SEC Proposes Liberalizing Amendments To Rule 15a-6 (Cross Border Regulation of Broker-Dealers)* - Financial Services

Originally published July 14, 2008

Keywords: SEC, amendments, Rule 15a-6, cross border regulation, broker-dealers, Securities Exchange Act, foreign broker-dealers, qualified invesetor, securities transactions, unsolicited trades

On June 27, 2008, the US Securities and Exchange Commission (the "SEC") published proposed amendments (the "Proposal") that, if adopted, will significantly liberalize Rule 15a-6 under the Securities Exchange Act (the "Exchange Act").¹ Rule 15a-6, which was originally adopted in 1989, currently permits foreign broker-dealers (i.e., non-US persons whose securities activities, if conducted in the United States, would come within the definitions of "broker" and/or "dealer" under the Exchange Act) to have certain limited contacts with US persons without such foreign broker-dealers being required to register with the SEC under Section 15(a) of the Exchange Act. The key changes proposed are highlighted below.

Comments on the Proposal should be submitted to the SEC on or before September 8, 2008.

Use of "Qualified Investor" Standard

The Proposal would generally expand the categories of US persons that a foreign broker-dealer may contact for the purposes of soliciting securities transactions and/or providing securities-related research reports. The current rule applies to such activities when conducted with respect to "US Institutional Investors" and "Major US Institutional Investors," both of which would be replaced with the single term "Qualified Investor" (as such term is defined in Section 3(a)(54) of the Exchange Act).

In most respects, the use of a Qualified Investor standard will be broader than the current rule because this new standard includes, among other things, institutional investors that own or invest on a discretionary basis $25 million or more in investments rather than the $100 million threshold currently applied to Major US Institutional Investors under the rule. Moreover, the Qualified Investor would also include any natural person who owns or invests on a discretionary basis not less than $25 million in investments whereas the current rule does not generally extend its exemptive provisions (other than the current unsolicited trades exemption) to any natural persons.

However, in some instances, the Qualified Investor standard may be more restrictive, such that greater investment experience and sophistication would be required. For example, the definition of Qualified Investor would include employee benefit plans in which investment decisions are made by certain plan fiduciaries. Under the current rule, the definition of US Institutional Investor does not require a fiduciary to make investment decisions for such plans. Also, like the existing definition, the definition of Qualified Investor would apply to business development companies. However, under the current rule, the definition of US Institutional Investor is broader in that it includes private business development companies and certain organizations described in Section 503(c) of the Internal Revenue Code.

Unsolicited Trades

Current Rule 15a-6(a)(1) provides an exemption from registration for foreign broker-dealers that effect transactions in securities for persons that have not been solicited. Under the Proposal, this provision will not change. However, the Proposal provides guidance regarding what activities would constitute "solicitation" in this context. In particular, the Proposal notes that distribution of foreign broker-dealers' quotations by third party systems (which do not allow securities transactions to be executed between foreign broker-dealers and persons in the United States through the system) would not be viewed as a form of solicitation, in the absence of other contacts with US investors initiated by the third-party system or the foreign broker-dealers.

Distribution of Research Reports to Qualified Investors

Current Rule 15a-6(a)(2) provides an exemption under which foreign broker-dealers may provide research reports to Major US Institutional Investors and effect transactions in the securities discussed in the research reports under certain conditions. This exemption would substantively remain the same under the Proposal, except that the class of investors to which foreign broker-dealers could directly provide research reports would be changed to Qualified Investors.

Solicited Trades with Qualified Investors

Under the Proposal, the onerous requirements for contacts with US Institutional Investors under current Rule 15a-6(a)(3) will be replaced with two flexible alternative exemptions for foreign broker-dealers effecting solicited securities transactions with Qualified Investors. If adopted, these new alternatives (referred to in the Proposal as "(A)(1)" and "(A)(2)") would, among other things, eliminate "chaperoning" — the requirements that foreign associated persons of a foreign broker-dealer be accompanied by an associated person of a US registered broker-dealer during in-person visits with US investors — and allow for direct, unchaperoned contacts with a Qualified Investor. The SEC has proposed to interpret a "visit" as one or more trips to the United States over a calendar year that do not last more than 180 days in the aggregate. More generally, both alternatives would also have fewer obligations for US registered broker-dealers and would permit foreign broker-dealers to play a greater role in effecting resulting transactions.

THE (A)(1) ALTERNATIVE

Under proposed Rule 15a-6(a)(3)(iii)(A)(1), a foreign broker-dealer would be allowed to effect transactions for Qualified Investors and to custody the funds and securities of such investors provided that the foreign broker-dealer satisfies a "foreign business" requirement. The foreign business requirement is satisfied only if at least 85 percent of the aggregate value of transactions, calculated on a rolling two-year basis, conducted by the foreign broker-dealer are derived from transactions in "foreign securities" (as defined under the proposed rule). This test may be difficult to apply and is likely to generate significant comment.

In addition, books and records for transactions effected by a foreign broker-dealer pursuant to this alternative would need to be maintained by a US registered broker-dealer, including confirmations and statements issued by the foreign broker-dealer to the Qualified Investor, relating to any such transactions. This requirement would be considered met, however, if these books and records are maintained by the foreign broker-dealer and the US registered broker-dealer is able to make a reasonable determination that copies of any such books and records could be furnished promptly to the SEC upon request.

Lastly, the foreign broker-dealer would also be required to disclose that US segregation requirements, US bankruptcy protections and protections under the Securities Investor Protection Act do not apply to any funds and securities of the Qualified Investor held by the foreign broker-dealer.

THE (A)(2) ALTERNATIVE

Under proposed Rule 15a-6(a)(3)(iii)(A)(2), a foreign broker-dealer could solicit transactions from Qualified Investors that have accounts, and custody their funds and securities, with US registered broker-dealers. Unlike alternative (A)(1), this alternative would not apply a foreign business test. Because the US registered broker-dealer would have custody of the funds, it would be required to receive, deliver and safeguard funds and securities in connection with transactions on behalf of the Qualified Investor in compliance with Rule 15c3-3 under the Exchange Act. The US registered broker-dealer would be responsible for maintaining books and records relating to any transactions effected under the exemption.

ADDITIONAL CONSIDERATIONS FOR BOTH (A)(1) AND (A)(2)

If adopted, the two alternatives will exempt from registration only foreign broker-dealers whose securities activities are regulated by a "foreign securities authority" (which, somewhat oddly, is not defined in the Proposal even though the SEC believes that such regulation ensures that a foreign broker-dealer is "legitimately in the business of conducting securities activities"). This requirement does not apply under current Rule 15a-6. Moreover, a foreign broker-dealer would have to disclose to the Qualified Investor that it is regulated not by the SEC but by a foreign securities authority.

Furthermore, both alternatives would require, in much the same way as the current rule, a US registered broker-dealer to obtain from the foreign broker-dealer, and each foreign associated person of such foreign broker-dealer, written consent to service of process for any civil action brought by or proceeding before the SEC or a self-regulatory organization. The Proposal places the burden on the foreign broker-dealer to determine that its foreign associated persons effecting transactions with a Qualified Investor are not subject to statutory disqualifications. The foreign broker-dealer would also be required to maintain documentation of sanctions imposed by foreign securities authorities, foreign exchanges or foreign associations. The US registered broker-dealer would be responsible for obtaining these representations from the foreign broker-dealer along with representations that the foreign broker-dealer has in its files, and would make available upon request by the US registered broker-dealer or the SEC certain documentation required by Rule 17a-3(a)(12) under the Exchange Act. The US registered 4 SEC Proposes Liberalizing Amendments to Rule 15a-6 (Cross Border Regulation of Broker-Dealers) broker-dealer would also be required to maintain records of these written consents and representations.

Solicited Trades with Certain Persons Other than Qualified Investors

Current Rule 15a-6(a)(4), which provides exemptions for foreign broker-dealers that effect transactions with or for certain persons (US registered broker-dealers and banks, certain supranational organizations, foreign persons temporarily present in the United States with whom a foreign broker-dealer has a pre-existing relationship, and certain US persons abroad), would remain largely unchanged. However, an additional exemption would be added for foreign broker-dealers that effect solicited securities transactions for US persons that act in a fiduciary capacity for an account of a "foreign resident client" (a newly defined term in the proposal that attempts to capture foreign entities that are predominately foreign-owned). The US-based fiduciary exemption would effectively codify a position taken by the SEC in a prior no-action letter. Although this new exemption would not, on its face, be limited like the no-action position to transactions only in foreign securities and US government securities, it will require foreign broker-dealers to meet the "foreign business" test used elsewhere in the Proposal for alternative (A)(1).

Familiarization with Foreign Options Exchanges

The Proposal would permit foreign options exchanges to "familiarize" Qualified Investors who have had prior actual experience with trading options in US options markets with the existence and operations of such foreign options exchanges. In addition, the Proposal would add a new provision as Rule 15a-6(a)(5), permitting a foreign broker-dealer to effect options transactions for a Qualified Investor that has not been solicited by the foreign broker-dealer on a foreign options exchange of which the foreign broker-dealer is a member, even if such exchange has made familiarization efforts towards the Qualified Investor. In other words, the outreach by the foreign options exchange, if properly conducted, would not be viewed as indirect solicitation by a member foreign broker-dealer of Qualified Investors.

Concluding Observations

Although the Proposal will be welcomed by non-US firms interested in providing cross-border brokerage services into the United States, many questions remain. Should the Proposal be viewed as a prelude to greater cross-border openness by the SEC (e.g., mutual recognition)?³ May foreign broker-dealers provide investment advice to Qualified Investors without being considered investment advisers if such investment advice is solely incidental to the conduct of cross-border brokerage under the rule and the foreign broker-dealer receives no special compensation therefor (as such terms are interpreted under Section 202(a)(11) of the Investment Advisers Act of 1940)? How will these changes to a rule under the Exchange Act interplay with state-level broker-dealer regulation? We encourage our readers to consider such larger structural questions in addition to the specific questions posed for comment by the SEC in the Proposal (e.g., Is the Qualified Investor standard appropriate?) when assessing the Proposal and evaluating whether to submit comments to the SEC.

Endnotes

^{* This client alert updates the previous alert, "SEC to Propose Liberalizing Changes to
Securities Exchange Act Rule 15a-6" distributed on
June 26, 2008, that was based on the open meeting of the SEC
that took place on June 25, 2008.

1. Exemption of Certain Foreign Brokers or Dealers; Proposed
Rule, Exch. Act Rel. No. 58,047 (June 27, 2008), 73 Fed. Reg.
39,182 (Jul. 8, 2008).

2. Under a mutual recognition framework, the SEC would, in
theory, allow foreign broker-dealers, foreign securities
exchanges and foreign issuers of securities to have contacts
with US persons through US jurisdictional means without being
subject to full regulation by the SEC. In effect, such non-US
persons would, with the SEC's express permission,
substitute compliance with comparable non-US regulation for
compliance with US regulation. See generally Ethiopis Tafara
and Robert J. Peterson, A Blueprint for Cross-Border Access to
US Investors: A New International Framework, 48 HARV.
INT'l. L.J. 31 (2007).}

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