Regulation R Explained Where Every Fiduciary Organization Must Be Now ABA/FIRMA Telephone Briefing Follow-up Q&As 12/17/09

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Alberta Wells
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1 Disclaimer: This document was created with permission and is furnished for informational use only. Neither the speakers, contributors, ABA or FIRMA is engaged in rendering legal nor other expert professional services, for which outside competent professionals should be sought. All statements and opinions contained herein are the sole opinion of the speakers and subject to change without notice. Receipt of this information constitutes your acceptance of these terms and conditions. Question 1 First of all, the Reg R briefing earlier was good! Materials were helpful especially the spreadsheets. As far as Trust and Fiduciary activities is concerned, I m glad to see that I m on track. However, correct me if I m wrong, but I thought I heard from the briefing that court ordered fees are included in the nonrelationship compensation bucket. I hope not. We ve always considered it part of relationship compensation. Do you mind sharing your list of items which may be under total compensation? I d like to make a comparison. Answer: Court ordered fees in at least one of the presenters institutions for guardianship accounts are classified as relationship compensation under the trust and fiduciary exemption. In general, transaction fees that are not securities related can be classified as relationship or nonrelationship income. See question 5 below for additional information related to this topic. If your question is about state statute mandated fees, those too can be classified as relationship compensation. Question 2 1. Our bank has a small trust department and a networking arrangement with a non-affiliated third party broker-dealer. Trust income is derived from flat per account fees, estate fees set by statute, negotiated fees based on assets under management, or on our published fee schedule which is based on a percentage fee of the assets under management. The department does receive 12b-1 fees and account servicing fees from mutual funds. In addition, a few trust clients have authorized the trust department to place fixed income trades through the third-party broker-dealer. Trust income and income from the broker-dealer are reported on one P/L. Does the trust department have to complete the chiefly compensated calculation? Answer: Since the financial institution is conducting fiduciary business, the chiefly compensated calculation is required unless you qualify under the de minimis provisions highlighted in Rule If we should perform the calculation, by what date does the initial calculation have to be done? Answer: Within sixty days of fiscal year end beginning after September 30, Should we include all the income derived from the third-party broker-dealer in the calculation or just the income from trust clients who have authorized trading with the broker-dealer? Answer: All applicable fiduciary income should be included in the calculation. Question 3 Please expand on the comment about Mutual Funds and how they can be purchased for discretionary accounts in a bank channel (fiduciary accounts).

2 Answer: Registered mutual funds are deemed to be securities and Rules 740 and 741 provide specific exemptions related to money market mutual funds. Regulation R does not dictate the viability of asset types for any account. Question 4 Can you give an example of a multi-factor bonus program that a bank may employ for unlicensed bankers which includes a metric for the investment program other than overall profitability? Answer: Potentially a qualifying threshold (by way of investment revenue) which has to be crossed before the eligibility is determined. One example might include net new revenue generated. Question 5 Regarding wire transfer fees, hourly rate fees for services, tax preparation fees, did I understand that everyone is suggesting you might want to separate these from relationship fees rather than having to do an analysis of what the actual cost of these would be? Answer: Rule 721 (a)(4)(i)(a) defines relationship compensation attributable to trust and fiduciary accounts as, without limitation, tax preparation fees, fees for personal services, and real estate management. For transactional fees that are securities-related, only the true "cost" of conducting the transaction can be included as relationship income. Fees related to wire transfers, tax preparation fees, and hourly service fees should qualify as relationship income. Having said this, some institutions may take a conservative approach and categorize all of the revenue related to a securities transaction as non-relationship income. For example, if you have minimal income related to securities transactions and it doesn't impact the chiefly compensated test (you're still above 70%), it may be easier to place all of the income into non-relationship income instead of researching the transaction to determine the cost. Question 6 Can you please share in a Word format the Sample at the back of the materials? Answer: Please see attached documents Question 7 For self-directed IRAs, we charge $150 for any note or mortgage that we are directed to do. Is that a relationship fee? Answer: Self-Directed IRAs may be more appropriately classified under the custody exemption. Under the Custody exemption relationship compensation becomes irrelevant. Relationship compensation pertains only to those accounts classified under the trust and fiduciary exemption. However, you should be mindful of the limitation on varying order taking fees under Rule 760(b)(3)(ii). If the bank is appointed a directed trustee, the account could qualify to be included in the Trust and Fiduciary calculation. In this case, the flat fee for a note or mortgage can be included in relationship compensation. Question 8 We had a question come up after the briefing as we were discussing issues relating to our particular trust dept. As was mentioned in the discussion, our trust department has paid referral fees to non-registered

3 employees in the amount of a percent of the first year trust fees. As I understood, we are okay with that. The question is this: Does it make a difference if the referral to Trust comes from a registered dual employee? In our case, we from time to time receive a referral from our Bank's Brokerage area. Are we okay in paying a referral fee as outlined above in this case? Answer: Regulation R does not prohibit the trust department from paying referral fees under either of the fact patterns you outline. Question 9 Our bank's fiscal year ended June 30th, so Reg R was effective for us on July 1, Would we do the trust "relationship compensation" calculation for each fiscal year, or do we need to do it for the calendar year. If it is the calendar year, would we do it for the full calendar year 2009, or the six months from 7/1/09-12/31/09. Answer: The bank has an option to perform the Chiefly Compensated calculation on a fiscal year or calendar year basis. If the bank chooses to perform the calculation on a calendar year basis, prudence would dictate that it be performed for the full 2009 calendar year. Question 10 We have a Trust & Investment Services Department and a Retail Brokerage Department affiliated with an outside Broker/Dealer. 1) It is my understanding that there is no fee calculation or reporting that needs to be done for the Retail Brokerage accounts since they are handled by licensed securities representatives (other than ensuring that there is only nominal compensation paid to non-licensed employees for referrals). Is this correct? Answer: Yes. 2) On the Trust & Investment Services side, I believe all of our accounts would fall under either Custody or the Trust & Fiduciary Exemption. For the Custody accounts, is the only requirement that we abide by the restrictions under Reg R? Is there is a compensation test for these accounts? Answer: Yes, you need to abide by the restrictions for custody accounts. There is no bank compensation test for these accounts. 3) For the bulk of our Trust & Fiduciary accounts, we only charge the following types of fees: i) a fee based on assets under management, ii) unique asset management fees, & iii) wire and/or tax prep fees. In this situation would all of the fees be considered relationship compensation and therefore be included in the denominator and numerator of the chiefly compensated calculation? In my situation, then it would appear that the only non-relationship compensation would be for a few accounts on a unique/negotiated fee schedule where they are charged a per trade charge. Answer: All of the fees raised, except for the per trade charge, would qualify as relationship compensation. Rule 721(a)(4) provides further details regarding what is acceptable to be included within Relationship compensation. 4) Lastly would a flat charge per security held be classified as relationship or non-relationship compensation? Answer: A flat or capped per order fee (transaction fee) can be included in relationship Compensation at cost only.

4 Question 11 We are interpreting Reg R based on the word relevant under rule 722 to mean the current operating year. You are interpreting relevant, per your formula on slide #19, as the corresponding year 1 and year 2. Can you please support your interpretation to clarify why we are misinterpreting. Though this is a subtle difference, obviously it has a major impact on the calculation. The issue becomes, short of the exception of running transactions at a loss, is it is possible for the calculation to be over 100%? Answer: The reference to Year 1 in the presentation refers to the first fiscal year beginning after September 30, Assuming that fiduciary accounts included in this calculation have relationship compensation, and since relationship compensation cannot exceed total compensation, the calculation results should be less than or equal to 100%. Question 12 On money market funds, if we are receiving a "marketing allowance" or supplemental fee from the fund company from its own revenue, not from the fund itself, does this qualify under the exemption? If not, how is it treated? Answer: Such fees, if received on behalf of trust and fiduciary accounts, may need to be reviewed for proper classification in the relationship and total compensation calculations. If received on behalf of safekeeping and custody accounts and the bank is engaged in order taking, the allowance may be a concern if based on the amount of dollars invested in the funds or fund units received. Question 13 If a Trust Department uses their own broker, who is a trust officer and a licensed rep, to place all trades, the commissions made off of those trades, is there special reporting issues for those? Does the Trust Department have to report those commissions or can they stay in the brokerage department income? Answer: If the securities related commissions are paid to the registered rep in accordance with FINRA Rules, those commissions fall outside of the Regulation R requirements. Question 14 To reiterate my question, after the telephone briefing on last week, Senior Management left with the impression that our bank must comply with the conditions/restrictions applicable to all four Exemptions (i.e., Trust & Fiduciary Activities, Third Party Broker Arrangements, Safekeeping and Custody Activities, and Money Market Fund Sweeps), even though page #56516 (1 st column, last paragraph) of the Federal Register states the following If more than one broker exception or exemption is available to a bank under the statute or rules for a securities transaction, the bank may choose the exception or exemption on which it relies to effect the transaction without registering as a broker-dealer. With respect to the the Custody and Safekeeping exemption, our bank holds less than 25 stand-alone (no fiduciary link) Custody and Safekeeping accounts. Does the de minimis rule apply to such accounts? Answer: The section of page #56516 that you are referring to does state that if you have a securities transaction that falls under more than one type of exemption, you may choose exemption in which to categorize that transaction. However, even if all of your securities transactions fall under an exemption (trust and fiduciary, custody), you will still need to meet the requirements of the Networking Exemption. For example, your referral programs and incentive compensation programs would have to meet the requirements outlined under Rule 700 even if your institution refers clients to a third-party or affiliated broker-dealer. The Money Market

5 Exemptions contained in Rules 740 and 741 might be helpful if you were sweeping cash in fiduciary, custodial or depository accounts into money market funds. There is, however, no requirement for you to use this exemption for trust and custody accounts. The de minimis rule applies only to excluding trust and fiduciary accounts but if your institution does not provide order taking services to the 25 standalone custody account, your institution may wish to take advantage of the statutory (GLBA) custody and safekeeping exception. That exception has significantly less conditions than Rule 760. Question 15 Application of Reg R's Trust and Fiduciary Exception for Banks: Are unsolicited orders within a Bank's discretionary advisory account still permitted to be received and processed by the Bank under Reg R? Answer: Grantor/principal directed trades in discretionary fiduciary accounts may be received by the bank and placed with a broker/dealer (under Regulation R) as long as they comply with the Trust and Fiduciary exemption requirements (i.e., relationship compensation meets or exceeds 70 % at the entity level or exceeds 50% if the calculation is performed at the account level. Question 16 We perform audit and compliance reviews for smaller institutions with asset size ranging anywhere between $200 million and the largest being around $1 billion. But we have a lot of clients that sell non-deposit investment products through dual employee agreements with third-party broker dealers. We also have clients that have sweep accounts, which they're sweeping funds into deposit products such as money market accounts but not your typical sweep accounts in which government securities are involved. My question is that Reg R would not seem to apply to these cases but what should institutions be doing to comply with Reg R. Do they have to perform any additional compliance documentation or is it something that they do not have to worry about? Answer: The five items we addressed in our teleconference - Networking, Trust and Fiduciary, Money Market, and Safekeeping and Custody exemptions as well as the Advertising restrictions - do apply to banks, thrifts and fiduciary organizations and compliance policies and procedures would need to be documented and followed. At a minimum, the networking provisions contained in the statue and Regulation R would appear to apply. Sweeps into deposit products would be exempt as identified banking products.

The DOL Fiduciary Rule. Questions & answers by Fred Reish. Retirement Plan Solutions. Content provided by. Compliments of

The DOL Fiduciary Rule. Questions & answers by Fred Reish. Retirement Plan Solutions. Content provided by. Compliments of Retirement Plan Solutions Content provided by The DOL Fiduciary Rule by Fred Reish Compliments of The law and analysis contained in these questions and answers are current as of June 2016, are general