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SEC to Banks: Selling Securities? Get a License

Industry convergence slowed by multiple regulators and accounting system limitations.

Don't try to purchase or sell securities without a license, warned Catherine McGuire, chief counsel, division of market regulation for the SEC, who spoke at "The Financial Services Firm of the Future: Broadening Opportunities with the Banking Charter," a recent conference sponsored by law firm Goodwin Proctor.

Several traditional fiduciary activities blur the line between banking and securities. That's why the SEC is working on a staff recommendation for new rules to clarify the situation, which it expects to release for comment in June. "Our goal is to make sure that the brokers are registered and that the banks can continue to do their business," McGuire said at the conference.

Banks had a blanket exemption from SEC regulation until the Gramm-Leach-Bliley Act of 1999, according to Melanie L. Fein, a Washington, D.C.-based attorney with Goodwin Procter. Now, financial institutions need a securities license and SEC oversight in order to act as a broker-dealer, except in a limited number of narrowly defined exemptions.

Most of the exemptions are driven by customer demand, such as the ability for banks to manage stock loans. "People don't want to necessarily have their stock loans arranged by broker-dealers - they like having banks do that," McGuire told the audience.

Similarly, people rely upon their banks' trust departments to invest securities on their behalf. That's fine, as long as the trust bankers are "chiefly compensated by fees that are based on assets under management, administrative fees, annual fees or capped or flat per-order processing fees," McGuire said.

The general rule: no commissions, no problem. But a common business practice in the mutual fund industry has given rise to a thorny exception. Many mutual funds compensate their distribution channel with 12(b)-1 fees, which are calculated as a fractional percentage of the sale. Accordingly, the SEC regards 12(b)-1 fees as commissions, which only brokers should be able to accept. Even though banks have argued that the fees offset the cost of running a trust department and are not paid out as compensation, it's still a commission under the law, according to McGuire. "We're trying to draft a rule which would allow banks to continue to perform this function, but which won't allow unlimited commissions or unlimited 12(b)-1 fees," she explained.

Using current systems, however, it would be a heavy compliance chore for banks to keep track of their 12(b)-1 fees. "The accounting systems at banks are not set up particularly to track 12(b)1 fees on an account-by-account basis," McGuire said. "So while that might be a theoretically pure way to do it and [it may be] intellectually consistent with the statute, it's not cost-effective," she added. "We're working to try to develop an exemption that is cost-effective."

Crossing Off the Cross-Sell

Aside from the technicalities that will spell out the boundaries between banks and brokerages, larger issues still loom in the wake of Gramm-Leach-Bliley. In the era of relationship banking, the inability for banks to speak candidly to customers about the securities in their portfolios has been stifling.

Although retail bankers may refer customers to a broker, they cannot participate in the portfolio evaluation or selection process, or even assess a customer's suitability for brokerage services. "You can pay people a one-time referral fee that has to be nominal and it has to be flat, and it's just for referring the customer," McGuire said. "This is completely inconsistent with the notion of a relationship manager at a bank, and it's very frustrating to banks."

Nevertheless, the alternative would be untenable for the SEC. "To have bank personnel discussing securities or analyzing the needs of a securities customer is very foreign to securities regulators," McGuire noted.

Some banks have pointed out that it's a matter of international competitiveness, especially when dealing with foreign customers of private banks. "People who have relationships with private banks really don't want to have two relationships," McGuire said.

For U.S. banks, the risk is that foreign nationals will use foreign banks, even when purchasing mutual funds designed for foreign nationals.

Still, the SEC intends to stand behind its capacity as functional regulator for the securities business. "The compliance culture that grows from being overseen by the SEC is the best way to avoid enforcement actions," McGuire asserted. "And that culture is very different than the culture of a bank."

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