SEC Bank Broker/Dealer Rules Derail

By Peter E. Feltman, M.A., CCH Washington News Bureau, contributing author, CCH FOCUS and James Hamilton, J.D., LL.M., Senior Writer Analyst, CCH Federal Securities Law Reporter; Co-Author, CCH Federal Privacy Rules for Financial Institutions and Financial Services Modernization - Gramm-Leach-Bliley Act of 1999 - Law and Explanation; contributing author, CCH FOCUS.

he Securities and Exchange Commission moved on July 18, 2001, to postpone enactment of controversial bank broker/dealer rules in the face of criticism from banks, Congress and the federal banking regulators. The top republican on the Senate Banking Committee, Phil Gramm, responded to the SEC’s action by writing to Acting Chair Laura S. Unger to say “I wish to applaud the action of the Securities and Exchange Commission today....” The move was also welcomed by the House Financial Services Committee, which stated that it “helps alleviate some of our concern.”

In May 2001, the SEC issued interim final rules implementing sections 201 and 202 of the Gramm-Leach-Bliley Act of 1999, which repealed a full exception that had allowed banks to engage in securities activities without registering as a broker or dealer and replaced it with new functional exceptions. The SEC interim final rules define terms in the statutory exceptions and grant banks additional exemptions from broker-dealer registration. In response to these rules, banks commented that the SEC requirements would be too cumbersome, and bank regulators questioned the process of implementing interim final rules instead of making a proposal. Based on the adverse response, the SEC has ordered an extension of compliance and comment dates and has committed to work with the banking industry to amend the rules.

CONCERNS

In a letter to the SEC, the federal banking regulators maintained that the SEC rules are contrary to the express provisions of the Gramm-Leach-Bliley Act bank exemptions. This view was echoed by House Financial Services Committee Chairman Michael G. Oxley, who expressed both process and substantive concerns regarding the SEC’s rules. “The SEC has overstepped normal regulatory bounds here,” Oxley said. “It’s a salvo in the regulatory turf battle that violates the letter and spirit of what was carefully crafted in Gramm-Leach-Bliley.” The rules are viewed as creating a costly and ultimately unworkable regime that negates the underlying statutory exemptions and congressional intent. Even more, contended the Federal Reserve Board, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp., the approach embodied in the interim rules is “fundamentally inconsistent” with the bedrock GLB principle of functional regulation.

Specifically, the banking regulators said that implementation of the rules could drive banks out of traditional trust relationships with their customers. The rules require banks to conduct an account-by-account review and establish that the bank is chiefly compensated by specified fees for each individual trust account, an approach the banking regulators deemed “unworkable” given the multi-faceted trust services banks perform and their multi-party trust relationships. Similarly, the SEC’s treatment of the GLB exemption for bank custodial services is contrary to the Act because it excludes ordertaking activities that are part of customary bank activities. In addition, the banking regulators argued that the rules contradict GLB’s networking exemption because they create new limits on referral fees not found in the statute.

In a detailed appendix attached to the letter, federal banking regulators emphasized that it is the SEC’s significant interference with traditional bank trust and fiduciary activities that most concerns them. Gramm-Leach-Bliley provides that the trust and fiduciary exception from SEC registration is available for securities transactions that a bank effects in a trustee or fiduciary capacity. The banking agencies cited a provision from the GLB conference report indicating that Congress expects that the SEC will not disturb traditional bank trust activities

But the SEC rules fail to recognize the fundamental reality of the trust business, in the view of the regulators, and their implementation would ultimately force trust activities out of banks. Very problematic, for example, is the SEC’s assertion that there is uncertainty over whether banks acting as trustees for ERISA plans or IRAs are trustees eligible for the GLB exception. According to the banking agencies, the SEC’s position “casts a cloud” over a wide range of trust relationships that banks have historically offered their customers. The banking regulators see no ambiguity in GLB’s trustee exception and believe it encompasses all relationships in which a bank acts as a trustee under applicable law. The SEC also heard objections that it is unfair to expect banks to comply with the initial SEC rules, since banks would then have to alter their actions in response to any future amending done by the SEC.

SEC RESPONDS

In the face of such objection, the SEC responded in a July 18 order stating its intent to amend the rules, emphasizing that, as such, banks are not expected to develop compliance systems until the amendments are made. The SEC order also extended until May 12, 2002, the compliance dates for banks with respect to the interim final rules. A notice extending the comment period on the interim final rules until September 4, 2001, was simultaneously issued.

According to the SEC, the extension will provide time to explore with banks possible means of reducing compliance costs. The extension also will allow the SEC time to amend its rules while providing banks additional time to seek compliance advice regarding issues under the GLB Act and to explore forming relationships with broker-dealers if necessary.