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Wednesday,
October 3, 2007

Part III

Federal Reserve
System
Securities and
Exchange
Commission

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12 CFR Part 218 and 17 CFR Parts 240
and 247
Definitions of Terms and Exemptions
Relating to the ‘‘Broker’’ Exceptions for
Banks and Exemptions for Banks Under
Section 3(a)(5) of the Securities Exchange
Act of 1934 and Related Rules; Final
Rules

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations

FEDERAL RESERVE SYSTEM
12 CFR Part 218
[Regulation R; Docket No. R–1274]

SECURITIES AND EXCHANGE
COMMISSION
17 CFR Parts 240 and 247
[Release No. 34–56501; File No. S7–22–06]
RIN 3235–AJ74

Definitions of Terms and Exemptions
Relating to the ‘‘Broker’’ Exceptions
for Banks
Board of Governors of the
Federal Reserve System (‘‘Board’’) and
Securities and Exchange Commission
(‘‘SEC’’ or ‘‘Commission’’) (collectively,
the Agencies).
ACTION: Final rule.

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AGENCIES:

SUMMARY: The Board and the
Commission jointly are adopting a
single set of final rules that implement
certain of the exceptions for banks from
the definition of the term ‘‘broker’’
under Section 3(a)(4) of the Securities
Exchange Act of 1934 (‘‘Exchange Act’’),
as amended by the Gramm-Leach-Bliley
Act (‘‘GLBA’’). The rules define terms
used in these statutory exceptions and
include certain related exemptions. In
developing these rules, the Agencies
have consulted with, and sought the
concurrence of, the Office of the
Comptroller of the Currency (‘‘OCC’’),
the Federal Deposit Insurance
Corporation (‘‘FDIC’’) and the Office of
Thrift Supervision (‘‘OTS’’), and have
taken into consideration all comments
received on the proposed rules issued in
December 2006. The rules are intended,
among other things, to facilitate banks’
compliance with the Exchange Act and
the GLBA.
DATES: Effective dates: The addition of
parts 12 CFR 218 and 17 CFR 247 is
effective September 28, 2007.
Regulations at 12 CFR 218.781 and 17
CFR 247.781 (collectively ‘‘Rule 781’’)
are effective on September 28, 2007.
Regulations at 12 CFR 218.100 through
218.780 and 17 CFR 247.100 through
247.780 are effective December 3, 2007.
Amendments affecting Part 240 of Title
17 are effective December 3, 2007.
Compliance date: Banks are exempt
from complying with the rules and the
‘‘broker’’ exceptions in Section
3(a)(4)(B) of the Exchange Act until the
first day of their first fiscal year that
commences after September 30, 2008.
FOR FURTHER INFORMATION CONTACT:
BOARD: Kieran J. Fallon, Assistant
General Counsel, (202) 452–5270,

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Andrea Tokheim, Counsel, (202) 452–
2300, or Brian Knestout, Attorney, (202)
452–2249, Legal Division, Board of
Governors of the Federal Reserve
System, 20th Street and Constitution
Avenue, NW., Washington, DC 20551.
Users of Telecommunication Device for
Deaf (TDD) only, call (202) 263–4869.
SEC: Catherine McGuire, Chief
Counsel, Linda Stamp Sundberg, Senior
Special Counsel, Joshua Kans, Senior
Special Counsel, John J. Fahey, Branch
Chief, or Elizabeth MacDonald, Special
Counsel, at (202) 551–5550, Office of the
Chief Counsel, Division of Market
Regulation, Securities and Exchange
Commission, 100 F Street, NE.,
Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Background
B. Overview of Comments
C. Final Rules and Related Matters
II. Networking Arrangements
A. Overview of Proposed Rules and
Comments
B. Rule 700: Definition of Terms Used in
Networking Exception
1. Definition of ‘‘Nominal One-Time Cash
Fee of a Fixed Dollar Amount’’
2. Definition of ‘‘Referral’’
3. Definition of ‘‘Contingent on Whether
the Referral Results in a Transaction’’
4. Definition of ‘‘Incentive Compensation’’
a. Exception for Discretionary, Multi-Factor
Bonus Plans
b. Safe Harbor for Plans Based on Overall
Profitability or Revenue
C. Rule 701: Exemption for Referrals
Involving Institutional Customers and
High Net Worth Customers
1. Definitions of ‘‘Institutional Customer’’
and ‘‘High Net Worth Customer’’
2. Determining that a Customer Meets the
Relevant Thresholds
3. Conditions Relating to Disclosures
4. Suitability or Sophistication Analysis by
Broker-Dealer
5. Conditions Relating to Bank Employees
6. Good Faith Compliance and Corrections
by Banks
7. Referral Fees Permitted Under the
Exemption
8. Permissible Bonus Compensation Not
Restricted
III. Trust and Fiduciary Activities
A. Trust and Fiduciary Exception and
Proposed Rules
B. Joint Final Rules
1. ‘‘Chiefly Compensated’’ Test and BankWide Exemption Based on Two-Year
Rolling Averages
2. ‘‘Relationship Compensation’’
3. Excluded Compensation
4. Trust or Fiduciary Accounts
5. Exemptions for Special Accounts,
Foreign Branches, Transferred Accounts,
and a De Minimis Number of Accounts
6. Advertising Restrictions
IV. Sweep Accounts and Transactions in
Money Market Funds
A. Rule 740: Definition of Terms Used in
Sweep Exception

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B. Exemption Regarding Money Market
Fund Transactions
V. Safekeeping and Custody
A. Background
B. Rule 760: Custody Exemption
1. Order-Taking for Employee Benefit Plan
Accounts and Individual Retirement or
Similar Accounts
a. Employee Compensation Restrictions
b. Advertisements and Sales Literature
c. Other Conditions
2. Order-Taking as an Accommodation for
Other Types of Accounts
a. Accommodation Basis
b. Employee Compensation Restrictions
c. Limitations on Bank Fees
d. Advertising and Sales Literature
Restrictions
e. Investment Advice or Recommendations
3. Other Conditions Applicable to OrderTaking for All Custody Accounts
a. Directed Trustees
b. Broker Execution Requirement
c. Carrying Broker Provisions
4. Custodians, Subcustodians, and
Administrators/Recordkeepers
a. ‘‘Account for Which a Bank Acts as a
Custodian’’
b. Administrators/Recordkeepers and
Subcustodians
5. Evasions
VI. Other Exemptions
A. Exemption for Regulation S
Transactions With Non-U.S. Persons and
Broker-Dealers
B. Exemption for Non-Custodial Securities
Lending Transactions
C. Exemption for Banks Effecting Certain
Excepted or Exempted Transactions in
Investment Company Securities and
Variable Insurance Products
D. Exemption for Certain Transactions
involving a Company’s Securities for Its
Employee Benefit Plans and Participants
E. Temporary and Permanent Exemption
for Contracts Entered Into by Banks From
Being Considered Void or Voidable
F. Extension of Time and Transition Period
VII. Finding That the Exemptions Are
Appropriate and in the Public Interest
and Consistent With the Protection of
Investors
VIII. Withdrawal of Proposed Regulation B
and Removal of Exchange Act Rules 3a4–
2–3a4–6, and 3b–17
IX. Administrative Law Matters
A. Paperwork Reduction Act Analysis
B. Consideration of Benefits and Costs
C. Consideration of Burden on
Competition, and on Promotion of
Efficiency, Competition, and Capital
Formation
D. Consideration of Impact on the
Economy
E. Regulatory Flexibility Analysis
F. Plain Language
X. Statutory Authority
XI. Text of Rules and Rule Amendment

I. Introduction
A. Background
The GLBA amended several federal
statutes governing the activities and
supervision of banks, bank holding

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
companies, and their affiliates.1 Among
other things, it lowered barriers between
the banking and securities industries
erected by the Banking Act of 1933
(‘‘Glass-Steagall Act’’).2 It also altered
the way in which the supervisory
responsibilities over the banking,
securities, and insurance industries are
allocated among financial regulators.
Among other things, the GLBA repealed
most of the separation of investment
and commercial banking imposed by the
Glass-Steagall Act. The GLBA also
revised the provisions of the Exchange
Act that had completely excluded banks
from broker-dealer registration
requirements.
In enacting the GLBA, Congress
adopted functional regulation for bank
securities activities, with certain
exceptions from Commission oversight
for specified securities activities. With
respect to the definition of ‘‘broker,’’ the
GLBA amended the Exchange Act to
provide eleven specific exceptions for
banks.3 Each of these exceptions
permits a bank to act as a broker or
agent in securities transactions that
meet specific statutory conditions.
In particular, Section 3(a)(4)(B) of the
Exchange Act as amended by the GLBA
provides conditional exceptions from
the definition of broker for banks that
engage in certain securities activities in
connection with third-party brokerage
arrangements; 4 trust and fiduciary
activities; 5 permissible securities
transactions; 6 certain stock purchase
plans; 7 sweep accounts; 8 affiliate
transactions; 9 private securities
offerings; 10 safekeeping and custody
1 Pub.

L. No. 106–102, 113 Stat. 1338 (1999).
L. No. 73–66, ch. 89, 48 Stat. 162 (1933)
(as codified in various Sections of 12 U.S.C.).
3 15 U.S.C. 78c(a)(4).
4 Exchange Act Section 3(a)(4)(B)(i). This
exception permits banks to enter into third-party
brokerage, or ‘‘networking’’ arrangements with
brokers under specific conditions.
5 Exchange Act Section 3(a)(4)(B)(ii). This
exception permits banks to effect transactions as
trustees or fiduciaries for securities customers
under specific conditions.
6 Exchange Act Section 3(a)(4)(B)(iii). This
exception permits banks to buy and sell commercial
paper, bankers’ acceptances, commercial bills,
exempted securities, certain Canadian government
obligations, and Brady bonds.
7 Exchange Act Section 3(a)(4)(B)(iv). This
exception permits banks, as part of their transfer
agency activities, to effect transactions for certain
issuer plans.
8 Exchange Act Section 3(a)(4)(B)(v). This
exception permits banks to sweep funds into noload money market funds.
9 Exchange Act Section 3(a)(4)(B)(vi). This
exception permits banks to effect transactions for
affiliates, other than broker-dealers.
10 Exchange Act Section 3(a)(4)(B)(vii). This
exception permits certain banks to effect
transactions in certain privately placed securities,
under certain conditions.

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activities; 11 identified banking
products; 12 municipal securities; 13 and
a de minimis number of other securities
transactions.14
In October 2006, the Financial
Services Regulatory Relief Act of 2006
(‘‘Regulatory Relief Act’’) became
effective.15 Among other things, the
Regulatory Relief Act requires that the
SEC and the Board jointly adopt a single
set of rules to implement the bank
broker exceptions in Section 3(a)(4) of
the Exchange Act.16 In addition, it
required that the Agencies issue a single
set of proposed rules to implement these
exceptions not later than 180 days after
enactment of the Regulatory Relief Act
(April 11, 2007).
In December 2006, the Agencies
jointly issued, and requested public
comment on, a single set of proposed
rules to implement the broker
exceptions for banks relating to thirdparty networking arrangements, trust
and fiduciary activities, sweep
activities, and safekeeping and custody
activities.17 The proposed rules
included certain exemptions related to
these activities, as well as exemptions
related to foreign securities transactions,
securities lending transactions
conducted in an agency capacity, the
execution of transactions involving
mutual fund shares, and the potential
liability of banks under Section 29 of
the Exchange Act. In developing the
proposed rules, the Agencies
considered, among other things, the
language and legislative history of the
‘‘broker’’ exceptions for banks adopted
in the GLBA, the rules previously issued
or proposed by the Commission relating
to these exceptions, and the comments
received in connection with those prior
rulemakings.
The Agencies requested comment on
all aspects of the proposed rules. In
addition, the Agencies requested
comment on whether it would be useful
or appropriate for the Agencies to adopt
rules implementing the other bank
11 Exchange Act Section 3(a)(4)(B)(viii). This
exception permits banks to engage in certain
enumerated safekeeping or custody activities,
including stock lending as custodian.
12 Exchange Act Section 3(a)(4)(B)(ix). This
exception permits banks to buy and sell certain
‘‘identified banking products,’’ as defined in
Section 206 of the GLBA.
13 Exchange Act Section 3(a)(4)(B)(x). This
exception permits banks to effect transactions in
municipal securities.
14 Exchange Act Section 3(a)(4)(B)(xi). This
exception permits banks to effect up to 500
transactions in securities in any calendar year in
addition to transactions referred to in the other
exceptions.
15 Public Law No. 109–351, 120 Stat. 1966 (2006).
16 See Exchange Act Section 3(a)(4)(F), as added
by Section 101 of the Regulatory Relief Act.
17 See 71 FR 77522, December 26, 2006.

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‘‘broker’’ exceptions in Section
3(a)(4)(B) of the Exchange Act that were
not addressed in the proposal.
B. Overview of Comments
The Agencies received comments
from 58 organizations and individuals
on the proposed rules. Commenters
included 22 trade associations, 20
banking organizations, 7 other
organizations in the financial services
industry, 3 community and nonprofit
groups, two credit unions, one state
government, one self-regulatory
organization, one association of state
securities administrators, and one
individual. Many commenters
supported the proposed rules as a
general matter. For example,
commenters asserted that the proposed
rules would provide banks considerable
flexibility in providing securities
services to their customers, would avoid
disrupting bank activities and customer
relationships, or were a significant
improvement over earlier proposals.18
In addition, many commenters
supported the general approaches
(including related exemptions) taken by
the proposed rules to implement the
networking, trust and fiduciary, sweep,
and safekeeping and custody
exceptions. Several commenters,
however, contended that the proposed
rules did not adequately protect
investors, and particularly retail
investors.19 Some of these commenters
argued that that the Agencies should
withdraw the proposed rules and issue
new rules based on those issued in
200120 or 2004.21
Most commenters also recommended
that the Agencies modify specific
provisions of the proposed rules to,
among other things, reduce
administrative burden, better protect
bank customers or investors, or clarify
the scope or effect of the rules. The
comments received on the proposed
rules are discussed in greater detail in
the following sections of this
SUPPLEMENTARY INFORMATION.
C. Final Rules and Related Matters
After carefully considering the
comments, the Agencies have adopted
18 See, e.g., Citigroup Letter, Independent
Community Bankers Ass’n (‘‘ICBA’’) Letter,
American Bankers Ass’n (‘‘ABA’’) Letter, JPMorgan
Chase & Co. (‘‘JP Morgan’’) Letter, Financial
Services Roundtable (‘‘Roundtable’’) Letter.
19 See, e.g., Massachusetts Securities Division
Letter, Pace Investors Rights Project (‘‘Pace Project’’)
Letter, Boyd Financial Letter.
20 Exchange Act Release No. 44291 (May 11,
2001), 66 FR 27760 (May 18, 2001).
21 Exchange Act Release No. 49879 (June 17,
2004), 69 FR 39682 (June 30, 2004). See, e.g., North
American Securities Administrators Association
(‘‘NASAA’’) Letter.

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final rules to implement the broker
exceptions for banks relating to thirdparty networking arrangements, trust
and fiduciary activities, sweep
activities, and custody and safekeeping
activities.22 The Board and SEC have
consulted extensively with, and sought
the concurrence of, the OCC, FDIC and
OTS in developing these final rules.
Like the proposal, the final rules
include certain exemptions related to
these activities, as well as exemptions
related to foreign securities transactions,
securities lending transactions
conducted in an agency capacity, the
execution of transactions other than
through a broker-dealer, the potential
liability of banks under Section 29 of
the Exchange Act, and the date on
which the GLB Act’s ‘‘broker’’
exceptions for banks will go into effect.
As discussed in the following
sections, the Agencies have modified
the rules in numerous respects in light
of the comments received. These
changes include, among other things,
modifications to the examples of
‘‘relationship compensation’’ in Rule
721 to clarify the scope of the term for
purposes of the rules relating to trust
and fiduciary activities; the custody
exemption in Rule 760 to permit banks
acting as a directed trustee to accept
orders under the exemption; and Rule
781 to extend the compliance date for a
bank until the first day of its first fiscal
year commencing after September 30,
2008. The Agencies also have adopted
new exemptions relating to trust or
fiduciary accounts held in a foreign
branch of a bank,23 and to permit a bank
to effect, under certain conditions and
without using a broker-dealer,
transactions in a fiduciary or custodial
capacity for an employee benefit plan in
the stock of the plan’s sponsor.24
The final rules are designed to
accommodate the business practices of
banks and protect investors. If more
than one broker exception or exemption
is available to a bank under the statute
or rules for a securities transaction, the
bank may choose the exception or
exemption on which it relies to effect
the transaction without registering as a
broker-dealer. For example, if the bank
effects a transaction in a security sold in
an offshore transaction for a custody
account that is permissible under either
the Regulation S exemption in Rule 771
or the custody exemption in Rule 760,
the bank may choose which exemption
22 Commenters generally did not request that the
Agencies adopt rules to implement the other broker
exceptions for banks at this time or stated that no
additional guidance was needed at this time with
respect to these exceptions. See ABA Letter.
23 See Rule 723(c).
24 See Rule 776.

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to rely on and comply with in effecting
the transaction. Similarly, if a bank
effects no more than 500 securities
transactions as agent for its customers in
a calendar year, the bank may rely on
the de minimis exception in Section
3(a)(4)(B)(xi) of the Exchange Act in lieu
of any other available exception or
exemption for such transactions. The
bank, of course, must comply with all of
the requirements contained in the
exception or exemption on which it
relies.25
Section 401 of the Regulatory Relief
Act amended the definition of ‘‘bank’’ in
Section 3(a)(6) of the Exchange Act to
include any Federal savings association
or other savings association the deposits
of which are insured by the FDIC.
Accordingly, as used in the final rules,
the term ‘‘bank’’ includes any savings
association that qualifies as a ‘‘bank’’
under Section 3(a)(6) of the Exchange
Act, as amended.26
Identical sets of the final rules are
being adopted by the Board and SEC
and will be published by the Board in
Title 12 of the Code of Federal
Regulations and by the SEC in Title 17
of the Code of Federal Regulations.27
Pursuant to the Regulatory Relief Act,
this single set of final rules supersedes
any and all other proposed or final rules
issued by the Commission on or after
the date of enactment of the GLBA with
regard to the definition of ‘‘broker’’
25 An employee of a bank that operates in
accordance with the exceptions in Section 3(a)(4)(B)
of the Exchange Act and, where applicable, the
rules is not required to register as a ‘‘broker’’ to the
extent that the employee’s activities are covered by
the relevant exception or rule.
26 Several commenters asked the Agencies, or the
Commission independently, to adopt rules that
would extend to federal or state-chartered credit
unions some or all of the ‘‘broker’’ exceptions or
exemptions provided banks under Section 3(a)(4)(B)
of the Exchange Act or the final rules. See, e.g.,
Credit Union Nat’l Ass’n Letter, Nat’l Ass’n of
Credit Union Service Organizations Letter, Nat’l
Ass’n of Fed. Credit Unions Letter, Navy Fed. Credit
Union Letter, and XCU Corp. Letter. While the
GLBA’s ‘‘bank’’ exceptions do not by their terms
apply to credit unions, these requests are under
consideration by the Commission, which is the
agency with authority to address these matters. The
Commission notes the existence of SEC staff
positions with regard to networking relationships
between a credit union and a broker-dealer and is
not addressing this issue at this time. See, e.g.,
Chubb Securities Corp., 1993 SEC No-Act. LEXIS
1204 (Nov. 24, 1993).
27 The final rules adopted by the Board and the
SEC within their respective titles of the Code of
Federal Regulation (12 CFR part 218 for the Board
and 17 CFR part 247 for the SEC) are identically
numbered from § ___.100 to § ___.781. For ease of
reference, the single set of final rules adopted by
each Agency are referred to in this release as Rule
___, excluding title and part designations. A similar
format is used to refer to the single set of proposed
rules issued by the Agencies.

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under Section 3(a)(4) of the Exchange
Act.28
Any additions or changes to these
rules that may be appropriate to
implement Section 3(a)(4)(B) of the
Exchange Act will be adopted jointly by
the SEC and Board in accordance with
the consultation provisions in Section
101(b) of the Regulatory Relief Act. In
addition, if any rules (including
exemptions) are proposed or adopted in
the future related to the other bank
‘‘broker’’ exceptions in Section
3(a)(4)(B) of the Exchange Act that are
not addressed in the final rules now
being adopted by the SEC and the
Board, they would be proposed and
adopted jointly by the SEC and Board.29
As required by the GLBA, the Board,
OCC, FDIC, and OTS (collectively, the
Banking Agencies) will develop, and
request public comment on,
recordkeeping rules for banks that
operate under the ‘‘broker’’ exceptions
in Section 3(a)(4) of the Exchange Act.30
These rules, which will be developed in
consultation with the SEC, will
establish recordkeeping requirements to
enable banks to demonstrate compliance
with the terms of the statutory
exceptions and the final rules and will
be designed to facilitate compliance
with the statutory exceptions and the
rules.
Several commenters urged the
Agencies also to cooperate in providing
interpretations or guidance (such as staff
no-action letters) concerning the final
rules or the broker exceptions for banks
in Section 3(a)(4)(B) of the Exchange Act
or in taking enforcement action to
enforce compliance with these rules or
exceptions.31 In addition, a number of
commenters urged the Agencies to work
28 Pub. L. No. 109–351, § 101(a)(3), 120 Stat. 1966,
1968 (2006).
29 A few commenters requested that the
Commission delegate authority to act on future
exemptive requests from banks to the Director of its
Division of Market Regulation. See America
Community Bankers Ass’n (‘‘ACB’’) Letter, Roma
Bank Letter. Because particular banks may have
individual situations that may be appropriate for
additional relief, the Commission delegated
authority to the Director of the Division of Market
Regulation to consider, on a case-by-case basis,
individual requests for exemptive relief from banks.
To facilitate the processing of these requests, the
Commission delegated this exemptive authority
within its Rules of Organization and Program
Management in Rule 30–3(a)(70) (17 CFR 200.30–
3(a)(70)). The Commission continues to expect the
staff to submit novel and complex requests for
exemptions to the Commission.
30 See 12 U.S.C. 1828(t)(1).
31 See, e.g., ABA Letter, Clearing House Ass’n
Letter, Citigroup Letter, The PNC Financial Services
Group, Inc. (‘‘PNC’’) Letter. One commenter,
however, expressed concern that coordination
among the Agencies might result in slower
responses to requests for guidance. See American
Bar Ass’n Section of Business Law Letter (‘‘Business
Law Section Letter’’).

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
with the Financial Industry Regulatory
Authority (‘‘FINRA’’) 32 to modify
promptly its Rule 3040 as it applies to
persons that are employees of both a
bank and a broker-dealer (so-called
‘‘dual employees’’).33
In light of the joint nature of the final
rules and the Agencies’ joint rulewriting authority for the bank broker
exceptions in Section 3(a)(4)(B),34 the
Agencies will jointly issue any
interpretations and responses to
requests for no-action letters or other
interpretive guidance concerning the
scope or terms of the exceptions and
rules, and will consult and, to the extent
appropriate, coordinate with each other
and the appropriate federal banking
agency for a bank concerning any formal
enforcement actions proposed to be
taken against a bank for violations of the
exceptions or rules.
The Agencies already consult with
and coordinate with each other and the
other federal banking agencies in a
variety of areas, and the Agencies and
the other federal banking agencies are in
the process of supplementing their
existing policies and procedures to
facilitate coordination with respect to
the broker exceptions and rules. Banks
or others that seek an interpretation of,
or a no-action letter or other staff
guidance concerning, the rules or the
exceptions should submit their request
to both Agencies. The Agencies also
expect to continue their dialogue with
FINRA concerning potential
modifications to that authority’s Rule
3040.
II. Networking Arrangements

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The third-party brokerage exception
(‘‘networking exception’’) in Section
3(a)(4)(B)(i) of the Exchange Act permits
a bank to avoid being considered a
broker if, under certain conditions, it
32 On July 26, 2007, the Commission approved a
proposed rule change filed by NASD to amend
NASD’s Certificate of Incorporation to reflect its
name change to Financial Industry Regulatory
Authority Inc., or FINRA, in connection with the
consolidation of member firm regulatory functions
of NASD and NYSE Regulation, Inc. See Securities
Exchange Act Release No. 56146 (July 26, 2007).
FINRA’s Rules currently consist of the rules
adopted by the NASD and effective on the date of
the consolidation (which include NASD Rule 3040),
as well as certain rules of the NYSE that FINRA has
incorporated into its own rules.
33 See, e.g., ABA Letter, Clearing House Ass’n
Letter, Harris Bank Letter, HSBC Bank, N.A.
(‘‘HSBC Bank’’) Letter, HSBC Securities (USA) Inc.
(‘‘HSBC Securities’’) Letter, Roundtable Letter.
These commenters asserted that it was important
for the requested modifications to FINRA’s Rule
3040 to be made prior to the date on which banks
would first have to comply with the new ‘‘broker’’
exceptions in the GLBA.
34 Rapaport v. U.S. Department of Treasury, 59 F.
3d 212, 216–217 (D.C. Cir. 1995), cert. denied 116
S.Ct. 775 (1996).

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enters into a contractual or other written
arrangement with a registered brokerdealer under which the broker-dealer
offers brokerage services to bank
customers.35 The networking exception
does not address the type or amount of
compensation that a bank may receive
from its broker-dealer partner under a
networking arrangement. However, the
networking exception provides that a
bank may not pay its unregistered
employees 36 incentive compensation
for brokerage transactions. Nevertheless,
the statutory exception does permit a
bank employee to receive a ‘‘nominal
one-time cash fee of a fixed dollar
amount’’ for referring bank customers to
the broker-dealer if payment of the
referral fee is not ‘‘contingent on
whether the referral results in a
transaction.’’ 37 Congress included this
general prohibition on, and limited
exception to, incentive compensation to
reduce concerns regarding the securities
sales practice of unregistered bank
employees.
A. Overview of Proposed Rules and
Comments
Proposed Rule 700 defined certain
key terms related to referral fees and
incentive compensation used in the
networking exception. For example, the
proposed rule provided that a referral
fee would be considered ‘‘nominal’’ if it
met any of four standards included in
the rule. The proposed rule also defined
when a referral fee would be
‘‘contingent on whether a referral results
in a transaction,’’ what constitutes
‘‘incentive compensation,’’ and what
types of bank bonus plans would not be
considered incentive compensation
under the networking exception.
Proposed Rule 701 included an
exemption that permitted bank
employees, subject to certain
conditions, to receive higher-thannominal, contingent referral fees for
referring institutional customers and
high net worth customers to a brokerdealer.
Many commenters supported the
general approach of Proposed Rules 700
and 701, including the range of
alternatives provided for determining if
a referral fee is nominal and the
adoption of an exemption for referrals
involving high net worth or institutional
35 15

U.S.C. 78c(a)(4)(B)(i).
unregistered bank employee is an employee
that is not registered or approved, or otherwise
required to be registered or approved, in accordance
with the qualification standards established by the
rules of any self-regulatory organization.
37 15 U.S.C. 78c(a)(4)(B)(i)(VI).
36 An

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56517

customers.38 Some commenters,
however. suggested that the proposed
rules would harm investors by giving
bank employees undue incentives to
direct unsophisticated customers into
potentially unsuitable investment
products.39
B. Rule 700: Definition of Terms Used in
Networking Exception
1. Definition of ‘‘Nominal One-Time
Cash Fee of a Fixed Dollar Amount’’
Proposed Rule 700 defined the term
‘‘nominal one-time cash fee of a fixed
dollar amount’’ to mean a cash payment
for a referral in an amount that meets
any one of four alternative standards:
the first based on twice the average
hourly base wage established by the
bank for the employee’s job family; the
second based on 1/1000th of the average
annual base salary established by the
bank for the employee’s job family; the
third based on twice the employee’s
actual base hourly wage; and the fourth
based on a specified dollar amount
($25), indexed for inflation.40
Many commenters generally
supported the flexibility that this range
of alternatives would afford in
determining whether a referral fee is
‘‘nominal.’’ 41 Some commenters
expressed concern that the proposed
rule placed greater limits on permissible
payments under networking
arrangements than exist currently under
applicable federal banking agency
guidance or questioned the need for a
definition of ‘‘nominal’’ to be
established by rule at all.42 A few
commenters contended that the specific
dollar amount in the proposed rule
($25) was too low.43 A number of
commenters, however, believed that the
alternatives would result in the payment
of fees that are higher than nominal and
would create incentives for bank
employees to make securities referrals
even when not appropriate for the
customer. These commenters
questioned, for example, whether twice
an employee’s hourly wage was truly
nominal and whether the Agencies had
sufficient basis for selecting that
measure of ‘‘nominal.’’ 44
38 See, e.g. ABA Letter, Roundtable Letter,
Citigroup Letter, Union Bank of California (‘‘Union
Bank’’) Letter.
39 See, e.g., Pace Project Letter.
40 Proposed Rule 700(c).
41 See, e.g., Roundtable Letter, ACB Letter.
42 See, e.g., Bank Insurance & Securities Ass’n
(‘‘BISA’’) Letter, Wisconsin Bankers Ass’n (‘‘WBA’’)
Letter.
43 See, e.g., Clearing House Ass’n Letter and ICBA
Letter.
44 See, e.g., Boyd Financial Letter, NASAA Letter,
Pace Project Letter, and University of Cincinnati
Corp. Law Ctr. Letter.

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After carefully reviewing the
comments, the Agencies have
determined to adopt the ‘‘nominal’’
definition substantially as proposed.
Including a definition of ‘‘nominal’’ in
the rule will provide banks with
certainty as to the Agencies’’
interpretation of that standard and
should facilitate compliance. The
Agencies believe that each of the
alternatives for defining ‘‘nominal’’ is
consistent with the statutory networking
exception, which provides that a bank
employee may receive compensation for
each referral if the compensation for
that referral is ‘‘nominal’’ and meets the
other requirements of the statute. Under
each of the alternatives established, the
amount of compensation a bank
employee may receive for each referral
will be small in relation to the
employee’s overall compensation and
therefore unlikely to create undue
incentives for the bank employee to
engage in activities, such as ‘‘preselling’’ specific securities to the
customer involved in violation of the
networking exception,45 which would
raise sales practice concerns. As
discussed below, the multiple
alternatives are designed to provide
flexibility for banks of all sizes and
locations to use different business
models and to take into account
economic differences around the
country and among their employees in
assessing how best to structure their
program(s) for paying ‘‘nominal’’ cash
referral fees under the networking
exception. The alternatives also were
designed to allow for roughly equivalent
treatment of bank employees at different
base or hourly compensation levels
within a bank.
Rule 700(c) provides that a referral fee
paid to any bank employee will be
considered ‘‘nominal’’ if it does not
exceed $25.46 This dollar amount will
be adjusted for inflation on April 1,
2012, and every five years thereafter, to
reflect any changes in the value of the
Employment Cost Index For Wages and
Salaries, Private Industry Workers (or
any successor index thereto), as
published by the Bureau of Labor
Statistics, from December 31, 2006.47
The Agencies selected this index
because it is a widely used and broad
indicator of increases in the wages of
private industry workers, which
includes bank employees. Available
data indicate that the $25 amount is
consistent with the level of referral fees
generally paid to tellers and other bank
45 See

Exchange Act Section 3(a)(4)(B)(i)(V).
700(c)(3).
47 Each adjustment would be rounded to the
nearest multiple of $1. Rule 700(f).
46 Rule

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employees engaged in making referrals
of retail customers under existing
Banking Agency guidance, which also
includes a ‘‘nominal’’ standard.48
As under the proposal, a referral fee
also will be considered ‘‘nominal’’
under Rule 700(c) if the payment does
not exceed (1) twice the employee’s
actual base hourly wage; (2) twice the
average of the minimum and maximum
hourly wage established by the bank for
the current or prior year for the job
family that includes the employee; or (3)
1/1000th of the average of the minimum
and maximum annual base salary
established by the bank for the current
or prior year for the job family that
includes the employee.49
In developing these alternatives to the
fixed $25 fee, the Agencies considered
data on the average hourly wages of
bank tellers, which are the class of bank
employees most typically engaged in
making referrals of retail customers.
These data indicate that the national
mean hourly wage in 2005 for tellers
was $10.59.50 Accordingly, the $25
amount is slightly more than twice the
national mean hourly wage for tellers in
2005, and slightly more than 1/1000th
of the annualized salary of an employee
that makes $12.50 per hour (or $25
every two hours) based on a 40 hour
work week.51 Thus, the alternatives
based on twice the employee’s hourly
base wage or 1/1000th of the employee’s
base annual salary, at current pay rates,
are designed to allow bank employees to
receive referral fees that are roughly
equivalent to those that may be received
by bank tellers under the flat dollar
option.
The options based on the employee’s
job family use these same measurements
but allow comparisons to the average of
the minimum and maximum hourly
base wage or base salary of the
employee’s job family. These options
are designed to reduce administrative
burden while also ensuring that referral
fees remain nominal in amount. To
provide comparability between the
alternative based on an employee’s
actual compensation and those based on
48 See ABA Securities Ass’n., 2003/2004 National
Survey of Bank Retail Investment Services, Vol. I,
at 60 (survey data demonstrate that 20 percent of
banks pay retail referral fees of $20 or more);
Banking Agencies’ Interagency Statement on Retail
Sales of Nondeposit Investment Products (Feb. 15,
1994).
49 Rule 700(c)(1) and (2).
50 Occupational Employment and Wages, May
2005, (Tellers), U.S. Department of Labor, Bureau of
Statistics.
51 Specifically, twice the hourly wage for an
employee who earns an annual base salary of
$25,000 (1,000 × $25) would be $24.04, based on
a 40 hour per week (or 1080 hours per year) work
schedule.

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the compensation established for the
employee’s job family, the Agencies
have modified the final rule to provide
that a referral fee also will be considered
nominal if it does not exceed 1/1000th
of the employee’s actual base annual
salary.52 Under the final rules, a bank
may use a different ‘‘nominal’’
methodology in its different business
lines or operating units and may alter
the methodology it uses within a given
year.
One commenter suggested that the
term ‘‘job family’’ was ambiguous and
could allow banks to include all
employees in a single job family, which
would result in payments to employees
with salaries at the lower end of the job
family that may be well in excess of
twice their hourly wage.53 Rule 700
defines a ‘‘job family’’ as a group of jobs
or positions involving similar
responsibilities, or requiring similar
skills, education or training, that a bank,
or a separate unit, branch or department
of a bank, has established and uses in
the ordinary course of its business to
distinguish among its employees for
purposes of hiring, promotion, and
compensation.54 The requirements that
a job family include jobs or positions
with similar responsibilities, or that
require similar skills, education and
training, and be used by the bank in the
ordinary course of its business for
hiring, promotion and compensation
purposes are designed to prevent a bank
from establishing special job family
classifications to evade the ‘‘nominal’’
standard. A bank may not deviate from
its ordinary classification of jobs for
purposes of determining whether a
referral fee is nominal under this
standard, and the Banking Agencies will
monitor the job family classifications
used by banks for ‘‘nominal’’
determination as part of the risk-focused
examination process. Depending on a
bank’s internal employee classification
system, examples of a job family may
include tellers, loan officers, or branch
managers. The Agencies note, moreover,
that other provisions of the networking
exception also provide significant
protection to customers. For example,
the networking exception provides that
unregistered bank employees may
perform only clerical or ministerial
functions in connection with brokerage
transactions.55 Accordingly, bank
employees referring a customer to a
broker-dealer under the exception may
not provide investment advice
concerning securities or make specific
52 Rule

700(c)(2).
Pace Project Letter.
54 Proposed Rule 700(d).
55 See 15 U.S.C. 78c(a)(4)(B)(i)(V).
53 See

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securities recommendations to the
customer.56
A few commenters suggested that, by
defining ‘‘nominal’’ by reference to
hourly wages and annual base salary,
the rule treats unfairly employees who
receive a considerable portion of their
compensation through bonuses tied to
sales of non-securities products.57
Because the five alternatives included in
the final rule are based on a set dollar
amount or the hourly wage or annual
base salary established by a bank for the
employee or the employee’s job family,
the alternatives help ensure that a
referral fee will be nominal in relation
to the employee’s compensation in the
year it is paid. Bonuses, however,
typically are discretionary, vary
significantly from year-to-year and, as
noted by commenters, may constitute a
significant portion of the compensation
of certain types of bank employees in
particular years. Permitting referral fees
to be based in part on the size of a bonus
paid in a previous year (or projected to
be paid in the current year) could allow
bank employees to receive a referral fee
that is not nominal in relation to the
employee’s compensation, or the
average compensation paid to
employees within the relevant job
family, in the year in which the fee is
paid and, thus, could increase the
potential for sales practice concerns.
Commenters also asserted that more
than one employee should be able to
receive a fee for a single referral and
also requested clarification as to
whether officers and directors of a bank
may receive referral fees under the
exception.58 The Agencies believe that
the networking exception permits a
bank employee who personally
participated in a referral to receive a
referral fee for the referral.59
Accordingly, the Agencies have
modified Rule 700(c) to clarify this
position. Thus, for example, a
supervisory employee may receive a
separate, nominal one-time cash fee for
a referral made by another individual
supervised by the employee only if the
supervisory employee personally
participated in the referral. A
supervisory employee may not,
56 A bank employee, however, may describe in
general terms the types of investment vehicles
available from the bank and the broker-dealer under
the arrangement. See id.
57 See, e.g., ABA Letter, BISA Letter, Clearing
House Ass’n Letter, Harris Bank Letter, Roundtable
Letter, PNC Letter, U.S. Trust Company, N.A. (‘‘U.S.
Trust’’) Letter, and WBA Letter.
58 See, e.g., Consumer Bankers Ass’n (‘‘CBA’’)
Letter, BISA Letter.
59 See Section 3(a)(4)(B)(i)(VI) of the Exchange
Act (permitting ‘‘the bank employee [to] receive
compensation for the referral of any customer’’ in
accordance with the exception).

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however, receive a referral fee merely
for supervising the employee making
the referral or administering the referral
process. An officer or director of a bank
who makes or personally participates in
making a referral may receive a nominal
fee for the referral as a bank employee.
The proposed rule permitted a
nominal referral fee to be paid only in
cash. Many commenters requested that
banks be given the flexibility to pay
referral fees in non-cash forms.60 The
terms of the networking exception,
however, provide for a ‘‘nominal, onetime cash fee of a fixed dollar
amount’’ 61 and, accordingly, the final
rule continues to require that referral
fees paid under the exception be paid in
cash. A bank, therefore, may not pay
referral fees in non-cash forms, such as
vacation packages, stock grants, annual
leave, or consumer goods. The final
rules do not, however, prevent a bank
from paying an employee on a quarterly
or more frequent periodic basis the total
amount of nominal, fixed cash fees the
employee earned during the period. For
example, if a bank employee is entitled
to receive a $25 referral fee for each
securities referral and the employee
makes three qualifying referrals in a
given quarter, the bank may pay the
employee $75 at the end of the quarter
instead of three individual payments of
$25. A bank also may use a ‘‘points’’
system to keep track of the number of
qualifying securities referrals made by
the employee during a quarterly or more
frequent period and the total amount of
nominal, fixed cash fees that the
employee is entitled to receive at the
end of the period. In all cases, however,
points must translate into cash
payments on a uniform basis and the
cash amount that an employee will
receive for a qualifying securities
referral (e.g., twice the employee’s
actual base hourly wage) must be fixed
before the referral is made and may not
be contingent or vary based on whether
an employee makes a specified number
or type of securities referrals during a
quarterly or more frequent period.62
60 See, e.g., ABA Letter, BISA Letter, Clearing
House Ass’n Letter, and JP Morgan Letter.
61 See Exchange Act Section 3(a)(4)(B)(i)(VI).
62 The exception and the final rules also do not
prohibit a bank from providing its employees noncash items, such as pizza or coffee mugs, in
connection with programs to familiarize bank
employees with new types of investment vehicles
offered by the bank or the broker-dealer through the
arrangement, provided that the programs or items
given to employees do not reward or compensate
an employee for making a referral to a brokerdealer. Thus, for example, a ‘‘pizza party’’ that is
made available only to those employees that have
made one or more referrals to a broker-dealer would
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2. Definition of ‘‘Referral’’
The statutory networking exception
permits bank employees to receive a
nominal one-time cash fee of a fixed
dollar amount for the ‘‘referral’’ of a
customer to a broker-dealer. Rule 700(e)
defines a referral as an action taken by
one or more bank employees to direct a
customer of the bank to a broker-dealer
for the purchase or sale of securities for
the customer’s account.63 For purposes
of the networking exception and Rules
700 and 701, the term ‘‘customer’’
includes both existing and potential
customers of the bank.
As proposed, a bank employee may
receive a referral fee under the
networking exception and Rule 700 for
each referral made to a broker-dealer,
including separate referrals of the same
individual or entity. In addition,
nothing in the statutory networking
exception or the final rules limits or
restricts the ability of a bank employee
to refer customers to other departments
or divisions of the bank itself, including,
for example, the bank’s trust, fiduciary
or custodial department. Likewise, the
networking exception and the rules do
not apply to referrals of retail,
institutional or high net worth
customers to a broker-dealer or other
third party solely for transactions not
involving securities, such as loans,
futures contracts (other than a security
future), foreign currency, or over-thecounter commodities, or solely for
transactions in securities (such as U.S.
Government obligations) that would not
require the other party to register under
section 15 of the Exchange Act.64
3. Definition of ‘‘Contingent on Whether
the Referral Results in a Transaction’’
Under the statutory networking
exception, a nominal fee paid to an
unregistered bank employee for
referring a customer to a broker-dealer
may not be contingent on whether the
referral results in a transaction. This
limitation is designed to allow banks to
reward bank employees for introducing
customers to a broker-dealer without
giving unregistered bank employees a
direct financial interest in any resulting
securities transaction at the brokerdealer.
The final rule, like the proposed rule,
provides that a referral fee will be
considered ‘‘contingent on whether the
referral results in a transaction’’ if
payment of the fee is dependent on
63 Rule

700(e).
bank that acts as a government securities
broker (as defined in Section 3(a)(43) of the
Exchange Act) is not exempt from and must comply
with the notification and other applicable
requirements of section 15C of the Exchange Act.
64 A

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whether the referral results in a
purchase or sale of a security; whether
an account is opened with a brokerdealer; whether the referral results in a
transaction involving a particular type
of security; or whether the referral
results in multiple securities
transactions.65 The final rule expressly
provides that a referral fee may be
contingent on whether a customer (1)
contacts or keeps an appointment with
a broker-dealer as a result of the referral;
or (2) meets any objective, base-line
qualification criteria established by the
bank or broker-dealer for customer
referrals, including such criteria as
minimum assets, net worth, income, or
marginal federal or state income tax
rate, or any requirement for citizenship
or residency that the broker-dealer, or
the bank, may have established
generally for referrals for securities
brokerage accounts.66 A bank or brokerdealer may establish and use different
objective, base-line qualification criteria
(including citizenship or residency
requirements) for different classes of
customers or for different business lines,
divisions or units of the bank or brokerdealer.
Commenters generally supported
these permissible contingencies. Some
commenters contended that the rule
also should allow payment of a nominal
referral fee to be contingent on other
events, such as the opening of an
account at the broker-dealer or on the
opening of an account that may be used
to conduct only securities transactions
that the bank itself could effect without
registering as a broker under the
exceptions for banks in Sections
3(a)(4)(B) of the Exchange Act.67
Opening a securities account at the
broker-dealer, however, is a necessary
first step to executing securities
transactions and one that a customer is
unlikely to take unless the customer
anticipates engaging in securities
transactions with the broker-dealer. In
light of this close link between opening
an account and executing securities
transactions, the Agencies have not
modified the rule as requested and the
final rule continues to provide that
payment of a referral fee may not be
contingent on whether the customer
opens an account (other than the types
of accounts described in Part B.2 supra.)
at the broker-dealer. Other
contingencies not specified in the rule
may be permissible if they are not based
on whether the referral results in a
700(a).
66 Rule 700(a).
67 See, e.g., BISA Letter, Clearing House Ass’n
Letter, and U.S. Trust Letter.

securities transaction at the brokerdealer.
In addition, the ‘‘broker’’ exceptions
in Sections 3(a)(4)(B) of the Exchange
Act are available only to banks.
Accordingly, a referral to a broker-dealer
for a securities transaction within the
scope of section 15 of the Exchange Act
still involves a ‘‘broker’’ transaction at
the broker-dealer even if a bank could
conduct the transaction itself without
registering as a broker, and a referral fee
may not be contingent on the
occurrence of such a transaction (or the
opening of an account to engage in such
transactions).68
4. Definition of ‘‘Incentive
Compensation’’
The networking exception prohibits
an unregistered employee of a bank that
refers a customer to a broker-dealer
under the exception from receiving
‘‘incentive compensation’’ for the
referral or any securities transaction
conducted by the customer at the
broker-dealer other than a nominal, noncontingent referral fee. To provide banks
and their employees additional
guidance in this area, Proposed Rule
700(b) defined ‘‘incentive
compensation’’ as compensation that is
intended to encourage a bank employee
to refer potential customers to a brokerdealer or give a bank employee an
interest in the success of a securities
transaction at a broker-dealer.
The proposed rule also excluded
certain types of bonus compensation
from the definition of ‘‘incentive
compensation.’’ Proposed Rule 700(b)(1)
excluded compensation paid by a bank
under a bonus or similar plan if such
compensation is paid on a discretionary
basis; based on multiple factors or
variables; such factors or variables
include significant factors or variables
that are not related to securities
transactions at the broker-dealer; and a
referral made by the employee or any
other person is not a factor or variable
in determining the employee’s
compensation under the plan.
In addition, Proposed Rule 700(b)(2)
provided that the definition of incentive
compensation did not prevent a bank
from compensating its employees on the
basis of any measure of the overall
profitability of (1) the bank, either on a
stand-alone or consolidated basis; (2)
any of the bank’s affiliates (other than a
broker-dealer) or operating units; or (3)
a broker-dealer if such profitability is
only one of multiple factors or variables
used to determine the compensation of

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the officer, director, or employee and
those factors or variables include
significant factors or variables that are
not related to the profitability of the
broker-dealer. The Agencies specifically
requested comment on whether existing
bank bonus programs would fit, or
could easily be adjusted to fit, within
these proposed exclusions.
Many commenters indicated that the
proposed bonus provisions worked well
and would not interfere with bank
bonus plans generally. One commenter,
however, opposed the proposed bonus
provisions arguing that permitting
bonuses to be based even in part on
revenues generated by activity
conducted at a broker-dealer would
encourage bank employees to make
referrals regardless of the
appropriateness of the referral in order
to increase their compensation under
the bonus plan.69 In addition, a number
of commenters requested that the
Agencies either confirm that bonus
programs structured in particular ways
identified by the commenter would not
fall within the definition of ‘‘incentive
compensation’’ or modify the terms of
the exclusions to encompass plans with
these features. For example, several
commenters asked the Agencies to
confirm that the rules would not
prohibit a bank from basing an
employee’s bonus on the assets,
revenues or profits brought to the bank
and its partner broker-dealer by that
employee. Other commenters asked that
the Agencies provide that all
‘‘traditional’’ bank bonus programs are
protected under the rule.
A number of commenters also raised
specific issues with one or more aspects
of the exception in Rule 700(b)(1) for
discretionary, multi-factor bonus plans
or the safe harbor in Rule 700(b)(2) for
plans based on overall profitability. For
example, some commenters requested
clarification of the ‘‘discretionary’’
requirement in paragraph (b)(1) and
asserted that a bonus plan should be
considered ‘‘discretionary’’ if employees
do not have an enforceable right to
compensation under the plan until it is
paid.70 One commenter also argued that
Proposed Rule 700(b)(1) should not
prohibit the number of referrals made by
an employee from playing a role in the
employee’s compensation under a
bonus plan.71
Several commenters also asserted that
the safe harbor in paragraph (b)(2)
should be clarified or expanded to cover
69 See

NASAA Letter.
e.g., U.S. Trust Letter and Union Bank

70 See,
68 For similar reasons, a referral to a broker-dealer
for such a transaction is a ‘‘referral’’ for purposes
of the networking exception and Rule 700.

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Letter.
71 See TD Banknorth, N.A. (‘‘TD Banknorth’’)
Letter.

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bonus programs based on any measure
of the financial performance, and not
just the ‘‘overall profitability,’’ of a
bank, affiliate, operating unit or brokerdealer.72 Commenters indicated that
bank bonus programs may be based on
a wide variety of measures or metrics
related to the operations or performance
of the bank, an affiliate or operating
unit.73 Some commenters also requested
that the safe harbor be revised to clarify
that a bonus program may be based on
the overall profitability of an operating
unit of an affiliate of a bank (other than
a broker-dealer), or be expanded to
allow bonus programs to be based on
the financial performance of a branch,
division, or geographical or operational
unit of a broker-dealer.74
The purpose of the exception and
exclusion in paragraph (b) is to
recognize that certain types of bonus
plans are not likely to give unregistered
bank employees a promotional interest
in the brokerage services offered by the
broker-dealers with which the bank
networks and to avoid affecting bonus
plans of banks generally. As described
below, the Agencies have made several
revisions to the exception and exclusion
to help clarify the types of bonus plans
that fall outside of the scope of
‘‘incentive compensation’’ and to ensure
that excepted or excluded plans are not
likely to give bank employees an
impermissible promotional interest in
the broker-dealer’s activities. These
exceptions and exclusions are crafted to
accommodate existing types of bank
bonus programs in general.
Nevertheless, a plan’s longevity or the
number of banks that utilize similar
plans are not factors in determining
whether a plan constitutes ‘‘incentive
compensation’’ under this definition.
Accordingly, banks that have
networking arrangements with a brokerdealer should review their existing
bonus programs in light of the standards
set forth in the rule to evaluate whether
they may constitute impermissible
incentive compensation.

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a. Exception for Discretionary, MultiFactor Bonus Plans
Under Rule 700(b)(1) of the final
rules, compensation paid by a bank
under a bonus or similar plan is
specifically excepted from ‘‘incentive
compensation’’ if it is paid on a
discretionary basis and based on
multiple factors or variables, provided
72 See, e.g., ABA Letter, Clearing House Ass’n
Letter.
73 See, e.g., Clearing House Ass’n Letter, Harris
Bank Letter, U.S. Trust Letter.
74 See, e.g., ABA Letter, Clearing House Ass’n
Letter, HSBC Bank Letter, PNC Letter, and Union
Bank Letter.

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that (1) those factors or variables
include multiple, significant factors or
variables that are not related to
securities transactions at the brokerdealer; (2) a referral made by the
employee is not a factor or variable in
determining the employee’s
compensation under the plan; and (3)
the employee’s compensation under the
plan is not determined by reference to
referrals made by any other person.75
The Agencies have modified the rule to
make clear that, to be excluded under
Rule 700(b)(1), a multi-factor plan must
include multiple, significant factors or
variables that are not related to
securities transactions at the brokerdealer.76 The proposed rule already
required that there be ‘‘significant
factors or variables’’ and the addition of
‘‘multiple’’ highlights the plural nature
of these terms.
Each factor or variable unrelated to
securities transactions at the brokerdealer will be considered ‘‘significant’’
for purpose of Rule 700(b) if it plays a
material role in determining an
employee’s compensation under the
bonus or similar plan, i.e., the amount
of the employee’s bonus could be
reduced or increased by a material
amount based on the non-securities
factor or variable. This clarification will
give banks greater certainty and will
allow them to more readily identify the
types of factors or variables not related
to securities transactions that must be
included within a discretionary, multifactor bonus plan under paragraph (b)(1)
of the Rule. Thus, under paragraph
(b)(1), a bank’s bonus program may take
account of the full range of banking,
securities or other business of one or
more customers brought to the bank and
its partner broker-dealer by an employee
so long as the bonus is paid on a
discretionary basis, the banking and
other factors or variables not related to
securities transactions at the brokerdealer are significant factors or variables
under the bonus program, and a referral
or number of referrals made by the
employee or others is not a factor or
variable under the program. In this way,
the rule is designed to accommodate
discretionary bank bonus programs that
are based on general measures of the
business or performance of a bank or a
particular customer, branch or other
75 Rule 700(b)(1). The requirement that an
employee’s compensation not be based on a
‘‘referral’’ made by the employee or another person
means that the employee’s compensation under the
bonus or similar plan may not vary based on the
fact that the employee or other person made a
referral to a broker-dealer or the number of
securities referrals made by the employee or other
person to a broker-dealer.
76 A similar change has been made to the
corresponding language in Rule 700(b)(2).

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56521

unit of the bank, that are not based on
referrals made by one or more bank
employees and that include some inputs
based on securities transactions at a
broker-dealer as well as multiple
significant factors or variables that are
unrelated to securities transactions at
the broker-dealer.
A bank may not establish or maintain
one or more ‘‘sham’’ non-securities
factors or variables in its bonus or
similar plan for the purpose of evading
the restrictions in Rule 700(b) and the
Banking Agencies will continue to
review the bonus and similar plans of
banks participating in networking
arrangements as part of the risk-focused
supervisory process. In considering if a
bonus program at a bank contains
sufficient banking or other factors
unrelated to securities transactions at a
broker-dealer, the agencies will
consider, among other things, whether
such factors or variables relate to
banking or other non-broker-dealer
business(es) actually being conducted
by the bank or its employees, the
resources devoted by the bank to such
business(es), and whether such
business(es) materially contributes to
the payments made under the plan over
time. It is not expected that the actual
payments made under a bank’s bonus or
similar plan would, over time, be based
predominantly on securities
transactions conducted at a brokerdealer. If such a situation were to occur,
the bank would be expected to make
appropriate modifications to its bonus
or similar plan going forward.
A bonus or similar plan will be
considered ‘‘discretionary’’ under the
final rule if the amount an employee
may receive under the plan is not fixed
in advance and the employee does not
have an enforceable right to payments
under the plan until the amount of any
payments are established and declared
by the bank. A plan may, however,
include targets or metrics that must be
met in order for any bonus to be paid,
provided the plan is otherwise a
‘‘discretionary’’ plan.
The Agencies have not modified the
rule to allow a bonus plan to be based
on the fact of a referral or the number
of referrals made by one or more bank
employees. The Agencies believe that
doing so would allow a direct linkage
between a referral and an employee’s
bonus compensation and be contrary to
the purposes of the exception.
b. Safe Harbor for Plans Based on
Overall Profitability or Revenue
The safe harbor provisions of Rule
700(b)(2) are designed to allow banks to
avoid having to analyze whether a
particular bonus program meets the

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requirements of the exception in
paragraph (b)(1) in circumstances where
the general structure of the program
clearly reduces the potential for sales
practice concerns in connection with a
referral to a broker-dealer. The Agencies
have made several changes to the safe
harbor to address the issues raised by
commenters and to ensure that the safe
harbor achieves its purpose. In
particular, the Agencies have modified
paragraph (b)(2) of the rule to cover any
bonus or similar plan that is based on
the overall profitability or revenue of:
(i) The bank, either on a stand-alone
or consolidated basis;
(ii) Any affiliate of the bank (other
than a broker-dealer), or any operating
unit of the bank or an affiliate (other
than a broker-dealer), if the affiliate or
operating unit does not over time
predominately engage in the business of
making referrals to a broker-dealer; or
(iii) A broker-dealer if:
(A) Such measure of overall
profitability or revenue is only one of
multiple factors or variables used to
determine the compensation of the
officer, director or employee;
(B) The factors or variables used to
determine the compensation of the
officer, director or employee include
multiple significant factors or variables
that are not related to the profitability or
revenue of the broker-dealer;
(C) A referral made by the employee
is not a factor or variable in determining
the employee’s compensation under the
plan; and
(D) The employee’s compensation
under the plan is not determined by
reference to referrals made by any other
person.
When a bonus program is based on
the overall profitability of a bank, an
affiliate of a bank (other than a brokerdealer), or an operating unit of the bank
or an affiliate (other than a brokerdealer), any relationship between a
referral made by an employee and the
amount of payments that the employee
may receive under the plan are likely to
be attenuated. In these circumstances,
for example, any potential connection
between the revenue received by a bank
from its partner broker-dealer as a result
of a referral and the payments made to
the referring bank employee under the
plan likely would be tenuous and
largely speculative given the number of
other employees, business and actions
that contribute to the overall
profitability of the bank, affiliate or most
operating units. The Agencies believe
this attenuation effectively addresses
any potential that payments under the
plan would give an employee an undue
promotional interest in any securities
transactions that may occur at the

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broker-dealer as a result of a referral. A
bonus plan based on the overall revenue
of a bank or qualifying affiliate or
operating unit would be similarly
attenuated and, for this reason, the
Agencies have modified the safe harbor
to cover plans based on either the
‘‘overall profitability or revenue’’ of a
bank or a qualifying affiliate or
operating unit. This would include
plans based on an entity’s earnings per
share or stock price, both of which are
directly related to the entity’s overall
profitability or revenue. Because other,
more granular measures of the financial
performance of a bank, affiliate or
operating unit could create an unduly
close connection between the
employee’s expected payment under the
bonus plan and referrals made to the
broker-dealer or the securities
transactions that result from those
referrals, the rules provide for plans
structured in more granular ways to be
analyzed under the multi-factor,
discretionary criteria in Rule 700(b)(1).
The potential connection between a
referral made by a bank employee and
the payments made to the employee
under a bonus plan may be particularly
strong if payments under the plan are
based on the profitability or revenue of
(i) the partner broker-dealer itself or a
specific branch or operating unit of the
broker-dealer (such as the branch or
operating unit responsible for handling
customers referred by the bank), or (ii)
an operating unit of the bank or a nonbroker-dealer affiliate that is
predominantly engaged over time in
referring customers to the broker-dealer.
To address the potential for improper
incentives in these situations, the
Agencies have modified Rule
700(b)(2)(iii) to allow a bonus program
to be based on the overall profitability
or revenue of a broker-dealer only if the
program meets the conditions specified
in (A)–(D) above. These conditions are
similar to those that would apply to a
discretionary bonus or similar plan
under paragraph (b)(1) and are designed
to ensure that the profitability or
revenue of the broker-dealer is only one
of multiple significant factors or
variables in determining the employee’s
compensation and that a referral or
number of referrals made by the
employee is not a factor or variable
under the program.77 Like the proposal,
the safe harbor in paragraph (b)(2) is not
available to bonus plans based on the
profitability or revenue of a particular
77 As with a multi-factor bonus plan under
paragraph (b)(1) of the Rule, a non-securities factor
or variable will be considered ‘‘significant’’ under
paragraph (b)(2)(iii) if it plays a material role in
determining an employee’s compensation under the
bonus or similar plan.

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branch, division or operating unit of the
partner broker-dealer.
In addition, the Agencies have
modified paragraph (b)(2)(ii) of the rule
to exclude bonus plans based on the
profitability or revenue of an operating
unit of a bank or non-broker-dealer
affiliate that over time predominantly
engages in the business of making
referrals to a broker-dealer. This
exclusion is intended to prevent a bank
from basing a bonus plan on the overall
profitability or revenue of a bank unit
that is focused solely or predominately
on making referrals to a broker-dealer.
This restriction, however, is not
intended to prevent a bonus plan from
being based on the overall profitability
or revenue of a bank unit, such as a call
center, that in fact markets, sells or
supports a range of bank products in
addition to making referrals to a brokerdealer and which is not, over time,
predominantly engaged in the business
of making referrals to a broker-dealer.
C. Rule 701: Exemption for Referrals
Involving Institutional Customers and
High Net Worth Customers
The proposed rules included an
exemption that would permit a bank,
subject to certain conditions, to pay an
employee a contingent referral fee of
more than a nominal amount for
referring an ‘‘institutional customer’’ or
‘‘high net worth customer’’ to a brokerdealer with which the bank has a
contractual or other written networking
arrangement.78 Among the conditions
included in the proposed rule were
conditions that—
• Established the financial thresholds
at which a customer would be
considered an ‘‘institutional customer’’
or ‘‘high net worth customer’’;
• Limited the types of bank
employees that may receive a higherthan-nominal referral fee under the
exemption and the manner in which
these fees may be structured; 79
• Required the bank to provide
certain disclosures to the customer
regarding the referral arrangement; 80
and
• Required that the agreement
between the bank and the broker-dealer
include certain provisions, including a
provision obligating the broker-dealer to
perform a suitability analysis of certain
securities transactions that may result
from the referral or a sophistication
analysis of the customer referred.81
Many commenters supported
providing an exemption for referrals
78 Proposed

Rule 701.
Proposed Rule 701(a)(1) and (d)(4).
80 See id. at 701(a)(2)(i).
81 See id. at 701(a)(3)(ii).
79 See

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involving sophisticated individuals and
entities.82 These commenters, for
example, asserted that the exemption
was appropriate in light of the required
sophistication of the customer
involved.83 Other commenters,
however, argued that providing an
exemption to the ‘‘nominal’’
requirement would not be in the interest
of investors or the public. These
commenters asserted that the exemption
as proposed would allow bank
employees to have a significant
salesman’s stake in securities
transactions and encourage bank
employees to act as finders or
salespeople for a broker-dealer.84
Many commenters, including a
number that supported the exemption,
also asked that the Agencies modify the
exemption to, among other things, lower
or alter the thresholds at which a person
would be considered an ‘‘institutional
customer’’ or ‘‘high net worth customer’’
under the rule; eliminate the provisions
of the rule requiring the broker-dealer to
perform a suitability or sophistication
analysis in connection with a referral; or
eliminate the limitations on the manner
in which a higher-than-nominal referral
fee may be structured. In addition, many
commenters requested that the Agencies
modify the rule in several respects to
reduce administrative burden and
complexity. For example, several
commenters asked that the Agencies
provide a bank and its partner brokerdealer greater flexibility to assign
between themselves the responsibility
for fulfilling the disclosure and other
obligations included in the rule.
After carefully considering the
comments, the Agencies have decided
to retain the exemption. The Agencies
continue to believe that it is appropriate
to provide an exemption from the
nominal and contingency limitations in
the networking exception for referrals
that both involve institutions and
individuals that meet certain financial
criteria and that occur under other
conditions designed for investor
protection. When provided appropriate
information, such institutions and
individuals are more likely to be able to
understand and evaluate the
relationship between a bank and its
employees and the bank’s broker-dealer
partner and the impact of that
relationship on any resulting securities
transaction with the broker-dealer. The
82 See, e.g., BISA Letter, CBA Letter, Citigroup
Letter, ICBA Letter, Roundtable Letter, Securities
Industry and Futures Markets Ass’n (‘‘SIFMA’’)
Letter, State Street Corp. Letter, U.S. Trust Letter,
Union Bank Letter.
83 See CBA Letter.
84 See, e.g., Massachusetts Securities Division
Letter, NASAA Letter.

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conditions in the final exemption are
designed to help ensure that, among
other things, institutional and high net
worth customers, as defined in the rule,
receive appropriate investor protections
and information that enables the
customer to understand the financial
interest of the bank employee so the
customer can make informed choices.
Moreover, as the exemption itself
provides, a bank operating under the
exemption also must comply with the
terms and conditions in the statutory
networking exception (other than the
compensation restrictions in Section
3(a)(4)(B)(i)(VI) of the Exchange Act’s
networking exception), including the
terms and conditions that require the
disclosure of the uninsured nature of
securities and that limit the role that a
bank employee may have in a brokerage
transaction.85 These conditions provide
additional protections to institutional
and high net worth customers that may
be referred to a broker-dealer under Rule
701.
The Agencies have modified the final
rule in several respects to, among other
things, provide banks and brokerdealers greater flexibility in complying
with the rule’s disclosure requirements
and to make the exemption more
workable in practice. In light of the
protections retained in the rule, the
Agencies also have modified the
thresholds at which a non-natural
person will be considered an
‘‘institutional customer’’ for purposes of
the rule. These modifications are
discussed further below.
Banks that pay their employees only
nominal, non-contingent fees in
accordance with Rule 700 for referring
customers—including institutional or
high net worth customers—to a brokerdealer do not need to rely on, or comply
with, the exemption provided in Rule
701. As under the proposal, the final
rule requires that the written agreement
between a bank operating under the
exemption and its partner broker-dealer
include terms that obligate the brokerdealer to take certain actions. Banks and
broker-dealers are expected to comply
with the terms of their written
networking arrangements. If a bank or
broker-dealer does not comply with the
terms of the agreement, however, the
bank would not become a ‘‘broker’’
under Section 3(a)(4) of the Exchange
Act or lose its ability to operate under
the proposed exemption.
85 See

Exchange Act Section 3(a)(4)(B)(i)(V) and

(IX).

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56523

1. Definitions of ‘‘Institutional
Customer’’ and ‘‘High Net Worth
Customer’’
Proposed Rule 701(d)(2) defined an
‘‘institutional customer’’ to mean any
corporation, partnership, limited
liability company, trust, or other nonnatural person that has at least $10
million in investments or $40 million in
assets. Under the proposal, a nonnatural person also would qualify as an
‘‘institutional customer’’ with respect to
a referral if the customer has $25
million in assets and the bank employee
refers the customer to the broker-dealer
for investment banking services.
Proposed Rule 701(d)(1) defined a ‘‘high
net worth customer’’ to mean any
natural person who, either individually
or jointly with his or her spouse, has at
least $5 million in net worth excluding
the primary residence and associated
liabilities of the person and, if
applicable, his or her spouse. Proposed
Rule 701 also included provisions
governing the allocation of assets held
by a natural person jointly with his or
her spouse and provided for the dollar
thresholds in the rule to be adjusted for
inflation every five years.
A number of commenters argued that
the proposed dollar thresholds for both
types of customers were too high in
light of the nature of the transactions
involved and the other requirements of
the exemption.86 Commenters asserted
that customers with lower levels of net
worth, assets or investments are
sophisticated enough to understand and
evaluate the implications of a higherthan-nominal or contingent referral fee.
Commenters suggested a wide variety of
alternative thresholds, with many
recommending that the Agencies use an
existing standard established under the
federal securities laws for assessing a
customer’s investment sophistication.
For example, commenters
recommended that the Agencies use the
‘‘accredited investor’’ definition in the
Commission’s Regulation D, or the
definition of that term proposed for use
in connection with investments in
certain private investment vehicles, for
purposes of defining an institutional or
high net worth customer; 87 treat all
corporate and non-natural persons as an
institutional customer; consider all
persons advised by a bank or a
registered investment adviser to be
sophisticated; or lower the asset
threshold for municipalities or
86 See, e.g., HSBC Bank Letter, U.S. Trust Letter,
SIFMA Letter, Roundtable Letter.
87 See 17 CFR 230.501(a)(3), (5) and (6); Securities
Act Rel. No. 33–8766, 72 FR 400, Jan. 4, 2007.

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charitable organizations.88 Several
commenters also asked that the
Agencies allow banks to use a business
customer’s revenues for purposes of
determining if the customer is an
institutional customer.
After carefully reviewing the
comments, the Agencies have modified
the definition of an ‘‘institutional
customer’’ in the final rule to mean any
corporation, partnership, limited
liability company, trust, or other nonnatural person that has, or is controlled
by a non-natural person that has, at
least: (i) $10 million in investments; or
(ii) $20 million in revenues; or (iii) $15
million in revenues if the bank
employee refers the customer to the
broker-dealer for investment banking
services.89 When converted to an
equivalent asset number, the $20
million and $15 million revenue
thresholds in the final rule are
somewhat lower than $40 million and
$25 million asset thresholds in the
proposed rule.90 The Agencies believe
that these lower thresholds are
appropriate for corporate and other nonnatural customers in light of the other
protections retained in the final rule,
including the provisions requiring a
suitability or sophistication
determination, and the greater internal
and external resources that business
entities typically have as compared to
individuals. The Agencies have
modified the thresholds to be based on
revenues (rather than assets) to
eliminate the potential for borrowings to
influence the status of a corporate
customer and to promote the equivalent
treatment of non-financial companies
and financial companies. In addition,
the Agencies have amended the rule to
provide that a company controlled by an
institutional customer will itself be
considered an institutional customer. A
company controlled by another
88 See, e.g., ABA Letter, Clearing House Ass’n
Letter, State Street Corp. Letter.
89 Rule 701(d)(2).
90 To develop comparable asset and revenue
thresholds for an institutional customer, the
Agencies used a dataset composed of all publicly
traded, U.S.-incorporated, non-financial companies
with a market capitalization of greater than $0 and
for which asset and sales data were available in the
2005 CompuStat Universe of North American
companies published by Standard & Poor’s
Corporation. For more information on the
CompuStat Universe, see http://
www2.standardandpoors.com/spf/pdf/products/
Compustat2006.pdf. A company with $40 million
in assets and a company with $25 million in assets
would rank at approximately the 27.5th percentile
and the 21.9th percentile, respectively, of all
companies within this dataset when ranked
according to assets. When the companies within
this dataset are ranked according to sales, the
companies at approximately the 27.5th percentile
and the 21.9th percentile have approximately $27.7
million and $15.7 million in sales.

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company should generally have access
to the resources and sophistication of
the controlling company.
The lower revenue threshold for
referrals involving investment banking
services is designed to facilitate access
to the capital markets by smaller
companies. Like the proposal, the final
rule defines ‘‘investment banking
services’’ to include, without limitation,
acting as an underwriter in an offering
for an issuer, acting as a financial
adviser in a merger, acquisition, tenderoffer or similar transaction, providing
venture capital, equity lines of credit,
private investment-private equity
transactions or similar investments,
serving as placement agent for an issuer,
and engaging in similar activities.91 The
phrase ‘‘other similar services’’ would
include, for example, acting as an
underwriter in a secondary offering of
securities and acting as a financial
adviser in a divestiture. These examples
are not exhaustive and are provided
solely for illustrative purposes.92
The final rule continues to define a
‘‘high net worth customer’’ as a natural
person who, either individually or with
his or her spouse, has at least $5 million
in net worth excluding the primary
residence and associated liabilities of
the person and, if applicable, his or her
spouse. In response to comments,93 the
Agencies have modified this definition
to include any revocable, inter vivos or
living trust the settlor of which is a
natural person who, either individually
or jointly with his or her spouse, meets
the $5 million in net worth test.94 This
change is designed to reflect the fact
that otherwise sophisticated individuals
may hold assets through such trusts for
estate planning or other purposes.
The Agencies believe that customers
that meet the net worth, investment and
revenue thresholds included in the final
rule should have the ability to
understand and evaluate the financial
interest of the bank employee making a
referral to a broker-dealer under the
exemption. In developing these
thresholds, the Agencies took into
account the limited nature of activities
covered by the exemption (i.e., a referral
91 See

Rule 701(d)(3).
used in this rule, the term ‘‘include,
without limitation’’ means a non-exhaustive list.
This usage is not intended to suggest that the term
‘‘including’’ as used in the Exchange Act and the
rules under that Act means an exhaustive list. The
use of the term ‘‘including, but not limited to’’ in
Exchange Act Rules 10b–10 and 15b7–1 is also not
intended to create a negative implication regarding
the use of ‘‘including’’ without the term ‘‘but not
limited to’’ in other Exchange Act rules. See
Exchange Act Release No. 49879, 69 FR 39682 (June
30, 2004), at footnote 76.
93 See ABA Letter, PNC Letter, Roundtable Letter.
94 Rule 701(d)(1)(i)(B).
92 When

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by a bank employee to a broker-dealer).
The Agencies have not modified the
rule, as requested by some commenters,
to treat any person advised by a bank or
a registered investment adviser as an
institutional or high net worth
customer. The existence of such an
advisory relationship generally is not,
by itself, sufficient to establish the
financial sophistication of an individual
or corporate entity for purposes of the
other similar standards in or developed
under the federal securities laws.95
For purposes of determining whether
a natural person meets the $5 million
net worth test, the assets of a person
include: (1) Any assets held
individually; (2) if the person is acting
jointly with his or her spouse, any assets
of the person’s spouse (whether or not
such assets are held jointly); and (3) if
the person is not acting jointly with his
or her spouse, fifty percent of any assets
held jointly with such person’s spouse
and any assets in which such person
shares with such person’s spouse a
community property or similar shared
ownership interest. These rules are
designed to ensure that the full amount
of jointly owned assets are not
considered in cases where one spouse
acts independently of the other in
contacting a broker-dealer.96 The
Agencies have re-formatted these
allocation provisions in the final rule to
make them easier to understand and
promote compliance.
As in the proposal, the dollar
threshold for both institutional
customers and high net worth customers
will be adjusted for inflation on April 1,
2012, and every five years thereafter, to
reflect changes in the value of the
Personal Consumption Expenditures
Chain-Type Price Index, as published by
the Department of Commerce, from
December 21, 2006. The Agencies
selected this index because it is a
widely used and broad indicator of
inflation in the U.S. economy.
2. Determining That a Customer Meets
the Relevant Thresholds
The proposal required the bank to
determine that the customer being
95 See, e.g., 15 U.S.C. 80a–2(a)(51), 78c(a)(54); 17
CFR 230.501(a).
96 One commenter asserted that the Agencies
should allow a person to include assets that the
person holds jointly with someone other than a
spouse, such as a relative or domestic partner, for
purposes of calculating whether the person meets
the net worth threshold. See Roundtable Letter. The
Agencies have not modified the rule in this manner
to keep the scope of individuals whose assets may
be considered in determining whether a natural
person has the appropriate level of financial
sophistication consistent with the standards used in
determining whether a natural person is an
accredited investor under the Commission’s
Regulation D. See 17 CFR 230.501(a).

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referred met the standards to be a high
net worth or institutional customer
either (i) before the referral fee was paid
to the bank employee, in the case of a
non-natural person, or (ii) prior to or at
the time of the referral, in the case of a
natural person.97 In making these
determinations for a natural person, the
proposed rule allowed the bank to rely
on a signed acknowledgment from the
person that he or she met the standards
to be a high net worth customer.98 The
proposed rule also required that the
written agreement between the bank and
the broker-dealer provide for the brokerdealer to (i) determine that the customer
being referred met the standards to be a
high net worth customer or institutional
customer before the referral fee was
paid,99 and (ii) promptly inform the
bank if the broker-dealer determined
that a customer referred under the
exemption did not meet the applicable
standard.100
Commenters argued that either the
bank or the broker-dealer, but not both,
should be required to make these
customer eligibility determinations and
that the bank and the broker-dealer
should be permitted to allocate
responsibility for these determinations
between themselves.101 In addition,
several commenters contended that a
bank should be allowed to make the
eligibility determinations for both high
net worth customers and institutional
customers before the referral fee is paid
or before a securities transaction is
effected at the broker-dealer.102 A few
commenters also asserted that banks
and broker-dealers should be permitted
to rely on a signed acknowledgement
from either an institutional or high net
worth customer.103
The status of the referred customer as
a high net worth or institutional
customer is a fundamental aspect of the
exemption and the final rule continues
to provide for both the bank and the
broker-dealer to determine that the
customer meets the necessary
qualification criteria to provide added
assurance that these criteria are met.104
97 Proposed

Rule 701(a)(2)(ii).
Rule 701(a)(2)(ii)(B)(2).
99 Proposed Rule 701(a)(3)(i).
100 Proposed Rule 701(a)(3)(iii)(A).
101 See, e.g., BISA Letter, Clearing House Ass’n
Letter, Citigroup Letter, and SIFMA Letter. Some
commenters, for example, suggested that requiring
bank employees to make these determinations
might require the employee to go beyond the
limited role a bank employee is permitted to play
in a brokerage transaction under the statute. See,
e.g., BISA Letter, ABA Letter.
102 See, e.g., ABA Letter, BISA Letter, Clearing
House Ass’n Letter, HSBC Bank Letter, and PNC
Letter.
103 See, e.g., Citigroup Letter, SIFMA Letter.
104 See Rule 701(a)(2)(ii) and (3)(ii)(B). The final
rule also continues to provide for the written

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98 Proposed

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In addition, less information typically is
in the public domain concerning the
financial resources of an individual than
of a corporation or other business entity
and, accordingly, there is a greater
likelihood that a bank employee—
without further investigation—will be
able to preliminarily identify corporate
or other business customers that are
likely to satisfy the rule’s eligibility
criteria than in the case of individuals.
For these reasons, the final rule
continues to provide for the bank to
determine that a natural person is a high
net worth customer before a referral is
made and before the employee
potentially develops an expectation of a
higher-than-nominal fee.
The Agencies, however, have
modified the final rule to make it more
flexible while retaining its underlying
purpose by providing that a bank or a
broker-dealer satisfies its customer
eligibility requirements if the bank or
broker-dealer ‘‘has a reasonable basis to
believe that the customer’’ is an
institutional customer or high net worth
customer before the time specified in
the rule.105 A bank or broker-dealer
would have a ‘‘reasonable basis to
believe’’ that a customer is a high net
worth customer or institutional
customer if, for example, the bank or
broker-dealer obtains a signed
acknowledgment from the customer (or,
in the case of an institutional customer,
from an appropriate representative of
the customer) that the customer meets
the applicable standards to be
considered a high net worth customer or
an institutional customer, respectively,
and the bank employee making the
referral or the broker-dealer employee
dealing with the referred customer does
not have information that would cause
the employee to believe that the
information provided by the customer
(or representative) is false.
3. Conditions Relating to Disclosures
The proposed exemption required
that the bank provide a high net worth
customer or institutional customer being
referred to the bank’s broker-dealer
partner certain written disclosures about
the bank employee’s potential interest
in the referral prior to or at the time of
the referral.106 Commenters generally
believed that providing these types of
disclosures to a high net worth or
institutional customer would help
ensure that the customer received
agreement between the bank and the broker-dealer
to require the broker-dealer to inform the bank if
the broker-dealer determines that a referred
customer does not meet the relevant eligibility
thresholds. See Rule 701(a)(3)(v)(A).
105 Rule 701(a)(2)(ii).
106 Proposed Rule 701(a)(2)(i).

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56525

appropriate information concerning the
relationship between the bank and the
broker-dealer,107 although a few
questioned whether sophisticated
customers required any disclosures at
all or suggested that more simplified
disclosures be permitted.108 A number
of commenters also asserted that the
requirement that the bank provide these
disclosures ‘‘prior to or at the time of
the referral’’ was impractical or
burdensome.109 Commenters instead
asserted that the rule should allow the
disclosures to be provided before the
referral fee is paid or before a securities
transaction is effected at the brokerdealer, or allow the bank and the brokerdealer to determine which entity would
make the disclosures.110
The final rule continues to require
that a high net worth or institutional
customer referred to a broker-dealer
under the exception receive disclosures
that clearly and conspicuously disclose
(i) the name of the broker-dealer; and (ii)
that the bank employee participates in
an incentive compensation program
under which the bank employee may
receive a fee of more than a nominal
amount for referring the customer to the
broker-dealer and that payment of this
fee may be contingent on whether the
referral results in a transaction with the
broker-dealer.111 This requirement
ensures that high net worth or
institutional customers receive notice of
the financial interest the referring
employee may have in the transaction
so they can make informed choices.
In light of the comments, the Agencies
have modified the provisions of the rule
governing how and when these
disclosures must be provided to make
the rule more workable and less
burdensome while also requiring that
customers receive the information in
time to make informed choices.
Specifically, the final rule provides two
options for providing the required
107 See, e.g., ABA Letter, JP Morgan Letter,
Roundtable Letter, BISA Letter.
108 See, e.g., Bank of America Corp. (‘‘BofA’’)
Letter and WBA Letter.
109 For example, some commenters noted that
some referrals may occur only by telephone or
asserted that it may be unclear to an employee
when a referral actually occurs.
110 See, e.g., ABA Letter, BISA Letter, Clearing
House Ass’n Letter, HSBC Bank Letter, and WBA
Letter. In addition, some commenters contended
that banks should be required to provide similar
conflict-of-interest disclosures to customers referred
to a broker-dealer under the statutory networking
exception. See, e.g., Boyd Financial Letter, Pace
Project Letter, University of Cincinnati Corp. Law
Center Letter. The statutory networking exception
itself sets certain disclosures that the bank or
broker-dealer must provide a customer in situations
where the bank employee making the referral may
receive only a ‘‘nominal’’ referral fee. 15 U.S.C.
78c(a)(4)(i)(IX).
111 Rule 701(b).

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disclosures. Under the first option, as
under the proposal, the bank must
provide the high net worth or
institutional customer the disclosures in
writing prior to or at the time of the
referral.112 The second option allows
the bank to provide the disclosure to the
customer orally prior to or at the time
of the referral. However, if the bank
provides the customer the required
disclosures only orally, then either (i)
the bank must provide the disclosure to
the customer in writing within 3
business days of the date of the referral;
or (ii) the broker-dealer must be
obligated, under the terms of its written
agreement with the bank, to provide the
disclosures in writing to the
customer.113 If the broker-dealer is
responsible for providing the written
disclosures, then it must provide the
disclosures to the customer prior to or
at the time the customer begins the
process of opening an account at the
broker-dealer (if the customer does not
already have an account with the
broker-dealer) or prior to the time the
customer places an order for a securities
transaction with the broker-dealer as a
result of the referral (if the customer
already has an account at the brokerdealer).114 In this way, the rule provides
a mechanism for customers to receive
the disclosures in writing when they
initially are provided only orally.
Whether provided orally or in writing,
the required disclosures will be
considered to have been made in a clear
and conspicuous manner if they are
provided in a manner designed to call
attention to the nature and significance
of the information.
4. Suitability or Sophistication Analysis
by Broker-Dealer
The proposed exemption required
that the written agreement between the
bank and the broker-dealer provide for
the broker-dealer to perform a suitability
or sophistication analysis of a securities
transaction or the customer being
referred, respectively. The type and
timing of the analysis needed to be
conducted by the broker-dealer
depended on whether the referral fee
was contingent on the completion of a
securities transaction at the brokerdealer.115 The proposed rule also
required that the written agreement
between the bank and its partner brokerdealer obligate the broker-dealer to
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112 Rule

700(a)(2)(i).
701(a)(2)(i) and (a)(3)(i).
114 Rule 701(a)(3)(i). As a general matter, a
customer begins the account-opening process when
the customer fills out the appropriate forms
provided by the broker-dealer to establish an
account.
115 Proposed Rule 701(a)(3)(ii).
113 Rule

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inform the bank if it determined that a
customer referred under the exemption,
or a transaction to be conducted by the
customer, did not meet the relevant
suitability or sophistication standard.116
Several commenters objected to this
suitability/sophistication requirement
arguing that the broker-dealer should be
required to conduct a suitability/
sophistication analysis only when such
an analysis would otherwise be required
under the rules of the broker-dealer’s
self-regulatory organization (‘‘SRO’’)
(i.e., in those cases where the brokerdealer makes a recommendation to the
customer concerning securities).117
Commenters also argued that the
suitability/sophistication requirement
was unworkable or unnecessary given
that the transaction may involve only a
referral (without a securities transaction
occurring) of a sophisticated
customer.118 In addition, some
commenters expressed concern that the
proposed standards would increase the
potential liability of broker-dealers or
delay the ability of a broker-dealer to
respond to a customer’s instructions.
After carefully considering the
comments, the Agencies have retained
the requirement that the parties’ written
agreement provide for the broker-dealer
to perform a suitability analysis when a
referral fee is contingent on a
transaction and a suitability or
sophistication analysis for other
referrals. These requirements provide
additional investor protections in those
circumstances where the bank employee
making the referral may receive a
higher-than-nominal referral fee. The
suitability and sophistication standards
included in the final rule are based on
the standards that broker-dealers
currently must apply and use under
applicable SRO rules and, thus, should
be familiar to those broker-dealers that
partner with banks operating under the
exemption.119 In addition, the
116 Proposed

Rule 701(a)(3)(iii)(C).
e.g., ABA Letter, Clearing House Ass’n
Letter, Citigroup Letter, and PNC Letter. See also
FINRA Rule 2310 and FINRA IM–2310–3
(discussing suitability obligations of member
broker-dealers). One commenter also asserted that
any expansion of a broker-dealer’s suitability
obligations should be processed and approved
through the normal market regulation and SRO
process. See SIFMA Letter.
118 See, e.g., Clearing House Ass’n Letter, SIFMA
Letter. Commenters also asserted that a brokerdealer may not be able to perform the proposed
‘‘sophistication’’ analysis if the customer does not
open an account or refuses to provide the brokerdealer the information necessary to perform the
analysis.
119 One commenter expressed concern that the
suitability/sophistication requirements of the rule
may discourage low-cost, execution-only brokers
from establishing relationships with banks under
the exemption. See Business Law Section Letter.
The Agencies are mindful of the need to keep
117 See,

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exemption gives a broker-dealer the
flexibility to perform a suitability
analysis, if one is otherwise required by
the rule, in connection with all referrals
made under the exemption if the brokerdealer determines that such an approach
is appropriate for business, compliance
or other reasons.
Specifically, for contingent referral
fees payable under the exemption, the
written agreement between the bank and
the broker-dealer must provide for the
broker-dealer to conduct a suitability
analysis of each securities transaction
that triggers any portion of the
contingency fee in accordance with the
rules of the broker-dealer’s applicable
SRO as if the broker-dealer had
recommended the securities
transaction.120 This analysis must be
performed by the broker-dealer before
each securities transaction on which the
referral fee is contingent is conducted.
For non-contingent referral fees
payable under the exemption, the
written agreement must provide for the
broker-dealer to conduct, before the
referral fee is paid, either (1) a
sophistication analysis of the customer
being referred; or (2) a suitability
analysis with respect to all securities
transactions requested by the customer
contemporaneously with the referral in
accordance with the rules of the brokerdealer’s applicable SRO as if the brokerdealer had recommended the securities
transaction.121 Under the sophistication
analysis option, the broker-dealer must
determine that the customer has the
capability to evaluate investment risk
and make independent decisions, and
determine that the customer is
exercising independent judgment based
on the customer’s own independent
assessment of the opportunities and
risks presented by a potential
investment, market factors, and other
investment considerations.122 This
sophistication analysis is based on
appropriate investment options, including low-cost
options, available to investors. However, given the
cost structure of low-cost brokers, the Agencies
expect that few such brokers would participate in
referral arrangements under the exemption that
provides for higher-than-nominal referral fees.
Broker-dealers that do not wish to become obligated
to perform the suitability/sophistication analyses
required by the rule also may continue to establish
and maintain networking arrangements pursuant to
the statutory networking exception.
120 Rule 701(a)(3)(ii)(A). Because the exemption
provides for a broker-dealer to conduct its
suitability analysis in accordance with the rules of
its applicable SRO, the broker-dealer may follow
and take advantage of any applicable SRO rules or
interpretations that allow the broker-dealer to make
an alternative suitability evaluation. See, e.g.,
FINRA IM–2310–3 (discussing a member’s
suitability obligations with respect to certain
institutional investors).
121 Rule 701(a)(3)(iii)(B).
122 Rule 701(a)(3)(ii)(B)(1).

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
elements of FINRA IM–2310–3
(Suitability Obligations to Institutional
Customers).
The Agencies have modified the final
rule to provide for the broker-dealer to
notify the customer, rather than the
bank, if the broker-dealer determines
that a high net worth or institutional
customer, or a securities transaction to
be conducted by such a customer, does
not meet the applicable sophistication
or suitability standard.123 Providing
such notification to the customer should
assist the customer in deciding whether
or not to conduct the transaction.

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5. Conditions Relating to Bank
Employees
Paragraph (b)(1) of the Proposed Rule
included certain limitations on the
types of bank employees that may
receive a higher-than-nominal referral
fee under the rule. In particular, the
Proposed Rule provided that the bank
employee: be predominantly engaged in
banking activities, other than making
referrals to a broker-dealer; encounter
the high net worth or institutional
customer in the ordinary course of the
employee’s assigned business for the
bank; not be qualified or required to be
qualified under the rules of a SRO; and
not be subject to statutory
disqualification under Section 3(a)(39)
of the Exchange Act (other than
subparagraph (E) of that Section)
(‘‘statutory disqualification’’).124
The proposed exemption also
included other provisions related to the
SRO and statutory disqualification
conditions. First, it required that the
written agreement between the bank and
the broker-dealer must provide for the
bank and the broker-dealer to
affirmatively determine, before a referral
fee is paid to a bank employee under the
exemption, that the employee is not
subject to statutory disqualification.125
Second, it required that the bank
provide the broker-dealer the name of
the employee and such other identifying
information that may be necessary for
the broker-dealer to determine whether
the bank employee is subject to
statutory disqualification or associated
with a broker-dealer.126 And third, it
required that the parties’ written
agreement obligate the broker-dealer to
promptly inform the bank if it
determined the bank employee was
subject to statutory disqualification.127
123 Rule

701(a)(3)(iv).
Proposed Rule 701(a)(1).
125 Proposed Rule 701(a)(3)(i)(A).
126 Proposed Rule 701(a)(2)(iii).
127 Proposed Rule 701(a)(3)(iii)(B).
124 See

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The final rule retains these provisions
with the following modifications.128 In
response to comments,129 the Agencies
have modified the SRO condition in
paragraph (a)(1)(A) of the Rule to
provide that the employee receiving the
referral fee must not be ‘‘registered or
approved, or otherwise required to be
registered or approved, in accordance
with the qualification standards
established by the rules of any selfregulatory organization.’’ The Agencies
have modified the related language in
paragraph (a)(2)(iii) of the rule in a
similar manner.
Several commenters argued that the
requirement that a bank employee
encounter the high net worth or
institutional customer ‘‘in the ordinary
course of the bank employee’s assigned
duties’’ was unnecessary and
ambiguous.130 The Agencies have
retained the requirement to help ensure
that a bank employee making a referral
under the rule does so as part of the
employee’s duties as a bank employee
and not as a sales representative of the
broker-dealer. However, the Agencies
recognize that in the ordinary course of
his or her assigned duties for the bank,
a bank employee may encounter
customers or potential customers
outside the employee’s regular business
hours or at locations outside of the
bank, such as at social or civic functions
or gatherings.
A number of commenters contended
that the bank and the broker-dealer
should not both be required to verify
that the bank employee is not subject to
statutory disqualification and suggested
that the bank and broker-dealer be
permitted to allocate this responsibility
between themselves.131 The Agencies
have modified the rule to provide for
these determinations to be made by the
broker-dealer under the terms of the
parties’ written agreement.132 The
Agencies believe that broker-dealers are
better suited to make this determination
given their familiarity with the
Exchange Act’s statutory
disqualification standards, provided
that they receive the necessary
128 See Rule 701(a)(1), (a)(2)(iii), (a)(3)(ii)(A), and
(a)(3)(v)(B).
129 See Business Law Section Letter.
130 See, e.g., ABA Letter, BISA Letter, Clearing
House Ass’n Letter, Comerica Bank Letter, and U.S.
Trust Letter. For example, some asserted that bank
employees may be expected to identify and develop
client relationships at social or other events and
expressed concern that the language might prevent
a bank employee from receiving a referral fee for
institutional or high net worth customers
encountered in these ways.
131 See, e.g., ABA Letter, BISA Letter, Clearing
House Ass’n Letter, Citigroup Letter, PNC Letter,
and SIFMA Letter.
132 Rule 701(a)(3)(ii)(A).

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56527

information concerning the employee
from the bank. A broker-dealer fulfills
its responsibilities under paragraph
(a)(3)(ii)(A) of Rule 701 if the brokerdealer determines that a bank employee
is not subject to statutory
disqualification before the employee
first receives a referral fee under Rule
701 and at least once each year
thereafter as long as the employee
remains eligible to receive referral fees
under the rule.
As a means designed to ensure that
the broker-dealer has the appropriate
information to make these
determinations, the rule continues to
require that, before a higher-thannominal referral fee is paid to a bank
employee under the exemption, the
bank provide the broker-dealer the name
of the employee and such other
identifying information that the brokerdealer may need to determine whether
the employee is subject to statutory
disqualification.133 Once the
information for a particular employee is
conveyed to the broker-dealer, the bank
should provide at least annually its
broker-dealer partner any changes to the
identifying information initially
provided under paragraph (a)(2)(iii) of
Rule 701 for an employee who
continues to make referrals and receive
referral fees under the exemption so that
the broker-dealer may perform its
periodic review of the employee’s
qualifications under paragraph
(a)(3)(ii)(A).
6. Good Faith Compliance and
Corrections by Banks
As in the proposal, the final
exemption provides that a bank that acts
in good faith and that has reasonable
policies and procedures in place to
comply with the requirements of the
exemption will not be considered a
‘‘broker’’ under Section 3(a)(4) of the
Exchange Act solely because the bank
fails, in a particular instance, to
determine that a customer is an
institutional or high net worth
customer, provide the customer the
required disclosures, or provide the
broker-dealer the required information
concerning the bank employee receiving
the referral fee within the time periods
prescribed. If the bank is seeking to
comply and takes reasonable and
prompt steps to remedy the error, such
as by promptly making the required
determination or promptly providing
the broker-dealer the required
information, the bank will not lose the
exemption from registration in these
circumstances. Similarly, to promote
compliance with the terms of the
133 Rule

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exemption, the bank must make
reasonable efforts to reclaim the portion
of the referral fee paid to the bank
employee for a referral that does not,
following any required remedial actions,
meet the requirements of the exemption
and that exceeds the amount the bank
otherwise would be permitted to pay
under the statutory networking
exception and Rule 700.134
A few commenters suggested that the
Agencies strike the requirement that the
bank seek to reclaim the higher-thannominal portion of a referral fee. The
Agencies have retained this requirement
as it helps provide employees an
incentive to comply with the rule.135
7. Referral Fees Permitted Under the
Exemption
Proposed Rule 701 placed certain
limits on how a higher-than-nominal
referral fee paid under the exemption
may be structured.136 Some commenters
argued that these restrictions are
unnecessary in light of the other
protections included in the exemption,
or that the rule should allow a higherthan-nominal referral fee to be based on
a percentage of any type of securities
transaction conducted at a broker-dealer
(rather than just investment banking
transactions).137 On the other hand, one
commenter asserted that, by allowing a
referral fee to be based on the total
amount of assets maintained in an
account with the broker-dealer, the rule
would provide an incentive for bank
employees to provide ongoing
investment advice to customers.138
The final rule continues to place
limits on the types of referral fees a bank
employee may receive under the
exemption. These limitations are
designed to reduce the potential
‘‘salesman’s stake’’ of the bank
employee in securities transactions
conducted at the broker-dealer.
Specifically, the exemption provides
that a referral fee paid under the
exemption may be a dollar amount
based on a fixed percentage of the
revenues received by the broker-dealer
134 Rule

701(a)(2)(iv).
commenter requested that the rule
provide a similar safe harbor for broker-dealers. See
SIFMA Letter. Any obligations of a broker-dealer
that arise by reason of Rule 701 run only to its bank
partner under the terms of their agreement and the
Agencies believe the issue of contractual liability
between the parties is best addressed by the parties
themselves. As stated in the proposal, the
Commission anticipates that it may be necessary for
either FINRA or the Commission to propose a rule
that would require broker-dealers to comply with
the written agreements entered into pursuant to
Rule 701.
136 Proposed Rule 701(d)(4).
137 See, e.g., Clearing House Ass’n Letter and
JPMorgan Letter.
138 See NASAA Letter.

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for investment banking services
provided to the customer.139
Alternatively, the referral fee may be a
predetermined dollar amount, or a
dollar amount determined in
accordance with a predetermined
formula, so long as the amount does not
vary based on (1) the revenue generated
by, or the profitability of, securities
transactions conducted by the customer
with the broker-dealer; (2) the quantity,
price, or identity of securities purchased
or sold over time by the customer with
the broker-dealer; or (3) the number of
customer referrals made.140 For these
purposes, ‘‘predetermined’’ means
established or fixed before the referral is
made. The requirement that the amount
of the referral fee not vary based on the
number of customer referrals made does
not prohibit an employee from receiving
a referral fee for each referral made by
the employee under the exemption.
As the exemption provides, these
restrictions do not prevent a referral fee
from being paid in multiple installments
or from being based on a fixed
percentage of the total dollar amount of
assets placed in an account with the
broker-dealer. Additionally, these
restrictions do not prevent a referral fee
from being based on a fixed percentage
of the total dollar amount of assets
(including securities and non-securities
assets) maintained by the customer with
the broker-dealer. Fees structured in this
manner and consistent with the
limitations in paragraph (d)(4)(i) of the
Rule do not provide a bank employee an
incentive to recommend the purchase or
sale of particular securities. In fact, the
bank employee would have no special
incentive to recommend the purchase of
any security, as the addition of cash or
other non-security instruments to the
account would count equally towards
the employee’s compensation as any
addition of securities to the account.
8. Permissible Bonus Compensation Not
Restricted
The exemption for high net worth and
institutional customers expressly
provides that nothing in the exemption
prevents or prohibits a bank from
paying, or a bank employee from
receiving, any type of compensation
under a bonus or similar plan that
would not be considered incentive
compensation under paragraph (b)(1), or
that is described in paragraph (b)(2), of
Rule 700 (implementing the networking
139 Rule

701(d)(4)(ii).
701(d)(4)(i). A referral fee paid under the
exemption may be contingent on whether the
customer opens an account with the broker-dealer
or executes one or more transactions in the account
during the initial phases of the account.
140 Rule

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exception).141 As explained above, these
types of bonus arrangements do not tend
to create the kind of financial incentives
for bank employees that the statute was
designed to address.
III. Trust and Fiduciary Activities
A. Trust and Fiduciary Exception and
Proposed Rules
Section 3(a)(4)(B)(ii) of the Exchange
Act (the ‘‘trust and fiduciary
exception’’) permits a bank, under
certain conditions, to effect securities
transactions in a trustee or fiduciary
capacity without being registered as a
broker.142 A bank must effect such
transactions in its trust department, or
other department that is regularly
examined by bank examiners for
compliance with fiduciary principles
and standards.143 In addition the bank
must be ‘‘chiefly compensated’’ for such
transactions, consistent with fiduciary
principles and standards, on the basis
of: (1) An administration or annual fee;
(2) a percentage of assets under
management; (3) a flat or capped per
order processing fee that does not
exceed the cost the bank incurs in
executing such securities transactions;
or (4) any combination of such fees.144
Banks relying on this exception may
not publicly solicit brokerage business,
other than by advertising that they effect
transactions in securities in conjunction
with advertising their other trust
activities.145 In addition, a bank that
effects a transaction in the United States
of a publicly traded security under the
exception must execute the transaction
in accordance with Exchange Act
Section 3(a)(4)(C).146 This Section
requires that the bank direct the trade to
a registered broker-dealer for execution,
effect the trade through a cross trade or
substantially similar trade either within
the bank or between the bank and an
affiliated fiduciary in a manner that is
not in contravention of fiduciary
principles established under applicable
federal or state law, or effect the trade
in some other manner that the
Commission permits.147 The trust and
fiduciary exception recognizes the
141 Rule
142 15

701(c).
U.S.C. 78c(a)(4)(B)(ii).

143 Id.
144 15

U.S.C. 78c(a)(4)(B)(ii)(I).
U.S.C. 78c(a)(4)(B)(ii)(II).
146 15 U.S.C. 78c(a)(4)(C).
147 15 U.S.C. 78c(a)(4)(C)(i)–(iii). As discussed
infra at Part VI.C, the Agencies have adopted Rule
775 that permits banks, subject to certain
conditions, to effect trades in securities issued by
an open-end company and certain variable
insurance contracts without sending the trade to a
registered broker-dealer. Trades effected by a bank
in accordance with Rule 775 are conducted in
accordance with Section 3(a)(4)(C) of the Exchange
Act.
145 15

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
traditional securities role banks have
performed for trust and fiduciary
customers and includes conditions to
help ensure that a bank does not operate
a securities broker in the trust
department.
The proposed rules provided that a
bank would meet the ‘‘chiefly
compensated’’ condition in the trust and
fiduciary exception if the bank’s
relationship compensation attributable
to each trust or fiduciary account
exceeded 50 percent of the total
compensation attributable to the
relevant account.148 The proposed rules
also included an exemption that would
permit a bank to use a bank-wide
approach to the ‘‘chiefly compensated’’
condition as an alternative to the
account-by-account approach. A bank
using this proposed alternative would
be able to use the aggregate relationship
and total compensation that the bank
received from its trust and fiduciary
business as a whole to monitor its
compliance with the chiefly
compensated test. The proposed rule
allowed a bank to use this bank-wide
alternative if, among other things, the
bank’s aggregate relationship
compensation attributable to its trust or
fiduciary business as a whole equaled or
exceeded 70 percent of the total
compensation attributable to its trust or
fiduciary business. This bank-wide
alternative was designed to simplify
compliance, alleviate concerns about
inadvertent noncompliance, and reduce
the costs and disruptions banks likely
would incur under the account-byaccount approach.
The proposal defined the term
‘‘relationship compensation’’ to mean
the types of trust and fiduciary
compensation specifically identified in
the trust and fiduciary exception. The
proposed rules also provided examples
of fees that would be considered an
administration fee or a fee based on a
percentage of assets under management
for these purposes. For example, the
proposed rules provided that fees paid
by an investment company pursuant to
a plan under 17 CFR 270.12b–1 (‘‘12b–
1 fees’’) or for personal service or the
maintenance of shareholder accounts
(‘‘service fees’’) would be considered
relationship compensation under the
rules. The proposed rules also
implemented the statute’s advertising
restriction and provided certain other
conditional exemptions.

148 Proposed

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B. Joint Final Rules
1. ‘‘Chiefly Compensated’’ Test and
Bank-Wide Exemption Based on TwoYear Rolling Averages
A majority of commenters supported
the general approach taken in the
proposed rules implementing the trust
and fiduciary exception, including the
proposed bank-wide alternative for the
chiefly compensated test. For example,
a number of commenters stated that the
proposed bank-wide approach would
provide banks an improved, workable
and flexible method of complying with
the statutory exception.149 Some
commenters, however, opposed either
the account-by-account or bank-wide
alternative to the ‘‘chiefly compensated’’
requirement. For example, some
commenters argued that the account-byaccount approach was inconsistent with
the terms and purposes of the trust and
fiduciary exception.150 Another
commenter argued that an account-byaccount approach to the chiefly
compensated test is the only way to
help ensure that a bank does not operate
a brokerage business out of its trust or
fiduciary departments and, for this
reason, recommended that the Agencies
eliminate the bank-wide alternative.151
Some commenters also requested that
the Agencies lower the 70 percent
relationship compensation/total
compensation percentage required by
the bank-wide exemption to 60 percent
or 50 percent to make it more consistent
with the percentage required by the
account-by-account approach.152
After carefully considering the
comments, the Agencies have retained
the two alternative approaches in
substantially the same form as
proposed. Specifically, Rule 721
provides that a bank meets the ‘‘chiefly
compensated’’ condition in the trust and
fiduciary exception if the ‘‘relationshiptotal compensation percentage’’ for each
trust or fiduciary account of the bank is
greater than 50 percent.153 The
‘‘relationship-total compensation
percentage’’ for a trust or fiduciary
account is calculated by (1) Dividing the
relationship compensation attributable
to the account during each of the
immediately preceding two years by the
total compensation attributable to the
account during the relevant year; (2)
translating the quotient obtained for
each of the two years into a percentage;
and (3) then averaging the percentages
149 See, e.g., ABA Letter, Roundtable Letter, U.S.
Trust Letter, WBA Letter.
150 See, e.g., Clearing House Ass’n Letter.
151 See NASAA Letter.
152 See ACB Letter, CBA Letter.
153 Rule 721(a)(1).

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obtained for each of the two
immediately preceding years.154
The final rules (Rule 722) also allow
a bank to use a bank-wide approach to
the ‘‘chiefly compensated’’ condition as
an alternative to the account-by-account
approach. To use this bank-wide
methodology, the bank must meet two
conditions. First, the ‘‘aggregate
relationship-total compensation
percentage’’ for the bank’s trust and
fiduciary business as a whole must be
at least 70 percent.155 The ‘‘aggregate
relationship-total compensation
percentage’’ of a bank operating under
the bank-wide approach is calculated in
a similar manner as the ‘‘relationshiptotal compensation percentage’’ of an
account under the account-by-account,
except that the calculations would be
based on the aggregate relationship
compensation and total compensation
received by the bank from its trust and
fiduciary business as a whole during
each of the two immediately preceding
years. In other words, the percentage
would be determined by (1) Dividing
the relationship compensation
attributable to the bank’s trust and
fiduciary business as a whole during
each of the immediately preceding two
years by the total compensation
attributable to the bank’s trust and
fiduciary business as a whole during the
relevant year; (2) translating the
quotient obtained for each of the two
years into a percentage; and (3) then
averaging the percentages obtained for
each of the two immediately preceding
years.156 Second, the bank must comply
with the conditions in the trust and
fiduciary exception (other than the
compensation test in Section
3(a)(4)(B)(ii)(I)) 157 and comply with
Section 3(a)(4)(C) (relating to trade
execution) of the Exchange Act.158
The Agencies believe that providing
banks these two alternatives is
consistent with the purposes of the trust
and fiduciary exception. In this regard,
the availability of these two alternatives
is designed to avoid disrupting the trust
and fiduciary operations of banks. The
154 The rule provides for this process to be
accomplished by calculating the ‘‘yearly
compensation percentage’’ and the ‘‘relationshiptotal compensation percentage’’ for the account. See
Rule 721(a)(2) and (3).
155 Rule 722(a)(2).
156 The rule provides for this process to be
accomplished by calculating the ‘‘yearly bank-wide
compensation percentage’’ and the ‘‘aggregate
relationship-total compensation percentage’’ for the
bank’s trust and fiduciary business as a whole. See
Rule 722(b) and (c).
157 The Agencies have modified the bank-wide
exemption to clarify that these conditions include
the advertising restrictions contained in the trust
and fiduciary exception as implemented by Rule
721(b). See Rule 722(a)(1).
158 Rule 722(a)(1).

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compensation tests in both the accountby-account and bank-wide approaches
are designed to ensure that a bank’s
trust department is not unduly
dependent on the types of securitiesrelated compensation not permitted by
the statute. The 70 percent
compensation threshold in the bankwide exemption is higher than that
required under the account-by-account
approach in order to compensate for the
loss of particularity when the chiefly
compensated test is implemented and
monitored on a bank-wide basis, rather
than on an account-by-account basis.
The Agencies note that several
commenters also asserted that the
proposed aggregate relationship
compensation-total compensation
percentage required by the bank-wide
alternative (70 percent) would not
disrupt the trust and fiduciary
operations or customer relationships of
banks in light of the proposal’s
definition of ‘‘relationship
compensation.’’
Some commenters asked that the
Agencies modify how the bank-wide
exemption could be applied in several
ways. For example, some asserted that
a bank should be allowed to apply the
70 percent compensation threshold
separately to each individual fiduciary
business line, operating unit or
geographic region of the bank, rather
than only on an aggregate bank-wide
basis. Others asked that the Agencies
allow a bank to use an aggregate
compensation approach only for some
trust or fiduciary business lines and use
the account-by-account approach for the
bank’s trust or fiduciary accounts in its
remaining business lines.159 In addition,
some asked that a bank be permitted to
monitor compliance with the 70 percent
compensation test on a combined basis
with its affiliated entities engaged in
trust or fiduciary activities (such as an
affiliated bank or a subsidiary or affiliate
registered as an investment adviser).160
Some commenters also asked the
Agencies to modify the bank-wide
approach to provide for a bank’s
relationship compensation-total
compensation percentage to be
calculated based on the compensation
attributable to all of the bank’s trust and
fiduciary accounts rather than the
compensation from the bank’s ‘‘trust
and fiduciary business.’’ 161
159 See

Clearing House Ass’n Letter.
160 See Citigroup Letter, Clearing House Ass’n
Letter, Mellon Bank, N.A. (‘‘Mellon’’) Letter, PNC
Letter, ABA Letter.
161 See, e.g., ABA Letter, Joint ABA/ABASA/
Clearing House Ass’n Letter of July 16, 2007, BISA
Letter, Clearing House Ass’n Letter, Comerica Bank
Letter.

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The Agencies believe that the bankwide alternative as structured provides
banks appropriate and adequate
flexibility in conducting their trust and
fiduciary operations while meeting the
statute’s goals. The bank-wide approach
is designed to reflect both the
relationship compensation and total
compensation received by a bank
through the conduct of its full range of
trust or fiduciary services, and, thus,
allow banks to avoid tracking their trust
or fiduciary revenue back to one or more
specific accounts. At the same time, the
use of two uniform methodologies
(account-by-account or bank-wide)
should facilitate the review of bank
compliance during the bank supervisory
process and aid the development of
software and related systems by banks
and their service providers for
compliance purposes. Furthermore,
because the broker exceptions for a bank
in Section 3(a)(4)(B), including the trust
and fiduciary exception, apply to each
bank individually and are not available
to a nonbank entity, including a
nonbank subsidiary or affiliate of a
bank, the Agencies have not modified
the rules to allow a bank to monitor its
compliance with the compensation limit
in Rule 721 on a combined basis with
one or more affiliated banks,
subsidiaries or affiliates. The Agencies
also do not believe that requiring banks
to monitor their compliance with the 70
percent compensation test on a bankwide basis, rather than on an individual
business line or operating unit basis,
will impose significant additional
burdens on banks.162
A bank has the flexibility to elect to
use a calendar year or the bank’s fiscal
year for purposes of complying with the
compensation provisions of either the
account-by-account or bank-wide
approach.163 In addition, whether a
bank decides to use the account-byaccount approach or the bank-wide
approach, the bank’s compliance with
the relevant compensation restriction is
based on a two-year rolling average of
the compensation attributable to the
trust or fiduciary account or the bank’s
trust or fiduciary business, respectively.
This two-year averaging is designed to
allow for short-term fluctuations that
otherwise could lead a bank to fall out
162 The Agencies note, for example, that a bank
that operates under the bank-wide approach may
use different systems across its trust or fiduciary
business lines, units or regions to monitor its
compensation within those business lines, units or
regions, provided that such information is then
aggregated on a bank-wide basis as provided in Rule
722.
163 Proposed Rule 721(a)(6).

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of compliance with the exception or
exemption from year-to-year.
Some commenters asked that the
Agencies clarify when a bank must
commence monitoring its compliance
with the two-year rolling compensation
test. As discussed infra in Part VI.F, a
bank must comply with the exceptions
in Section 3(a)(4)(B) of the Exchange Act
and the final rules starting the first day
of the bank’s first fiscal year
commencing after September 30, 2008.
Thus, a bank that operates on a
calendar-year basis must start
monitoring its compliance with the
compensation requirements on either an
account-by-account or bank-wide basis
beginning January 1, 2009, and would
first have to meet the applicable
compensation restriction after the
conclusion of 2010 (based on the
average of the bank’s year-end
compensation ratios for 2009 and
2010).164 To allow banks sufficient time
to obtain and verify the relevant
compensation data, the Agencies have
modified both the account-by-account
approach and the bank-wide approach
to provide banks up to 60 days after the
end of a year to calculate their
compliance with the relevant
compensation restriction.165 While the
rules provide for a bank’s compliance
with the compensation tests to be
determined based solely on calculations
as of year-end, banks are encouraged to
monitor their trust and fiduciary
compensation on a regular basis as
appropriate to identify and address
potential compliance issues before the
end of the relevant two-year period.
2. ‘‘Relationship Compensation’’
Both the account-by-account and
bank-wide approaches are based on the
ratio of the relationship compensation
attributable to a trust or fiduciary
account or a bank’s trust and fiduciary
business to the total compensation
attributable to the account or business.
The proposal defined the term
‘‘relationship compensation’’ to mean
the types of trust and fiduciary
compensation identified in the statute:
an administration fee; an annual fee
(payable on a monthly, quarterly or
other basis); a fee based on a percentage
164 This same schedule also would apply to a
bank that operates on an October 1st to September
30th fiscal year, but that elects to use the calendar
year for purposes of monitoring its compliance with
the chiefly compensated test. The Agencies believe
the delay and phased-in nature of the compensation
tests should provide banks as a general matter
sufficient notice and time to address potential
compensation issues across the full range of their
trust and fiduciary accounts, including personal
and charitable accounts and estates. See Business
Law Section Letter.
165 See Rule 721(a)(3)(ii) and Rule 722(c)(2).

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
of assets under management; a flat or
capped per order processing fee that is
equal to not more than the cost incurred
by the bank in connection with
executing securities transactions for
trust or fiduciary accounts; or any
combination of these fees.166 The
proposed rules also provided examples
of fees that would be considered an
administration fee or a fee based on a
percentage of assets under management
for these purposes. For example, the
proposed rules provided that 12b–1
fees,167 service fees,168 and fees for
certain sub-transfer agent, subaccounting or related services 169 paid
by an investment company on the basis
of assets under management would be
considered relationship compensation
under the rules.
The Agencies received numerous
comments on the definition of
relationship compensation. A number of
commenters supported the definition
including, in particular, the examples
recognizing 12b–1 and service fees as
relationship compensation. For
example, some commenters stated that
treating these fees as relationship
compensation is consistent with the
terms and purposes of the trust and
fiduciary exception and ‘‘critical’’ to
ensuring that the rules do not disrupt
the trust and fiduciary operations and
customer relationships of banks.170
Other commenters, however, argued
that all 12b–1 fees, or the portion of
such fees paid for distribution expenses,
should be excluded from relationship
compensation.171 These commenters
asserted that treating 12b–1 fees as
relationship compensation would allow
banks to have a ‘‘salesman’s stake’’ in
their customers’’ securities transactions
in contravention of the purposes of the
166 Proposed

Rule 721(a)(4).
Rule 721(a)(4)(iii)(A).
168 Proposed Rule 721(a)(4)(iii)(B).
169 See Proposed Rule 721(a)(4)(i) and (iii)(C).
Specifically, these fees, which are hereinafter
referred to as ‘‘sub-transfer agent and related fees’’
are paid for (1) providing transfer agent or subtransfer agent services for the beneficial owners of
investment company shares; (2) aggregating and
processing purchase and redemption orders for
investment company shares; (3) providing the
beneficial owners with account statements showing
their purchases, sales, and positions in the
investment company; (4) processing dividend
payments to the account for the investment
company; (5) providing sub-accounting services to
the investment company for shares held
beneficially in the account; (6) forwarding
communications from the investment company to
the beneficial owners, including proxies,
shareholder reports, dividend and tax notices, and
updated prospectuses; or (7) receiving, tabulating,
and transmitting proxies executed by the beneficial
owners of investment company shares in the
account.
170 See Joint ABA/ABASA/Clearing House Ass’n
Letter of June 7, 2007.
171 See NASD Letter, NASAA Letter.

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167 Proposed

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statute, result in the disparate treatment
of banks and registered investment
advisers, and create confusion as to how
12b–1 fees should be treated under
other aspects of the federal securities
laws and rules of the NASD (now
FINRA).
In addition, many commenters asked
that the Agencies clarify whether
additional types of fees not mentioned
in the proposed rules would qualify as
relationship compensation. For
example, commenters asked the
Agencies to confirm that fees separately
charged a trust or fiduciary customer for
custodial services and fees charged or
earned in connection with securities
lending and borrowing transactions
conducted for a trust or fiduciary
customer are relationship
compensation.
After carefully considering the
comments, the Agencies have retained,
consistent with the statute, the
definition of relationship compensation
as any compensation that a bank
receives that is attributable to a trust or
fiduciary account and that consists of
(1) an administration fee, (2) an annual
fee (payable on a monthly, quarterly or
other basis), (3) a fee based on a
percentage of assets under management
(an ‘‘AUM fee’’), (4) a flat or capped per
order processing fee, paid by or on
behalf of a customer or beneficiary, that
is equal to not more than the cost
incurred by the bank in connection with
executing securities transactions for
trust or fiduciary accounts; or (5) any
combination of these fees.172
The final rules also continue to list all
12b–1 fees that are paid on the basis of
assets under management and
attributable to a trust or fiduciary
account (under the account-by-account
test) or the bank’s trust and fiduciary
business as a whole (under the bankwide test) as examples of AUM fees that
are relationship compensation. The
Agencies believe that treating 12b–1 fees
in this manner is consistent with both
the language and purposes of the trust
and fiduciary exception. When paid on
the basis of a percentage of assets under
management these fees fall within the
types of fees expressly permitted by the
trust and fiduciary exception. 12b–1
fees that are paid on the basis of assets
under management also are
distinguishable from the types of nonrelationship compensation, such as
front-end or back-end sales loads 173 or
172 Rule 721(a)(4). For banks operating under the
bank-wide alternative, fees of these types are
relationship compensation if they are attributable to
the bank’s trust or fiduciary business as a whole.
See Rule 722(c)(1).
173 A front-end sales charge is a charge that is
used to finance sales or sales promotion expenses

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56531

per-order transaction fees that exceed a
bank’s costs, that are limited by the
statute’s chiefly compensated test.
Treating 12b–1 fees in this manner
also will avoid significant disruptions to
the trust and fiduciary operations of
banks and, when viewed in light of
other provisions and protections, is
consistent with investor protection.
Many bank trust and fiduciary
departments, particularly those that act
as a corporate trustee or as a trustee or
fiduciary for employee benefit plans,
receive a significant portion of their
trust and fiduciary compensation
through payments made under a 12b–1
plan.
Importantly, as provided in the trust
and fiduciary exception, all 12b–1 fees
received by a bank must be consistent
with the fiduciary principles and
standards governing the bank-customer
relationship,174 and the bank’s
compliance with these principles and
standards will continue to be regularly
examined by bank examiners during the
bank supervisory and examination
process. In addition, the treatment of
12b–1 fees that are paid on the basis of
assets under management and service
fees as ‘‘relationship compensation’’ for
purposes of the trust and fiduciary
exception and related rules does not
affect the treatment of such fees under
other provisions of the federal securities
laws, the federal banking laws,
applicable trust or fiduciary principles
and standards, or the rules of an SRO.
Thus, for example, the treatment of 12b–
1 fees that are paid on the basis of assets
under management and service fees as
relationship compensation for purposes
of these rules does not alter or affect the
and that is included in the public offering price of
the shares of an investment company. A deferred
sales charge is an amount properly chargeable to
sales or promotional expenses that is paid by a
shareholder of an investment company after
purchase of the company’s shares but before or
upon redemption. See FINRA Rule 2830(b)(8)(B)
and (c); 17 CFR 270.6c–10.
174 Section 802(f) of the Uniform Trust Code, for
example, provides that a trustee may receive
compensation from an investment company in
which the trustee has invested trust funds and
receipt of such compensation will not be presumed
to represent a conflict of interest if the investment
otherwise complies with the jurisdiction’s prudent
investor rule. See Uniform Trust Code, § 902(f) and
related comment (2005). In addition, a bank’s
receipt of 12b–1 fees from an employee benefit plan
for which the bank acts as a fiduciary is governed
by the Employee Retirement Income Security Act
(‘‘ERISA’’) and the regulations and guidance issued
by the Department of Labor thereunder. See 29
U.S.C. 1001 et seq.; DOL Advisory Opinion 2003–
09A (June 25, 2003) (discussing conditions under
which a directed trustee may receive 12b–1 fees
under ERISA).

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treatment of, or limitations imposed on,
these fees under FINRA Rule 2830.175
In light of the comments received, the
Agencies have modified Rule 721 to
provide additional examples of the
types of fees that qualify as relationship
compensation under the statute and the
rules. For example, the Agencies have
modified the rule to include, as
additional examples of an
administration fee, compensation
received by a bank (1) for disbursing
funds from, or for recording payments
to, a trust or fiduciary account; (2) in
connection with securities lending and
borrowing transactions conducted for a
trust or fiduciary account; and (3) for
custody services provided to a trust or
fiduciary account (whether or not
separately charged).176 In addition, the
Agencies have included (1) as an
example of an annual fee, an annual fee
paid for assessing the investment
performance of a trust or fiduciary
account or for reviewing such an
account’s compliance with applicable
investment guidelines or restrictions,
and (2) as an example of an assets under
management fee, a fee based on the
financial performance, such as capital
gains or capital appreciation, of trust or
fiduciary assets under management. The
Agencies believe the characterization of
these fees comports with the manner in
which banks generally receive
compensation for these services. Several
commenters noted that banks currently
may receive 12b–1 fees, service fees or
sub-transfer agent and related fees either
directly from a mutual fund or from the
fund’s distributor, transfer agent,
administrator or adviser.177 In light of
these comments, the Agencies have
eliminated the language in the proposed
rules that required that these types of
fees be ‘‘paid by an investment
company.’’
The examples of an administration
fee, annual fee and an asset under
management fee included in Rule 721(b)
175 The rules also do not alter or affect the ability
of a nonbank registered investment adviser to
receive 12b–1 fees under the federal securities laws
or the rules of an SRO. The ‘‘broker’’ exceptions for
banks in Section 3(a)(4)(B) of the Exchange Act,
including the trust and fiduciary exception, are not
available to nonbank entities such as nonbank
investment advisers.
176 Rule 721(a)(4)(i)(B), (C) and (D). Because
securities lending/borrowing fees and custody fees
may be charged on an assets under management
basis, the rule also provides that these fees are
relationship compensation when charged in this
manner. Rule 721(a)(4)(iii)(E). As with other types
of relationship compensation, the fees that a bank
receives for effecting securities lending/borrowing
transactions for a trust or fiduciary account must be
consistent with applicable fiduciary principles and
standards.
177 See Investment Company Institute (‘‘ICI’’)
Letter, Federated Investors, Inc. (‘‘Federated
Investors’’) Letter.

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are provided only for illustrative
purposes. Other types of fees or fees for
other types of services could be an
administration fee, annual fee or an
AUM fee. In addition, an administration
fee, annual fee or assets under
management fee attributable to a trust or
fiduciary account or a bank’s trust or
fiduciary business is considered
relationship compensation regardless of
what entity or person pays the fee, and
regardless of whether the fee is related
to only securities assets, to a
combination of securities and nonsecurities assets, or to only nonsecurities assets. These fees are part of
the compensation for acting as a trustee
or fiduciary.
Some commenters asserted that a
bank should be permitted to include
within its relationship compensation
any per-transaction securities
processing fee it charges as a directed
trustee or in another fiduciary capacity
even if the fee exceeds the bank’s costs
in processing the transaction.178 The
statute, however, expressly provides
that a per-order securities processing fee
may be counted towards the statute’s
chiefly compensated requirement only if
the fee is ‘‘equal to not more than the
cost incurred by the bank in connection
with executing securities transactions’’
for its trust or fiduciary customers. For
this reason, the Agencies have not
modified the rule in the manner
requested.
However, as discussed further in Part
V, the Agencies have modified the
custody exemption (Rule 760) to permit
banks that accept securities orders as a
directed trustee to do so under that
exemption in lieu of the trust and
fiduciary exception and related rules. In
addition, as the Agencies explained in
the proposal, a per order processing fee
included in relationship compensation
may include the fee charged by the
executing broker-dealer as well as any
additional fixed or variable costs
incurred by the bank in processing the
transaction. If a bank includes any such
additional fixed or variable costs in the
per order processing fees it includes in
its relationship compensation, the bank
should maintain appropriate policies
and procedures governing the allocation
of these costs to the orders processed for
trust or fiduciary customers. This
should help ensure that profits derived
from per trade charges are not masked
as costs of processing the trades and
thereby included in relationship
compensation.
178 See, e.g., Wells Fargo & Company (‘‘Wells
Fargo’’) Letter, State Street Corp. Letter, Mellon
Letter.

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3. Excluded Compensation
A number of commenters asserted
that the revenues derived from
securities transactions conducted by a
bank for a trust or fiduciary customer
under a different exception or
exemption (such as the exemption
provided in Rule 771 for transactions in
Regulation S securities) should be
excluded from the account-by-account
or bank-wide compensation test
completely.179 Others asked that certain
other types of fees, such as internal
credits from other areas of the bank,
credits received from broker-dealers for
brokerage or research services in
accordance with Section 28(e) of the
Exchange Act, or revenues earned from
providing trust or fiduciary services to
mutual funds, be excluded from the
chiefly compensated calculation as well.
As discussed in Part I.C supra, if more
than one ‘‘broker’’ exception or
exemption is available for a securities
transaction effected by a bank for a
customer, the bank may choose the
exception or exemption on which it
relies in effecting the transaction. In
light of the comments received, the
Agencies have modified Rules 721 and
722 to explicitly provide that, if a bank
effects a securities transaction for a trust
or fiduciary customer in accordance
with the terms of an exception or
exemption other than Rule 721 or Rule
722, the bank may, at its election,
exclude the revenues associated with
those transactions from the applicable
relationship-total compensation
calculation in Rule 721 or Rule 722.180
As the rules provide, if a bank elects to
exclude the revenues associated with
transactions conducted under another
exception or exemption, the bank must
exclude such revenue from both the
bank’s relationship compensation (if the
compensation would otherwise qualify
as relationship compensation) and total
compensation. Of course, the bank also
must comply with the conditions
applicable to the other available
exception or exemption on which the
bank chooses to rely.181
In addition, compensation that is not
derived from the provision of trust or
fiduciary services should not be
179 See, e.g., Institute of Int’l Bankers (‘‘IIB’’)
Letter, Clearing House Ass’n Letter.
180 Rule 721(b) and Rule 722(d).
181 Some commenters asserted that a bank should
be allowed to include in its relationship
compensation all of the revenue from securities
transactions conducted for a trust or fiduciary
account under another exception or exemption,
regardless of whether that revenue otherwise
qualifies as relationship compensation. The
Agencies have not amended the rule in this manner
as it is inconsistent with the terms of the trust and
fiduciary exception which sets forth the types of
fees that are included in relationship compensation.

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
included in a bank’s relationship or
total compensation under either the
account-by-account or bank-wide
alternative. Such compensation
includes, for example, (1) revenue
earned by a trust or fiduciary
department from providing back-office
services to an affiliated or unaffiliated
party,182 (2) revenue from the sale of an
office or assets of the trust department,
or from the provision on a stand-alone
basis of other services (such as custody
services or the sale of portfolio
management software to a third party
that independently operates and uses
the software in connection with its own
business) that do not involve trust or
fiduciary services as defined in section
3(a)(4)(D) of the Act; and (3) internal
payments or credits allocated to a bank’s
trust or fiduciary department or unit
from another department or unit of the
bank for deposits and other similar
services not involving a security. Credits
received by a bank from a broker-dealer
for brokerage and research services
provided by a broker-dealer in
accordance with section 28(e) of the Act
(15 U.S.C. 78bb(e)) and the regulations
issued thereunder also should be
excluded from the compensation tests.
The Agencies do not believe these
credits constitute compensation to the
bank for purposes of the exception and
rules because these credits must be
reasonable in relation to the value of the
brokerage and research provided by the
broker-dealer in connection with the
bank’s exercise of investment discretion
for its fiduciary accounts.
4. Trust or Fiduciary Accounts

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The final rules, like the proposal,
define a trust or fiduciary account as an
account for which the bank acts in a
trustee or ‘‘fiduciary capacity’’ as that
term is defined in Section 3(a)(4)(D) of
the Exchange Act.183 This definition is
based on the definition of ‘‘fiduciary
capacity’’ in part 9 of the OCC’s
regulations, which relates to the trust
and fiduciary activities of national
banks, in effect at the time of enactment
of the GLB Act.
Section 3(a)(4)(D) identifies a number
of particular situations where a bank
serves in a fiduciary capacity.184 The
182 On the other hand, the revenue derived from
providing fiduciary services to investment
companies or companies affiliated with the bank
should be included in the relevant chiefly
compensated calculation.
183 Rule 721(a)(5).
184 Section 3(a)(4)(D) of the Exchange Act
provides that a bank acts in a ‘‘fiduciary capacity’’
if, among other situations, the bank has investment
discretion on behalf of another. Thus, for example,
if a bank has investment discretion over an escrow
account on behalf of another, the bank would be

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definition also provides that a bank acts
in a ‘‘fiduciary capacity’’ if it acts ‘‘in
any other similar capacity’’ to those
specifically identified. Accordingly, the
scope of the term ‘‘fiduciary capacity’’ is
not fixed in time.
The Agencies recognize, moreover,
that different nomenclature may be used
to identify a fiduciary capacity in the
relevant governing documents or state
laws. For example, the Uniform Probate
Code uses the term ‘‘Personal
representative’’ and similar successor
titles in place of the terms ‘‘executor’’ or
‘‘administrator’’ to identify the
representative of a decedent; the
Uniform Custodial Trust Act uses the
terms ‘‘Conservator’’ and ‘‘Custodial
trustee’’ to refer to persons that act as a
fiduciary for another person who has
become incapacitated; and the Uniform
Transfers to Minors Act uses both the
terms ‘‘Conservator’’ and ‘‘Custodian’’ to
refer to fiduciaries that act on behalf of
a minor.185
Some commenters asked whether a
bank that engages in trust or fiduciary
activities may conduct securities
transactions under the trust and
fiduciary exception and related rules
even if the bank does not maintain a
separate trust department or has not had
to obtain formal trust powers from its
appropriate federal banking agency.186
The trust and fiduciary exception and
related rules do not require that a bank
effecting securities transactions for a
customer in a trust or fiduciary capacity
do so through a separate trust
department or have obtained formal
trust powers from its appropriate federal
banking agency. However, securities
transactions conducted for a trust or
fiduciary customer under the exception
and related rules must be effected in a
department of the bank ‘‘that is
regularly examined for compliance with
fiduciary principles and standards’’ by
the bank’s appropriate federal or state
banking supervisor.187 As stated in the
acting in a ‘‘fiduciary capacity’’ with respect to the
account.
185 The text of and additional information on
these Uniform Codes and Acts, which are
developed under the auspices of the National
Conference of Commissioners of Uniform State
Laws (‘‘NCCUSL’’), may be found on NCCUSL’s
Web site at http://www.nccusl.org.
186 See, e.g., ACB Letter, Roundtable Letter.
Federal savings associations, for example, are not
required to obtain approval from their appropriate
federal banking agency to act as a trustee for an
individual retirement account under section 408(a)
of the Internal Revenue Code. See 12 CFR 550.580.
187 15 U.S.C. 78c(a)(4)(B)(ii); Rule 722(a)(1). A
bank effecting transactions for trust or fiduciary
customers through a department examined for
compliance with trust or fiduciary principles may
use other divisions or departments of the bank, or
other affiliated or unaffiliated third parties, to
handle aspects of these transactions. The bank must

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56533

proposal, the Agencies will rely on the
appropriate federal banking agency for a
bank to determine whether the bank’s
activities are conducted in the bank’s
trust department or other department
regularly examined by the agency’s
examiners for compliance with
fiduciary principles and standards.188
5. Exemptions for Special Accounts,
Foreign Branches, Transferred
Accounts, and a De Minimis Number of
Accounts
The Agencies also proposed a rule
(Proposed Rule 723) that would permit
a bank to exclude certain types of
accounts for purposes of determining its
compliance with the account-byaccount or bank-wide compensation
tests. As proposed, Rule 723 allowed a
bank, in calculating its compensation
under either approach, to exclude
compensation received from any trust or
fiduciary account open only for a short
period of time (less than 3 months) or
acquired within the past 12 months as
part of a merger or similar transaction.
In addition, the Proposed Rule allowed
a bank using the account-by-account
approach, subject to certain conditions,
to (1) exclude the lesser of 1 percent or
500 of its trust or fiduciary accounts in
a year from the chiefly compensated
test, and (2) transfer any trust or
fiduciary account ultimately determined
to be non-conforming to a registered
broker-dealer or an unaffiliated entity
exempt from registration within 3
months of the end of the relevant year.
Commenters generally favored these
exemptions. One commenter, however,
argued that these exemptions should be
eliminated because they would allow
banks to manipulate the chiefly
compensated test.189 Several
commenters also requested that the
Agencies adopt an additional exemption
continue to act in a trustee or fiduciary capacity
with respect to the account and, accordingly,
should exercise appropriate diligence in selecting
persons to provide services to the bank’s trust or
fiduciary customers and in overseeing the services
provided in accordance with the bank’s fiduciary
obligations. No party, other than the bank
(including, without limitation, a transfer agent or
investment adviser), working in conjunction with
the bank may rely on the bank’s exception or
exemption from ‘‘broker’’ status. To the extent that
any such third party performs activities that would
make that entity a broker under Section 3(a)(4) of
the Exchange Act that entity would be required to
register as a broker (in the absence of an applicable
exemption or regulatory relief) notwithstanding any
written or unwritten agreement the third party may
have with the bank.
188 The OTS, for example, is in the process of
revising its examination procedures to provide for
the regular examination of individual retirement
accounts held by a federal savings association as
trustee for compliance with fiduciary principles
and standards.
189 NASAA Letter.

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
before the account is closed.198 The
exclusions in Rule 723(a), (b) and (d) are
designed to help prevent such shortterm fluctuations in the amount of
securities transactions conducted for a
trust or fiduciary account from
distorting, or causing a bank to fail, the
relevant compensation test. At the same
time, these exclusions promote
compliance by requiring that the bank
bring the relevant accounts into
compliance within a short and
prescribed period of time. For this
reason, the Agencies do not believe it
would be appropriate to expand the
Rule 723(d) to allow a bank to exclude
an account from the chiefly
compensated test in consecutive years
as requested by some commenters.
Some commenters also asked the
Agencies to raise the 500 account
maximum in Rule 723(d) to avoid
discriminating against large banks.199
The Agencies expect that most banks
that have more than 50,000 trust and
fiduciary accounts, and thus would be
subject to the 500 account cap in Rule
723(d), will operate under the bankwide test and for this reason have not
made the requested change.
Rule 723(c) also provides that a bank
that uses the account-by-account
approach will not be considered a
broker for purposes of Section 3(a)(4) of
the Exchange Act solely because a
particular trust or fiduciary account
does not meet the ‘‘chiefly
compensated’’ test if, within 3 months
of the end of the year in which the
account fails to meet such standard, the
bank transfers the account or the
securities held by or on behalf of the
account to a registered broker-dealer or
another unaffiliated entity (such as an
unaffiliated bank) that is not required to
be registered as a broker-dealer.200

permitting banks to exclude trust and
fiduciary accounts held at a foreign
branch of a bank from the chiefly
compensated tests.190 These
commenters contended that few, if any,
of the trust and fiduciary accounts of a
foreign branch (other than an offshore
‘‘shell’’ branch servicing U.S. branches
of the bank) likely are to be held by or
on behalf of a U.S. person and,
accordingly, the costs of applying the
chiefly compensated test to the foreign
branches of a U.S. bank would
significantly outweigh any potential
benefits to U.S. persons. After carefully
considering these comments, the
Agencies have adopted, without change,
the exemptions included in Proposed
Rule 723. In addition, the Agencies have
adopted a new conditional exemption
(Rule 723(c)) for trust and fiduciary
accounts held at a foreign branch of a
bank.
Rule 723(a) permits a bank that uses
either the account-by-account or bankwide compensation test to exclude any
trust or fiduciary account that was open
for a period of less than 3 months
during the relevant year.191 Rule 723(b)
permits a bank to exclude, for purposes
of determining its compliance with
either compensation test, any trust or
fiduciary account that the bank acquired
from another person as part of a merger,
consolidation, acquisition, purchase of
assets or similar transaction by the bank
for 12 months after the date the bank
acquired the account from the other
person.192 A bank that elects to use Rule
723(a) or (b) for one or more accounts
must exclude both the relationship
compensation and total compensation
attributable to such accounts for
purposes of the applicable
compensation test.
Rule 723(c) provides a new exemption
under which a bank using the bankwide approach may exclude for
purposes of the chiefly compensated
test the trust or fiduciary accounts held
at a ‘‘non-shell’’ foreign branch of the
bank, provided that the bank has
reasonable cause to believe that the trust
or fiduciary accounts of the foreign
branch held by or for the benefit of a
U.S. person constitute less than 10
percent of the total trust or fiduciary
accounts of the foreign branch.193 The

rule provides that a bank will be
deemed to have reasonable cause to
believe that less than 10 percent of the
total number of trust or fiduciary
accounts of the foreign branch are held
by or for the benefit of a U.S. person if
the principal mailing address for the
accountholder(s) and beneficiary(ies) of
the account is not in the United States,
or the records of the foreign branch
indicate that the accountholder(s) and
beneficiary(ies) of the account is not a
U.S. person as defined in 17 CFR
230.902(k).
The rule defines a ‘‘non-shell foreign
branch’’ of a bank to mean a branch of
the bank that is located outside the
United States and provides banking
services to residents of the foreign
jurisdiction in which the branch is
located, and for which the decisions
relating to day-to-day operations and
business of the branch are not made by
an office of the bank located in the
United States.194 The Agencies believe
this exemption provides appropriate
relief to banks with respect to foreign
branches where the records of the bank
indicate that it is not significantly
engaged in providing trust or fiduciary
services to U.S. customers.
Rule 723(e) permits a bank using the
account-by-account approach to
exclude, for purposes of the chiefly
compensated test, the lesser of (1) 1
percent of the total number of trust or
fiduciary accounts held by the bank; or
(2) 500 accounts.195 To rely on this
exemption with respect to an account,
the bank must not have relied on this
exemption for such account during the
immediately preceding year.196 In
addition, the bank must maintain
records demonstrating that the
securities transactions conducted by or
on behalf of the excluded account were
undertaken by the bank in the exercise
of its trust or fiduciary responsibilities
with respect to the account.197
The Agencies believe these exclusions
reduce administrative burdens and
facilitate compliance. A bank, consistent
with its fiduciary duties, may need to
conduct a higher level of securities
transactions for a trust or fiduciary
account at certain times, such as shortly
after the account is established or
acquired from another person or shortly

6. Advertising Restrictions
Proposed Rule 721(b) implemented
the advertising restrictions in Section
3(a)(4)(B)(ii)(II) of the Act applicable to
banks conducting securities transactions
under the trust and fiduciary exception.
No commenters opposed the advertising
restrictions of the rule and the Agencies
have adopted these restrictions as
proposed. The final rules provide that a
bank complies with the advertising
restriction applicable under either Rule

190 See ABA Letter, Clearing House Ass’n Letter,
Joint ABA/ABASA/Clearing House Ass’n Letter of
July 16, 2007.
191 Rule 723(a).
192 Rule 723(b).
193 The Agencies expect that few, if any banks,
that use the account-by-account approach to the
chiefly compensated test will have foreign branches
engaged in trust or fiduciary services and,
accordingly, have limited the exemption to banks
that use the bank-wide approach.

194 This definition is designed to exclude
branches that are established in certain offshore
jurisdictions primarily to provide services to U.S.
customers and, for this reason, are managed on a
day-to-day basis from the United States.
195 Rule 723(d). Under the rule, if a bank has less
than 100 trust or fiduciary accounts in the
aggregate, the bank may exclude 1 account under
the exemption in any given year.
196 Rule 723(d)(3).
197 Rule 723(d)(1).

198 For example, after a trust or fiduciary account
is acquired or established, the bank may need to
conduct a number of securities transactions to
invest or rebalance the account’s holdings in
accordance with the terms of the agreement
establishing the account or, in cases where the bank
has investment discretion, to implement the bank’s
investment strategy for the account.
199 See, e.g., ACB Letter; Clearing House Ass’n
Letter.
200 Rule 723(c).

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
721 or 722 if advertisements by or on
behalf of the bank do not advertise that
the bank provides securities brokerage
services for trust or fiduciary accounts
except as part of advertising the bank’s
broader trust or fiduciary services, and
do not advertise the securities brokerage
services provided by the bank to trust or
fiduciary accounts more prominently
than the other aspects of the trust or
fiduciary services provided to such
accounts.201
An ‘‘advertisement’’ for these
purposes means any material that is
published or used in any electronic or
other public media, including any Web
site, newspaper, magazine or other
periodical, radio, television, telephone
or tape recording, videotape display,
signs or billboards, motion pictures,
blast e-mail, or telephone directories
(other than routine listings).202 Other
types of material or information that is
not distributed through public media,
such as mailings or e-mails to a bank’s
own customers, are not considered an
advertisement. In addition, in
considering whether an advertisement
advertises the securities brokerage
services provided to trust or fiduciary
customers more prominently than the
bank’s other trust or fiduciary services,
the nature, context and prominence of
the information presented—and not
simply the length of text or information
devoted to a particular subject—should
be considered.

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IV. Sweep Accounts and Transactions
in Money Market Funds
Exchange Act Section 3(a)(4)(B)(v)
(‘‘sweep exception’’) excepts a bank
from the definition of ‘‘broker’’ to the
extent it ‘‘effects transactions as part of
a program for the investment or reinvestment of deposit funds into any noload, open-end management investment
company registered under the
Investment Company Act that holds
itself out as a money market fund.’’ 203
To provide banks with guidance on the
sweep exception, Proposed Rule 740
defined several terms used in the
exception, including the terms ‘‘money
market fund’’ and ‘‘no-load.’’ 204 The
Agencies also requested comment on a
separate exemption (Proposed Rule 741)
that would permit banks, without
registering as a broker, to effect
transactions in securities issued by a
money market fund on behalf of a
customer in a broader set of
201 Rule

721(b).
721(b)(2) (referencing Rule 760(g)(2)).
203 See Exchange Act Section 3(a)(4)(B)(v) (15
U.S.C. 78c(a)(4)(B)(v)).
204 Proposed Rule 740(b) and (c).
202 Rule

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circumstances, subject to certain
conditions.205
Most commenters that addressed
Proposed Rules 740 and 741 supported
the rules and Rule 741 in particular.206
One commenter objected to the
exemption in Rule 741 on the basis that
it would permit banks to effect
transactions in money market funds that
did not meet the ‘‘no-load’’
requirements of the sweep exception.207
Another commenter asked that the
Agencies clarify whether a bank may
effect transactions under the rules for
deposits held by another bank.
A. Rule 740: Definition of Terms Used
in Sweep Exception
As under the proposal, the final rule
defines a ‘‘money market fund’’ for
purposes of the sweep exception to
mean an open-end investment company
registered under the Investment
Company Act of 1940 (15 U.S.C. 80a–1
et seq.) that is regulated as a money
market fund pursuant to 17 CFR 270.2a–
7.208 In addition, consistent with FINRA
rules, the final rule provides that a class
or series of securities of an investment
company will be considered ‘‘no-load’’
if (1) the class or series is not subject to
a sales charge or a deferred sales charge;
and (2) total charges against net assets
of the class or series of securities for
sales or sales promotion expenses,
personal service, or the maintenance of
shareholder accounts do not exceed
0.0025 of average net assets annually.209
205 Proposed

Rule 741.
e.g., Federated Investors Letter, ICBA
Letter, Clearing House Ass’n Letter, ABA Letter.
207 See, e.g., NASAA Letter.
208 Rule 740(b). One commenter requested that
Rule 740(b) be modified to allow banks to sweep
deposits into an unregistered investment company
that operates pursuant to Rule 12d1–1 under the
Investment Company Act (17 CFR 270.12d1–1). See
State Street Corp. Letter. The statutory sweep
exception, however, provides only for deposit funds
to be swept into an investment company ‘‘registered
under the Investment Company Act of 1940.’’
Exchange Act Section 3(a)(4)(B)(v).
209 See Rule 740(c); FINRA Rule 2830. Consistent
with FINRA Rule 2830, charges for the following
are not be considered charges against net assets of
a class or series of an investment company’s
securities for sales or sales promotion expenses,
personal service, or the maintenance of shareholder
accounts: (1) Providing transfer agent or subtransfer agent services for beneficial owners of
investment company shares; (2) Aggregating and
processing purchase and redemption orders for
Investment company shares; (3) Providing
beneficial owners with account statements showing
their purchases, sales, and positions in the
investment company; (4) Processing dividend
payments for the investment company; (5)
Providing sub-accounting services to the investment
company for shares held beneficially; (6)
Forwarding communications from the investment
company to the beneficial owners, including
proxies, shareholder reports, dividend and tax
notices, and updated prospectuses; or (7) Receiving,
tabulating, and transmitting proxies executed by
beneficial owners of investment company shares.
206 See,

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56535

A bank may effect transactions under
the sweep exception and Rule 740 as
part of a program to sweep deposit
funds of, or collected by, another bank
into a no-load money market fund in
accordance with the exception and the
Rule.
B. Exemption Regarding Money Market
Fund Transactions
After carefully considering the
comments, the Agencies have adopted
Rule 741, which permits banks, without
registering as a broker, to effect
transactions on behalf of a customer in
securities issued by a money market
fund under certain conditions.210 To
qualify for this exemption, the bank
must provide the customer, directly or
indirectly, some other product or
service, the provision of which would
not, in and of itself, require the bank to
register as a broker-dealer under Section
15(a) of the Exchange Act.211 Examples
of other products or services that may be
a qualifying ‘‘other’’ product or service
include an escrow, trust, fiduciary or
custody account, a deposit account or a
loan or other extension of credit. The
Agencies have modified the rule to also
permit a bank to effect transactions
under the exemption on behalf of
another bank as part of a program for the
investment or reinvestment of the
deposit funds of, or collected by, the
other bank.212 This change is designed
to allow banks to provide sweep
services to other banks under the
exemption, as they may do under the
sweep exception itself.
The final exemption continues to
allow banks to effect transactions only
in securities of a registered money
market fund. In addition, the rule
continues to provide that, if the class or
series of money market fund securities
is not no-load (as defined in Rule 740),
the bank may not characterize or refer
to the class or series of securities as noload and the bank must provide the
customer, not later than at the time the
customer authorizes the bank to effect
the transactions, a prospectus for the
securities.213 The Agencies believe these
conditions and limitations provide bank
customers adequate protections in light
of the limited nature of the transactions
210 Rule

741.
741(a)(1)(A).
212 Rule 741(a)(1)(B).
213 Rule 741(a)(2)(ii). If a bank relies on the
exemption to sweep the deposits of another bank
into a money market fund that is not ‘‘no-load,’’
then neither the deposit-holding bank nor the
sweeping bank may characterize the fund as a ‘‘noload’’ fund, and either the deposit-taking bank or
the sweeping bank must provide the customer with
a prospectus for the fund within the time prescribed
by the rule. See Rule 741(a)(2)(ii)(A) and (B).
211 Rule

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permitted under the exemption.214 In
addition, the exemption recognizes that
banks have long offered sweeps and
other services that invest customer
funds in money market funds that do
not qualify as ‘‘no-load’’ funds under
Commission and FINRA rules.
V. Safekeeping and Custody

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A. Background
Section 3(a)(4)(B)(viii) of the
Exchange Act provides banks with an
exception from the ‘‘broker’’ definition
for certain bank custody and
safekeeping activities (‘‘custody and
safekeeping exception’’). In particular,
this exception allows a bank to perform
the following activities as part of its
customary banking activities without
registering as a ‘‘broker’:
• Providing safekeeping or custody
services with respect to securities,
including the exercise of warrants and
other rights on behalf of customers;
• Facilitating the transfer of funds or
securities, as a custodian or a clearing
agency, in connection with the
clearance and settlement of its
customers’ transactions in securities;
• Effecting securities lending or
borrowing transactions with or on
behalf of customers as part of the above
described custodial services or investing
cash collateral pledged in connection
with such transactions;
• Holding securities pledged by a
customer to another person or securities
subject to purchase or resale agreements
involving a customer, or facilitating the
pledging or transfer of such securities by
book entry or as otherwise provided
under applicable law, if the bank
maintains records separately identifying
the securities and the customer; and
• Serving as a custodian or provider
of other related administrative services
to any individual retirement account,
pension, retirement, profit sharing,
bonus, thrift savings, incentive, or other
similar benefit plan.215
The proposed rules included an
exemption to allow banks, subject to
214 Some commenters requested that the
prospectus-delivery requirement be eliminated or
modified so that delivery is required before a
transaction is effected rather than before the
customer authorizes the transaction. See, e.g., ABA
Letter, Clearing House Ass’n Letter, and HSBC Bank
Letter. The final rule retains this requirement to
ensure that a customer receives notice that its funds
are to be invested in a fund that is not ‘‘no-load’’
before the customer authorizes the transaction(s). If
a customer’s funds are invested in a no-load fund
and the bank is authorized, under the terms of its
agreement with the customer to alter the specific
fund into which the customer’s balances are
invested, the bank should provide the customer a
prospectus for any money market fund that is not
a ‘‘no-load’’ fund prior to the date on which the
bank first invests the customer’s balances in the
fund.
215 15 U.S.C. 78c(a)(4)(B)(viii).

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certain conditions, to accept orders for
securities transactions from employee
benefit plan accounts and individual
retirement and similar accounts for
which the bank acts as custodian.216 In
addition, the proposed exemption
allowed banks, subject to certain
conditions, to accept orders for
securities transactions on an
accommodation basis from other types
of custody accounts.217
Some commenters contended that an
exemption for custodial order-taking
activity is unnecessary because, they
argued, order-taking activity is
permitted directly under the statutory
exception.218 Other commenters stated
that the exemption was important
because it would allow banks to
continue to provide order-taking
services to employee benefit plans and
individual retirement accounts and
similar accounts, or that the restrictions
in the exemption were reasonable.219
Another commenter, however, objected
to the proposed exemption arguing that
permitting custodial banks to take
orders for securities is inconsistent with
functional regulation.220
B. Rule 760: Custody Exemption
After carefully considering the
comments, the Agencies have adopted
Rule 760. The Agencies have crafted the
exemption to allow banks to continue to
accept securities orders in a custodial
capacity and to permit bank customers
to take advantage of those order-taking
services subject to important conditions
designed to limit the scope of the
activity and provide appropriate
investor protections. In this way, the
Agencies believe the exemption is
consistent with functional regulation
and the purposes of the GLBA.
Rule 760 and the other final rules do
not implement the statutory custody
and safekeeping exception.221 A bank
does not need to rely on the custody
exemption in Rule 760 to the extent the
bank conducts other custodial activities
permitted by Section
3(a)(4)(B)(viii)(I)(aa)–(ee) (e.g.,
exercising warrants or other rights with
respect to securities or effecting
securities lending or borrowing
transactions on behalf of custodial
customers) or another of the final rules
216 Proposed

Rule 760(a).
Rule 760(b).
218 See, e.g., Union Bank Letter, Harris Bank
Letter, Clearing House Ass’n Letter, ABA Letter.
219 See, e.g., The Charles Schwab Corp.
(‘‘Schwab’’) Letter, ICBA Letter.
220 See NASAA Letter.
221 The Agencies asked for comment on whether
the Agencies should adopt rules to implement the
statutory custody and safekeeping exception. No
commenters requested that the Agencies do so at
this time.
217 Proposed

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(e.g., Rule 772, which permits banks to
effect securities lending or borrowing
transactions on behalf of certain noncustodial customers).222 In addition, a
bank would not have to rely on Rule 760
to the extent the bank holds securities
in custody for a customer and provides
clearance and settlement services to the
account in connection with such
securities, but the bank does not accept
orders for securities transactions for the
account or engage in other activities
with respect to the account that would
require the bank to be registered as a
broker.
The following discusses the scope and
terms of the custody exemption.
1. Order-Taking for Employee Benefit
Plan Accounts and Individual
Retirement or Similar Accounts
We are adopting, largely as proposed,
the sections of Rule 760 providing that
a bank will not be considered a broker
to the extent that, as part of its
customary banking activities, the bank
accepts orders to effect transactions in
securities in an ‘‘employee benefit plan
account’’ or an ‘‘individual retirement
account or similar account’’ for which
the bank acts as a custodian.223 The rule
defines an ‘‘employee benefit plan
account’’ as a pension plan, retirement
plan, profit sharing plan, bonus plan,
thrift savings plan, incentive plan, or
other similar plan, and provides a
number of non-exclusive examples of
plans that meet this definition.224 The
rule defines an ‘‘individual retirement
account or similar account’’ to mean an
222 One commenter asserted that a bank would
not ‘‘accept’’ a securities order if it received the
order from a custodial customer and at the
customer’s request transmitted the order to a
broker-dealer selected by the customer. See Union
Bank Letter. Such activities, however, constitute
‘‘accepting’’ a securities order for purposes of Rule
760 and a bank engaged in such activities for a
custodial customer must comply with Rule 760
unless some other exception or exemption is
available for the transaction (e.g., Section
3(a)(4)(B)(x) of the Act if the transaction involves
municipal securities).
223 See Rule 760(a).
224 Rule 760(h)(4). The rule provides that the term
‘‘employee benefit plan account’’ includes, without
limitation, an employer-sponsored plan qualified
under Section 401(a) of the Internal Revenue Code
(26 U.S.C. 401(a)), a governmental or other plan
described in Section 457 of the Internal Revenue
Code (26 U.S.C. 457), a tax-deferred plan described
in Section 403(b) of the Internal Revenue Code (26
U.S.C. 403(b)), a church plan, governmental, multiemployer or other plan described in Section 414(d),
(e) or (f) of the Internal Revenue Code (26 U.S.C.
414(d), (e) or (f)), an incentive stock option plan
described in Section 422 of the Internal Revenue
Code (26 U.S.C. 422); a Voluntary Employee
Beneficiary Association Plan described in Section
501(c)(9) of the Internal Revenue Code (26 U.S.C.
501(c)(9)), a non-qualified deferred compensation
plan (including a rabbi or secular trust), a
supplemental or mirror plan, and a supplemental
unemployment benefit plan.

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
individual retirement account as
defined in Section 408 of the Internal
Revenue Code (26 U.S.C. 408), a Roth
IRA as defined in Section 408A of the
Internal Revenue Code (26 U.S.C. 408A),
a health savings account as defined in
Section 223(d) of the Internal Revenue
Code (26 U.S.C. 223(d)), an Archer
medical savings account as defined in
Section 220(d) of the Internal Revenue
Code (26 U.S.C. 220(d)), a Coverdell
education savings account as defined in
Section 530 of the Internal Revenue
Code (26 U.S.C. 530), or other similar
account.225
A number of commenters supported
these definitions of ‘‘employee benefit
plan account’’ and ‘‘individual
retirement account or similar
account.’’ 226 The Agencies note that
both definitions, by their terms,
encompass ‘‘other similar’’ plans or
accounts. So, for example, similar plans
or accounts, such as ‘‘lifetime savings
accounts,’’ that are established under
the Internal Revenue Code in the future
would be employee benefit plan
accounts or individual retirement
accounts or similar accounts for
purposes of the rule. In addition, the
term ‘‘employee benefit plan account’’
includes a non-U.S. plan that meets the
definition of an employee benefit plan
account.
Under the final rules, a bank relying
on the employee benefit plan and
individual retirement and similar
account provisions must comply with
the advertising and sales literature
limitations in paragraphs (a)(2) and (3),
the employee compensation limitations
in paragraph (c), and the other
conditions in the paragraph (d) of the
rule. These conditions are discussed
below.
Some commenters asked that the
Agencies permit a bank to accept
securities orders for other types of
accounts that may involve custody of
securities, such as accounts for which
the bank acts as escrow agent, issuing
and paying agent, tender agent, or
disbursement agent, subject to the
conditions applicable to employee
benefit plan accounts and individual
retirement and similar accounts, rather
than the expanded set of conditions
applicable to accommodation orders
accepted for other types of custody
accounts. The provisions in Rule 760(a)
for employee benefit plan accounts and
individual retirement and similar
accounts are designed to reflect the
extent and manner in which banks
provide order-taking services for these
225 Rule

760(h)(5).
e.g., ABA Letter, Clearing House Assn.
Letter, WBA Letter.
226 See,

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types of accounts. In addition, these
provisions take account of the special
mention of these accounts in the
custody and safekeeping exception 227
and the additional protections to which
these accounts typically are subject
under the ERISA, the Internal Revenue
Code, and other applicable law. For
these reasons, the Agencies have not
expanded Rule 760(a) to cover accounts
other than employee benefit plan
accounts and individual retirement and
other similar accounts. Banks may
continue to accept orders from other
types of accounts for which the bank
acts as a custodian under the
accommodation provisions of the rule.
a. Employee Compensation Restrictions
We are adopting the employee
compensation restrictions in Rule 760(c)
as proposed. These restrictions apply
when a bank, acting in a custodial
capacity, accepts a securities order for
an employee benefit plan account or an
individual retirement account or similar
account under paragraph (a) of the rule,
and when a bank accepts a securities
order for another type of custodial
account under paragraph (b) of the rule.
Under these restrictions, if a bank
accepts securities orders pursuant to
Rule 760, then no employee of the bank
may receive compensation (including a
fee paid pursuant to a 12b–1 plan) from
the bank, the executing broker-dealer, or
any other person that is based on: (1)
Whether a securities transaction is
executed for the account; or (2) the
quantity, price, or identity of the
securities purchased or sold by the
account. These restrictions are designed
to be consistent with banking practices
and reduce the financial incentives a
bank employee might have to encourage
a customer to submit securities orders to
the bank and use a custody account as
the functional equivalent of a securities
brokerage account.
Only a few commenters addressed the
employee compensation restrictions of
the rule. For example, one commenter
asserted that the rule should permit a
bank to compensate its employees based
on the potential revenues associated
with a custodial account, including
revenues received from processing
securities transactions or from a mutual
fund in which the account is
invested.228 In addition, a commenter
expressed concern that the restrictions
would prohibit employees from
receiving bonuses based on the total
revenues derived from the custodial
227 See Section 3(a)(4)(B)(viii)(I)(ee) of the
Exchange Act.
228 See, e.g., Wells Fargo Letter.

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56537

accounts for which the employee is
responsible.
As the Agencies noted in the
proposal, the employee compensation
restrictions in Rule 760(c) do not
prohibit a bank employee from receiving
compensation that is based on whether
a customer establishes a custodial
account with the bank, or that is based
on the total amount of assets in a
custodial account at account opening or
at any other time. Moreover the rule
expressly provides that the employee
compensation restrictions do not
prevent a bank employee from receiving
payments under a bonus or similar plan
that are permissible under the exception
in Rule 700(b)(1) as if a referral had
been made by the bank employee, or
from receiving any compensation
described in Rule 700(b)(2) of the
networking rules.229
Thus, for example, the rule does
prohibit a bank from directly passing on
to an employee a portion or percentage
of the 12b–1 fees received by the bank
from a custody account’s investment in
a mutual fund, or a portion of a fee that
is charged only when, or that varies
based on whether, a securities
transaction is executed for the account.
A bank employee may receive payments
under a bonus or similar plan rule that
includes within its allocation pool the
revenues generated by one or more
custodial accounts if the plan meets the
criteria for a discretionary, multi-factor
bonus program in Rule 700(b)(1), or the
bonus program is based on the overall
profitability or revenues of the bank, an
affiliate, or operating unit and the
program complies with the
requirements of the safe harbor in Rule
700(b)(2). If a bank’s compensation
practices are inconsistent with these
limitations, the bank may not rely on
the exemption to take securities orders
in a custodial capacity.
b. Advertisements and Sales Literature
As under the proposed rule, final Rule
760(a)(2) provides that a bank relying on
the exemption may not advertise that it
accepts orders for securities transactions
for employee benefit plan accounts or
individual retirement accounts or
similar accounts for which the bank acts
as custodian, except as part of
advertising the other custodial or
229 Because the employee compensation
restrictions relate to securities transactions
conducted in the relevant custody account, they
would not prevent a bank employee from receiving
a referral fee for referring the customer to a brokerdealer to engage in securities transactions at the
broker-dealer that are unrelated to the custody
account in accordance with the networking
exception or the institutional customer and high net
worth customer exemption (Rule 701) for
networking arrangements.

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations

safekeeping services the bank provides
to these accounts.230 The bank also may
not advertise that such accounts are
securities brokerage accounts or that the
bank’s safekeeping and custody services
substitute for a securities brokerage
account.231 Moreover, advertisements
and sales literature for individual
retirement or similar accounts that are
issued by or on behalf of the bank may
not describe the securities order-taking
services provided by the bank to these
accounts more prominently than the
other aspects of the custody or
safekeeping services the bank
provides.232
One commenter indicated that these
advertising restrictions were
reasonable.233 Another commenter
suggested that these advertising
limitations should not apply to certain
advertisements for which a brokerdealer takes compliance
responsibility.234 The advertising and
sales literature restrictions are designed
to help prevent a bank from operating a
brokerage business out of its custody
department and, for this reason, apply
to all advertisements and sales literature
issued by or on behalf of a bank,
whether or not a broker-dealer has some
compliance responsibility with respect
to the advertisement or sales literature.
These limitations would not, however,
apply to the advertisements or sales
literature that a registered broker-dealer
may make to inform the public or others
about the availability of brokerage
services from the broker-dealer.
c. Other Conditions

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A bank that accepts orders for a
securities transaction for an employee
benefit plan account or individual
retirement account or similar account
also must comply with the conditions
set forth in paragraph (d) of the Rule.235
These conditions are discussed below in
Part V.B.3.236
230 Rule 760(h)(2) defines an ‘‘advertisement’’ to
mean material that is published or used in any
electronic or other public media, including any
Web site, newspaper, magazine or other periodical,
radio, television, telephone or tape recording,
videotape display, signs or billboards, motion
pictures, or telephone directories (other than
routine listings).
231 Rule 760(a)(2)(i) and (ii).
232 Rule 760(a)(3). Rule 760(h)(6) defines ‘‘sales
literature’’ to mean any written or electronic
communication, other than an advertisement, that
is generally distributed or made generally available
to customers of the bank or the public, including
circulars, form letters, brochures, telemarketing
scripts, seminar texts, published articles, and press
releases concerning the bank’s products or services.
233 See ICBA Letter.
234 See UMB Bank, N.A. Letter.
235 Rule 760(a)(1).
236 The Agencies have made a technical change
from the proposal to make clear that a bank

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2. Order-Taking as an Accommodation
for Other Types of Accounts
The proposed rule also permitted
banks to continue to accept securities
orders for custodial accounts other than
employee benefit plan and individual
retirement and similar accounts as an
accommodation to the customer, subject
to certain conditions designed to help
ensure that these services continue to be
provided only as an accommodation to
customers and that a bank does not
operate as a securities broker out of its
custody department. While commenters
generally supported permitting banks to
accept securities orders for other
custodial accounts on an
accommodation basis, several
commenters asked the Agencies to
modify or clarify the scope or terms of
the exemption, including the meaning
of ‘‘accommodation’’ and the
prohibition on providing investment
advice, research, and recommendations.
The Agencies are adopting, largely as
proposed, the provisions of the rule
permitting banks to accept orders as an
accommodation for these other
custodial accounts.237 A bank relying on
this part of the exemption must comply
with the conditions discussed below.
a. Accommodation Basis
For the reasons stated in the
proposing release, the final rule, like the
proposal, permits a bank to accept
securities orders for other types of
custodial accounts only as an
accommodation to the customer.238
Some commenters suggested that the
Agencies define the term
‘‘accommodation’’ in the rule to mean
any trade that is effected solely on the
request of the customer or on an
unsolicited basis.239 As noted in the
proposal, the Banking Agencies will
develop guidance to assist Banking
Agency examiners in reviewing, as part
of the agencies’ ongoing risk-focused
supervisory and examination process,
the order-taking services provided to
these custodial accounts. The guidance
will describe the types of policies,
procedures and systems that a bank
should have in place to help ensure that
the bank accepts securities orders for
these custodial accounts only as an
operating under Rule 760(a) must comply with the
conditions set forth in paragraph (d) as well as with
the employee compensation limitations of
paragraph (c). See Rule 760(a)(1). This should better
clarify banks’ responsibilities under these
provisions, and the Agencies have made a
conforming change to the text of Rule 760(b)
relating to accommodation trades.
237 Rule 760(b).
238 Rule 760(b)(1).
239 See Fiserv Trust Company Letter; Ass’n of
Colorado Trust Companies Letter.

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accommodation to the customer and in
a manner consistent with the custody
exemption.240 As part of these reviews,
Banking Agency examiners also will,
consistent with the rule, consider the
form and substance of the relevant
accounts, transactions, and activities to
prevent evasions of the requirements of
the rule.241 The Agencies believe this
approach, rather than adopting by rule
a definition of ‘‘accommodation,’’ is
appropriate given the disparity in the
types, characteristics and uses of other
custody accounts, the size and
operations of banks that provide these
services and the manner in which they
do so.
b. Employee Compensation Restrictions
For the reasons stated in the
proposing release, final Rule 760(b)(2)
continues to provide that a bank that
accepts orders for other custody
accounts must comply with the
employee compensation limitations in
paragraph (c) of the rule. These
limitations were previously discussed in
Part V.B.I.a., supra. 242
c. Limitations on Bank Fees
The rule prohibits a bank that accepts
accommodation orders for a custody
account from charging or receiving any
fee that varies based on (1) whether the
bank accepted the order for the
transaction or (2) the quantity or price
of the securities to be bought or sold.243
These restrictions do not prevent a bank
from charging or receiving a fee that is
based on the type of security purchased
or sold by the account (e.g., a foreign
security), provided the fee complies
with the conditions set forth in Rule
760(b)(3). Commenters did not raise
concerns with these restrictions.
d. Advertising and Sales Literature
Restrictions
Under the final rule, the bank’s
advertisements may not state that the
bank accepts orders for securities
transactions for a custodial account
(other than an employee benefit plan or
individual retirement account or similar
account). In addition, the bank’s sales
literature: (1) May state that the bank
accepts securities orders for such an
account only as part of describing the
other custodial or safekeeping services
the bank provides to the account, and
(2) may not describe the securities
order-taking services provided to such
an account more prominently than the
other aspects of the custody or
240 See

71 FR at 77532–33.
Rule 760(f).
242 Rule 760(b)(2).
243 Rule 760(b)(3).
241 See

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
safekeeping services provided by the
bank to the account.244

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e. Investment Advice or
Recommendations
The proposed rule imposed certain
restrictions on the ability of a bank to
provide investment advice or research
concerning securities to an account for
which it accepts accommodations
orders, make recommendations
concerning securities to the account, or
otherwise solicit securities transactions
from the account.245
Several commenters, expressed
concerns with the proposed limitations
on investment advice, research and
recommendations. For example,
commenters expressed concern that the
restrictions would negatively affect a
bank’s ability to cross-market its trust,
fiduciary or other services to custody
customers.246 Some expressed concern
that the limitations would interfere with
a bank’s ability to share research with
custody customers or make the bank’s
views concerning securities or markets
available to the public through Web
sites, mailings, interviews or other
means.247
After carefully considering the
comments received, the Agencies
believe that no change is necessary to
accommodate the cross-marketing of
other bank services. Accordingly, we are
adopting the provisions related to
investment advice, research and
recommendations without change. The
Agencies note that the prohibitions do
not prevent a bank from cross-marketing
its trust, fiduciary or other services to its
custody customers. A bank’s marketing
to custody account customers may—
without violating the rule’s general
prohibition against providing advice,
research or recommendations—include
non-account specific information
provided in media such as newsletters
and websites. In addition, the advice,
research, recommendation and
solicitation prohibition does not
prohibit a bank from providing samples
244 Rule 760(b)(5). One commenter urged the
Agencies to abandon the prohibitions on
advertising order-taking as an accommodation to
other custodial accounts, arguing that the
prohibition violates a bank’s constitutional free
speech rights. See CBA Letter. The Agencies believe
these restrictions are appropriate to effectuate the
purposes of the exemption and have tailored the
restrictions to comply with the customary practices
of banks and minimize potential disruptions. The
Agencies specifically requested comments on the
conditions of the rule, and no commenter indicated
that the advertising restrictions on accommodation
trade would materially disrupt their business or
operations.
245 Rule 760(b)(6).
246 See, e.g., Harris Bank Letter; U.S. Trust Letter.
247 See, e.g., PNC Letter; National City Corp.
Letter.

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of research, including stock-specific
research, to custody customers that the
bank provides to other persons for
marketing purposes. Thus, the Agencies
believe that banks will continue to be
able to cross-market their products and
services to their custody customers. A
custody account, however, is not a
fiduciary account, and a bank operating
under Rule 760(b) with respect to a
custodial account may not provide such
samples in such a way or with such a
frequency as to provide the custody
account securities services that only are
permissible for a trust or fiduciary
customer. The bank, moreover, may not
provide personalized investment advice,
research or recommendations regarding
particular securities to the custodial
account for any reason.248
Some commenters questioned
whether providing custody customers
with a choice of investments from
which to select would constitute
providing investment advice.249 Banks
may use menus or other lists to make
custodial customers aware of the
securities available to them through the
custodial account. For example, the
restrictions in paragraph (b)(6) of the
rule do not prevent a bank from
providing its customers with an online
menu of the mutual funds that the
customer is able to purchase through the
custody account.
The limitations and restrictions in
Rule 760(b), including those relating to
investment advice and
recommendations, relate only to those
custodial accounts for which the bank
accepts securities orders on an
accommodation basis. Thus, for
example, these limitations would not
apply to (1) an employee benefit plan
account or an individual retirement
account or similar account; or (2) a trust
or fiduciary account maintained by a
customer with a bank even if that
customer also maintains a custodial
account with the bank.
Commenters asked how the
limitations on investment advice and
research would apply when a customer
has both a custody account and a
separate trust or fiduciary account with
a bank, and asked the Agencies to
clarify that a bank would not violate the
restrictions if the bank provides a trust
or fiduciary customer with research or
advice that the customer then uses to
make orders through its custody
accounts.250 Rule 760(b)(6) prohibits
248 This would include providing personalized
advice, research or recommendations concerning
securities to the account in an effort to convert the
account to another type of account, for goodwill or
to obtain referrals.
249 See Harris Bank Letter; PNC Letter.
250 See ABA Letter; Harris Bank Letter.

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56539

banks from providing investment
advice, research or recommendations
concerning securities to, or soliciting
securities transactions from, a custody
account for which the bank accepts
orders under the accommodation trade
authority. The rule does not limit the
types of research or other services a
bank may provide to a customer’s trust
or fiduciary account, and the Agencies
recognize that a bank may have no
control over which account the
customer uses to place any orders that
result from such research or other
services.
The final rule, like the proposal,
continues to provide that, in order to
prevent evasions of the custody
exemption, the Agencies will consider
both the form and substance of the
relevant account(s), transaction(s) and
activities (including advertising
activities) in considering whether a
bank meets the terms of the
exemption.251 For example, the
Agencies will consider the content,
format and frequency of any investment
research provided to an accommodation
custodial account in considering if such
research in purpose or effect evades the
restrictions in the rule or provides a
custody account securities services that
only are permissible for a trust or
fiduciary customer. Similarly, a bank
may not evade the rule’s restrictions by
providing an accommodation customer
that has both a custody account and a
trust or fiduciary account with
investment advice, recommendations or
research that is targeted to the securities
held in the customer’s custody account.
For example, if a customer’s custody
account has a large position in a
particular security and that security is
not held in the customer’s trust or
fiduciary account, a bank may not
routinely provide the customer with
research focused on that security. Banks
should have and maintain policies and
procedures to abide by these limitations
and bank examiners will review bank
compliance with these limits in
accordance with the risk-based
supervisory and examination process,
considering both the form and substance
of the cross-marketing activities in
applying the anti-evasion provisions of
the rule.
The restrictions in Rule 760(b)(6) do
not prohibit the bank from advertising
its custodial services and disseminating
sales literature that meets the conditions
in the exemption.252 These restrictions
also will not prevent a bank employee
from responding to customer inquiries
regarding the bank’s safekeeping and
251 Rule
252 Rule

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760(b)(6)(i).

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custody services by providing
advertisements or sales literature
describing the safekeeping, custody and
related services the bank offers
(provided those advertisements and
sales literature comply with the
restrictions in the proposed exemption),
a prospectus prepared by a registered
investment company, sales literature
prepared by a registered investment
company or by the broker-dealer that is
the principal underwriter of the
registered investment company
pertaining to the registered investment
company’s products, or information
based on any of those materials.253 The
exemption allows a bank’s employees to
respond to customer inquiries
concerning the bank’s safekeeping,
custodial or other services, such as
inquiries concerning the customer’s
account or the availability of sweep or
other services, so long as the bank does
not provide investment advice or
research concerning securities to the
account or make a recommendation to
the account concerning securities.254
3. Other Conditions Applicable to
Order-Taking for All Custody Accounts
The proposed exemption provided
that a bank may accept orders for a
securities transaction for a custody
account under the exemption only if the
bank (1) does not act in a trustee or
fiduciary capacity (as defined in section
3(a)(4)(D) of the Exchange Act) with
respect to the account; (2) complies with
section 3(a)(4)(C) of the Act in handling
any order for a securities transaction for
the account; and (3) complies with
section 3(a)(4)(B)(viii)(II) of the Act
regarding carrying broker activities.

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a. Directed Trustees
Some commenters requested that the
Agencies modify the exemption to allow
a bank that acts as a directed trustee for
an account to accept orders and effect
transactions for the account under the
custody exemption in Rule 760 in lieu
of relying on the trust and fiduciary
rules (Rule 721 to 723) for the
transaction.255 In light of the comments
and the protections included in Rule
760, the Agencies have modified the
253 Rule 760(b)(6)(ii). ‘‘Principal underwriter’’ has
the same meaning as in section 2(a)(29) of the
Investment Company Act of 1940 (15 U.S.C. 80a–
2(a)(29)). Rule 760(h)(7).
254 Rule 760(b)(6)(iii).
255 See Teachers Insurance and Annuity
Association of America and College Retirement
Equities Fund (‘‘TIAA–CREF’’) Letter; ACB Letter;
Roma Bank Letter. Commenters asserted, for
example, that a bank acting as a directed trustee
provides services that are functionally similar to
those provided as a custodian and in either case
does not have investment discretion with respect to
the account.

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final rule to provide that a bank that acts
as a directed trustee for an account may
rely on the custody exception to accept
orders for, and effect transactions in,
securities for the account.256 If a bank
acting as directed trustee relies on the
rule to effect transactions for an
employee benefit plan account or an
individual retirement account or similar
account, the bank must comply with the
conditions in Rule 760(a). If a bank
acting as directed trustee relies on the
rule to effect transactions for another
type of account, the bank must comply
with the conditions governing
accommodation accounts in Rule
760(b).
The rule defines a directed trustee as
‘‘a trustee that does not exercise
investment discretion with respect to
the account.’’ 257 The Agencies also have
modified the definition of ‘‘an account
for which the bank acts as a custodian’’
to include an account for which a bank
acts as a directed trustee.258 Although a
bank acting as directed trustee for an
account may effect transactions under
the custody exemption, the bank’s
trustee relationship with the account
remains a trust and fiduciary
relationship and, as such, the bank must
continue to comply with applicable
fiduciary principles and standards in its
relationships with the account.
b. Broker Execution Requirement
Consistent with the requirements of
the custody and safekeeping exception,
Rule 760(d)(2) requires a bank that
accepts orders for a custody account
under the rule to comply with Section
3(a)(4)(C) of the Exchange Act 259 in
handling any order for a securities
transaction for the account.260 Under
this provision, (i) the bank must direct
the trade to a registered broker-dealer
for execution, or (ii) the trade must be
a cross trade or other substantially
similar trade of a security that is made
by the bank or between the bank and an
affiliated fiduciary and is not in
contravention of fiduciary principles
established under applicable Federal or
State law, or (iii) the trade must be
conducted in some other manner
permitted under rules, regulations, or
orders as the Commission may prescribe
or issue.
256 See Rule 760(d)(1). Alternatively, the bank
may continue to effect transactions for the account
under the rules relating to trust or fiduciary
accounts.
257 Rule 760(h)(3).
258 See Rule 760(h)(1).
259 15 U.S.C. 78c(a)(4)(C).
260 See Rule 760(d)(2).

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c. Carrying Broker Provisions
A number of commenters addressed
the proposed provision limiting the
availability of the custody exemption to
banks that comply with Section
3(a)(4)(B)(viii)(II) of the Exchange
Act 261 relating to carrying broker
activities.262 Some stated that the
Agencies should define the term
‘‘carrying broker’’ by rule rather than by
interpretation.263 One commenter
requested that we interpret the term
based on the view that the essence of a
carrying broker relationship is
‘‘complete dependence’’ of a brokerdealer on another entity for back office
functions and execution.264 Another
commenter took the position that a
custodian bank should not be deemed a
carrying broker so long as ‘‘it is not
enabling’’ broker-dealers to avoid the
net capital requirements applicable to
carrying brokers.265 One commenter
generally suggested that we either
eliminate the carrying broker limitation
from the proposed rules, or amend it to
avoid affecting the ability of banks to
undertake traditional banking
activities.266
Section 3(a)(4)(B)(viii)(II) of the
Exchange Act provides that a bank
relying on the custody exception may
not act as a ‘‘carrying broker,’’ as that
term and different formulations of the
term are used in Section 15(c)(3) of the
Act and the underlying rules and
regulations, for a broker-dealer other
than with respect to government
securities. Section 15(c)(3) of the Act in
relevant part requires broker-dealers to
comply with the Commission’s
regulations with respect to financial
responsibility and related customer
protection practices of broker-dealers.267
The Commission’s financial
responsibility and customer protection
rules expand on what it means to carry
261 15 U.S.C. 78c(a)(4)(B)(viii)(II). This provision
prohibits a custodian bank from acting as a carrying
broker (as such term, and different formulations
thereof, are used in Exchange Act Section 15(c)(3)
and the rules and regulations under that Section)
for any broker-dealer, unless such carrying broker
activities are engaged in with respect to government
securities.
262 Rule 760(d)(3).
263 See ABA Letter; State Street Corp. Letter; PNC
Letter.
264 See Clearing House Ass’n Letter.
265 See U.S. Trust Letter.
266 See HSBC Bank Letter. In addition, a few
commenters asserted that the description of
potential carrying broker activity in prior
rulemakings under the GLB Act would, if adopted,
be highly problematic and disruptive for banks and
broker-dealers. See Clearing House Ass’n Letter;
ABA Letter.
267 Exchange Act Section 15(c)(3)(A), 15 U.S.C.
78o(c)(3)(A).

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customer securities.268 In general,
broker-dealers establish carrying
arrangements in which other brokerdealers carry their accounts to permit
the non-carrying broker-dealer to be
subject to lesser financial responsibility
requirements under the Exchange Act. A
broker-dealer entering into such an
agreement with a carrying entity that is
not a registered broker-dealer, however,
may not take advantage of those lesser
requirements.269
After carefully considering the
comments, the Agencies have retained
this limitation as a condition of the
custody exemption without change as it
is a term of the statutory custody
exception. Banks may look to certain
key factors to help distinguish
permissible custodial activity from
impermissible carrying broker activity.
In particular, key factors in considering
whether the existence of shared
customers between a broker-dealer and
a bank may entail impermissible
carrying broker activity by the bank are
the broker-dealer’s own regulatory
obligations and whether the brokerdealer either makes formal or informal
arrangements with the bank or
structures its operations or offerings to
cause the broker-dealer’s customers
generally (or one or more broad
segments of the broker-dealer’s
customers) to use the bank’s custody
accounts instead of maintaining funds
268 The Commission’s net capital rule specifies
that a broker-dealer shall be deemed to carry
customer or broker-dealer accounts ‘‘if, in
connection with its activities as a broker or dealer,
it receives checks, drafts, or other evidences of
indebtedness made payable to itself or persons
other than the requisite registered broker or dealer
carrying the account of a customer, escrow agent,
issuer, underwriter, sponsor, or other distributor of
securities’’ or ‘‘if it does not promptly forward or
promptly deliver all of the securities of customers
or of other brokers or dealers received by the firm
in connection with its activities as a broker or
dealer.’’ Exchange Act Rule 15c3–1(a)(2)(i)
The Commission’s customer protection rule
governing reserves and custody of securities defines
the term ‘‘securities carried for the account of a
customer’’ to mean ‘‘securities received by or on
behalf of a broker or dealer for the account of any
customer and securities carried long by a broker or
dealer for the account of any customer,’’ as well as
securities sold to, or bought for, a customer by a
broker-dealer. Exchange Act Rule 15c3–3(a)(2).
269 Within common securities industry usage, the
terms ‘‘carrying broker’’ and ‘‘clearing broker’’ are
virtually identical and often are used
interchangeably. In certain instances, the terms
mean a broker that, as part of an arrangement with
a second broker (an ‘‘introducing’’ or
‘‘corresponding’’ broker), allows the second broker
to be subject to lesser regulatory requirements (e.g.,
under the net capital provisions of Exchange Act
Rule 15c3–1 and the customer protection provisions
of Exchange Act Rule 15c3–3). Technically,
however, a ‘‘carrying broker’’ is a broker that holds
funds and securities on behalf of customers,
whether its own customers or customers introduced
by another broker-dealer, and a ‘‘clearing broker’’ is
a member of a registered clearing agency.

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and securities in accounts at the brokerdealer (thereby avoiding the brokerdealer’s financial and related
responsibilities). The existence of a
substantial number of common
customers between a broker-dealer and
a bank’s custody department in the
absence of such an arrangement or
structure would not cause the bank to
act as a carrying broker for the brokerdealer.
Similarly, a bank may perform or
share systems that perform limited backoffice functions on behalf of a brokerdealer without becoming a carrying
broker for the broker-dealer. A brokerdealer, for example, may contract with
an unregistered party such as a bank to
send out transaction confirmations on
behalf of the broker-dealer or have an
arrangement with an affiliated bank to
provide customers with combined
statements, with the broker-dealer
remaining responsible for the accuracy
and completeness of those
confirmations and the broker-dealer
aspects of the statements. A bank and an
affiliated broker-dealer also may share
or coordinate risk management systems
such as, for example, those relating to
Bank Secrecy Act and anti-money
laundering compliance.270 A brokerdealer, however, may not delegate core
functions to a bank or other unregistered
entity or functions that would require
an individual to pass a qualification
examination or register with an SRO.271
A broker-dealer also must maintain
possession or control over the brokerdealer’s proprietary cash or securities
and its customers’ cash or securities in
accordance with the Commission’s
financial responsibility rules.272 Of
course, a bank may serve as custodian
for proprietary or customer cash or
securities of the broker-dealer and may
accept and use in the ordinary course of
its banking business cash deposited
with the bank by the broker-dealer or its
customers.273
270 Other examples of current permissible
coordination arrangements between banks and
broker-dealers include legal and compliance
functions, accounting and finance functions (such
as payroll and expense account reporting),
information technology, operations functions (such
as disaster recovery services), and administration
functions (such as human resources and internal
audits). See NASD Notice to Members 05–48 (July
2005) at 2.
271 NASD Notice to Members 05–48 (July 2005),
‘‘Outsourcing,’’ provides guidance to member firms
regarding the outsourcing activities and functions
that, if performed directly by members, would be
required to be the subject of a supervisory system
and written supervisory procedures pursuant to
NASD Rule 3010.
272 See e.g., Rules 15c3–1 and 15c3–3 [17 CFR
240.15c3–1, 15c3–3]. This is true even if the brokerdealer is not ‘‘completely dependent’’ on the bank
for all back office functions and execution.
273 See Rule 15c3–3(c)(5).

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56541

4. Custodians, Subcustodians and
Administrators/Recordkeepers
a. ‘‘Account for which a bank acts as a
custodian’’
As a general matter, the exemption in
Rule 760 is available only for an
‘‘account for which the bank acts as a
custodian.’’ The proposed rule defined
this term to mean an account that is: (i)
An employee benefit plan account for
which the bank acts as a custodian; (ii)
an individual retirement account or
similar account for which the bank acts
as a custodian; or (iii) an account
established by a written agreement
between the bank and the customer that
sets forth the terms that will govern the
fees payable to, and rights and
obligations of, the bank regarding the
safekeeping or custody of securities.274
As discussed in Part V.B.3.a supra, the
Agencies have amended this definition
in the final rule also to include an
account for which a bank acts as a
directed trustee.
A few commenters asked whether a
bank performing custodial functions in
a non-trustee and non-fiduciary capacity
(such as escrow agent, fiscal agent or
paying agent) may use the custody
exemption even if it is not formally
designated as ‘‘custodian’’ by the bankcustomer agreement.275 Whether a bank
serves as custodian for the securities or
other assets of an account depends on
the services the bank provides to the
account with respect to such securities
or assets, not the label used to identify
the account or the bank’s services in the
agreement between the bank and the
customer. Thus, for example, a bank
that acts as an escrow agent, fiscal agent
or paying agent with respect to an
account, and that provides safekeeping
or custody services for the securities or
other assets in the account, is
considered to be a custodian for the
account for purpose of the rule
regardless of whether the account
agreement uses the term ‘‘custodian’’ or
any other particular language.
b. Administrators/Recordkeepers and
Subcustodians
The proposed exemption permitted a
bank acting as a non-fiduciary and noncustodial administrator or recordkeeper
for an employee benefit plan to accept
securities orders for the plan on behalf
of a custodian bank.276 Under the
proposed exemption, both the
administrator/recordkeeper bank and
the custodial bank had to comply with
the requirements relating to employee
274 Proposed

Rule 760(g)(1).
Union Bank Letter, Wells Fargo Letter.
276 Proposed Rule 760(e).
275 See

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations

benefit plan accounts.277 In addition,
the proposed rule prohibited an
administrator/recordkeeper bank from
executing a cross-trade with or for the
employee benefit plan or from netting
orders for securities for the plan, other
than orders for shares of open-end
investment companies not traded on an
exchange.278
A few commenters supported these
provisions, but opposed the restrictions
on cross-trading and netting.279 One
commenter maintained that the
administrator/recordkeeper provisions
should also be available to banks
providing administrative services to
individual retirement accounts.280
Some commenters also questioned
whether or how the proposed
exemption would apply to a bank that
acts as a subcustodian for the trust or
fiduciary or custody accounts of another
bank. For example, some commenters
asserted that a bank acting as a
subcustodian for another bank’s trust or
fiduciary accounts should be permitted
to accept orders for those accounts
under the less restrictive conditions in
Rule 760(a) regardless of the type of
accounts actually involved.281 Other
commenters suggested that a
subcustodian bank be permitted to effect
trades for the accounts of the other bank
with a direct custodial relationship with
the customer under the same rules (e.g.,
trust and fiduciary or custody), and
subject to the same conditions, that
would apply to the other bank if it
conducted the transactions directly.282
Commenters also noted that banks, and
particularly smaller banks, at times use
subcustodian arrangements with other
banks to provide their customers
custodial services more efficiently and
at lower cost than they may be able to
do on their own.
After carefully considering the
comments, the Agencies have adopted
Rule 760(e), which permits a bank that
acts as a non-fiduciary and noncustodial administrator or recordkeeper
for an employee benefit plan for which
another bank acts as a custodian to
accept orders for the account under Rule
760.283 In addition, the Agencies have

adopted a new paragraph (f) of the rule
that permits a bank that acts as a
subcustodian for any type of account for
which another bank acts as custodian to
accept orders for the account under Rule
760. This change was made in response
to comments that greater flexibility and
clarity was needed for banks that use,
and banks that provide, subcustodial
services. Under these provisions of the
final rule, the administrator/
recordkeeper bank or subcustodian
bank, as well as the initial custodian
bank for the account, must comply with
the provisions of Rule 760 applicable to
the type of account involved (i.e.
employee benefit plan account,
individual retirement account or similar
account, or other types of accounts).284
The final rule generally prohibits a
recordkeeper/administrator bank or
subcustodian bank relying on the
exemption from executing a cross-trade
or netting orders with or for the relevant
account.285 However, the Agencies have
expanded the exceptions to this general
prohibition in light of the comments
received. In particular, the final rule
permits the administrator/recordkeeper
bank or subcustodian bank to cross or
net orders for shares of open-end
investment companies not traded on an
exchange.286 In addition, the final rule
permits the administrator/recordkeeper
bank or subcustodian bank to cross
orders between or net orders for
accounts of the custodian bank that
contracted with the administrator/
recordkeeper bank or subcustodian bank
for services.287 Permitting this
additional type of cross-trade and
netting activity is consistent with the
exceptions to broker execution
requirement in section 3(a)(4)(C) of the
Exchange Act and should allow costsavings for the customer by eliminating
the need for a broker intermediary. At
the same time, by prohibiting an
administrator/recordkeeper bank or
subcustodian bank operating under the
rule from executing cross-trades or
netting orders among the accounts of
different custodian banks to which it
provides services will help prevent

banks from establishing a market for
securities under the exemption.
The Agencies note that these
provisions do not apply to a bank that
provides custody and order-taking
services to the trust or fiduciary
accounts of another bank. In these
circumstances, the bank providing
custodial services is treated as a
custodian, and not a subcustodian, for
purposes of the rule and may provide
order-taking services to the account in
accordance with the provisions of Rule
760(a) or (b) applicable to the type of
account involved.
5. Evasions
The Agencies are adopting, as
proposed, the provision that states the
Agencies will consider both the form
and substance of the relevant accounts,
transactions and activities (including
advertising activities) in considering
whether a bank meets the terms of the
exemption, to prevent evasions of the
exemption.288 We received no
comments on this anti-evasion
provision. As part of the regular riskfocused examination process, the
Banking Agencies will monitor the
securities transactions in custodial
accounts. If the appropriate Banking
Agency were to find that a bank is
evading the terms of the custody
exemption to run a brokerage business
out of its custody department, the
agency would take appropriate action to
address the problem.
VI. Other Exemptions
The Agencies also are adopting
certain other exemptions relating to the
securities ‘‘broker’’ activities of banks.
These are discussed below.
A. Exemption for Regulation S
Transactions With Non-U.S. Persons
and Broker-Dealers
We are adopting Rule 771 of
Regulation R to exempt banks from the
definition of ‘‘broker’’ under the
Exchange Act for certain agency
transactions involving Regulation S
securities.289 As with Rule 3a5–2 under
288 Rule

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277 Proposed

Rule 760(e)(1).
278 Proposed Rule 760(e)(2).
279 See ABA Letter; Clearing House Ass’n Letter;
CBA Letter. The commenters asserted that the crosstrading and netting restrictions were too restrictive
and noted that section 3(a)(4)(C) of the Exchange
Act permits bank custodians to engage in a broader
range of cross-trade and netting activities.
280 See CBA Letter.
281 See, e.g., ABA Letter, CBA Letter, PNC Letter,
Schwab Letter.
282 See TIAA–CREF Letter.
283 The Agencies understand that the type of
administrator/recordkeeper arrangements described
in Rule 760(e) are not typically used with respect

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to accounts other than employee benefit plan
accounts and, for this reason, have not expanded
the paragraph to cover other types of accounts.
284 See Rule 760(e)(1) and (f)(1) and (2). The
Agencies made a technical change to Rule 760(e) to
clarify that the administrator/recordkeeper bank
and the custodial bank for employee benefit
accounts need to comply only with the
requirements in the rule applicable to employee
benefit plan accounts and do not need to comply
with the conditions applicable to accommodation
trades.
285 Rule 760(e)(2) and (f)(3).
286 See Rule 760(e)(2)(i) and (f)(3)(i).
287 See Rule 760(e)(2)(ii) and (f)(3)(ii).

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760(g).
Commission’s Regulation S (17 CFR
230.901 et seq.) provides that offers and sales of
securities conducted in accordance with the terms
of the regulation will not be deemed to constitute
an offer, offer to sell, sale or offer to buy within the
United States for purposes of the securities
registration requirements of Section 5 of the
Securities Act. See 17 CFR 230.901. Specifically,
Rule 903 of Regulation S provides that an offer or
sale of securities by the issuer, a distributor, or an
affiliate or a person acting on their behalf shall be
deemed to occur outside the U.S. within the
meaning of Rule 901 if the offer or sale is made in
an offshore transaction (as defined in Rule 901), and
no directed selling efforts are made in the U.S. by
the issuer, a distributor, affiliate, or person acting
289 The

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the Exchange Act, which the
Commission separately is adopting to
permit banks to engage in certain
Regulation S transactions on a riskless
principal basis without being ‘‘dealers,’’
Rule 771 recognizes that non-U.S.
persons located outside the United
States generally will not rely on the
protections of the U.S. securities laws
when purchasing Regulation S
securities from U.S. banks, and that
those persons may purchase the same
securities from foreign banks located
outside the U.S. without subjecting the
foreign bank to U.S. broker-dealer
registration.
Commenters generally supported the
proposal while suggesting certain
modifications and clarifications.290 For
example, commenters requested that the
Agencies clarify that the exemption is
available to banks both during and after
any applicable distribution compliance
period for the securities required by
Regulation S, and allow banks to
conduct resales of eligible securities for
either non-U.S. persons or registered
broker-dealers if the bank has a
reasonable belief that the securities were
initially sold in compliance with
Regulation S.291 In addition, some
commenters argued that the exemption
should not require a bank to comply
on their behalf. Other conditions may also apply
depending on the place of incorporation and
reporting status of the issuer, and the amount of
U.S. market interest in the securities.
Rule 904 of Regulation S provides that an offer
or sale of securities by any person other than the
issuer, a distributor, an affiliate (except an officer
or director who is an affiliate solely by virtue of that
position) or person acting on their behalf will be
deemed to occur outside the U.S. within the
meaning of Rule 901 if the offer or sale is made in
an offshore transaction (as defined in Rule 901), and
no directed selling efforts are made in the U.S. by
the seller, an affiliate or person acting on their
behalf. Additional conditions apply in the case of
resales of certain types of securities by dealers and
persons receiving selling concessions, and in the
case of resales by certain affiliates of the issuer or
a distributor.
290 See IIB Letter; ABA Letter; Clearing House
Ass’n Letter.
291 See IIB Letter; Clearing House Ass’n Letter.
Rules 903(b)(2) and (b)(3) of Regulation S subject
Category 2 securities and Category 3 debt securities
to a 40-day distribution compliance period, and
subject Category 3 equity securities to a one-year
distribution compliance period, during which
certain restrictions apply to offers or sales of the
securities in order to preserve the foreign nature of
the transactions. Under Rule 903 of Regulation S,
Category 1 encompasses certain securities: (i) Issued
by a foreign issuer, for which there is no substantial
U.S. market interest, (ii) that are offered and sold
in an overseas directed offering, (iii) that are backed
by the full faith and credit of a foreign government,
or (iv) that are offered and sold to employees of the
issuer or its affiliates pursuant to certain foreign
employee benefit plans. Category 2 encompasses
securities, not eligible for Category 1, that are equity
securities of a reporting foreign issuer, or debt
securities of a reporting issuer or of a non-reporting
foreign issuer. Category 3 applies to all offerings of
securities that do not fall within Category 1 or 2.

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with the resale restrictions in Rule 904
of Regulation S if the bank effects a
resale of an eligible security in
accordance with Rule 903 of Regulation
S prior to the end of any applicable
distribution compliance period for the
security.292 Commenters also urged the
Agencies to make the proposed ‘‘broker’’
exemption in Regulation R and the
‘‘dealer’’ exemption proposed by the
Commission as consistent as possible
and to make both exemptions as
consistent as possible with Regulation
S.
The Agencies have modified the rule
in several respects in light of the
comments, to enhance its clarity and to
better conform it to Regulation S. The
final rule, like the proposed rule,
continues to have three parts. The first
part permits a bank to effect a sale of an
eligible security in compliance with the
requirements of Rule 903 of Regulation
S to a purchaser who is not in the
United States.293 The term ‘‘purchaser’’
is defined to mean a person who
purchases an eligible security and who
is not a U.S. person under Rule 902(k)
of Regulation S.294
The second part permits a bank to
effect, by or on behalf of a person who
is not a U.S. person under Rule 902(k)
of Regulation S, a resale of an eligible
security after its initial sale to a
purchaser who is not in the United
States or to a registered broker-dealer.295
To take advantage of this second
exemption, the bank (1) must have a
reasonable belief that the eligible
security was initially sold outside of the
United States within the meaning of and
in compliance with Rule 903 of
Regulation S, and (2) if the resale is
made prior to any applicable
distribution compliance period
specified in Rules 903(b)(2) or (b)(3) of
292 See

IIB Letter.
771(a)(1).
294 Rule 771(b)(3). Rule 902(k) of Regulation S
defines the term ‘‘U.S. person’’ to mean: (i) Any
natural person resident in the U.S.; (ii) any
partnership or corporation organized or
incorporated under the laws of the U.S.; (iii) any
estate of which any executor or administrator is a
U.S. person; (iv) any trust of which any trustee is
a U.S. person; (v) any agency or branch of a foreign
entity located in the U.S.; (vi) any non-discretionary
account or similar account (other than an estate or
trust) held by a dealer or other fiduciary for the
benefit or account of a U.S. person; and (vii) any
discretionary account or similar account (other than
an estate or trust) held by a dealer or other fiduciary
organized, incorporated, or (if an individual)
resident in the U.S., and (viii) any partnership or
corporation if (A) organized or incorporated under
the laws of any foreign jurisdiction, and (B) formed
by a U.S. person principally for the purpose of
investing in securities not registered under the Act,
unless it is organized or incorporated, and owned,
by accredited investors (as defined in Rule 501(a)
under the Securities Act) who are not natural
persons, estates or trusts.
295 Rule 771(a)(2).
293 Rule

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56543

Regulation S, the resale must be made
in compliance with the requirements of
Rule 904 of Regulation S.296
The third part of the exemption
permits a bank to effect, by or on behalf
of a registered broker-dealer, a resale of
an eligible security after its initial sale
to a purchaser who is not in the United
States.297 As under the second part, the
bank must have a reasonable belief that
the eligible security was initially sold
outside of the United States within the
meaning of and in compliance with
Rule 903 of Regulation S and, if the
resale is made prior to the expiration of
any applicable distribution compliance
period in Rules 903(b)(2) or (b)(3) of
Regulation S, the bank must effect the
resale in compliance with the
requirements of Rule 904 of Regulation
S. The proposed rule would have
allowed a bank to rely on a reasonable
belief that the security was sold in
compliance with Regulation S only
when it purchases a security from a
non-U.S. person but not when it
purchases a security from a brokerdealer. In light of comments received,
the reasonable belief standard is also
available under the final rule for a
bank’s transactions with a broker-dealer
because the process of determining
whether a security initially was issued
in compliance with Regulation S should
be similar whether the purchase is from
a broker-dealer or a non-U.S. person.298
As the rule makes clear, a bank effecting
a resale of an eligible security under the
exemption must effect the transaction in
accordance with the conditions of Rule
904 if the transaction occurs during, but
not after, any applicable distribution
compliance period for the security
under Rule 903(b)(2) or (b)(3) of
Regulation S.
The final rule continues to require,
however, that any sale effected under
paragraph (b)(1) of the Rule, or resale
effected under paragraphs (b)(2) or (b)(3)
of the Rule (other than one to a
registered broker-dealer), be to a
‘‘purchaser who is not in the United
States.’’ This is true even if the
applicable distribution compliance
period for the overseas offering of the
security under Regulation S has expired.
Consistent with Regulation S, which
permits the offshore resale of securities,
the purpose of the exemption in Rule
771 is to permit U.S. banks to sell
Regulation S securities to customers
outside the United States. It does not
permit banks to sell those securities
domestically (other than to a registered
296 Rule

771(a)(2).
771(a)(3).
298 See IIB Letter and Clearing House Ass’n Letter.
297 Rule

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broker-dealer).299 For purposes of the
exemption, an ‘‘eligible security’’ means
any security other than a security that
is being sold from the inventory of the
bank or an affiliate of the bank or that
is being underwritten by the bank or an
affiliate of the bank on a firmcommitment basis unless the bank
acquired the security from an
unaffiliated distributor that did not
purchase the security from the bank or
an affiliate of the bank.300 Commenters
requested that the Agencies clarify that
the definition of ‘‘eligible security’’
would not prohibit a bank from effecting
transactions under the exemption in
securities that have been issued by the
bank or an affiliate.301 A security that is
issued by a bank or an affiliate of a
bank, such as a structured note or share
in a pooled investment vehicle, may be
an eligible security if it otherwise meets
the terms of paragraph (b)(2) of Rule
771.

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B. Exemption for Non-Custodial
Securities Lending Transactions
The Agencies are adopting, as
proposed, Rule 772 of Regulation R to
provide banks engaged in certain
securities lending transactions with a
conditional exemption from the
definition of ‘‘broker.’’ The exemption
allows a bank to engage in securities
lending transactions as agent in
circumstances where the bank does not
have custody of the securities or has
custody of such securities for less than
the entire period of the transaction. This
exemption reinstates, without
modification, an exemption that the
Commission adopted previously.302
299 The Agencies recognize that the ‘‘offshore
transaction’’ condition in Rules 903 and 904 of
Regulation S also require that the offer not be made
to a person in the United States. See 17 CFR
230.902(h), 230.903(a)(1) and 230.904(a)(1). For this
reason, one commenter stated that the rule simply
should refer to sales to a ‘‘purchaser,’’ rather than
to a purchaser who is outside the United States. See
IIB Letter. The Agencies have retained the
‘‘purchaser who is not in the United States’’
language in the final rule, even for those
transactions that must be conducted in accordance
with Rule 903 or 904 of Regulation S, to highlight
and reaffirm that these transactions must be with
persons outside the United States.
300 Rule 771(b)(1). For purposes of the rule, the
term ‘‘distributor’’ has the same meaning as in Rule
902(k) of Regulation S (17 CFR 230.902(k)).
301 See IIB Letter, ABA Letter.
302 See Exchange Act Release No. 47364 (Feb. 13,
2003), 68 FR 8686 (Feb. 24, 2003) (adopting
Exchange Act Rule 15a–11 to provide an exemption
from the definitions of both ‘‘broker’’ and ‘‘dealer’’
for banks engaging in securities lending
transactions). The broker provisions of the Rule
15a–11 exemption, which never became operable
due to the temporary exemption applicable to all
bank broker activities, will become void under the
Regulatory Relief Act with the Agencies’ adoption
of a single set of final ‘‘broker’’ rules. See Pub. L.
No. 109–351, § 101(a)(3), 120 Stat. 1968 (1999). In
light of this, the Commission separately has

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Most commenters that addressed the
exemption supported its adoption.303
One commenter opposed the exemption,
arguing that securities lending and
borrowing transactions should be
conducted only by broker-dealers or,
alternatively, banks providing such
services should be subject to additional
disclosure and customer approval
requirements.304 The Agencies continue
to believe that the exemption is
appropriate and necessary. The
exemption enables sizable and
sophisticated customers to divide
custody and securities lending
management between two expert
entities when the customer decides such
actions are in the customer’s interest,
and permits banks to continue to
provide the types of non-custodial
securities lending services that they
currently provide without disruption.
The Agencies note, moreover, that the
statutory custody and safekeeping
exception permits banks to effect
securities lending transactions (and
provide related securities lending
services) when the bank has custody of
the securities. A bank need not rely on
the exemption in Rule 772 to engage in
securities lending transactions when
acting in this capacity.
Rule 772 provides that a bank is
exempt from the broker definition to the
extent that, as agent, it engages in or
effects certain ‘‘securities lending
transactions’’ 305 and ‘‘securities lending
services’’ 306 in connection with such
transactions.307 The exemption applies
only to securities lending activities with
amended Rule 15a–11 to remove the ‘‘broker’’
aspects of that rule. As discussed in the
accompanying release, the Commission is readopting, without modification, the ‘‘dealer’’
portions of Rule 15a–11, as Exchange Act Rule 3a5–
3. See Exchange Act Release No. 56502 (Sept. 24,
2007).
303 See, e.g., State Street Corp. Letter, PNC Letter,
Mellon Letter, and ABA Letter.
304 See NASAA Letter.
305 Rule 772(b) defines the term ‘‘securities
lending transaction’’ to mean a transaction in which
the owner of a security lends the security
temporarily to another party pursuant to a written
securities lending agreement under which the
lender retains the economic interests of an owner
of such securities, and has the right to terminate the
transaction and to recall the loaned securities on
terms agreed by the parties.
306 Rule 772(c) defines the term ‘‘securities
lending services’’ to mean: (1) Selecting and
negotiating with a borrower and executing, or
directing the execution of the loan with the
borrower; (2) receiving, delivering, or directing the
receipt or delivery of loaned securities; (3)
receiving, delivering, or directing the receipt or
delivery of collateral; (4) providing mark-to-market,
corporate action, recordkeeping or other services
incidental to the administration of the securities
lending transaction; (5) investing, or directing the
investment of, cash collateral; or (6) indemnifying
the lender of securities with respect to various
matters.
307 Rule 772(a).

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or on behalf of a person that the bank
reasonably believes to be: (1) A qualified
investor as defined in Section
3(a)(54)(A) of the Exchange Act;308 or (2)
any employee benefit plan that owns
and invests, on a discretionary basis, not
less than $25 million in investments.
One commenter requested that the
Agencies modify the rule to allow banks
to engage in securities lending
transactions under the exemption as
agent for institutional customers that
have less than $25 million in
investments.309 We have not amended
the investment requirements, however,
as we believe they are consistent with
the nature of customers that utilize
banks for non-custodial securities
lending transactions.310
Another commenter suggested that
the Agencies exempt banks involved, as
agent, in securities repurchase and
reverse repurchase transactions in nonexempt securities from the ‘‘broker’’
definition, stating that repurchase and
reverse repurchase activities are
functionally equivalent to securities
lending.311 As discussed in the
accompanying release, moreover, a
number of commenters also requested
that banks be exempted from the
‘‘dealer’’ definition for repurchase and
reverse repurchase agreement activities
involving non-exempt securities they
undertake in a principal capacity.312
The Agencies have not acted on these
requests at this time because we believe
additional information from banks and
other interested parties would be
helpful in understanding the issues
raised by these requests. For this reason,
we invite comment on the following
matters, as well as any other matters
that interested parties believe may be
relevant to the Agencies’ consideration
of the issues posed by the requests: (1)
The nature, structure (including term
and type of security involved), and
purpose of repurchase and reverse
repurchase agreements currently
conducted with respect to non-exempt
securities; (2) the types of customers
308 15 U.S.C. 78c(a)(54)(A). In part, this definition
encompasses corporations and partnerships with at
least $25 million in investments.
309 See Union Bank Letter.
310 See, e.g. Letter from Edward J. Rosen, Cleary,
Gottlieb, Stein & Hamilton, to Annette Nazareth,
Director, Division of Market Regulation,
Commission, dated Oct. 9, 2002 (requesting that the
exemption encompass banks’ securities lending
activity involving any entity that owns and invests
on a discretionary basis at least $25 million in
investments).
311 See Clearing House Ass’n Letter. Banks are
permitted by statutory exception to engage in
repurchase and reverse repurchase activities with
respect to exempt securities such as government
securities. Exchange Act Section 3(a)(5)(C)(i)(II).
312 See Exchange Act Release No. [llll]
(Sept. ll, 2007).

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
and financial institutions currently
involved in repurchase and reverse
repurchase agreements with respect to
non-exempt securities; (3) the extent to
and manner in which banks currently
engage, as agent or principal, in
repurchase and reverse repurchase
agreements with respect to non-exempt
securities; (4) recent developments or
trends in the market for repurchase and
reverse repurchase agreements with
respect to non-exempt securities; (5) any
material similarities or differences in
the use, structure, customer base, or
legal, regulatory, tax or accounting
treatment of repurchase and reverse
repurchase agreements with respect to
non-exempt securities, on the one hand,
and repurchase or reverse repurchase
agreements with respect to exempt
securities or securities lending
transactions involving exempt or nonexempt securities. The information we
receive through this process should help
inform any future actions the Agencies
may take in this area.

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C. Exemption for Banks Effecting
Certain Excepted or Exempted
Transactions in Investment Company
Securities and Variable Insurance
Products
The Agencies are adopting Rule 775
of Regulation R to allow banks to take
advantage of certain exceptions and
exemptions to the broker definition for
transactions involving mutual funds,
variable annuity contracts and variable
life insurance policies without having to
comply with the broker-execution
requirement of Exchange Act Section
3(a)(4)(C)(i).313 The rule as proposed
permitted banks to effect transactions in
open-end mutual funds through the
National Securities Clearing Corporation
(‘‘NSCC’’) or the fund’s transfer agent,
rather than through a broker-dealer.
A number of commenters stated,
however, that the exemption should be
broadened to also encompass variable
annuities and variable life insurance,
with some commenters noting that only
variable annuities and mutual funds are
permissible investments for 403(b)
plans.314 Commenters noted that
313 As discussed above, Section 3(a)(4)(C)
generally provides that a bank effecting a
transaction in any ‘‘publicly traded security’’ in the
United States under the trust and fiduciary, stock
purchase plan, or custody and safekeeping
exception must direct the resulting trade to a
broker-dealer for execution unless the trade is a
cross trade or similar trade or the trade otherwise
is permitted by Commission rule, regulation or
order. 15 U.S.C. 78c(a)(4)(C). Rule 760, the
exemption for order-taking by banks acting as
custodians, also requires banks to comply with
Section 3(a)(4)(C). See Rule 760(d)(2).
314 See ABA Letter; TIAA–CREF Letter; American
Council of Life Insurers Letters of March 26 (‘‘ACLI
March 26 Letter’’) and August 2, 2007, Roundtable

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transactions in variable annuity and
variable life products typically are
effected directly with the relevant
insurance company.315
In light of these comments, the
Agencies have expanded the rule to
cover transactions involving variable
annuities and variable life insurance
policies, as well as transactions
involving mutual funds. Applying the
exemption to transactions in variable
insurance products, as well as to
transactions involving mutual funds,
will avoid needless disruptions and
costs with respect to banks’ transactions
with customers in which interposing an
executing broker-dealer would be
inefficient, inconsistent with market
practice and unnecessary for investor
protection.
Specifically, Rule 775 as modified is
available for transactions involving
securities issued by an open-end
company, as defined by Section 5(a)(1)
of the Investment Company Act,316 that
is registered under that Act,317 as well
as variable insurance contracts funded
by any separate account, as defined by
Section 2(a)(37) of the Investment
Company Act, that is registered under
that Act. To take advantage of the
exemption, the security must not be
traded on a national securities exchange
or traded through the facilities of a
national securities association or an
interdealer quotation system.318 In
addition, the securities must be
distributed by a registered broker-dealer,
or the sales charge must be no more
than the amount permissible for a
security sold by a registered brokerdealer pursuant to any applicable rules
of a registered securities association.319
Finally, the transaction must be effected
through the NSCC, or directly with a
transfer agent or with an insurance
Letter, Business Law Section Letter, The Depository
Trust & Clearing Corp. (‘‘DTCC’’) Letter.
315 See ACLI March 26 Letter, DTCC Letter.
316 Rule 775(b)(1). We note that banks may effect
transactions in securities that meet the conditions
to be an ‘‘exempted security’’ under Exchange Act
Section 3(a)(12)(A)(iv) without complying with the
exemption provided by Rule 775. Exchange Act
Section 3(a)(4)(B)(iii)(II) permits banks to effect
transactions involving ‘‘exempted securities’’
without registering as a broker and without
effecting the transaction through a registered
broker-dealer.
317 Rule 775(b)(2).
318 Rule 775(a)(1).
319 Rule 775(a)(2). FINRA currently is the only
registered securities association. FINRA Rule 2830
limits the sales charges associated with open-end
mutual funds. Currently, there are no FINRA rules
limiting the sales charges associated with the
insurance securities subject to Rule 775. Therefore
currently, in all cases, these insurance securities
would satisfy the condition under Rule 775(a)(2)
that the sales charge be no more than the amount
permissible under applicable registered securities
association rules.

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56545

company or a separate account that is
excluded from the definition of transfer
agent in Section 3(a)(25) of the
Exchange Act.320
D. Exemption for Certain Transactions
involving a Company’s Securities for its
Employee Benefit Plans and
Participants
In response to issues raised by a
commenter, the Agencies are adopting
an additional exemption (Rule 776) to
permit banks that rely on certain
exceptions and exemptions to effect
certain transactions involving the
securities of a company for the
company’s employee benefit plans and
participants without complying with the
broker-execution requirements of
Exchange Act Section 3(a)(4)(C)(i).321
The commenter stated that banks that
act as trustee or custodian for the
defined benefit or defined contribution
plans of a company at times effect inkind contributions, purchases and sales,
and distribution transactions for the
plan involving the securities of the
company without the involvement of a
broker-dealer. The commenter indicated
that these transactions are effected
through the company’s transfer agent
and that no commission is charged in
connection with the transaction.322
In light of these comments, Rule 776
permits a bank utilizing particular
exceptions and exemptions to effect a
transaction in the securities of a
company to do so directly with a
transfer agent acting for the company,
subject to four conditions. First, no
commission may be charged with
respect to the transaction.323 Second,
the transaction must be conducted
solely for the benefit of an employee
benefit plan.324 Third, the security must
be obtained directly from the company
or an employee benefit plan of the
company.325 And fourth, the security
must be transferred only to the company
or an employee benefit plan of the
company.326 Securities obtained from,
or transferred to, a participant in an
employee benefit plan on behalf of the
320 Rule

775(a)(3).
note 313 supra for a listing of the relevant
exceptions and exemptions.
322 See The Northern Trust Company Letter. The
commenter further stated that ERISA effectively
prohibits a commission from being charged in
connection with in-kind contributions by a
company of its stock to the company’s benefit plans
and direct purchases and sales by the company of
its stock with the company’s plans.
323 Rule 776(a)(1).
324 Rule 776(a)(2). For these purposes, an
‘‘employee benefit plan’’ is defined to mean any
pension plan, retirement plan, profit sharing plan,
bonus plan, thrift savings plan, incentive plan, or
other similar plan. Rule 776(b).
325 Rule 776(a)(3).
326 Rule 776(d).
321 See

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plan are considered to be obtained from,
or transferred to, the plan.
We are adopting this rule because we
believe that requiring banks to send
these types of transactions to a brokerdealer for execution—as would be
required to comply with Section
3(a)(4)(C)(i) of the Exchange Act—at
times would preclude plans from
engaging in these transactions, would
disrupt existing practices and otherwise
would introduce cost and complexity to
those transactions without materially
promoting functional regulation and
investor protection.327

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E. Temporary and Permanent
Exemption for Contracts Entered Into by
Banks From Being Considered Void or
Voidable
The Agencies are adopting as
proposed Rule 780, which grants one
temporary and one permanent
exemption from section 29(b) of the
Exchange Act, which addresses
inadvertent failures by banks that could
trigger rescission of contracts between a
bank and a customer.328 Under the
temporary exemption, no contract
entered into before 18 months after the
effective date of the exemption would
be void or considered voidable by
reason of Section 29 of the Exchange
Act because any bank that is a party to
the contract violated the registration
requirements of Section 15(a) of the
Exchange Act, any other applicable
provision of that Act, or the rules and
regulations adopted under the Exchange
Act based solely on the bank’s status as
a broker when the contract was
created.329
Under the permanent exemption, no
contract entered into is void or
considered voidable by reason of
Section 29(b) of the Exchange Act
because any bank that is a party to the
contract violated the registration
requirements of Section 15(a) of the
Exchange Act or the rules and
regulations adopted thereunder based
solely on the bank’s status as a broker
when the contract was created if two
327 The commenter also stated that banks acting
as trustees and custodians at times directly effect
transactions with and for different employee benefit
plans involved in a corporate spin-off transaction
with respect to company stock of both companies
involved in the spin-off transaction. See Northern
Trust letter. We understand that the same bank
typically is the trustee or custodian for the different
plans in such transactions and conducts such
transactions through cross-trades within the bank.
Accordingly, no additional exemption is required
for these transactions.
328 15 U.S.C. 78cc(b). Exchange Act Section 29(b)
provides, in pertinent part, that every contract made
in violation of the Exchange Act or of any rule or
regulation adopted under the Exchange Act (with
certain exceptions) shall be void.
329 Rule 780(a).

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conditions are met. First, at the time the
contract was created, the bank must
have acted in good faith and had
reasonable policies and procedures in
place to comply with Section 3(a)(4)(B)
of the Exchange Act, and the rules and
regulations, thereunder. Second, any
violation of the registration
requirements by the bank must not have
resulted in any significant harm,
financial loss or cost to the person
seeking to void the contract. This
exemption is provided because a bank
that is acting in good faith and has
reasonable policies and procedures in
effect at the time a securities contract is
created should not be subject to
rescission claims as a result of an
inadvertent failure to comply with the
requirements under Section 3(c)(4) of
the Exchange Act if customers are not
significantly harmed. One commenter
supported the exemptions,330 and no
commenters objected to their adoption.
F. Extension of Time and Transition
Period
The Agencies are further extending
the time that banks have to come into
compliance with the Exchange Act
provisions relating to the definition of
‘‘broker.’’ Under the final rule, a bank is
exempt from the definition of ‘‘broker’’
under Section 3(a)(4) of the Exchange
Act until the first day of its first fiscal
year commencing after September 30,
2008. This is an additional calendar
quarter beyond the date (June 30, 2008)
provided in the proposed rule. A bank
that has a fiscal year based on the
calendar year, for example, must
comply with the new exceptions for
banks and these rules beginning on
January 1, 2009. Some commenters
noted that banks and broker-dealers
would need sufficient time to make the
changes necessary to come into
compliance with the statute and these
rules.331 The Agencies believe that the
extension granted by the rule, which is
a minimum of one year, should provide
banks a reasonable period of time to
come into compliance with these
provisions.
The Administrative Procedure Act
(‘‘APA’’) permits an agency to issue a
rule without delaying its effective date
for 30 days from the date of publication
if, among other reasons, the rule is a
substantive rule which grants or
recognizes an exemption or relieves a
restriction, or if the agency finds good
cause and publishes its finding with the
rule.332 The Agencies find that this Rule
330 ICBA

Letter.
e.g., HSBC Securities Letter.
332 The APA provides that publication of a
substantive rule must be made not less than 30 days
331 See,

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781 grants or recognizes an exemption
or relieves a restriction and also that
there is good cause for adopting Rule
781 without a delayed effective date
because it is in the public interest that
banks not unnecessarily incur costs to
comply with the statutory exceptions
and related rules before such exceptions
and rules would become effective in
accordance with Rule 781.333
VII. Finding That the Exemptions are
Appropriate in the Public Interest and
Consistent With the Protection of
Investors
Section 36(a)(1) of the Exchange Act
generally provides that the Commission
may conditionally or unconditionally
exempt any person or class of persons
from any provision of the Exchange Act
to the extent that an exemption is
necessary or appropriate in the public
interest and consistent with the
protection of investors.334 Taken as a
whole, the exemptions will implement
the bank broker provisions of the GLBA
while providing banks with flexibility to
structure their business models under
conditions designed to preserve key
investor protections, and therefore, as
discussed above more fully, are
appropriate in the public interest and
consistent with the protection of
investors.
VIII. Withdrawal of Proposed
Regulation B and Removal of Exchange
Act Rules 3a4–2 Through 3a4–6, and
3b–17
Under the Regulatory Relief Act, a
final single set of rules or regulations
jointly adopted by the Board and
Commission in accordance with that
Act shall supersede any other proposed
or final rule issued by the Commission
on or after the date of enactment of
Section 201 of the GLBA with regard to
the definition of ‘‘broker’’ under
Exchange Act Section 3(a)(4).335
Moreover, the law states that ‘‘[n]o such
other rule, whether or not issued in final
form, shall have any force or effect on
or after that date of enactment.’’
In 2001, the Commission adopted
Interim Rules discussing the way in
prior to its effective date, except ‘‘(1) a substantive
rule which grants or recognizes an exemption or
relieves a restriction; (2) interpretive rules and
statements of policy; or (3) otherwise provided by
the agency for good cause found and published
with the rule.’’ 5 U.S.C. 553(d).
333 This finding also satisfies the requirements of
5 U.S.C. Section 808(2), which allows a rule to
become effective immediately notwithstanding the
requirements of 5 U.S.C. Section 801 if an agency
‘‘for good cause finds that notice and public
procedure thereon are impracticable, unnecessary,
or contrary to the public interest.’’
334 15 U.S.C. 78mm(a)(1).
335 President Clinton signed the GLBA into law
on November 12, 1999.

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which the Commission would interpret
the GLBA.336 The rules that address the
definition of ‘‘broker’’ under Section
3(a)(4) of the Exchange Act (and
applicable exemptions) are Exchange
Act Rules 3a4–2 through 3a4–6 and
Rule 3b–17.337 In 2004, the Commission
proposed to revise and restructure the
‘‘broker’’ provisions of the Interim Rules
and codify them in a new regulation,
proposed Regulation B, which would
consist of proposed new Exchange Act
Rules 710 through 781.338 By operation
of the Regulatory Relief Act, the joint
adoption of these final rules by the
Board and the Commission supersedes
Exchange Act Rules 3a4–2 through 3a4–
6, 3b–17, and proposed Rules 710
through 781. Any discussion or
interpretation of these prior rules in
their accompanying releases does not
apply to this single set of rules adopted
by the Agencies.

4025). The Board’s OMB control number
will be 7100–0316. An agency may not
conduct or sponsor, and a person is not
required to respond to, a collection of
information unless it displays a
currently valid control number.341 We
received no comments on the
paperwork reduction analysis in the
proposal.

IX. Administrative Law Matters

a. Collection of Information
Rules 701(a)(2)(i), (a)(3)(i) and (b)
require banks or their broker-dealer
partners that utilize the exemption
provided in this rule to make certain
disclosures to high net worth or
institutional customers. Specifically,
these disclosures must clearly and
conspicuously disclose (1) the name of
the broker-dealer; and (2) that the bank
employee participates in an incentive
compensation program under which the
bank employee may receive a fee of
more than a nominal amount for
referring the customer to the brokerdealer and payment of this fee may be
contingent on whether the referral
results in a transaction with the brokerdealer.342 These requirements were
modified from the proposal to permit
timely oral disclosure of this
information, followed by written
disclosure, to better accommodate the
variety of circumstances in which
referrals may occur.
In addition, one of the conditions of
the exemption is that the broker-dealer
and the bank need to have a contractual
or other written arrangement containing
certain elements, including notification
and information requirements.343 Rule
701(a)(3)(v) requires the written
agreement to obligate a broker-dealer to
notify its bank partner if the brokerdealer determines that (1) the customer
referred under the exemption is not a
high net worth or institutional
customer, as applicable; or (2) the bank
employee making the referral is subject
to statutory disqualification (as defined
in Section 3(a)(39) of the Exchange

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A. Paperwork Reduction Act Analysis
Certain provisions of Rules 701, 723,
and 741, contain ‘‘collection of
information’’ requirements within the
meaning of the Paperwork Reduction
Act of 1995.339 The Commission has
submitted these information collections
to the Office of Management and Budget
(‘‘OMB’’) for review in accordance with
44 U.S.C. 3507(d) and 5 CFR 1320.11.
The Board has reviewed the rules under
authority delegated by OMB.340
The collections of information under
Rules 701, 723, and 741 are new. The
Commission’s title for the new
collection of information under Rule
701 is ‘‘Rule 701: Exemption from the
definition of ‘broker’ for certain
institutional referrals.’’ The
Commission’s title for the new
collection of information under Rule
723 is ‘‘Rule 723: Exemptions for special
accounts, foreign branches, transferred
accounts, and a de minimis number of
accounts.’’ The Commission’s title for
the new collection of information under
Rule 741 is ‘‘Rule 741: Exemption for
banks effecting transactions in money
market funds.’’ The Commission’s OMB
control number for the three rules is
3235–0624. The Board’s title for the new
collection of information under Rules
701, 723, and 741 is ‘‘Recordkeeping
and Disclosure Requirements
Associated with Regulation R’’ (FR
336 Exchange Act Release No. 44291 (May 11,
2001), 66 FR 27760 (May 18, 2001).
337 17 CFR 240.3a4–2 through 3a4–6 and 17 CFR
240.3b–17.
338 17 CFR 242.710 through 781. See Exchange
Act Release No. 49879 (June 17, 2004), 69 FR 39682
(June 30, 2004).
339 44 U.S.C. 3501, et seq.
340 5 CFR 1320.16; Appendix A.1.

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1. Rule 701
Rule 701 provides a conditional
exemption from the requirements under
the networking exception under the
Exchange Act. This exemption permits
bank employees to receive payment of
more than a nominal amount for
referring institutional customers and
high net worth customers to a brokerdealer and permits such payments to be
contingent on whether the customer
effects a securities transaction with the
broker-dealer.

341 44

U.S.C. 3512.
Rules 701(a)(2)(i), (a)(3)(i) and (b).
343 See Rule 701(a) and (a)(3).
342 See

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56547

Act).344 In addition, Rule 701(a)(3)(iv)
requires the written agreement to
obligate the broker-dealer to notify the
customer if the securities transaction(s)
to be conducted by the customer or the
customer do not meet the applicable
suitability or sophistication
determination standards set forth in the
rule.345 Similarly, the bank is required
to provide its broker-dealer partner with
the name of the bank employee
receiving the referral fee and certain
other identifying information.346
b. Use of Information
The purpose of the collection of
information in Rules 701(a)(2)(i),
(a)(3)(i) and (b) is to provide a customer
of a bank relying on the exemption with
information to assist the customer in
identifying and assessing any conflict of
interest on the part of the bank
employee making a referral to a brokerdealer and for which the bank employee
may receive a higher-than-nominal and/
or contingent referral fee. The collection
of information in Rule 701(a)(2)(iii) and
(a)(3)(v) is designed to help a bank
determine whether it is acting in
compliance with the exemption. The
collection of information in Rule
701(a)(3)(iv) is designed to provide the
customer with information that may be
helpful to the customer in deciding
whether to engage in a securities
transaction with the broker-dealer.
c. Respondents
The collections of information in Rule
701 will apply to banks that wish to
utilize the exemption provided in this
rule and broker-dealers with which
those banks enter into networking
arrangements.
d. Disclosure Burden
The Agencies estimate that
approximately 1,000 banks annually
will use the exemption in Rule 701 and
that each bank, individually or working
with its partner broker-dealer, will on
average make the required referral fee
disclosures to 200 customers annually.
In addition, we estimate that each bank
will provide one notice annually to its
broker-dealer partner regarding names
and other identifying information about
bank employees. The Agencies also
estimate that broker-dealers will, on
average, notify each of the 1,000 banks
approximately twice a year about a
determination regarding a customer’s
high net worth or institutional status as
well as a bank employee’s statutory
344 See Rule 701(a)(3)(v). The latter requirement
does not apply to subparagraph (E) of Section
3(a)(39) of the Exchange Act ((15 U.S.C. 78c(a)(39)).
345 See Rule 701(a)(3)(iv).
346 See Rule 701(a)(2)(iii).

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disqualification status. The Agencies
further estimate that each broker-dealer
will notify three customers of each
partner bank per year concerning
transaction suitability or the customer’s
financial sophistication.
Based on these estimates, the
Agencies anticipate that Rule 701 will
result in approximately 200,000
disclosures to customers, 1,000 notices
to broker-dealers about bank employees,
2,000 notices to banks about customer
status, and 3,000 notices to customers
per year about suitability or
sophistication. The Agencies further
estimate (based on the level of difficulty
and complexity of the applicable
activities) that a bank or broker-dealer
will spend approximately 5 minutes per
customer to comply with the disclosure
requirement, and that a bank will spend
approximately 15 minutes per notice to
a broker-dealer. The Agencies also
estimate that a broker-dealer will spend
approximately 15 minutes per notice to
a bank or customer. Thus, the estimated
total annual disclosure burden for these
requirements in Rule 701 is
approximately 8,583 hours for banks
and approximately 9,583 hours for
broker-dealers.347
e. Collection of Information Is
Mandatory
This collection of information is
mandatory for banks relying on Rule
701 and their broker-dealer partners.
f. Confidentiality

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A bank relying on the exemption
provided in Rule 701 or its partner
broker-dealer is required to provide
certain referral fee disclosures to the
customers referred by the bank under
this rule. Banks relying on the
exemption provided in Rule 701 are
required also to enter into agreements
with a broker-dealer obligating the
broker-dealer to notify the bank upon
becoming aware of certain information
with respect to the customer or the bank
employee, and to notify the customer
upon becoming aware of certain
information concerning the customer or
the nature of a securities transaction.348
Similarly, a bank is required to notify a
broker-dealer about the name of the
bank employee receiving a referral fee
and certain other identifying
information.
347 Because banks and broker-dealers will share
the disclosure obligation under the final rule, these
estimates attribute 50 percent of that disclosure
burden to banks and 50 percent to broker-dealers.
348 These requirements are discussed in more
detail in section 1.d (Rule 701, Disclosure Burden),
supra.

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g. Record Retention Period
Rule 701 does not include a specific
record retention requirement. Banks,
however, are required to retain the
records in compliance with any existing
or future recordkeeping or disclosure
requirements established by the Banking
Agencies. Broker-dealers are also
required to retain records in compliance
with existing or future recordkeeping or
disclosure requirements established by
the Commission or any self-regulatory
organization.
2. Rule 723
a. Collection of Information
Rule 723(e)(1) requires a bank that
desires to exclude a trust or fiduciary
account in determining its compliance
with the chiefly compensated test,
pursuant to a de minimis exclusion,349
to maintain records demonstrating that
the securities transactions conducted by
or on behalf of the account were
undertaken by the bank in the exercise
of its trust or fiduciary responsibilities
with respect to the account.350
b. Use of Information
The collection of information in Rule
723 is designed to help ensure that a
bank relying on the de minimis
exclusion is able to demonstrate that it
was acting in a trust or fiduciary
capacity with respect to an account
excluded from the chiefly compensated
test in Rule 721(a)(1).
c. Respondents
The collection of information in Rule
723 will apply to banks relying on the
de minimis exclusion from the chiefly
compensated test.
d. Recordkeeping Burden
Because the Agencies expect a small
number of banks may use the accountby-account approach in monitoring their
compliance with the chiefly
compensated test, the Agencies estimate
that approximately 50 banks annually
will use the de minimis exclusion in
Rule 723 and each such bank will, on
average, need to maintain records with
respect to 10 trust or fiduciary accounts
annually conducted in the exercise of
the banks’ trust or fiduciary
responsibilities. Therefore, the Agencies
estimate that Rule 723 will result in
approximately 500 accounts annually
349 See Rule 723(e)(2), which requires that the
total number of accounts excluded by the bank,
under the exclusion from the chiefly compensated
test in Rule 721(a)(1), do not exceed the lesser of
1 percent of the total number of trust or fiduciary
accounts held by the bank (if the number so
obtained is less than 1, the amount will be rounded
up to 1) or 500.
350 See Rule 723(e)(1).

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for which records are required to be
maintained. The Agencies anticipate
that these records will consist of records
that are generally created as part of the
securities transaction and the account
relationship and minimal additional
time will be required in maintaining
these records. Based on this analysis,
the Agencies estimate that a bank will
spend approximately 15 minutes per
account to comply with the record
maintenance requirement of Rule 723.
Thus, the estimated total annual
recordkeeping burden for Rule 723 is
125 hours.
e. Collection of Information Is
Mandatory
This collection of information is
mandatory for banks desiring to rely on
de minimis exclusion contained in Rule
723.
f. Confidentiality
Rule 723 does not address or restrict
the confidentiality of the documentation
prepared by banks under the rule.
Accordingly, banks will have to make
the information available to regulatory
authorities or other persons to the extent
otherwise provided by law.
g. Record Retention Period
Rule 723 will include a requirement
to maintain records related to certain
securities transactions. Banks will be
required to retain these records in
compliance with any existing or future
recordkeeping requirements established
by the Banking Agencies.
3. Rule 741
a. Collection of Information
Rule 741(a)(2)(ii)(A) requires a bank
relying on this exemption (i.e., the
exemption from the definition of the
term ‘‘broker’’ under Section 3(a)(4) of
the Exchange Act for effecting
transactions on behalf of a customer in
securities issued by a money market
fund) to provide customers with a
prospectus of the money market fund
securities, not later than the time the
customer authorizes the bank to effect
the transaction in such securities, if they
are not no-load. In situations where a
bank effects transactions under the
exemption as part of a program for the
investment or reinvestment of deposits
funds of, or collected by, another bank,
the rule permits either the effecting
bank or deposit-taking bank to provide
the customer a prospectus for the money
market fund securities.
b. Use of Information
The purpose of the collection of
information in Rule 741 is to help
ensure that a customer of a bank whose

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funds or deposits are invested into a
money market fund that is not a no-load
fund under the exemption will have
sufficient information upon which to
make an informed investment decision,
in particular, regarding the fees the
customer will pay with respect to the
securities.
c. Respondents
The collection of information in Rule
741 applies to banks that directly or
indirectly rely on the exemption
provided in the rule in the manner
described above.
d. Disclosure Burden
The Agencies believe that banks
generally sweep or invest their customer
funds into no-load money market funds.
Accordingly, the Agencies estimate that
approximately 500 banks annually will
use the exemption in Rule 741 and each
bank (or its partner bank), on average,
will deliver the prospectus required by
the rule to approximately 1,000
customers annually. Therefore, the
Agencies estimate that Rule 741 will
result in approximately 500,000
disclosures per year. The Agencies
estimate further that a bank will spend
approximately 5 minutes per response
to comply with the delivery requirement
of Rule 741. Thus, the estimated total
annual disclosure burden for Rule 741
is 41,667 hours.
e. Collection of Information Is
Mandatory
This collection of information is
mandatory for banks relying on the
exemption.
f. Confidentiality
The collection of information
delivered pursuant to Rule 741 must be
provided by banks relying on the
exemption in this rule (or in the case of
programs involving deposits of another
bank, the other bank) to customers that
are engaging in transactions in securities
issued by a money market fund that is
not a no-load fund.
g. Record Retention Period
Rule 741 does not include a record
retention requirement.

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B. Consideration of Benefits and Costs
1. Introduction
Prior to enactment of the GLBA, banks
were exempted from the definition of
‘‘broker’’ in Section 3(a)(4) of the
Exchange Act. Therefore,
notwithstanding the fact that banks may
have conducted activities that will have
brought them within the scope of the
broker definition, they were not
required by the Exchange Act to register

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as such. The GLBA replaced banks’
historic exemption from the definition
of ‘‘broker’’ with eleven exceptions.351
While banks’ efforts to comply with
the GLBA and the exemptions will
result in certain costs, the Agencies
have sought to minimize these burdens
to the extent possible consistent with
the language and purposes of the GLBA.
For example, the Agencies are adopting
exemptions and interpretations that are
expected to provide banks with
increased options and flexibility and
help to reduce overall costs. Some
commenters noted that the rules as
proposed will give banks flexibility in
structuring their operations, and one
bank trade association stated that small
banks will be able to comply with the
proposed rules without significantly
altering their activities.352 Two
commenters stated that the Agencies
had underestimated the costs associated
with coming into compliance with
Regulation R and also provided
estimates of ongoing compliance
costs.353
2. Discussion of Rule Interpretations
and Exemptions
The benefits and costs of the principal
exemptions and interpretations in the
rules are discussed below.
a. Networking Exception
Exchange Act Section 3(a)(4)(B)(i)
excepts banks from the definition of
‘‘broker’’ if they enter into a contractual
or other written arrangement with a
registered broker-dealer under which
the broker-dealer offers brokerage
services to bank customers. This
networking exception is subject to
several conditions. The Section also
prohibits banks from paying
unregistered bank employees—such as
tellers, loan officers, and private
bankers—‘‘incentive compensation’’ for
any brokerage transaction, except that
bank employees may receive a
‘‘nominal’’ referral fee for referring bank
customers to their broker-dealer
networking partners.354
Under the rule, a ‘‘nominal’’ referral
fee is defined as a fee that does not
exceed any of the following standards:
(1) Twice the average of the minimum
and maximum hourly wage established
by the bank for the current or prior year
for the job family that includes the
employee or 1/1000th of the average of
351 See

Exchange Act Section 3(a)(4)(B)(i)–(xi).
Citigroup Letter, ACB Letter, ICBA Letter.
353 See Fiserv Letter, Colorado Trust Letter.
354 Exchange Act Section 3(a)(4)(B)(i)(VI) limits
such referral fees to a ‘‘nominal one-time cash fee
of a fixed dollar amount’’ and requires that the
payment of the fees not be contingent on whether
the referral results in a transaction.
352 See

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56549

the minimum and maximum annual
base salary established by the bank for
the current or prior year for the job
family that includes the employee; (2)
twice the employee’s actual base hourly
wage or 1/1000th of the employee’s
actual annual base salary; or (3) twentyfive dollars ($25), as adjusted for
inflation pursuant to Rule 700(f).
The Agencies believe these
alternatives likely will provide banks
appropriate flexibility while being
consistent with the statute. For example,
some banks, and particularly small
banks, may find it most useful to
establish a flat fee or inflation-adjusted
fee for securities referrals as this method
is easy to understand and requires no
complicated calculations. In addition,
permitting banks to pay referral fees
based on either an employee’s base
hourly or annual rate of pay or the
average hourly or annual rate of pay for
a job family gives banks objective and
easily calculable approaches to paying
their employees referrals while
remaining consistent with the
requirements of the GLBA that such fees
be ‘‘nominal’’ in relation to the overall
compensation of the referring
employees. While some start-up costs
may be incurred by banks in the process
of developing a fee structure in line
with the requirements of the GLBA, the
ability to choose among alternative
methods (as reflected in the rules) is
expected to enable banks to minimize
their overall costs based on their
individual referral programs and cost
structures. Several commenters
supported these alternatives, or stated
that the rules implementing the
networking exception as a whole struck
an appropriate balance.355
In light of the statutory provision
allowing banks to pay a ‘‘nominal onetime cash fee,’’ the rule requires that all
referral fees paid under the exception be
paid in cash. At the same time, the
Agencies have clarified that banks have
the flexibility to use cash-equivalent
points, paid no less often than quarterly,
in paying nominal referral fees under
the exception.
Rule 700(b) also contains a definition
of ‘‘incentive compensation’’ and
excludes from this definition
compensation paid by a bank under a
bonus or similar plan that meets certain
criteria. The bonus or similar program
must be paid on a discretionary basis
and based on multiple factors or
variables. These factors or variables
must include multiple, significant
factors or variables that are not related
to securities transactions at the broker355 See ABA Letter, Roundtable Letter, ACB
Letter.

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dealer. Moreover, a referral made by the
employee may not be a factor or variable
in determining the employee’s
compensation under the plan and the
employee’s compensation under the
plan may not be determined by
reference to referrals made by any other
person. Rule 700(b) also provides a
conditional safe harbor from the
definition of ‘‘incentive compensation’’
for certain bonus or similar plans that
are based on any measure of the overall
profitability of a bank; an affiliate of a
bank (other than a broker-dealer); an
operating unit of a bank or of an affiliate
of a bank (other than a broker-dealer); or
a broker-dealer (if the bonus plan meets
certain criteria designed to ensure,
among other things, that the plan
includes other factors or variables). The
final definition has been revised from
the proposal to give banks more
flexibility in using their existing bonus
plans within the framework required by
the GLBA.
The rules also include a conditional
exemption to permit a bank to pay an
employee a contingent referral fee of
more than a nominal amount for
referring an institutional customer or
high net worth customer to a brokerdealer with which the bank has a
contractual or other written networking
arrangement. This exemption provides a
benefit to banks by expanding the types
of referral fees that banks may utilize
with respect to institutional customers
and high net worth customers. A
number of commenters supported
granting an exemption for such
referrals.356 There likely will be costs
associated with complying with the
conditions in the exemption (such as
the requirement for banks to make
certain disclosures to high net worth or
institutional customers and the
requirement for broker-dealers to make
certain determinations and provide
certain notifications to banks or a
customer) 357 as well as the other terms
and conditions in the statutory
networking exception. These costs,
however, will be either a result of the
statutory requirements or costs
voluntarily incurred by banks because
they want to take advantage of the
exemption.
b. Trust and Fiduciary Activities
Exception
Exchange Act Section 3(a)(4)(B)(ii)
permits a bank, under certain
conditions, to effect transactions in a
trustee or fiduciary capacity in its trust
department or other department that is
356 See State Street Letter, SIMFA Letter, U.S.
Trust Letter, BISA Letter.
357 Rule 701(a)(2)(i), (a)(3)(iii)–(v), and 701(b).

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regularly examined by bank examiners
for compliance with fiduciary principles
and standards without registering as a
broker. To qualify for the trust and
fiduciary activities exception, Exchange
Act Section 3(a)(4)(B)(ii) requires that
the bank be ‘‘chiefly compensated’’ for
such transactions on the basis of the
types of fees specified in the GLBA and
comply with certain advertising
restrictions set forth in the statute.
The Agencies believe that the rules
dealing with the trust and fiduciary
activities exception will provide a
number of benefits to banks and their
customers without imposing significant
costs on either group.358 The provisions
regarding the ‘‘chiefly compensated’’
condition and related exemptions, while
imposing some costs related to systems
necessary to perform the calculations
and track compensation, are expected to
reduce banks’ compliance costs and
make the trust and fiduciary activities
exception more useful. For example, the
rules permit a bank to follow an
alternate test to the account-by-account
approach to the ‘‘chiefly compensated’’
condition. Under this exemption, a bank
may calculate the compensation it
receives from its trust and fiduciary
business as a whole on a bank-wide
basis, subject to certain conditions.359
This alternative is designed to provide
banks with a potentially less costly
approach for determining compliance
with the trust and fiduciary activities
exception. Some commenters noted that
this alternative approach was
workable.360 Similarly, the Agencies’
exemptions from the ‘‘chiefly
compensated’’ condition for certain
short-term accounts, accounts acquired
as part of a business combination or
asset acquisition, accounts held at a
non-shell foreign branch, accounts
transferred to a broker-dealer or other
unaffiliated entity, and a de minimis
number of accounts are expected also to
reduce banks’ compliance costs by
facilitating banks’ ability to comply with
the ‘‘chiefly compensated’’ condition.361
While compliance with the conditions
in these exemptions likely will result in
some costs, such as the recordkeeping
requirement associated with the de
minimis exclusion, these costs are likely
more than justified by the benefits
associated with the exemptions given
that banks could individually determine
whether they wish to utilize the
exemptions.
358 The trust and fiduciary exception is addressed
in Rules 721–723.
359 See Rule 722.
360 See, e.g., ABA Letter, WBA Letter, U.S. Trust
Letter, PNC Letter.
361 See Rule 723.

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As previously noted, banks are likely
to incur some costs to comply with the
GLBA. The rules, however, include a
number of exemptions which are
intended to help to reduce overall costs.
As a result, the Agencies do not believe
that banks will incur significant
additional costs to comply with the
liberalized exemptions of Rules 722
through 723 or the definitional guidance
of Rule 721.
c. Sweep Accounts and Transactions in
Money Market Funds
Section 3(a)(4)(B)(v) of the Exchange
Act provides a bank with an exception
from the definition of ‘‘broker’’ to the
extent it effects transactions as part of a
program for the investment or reinvestment of deposit funds for a
customer or on behalf of another bank
into any no-load, open-end management
investment company registered under
the Investment Company Act that holds
itself out as a money market fund. The
rules provide guidance, consistent with
FINRA rules,362 regarding the definition
of ‘‘no-load’’ as used in the exception.
This guidance likely will benefit banks
by clarifying the types of charges that
are permissible and by providing greater
legal certainty.
The rules also contain an exemption
that permits banks to effect transactions
on behalf of a customer, or for the
deposit funds of another bank, in
securities issued by a money market
fund, subject to certain conditions.363
While compliance with the conditions
associated with this exemption, such as
the prospectus delivery requirement in
certain circumstances, may require
banks to incur some costs, these costs
are likely to be more than justified by
the investor protection benefits enjoyed
by the banks’ customers and the
enhanced flexibility granted banks by
the exemption. Furthermore, because
banks are free to determine whether to
incur these costs, the exemption is
expected to provide a net benefit for
banks that wish to utilize the
exemption.
d. Safekeeping and Custody Exception
Section 3(a)(4)(B)(viii) of the
Exchange Act provides banks with an
exception from the definition of
‘‘broker’’ for certain bank custody and
safekeeping activities. The rules contain
an exemption that permits a bank,
subject to certain conditions, to accept
orders to effect transactions in securities
for accounts for which the bank acts as
a custodian (including an account for
which a bank acts as directed trustee),
362 See
363 See

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or, in some cases, for which the bank
acts as a subcustodian or a nonfiduciary administrator or recordkeeper.
Specifically, this custody exemption
(Rule 760) allows banks, subject to
certain conditions, to accept orders for
securities transactions from employee
benefit plan accounts and individual
retirement and similar accounts for
which the bank acts as a custodian. In
addition, the exemption allows banks,
subject to certain conditions, to accept
orders for securities transactions on an
accommodation basis from other types
of custodial accounts. This exemption
allows banks to accept orders from
custody accounts while imposing
conditions designed to prevent a bank
from operating a brokerage business out
of its custody department.
The exemption is designed to benefit
banks by permitting certain order-taking
activities for securities transactions.
While banks may incur some costs in
complying with the conditions
contained in the exemption, such as
developing systems for making
determinations regarding compliance
with advertising and compensation
restrictions, the Agencies believe the
conditions contained in the rules are
consistent with the practices of banks
and any costs will only be imposed on
banks that choose to utilize the
exemption.
e. Other Rules
The Agencies are also adopting
certain special purpose exemptions.
Specifically, we are adopting an
exemption that permits banks to effect
transactions in Regulation S securities
with non-U.S. persons or registered
broker-dealers.364 Another exemption
also allows, under certain conditions, a
bank to effect transactions in investment
company securities and variable life
insurance and variable annuities
through the National Securities Clearing
Corporation or directly with a transfer
agent or insurance company or separate
account that is excluded from the
definition of transfer agent, instead of
through a broker-dealer.365 In addition,
an exemption permits banks that rely on
certain exceptions and exemptions to
effect certain transactions involving the
securities of a company for the
company’s employee benefit plans and
participants through the National
Securities Clearing Corporation or
directly with a transfer agent or
insurance company or separate account
that is excluded from the definition of
transfer agent, instead of through a
broker-dealer. An additional exemption

permits a bank, as agent, to effect
securities lending transactions (and
engage in related securities lending
services) for securities that they do not
hold in custody with or on behalf of a
person the bank reasonably believes is
a qualified investor (as defined in
Section 3(a)(54)(A) of the Exchange Act)
or any employee benefit plan that owns
and invests on a discretionary basis at
least $25 million in investments.366 We
also are extending the exemption from
rescission liability under Exchange Act
Section 29 to contracts entered into by
banks acting in a broker capacity until
a date that is 18 months after the
effective date of the final rule.367 This
exemption also provides, under certain
circumstances, protections from
rescission liability under Exchange Act
Section 29 resulting solely from a bank’s
status as a broker, if the bank has acted
in good faith, adopted reasonable
policies and procedures, and any
violation of broker registration
requirements did not result in
significant harm or financial loss to the
person seeking to void the contract.368
Finally, we are issuing a temporary
general exemption from the definition of
‘‘broker’’ under Section 3(a)(4) of the
Exchange Act until the first day of a
bank’s first fiscal year commencing after
September 30, 2008.369
The Agencies believe these provisions
offer a number of benefits to banks and
their customers. In particular, the
Regulation S exemption helps ensure
that U.S. banks that effect transactions
in Regulation S securities with non-U.S.
customers will be more competitive
with foreign banks or other entities that
offer those services without being
registered as broker-dealers. The
exemption from rescission liability
under Exchange Act Section 29 also
provides banks some legal certainty,
both temporarily and on a permanent
basis, as they conduct their securities
activities. The exemption related to
securities lending services enables
banks to engage in the types of services
in which they currently engage thereby
minimizing compliance costs, while
providing the banks’ customers with
continuity of service. The temporary
general exemption from the definition of
‘‘broker’’ also benefits banks by
providing them with an adequate period
of time to transition to the requirements
under the statute and the rules.
The Agencies estimate that the costs
of these exemptions will be minimal
and are justified by the benefits the
366 See
367 See

364 See
365 See

Rule 771.
Rule 775.

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Rule 772.
Rule 780.

368 Id.
369 See

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exemptions offer. For example, the
Regulation S exemption may impose
certain costs on banks that are designed
to ensure that they remain in
compliance with the conditions under
the exemption. In particular, the
exemption permits banks to rely on the
exemption only for transactions in
‘‘eligible securities’’ and with either
broker-dealers or purchasers who are
not U.S. persons within the meaning of
Section 903 of Regulation S. Banks may
incur certain administrative costs to
ensure that a transaction meets these
requirements. Nevertheless, the
exemption is an accommodation to
banks that wish to effect transactions in
Regulation S securities and, as a result,
the compliance costs will be imposed
only on those banks that believe that it
is in their best business interests to take
advantage of the exemption.
Given that Exchange Act Section 29 is
rarely used as a remedy, we do not
anticipate that this exemption will
impose significant costs on the industry
or on investors.
3. General Costs and Benefits
Based on the burden hours discussed
in the Paperwork Reduction Act
Analysis section, supra, the Agencies
expect the ongoing requirements of the
rules to result in a total of 50,375 annual
burden hours for banks and 9583 annual
burden hours for broker-dealers, for a
grand total of 59,958 annual burden
hours.370 The Agencies estimate that the
hourly costs for these burden hours will
be approximately $68 per hour.371
Therefore, the annual total costs will be
approximately $4,077,144.
In addition to the costs associated
with burden hours discussed in the
Paperwork Reduction Act Analysis
section, supra, the Agencies expect that
many banks also could incur start-up
costs for legal and other professional
services.372 Many banks will utilize
their in-house counsel, accountants,
compliance officers, and programmers
in an effort to achieve compliance with
the rules. Industry sources indicate the
370 See infra at VIII.A.1.d., VIII.A.2.d., and
VIII.A.3.d.
371 $68/hour figure for a clerk (e.g. compliance
clerk) is from the Securities Industry Association
(now SIFMA) Report on Office Salaries in the
Securities Industry 2005, modified to account for an
1800-hour work-year and multiplied by 2.93 to
account for bonuses, firm size, employee benefits
and overhead.
372 For example, banks may incur start-up costs
in the process of reviewing or developing their
networking arrangements in line with the
requirements of the rules. See supra at VIII.B.2.a.
In addition, there likely will be costs for developing
systems for making determinations regarding
compliance with advertising and compensation
restrictions pursuant to the rules regarding
safekeeping and custody. See supra at VIII.B.2.d.

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following hourly labor costs:
Attorneys—$324 per hour, intermediate
accountants—$162 per hour,
compliance manager—$205 per hour,
and senior programmer—$268.373
Taking an average of these professional
costs, the Agencies estimate a general
hourly in-house labor cost of $240 per
hour for professional services.
Based on our expectation that most
start-up costs will involve bringing
systems into compliance and that many
banks will be able to do so either using
existing systems or by slightly
modifying existing systems, the
Agencies estimate that the rules will
require banks to utilize an average of 30
hours of professional services. The
Agencies expect that most banks
affected by the rules will either use inhouse counsel or employees resulting in
an average total cost of $7,200 per
affected bank.374 The Agencies estimate
that the rules will apply to
approximately 9,475 banks and
approximately 25 percent of these banks
will incur more than a de minimis cost.
Using these values, the Agencies
estimate total start-up costs of
$17,055,000 (9,475 × .25 × $7,200). As
previously discussed, the Agencies have
sought to minimize these costs to the
extent possible consistent with the
language and purposes of the GLBA.
Two commenters stated that the
Agencies’ estimates of hourly rates in
the proposal were fair, but that the
estimates of the time requirements were
too low. These commenters estimated
startup costs of between $43,000 and
$55,000.375 In addition, these
commenters estimated ongoing costs to
be between $60,000 and $95,000 per
year. Based on these commenters’
estimates, startup costs would range
from $101.9 million (9475 banks × 0.25
affected × $43,000) to $130.3 million
(9475 × 0.25 × $55,000), and a range of
annual ongoing costs of $142.1 million
(9475 × 0.25 × $60,000) to $225 million
(9475 × 0.25 × $95,000). The Agencies,
however, believe that these cost
estimates are not representative of the
costs for the majority of banks affected
by Regulation R. The Agencies received
373 The hourly figures for an attorney,
intermediate account, and compliance manager is
from the SIA Report on Management & Professional
Earnings in the Securities Industry 2005, modified
to account for an 1800-hour work-year and
multiplied by 5.35 to account for bonuses, firm size,
employee benefits and overhead.
374 Some banks may choose to utilize outside
counsel, either exclusively or as a supplement to inhouse resources. The Agencies estimate these costs
as being similar to the in-house costs (Industry
sources indicate the following hourly costs for
hiring external workers: Attorneys—$400,
accountant—$250, auditor—$250, and
programmer—$160.).
375 See Fiserv Letter, Colorado Trust Letter.

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approximately 60 comments, primarily
from banks and banking industry
groups, and the comments generally
were favorable. Only these two
commenters stated that the Agencies
had underestimated start-up and
continuing compliance costs. The
Agencies therefore believe that the
estimates in the proposal reflect the
costs that the majority of the banks
affected by the rules are likely, on
average, to incur, and are appropriately
used to estimate the overall compliance
costs of Regulation R.
The Agencies believe that the rules
will provide greater legal certainty for
banks in connection with their
determination of whether they meet the
terms and conditions for an exception to
the definition of broker under the
Exchange Act as well as provide
additional relief through the
exemptions. Without the rules, banks
may have difficulty planning their
businesses and determining whether
their operations are in compliance with
the GLBA. This, in turn, could hamper
their business. The Agencies anticipate
these benefits will be useful to banks in
a number of ways.
The Agencies expect that one
component of the benefits to banks will
be savings in legal fees, given that
difficulties in interpreting the GLBA
absent any regulatory guidance could
result in the need for greater input from
outside counsel. Based on the number of
interpretive issues raised by the GLBA,
the Agencies estimate that, absent any
regulatory guidance, banks on average
will use the services of outside counsel
for approximately 25 more hours for the
initial year and 5 more hours per year
thereafter, than with the existence of the
rules. Industry sources indicate that the
hourly costs for hiring outside counsel
are approximately $400 per hour. The
rules will therefore result in an average
total cost savings of approximately
$10,000 per affected bank per year
during the initial year and $2,000 per
affected bank per year thereafter. The
Agencies estimate that the rules will
apply to approximately 9,475 banks and
approximately 25 percent of these banks
will enjoy more than a de minimis cost
savings benefit. Using these values, the
Agencies estimate a cost savings related
to reduced legal fees of $23,687,500
(9,475 × 0.25 × $10,000) for the initial
year and $4,737,500 (9,475 × 0.25 ×
$2,000) per year thereafter.
The Agencies believe that the benefits
of Regulation R justify the costs.

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C. Consideration of Burden on
Competition, and on Promotion of
Efficiency, Competition, and Capital
Formation
Exchange Act Section 3(f) requires the
Commission, whenever it engages in
rulemaking and is required to consider
or determine if an action is necessary or
appropriate in the public interest, to
consider whether the action will
promote efficiency, competition, and
capital formation.376 Exchange Act
Section 23(a)(2) requires the
Commission, in adopting rules under
that Act, to consider the impact that any
such rule will have on competition.
This Section also prohibits the
Commission from adopting any rule that
will impose a burden on competition
not necessary or appropriate in
furtherance of the purposes of the
Exchange Act.377
The Agencies have designed the
interpretations, definitions, and
exemptions to minimize any burden on
competition. Indeed, the Agencies
believe that by providing legal certainty
to banks that conduct securities
activities, by clarifying the GLBA
requirements, and by exempting a
number of activities from those
requirements, the rules allow banks to
continue to conduct securities activities
consistent with the GLBA.
The rules define terms in the statutory
exceptions to the definition of broker
added to the Exchange Act by Congress
in the GLBA, and provide guidance to
banks as to the appropriate scope of
those exceptions. In addition, the rules
contain a number of exemptions that
provide banks flexibility in conducting
their securities activities, which will
promote competition and reduce costs.
D. Final Regulatory Flexibility Analysis
The Agencies have prepared a Final
Regulatory Flexibility Analysis
(‘‘FRFA’’), in accordance with the
provisions of the Regulatory Flexibility
Act (‘‘RFA’’),378 regarding the rules.
1. Reasons for the Action
Section 201 of the GLBA amended the
definition of ‘‘broker’’ in Section 3(a)(4)
of the Exchange Act to replace a blanket
exemption from that term for ‘‘banks,’’
as defined in Section 3(a)(6) of the
Exchange Act. Congress replaced this
blanket exemption with eleven specific
exceptions for securities activities
conducted by banks.379 On October 13,
2006, President Bush signed into law
376 15

U.S.C. 78c(f).
U.S.C. 78w(a)(2).
378 5 U.S.C. 604.
379 15 U.S.C. 78c(a)(4).
377 15

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the Regulatory Relief Act.380 Section
101 of that Act, among other things,
requires the Agencies jointly to issue a
single set of rules implementing the
bank broker exceptions in Section
3(a)(4) of the Exchange Act.381 These
rules are being adopted by the Agencies
to fulfill this requirement. The rules are
designed generally to provide guidance
on the GLBA’s bank exceptions from the
definition of broker in Exchange Act
Section 3(a)(4) and to provide
conditional exemptions from the broker
definition consistent with the purposes
of the Exchange Act and the GLBA.
2. Objectives
The rules provide guidance to the
industry with respect to the GLBA
requirements. The rules also provide
certain conditional exemptions from the
broker definition to allow banks to
perform certain securities activities. The
Supplementary Information section,
supra, contains more detailed
information on the objectives of the
rules.
3. Legal Basis
Pursuant to Section 101 of the
Regulatory Relief Act, the Agencies are
issuing the rules.
4. Small Entities Subject to the Rule
The rules apply to ‘‘banks,’’ which is
defined in Section 3(a)(6) of the
Exchange Act to include banking
institutions organized in the United
States, including members of the
Federal Reserve System, Federal savings
associations, as defined in Section 2(5)
of the Home Owners’ Loan Act, and
other commercial banks, savings
associations, and nondepository trust
companies that are organized under the
laws of a state or the United States and
subject to supervision and examination
by state or federal authorities having
supervision over banks and savings
associations.382 Congress did not
exempt small entity banks from the
application of the GLBA. Moreover,
because the rules are intended to
provide guidance to, and exemptions
for, all banks that are subject to the
GBLA, the Agencies determined that it
would not be appropriate or necessary
to exempt small entity banks from the
operation of the rules. The rules
L. No. 109–351, 120 Stat. 1966 (2006).
Exchange Act Section 3(a)(4)(F), as added
by Section 101 of the Regulatory Relief Act. The
Regulatory Relief Act also requires that the Board
and SEC consult with, and seek the concurrence of,
the OCC, FDIC and OTS prior to jointly adopting
final rules. As noted above, the Board and the SEC
also have consulted extensively with the OCC, FDIC
and OTS in developing these joint rules.
382 See 15 U.S.C. 78c(a)(6); Pub. L. No. 109–351,
120 Stat. 1966 (2006).

generally apply to all banks, including
banks that would be considered small
entities (i.e., banks with total assets of
$165 million or less) for purposes of the
RFA.383 The Agencies, however, have
adopted several interpretations or
exceptions that likely will be
particularly useful for small banks such
as, for example, the fixed inflationadjusted dollar alternative to the
‘‘nominal’’ requirement in the
networking exception and the exception
in Rule 723 from the chiefly
compensated test for a de minimis
number of trust or fiduciary accounts.
The Agencies estimate that the rules
will apply to approximately 9,475
banks, approximately 5,816 of which
could be considered small banks with
assets of $165 million or less. Moreover,
we do not anticipate any significant
costs to small entity banks as a result of
the rules. We note that a trade
association whose membership consists
primarily of small banking organizations
indicated that small banks would be
able to comply with the rules as
proposed without significantly altering
their activities.384
5. Reporting, Recordkeeping and Other
Compliance Requirements
The rules will not impose any
significant reporting, recordkeeping, or
other compliance requirements on
banks that are small entities.385
6. Duplicative, Overlapping, or
Conflicting Federal Rules
The Agencies believe that no other
rules duplicate, overlap, or conflict with
the final rules.
7. Significant Alternatives
Pursuant to Section 3(a) of the
RFA,386 the Agencies must consider the
following types of alternatives: (1) The
establishment of differing compliance or
reporting requirements or timetables
that take into account the resources
available to small entities; (2) the
clarification, consolidation, or
simplification of compliance and
reporting requirements under the rule
for small entities; (3) the use of
performance rather than design
standards; and (4) an exemption from
coverage of the rules, or any part
thereof, for small entities.

380 Pub.

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381 See

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383 Small Business Administration regulations
define ‘‘small entities’’ to include banks and savings
associations with total assets of $165 million or
less. 13 CFR 121.201.
384 See ICBA Letter.
385 The Agencies’ estimates related to
recordkeeping and disclosure are detailed in the
‘‘Paperwork Reduction Act Analysis’’ Section of
this Release.
386 5 U.S.C. 604(a).

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As discussed above, the GLBA does
not exempt small entity banks from the
Exchange Act broker registration
requirements and because the rules are
intended to provide guidance to, and
exemptions for, all banks that are
subject to the GLBA and are designed to
accommodate the business practices of
all banks (including small entity banks),
the Agencies determined that it would
not be appropriate or necessary to
exempt small entity banks from the
operation of the rules. Moreover,
providing one or more special
exemptions for small banks could place
broker-dealers, including small brokerdealers, or larger banks at a competitive
disadvantage versus small banks.
The rules are intended to clarify and
simplify compliance with the GLBA by
providing guidance with respect to
exceptions and by providing additional
exemptions. As such, the rules are
expected to facilitate compliance by
banks of all sizes, including small entity
banks.
The Agencies do not believe that it is
necessary to consider whether small
entity banks should be permitted to use
performance rather than design
standards to comply with the rules
because the rules already use
performance standards. Moreover, the
rules do not dictate for entities of any
size any particular design standards
(e.g., technology) that must be employed
to achieve the objectives of the rules.
E. Plain Language
Section 722 of the GLBA (12 U.S.C.
4809) requires the Board to use plain
language in all proposed and final rules
published by the Board after January 1,
2000. The Board believes the rules, to
the maximum extent possible, are
presented in a simple and
straightforward manner.
X. Statutory Authority
Pursuant to authority set forth in the
Exchange Act and particularly Sections
3(a)(4), 3(b), 15, 17, 23(a), and 36 thereof
(15 U.S.C. 78c(a)(4), 78c(b), 78o, 78q,
78w(a), and 78mm, respectively) the
Commission is repealing by operation of
statute current Rules 3a4–2, 3a4–3, 3a4–
4, 3a4–5, 3a4–6, and 3b–17 (§§ 240.3a4–
2, 240.3a4–3, 240.3a4–4, 240.3a4–5,
240.3a4–6, and 240.3b–17, respectively).
The Commission is repealing Exchange
Act Rules 15a–7 and 15a–8 (§ 240.15a–
7 and § 240.15a–8, respectively). The
Commission, jointly with the Board of
Governors of the Federal Reserve
System, is also adopting new Rules 700,
701, 721, 722, 723, 740, 741, 760, 771,
772, 775, 776, 780, and 781 under the
Exchange Act (§§ 247.700, 247.701,
247.721, 247.722, 247.723, 247.740,

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247.741, 247.760, 247.771, 247.772,
247.775, 247.776, 247.780, and 247.881,
respectively).
XI. Text of Rules and Rule Amendment
List of Subjects

Authority: 15 U.S.C. 78c(a)(4)(F).

12 CFR Part 218
Banks, Brokers, Securities.

Securities and Exchange Commission

17 CFR Part 240
Broker-dealers, Reporting and
recordkeeping requirements, Securities.
17 CFR Part 247
Banks, Brokers, Securities.
Authority and Issuance
For the reasons set forth in the
preamble, the Board amends Title 12,
Chapter II of the Code of Federal
Regulations by adding a new Part 218 as
set forth under Common Rules at the
end of this document:

■

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PART 218—EXCEPTIONS FOR BANKS
FROM THE DEFINITION OF BROKER
IN THE SECURITIES EXCHANGE ACT
OF 1934 (REGULATION R)
Sec.
218.100 Definition.
218.700 Defined terms relating to the
networking exception from the definition
of ‘‘broker.’’
218.701 Exemption from the definition of
‘‘broker’’ for certain institutional
referrals.
218.721 Defined terms relating to the trust
and fiduciary activities exception from
the definition of ‘‘broker.’’
218.722 Exemption allowing banks to
calculate trust and fiduciary
compensation on a bank-wide basis.
218.723 Exemptions for special accounts,
transferred accounts, and a de minimis
number of accounts.
218.740 Defined terms relating to the sweep
accounts exception from the definition of
‘‘broker.’’
218.741 Exemption for banks effecting
transactions in money market funds.
218.760 Exemption from definition of
‘‘broker’’ for banks accepting orders to
effect transactions in securities from or
on behalf of custody accounts.
218.771 Exemption from the definition of
‘‘broker’’ for banks effecting transactions
in securities issued pursuant to
Regulation S.
218.772 Exemption from the definition of
‘‘broker’’ for banks engaging in securities
lending transactions.
218.775 Exemption from the definition of
‘‘broker’’ for banks effecting certain
excepted or exempted transactions in
investment company securities.
218.776 Exemption from the definition of
‘‘broker’’ for banks effecting certain
excepted or exempted transactions in a
company’s securities for its employee
benefit plans.

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Authority and Issuance
For the reasons set forth in the
preamble, the Commission amends Title
17, Chapter II of the Code of Federal
Regulations as follows:

■

PART 240—GENERAL RULES AND
REGULATIONS, SECURITIES
EXCHANGE ACT OF 1934

Federal Reserve System

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218.780 Exemption for banks from liability
under section 29 of the Securities
Exchange Act of 1934.
218.781 Exemption from the definition of
‘‘broker’’ for banks for a limited period
of time.

1. The authority citation for part 240
continues to read, in part, as follows:

■

Authority: 15 U.S.C. 77c, 77d, 77g, 77j,
77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn,
77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j,
78j–1, 78k, 78k–1, 78l, 78m, 78n, 78o, 78p,
78q, 78s, 78u–5, 78w, 78x, 78ll, 78mm, 80a–
20, 80a–23, 80a–29, 80a–37, 80b–3, 80b–4,
80b–11, and 7201 et seq.; and 18 U.S.C. 1350,
unless otherwise noted.
§§ 240.3a4–2 through 240.3a4–6, 240.3b–17,
240.15a–7, and 240.15a–8 [Removed and
Reserved]

247.771 Exemption from the definition of
‘‘broker’’ for banks effecting transactions
in securities issued pursuant to
Regulation S.
247.772 Exemption from the definition of
‘‘broker’’ for banks engaging in securities
lending transactions.
247.775 Exemption from the definition of
‘‘broker’’ for banks effecting certain
excepted or exempted transactions in
investment company securities.
247.776 Exemption from the definition of
‘‘broker’’ for banks effecting certain
excepted or exempted transactions in a
company’s securities for its employee
benefit plans.
247.780 Exemption for banks from liability
under section 29 of the Securities
Exchange Act of 1934.
247.781 Exemption from the definition of
‘‘broker’’ for banks for a limited period
of time.
Authority: 15 U.S.C. 78c, 78o, 78q, 78w,
and 78mm.

Common Rules
The common rules that are adopted
by the Commission as Part 247 of Title
17, Chapter II of the Code of Federal
Regulations and by the Board as Part
218 of Title 12, Chapter II of the Code
of Federal Regulations follow:
§ ll.100

Definition.

2. Sections 240.3a4–2 through
240.3a4–6, 240.3b–17, 240.15a–7, and
240.15a–8 are removed and reserved.
■ 3. Part 247 is added as set forth under
Common Rules at the end of this
document:

For purposes of this part the following
definition shall apply: Act means the
Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).

PART 247—REGULATION R—
EXEMPTIONS AND DEFINITIONS
RELATED TO THE EXCEPTIONS FOR
BANKS FROM THE DEFINITION OF
BROKER

When used with respect to the Third
Party Brokerage Arrangements
(‘‘Networking’’) Exception from the
definition of the term ‘‘broker’’ in
section 3(a)(4)(B)(i) of the Act (15 U.S.C.
78c(a)(4)(B)(i)) in the context of
transactions with a customer, the
following terms shall have the meaning
provided:
(a) Contingent on whether the referral
results in a transaction means
dependent on whether the referral
results in a purchase or sale of a
security; whether an account is opened
with a broker or dealer; whether the
referral results in a transaction
involving a particular type of security;
or whether it results in multiple
securities transactions; provided,
however, that a referral fee may be
contingent on whether a customer:
(1) Contacts or keeps an appointment
with a broker or dealer as a result of the
referral; or
(2) Meets any objective, base-line
qualification criteria established by the
bank or broker or dealer for customer
referrals, including such criteria as
minimum assets, net worth, income, or

■

Sec.
247.100 Definition.
247.700 Defined terms relating to the
networking exception from the definition
of ‘‘broker.’’
247.701 Exemption from the definition of
‘‘broker’’ for certain institutional
referrals.
247.721 Defined terms relating to the trust
and fiduciary activities exception from
the definition of ‘‘broker.’’
247.722 Exemption allowing banks to
calculate trust and fiduciary
compensation on a bank-wide basis.
247.723 Exemptions for special accounts,
transferred accounts, and a de minimis
number of accounts.
247.740 Defined terms relating to the sweep
accounts exception from the definition of
‘‘broker.’’
247.741 Exemption for banks effecting
transactions in money market funds.
247.760 Exemption from definition of
‘‘broker’’ for banks accepting orders to
effect transactions in securities from or
on behalf of custody accounts.

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§ ll.700 Defined terms relating to the
networking exception from the definition of
‘‘broker.’’

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marginal federal or state income tax
rate, or any requirement for citizenship
or residency that the broker or dealer, or
the bank, may have established
generally for referrals for securities
brokerage accounts.
(b)(1) Incentive compensation means
compensation that is intended to
encourage a bank employee to refer
customers to a broker or dealer or give
a bank employee an interest in the
success of a securities transaction at a
broker or dealer. The term does not
include compensation paid by a bank
under a bonus or similar plan that is:
(i) Paid on a discretionary basis; and
(ii) Based on multiple factors or
variables and:
(A) Those factors or variables include
multiple significant factors or variables
that are not related to securities
transactions at the broker or dealer;
(B) A referral made by the employee
is not a factor or variable in determining
the employee’s compensation under the
plan; and
(C) The employee’s compensation
under the plan is not determined by
reference to referrals made by any other
person.
(2) Nothing in this paragraph (b) shall
be construed to prevent a bank from
compensating an officer, director or
employee under a bonus or similar plan
on the basis of any measure of the
overall profitability or revenue of:
(i) The bank, either on a stand-alone
or consolidated basis;
(ii) Any affiliate of the bank (other
than a broker or dealer), or any
operating unit of the bank or an affiliate
(other than a broker or dealer), if the
affiliate or operating unit does not over
time predominately engage in the
business of making referrals to a broker
or dealer; or
(iii) A broker or dealer if:
(A) Such measure of overall
profitability or revenue is only one of
multiple factors or variables used to
determine the compensation of the
officer, director or employee;
(B) The factors or variables used to
determine the compensation of the
officer, director or employee include
multiple significant factors or variables
that are not related to the profitability or
revenue of the broker or dealer;
(C) A referral made by the employee
is not a factor or variable in determining
the employee’s compensation under the
plan; and
(D) The employee’s compensation
under the plan is not determined by
reference to referrals made by any other
person.
(c) Nominal one-time cash fee of a
fixed dollar amount means a cash
payment for a referral, to a bank

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employee who was personally involved
in referring the customer to the broker
or dealer, in an amount that meets any
of the following standards:
(1) The payment does not exceed:
(i) Twice the average of the minimum
and maximum hourly wage established
by the bank for the current or prior year
for the job family that includes the
employee; or
(ii) 1/1000th of the average of the
minimum and maximum annual base
salary established by the bank for the
current or prior year for the job family
that includes the employee; or
(2) The payment does not exceed
twice the employee’s actual base hourly
wage or 1/1000th of the employee’s
actual annual base salary; or
(3) The payment does not exceed
twenty-five dollars ($25), as adjusted in
accordance with paragraph (f) of this
section.
(d) Job family means a group of jobs
or positions involving similar
responsibilities, or requiring similar
skills, education or training, that a bank,
or a separate unit, branch or department
of a bank, has established and uses in
the ordinary course of its business to
distinguish among its employees for
purposes of hiring, promotion, and
compensation.
(e) Referral means the action taken by
one or more bank employees to direct a
customer of the bank to a broker or
dealer for the purchase or sale of
securities for the customer’s account.
(f) Inflation adjustment—(1) In
general. On April 1, 2012, and on the 1st
day of each subsequent 5-year period,
the dollar amount referred to in
paragraph (c)(3) of this section shall be
adjusted by:
(i) Dividing the annual value of the
Employment Cost Index For Wages and
Salaries, Private Industry Workers (or
any successor index thereto), as
published by the Bureau of Labor
Statistics, for the calendar year
preceding the calendar year in which
the adjustment is being made by the
annual value of such index (or
successor) for the calendar year ending
December 31, 2006; and
(ii) Multiplying the dollar amount by
the quotient obtained in paragraph
(f)(1)(i) of this section.
(2) Rounding. If the adjusted dollar
amount determined under paragraph
(f)(1) of this section for any period is not
a multiple of $1, the amount so
determined shall be rounded to the
nearest multiple of $1.
§ ll.701 Exemption from the definition
of ‘‘broker’’ for certain institutional
referrals.

(a) General. A bank that meets the
requirements for the exception from the

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56555

definition of ‘‘broker’’ under section
3(a)(4)(B)(i) of the Act (15 U.S.C.
78c(a)(4)(B)(i)), other than section
3(a)(4)(B)(i)(VI) of the Act (15 U.S.C.
78c(a)(4)(B)(i)(VI)), is exempt from the
conditions of section 3(a)(4)(B)(i)(VI) of
the Act solely to the extent that a bank
employee receives a referral fee for
referring a high net worth customer or
institutional customer to a broker or
dealer with which the bank has a
contractual or other written arrangement
of the type specified in section
3(a)(4)(B)(i) of the Act, if:
(1) Bank employee. (i) The bank
employee is:
(A) Not registered or approved, or
otherwise required to be registered or
approved, in accordance with the
qualification standards established by
the rules of any self-regulatory
organization;
(B) Predominantly engaged in banking
activities other than making referrals to
a broker or dealer; and
(C) Not subject to statutory
disqualification, as that term is defined
in section 3(a)(39) of the Act (15 U.S.C.
78c(a)(39)), except subparagraph (E) of
that section; and
(ii) The high net worth customer or
institutional customer is encountered by
the bank employee in the ordinary
course of the employee’s assigned duties
for the bank.
(2) Bank determinations and
obligations—(i) Disclosures. The bank
provides the high net worth customer or
institutional customer the information
set forth in paragraph (b) of this section
(A) In writing prior to or at the time
of the referral; or
(B) Orally prior to or at the time of the
referral and
(1) The bank provides such
information to the customer in writing
within 3 business days of the date on
which the bank employee refers the
customer to the broker or dealer; or
(2) The written agreement between
the bank and the broker or dealer
provides for the broker or dealer to
provide such information to the
customer in writing in accordance with
paragraph (a)(3)(i) of this section.
(ii) Customer qualification. (A) In the
case of a customer that is a not a natural
person, the bank has a reasonable basis
to believe that the customer is an
institutional customer before the referral
fee is paid to the bank employee.
(B) In the case of a customer that is
a natural person, the bank has a
reasonable basis to believe that the
customer is a high net worth customer
prior to or at the time of the referral.
(iii) Employee qualification
information. Before a referral fee is paid
to a bank employee under this section,

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the bank provides the broker or dealer
the name of the employee and such
other identifying information that may
be necessary for the broker or dealer to
determine whether the bank employee
is registered or approved, or otherwise
required to be registered or approved, in
accordance with the qualification
standards established by the rules of any
self-regulatory organization or is subject
to statutory disqualification, as that term
is defined in section 3(a)(39) of the Act
(15 U.S.C. 78c(a)(39)), except
subparagraph (E) of that section.
(iv) Good faith compliance and
corrections. A bank that acts in good
faith and that has reasonable policies
and procedures in place to comply with
the requirements of this section shall
not be considered a ‘‘broker’’ under
section 3(a)(4) of the Act (15 U.S.C.
78c(a)(4)) solely because the bank fails
to comply with the provisions of this
paragraph (a)(2) with respect to a
particular customer if the bank:
(A) Takes reasonable and prompt
steps to remedy the error (such as, for
example, by promptly making the
required determination or promptly
providing the broker or dealer the
required information); and
(B) Makes reasonable efforts to
reclaim the portion of the referral fee
paid to the bank employee for the
referral that does not, following any
required remedial action, meet the
requirements of this section and that
exceeds the amount otherwise permitted
under section 3(a)(4)(B)(i)(VI) of the Act
(15 U.S.C. 78c(a)(4)(B)(i)(VI)) and
§ ll.700.
(3) Provisions of written agreement.
The written agreement between the
bank and the broker or dealer shall
require that:
(i) Broker-dealer written disclosures.
If, pursuant to paragraph (a)(2)(i)(B)(2)
of this section, the broker or dealer is to
provide the customer in writing the
disclosures set forth in paragraph (b) of
this section, the broker or dealer
provides such information to the
customer in writing:
(A) Prior to or at the time the
customer begins the process of opening
an account at the broker or dealer, if the
customer does not have an account with
the broker or dealer; or
(B) Prior to the time the customer
places an order for a securities
transaction with the broker or dealer as
a result of the referral, if the customer
already has an account at the broker or
dealer.
(ii) Customer and employee
qualifications. Before the referral fee is
paid to the bank employee:
(A) The broker or dealer determine
that the bank employee is not subject to

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statutory disqualification, as that term is
defined in section 3(a)(39) of the Act (15
U.S.C. 78c(a)(39)), except subparagraph
(E) of that section; and
(B) The broker or dealer has a
reasonable basis to believe that the
customer is a high net worth customer
or an institutional customer.
(iii) Suitability or sophistication
determination by broker or dealer—(A)
Contingent referral fees. In any case in
which payment of the referral fee is
contingent on completion of a securities
transaction at the broker or dealer, the
broker or dealer, before such securities
transaction is conducted, perform a
suitability analysis of the securities
transaction in accordance with the rules
of the broker or dealer’s applicable selfregulatory organization as if the broker
or dealer had recommended the
securities transaction.
(B) Non-contingent referral fees. In
any case in which payment of the
referral fee is not contingent on the
completion of a securities transaction at
the broker or dealer, the broker or
dealer, before the referral fee is paid,
either:
(1) Determine that the customer:
(i) Has the capability to evaluate
investment risk and make independent
decisions; and
(ii) Is exercising independent
judgment based on the customer’s own
independent assessment of the
opportunities and risks presented by a
potential investment, market factors and
other investment considerations; or
(2) Perform a suitability analysis of all
securities transactions requested by the
customer contemporaneously with the
referral in accordance with the rules of
the broker or dealer’s applicable selfregulatory organization as if the broker
or dealer had recommended the
securities transaction.
(iv) Notice to the customer. The
broker or dealer inform the customer if
the broker or dealer determines that the
customer or the securities transaction(s)
to be conducted by the customer does
not meet the applicable standard set
forth in paragraph (a)(3)(iii) of this
section.
(v) Notice to the bank. The broker or
dealer promptly inform the bank if the
broker or dealer determines that:
(A) The customer is not a high net
worth customer or institutional
customer, as applicable; or
(B) The bank employee is subject to
statutory disqualification, as that term is
defined in section 3(a)(39) of the Act (15
U.S.C. 78c(a)(39)), except subparagraph
(E) of that section.
(b) Required disclosures. The
disclosures provided to the high net
worth customer or institutional

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customer pursuant to paragraphs
(a)(2)(i) or (a)(3)(i) of this section shall
clearly and conspicuously disclose
(1) The name of the broker or dealer;
and
(2) That the bank employee
participates in an incentive
compensation program under which the
bank employee may receive a fee of
more than a nominal amount for
referring the customer to the broker or
dealer and payment of this fee may be
contingent on whether the referral
results in a transaction with the broker
or dealer.
(c) Receipt of other compensation.
Nothing in this section prevents or
prohibits a bank from paying or a bank
employee from receiving any type of
compensation that would not be
considered incentive compensation
under § ll.700(b)(1) or that is
described in § ll.700(b)(2).
(d) Definitions. When used in this
section:
(1) High net worth customer—(i)
General. High net worth customer
means:
(A) Any natural person who, either
individually or jointly with his or her
spouse, has at least $5 million in net
worth excluding the primary residence
and associated liabilities of the person
and, if applicable, his or her spouse; and
(B) Any revocable, inter vivos or
living trust the settlor of which is a
natural person who, either individually
or jointly with his or her spouse, meets
the net worth standard set forth in
paragraph (d)(1)(i)(A) of this section.
(ii) Individual and spousal assets. In
determining whether any person is a
high net worth customer, there may be
included in the assets of such person
(A) Any assets held individually;
(B) If the person is acting jointly with
his or her spouse, any assets of the
person’s spouse (whether or not such
assets are held jointly); and
(C) If the person is not acting jointly
with his or her spouse, fifty percent of
any assets held jointly with such
person’s spouse and any assets in which
such person shares with such person’s
spouse a community property or similar
shared ownership interest.
(2) Institutional customer means any
corporation, partnership, limited
liability company, trust or other nonnatural person that has, or is controlled
by a non-natural person that has, at
least:
(i) $10 million in investments; or
(ii) $20 million in revenues; or
(iii) $15 million in revenues if the
bank employee refers the customer to
the broker or dealer for investment
banking services.
(3) Investment banking services
includes, without limitation, acting as

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an underwriter in an offering for an
issuer; acting as a financial adviser in a
merger, acquisition, tender offer or
similar transaction; providing venture
capital, equity lines of credit, private
investment-private equity transactions
or similar investments; serving as
placement agent for an issuer; and
engaging in similar activities.
(4) Referral fee means a fee (paid in
one or more installments) for the referral
of a customer to a broker or dealer that
is:
(i) A predetermined dollar amount, or
a dollar amount determined in
accordance with a predetermined
formula (such as a fixed percentage of
the dollar amount of total assets placed
in an account with the broker or dealer),
that does not vary based on:
(A) The revenue generated by or the
profitability of securities transactions
conducted by the customer with the
broker or dealer; or
(B) The quantity, price, or identity of
securities transactions conducted over
time by the customer with the broker or
dealer; or
(C) The number of customer referrals
made; or
(ii) A dollar amount based on a fixed
percentage of the revenues received by
the broker or dealer for investment
banking services provided to the
customer.
(e) Inflation adjustments—(1) In
general. On April 1, 2012, and on the 1st
day of each subsequent 5-year period,
each dollar amount in paragraphs (d)(1)
and (d)(2) of this section shall be
adjusted by:
(i) Dividing the annual value of the
Personal Consumption Expenditures
Chain-Type Price Index (or any
successor index thereto), as published
by the Department of Commerce, for the
calendar year preceding the calendar
year in which the adjustment is being
made by the annual value of such index
(or successor) for the calendar year
ending December 31, 2006; and
(ii) Multiplying the dollar amount by
the quotient obtained in paragraph
(e)(1)(i) of this section.
(2) Rounding. If the adjusted dollar
amount determined under paragraph
(e)(1) of this section for any period is
not a multiple of $100,000, the amount
so determined shall be rounded to the
nearest multiple of $100,000.
§ ll.721 Defined terms relating to the
trust and fiduciary activities exception from
the definition of ‘‘broker.’’

(a) Defined terms for chiefly
compensated test. For purposes of this
part and section 3(a)(4)(B)(ii) of the Act
(15 U.S.C. 78c(a)(4)(B)(ii)), the following
terms shall have the meaning provided:

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(1) Chiefly compensated—account-byaccount test. Chiefly compensated shall
mean the relationship-total
compensation percentage for each trust
or fiduciary account of the bank is
greater than 50 percent.
(2) The relationship-total
compensation percentage for a trust or
fiduciary account shall be the mean of
the yearly compensation percentage for
the account for the immediately
preceding year and the yearly
compensation percentage for the
account for the year immediately
preceding that year.
(3) The yearly compensation
percentage for a trust or fiduciary
account shall be
(i) Equal to the relationship
compensation attributable to the trust or
fiduciary account during the year
divided by the total compensation
attributable to the trust or fiduciary
account during that year, with the
quotient expressed as a percentage; and
(ii) Calculated within 60 days of the
end of the year.
(4) Relationship compensation means
any compensation a bank receives
attributable to a trust or fiduciary
account that consists of:
(i) An administration fee, including,
without limitation, a fee paid—
(A) For personal services, tax
preparation, or real estate settlement
services;
(B) For disbursing funds from, or for
recording receipt of payments to, a trust
or fiduciary account;
(C) In connection with securities
lending or borrowing transactions;
(D) For custody services; or
(E) In connection with an investment
in shares of an investment company for
personal service, the maintenance of
shareholder accounts or any service
described in paragraph (a)(4)(iii)(C) of
this section;
(ii) An annual fee (payable on a
monthly, quarterly or other basis),
including, without limitation, a fee paid
for assessing investment performance or
for reviewing compliance with
applicable investment guidelines or
restrictions;
(iii) A fee based on a percentage of
assets under management, including,
without limitation, a fee paid
(A) Pursuant to a plan under
§ 270.12b–1;
(B) In connection with an investment
in shares of an investment company for
personal service or the maintenance of
shareholder accounts;
(C) Based on a percentage of assets
under management for any of the
following services—
(I) Providing transfer agent or subtransfer agent services for beneficial
owners of investment company shares;

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56557

(II) Aggregating and processing
purchase and redemption orders for
investment company shares;
(III) Providing beneficial owners with
account statements showing their
purchases, sales, and positions in the
investment company;
(IV) Processing dividend payments for
the investment company;
(V) Providing sub-accounting services
to the investment company for shares
held beneficially;
(VI) Forwarding communications
from the investment company to the
beneficial owners, including proxies,
shareholder reports, dividend and tax
notices, and updated prospectuses; or
(VII) Receiving, tabulating, and
transmitting proxies executed by
beneficial owners of investment
company shares;
(D) Based on the financial
performance of the assets in an account;
or
(E) For the types of services described
in paragraph (a)(4)(i)(C) or (D) of this
section if paid based on a percentage of
assets under management;
(iv) A flat or capped per order
processing fee, paid by or on behalf of
a customer or beneficiary, that is equal
to not more than the cost incurred by
the bank in connection with executing
securities transactions for trust or
fiduciary accounts; or
(v) Any combination of such fees.
(6) Trust or fiduciary account means
an account for which the bank acts in
a trustee or fiduciary capacity as defined
in section 3(a)(4)(D) of the Act (15
U.S.C. 78c(a)(4)(D)).
(7) Year means a calendar year, or
fiscal year consistently used by the bank
for recordkeeping and reporting
purposes.
(b) Revenues derived from
transactions conducted under other
exceptions or exemptions. For purposes
of calculating the yearly compensation
percentage for a trust or fiduciary
account, a bank may at its election
exclude the compensation associated
with any securities transaction
conducted in accordance with the
exceptions in section 3(a)(4)(B)(i) or
sections 3(a)(4)(B)(iii)–(xi) of the Act (15
U.S.C. 78c(a)(4)(B)(i) or 78c(a)(4)(B)(iii)–
(xi)) and the rules issued thereunder,
including any exemption related to such
exceptions jointly adopted by the
Commission and the Board, provided
that if the bank elects to exclude such
compensation, the bank must exclude
the compensation from both the
relationship compensation (if
applicable) and total compensation for
the account.
(c) Advertising restrictions—

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(1) In general. A bank complies with
the advertising restriction in section
3(a)(4)(B)(ii)(II) of the Act (15 U.S.C.
78c(a)(4)(B)(ii)(II)) if advertisements by
or on behalf of the bank do not
advertise—
(i) That the bank provides securities
brokerage services for trust or fiduciary
accounts except as part of advertising
the bank’s broader trust or fiduciary
services; and
(ii) The securities brokerage services
provided by the bank to trust or
fiduciary accounts more prominently
than the other aspects of the trust or
fiduciary services provided to such
accounts.
(2) Advertisement. For purposes of
this section, the term advertisement has
the same meaning as in § ll.760(g)(2).

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§ ll.722 Exemption allowing banks to
calculate trust and fiduciary compensation
on a bank-wide basis.

(a) General. A bank is exempt from
meeting the ‘‘chiefly compensated’’
condition in section 3(a)(4)(B)(ii)(I) of
the Act (15 U.S.C. 78c(a)(4)(B)(ii)(I)) to
the extent that it effects transactions in
securities for any account in a trustee or
fiduciary capacity within the scope of
section 3(a)(4)(D) of the Act (15 U.S.C.
78c(a)(4)(D)) if:
(1) The bank meets the other
conditions for the exception from the
definition of the term ‘‘broker’’ under
sections 3(a)(4)(B)(ii) and 3(a)(4)(C) of
the Act (15 U.S.C. 78c(a)(4)(B)(ii) and 15
U.S.C. 78c(a)(4)(C)), including the
advertising restrictions in section
3(a)(4)(B)(ii)(II) of the Act (15 U.S.C.
78c(a)(4)(B)(ii)(II) as implemented by
§ l.721(c); and
(2) The aggregate relationship-total
compensation percentage for the bank’s
trust and fiduciary business is at least
70 percent.
(b) Aggregate relationship-total
compensation percentage. For purposes
of this section, the aggregate
relationship-total compensation
percentage for a bank’s trust and
fiduciary business shall be the mean of
the bank’s yearly bank-wide
compensation percentage for the
immediately preceding year and the
bank’s yearly bank-wide compensation
percentage for the year immediately
preceding that year.
(c) Yearly bank-wide compensation
percentage. For purposes of this section,
a bank’s yearly bank-wide compensation
percentage for a year shall be
(1) Equal to the relationship
compensation attributable to the bank’s
trust and fiduciary business as a whole
during the year divided by the total
compensation attributable to the bank’s
trust and fiduciary business as a whole

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during that year, with the quotient
expressed as a percentage; and
(2) Calculated within 60 days of the
end of the year.
(d) Revenues derived from
transactions conducted under other
exceptions or exemptions. For purposes
of calculating the yearly compensation
percentage for a trust or fiduciary
account, a bank may at its election
exclude the compensation associated
with any securities transaction
conducted in accordance with the
exceptions in section 3(a)(4)(B)(i) or
sections 3(a)(4)(B)(iii)–(xi) of the Act (15
U.S.C. 78c(a)(4)(B)(i) or 78c(a)(4)(B)(iii)–
(xi)) and the rules issued thereunder,
including any exemption related to such
sections jointly adopted by the
Commission and the Board, provided
that if the bank elects to exclude such
compensation, the bank must exclude
the compensation from both the
relationship compensation (if
applicable) and total compensation of
the bank.
§ ll.723 Exemptions for special
accounts, transferred accounts, foreign
branches and a de minimis number of
accounts.

(a) Short-term accounts. A bank may,
in determining its compliance with the
chiefly compensated test in
§ ll.721(a)(1) or § ll.722(a)(2),
exclude any trust or fiduciary account
that had been open for a period of less
than 3 months during the relevant year.
(b) Accounts acquired as part of a
business combination or asset
acquisition. For purposes of
determining compliance with the
chiefly compensated test in
§ ll.721(a)(1) or § ll.722(a)(2), any
trust or fiduciary account that a bank
acquired from another person as part of
a merger, consolidation, acquisition,
purchase of assets or similar transaction
may be excluded by the bank for 12
months after the date the bank acquired
the account from the other person.
(c) Non-shell foreign branches—(1)
Exemption. For purposes of determining
compliance with the chiefly
compensated test in § ll.722(a)(2), a
bank may exclude the trust or fiduciary
accounts held at a non-shell foreign
branch of the bank if the bank has
reasonable cause to believe that trust or
fiduciary accounts of the foreign branch
held by or for the benefit of a U.S.
person as defined in 17 CFR 230.902(k)
constitute less than 10 percent of the
total number of trust or fiduciary
accounts of the foreign branch.
(2) Rules of construction. Solely for
purposes of this paragraph (c), a bank
will be deemed to have reasonable cause
to believe that a trust or fiduciary

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account of a foreign branch of the bank
is not held by or for the benefit of a U.S.
person if
(i) The principal mailing address
maintained and used by the foreign
branch for the accountholder(s) and
beneficiary(ies) of the account is not in
the United States; or
(ii) The records of the foreign branch
indicate that the accountholder(s) and
beneficiary(ies) of the account is not a
U.S. person as defined in 17 CFR
230.902(k).
(3) Non-shell foreign branch. Solely
for purposes of this paragraph (c), a nonshell foreign branch of a bank means a
branch of the bank
(i) That is located outside the United
States and provides banking services to
residents of the foreign jurisdiction in
which the branch is located; and
(ii) For which the decisions relating to
day-to-day operations and business of
the branch are made at that branch and
are not made by an office of the bank
located in the United States.
(d) Accounts transferred to a broker or
dealer or other unaffiliated entity.
Notwithstanding section 3(a)(4)(B)(ii)(I)
of the Act (15 U.S.C. 78c(a)(4)(B)(ii)(I))
and § ll.721(a)(1) of this part, a bank
operating under § ll.721(a)(1) shall
not be considered a broker for purposes
of section 3(a)(4) of the Act (15 U.S.C.
78c(a)(4)) solely because a trust or
fiduciary account does not meet the
chiefly compensated standard in
§ ll.721(a)(1) if, within 3 months of
the end of the year in which the account
fails to meet such standard, the bank
transfers the account or the securities
held by or on behalf of the account to
a broker or dealer registered under
section 15 of the Act (15 U.S.C. 78o) or
another entity that is not an affiliate of
the bank and is not required to be
registered as a broker or dealer.
(e) De minimis exclusion. A bank
may, in determining its compliance
with the chiefly compensated test in
§ ll.721(a)(1), exclude a trust or
fiduciary account if:
(1) The bank maintains records
demonstrating that the securities
transactions conducted by or on behalf
of the account were undertaken by the
bank in the exercise of its trust or
fiduciary responsibilities with respect to
the account;
(2) The total number of accounts
excluded by the bank under this
paragraph (d) does not exceed the lesser
of—
(i) 1 percent of the total number of
trust or fiduciary accounts held by the
bank, provided that if the number so
obtained is less than 1 the amount shall
be rounded up to 1; or
(ii) 500; and

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
Investment Company Act of 1940 (15
U.S.C. 80a–5(a)(1)).
(e) Sales load has the same meaning
as in section 2(a)(35) of the Investment
Company Act of 1940 (15 U.S.C. 80a–
2(a)(35)).

(3) The bank did not rely on this
paragraph (d) with respect to such
account during the immediately
preceding year.

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§ ll.740 Defined terms relating to the
sweep accounts exception from the
definition of ‘‘broker.’’

For purposes of section 3(a)(4)(B)(v) of
the Act (15 U.S.C. 78c(a)(4)(B)(v)), the
following terms shall have the meaning
provided:
(a) Deferred sales load has the same
meaning as in 17 CFR 270.6c–10.
(b) Money market fund means an
open-end company registered under the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.) that is regulated as
a money market fund pursuant to 17
CFR 270.2a–7.
(c)(1) No-load, in the context of an
investment company or the securities
issued by an investment company,
means, for securities of the class or
series in which a bank effects
transactions, that:
(i) That class or series is not subject
to a sales load or a deferred sales load;
and
(ii) Total charges against net assets of
that class or series of the investment
company’s securities for sales or sales
promotion expenses, for personal
service, or for the maintenance of
shareholder accounts do not exceed 0.25
of 1% of average net assets annually.
(2) For purposes of this definition,
charges for the following will not be
considered charges against net assets of
a class or series of an investment
company’s securities for sales or sales
promotion expenses, for personal
service, or for the maintenance of
shareholder accounts:
(i) Providing transfer agent or subtransfer agent services for beneficial
owners of investment company shares;
(ii) Aggregating and processing
purchase and redemption orders for
investment company shares;
(iii) Providing beneficial owners with
account statements showing their
purchases, sales, and positions in the
investment company;
(iv) Processing dividend payments for
the investment company;
(v) Providing sub-accounting services
to the investment company for shares
held beneficially;
(vi) Forwarding communications from
the investment company to the
beneficial owners, including proxies,
shareholder reports, dividend and tax
notices, and updated prospectuses; or
(vii) Receiving, tabulating, and
transmitting proxies executed by
beneficial owners of investment
company shares.
(d) Open-end company has the same
meaning as in section 5(a)(1) of the

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§ ll.741 Exemption for banks effecting
transactions in money market funds.

(a) A bank is exempt from the
definition of the term ‘‘broker’’ under
section 3(a)(4) of the Act (15 U.S.C.
78c(a)(4)) to the extent that it effects
transactions on behalf of a customer in
securities issued by a money market
fund, provided that:
(1) The bank either
(A) Provides the customer, directly or
indirectly, any other product or service,
the provision of which would not, in
and of itself, require the bank to register
as a broker or dealer under section 15(a)
of the Act (15 U.S.C. 78o(a)); or
(B) Effects the transactions on behalf
of another bank as part of a program for
the investment or reinvestment of
deposit funds of, or collected by, the
other bank; and
(2)(i) The class or series of securities
is no-load; or
(ii) If the class or series of securities
is not no-load
(A) The bank or, if applicable, the
other bank described in paragraph
(a)(1)(B) of this section provides the
customer, not later than at the time the
customer authorizes the securities
transactions, a prospectus for the
securities; and
(B) The bank and, if applicable, the
other bank described in paragraph
(a)(1)(B) of this section do not
characterize or refer to the class or series
of securities as no-load.
(b) Definitions. For purposes of this
section:
(1) Money market fund has the same
meaning as in § ll.740(b).
(2) No-load has the same meaning as
in § ll.740(c).
§ ll.760 Exemption from definition of
‘‘broker’’ for banks accepting orders to
effect transactions in securities from or on
behalf of custody accounts.

(a) Employee benefit plan accounts
and individual retirement accounts or
similar accounts. A bank is exempt from
the definition of the term ‘‘broker’’
under section 3(a)(4) of the Act (15
U.S.C. 78c(a)(4)) to the extent that, as
part of its customary banking activities,
the bank accepts orders to effect
transactions in securities for an
employee benefit plan account or an
individual retirement account or similar
account for which the bank acts as a
custodian if:
(1) Employee compensation
restriction and additional conditions.

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56559

The bank complies with the employee
compensation restrictions in paragraph
(c) of this section and the other
conditions in paragraph (d) of this
section;
(2) Advertisements. Advertisements
by or on behalf of the bank do not:
(i) Advertise that the bank accepts
orders for securities transactions for
employee benefit plan accounts or
individual retirement accounts or
similar accounts, except as part of
advertising the other custodial or
safekeeping services the bank provides
to these accounts; or
(ii) Advertise that such accounts are
securities brokerage accounts or that the
bank’s safekeeping and custody services
substitute for a securities brokerage
account; and
(3) Advertisements and sales
literature for individual retirement or
similar accounts. Advertisements and
sales literature issued by or on behalf of
the bank do not describe the securities
order-taking services provided by the
bank to individual retirement accounts
or similar accounts more prominently
than the other aspects of the custody or
safekeeping services provided by the
bank to these accounts.
(b) Accommodation trades for other
custodial accounts. A bank is exempt
from the definition of the term ‘‘broker’’
under section 3(a)(4) of the Act (15
U.S.C. 78c(a)(4)) to the extent that, as
part of its customary banking activities,
the bank accepts orders to effect
transactions in securities for an account
for which the bank acts as custodian
other than an employee benefit plan
account or an individual retirement
account or similar account if:
(1) Accommodation. The bank accepts
orders to effect transactions in securities
for the account only as an
accommodation to the customer;
(2) Employee compensation
restriction and additional conditions.
The bank complies with the employee
compensation restrictions in paragraph
(c) of this section and the other
conditions in paragraph (d) of this
section;
(3) Bank fees. Any fee charged or
received by the bank for effecting a
securities transaction for the account
does not vary based on:
(i) Whether the bank accepted the
order for the transaction; or
(ii) The quantity or price of the
securities to be bought or sold;
(4) Advertisements. Advertisements
by or on behalf of the bank do not state
that the bank accepts orders for
securities transactions for the account;
(5) Sales literature. Sales literature
issued by or on behalf of the bank:

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(i) Does not state that the bank accepts
orders for securities transactions for the
account except as part of describing the
other custodial or safekeeping services
the bank provides to the account; and
(ii) Does not describe the securities
order-taking services provided to the
account more prominently than the
other aspects of the custody or
safekeeping services provided by the
bank to the account; and
(6) Investment advice and
recommendations. The bank does not
provide investment advice or research
concerning securities to the account,
make recommendations to the account
concerning securities or otherwise
solicit securities transactions from the
account; provided, however, that
nothing in this paragraph (b)(6) shall
prevent a bank from:
(i) Publishing, using or disseminating
advertisements and sales literature in
accordance with paragraphs (b)(4) and
(b)(5) of this section; and
(ii) Responding to customer inquiries
regarding the bank’s safekeeping and
custody services by providing:
(A) Advertisements or sales literature
consistent with the provisions of
paragraphs (b)(4) and (b)(5) of this
section describing the safekeeping,
custody and related services that the
bank offers;
(B) A prospectus prepared by a
registered investment company, or sales
literature prepared by a registered
investment company or by the broker or
dealer that is the principal underwriter
of the registered investment company
pertaining to the registered investment
company’s products;
(C) Information based on the materials
described in paragraphs (b)(6)(ii)(A) and
(B) of this section; or
(iii) Responding to inquiries regarding
the bank’s safekeeping, custody or other
services, such as inquiries concerning
the customer’s account or the
availability of sweep or other services,
so long as the bank does not provide
investment advice or research
concerning securities to the account or
make a recommendation to the account
concerning securities.
(c) Employee compensation
restriction. A bank may accept orders
pursuant to this section for a securities
transaction for an account described in
paragraph (a) or (b) of this section only
if no bank employee receives
compensation, including a fee paid
pursuant to a plan under 17 CFR
270.12b–1, from the bank, the executing
broker or dealer, or any other person
that is based on whether a securities
transaction is executed for the account
or that is based on the quantity, price,
or identity of securities purchased or

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sold by such account, provided that
nothing in this paragraph shall prohibit
a bank employee from receiving
compensation that would not be
considered incentive compensation
under § ll.700(b)(1) as if a referral had
been made by the bank employee, or
any compensation described in
§ ll.700(b)(2).
(d) Other conditions. A bank may
accept orders for a securities transaction
for an account for which the bank acts
as a custodian under this section only
if the bank:
(1) Does not act in a trustee or
fiduciary capacity (as defined in section
3(a)(4)(D) of the Act (15 U.S.C.
78c(a)(4)(D)) with respect to the
account, other than as a directed trustee;
(2) Complies with section 3(a)(4)(C) of
the Act (15 U.S.C. 78c(a)(4)(C)) in
handling any order for a securities
transaction for the account; and
(3) Complies with section
3(a)(4)(B)(viii)(II) of the Act (15 U.S.C.
78c(a)(4)(B)(viii)(II)) regarding carrying
broker activities.
(e) Non-fiduciary administrators and
recordkeepers. A bank that acts as a
non-fiduciary and non-custodial
administrator or recordkeeper for an
employee benefit plan account for
which another bank acts as custodian
may rely on the exemption provided in
this section if:
(1) Both the custodian bank and the
administrator or recordkeeper bank
comply with paragraphs (a), (c) and (d)
of this section; and
(2) The administrator or recordkeeper
bank does not execute a cross-trade with
or for the employee benefit plan account
or net orders for securities for the
employee benefit plan account, other
than:
(i) Crossing or netting orders for
shares of open-end investment
companies not traded on an exchange,
or
(ii) Crossing orders between or netting
orders for accounts of the custodian
bank that contracted with the
administrator or recordkeeper bank for
services.
(f) Subcustodians. A bank that acts as
a subcustodian for an account for which
another bank acts as custodian may rely
on the exemptions provided in this
section if:
(1) For employee benefit plan
accounts and individual retirement
accounts or similar accounts, both the
custodian bank and the subcustodian
bank meet the requirements of
paragraphs (a), (c) and (d) of this
section;
(2) For other custodial accounts, both
the custodian bank and the
subcustodian bank meet the

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requirements of paragraphs (b), (c) and
(d) of this section; and
(3) The subcustodian bank does not
execute a cross-trade with or for the
account or net orders for securities for
the account, other than:
(i) Crossing or netting orders for
shares of open-end investment
companies not traded on an exchange,
or
(ii) Crossing orders between or netting
orders for accounts of the custodian
bank.
(g) Evasions. In considering whether a
bank meets the terms of this section,
both the form and substance of the
relevant account(s), transaction(s) and
activities (including advertising
activities) of the bank will be considered
in order to prevent evasions of the
requirements of this section.
(h) Definitions. When used in this
section:
(1) Account for which the bank acts
as a custodian means an account that is:
(i) An employee benefit plan account
for which the bank acts as a custodian;
(ii) An individual retirement account
or similar account for which the bank
acts as a custodian;
(iii) An account established by a
written agreement between the bank and
the customer that sets forth the terms
that will govern the fees payable to, and
rights and obligations of, the bank
regarding the safekeeping or custody of
securities; or
(iv) An account for which the bank
acts as a directed trustee.
(2) Advertisement means any material
that is published or used in any
electronic or other public media,
including any Web site, newspaper,
magazine or other periodical, radio,
television, telephone or tape recording,
videotape display, signs or billboards,
motion pictures, or telephone
directories (other than routine listings).
(3) Directed trustee means a trustee
that does not exercise investment
discretion with respect to the account.
(4) Employee benefit plan account
means a pension plan, retirement plan,
profit sharing plan, bonus plan, thrift
savings plan, incentive plan, or other
similar plan, including, without
limitation, an employer-sponsored plan
qualified under section 401(a) of the
Internal Revenue Code (26 U.S.C.
401(a)), a governmental or other plan
described in section 457 of the Internal
Revenue Code (26 U.S.C. 457), a taxdeferred plan described in section
403(b) of the Internal Revenue Code (26
U.S.C. 403(b)), a church plan,
governmental, multiemployer or other
plan described in section 414(d), (e) or
(f) of the Internal Revenue Code (26
U.S.C. 414(d), (e) or (f)), an incentive

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Federal Register / Vol. 72, No. 191 / Wednesday, October 3, 2007 / Rules and Regulations
stock option plan described in section
422 of the Internal Revenue Code (26
U.S.C. 422); a Voluntary Employee
Beneficiary Association Plan described
in section 501(c)(9) of the Internal
Revenue Code (26 U.S.C. 501(c)(9)), a
non-qualified deferred compensation
plan (including a rabbi or secular trust),
a supplemental or mirror plan, and a
supplemental unemployment benefit
plan.
(5) Individual retirement account or
similar account means an individual
retirement account as defined in section
408 of the Internal Revenue Code (26
U.S.C. 408), Roth IRA as defined in
section 408A of the Internal Revenue
Code (26 U.S.C. 408A), health savings
account as defined in section 223(d) of
the Internal Revenue Code (26 U.S.C.
223(d)), Archer medical savings account
as defined in section 220(d) of the
Internal Revenue Code (26 U.S.C.
220(d)), Coverdell education savings
account as defined in section 530 of the
Internal Revenue Code (26 U.S.C. 530),
or other similar account.
(6) Sales literature means any written
or electronic communication, other than
an advertisement, that is generally
distributed or made generally available
to customers of the bank or the public,
including circulars, form letters,
brochures, telemarketing scripts,
seminar texts, published articles, and
press releases concerning the bank’s
products or services.
(7) Principal underwriter has the same
meaning as in section 2(a)(29) of the
Investment Company Act of 1940 (15
U.S.C. 80a–2(a)(29)).

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§ l.771 Exemption from the definition of
‘‘broker’’ for banks effecting transactions in
securities issued pursuant to Regulation S.

(a) A bank is exempt from the
definition of the term ‘‘broker’’ under
section 3(a)(4) of the Act (15 U.S.C.
78c(a)(4)), to the extent that, as agent,
the bank:
(1) Effects a sale in compliance with
the requirements of 17 CFR 230.903 of
an eligible security to a purchaser who
is not in the United States;
(2) Effects, by or on behalf of a person
who is not a U.S. person under 17 CFR
230.902(k), a resale of an eligible
security after its initial sale with a
reasonable belief that the eligible
security was initially sold outside of the
United States within the meaning of and
in compliance with the requirements of
17 CFR 230.903 to a purchaser who is
not in the United States or a registered
broker or dealer, provided that if the
resale is made prior to the expiration of
any applicable distribution compliance
period specified in 17 CFR 230.903(b)(2)
or (b)(3), the resale is made in

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compliance with the requirements of 17
CFR 230.904; or
(3) Effects, by or on behalf of a
registered broker or dealer, a resale of an
eligible security after its initial sale with
a reasonable belief that the eligible
security was initially sold outside of the
United States within the meaning of and
in compliance with the requirements of
17 CFR 230.903 to a purchaser who is
not in the United States, provided that
if the resale is made prior to the
expiration of any applicable distribution
compliance period specified in 17 CFR
230.903(b)(2) or (b)(3), the resale is
made in compliance with the
requirements of 17 CFR 230.904.
(b) Definitions. For purposes of this
section:
(1) Distributor has the same meaning
as in 17 CFR 230.902(d).
(2) Eligible security means a security
that:
(i) Is not being sold from the
inventory of the bank or an affiliate of
the bank; and
(ii) Is not being underwritten by the
bank or an affiliate of the bank on a
firm-commitment basis, unless the bank
acquired the security from an
unaffiliated distributor that did not
purchase the security from the bank or
an affiliate of the bank.
(3) Purchaser means a person who
purchases an eligible security and who
is not a U.S. person under 17 CFR
230.902(k).
§ ll.772 Exemption from the definition
of ‘‘broker’’ for banks engaging in
securities lending transactions.

(a) A bank is exempt from the
definition of the term ‘‘broker’’ under
section 3(a)(4) of the Act (15 U.S.C.
78c(a)(4)), to the extent that, as an agent,
it engages in or effects securities lending
transactions, and any securities lending
services in connection with such
transactions, with or on behalf of a
person the bank reasonably believes to
be:
(1) A qualified investor as defined in
section 3(a)(54)(A) of the Act (15 U.S.C.
78c(a)(54)(A)); or
(2) Any employee benefit plan that
owns and invests on a discretionary
basis, not less than $ 25,000,000 in
investments.
(b) Securities lending transaction
means a transaction in which the owner
of a security lends the security
temporarily to another party pursuant to
a written securities lending agreement
under which the lender retains the
economic interests of an owner of such
securities, and has the right to terminate
the transaction and to recall the loaned
securities on terms agreed by the
parties.

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(c) Securities lending services means:
(1) Selecting and negotiating with a
borrower and executing, or directing the
execution of the loan with the borrower;
(2) Receiving, delivering, or directing
the receipt or delivery of loaned
securities;
(3) Receiving, delivering, or directing
the receipt or delivery of collateral;
(4) Providing mark-to-market,
corporate action, recordkeeping or other
services incidental to the administration
of the securities lending transaction;
(5) Investing, or directing the
investment of, cash collateral; or
(6) Indemnifying the lender of
securities with respect to various
matters.
§ ll.775 Exemption from the definition
of ‘‘broker’’ for banks effecting certain
excepted or exempted transactions in
investment company securities.

(a) A bank that meets the conditions
for an exception or exemption from the
definition of the term ‘‘broker’’ except
for the condition in section 3(a)(4)(C)(i)
of the Act (15 U.S.C. 78c(a)(4)(C)(i)), is
exempt from such condition to the
extent that it effects a transaction in a
covered security, if:
(1) Any such security is neither traded
on a national securities exchange nor
through the facilities of a national
securities association or an interdealer
quotation system;
(2) The security is distributed by a
registered broker or dealer, or the sales
charge is no more than the amount
permissible for a security sold by a
registered broker or dealer pursuant to
any applicable rules adopted pursuant
to section 22(b)(1) of the Investment
Company Act of 1940 (15 U.S.C. 80a–
22(b)(1)) by a securities association
registered under section 15A of the Act
(15 U.S.C. 78o–3); and
(3) Any such transaction is effected:
(i) Through the National Securities
Clearing Corporation; or
(ii) Directly with a transfer agent or
with an insurance company or separate
account that is excluded from the
definition of transfer agent in Section
3(a)(25) of the Act.
(b) Definitions. For purposes of this
section:
(1) Covered security means:
(i) Any security issued by an openend company, as defined by section
5(a)(1) of the Investment Company Act
(15 U.S.C. 80a5(a)(1)), that is registered
under that Act; and
(ii) Any variable insurance contract
funded by a separate account, as defined
by section 2(a)(37) of the Investment
Company Act (15 U.S.C. 80a–2(a)(37)),
that is registered under that Act.

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(2) Interdealer quotation system has
the same meaning as in 17 CFR
240.15c2–11.
(3) Insurance company has the same
meaning as in 15 U.S.C. 77b(a)(13).
§ ll.776 Exemption from the definition
of ‘‘broker’’ for banks effecting certain
excepted or exempted transactions in a
company’s securities for its employee
benefit plans.

(a) A bank that meets the conditions
for an exception or exemption from the
definition of the term ‘‘broker’’ except
for the condition in section 3(a)(4)(C)(i)
of the Act (15 U.S.C. 78c(a)(4)(C)(i)), is
exempt from such condition to the
extent that it effects a transaction in the
securities of a company directly with a
transfer agent acting for the company
that issued the security, if:
(1) No commission is charged with
respect to the transaction;
(2) The transaction is conducted by
the bank solely for the benefit of an
employee benefit plan account;
(3) Any such security is obtained
directly from:
(i) The company; or
(ii) An employee benefit plan of the
company; and
(4) Any such security is transferred
only to:
(i) The company; or
(ii) An employee benefit plan of the
company.
(b) For purposes of this section, the
term employee benefit plan account has
the same meaning as in § ll.760(h)(4).

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§ ll.780 Exemption for banks from
liability under section 29 of the Securities
Exchange Act of 1934.

(a) No contract entered into before
March 31, 2009, shall be void or
considered voidable by reason of section
29(b) of the Act (15 U.S.C. 78cc(b))
because any bank that is a party to the
contract violated the registration
requirements of section 15(a) of the Act
(15 U.S.C. 78o(a)), any other applicable
provision of the Act, or the rules and
regulations thereunder based solely on
the bank’s status as a broker when the
contract was created.
(b) No contract shall be void or
considered voidable by reason of section
29(b) of the Act (15 U.S.C. 78cc(b))
because any bank that is a party to the
contract violated the registration
requirements of section 15(a) of the Act
(15 U.S.C. 78o(a)) or the rules and
regulations thereunder based solely on
the bank’s status as a broker when the
contract was created, if:
(1) At the time the contract was
created, the bank acted in good faith and
had reasonable policies and procedures
in place to comply with section
3(a)(4)(B) of the Act (15 U.S.C.

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78c(a)(4)(B)) and the rules and
regulations thereunder; and
(2) At the time the contract was
created, any violation of the registration
requirements of section 15(a) of the Act
by the bank did not result in any
significant harm or financial loss or cost
to the person seeking to void the
contract.
§ ll.781 Exemption from the definition
of ‘‘broker’’ for banks for a limited period
of time.

A bank is exempt from the definition
of the term ‘‘broker’’ under section
3(a)(4) of the Act (15 U.S.C. 78c(a)(4))
until the first day of its first fiscal year
commencing after September 30, 2008.
By order of the Board of Governors of the
Federal Reserve System, September 24, 2007.
Jennifer J. Johnson,
Secretary of the Board.
Dated: September 24, 2007.
By the Securities and Exchange
Commission.
Nancy M. Morris,
Secretary.
[FR Doc. 07–4769 Filed 9–28–07; 8:45 am]
BILLING CODE 8011–01–P; 6210–01–P

SECURITIES AND EXCHANGE
COMMISSION
17 CFR Part 240
[Release No. 34–56502; File No. S7–23–06]
RIN 3235–AJ77

Exemptions for Banks Under Section
3(a)(5) of the Securities Exchange Act
of 1934 and Related Rules
Securities and Exchange
Commission.
ACTION: Final rule.
AGENCY:

SUMMARY: The Securities and Exchange
Commission (‘‘Commission’’) is
adopting rules and rule amendments
regarding exemptions from the
definitions of ‘‘broker’’ and ‘‘dealer’’
under the Securities Exchange Act of
1934 (‘‘Exchange Act’’) for banks’
securities activities. In particular, the
Commission is adopting a conditional
exemption that will allow banks to
effect riskless principal transactions
with non-U.S. persons pursuant to
Regulation S under the Securities Act of
1933 (‘‘Securities Act’’). The
Commission also is amending and
redesignating an existing exemption
from the definition of ‘‘dealer’’ for
banks’ securities lending activities as a
conduit lender. In addition, the
Commission is conforming a rule that
grants a limited exemption from U.S.
broker-dealer registration for foreign

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broker-dealers to the amended
definitions of ‘‘broker’’ and ‘‘dealer’’
under the Exchange Act. Finally, the
Commission is withdrawing three rules
under the Exchange Act: A rule defining
the term ‘‘bank’’ for purposes of the
Exchange Act’s definitions of ‘‘broker’’
and ‘‘dealer,’’ due to judicial
invalidation; a time-limited exemption
for banks’ securities activities, due to
the passage of time; and an exemption
from the definitions of ‘‘broker’’ and
‘‘dealer’’ for savings associations and
savings banks, as the exemption no
longer necessary in light of subsequent
legislation.
DATES: Effective Date: The final rules are
effective on November 2, 2007.
FOR FURTHER INFORMATION CONTACT:
Catherine McGuire, Chief Counsel,
Linda Stamp Sundberg, Senior Special
Counsel, Joshua Kans, Senior Special
Counsel, John Fahey, Branch Chief, or
Elizabeth K. MacDonald, Special
Counsel, at (202) 551–5550, Office of
Chief Counsel, Division of Market
Regulation, Securities and Exchange
Commission, 100 F Street, NE.,
Washington, DC 20549.
SUPPLEMENTARY INFORMATION: The
Commission is adopting new Rules 3a5–
2 [17 CFR 240.3a5–2] and 3a5–3 [17
CFR 3a5–3], amending Rule 15a–6 [17
CFR 240.15a–6], and withdrawing Rules
3b–9 [17 CFR 240.3b–9], 15a–8 [17 CFR
240.15a–8], 15a–9 [17 CFR 240.15a–9]
and 15a–11 [17 CFR 15a–11] under the
Exchange Act.
Table of Contents
I. Introduction and Background
II. Adopted Rules and Rule Amendments
A. Regulation S Transactions with NonU.S. Persons
B. Amendment to Exchange Act Rule 15a–
6
C. Securities Lending by Bank Dealers
D. Withdrawal of Exchange Act Rule 3b–
9, Rule 15a–8, and Rule 15a–9
III. Administrative Law Matters
A. Paperwork Reduction Act Analysis
B. Consideration of Benefits and Costs
C. Consideration of Burden on
Competition, and on Promotion of
Efficiency, Competition, and Capital
Formation
D. Regulatory Flexibility Certification
IV. Statutory Authority
V. Text of Final Rules and Rule Amendments

I. Introduction and Background
The rules and rule amendments
discussed below complement
Regulation R, which we are adopting
jointly with the Board of Governors of
the Federal Reserve System (‘‘Board’’).1
These rules and rule amendments in
large part reflect changes that the
1 Exchange Act Release No. 56501 (Sept. 24,
2007).

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