Marilyn SmithHead U.S. Risk Policy &

GovernanceBMO Financial Group/ Harris Bank

Bank Broker-Dealers / What You Should Know

April 18 2011

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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 Broker-Dealers

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-DealersCustomers Retail/Individuals

Institutions

Products/Services Trade executionRecommendationsResearchCustodySecurities Lending

Compensation CommissionsFee-Based

Registration SECFINRAMSRB, if applicableOr States

Disclosures Form BDAdvertisements/ marketing materials

Primary Regulator SECFINRA, SRO

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Some General Standards For Bank-Owned B-DsCustomers Retail/Individuals

Institutions

Products/Services Trade executionRecommendationsResearchCustodySecurities Lending

Compensation CommissionsFee-Based

Registration SECFINRAMSRB, if applicableOr States

Disclosures Form BDAdvertisements/marketing materials

Primary Regulator SECFINRA , SRO

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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

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Additional Standards For Bank-Owned B-Ds

Customers Retail/IndividualsInstitutions

Information barriers must be maintained between and among entities

Products/Services Trade executionRecommendationsResearchCustodySecurities Lending

Services provided by/for affiliates should not receive preferential treatment; apply robust due-diligence to document arms-length handling; may need a horizontal view of rationale for differences

Compensation CommissionsFee-BasedReferral Fees

No tying

Registrations SECFINRAMSRB, if applicableOr States

Dual employees-roles and responsibilities should be clear and accurate recordkeeping

Avoid the danger of ‘parking’

Disclosures Form BDAdvertisements

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

Heightened Potential Conflicts of Interest

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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

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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

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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

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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-DealersRegistered Broker-Dealer Registered Investment Adviser

Suitability Rules Based Investment Objectivesat time of a/c openingat time of transaction

Standards Based Investment Objectivesat time of a/c openingat time of transactionafter the fact

Products/Services IPOsPrivate PlacementsHedge FundsPenny stocksOptionsStructured ProductsSophisticated Investor

Broker selectionTrade AllocationRecommendationsResearchWealth ManagementCustodyPrudent Investor Rule full range of services

Compensation CommissionsFee-BasedProducts sold

AUM Advisory FeePerformance, limited, explicit permissionMust be fair & reasonable and if higher than other advisers, must disclose this

Registration SECFINRAStates with clientsMSRB, if applicable

SEC >15 clients and $25mil AUM*States, where place of business,

some >6 clients

Disclosures Form BDAdvertisements

Form ADVReports/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

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Samples

Sample Brokerage Applications with Investment Objectives

Form BD

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QUESTIONS