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Staff Compliance Guide to Banks on Dealer Statutory Exceptions and RulesDivision of Trading and MarketsThis Staff Compliance Guide to Banks on Dealer Statutory Exceptions and Rules was prepared by and represents the views of the staff of the Division of Trading and Markets and does not constitute rules, regulations, or statements of the Securities and Exchange Commission ("Commission"). The Commission has neither approved nor disapproved its contents. Beginning October 1, 2003, banks that buy and sell securities need to consider whether they are "dealers" under the federal securities laws. Dealer activity is not interpreted the same way under securities law and banking law.Banks need to be aware that "dealer" activity under the federal securities laws is not necessarily the same thing as "dealer" activity under banking law. For example, so-called "riskless principal" transactions are dealer activity for securities law purposes, even though they are agency activity for banking law purposes. Similarly, repurchase agreement transactions are treated as purchases and sales of securities for securities law purposes. Generally, these transactions would also be characterized for securities law purposes as transactions in the underlying security. Although this Staff Compliance Guide highlights some of the significant provisions of the Securities Exchange Act of 1934 ("Exchange Act") and the Commission's rules, it is not comprehensive. We urge banks that need more information about particular exceptions and exemptions to consult the applicable law, including Section 3(a)(5) of the Exchange Act and the rules cited below. Banks can also obtain additional information by reading Exchange Act Release No. 56502 (September 24, 2007) (which can be found at http://www.sec.gov/rules/final/2007/34-56502.pdf), Exchange Act Release No.47364 (February 14, 2003) (which can be found at http://www.sec.gov/rules/final/34-47364.htm) and Exchange Act Release No. 44291 (May 11, 2001) (which can be found at http://www.sec.gov/rules/final/34-44291.htm). Banks that have additional questions may contact SEC staff for guidance at 202-551-5777 or at tradingandmarkets@sec.gov. Banks may also wish to consult with private counsel. What is a "dealer" under the federal securities laws?Section 3(a)(5) of the Exchange Act generally defines a "dealer" as "any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise." All transactions that go through a bank's own accounting books are potential dealer transactions. The securities laws and rules, however, distinguish "dealers" (which buy and sell securities as part of a regular business) from "traders" (which buy and sell securities for investment and not as part of a regular business). For additional information on distinguishing "dealers" from "traders," see http://www.sec.gov/rules/proposed/34-46745.htm and http://www.sec.gov/rules/final/34-47364.htm at "Dealer Activities and the Dealer/Trader Distinction." Typical dealer functions include:
If you are trying to determine whether a particular bank is acting as a dealer, you might want to consider the following questions:
A "yes" answer to any of these questions indicates that the bank may be a dealer. Special Rules for Banks and FDIC-Insured Savings AssociationsIf a bank — or an FDIC-insured savings association or savings bank (which we will refer to as "savings banks") — is engaging in dealer activity, it does not necessarily have to register as a dealer with the Commission. Rather, Section 3(a)(5) of the Exchange Act and certain Commission rules provide transaction-specific exceptions and exemptions from the definition of "dealer" for banks and savings banks. These exceptions and exemptions are outlined below. Exceptions From the Definition of "Dealer" Under Exchange Act Section 3(a)(5)The Exchange Act provides four exceptions from the definition of "dealer." While the statute only makes these exceptions available to "banks" as defined in Section 3(a)(6) of the Exchange Act, the Commission has extended the scope of these exceptions to include savings banks. The four exceptions cover permissible securities transactions, investment transactions, asset-backed transactions, and identified banking products. 1. Permissible securities transactions. This exception permits banks to buy and sell commercial paper, bankers acceptances or commercial bills, certain Canadian government obligations, Brady bonds, and "exempted securities." "Exempted securities" include government securities, municipal securities, and interests or participations in common or collective trust funds. Note: Banks that deal in municipal securities, government securities, and Canadian government obligations have other registration requirements under the Exchange Act. These requirements are discussed below in the question and answer section of this guide. 2. Investment transactions. This exception permits banks to buy and sell securities for investment purposes. It applies to transactions both for the bank itself and for its trustee and fiduciary accounts. It does not apply to transactions between the bank and its customers. This exception is analogous to the "trader" distinction discussed above. 3. Asset-backed transactions. This exception permits banks — through a grantor trust or other separate entity — to issue and sell certain asset-backed securities to "qualified investors." These securities must represent obligations predominantly (85% or more) originated by the bank, or an affiliate of the bank other than a broker-dealer. If the underlying assets are mortgage obligations or consumer-related receivables, a syndicate of banks that includes the bank issuing and selling the securities must have originated 85% or more of the obligations, and the bank issuing and selling the securities must have originated at least 10% of the value of the pool of obligations backing the securities. The term "qualified investor" is defined in Exchange Act Section 3(a)(54) to include other banks, broker-dealers, savings associations, and other parties that meet specified criteria. The exception is limited to the original placement of securities. It does not permit a bank to repurchase and re-sell securities in the secondary market. For additional information, see Exchange Act Rule 3b-18, which defines terms used in the asset-backed transaction exception. 4. Identified banking products. This exception permits banks to buy and sell certain "identified banking products," which include deposit accounts, savings accounts, certificates of deposit, other deposit instruments issued by a bank, banker's acceptances, bank issued letters of credit, bank loans, and debit accounts. "Identified banking products" also include loan participations if they are sold to "qualified investors," or to other persons who have the opportunity to review and assess any material information. In addition, "identified banking products" include (i) credit swaps and (ii) equity swaps that are sold directly to "qualified investors." (As noted above, "qualified investors" include other banks, broker-dealers, savings associations, and other parties that meet specified criteria.) Exemptions from the Definition of "Dealer"In addition to the four exceptions from the definition of "dealer" outlined above, banks and savings banks should also consider two exemptions adopted by the Commission by rule. These exemptions pertain to riskless principal transactions and securities lending transactions. 1. Riskless principal transactions. [17 CFR 240.3a5-1.] This exemption, under Exchange Act Rule 3a5-1, permits banks to engage in a limited number (up to 500) of "riskless principal" transactions per calendar year without registering with the Commission as dealers. A "riskless principal" transaction is one in which, after having received an order to buy from a customer, a bank purchases the security from another person to offset that contemporaneous sale. Alternatively, a riskless principal transaction is one in which after having received an order to sell from a customer, a bank sells the security to another person to offset that contemporaneous purchase. How to count transactions for purposes of this exemption: Transactions with two customers where the bank acts as a riskless principal between them count as one transaction. However, if a bank acts as a riskless principal between one counterparty and multiple counterparties by arranging multiple transactions, each of the transactions on the side that involves the largest number of transactions would count as separate transactions against the annual transaction-limit. How counting will be affected by banks' brokerage activities: The Exchange Act also permits banks to engage in certain "broker" activities without registering with the Commission. At the time the "dealer" provisions become effective, however, the "broker" provisions still will be subject to a Commission order delaying their effectiveness. See Regulation R, Rule 781 [12 CFR 218.781 and 17 CFR 247.781], Exchange Act Release No. 56501 (September 24, 2007) (which can be found at http://www.sec.gov/rules/final/2007/34-56501.pdf). One of the "broker" exceptions — known as the de minimis exception — permits banks to engage in no more than 500 brokerage transactions per year that are not otherwise exempt without registering with the Commission. When banks utilize this exception after the compliance date is set for the broker rules, banks' riskless principal transactions and brokerage transactions effected under the de minimis exception will count toward the same 500-transaction limit. In other words, banks may be able to engage in any combination of brokerage transactions under the de minimis exception and riskless principal transactions under Rule 3a5-1, so long as the total number of these transactions does not exceed 500 per year. Until the broker rules are effective, however, banks may use the entire 500-transaction limit for riskless principal transactions. A final note about this interim period: Banks will have additional flexibility initially, during the period when the dealer exceptions are effective but the broker rules are not. Until the broker rules become effective, banks may also choose to accommodate customers by executing securities transactions as agent for a commission, rather than assuming the role of a principal without risk. 2. Securities lending transactions. [17 CFR 240.3a5-3.] This exemption, under Rule 3a5-3, permits banks to engage in, or effect, securities lending transactions with certain counterparties. A "securities lending transaction" is a transaction in which the owner of a security lends the security temporarily to another party under a written securities lending agreement. Through this agreement, the lender retains the economic interests of an owner of the securities. Subject to any terms agreed upon by the parties, including an agreement to loan the securities for a fixed term, the lender also has the right to terminate the transaction and to recall the loaned securities. Who can be a counterparty under this exemption? The counterparty to these securities lending transactions must be either a person the bank reasonably believes is a "qualified investor," or any employee benefit plan that owns and invests on a discretionary basis, at least $25,000,000 in investments. (As noted above, "qualified investors" include other banks, broker-dealers, savings associations, and other parties that that meet specified criteria.) See Exchange Act Section 3(a)(54). In what capacities may a bank act under this exemption? A bank may act as a conduit lender, or as an agent. A bank is a "conduit lender" if, as principal for its own account, it borrows or loans securities, and contemporaneously loans or borrows the same securities. A bank that qualifies as a conduit lender at the commencement of a transaction will continue to qualify if the lending or borrowing transaction terminates so long as it is replaced within one business day by another lending or borrowing transaction involving the same securities. It will also continue to qualify if substitutions of collateral occur. Securities lending services are included within this exemption. Banks may also provide securities lending services in connection with securities lending transactions. "Securities lending services" encompass (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; and (6) indemnifying the lender of securities with respect to various matters. Who can be a counterparty under this exemption? The counterparty to these securities lending transactions must be either a person the bank reasonably believes is a "qualified investor," or any employee benefit plan that owns and invests on a discretionary basis, at least $25,000,000 in investments. (As noted above, "qualified investors" include other banks, broker-dealers, savings associations, and other parties that that meet specified criteria.) See Exchange Act Section 3(a)(54). A final note about safekeeping and custody activities: Banks also have a conditional exception under Section 3(a)(4)(B)(viii) from the Exchange Act definition of "broker" for safekeeping and custody activities. Under that exception, banks may engage in securities lending services for custody customers without meeting the requirements of this exemption. For example, the safekeeping and custody exception permits a bank to engage in securities lending transactions for custody customers that are not "qualified investors." Of course, because the custody exception is only an exception from the definition of "broker," it does not cover "dealer" transactions. 3. Regulation S transactions. [17 CFR 240.3a5-2.] This exemption, under Rule 3a5-2, permits banks to effect certain riskless principal transactions involving Regulation S securities with non-U.S. persons who are not in the U.S. Regulation S permits the sale of newly issued off-shore securities and re-sales of off-shore securities to a non-U.S. person without triggering the registration requirements of Section 5 of the Securities Act of 1933. A bank that sells a new issue eligible security in compliance with Regulation S to a non-U.S. person who is not in the U.S. will be exempt from dealer registration. A bank that purchases an eligible security from either a non-U.S. person who is not in the U.S. or from a broker-dealer and has a reasonable belief that the security was initially sold outside the U.S. in compliance with Regulation S, and resells that security to a non-U.S. person who is not in the U.S. or to a broker-dealer, will also be exempt from dealer registration.
Reminder: If your bank is doing, or may do, any of the activities of a dealer, you should find out if the bank needs to register with the SEC or stop engaging in dealer transactions. We want to underscore that similar topics may be analyzed differently under the securities laws and interpretations than under banking law and interpretations. If you are not certain, you may want to review SEC laws, rules, interpretations, consult with private counsel, or ask for Commission staff advice. * * * * * Frequently Asked QuestionsQuestion #1: May a bank holding company, subsidiary of a bank, or affiliate of a bank use the bank exceptions in the Exchange Act? Answer #1: No. The exceptions in the Exchange Act only exclude banks' securities activities from broker-dealer regulation, and then only in certain specified circumstances. Only the bank itself may claim an exception or exemption. The exceptions and exemptions are not available to a subsidiary or affiliate of a bank (unless the subsidiary or affiliate is itself a bank). Question #2: May a bank conduct securities transactions with its subsidiaries or affiliates without registering as a broker-dealer? Answer #2: Each of a bank's securities transactions with a subsidiary or affiliate of the bank must qualify for an exception or exemption. Question #3: May a bank use more than one exception or exemption? Answer #3: Yes, if the bank meets all of the conditions of any exception or exemption on which it is relying. For example, a bank may engage in securities lending transactions in accordance with Exchange Act Rule 15a-1, or if the security lent is an exempted security, in accordance with Exchange Act Section 3(a)(5)(C)(i)(II). Question #4: What can a bank do if it needs additional time to bring its activities into conformity with the bank dealer exceptions and exemptions? Answer #4: As the Commission noted in adopting the final dealer rules, individual banks may have specific transactions in progress for which they may need an extension of the implementation date of these rules. Banks in this situation should contact SEC's staff to determine if specific relief may be available to them. Each bank's situation will be considered on a case-by-case basis for specified transactions for which a demonstrated burden could be avoided or alleviated through a reasonably short extension of the compliance date, or during any period when additional specific exemption requests are being considered. Question #5: What kinds of issues will the Commission staff address by telephone? Answer #5: The Commission staff is available to discuss any legal issue under the federal securities laws. However, banks should understand that this guidance is highly informal and, while intended to be helpful to the persons making the inquiries, not binding on the Commission. A bank seeking more formal assurance with respect to particular proposed activities should submit a written request to the Office of Chief Counsel of the Division of Trading and Markets. Question #6: If my bank has a program where it sweeps deposit accounts into government securities subject to repurchase agreements, will the bank have to change or end that program when the bank "broker" and "dealer" rules go into effect? Answer #6: As explained above, repurchase agreement transactions ("repos") are treated as purchases and sales of securities for securities law purposes. Generally, these transactions would also be characterized for securities law purposes as transactions in the underlying security. Therefore, the bank would need to consider whether it is acting as a broker (that is, if the bank forwards the money to another entity which enters into the repo as principal) or as a dealer (that is, if the the bank itself enters into the repo as principal). Under the bank exception to the definition of broker, banks are permitted to effect transactions in "exempted securities." Under the bank exception to the definition of dealer, banks are permitted to buy and sell exempted securities as defined in Section 3(a)(12) of the Exchange Act. Exempted securities include government securities. Thus, a bank has an exception from the definition of broker for transactions in government securities and an exception from the definition of dealer for buying and selling government securities. Banks must also, however, comply with the requirements of the Government Securities Act of 1986 and the related regulations. An analysis of those requirements is beyond the scope of this guide. Question #7: If my bank was doing riskless principal transactions as a service to our customers when banks had a complete exemption from broker-dealer registration under the federal securities laws, how many riskless principal transactions may the bank engage in from October 1, 2003 until December 31, 2003, after the more limited exemption takes effect? Answer #7: During the period before the broker rules become effective, a bank is exempt from the definition of "dealer" for 500 riskless principal transactions during a calendar year. The blanket bank broker exemption has been extended until the first day of a bank’s fiscal year commencing after September 30, 2008. A bank that has a fiscal year based on the calendar year, for example, must comply with the bank broker exceptions and rules (Regulation R) beginning on January 1, 2009. After that date, the bank will have to combine its riskless principal transactions with the transactions in which the bank is acting as an agent for a customer under the statutory exception for de minimis transactions during each calendar year. The combined number of transactions may not exceed 500 per calendar year. [17 CFR 240.3a5-1.] Question #8: If my bank wants to act as a riskless principal to fill a securities order as a service to a customer, how does the bank count the order when the bank transacts with several broker-dealers to get best execution? Answer #8: The bank would count the order as one transaction, assuming the customer only placed one order with the bank. In other words, multiple transactions with broker-dealers to fill a single customer order would only count as one transaction for the purpose of this exemption. Moreover, if the bank routes an order to a single broker-dealer, and the broker-dealer splits the order among several of its customers, the bank would still count the transaction as one transaction. In contrast, if the bank acts as an intermediary between one customer and multiple customers by arranging multiple transactions, the bank must count each of the transactions on the side of the intermediation that involves the largest number of transactions against the annual 500-transaction limit. Question #9: What does it mean for a bank to act as a fiduciary for purposes of Exchange Act Section 3(a)(5)(C)(ii)? Answer #9: The exception for trustee and fiduciary transactions applies when the bank buys or sells securities for investment purposes for accounts for which the bank acts as a trustee or fiduciary. In giving meaning to the term "fiduciary" in Section 3(a)(5)(C)(ii), we look to the legislative history, which states that Exchange Act Section 3(a)(5) "excepts a bank from the definition of 'dealer' when it buys and sells securities for investment purposes for the bank or for accounts for which the bank acts as trustee or fiduciary. This mirrors existing law distinguishing between investors and dealers, and is limited to the portfolio trading of the bank and accounts for which it makes investment decisions." H.R. Rep. No. 106-74, pt. 3, at 170-71(1999). Question #11: What does it mean to underwrite securities? Answer #11: Confusion about what it means to be a dealer sometimes is caused by the belief that dealers only underwrite securities, although in general the determination of broker or dealer status under the Exchange Act primarily depends on the broader definitions of 'purchase' and 'sale.' See Exchange Act Section 3(a)(13) and 3(a)(14) [15 USC 78c(a)(13) and 78c(a)(14)]. As the Commission stated in footnote 21 of Exchange Act Release No 47364 (February 14, 2003): "The term 'underwriter' is defined in Section 2(a)(11) of the Securities Act of 1933 [15 USC 77b(a)(11)]. In determining whether a bank is acting as an underwriter when it undertakes particular securities activities, the Commission is not expressing any views on whether those activities would constitute 'underwriting' for purposes of Section 16 of the Glass-Steagall Act. The Commission wishes to emphasize that the determination of dealer status with respect to securities transactions, including those that do not involve a public offering, must be made by reference to the federal securities laws. It is the Commission's view, however, that the fact that an offering is exempt from registration under the Securities Act of 1933 ("Securities Act") [15 USC 77a, et seq.] does not necessarily affect the status of a participant in that offering as an 'underwriter' as defined in Securities Act Section 2(a)(11)." [68 FR 8686 at 8688, note 21.] Question #12: May a bank register itself as a broker-dealer? Answer #12: While this is possible as a theoretical matter, it may not be practical for most banks (except in the case of banks that do not make loans). As the Commission noted in Exchange Act Release No. 44291 (May 11, 2001) http://www.sec.gov/rules/final/34-44291.htm at note 266 and the sources cited therein, banks have traditionally had varying reasons for choosing to conduct securities activities through a separate entity. Question #13: Why is the definition of "dealer" for purposes of broker-dealer registration different from the analysis under the Commission's net capital rule of when a registered broker-dealer must maintain the required minimum capital as a "dealer"? Answer #13: The analysis is different because the purpose of the analysis is different. All registered broker-dealers, including any bank that registered with the Commission, are subject to the net capital rule. The net capital rule sets forth appropriate capital levels to comply with the financial responsibility requirements for a registered broker-dealer based on its business model. Exchange Act Rule 15c3-1(a)(2)(iii)(B) establishes minimum net capital requirements for broker-dealers that are designated as "dealers" because they engage in a certain level of proprietary trading. Under that rule, a "dealer" includes "any broker or dealer that effects more than ten transactions in any one calendar year for its own investment account." In contrast, determining when a person meets the initial threshold that requires registration as a broker-dealer is subject to the analysis of the factors set forth at the beginning of this special notice as well as the broker factors set forth in the Compliance Guide to the Registration and Regulation of Brokers and Dealers. Question #14: If a bank acts only as a municipal securities dealer, must it register as a broker-dealer? Answer #14: No, it has an exception from broker-dealer registration. It, or its separately identified department or division, must, however, register as a municipal securities dealer under Exchange Act Section 15B. A bank should use Form MSD to register with the Commission. The bank, or its separately identified department or division, must follow the rules governing municipal securities dealers, including the rules of the Municipal Securities Rulemaking Board ("MSRB"). Question #15: If a bank is registered as a municipal securities dealer, must it also register as a municipal securities broker? Answer #15: No, there is no separate registration for municipal securities brokers. However, if a bank has a separately identified department or division registered as a municipal securities dealer, the bank must conduct its municipal brokerage business in that separately identifiable department or division. For additional information on this subject, see MSRB Rule G-1, which defines the separately identifiable department or division of a bank. Question #16: Do a bank's transactions in municipal fund securities have to comply with Commission and MSRB rules? Answer #16: Banks must register as municipal securities dealers to deal in municipal securities that States issue to provide tax-favored vehicles for educational savings, such as 529 plans. All those banks' municipal securities activities — including municipal fund securities transactions in which the bank acts solely as an agent — must conform with MSRB rules and all Commission rules that apply to municipal securities dealers. On the other hand, if a bank does not act as a dealer in municipal securities, then the bank may engage in agency transactions involving municipal fund securities without registering with the Commission and registering with the MSRB. Question #17: If a bank acts as a dealer of U.S. government or Canadian government securities, must it register as a broker-dealer? Answer #17: No, because banks are exempted from broker-dealer registration for "permissible securities transactions." Permissible securities transactions include "exempt securities," which include government securities and Canadian securities and are defined in Exchange Act Section 3(a)(12). Banks, however, must also comply with the requirements of the Government Securities Act of 1986 [15 USC § 78o-5] as well as the legal requirements of the implementing regulations promulgated by Treasury, 17 C.F.R. Parts 400 to 450 when they effect transactions in or buy or sell government securities and Canadian securities. For hold-in-custody repurchase transactions, 17 C.F.R. § 450 also is applicable. Banks that are dealing in government securities also should review the Federal Financial Institutions Examination Council ("FFIEC") Modification of Policy Statement, 63 F.R. 6935 (February 11, 1998). Question # 18: If a bank may deal only with "qualified investors" to meet the terms of an exemption or exception, who can be its customers or counterparties? Answer #18: The term "qualified investor" is defined in Exchange Act Section 3(a)(54). [15 USC 78c(a)(54).] Qualified investors include investment companies, banks, small business investment companies, any State sponsored employee benefit plan, institutional trusts, market intermediaries, and individuals, corporations or partnerships that own and invest on a discretionary basis more than $25,000,000. How to Contact UsFor general questions regarding broker-dealer registration and regulation: Office of Interpretation and Guidance Where to Get Further InformationFor copies of SEC forms and recent SEC releases: Publications Section Other useful telephone numbers, and Web sites:
References:Exemptions for Banks Under Section 3(a)(5) of the Securities Exchange Act of 1934 and Related Rules, Exchange Act Release No. 34-56502, 72 FR 56562 (Oct. 3, 2007). Definition of Terms in and Specific Exemptions for Banks, Savings Associations, and Savings Banks Under Sections 3(a)(4) and 3(a)(5) of Exchange Act Release No. 34-47364, 68 FR 8686 (February 24, 2003). Definition of Terms in and Specific Exemptions for Banks, Savings Associations, and Savings Banks Under Sections 3(a)(4) and 3(a)(5) of Exchange Act Release No. 34-46745, 67 FR 67495 (November 5, 2002). Definition of Terms in and Specific Exemptions for Banks, Savings Associations, and Savings Banks Under Sections 3(a)(4) and 3(a)(5) of Exchange Act Release No. 34-44291, 66 FR 27760 (May 18, 2001). Division of Market Regulation: Guide to Broker-Dealer Registration, http://www.sec.gov/divisions/marketreg/bdguide.htm
http://www.sec.gov/divisions/marketreg/bankdealerguide.htm
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