Skip to main content
  1. Home
  2. Banks and Banking
  3. Regulation R
  4. Background and Summary of Regulation R

Background and Summary of Regulation R

3-3635
Regulation R implements certain of the exceptions for banks from the definition of the term broker under section 3(a)(4) of the Securities Exchange Act of 1934 (the Exchange Act), as amended by the Gramm-Leach-Bliley Act (GLBA).1 GLBA removed the blanket exemption that banks traditionally had from the definition of broker and replaced this blanket exemption with 11 exceptions for banks. Each of these exceptions permits a bank to act as a broker or agent in securities transactions that meet specific statutory conditions. In particular, section 3(a)(4)(B) of the Exchange Act provides conditional exceptions from the definition of broker for banks that engage in certain securities activities in connection with third-party brokerage arrangements, trust and fiduciary activities, transactions in exempt securities (such as U.S. government securities), transactions in certain stock-purchase plans, deposit sweep arrangements, affiliate transactions, private securities offerings, safekeeping and custody activities, transactions in identified banking products, transactions in municipal securities, and a de minimis number of other securities transactions.
Regulation R implements the broker exceptions for banks relating to third-party networking arrangements, trust and fiduciary activities, sweep activities, and safekeeping custody activities. Regulation R also includes certain exemptions related to foreign securities transactions, securities-lending transactions conducted in an agency capacity, the execution of transactions involving mutual fund shares, and the potential liability of banks under section 29 of the Exchange Act.
Banks are exempt from complying with Regulation R and the broker exceptions in section 3(a)(4)(B) of the Exchange Act until the first day of their first fiscal year that commences after September 30, 2008.
1
On September 28, 2007, the Board and the Securities and Exchange Commission jointly adopted identical sets of final rules (at 12 CFR 218 and 17 CFR 247, respectively). Citations in this summary refer to the Board’s rules.
3-3636

NETWORKING ARRANGEMENTS

The statutory “networking” exception in section 3(a)(4)(B)(i) of the Exchange Act permits bank employees to refer customers to a broker-dealer subject to several conditions that are designed, among other things, to help ensure that customers receive adequate disclosures concerning the uninsured nature of securities products offered by the broker-dealer and to prevent bank personnel from providing investment advice or engaging in other inappropriate securities sales activities (15 USC 78c(a)(4)(B)(i)). One of these conditions generally prohibits a bank employee who refers a customer to a securities broker from receiving “incentive compensation” for a securities brokerage transaction, other than a “nominal” one-time cash fee for making the referral. This fee cannot be contingent on whether the referral results in a securities transaction. In addition, a bank employee may not provide advice or recommendations to a customer about securities but may describe, in general terms, the types of investments available from the securities broker.
Section 218.700 defines a number of key terms used in the statute, including the term nominal. Regulation R also provides an exemption (section 218.701) that allows a bank to pay its employees a higher-than-nominal referral fee that is contingent on a transaction for the referral of a high-net-worth customer or an institutional customer to a broker-dealer, subject to a number of conditions.
3-3637

Nominal Referral Fees

The regulation lists five options for determining whether a referral fee will be considered nominal. In particular, a referral fee will be considered nominal if it does not exceed any one of the following standards:
  • twice the average of the minimum and maximum hourly wage established by the bank for the employee’s job family (tellers, loan officers, etc.)
  • twice the employee’s actual base hourly wage
  • 1/1,000th of the minimum and maximum base salary established by the bank for the employee’s job family
  • 1/1,000th of the employee’s actual annual base salary
  • $25, as adjusted periodically for inflation
The statutory networking exception requires that a nominal referral fee be paid in cash. Section 218.700, however, provides that banks may use a point system to track nominal cash referral fees payable to an employee, so long as the points translate into a cash fee and the amount of cash ultimately received for a referral does not vary on the basis of the number or type of securities referrals the employee makes.
3-3638

Referrals of High-Net-Worth and Institutional Customers

Section 218.701 includes an exemption that permits a bank, subject to a variety of conditions, to pay its employees a higher-than-nominal contingent fee for the referral of a high-net-worth or an institutional customer to a broker-dealer. A high-net-worth customer is defined as a natural person who has at least $5 million in net worth (either individually or together with the person’s spouse), excluding the primary residence and associated liabilities of the person and, if applicable, the spouse. An institutional customer is any corporation, partnership, limited-liability company, trust, or other non-natural person that has, or is controlled by, a non-natural person that has at least (1) $10 million in investments, (2) $20 million in revenues, or (3) $15 million in revenues if the bank employee refers the customer to the broker-dealer for investment banking services.
Under the exemption, a referral fee that a bank employee receives may be a dollar amount based on a fixed percentage of the revenues received by the broker-dealer for investment banking services provided to the customer. Alternatively, the referral fee may be a predetermined dollar amount, or a dollar amount determined in accordance with a predetermined formula, so long as the amount does not vary on the basis of (1) the revenue generated by, or the profitability of, securities transactions conducted by the customer with the broker-dealer; (2) the quantity, price, or identity of securities purchased or sold over time by the customer with the broker-dealer; or (3) the number of customer referrals made.
The conditions that must be satisfied for a bank employee to receive a higher-than-nominal contingent referral fee include the following:
  • Written agreement. The bank and broker-dealer must enter into a written agreement that governs the networking arrangement.
  • Bank employee eligibility. The bank employee must be predominantly engaged in activities other than making referrals to broker-dealers; must encounter the high-net-worth or institutional customer in the ordinary course of the employee’s assigned duties; and must not be qualified or required to be qualified under the rules of a self-regulatory organization. In addition, the broker-dealer must determine that the bank employee making the referral is not subject to statutory disqualification under the Exchange Act.
  • Customer eligibility. Before a referral fee is paid to the employee, the bank or broker-dealer must have a reasonable basis to believe that the customer is a high-net-worth customer or an institutional customer.
  • Disclosures. The bank must provide a high-net-worth or an institutional customer with the required disclosures, either orally or in writing, before or at the time of the referral.2 If the disclosures are initially provided orally, then the bank or the broker-dealer must provide the disclosures to the customer in writing within certain time periods specified in the exemption.
  • Suitability or sophistication analysis. When a referral fee is contingent on a transaction, the broker-dealer must perform a suitability analysis, in accordance with the rules of its self-regulatory organization, as if a recommendation had been made. When the referral fee is not contingent on a transaction, the broker-dealer must perform either a suitability or sophistication analysis.
A bank that acts in good faith and that has reasonable policies and procedures in place to comply with the requirements of the exemption will not be considered a broker solely because the bank fails, in a particular instance, to meet the requirements of section 218.701.
2
The required disclosures inform the customer that the bank employee participates in an incentive compensation program under which the employee may receive a higher-than-nominal referral fee that may be contingent on whether the customer engages in a securities transaction with the broker-dealer.
3-3639

Bank Bonus Plans

Because the Exchange Act prohibits employees from receiving incentive compensation other than a nominal one-time cash fee of a fixed dollar amount, section 218.701 specifically includes two separate protections for bank bonus programs. The first provides that Regulation R does not affect discretionary bonus programs that are based on multiple factors and variables, including significant factors or variables that are not related to securities transactions at the broker-dealer.3
The second safe harbor expressly provides that nothing in the regulation prevents a bank from compensating its employees under a bonus plan that is based on any measure of the overall profitability or revenue of (1) the bank or (2) an affiliate of the bank (other than a broker-dealer), an operating unit of the bank, or a non-broker-dealer affiliate, so long as the affiliate or operating unit does not over time predominately engage in the business of making referrals to a broker-dealer.4 The term operating unit encompasses, among other things, a branch, department, division, or business line of a bank or an affiliate.
3
A nonsecurities factor or variable would be considered “significant” under the regulation if the amount of an employee’s bonus could be reduced or increased by a material amount on the basis of the nonsecurities factor or variable. The fact that a bank employee made a securities referral and the number of securities referrals made by a bank employee may not be factors or variables under a bank’s bonus plan.
4
The safe harbor is also available for bonus plans that are based on the overall profitability or revenue of a broker-dealer; in such cases, additional conditions apply that are similar to those applicable to a multifactor bonus program.
3-3640

TRUST AND FIDUCIARY ACTIVITIES

Section 3(a)(4)(B)(ii) of the Exchange Act permits a bank, under certain conditions, to effect securities transactions in a trustee or fiduciary capacity without being registered as a broker. 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. In addition, the bank must be “chiefly compensated” for such transactions on the basis of (1) an administration or annual fee; (2) a percentage of assets under management; (3) a flat or capped per-order processing fee that does not exceed the cost the bank incurs in executing such securities transactions; or (4) any combination of such fees. In the regulation, these fees are referred to collectively as “relationship compensation.”
Regulation R provides banks with two alternative methods for monitoring their compliance with the statute’s chiefly compensated condition—a bankwide methodology (section 218.722) and an account-by-account methodology (section 218.721). Under either approach, a bank’s compliance with the chiefly compensated test would be based on a two-year rolling average of the bank’s compensation that is attributable to its trust and fiduciary accounts or business.
Under the bankwide alternative, a bank would meet the chiefly compensated test if the aggregate amount of relationship compensation the bank received from its trust and fiduciary business as a whole during the preceding two years equaled or exceeded 70 percent of the total compensation attributable to the bank’s trust and fiduciary business during those years (after the annual ratios for both years have been averaged together). The account-by-account alternative is structured similarly, except that a bank must separately compare the relationship compensation and total compensation attributable to each trust or fiduciary account individually, rather than on a bankwide basis. If a bank decides to follow the account-by-account approach, the relationship compensation attributable to each trust or fiduciary account must represent more than 50 percent of the bank’s total compensation from the account. Section 218.723 includes exemptions that allow a bank to exclude compensation from certain types of accounts from the chiefly compensated test, under one or both of the approaches, in limited circumstances.5
Banks relying on the trust and fiduciary exception may not publicly solicit brokerage business, other than by advertising that they effect transactions in securities, and such advertising must be in conjunction with advertising the bank’s other trust activities. Banks relying on the trust and fiduciary exception must also comply with the broker-execution requirement in section 3(a)(4)(C) of the Exchange Act.
5
Generally, section 218.723 allows a bank to exclude certain types of short-term accounts, transferred accounts, and accounts at non-shell foreign branches, as well as a de minimis number of accounts in other limited circumstances.
3-3641

DEPOSIT SWEEP PROGRAMS AND TRANSACTIONS IN MONEY MARKET FUNDS

Section 3(a)(4)(B)(v) of the Exchange Act excepts a bank from the definition of broker to the extent the bank effects transactions as part of a program for the investment or reinvestment of deposit funds into any no-load, open-end management investment company registered under the Investment Company Act of 1940 (15 USC 80a-1 et seq.) that holds itself out as a money market fund. Regulation R implements this exception in section 218.740. Consistent with the rules of the Financial Industry Regulatory Authority, Inc. (FINRA), a money market fund will be considered no-load under section 218.740 if it does not charge a front-end or back-end sales load and does not charge more than 25 basis points in asset-based fees for sales expenses or personal services. A bank may rely on the “sweep” exception and section 218.740 to sweep deposit funds of, or collected by, another bank into a no-load money market fund.
In addition, Regulation R includes an exemption (section 218.741) that would allow banks to invest customer funds in any money market fund, so long as the customer has some other banking relationship with the bank. If the fund does not meet FINRA’s definition of a no-load fund, the bank cannot characterize the fund as being no-load and must provide the customer with a prospectus for the fund at or before the time when the customer authorizes the transaction.
3-3642

SAFEKEEPING AND CUSTODY

The safekeeping and custody exception in section 3(a)(4)(B)(viii) of the Exchange Act permits banks to engage in a variety of securities activities in connection with their customary safekeeping and custody activities, such as clearing and settling securities transactions, exercising warrants and other rights associated with securities held in custody, effecting securities-lending or -borrowing transactions as part of their custodial services, holding pledged securities on behalf of a customer, and serving as a custodian or providing other related administrative services to certain accounts and benefit plans.
Regulation R includes an exemption (section 218.760) that permits banks acting as a custodian to accept securities orders for (1) employee benefit plans and individual retirement and similar accounts (IRAs) as a regular part of their business6 and (2) other custodial customers as an accommodation to the customers.7 The principal conditions that apply to banks that accept securities orders from a custody account vary according to the type of custodial account involved. A lesser set of conditions applies to accepting securities orders for employee benefit plans and IRAs than for other custody accounts. A bank may not rely on section 218.760 if it acts in a trustee or fiduciary capacity with respect to the account, other than as a directed trustee.
The exemption requires a bank that accepts orders from any type of custodial account (including an employee benefit plan or IRA) to abide by certain restrictions relating to (1) employee compensation8 and (2) the advertising of the bank’s order-taking services.9
Additional limitations apply if the bank accepts securities orders from a custodial account other than an employee benefit plan or IRA. As a general matter, these conditions provide that the bank—
  • may accept orders for these accounts only as an accommodation to the customer;
  • may not provide investment advice or recommendations concerning securities to the account or solicit securities transactions from the account; and
  • may not charge or receive fees that vary on the basis of whether the bank accepted the securities order or that vary on the basis of the quantity or price of the securities bought or sold by the account (thus, the bank must charge the same securities-movement fee for transferring securities into or out of the custody account regardless of whether the customer places the securities order with the bank or a securities broker).10
To rely on the exemption in section 218.760 regarding the acceptance of orders for any type of custody account, a bank must also comply with the carrying-broker prohibition in section 3(a)(4)(B)(viii)(II) of the Exchange Act and the broker-execution requirement in section 3(a)(4)(C) of the Exchange Act.
6
The regulation broadly defines the term employee benefit plan to include both tax-qualified plans (such as 401(k) plans) and nonqualified plans (such as so-called rabbi and secular trusts). In addition, Roth IRAs, health savings ac counts, and education savings accounts are treated as IRAs for purposes of the exemption.
7
A bank acting as a nonfiduciary and noncustodial administrator or recordkeeper for an employee benefit plan, and a bank acting as a subcustodian for any account, may also rely on section 218.760 to accept orders for the custody account.
8
Specifically, employees of the bank may not receive compensation that is based on whether a securities transaction is executed for the account or that is based on the quantity, price, or identity of the securities purchased or sold by the account. This restriction does not prevent bank employees from receiving compensation under the types of traditional bonus plans described under “Networking Arrangements.”
9
As a general matter, the exemption prohibits a bank from advertising its order-taking services for employee benefit plan and IRA custodial accounts more prominently than the other custody services the bank provides to these accounts; banks are also prohibited from advertising such accounts as “securities brokerage accounts.” The regulation generally prohibits a bank from advertising in the public media its order-taking services for other types of custody accounts at all. However, a bank may distribute sales literature (for example, form letters, pamphlets, or brochures) to customers and others that describes the order-taking services provided to these accounts, so long as the bank’s order-taking services are not described independently of, or more prominently than, the bank’s other custody services.
10
Unlike fees paid to a bank employee, the securities-movement fee that a bank charges its custodial customers may, consistent with current practice, vary on the basis of the identity or type of security bought or sold (for example, government debt, corporate equity, or foreign securities).
3-3643

OTHER EXEMPTIONS

Regulation R includes additional regulatory exemptions that banks may rely on in certain circumstances. These exemptions allow banks, under certain conditions, to effect transactions in so-called Regulation S securities (section 218.771), engage in securities-lending transactions for customers on a noncustodial basis (section 218.772), effect transactions involving mutual fund shares and variable insurance contracts without sending the trade to a broker-dealer for execution (section 218.775), and effect certain transactions for an employee benefit plan in the securities of the plan’s sponsor (section 218.776). Regulation R also includes an exemption for banks from potential liability under section 29 of the Exchange Act, subject to certain conditions (section 218.780).
Back to top