Regulation R: It’s Finally Here ABA’s Regulatory Compliance Conference Chicago, IL June 8-11, 2008 Sally Miller

2 Gramm-Leach-Bliley Act Background  Enacted 11/12/99  Intermediaries ability to offer a full array of products and services through functional regulation  When is a bank functioning as a broker and subject to SEC jurisdiction?

3 Regulation R Finalized on 9/24/07 Compliance date: first day of fiscal year ending after 9/30/08 Forthcoming  Record keeping rules  Examiner guidance  Resolution of Dual Employee

4 Networking Arrangements With third party or affiliated broker-dealers Statutory conditions similar to 1994 Inter-Agency Statement; e.g.  B/D services provided in an area that is clearly marked and to the extent practicable physically separate from routine deposit-taking  Advertisement and promotional material provided by b/d and comply with securities laws

5 Networking Arrangements Statutory Conditions (cont.)  Bank employees perform only clerical and ministerial but can: –Schedule appointments –Describe in general terms investment products –No incentive compensation but can receive nominal one-time cash fee of a fixed dollar amount not tied to the success of the sale

6 Referral Fees- Rule 700 Not “contingent on whether the referral results in a transaction”  Can not tie fee to: (1) purchase or sale of a security; (2) account opening (3) purchase or sale of a particular type of security or multiple securities transactions occurring.  Can tie fee to: (1) customer contacting or keeping appointment with b/d: (2) qualifications criteria (minimum assets, net worth, income, income tax rate, citizenship or residency)

7 Referral Fees Nominal one-time cash fee of a fixed $ amount Referral Fee  2x base hourly rate/ 1/1000th of the employee’s actual annual base salary  2x average min-max hourly wage for job family (defined term)  1/1000 th average min-max annual base salary for job family  $25, adjusted for inflation  No points

8 Institutional Referrals (Rule 701) Can pay larger referral fees if  HNW Customer  Institutional HNW  Individually or jointly, with spouse, has at least $5 million in net worth excluding primary residence and associated liabilities or  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 net worth standard.  Need reasonable basis to believe prior to or at time of referral

9 Institutional Investor $10 million in investments: $20 million in revenues or $15 million in revenues if the bank employee refers the customer to the broker-dealer for investment banking services Need reasonable basis to believe prior to or at time of referral

10 HNW/ Institutional Exemption Bank employee  Predominantly engaged in banking activities other than referral activities  HNW/ Institutional customer encountered in ordinary course of performing assigned duties

11 HNW/ Institutional Exemption Disclosures  Clear and conspicuous: may receive more than a nominal referral fee for making referral and payment contingent on whether referral results in a transaction  Writing or orally prior to or at time of referral  If oral, must give written within 3 business days of referral  By bank employee or by agreement broker-dealer

12 Referrals Contingent  B/D must perform suitability analysis even if b/d had not recommended transaction Non-Contingent  B/D must determine that customer has (1) ability to evaluate investment risk and make independent decisions and (2) is exercising independent judgment, or  B/D performs suitability analysis

13 Referral Fees Paid Predetermined $ amount or $ amount determined in accordance with a predetermined formula Cannot vary based on: (1) revenue or profitability of securities transactions *; (2) quantity, price or type of security; (3) number of customer referrals *Exception for investment banking services -can pay based on a fixed percent of revenues

14 Incentive Compensation Cannot pay to bank employees Defined as compensation that is intended to encourage a bank employee to refer customers to a b/d or give a bank employee an interest in the success of a securities transaction

15 Bonus Plans Overall profitability or revenue of:  Bank or BHC  Any bank affiliate (other than b-d) or operating units  B-D if –Profitability only one of multiple factors/variables used –Significant factors/variables that are not related to profitability of broker dealer

16 Bonus Plans Discretionary Multiple factors/variables  Factors/variables include significant factors/variables not related to security transactions Referral not a factor Bonus not determined by reference to others’ referrals

17 Sales of Money Market Mutual Funds (Rule 741) Can sweep into mmmf so long as  Customer also buys other banking product, e.g. deposit, credit, custody or  Provided as part of a program for the investment or reinvestment of deposit funds collected by another bank

18 Sales of Money Market Mutual Funds (Rule 741) MMMF  No-load  Load –Provides prospectus –Doesn’t describe fund as no-load  Also have statutory exemption for sweep activity

19 Dual Employee FINRA rule: Rule 3040  Transaction-by-transaction pre-approval  Regulatory access to bank books & records Anticipate resolution by 9/30/08

20 Trust & Fiduciary Exception A bank acting in a trustee or fiduciary capacity will be excepted from registration if:  Does not publicly solicit brokerage business  Directs the trades to a registered broker-dealer  Chiefly compensated through relationship compensation

21 Trust & Fiduciary Exception Applies to personal, institutional (inc. retirement), charitable and corporate trust accounts Chiefly compensated test – need to build systems to both characterize and measure compensation received on trust and fiduciary accounts.

22 Relationship Compensation Administrative Annual fees Fee based on a % of assets under management 12b-1 fees

23 Not Relationship Compensation Processing Fees Soft dollars Internal payments Credits for deposits Sale of portfolio management software

24 Trust & Fiduciary Exception Two ways of measuring:  Bank-wide basis, then relationship comp must at least make up 70% of total compensation  Account-by-account, then relationship compensation must be greater than 50% of total compensation

25 Trust & Fiduciary Exception Calculation to be performed by average preceding two year compensation ratios. Impact on compliance date:  1/1/11 for bank with fiscal year the same as calendar year.

26 International Applies to foreign branches managed from US Exception for foreign branches managed from foreign locations, may require sampling of foreign account addresses to demonstrate that number of US accounts managed from foreign branch is minimal.

27 Custody Accounts Statute protects all custodial accounts and related securities lending activities But if engaged in order taking, i.e., taking orders from trustee, investment adviser, need to look at Regulation R.

28 Order-Taking: Rule 760 Order Taking Permissible for:  Employee Benefit, IRA and Similar Accounts, so long as: –Bank employees do not receive compensation based on any securities transaction that resulted from the order; –Advertisements do not advertise bank order taking capabilities separate from other custodial services or that the bank custodial accounts are a substitute for brokerage accounts;

29 Order-Taking: Rule 760 –Advertisements and sales literature for IRAs and other similar accounts do not advertise order taking capabilities more prominently than other custodial services.

30 Order-Taking As Accommodation All Other Accounts (Accommodation Orders), so long as:  Bank employee compensation restriction same as above;  Fees charged for providing services same as if order came through broker-dealer and do not vary based on the quantity or price of the transaction. Note: can vary based on the type of security;

31 Accommodation Order Conditions Advertisements cannot state that bank accepts orders; Sales literature cannot state that bank accepts orders separate from other custodial services or describe order taking capabilities more prominently than other custodial services; Cannot provide investment advice or research or make recommendations

32 Which Exemption Should Apply? Multiple exemptions might work for a particular account Decision should be made based on compensation test, as well as systems and operational limitations

33 Which Exemption Should Apply? Directed trust accounts may not fit well within the trust and fiduciary because of the compensation structure

34 Directed Trust Carve-Out Under “other conditions,” the rule specifically allows directed trustees to use the custody exception

35 Questions?