Financial Services Reform Legislation of 1999, the Gramm-Leach-Bliley Act of 1999
Barry A. Abbott, Andre W. Brewster and Charles P. Ortmeyer of Howard, Rice, Nemerovski, Canady, Falk & Rabkin, A Professional Corporation
Title II: Functional regulation
Title II of the Act amends the federal securities laws to provide for functional regulation of bank securities activities. Subtitles A and B (affecting broker-dealers and bank investment companies) are effective 18 months after enactment of the bill, while Subtitles C and D (affecting SEC supervision of investment bank holding companies and banks and bank holding companies) are effective immediately.
6. Bank Securities Activities Not Requiring Licensure as a Broker-Dealer.
Under current law, a bank is not required to register and is not regulated as a securities “broker” or a “dealer” under the Securities Exchange Act of 1934. Subtitle A of Title II retains the exempt status only for certain activities in which banks have traditionally engaged.
Thus, a bank will not be considered a broker if it enters into a networking arrangement with a third party broker provided the broker is clearly identified, brokerage services are performed in an area that is clearly marked (and, if practical, physically separate), bank employees perform only clerical functions (other than forwarding funds and describing available investments in general terms), and compensation for referrals by bank employees is limited to a nominal fixed cash fee that is not contingent.
A bank will not be a broker while acting in a trustee or fiduciary capacity, as long as it is chiefly compensated on the basis of an administrative, asset-based, or per order processing fee at cost and it does not publicly solicit brokerage business. A bank will also not be a broker where, as transfer agent, it effects transactions in issuer securities as part of certain employee benefit plans, dividend reinvestment plans and securities purchase plans. Nor will a bank be a broker when providing safekeeping, custody, clearing, securities lending and borrowing, escrow and related administrative services, provided that it does not act as a “carrying broker” for other than government securities. While serving as a fiduciary, custodian or transfer agent, the bank must generally direct any trades to a registered broker or dealer.
Banks may, without being a broker, continue to effect transactions in commercial paper, bankers acceptances and commercial bills; in no-load mutual funds as part of a sweep account; in municipal securities; and in “identified banking products.” Identified banking products are defined as deposit accounts, bankers acceptances, letters of credit, loans, debit accounts, loan participations sold to “qualified investors” and certain other sophisticated investors, and certain swap agreements. A new definition of qualified investor is added to the Securities Exchange Act to apply to certain investment companies, banks, savings associations, brokers, dealers, insurance companies, employee benefit plans, related trusts, companies or individuals owning and investing at least $25 million ($10 million for asset-backed securities and loan participations), governments or agencies owning and investing at least $50 million, and multinational entities.
Banks may also, without being a broker, effect transactions for most bank affiliates and engage in certain private securities offerings. To engage in private offerings, a bank must not, after one year following the enactment of the bill, be affiliated with a broker or dealer and, if the bank is not affiliated with a broker or dealer, the aggregate amount of any private offering may not exceed 25% of the bank’s capital. Finally, there is a de minimis exception for banks effecting in a calendar year no more than 500 transactions that are not otherwise exempt, provided the transactions are not effected by a dual employee of a broker or dealer.
A bank will not be considered a dealer if the bank buys or sells commercial paper, bankers acceptances, commercial bills, exempted securities or identified banking products. A bank may also buy or sell securities for the bank or for fiduciary accounts for investment purposes and may sell to qualified investors asset-backed securities supported by obligations predominantly originated by the bank, a bank affiliate or a bank syndicate.
The SEC may not impose broker or dealer registration requirements with respect to any “new hybrid product” except through a rulemaking after consultation with the Federal Reserve and consideration of specified factors. Any such rulemaking is subject to judicial review upon a petition by the Federal Reserve. “New hybrid product” is defined as a product which was not previously regulated by the SEC as a security, is not an identified banking product and is not an equity swap.
Banks whose activities do not fit within the specific exceptions for brokers and dealers will be subject to registration and regulation as such by the SEC and the various self regulatory organizations supervised by the SEC, including the NASD and the stock exchanges. One consequence of such regulation will be that bank employees who engage in retail sales of securities will be required to meet the same licensing and conduct standards as employees of securities firms. The bill amends the Securities Exchange Act to require a registered securities association, such as the NASD, to create a limited qualification category for any employee who effects only private securities transactions. Bank employees who have engaged in such transactions in the six-month period preceding the enactment of the bill will be deemed qualified without testing.
7. Investment Company Activities.
Subtitle B of Title II amends provisions of the Investment Company Act of 1940 and Investment Advisers Act of 1940 that relate to bank investment company activities.
The bill amends the conflict of interest provisions of the Investment Company Act to permit the SEC, after consultation with the federal banking agencies, to prescribe conditions under which a bank (or bank affiliate) may serve as a custodian or make loans to an investment company with which it is affiliated. The bill adds to the list of interested directors of an investment company any person or affiliate (including a bank) that has loaned money to the investment company or any related investment company or investment account. The bill also removes from the list of interested directors the general category of persons affiliated with broker-dealers and replaces it with the narrower concept of persons affiliated with entities that have acted within the past six months as a broker, dealer or distributor for the investment company or any related investment company or investment account.
The bill amends the Investment Company Act to require prominent disclosure that securities of investment companies advised by or sold through a bank are not FDIC insured and to make it unlawful to imply that any investment company security has been insured by the FDIC. The definitions of broker and dealer under the Investment Company Act and Investment Advisers Act are also conformed, with certain exceptions, to the new definitions under the Securities Exchange Act.
The most significant change in Subtitle B is the removal of the exclusion from the definition of investment adviser in the Investment Advisers Act of banks and bank holding companies that advise investment companies. In the case of a bank, if the advisory services are performed through a “separately identifiable department or division,” only the department or division is deemed the investment adviser. This change means that banks and bank holding companies that advise investment companies will now be subject to registration and regulation as investment advisers under the Investment Advisers Act in the same manner as bank subsidiaries. The federal banking agencies and the SEC are required to share examination results and other information regarding the investment advisory activities of banks, bank holding companies and their departments and divisions.
The bill clarifies the exclusion from investment company treatment for bank common trust funds and conforms the related exemptions under the Securities Act of 1933 and the Securities Exchange Act. The exclusion is available only where the common trust fund is employed by the bank solely as an aid to the administration of fiduciary accounts and is not advertised or offered to the general public. The bill also adds to the list of persons barred from serving as an employee, officer, director, adviser or underwriter of an investment company any affiliated person of a bank which has been convicted or enjoined for securities activities.
8. Investment Bank Holding Companies.
Subtitle C of Title II introduces the new concept of an “investment bank holding company” under the Securities Exchange Act, which is defined as any person (other than a natural person) that owns or controls one or more brokers or dealers. Investment bank holding companies that are not affiliated with insured banks may elect to be supervised by the SEC. The SEC’s examination authority is limited to the investment bank holding company and certain material affiliates. The SEC is directed to use the examination reports of the appropriate banking or insurance regulator to the extent possible and to defer to the appropriate regulator on applicable banking and state insurance laws.
9. Loan Loss Reserves.
Subtitle D of Title II requires the SEC to consult with the appropriate federal banking agency before taking any action with respect to the manner in which an insured depository institution or holding company reports loan loss reserves in its financial statements. This provision was added because of recent friction between the SEC and the federal banking agencies over the reporting of loan loss reserves.