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New Barbarians at the Gate
Foreign brokers get leg up on U.S. firms under SEC proposal
Traders Magazine, August 2008
Traders enjoy complaining about regulation and are justified in doing so. There is hardly any action that a trader can take during the day, no matter how basic, that is not the subject of some regulation. And, with every regulation, there is a cost. We lawyers may commiserate with our clients about regulation, but regulation is good for us.
Heavily regulated industries need lawyers to help decipher their responsibilities and defend them when they run afoul of the regulations. Complex regulation requires smarter and higher-priced lawyers.
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As much as traders complain about regulation (and lawyers), however, the truth is that the financial services industry receives one enormous benefit from regulation. Regulation offers a competitive advantage to the regulated. The unregulated are not permitted to play. And that's what raises the importance to the SEC's recent proposed changes to Exchange Act Rule 15a-6. The proposal would permit foreign broker-dealers that are not registered with the SEC to invade turf that currently can only be occupied by registered broker-dealers.
At present, a U.S. person is free to open a foreign brokerage account with a foreign broker-dealer and trade foreign securities. But, the U.S. person has to take the initiative. The foreign broker-dealer cannot advertise its services or provide research to U.S. persons, make sales calls on U.S. persons or do any of the activities that fall within the broad category of "solicitation."
There is a limited exception to all of this for "major U.S. institutional investors," generally defined as investment companies and registered investment advisers with assets under management greater than $100 million. Note that hedge funds with unregistered investment managers are not included in this definition. If a foreign broker-dealer wishes to make a sales call on a major U.S. institutional investor, a U.S. broker-dealer must accompany them. The U.S. broker-dealer must review any research for compliance with U.S. rules. If the solicitation results in an order, that order must be executed through a U.S. broker-dealer, the customer's assets must be in the custody of a U.S. broker-dealer and the assets are subject to U.S. customer protection rules. Finally, any margin must be provided by the U.S. broker-dealer, rather than by the foreign broker-dealer.
The proposed new rule would expand this exemption significantly. First, the exemption for solicitation would apply to just about any company, partnership, trust or high net worth individual with an investment portfolio greater than $25 million. These institutions and high net worth individuals are defined in the rule as "qualified investors." Second, and most importantly for the trading community, the proposed rule would also reduce the role of U.S. broker-dealers in this process.
The proposal divides the world of foreign broker-dealers into two camps: Foreign broker-dealers that conduct a "foreign business" and other foreign broker-dealers. A foreign broker-dealer conducts a "foreign business" if 85 percent of the securities purchased and sold by or on behalf of its clients are "foreign securities."
Foreign broker-dealers that conduct a "foreign business" could engage in a wide range of solicitation activities to U.S. "qualified investors." The rule would permit them to provide research, make sales calls, maintain custody of client cash and securities, provide margin and execute trades. They would be required to agree to provide a U.S. broker-dealer with access to the foreign broker-dealer's records so that the SEC could obtain them easily. However, those records need not comply with the elaborate record-keeping requirements of Exchange Act Rules 17a-3 and 17a-4. Instead, the foreign broker-dealer would only have to comply with its home country record-keeping regulations. Serving as go-between for SEC records requests would be the extent of the U.S. broker-dealer's role in dealing with U.S. customers.
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