Bank Broker-Dealers /
What You Should Know
Marilyn Smith
Head U.S. Risk Policy & Governance
BMO Financial Group/ Harris Bank
April 18  2011
Disclaimer
ANY PART OF THIS PRESENTATION OR
DISCUSSION REPRESENTS VIEWS AND
OPINIONS THAT ARE SOLEY MINE AND NOT
OF MY COMPANY OR ANY COMPANY YOU
MAY PRESUME THAT I REPRESENT. THESE
VIEWS ARE SUBJECT TO CHANGE WITHOUT
NOTICE.
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Bank Broker-Dealers/What You Should Know
What is a Broker-Dealer – Quick Review
General standards for Broker-Dealers
General standards for Bank-Owned BrokerDealers
Dodd-Frank Implications
Broker Dealers as Fiduciaries
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Common Functions of Broker-Dealers
 Order execution
 Transaction clearing
 Custody
 Research
 Recommendations
 Valuations
 Underwriting
 Wealth Management
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Types of Brokers
Principal
Buys and sells to their clients’ from own inventory
Agent
Buys or sells their clients market items
Wholesalers/
Distributors
Distributes own proprietary products to other firms
(no retail clients)
Introducing
Does not hold their clients’ funds or securities
Clearing
Receives orders from introducing broker to execute
and settle orders; holds funds and securities
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Some General Standards For Broker-Dealers
Customers
Retail/Individuals
Institutions
Products/Services
Trade execution
Recommendations
Research
Custody
Securities Lending
Compensation
Commissions
Fee-Based
Registration
SEC
FINRA
MSRB, if applicable
Or States
Disclosures
Form BD
Advertisements/ marketing materials
Primary Regulator
SEC
FINRA, SRO
FIRMA 25th Annual Risk Management Conference – April 18 • 2011
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Some General Standards For Bank-Owned B-Ds
Customers
Retail/Individuals
Institutions
Products/Services
Trade execution
Recommendations
Research
Custody
Securities Lending
Compensation
Commissions
Fee-Based
Registration
SEC
FINRA
MSRB, if applicable
Or States
Disclosures
Form BD
Advertisements/marketing materials
Primary Regulator
SEC
FINRA , SRO
FIRMA 25th Annual Risk Management Conference – April 18 • 2011
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Advantages to Bank-Owned BDs
Provides customers :
 ‘One Stop Shopping’ for Financial Services
 Retention of certain securities positions
 Access other products and services
 Different levels of discretion over their assets
Provides the BD:
 Access to less costly funding
 More sales opportunity
 Retention of assets
FIRMA 25th Annual Risk Management Conference – April 18 • 2011
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Additional Standards For Bank-Owned B-Ds
Heightened Potential Conflicts of Interest
Customers
Retail/Individuals
Institutions
Information barriers must be maintained
between and among entities
Products/Services
Trade execution
Recommendations
Research
Custody
Securities Lending
Services provided by/for affiliates should
not receive preferential treatment; apply
robust due-diligence to document armslength handling; may need a horizontal
view of rationale for differences
Compensation
Commissions
Fee-Based
Referral Fees
No tying
Registrations
SEC
FINRA
MSRB, if applicable
Or States
Dual employees-roles and responsibilities
should be clear and accurate
recordkeeping
Avoid the danger of ‘parking’
Disclosures
Form BD
Advertisements
May need to be more prominent – more
explicit language on Form BD and in
marketing materials to clients
Primary Regulator
FINRA
BHC coverage by Fed and expectation of
adequate oversight and due-diligence
FIRMA 25th Annual Risk Management Conference – April 18 • 2011
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Dodd-Frank Act
, 7/21/2011
Applies to financial institutions
Defines ‘financial institution”
 a depository institution or depository institution holding company,
 a broker-dealer registered under section 15 of the ‘34 Act




a credit union,
an investment adviser under the ’40 Act
the mortgage agencies (FNMA, FHLM), or
any other financial institution that the appropriate Federal regulators,
jointly, by rule, determine should be treated as a covered financial
institution for these purposes.
And for purposes of defining “large” or “significant” it includes the
“consolidated” holdings of a financial holding company
FIRMA 25th Annual Risk Management Conference – April 18 • 2011
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Dodd-Frank Act Implications for Broker-Dealers 7/21/2010
 Accredited Investor
 Compensation
 Derivatives/Swaps
 Fiduciary Standards [913]
 Transactions with Affiliates
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Definition of Accredited Investor
[413]
 Definition of Accredited Investor changes to EXCLUDE the value of
the primary residence:
(i) individual net worth (or joint net worth with his or her spouse) in
excess of $1 million or
(ii) annual income in excess of $200,000 (or joint annual income with
his or her spouse in excess of $300,000) for the past two years and
(iii) the reasonable expectation of meeting the same level of income
in the current year.
 Defines “Qualified Purchasers” for participation in certain products or
transactions
- private placements ( Reg D)
- private equity funds
- hedge funds
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Compensation
[956]
 For publicly traded companies
 Executive Compensation
 Say-on-Pay
 shareholder approval
 clawback policies following a restatement (3 yr period)
 Elimination of broker-dealer voting of proxies re exec comp
 For financial institutions with assets > $1Bil Financial Institution
 Prohibits ‘incentive-based’ compensation, fees, or benefits that
encourages inappropriate risk or that could lead to losses
 Directs Bank regulators to prohibit it ,and
 Allows Bank regulators to impose higher capital charges
 For financial institutions > $50Bil
 Deferrals of compensation of executives
Policy and procedure and disclosures requirements as well
FIRMA 25th Annual Risk Management Conference – April 18 • 2011
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Derivatives/Swaps
[Title VII]
 Definition of a swap dealer and major participant
 Requires registration by swap dealers and major swap
participants with CFTC
 Defines a major participant as anyone who is not a swap dealer
and maintains substantial positions excluding hedging positions
for commercial or employee benefit plan risk
 Defines “significant position” as whatever the CFTC determines
to be effective
 Requires introducing broker to implement conflict-of-interest
procedures to ensure independence between research and
analysis and trading and clearing.
 Establish robust procedures for day to day management
 Allows CFTC to impose limits on amount of positions held of any
one person
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Affiliate Transaction Restrictions
[Title VI]
Title VI (amends 23A & 23B)
Applies to Banks…
 eliminates the exception for affiliated transactions in credit exposed
derivatives, repos, reverse repos, securities lending and borrowing
transactions, and additional categories of ‘covered’ transactions
 considered to be extensions of credit
 factored into the Bank’s legal lending limits
 prohibits use as collateral of low-quality issues of an affiliate
FIRMA 25th Annual Risk Management Conference – April 18 • 2011
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Fiduciary Standard for Broker-Dealers
Section 913
SEC study concluded January 2011 regarding proposal …
Recommends that the Commission “promulgate a rule that the
standard of conduct for all brokers, dealers, and investment
advisers, when providing personalized investment advice about
securities to retail customers (and such other customers as the
Commission may by rule provide), shall be to act in the best interest
of the customer without regard to the financial or other interest of the
broker, dealer, or investment adviser providing the advice”.
aka
“…the uniform fiduciary standard
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Fiduciary “Standards” For Broker-Dealers
Registered Broker-Dealer
Registered Investment Adviser
Suitability
Rules Based Investment Objectives
at time of a/c opening
at time of transaction
Standards Based Investment Objectives
at time of a/c opening
at time of transaction
after the fact
Products/Services
IPOs
Private Placements
Hedge Funds
Penny stocks
Options
Structured Products
Sophisticated Investor
Broker selection
Trade Allocation
Recommendations
Research
Wealth Management
Custody
Prudent Investor Rule full range of services
Compensation
Commissions
Fee-Based
Products sold
AUM Advisory Fee
Performance, limited, explicit permission
Must be fair & reasonable and if higher than
other advisers, must disclose this
Registration
SEC
FINRA
States with clients
MSRB, if applicable
SEC >15 clients and $25mil AUM*
States, where place of business,
 some >6 clients
Disclosures
Form BD
Advertisements
Form ADV
Reports/Materials
Full Transparency including omissions
* $100mil a/o 7/1/2011
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Recommendations for Approaching Implementation
 Make sure your business assessments/maps are up-to-date
 Affiliations
 Dual employees
 Establish internal ‘rules’ for your business/activity/product scenarios
 What can happen
 How will we know when it happens
 What can we do when it does happen
 Document, document, document
 “standards” are presumptive; remember that they will be applied
after the fact
FIRMA 25th Annual Risk Management Conference – April 18 • 2011
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Samples
 Sample Brokerage Applications with Investment Objectives
 Form BD
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QUESTIONS
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