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IV. Exception for “Networking” Arrangements

The GLB Act permits banks, subject to certain conditions, to establish and maintain “networking” arrangements with registered broker-dealers through which the services of the broker-dealer are offered to customers of the bank.51 The Networking Exception generally prohibits bank employees (other than those who are employed by the broker-dealer and registered with the NASD or another self-regulatory organization) from receiving “incentive compensation” for a brokerage transaction, but explicitly permits bank employees to receive compensation for the referral of a customer to a broker-dealer “if the compensation is a nominal one-time cash fee of a fixed dollar amount and the payment of the fee is not contingent on whether the referral results in a transaction.” The Networking Exception and the conditions incorporated into the Exception were based on a line of no-action letters issued by SEC staff, as well as guidance issued by the Banking Agencies, concerning networking arrangements.52

The Commission has proposed a number of changes to the provisions of the Initial Rules implementing the Networking Exception in order to provide banks increased flexibility and reduce the significant compliance burdens that would have been imposed by the Initial Rules. Nevertheless, the Proposed Rules in this area remain unnecessarily rigid and inflexible. Additional flexibility is particularly warranted in light of the limited nature of the bank activities involved. Because the Networking Exception permits banks to refer a customer to a broker-dealer, registered representatives of a broker-dealer would continue to have the opportunity and responsibility to ensure that any securities transactions actually conducted by the customer comply with the suitability and other standards of the Federal securities laws.

A. Definition of “Nominal One-time Cash Fee of a Fixed Dollar Amount”

The Proposed Rules provide that a referral fee paid in cash will be considered “nominal” if the fee does not exceed the greater of: (1) the employee’s base hourly rate of pay; (2) $25; or (3) $15 in 1999 dollars, adjusted for inflation (based on the Consumer Price Index All Urban Consumers published by the Department of Labor on June 1st of the preceding year) to the whole dollar amount nearest to $15 dollars. These complex restrictions are unnecessary, unworkable and ill advised.

As we indicated in the 2001 Comment Letter, the base hourly approach is unworkable in practice and has significant problems. In addition, the Banking Agencies do not believe that the dollar amounts established by the Proposed Rules properly reflect what may constitute a nominal payment for the full range of employees that may receive these payments. For example, branch managers and platform personnel typically are more highly compensated than tellers and, accordingly, should be permitted to receive higher referral fees than tellers. Institutional referrals also typically are made by employees who are more highly compensated than employees making retail referrals. Establishing higher dollar thresholds for these types of referrals would free banks from the significant burden of monitoring the base hourly rate of pay of the individual involved simply to pay referral fees that are clearly “nominal” within the circumstances. If any dollar thresholds were to be established, those thresholds (expressed in current dollars) should be indexed for inflation. We see no reason to allow for indexing based only on a lower dollar threshold expressed in 1999 dollars. This approach is unnecessarily complicated and effectively prevents referral fees to be adjusted for inflation until such time as inflation causes $15 in 1999 dollars to equal or exceed an estimated $26 in current dollars.

We continue to believe that the Commission should not establish a fixed definition of what constitutes a “nominal” referral fee that attempts to fit one size to all cases. Whether a referral fee paid in a particular instance is “nominal” depends on a wide variety of factors including, for example, the geographic location of the employee making the referral (e.g., high cost urban area vs. low cost rural area), the employee’s overall compensation, the amount paid by the bank for other types of referrals (e.g., insurance referrals), the nature of the customer and business involved (institutional vs. retail), and the overall structure of the bank’s referral compensation program.

Accordingly, the determination of whether a referral fee is “nominal” is one that is best made in the context of the supervision and examination process. This process allows examiners to review the referral fee in light of all relevant circumstances and to make appropriate adjustments for geographic and other differences between institutions and referral programs.

This, in fact, is the way that the Commission and the self-regulatory organizations historically have monitored the “nominal” requirement embodied in the SEC staff no-action letters, on which the Networking Exception is based. Our Agencies also have used this approach in monitoring the “nominal” referral fee element of our inter-agency guidelines governing retail networking arrangements, as well as the “nominal” component of our inter-agency regulations implementing the insurance customer protection provisions established by Congress in the GLB Act.53 We believe this supervisory approach has worked well and has allowed us to monitor and enforce these “nominal” requirements in both an effective and flexible way. We would welcome the opportunity to discuss with the Commission how we would apply this same process to monitor the “nominal” requirement in the Networking Exception on an ongoing basis.

The Proposed Rules also impose restrictions on non-cash referral programs that are unnecessary and unduly restrictive. For example, the Proposed Rules would allow banks to pay securities referral fees in the form of points only if the points are awarded under an incentive program that covers a broad range of products and that is designed primarily to reward activities unrelated to securities. We see no reason for this requirement. So long as the points awarded for a securities referral have a nominal value it should not matter whether the bank’s program covers just securities or both securities and non-securities products.

In addition, the Proposed Rules provide that any non-cash referral fee must have a “readily ascertainable cash equivalent.” The Adopting Release explains that this would require that the value of a points-based referral fee must be "known to an employee before the employee makes a brokerage referral."54 However, it is often not possible to establish precisely a cash equivalent value of points because the gifts or prizes that an employee may obtain by the points often may vary in value and may not be determinable until a later date (such as, for example, the end of a fiscal quarter). A non-cash, “points” program should be permissible so long as the methodology for granting points for securities referrals is fixed in advance (even though the precise value of a point may not be known until a later time) and the ultimate value of the points awarded for any securities referral is nominal. Such a change would provide banks important flexibility without creating undue incentives for bank employees. In all cases, employees would know at the time a securities referral is made that their compensation for the referral would not exceed a nominal amount.

The Proposed Rules also provide that a bank may not pay a referral fee to an employee more than one-time per customer. The statute, however, prohibits an employee from receiving a referral fee more than one-time for each referral the employee makes to the registered broker-dealer; it does not prohibit an employee from receiving separate referral fees if a customer is referred to the broker-dealer on separate occasions or by different employees. Moreover, we understand that it would be difficult for banks to develop the systems that would be necessary for them to track each customer referred to a broker-dealer, and the employee that referred that customer, on an ongoing basis.

B. Contingent on a Securities Transaction

The Networking Exception provides that a referral fee paid to an unregistered bank employee may not be “contingent on whether the referral results in a transaction.” We appreciate the Commission’s decision to clarify that this restriction does not prohibit a bank from making a referral fee contingent on whether the customer (1) contacts or keeps an appointment with the broker-dealer, or (2) has assets, net worth, or income meeting any minimum requirement that the broker-dealer, or the bank, may have established generally for securities referrals.55

We believe the rule also should be expanded to allow a bank to make the payment of a referral fee contingent on whether the customer meets any general and objective criteria established by the broker-dealer or bank for customer referrals (so long as the fee is not contingent on whether the referral results in a transaction). Broker-dealers may well establish other objective criteria (such as residency requirements or tax bracket criteria) for customer referrals, and allowing bank employees to screen customers for compliance with these restrictions would help prevent the unnecessary referral of customers.

C. Bonus Programs

The Adopting Release includes a discussion of the bonus programs employed by banks and bank holding companies. However, it is unclear from the text of the Adopting Release whether the Commission believes it has jurisdiction to regulate the general bonus programs of banks and bank holding companies through the referral fee restrictions embedded in the Networking Exception of the GLB Act and, if so, on what basis the Commission believes it has such jurisdiction.

We agree that an unregistered bank employee who has received a fee for a securities referral fee under the Networking Exception cannot receive additional compensation for that referral through the form of a bonus in a way that would cause the employee’s compensation for the referral to exceed a nominal amount. We believe the most appropriate way to monitor that bonus programs are not used as a conduit for such payments is through the bank supervisory and examination process.

We do not believe, however, that Congress, in authorizing banks to have networking arrangements with broker-dealers, intended to grant the Commission broad authority over the bonus programs utilized by banks and bank holding companies to compensate their employees generally. Indeed, we see nothing in the Networking Exception or its legislative history that would even hint that Congress intended to give the Commission such broad authority.

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51 See 15 U.S.C. § 78c(a)(4)(B)(i) (“Networking Exception”).

52 See Chubb Securities Corp., 1993 SEC No-Act. LEXIS 1204 (Nov. 24, 1993); Interagency Statement on the Retail Sale of Nondeposit Investment Products, reprinted in Federal Reserve Regulatory Service, 3-1579.51.

53 See 12 U.S.C. § 1831x(d)(2)(B); 12 C.F.R. § 14.50(b) (OCC); § 208.85(b) (Board); and § 343.50(b) (FDIC).

54 See Adopting Release at 39,690, n. 67.

55 See Proposed Rule 242.710(a).

Last Updated 10/08/2004

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