[Federal Register Volume 67, Number 214 (Tuesday, November 5, 2002)]
[Proposed Rules]
[Pages 67496-67507]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-28097]



[[Page 67495]]

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Part III





Securities and Exchange Commission





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17 CFR Part 240



Definition of Terms in and Specific Exemptions for Banks, Savings 
Associations, and Savings Banks Under Sections 3(a)(4) and 3(a)(5) of 
the Securities Exchange Act of 1934; Proposed Rule

  Federal Register / Vol. 67, No. 214 / Tuesday, November 5, 2002 / 
Proposed Rules  

[[Page 67496]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-46745; File No. S7-41-02]
RIN 3235-AI19


Definition of Terms in and Specific Exemptions for Banks, Savings 
Associations, and Savings Banks Under Sections 3(a)(4) and 3(a)(5) of 
the Securities Exchange Act of 1934

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission is proposing to amend 
its rule granting an exemption to banks from dealer registration for 
certain de minimis riskless principal transactions, to amend certain of 
its rules that define terms used in the bank exceptions to dealer 
registration, and to grant a new exemption to banks from broker and 
dealer registration for certain securities lending under the Securities 
Exchange Act of 1934. These rules address certain of the exceptions for 
banks from the definitions of ``broker'' and ``dealer'' that were added 
to the Securities Exchange Act of 1934 by the Gramm-Leach-Bliley Act.

DATES: Comments should be submitted on or before December 5, 2002.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G. 
Katz, Secretary, Securities and Exchange Commission, 450 5th Street, 
NW., Washington, DC 20549-0609. Comments also may be submitted 
electronically at the following e-mail address: [email protected]. 
All comment letters should refer to File No. S7-41-02; this file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, comments should be 
submitted by one method only. All comments received will be available 
for public inspection and copying in the Commission's Public Reference 
Room, 450 5th Street, NW., Washington, DC 20549-0102. Electronically 
submitted comment letters will be posted on the Commission's Internet 
site (http://www.sec.gov). Personal identifying information, such as 
names or e-mail addresses will not be edited from electronic 
submissions. Submit only information you wish to make publicly 
available.

FOR FURTHER INFORMATION CONTACT: Catherine McGuire, Chief Counsel; 
Lourdes Gonzalez, Assistant Chief Counsel; or Linda Stamp Sundberg, 
Attorney Fellow; (202) 942-0073, Office of the Chief Counsel, Division 
of Market Regulation, Securities and Exchange Commission, 450 5th 
Street., NW, Washington, DC 20549-1001.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is requesting public comment on the proposed 
amendments to Rules 3a5-1 [17 CFR 240.3a5-1] and 3b-18 (17 CFR 240.3b-
18) under the Securities Exchange Act of 1934 (``Exchange Act''). The 
Commission also is requesting public comment on the proposed exemption 
from the definitions of ``broker'' and ``dealer'' for banks engaging in 
securities lending transactions pursuant to new Exchange Act Rule 15a-
11 (17 CFR 240.15a-11).

Table of Contents

I. Introduction
    A. Statutory Background--The Gramm-Leach-Bliley Act
    B. Regulatory and Procedural Background--the Interim Final 
Rules, Public Comment, and the Temporary Exemptions
II. Dealer Activities and the Dealer/Trader Distinction
    A. Buying and Selling Securities for Own Account
    B. ``Engaged in the Business'' Test
III. Discussion of Comments Received on ``Dealer'' Rules
    A. De Minimis Exception and Rule 3a5-1
    1. Discussion of Comments Received on Rule 3a5-1, the De Minimis 
Exemption
    2. Proposed Amendment to Rule 3a5-1, the De Minimis Exemption
    B. Rule 3b-18--Definition of Terms Used in Asset-Backed 
Transaction Exception to Dealer Registration
    1. Discussion of Comments Received on Rule 3b-18 `` Definition 
of Terms Used in Asset-Backed Exception to Dealer Registration
    2. Proposed Amendment to Rule 3b-18--Definition of Terms Used in 
Asset-Backed Exception to Dealer Registration
IV. Rule 15a-11--Exemption from the Definitions of ``Broker'' and 
``Dealer'' for Banks Engaging in Securities Lending Transactions
V. Definition of ``Qualified Investor''
VI. Procedural Matters
    A. General Request for Comments
    B. Paperwork Reduction Act
    C. Consideration of Benefits and Costs
    1. Benefits
    2. Costs
    D. Consideration of Burden on Competition, and on Promotion of 
Efficiency, Competition, and Capital Formation
    E. Regulatory Flexibility Act Certification

Statutory Authority

Text of Proposed Rules and Rule Amendments

I. Introduction

A. Statutory Background--The Gramm-Leach-Bliley Act

    On November 12, 1999, the President signed the Gramm-Leach-Bliley 
Act (``GLBA'') into law.\1\ The GLBA changed federal statutes governing 
the scope of permissible activities and the supervision of banks, bank 
holding companies, and their affiliates. The GLBA lowered barriers 
between the banking and securities industries erected by the Banking 
Act of 1933 (popularly known as the ``Glass-Steagall Act'')\2\ and 
between the banking and the insurance industries erected by the 1982 
amendments to the Bank Holding Company Act of 1956 (the ``Bank Holding 
Company Act'').\3\
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    \1\ Pub. L. No. 106-102, 113 Stat. 1338 (1999).
    \2\ Pub. L. No. 73-66, ch. 89, 48 Stat. 162 (1933) (as codified 
in various sections of 12 U.S.C.).
    \3\ The Garn-St. Germain Depository Institutions Act of 1982, 
Pub. L. No. 97-320, 96 Stat. 1469 (1982) (as codified in various 
sections of 12 U.S.C.), amending section 4(c)(8) of the Bank Holding 
Company Act, 12 U.S.C. 1841-1850 (1994).
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    When first enacted in 1934, the Exchange Act completely exempted 
banks from the regulatory scheme provided for brokers and dealers. Over 
the past 60 years, however, evolution of the financial markets driven 
by competition and technology eroded the separation that previously 
existed between banks, insurance companies, and securities firms. 
Regulators responded to these changes with interpretations that 
increasingly sought to accommodate these market changes.\4\ In recent 
years, the Board of Governors of the Federal Reserve System (``Federal 
Reserve''), the Office of the Comptroller of the Currency (``OCC''), 
and the Federal Deposit Insurance Corporation (``FDIC'') have permitted 
banks and bank holding companies to engage in retail and institutional 
securities brokerage and private placement activities.
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    \4\ See Mayer, Martin, ``Banking's Future Lies in its Past,'' 
The New York Times, Sec. 4, page 9, August 25, 2002.
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    The Commission supported modernizing the legal framework governing 
financial services consistent with a system of functional regulation to 
ensure that investors purchasing securities through banks received the 
same protections as when they purchased securities from registered 
broker-dealers.\5\ The GLBA codified this

[[Page 67497]]

concept of functional regulation--that is, regulation of the same 
functions, or activities, by the same expert regulator, regardless of 
the type of entity engaging in those activities. Congress believed 
that, given the expansion of the activities and affiliations in the 
financial marketplace, functional regulation was important in building 
a coherent financial regulatory scheme.\6\
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    \5\ See, e.g., letter from Arthur Levitt, Chairman, U.S. 
Securities and Exchange Commission, to Senator Phil Gramm, Chairman, 
Committee on Banking, Housing and Urban Affairs, U.S. Senate (Oct. 
14, 1999) (stating that ``the Securities and Exchange Commission has 
long supported financial modernization legislation that provides the 
protections of the securities laws to all investors.'').
    \6\ H.R. Rep. No. 106-74, pt. 3, at 113 (1999).
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    Accordingly, Title II of the GLBA amended the federal securities 
laws to provide for functional regulation of securities activities by 
eliminating the complete exception for banks from the definitions of 
``broker'' and ``dealer.'' As the legislative history noted, prior to 
the passage of the GLBA, the exception for banks from broker-dealer 
registration created a competitive disparity by permitting banks to 
engage in securities activities without being subject to the same 
regulatory requirements as broker-dealers. Indeed, Congress 
specifically expressed concern that the complete exception had 
permitted banks to engage in securities activities without being 
subject to the provisions of the federal securities laws that were 
designed to protect investors.\7\
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    \7\ Id. at 113-14.
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    The federal securities laws provide a comprehensive and coordinated 
system of regulation of securities activities under the oversight of a 
single regulator. The primary purpose of the federal securities laws is 
the protection of investors. The securities laws are also aimed at 
ensuring the maintenance of fair and orderly markets as well as fair 
competition among all participants in the securities markets. In 
contrast, the primary purpose of the federal banking laws is to protect 
the solvency of banks.\8\ Bank securities activities have historically 
taken place outside of the coordinated system of securities regulation 
that is designed to protect investors. This led to regulatory 
disparities that, in part, fostered the GLBA.\9\
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    \8\ See Board of Governors of Federal Reserve System v. 
Investment Co. Institute, 450 U.S. 46, 61, 101 S. Ct. 973, 984, 67 
L. Ed. 2d 36 (1981); 75 Cong. Rec. 9913-9914 (1932) (remarks of Sen. 
Bulkley).
    \9\ See U.S. General Accounting Office, Report to Congressional 
Requesters: Bank Mutual Sales Practices and Regulatory Issues GAO/
GGD-95-210, at p. 52 (Sept. 1995); U.S. General Accounting Office, 
Report to Congressional Requesters: Banks' Securities Activities--
Oversight Differs Depending on Activity and Regulator, GAO/GGD-95-
214, at p. 25 (Sept. 1995).
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    The GLBA is the product of many years of Congressional 
deliberation. It reflects a careful balance between providing investors 
with the same protections wherever they purchase securities, while not 
unnecessarily disturbing certain bank securities activities.
    In particular, Sections 201 and 202 of the GLBA substantially 
amended the Exchange Act's definitions of ``broker'' and ``dealer,'' 
respectively.\10\ Before amendment, Sections 3(a)(4) and 3(a)(5) of the 
Exchange Act provided that the terms ``broker'' and ``dealer'' did not 
include a ``bank.''\11\ Accordingly, banks \12\ that engaged in 
securities activities were excepted from the requirement to register as 
broker-dealers under the Exchange Act.\13\ The amended definitions 
narrowed this general exception for banks by specifying particular 
functional exceptions from broker-dealer registration for certain bank 
securities activities.
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    \10\ Exchange Act Sections 3(a)(4) and 3(a)(5) [15 U.S.C. 
78c(a)(4) and 78c(a)(5)].
    \11\ Before the GLBA, Exchange Act Section 3(a)(4) defined the 
term ``broker'' as ``any person engaged in the business of effecting 
transactions in securities for the account of others, but does not 
include a bank.'' Before the GLBA, Exchange Act Section 3(a)(5) 
defined the term ``dealer'' as ``any person engaged in the business 
of buying and selling securities for his own account, through a 
broker or otherwise, but does not include a bank * * *.''
    \12\ Exchange Act Section 3(a)(6) [15 U.S.C. 78c(a)(6)] defines 
the term ``bank'' as:
    (A) a banking institution organized under the laws of the United 
States, (B) a member bank of the Federal Reserve System, (C) any 
other banking institution, whether incorporated or not, doing 
business under the laws of any State or of the United States, a 
substantial portion of the business of which consists of receiving 
deposits or exercising fiduciary powers similar to those permitted 
to national banks under the authority of the Comptroller of the 
Currency * * * and which is supervised and examined by State or 
Federal authority having supervision over banks, and which is not 
operated for the purpose of evading the provisions of this title, 
and (D) a receiver, conservator, or other liquidating agent of any 
institution or firm included in clauses (A), (B), or (C) of this 
paragraph.
    \13\ Exchange Act Section 15(a) [15 U.S.C. 78o(a)] generally 
provides that:
    [i]t shall be unlawful for any broker or dealer which is either 
a person other than a natural person or a natural person not 
associated with a broker or dealer which is a person other than a 
natural person (other than such a broker or dealer whose business is 
exclusively intrastate and who does not make use of any facility of 
a national securities exchange) to make use of the mails or any 
means or instrumentality of interstate commerce to effect any 
transactions in, or to induce or attempt to induce the purchase or 
sale of, any security (other than an exempted security or commercial 
paper, bankers' acceptances, or commercial bills) unless such broker 
or dealer is registered in accordance with [the provisions] of this 
section.
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    The amended definitions create eleven ``broker'' and four 
``dealer'' exceptions for banks. The GLBA provided that these amended 
definitions had a delayed effective date of May 12, 2001. To 
accommodate the industry's compliance concerns, the Commission delayed 
the effective dates as more fully set forth below.

B. Regulatory and Procedural Background--the Interim Final Rules, 
Public Comment, and the Temporary Exemptions

    Because the exceptions from the definition of ``dealer'' are 
exceptions to the Exchange Act, the Commission is statutorily charged 
with interpreting these exceptions. In response to interpretive 
questions as well as industry-specific concerns, the Commission adopted 
interim final rules (``the Rules'') on May 11, 2001.\14\ The Rules were 
designed to provide guidance by defining certain key terms used in the 
new statutory exceptions. The Rules also provided additional exemptions 
from the definition of broker for banks that were engaged in certain 
types of securities activities. Although the Rules were adopted as 
interim final rules, the Commission specifically solicited public 
comment on them. Moreover, in order to give banks time to comply, the 
Rules included a temporary exemption that effectively extended the 
general exception from broker-dealer registration until October 1, 
2001.\15\
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    \14\ Definition of Terms in and Specific Exemptions for Banks, 
Savings Associations, and Savings Banks Under Sections 3(a)(4) and 
3(a)(5) of the Securities Exchange Act of 1934, Release No. 34-
44291, 66 FR 27760 (May 18, 2001).
    \15\ 17 CFR 240.15a-7.
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    The Commission received over 200 letters commenting on the Rules. 
The vast majority of these letters came from banks or persons 
representing banks and the banking industry. Of those letters, 33 
described concerns about the process of adopting the Rules, with most 
of those expressing concern about the lack of a comment period before 
adoption. Of those 33 letters, thirteen were from trade

[[Page 67498]]

groups,\16\ thirteen were from banks,\17\ two were from eight 
Congressmen,\18\ two were from mutual fund companies,\19\ one was from 
a Senator,\20\ one was from a law firm,\21\ and one was from three 
Federal banking agencies.\22\
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    \16\ See letter dated June 4, 2001 from James D. McLaughlin, 
Director, Regulatory and Trust Affairs, American Bankers Association 
and Beth L. Climo, Executive Director, ABA Securities Association; 
letter dated July 17, 2001 from Edward L. Yingling, Deputy Executive 
Vice President and Executive Director, American Bankers Association, 
and Beth L. Climo, Executive Director, ABA Securities Association; 
letter dated July 17, 2001 from John Duncan, American Bar 
Association Banking Law Committee of the Business Law Section; 
letter dated July 16, 2001 from Roger D. Wiegley, Chair, Committee 
on Banking Law, The Association of The Bar of the City of New York; 
letter dated July 17, 2001 from Charlotte M. Bahin, Director of 
Regulatory Affairs, Senior Regulatory Counsel, America's Community 
Bankers; letter dated July 17, 2001 from Robert M. Kurucza, General 
Counsel, Bank Securities Association (``the BSA letter''); letter 
dated July 17, 2001 from Neil Milner, President and CEO, the 
Conference of State Bank Supervisors; letter dated July 17, 2001 
from Gerald M. Noonan, President, the Connecticut Bankers 
Association; letter dated July 17, 2001 from Richard M. Whiting, 
Executive Director, Financial Services Roundtable; letter dated July 
17, 2001 from Robert I. Gulledge, Chairman, Independent Community 
Bankers of America (``the ICBA letter''); letter dated July 17, 2001 
from Lawrence R. Uhlick, Executive Director and General Counsel, 
Institute of International Bankers; letter dated August 1, 2001 from 
Jeffrey P. Neubert, President and Chief Executive Officer, New York 
Clearing House (``the NYCH letter''); and letter dated July 17, 2001 
from A. Michelle Roberts, Executive Director, The Trust Financial 
Services Division of the Texas Bankers Association.
    \17\ See letter dated July 16, 2001 from Alan R. Leach, 
President, BancorpSouth Investment Services, Inc.; letter dated July 
16, 2001 from John M. Kramer, Deputy General Counsel, Bank One 
Corporation; letter dated September 10, 2001 from David P. Johnson, 
Investment Advisor, Bank Midwest; letter dated September 4, 2001 
from Warren R. Jamieson, Chairman, Bonham State Bank; letter dated 
July 17, 2001 from Jeffrey S. Missman, Vice President, Director--
Regulatory Compliance, Commerce Bancshares, Inc.; letter dated July 
10, 2001 from William Nappi, CTCP, Trust Compliance Officer, 
FirstMerit Corp., N.A.; letter dated July 16, 2001 from William C. 
Mutterperl, Executive Vice President, General Counsel and Secretary, 
FleetBoston Financial Corporation; letter dated July 17, 2001 from 
Maureen W. Sullivan, Associate General Counsel, Manufacturers and 
Traders Trust Company; letter dated July 16, 2001 from David A. 
Daberko, Chairman and Chief Executive Officer, National City 
Corporation; letter dated July 17, 2001 from James S. Keller, Chief 
Regulatory Counsel, PNC Financial Services Group (PNC); letter dated 
July 17, 2001 from Norimichi Kanari, President and CEO, Union Bank 
of California; letter dated July 16, 2001 from W. David Hemingway, 
Chief Financial Officer Zions Bancorporation; and letter dated July 
16, 2001 from A. Scott Anderson, President and Chief Executive 
Officer, Zions Bank Capital Markets, Zions First National.
    \18\ See letter dated July 19, 2001 from Representative Michael 
G. Oxley, Chairman, Committee on Financial Services, Representative 
Richard H. Baker, Chairman Subcommittee on Capital Markets, 
Insurance, and Government Sponsored Enterprises, Representative 
Spencer Bachus, Chairman, Subcommittee on Financial Institutions and 
Consumer Credit, Marge Roukema, Chairwoman, Subcommittee on Housing 
and Community Opportunity, Sue W. Kelly, Chairwoman, Subcommittee on 
Oversight and Investigations, Peter T. King, Chairman, Subcommittee 
on Domestic Monetary Policy, Technology, and Economic Growth, Doug 
Bereuter, Chairman, Subcommittee on International Monetary Policy 
and Trade, U.S. House of Representatives; and letter dated July 20, 
2001 from Representative John J. LaFalce, Ranking Member, Committee 
on Financial Services, U.S. House of Representatives.
    \19\ See letter dated July 2, 2001 from Melanie L. Fein, 
Attorney at Law, on behalf of Federated Investors, Inc.; letter 
dated July 17, 2001 from Stewart P. Greene, Chief Counsel, 
Securities Law, Teachers Insurance and Annuity-College Retirement 
Equities Fund.
    \20\ See letter dated July 18, 2001 from Senator Phil Gramm, 
Ranking Member, Committee on Banking, Housing and Urban Affairs, 
United States Senate.
    \21\ See letter dated July 17, 2001 from Satish M. Kini of 
Wilmer, Cutler & Pickering.
    \22\ See letter dated June 29, 2001 from Alan Greenspan, 
Chairman, Board of Governors of the Federal Reserve System, Donna 
Tanoue, Chairman, Federal Deposit Insurance Corporation, and John D. 
Hawke, Comptroller of the Currency (collectively, ``the banking 
agencies'' and ``the Banking Agencies' letter'').
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    Commenters offered various reasons for their concern about adopting 
the Rules before considering public comment. Some of the Congressmen 
expressed concern that this process may have caused confusion and 
created a dilemma for banks. The banking agencies stated that there 
would be significant practical operational implications of potential 
approaches to implementing the statutory exceptions and they 
specifically urged that resolution of those issues could be greatly 
aided by an open process of public comment on a proposal. One trade 
group questioned whether the Commission had satisfied section 553 of 
the Administrative Procedure Act by publishing the Rules without prior 
notice and comment.\23\
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    \23\ The BSA letter.
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    Separate from the issue of public comment, the banking agencies, as 
well as some trade groups and individual banks, stated that the 
immediate effective date, coupled with exemptions that function only to 
suspend temporarily the Rules' effectiveness, placed banks in an 
untenable position. The banking agencies strongly urged the Commission 
to extend the effective date of these GLBA provisions (until after 
considering public comment and adopting final rules) and to provide 
banks with at least a one-year transition period after the revised 
rules become final.
    In response to concerns that banks needed more time, and in 
recognition of the likelihood that the Rules would be amended in light 
of the continuing dialogue between the Commission and industry 
participants, we extended the effective date of the Rules on July 18, 
2001.\24\ At the same time, we extended the temporary exemption from 
the definitions of ``broker'' and ``dealer'' provided in Exchange Act 
Rule 15a-7. On May 8, 2002, we further extended the temporary exemption 
from the definition of ``dealer'' to November 12, 2002.\25\ By separate 
order issued in conjunction with this release, we are further extending 
that temporary exemption to February 10, 2003.
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    \24\ Release No. 34-44570.
    \25\ Release No. 34-45897. At the same time, we further extended 
the temporary exemption from the definition of broker until May 12, 
2003.
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II. Dealer Activities and the Dealer/Trader Distinction

    Exchange Act section 3(a)(5) defines a ``dealer'' generally as a 
person that is ``engaged in the business of buying and selling 
securities'' for its own account through a broker or otherwise, but 
excepts persons, whether bank or non-bank, who do not buy or sell 
securities ``as part of a regular business.''\26\ Undertaking the 
analysis of whether a bank's securities activities come within the 
definition of dealer under the federal securities laws is something 
that banks did not have to consider before the passage of the GLBA. 
Banks, however, can take advantage of several additional exceptions or 
exemptions from the ``dealer'' definition, as discussed below. If a 
bank's securities-related activities fall under the general definition 
of ``dealer,'' the bank must register as a broker-dealer unless that 
bank can meet the terms of an exception or exemption from the dealer 
definition.
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    \26\ Exchange Act Section 3(a)(5) [15 U.S.C. 78c(a)(5)].
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    The question of whether a bank acts as a ``dealer'' that must 
register with the Commission therefore turns upon a two-stage analysis. 
The first stage focuses on two factual questions: (1) Whether the bank 
is ``buying and selling securities'' for its own account; and (2) 
whether the bank is ``engaged in the business'' of that activity ``as 
part of a regular business.'' A bank would not be a dealer unless both 
of those factual tests are met. The second stage of the analysis 
focuses on whether the bank can take advantage of bank-specific 
exceptions or exemptions from the definition of dealer. If all of the 
bank's securities activities fall within one or more of those bank-
specific exceptions or exemptions, the bank does not have to register 
as a broker-dealer.
    As a result, a bank has flexibility in the way that it analyzes 
whether its securities activities would require it to register with the 
Commission as a dealer. A bank may opt first to consider whether its 
proprietary securities purchases and sales cause it to be ``engaged in 
the business'' of buying and

[[Page 67499]]

selling securities for its own account ``as part of a regular 
business.'' If the bank meets that part of the test, the bank then 
would have to consider whether those securities activities fall within 
one of the bank-specific exceptions or exemptions from the dealer 
definition in Exchange Act section 3(a)(5). Alternatively, a bank may 
simply analyze whether its proprietary securities purchases and sales 
fall within an exception or exemption from section 3(a)(5). If all of 
the bank's securities activities fall within one or more exception or 
exemption from the dealer definition, then the bank could avoid having 
to determine separately whether it satisfies the ``engaged in the 
business'' component of the definition.
    As exemplified by the discussion of riskless principal transactions 
below, the question of whether a bank acts as a dealer under the 
securities laws is entirely separate from the question of whether it 
acts as a dealer under the banking laws, and it is possible for a bank 
to be a ``dealer'' under the securities laws but not under the banking 
laws. Banks therefore should look to the securities laws and the 
Commission's rules and interpretations in conducting the analysis under 
the Exchange Act. A bank also should continue to determine whether any 
proposed securities activity is permitted under banking law, and should 
consult its appropriate Federal banking agency to assist it in that 
analysis.
    In addition, the bank-specific exceptions and exemptions from the 
definition of ``dealer'' for specific products or transactions are 
independent of the question of whether a person would satisfy the 
general definition of ``dealer'' in the first instance.\27\
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    \27\ The SEC's analysis of what constitutes ``dealer'' activity 
has not changed for persons that are not banks just because banks 
have exceptions and exemptions for specific securities activities 
and products. These exceptions and exemptions provide banks with 
legal certainty for their securities business.
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A. Buying and Selling Securities for Own Account

    The phrase ``buying and selling securities for such person's own 
account'' means purchasing or selling securities as principal, which 
includes so-called ``riskless principal'' transactions. Under the 
securities laws, ``riskless principal'' transactions are dealer 
activity.\28\ Entities that engage in these transactions as a matter of 
course would be involved in the business of buying and selling 
securities for their own accounts, even if the risk associated with the 
transactions is minimal or non-existent.\29\ Although the OCC and the 
Federal Reserve interpret ``riskless'' principal activity as equivalent 
to agency activity under the banking laws,\30\ ``riskless'' principal 
activity requires registration under the securities laws unless an 
exception or exemption applies.
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    \28\ ``Riskless principal'' transactions are generally described 
as trades in which, after receiving an order to buy (or sell) from a 
customer, the broker-dealer purchases (or sells) the security from 
(or to) another person in a contemporaneous offsetting transaction. 
See Exchange Act Rule 10b-10(a)(2)(ii)(A) [17 CFR 240. 10b-
10(a)(2)(ii)(A)]; Rel. No. 34-33743 (Mar. 9, 1994) at n.11.
    \29\ See Exchange Act Section 3(a)(5). The Commission has noted 
that ``riskless'' principal transactions are in many respects 
equivalent to transactions effected on an agency basis. See 
Securities Confirmations, Rel. No. 34-15219 (Oct. 6, 1978), 43 FR 
47495 (Oct. 6, 1978).
    \30\ The OCC stated that, ``riskless principal activities are 
the legal and economic equivalent of permissible brokerage 
activities inasmuch as riskless principal brokerage is conducted in 
a manner consistent with the express terms of section 16,'' of the 
Glass-Steagall Act. See OCC Interpretive Letter No. 371 (June 13, 
1986). See also 1989 FRB 829 (October 30, 1989) and 1996 FRB 748 
(June 13, 1996).
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B. ``Engaged in the Business'' Test

    As noted above, a person that is buying securities for its own 
account may still not be a ``dealer'' because it is not ``engaged in 
the business'' of buying and selling securities for its own account as 
part of a regular business. This exclusion is often referred to as the 
dealer/trader distinction. A ``trader'' does not have to register as a 
broker-dealer.
    As developed over the years, the dealer/trader distinction 
recognizes that dealers normally have a regular clientele, hold 
themselves out as buying or selling securities at a regular place of 
business, have a regular turnover of business (or participate in the 
distribution of new issues), and generally transact a substantial 
portion of their business with investors (or, in the case of dealers 
who are market makers, principally trade with other professionals).\31\ 
In contrast, traders have a less regular volume, do not handle others' 
money or securities, do not make a market, and do not furnish dealer-
type services such as rendering investment advice, extending or 
arranging for credit, or lending securities.\32\
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    \31\ See, e.g., Rel. No. 34-11742 (October 5, 1975) (noting that 
a bank might be subject to registration as a municipal securities 
dealer if it engaged in underwriting, maintain a trading account or 
carried a dealer inventory, advertised itself as a dealer or 
otherwise held itself out as a dealer).
    \32\ See generally L. Loss & J. Seligman, Securities Regulation, 
Sec. Sec.  8-A-2 and 8-A-3 nn.115 and 143 (3d ed. 2001).
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    A person generally may satisfy the definition, and therefore, be 
acting as a dealer in the securities markets by conducting various 
activities: (1) Underwriting; (2) acting as a market maker or 
specialist on an organized exchange or trading system; (3) acting as a 
de facto market maker whereby market professionals or the public look 
to the firm for liquidity; or (4) buying and selling directly to 
securities customers together with conducting any of an assortment of 
professional market activities such as providing investment advice, 
extending credit and lending securities in connection with transactions 
in securities, and carrying a securities account. These principles 
demonstrate that the analysis of whether a person meets the definition 
of a dealer depends upon all of the relevant facts and circumstances.
    A person must evaluate the totality of its securities activities to 
determine if those activities may constitute engaging in dealer 
activities for which there is no exception or exemption from the dealer 
registration requirements. By analogy when analyzing whether a security 
exists, some courts have used an analysis that turns on the ``economic 
realities'' underlying a transaction and not the name appended to the 
transaction.\33\
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    \33\ See United Housing Foundation, Inc. v. Forman, 421 U.S. 
837, 849, rehearing denied, 423 U.S. 884 (1975).
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    The GLBA bank ``dealer'' exceptions are outlined briefly below.\34\
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    \34\ This outline is a summary. It does not describe the 
exceptions in full.
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    [sbull] Investment transactions: permits banks to buy and sell 
securities for investment purposes for the bank and for its customers' 
trustee and fiduciary accounts.
    [sbull] Permissible securities transactions: permits banks to buy 
and sell exempted securities, certain Canadian government obligations, 
and Brady bonds.
    [sbull] Identified banking products: permits banks to buy and sell 
certain ``identified banking products,'' as defined in Section 206 of 
the GLBA.
    [sbull] Asset-backed transactions: permits banks through a grantor 
trust or other separate entity to issue and sell to qualified investors 
certain asset-backed securities representing obligations predominantly 
originated by a bank, an affiliate of the bank other than a broker-
dealer, or a syndicate in which the bank is a member for some types of 
products.
    With respect to the ``dealer'' exceptions, the Rules defined terms 
found in the asset-backed transactions exception and provided an 
exemption for a de minimis number of riskless principal transactions.
    In general, the bank dealer exceptions apply to specified products 
and contain

[[Page 67500]]

certain limiting conditions. For example, some of the bank dealer 
exceptions permit a bank to buy and sell securities, but the asset-
backed transactions exception only permits a bank to issue and sell 
securities through a grantor trust or other separate entity to 
qualified investors. The investment transactions exception only permits 
the bank to buy or sell securities ``for investment purposes'' for its 
own account or for the accounts for which it acts as a trustee or 
fiduciary.
    As a bank considers its securities activities, the bank must 
evaluate the totality of its securities activities to determine if 
those activities are permissible under banking law, meet the definition 
of dealer (or broker) activities under the securities laws, and are 
excepted or exempted from the dealer registration requirements under 
the Exchange Act.\35\
---------------------------------------------------------------------------

    \35\ A bank that contemplates a new securities activity may also 
seek an exemption or no-action relief from the Commission. Exchange 
Act Section 36 [15 U.S.C. 78mm] authorizes us to exempt any person, 
security, or transaction from the provisions of the Exchange Act, to 
the extent that such exemption is necessary or appropriate in the 
public interest, and consistent with the protection of investors. We 
authorized the Director of the Division of Market Regulation to 
consider, on a case-by-case basis, individual requests for exemptive 
relief from banks, savings associations, and savings banks. Exchange 
Act Rule 30-3 [17 CFR 200.30-3(a)(72)].
    In appropriate circumstances, the staff also may provide 
guidance in the form of no-action letters. See Release No. 33-5127 
(January 25, 1971). See also Release No. 33-6279 (December 5, 1980).
---------------------------------------------------------------------------

III. Discussion of Comments Received on ``Dealer'' Rules

    As outlined above, the GLBA provides four exceptions to banks from 
the definition of ``dealer.'' Each of these exceptions permits a bank 
to act as a dealer with respect to the specified securities products if 
the bank complies with the enumerated statutory conditions. Only six 
comment letters addressed either the dealer statutory exceptions or the 
dealer exemption.\36\
---------------------------------------------------------------------------

    \36\ See the ICBA letter, the NYCH letter, the Banking Agencies' 
letter, letter dated July 17, 2001 from Rick D. Burtenshaw, Senior 
Vice President, Investment Division, Zions First National Bank 
(``the Zions letter''). In addition, a letter dated October 16, 2002 
from Elizabeth Shea Fries of Goodwin Proctor on behalf the Risk 
Management Association (``the RMA letter'') addresses the need for 
an exemption for activities related to securities lending. Moreover, 
a letter to Annette Nazareth, Director, Division of Market 
Regulation, dated October 9, 2002, from Edward J. Rosen, Cleary, 
Gottlieb, Steen & Hamilton, on behalf of a coalition of banks 
actively involved in securities lending (``Coalition of Banks 
letter'') suggests that the definition of ``qualified investor'' be 
clarified to cover all entities with at least $25 million in 
investments that are not otherwise covered under the statutory 
definition in connection with the securities lending exemption.
---------------------------------------------------------------------------

    In particular, the Risk Management Association (``RMA'') addressed 
the need for interpretive relief or an exemption for noncustodial 
securities lending. A letter from a coalition of banks also addressed 
the need for clarification that would provide legal certainty for banks 
engaging in securities lending with entities that might not strictly 
meet the statutory definition of qualified investor in Exchange Act 
section 3(a)(54).
    The Banking Agencies' and the NYCH addressed the definitions 
interpreting the statutory dealer exception for asset-backed 
activities. The remaining two commenters addressed the asset-backed 
exception and the de minimis exception. To more fully understand the 
concerns leading to these comments, the staff held meetings in person 
and by telephone with interested parties.

A. De Minimis Exception and Rule 3a5-1

    Exchange Act section 3(a)(4)(B)(xi)\37\ excepts a bank from the 
definition of broker, if the bank effects no more than 500 securities 
transactions per calendar year, other than transactions that qualify 
for one of the other statutory exceptions. A transaction in which a 
bank is acting as an agent for a customer would count as one 
transaction toward the 500-transaction limit. The GLBA provisions did 
not extend this de minimis exception to dealer transactions.
---------------------------------------------------------------------------

    \37\ 15 U.S.C. 78c(a)(4)(B)(xi).
---------------------------------------------------------------------------

    Questions arose as to whether banks can rely on the de minimis 
exception from the definition of broker when they engage in riskless 
principal transactions.\38\ The Commission addressed this issue in the 
Rules by providing an exemption that permits riskless principal 
transactions as well as agency transactions to be counted under the 
500-transaction limit. The Rules provide that a transaction in which 
the dealer bank is acting as a riskless principal intermediary between 
two non-broker-dealer customers counts as two trades (one with each 
customer) under the 500-transaction limit.
---------------------------------------------------------------------------

    \38\ See description of riskless principal transactions under 
the securities laws at notes 28 to 30, supra.
---------------------------------------------------------------------------

1. Discussion of Comments Received on Rule 3a5-1, the De Minimis 
Exemption
    Two commenters addressed this exemption. Both commenters criticized 
the Rules for counting as two transactions something that they 
characterize as essentially being a single transaction.
2. Proposed Amendment to Rule 3a5-1, the De Minimis Exemption
    As we explained in adopting the Rules, riskless principal 
transactions are ``dealer'' transactions under the securities laws. The 
GLBA did not provide an exception for dealer transactions, except for 
limited types of securities. Indeed, the GLBA did not provide any 
exception from the definition of dealer that would allow banks to 
continue to engage in riskless principal transactions. By allowing 
banks to use the de minimis transaction exception found in the broker 
exceptions for riskless principal transactions, the Commission was 
attempting to give banks more--not less--flexibility than provided 
under the literal terms of the GLBA. In other words, this exemption 
permits banks to continue to engage in a limited number of these 
transactions without having to register as a dealer.
    We continue to believe that a de minimis exemption for a limited 
number of riskless principal transactions is appropriate. We believe 
that one reason that the GLBA may not have extended the de minimis 
exception to riskless principal transactions is the difference in the 
way riskless principal transactions are viewed under banking law as 
compared to the securities laws. In banking law, riskless principal 
transactions are considered agency activity because the principal does 
not assume principal risk.\39\ Under the securities laws, however, 
riskless principal activity is conducted by a dealer, acting as 
principal, attempting to eliminate his principal risk. Because the 
exception is in the Exchange Act, the interpretation under the 
securities laws is controlling.
---------------------------------------------------------------------------

    \39\ See Bankers Trust New York Corporation, 75 Fed. Res. Bull. 
829 (1989); Bank of New York Company, Inc. (Order dated June 10, 
1996); and OCC Interp. Ltr. No. 626, reprinted in [1993-1994 
Transfer Binder] Fed. Banking L. Rep. (CCH) ] (July 7, 1993).
---------------------------------------------------------------------------

    The Commission addressed this distinction in the Rules by providing 
that riskless principal transactions as well as agency transactions can 
be counted under the limit of 500 securities transactions per calendar 
year. Exchange Act Rule 3a5-1 counted a transaction in which the dealer 
bank is acting as a riskless principal intermediary between two non-
broker-dealer customers as two trades under the 500-transaction limit.
    In response to the two comments on this issue that expressed the 
view that counting a riskless principal transaction as two trades in 
certain circumstances may be needlessly restrictive, we

[[Page 67501]]

propose amending the counting of the number of riskless principal 
transactions. Under the proposed amendment to Rule 3a5-1, a riskless 
principal transaction, even if it involves two separate counterparties, 
would count as only one transaction against the annual 500-transaction 
limit.\40\ We believe that this change will simplify the rule and make 
it easier for banks to understand and apply its terms to a small annual 
number of riskless principal securities transactions.
---------------------------------------------------------------------------

    \40\ If, however, a bank offsets the risk in a transaction with 
one counterparty by arranging multiple transactions with other 
counterparties, the bank must count each of the transactions on the 
side of the transaction that involves the largest number of 
transactions as a separate transaction against the annual 500 
transaction-limit.
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    We request comment on this proposed amendment to Exchange Act Rule 
3a5-1 and whether this is an appropriate way to count transactions 
under this exemption.

B. Rule 3b-18--Definition of Terms Used in Asset-Backed Transaction 
Exception to Dealer Registration

    The GLBA exception to the definition of dealer for banks engaging 
in certain asset-backed issuance and sale transactions provides that a 
bank may engage in the issuance or sale to qualified investors, through 
a grantor trust or other separate entity, of securities backed by or 
representing an interest in notes, drafts, acceptances, loans, leases, 
receivables, other obligations (other than securities of which the bank 
is not the issuer), or pools of any of these obligations predominantly 
originated by the bank, an affiliate of the bank other than a broker-
dealer, or a syndicate in which the bank is a member.\41\ As we 
explained when we adopted the Rules, this statutory exception allows 
banks to issue and sell asset-backed securities through a grantor trust 
or other separate entity. It does not, however, allow banks to deal in 
asset-backed securities. In other words, this exception is not broad 
enough to permit banks to regularly purchase and sell these securities 
in the secondary market.\42\
---------------------------------------------------------------------------

    \41\ Exchange Act section 3(a)(5)(C)(iii) [15 U.S.C. 
78c(a)(5)(C)(iii)].
    \42\ 66 FR 27760 at 27785 (May 18, 2001).
---------------------------------------------------------------------------

    Exchange Act Rule 3b-18 defined terms used in the asset-backed 
transactions exception to clarify the parameters of this exception. In 
particular, Rule 3b-18 defined the terms: ``affiliate,'' ``consumer-
related receivable,'' ``member of a syndicate of banks,'' 
``obligation,'' ``originated,'' ``pool,'' ``predominantly originated,'' 
and ``syndicate of banks.''
1. Discussion of Comments Received on Rule 3b-18--Definition of Terms 
Used in Asset-Backed Exception to Dealer Registration
    Four commenters addressed these definitions.\43\ All four 
commenters focused primarily on the definition of ``predominantly 
originated.'' One commenter also addressed the requirement that a 
member of a syndicate originate more than 10% of the value of a pool of 
obligations.\44\
---------------------------------------------------------------------------

    \43\ See note 36, supra.
    \44\ See the NYCH letter.
---------------------------------------------------------------------------

    For the purpose of the asset-backed transaction exception, the 
Rules defined ``predominantly originated'' so that a bank could engage 
in the issuance or sale of asset-backed securities without registration 
as a dealer if at least 85% of the obligations underlying the 
securities were originated by the bank or its affiliates, other than 
its broker-dealer affiliates. The definition also stated that the bank 
and its affiliates include any financial institution with which the 
bank or its affiliates have merged but does not include the purchase of 
a pool of obligations or the purchase of a line of business.
    Each of the commenters stated that the definition was too narrow 
and should be expanded to permit a greater percentage of the assets in 
a pool to be purchased. The commenters suggested that the percentage 
used in this definition should be reduced to a simple majority or 51% 
to permit a bank to issue asset-backed securities on pools with a 
smaller percentage of assets originated by the bank and its affiliates. 
Each of the commenters urged the Commission to consider the impact that 
a rule that discourages banks from selling assets could have on smaller 
banks.
    One commenter also addressed the definition of the term, 
``syndicate of banks of which the bank is a member.'' \45\ That 
commenter stated that Exchange Act Rule 3b-18 defines a ``syndicate'' 
in a manner that is wholly inconsistent with banking practice and, 
thus, effectively eliminates the statutory provisions authorizing 
syndicate transactions. In particular, the commenter stated that by 
defining a ``syndicate'' to mean ``a group of banks that acts jointly, 
on a temporary basis, to loan money in one or more bank credit 
obligations,'' the rule reflected a fundamental misunderstanding of how 
syndicates function in the banking industry. This would effectively 
preclude banks from taking advantage of the syndicate portion of the 
asset-backed transactions exception in the GLBA, and will have 
``seriously deleterious effects on bank securitization activities.''
---------------------------------------------------------------------------

    \45\ See the Banking Agencies' letter.
---------------------------------------------------------------------------

    One commenter addressed the requirement that each member of a 
syndicate of banks originate at least 10% of the value of a pool of 
obligations.\46\ This commenter stated that this test is too high, that 
there is no reason to impose a minimum percentage on the concept of 
syndicate membership, and that the test discriminates against smaller 
banks that may be unable to securitize obligations individually and 
must participate in a syndicate.
---------------------------------------------------------------------------

    \46\ See the NYCH letter.
---------------------------------------------------------------------------

2. Proposed Amendments to Rule 3b-18--Definition of Terms Used in 
Asset-Backed Exception to Dealer Registration
    The asset-backed transactions exception permits a bank to create, 
issue, and sell through a grantor trust or other separate entity asset-
backed securities predominantly originated by the bank and its 
affiliates. This exception does not permit a bank to be a dealer by 
regularly repurchasing and reselling the asset-backed securities that 
it issues.\47\ However, a bank may purchase these asset-backed 
securities for investment purposes, so long as the bank is not acting 
as a dealer.\48\
---------------------------------------------------------------------------

    \47\ See Section II, supra, for a discussion of dealer 
activities and the dealer/trader distinction.
    \48\ Exchange Act Section 3(a)(5)(C)(ii) [15 U.S.C. 
78c(a)(C)(ii)]. In contrast, a bank also may deal in government 
securities, such as securities of the Federal National Mortgage 
Association (``Fannie Mae'') and the Federal Home Loan Mortgage 
Corporation (``Freddie Mac''). Exchange Act Sections 3(a)(5)(C)(II) 
(exception from ``dealer'' for exempted securities) [15 U.S.C. 
78c(a)(5)(C)(II)], 3(a)(12)(A) (exempted security defined) [15 
U.S.C. 78c(a)(12)(A)], and 3(a)(42)(B) and (C) (government 
securities defined) [15 U.S.C. 78c(a)(42)(B) and (C)].
---------------------------------------------------------------------------

    We considered the comments we received as well as additional 
factual information that the staff learned during subsequent 
conversations with banking agencies and some individual banks.\49\ 
After considering the banks' business practices, we propose to expand 
the definition of ``originated'' by considering obligations that a bank 
initially approves and underwrites, or agrees to purchase, to be 
``originated'' by the bank as long as the bank meet two

[[Page 67502]]

conditions. First, the obligation would have to conform to the bank's 
underwriting standards or be evidenced on the bank's documents. This 
requirement is imposed to ensure that the bank and the entity from whom 
it obtains the loan have an established arrangement prior to the time 
the loan is made to either use the bank's underwriting standards or 
documentation prepared by the bank. Second, the bank would be required 
to fund the obligation in a timely manner, not to exceed six months 
after the obligation is created. We also continue to define an 
obligation that the bank funds at the time that the obligation is 
closed as ``originated'' by the bank.
---------------------------------------------------------------------------

    \49\ We were informed that very few banks issue and sell asset-
backed securities without employing a registered broker-dealer. The 
banking agencies identified only four banks that might have issued 
and sold asset-backed securities directly without using a broker-
dealer within the past two years. Of these four banks, only two 
regularly issue and sell asset-backed securities without employing a 
broker-dealer. These two banks actively participate in making new 
small business, residential and automobile loans for securitization 
but employ loan distribution channels that would not permit the 
banks to meet the definition of ``originated'' in Exchange Act Rule 
3b-18.
---------------------------------------------------------------------------

    Under this revised definition, a bank should be able to use loan 
origination channels such as automobile dealers, mortgage companies, 
and other banks, even though the bank does not ``make and fund'' the 
obligation at the exact time that the obligation is created. 
Conversely, a bank that purchases obligations that do not meet the 
conditions of this exemption would not have originated that particular 
obligation for the purpose of the 85% test. We believe that it is 
important to limit the time within which funding of the obligation must 
occur in order to give meaning to the term ``originate'' in the 
exception.
    Although commenters urged the Commission to modify the definition 
of ``predominantly originated'' to permit banks to purchase more of the 
underlying obligations being securitized, we have not proposed to 
modify the 85% test because the test closely tracks the language of the 
statute.\50\ To enhance clarity, however, we are modifying the 
definition to expressly set forth the meaning of the term in the 
context of a syndicate of banks. Thus, the banks, and their affiliates 
other than broker-dealer affiliates, participating in any such 
syndicate must have originated 85% of the obligations in any pool as 
measured by the value of the obligations.
---------------------------------------------------------------------------

    \50\ In defining the term ``predominantly,'' which modifies the 
term ``originated,'' we looked to other sections of the GLBA in 
which the term is used. Section 103(n) of the GLBA uses the term 
``predominantly'' to modify ``financial'' and to allow analysis of 
whether nonfinancial activities and affiliations may be retained. 
Bank Holding Company Act Section 4(n)(2) [12 U.S.C.1843(n)(2)]. 
Section 103(n)(2) of the GLBA expressly provides that a firm is 
predominantly engaged in financial activities when at least 85% of 
the annual gross revenues of the consolidated company derive from 
financial activities, excluding any revenue from banks. To be 
consistent, we applied the same numerical test found in Section 
103(n)(2) of GLBA for loan product originations for the purpose of 
the asset-backed securities exception from the definition of dealer.
---------------------------------------------------------------------------

    We also propose to clarify the rule by replacing the definition of 
``member of a syndicate of banks'' with two separate definitions. In 
particular, we first propose to define ``member'' as it relates to the 
term ``syndicate of banks'' to make clear that the individual banks and 
their affiliates other than their broker or dealer affiliates, 
originate the obligations, rather than the syndicate. The syndicate of 
banks only comes together to issue and sell the obligations. Second, we 
propose to modify the definition of ``syndicate of banks'' to mean a 
group of banks that acts jointly, on a temporary basis, to issue 
securities backed by obligations originated by each of the individual 
banks and their affiliates other than their broker or dealer 
affiliates. These definitions will make it clear that banks may join 
together for the purpose of issuing securities backed by the pool of 
obligations, rather than having to join together before the obligations 
are created.
    We propose to retain the requirement that when a syndicate of banks 
issues asset-backed securities through a grantor trust or other 
separate entity, each bank and its affiliates other than its broker or 
dealer affiliates selling the securities, and thus acting as a dealer 
in the transaction, must have originated at least 10% of the value of 
the pool of obligations backing the securities. This 10% requirement is 
applicable only to the bank or banks that actively sell the securities 
backed by the pool because these are the only banks that need to use 
the dealer exception. We received only one comment on this 
requirement.\51\ We believe that this commenter viewed the definition 
as applicable to all of the banks that provide assets to the pool but 
do not actually sell the securities.
---------------------------------------------------------------------------

    \51\ See the NYCH letter.
---------------------------------------------------------------------------

    We propose to retain this requirement because the legislative 
history indicates that each bank selling the securities should be more 
than an insignificant member of the syndicate.\52\ The legislative 
history suggests that threshold is met when a bank together with its 
affiliates other than broker or dealer affiliates provided at least 10% 
of the obligations in the pool. We believe that it is reasonable as 
well as in accordance with the legislative history to retain this 
requirement for the bank or banks that need the exception because they 
sell the securities secured by the pool of obligations originated by 
banks that are members of a syndicate of banks. We did, however, modify 
the rule to clarify that the affiliates of the banks other than broker 
or dealer affiliates also may originate the obligations.
---------------------------------------------------------------------------

    \52\ The legislative history states that, ``[t]he Committee 
expects this provision shall be interpreted so that the bank will 
[have] not less than ten percent of the assets in the syndicate or 
pool of obligations.'' H.R. Rep. No. 106-74, pt. 3, at 171 (1999).
---------------------------------------------------------------------------

    Based on our staff's conversations with those banks that sold 
asset-backed securities, we expect that the changes we propose will 
permit the banks that currently issue and sell asset-backed securities 
directly to continue to do so under the terms of the exception without 
having to employ a broker-dealer.
    We request comment on all aspects of the proposed amendments to 
Rule 3b-18. In particular, we request comment from banks that currently 
sell asset-backed securities on the impact, if any, of the proposed 
definition of ``originate'' on them. We request that these banks 
confirm whether the proposed changes to the definitions will permit 
them to continue to conduct this business. We also request comment on 
the requirement to fund the loans in a timely manner not to exceed six 
months and whether this requirement will have any impact on the banks 
making or funding the loans. In addition, we request comment on the 
requirement that there be established relationships as shown by 
conforming loans to the underwriting standards of the bank or using 
documentation prepared by the bank to evidence the loans. Commenters 
are invited to discuss whether these requirements would impose any 
burdens on banks.

IV. Rule 15a-11 Exemption From the Definitions of ``Broker'' and 
``Dealer'' for Banks Engaging in Securities Lending Transactions

    Institutional investors often place securities in custody with 
banks. These custodian banks effect and administer securities loans in 
return for an agreed fee. Banks also may engage in securities lending 
transactions when they do not have custody of the securities. A non-
custodial securities lending arrangement permits a customer to divide 
custody and securities lending management between two expert entities. 
For example, a custodian may be selected for efficiency and low cost, 
while a lending agent may be selected for its ability to maximize the 
profitability of the portfolio.
    Although banks play a role in both custodial and non-custodial 
securities lending transactions, the GLBA bank exceptions to the 
definitions of broker and dealer provide only one exception for 
securities lending and borrowing

[[Page 67503]]

transactions. The need for an exemption to give banks legal certainty 
for securities lending transactions when the bank does not have custody 
of the securities was initially drawn to our attention through a letter 
from a trade group.\53\
---------------------------------------------------------------------------

    \53\ See the RMA letter, supra, note 36.
---------------------------------------------------------------------------

    Exchange Act section 3(a)(4)(B)(viii) addresses securities lending 
by custodian banks as an exception to the definition of broker.\54\ 
Under paragraph (cc) of section 3(a)(4)(B)(viii), a bank is permitted, 
without being considered a broker, to effect securities lending or 
borrowing transactions by custodian banks with or on behalf of 
customers in two situations: (1) As part of the services provided to 
safekeeping and custody customers; and (2) when facilitating the 
transfer of funds or securities as a custodian or a clearing agency in 
connection with the settlement of customers' transactions in 
securities.
---------------------------------------------------------------------------

    \54\ 15 U.S.C. 78c(a)(4)(B)(viii).
---------------------------------------------------------------------------

    We have been advised that the existence of this limited bank 
exception from the definition of broker creates uncertainty for banks 
that may engage in securities lending or borrowing transactions without 
having custody of the underlying securities or in situations where a 
bank might meet the definition of dealer under the securities laws. To 
provide legal certainty to banks engaging in securities lending 
transactions, we propose to add an exemption from the definition of 
broker for banks engaging in non-custodial securities lending 
activities as well as an exemption from the definition of dealer for 
banks engaging in certain custodial and non-custodial securities 
lending activities. This exemption would also enhance legal certainty 
for banks that have custody of collateral or that have custody of the 
securities subject to a lending arrangement for less than the entire 
period of the stock loan.
    Industry representatives have advised our staff that banks' primary 
role in securities lending transactions, whether operating with or 
without custody of the securities, is to act in an agency capacity. 
Less frequently, banks may engage in securities lending as principal 
while acting as a conduit between the parties.\55\ In that role, a bank 
provides credit intermediation and anonymity by standing between the 
lender and borrower.
---------------------------------------------------------------------------

    \55\ This conduit role is similar to a riskless principal 
transaction, but does not involve activities that could be 
characterized as running a matched book. Running a matched book of 
repurchase agreements or other stock loans has been characterized as 
a dealer activity because the ``book running dealer'' holds itself 
out as willing to buy and sell and as thus, engaged in the business 
of buying and selling securities. Unlike a riskless principal 
transaction, a conduit lender may on occasion substitute collateral 
on the securities borrowing side of the transaction while the 
original securities lending transaction remains outstanding.
---------------------------------------------------------------------------

    The proposed exemption would require a written securities lending 
agreement, which would be any contract to conduct securities lending 
transactions on behalf of a qualified investor. In connection with a 
securities lending transaction, the bank may select and negotiate with 
a borrower and execute, or direct the execution of, the loan with the 
borrower; receive, deliver, or take custody of loaned securities; 
receive, deliver, or take custody of collateral; provide mark-to-
market, corporate action, recordkeeping or other services incidental to 
the administration of the securities lending transaction; reinvest, or 
direct the reinvestment of, cash collateral; or indemnify the lender of 
securities with respect to various matters.
    We propose to make this exemption available for banks' current 
securities lending business. The exemption would be limited to 
transactions with ``qualified investors,'' as defined in Exchange Act 
section 3(a)(54).\56\ Commenters have suggested that both custodial and 
non-custodial banks should be able to act either as a conduit lender or 
as agent in order to offer to institutional investors the opportunity 
to select different banks to provide this service.\57\
    We propose that a bank be required to deal with a qualified 
investor on both sides of the transaction as a condition of this 
exemption. We understand that borrowers of securities that are not 
qualified investors do not directly borrow securities from noncustodial 
banks. Any borrowers of securities that do not meet the qualified 
investor test generally borrow securities through intermediaries that 
would be qualified investors. We request comment on any business 
practices that involve banks engaging in noncustodial securities 
lending directly with persons that are not qualified investors.
---------------------------------------------------------------------------

    \56\ See discussion at Section V, infra.
    \57\ See the RMA letter, supra note 36.
---------------------------------------------------------------------------

    We do not propose extending the securities lending exemption to 
banks borrowing securities for, or lending from, their own accounts 
except as a conduit lender.\58\ For the purposes of this provision, the 
term conduit lender means a bank that borrows (or loans) securities, as 
principal, for its own account, and contemporaneously loans (or 
borrows) the same securities, as principal, for its own account. A bank 
that qualifies under this definition as a conduit lender at the 
commencement of a transaction would continue to qualify as long as the 
original securities lending transaction remains outstanding, even 
though substitutions of collateral may occur on the securities 
borrowing side of the transaction.
---------------------------------------------------------------------------

    \58\ Under banking law, with some exceptions, banks are not 
permitted to own equity securities.
---------------------------------------------------------------------------

    To the extent that banks may have a legitimate need to, on 
occasion, lend or borrow securities on their own behalf for hedging or 
for other reasons, they should be subject to the same dealer/trader 
distinction that applies to all other market participants.\59\ In 
addition, the exemption is not indicative of whether banks or other 
persons may otherwise engage in securities lending as principal without 
being considered a dealer.
---------------------------------------------------------------------------

    \59\ See Section II, supra, for a discussion of dealer 
activities and the dealer/trader distinction.
---------------------------------------------------------------------------

    Even though we recognize that engaging in securities lending 
transactions involves taking risks that require effective internal 
controls, we have not proposed conditions to the exemption that would 
require that banks conform to the standards applicable to registered 
broker-dealers that engage in securities lending transactions.\60\ We 
are proposing an exemption because we believe that it will assist 
institutional investors in obtaining stock loan services for banks that 
do not act as their custodians. We also believe that the exemption is 
appropriate in the public interest and is consistent with the 
protection of investors because it is limited to qualified investors.
---------------------------------------------------------------------------

    \60\ See Rule 15c3-3(b)(3) [17 CFR 240.15c3-3(b)(3)].
---------------------------------------------------------------------------

    We have asked bank regulators to advise us if this exemption would 
pose any risks that the Commission should address. We specifically 
request commenters to address our decision not to impose the kinds of 
conditions that are applicable to broker-dealers that engage in 
securities lending, which require them to take precautions against 
financial risks to the firm.
    If conditions were to be imposed, we request comment on whether we 
should require banks to verify that: (1) The participants to the 
securities lending transactions are borrowing securities for a proper 
purpose; or (2) the participants to the transaction have been evaluated 
for their suitability to participate in the transaction, including 
their creditworthiness. Moreover, we request comment on whether this 
exemption should include a condition that it not be used to avoid U.S. 
margin requirements applicable to securities financing

[[Page 67504]]

transactions, or to avoid other restrictions on the alienability of 
securities. We also request comment on all other aspects of the 
proposed exemption for securities lending transactions.

V. Definition of ``Qualified Investor''

    In defining the term ``qualified investor,'' Exchange Act section 
3(a)(54) expressly provides authority to the Commission by rule or 
order to expand the definition to include any other person, taking into 
consideration such factors as the financial sophistication of the 
person, net worth, and knowledge and experience in financial 
matters.\61\ In the context of the securities lending exemption, one 
commenter suggested that we use this authority to clarify the 
definition of ``qualified investor'' so that it would include any other 
person, plan, or legal entity of any kind that owns or invests on a 
discretionary basis not less than $25 million in investments, even if 
it is not expressly included in section 3(a)(54).\62\
---------------------------------------------------------------------------

    \61\ 15 U.S.C. 78c(a)(54). Under this definition qualified 
investors include investment companies, banks, small business 
investment companies, any State sponsored employee benefit plan, 
institutional trusts, market intermediaries, and natural persons, 
corporations or partnerships that own and invest on a discretionary 
basis more than $25,000,000.
    \62\ See Coalition of Securities Lending Banks letter.
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    The term ``qualified investor'' was defined as a part of the GLBA 
and has application to several of the bank exceptions from broker-
dealer registration. Under the GLBA bank exceptions to broker and 
dealer registration, certain securities may only be sold to qualified 
investors. The sections that list the securities that may only be sold 
to qualified investors include: \63\ (1) The broker exception for 
identified banking products when the product is an equity swap 
agreement; \64\ (2) the dealer exception for identified banking 
products when the product is an equity swap agreement; \65\ and (3) the 
dealer exception for asset-backed securities.\66\
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    \63\ In addition to these three provisions, a participation in a 
loan to be an ``identified banking product,'' also must either be 
sold to: (1) A qualified investor; or (2) to other persons that have 
an opportunity to review and assess any material information 
regarding the borrower's creditworthiness and based on such factors 
as financial sophistication, net worth, and knowledge and experience 
in financial matters, have the capability to evaluate the 
information available, as determined under generally applicable 
banking standards or guidelines. Thus, a bank utilizing the 
exceptions to broker and dealer registration to sell a participation 
interest would either have to sell such an interest to a qualified 
investor or undertake a more extensive factual assessment of the 
purchaser. See Section 206(a)(5) of Pub. L. 106-102 [15 U.S.C. 78c 
note] as incorporated into Exchange Act Section 3(a)(4)(B)(ix) [15 
U.S.C. 78c(a)(4)(B)(ix)] and Section 3(a)(5)(C)(iv) [15 U.S.C. 
78c(a)(5)(C)(iv)].
    \64\ Section 206(a)(6) of Pub. L. 106-102 [15 U.S.C. 78c note] 
as incorporated into Exchange Act Section 3(a)(4)(B)(ix) [15 U.S.C. 
78c(a)(4)(B)(ix)].
    \65\ Section 206(a)(6) of Pub. L. 106-102 [15 U.S.C. 78c note] 
as incorporated into Exchange Act Section 3(a)(5)(C)(iv) [15 U.S.C. 
78c(a)(5)(C)(iv)].
    \66\ Exchange Act Section 3(a)(5)(C)(iii) [15 U.S.C. 
78c(a)(5)(C)(iii)].
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    With regard to the expansion of the definition of qualified 
investor in the context of the exemption for securities lending 
transactions, one commenter stated:
    As you are aware, banks provide custodial and non-custodial 
securities lending services to a variety of different types of 
lenders of securities. Frequently, these lenders include U.S. 
persons that are not organized as corporations, companies, or 
partnerships. For example, a significant number of lenders are 
organized as trusts. In addition, some banks regularly provide 
securities lending services to non-U.S. entities whose legal form 
has been established pursuant to applicable non-U.S. law. Such 
entities may be organized as trusts, pension plans managed by 
foreign banks or advisers qualified under local law (and as a result 
not included within Section 3(a)(54)(A)(v)), or as some other legal 
form that does not fit clearly within the U.S.-based concepts of a 
``corporation, company or partnership.'' \67\

    \67\ Coalition of Securities Lending Banks letter.
---------------------------------------------------------------------------

    Exchange Act section 3(a)(54) enumerates an extensive list of 
persons who qualify for the designation, ``qualified investor. ''\68\ 
Some of these entities qualify by merely being certain types of 
entities, while other entities must qualify by being both a certain 
type of entity and by meeting an ownership and investment test. For 
example, subsection (xi) of section 3(a)(54)(A) provides that ``any 
corporation, company, or partnership that owns and invests on a 
discretionary basis, not less than $25,000,000 in investments'' is a 
qualified investor.
---------------------------------------------------------------------------

    \68\ Subsections (i) through (xiv) of Section 3(a)(54) list 
entities that are qualified investors.
---------------------------------------------------------------------------

    In considering this definition, we first looked to Exchange Act 
section 3(a)(9), which defines the term ``person'' to mean ``a natural 
person, company, government, or political subdivision, agency, or 
instrumentality of a government.'' \69\ We also looked to Investment 
Company Act section 2(a)(8), which provides that the term ``company'' 
means a corporation, a partnership, an association, a joint-stock 
company, a trust, a fund, or any organized group of persons whether 
incorporated or not; or any receiver, trustee in a case under title 11 
of the United States Code or similar official or any liquidating agent 
for any of the foregoing, in his capacity as such.''\70\
---------------------------------------------------------------------------

    \69\ Exchange Act Section 3(a)(9) [15 U.S.C. 78c(a)(9)].
    \70\ Investment Company Act Section 2(a)(8) [15 U.S.C. 80a-
2(a)(8)].
---------------------------------------------------------------------------

    In light of these other definitions, for the purposes of the GLBA 
provisions in the Exchange Act, we interpret the term ``company'' as 
used in the definition of ``qualified investor'' in subsection (xi) of 
section 3(a)(54) to have a broad meaning that encompasses any other 
type of entity not otherwise specifically listed in section 3(a)(54). 
We believe that interpreting the definition of qualified investor in 
this way is an appropriate way to enhance legal certainty for entities 
that are not as precisely described as others in the list of entities 
expressly listed as ``qualified investors.''
    We believe that it may be appropriate to utilize this 
interpretation in all circumstances where the term is used in the GLBA 
exceptions as well as in the securities lending exemption. However, any 
type of entity that is specifically listed in Exchange Act section 
3(a)(54) will continue to be subject to the requirements imposed by 
that section. For example, a government or political subdivision, 
agency, or instrumentality of a government is required to invest on a 
discretionary basis at least $50 million in investments in order to be 
considered a qualified investor.\71\ The statutory requirement for 
these governmental entities would not be changed by this 
interpretation.
---------------------------------------------------------------------------

    \71\ Section 3(a)(54)(C)(xiii) of the Exchange Act [15 U.S.C. 
78c(a)(54)(C)(xiii)].
---------------------------------------------------------------------------

    We request comment on all aspects of this interpretation, including 
whether there are any other entities that should be considered 
qualified investors or whether we should exclude any entities that 
might meet the qualifying investment threshold but that nonetheless 
should be excluded from the definition. In addition, we request comment 
on whether the expansion of the definition of ``qualified investor'' 
should apply: (1) Whenever the term is used in the GLBA exceptions; or 
(2) only to securities lending transactions. We also request comment on 
whether this interpretation brings sufficient clarity to provide legal 
certainty to banks and their customers.

VI. Procedural Matters

A. General Request for Comments

    We are soliciting comments on all aspects of these proposed 
amendments as well as the portions of the Rules pertaining to banks' 
dealer activities that we are not proposing to amend. We will amend the 
Rules as appropriate in response to comments received when we adopt 
final rules relating to the

[[Page 67505]]

exceptions from the definition of dealer and the new proposed exemption 
set forth in this proposal. We also specifically request comment on the 
timing of the final implementation of this proposal and the Rules 
relating to the exceptions from the definition of dealer as well as any 
specific extensions that individual banks may need.

B. Paperwork Reduction Act

    These proposed rules do not impose recordkeeping or information 
collection requirements, or other collections of information that 
require approval of the Office of Management and Budget under 44 U.S.C. 
3501, et seq. Accordingly, the Paperwork Reduction Act does not 
apply.\72\
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    \72\ We would expect banks, as a matter of good business 
practice, to be able to demonstrate that they meet the terms of a 
particular exemption. We also note that Section 203 of the GLBA 
specifically requires the bank regulators to promulgate 
recordkeeping requirements.
---------------------------------------------------------------------------

C. Consideration of Benefits and Costs

    We believe that these proposed amendments and the new exemption are 
consistent with Congress's intent in enacting the GLBA and are 
responsive to the comments we received. These proposed amendments to 
the Rules are very limited in scope. The amendments propose three 
changes. In particular, we propose to: (1) Modify the way in which 
transactions are counted under the exemption from the definition of 
``dealer'' for a bank engaged in riskless principal transactions, which 
would permit the bank to engage in more transactions under the de 
minimis exception to broker and dealer registration; (2) modify certain 
definitions under the exemption for asset-backed transactions exception 
to the ``dealer'' rules to permit banks to issue and sell more asset-
backed securities; and (3) add a new exemption from the definitions of 
both ``broker'' and ``dealer'' to provide banks with enhanced legal 
certainty when they engage in securities lending transactions.
1. Benefits
    Both of the proposed amendments to the existing Rules would modify 
the exceptions and the interpretations found in Rules 3a5-1 and 3b-18 
in a way that expands the scope of activity in which banks may engage 
without registering as dealers. The new proposed exemption for banks to 
engage in securities lending transactions found in new Rule 15a-11 also 
grants increased legal certainty to banks. All of these proposals make 
it easier for banks to conduct these activities.
    Amending Rule 3a5-1 to change the way riskless principal 
transactions are counted will allow banks to engage in more such 
transactions before triggering the dealer registration requirement.
    Directly engaging in asset-backed transactions without employing a 
broker-dealer is very unusual for banks. We found only two banks that 
regularly issue and sell asset-backed securities. Based on the staff 
discussions with these two banks, we believe that the proposed 
amendments to Rule 3b-18 will permit these two banks to continue to 
utilize their existing business models with little or no change in 
their procedures. These proposed amendments modify the definition of 
``originate'' to permit banks to use loan origination channels that 
would not be permitted under the Rules. We believe that the proposed 
amendments to the definitions under the asset-backed transactions 
exception will accommodate these banks' business without sacrificing 
the statutory limits Congress imposed on banks' dealer activities.
    Lending securities is a highly specialized business for which 
Congress provided partial relief under the custody exception to broker 
registration. As discussed above, some banks were concerned about legal 
certainty for securities lending transactions that may not meet the 
terms of the custody exception to broker registration and to the extent 
that some securities lending transactions might be considered to be 
subject to dealer registration. The proposed amendments modify the 
definition of ``originate'' to permit banks to use loan pipelines that 
would not be permitted under the Rules. We believe that banks provide 
an important function in this market and that it is in the public 
interest that they continue to do so. The proposed exemption should 
provide banks that lend securities with enhanced legal certainty that 
will permit them to continue to engage in this activity without broker-
dealer registration.
2. Costs
    Although banks may incur certain costs to comply with the GLBA, 
these costs will be necessary because of the statutory change. Congress 
determined that all securities activities should be functionally 
regulated by the expert securities regulator to ensure investor 
protection, regardless of the entity in which the activities occur. 
Thus, any regulatory costs arise from Congress's determination that 
amendment of the Exchange Act was necessary. There are no out-of-pocket 
costs as a result of these proposals. Any costs would be those 
associated with moving the supervision of these limited securities 
transactions or products from the Commission and placing them under the 
banking agencies, which we do not believe to be significant.
    In addition, because the types of dealer activities that are the 
subject of these rules are not the types of activities in which small 
banks or small broker-dealers participate, there should be no 
competitive costs to small broker-dealers due to the way in which these 
rules modify the terms of the bank exceptions and exemptions. None of 
the commenters on the dealer rules specifically identified costs to 
complying with those rules.

D. Consideration of Burden on Competition, and on Promotion of 
Efficiency, Competition, and Capital Formation

    In accordance with our responsibilities under section 3(f) of the 
Exchange Act, we have considered both the protection of investors and 
whether these proposed amendments to certain of the Rules would promote 
efficiency, competition, and capital formation in determining whether 
they are consistent with the public interest.\73\ In addition, section 
23(a)(2) of the Exchange Act \74\ requires us, in adopting rules under 
the Exchange Act, to consider the anticompetitive effects of such 
rules, if any, and to refrain from adopting a rule that will impose a 
burden on competition not necessary or appropriate in furthering the 
purpose of the Exchange Act.
---------------------------------------------------------------------------

    \73\ 15 U.S.C. 78c(f).
    \74\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    We do not believe that the interpretations, definitions, and 
exemptions contained in these proposed amendments to certain of the 
Rules, or the proposed rules will result in any burden on competition 
that is not necessary or appropriate in furtherance of the purposes of 
the Exchange Act. The interim final rules define terms in the statutory 
exceptions to the definitions of broker and dealer added to the 
Exchange Act by Congress in the GLBA, and provide guidance to banks 
regarding the scope of those exceptions. The proposed rule amendments 
and proposed rules also do not impose any additional competitive 
burdens on banks engaging in a securities business, other than those 
imposed by Congress through functional regulation in the GLBA.
    Because the types of dealer activities that are the subject of 
these rules are not the types of activities in which small banks or 
small broker-dealers directly

[[Page 67506]]

participate, there should be no competitive costs to small banks or 
small broker-dealers due to the way in which these rules modify the 
terms of the bank exceptions and exemptions.
    The new conditional exemption from broker-dealer registration would 
provide banks increased legal certainty when they engage in securities 
lending transactions without any new burdens on banks seeking to use 
this limited exemption. Nothing in the proposed amendments to the 
Rules, in the new proposed exemption, or in the proposed rule will 
adversely affect capital formation. Banks that alter their securities-
related activities in accordance with the GLBA will continue to be able 
to provide securities services to their customers. In enacting the 
GLBA, Congress determined that functional regulation was appropriate--
that is, when a bank was conducting a securities business outside of 
the enumerated exceptions, that bank should be registered as a broker-
dealer or shifted securities activities to a registered broker-dealer. 
In the interest of protecting the public and ensuring orderly markets, 
Congress determined that banks conducting a broad securities business 
should be subject to the same regulatory oversight as broker-dealers 
conducting the same types of activities. These amendments to the Rules 
and the new proposed exemption promote Congress' intent and make it 
easier for banks to comply with the requirements of the GLBA.
    Since certain of these proposed amendments to the Rules define 
statutory exceptions mandated by Congress, we do not believe that those 
rules impose any extra-statutory adverse effects on efficiency, 
competition, or capital formation. With respect to the proposed 
amendment to a Rule that provides exemptive relief and the new proposed 
exemption for banks, both changes would make it easier for banks to 
comply with the GLBA and the Rules and give them enhanced legal 
certainty. We also do not believe that those rules impose any extra-
statutory adverse effects on efficiency, competition, or capital 
formation. When Congress passed the GLBA, it effectively determined 
that regulation of banks conducting a securities operation outside of 
certain exceptions was necessary, appropriate, and in the public 
interest.
    We are, however, interested in receiving comments regarding the 
effect of these proposed amendments to the Rules, the new proposed 
exemption, and the proposed rule may have on efficiency, competition, 
and capital formation. We will consider those comments in making any 
changes to the proposed amendments to the Rules, the new proposed 
exemption, and the new rule as necessary.
    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, the Commission is also requesting information regarding 
the potential impact of the proposed rules and rule amendments on the 
economy on an annual basis. Commenters should provide empirical data to 
support their views.

E. Regulatory Flexibility Act Certification

    Section 3(a) of the Regulatory Flexibility Act \75\ requires the 
Commission to undertake an initial regulatory flexibility analysis of 
the effects of proposed rules and rule amendments on small entities, 
unless the Commission certifies that the rules and rule amendments, if 
adopted, would not have a significant economic impact on a substantial 
number of small entities.\76\
---------------------------------------------------------------------------

    \75\ 5 U.S.C. 603(a).
    \76\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------

    The Commission hereby certifies pursuant to 5 U.S.C. 605(b) that 
proposed amendments to Rules 3a5-1 and 3b-18 under the Exchange Act, 
and a proposed exemption for securities lending transactions in Rule 
15a-11 under the Exchange Act under the Exchange Act contained in this 
release, if adopted, would not have a significant economic impact on a 
substantial number of small entities. The proposed amendments and 
proposed rules will not impose compliance requirements on depository 
institutions of any size. They impose no performance standards, no 
fees, no reporting or recordkeeping criteria, nor any other type of 
restriction or requirement with which depository institutions must 
comply. Furthermore, nothing in these rules prevents or impedes small 
banks from engaging in any of these activities. The activities 
addressed by these proposed amendments and proposed rules are not of a 
type that a small bank is likely to engage in. In addition, all of 
these rules remove impediments to any bank, including a small bank, 
engaging these activities.
    First, the proposals would modify the method of counting a bank's 
riskless principal transactions for purposes of determining whether the 
volume of such transactions requires the bank to register as a dealer. 
The modification would, if anything, permit banks to engage in more 
transactions than would be permitted without registration under the 
Rules. Second, the proposals would amend a rule defining certain terms 
in section 3(a)(5) of the Exchange Act concerning exceptions to the 
statutory definition of ``dealer'' for certain bank activities. These 
amendments also would, if anything, permit banks to engage in more 
transactions than would be permitted without registration under the 
Rules. Third, the proposals would add a new rule permitting banks to 
engage in certain securities lending activities without triggering 
registration requirements. Again, this proposal would, if anything, 
permit banks to engage in more transactions than would be permitted 
without registration under the Rules. For these reasons, none of the 
proposals should have a significant economic impact on a substantial 
number of small entities.
    We encourage written comments regarding this certification. We 
solicit comment as to whether the proposed changes could have an effect 
that we have not considered. We request that commenters describe the 
nature of any impact on small entities and provide empirical data to 
support the extent of the impact.

Statutory Authority

    The Commission is proposing amendments to Rules 3a5-1 and 3b-18, 
and a new exemption for securities lending transactions in Rule 15a-11 
under the Exchange Act, pursuant to authority set forth in sections 
3(b), 15, 23(a), and 36 of the Exchange Act (15 U.S.C. 78c(b), 78o, 
78w(a), and 78mm, respectively).

Text of Proposed Rules and Rule Amendments

List of Subjects in 17 CFR Part 240

    Broker-dealers, Reporting and recordkeeping requirements, 
Securities.

Text of Amendment

    For the reasons set forth in the preamble, title 17, chapter II of 
the Code of Federal Regulations is proposed to be amended as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    1. The authority citation for part 240 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
    2. Section 240.3a5-1 is revised to read as follows:

[[Page 67507]]

Sec.  240.3a5-1  Exemption from the definition of ``dealer'' for a bank 
engaged in riskless principal transactions.

    (a) A bank is exempt from the definition of the term ``dealer'' 
solely for engaging in riskless principal transactions if the number of 
such riskless principal transactions during a calendar year combined 
with transactions in which the bank is acting as an agent for a 
customer pursuant to section 3(a)(4)(B)(xi) of the Act (15 U.S.C. 
78c(a)(4)(B)(xi)) during that same year does not exceed 500.
    (b) For purposes of this section, the term riskless principal 
transaction means a transaction in which, after having received an 
order to buy from a customer, the bank purchased the security from 
another person to offset a contemporaneous sale to such customer or, 
after having received an order to sell from a customer, the bank sold 
the security to another person to offset a contemporaneous purchase 
from such customer.
    3. Section 240.3b-18 is revised to read as follows:


Sec.  240.3b-18  Definitions of terms used in Section 3(a)(5) of the 
Act.

    For the purposes of section 3(a)(5)(C) of the Act (15 U.S.C. 
78c(a)(5)(C):
    (a) The term affiliate means any company that controls, is 
controlled by, or is under common control with another company.
    (b) The term consumer-related receivable means any obligation 
incurred by any natural person to pay money arising out of a 
transaction in which the money, property, insurance, or services (being 
purchased) are primarily for personal, family, or household purposes.
    (c) The term member as it relates to the term ``syndicate of 
banks'' means a bank that is a participant in a syndicate of banks and 
together with its affiliates other than its broker or dealer 
affiliates, originates no less than 10% of the value of the obligations 
in a pool of obligations used to back the securities issued through a 
grantor trust or other separate entity.
    (d) The term obligation means any note, draft, acceptance, loan, 
lease, receivable, or other evidence of indebtedness that is not a 
security issued by a person other than the bank.
    (e) The term originated means:
    (1) Funding an obligation at the time that the obligation is 
created; or
    (2) Initially approving and underwriting the obligation, or 
initially agreeing to purchase the obligation, provided that:
    (i) The obligation conforms to the bank's own underwriting 
standards or is evidenced by the bank's own loan documents; and
    (ii) The bank funds the obligation in a timely manner, not to 
exceed six months after the obligation is created.
    (f) The term pool means more than one obligation or type of 
obligation grouped together to provide collateral for a securities 
offering.
    (g) The term predominantly originated means that no less than 85% 
of the value of the obligations in any pool were originated by:
    (1)The bank, or its affiliates other than its broker or dealer 
affiliates; or
    (2) Banks that are members of a syndicate of banks and affiliates 
of such banks other than their broker or dealer affiliates, if the 
obligations or pool of obligations consist of mortgage obligations or 
consumer-related receivables.
    (3) For this purpose, the bank and its affiliates include any 
financial institution with which the bank or its affiliates have merged 
but does not include the purchase of a pool of obligations or the 
purchase of a line of business.
    (h) The term syndicate of banks means a group of banks that acts 
jointly, on a temporary basis, to issue through a grantor trust or 
other separate entity, securities backed by obligations originated by 
each of the individual banks or their affiliates other than their 
broker or dealer affiliates.
    4. Section 240.15a-11 is added to read as follows:


Sec.  240.15a-11  Exemption from the definitions of ``broker'' and 
``dealer'' for banks engaging in securities lending transactions.

    (a) Except as otherwise provided in paragraph (d) of this section, 
a bank is exempt from the definitions of the terms ``broker'' and 
``dealer'' under sections 3(a)(4) and 3(a)(5) of the Act (15 U.S.C. 
78c(a)(4) and (a)(5)), solely to engage in or effect securities lending 
transactions with a qualified investor, pursuant to an agreement to 
provide securities lending services to a qualified investor, whether 
the bank acts as a conduit lender, or an agent.
    (b) Securities lending transaction means a transaction in which the 
owner of a security lends the security temporarily to another party 
pursuant to a written securities lending agreement under which the 
lender retains the economic interests of an owner of such securities, 
and has the right to terminate the transaction and to recall the loaned 
securities on terms agreed by the parties.
    (c) An agreement to provide securities lending services means any 
contract to conduct securities lending transactions on behalf of a 
qualified investor in connection with which the bank may:
    (1) Select and negotiate with a borrower and execute, or direct the 
execution, of the loan with the borrower;
    (2) Receive, deliver, or take custody of loaned securities;
    (3) Receive, deliver, or take custody of collateral;
    (4) Provide mark-to-market, corporate action, recordkeeping or 
other services incidental to the administration of the securities 
lending transaction;
    (5) Reinvest, or direct the reinvestment of, cash collateral; or
    (6) Indemnify the lender of securities with respect to various 
matters.
    (d) For the purposes of this section, the term conduit lender means 
a bank that borrows (or loans) securities, as principal, for its own 
account, and contemporaneously loans (or borrows) the same securities, 
as principal, for its own account. A bank that qualifies under this 
definition as a conduit lender at the commencement of a transaction 
will continue to have that character as long as the original securities 
lending transaction remains outstanding, even though substitutions of 
collateral may occur on the securities borrowing side of the 
transaction.
    (e) For the purposes of this section, the term qualified investor 
has the meaning set forth in section 3(a)(54) of the Act (15 U.S.C. 
78c(a)(54)).

    Dated: October 30, 2002.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-28097 Filed 11-4-02; 8:45 am]
BILLING CODE 8010-01-P