Fees structured in this manner and consistent with the limitations in
paragraph (d)(4)(i) of the Rule do not provide a bank employee an
incentive to recommend the purchase or sale of particular securities.
In fact, the bank employee would have no special incentive to recommend
the purchase of any security, as the addition of cash or other non-
security instruments to the account would count equally towards the
employee's compensation as any addition of securities to the account.
8. Permissible Bonus Compensation Not Restricted
    The exemption for high net worth and institutional customers
expressly provides that nothing in the exemption prevents or prohibits
a bank from paying, or a bank employee from receiving, any type of
compensation under a bonus or similar plan that would not be considered
incentive compensation under paragraph (b)(1), or that is described in
paragraph (b)(2), of Rule 700 (implementing the networking
exception).\141\ As explained above, these types of bonus arrangements
do not tend to create the kind of financial incentives for bank
employees that the statute was designed to address.
---------------------------------------------------------------------------

    \141\ Rule 701(c).
---------------------------------------------------------------------------

III. Trust and Fiduciary Activities

A. Trust and Fiduciary Exception and Proposed Rules

    Section 3(a)(4)(B)(ii) of the Exchange Act (the ``trust and
fiduciary exception'') permits a bank, under certain conditions, to
effect securities transactions in a trustee or fiduciary capacity
without being registered as a broker.\142\ 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.\143\ In addition the bank must be ``chiefly
compensated'' for such transactions, consistent with fiduciary
principles and standards, 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.\144\
---------------------------------------------------------------------------

    \142\ 15 U.S.C. 78c(a)(4)(B)(ii).
    \143\ Id.
    \144\ 15 U.S.C. 78c(a)(4)(B)(ii)(I).
---------------------------------------------------------------------------

    Banks relying on this exception may not publicly solicit brokerage
business, other than by advertising that they effect transactions in
securities in conjunction with advertising their other trust
activities.\145\ In addition, a bank that effects a transaction in the
United States of a publicly traded security under the exception must
execute the transaction in accordance with Exchange Act Section
3(a)(4)(C).\146\ This Section requires that the bank direct the trade
to a registered broker-dealer for execution, effect the trade through a
cross trade or substantially similar trade either within the bank or
between the bank and an affiliated fiduciary in a manner that is not in
contravention of fiduciary principles established under applicable
federal or state law, or effect the trade in some other manner that the
Commission permits.\147\ The trust and fiduciary exception recognizes
the

traditional securities role banks have performed for trust and
fiduciary customers and includes conditions to help ensure that a bank
does not operate a securities broker in the trust department.
---------------------------------------------------------------------------

    \145\ 15 U.S.C. 78c(a)(4)(B)(ii)(II).
    \146\ 15 U.S.C. 78c(a)(4)(C).
    \147\ 15 U.S.C. 78c(a)(4)(C)(i)-(iii). As discussed infra at
Part VI.C, the Agencies have adopted Rule 775 that permits banks,
subject to certain conditions, to effect trades in securities issued
by an open-end company and certain variable insurance contracts
without sending the trade to a registered broker-dealer. Trades
effected by a bank in accordance with Rule 775 are conducted in
accordance with Section 3(a)(4)(C) of the Exchange Act.
---------------------------------------------------------------------------

    The proposed rules provided that a bank would meet the ``chiefly
compensated'' condition in the trust and fiduciary exception if the
bank's relationship compensation attributable to each trust or
fiduciary account exceeded 50 percent of the total compensation
attributable to the relevant account.\148\ The proposed rules also
included an exemption that would permit a bank to use a bank-wide
approach to the ``chiefly compensated'' condition as an alternative to
the account-by-account approach. A bank using this proposed alternative
would be able to use the aggregate relationship and total compensation
that the bank received from its trust and fiduciary business as a whole
to monitor its compliance with the chiefly compensated test. The
proposed rule allowed a bank to use this bank-wide alternative if,
among other things, the bank's aggregate relationship compensation
attributable to its trust or fiduciary business as a whole equaled or
exceeded 70 percent of the total compensation attributable to its trust
or fiduciary business. This bank-wide alternative was designed to
simplify compliance, alleviate concerns about inadvertent
noncompliance, and reduce the costs and disruptions banks likely would
incur under the account-by-account approach.
---------------------------------------------------------------------------

    \148\ Proposed Rule 721.
---------------------------------------------------------------------------

    The proposal defined the term ``relationship compensation'' to mean
the types of trust and fiduciary compensation specifically identified
in the trust and fiduciary exception. The proposed rules also provided
examples of fees that would be considered an administration fee or a
fee based on a percentage of assets under management for these
purposes. For example, the proposed rules provided that fees paid by an
investment company pursuant to a plan under 17 CFR 270.12b-1 (``12b-1
fees'') or for personal service or the maintenance of shareholder
accounts (``service fees'') would be considered relationship
compensation under the rules. The proposed rules also implemented the
statute's advertising restriction and provided certain other
conditional exemptions.

B. Joint Final Rules

1. ``Chiefly Compensated'' Test and Bank-Wide Exemption Based on Two-
Year Rolling Averages
    A majority of commenters supported the general approach taken in
the proposed rules implementing the trust and fiduciary exception,
including the proposed bank-wide alternative for the chiefly
compensated test. For example, a number of commenters stated that the
proposed bank-wide approach would provide banks an improved, workable
and flexible method of complying with the statutory exception.\149\
Some commenters, however, opposed either the account-by-account or
bank-wide alternative to the ``chiefly compensated'' requirement. For
example, some commenters argued that the account-by-account approach
was inconsistent with the terms and purposes of the trust and fiduciary
exception.\150\ Another commenter argued that an account-by-account
approach to the chiefly compensated test is the only way to help ensure
that a bank does not operate a brokerage business out of its trust or
fiduciary departments and, for this reason, recommended that the
Agencies eliminate the bank-wide alternative.\151\ Some commenters also
requested that the Agencies lower the 70 percent relationship
compensation/total compensation percentage required by the bank-wide
exemption to 60 percent or 50 percent to make it more consistent with
the percentage required by the account-by-account approach.\152\
---------------------------------------------------------------------------

    \149\ See, e.g., ABA Letter, Roundtable Letter, U.S. Trust
Letter, WBA Letter.
    \150\ See, e.g., Clearing House Ass'n Letter.
    \151\ See NASAA Letter.
    \152\ See ACB Letter, CBA Letter.
---------------------------------------------------------------------------

    After carefully considering the comments, the Agencies have
retained the two alternative approaches in substantially the same form
as proposed. Specifically, Rule 721 provides that a bank meets the
``chiefly compensated'' condition in the trust and fiduciary exception
if the ``relationship-total compensation percentage'' for each trust or
fiduciary account of the bank is greater than 50 percent.\153\ The
``relationship-total compensation percentage'' for a trust or fiduciary
account is calculated by (1) Dividing the relationship compensation
attributable to the account during each of the immediately preceding
two years by the total compensation attributable to the account during
the relevant year; (2) translating the quotient obtained for each of
the two years into a percentage; and (3) then averaging the percentages
obtained for each of the two immediately preceding years.\154\
---------------------------------------------------------------------------

    \153\ Rule 721(a)(1).
    \154\ The rule provides for this process to be accomplished by
calculating the ``yearly compensation percentage'' and the
``relationship-total compensation percentage'' for the account. See
Rule 721(a)(2) and (3).
---------------------------------------------------------------------------

    The final rules (Rule 722) also allow a bank to use a bank-wide
approach to the ``chiefly compensated'' condition as an alternative to
the account-by-account approach. To use this bank-wide methodology, the
bank must meet two conditions. First, the ``aggregate relationship-
total compensation percentage'' for the bank's trust and fiduciary
business as a whole must be at least 70 percent.\155\ The ``aggregate
relationship-total compensation percentage'' of a bank operating under
the bank-wide approach is calculated in a similar manner as the
``relationship-total compensation percentage'' of an account under the
account-by-account, except that the calculations would be based on the
aggregate relationship compensation and total compensation received by
the bank from its trust and fiduciary business as a whole during each
of the two immediately preceding years. In other words, the percentage
would be determined by (1) Dividing the relationship compensation
attributable to the bank's trust and fiduciary business as a whole
during each of the immediately preceding two years by the total
compensation attributable to the bank's trust and fiduciary business as
a whole during the relevant year; (2) translating the quotient obtained
for each of the two years into a percentage; and (3) then averaging the
percentages obtained for each of the two immediately preceding
years.\156\ Second, the bank must comply with the conditions in the
trust and fiduciary exception (other than the compensation test in
Section 3(a)(4)(B)(ii)(I)) \157\ and comply with Section 3(a)(4)(C)
(relating to trade execution) of the Exchange Act.\158\
---------------------------------------------------------------------------

    \155\ Rule 722(a)(2).
    \156\ The rule provides for this process to be accomplished by
calculating the ``yearly bank-wide compensation percentage'' and the
``aggregate relationship-total compensation percentage'' for the
bank's trust and fiduciary business as a whole. See Rule 722(b) and
(c).
    \157\ The Agencies have modified the bank-wide exemption to
clarify that these conditions include the advertising restrictions
contained in the trust and fiduciary exception as implemented by
Rule 721(b). See Rule 722(a)(1).
    \158\ Rule 722(a)(1).
---------------------------------------------------------------------------

    The Agencies believe that providing banks these two alternatives is
consistent with the purposes of the trust and fiduciary exception. In
this regard, the availability of these two alternatives is designed to
avoid disrupting the trust and fiduciary operations of banks. The

compensation tests in both the account-by-account and bank-wide
approaches are designed to ensure that a bank's trust department is not
unduly dependent on the types of securities-related compensation not
permitted by the statute. The 70 percent compensation threshold in the
bank-wide exemption is higher than that required under the account-by-
account approach in order to compensate for the loss of particularity
when the chiefly compensated test is implemented and monitored on a
bank-wide basis, rather than on an account-by-account basis. The
Agencies note that several commenters also asserted that the proposed
aggregate relationship compensation-total compensation percentage
required by the bank-wide alternative (70 percent) would not disrupt
the trust and fiduciary operations or customer relationships of banks
in light of the proposal's definition of ``relationship compensation.''
    Some commenters asked that the Agencies modify how the bank-wide
exemption could be applied in several ways. For example, some asserted
that a bank should be allowed to apply the 70 percent compensation
threshold separately to each individual fiduciary business line,
operating unit or geographic region of the bank, rather than only on an
aggregate bank-wide basis. Others asked that the Agencies allow a bank
to use an aggregate compensation approach only for some trust or
fiduciary business lines and use the account-by-account approach for
the bank's trust or fiduciary accounts in its remaining business
lines.\159\ In addition, some asked that a bank be permitted to monitor
compliance with the 70 percent compensation test on a combined basis
with its affiliated entities engaged in trust or fiduciary activities
(such as an affiliated bank or a subsidiary or affiliate registered as
an investment adviser).\160\ Some commenters also asked the Agencies to
modify the bank-wide approach to provide for a bank's relationship
compensation-total compensation percentage to be calculated based on
the compensation attributable to all of the bank's trust and fiduciary
accounts rather than the compensation from the bank's ``trust and
fiduciary business.'' \161\
---------------------------------------------------------------------------

    \159\ See Clearing House Ass'n Letter.
    \160\ See Citigroup Letter, Clearing House Ass'n Letter, Mellon
Bank, N.A. (``Mellon'') Letter, PNC Letter, ABA Letter.
    \161\ See, e.g., ABA Letter, Joint ABA/ABASA/Clearing House
Ass'n Letter of July 16, 2007, BISA Letter, Clearing House Ass'n
Letter, Comerica Bank Letter.
---------------------------------------------------------------------------

    The Agencies believe that the bank-wide alternative as structured
provides banks appropriate and adequate flexibility in conducting their
trust and fiduciary operations while meeting the statute's goals. The
bank-wide approach is designed to reflect both the relationship
compensation and total compensation received by a bank through the
conduct of its full range of trust or fiduciary services, and, thus,
allow banks to avoid tracking their trust or fiduciary revenue back to
one or more specific accounts. At the same time, the use of two uniform
methodologies (account-by-account or bank-wide) should facilitate the
review of bank compliance during the bank supervisory process and aid
the development of software and related systems by banks and their
service providers for compliance purposes. Furthermore, because the
broker exceptions for a bank in Section 3(a)(4)(B), including the trust
and fiduciary exception, apply to each bank individually and are not
available to a nonbank entity, including a nonbank subsidiary or
affiliate of a bank, the Agencies have not modified the rules to allow
a bank to monitor its compliance with the compensation limit in Rule
721 on a combined basis with one or more affiliated banks, subsidiaries
or affiliates. The Agencies also do not believe that requiring banks to
monitor their compliance with the 70 percent compensation test on a
bank-wide basis, rather than on an individual business line or
operating unit basis, will impose significant additional burdens on
banks.\162\
---------------------------------------------------------------------------

    \162\ The Agencies note, for example, that a bank that operates
under the bank-wide approach may use different systems across its
trust or fiduciary business lines, units or regions to monitor its
compensation within those business lines, units or regions, provided
that such information is then aggregated on a bank-wide basis as
provided in Rule 722.
---------------------------------------------------------------------------

    A bank has the flexibility to elect to use a calendar year or the
bank's fiscal year for purposes of complying with the compensation
provisions of either the account-by-account or bank-wide approach.\163\
In addition, whether a bank decides to use the account-by-account
approach or the bank-wide approach, the bank's compliance with the
relevant compensation restriction is based on a two-year rolling
average of the compensation attributable to the trust or fiduciary
account or the bank's trust or fiduciary business, respectively. This
two-year averaging is designed to allow for short-term fluctuations
that otherwise could lead a bank to fall out of compliance with the
exception or exemption from year-to-year.
---------------------------------------------------------------------------

    \163\ Proposed Rule 721(a)(6).
---------------------------------------------------------------------------

    Some commenters asked that the Agencies clarify when a bank must
commence monitoring its compliance with the two-year rolling
compensation test. As discussed infra in Part VI.F, a bank must comply
with the exceptions in Section 3(a)(4)(B) of the Exchange Act and the
final rules starting the first day of the bank's first fiscal year
commencing after September 30, 2008. Thus, a bank that operates on a
calendar-year basis must start monitoring its compliance with the
compensation requirements on either an account-by-account or bank-wide
basis beginning January 1, 2009, and would first have to meet the
applicable compensation restriction after the conclusion of 2010 (based
on the average of the bank's year-end compensation ratios for 2009 and
2010).\164\ To allow banks sufficient time to obtain and verify the
relevant compensation data, the Agencies have modified both the
account-by-account approach and the bank-wide approach to provide banks
up to 60 days after the end of a year to calculate their compliance
with the relevant compensation restriction.\165\ While the rules
provide for a bank's compliance with the compensation tests to be
determined based solely on calculations as of year-end, banks are
encouraged to monitor their trust and fiduciary compensation on a
regular basis as appropriate to identify and address potential
compliance issues before the end of the relevant two-year period.
---------------------------------------------------------------------------

    \164\ This same schedule also would apply to a bank that
operates on an October 1st to September 30th fiscal year, but that
elects to use the calendar year for purposes of monitoring its
compliance with the chiefly compensated test. The Agencies believe
the delay and phased-in nature of the compensation tests should
provide banks as a general matter sufficient notice and time to
address potential compensation issues across the full range of their
trust and fiduciary accounts, including personal and charitable
accounts and estates. See Business Law Section Letter.
    \165\ See Rule 721(a)(3)(ii) and Rule 722(c)(2).
---------------------------------------------------------------------------

2. ``Relationship Compensation''
    Both the account-by-account and bank-wide approaches are based on
the ratio of the relationship compensation attributable to a trust or
fiduciary account or a bank's trust and fiduciary business to the total
compensation attributable to the account or business. The proposal
defined the term ``relationship compensation'' to mean the types of
trust and fiduciary compensation identified in the statute: an
administration fee; an annual fee (payable on a monthly, quarterly or
other basis); a fee based on a percentage

of assets under management; a flat or capped per order processing fee
that is equal to not more than the cost incurred by the bank in
connection with executing securities transactions for trust or
fiduciary accounts; or any combination of these fees.\166\ The proposed
rules also provided examples of fees that would be considered an
administration fee or a fee based on a percentage of assets under
management for these purposes. For example, the proposed rules provided
that 12b-1 fees,\167\ service fees,\168\ and fees for certain sub-
transfer agent, sub-accounting or related services \169\ paid by an
investment company on the basis of assets under management would be
considered relationship compensation under the rules.
---------------------------------------------------------------------------

    \166\ Proposed Rule 721(a)(4).
    \167\ Proposed Rule 721(a)(4)(iii)(A).
    \168\ Proposed Rule 721(a)(4)(iii)(B).
    \169\ See Proposed Rule 721(a)(4)(i) and (iii)(C). Specifically,
these fees, which are hereinafter referred to as ``sub-transfer
agent and related fees'' are paid for (1) providing transfer agent
or sub-transfer agent services for the beneficial owners of
investment company shares; (2) aggregating and processing purchase
and redemption orders for investment company shares; (3) providing
the beneficial owners with account statements showing their
purchases, sales, and positions in the investment company; (4)
processing dividend payments to the account for the investment
company; (5) providing sub-accounting services to the investment
company for shares held beneficially in the account; (6) forwarding
communications from the investment company to the beneficial owners,
including proxies, shareholder reports, dividend and tax notices,
and updated prospectuses; or (7) receiving, tabulating, and
transmitting proxies executed by the beneficial owners of investment
company shares in the account.
---------------------------------------------------------------------------

    The Agencies received numerous comments on the definition of
relationship compensation. A number of commenters supported the
definition including, in particular, the examples recognizing 12b-1 and
service fees as relationship compensation. For example, some commenters
stated that treating these fees as relationship compensation is
consistent with the terms and purposes of the trust and fiduciary
exception and ``critical'' to ensuring that the rules do not disrupt
the trust and fiduciary operations and customer relationships of
banks.\170\ Other commenters, however, argued that all 12b-1 fees, or
the portion of such fees paid for distribution expenses, should be
excluded from relationship compensation.\171\ These commenters asserted
that treating 12b-1 fees as relationship compensation would allow banks
to have a ``salesman's stake'' in their customers'' securities
transactions in contravention of the purposes of the statute, result in
the disparate treatment of banks and registered investment advisers,
and create confusion as to how 12b-1 fees should be treated under other
aspects of the federal securities laws and rules of the NASD (now
FINRA).
---------------------------------------------------------------------------

    \170\ See Joint ABA/ABASA/Clearing House Ass'n Letter of June 7,
2007.
    \171\ See NASD Letter, NASAA Letter.
---------------------------------------------------------------------------

    In addition, many commenters asked that the Agencies clarify
whether additional types of fees not mentioned in the proposed rules
would qualify as relationship compensation. For example, commenters
asked the Agencies to confirm that fees separately charged a trust or
fiduciary customer for custodial services and fees charged or earned in
connection with securities lending and borrowing transactions conducted
for a trust or fiduciary customer are relationship compensation.
    After carefully considering the comments, the Agencies have
retained, consistent with the statute, the definition of relationship
compensation as any compensation that a bank receives that is
attributable to a trust or fiduciary account and that consists of (1)
an administration fee, (2) an annual fee (payable on a monthly,
quarterly or other basis), (3) a fee based on a percentage of assets
under management (an ``AUM fee''), (4) a flat or capped per order
processing fee, paid by or on behalf of a customer or beneficiary, that
is equal to not more than the cost incurred by the bank in connection
with executing securities transactions for trust or fiduciary accounts;
or (5) any combination of these fees.\172\
---------------------------------------------------------------------------

    \172\ Rule 721(a)(4). For banks operating under the bank-wide
alternative, fees of these types are relationship compensation if
they are attributable to the bank's trust or fiduciary business as a
whole. See Rule 722(c)(1).
---------------------------------------------------------------------------

    The final rules also continue to list all 12b-1 fees that are paid
on the basis of assets under management and attributable to a trust or
fiduciary account (under the account-by-account test) or the bank's
trust and fiduciary business as a whole (under the bank-wide test) as
examples of AUM fees that are relationship compensation. The Agencies
believe that treating 12b-1 fees in this manner is consistent with both
the language and purposes of the trust and fiduciary exception. When
paid on the basis of a percentage of assets under management these fees
fall within the types of fees expressly permitted by the trust and
fiduciary exception. 12b-1 fees that are paid on the basis of assets
under management also are distinguishable from the types of non-
relationship compensation, such as front-end or back-end sales loads
\173\ or per-order transaction fees that exceed a bank's costs, that
are limited by the statute's chiefly compensated test.
---------------------------------------------------------------------------

    \173\ A front-end sales charge is a charge that is used to
finance sales or sales promotion expenses and that is included in
the public offering price of the shares of an investment company. A
deferred sales charge is an amount properly chargeable to sales or
promotional expenses that is paid by a shareholder of an investment
company after purchase of the company's shares but before or upon
redemption. See FINRA Rule 2830(b)(8)(B) and (c); 17 CFR 270.6c-10.
---------------------------------------------------------------------------

    Treating 12b-1 fees in this manner also will avoid significant
disruptions to the trust and fiduciary operations of banks and, when
viewed in light of other provisions and protections, is consistent with
investor protection. Many bank trust and fiduciary departments,
particularly those that act as a corporate trustee or as a trustee or
fiduciary for employee benefit plans, receive a significant portion of
their trust and fiduciary compensation through payments made under a
12b-1 plan.
    Importantly, as provided in the trust and fiduciary exception, all
12b-1 fees received by a bank must be consistent with the fiduciary
principles and standards governing the bank-customer relationship,\174\
and the bank's compliance with these principles and standards will
continue to be regularly examined by bank examiners during the bank
supervisory and examination process. In addition, the treatment of 12b-
1 fees that are paid on the basis of assets under management and
service fees as ``relationship compensation'' for purposes of the trust
and fiduciary exception and related rules does not affect the treatment
of such fees under other provisions of the federal securities laws, the
federal banking laws, applicable trust or fiduciary principles and
standards, or the rules of an SRO. Thus, for example, the treatment of
12b-1 fees that are paid on the basis of assets under management and
service fees as relationship compensation for purposes of these rules
does not alter or affect the

treatment of, or limitations imposed on, these fees under FINRA Rule
2830.\175\
---------------------------------------------------------------------------

    \174\ Section 802(f) of the Uniform Trust Code, for example,
provides that a trustee may receive compensation from an investment
company in which the trustee has invested trust funds and receipt of
such compensation will not be presumed to represent a conflict of
interest if the investment otherwise complies with the
jurisdiction's prudent investor rule. See Uniform Trust Code, Sec.
902(f) and related comment (2005). In addition, a bank's receipt of
12b-1 fees from an employee benefit plan for which the bank acts as
a fiduciary is governed by the Employee Retirement Income Security
Act (``ERISA'') and the regulations and guidance issued by the
Department of Labor thereunder. See 29 U.S.C. 1001 et seq.; DOL
Advisory Opinion 2003-09A (June 25, 2003) (discussing conditions
under which a directed trustee may receive 12b-1 fees under ERISA).
    \175\ The rules also do not alter or affect the ability of a
nonbank registered investment adviser to receive 12b-1 fees under
the federal securities laws or the rules of an SRO. The ``broker''
exceptions for banks in Section 3(a)(4)(B) of the Exchange Act,
including the trust and fiduciary exception, are not available to
nonbank entities such as nonbank investment advisers.
---------------------------------------------------------------------------

    In light of the comments received, the Agencies have modified Rule
721 to provide additional examples of the types of fees that qualify as
relationship compensation under the statute and the rules. For example,
the Agencies have modified the rule to include, as additional examples
of an administration fee, compensation received by a bank (1) for
disbursing funds from, or for recording payments to, a trust or
fiduciary account; (2) in connection with securities lending and
borrowing transactions conducted for a trust or fiduciary account; and
(3) for custody services provided to a trust or fiduciary account
(whether or not separately charged).\176\ In addition, the Agencies
have included (1) as an example of an annual fee, an annual fee paid
for assessing the investment performance of a trust or fiduciary
account or for reviewing such an account's compliance with applicable
investment guidelines or restrictions, and (2) as an example of an
assets under management fee, a fee based on the financial performance,
such as capital gains or capital appreciation, of trust or fiduciary
assets under management. The Agencies believe the characterization of
these fees comports with the manner in which banks generally receive
compensation for these services. Several commenters noted that banks
currently may receive 12b-1 fees, service fees or sub-transfer agent
and related fees either directly from a mutual fund or from the fund's
distributor, transfer agent, administrator or adviser.\177\ In light of
these comments, the Agencies have eliminated the language in the
proposed rules that required that these types of fees be ``paid by an
investment company.''
---------------------------------------------------------------------------

    \176\ Rule 721(a)(4)(i)(B), (C) and (D). Because securities
lending/borrowing fees and custody fees may be charged on an assets
under management basis, the rule also provides that these fees are
relationship compensation when charged in this manner. Rule
721(a)(4)(iii)(E). As with other types of relationship compensation,
the fees that a bank receives for effecting securities lending/
borrowing transactions for a trust or fiduciary account must be
consistent with applicable fiduciary principles and standards.
    \177\ See Investment Company Institute (``ICI'') Letter,
Federated Investors, Inc. (``Federated Investors'') Letter.
---------------------------------------------------------------------------

    The examples of an administration fee, annual fee and an asset
under management fee included in Rule 721(b) are provided only for
illustrative purposes. Other types of fees or fees for other types of
services could be an administration fee, annual fee or an AUM fee. In
addition, an administration fee, annual fee or assets under management
fee attributable to a trust or fiduciary account or a bank's trust or
fiduciary business is considered relationship compensation regardless
of what entity or person pays the fee, and regardless of whether the
fee is related to only securities assets, to a combination of
securities and non-securities assets, or to only non-securities assets.
These fees are part of the compensation for acting as a trustee or
fiduciary.
    Some commenters asserted that a bank should be permitted to include
within its relationship compensation any per-transaction securities
processing fee it charges as a directed trustee or in another fiduciary
capacity even if the fee exceeds the bank's costs in processing the
transaction.\178\ The statute, however, expressly provides that a per-
order securities processing fee may be counted towards the statute's
chiefly compensated requirement only if the fee is ``equal to not more
than the cost incurred by the bank in connection with executing
securities transactions'' for its trust or fiduciary customers. For
this reason, the Agencies have not modified the rule in the manner
requested.
---------------------------------------------------------------------------

    \178\ See, e.g., Wells Fargo & Company (``Wells Fargo'') Letter,
State Street Corp. Letter, Mellon Letter.
---------------------------------------------------------------------------

    However, as discussed further in Part V, the Agencies have modified
the custody exemption (Rule 760) to permit banks that accept securities
orders as a directed trustee to do so under that exemption in lieu of
the trust and fiduciary exception and related rules. In addition, as
the Agencies explained in the proposal, a per order processing fee
included in relationship compensation may include the fee charged by
the executing broker-dealer as well as any additional fixed or variable
costs incurred by the bank in processing the transaction. If a bank
includes any such additional fixed or variable costs in the per order
processing fees it includes in its relationship compensation, the bank
should maintain appropriate policies and procedures governing the
allocation of these costs to the orders processed for trust or
fiduciary customers. This should help ensure that profits derived from
per trade charges are not masked as costs of processing the trades and
thereby included in relationship compensation.
3. Excluded Compensation
    A number of commenters asserted that the revenues derived from
securities transactions conducted by a bank for a trust or fiduciary
customer under a different exception or exemption (such as the
exemption provided in Rule 771 for transactions in Regulation S
securities) should be excluded from the account-by-account or bank-wide
compensation test completely.\179\ Others asked that certain other
types of fees, such as internal credits from other areas of the bank,
credits received from broker-dealers for brokerage or research services
in accordance with Section 28(e) of the Exchange Act, or revenues
earned from providing trust or fiduciary services to mutual funds, be
excluded from the chiefly compensated calculation as well.
---------------------------------------------------------------------------

    \179\ See, e.g., Institute of Int'l Bankers (``IIB'') Letter,
Clearing House Ass'n Letter.
---------------------------------------------------------------------------

    As discussed in Part I.C supra, if more than one ``broker''
exception or exemption is available for a securities transaction
effected by a bank for a customer, the bank may choose the exception or
exemption on which it relies in effecting the transaction. In light of
the comments received, the Agencies have modified Rules 721 and 722 to
explicitly provide that, if a bank effects a securities transaction for
a trust or fiduciary customer in accordance with the terms of an
exception or exemption other than Rule 721 or Rule 722, the bank may,
at its election, exclude the revenues associated with those
transactions from the applicable relationship-total compensation
calculation in Rule 721 or Rule 722.\180\ As the rules provide, if a
bank elects to exclude the revenues associated with transactions
conducted under another exception or exemption, the bank must exclude
such revenue from both the bank's relationship compensation (if the
compensation would otherwise qualify as relationship compensation) and
total compensation. Of course, the bank also must comply with the
conditions applicable to the other available exception or exemption on
which the bank chooses to rely.\181\
---------------------------------------------------------------------------

    \180\ Rule 721(b) and Rule 722(d).
    \181\ Some commenters asserted that a bank should be allowed to
include in its relationship compensation all of the revenue from
securities transactions conducted for a trust or fiduciary account
under another exception or exemption, regardless of whether that
revenue otherwise qualifies as relationship compensation. The
Agencies have not amended the rule in this manner as it is
inconsistent with the terms of the trust and fiduciary exception
which sets forth the types of fees that are included in relationship
compensation.
---------------------------------------------------------------------------

    In addition, compensation that is not derived from the provision of
trust or fiduciary services should not be

included in a bank's relationship or total compensation under either
the account-by-account or bank-wide alternative. Such compensation
includes, for example, (1) revenue earned by a trust or fiduciary
department from providing back-office services to an affiliated or
unaffiliated party,\182\ (2) revenue from the sale of an office or
assets of the trust department, or from the provision on a stand-alone
basis of other services (such as custody services or the sale of
portfolio management software to a third party that independently
operates and uses the software in connection with its own business)
that do not involve trust or fiduciary services as defined in section
3(a)(4)(D) of the Act; and (3) internal payments or credits allocated
to a bank's trust or fiduciary department or unit from another
department or unit of the bank for deposits and other similar services
not involving a security. Credits received by a bank from a broker-
dealer for brokerage and research services provided by a broker-dealer
in accordance with section 28(e) of the Act (15 U.S.C. 78bb(e)) and the
regulations issued thereunder also should be excluded from the
compensation tests. The Agencies do not believe these credits
constitute compensation to the bank for purposes of the exception and
rules because these credits must be reasonable in relation to the value
of the brokerage and research provided by the broker-dealer in
connection with the bank's exercise of investment discretion for its
fiduciary accounts.
---------------------------------------------------------------------------

    \182\ On the other hand, the revenue derived from providing
fiduciary services to investment companies or companies affiliated
with the bank should be included in the relevant chiefly compensated
calculation.
---------------------------------------------------------------------------

4. Trust or Fiduciary Accounts
    The final rules, like the proposal, define a trust or fiduciary
account as an account for which the bank acts in a trustee or
``fiduciary capacity'' as that term is defined in Section 3(a)(4)(D) of
the Exchange Act.\183\ This definition is based on the definition of
``fiduciary capacity'' in part 9 of the OCC's regulations, which
relates to the trust and fiduciary activities of national banks, in
effect at the time of enactment of the GLB Act.
---------------------------------------------------------------------------

    \183\ Rule 721(a)(5).
---------------------------------------------------------------------------

    Section 3(a)(4)(D) identifies a number of particular situations
where a bank serves in a fiduciary capacity.\184\ The definition also
provides that a bank acts in a ``fiduciary capacity'' if it acts ``in
any other similar capacity'' to those specifically identified.
Accordingly, the scope of the term ``fiduciary capacity'' is not fixed
in time.
---------------------------------------------------------------------------

    \184\ Section 3(a)(4)(D) of the Exchange Act provides that a
bank acts in a ``fiduciary capacity'' if, among other situations,
the bank has investment discretion on behalf of another. Thus, for
example, if a bank has investment discretion over an escrow account
on behalf of another, the bank would be acting in a ``fiduciary
capacity'' with respect to the account.
---------------------------------------------------------------------------

    The Agencies recognize, moreover, that different nomenclature may
be used to identify a fiduciary capacity in the relevant governing
documents or state laws. For example, the Uniform Probate Code uses the
term ``Personal representative'' and similar successor titles in place
of the terms ``executor'' or ``administrator'' to identify the
representative of a decedent; the Uniform Custodial Trust Act uses the
terms ``Conservator'' and ``Custodial trustee'' to refer to persons
that act as a fiduciary for another person who has become
incapacitated; and the Uniform Transfers to Minors Act uses both the
terms ``Conservator'' and ``Custodian'' to refer to fiduciaries that
act on behalf of a minor.\185\
---------------------------------------------------------------------------

    \185\ The text of and additional information on these Uniform
Codes and Acts, which are developed under the auspices of the
National Conference of Commissioners of Uniform State Laws
(``NCCUSL''), may be found on NCCUSL's Web site at http://www.nccusl.org
.

---------------------------------------------------------------------------

    Some commenters asked whether a bank that engages in trust or
fiduciary activities may conduct securities transactions under the
trust and fiduciary exception and related rules even if the bank does
not maintain a separate trust department or has not had to obtain
formal trust powers from its appropriate federal banking agency.\186\
The trust and fiduciary exception and related rules do not require that
a bank effecting securities transactions for a customer in a trust or
fiduciary capacity do so through a separate trust department or have
obtained formal trust powers from its appropriate federal banking
agency. However, securities transactions conducted for a trust or
fiduciary customer under the exception and related rules must be
effected in a department of the bank ``that is regularly examined for
compliance with fiduciary principles and standards'' by the bank's
appropriate federal or state banking supervisor.\187\ As stated in the
proposal, the Agencies will rely on the appropriate federal banking
agency for a bank to determine whether the bank's activities are
conducted in the bank's trust department or other department regularly
examined by the agency's examiners for compliance with fiduciary
principles and standards.\188\
---------------------------------------------------------------------------

    \186\ See, e.g., ACB Letter, Roundtable Letter. Federal savings
associations, for example, are not required to obtain approval from
their appropriate federal banking agency to act as a trustee for an
individual retirement account under section 408(a) of the Internal
Revenue Code. See 12 CFR 550.580.
    \187\ 15 U.S.C. 78c(a)(4)(B)(ii); Rule 722(a)(1). A bank
effecting transactions for trust or fiduciary customers through a
department examined for compliance with trust or fiduciary
principles may use other divisions or departments of the bank, or
other affiliated or unaffiliated third parties, to handle aspects of
these transactions. The bank must continue to act in a trustee or
fiduciary capacity with respect to the account and, accordingly,
should exercise appropriate diligence in selecting persons to
provide services to the bank's trust or fiduciary customers and in
overseeing the services provided in accordance with the bank's
fiduciary obligations. No party, other than the bank (including,
without limitation, a transfer agent or investment adviser), working
in conjunction with the bank may rely on the bank's exception or
exemption from ``broker'' status. To the extent that any such third
party performs activities that would make that entity a broker under
Section 3(a)(4) of the Exchange Act that entity would be required to
register as a broker (in the absence of an applicable exemption or
regulatory relief) notwithstanding any written or unwritten
agreement the third party may have with the bank.
    \188\ The OTS, for example, is in the process of revising its
examination procedures to provide for the regular examination of
individual retirement accounts held by a federal savings association
as trustee for compliance with fiduciary principles and standards.
---------------------------------------------------------------------------

5. Exemptions for Special Accounts, Foreign Branches, Transferred
Accounts, and a De Minimis Number of Accounts
    The Agencies also proposed a rule (Proposed Rule 723) that would
permit a bank to exclude certain types of accounts for purposes of
determining its compliance with the account-by-account or bank-wide
compensation tests. As proposed, Rule 723 allowed a bank, in
calculating its compensation under either approach, to exclude
compensation received from any trust or fiduciary account open only for
a short period of time (less than 3 months) or acquired within the past
12 months as part of a merger or similar transaction. In addition, the
Proposed Rule allowed a bank using the account-by-account approach,
subject to certain conditions, to (1) exclude the lesser of 1 percent
or 500 of its trust or fiduciary accounts in a year from the chiefly
compensated test, and (2) transfer any trust or fiduciary account
ultimately determined to be non-conforming to a registered broker-
dealer or an unaffiliated entity exempt from registration within 3
months of the end of the relevant year.
    Commenters generally favored these exemptions. One commenter,
however, argued that these exemptions should be eliminated because they
would allow banks to manipulate the chiefly compensated test.\189\
Several commenters also requested that the Agencies adopt an additional
exemption

permitting banks to exclude trust and fiduciary accounts held at a
foreign branch of a bank from the chiefly compensated tests.\190\ These
commenters contended that few, if any, of the trust and fiduciary
accounts of a foreign branch (other than an offshore ``shell'' branch
servicing U.S. branches of the bank) likely are to be held by or on
behalf of a U.S. person and, accordingly, the costs of applying the
chiefly compensated test to the foreign branches of a U.S. bank would
significantly outweigh any potential benefits to U.S. persons. After
carefully considering these comments, the Agencies have adopted,
without change, the exemptions included in Proposed Rule 723. In
addition, the Agencies have adopted a new conditional exemption (Rule
723(c)) for trust and fiduciary accounts held at a foreign branch of a
bank.
---------------------------------------------------------------------------

    \189\ NASAA Letter.
    \190\ See ABA Letter, Clearing House Ass'n Letter, Joint ABA/
ABASA/Clearing House Ass'n Letter of July 16, 2007.
---------------------------------------------------------------------------

    Rule 723(a) permits a bank that uses either the account-by-account
or bank-wide compensation test to exclude any trust or fiduciary
account that was open for a period of less than 3 months during the
relevant year.\191\ Rule 723(b) permits a bank to exclude, for purposes
of determining its compliance with either compensation test, any trust
or fiduciary account that the bank acquired from another person as part
of a merger, consolidation, acquisition, purchase of assets or similar
transaction by the bank for 12 months after the date the bank acquired
the account from the other person.\192\ A bank that elects to use Rule
723(a) or (b) for one or more accounts must exclude both the
relationship compensation and total compensation attributable to such
accounts for purposes of the applicable compensation test.
---------------------------------------------------------------------------

    \191\ Rule 723(a).
    \192\ Rule 723(b).
---------------------------------------------------------------------------

    Rule 723(c) provides a new exemption under which a bank using the
bank-wide approach may exclude for purposes of the chiefly compensated
test the trust or fiduciary accounts held at a ``non-shell'' foreign
branch of the bank, provided that the bank has reasonable cause to
believe that the trust or fiduciary accounts of the foreign branch held
by or for the benefit of a U.S. person constitute less than 10 percent
of the total trust or fiduciary accounts of the foreign branch.\193\
The rule provides that a bank will be deemed to have reasonable cause
to believe that less than 10 percent of the total number of trust or
fiduciary accounts of the foreign branch are held by or for the benefit
of a U.S. person if the principal mailing address for the
accountholder(s) and beneficiary(ies) of the account is not in the
United States, or the records of the foreign branch indicate that the
accountholder(s) and beneficiary(ies) of the account is not a U.S.
person as defined in 17 CFR 230.902(k).
---------------------------------------------------------------------------

    \193\ The Agencies expect that few, if any banks, that use the
account-by-account approach to the chiefly compensated test will
have foreign branches engaged in trust or fiduciary services and,
accordingly, have limited the exemption to banks that use the bank-
wide approach.
---------------------------------------------------------------------------

    The rule defines a ``non-shell foreign branch'' of a bank to mean a
branch of the bank that is located outside the United States and
provides banking services to residents of the foreign jurisdiction in
which the branch is located, and for which the decisions relating to
day-to-day operations and business of the branch are not made by an
office of the bank located in the United States.\194\ The Agencies
believe this exemption provides appropriate relief to banks with
respect to foreign branches where the records of the bank indicate that
it is not significantly engaged in providing trust or fiduciary
services to U.S. customers.
---------------------------------------------------------------------------

    \194\ This definition is designed to exclude branches that are
established in certain offshore jurisdictions primarily to provide
services to U.S. customers and, for this reason, are managed on a
day-to-day basis from the United States.
---------------------------------------------------------------------------

    Rule 723(e) permits a bank using the account-by-account approach to
exclude, for purposes of the chiefly compensated test, the lesser of
(1) 1 percent of the total number of trust or fiduciary accounts held
by the bank; or (2) 500 accounts.\195\ To rely on this exemption with
respect to an account, the bank must not have relied on this exemption
for such account during the immediately preceding year.\196\ In
addition, the bank must maintain records demonstrating that the
securities transactions conducted by or on behalf of the excluded
account were undertaken by the bank in the exercise of its trust or
fiduciary responsibilities with respect to the account.\197\
---------------------------------------------------------------------------

    \195\ Rule 723(d). Under the rule, if a bank has less than 100
trust or fiduciary accounts in the aggregate, the bank may exclude 1
account under the exemption in any given year.
    \196\ Rule 723(d)(3).
    \197\ Rule 723(d)(1).
---------------------------------------------------------------------------

    The Agencies believe these exclusions reduce administrative burdens
and facilitate compliance. A bank, consistent with its fiduciary
duties, may need to conduct a higher level of securities transactions
for a trust or fiduciary account at certain times, such as shortly
after the account is established or acquired from another person or
shortly before the account is closed.\198\ The exclusions in Rule
723(a), (b) and (d) are designed to help prevent such short-term
fluctuations in the amount of securities transactions conducted for a
trust or fiduciary account from distorting, or causing a bank to fail,
the relevant compensation test. At the same time, these exclusions
promote compliance by requiring that the bank bring the relevant
accounts into compliance within a short and prescribed period of time.
For this reason, the Agencies do not believe it would be appropriate to
expand the Rule 723(d) to allow a bank to exclude an account from the
chiefly compensated test in consecutive years as requested by some
commenters. Some commenters also asked the Agencies to raise the 500
account maximum in Rule 723(d) to avoid discriminating against large
banks.\199\ The Agencies expect that most banks that have more than
50,000 trust and fiduciary accounts, and thus would be subject to the
500 account cap in Rule 723(d), will operate under the bank-wide test
and for this reason have not made the requested change.
---------------------------------------------------------------------------

    \198\ For example, after a trust or fiduciary account is
acquired or established, the bank may need to conduct a number of
securities transactions to invest or rebalance the account's
holdings in accordance with the terms of the agreement establishing
the account or, in cases where the bank has investment discretion,
to implement the bank's investment strategy for the account.
    \199\ See, e.g., ACB Letter; Clearing House Ass'n Letter.
---------------------------------------------------------------------------

    Rule 723(c) also provides that a bank that uses the account-by-
account approach will not be considered a broker for purposes of
Section 3(a)(4) of the Exchange Act solely because a particular trust
or fiduciary account does not meet the ``chiefly compensated'' test if,
within 3 months of the end of the year in which the account fails to
meet such standard, the bank transfers the account or the securities
held by or on behalf of the account to a registered broker-dealer or
another unaffiliated entity (such as an unaffiliated bank) that is not
required to be registered as a broker-dealer.\200\
---------------------------------------------------------------------------

    \200\ Rule 723(c).
---------------------------------------------------------------------------

6. Advertising Restrictions
    Proposed Rule 721(b) implemented the advertising restrictions in
Section 3(a)(4)(B)(ii)(II) of the Act applicable to banks conducting
securities transactions under the trust and fiduciary exception. No
commenters opposed the advertising restrictions of the rule and the
Agencies have adopted these restrictions as proposed. The final rules
provide that a bank complies with the advertising restriction
applicable under either Rule

721 or 722 if advertisements by or on behalf of the bank do not
advertise that the bank provides securities brokerage services for
trust or fiduciary accounts except as part of advertising the bank's
broader trust or fiduciary services, and do not advertise the
securities brokerage services provided by the bank to trust or
fiduciary accounts more prominently than the other aspects of the trust
or fiduciary services provided to such accounts.\201\
---------------------------------------------------------------------------

    \201\ Rule 721(b).
---------------------------------------------------------------------------

    An ``advertisement'' for these purposes means any material that is
published or used in any electronic or other public media, including
any Web site, newspaper, magazine or other periodical, radio,
television, telephone or tape recording, videotape display, signs or
billboards, motion pictures, blast e-mail, or telephone directories
(other than routine listings).\202\ Other types of material or
information that is not distributed through public media, such as
mailings or e-mails to a bank's own customers, are not considered an
advertisement. In addition, in considering whether an advertisement
advertises the securities brokerage services provided to trust or
fiduciary customers more prominently than the bank's other trust or
fiduciary services, the nature, context and prominence of the
information presented--and not simply the length of text or information
devoted to a particular subject--should be considered.
---------------------------------------------------------------------------

    \202\ Rule 721(b)(2) (referencing Rule 760(g)(2)).
---------------------------------------------------------------------------

IV. Sweep Accounts and Transactions in Money Market Funds

    Exchange Act Section 3(a)(4)(B)(v) (``sweep exception'') excepts a
bank from the definition of ``broker'' to the extent it ``effects
transactions as part of a program for the investment or re-investment
of deposit funds into any no-load, open-end management investment
company registered under the Investment Company Act that holds itself
out as a money market fund.'' \203\ To provide banks with guidance on
the sweep exception, Proposed Rule 740 defined several terms used in
the exception, including the terms ``money market fund'' and ``no-
load.'' \204\ The Agencies also requested comment on a separate
exemption (Proposed Rule 741) that would permit banks, without
registering as a broker, to effect transactions in securities issued by
a money market fund on behalf of a customer in a broader set of
circumstances, subject to certain conditions.\205\
---------------------------------------------------------------------------

    \203\ See Exchange Act Section 3(a)(4)(B)(v) (15 U.S.C.
78c(a)(4)(B)(v)).
    \204\ Proposed Rule 740(b) and (c).
    \205\ Proposed Rule 741.
---------------------------------------------------------------------------

    Most commenters that addressed Proposed Rules 740 and 741 supported
the rules and Rule 741 in particular.\206\ One commenter objected to
the exemption in Rule 741 on the basis that it would permit banks to
effect transactions in money market funds that did not meet the ``no-
load'' requirements of the sweep exception.\207\ Another commenter
asked that the Agencies clarify whether a bank may effect transactions
under the rules for deposits held by another bank.
---------------------------------------------------------------------------

    \206\ See, e.g., Federated Investors Letter, ICBA Letter,
Clearing House Ass'n Letter, ABA Letter.
    \207\ See, e.g., NASAA Letter.
---------------------------------------------------------------------------

A. Rule 740: Definition of Terms Used in Sweep Exception

    As under the proposal, the final rule defines a ``money market
fund'' for purposes of the sweep exception to mean an open-end
investment company registered under the Investment Company Act of 1940
(15 U.S.C. 80a-1 et seq.) that is regulated as a money market fund
pursuant to 17 CFR 270.2a-7.\208\ In addition, consistent with FINRA
rules, the final rule provides that a class or series of securities of
an investment company will be considered ``no-load'' if (1) the class
or series is not subject to a sales charge or a deferred sales charge;
and (2) total charges against net assets of the class or series of
securities for sales or sales promotion expenses, personal service, or
the maintenance of shareholder accounts do not exceed 0.0025 of average
net assets annually.\209\ A bank may effect transactions under the
sweep exception and Rule 740 as part of a program to sweep deposit
funds of, or collected by, another bank into a no-load money market
fund in accordance with the exception and the Rule.
---------------------------------------------------------------------------

    \208\ Rule 740(b). One commenter requested that Rule 740(b) be
modified to allow banks to sweep deposits into an unregistered
investment company that operates pursuant to Rule 12d1-1 under the
Investment Company Act (17 CFR 270.12d1-1). See State Street Corp.
Letter. The statutory sweep exception, however, provides only for
deposit funds to be swept into an investment company ``registered
under the Investment Company Act of 1940.'' Exchange Act Section
3(a)(4)(B)(v).
    \209\ See Rule 740(c); FINRA Rule 2830. Consistent with FINRA
Rule 2830, charges for the following are not be considered charges
against net assets of a class or series of an investment company's
securities for sales or sales promotion expenses, personal service,
or the maintenance of shareholder accounts: (1) Providing transfer
agent or sub-transfer agent services for beneficial owners of
investment company shares; (2) Aggregating and processing purchase
and redemption orders for Investment company shares; (3) Providing
beneficial owners with account statements showing their purchases,
sales, and positions in the investment company; (4) Processing
dividend payments for the investment company; (5) Providing sub-
accounting services to the investment company for shares held
beneficially; (6) Forwarding communications from the investment
company to the beneficial owners, including proxies, shareholder
reports, dividend and tax notices, and updated prospectuses; or (7)
Receiving, tabulating, and transmitting proxies executed by
beneficial owners of investment company shares.
---------------------------------------------------------------------------

B. Exemption Regarding Money Market Fund Transactions

    After carefully considering the comments, the Agencies have adopted
Rule 741, which permits banks, without registering as a broker, to
effect transactions on behalf of a customer in securities issued by a
money market fund under certain conditions.\210\ To qualify for this
exemption, the bank must provide the customer, directly or indirectly,
some other product or service, the provision of which would not, in and
of itself, require the bank to register as a broker-dealer under
Section 15(a) of the Exchange Act.\211\ Examples of other products or
services that may be a qualifying ``other'' product or service include
an escrow, trust, fiduciary or custody account, a deposit account or a
loan or other extension of credit. The Agencies have modified the rule
to also permit a bank to effect transactions under the exemption on
behalf of another bank as part of a program for the investment or
reinvestment of the deposit funds of, or collected by, the other
bank.\212\ This change is designed to allow banks to provide sweep
services to other banks under the exemption, as they may do under the
sweep exception itself.
---------------------------------------------------------------------------

    \210\ Rule 741.
    \211\ Rule 741(a)(1)(A).
    \212\ Rule 741(a)(1)(B).
---------------------------------------------------------------------------

    The final exemption continues to allow banks to effect transactions
only in securities of a registered money market fund. In addition, the
rule continues to provide that, if the class or series of money market
fund securities is not no-load (as defined in Rule 740), the bank may
not characterize or refer to the class or series of securities as no-
load and the bank must provide the customer, not later than at the time
the customer authorizes the bank to effect the transactions, a
prospectus for the securities.\213\ The Agencies believe these
conditions and limitations provide bank customers adequate protections
in light of the limited nature of the transactions

permitted under the exemption.\214\ In addition, the exemption
recognizes that banks have long offered sweeps and other services that
invest customer funds in money market funds that do not qualify as
``no-load'' funds under Commission and FINRA rules.
---------------------------------------------------------------------------

    \213\ Rule 741(a)(2)(ii). If a bank relies on the exemption to
sweep the deposits of another bank into a money market fund that is
not ``no-load,'' then neither the deposit-holding bank nor the
sweeping bank may characterize the fund as a ``no-load'' fund, and
either the deposit-taking bank or the sweeping bank must provide the
customer with a prospectus for the fund within the time prescribed
by the rule. See Rule 741(a)(2)(ii)(A) and (B).
    \214\ Some commenters requested that the prospectus-delivery
requirement be eliminated or modified so that delivery is required
before a transaction is effected rather than before the customer
authorizes the transaction. See, e.g., ABA Letter, Clearing House
Ass'n Letter, and HSBC Bank Letter. The final rule retains this
requirement to ensure that a customer receives notice that its funds
are to be invested in a fund that is not ``no-load'' before the
customer authorizes the transaction(s). If a customer's funds are
invested in a no-load fund and the bank is authorized, under the
terms of its agreement with the customer to alter the specific fund
into which the customer's balances are invested, the bank should
provide the customer a prospectus for any money market fund that is
not a ``no-load'' fund prior to the date on which the bank first
invests the customer's balances in the fund.
---------------------------------------------------------------------------

V. Safekeeping and Custody

A. Background

    Section 3(a)(4)(B)(viii) of the Exchange Act provides banks with an
exception from the ``broker'' definition for certain bank custody and
safekeeping activities (``custody and safekeeping exception''). In
particular, this exception allows a bank to perform the following
activities as part of its customary banking activities without
registering as a ``broker':
     Providing safekeeping or custody services with respect to
securities, including the exercise of warrants and other rights on
behalf of customers;
     Facilitating the transfer of funds or securities, as a
custodian or a clearing agency, in connection with the clearance and
settlement of its customers' transactions in securities;
     Effecting securities lending or borrowing transactions
with or on behalf of customers as part of the above described custodial
services or investing cash collateral pledged in connection with such
transactions;
     Holding securities pledged by a customer to another person
or securities subject to purchase or resale agreements involving a
customer, or facilitating the pledging or transfer of such securities
by book entry or as otherwise provided under applicable law, if the
bank maintains records separately identifying the securities and the
customer; and
     Serving as a custodian or provider of other related
administrative services to any individual retirement account, pension,
retirement, profit sharing, bonus, thrift savings, incentive, or other
similar benefit plan.\215\
---------------------------------------------------------------------------

    \215\ 15 U.S.C. 78c(a)(4)(B)(viii).
---------------------------------------------------------------------------

    The proposed rules included an exemption to allow banks, subject to
certain conditions, to accept orders for securities transactions from
employee benefit plan accounts and individual retirement and similar
accounts for which the bank acts as custodian.\216\ In addition, the
proposed exemption allowed banks, subject to certain conditions, to
accept orders for securities transactions on an accommodation basis
from other types of custody accounts.\217\
---------------------------------------------------------------------------

    \216\ Proposed Rule 760(a).
    \217\ Proposed Rule 760(b).
---------------------------------------------------------------------------

    Some commenters contended that an exemption for custodial order-
taking activity is unnecessary because, they argued, order-taking
activity is permitted directly under the statutory exception.\218\
Other commenters stated that the exemption was important because it
would allow banks to continue to provide order-taking services to
employee benefit plans and individual retirement accounts and similar
accounts, or that the restrictions in the exemption were
reasonable.\219\ Another commenter, however, objected to the proposed
exemption arguing that permitting custodial banks to take orders for
securities is inconsistent with functional regulation.\220\
---------------------------------------------------------------------------

    \218\ See, e.g., Union Bank Letter, Harris Bank Letter, Clearing
House Ass'n Letter, ABA Letter.
    \219\ See, e.g., The Charles Schwab Corp. (``Schwab'') Letter,
ICBA Letter.
    \220\ See NASAA Letter.
---------------------------------------------------------------------------

B. Rule 760: Custody Exemption

    After carefully considering the comments, the Agencies have adopted
Rule 760. The Agencies have crafted the exemption to allow banks to
continue to accept securities orders in a custodial capacity and to
permit bank customers to take advantage of those order-taking services
subject to important conditions designed to limit the scope of the
activity and provide appropriate investor protections. In this way, the
Agencies believe the exemption is consistent with functional regulation
and the purposes of the GLBA.
    Rule 760 and the other final rules do not implement the statutory
custody and safekeeping exception.\221\ A bank does not need to rely on
the custody exemption in Rule 760 to the extent the bank conducts other
custodial activities permitted by Section 3(a)(4)(B)(viii)(I)(aa)-(ee)
(e.g., exercising warrants or other rights with respect to securities
or effecting securities lending or borrowing transactions on behalf of
custodial customers) or another of the final rules (e.g., Rule 772,
which permits banks to effect securities lending or borrowing
transactions on behalf of certain non-custodial customers).\222\ In
addition, a bank would not have to rely on Rule 760 to the extent the
bank holds securities in custody for a customer and provides clearance
and settlement services to the account in connection with such
securities, but the bank does not accept orders for securities
transactions for the account or engage in other activities with respect
to the account that would require the bank to be registered as a
broker.
---------------------------------------------------------------------------

    \221\ The Agencies asked for comment on whether the Agencies
should adopt rules to implement the statutory custody and
safekeeping exception. No commenters requested that the Agencies do
so at this time.
    \222\ One commenter asserted that a bank would not ``accept'' a
securities order if it received the order from a custodial customer
and at the customer's request transmitted the order to a broker-
dealer selected by the customer. See Union Bank Letter. Such
activities, however, constitute ``accepting'' a securities order for
purposes of Rule 760 and a bank engaged in such activities for a
custodial customer must comply with Rule 760 unless some other
exception or exemption is available for the transaction (e.g.,
Section 3(a)(4)(B)(x) of the Act if the transaction involves
municipal securities).
---------------------------------------------------------------------------

    The following discusses the scope and terms of the custody
exemption.
1. Order-Taking for Employee Benefit Plan Accounts and Individual
Retirement or Similar Accounts
    We are adopting, largely as proposed, the sections of Rule 760
providing that a bank will not be considered a broker to the extent
that, as part of its customary banking activities, the bank accepts
orders to effect transactions in securities in an ``employee benefit
plan account'' or an ``individual retirement account or similar
account'' for which the bank acts as a custodian.\223\ The rule defines
an ``employee benefit plan account'' as a pension plan, retirement
plan, profit sharing plan, bonus plan, thrift savings plan, incentive
plan, or other similar plan, and provides a number of non-exclusive
examples of plans that meet this definition.\224\ The rule defines an
``individual retirement account or similar account'' to mean an

individual retirement account as defined in Section 408 of the Internal
Revenue Code (26 U.S.C. 408), a Roth IRA as defined in Section 408A of
the Internal Revenue Code (26 U.S.C. 408A), a health savings account as
defined in Section 223(d) of the Internal Revenue Code (26 U.S.C.
223(d)), an Archer medical savings account as defined in Section 220(d)
of the Internal Revenue Code (26 U.S.C. 220(d)), a Coverdell education
savings account as defined in Section 530 of the Internal Revenue Code
(26 U.S.C. 530), or other similar account.\225\
---------------------------------------------------------------------------

    \223\ See Rule 760(a).
    \224\ Rule 760(h)(4). The rule provides that the term ``employee
benefit plan account'' includes, without limitation, an employer-
sponsored plan qualified under Section 401(a) of the Internal
Revenue Code (26 U.S.C. 401(a)), a governmental or other plan
described in Section 457 of the Internal Revenue Code (26 U.S.C.
457), a tax-deferred plan described in Section 403(b) of the
Internal Revenue Code (26 U.S.C. 403(b)), a church plan,
governmental, multi-employer or other plan described in Section
414(d), (e) or (f) of the Internal Revenue Code (26 U.S.C. 414(d),
(e) or (f)), an incentive stock option plan described in Section 422
of the Internal Revenue Code (26 U.S.C. 422); a Voluntary Employee
Beneficiary Association Plan described in Section 501(c)(9) of the
Internal Revenue Code (26 U.S.C. 501(c)(9)), a non-qualified
deferred compensation plan (including a rabbi or secular trust), a
supplemental or mirror plan, and a supplemental unemployment benefit
plan.
    \225\ Rule 760(h)(5).
---------------------------------------------------------------------------

    A number of commenters supported these definitions of ``employee
benefit plan account'' and ``individual retirement account or similar
account.'' \226\ The Agencies note that both definitions, by their
terms, encompass ``other similar'' plans or accounts. So, for example,
similar plans or accounts, such as ``lifetime savings accounts,'' that
are established under the Internal Revenue Code in the future would be
employee benefit plan accounts or individual retirement accounts or
similar accounts for purposes of the rule. In addition, the term
``employee benefit plan account'' includes a non-U.S. plan that meets
the definition of an employee benefit plan account.
---------------------------------------------------------------------------

    \226\ See, e.g., ABA Letter, Clearing House Assn. Letter, WBA
Letter.
---------------------------------------------------------------------------

    Under the final rules, a bank relying on the employee benefit plan
and individual retirement and similar account provisions must comply
with the advertising and sales literature limitations in paragraphs
(a)(2) and (3), the employee compensation limitations in paragraph (c),
and the other conditions in the paragraph (d) of the rule. These
conditions are discussed below.
    Some commenters asked that the Agencies permit a bank to accept
securities orders for other types of accounts that may involve custody
of securities, such as accounts for which the bank acts as escrow
agent, issuing and paying agent, tender agent, or disbursement agent,
subject to the conditions applicable to employee benefit plan accounts
and individual retirement and similar accounts, rather than the
expanded set of conditions applicable to accommodation orders accepted
for other types of custody accounts. The provisions in Rule 760(a) for
employee benefit plan accounts and individual retirement and similar
accounts are designed to reflect the extent and manner in which banks
provide order-taking services for these types of accounts. In addition,
these provisions take account of the special mention of these accounts
in the custody and safekeeping exception \227\ and the additional
protections to which these accounts typically are subject under the
ERISA, the Internal Revenue Code, and other applicable law. For these
reasons, the Agencies have not expanded Rule 760(a) to cover accounts
other than employee benefit plan accounts and individual retirement and
other similar accounts. Banks may continue to accept orders from other
types of accounts for which the bank acts as a custodian under the
accommodation provisions of the rule.
---------------------------------------------------------------------------

    \227\ See Section 3(a)(4)(B)(viii)(I)(ee) of the Exchange Act.
---------------------------------------------------------------------------

a. Employee Compensation Restrictions
    We are adopting the employee compensation restrictions in Rule
760(c) as proposed. These restrictions apply when a bank, acting in a
custodial capacity, accepts a securities order for an employee benefit
plan account or an individual retirement account or similar account
under paragraph (a) of the rule, and when a bank accepts a securities
order for another type of custodial account under paragraph (b) of the
rule. Under these restrictions, if a bank accepts securities orders
pursuant to Rule 760, then no employee of the bank may receive
compensation (including a fee paid pursuant to a 12b-1 plan) from the
bank, the executing broker-dealer, or any other person that is based
on: (1) Whether a securities transaction is executed for the account;
or (2) the quantity, price, or identity of the securities purchased or
sold by the account. These restrictions are designed to be consistent
with banking practices and reduce the financial incentives a bank
employee might have to encourage a customer to submit securities orders
to the bank and use a custody account as the functional equivalent of a
securities brokerage account.
    Only a few commenters addressed the employee compensation
restrictions of the rule. For example, one commenter asserted that the
rule should permit a bank to compensate its employees based on the
potential revenues associated with a custodial account, including
revenues received from processing securities transactions or from a
mutual fund in which the account is invested.\228\ In addition, a
commenter expressed concern that the restrictions would prohibit
employees from receiving bonuses based on the total revenues derived
from the custodial accounts for which the employee is responsible.
---------------------------------------------------------------------------

    \228\ See, e.g., Wells Fargo Letter.
---------------------------------------------------------------------------

    As the Agencies noted in the proposal, the employee compensation
restrictions in Rule 760(c) do not prohibit a bank employee from
receiving compensation that is based on whether a customer establishes
a custodial account with the bank, or that is based on the total amount
of assets in a custodial account at account opening or at any other
time. Moreover the rule expressly provides that the employee
compensation restrictions do not prevent a bank employee from receiving
payments under a bonus or similar plan that are permissible under the
exception in Rule 700(b)(1) as if a referral had been made by the bank
employee, or from receiving any compensation described in Rule
700(b)(2) of the networking rules.\229\
---------------------------------------------------------------------------

    \229\ Because the employee compensation restrictions relate to
securities transactions conducted in the relevant custody account,
they would not prevent a bank employee from receiving a referral fee
for referring the customer to a broker-dealer to engage in
securities transactions at the broker-dealer that are unrelated to
the custody account in accordance with the networking exception or
the institutional customer and high net worth customer exemption
(Rule 701) for networking arrangements.
---------------------------------------------------------------------------

    Thus, for example, the rule does prohibit a bank from directly
passing on to an employee a portion or percentage of the 12b-1 fees
received by the bank from a custody account's investment in a mutual
fund, or a portion of a fee that is charged only when, or that varies
based on whether, a securities transaction is executed for the account.
A bank employee may receive payments under a bonus or similar plan rule
that includes within its allocation pool the revenues generated by one
or more custodial accounts if the plan meets the criteria for a
discretionary, multi-factor bonus program in Rule 700(b)(1), or the
bonus program is based on the overall profitability or revenues of the
bank, an affiliate, or operating unit and the program complies with the
requirements of the safe harbor in Rule 700(b)(2). If a bank's
compensation practices are inconsistent with these limitations, the
bank may not rely on the exemption to take securities orders in a
custodial capacity.
b. Advertisements and Sales Literature
    As under the proposed rule, final Rule 760(a)(2) provides that a
bank relying on the exemption may not advertise that it accepts orders
for securities transactions for employee benefit plan accounts or
individual retirement accounts or similar accounts for which the bank
acts as custodian, except as part of advertising the other custodial or

safekeeping services the bank provides to these accounts.\230\ The bank
also may not advertise that such accounts are securities brokerage
accounts or that the bank's safekeeping and custody services substitute
for a securities brokerage account.\231\ Moreover, advertisements and
sales literature for individual retirement or similar accounts that are
issued by or on behalf of the bank may not describe the securities
order-taking services provided by the bank to these accounts more
prominently than the other aspects of the custody or safekeeping
services the bank provides.\232\
---------------------------------------------------------------------------

    \230\ Rule 760(h)(2) defines an ``advertisement'' to mean
material that is published or used in any electronic or other public
media, including any Web site, newspaper, magazine or other
periodical, radio, television, telephone or tape recording,
videotape display, signs or billboards, motion pictures, or
telephone directories (other than routine listings).
    \231\ Rule 760(a)(2)(i) and (ii).
    \232\ Rule 760(a)(3). Rule 760(h)(6) defines ``sales
literature'' to mean any written or electronic communication, other
than an advertisement, that is generally distributed or made
generally available to customers of the bank or the public,
including circulars, form letters, brochures, telemarketing scripts,
seminar texts, published articles, and press releases concerning the
bank's products or services.
---------------------------------------------------------------------------

    One commenter indicated that these advertising restrictions were
reasonable.\233\ Another commenter suggested that these advertising
limitations should not apply to certain advertisements for which a
broker-dealer takes compliance responsibility.\234\ The advertising and
sales literature restrictions are designed to help prevent a bank from
operating a brokerage business out of its custody department and, for
this reason, apply to all advertisements and sales literature issued by
or on behalf of a bank, whether or not a broker-dealer has some
compliance responsibility with respect to the advertisement or sales
literature. These limitations would not, however, apply to the
advertisements or sales literature that a registered broker-dealer may
make to inform the public or others about the availability of brokerage
services from the broker-dealer.
---------------------------------------------------------------------------

    \233\ See ICBA Letter.
    \234\ See UMB Bank, N.A. Letter.
---------------------------------------------------------------------------

c. Other Conditions
    A bank that accepts orders for a securities transaction for an
employee benefit plan account or individual retirement account or
similar account also must comply with the conditions set forth in
paragraph (d) of the Rule.\235\ These conditions are discussed below in
Part V.B.3.\236\
---------------------------------------------------------------------------

    \235\ Rule 760(a)(1).
    \236\ The Agencies have made a technical change from the
proposal to make clear that a bank operating under Rule 760(a) must
comply with the conditions set forth in paragraph (d) as well as
with the employee compensation limitations of paragraph (c). See
Rule 760(a)(1). This should better clarify banks' responsibilities
under these provisions, and the Agencies have made a conforming
change to the text of Rule 760(b) relating to accommodation trades.
---------------------------------------------------------------------------

2. Order-Taking as an Accommodation for Other Types of Accounts
    The proposed rule also permitted banks to continue to accept
securities orders for custodial accounts other than employee benefit
plan and individual retirement and similar accounts as an accommodation
to the customer, subject to certain conditions designed to help ensure
that these services continue to be provided only as an accommodation to
customers and that a bank does not operate as a securities broker out
of its custody department. While commenters generally supported
permitting banks to accept securities orders for other custodial
accounts on an accommodation basis, several commenters asked the
Agencies to modify or clarify the scope or terms of the exemption,
including the meaning of ``accommodation'' and the prohibition on
providing investment advice, research, and recommendations.
    The Agencies are adopting, largely as proposed, the provisions of
the rule permitting banks to accept orders as an accommodation for
these other custodial accounts.\237\ A bank relying on this part of the
exemption must comply with the conditions discussed below.
---------------------------------------------------------------------------

    \237\ Rule 760(b).
---------------------------------------------------------------------------

a. Accommodation Basis
    For the reasons stated in the proposing release, the final rule,
like the proposal, permits a bank to accept securities orders for other
types of custodial accounts only as an accommodation to the
customer.\238\ Some commenters suggested that the Agencies define the
term ``accommodation'' in the rule to mean any trade that is effected
solely on the request of the customer or on an unsolicited basis.\239\
As noted in the proposal, the Banking Agencies will develop guidance to
assist Banking Agency examiners in reviewing, as part of the agencies'
ongoing risk-focused supervisory and examination process, the order-
taking services provided to these custodial accounts. The guidance will
describe the types of policies, procedures and systems that a bank
should have in place to help ensure that the bank accepts securities
orders for these custodial accounts only as an accommodation to the
customer and in a manner consistent with the custody exemption.\240\ As
part of these reviews, Banking Agency examiners also will, consistent
with the rule, consider the form and substance of the relevant
accounts, transactions, and activities to prevent evasions of the
requirements of the rule.\241\ The Agencies believe this approach,
rather than adopting by rule a definition of ``accommodation,'' is
appropriate given the disparity in the types, characteristics and uses
of other custody accounts, the size and operations of banks that
provide these services and the manner in which they do so.
---------------------------------------------------------------------------

    \238\ Rule 760(b)(1).
    \239\ See Fiserv Trust Company Letter; Ass'n of Colorado Trust
Companies Letter.
    \240\ See 71 FR at 77532-33.
    \241\ See Rule 760(f).
---------------------------------------------------------------------------

b. Employee Compensation Restrictions
    For the reasons stated in the proposing release, final Rule
760(b)(2) continues to provide that a bank that accepts orders for
other custody accounts must comply with the employee compensation
limitations in paragraph (c) of the rule. These limitations were
previously discussed in Part V.B.I.a., supra. \242\
---------------------------------------------------------------------------

    \242\ Rule 760(b)(2).
---------------------------------------------------------------------------

c. Limitations on Bank Fees
    The rule prohibits a bank that accepts accommodation orders for a
custody account from charging or receiving any fee that varies based on
(1) whether the bank accepted the order for the transaction or (2) the
quantity or price of the securities to be bought or sold.\243\ These
restrictions do not prevent a bank from charging or receiving a fee
that is based on the type of security purchased or sold by the account
(e.g., a foreign security), provided the fee complies with the
conditions set forth in Rule 760(b)(3). Commenters did not raise
concerns with these restrictions.
---------------------------------------------------------------------------

    \243\ Rule 760(b)(3).
---------------------------------------------------------------------------

d. Advertising and Sales Literature Restrictions
    Under the final rule, the bank's advertisements may not state that
the bank accepts orders for securities transactions for a custodial
account (other than an employee benefit plan or individual retirement
account or similar account). In addition, the bank's sales literature:
(1) May state that the bank accepts securities orders for such an
account only as part of describing the other custodial or safekeeping
services the bank provides to the account, and (2) may not describe the
securities order-taking services provided to such an account more
prominently than the other aspects of the custody or

safekeeping services provided by the bank to the account.\244\
---------------------------------------------------------------------------

    \244\ Rule 760(b)(5). One commenter urged the Agencies to
abandon the prohibitions on advertising order-taking as an
accommodation to other custodial accounts, arguing that the
prohibition violates a bank's constitutional free speech rights. See
CBA Letter. The Agencies believe these restrictions are appropriate
to effectuate the purposes of the exemption and have tailored the
restrictions to comply with the customary practices of banks and
minimize potential disruptions. The Agencies specifically requested
comments on the conditions of the rule, and no commenter indicated
that the advertising restrictions on accommodation trade would
materially disrupt their business or operations.
---------------------------------------------------------------------------

e. Investment Advice or Recommendations
    The proposed rule imposed certain restrictions on the ability of a
bank to provide investment advice or research concerning securities to
an account for which it accepts accommodations orders, make
recommendations concerning securities to the account, or otherwise
solicit securities transactions from the account.\245\
---------------------------------------------------------------------------

    \245\ Rule 760(b)(6).
---------------------------------------------------------------------------

    Several commenters, expressed concerns with the proposed
limitations on investment advice, research and recommendations. For
example, commenters expressed concern that the restrictions would
negatively affect a bank's ability to cross-market its trust, fiduciary
or other services to custody customers.\246\ Some expressed concern
that the limitations would interfere with a bank's ability to share
research with custody customers or make the bank's views concerning
securities or markets available to the public through Web sites,
mailings, interviews or other means.\247\
---------------------------------------------------------------------------

    \246\ See, e.g., Harris Bank Letter; U.S. Trust Letter.
    \247\ See, e.g., PNC Letter; National City Corp. Letter.
---------------------------------------------------------------------------

    After carefully considering the comments received, the Agencies
believe that no change is necessary to accommodate the cross-marketing
of other bank services. Accordingly, we are adopting the provisions
related to investment advice, research and recommendations without
change. The Agencies note that the prohibitions do not prevent a bank
from cross-marketing its trust, fiduciary or other services to its
custody customers. A bank's marketing to custody account customers
may--without violating the rule's general prohibition against providing
advice, research or recommendations--include non-account specific
information provided in media such as newsletters and websites. In
addition, the advice, research, recommendation and solicitation
prohibition does not prohibit a bank from providing samples of
research, including stock-specific research, to custody customers that
the bank provides to other persons for marketing purposes. Thus, the
Agencies believe that banks will continue to be able to cross-market
their products and services to their custody customers. A custody
account, however, is not a fiduciary account, and a bank operating
under Rule 760(b) with respect to a custodial account may not provide
such samples in such a way or with such a frequency as to provide the
custody account securities services that only are permissible for a
trust or fiduciary customer. The bank, moreover, may not provide
personalized investment advice, research or recommendations regarding
particular securities to the custodial account for any reason.\248\
---------------------------------------------------------------------------

    \248\ This would include providing personalized advice, research
or recommendations concerning securities to the account in an effort
to convert the account to another type of account, for goodwill or
to obtain referrals.
---------------------------------------------------------------------------

    Some commenters questioned whether providing custody customers with
a choice of investments from which to select would constitute providing
investment advice.\249\ Banks may use menus or other lists to make
custodial customers aware of the securities available to them through
the custodial account. For example, the restrictions in paragraph
(b)(6) of the rule do not prevent a bank from providing its customers
with an online menu of the mutual funds that the customer is able to
purchase through the custody account.
---------------------------------------------------------------------------

    \249\ See Harris Bank Letter; PNC Letter.
---------------------------------------------------------------------------

    The limitations and restrictions in Rule 760(b), including those
relating to investment advice and recommendations, relate only to those
custodial accounts for which the bank accepts securities orders on an
accommodation basis. Thus, for example, these limitations would not
apply to (1) an employee benefit plan account or an individual
retirement account or similar account; or (2) a trust or fiduciary
account maintained by a customer with a bank even if that customer also
maintains a custodial account with the bank.
    Commenters asked how the limitations on investment advice and
research would apply when a customer has both a custody account and a
separate trust or fiduciary account with a bank, and asked the Agencies
to clarify that a bank would not violate the restrictions if the bank
provides a trust or fiduciary customer with research or advice that the
customer then uses to make orders through its custody accounts.\250\
Rule 760(b)(6) prohibits banks from providing investment advice,
research or recommendations concerning securities to, or soliciting
securities transactions from, a custody account for which the bank
accepts orders under the accommodation trade authority. The rule does
not limit the types of research or other services a bank may provide to
a customer's trust or fiduciary account, and the Agencies recognize
that a bank may have no control over which account the customer uses to
place any orders that result from such research or other services.
---------------------------------------------------------------------------

    \250\ See ABA Letter; Harris Bank Letter.
---------------------------------------------------------------------------

    The final rule, like the proposal, continues to provide that, in
order to prevent evasions of the custody exemption, the Agencies will
consider both the form and substance of the relevant account(s),
transaction(s) and activities (including advertising activities) in
considering whether a bank meets the terms of the exemption.\251\ For
example, the Agencies will consider the content, format and frequency
of any investment research provided to an accommodation custodial
account in considering if such research in purpose or effect evades the
restrictions in the rule or provides a custody account securities
services that only are permissible for a trust or fiduciary customer.
Similarly, a bank may not evade the rule's restrictions by providing an
accommodation customer that has both a custody account and a trust or
fiduciary account with investment advice, recommendations or research
that is targeted to the securities held in the customer's custody
account. For example, if a customer's custody account has a large
position in a particular security and that security is not held in the
customer's trust or fiduciary account, a bank may not routinely provide
the customer with research focused on that security. Banks should have
and maintain policies and procedures to abide by these limitations and
bank examiners will review bank compliance with these limits in
accordance with the risk-based supervisory and examination process,
considering both the form and substance of the cross-marketing
activities in applying the anti-evasion provisions of the rule.
---------------------------------------------------------------------------

    \251\ Rule 760(e).
---------------------------------------------------------------------------

    The restrictions in Rule 760(b)(6) do not prohibit the bank from
advertising its custodial services and disseminating sales literature
that meets the conditions in the exemption.\252\ These restrictions
also will not prevent a bank employee from responding to customer
inquiries regarding the bank's safekeeping and

custody services by providing advertisements or sales literature
describing the safekeeping, custody and related services the bank
offers (provided those advertisements and sales literature comply with
the restrictions in the proposed exemption), a prospectus prepared by a
registered investment company, sales literature prepared by a
registered investment company or by the broker-dealer that is the
principal underwriter of the registered investment company pertaining
to the registered investment company's products, or information based
on any of those materials.\253\ The exemption allows a bank's employees
to respond to customer inquiries concerning the bank's safekeeping,
custodial or other services, such as inquiries concerning the
customer's account or the availability of sweep or other services, so
long as the bank does not provide investment advice or research
concerning securities to the account or make a recommendation to the
account concerning securities.\254\
---------------------------------------------------------------------------

    \252\ Rule 760(b)(6)(i).
    \253\ Rule 760(b)(6)(ii). ``Principal underwriter'' has the same
meaning as in section 2(a)(29) of the Investment Company Act of 1940
(15 U.S.C. 80a-2(a)(29)). Rule 760(h)(7).
    \254\ Rule 760(b)(6)(iii).
---------------------------------------------------------------------------

3. Other Conditions Applicable to Order-Taking for All Custody Accounts
    The proposed exemption provided that a bank may accept orders for a
securities transaction for a custody account under the exemption only
if the bank (1) does not act in a trustee or fiduciary capacity (as
defined in section 3(a)(4)(D) of the Exchange Act) with respect to the
account; (2) complies with section 3(a)(4)(C) of the Act in handling
any order for a securities transaction for the account; and (3)
complies with section 3(a)(4)(B)(viii)(II) of the Act regarding
carrying broker activities.
a. Directed Trustees
    Some commenters requested that the Agencies modify the exemption to
allow a bank that acts as a directed trustee for an account to accept
orders and effect transactions for the account under the custody
exemption in Rule 760 in lieu of relying on the trust and fiduciary
rules (Rule 721 to 723) for the transaction.\255\ In light of the
comments and the protections included in Rule 760, the Agencies have
modified the final rule to provide that a bank that acts as a directed
trustee for an account may rely on the custody exception to accept
orders for, and effect transactions in, securities for the
account.\256\ If a bank acting as directed trustee relies on the rule
to effect transactions for an employee benefit plan account or an
individual retirement account or similar account, the bank must comply
with the conditions in Rule 760(a). If a bank acting as directed
trustee relies on the rule to effect transactions for another type of
account, the bank must comply with the conditions governing
accommodation accounts in Rule 760(b).
---------------------------------------------------------------------------

    \255\ See Teachers Insurance and Annuity Association of America
and College Retirement Equities Fund (``TIAA-CREF'') Letter; ACB
Letter; Roma Bank Letter. Commenters asserted, for example, that a
bank acting as a directed trustee provides services that are
functionally similar to those provided as a custodian and in either
case does not have investment discretion with respect to the
account.
    \256\ See Rule 760(d)(1). Alternatively, the bank may continue
to effect transactions for the account under the rules relating to
trust or fiduciary accounts.
---------------------------------------------------------------------------

    The rule defines a directed trustee as ``a trustee that does not
exercise investment discretion with respect to the account.'' \257\ The
Agencies also have modified the definition of ``an account for which
the bank acts as a custodian'' to include an account for which a bank
acts as a directed trustee.\258\ Although a bank acting as directed
trustee for an account may effect transactions under the custody
exemption, the bank's trustee relationship with the account remains a
trust and fiduciary relationship and, as such, the bank must continue
to comply with applicable fiduciary principles and standards in its
relationships with the account.
---------------------------------------------------------------------------

    \257\ Rule 760(h)(3).
    \258\ See Rule 760(h)(1).
---------------------------------------------------------------------------

b. Broker Execution Requirement
    Consistent with the requirements of the custody and safekeeping
exception, Rule 760(d)(2) requires a bank that accepts orders for a
custody account under the rule to comply with Section 3(a)(4)(C) of the
Exchange Act \259\ in handling any order for a securities transaction
for the account.\260\ Under this provision, (i) the bank must direct
the trade to a registered broker-dealer for execution, or (ii) the
trade must be a cross trade or other substantially similar trade of a
security that is made by the bank or between the bank and an affiliated
fiduciary and is not in contravention of fiduciary principles
established under applicable Federal or State law, or (iii) the trade
must be conducted in some other manner permitted under rules,
regulations, or orders as the Commission may prescribe or issue.
---------------------------------------------------------------------------

    \259\ 15 U.S.C. 78c(a)(4)(C).
    \260\ See Rule 760(d)(2).
---------------------------------------------------------------------------

c. Carrying Broker Provisions
    A number of commenters addressed the proposed provision limiting
the availability of the custody exemption to banks that comply with
Section 3(a)(4)(B)(viii)(II) of the Exchange Act \261\ relating to
carrying broker activities.\262\ Some stated that the Agencies should
define the term ``carrying broker'' by rule rather than by
interpretation.\263\ One commenter requested that we interpret the term
based on the view that the essence of a carrying broker relationship is
``complete dependence'' of a broker-dealer on another entity for back
office functions and execution.\264\ Another commenter took the
position that a custodian bank should not be deemed a carrying broker
so long as ``it is not enabling'' broker-dealers to avoid the net
capital requirements applicable to carrying brokers.\265\ One commenter
generally suggested that we either eliminate the carrying broker
limitation from the proposed rules, or amend it to avoid affecting the
ability of banks to undertake traditional banking activities.\266\
---------------------------------------------------------------------------

    \261\ 15 U.S.C. 78c(a)(4)(B)(viii)(II). This provision prohibits
a custodian bank from acting as a carrying broker (as such term, and
different formulations thereof, are used in Exchange Act Section
15(c)(3) and the rules and regulations under that Section) for any
broker-dealer, unless such carrying broker activities are engaged in
with respect to government securities.
    \262\ Rule 760(d)(3).
    \263\ See ABA Letter; State Street Corp. Letter; PNC Letter.
    \264\ See Clearing House Ass'n Letter.
    \265\ See U.S. Trust Letter.
    \266\ See HSBC Bank Letter. In addition, a few commenters
asserted that the description of potential carrying broker activity
in prior rulemakings under the GLB Act would, if adopted, be highly
problematic and disruptive for banks and broker-dealers. See
Clearing House Ass'n Letter; ABA Letter.
---------------------------------------------------------------------------

    Section 3(a)(4)(B)(viii)(II) of the Exchange Act provides that a
bank relying on the custody exception may not act as a ``carrying
broker,'' as that term and different formulations of the term are used
in Section 15(c)(3) of the Act and the underlying rules and
regulations, for a broker-dealer other than with respect to government
securities. Section 15(c)(3) of the Act in relevant part requires
broker-dealers to comply with the Commission's regulations with respect
to financial responsibility and related customer protection practices
of broker-dealers.\267\ The Commission's financial responsibility and
customer protection rules expand on what it means to carry

customer securities.\268\ In general, broker-dealers establish carrying
arrangements in which other broker-dealers carry their accounts to
permit the non-carrying broker-dealer to be subject to lesser financial
responsibility requirements under the Exchange Act. A broker-dealer
entering into such an agreement with a carrying entity that is not a
registered broker-dealer, however, may not take advantage of those
lesser requirements.\269\
---------------------------------------------------------------------------

    \267\ Exchange Act Section 15(c)(3)(A), 15 U.S.C. 78o(c)(3)(A).
    \268\ The Commission's net capital rule specifies that a broker-
dealer shall be deemed to carry customer or broker-dealer accounts
``if, in connection with its activities as a broker or dealer, it
receives checks, drafts, or other evidences of indebtedness made
payable to itself or persons other than the requisite registered
broker or dealer carrying the account of a customer, escrow agent,
issuer, underwriter, sponsor, or other distributor of securities''
or ``if it does not promptly forward or promptly deliver all of the
securities of customers or of other brokers or dealers received by
the firm in connection with its activities as a broker or dealer.''
Exchange Act Rule 15c3-1(a)(2)(i)
    The Commission's customer protection rule governing reserves and
custody of securities defines the term ``securities carried for the
account of a customer'' to mean ``securities received by or on
behalf of a broker or dealer for the account of any customer and
securities carried long by a broker or dealer for the account of any
customer,'' as well as securities sold to, or bought for, a customer
by a broker-dealer. Exchange Act Rule 15c3-3(a)(2).
    \269\ Within common securities industry usage, the terms
``carrying broker'' and ``clearing broker'' are virtually identical
and often are used interchangeably. In certain instances, the terms
mean a broker that, as part of an arrangement with a second broker
(an ``introducing'' or ``corresponding'' broker), allows the second
broker to be subject to lesser regulatory requirements (e.g., under
the net capital provisions of Exchange Act Rule 15c3-1 and the
customer protection provisions of Exchange Act Rule 15c3-3).
Technically, however, a ``carrying broker'' is a broker that holds
funds and securities on behalf of customers, whether its own
customers or customers introduced by another broker-dealer, and a
``clearing broker'' is a member of a registered clearing agency.
---------------------------------------------------------------------------

    After carefully considering the comments, the Agencies have
retained this limitation as a condition of the custody exemption
without change as it is a term of the statutory custody exception.
Banks may look to certain key factors to help distinguish permissible
custodial activity from impermissible carrying broker activity. In
particular, key factors in considering whether the existence of shared
customers between a broker-dealer and a bank may entail impermissible
carrying broker activity by the bank are the broker-dealer's own
regulatory obligations and whether the broker-dealer either makes
formal or informal arrangements with the bank or structures its
operations or offerings to cause the broker-dealer's customers
generally (or one or more broad segments of the broker-dealer's
customers) to use the bank's custody accounts instead of maintaining
funds and securities in accounts at the broker-dealer (thereby avoiding
the broker-dealer's financial and related responsibilities). The
existence of a substantial number of common customers between a broker-
dealer and a bank's custody department in the absence of such an
arrangement or structure would not cause the bank to act as a carrying
broker for the broker-dealer.
    Similarly, a bank may perform or share systems that perform limited
back-office functions on behalf of a broker-dealer without becoming a
carrying broker for the broker-dealer. A broker-dealer, for example,
may contract with an unregistered party such as a bank to send out
transaction confirmations on behalf of the broker-dealer or have an
arrangement with an affiliated bank to provide customers with combined
statements, with the broker-dealer remaining responsible for the
accuracy and completeness of those confirmations and the broker-dealer
aspects of the statements. A bank and an affiliated broker-dealer also
may share or coordinate risk management systems such as, for example,
those relating to Bank Secrecy Act and anti-money laundering
compliance.\270\ A broker-dealer, however, may not delegate core
functions to a bank or other unregistered entity or functions that
would require an individual to pass a qualification examination or
register with an SRO.\271\ A broker-dealer also must maintain
possession or control over the broker-dealer's proprietary cash or
securities and its customers' cash or securities in accordance with the
Commission's financial responsibility rules.\272\ Of course, a bank may
serve as custodian for proprietary or customer cash or securities of
the broker-dealer and may accept and use in the ordinary course of its
banking business cash deposited with the bank by the broker-dealer or
its customers.\273\
---------------------------------------------------------------------------

    \270\ Other examples of current permissible coordination
arrangements between banks and broker-dealers include legal and
compliance functions, accounting and finance functions (such as
payroll and expense account reporting), information technology,
operations functions (such as disaster recovery services), and
administration functions (such as human resources and internal
audits). See NASD Notice to Members 05-48 (July 2005) at 2.
    \271\ NASD Notice to Members 05-48 (July 2005), ``Outsourcing,''
provides guidance to member firms regarding the outsourcing
activities and functions that, if performed directly by members,
would be required to be the subject of a supervisory system and
written supervisory procedures pursuant to NASD Rule 3010.
    \272\ See e.g., Rules 15c3-1 and 15c3-3 [17 CFR 240.15c3-1,
15c3-3]. This is true even if the broker-dealer is not ``completely
dependent'' on the bank for all back office functions and execution.
    \273\ See Rule 15c3-3(c)(5).
---------------------------------------------------------------------------

4. Custodians, Subcustodians and Administrators/Recordkeepers
a. ``Account for which a bank acts as a custodian''
    As a general matter, the exemption in Rule 760 is available only
for an ``account for which the bank acts as a custodian.'' The proposed
rule defined this term to mean an account that is: (i) An employee
benefit plan account for which the bank acts as a custodian; (ii) an
individual retirement account or similar account for which the bank
acts as a custodian; or (iii) an account established by a written
agreement between the bank and the customer that sets forth the terms
that will govern the fees payable to, and rights and obligations of,
the bank regarding the safekeeping or custody of securities.\274\ As
discussed in Part V.B.3.a supra, the Agencies have amended this
definition in the final rule also to include an account for which a
bank acts as a directed trustee.
---------------------------------------------------------------------------

    \274\ Proposed Rule 760(g)(1).
---------------------------------------------------------------------------

    A few commenters asked whether a bank performing custodial
functions in a non-trustee and non-fiduciary capacity (such as escrow
agent, fiscal agent or paying agent) may use the custody exemption even
if it is not formally designated as ``custodian'' by the bank-customer
agreement.\275\ Whether a bank serves as custodian for the securities
or other assets of an account depends on the services the bank provides
to the account with respect to such securities or assets, not the label
used to identify the account or the bank's services in the agreement
between the bank and the customer. Thus, for example, a bank that acts
as an escrow agent, fiscal agent or paying agent with respect to an
account, and that provides safekeeping or custody services for the
securities or other assets in the account, is considered to be a
custodian for the account for purpose of the rule regardless of whether
the account agreement uses the term ``custodian'' or any other
particular language.
---------------------------------------------------------------------------

    \275\ See Union Bank Letter, Wells Fargo Letter.
---------------------------------------------------------------------------

b. Administrators/Recordkeepers and Subcustodians
    The proposed exemption permitted a bank acting as a non-fiduciary
and non-custodial administrator or recordkeeper for an employee benefit
plan to accept securities orders for the plan on behalf of a custodian
bank.\276\ Under the proposed exemption, both the administrator/
recordkeeper bank and the custodial bank had to comply with the
requirements relating to employee

benefit plan accounts.\277\ In addition, the proposed rule prohibited
an administrator/recordkeeper bank from executing a cross-trade with or
for the employee benefit plan or from netting orders for securities for
the plan, other than orders for shares of open-end investment companies
not traded on an exchange.\278\
---------------------------------------------------------------------------

    \276\ Proposed Rule 760(e).
    \277\ Proposed Rule 760(e)(1).
    \278\ Proposed Rule 760(e)(2).
---------------------------------------------------------------------------

    A few commenters supported these provisions, but opposed the
restrictions on cross-trading and netting.\279\ One commenter
maintained that the administrator/recordkeeper provisions should also
be available to banks providing administrative services to individual
retirement accounts.\280\
---------------------------------------------------------------------------

    \279\ See ABA Letter; Clearing House Ass'n Letter; CBA Letter.
The commenters asserted that the cross-trading and netting
restrictions were too restrictive and noted that section 3(a)(4)(C)
of the Exchange Act permits bank custodians to engage in a broader
range of cross-trade and netting activities.
    \280\ See CBA Letter.
---------------------------------------------------------------------------

    Some commenters also questioned whether or how the proposed
exemption would apply to a bank that acts as a subcustodian for the
trust or fiduciary or custody accounts of another bank. For example,
some commenters asserted that a bank acting as a subcustodian for
another bank's trust or fiduciary accounts should be permitted to
accept orders for those accounts under the less restrictive conditions
in Rule 760(a) regardless of the type of accounts actually
involved.\281\ Other commenters suggested that a subcustodian bank be
permitted to effect trades for the accounts of the other bank with a
direct custodial relationship with the customer under the same rules
(e.g., trust and fiduciary or custody), and subject to the same
conditions, that would apply to the other bank if it conducted the
transactions directly.\282\ Commenters also noted that banks, and
particularly smaller banks, at times use subcustodian arrangements with
other banks to provide their customers custodial services more
efficiently and at lower cost than they may be able to do on their own.
---------------------------------------------------------------------------

    \281\ See, e.g., ABA Letter, CBA Letter, PNC Letter, Schwab
Letter.
    \282\ See TIAA-CREF Letter.
---------------------------------------------------------------------------

    After carefully considering the comments, the Agencies have adopted
Rule 760(e), which permits a bank that acts as a non-fiduciary and non-
custodial administrator or recordkeeper for an employee benefit plan
for which another bank acts as a custodian to accept orders for the
account under Rule 760.\283\ In addition, the Agencies have adopted a
new paragraph (f) of the rule that permits a bank that acts as a
subcustodian for any type of account for which another bank acts as
custodian to accept orders for the account under Rule 760. This change
was made in response to comments that greater flexibility and clarity
was needed for banks that use, and banks that provide, subcustodial
services. Under these provisions of the final rule, the administrator/
recordkeeper bank or subcustodian bank, as well as the initial
custodian bank for the account, must comply with the provisions of Rule
760 applicable to the type of account involved (i.e. employee benefit
plan account, individual retirement account or similar account, or
other types of accounts).\284\
---------------------------------------------------------------------------

    \283\ The Agencies understand that the type of administrator/
recordkeeper arrangements described in Rule 760(e) are not typically
used with respect to accounts other than employee benefit plan
accounts and, for this reason, have not expanded the paragraph to
cover other types of accounts.
    \284\ See Rule 760(e)(1) and (f)(1) and (2). The Agencies made a
technical change to Rule 760(e) to clarify that the administrator/
recordkeeper bank and the custodial bank for employee benefit
accounts need to comply only with the requirements in the rule
applicable to employee benefit plan accounts and do not need to
comply with the conditions applicable to accommodation trades.
---------------------------------------------------------------------------

    The final rule generally prohibits a recordkeeper/administrator
bank or subcustodian bank relying on the exemption from executing a
cross-trade or netting orders with or for the relevant account.\285\
However, the Agencies have expanded the exceptions to this general
prohibition in light of the comments received. In particular, the final
rule permits the administrator/recordkeeper bank or subcustodian bank
to cross or net orders for shares of open-end investment companies not
traded on an exchange.\286\ In addition, the final rule permits the
administrator/recordkeeper bank or subcustodian bank to cross orders
between or net orders for accounts of the custodian bank that
contracted with the administrator/recordkeeper bank or subcustodian
bank for services.\287\ Permitting this additional type of cross-trade
and netting activity is consistent with the exceptions to broker
execution requirement in section 3(a)(4)(C) of the Exchange Act and
should allow cost-savings for the customer by eliminating the need for
a broker intermediary. At the same time, by prohibiting an
administrator/recordkeeper bank or subcustodian bank operating under
the rule from executing cross-trades or netting orders among the
accounts of different custodian banks to which it provides services
will help prevent banks from establishing a market for securities under
the exemption.
---------------------------------------------------------------------------

    \285\ Rule 760(e)(2) and (f)(3).
    \286\ See Rule 760(e)(2)(i) and (f)(3)(i).
    \287\ See Rule 760(e)(2)(ii) and (f)(3)(ii).
---------------------------------------------------------------------------

    The Agencies note that these provisions do not apply to a bank that
provides custody and order-taking services to the trust or fiduciary
accounts of another bank. In these circumstances, the bank providing
custodial services is treated as a custodian, and not a subcustodian,
for purposes of the rule and may provide order-taking services to the
account in accordance with the provisions of Rule 760(a) or (b)
applicable to the type of account involved.
5. Evasions
    The Agencies are adopting, as proposed, the provision that states
the Agencies will consider both the form and substance of the relevant
accounts, transactions and activities (including advertising
activities) in considering whether a bank meets the terms of the
exemption, to prevent evasions of the exemption.\288\ We received no
comments on this anti-evasion provision. As part of the regular risk-
focused examination process, the Banking Agencies will monitor the
securities transactions in custodial accounts. If the appropriate
Banking Agency were to find that a bank is evading the terms of the
custody exemption to run a brokerage business out of its custody
department, the agency would take appropriate action to address the
problem.
---------------------------------------------------------------------------

    \288\ Rule 760(g).
---------------------------------------------------------------------------

VI. Other Exemptions

    The Agencies also are adopting certain other exemptions relating to
the securities ``broker'' activities of banks. These are discussed
below.

A. Exemption for Regulation S Transactions With Non-U.S. Persons and
Broker-Dealers

    We are adopting Rule 771 of Regulation R to exempt banks from the
definition of ``broker'' under the Exchange Act for certain agency
transactions involving Regulation S securities.\289\ As with Rule 3a5-2
under

the Exchange Act, which the Commission separately is adopting to permit
banks to engage in certain Regulation S transactions on a riskless
principal basis without being ``dealers,'' Rule 771 recognizes that
non-U.S. persons located outside the United States generally will not