News 2004

July 15 : June 15

July 15, 2004


    Washington, D.C., July 14, 2004 - The Securities and Exchange Commission today voted to publish for comment proposed new Rule 203(b)(3)-2 that would require hedge fund advisers to register with the Commission under the Investment Advisers Act of 1940. The Commission also voted to propose related rule amendments.

    The Commission's staff estimate that approximately 40 to 50 percent of all hedge fund advisers are currently registered with the Commission. Registration under the new rule would permit the Commission to--
    • Collect and provide to the public basic information about hedge funds and hedge fund advisers, including the number of hedge funds operating in the United States, the amount of assets, and the identity of their advisers.
    • Examine hedge fund advisers to identify compliance problems early and deter questionable practices. If fraud does occur, examinations offer a chance to discover it early and limit the harm to investors.
    • Require all hedge fund advisers to adopt basic compliance controls to prevent violation of the federal securities laws.
    • Improve disclosures made to prospective and current hedge fund investors.
    • Prevent felons or individuals with other serious disciplinary records from managing hedge funds.

    The proposed new rule would require advisers to "private funds" to register with the Commission by requiring the advisers to "look through" the funds and to count the number of investors (rather than the fund) when determining whether the advisers are eligible for the Adviser Act's exemption for advisers with 14 or fewer clients.

    A "private fund" would be one that

      o would be an investment company but for the exceptions in Sections 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940;
      o permits owners to redeem their ownership interests within two years of purchase; and
      o is offered based on the investment advisory skills, ability or expertise of the investment adviser.

    The proposed rule would contain special provisions for advisers located outside the United States designed to limit the extraterritorial application of the Advisers Act to offshore advisers to offshore funds that have U.S. investors.

    Comments on the proposed provisions should be submitted to the Commission by September 15, 2004.

    *** The full text of the detailed release concerning this proposal will be posted to the SEC Web site as soon as possible.

June 15, 2004


    Washington, D.C., June 2, 2004 - The Securities and Exchange Commission today voted to publish for comment proposed Regulation B. This new regulation is designed to implement provisions of the Gramm-Leach-Bliley Act of 1999 that delineate the securities activities banks may engage in without registering as brokers under the Securities Exchange Act of 1934.
    1. Regulation B Proposals
    The Gramm-Leach-Bliley Act (GLBA) replaced banks' complete exception from the definition of "broker" with eleven "functional exceptions." The Commission today voted to propose new rules to implement the GLBA definition by defining some of the statutory terms used in the eleven exceptions. It also proposed a number of new exemptions for some particular bank activities, under conditions that are consistent with investor protections. All of these provisions build off of rules the Commission adopted in 2001 (Interim Rules). The proposals would extend many of these provisions to savings associations and savings banks, and also exempt credit unions that engage in certain limited securities activities as long as they are conducted under the terms applicable to certain of the bank exceptions from the definitions of broker and dealer.

    Networking Exception
    The statutory third-party brokerage (networking) exception allows banks to partner with broker-dealers in offering their customers a wide range of financial services, including securities brokerage. Under this exception, a broker-dealer offers brokerage services to bank customers and shares the compensation with the bank. The exception also allows unregistered bank employees to receive incentive compensation in the form of a "nominal one-time cash fee of a fixed dollar amount" for referring bank customers to the broker-dealer. The Commission voted to propose amendments to the Interim Rules to
    * clarify the scope of activities in which unregistered bank employees may engage
    * define nominal compensation as:
      o the employee's base hourly rate of pay;
      o a flat $25 dollar amount; or
      o an inflation adjusted amount based on fifteen 1999 dollars

    Trustee and Fiduciary Account Exception
    The trust and fiduciary activities exception permits a bank, under certain conditions, to receive "sales compensation" (e.g., commission-type compensation or sales charges and service fees paid out of mutual fund assets pursuant to a distribution plan adopted under rule 12b-1) for effecting transactions for its customers in a trustee or fiduciary capacity without registering as a broker. Under this exception, a bank must effect such transactions in its trust department, or other department that is regularly examined by bank examiners for compliance with fiduciary principles and standards. The bank also must be "chiefly compensated" for any securities transactions, consistent with fiduciary principles and standards, on the basis of "relationship compensation" (i.e., an administration or annual fee, a percentage of assets under management, a flat or capped per order processing fee that does not exceed the cost the bank incurs in executing such securities transactions, or any combination of these fees). The term "chiefly compensated" is not defined in the statute. The Interim Rules both defined the term to mean that relationship compensation exceeds sales compensation as determined on an account-by-account basis and provided a limited exemption to permit a bank to assess its compliance on an aggregate, rather than an account-by-account, basis using a proportion of 9 to 1 as the ratio for relationship to sales compensation as long as other procedural requirements were met. They also provided a limited exemption for banks acting as indenture trustees. The Commission decided to propose several amendments to the Interim Rules. These amendments are intended to simplify banks' compliance with this statutory requirement through both definitions and targeted exceptions. These amendments would
    * expand the definition of "relationship compensation," which is a component of the comparison, to include fees generated by all types of assets
    * provide additional exemptions, including
      o a small bank custody exemption that can be used by qualifying small banks in lieu of the "chiefly compensated" comparison and the other requirements of the trust and fiduciary activities exemption (Additional details regarding this exemption are provided below under the custody discussion.)
      o a new exemption from the "chiefly compensated" requirement for banks acting as trustees and in other limited capacities (as well as for qualified investors) to be able to make investments in money market funds that pay 12b-1 fees
      o a revision of the 9 to 1 exemption that substantially reduces the procedural requirements and allows the exemption to be utilized on a line-of-business basis, on a bank-wide basis, and for accounts that predate the development of an account-by-account compliance system
      o a personal trust account exemption for personal trust accounts that were established prior to this proposal
      o a conditional safe harbor that allows banks to measure their compensation in one year to determine their status for the next year and provides appropriate cure periods
      o an account-by-account exemption that would give a bank some additional flexibility when evaluating individual accounts for which its compensation would not meet the "chiefly compensated" comparison. This exemption would also provide formulas to allocate "sales compensation" (which goes into the comparison) from sources such as mutual funds that are paid on an aggregate basis.
      o an exemption, retained from the Interim Rules, for a bank acting as an indenture trustee

    Bank Custody Exception
    The safekeeping and custody exception gives a bank, acting as a custodian, legal certainty that it may engage in specified securities transactions while holding the funds and securities related to those transactions. This exception lists transactions that a bank may undertake for investors, and permits a bank to provide "related administrative services" to retirement and benefit plans. The Interim Rules provided banks with two exemptions - one for small banks and one for all banks. Both exemptions contained solicitation, compensation, and staffing limits that were designed to allow banks to engage in a small number of accommodation trades, but not to run a large-scale brokerage business without the investor protections of the federal securities laws. The Commission voted to propose to
    * retain the small bank custody exemption, but make it available to more banks, and eliminate many of its restrictions by:
      o establishing a $100,000 revenue limit for securities transactions effected under the exemption, including transactions in trust accounts if other trust exemptions are not utilized
      o defining a "small bank" as a bank with $500 million in assets that is not associated with a broker-dealer
      o retaining the condition that a small bank may not qualify for this exemption if it is a part of large bank holding company with more than $1 billion in consolidated assets
      o extending the exemption to include transactions in all securities
      o permitting small banks to enter into networking arrangements with unaffiliated broker-dealers and use dual employees (i.e., bank employees that are also registered representatives of an unaffiliated broker-dealer) to effect securities transactions
    * retain the general bank custody exemption with modifications that would
      o permit a bank to accept securities orders so long as the fees it receives for clearing and settling securities transactions do not vary, directly or indirectly, based on whether the bank accepts an order to purchase or sell a security
      o limit the availability of this exemption to "qualified investors" as defined in Exchange Act Section 3(a)(54) on a going forward basis
      o grandfather all existing custody accounts to avoid disrupting existing custody relationships
      o permit a bank to continue to receive 12b-1 or shareholder servicing fees for these custody accounts
      o continue to permit a bank to pass any executing broker-dealer's charges through to the customer

    Other New Bank Exemptions
    The Commission proposed three new targeted exemptions in recognition of banks' existing business practices. These exemptions would
    * permit a bank to effect transactions for qualified investors, trustee and fiduciary accounts, and certain agency accounts, including escrow agency accounts, in money market funds that pay 12b-1 fees
    * permit bank trustees and non-fiduciary administrators to receive asset-based sales charges and service fees from mutual funds to offset plan administration fees
    * permit a bank, under limited conditions, to sell securities that are exempt from registration under Regulation S to non-U.S. persons who are located outside of the U.S.

    Other Financial Institution Exemptions
    The Commission proposed extending by exemption appropriate exceptions and exemptions to thrifts and credit unions based on their current securities activities. Comment will be solicited on whether additional exemptions are needed. Comments on these proposed rules should be received by the Commission on or before August 1, 2004.


    The full text of detailed releases concerning these items will be posted to the SEC Web site as soon as possible.

2004 The Federalist Society