33.1 Regulation R and bank brokerage exceptions

Why a bank brokerage exception matters

The Securities Exchange Act’s definition of broker focuses on engaging in the business of effecting securities transactions for others. Banks have statutory exceptions for certain activities, rather than a blanket exemption for every securities business. Regulation R, issued jointly by the Federal Reserve and SEC, implements important bank exceptions and related exemptions. It addresses third-party networking, trust and fiduciary activities, sweeps and safekeeping or custody, among other matters.

Start with the actual activity, the legal entity performing it and the compensation arrangement. A bank-affiliated broker-dealer is different from the bank itself. The affiliate’s registration does not authorize every bank employee to negotiate securities trades. Likewise, meeting a bank broker exception does not transform a mutual fund into an insured deposit or remove applicable antifraud, disclosure and supervisory obligations.

Networking with a registered broker-dealer

A common arrangement places a registered broker-dealer’s investment services at a bank office. The bank must meet the networking exception’s conditions, including the agreement, customer identification of the broker-dealer and limits on bank employee activities and compensation. Unregistered bank employees generally refer customers and perform permissible clerical functions; they do not independently provide the full services of a registered securities salesperson.

The ordinary referral fee must be a nominal one-time cash fee of a fixed dollar amount that is not contingent on the referral resulting in a securities transaction. Regulation R defines and permits methods of establishing nominal compensation. Do not create a universal dollar cap from a bank’s internal policy or assume that any fee called nominal qualifies. Examine the formula, employee role and transaction contingency.

Special exemptions permit higher-than-nominal or contingent referral compensation for qualifying institutional or high-net-worth customers, subject to detailed conditions. Those exceptions do not authorize retail tellers to receive ordinary sales commissions for every depositor. Before using one, confirm the customer definition, employee eligibility, agreement and disclosure or acknowledgment provisions. An examiner question about a typical retail referral ordinarily does not establish those special facts.

Trust and fiduciary activities

Banks can effect securities transactions in a trustee or other fiduciary capacity under the statutory exception when its conditions are met. The chiefly compensated test focuses on qualifying relationship compensation rather than treating the function as a brokerage sales business. Regulation R provides calculation rules and permitted alternatives, including a bank-wide approach under specified conditions. Account fees, transaction-related compensation and other receipts must be classified accurately.

A title such as “trust account” does not establish fiduciary status or the compensation test. Retain the governing instrument, authority, account purpose and revenue classification. If a business line changes its fee model to charge mainly per-trade commissions, reassess the exception before implementing the change. A review that looks only at assets under management misses the feature that can determine whether the activity fits.

Sweeps and custody

The sweep exception concerns investment of deposit funds into specified money market funds under its statutory conditions, including the relevant no-load requirement. Do not describe every automatic purchase of any security as an exempt bank sweep. Insurance coverage follows the resulting ownership and product, not the convenience of automatic transfer. Securities held after a sweep are not simply ordinary insured deposit balances.

Safekeeping and custody exceptions and exemptions address particular custodial functions and transactions. Some arrangements include employee benefit or other specified accounts; others have compensation, solicitation and operational limitations. The bank should map the actual service to the relevant exception rather than assuming that custody permits unrestricted retail brokerage solicitation.

Coordinate compliance controls

Regulation R and the interagency retail nondeposit investment guidance address related but different issues. The former helps determine whether the bank’s activity requires broker registration; the latter addresses consumer understanding, sales practices, separation and oversight. A nominal referral fee can satisfy one condition while a misleading insured-status claim creates another problem. Test both instead of checking one box marked securities compliance.

Consider a branch teller receiving a modest fixed fee for introducing a depositor to the registered broker-dealer, regardless of whether the depositor buys anything. Review the networking agreement, nominal-fee method, teller’s role and required customer information. If the bank adds a bonus when a trade closes, reassess the ordinary referral condition and determine whether a specific exemption actually applies. A marketing objective is not an exemption.

Maintain an inventory of securities activities, governing exceptions, compensation formulas, customer categories and supervising functions. Include changes in fees and vendor arrangements in regulatory change and product review. Validate records and provide training that explains which discussions unregistered employees may have.

Federal Reserve Regulation R summary identifies the exceptions and exemptions. Consult the jointly issued rule and underlying Exchange Act provisions for the precise conditions before approving a new activity.