Marilyn Smith Head U.S. Risk Policy & Governance BMO Financial Group/ Harris Bank Bank Broker-Dealers / What You Should Know  April

1 FIRMA 25 th Annual Risk Management Conference – April Disclaimer ANY PART OF THIS PRESENTATION OR DISCUSSION REPRESENTS VIEWS AND OPINIONS THAT ARE SOLEY MINE AND NOT OF MY COMPANY OR ANY COMPANY YOU MAY PRESUME THAT I REPRESENT. THESE VIEWS ARE SUBJECT TO CHANGE WITHOUT NOTICE.

2 FIRMA 25 th Annual Risk Management Conference – April Bank Broker-Dealers/What You Should Know  What is a Broker-Dealer – Quick Review  General standards for Broker-Dealers  General standards for Bank-Owned Broker- Dealers  Dodd-Frank Implications  Broker Dealers as Fiduciaries

3 FIRMA 25 th Annual Risk Management Conference – April Common Functions of Broker-Dealers  Order execution  Transaction clearing  Custody  Research  Recommendations  Valuations  Underwriting  Wealth Management

4 FIRMA 25 th Annual Risk Management Conference – April Types of Brokers PrincipalBuys and sells to their clients’ from own inventory AgentBuys or sells their clients market items Wholesalers/ Distributors Distributes own proprietary products to other firms (no retail clients) IntroducingDoes not hold their clients’ funds or securities ClearingReceives orders from introducing broker to execute and settle orders; holds funds and securities

5 FIRMA 25 th Annual Risk Management Conference – April Some General Standards For Broker-Dealers Customers  Retail/Individuals  Institutions Products/Services  Trade execution  Recommendations  Research  Custody  Securities Lending Compensation  Commissions  Fee-Based Registration  SEC  FINRA  MSRB, if applicable  Or States Disclosures  Form BD  Advertisements/ marketing materials Primary Regulator  SEC  FINRA, SRO

6 FIRMA 25 th Annual Risk Management Conference – April Some General Standards For Bank-Owned B-Ds Customers  Retail/Individuals  Institutions Products/Services  Trade execution  Recommendations  Research  Custody  Securities Lending Compensation  Commissions  Fee-Based Registration  SEC  FINRA  MSRB, if applicable  Or States Disclosures  Form BD  Advertisements/marketing materials Primary Regulator  SEC  FINRA, SRO

7 FIRMA 25 th Annual Risk Management Conference – April Advantages to Bank-Owned BDs Provides customers :  ‘One Stop Shopping’ for Financial Services  Retention of certain securities positions  Access other products and services  Different levels of discretion over their assets Provides the BD:  Access to less costly funding  More sales opportunity  Retention of assets

8 FIRMA 25 th Annual Risk Management Conference – April Additional Standards For Bank-Owned B-Ds Customers  Retail/Individuals  Institutions Information barriers must be maintained between and among entities Products/Services  Trade execution  Recommendations  Research  Custody  Securities Lending Services provided by/for affiliates should not receive preferential treatment; apply robust due-diligence to document arms- length handling; may need a horizontal view of rationale for differences Compensation  Commissions  Fee-Based  Referral Fees No tying Registrations  SEC  FINRA  MSRB, if applicable  Or States Dual employees-roles and responsibilities should be clear and accurate recordkeeping Avoid the danger of ‘parking’ Disclosures  Form BD  Advertisements May need to be more prominent – more explicit language on Form BD and in marketing materials to clients Primary Regulator  FINRABHC coverage by Fed and expectation of adequate oversight and due-diligence Heightened Potential Conflicts of Interest

9 FIRMA 25 th Annual Risk Management Conference – April Dodd-Frank Act, 7/21/2011 Applies to financial institutions Defines ‘financial institution”  a depository institution or depository institution holding company,  a broker-dealer registered under section 15 of the ‘34 Act  a credit union,  an investment adviser under the ’40 Act  the mortgage agencies (FNMA, FHLM), or  any other financial institution that the appropriate Federal regulators, jointly, by rule, determine should be treated as a covered financial institution for these purposes. And for purposes of defining “large” or “significant” it includes the “consolidated” holdings of a financial holding company

10 FIRMA 25 th Annual Risk Management Conference – April Dodd-Frank Act Implications for Broker-Dealers 7/21/2010  Accredited Investor  Compensation  Derivatives/Swaps  Fiduciary Standards [913]  Transactions with Affiliates

11 FIRMA 25 th Annual Risk Management Conference – April Definition of Accredited Investor [413]  Definition of Accredited Investor changes to EXCLUDE the value of the primary residence: (i) individual net worth (or joint net worth with his or her spouse) in excess of $1 million or (ii) annual income in excess of $200,000 (or joint annual income with his or her spouse in excess of $300,000) for the past two years and (iii) the reasonable expectation of meeting the same level of income in the current year.  Defines “Qualified Purchasers” for participation in certain products or transactions - private placements ( Reg D) - private equity funds - hedge funds

12 FIRMA 25 th Annual Risk Management Conference – April Compensation [956]  For publicly traded companies  Executive Compensation  Say-on-Pay  shareholder approval  clawback policies following a restatement (3 yr period)  Elimination of broker-dealer voting of proxies re exec comp  For financial institutions with assets > $1Bil Financial Institution  Prohibits ‘incentive-based’ compensation, fees, or benefits that encourages inappropriate risk or that could lead to losses  Directs Bank regulators to prohibit it,and  Allows Bank regulators to impose higher capital charges  For financial institutions > $50Bil  Deferrals of compensation of executives Policy and procedure and disclosures requirements as well

13 FIRMA 25 th Annual Risk Management Conference – April Derivatives/Swaps [Title VII]  Definition of a swap dealer and major participant  Requires registration by swap dealers and major swap participants with CFTC  Defines a major participant as anyone who is not a swap dealer and maintains substantial positions excluding hedging positions for commercial or employee benefit plan risk  Defines “significant position” as whatever the CFTC determines to be effective  Requires introducing broker to implement conflict-of-interest procedures to ensure independence between research and analysis and trading and clearing.  Establish robust procedures for day to day management  Allows CFTC to impose limits on amount of positions held of any one person

14 FIRMA 25 th Annual Risk Management Conference – April Affiliate Transaction Restrictions [Title VI] Title VI (amends 23A & 23B) Applies to Banks…  eliminates the exception for affiliated transactions in credit exposed derivatives, repos, reverse repos, securities lending and borrowing transactions, and additional categories of ‘covered’ transactions  considered to be extensions of credit  factored into the Bank’s legal lending limits  prohibits use as collateral of low-quality issues of an affiliate

15 FIRMA 25 th Annual Risk Management Conference – April Fiduciary Standard for Broker-Dealers Section 913 SEC study concluded January 2011 regarding proposal … Recommends that the Commission “promulgate a rule that the standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice”. aka “…the uniform fiduciary standard

16 FIRMA 25 th Annual Risk Management Conference – April Fiduciary “Standards” For Broker-Dealers Registered Broker-DealerRegistered Investment Adviser Suitability  Rules Based Investment Objectives  at time of a/c opening  at time of transaction  Standards Based Investment Objectives  at time of a/c opening  at time of transaction  after the fact Products/Services  IPOs  Private Placements  Hedge Funds  Penny stocks  Options  Structured Products Sophisticated Investor  Broker selection  Trade Allocation  Recommendations  Research  Wealth Management  Custody Prudent Investor Rule full range of services Compensation  Commissions  Fee-Based Products sold  AUM Advisory Fee  Performance, limited, explicit permission Must be fair & reasonable and if higher than other advisers, must disclose this Registration  SEC  FINRA  States with clients  MSRB, if applicable  SEC >15 clients and $25mil AUM*  States, where place of business,  some >6 clients Disclosures  Form BD  Advertisements  Form ADV  Reports/Materials Full Transparency including omissions * $100mil a/o 7/1/2011

17 FIRMA 25 th Annual Risk Management Conference – April Recommendations for Approaching Implementation  Make sure your business assessments/maps are up-to-date  Affiliations  Dual employees  Establish internal ‘rules’ for your business/activity/product scenarios  What can happen  How will we know when it happens  What can we do when it does happen  Document, document, document  “standards” are presumptive; remember that they will be applied after the fact

18 FIRMA 25 th Annual Risk Management Conference – April Samples  Sample Brokerage Applications with Investment Objectives  Form BD

19 FIRMA 25 th Annual Risk Management Conference – April QUESTIONS