other specified traditional banking products.
Rather than recognizing that the conduct of those activities of banks that Congress chose to continue to leave outside the definitions of "broker" and "dealer" should be subjected to neither SEC registration nor regulation, the Rules in effect create an alternative scheme for regulation of these activities by defining any activities not conducted according to the Rules' narrow constraints as being "broker" or "dealer" activities. We believe that this comprehensive scheme of regulation is inconsistent with both the intent of Congress in enacting Title II and the clear language of the resulting, amended Exchange Act. Not only do the Rules provide interpretations and modifications of unambiguous provisions of the Definitions, in some cases the interpretations appear actually to contradict the Definitions. We believe the Rules should do neither.
The comprehensive regulation of fiduciary- and custody-related securities activities implemented by the Interim Final Rules will make it impossible, or at least uneconomic, for most banks to conduct such securities activities within the bank as authorized by the GLBA. This will have a particularly deleterious effect due to the adoption of interim, immediately effective rules without public comment and with only a five months compliance transition period.2 Consequently, banks which conclude that their securities activities may not be conducted economically under the Rules in their current form will be placed in a difficult position of having to try to comply by a short deadline with the current Rules notwithstanding any reasonable hope that the Rules will be modified before the compliance date in a manner that would allow those activities to be more economically conducted.
Request. Because of the concerns expressed above and, regarding specific provisions of the Rules, below, we request that the Rules be restated as "proposed" rather than "final" and that at least a full year's transition period after the issuance of any final rules be allowed before compliance becomes mandatory.
Specific Areas of Concern. In this section we enumerate some of our concerns with specific provisions of the Rules as they affect the conduct of specific traditional securities activities within banks and trust companies. While we hope the SEC will address each of these concerns, we wish to point out that doing so will not fully address the broader problem described above, which is that the Rules create a comprehensive program for regulation of bank securities activities not authorized by and inconsistent with the delineation of regulatory authority adopted by Congress in Title II.
Referral Fees. We understand the concern of the Commission as to referral fees. When improperly applied and administered, a referral fee may create an incentive to unlicensed bank employees to begin the sales process. However, we submit that the Rules unnecessarily micro-manage the area. The focus of our concern relates to the limitation of each referral fee to "one hour of the gross cash wages of the unregistered bank employee" and the limitations on bonuses based on a variety of factors besides referrals. These limitations are unnecessary, create immense complexity in the process and deviate from existing law and regulatory guidance, as expressed in the Interagency Statement on Retail Sales of Nondeposit Investment Products ("Retail Nondeposit Products Statement") and the Chubb Letter.3
These measures, which have been in effect for many years, have been thoroughly implemented by the banking industry and have been extremely effective in controlling abuses. There were no changes to existing law by Title II which require such a wholesale overhaul of existing regulatory positions or financial institution practices.
Under existing law and guidance as developed by the Commission and the federal bank regulatory agencies, referral fees must be one-time, fixed in amount and not based on a sale being made. Banks generally pay referral fees in the range of $10.00 to $100.00 based on a variety of factors, including the local competitive market. To require an institution to tie levels of such fees to individuals' hourly wages and to monitor these amounts is an unnecessary, even crippling burden. Moreover, can it be fair to require a bank to pay a lower-compensated employee lower referral fees than it pays a higher-compensated one for the same referral?
We submit that the Rules' provisions which are consistent with the Chubb Letter and the Retail Nondeposit Product Statement otherwise protect the integrity of referral fee programs and will prevent referral fees from becoming an incentive for inappropriate behavior; therefore, the referral fees "hourly wage" and bonus limitation may be removed from the Rules without increasing risk. As it stands, the Rules specify that referral payments may not be based on:
We do not understand why these limitations are not sufficient. They are consistent with the Chubb Letter. They are consistent with the Retail Nondeposit Products Statement. They are consistent with referral fees paid with respect to a broad range of investment products, including insurance products.
Moreover, Congress in the Definitions as amended has already delineated where the referral fee line is to be drawn, and the Commission's proposal varies sufficiently from the Definitions and even current law to constitute a redrawing of Congress' statutory line.
We request that the Commission not attempt to establish the appropriate amount for referral fees and instead rely on the other safeguards of existing law codified in the Rules. We do not believe, in this regard, that it would be appropriate for the Commission to consider a gross percent of compensation that may not be exceeded because it would be arbitrary and capricious in amount and would not indicate whether referrals are being made correctly. We believe that these safeguards protect the integrity of the referral fee system, assure that referral fees will not create incentives to bank employees to attempt to inappropriately promote securities products to bank customers and are consistent with the current, appropriate regulatory emphasis on risk management tailored to the risks and other circumstances of each institution.
As to bonus programs, we commend the Commission on recognizing programs based on points and are confident that bonus programs can be designed consistently with safety and soundness and industry practice. We also support the Commission's recognition of bonus programs based on overall profitability of the bank family. We believe that the ability to provide institution-wide incentive plans that factor in all lines of business is extremely important to the industry. However, the mechanisms of the Rules for restricting bonus plans appear to us unworkable and will make it extremely difficult to design any effective bonus plans for employees or business that include referral activities.
Trust and Fiduciary Activities. The Definitions provide that banks which engage in securities activities as trustees and other fiduciaries are exempt from broker registration if, among other things, the bank is "chiefly compensated" for such activities on the basis of an administration or annual fee, a percentage of assets under management fee or a flat fee or capped per order processing fee not greater than certain costs, or some combination of these fees. The purpose of these limits is to prevent a bank from conducting a full-fledged securities business under the guise of merely serving the needs of its trust and fiduciary customers. Subject to this requirement, Congress concluded that the trust and fiduciary laws and the oversight by federal and state banking agencies provide sufficient consumer protection for banks that operate within the statutory standards.
Nothing in the language of the GLBA or its legislative history suggests that the "chiefly compensated" limit should be applied on an account-by-account basis rather than on an aggregate basis to a bank's trust and fiduciary activities. The Interim Final Rules, however, require banks to conduct an account-by-account review in order to establish for each individual trust or fiduciary account that the bank is "chiefly compensated" by specified fees. This approach is inappropriate and, in many cases, unworkable as applied to banks' multi-faceted trust and fiduciary services and frequent multi-party trust and fiduciary relationships.
The account-by-account requirement of the Rules not only moves the line between securities activities that require registration as a broker and those that do not to a different point from that at which Congress statutorily drew the line, it also constitutes an intrusion into the day-to-day operations of trust companies and bank trust departments contrary to Congress' intent "that the Commission will not disturb traditional bank trust activities."4
The GLBA expressly provides that the exemption will be available when banks effect transactions in a "trustee" capacity or in any other "fiduciary capacity." The GLBA even provides an express definition of fiduciary capacity modeled on the Office of the Comptroller of the Currency's definition in its Regulation 9 (12 CFR Part 9). Rather than accepting the well understood and traditional definitions of "trustee" under federal and state laws or the unambiguous and ordinary meanings of the terms used by the GLBA to define "fiduciary capacity," the Commission has found ambiguities in the statute where none exist and supplied in the Rules new definitions that vary from accepted definitions under the common law, state and federal statutes and regulations of banking agencies long involved with fiduciary activities. There is no compelling or even acceptable reason for supplying definitions of these clear statutory terms adopted by the GLBA, especially new definitions that materially vary from accepted and well understood meanings of these terms.
The effect of these definitions is not to clarify but to throw into doubt the fiduciary capacities to which the exemption applies and to impose complicated and unnecessary new requirements for banks acting in those capacities to qualify for the exemption. Again, lines are being drawn in places that are inconsistent with statutorily drawn lines, and under the rubric of interpretation, a comprehensive system of SEC regulation is being imposed on banks.
A further example of an overly intrusive regulatory regime imposed by the Rules is to require a bank acting in an investment advisory capacity to provide its advisory services on a "continuous and regular" basis to the customer and under laws imposing on it a duty of loyalty in order to qualify as "fiduciary" under the Definitions of "broker." No such requirements or a rationale for imposing them may be found anywhere in the Definitions.
Custody and Safekeeping Activities. The Interim Final Rules also are contrary to the statute and legislative history of the GLBA's exemption for custody and safekeeping activities because they exclude order-taking activities that are part of customary banking activities. Bank custodians have a long-standing history of accommodating customers by accepting and transferring orders for securities to a registered broker-dealer. The GLBA includes an exception for safekeeping and custody services to preserve the traditional role of banks in providing customary custodial services for their customers, which customarily included order-taking. In enacting this exemption, Congress expressed a clear intent that traditional custodial, safekeeping and clearing activities, including custodial IRA relationships, be allowed to remain within the bank. Contrary to this statutory scheme and congressional intent, the Interim Final Rules do not include customary custodial order-taking services within the exemption.
The Interim Final Rules create two special exemptions that would not be needed if the Commission recognized that the Act permits banks to continue offering order-taking services to customers. One exemption permits bank custodians to continue providing customary order-taking services if they do not charge any fees for the service. Neither the statute nor its legislative history provides any support for prohibiting banks from charging fees for their customary custody and safekeeping activities. This restriction will cause banks either to stop offering this service, or to move custodial activities outside the bank, contrary to the statute and Congressional intent.
Notwithstanding our concerns with the current Rules' provisions governing order-taking in the custody context, we are sensitive to the SEC's concern that custody not be a vehicle through which banks may engage in a full-scale brokerage business with the custody activity only being a nominal part. We think, however, that the requirement that transactions be either crossed or executed through a broker adequately assures all the protections of the Exchange Act to custody customers and counterparties, and that in any event the Rules' restrictions, as currently formulated, are overly burdensome and intrusive to legitimate custody and safekeeping activities.
Dual Employees and Applicability of NASD Rule 3040. The Commission fails to address in the Rules the applicability of NASD Rule 3040 to "dual employee" arrangements in which bank personnel serve as employees of both a bank and a broker-dealer. We believe that it is necessary that the Commission issue guidance that clarifies that NASD Rule 3040 does not apply to dual employees operating in their capacity as bank employees when effecting securities transactions pursuant to an exception. Because of the inclusion by the Commission of a substantial sum for examinations of banks in connection with its appropriations request to Congress, we are particularly concerned that it intends to extend its examinations of dual employees beyond their activities on behalf of their broker-dealer employer.
Extension of Rule 3040 to the exempt securities activities of dual employees would effectively force banks to "push out" bank securities activities that the GLBA intended to remain in the bank in order to avoid unnecessary administrative burdens. The GLBA embraced the principles of functional regulation and placed the authority with the federal banking agencies for examining the securities activities conducted by bank employees consistent with the exceptions. SEC examination of dual employees engaged in exempt activities is inconsistent with the principles of functional regulation and not authorized by the amendments to the Exchange Act.
Once again, we wish to thank you for this opportunity to comment on the Interim Final Rules. If you have any questions regarding this comment or if we can be of assistance in any way, please feel free to contact John Duncan at 312-580-4949 or at email@example.com or any of the other undersigned individuals.
Marcy S. Cohen
New York, New York
John C. Deal
Kegler, Brown, Hill & Ritter
John P.C. Duncan
Duncan Associates, LLC
Harold B. Finn III
Finn, Dixon & Herling LLP
Eric R. Fischer
Goodwin Procter LLP
Ronald R. Glancz
Venable, Baetjer, Howard & Civiletti, LLP
Michael J. Halloran
Pillsbury Madison & Sutro, LLP
San Francisco, California
Venable, Baetjer, Howard & Civiletti, LLP
Eugene M. Katz
Womble, Carlyle, Sandridge & Rice
Charlotte, North Carolina
Richard K. Kim
Wachtell, Lipton, Rosen & Katz
New York, New York
Boston University School of Law
Jonathan L. Levin
Reed Smith LLP
Timothy R. McTaggart
Nixon Peabody LLP
Félix J. Montañez
San Juan, Puerto Rico
Laura N. Pringle
Pringle & Pringle
Oklahoma City, Oklahoma
James E. Scott
Venable, Baetjer, Howard & Civiletti, LLP
John E. Shockey
Milbank Tweed Hadley & McCloy
Karol K. Sparks
Krieg DeVault LLC
Deborah Hope Wedgeworth
Hempstead, New York
David J. Weise
Tyler Cooper & Alcorn, LLP
Richard M. Whiting
|1||This is not to imply that the SEC's vital, historic enforcement role with respect to violations of Section 10(b) of the Exchange Act and other provisions of federal securities laws proscribing fraudulent activities has in any way been diminished by the Definitions or the GLBA generally.|
|2||We question the authority under the Administrative Procedure Act for publication of the Rules without prior notice and comment on the "good cause" grounds cited in the Commission's release (66 Federal Register 27760 at 27788-27789, May 18, 2001). We do not believe that informal consultations with or requests from industry personnel were intended by Congress as good cause for omitting the entire APA statutory notice and comment procedure; nor do we believe that the final ground cited, that the Rules do not impose new obligations (in effect, are not substantive), lends the necessary support given the complexity of the Rules and their significant impacts on the securities activities of banks, which impacts were not anticipated nor anticipatable from the language of the Exchange Act.|
|3||Letter re: Chubb Securities Corp. (Nov. 24, 1993) ("Chubb Letter").|
|4||See H.R. Conf. Rep. No. 106-434 at 163, 164 (1999).|