[Federal Register Volume 68, Number 36 (Monday, February 24, 2003)]
[Rules and Regulations]
[Pages 8686-8701]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-4095]



[[Page 8685]]

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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; Final Rule

  Federal Register / Vol. 68, No. 36 / Monday, February 24, 2003 / 
Rules and Regulations  

[[Page 8686]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-47364; 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: Final rule.

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SUMMARY: The Securities and Exchange Commission is adopting amendments 
to its rule granting an exemption to banks from dealer registration for 
a de minimis number of riskless principal transactions, and to its rule 
that defines terms used in the bank exception to dealer registration 
for asset-backed transactions. The Commission also is adopting a new 
exemption for banks the definition of broker and dealer under the 
Securities Exchange Act of 1934 for certain securities lending 
transactions. In addition, the Commission is extending the exemption 
from rescission liability under Exchange Act Section 29 to contracts 
entered into by banks acting in a dealer capacity before March 31, 
2005. 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: Effective Date: March 26, 2003.
    Compliance Date: September 30, 2003.

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 adopting amendments to Rules 3a5-1 [17 CFR 240.3a5-
1], 3b-18 [17 CFR 240.3b-18], and 15a-8 [17 CFR 240.15a-8] under the 
Securities Exchange Act of 1934 (``Exchange Act''). The Commission also 
is adopting an 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
II. Temporary Exemption from the Definition of ``Dealer''
III. General Comments on the Proposed Amendments
IV. Dealer Activities and the Dealer/Trader Distinction
V. Discussion of Comments and Adoption of ``Dealer'' Rules
    A. Rule 3a5-1--the De Minimis Exemption for Riskless Principal 
Transactions
    1. Discussion of Comments Received on the Amendment to Rule 3a5-
1--the De Minimis Exemption
    2. 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 the Amendment to Rule 3b-
18--Definition of Terms Used in Asset-Backed Exception to Dealer 
Registration
    2. Amendment to Rule 3b-18--Definition of Terms Used in Asset-
Backed Exception to Dealer Registration
    C. Rule 15a-11--Exemption from the Definitions of ``Broker'' and 
``Dealer'' for Banks Engaging in Securities Lending Transactions
    1. Discussion of Comments Received on the Amendment to Rule 15a-
11--Exemption from the Definitions of ``Broker'' and ``Dealer'' for 
Banks Engaging in Securities Lending Transactions
    2. Amendment to Rule 15a-11--Exemption from the Definitions of 
``Broker'' and ``Dealer'' for Banks Engaging in Securities Lending 
Transactions
    D. Definition of ``Qualified Investor''
    E. Temporary Exemption
    1. Discussion of Comments on the Temporary Exemption
    2. Adoption of Temporary Exemption and Effective Date of Dealer 
Rules
    F. Extension of Rule 15a-8--Section 29 Liability Exemption
VI. Procedural Matters
    A. Paperwork Reduction Act
    B. Consideration of Comments on Benefits and Costs
    1. Benefits
    2. Costs
    C. Consideration of Burden on Competition, and on Promotion of 
Efficiency, Competition, and Capital Formation
    D. Regulatory Flexibility Act Certification
Statutory Authority
Text of Rules and Rule Amendments

I. Introduction

    On October 30, 2002, the Commission proposed amendments to the 
Interim Final Rules \1\ (``the Rules'') under the Exchange Act 
concerning the definition of ``dealer.'' \2\ Today, the Commission 
adopts these ``dealer'' rules substantially as proposed with some 
technical amendments to the exemptions in response to comments 
received. In addition, the Commission is, by separate order, extending 
the banks' temporary exemption from the definition of dealer until 
September 30, 2003. Finally, the Commission is amending Rule 15a-8 to 
give practical effect to the exemption from rescission liability under 
Exchange Act Section 29 on contracts entered into by banks in a dealer 
capacity for a finite transition period until March 31, 2005. This 
exemption was previously adopted, subject to comment.
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    \1\ 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).
    \2\ 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-
46745, 67 FR 67495 (November 5, 2002) (``the Proposing Release'').
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    The Commission previously adopted Exchange Act Rules 3a5-1, 3b-18, 
and 15a-8 on May 11, 2001 as part of the Rules, which were designed to 
implement the specific transactional exceptions for banks from the 
definitions of ``broker'' and ``dealer.'' The definitions of ``broker'' 
and ``dealer,'' in Exchange Act Sections 3(a)(4) and 3(a)(5), 
respectively, were amended by the Gramm-Leach-Bliley Act (``GLBA'').\3\
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    \3\ Pub. L. No. 106-102, 113 Stat. 1338 (1999). On November 12, 
1999, the President signed the GLBA into law. 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'') Pub. L. No. 73-66, ch. 89, 48 
Stat. 162 (1933) (as codified in various sections of 12 U.S.C.). 
Section 101 of the GLBA repealed Sections 20 (12 U.S.C. 377) and 32 
(12 U.S.C. 78) of the Banking Act of 1933. The GLBA did not repeal 
Sections 16 (12 U.S.C. 24 (Seventh)) and 21 (12 U.S.C. 377) of the 
Banking Act of 1933, which were retained as continuing safeguards. 
Section 16 prohibits national banks from underwriting, selling, or 
dealing in securities, except for certain bank-eligible securities 
such as U.S. government securities, and section 5(c) of the Glass-
Steagall Act applies those same Section 16 restrictions to state-
chartered banks that are members of the Federal Reserve System. See 
12 U.S.C. 24 (Seventh) and 12 U.S.C. 335. Section 16 excludes from 
its prohibitions securities transactions in which the bank acts as 
agent for its customers, which is considered agency activity under 
banking law. Under state banking law, insured state banks also 
generally may act as agent for their customers. Under federal law, 
insured state banks are prohibited from engaging as principal in any 
activities that are not permissible for national banks, unless the 
state banks comply with applicable capital standards and the Federal 
Deposit Insurance Corporation (``FDIC'') has determined that the 
activity will not pose a significant risk to the appropriate 
insurance fund. Federal Deposit Insurance Corporation Improvement 
Act of 1991, Pub. L. 102-242, Title III, Section 303, 12 U.S.C. 
1831a. Glass-Steagall Act Section 21, which is also still in effect, 
prohibits investment banks from offering checking or savings 
accounts. See 12 U.S.C. 378a.
    The GLBA also lowered barriers 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''). 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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[[Page 8687]]

    Among other things, the GLBA provided for functional regulation of 
securities activities by eliminating the complete exception for banks 
from the definitions of ``broker'' and ``dealer'' and replacing them 
with specific transaction-based exceptions. Before the GLBA amendments, 
Sections 3(a)(4) and 3(a)(5) of the Exchange Act provided that the 
terms ``broker'' and ``dealer'' did not include a ``bank.'' \4\ 
Accordingly, banks \5\ that engaged in securities activities were 
excepted from the requirement to register as broker-dealers under the 
Exchange Act.\6\ The amended statutory definitions create eleven 
``broker'' and four ``dealer'' exceptions for banks.
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    \4\ 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 * * *.''
    \5\ 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.
    \6\ 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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    In response to interpretive questions as well as industry-specific 
concerns, the Commission adopted the Rules on May 11, 2001 to give the 
banking industry guidance on the parameters of these new bank 
exceptions. Although the GLBA became law in November 1999, these 
amended statutory definitions had a delayed effective date of May 12, 
2001. Because the exceptions from the definition of ``broker'' and 
``dealer'' are exceptions to the Exchange Act, the Commission is 
statutorily charged with interpreting them. The Rules were designed to 
provide guidance by defining certain key terms used in the new 
statutory exceptions and provided additional exemptions from the 
definition of ``broker'' and ``dealer'' for banks that were engaged in 
certain types of securities transactions. Although the Rules were 
adopted as interim final rules, the Commission specifically solicited 
public comment on them.
    The amendments we are adopting today generally are limited to 
certain of the ``dealer'' exceptions under GLBA. While there are four 
statutory dealer exceptions, these amendments only define terms used in 
one of them--the exception for asset-backed transactions. These 
amendments also make the counting of riskless principal transactions 
more flexible under the de minimis exemption and create a new exemption 
for securities lending transactions, which will be an exception to the 
definitions of both broker and dealer for qualifying transactions.
    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.\7\ 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 through registered 
broker-dealers.\8\
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    \7\ H.R. Rep. No. 106-74, pt. 3, at 113 (1999).
    \8\ 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.'').
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II. Temporary Exemption From the Definition of ``Dealer''

    In order to give banks time to ensure that their securities 
transactions conform to the requirements of the GLBA, the Rules 
included a temporary exemption that effectively extended the general 
bank exception from broker-dealer registration.\9\ To further 
accommodate the industry's continuing compliance concerns, the 
Commission delayed the effective date of the bank ``dealer'' rules 
through a series of orders that ultimately extended the temporary 
exemption to February 10, 2003.\10\ Concurrently with issuing this 
Release, the Commission is issuing an additional Order extending the 
temporary exemption from the effective date of the bank ``dealer'' 
rules through September 30, 2003.\11\
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    \9\ 17 CFR 240.15a-7.
    \10\ Through an earlier order, the Commission delayed the 
effective date of the bank ``broker'' exceptions through orders that 
extended the temporary exemption to May 12, 2003.
    \11\ Rule 15a-9 continues to exempt savings associations and 
savings banks from the definitions of ``broker'' and ``dealer'' 
under Exchange Act Sections 3(a)(4) and 3(a)(5) on the same terms 
and conditions that apply to banks. This exemption is limited to 
savings associations and savings banks that have deposits insured by 
the FDIC under the Federal Deposit Insurance Act (``FDIA''). 12 
U.S.C. 1811 et. seq.
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III. General Comments on the Proposed Amendments

    We received 12 comments on the proposed amendments to the Rules 
relating to the definition of ``dealer'' for banks and the proposed 
exemption for securities lending.\12\ These comments

[[Page 8688]]

were from two banks, five bank associations, a coalition of banks, the 
general counsels of the Federal banking agencies, the state securities 
administrators' association, a pension fund, and one unknown 
person.\13\
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    \12\ See letter dated November 19, 2002, signed by Jackie G. 
Prester of Baker, Donelson, Bearman & Caldwell, on behalf of First 
Tennessee Bank, N.A. (``the First Tennessee Letter''); letter dated 
December 2, 2002, received incomplete and unsigned (``the Anonymous 
letter''); letter dated December 9, 2002, signed by Edward Rosen of 
Cleary, Gottlieb, Steen & Hamilton on behalf of an ad hoc coalition 
of banks consisting of The Bank of New York, Barclays Global 
Investors, N.A., Citibank, Credit Suisse First Boston, Deutsche 
Bank, HSBC, and JP Morgan Chase Bank (``the Coalition of Banks'' 
Letter''); letter dated December 10, 2002, signed by J. Virgil 
Mattingly, Board of Governors of the Federal Reserve System 
(``Federal Reserve''), William F. Kroener, FDIC, and Julie L. 
Williams, Office of the Comptroller of the Currency (``OCC'') (``the 
General Counsels'' Letter''); letter dated December 5, 2002, signed 
by Lawrence R. Uhlick of the Institute of International Bankers 
(``the IIB Letter''); letter dated December 5, 2002, signed by Sarah 
A. Miller of the American Bankers Association and ABA Securities 
Association (``the ABA/ABASA Letter''); letter dated December 6, 
2002, signed by Jeffrey P. Neubert of the New York Clearinghouse 
Association, whose members are: Bank of America, National 
Association; The Bank of New York; Bank One, National Association; 
Citibank, N.A.; Deutsche Bank Trust Company Americas; Fleet National 
Bank; HSBC Bank USA; JPMorgan Chase Bank; LaSalle Bank National 
Association; Wachovia Bank, National Association; and Wells Fargo 
Bank, National Association (``the NYCH Letter''); letter dated 
December 5, 2002, signed by Jeffrey S. Missman of the Compliance 
Department of Commerce Bancshares (``the Commerce Banc Letter''); 
letter dated December 5, 2002, signed by Joanne F. Shephard of the 
Independent Community Bankers of America (``the ICBA Letter''); 
letter dated December 12, 2002, signed Christine A. Bruenn of the 
North American Securities Administrators Association (``the NASAA 
Letter''); letter dated December 13, 2002, signed by Jose Arau of 
CalPERS (``the CalPERS Letter''); and letter dated December 24, 
2002, signed by Richard Whiting of the Financial Services Roundtable 
(``the Roundtable Letter'').
    \13\ One comment letter was received in an unsigned and 
incomplete form.
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    Generally, the commenters supported the efforts of the Commission 
and its staff in listening to the concerns of the banking industry, 
making the dealer rules more flexible, and making banks' compliance 
with the dealer rules easier.\14\ Several commenters also generally 
praised the Commission and its staff for proposing the securities 
lending exemption to provide banks with greater legal certainty in 
connection with their activities as custodians, clearing agents, and 
noncustodial agents or intermediaries, and in facilitating securities 
lending and borrowing transactions.\15\
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    \14\ See the First Tennessee Letter, the Coalition of Banks' 
Letter, the Commerce Banc Letter, the ICBA Letter, the IIB Letter, 
the ABA/ABASA Letter, the NYCH Letter, the NASAA Letter, and the 
CalPERS Letter.
    \15\ See the Coalition of Banks' Letter, the NYCH Letter, the 
CalPERS Letter, the ICBA Letter, the NASAA Letter, the IIB Letter, 
and the ABA/ABASA Letter.
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    The General Counsels of the Federal Reserve, the OCC, and the FDIC 
(``the General Counsels'') stated that they appreciate the efforts of 
the SEC reflected in the proposed rules as well as the opportunity 
provided to discuss how the Interim Final Rules would affect the 
activities and customer relationships of banks.\16\
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    \16\ See the General Counsels' Letter.
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    Finally, one commenter noted that the proposing Release included a 
discussion of the background of the GLBA.\17\ This commenter 
acknowledged that the primary purpose of the federal securities laws is 
to protect investors and that the primary purpose of the federal 
banking laws is to protect the solvency of banks. The Commenter, 
however, stated that federal banking laws, ``implement the banking 
laws'' purpose of protecting investors.''\18\
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    \17\ See the NYCH Letter.
    \18\ Id.
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    We note, however, that the federal securities laws are unique in 
providing a comprehensive, uniform, and coordinated system of 
regulation of securities activities under the oversight of a single 
expert regulator with the protection of investors as its overarching 
purpose.\19\
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    \19\ Among the unique investor protections provided by the 
federal securities laws are:
    (1) Uniform qualifications and testing requirements, including 
continuing education, of the registered representative sales force.
    (2) Explicit supervision of sales personnel through liability 
that is imposed on a registered broker-dealer and its supervisory 
personnel under statutory provisions addressing responsibility for 
``failure to supervise'' and ``controlling person liability.'' See 
Exchange Act Sections 15(b)(4)(E) and 20 [15 U.S.C. 78o(b)(4)(E) and 
78t(a)]. These provisions hold broker-dealers and broker-dealer 
supervisory personnel responsible for the conduct of line personnel.
    (3) Membership in the Securities Investor Protection Corporation 
(SIPC), which provides insurance in the event of broker-dealer 
insolvency. Missing securities and cash of investors are guaranteed 
up to $500,000, including a maximum of $100,000 for cash claims. 
Transactions with affiliates of SIPC insured broker-dealers, such as 
banks, are not covered by SIPC.
    (4) Self-Regulatory Organization rules governing broker-dealer 
sales practices aimed at protecting investors, as well as other 
market-oriented rules aimed at fostering fair and competitive 
securities markets.
    See generally Statement of the U.S. Securities and Exchange 
Commission Concerning Bank Securities Issues to the Subcommittee on 
Oversight and Investigations, Committee on Commerce, U.S. House of 
Representatives Testimony of Arthur Levitt, Chairman, U.S. 
Securities and Exchange Commission, Concerning Financial 
Modernization Legislation, Before the Committee on Banking, Housing, 
and Urban Affairs, U.S. Senate (February 24, 1999).
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    The remainder of the comments dealt with specific issues related to 
the proposal and will be discussed in connection with the final rules, 
below.

IV. 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, and 
excepts persons, whether banks or non-banks, who do not buy or sell 
securities ``as part of a regular business.'' \20\ Therefore, banks, 
like other active participants in the securities markets need not 
register unless they satisfy these criteria.
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    \20\ Exchange Act Section 3(a)(5) [15 U.S.C. 78c(a)(5)]. See 
also Proposing Release at 67 FR 67498.
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    As developed over the years, the dealer definition has been 
interpreted to exclude ``traders.'' 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 inventory (or participate in the 
sale or distribution of new issues, such as by acting as an underwriter 
\21\), and generally provide liquidity services in transactions with 
investors (or, in the case of dealers who are market makers, for other 
professionals).\22\
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    \21\ The term ``underwriter'' is defined in Section 2(a)(11) of 
the Securities Act of 1933 [15 U.S.C. 77b(a)(11)]. In determining 
whether a bank is acting as an underwriter when it undertakes 
particular securities activities, the Commission is not expressing 
any views on whether those activities would constitute 
``underwriting'' for purposes of Section 16 of the Glass-Steagall 
Act. The Commission wishes to emphasize that the determination of 
dealer status with respect to securities transactions, including 
those that do not involve a public offering, must be made by 
reference to the federal securities laws. It is the Commission's 
view, however, that the fact that an offering is exempt from 
registration under the Securities Act of 1933 (``Securities Act'') 
[15 U.S.C. 77a, et seq.] does not necessarily affect the status of a 
participant in that offering as an ``underwriter'' as defined in 
Securities Act Section 2(a)(11). Furthermore, in general the 
determination of broker or dealer status under the Exchange Act 
primarily depends on the broader definitions of ``purchase'' and 
``sale.'' See Exchange Act Section 3(a)(13) and 3(a)(14) [15 U.S.C. 
78c(a)(13) and78c(a)(14)].
    \22\ 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, maintained a trading account 
or carried a dealer inventory, advertised itself as a dealer or 
otherwise held itself out as a dealer).
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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 of the analysis, which is the general ``dealer/trader'' 
distinction,\23\ 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 
transactional 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.
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    \23\ 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. 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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    We received two comments on the dealer/trader analysis that we set 
forth in the proposing Release.\24\ One commenter stated: ``The Release 
also recognized the customary distinction under the securities laws 
between a ``dealer'' and a ``trader,'' observing that ``banks may have 
a legitimate need to, on occasion, lend or borrow securities on their 
own behalf for hedging or for other reasons' and that, in such 
circumstances, ``they should be subject to the same dealer/trader 
distinction that applies to all other market participants.'' We agree 
wholeheartedly with all of these statements.'' \25\
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    \24\ See the NYCH letter and the Coalition of Banks' letter.
    \25\ See the NYCH Letter.

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[[Page 8689]]

    Our dealer/trader discussion was meant to give guidance on the 
underlying principles that should be applied to any factual 
situation.\26\ 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. A bank therefore should look to the securities laws and 
the Commission's rules and interpretations in conducting its analysis 
under the Exchange Act.\27\
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    \26\ We have given recent guidance on what constitutes 
``dealer'' activity. See OTC Derivatives Dealers, Release No. 34-
40594, Section II.A.1., n. 61, 63 FR 59362 at 59370 (November 3, 
1998). As we explained with respect to a group of derivative dealers 
that engage in limited activities:
    [E]xcept to the extent expressly permitted under the rules and 
rule amendments, an OTC derivatives dealer may not engage directly 
or indirectly in any activity that may otherwise cause it to be a 
``'dealer''' as defined in Section 3(a)(5) of the Exchange Act (15 
U.S.C. Sec.  78c(a)(5)). This includes, but is not limited to, 
without regard to the security, (1) purchasing or selling securities 
as principal from or to customers; (2) carrying a dealer inventory 
in securities (or any portion of an affiliated broker-dealer's 
inventory); (3) quoting a market in or publishing quotes for 
securities (other than quotes on one side of the market on a 
quotations system generally available to non-broker-dealers, such as 
a retail screen broker for government securities) in connection with 
the purchase or sale of securities permitted under Rule 15a-1; (4) 
holding itself out as a dealer or market-maker or as being otherwise 
willing to buy or sell one or more securities on a continuous basis; 
(5) engaging in trading in securities for the benefit of others 
(including any affiliate), rather than solely for the purpose of the 
OTC derivatives dealer's investment, liquidity, or other permissible 
trading objective; (6) providing incidental investment advice with 
respect to securities; (7) participating in a selling group or 
underwriting with respect to securities; or (8) engaging in 
purchases or sales of securities from or to an affiliated broker-
dealer except at prevailing market prices.
    \27\ Of course, 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, if necessary, 
to assist it in that analysis.
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    The other commenter asked whether the failure to meet a condition 
of a statutory exception or Commission exemption was sufficient reason 
to presume dealer activity.\28\ A bank has flexibility when it analyzes 
whether its securities activities would require it to register with the 
Commission as a dealer. As we stated in the proposing Release, as an 
analytical matter, 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 selling securities for its own account 
``as part of a regular business.'' If the bank meets that part of the 
test, then the bank would have to consider whether those securities 
activities fall within one of the bank-specific transaction 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 exceptions or exemptions 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. A bank that relies on a transaction 
exception or an exemption must meet all of the terms of that exception 
or exemption in order to claim it.
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    \28\ See the Coalition of Banks' letter. This commenter also 
urged the Commission to confirm that in analyzing whether a 
particular activity undertaken by a non-bank person, the existence 
or non-existence of a GLBA bank exception or exemption for that 
activity is not relevant to the analysis of whether that activity 
would constitute ``broker'' activity. Although we believe that this 
statement is generally true, we will address ``broker'' activity 
later when we propose amendments to the Rules pertaining to banks' 
exceptions from the definition of broker. In addition, this 
commenter noted that because so much of the dealer/trader 
distinction is set forth in the context of the Commission staff's 
no-action and interpretive letters, it would be helpful for the 
Commission to note the existence of these letters, clarify that 
these letters are still valid, and confirm that the proposing 
Release was intended to summarize, but not to modify, the 
traditional ``dealer/trader'' distinction. Because the Commission 
staff's letters have been written over the seven decades of the 
Commission's existence and are based on specific factual situations, 
we do not believe that it is appropriate to re-visit these letters 
in the context of adopting these amendments to the Rules.
---------------------------------------------------------------------------

    Finally, we note that our analysis of what constitutes ``dealer'' 
activity has not changed for persons that are not banks merely because 
banks have specific transactional exceptions and exemptions. These bank 
exceptions and exemptions provide banks with legal certainty for 
transactions conducted in accordance with the terms of these exceptions 
and exemptions. 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.
    In general, the bank dealer exceptions apply to transactions in 
specified products and contain limiting conditions. Some of these bank 
exceptions and exemptions are more restrictive than others. For 
example, while some bank dealer exceptions permit a bank to buy and 
sell securities, 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.\29\ In addition, the investment 
transactions exception only permits the bank to buy or sell securities 
``for investment purposes'' for its own account or in the accounts for 
which it acts as a trustee or fiduciary.\30\
---------------------------------------------------------------------------

    \29\ See Exchange Act Section 3(a)(5)(C)(iii). [15 U.S.C. 
78c(a)(5)(C)(iii).]
    \30\ See Exchange Act Section 3(a)(5)(C)(ii). [15 U.S.C. 
78c(a)(5)(C)(ii).]
---------------------------------------------------------------------------

    In sum, as a bank considers its securities activities, it must 
evaluate the totality of these activities to determine if they 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 (or broker) registration requirements under 
the Exchange Act.\31\
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    \31\ 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 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).
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V. Discussion of Comments and Adoption of ``Dealer'' Rules

    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 specified securities products if the bank complies with 
the enumerated statutory conditions. The GLBA bank ``dealer'' 
exceptions are outlined briefly below.\32\
---------------------------------------------------------------------------

    \32\ This outline is a summary. It does not describe the 
exceptions in full. See Exchange Act Section 3(a)(5). [15 U.S.C. 
78c(a)(5).]
---------------------------------------------------------------------------

    [sbull] Investment transactions: permits banks to buy and sell 
securities for investment purposes for the bank and in 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-

[[Page 8690]]

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 the proposing Release, we proposed amendments to those definitions 
as well as to the exemption for a de minimis number of riskless 
principal transactions. We also proposed a new exemption for securities 
lending transactions. The changes we have made in response to comments 
are discussed below.

A. Rule 3a5-1--the De Minimis Exemption for Riskless Principal 
Transactions

    In the Rules, the Commission provided an exemption that permits 
riskless principal transactions \33\ as well as brokerage transactions 
to be counted under the 500-transaction limit.\34\ The proposed 
amendment would permit a riskless principal transaction, even if it 
involves two separate counterparties, to count as only one transaction 
against the annual 500-transaction limit.
---------------------------------------------------------------------------

    \33\ ``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)]; Release No. 34-33743 (Mar. 9, 1994) at n.11.
    Under the securities laws, riskless principal transactions are 
dealer activity. One commenter urged the Commission to adopt the 
position that riskless principal transactions are agency 
transactions and suggested that the Commission bring its views into 
accord with long-held banking practice. See the ICBA Letter. Because 
the securities laws' interpretations of riskless principal 
transactions are also long-standing and specifically designed for 
the protection of investors, we decline to adopt the banking law 
view. We note that the statutory bank exceptions from the 
definitions of broker and dealer are limited by their terms to the 
statutory language, and do not extend to transactions that are the 
legal or economic equivalent of the statutory exceptions.
    \34\ Exchange Act Section 3(a)(4)(B)(xi) [15 U.S.C. 
78c(a)(4)(B)(xi)] excepts a bank from the definition of broker if it 
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.
---------------------------------------------------------------------------

1. Discussion of Comments Received on the Amendment to Rule 3a5-1--the 
De Minimis Exemption
    Only two commenters addressed this exemption.\35\ Both commenters 
commended the Commission for proposing to count the buy and sell 
components of a ``riskless principal'' transaction as one transaction 
for purposes of the de minimis exemption.\36\
---------------------------------------------------------------------------

    \35\ See the ICBA Letter and the IIB Letter.
    \36\ Id.
---------------------------------------------------------------------------

2. Amendment to Rule 3a5-1--the De Minimis Exemption
    After considering the comments, we are adopting this amendment 
without substantive change.\37\ We believe that this amendment 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. Thus, under 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.\38\
---------------------------------------------------------------------------

    \37\ We are, however, making a technical amendment to the rule 
to conform to a technical comment we received on the securities 
lending exemption. Because of that comment, we are changing the 
language of this rule. Instead of a bank being exempt, ``solely for 
engaging in,'' it will be exempt from the definition of the term 
dealer ``to the extent that it engages in or effects,'' riskless 
principal transactions. We are persuaded that this language more 
clearly sets forth the limited conduct permitted under the 
exemption. Although the comment was directed only to the securities 
lending exemption, we believe that the language of the exemptions 
should be consistent and are adopting this rule with this amendment.
    \38\ If, however, a bank acts as an intermediary between one 
counterparty and multiple counterparties by arranging multiple 
transactions, the bank must count each of the transactions on the 
side of the intermediation that involves the largest number of 
transactions as a separate transaction against the annual 500 
transaction-limit.
---------------------------------------------------------------------------

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

    The GLBA asset-backed exception 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.\39\ As we explained when we 
adopted the Rules, this statutory exception only allows banks to issue 
and sell asset-backed securities to qualified investors through a 
grantor trust or other separate entity. It does not 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.\40\
---------------------------------------------------------------------------

    \39\ Exchange Act Section 3(a)(5)(C)(iii) [15 U.S.C. 
78c(a)(5)(C)(iii)].
    \40\ 66 FR 27760 at 27785 (May 18, 2001).
---------------------------------------------------------------------------

    Exchange Act Rule 3b-18 defines terms used in the asset-backed 
transactions exception to clarify the parameters of this exception. In 
particular, Rule 3b-18 defines the terms: ``affiliate,'' ``consumer-
related receivable,'' ``member of a syndicate of banks,'' 
``obligation,'' ``originated,'' ``pool,'' ``predominantly originated,'' 
and ``syndicate of banks.'' After consulting the banks that engage in 
this business and considering their business practices, we proposed 
amendments to some of the definitions of terms used in the asset-backed 
transactions exception.
    In particular, we proposed expanding the definition of 
``originated'' in Rule 3b-18(e) 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 meets two conditions. 
First, the obligation must conform to the bank's underwriting standards 
or be evidenced on the bank's documents. This requirement is intended 
to ensure that the bank and the entity from which 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 must fund the obligation in a timely 
manner, not to exceed six months after the obligation is created.
    As we explained in the proposing Release, 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 an obligation that does not meet the 
conditions of this exemption would not have ``originated'' the 
particular obligation for the purpose of meeting the test that the 
obligations in the pool backing an issuance of securities were 
predominately originated by the bank and its affiliates.
    Rule 3b-18(g) defines ``predominantly originated'' so that a bank 
may 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, or any permitted syndicate of which 
the bank is more than an insignificant member. Specifically, the bank, 
its affiliates, or any such syndicate must

[[Page 8691]]

have originated 85% of the obligations in any pool as measured by the 
value of the obligations. We did not change the 85% requirement for the 
purpose of the asset-backed transaction exception. To enhance clarity, 
however, we proposed a change to the definition of ``predominantly 
originated'' in Rule 3b-18(g) 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. We received no comments on 
this change.
    To enhance clarity, we also proposed to substitute two separate 
definitions for the definition of ``member of a syndicate of banks'' 
found Rule 3b-18(c). In particular, we first proposed to define 
``member'' as it relates to the term ``syndicate of banks'' in proposed 
Rule 3b-18(c) to make clear that the individual banks and their 
affiliates other than their broker or dealer affiliates, originate the 
obligations, rather than the syndicate. This change recognizes that the 
syndicate of banks only comes together to issue and sell the 
obligations. Second, we proposed to modify the definition of 
``syndicate of banks'' in Rule 3b-18(h) 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.
    We proposed to keep the requirement found in Rule 3b-18(c) 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 an exception from the 
definition of dealer.\41\ 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, propose a change 
to the rule to clarify that the affiliates of the banks other than 
broker or dealer affiliates also may originate the obligations.
---------------------------------------------------------------------------

    \41\ We proposed 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. 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. 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).
---------------------------------------------------------------------------

1. Discussion of Comments Received on the Amendment to Rule 3b-18--
Definition of Terms Used in Asset-Backed Exception to Dealer 
Registration
    We received four comments regarding the proposed amendments to Rule 
3b-18.\42\ One commenter supported the proposed amendments and 
specifically agreed with our clarification of when a bank 
``predominantly originates'' obligations.\43\ One commenter stated that 
requiring a bank to originate at least 85% of the loans under an asset-
backed transaction is likely to be a barrier to community banks' 
ability to sell loans on the secondary market and recommended that we 
adopt a definition that would allow a bank to originate only a simple 
majority (i.e. 51%) of the underlying loans.\44\
---------------------------------------------------------------------------

    \42\ See the ICBA Letter, the First Tennessee Letter, the 
General Counsels' Letter, and the NASAA Letter.
    \43\ See the NASAA Letter.
    \44\ See the ICBA Letter.
---------------------------------------------------------------------------

    Two commenters stated that the use of the term ``initially'' in the 
definition of ``originate'' could be interpreted to require a 
correspondent bank to enter into a firm contractual commitment to sell 
a loan prior to funding for the loan to be considered ``originated'' by 
the bank utilizing the asset-backed transactions exception.\45\ These 
commenters suggested eliminating the word ``initially'' or changing the 
term ``provided that'' to ``as evidenced by'' to indicate that the test 
would be met by fulfilling the conditions. Alternatively, they 
suggested that the Commission provide guidance as to the meaning of 
``initially approving and underwriting'' and ``initially agreeing to 
purchase'' to clarify when the approval or agreement must be in place 
and whether a contractual commitment must be in place to fund a loan 
for the loan to be considered originated by the purchasing bank.
---------------------------------------------------------------------------

    \45\ See the First Tennessee Letter and the General Counsels' 
Letter.
---------------------------------------------------------------------------

2. Amendments to Rule 3b-18--Definition of Terms Used in Asset-Backed 
Exception to Dealer Registration
    In the proposing Release, we noted we had been informed that very 
few banks issue and sell asset-backed securities without employing a 
registered broker-dealer. Indeed, we had identified only two banks that 
conduct this business without a broker-dealer. Although we requested 
comment on whether any additional banks engage in issuing and selling 
asset-backed securities without utilizing a broker-dealer, we received 
no comments on this question.
    Based on the comments received, we expect that the amendments we 
are adopting 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. Thus, while not 
necessarily covering all hypothetical business practices, the proposed 
amendments appear to accommodate current business practice. We are, 
therefore, adopting the definitions as proposed.
    Although we are sensitive to the concerns expressed by the two 
commenters regarding the definition of ``originated,'' we continue to 
believe that to meet the test of having ``originated'' a loan, a bank 
must have some established relationship to the entity making the loan 
at the time the loan is initially made. The proposed definition does 
not require the bank to have a binding contractual relationship with 
the person making the loan at the time the loan is made. Rather, the 
rule requires the bank to have some established relationship to the 
entity making the loan. In addition, the loan must be made using the 
underwriting standards of the bank. We believe the proposed definition 
of the term ``originated'' permits a bank to have some flexibility in 
the way that it structures its relationship to the borrower and to the 
person who deals directly with the borrower. We believe that the 
proposed definition of the term ``originated'' appropriately balances 
the needs of banks for flexibility while also giving effect to the 
statutory requirement that the bank and its affiliates predominantly 
originate the loans backing the securities.
    With respect to the 85% test, as we explained in the proposing 
Release, we included this requirement to define ``predominantly 
originated'' because the test closely tracks the language of the 
statute.\46\ We did not propose changing

[[Page 8692]]

this test, and only one trade group urged us to relax this requirement. 
Because the definition closely tracks the statutory provision, we are 
retaining the current test.
---------------------------------------------------------------------------

    \46\ 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 
``predominately'' 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 received no comments on the technical, clarifying changes that 
we proposed. First, we revised the definition of ``predominantly 
originated'' in Rule 3b-18(g) to expressly set forth the meaning of the 
term in the context of a syndicate of banks. Second, we substituted the 
definitions of ``member'' as it relates to the term ``syndicate of 
banks'' for the definition of ``member of a syndicate of banks'' found 
in Rule 3b-18(c). Third, we proposed a change to Rule 3b-18(c) to 
clarify that the affiliates of banks other than broker-dealer 
affiliates, also may originate the obligations in a pool of obligations 
issued by a syndicate of banks. We are adopting each of these 
amendments without substantive change.\47\
---------------------------------------------------------------------------

    \47\ We are, however, making a technical amendment to paragraph 
(e) of the rule to conform the language in the definition of 
``originate'' to include obligations of an affiliate of a bank, 
other than a broker-dealer affiliate within the broader reading of 
the term.
---------------------------------------------------------------------------

C. 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 transactions. Exchange Act Section 
3(a)(4)(B)(viii) addresses securities lending by custodian banks as an 
exception to the definition of broker.\48\ Under paragraph (cc) of this 
section, 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.
---------------------------------------------------------------------------

    \48\ 15 U.S.C. 78c(a)(4)(B)(viii).
---------------------------------------------------------------------------

    We proposed the exemption in Rule 15a-11 in part because we had 
been advised that the existence of this limited statutory 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 proposed 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 was also intended to 
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 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.\49\ Less 
frequently, banks may engage in securities lending as principal while 
acting as a conduit between the parties.\50\ We did not propose 
extending the securities lending exemption to a bank borrowing 
securities for, or lending from, its own accounts, except as a conduit 
lender. For the purposes of this exemption, we proposed to define the 
term conduit lender as 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.\51\ 
When banks conduct conduit transactions, they are conducting principal 
transactions that involve principal risk, including reliance by the 
counterparty on the creditworthiness of the bank.\52\ We proposed that 
a bank that qualifies under our definition of 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.
---------------------------------------------------------------------------

    \49\ Under banking law, with some limited exceptions, banks are 
not permitted to own equity securities.
    \50\ See the Coalition of Banks' Letter, which stated that by 
confirming that banks may continue to engage in securities lending 
as riskless principals, the proposed exemption will help ensure that 
institutional lenders can still achieve the benefits of credit 
intermediation and anonymity when lending through banks.
    \51\ 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 is a dealer activity 
because the ``book running dealer'' holds itself out as willing to 
buy and sell and thus as engaged in the business of buying and 
selling securities.
    \52\ This is not meant to indicate that an agent for an 
undisclosed principal would not also have direct personal liability 
to the parties with whom it dealt because the counterparty would be 
relying on the credit of the agent, rather than the principal. See 
Restatement (Second) of Agency Sec.  322 (1958).
---------------------------------------------------------------------------

    The proposed exemption required 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, a 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 proposed to limit the exemption to transactions with ``qualified 
investors,'' as defined in Exchange Act Section 3(a)(54).\53\ We 
proposed a requirement that a bank deal with a qualified investor on 
both sides of the transaction as a condition of this exemption because 
we are making this exemption available for banks' current securities 
lending business. Broker-dealers are currently the most frequent 
borrowers of securities. 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

[[Page 8693]]

intermediaries that would be qualified investors.
---------------------------------------------------------------------------

    \53\ See discussion at Section D, infra.
---------------------------------------------------------------------------

    In the proposing Release, we specifically acknowledged that 
engaging in securities lending transactions involves taking risks that 
require effective internal controls, and highlighted the fact that we 
were not proposing a requirement that banks meet the conditions that 
are applicable to broker-dealers engaging in stock lending. We proposed 
an exemption for banks because we believe that it will assist 
institutional investors in obtaining stock loan services from banks 
that do not act as their custodians and because it would cause less 
disruption to the market if banks were permitted to continue to engage 
in these transactions.
1. Discussion of Comments Received on the Amendment to Rule 15a-11--
Exemption From the Definitions of ``Broker'' and ``Dealer'' for Banks 
Engaging in Securities Lending Transactions
    Several commenters strongly supported the Commission for proposing 
the adoption of the exemption for securities lending to allow banks to 
continue engaging in custodial and non-custodial securities lending 
activities.\54\
---------------------------------------------------------------------------

    \54\ See the Coalition of Banks' Letter, the NYCH Letter, the 
CalPERS Letter, the ICBA Letter, the NASAA Letter, the IIB Letter, 
and the ABA/ABASA Letter.
---------------------------------------------------------------------------

    One of these commenters specifically urged the Commission to adopt 
the securities lending exemption to provide banks with greater legal 
certainty in connection with their activities as custodians, clearing 
agents, and noncustodial agents or intermediaries, and in facilitating 
securities lending and borrowing transactions.\55\ The same commenter 
also stated that by confirming that banks may engage in securities 
lending transactions regardless of whether they are also custodians or 
clearing agents, the proposed exemption will help ensure that 
institutional investors can continue to ``unbundle'' securities lending 
services from other bank services and obtain such services in the 
manner that best addresses their needs.\56\
---------------------------------------------------------------------------

    \55\ See the Coalition of Banks' Letter.
    \56\ See the Coalition of Banks' Letter.
---------------------------------------------------------------------------

    The General Counsels, however, expressed the view that an SEC-
granted exemption for non-custodial agency activities is unnecessary 
because the custody exception in Exchange Act Section 3(a)(4) is 
sufficiently broad to encompass situations where a bank acts as a non-
custodial agent in securities lending transactions.\57\ They stated 
that the statute ``protects securities lending services that a bank 
provides as agent and `as part of' the bank's custodial and safekeeping 
activities. They also stated that both the custodial and non-custodial 
securities lending services offered by banks have grown out of, and 
remain integrally related to, the custody business of banks and, thus, 
are offered `as part of' customary custody services.'' \58\
---------------------------------------------------------------------------

    \57\ See the General Counsels' Letter.
    \58\ Id.
---------------------------------------------------------------------------

    We disagree with the interpretation of the Exchange Act bank 
exceptions advanced in this comment letter. The exceptions found in the 
GLBA and the additional exemptions granted by the Commission apply to 
specific, qualifying transactions that permit banks to engage in these 
transactions without having to register as broker-dealers under the 
securities laws. The exceptions found in the GLBA and the additional 
exemptions granted by the Commission are limited by their terms to the 
transactions listed and do not extend to transactions that are related, 
incidental, or the economic equivalent of the transactions listed in an 
exception or exemption. They are also not activity-based exceptions and 
exemptions that should be read to include any related transactions that 
might be performed by the same employees that engage in transactions 
that are covered within the terms of the exceptions or exemptions.
    Specifically, paragraph (cc) of Exchange Act Section 
3(a)(4)(B)(viii) limits securities lending to two situations.\59\ A 
bank is permitted, without being considered a broker, to effect 
securities lending or borrowing transactions: (1) As part of customary 
banking activities 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 as part of customary banking 
activities.
---------------------------------------------------------------------------

    \59\ Exchange Act Section 3(a)(4)(B)(viii)(cc) [15 U.S.C. 
78c(a)(4)(B)(viii)(cc)] provides that a bank may effect ``securities 
lending or borrowing transactions with or on behalf of customers as 
part of services provided to customers pursuant to division (aa) or 
(bb)'' or invest ``cash collateral pledged in connection with such 
transactions.''
---------------------------------------------------------------------------

    In response to the exemption we proposed, General Counsels advanced 
a general argument that no securities lending exemption was necessary, 
except with respect to conduit transactions. This argument fails to 
address the limits that Congress imposed on securities lending 
transactions within the custody exception, or to give effect to all of 
the terms found in the statutory provisions. Thus, we believe that this 
argument disregards the plain meaning of the statute.
    Moreover, the argument advanced by the General Counsels, even if we 
were to accept it, would not give banks legal certainty for engaging in 
securities lending transactions because the argument fails to address 
all of the uncertainty that banks have identified. For example, their 
interpretation would only permit a bank to be excepted from the 
definition of broker without having custody of the underlying 
securities when it invests cash collateral pledged in connection with a 
securities lending transaction. Their interpretation would not address 
any other actions the bank might take in connection with the securities 
lending transaction, and also would not address any transactions that 
would not be excepted from the bank definition of dealer. In contrast, 
we believe that our interpretation gives effect to all of the statutory 
provisions, and that the exemption we are adopting will permit banks to 
continue to engage in securities lending transactions with the legal 
certainty they requested.
    Two commenters agreed with limiting the exemption to transactions 
with qualified investors.\60\ In particular, a pension fund in support 
of the exemption stated that: ``[a]s a supplier of securities for 
lending, CalPERS believes that a leveling of the playing field for non-
custodial banks should lead to increased competition between custodial 
and non-custodial banks, expanded liquidity, greater trading 
efficiencies, and lower borrowing and execution costs. As a major 
institutional investor, CalPERS believes the limitation of the 
exemption to ``qualified investors'' ensures that the regulatory gap 
between banking law (concerned about bank solvency) and securities law 
(concerned about investor protection) has been successfully narrowed.'' 
\61\ The state securities administrators also specifically agreed with 
limiting the securities lending exemption to ``qualified investors.'' 
\62\
---------------------------------------------------------------------------

    \60\ See the CalPERS Letter and the NASAA Letter.
    \61\ See the CalPERS Letter.
    \62\ See the NASAA Letter.
---------------------------------------------------------------------------

    The General Counsels, however, stated that they believed that an 
exemption for conduit lending activities is appropriate but should not 
be limited to qualified investors.\63\
---------------------------------------------------------------------------

    \63\ See the General Counsels' Letter.
---------------------------------------------------------------------------

    Although they conceded that the securities lending market is 
institutional in nature, they stated that the proposed ``qualified 
investor'' restriction is inconsistent with the statutory framework and 
should be deleted

[[Page 8694]]

because Congress did not place any such restriction on the statutory 
exception for securities lending.\64\ Another commenter noted that the 
``qualified investor'' requirement may limit the scope of securities 
lending activities that banks might otherwise engage in, but also 
indicated that it does not believe that there is a substantial amount 
of securities lending transactions conducted by banks in a non-
custodial or non-clearing capacity with persons other than qualified 
investors.\65\ In adopting this exemption, we plan to retain the 
requirement that securities lending transactions be conducted only with 
qualified investors.
---------------------------------------------------------------------------

    \64\ Id.
    \65\ See the Coalition of Banks' Letter.
---------------------------------------------------------------------------

    We specifically asked banking regulators to advise us if the 
securities lending exemption would pose any risks that the Commission 
should address. Neither the banking regulators, nor any other commenter 
identified any risks that we should address. The General Counsels 
specifically stated that: ``we do not believe there are any risks 
related to the securities lending activities of banks that the 
Commission needs to address in this rulemaking.'' \66\
---------------------------------------------------------------------------

    \66\ See the General Counsels' Letter.
---------------------------------------------------------------------------

    We also requested comment on whether our choice not to impose 
conditions to the exemption that would require that banks conform to 
the standards applicable to registered broker-dealers that engage in 
securities lending transactions was appropriate.\67\ Three commenters 
stated that no additional conditions were necessary and that the 
conditions applicable to broker-dealers should not be imposed on banks' 
securities lending transactions.\68\ One of these commenters stated 
that any such conditions would create an unfair burden on banks and 
would be unnecessary due to the exemption's limit to transactions with 
qualified investors.\69\ The General Counsels' Letter stated, ``it 
would be unnecessary and inappropriate for the Commission to impose any 
additional restrictions on the securities lending activities of 
banks.'' \70\ No commenters suggested that those conditions should be 
imposed on banks under this exemption.
---------------------------------------------------------------------------

    \67\ See e.g., Rule 15c3-3(b)(3) [17 CFR 240.15c3-3(b)(3)].
    \68\ See the General Counsels' Letter, the NYCH Letter, and the 
Coalition of Banks' Letter.
    \69\ See the NYCH Letter.
    \70\ See the General Counsels' Letter.
---------------------------------------------------------------------------

    One commenter agreed that securities lending should be conducted 
under a written agreement.\71\ Some commenters suggested technical and 
other clarifications, or changes.\72\ These specific suggestions will 
be discussed and responded to in the next section.
---------------------------------------------------------------------------

    \71\ See the ICBA Letter.
    \72\ See e.g., the Coalition of Banks' Letter and the NYCH 
Letter.
---------------------------------------------------------------------------

2. Amendment to Rule 15a-11--Exemption From the Definitions of 
``Broker'' and ``Dealer'' for Banks Engaging in Securities Lending 
Transactions
    We received a number of comments that requested technical changes 
to the language in the securities lending exemption. We agree that many 
of these changes will enhance the clarity of the securities lending 
exemption as well as the legal certainty afforded to banks. In 
addition, some of the comments requested that we expand the exemption 
in certain respects to give banks greater flexibility in conducting 
securities lending transactions. We also agree with many of these 
changes and are adopting a more flexible rule.
    One commenter asked the Commission to confirm that term loans of 
securities are as ``agreed by the parties'' in Rule 15a-11(b).\73\ We 
agree that term loans of securities would be considered as ``agreed by 
the parties'' under the exemption.
---------------------------------------------------------------------------

    \73\ See the Coalition of Banks' Letter.
---------------------------------------------------------------------------

    Two commenters urged the Commission to change the required form of 
the documentation in Rule 15a-11(a) as long as the bank is dealing with 
a ``qualified investor.'' \74\ These commenters argued that the 
availability of the exemption should not turn on the form of 
documentation used by the parties.\75\ In their view, where a bank is 
acting as a conduit lender, it may not enter into a separate 
``agreement to provide securities lending services'' with the lender. 
Instead, it may have two ``securities lending agreements': one with the 
lender and one with the borrower. The terms of the agreement with the 
lender would normally include those items listed in the proposed 
exception that the parties deemed relevant. These commenters suggested 
that the bank would still, in effect, be providing securities lending 
services to the lender by borrowing securities in accordance with the 
securities lending agreement between the parties and in turn lending 
those securities to a third party.\76\ We agree. We believe that it is 
unnecessary for a bank taking advantage of this exemption to develop a 
form of agreement solely to meet the terms of the wording of our 
exemption. Thus, we are eliminating the requirement that there be a 
securities lending agreement. We believe that in many instances, banks 
will have a securities lending agreement, especially for agency lending 
transactions, but we do not believe that it is necessary for us to make 
the existence of a securities lending agreement a condition of this 
exemption. We are, however, retaining the list of securities lending 
services that may be conducted in connection with a securities lending 
transaction within a definition of ``securities lending services.''
---------------------------------------------------------------------------

    \74\ See the Coalition of Banks' Letter and the NYCH Letter.
    \75\ Id.
    \76\ Id.
---------------------------------------------------------------------------

    Two commenters urge that replacement transactions for a conduit 
lender should be permitted under this exemption.\77\ One of these 
commenters states that ``[p]ermitting a replacement transaction would 
maintain the bank's matched loan and borrow of securities.'' \78\ We 
proposed an exemption that did not permit conduit lenders to replace 
transactions, because we believed that these bank conduit transactions 
should be riskless principal transactions as evidenced by being entered 
into contemporaneously. We considered limiting the number of 
substitutions of parties that could occur. Although we continue to have 
some reservations about the risk that we may be permitting banks to 
have a book of matched securities loans, we have become convinced that 
limiting the number of substitutions of parties that could occur would 
require banks to prepare additional documentation without necessarily 
limiting their dealer transactions. We continue to believe, however, 
that any substitution of parties to securities lending transactions 
should occur within one business day of the termination of the 
securities lending contract by the other party. We are, therefore, 
adopting this change to the rule.
---------------------------------------------------------------------------

    \77\ See the Coalition of Banks' Letter and the NYCH Letter.
    \78\ See the NYCH Letter.
---------------------------------------------------------------------------

    We also proposed amendments providing only for substitutions of 
collateral on the securities borrowing side of the transaction. In re-
evaluating the language of Rule 15a-11(d), however, we are deleting the 
words, ``on the securities borrowing side of the transaction'' to 
permit substitutions of collateral to occur on both sides of the 
securities lending transaction as suggested by one of the 
commenters.\79\ We have been persuaded that we should permit a conduit 
lender to replace collateral on either side of a conduit transaction 
under this rule.
---------------------------------------------------------------------------

    \79\ See the NYCH Letter.
---------------------------------------------------------------------------

    This same commenter stated that the position of the word ``solely'' 
in the

[[Page 8695]]

context of the exemption may be confusing because it might be 
interpreted as attempting to narrow in certain respects the statutory 
custodial lending exception by imposing a restriction to ``qualified 
investors.'' \80\ This commenter asks that we replace ``solely to 
engage in or effect'' with ``to the extent that it engages in or 
effects.'' We agree that the language suggested by the commenter avoids 
this ambiguity and have incorporated this suggestion into the final 
rule we are adopting today.\81\
---------------------------------------------------------------------------

    \80\ Id.
    \81\ For consistency, we made a similar change in the language 
of Rule 3a5-1.
---------------------------------------------------------------------------

    Another commenter stated that the use of the word ``solely'' in the 
securities lending exemption could be read to mean that a bank may not 
provide any other services in connection with non-custodial securities 
lending transactions.\82\ That commenter asked that we clarify that the 
securities lending exemption and fiduciary exception could both be used 
for the same client. Although both the exemption and the exception 
could be used for the same client, each transaction would have to meet 
all of the elements of one of them.\83\
---------------------------------------------------------------------------

    \82\ See the ABA/ABASA Letter.
    \83\ This issue arises only in the context of the ``broker'' 
exception for trust and fiduciary activities. The issue does not 
arise in the context of the ``dealer'' exception for fiduciary 
transactions because the ``dealer'' exception for trustee and 
fiduciary transactions only applies when the bank buys or sells 
securities for investment purposes for the bank, or in accounts for 
which the bank acts as a trustee or fiduciary. We note, however, 
that in giving meaning to the term ``fiduciary'' in Section 
3(a)(5)(C)(ii), we look to the legislative history. The legislative 
history states that [Exchange Act Section 3(a)(5)] ``excepts a bank 
from the definition of `dealer' when it buys and sells securities 
for investment purposes for the bank or for accounts for which the 
bank acts as trustee or fiduciary. This mirrors existing law 
distinguishing between investors and dealers, and is limited to the 
portfolio trading of the bank and accounts for which it makes 
investment decisions.'' H.R. Rep. No. 106-74, pt. 3, at 170-171 
(1999).
---------------------------------------------------------------------------

    Two commenters recommended adding the words ``or on behalf of'' 
prior to the words ``qualified investor'' in two instances in paragraph 
(a) with conforming language in paragraph (c) to more closely track the 
statutory language found in the custody exception.\84\ We agree that 
the language suggested by these commenters avoids this ambiguity and 
have incorporated this suggestion in the final rule.
---------------------------------------------------------------------------

    \84\ See the Coalition of Banks' Letter and the NYCH Letter.
---------------------------------------------------------------------------

    Two commenters recommended deleting the words ``[e]xcept as 
otherwise provided in paragraph (d) of this section * * *'' as an 
unnecessary reference to the definition of ``conduit lender.'' \85\ We 
agree that this technical suggestion would improve the clarity of the 
rule and have incorporated this suggestion in the final rule.
---------------------------------------------------------------------------

    \85\ See the Coalition of Banks' Letter and the NYCH Letter.
---------------------------------------------------------------------------

    These same two commenters also made two other technical suggestions 
with which we agree. First, they recommended that we clarify that a 
bank may direct the receipt and delivery of loaned securities and 
collateral by third parties in Rule 15a-11(c)(2) and (3). Second, they 
suggested that we revise the rule language to refer to a bank investing 
or directing the investment of cash collateral, rather than to the 
reinvesting of such collateral in Rule 15a-11(c)(5).
    In sum, we are adopting the exemption for securities lending, Rule 
15a-11, with the technical changes described above. We continue to 
believe that, because it is limited to qualified investors,\86\ the 
exemption is appropriate in the public interest and is consistent with 
the protection of investors.
---------------------------------------------------------------------------

    \86\ See additional discussion of ``qualified investors'' at 
Section D, infra.
---------------------------------------------------------------------------

D. Definition of ``Qualified Investor''

    Exchange Act Section 3(a)(54) expressly defines the term 
``qualified investor,'' and 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 person's financial 
sophistication, net worth, and knowledge and experience in financial 
matters.\87\
---------------------------------------------------------------------------

    \87\ 15 U.S.C. 78c(a)(54)(A). Under this definition qualified 
investors include persons such as 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. 15 U.S.C. 78c(a)(54)(C) 
gives the Commission additional authority to define a ``qualified 
investor.''
---------------------------------------------------------------------------

    The definition of ``qualified investor'' was added to the Exchange 
Act by the GLBA and has application to several of the bank exceptions 
from broker-dealer registration, including: \88\ (1) The broker 
exception for identified banking products when the product is an equity 
swap agreement; \89\ (2) the dealer exception for identified banking 
products when the product is an equity swap agreement; \90\ and (3) the 
dealer exception for asset-backed securities.\91\ Under these 
exceptions, banks may sell certain securities to qualified investors.
---------------------------------------------------------------------------

    \88\ 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 Public Law 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)].
    \89\ Section 206(a)(6) of Public Law 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)].
    \90\ Section 206(a)(6) of Public Law 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)].
    \91\ Exchange Act Section 3(a)(5)(C)(iii) [15 U.S.C. 
78c(a)(5)(C)(iii)].
---------------------------------------------------------------------------

    Exchange Act Section 3(a)(54)(A) enumerates an extensive list of 
persons that are ``qualified investors.'' \92\ Some of these entities 
meet the definition by merely being certain types of entities, while 
other entities must both be a certain type of entity and meet 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.
---------------------------------------------------------------------------

    \92\ Subsections (i) through (xiv) of Section 3(a)(54)(A) 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.'' \93\ 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.'' \94\
    In light of these other definitions, for the purposes of the GLBA 
provisions in the Exchange Act, we interpreted the term ``company'' as 
used in the definition of ``qualified investor'' in subsection (xi) of 
Section 3(a)(54)(A) to have a broad meaning that encompasses types of 
entities other than those specifically listed in Section 3(a)(54)(A).
---------------------------------------------------------------------------

    \93\ Exchange Act Section 3(a)(9) [15 U.S.C. 78c(a)(9)].
    \94\ Investment Company Act Section 2(a)(8) [15 U.S.C. 80a-
2(a)(8)].
---------------------------------------------------------------------------

    We asked for comment on our interpretation of this term. One

[[Page 8696]]

commenter urged caution in applying the expanded definition of 
``qualified investor'' in all circumstances.\95\ This commenter stated 
that while it may be appropriate to utilize a single definition of a 
``qualified investor'' as a means to simplify compliance, the 
application should be limited to securities lending activities pending 
more careful and thorough analysis.\96\ In contrast, three other 
commenters advocated using one interpretation of the definition of 
qualified investor.\97\
---------------------------------------------------------------------------

    \95\ See the ICBA Letter.
    \96\ Id.
    \97\ See the NYCH Letter, the ABA/ABASA Letter, and the 
Coalition of Banks' Letter.
---------------------------------------------------------------------------

    We believe that the simplicity of having one interpretation of the 
statutory definition of ``qualified investor'' outweighs any risk that 
it could be overbroad in other circumstances. Thus, we believe that it 
is appropriate to utilize this interpretation in all circumstances 
where the term is used in the GLBA exceptions. We continue, however, to 
apply the statutory requirements to the entities expressly listed in 
Exchange Act Section 3(a)(54)(A). 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.\98\ The 
statutory requirement for these governmental entities would not be 
changed by this interpretation.
---------------------------------------------------------------------------

    \98\ Section 3(a)(54)(A)(xiii) of the Exchange Act [15 U.S.C. 
78c(a)(54)(C)(xiii)].
---------------------------------------------------------------------------

    Similarly, any State sponsored employee benefit plan, or any other 
employee benefit plan, within the meaning of the Employee Retirement 
Income Security Act of 1974, other than an individual retirement 
account, qualifies only if the investment decisions are made by a plan 
fiduciary, as defined in section 3(21) of that Act, which is either a 
bank, savings and loan association, insurance company, or registered 
investment adviser.\99\ GLBA expressly limited the definition of 
``qualified investor'' to these types of employee benefit plans, and 
this interpretation does not cover other types of employee benefit 
plans.
---------------------------------------------------------------------------

    \99\ Section 3(a)(54)(A)(v) of the Exchange Act [15 U.S.C. 
78c(a)(54)(C)(v)].
---------------------------------------------------------------------------

    In the interest of clarity and legal certainty, two commenters also 
recommended that the Commission adopt a rule to implement its 
interpretation of the definition of a qualified investor.\100\ We 
believe the Commission's interpretation suffices to enhance legal 
certainty for entities that are not as precisely described as others in 
the list of entities expressly listed as ``qualified investors.'' It, 
therefore, is not necessary to adopt a general rule at this time.
---------------------------------------------------------------------------

    \100\ See the NYCH Letter and the Coalition of Banks' Letter.
---------------------------------------------------------------------------

    In the context of the securities lending exemption, we are, 
however, revising the regulation so that the exemption encompasses not 
only securities lending transactions with or on behalf of any 
``qualified investor'' (as that term is defined in Exchange Act Section 
3(a)(54)(A) and interpreted above), but also securities lending 
transactions with or on behalf of any employee benefit plan that owns 
and invests on a discretionary basis not less than $25,000,000 in 
investments. Thus, we are amending Rule 15a-11 to add certain employee 
benefit plans that do not meet the terms of Exchange Act Section 
3(a)(54)(A)(v).\101\ We are making this change in response to a request 
by one of the commenters.\102\ We believe that this addition to the 
exemption is appropriate. This addition will permit banks to engage in 
or effect securities lending transactions, and any securities lending 
services in connection with such transactions, with or on behalf of a 
person the bank reasonably believes to be a pension plan that, although 
it would not meet the qualitative standard set forth in paragraph 
(v),\103\ may own and invest on a discretionary basis, not less than 
$25,000,000 in investments.\104\
---------------------------------------------------------------------------

    \101\ 15 U.S.C. 78c(a)(54)(A)(v).
    \102\ See the Coalition of Banks' Letter, which asked for 
clarification of the status of foreign pension plans.
    \103\ This provision relates to pension plans that are ``any 
State sponsored employee benefit plan, or any other employee benefit 
plan, within the meaning of the Employee Retirement Income Security 
Act of 1974, other than an individual retirement account, if the 
investment decisions are made by a plan fiduciary, as defined in 
section 3(21) of that Act, which is either a bank, savings and loan 
association, insurance company, or registered investment adviser.'' 
15 U.S.C. 78c(a)(54)(A)(v).
    \104\ Rule 15a-11(e). [17 CFR 240.15a-11.] When the individual 
plan participants or beneficiaries of a pension plan make their own 
investment decisions, the plan itself would not meet the requirement 
that it invests the plan assets on a discretionary basis. See 
Section 3(a)(35) of the Exchange Act [15 U.S.C. 78c(a)(35)].
---------------------------------------------------------------------------

    Two commenters suggested that it would be helpful if the Commission 
would confirm that banks may enter into securities lending transactions 
with parties that they reasonably believe are ``qualified investors.'' 
These commenters suggested that one non-exclusive means by which a bank 
should be able to reasonably conclude that a party is a ``qualified 
investor'' could be to obtain a representation to that effect by a 
party, unless reliance on that representation would not be reasonable 
under the circumstances.\105\ After considering this suggestion, we 
have modified the definition of ``qualified investor'' within the 
context of the securities lending exemption to provide a reasonable 
belief standard.\106\
---------------------------------------------------------------------------

    \105\ See the Coalition of Banks' Letter and the NYCH Letter.
    \106\ For guidance on how to ascertain whether a person is a 
qualified investor, see Rule 144A(d)(1) under the Securities Act of 
1933 [17 CFR 230.144A(d)(1)]. We note that the determination of 
whether a person is a qualified investor may involve both a 
qualitative analysis and a quantitative analysis. The source 
materials listed in Rule 144A would provide information that could 
be used in both types of determinations.
---------------------------------------------------------------------------

    With regard to the places where the statutory provisions require 
that banks deal only with ``qualified investors,'' we have reviewed the 
legislative history in this area, as well as the statutory language, 
and find no indication that it was Congress' intent to provide a 
reasonable belief standard with regard to transactions that are limited 
to qualified investors.\107\ Although our exemptive authority would 
permit us to add a reasonable belief standard if we found that it is 
necessary or appropriate in the public interest, and consistent with 
the protection of investors,\108\ we believe that this kind of a change 
should properly be made in a rule that has been subject to public 
notice and comment. Further, we believe that there are competing 
interests in this area that should be considered and that banks may be 
in a position to ascertain whether their customers meet the criteria of 
qualified investors so that they may engage in transactions that are 
restricted by statute to qualified investors. We also believe that we 
should consider whether banks should conduct the transactions that are 
limited by statute to qualified investors only with persons with which 
they have a sufficient relationship to know whether those persons are 
indeed ``qualified investors.'' For all of these reasons, we will 
consider this question further to determine whether to propose a

[[Page 8697]]

reasonable belief standard applicable to transactions other than 
securities lending.
---------------------------------------------------------------------------

    \107\ See H.R. Rep. No. 106-74, pt. 3, at 175 (1999).
    \108\ Under Exchange Act Section 36(a), ``the Commission, by 
rule, regulation, or order, may conditionally or unconditionally 
exempt any person, security, or transaction, or any class or classes 
of persons, securities, or transactions, from any provision or 
provisions of this title or of any rule or regulation thereunder, to 
the extent that such exemption is necessary or appropriate in the 
public interest, and is consistent with the protection of 
investors.'' 15 U.S.C. 78mm(a). The Commission also has authority to 
issue exemptive orders that grant relief from specific provisions of 
the Exchange Act as well as from specific Commission rules 
promulgated thereunder. For example, either by rule or by order, the 
Commission may, pursuant to Section 15(a)(2) of the Exchange Act, 
conditionally or unconditionally exempt any broker or dealer from 
the registration provisions of Section 15(a)(1). 15 U.S.C. 
78o(a)(1).
---------------------------------------------------------------------------

E.Temporary Exemption

1. Discussion of Comments on the Temporary Exemption
    Several commenters stated that the final implementation of the 
rules pertaining to the bank exceptions from the definition of dealer 
should be coordinated with the upcoming revisions to the rules 
pertaining to the bank exceptions from the definition of broker. These 
commenters expressed concern that banks would have to contend with 
multiple implementation dates.\109\ None of the comments we received 
were supported by specific examples or references to any specific costs 
that would be incurred by any bank. We received only one comment from a 
bank stating that the dealer rules should be delayed until the broker 
rules were finalized.\110\ Moreover, the bank commenter offered no 
indication that it engages in significant dealer activities.
---------------------------------------------------------------------------

    \109\ See the ABA/ABASA Letter, the General Counsels' Letter, 
the IIB Letter, the Commerce Banc Letter, and the Roundtable Letter.
    \110\ See the Commerce Banc Letter.
---------------------------------------------------------------------------

    We have carefully considered this view in light of the few banks 
that actually conduct dealer activities other than as riskless 
principal. We note that the provisions of Section 16 of the Glass-
Steagall Act continue to prohibit national banks from underwriting, 
selling, or dealing in most securities.\111\ After extensive 
discussions with the banks that conduct significant dealer activities, 
and our efforts to accommodate existing practices, we continue to 
believe that this rule will not require banks to make significant 
changes to their existing dealer activities, except in connection with 
riskless principal transactions, and that a longer phase-in period will 
not be necessary. Moreover, based on our discussions with banks engaged 
in limited dealer activities, other than riskless principal 
transactions, we believe that there is insignificant overlap in the 
broker and dealer activities conducted by banks, and that most riskless 
principal transactions can be restructured as agency transactions, 
which remain exempt under the blanket broker exception. In addition, 
because the broker and dealer activities are sufficiently distinct, we 
believe that there would not be a significant compliance benefit to 
banks in coordinating the effective dates of the broker and dealer 
rules.
---------------------------------------------------------------------------

    \111\ This section excepted certain bank-eligible securities 
such as U.S. government securities. Section 5(c) of the Glass-
Steagall Act also applied the same Section 16 restrictions to state-
chartered banks that are members of the Federal Reserve System. 
Savings Associations and savings banks did not have the exemption 
from broker-dealer registration until we adopted the Rule 15a-9 as 
part of the Interim Final Rules.
---------------------------------------------------------------------------

    Implementing the dealer rule first will permit banks to use the 
entire 500-transaction limit set forth in the de minimis exception to 
broker for riskless principal transactions under the dealer exemption. 
We believe that having this much room available to banks to conduct 
riskless principal transactions will give banks an opportunity to 
realistically assess their use of the de minimis exemption in an 
environment that provides them with the maximum flexibility to do so. 
Later, when the broker rules also are effective, banks will have to 
consider their use of the de minimis exception for broker transactions 
as well as any riskless principal transactions they may conduct while 
utilizing the same 500-transaction limit. We believe that this 
transition period when only the dealer requirements, exceptions, and 
exemptions are effective will permit banks to gain experience in 
identifying securities transactions in the most forgiving environment, 
not only because of the full availability of the 500 transactions for 
riskless principal transactions but also because the temporal exemption 
for broker transactions remains in place. Thus, transactions that may 
previously have been done on a principal basis in the bank may instead 
be carried out by the bank on an agency basis, until the blanket broker 
exemption ends.
    This experience may lead some banks to conclude that other 
arrangements, such as affiliating with a broker-dealer or shifting 
transactions to a broker-dealer, may be necessary when all of the 
broker-dealer exceptions and exemptions become effective. In those 
instances, we believe that the banks will benefit from having this 
knowledge sooner and may be able to use this knowledge to take steps 
that will make their transition smoother.
    In addition, we believe that implementing the dealer exceptions and 
exemptions will permit banks to gain experience in identifying 
securities transactions before they are required to implement 
compliance with the broker exceptions and exemptions. Thus, we believe 
that staggering the implementation dates may actually enhance 
compliance and permit banks to achieve a more orderly transition to 
conducting their securities activities in accordance with the mandates 
of the GLBA.
    We are, however, sympathetic to individual banks that may have 
specific transactions in progress for which they may need an extension 
of the implementation date of these rules. We urge those banks to 
contact our staff to determine if specific relief may be available to 
any such bank on a case-by-case basis for specified transactions for 
which a demonstrated burden could be avoided or alleviated through a 
reasonable short extension of the compliance date, or during any period 
when additional specific exemption requests are being considered.\112\
---------------------------------------------------------------------------

    \112\ See supra note 109.
---------------------------------------------------------------------------

2. Adoption of Temporary Exemption and Effective Date of Dealer Rules
    Concurrent with this release, the Commission, through separate 
order, is further extending the temporary exemption from the definition 
of ``dealer'' for banks until September 30, 2003. On that date, the 
rules we are adopting today will apply to dealer transactions of banks, 
savings associations, and savings banks.

F. Extension of Rule 15a-8--Section 29 Liability Exemption

    Two commenters asked the Commission to extend the exemption from 
liability under Exchange Act Section 29, since it applied only to 
contracts made before January 1, 2003.\113\ Other commenters asked for 
some type of regulatory ``safe harbor,'' or cure period.\114\ Exchange 
Act Section 29(b) \115\ provides that any contract made in violation of 
the Exchange Act or rules adopted under the Exchange Act shall be void 
as regards the rights of any person who made or engaged in the 
performance of any such contract.\116\ Private parties have invoked 
this equitable remedy rarely \117\ in instances involving broker-dealer 
registration violations by the opposite party.\118\
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    \113\ See the ABA/ABASA Letter and the NYCH Letter.
    \114\ See the General Counsels' Letter, the ABA/ABASA Letter, 
the NYCH Letter, the Coalition of Banks' Letter, and the Roundtable 
Letter.
    \115\ 15 U.S.C. 78cc(b).
    \116\ Exchange Act Section 29(b) does not make the contract 
automatically a nullity. Rather, the contract is voidable at the 
option of the innocent party. Mills v. Electric Auto-Lite Co., 396 
U.S. 375, 387 (1970). In this manner, ``the interests of the victim 
are sufficiently protected by giving him the right to rescind; to 
regard the contract as void where he has not invoked the right would 
only create the possibility of hardships to him or others without 
necessarily advancing the statutory policy of disclosure.'' Id. at 
388.
    \117\ Id. at 388; see also Occidental Life Ins. Co. v. Pat Ryan 
and Assoc., 496 F.2d 1255, 1267 (4th Cir.), cert. denied, 419 U.S. 
1023 (1974) (principles of equity, like estoppel and waiver, apply 
to actions brought under Exchange Act Section 29(b)).
    \118\ See Boguslavsky v. Kaplan, 159 F.3d 715, 722 (2nd Cir. 
1998) (under the liberal pleading standard accorded pro se 
litigants, an investor properly presented an identifiable claim for 
rescission under Exchange Act Section 29(b) in asserting that the 
firm operated without director of compliance and thus was not 
properly registered as securities broker-dealer); Regional 
Properties, Inc. v. Financial and Real Estate Consulting Co., 752 
F.2d 178, 182 (5th Cir. 1985) (subject to equitable defenses, real 
estate developers were entitled to rescind agreement with broker to 
structure and market limited partnership interest where broker had 
failed to register as required by the Exchange Act); Regional 
Properties v. Financial and Real Estate Consulting Co., 678 F.2d 
552, 557, 566-67 (5th Cir. 1982), aff'd on other grounds, 752 F.2d 
178 (5th Cir. 1985) (later appeal) (recognizing that Exchange Act 
Section 29(b) provides for a private, equitable cause of action for 
the rescission of a contract where the securities broker was 
unlicensed); Eastside Church of Christ v. National Plan, Inc., 391 
F.2d 357, 362 (5th Cir.), cert. denied, 393 U.S. 913 (1968) 
(churches could void a transaction with broker under Exchange Act 
Section 29(b) because the broker was unregistered); Couldock and 
Bohan, Inc. v. Societe Generale Securities, Corp., 93 F. Supp. 2d 
220, 233 (D. Conn. 2000) (a contract violating broker registration 
requirements of the Exchange Act is voidable at the option of the 
innocent party under Exchange Act Section 29(b)).

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[[Page 8698]]

    Rule 15a-8 \119\ was included in the Rules because we recognized 
that the amended Exchange Act contains numerous broker-dealer 
definitional provisions that apply only to banks, which were previously 
excepted from broker-dealer regulation.\120\ We understand that banks 
may need to adjust their procedures to shift their securities 
activities to registered broker-dealers or to comply with the 
conditions of the specific functional exceptions or exemptions to the 
definitions of broker and dealer. We also are aware that there may be 
instances where, despite having reasonable procedures in place, a bank 
may inadvertently fail to meet the terms and conditions of the specific 
functional exceptions or exemptions upon which it is relying. This 
could result in the bank engaging in securities activities in violation 
of the registration requirements of Exchange Act Section 15 and the 
rules promulgated under that section. We, therefore, adopted Rule 15a-
8.
---------------------------------------------------------------------------

    \119\ 17 CFR 240.15a-8.
    \120\ In the past, the Commission has been asked for this type 
of relief and has declined to grant it. See Registration 
Requirements for Foreign Broker-Dealers, Release No. 34-27017, 54 FR 
30013 at 30021 (July 18, 1989). Our research indicates that there 
was not an increase in suits against foreign broker-dealers under 
Section 29 of the Exchange Act.
---------------------------------------------------------------------------

    Now that we are adopting an effective date for the bank dealer 
rules, banks may need time to adjust to these definitional provisions 
and exemptions. Thus, we continue to believe that it is appropriate to 
provide a transitional period before these provisions fully apply.
    To provide certainty to banks while they become fully familiar with 
the operation of the exceptions, we are, therefore, adopting an amended 
Rule 15a-8.\121\ This amendment provides an exemption for contracts 
entered into by banks before March 31, 2005 from being considered void 
or voidable by reason of Exchange Act Section 29 because a bank that is 
a party to the contract violated the registration requirements of 
Section 15(a) of the Exchange Act or any applicable provision of this 
Act and the rules and regulations thereunder based solely on a bank's 
status as a dealer when the contract was created. Banks may have 
inadvertent, technical violations as they become accustomed to the new 
regulatory requirements. This exemption is designed to recognize the 
unique compliance problems that banks may have by preventing any 
inadvertent failures by banks to meet the conditions of the functional 
exceptions from triggering potential rescission under Exchange Act 
Section 29 during this transitional period.
---------------------------------------------------------------------------

    \121\ 17 CFR 240.15a-8. On May 11, 2001, we adopted Rule 15a-8 
as part of the Rules and sought comment on it. See Release No. 34-
44291, 66 FR 27760 (May 18, 2001). At that time, we provided and 
anticipated that the general exemption for banks from the definition 
of dealer would end on October 1, 2001, and that an additional 
conditional exemption from the definition would end on January 1, 
2002. Accordingly, to provide for sufficient transition time, we 
adopted Rule 15a-8 to provide for exemption from Section 29 
rescission liability until January 1, 2003. During the comment 
period on the Rules, we received no comments suggesting that such an 
exemption was inappropriate.
    Ultimately, however, to allow sufficient time to address 
concerns raised about the Rules, we further extended the exemption 
from the definition of dealer until September 30, 2003 (with today's 
extension). Accordingly, the transition period that we proposed and 
adopted in Rule 15a-8 has not yet commenced, because the existing 
Rule includes a specific termination date of January 1, 2003. Thus, 
the Rule as currently written would provide no adjustment period for 
banks. Accordingly, the recommended amendment to 15a-8 does nothing 
more than amend the Rule to establish a transition period commencing 
on the date that the general exemption from the definition actually 
expires, exactly as was contemplated when the existing Rule was 
adopted on an interim basis and published for public comment. Under 
these circumstances, we find good cause to conclude that this 
amendment to Rule 15a-8 may be accomplished without our separately 
and specifically providing notice of and an opportunity to comment 
on the amendment. We also believe that such notice is 
``unnecessary'' within the meaning of 5 U.S.C. 553(b)(3)(B). 
Moreover, the proposing Release did include questions seeking input 
about any necessary accommodations for an orderly transition, and 
two commenters specifically suggested the accommodation that this 
amendment to Rule 15a-8 provides.
---------------------------------------------------------------------------

    We note that this provision does not relieve a bank of the 
obligation to register as a dealer if their securities activities do 
not fit within a specific functional exception or exemption. We also 
note that a bank's securities activities continue to be subject to the 
antifraud provisions of the federal securities laws, irrespective of 
the bank's lack of registration or failure to comply with the 
provisions of the Exchange Act and the rules thereunder that otherwise 
apply to banks based on their status as broker-dealers. We, therefore, 
find that this exemption for dealer contracts entered into by banks 
before March 31, 2005 from being considered void or voidable by reason 
of Exchange Act Section 29 is appropriate in the public interest and 
consistent with the protection of investors.\122\
---------------------------------------------------------------------------

    \122\ Exchange Act Section 36(a)(1) [15 U.S.C. 78mm(a)(1)].
---------------------------------------------------------------------------

VI. Procedural Matters

A. Paperwork Reduction Act

    These rule amendments and new exemption 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.\123\ We received no comments on this 
issue.
---------------------------------------------------------------------------

    \123\ 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 204 of the GLBA 
specifically requires the bank agencies to promulgate recordkeeping 
requirements.
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B. Consideration of Comments on Benefits and Costs

    We believe that these rule amendments and the new exemption are 
consistent with Congress's intent in enacting the GLBA and are 
responsive to the comments we received. These rule amendments and the 
new exemption are very limited in scope. The amendments adopt four 
changes. In particular, we are adopting rules that: (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 dealer exception 
that permits banks to issue and sell asset-backed securities to 
qualified investors to permit banks to possibly issue and sell more 
such securities; (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; and (4) 
extend the exemption from liability under Section 29(b) to contracts 
entered into before March 31, 2005 based solely on a bank's

[[Page 8699]]

status as dealer when the contract was created. The amendments to the 
first two rules are being adopted as proposed. The new exemption is 
being adopted with minor, technical changes from the proposal. We 
received no comments on the costs and benefits of the proposed 
amendments or new exemptions.
1. Benefits
    Both of the rule amendments 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 exemption for banks to engage in securities lending 
transactions, new Rule 15a-11, also provides increased legal certainty 
to banks. All of these rule amendments make it easier for banks to 
conduct these activities in light of the changes to the Federal 
securities laws. We received no comments directed to this issue.
    The amendment to Rule 3a5-1, the de minimis exemption, changes the 
way riskless principal transactions are counted to 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 staff 
discussions with these two banks, we believe that the 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 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 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. In response to the comments on these proposed 
amendments, we have clarified certain matters in this adopting release.
    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. 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 exemption will provide banks that lend 
securities with enhanced legal certainty that will permit them to 
continue to engage in this activity without broker-dealer registration. 
In the final rule, we are making the securities lending exemption more 
flexible by eliminating the requirement that these transactions be 
conducted pursuant to a securities lending agreement.
    In addition, we are adopting an amended Rule 15a-8 that will 
provide an exemption for contracts entered into by banks before March 
31, 2005 from being considered void or voidable by reason of Exchange 
Act Section 29 because a bank that is a party to the contract violated 
the registration requirements of Section 15(a) of the Exchange Act or 
any applicable provision of this Act and the rules and regulations 
thereunder based solely on a bank's status as a dealer when the 
contract was created. This temporary exemption provides banks with 
relief from being subject to rescission rights while they become 
accustomed to the new bank exceptions and exemptions from the 
definition of dealer under the Exchange Act. This relief should provide 
banks with savings from being spared potential liability under this 
statutory section.
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 rules and rule amendments. Because all of 
these amendments make it easier for banks to conduct these activities 
in light of the changes to the federal securities laws, any costs would 
be those associated with moving the supervision of these limited 
securities transactions or products from the regulatory oversight of 
the Commission and placing them under the banking agencies. We do not 
believe any such cost 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. We did 
not receive any comments on this issue, nor did we receive any comments 
that identified specific costs related to complying with these rules.

C. 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 rule amendments would promote efficiency, competition, 
and capital formation in determining whether they are consistent with 
the public interest.\124\ In addition, Section 23(a)(2) of the Exchange 
Act \125\ 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. We received no comments on these issues.
---------------------------------------------------------------------------

    \124\ 15 U.S.C. 78c(f).
    \125\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    We do not believe that the interpretations, definitions, and 
exemptions contained in these amendments, the interpretation of the 
term ``qualified investor,'' or the new exemption will result in any 
burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Exchange Act. The 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 rule amendments 
and exemption 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 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 in 
Rule 15a-11 would provide banks increased legal certainty when they 
engage in securities lending transactions without any new

[[Page 8700]]

burdens on banks seeking to use this limited exemption. Nothing in the 
rule amendments, in the new exemption, or in the Commission's 
interpretation of the term qualified investor 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 shift 
its 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 rule amendments and the 
new exemption promote Congress' intent and make it easier for banks to 
comply with the requirements of the GLBA.
    Since certain of these rule amendments 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. We also are making three exemptive amendments to the Rules. 
We are adding a rule that provides banks with exemptive relief for 
certain securities lending transactions, amending the de minimis 
exemption for banks to make the counting of riskless principal 
transactions more flexible, and extending the exemption from liability 
under section 29(b) to contracts entered into before March 31, 2005 
based solely on a bank's status as dealer when the contract was 
created. Each of these exemptive rules would make it easier for banks 
to comply with the GLBA in light of the changes to the federal 
securities laws and will give banks enhanced legal certainty for their 
securities activities. 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.

D. Regulatory Flexibility Act Certification

    Pursuant to Section 605(b) of the Regulatory Flexibility Act,\126\ 
the Commission certified that the amendment to the rule would not have 
a significant economic impact on a substantial number of small 
entities. This certification was incorporated into the Proposing 
Release.\127\ We received no comments concerning the impact on small 
entities or the Regulatory Flexibility Act Certification.
---------------------------------------------------------------------------

    \126\ 5 U.S.C. 605(b).
    \127\ See Proposing Release, supra note 2.
---------------------------------------------------------------------------

Statutory Authority

    The Commission is adopting amendments Rules 3a5-1, 3b-18 and 15a-8, 
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 Rules and Rule Amendments

List of Subjects in 17 CFR Part 240

    Broker-dealers, Reporting and recordkeeping requirements, 
Securities.


    For the reasons set forth in the preamble, Title 17, Chapter II of 
the Code of Federal Regulations is 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:


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'' to 
the extent that it engages in or effects 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 underwriting standards or is 
evidenced by the loan documents of the bank or its affiliates, other 
than its broker or dealer affiliates; and
    (ii) The bank or its affiliates, other than its broker or dealer 
affiliates, fund 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

[[Page 8701]]

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-8 is revised to read as follows:


Sec.  240.15a-8  Exemption for banks from Section 29 liability.

    (a) No contract entered into before January 1, 2003 shall be void 
or considered voidable by reason of section 29 of the Act (15 U.S.C. 
78cc) because any bank that is a party to the contract violated the 
registration requirements of section 15(a) of the Act (15 U.S.C. 
78o(a)) or any applicable provision of the Act (15 U.S.C. 78a et seq.) 
and the rules and regulations thereunder based solely on the bank's 
status as a broker or dealer when the contract was created.
    (b) No contract entered into before March 31, 2005, shall be void 
or considered voidable by reason of section 29 of the Act (15 U.S.C. 
78cc) because any bank that is a party to the contract violated the 
registration requirements of section 15(a) of the Act (15 U.S.C. 
78o(a)) or any applicable provision of the Act (15 U.S.C. 78a et seq.) 
and the rules and regulations thereunder based solely on the bank's 
status as a dealer when the contract was created.

    5. 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) 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)), to the extent that, as a conduit lender, or as 
an agent, it engages in or effects securities lending transactions, and 
any securities lending services in connection with such transactions, 
with or on behalf of a person the bank reasonably believes to be:
    (1) A qualified investor as defined in section 3(a)(54)(A) of the 
Act (15 U.S.C. 78c(a)(54)(A)); or
    (2) Any employee benefit plan that owns and invests on a 
discretionary basis, not less than $25,000,000 in investments.
    (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) Securities lending services means:
    (1) Selecting and negotiating with a borrower and executing, or 
directing the execution of the loan with the borrower;
    (2) Receiving, delivering, or directing the receipt or delivery of 
loaned securities;
    (3) Receiving, delivering, or directing the receipt or delivery of 
collateral;
    (4) Providing mark-to-market, corporate action, recordkeeping or 
other services incidental to the administration of the securities 
lending transaction;
    (5) Investing, or directing the investment of, cash collateral; or
    (6) Indemnifying 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 qualify, notwithstanding whether:
    (1) The lending or borrowing transaction terminates and so long as 
the transaction is replaced within one business day by another lending 
or borrowing transaction involving the same securities; and
    (2) Any substitutions of collateral occur.

    Dated: February 13, 2003.

    By the Commission.
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 03-4095 Filed 2-21-03; 8:45 am]
BILLING CODE 8010-01-P