Alert July 22, 2008

SEC Proposes to Expand the Broker-Dealer Registration Exemptions under Rule 15a-6 for Foreign Broker-Dealers

The SEC recently proposed much-anticipated amendments to Rule 15a-6 under the Securities Exchange Act of 1934 (the “Exchange Act”).  The proposed amendments are designed to update and expand the ability of U.S. investors to do business with foreign broker-dealers, which would not need to register under the Exchange Act by reason of engaging in such business.

The Exchange Act generally requires entities using any means of interstate commerce to effect transactions in, or to induce or attempt to induce purchases and sales of, securities to register with the SEC.  Absent an exemption, broker-dealers outside the United States engaged in transactions with persons in the United States would need to register under U.S. securities rules.  Rule 15a-6 was adopted by the SEC in 1989 to provide certain exemptions from this registration requirement for non-U.S. broker-dealers engaged in certain narrowly defined types of transactions with U.S. persons.  Specifically, Rule 15a-6 allows foreign broker-dealers to effect transactions with U.S. persons that have not been solicited by the foreign broker-dealer (Rule 15a-6(a)(1)); to provide research reports to certain so-called “major institutional investors” (Rule 15a-6(a)(2)); to solicit brokerage transactions from other “institutional investors,” so long as such dealings are chaperoned by SEC-registered broker-dealers (Rule 15a-6(a)(3)); and to effect securities transactions with certain other U.S. entities and persons, such as U.S. banks and persons temporarily resident in the United States (Rule 15a-6(a)(4)). 

The SEC’s proposal is designed to update Rule 15a-6, which, by many accounts, is significantly outmoded in an era of increasingly international securities markets.  As described in greater detail below, the proposal generally (i) broadens the category of U.S. investors that foreign broker-dealers may contact for the purpose of providing research reports and soliciting securities transactions, and (ii) reduces the required involvement of SEC-registered broker-dealers in intermediating transactions effected by foreign broker-dealers on behalf of certain U.S. investors. 

Unsolicited Trades – Rule 15a-6(a)(1)

The proposal reaffirms the SEC’s view – as embodied in current Rule 15a-6 – that a foreign broker-dealer does not trigger the Exchange Act’s registration requirements when a U.S. investor has sought out the foreign broker-dealer outside the U. S. and initiated transactions in foreign securities markets entirely of the investor’s own accord.  The principal change proposed by the SEC is to add the title “Unsolicited Trades” to Rule 15a-6(a)(1).  The proposing release also emphasizes that the SEC construes the term “solicitation” broadly and, thus, relatively few transactions would qualify for the unsolicited trades exemption. 

The release also proposes to revise past interpretive guidance regarding the U.S. distribution of foreign broker-dealers’ quotations by third-party systems.  Under the proposed interpretation, the distribution in the United States of foreign broker-dealers’ quotations by a third-party system would not be viewed as a form of “solicitation” under revised Rule 15a-6 so long as (i) the third-party system did not itself allow execution of securities transactions between the foreign broker-dealer and persons in the United States, and (ii) there were no other contacts with U.S. investors initiated by the third-party system or the foreign broker-dealer.

Extension of Rule 15a-6 to “Qualified Investors – Rules 15a-6(a)(2) and 15a-6(a)(3)

The proposal broadens the category of U.S. investors with which a foreign broker-dealer may interact without triggering registration and other requirements of the Exchange Act.  Citing its belief that advances in communications and other technology have made it increasingly likely that a broader group of U.S. investors have the skills and experience to be able to assess independently the integrity and competence of foreign broker-dealers providing access to foreign markets, the SEC proposes to replace the categories of “major U.S. institutional investor” and “U.S. institutional investor” with a “qualified investor” standard, which is defined in Section 3(a)(54) of the Exchange Act.  Such “qualified investors” generally would include entities engaged primarily in financial activities (including the business of investing) and corporations and other entities that, or natural persons who, own and invest on a discretionary basis not less than $25 million in investments. 

As a general matter, this proposed change effectively would lower the asset level at which a foreign broker-dealer may deal with U.S. investors from the current level of more than $100 million in total assets to $25 million or more in investments.  That said, there are limitations in the proposed revision.  First, there are certain instances in which the qualified investor standard would require a U.S. investor to have greater investment experience than currently required under the Rule 15a-6.  For example, the current standard encompasses employee benefit plans that have $5 million or more in assets, while the proposed standard would only encompass employee benefit plans in which investment decisions are made by certain plan fiduciaries.  Second, the proposed amendments would not affect the applicability of U.S. state securities (blue sky) laws, which may impose other limits on foreign broker-dealers.

Provision of Research Reports – Rule 15a-6(a)(2)

The proposed amendments also would expand the class of investors to which a foreign broker-dealer could directly provide research reports.  Under the current Rule 15a-6, foreign broker-dealers may only furnish research reports to major institutional investors – those investors having assets in excess of $100 million.  The proposed rule would permit a foreign broker-dealer to provide research reports to qualified investors and to effect transactions in the securities discussed in the research reports with or for those qualified investors, under certain conditions.  This exemption would be available where (i) the research reports did not recommend the use of the foreign broker-dealer to effect trades in any security, (ii) the foreign broker-dealer did not initiate follow-up contacts with the qualified investors, (iii) if the foreign broker-dealer had a relationship with a U.S. registered broker-dealer that would enable it to satisfy the requirements of Rule 15a-6(a)(3) as revised by the proposed amendments (see the discussion below under “Solicited Trades”), any transactions with the foreign broker-dealer in securities discussed in the research reports were effected in accordance with the conditions of Rule 15a-6(a)(3) as proposed to be amended, and (iv) the foreign broker-dealer did not provide research to U.S. persons pursuant to any express or implied understanding that those U.S. persons would direct commission income to the foreign broker-dealer.

Solicited Trades – Rule 15a-6(a)(3)

The proposed amendments to Rule 15a-6(a)(3) would significantly revise the conditions under which a regulated foreign broker-dealer (i.e., a foreign broker-dealer that is in the business of and regulated for conducting securities activities in a foreign country by a foreign securities authority) could induce or attempt to induce the purchase or sale of a security by certain U.S. investors and still rely on the exemption available under Rule 15a-6(a)(3).  Under the SEC’s proposed changes, Rule 15a‑6(a)(3) would offer an exemption to a foreign broker-dealer that solicits trades from U.S. investors under two sets of circumstances.  Notably, neither set of circumstances includes Rule 15a‑6(a)(3)’s current so‑called “chaperoning” requirement under which a U.S. registered broker‑dealer must accompany a foreign broker-dealer during in-person visits with U.S. investors. 

In the first set of circumstances under the proposed amendments, a foreign broker-dealer could solicit trades and effect securities transactions if the broker-dealer conducted a so-called “foreign business.”  In general terms, a foreign broker-dealer would be deemed to conduct “foreign business” if at least 85% of the aggregate value of the securities purchased or sold in transactions with U.S. investors (calculated on a rolling, two-year basis) is derived from transactions in foreign securities.  The proposed definition of “foreign securities” is broad, including issues of debt and equity securities of issuers organized or incorporated in the United States that have been distributed outside the United States in compliance with Regulation S, and certain securities issued by foreign governments.  A foreign broker-dealer would be permitted to custody the funds and securities of qualified investors in connection with transactions as to which it was relying on this exemption. 

A U.S. registered broker-dealer would be required to maintain copies of all books and records relating to any transactions effected by a foreign broker-dealer pursuant to this exemption, but could maintain them (i) in the form, manner and for the periods prescribed by the foreign securities authority that regulates the foreign broker-dealer or (ii) with the foreign broker-dealer so long as the U.S. registered broker-dealer reasonably determined that copies of such books and records could be furnished promptly to the SEC (and promptly provided any such books and records on request). 

In the second set of circumstances under the proposed amendments, a foreign broker-dealer could solicit trades from and effect securities transactions for qualified investors that already had an account with a U.S. registered broker-dealer, provided that, among other things, a U.S. registered broker-dealer acted as a custodian (and, thus, held the funds and securities of the qualified investor) for any resulting transactions.  A foreign broker-dealer would not be permitted to maintain custody of qualified investor funds and securities relating to any resulting transactions.  This exemption would be available to all foreign broker-dealers and not just those that conduct a foreign business.

To rely on either exemption, a foreign broker-dealer would be required to make specific disclosures to qualified investors related to the fact that the broker-dealer was not regulated by the SEC and, in the case of the exemption available only to foreign broker-dealers that conduct a foreign business, that funds and securities being held by the foreign broker-dealer were not being held subject to certain protections under the Exchange Act and other U.S. securities laws.  The foreign broker-dealer also would need to meet certain other requirements, including determining that none of its associated persons are subject to statutory disqualification under the Exchange Act.

Counterparties and Specific Customers – Rule 15a-6(a)(4)

The proposal would add to a new category to current Rule 15a-6(a)(4)’s exemptions, which allow foreign broker-dealers that effect securities transactions with SEC-registered broker-dealers, certain banks, certain foreign persons temporarily present in the United States, and certain U.S. persons or groups of U.S. persons abroad.  The additional exemption would be for U.S. persons that act in a fiduciary capacity for an account of a “foreign resident client,” which would be defined as (i) any entity not organized or incorporated under the laws of the United States and not engaged in a trade or business in the United States for federal income tax purposes, (ii) any natural person not a U.S. resident for U.S. tax purposes and (iii) any entity not incorporated or organized under U.S. law, 85% or more of whose outstanding securities are beneficially owned by persons described in clauses (i) or (ii). 

Familiarization with Foreign Options Exchanges – Rule 15a-6(a)(5)

Under the proposed amendments, new Rule 15a-6(a)(5) would allow a foreign broker-dealer that is a member of a foreign options exchange to effect transactions in options on foreign securities listed on that exchange for a qualified investor that the foreign broker-dealer has not otherwise solicited.  A foreign broker-dealer, a foreign options exchange and representatives of the foreign options exchange could conduct certain activities or communicate with a qualified investor in a manner that might otherwise be considered a form of solicitation, and transactions effected by or through the foreign broker-dealer with or for qualified investors that result from these activities or communications would not require registration and, in some cases, would not require compliance with proposed Rule 15a-6(a)(3). 

Public Comment

The SEC has solicited public comment on numerous aspects of its fairly sweeping proposal, which is likely to draw close scrutiny from many in the securities industry, both in the United States and abroad.  As a result, there is likely to be a significant volume of comment on the proposed revisions, which could substantially influence any amendments to Rule 15a-6 that the SEC ultimately adopts.   Comments on the SEC’s proposal are due by September 8, 2008.