SEC and Federal Reserve Board Issue Regulation R Guidance for Small Entities

Guidance prepared by the staffs of the SEC and Federal Reserve Board has been issued for small entities. The guidance was prepared as a “small entity compliance guide” under Section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996.

Regulation R was jointly adopted last year by the Fed and the SEC to implement the bank broker provisions of the Gramm-Leach-Bliley Act. Regulation R provides a flexible framework for banks to continue to serve the demands of their customers for banking services that include securities products while ensuring consumer protection.

The Gramm-Leach-Bliley Act repealed the blanket exemption banks had historically enjoyed from the Exchange Act definition of broker and replaced it with a set of limited exemptions that allow the continuation of traditional activities performed by banks. Thus, a bank will be considered a broker under the Exchange Act and subject to the full panoply of SEC regulation if it engages in the business of effecting transactions in securities for the accounts of others. However, at the same time, the Act carves out a number of exemptions from the definition of broker. Regulation R implements those exemptions.

The exemptions embrace a number of activities and transactions traditionally performed by banks and those involving identified excepted banking products. If a bank limits its brokerage activities to those described in the exceptions, the bank will not be subject to broker-dealer registration.

In the guidance, the staffs noted that, if more than one broker exemption is available to a bank under the statute or Regulation R, the bank may choose the exemption on which it relies to effect the transaction without registering as a broker-dealer. For example, if a bank effects no more than 500 securities transactions as agent for its customer in a calendar year, the bank may rely on the de minimis exception in lieu of any other available exception for such transactions. The bank, of course, must comply with all of the requirements contained in the exception on which it relies. More broadly, the staffs advise that any bank that wants to rely on one of these exemptions to the definition of broker should review and understand the terms, limits and conditions to the particular exemption.

The safekeeping and custody exception allows banks to engage in a variety of securities activities in connection with their customary custody and safekeeping activities, such as, for example, clearing and settling securities transactions and holding pledged securities on behalf of a customer. The staffs noted that a bank does not need to rely on this exception if it does not accept orders from or on behalf of custody accounts.

The networking exception permits bank employees that are not registered representatives of a brokerage firm to refer customers to the firm subject to several conditions, including a prohibition on the a bank employee referring a customer to a securities broker from receiving incentive compensation for a securities transaction other than a nominal one-time cash fee for making the referral. The staffs pointed out that the definition of incentive compensation in Regulation R includes exclusions from that definition for certain types of bank bonus plans.

There is also an exemption for securities transactions effected by a bank in a trustee or fiduciary capacity so long as the bank is chiefly compensated for effecting such transactions with certain types of fees called relationship compensation. Regulation R provides examples of the type of fees that qualify as relationship compensation and also specifies the conditions a bank must comply with in order to rely on the trust and fiduciary exception, such as restrictions on the bank’s advertisement of its securities activities for its trust and fiduciary accounts.