(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

SEC Proposes Regulation B on Bank Securities Activities

The SEC approved the issuance of proposed rules to clarify the securities-related activities in which banks, thrifts and credit unions may engage without having to register as brokers under the Exchange Act. The provisions modify the interim rules that were adopted in 2001 to implement the provisions of the Gramm-Leach-Bliley Act.

The Commission emphasized the importance of obtaining the banking industry's input on the impact of the rules on banks of all sizes, including the costs of implementing proposed Regulation B. Chairman William Donaldson explained in opening remarks that "theoretical possibilities will be of little use" when weighed against the SEC's mandate of investor protection. Accordingly, he urged banks to " run the numbers" on the proposal and share the results with the Commission.

The Gramm-Leach-Bliley Act provided 11 functional exceptions for banks from the definition of a "broker." These exceptions outline the securities activities in which a bank may engage without registering with the SEC. The SEC's proposal defines some of the terms within the 11 exceptions and includes new exemptions for certain bank activities.

The proposal would amend the 2001 interim rules relating to the third-party brokerage networking exception by clarifying the scope of activities in which unregistered bank employees may engage and by defining the nominal compensation that an unregistered employee may receive for referring bank customers to a broker-dealer. The exception permits banks to partner with broker-dealers to offer a wide range of financial services to their customers and to share the compensation.

The trust and fiduciary account exception permits a bank to receive sales compensation under certain conditions for effecting transactions for customers in its trustee or fiduciary capacity. The transactions must be effected through a trust department or another department that is regularly reviewed by bank examiners for compliance with fiduciary principles and standards. The bank must be chiefly compensated for its securities transactions in accordance with fiduciary principles and standards on the basis of relationship compensation.

The proposed amendments to the interim rules should simplify the compliance standards through definitions and targeted exceptions. For instance, the proposal expands the definition of relationship compensation to include fees generated by all types of assets. The additional exceptions would include one for small bank custody arrangements that can be used instead of the chiefly compensated comparison and the other requirements of the trust and fiduciary activities exemption.

The SEC also proposes an exemption from the chiefly compensated requirement for banks acting as trustees and in other limited capacities to permit investments in money market funds that pay 12b-1 fees. Commissioner Roel Campos inquired whether the elimination of 12b-1 fees altogether, which some have urged the SEC to consider, would solve some of the issues that arose in drafting the proposal. Annette Nazareth, the director of the Division of Market Regulation, replied that the elimination of the rule would have made the drafting much easier.

Whether a bank is chiefly compensated for securities transactions based on relationship compensation is determined by whether the relationship compensation, such as annual fees or percentage of assets under management, exceeds the sale compensation on an account-by-account basis. Banks may determine compliance in the aggregate using a 9-to-1 ratio for the relationship to sales compensation as long as the other procedural requirements are met. The SEC is proposing to revise the 9-to-1 exemption to reduce the procedural requirements and to permit its use on a line-of-business basis, on a bank-wide basis and for accounts that predate the development of an account-by-account compliance system.

The proposal would provide an exemption for previously established personal trust accounts and a conditional safe harbor to allow banks to measure their compensation in one year to determine their status for the next year. A proposed account-by-account exemption would provide more flexibility in determining whether individual accounts meet the chiefly compensated comparison.

The SEC is proposing to retain the small bank custody exemption in the interim rules but to make it available to more banks. It would also retain the general bank custody exemption with modifications. Three new exemptions would take into account banks' existing business practices. These exemptions would permit a bank to effect transactions for qualified investors, trustee and fiduciary accounts and certain agency accounts. They would permit bank trustees and non-fiduciary administrators to receive asset-based sales charges and service fees from mutual funds to offset plan administration fees, and would permit a bank, under limited conditions, to sell securities that are exempt from registration under Regulation S to non-U.S. persons who are located outside of the United States

The proposing release will be published in a forthcoming REPORT .