FINMA Circular 08/5. Securities Dealers

AUDIT FINANCIAL SERVICES FINMA Circular 08/5 Securities Dealers 1 Summary Circular 08/5 defines the term securities dealer in accordance with Art. 2 lit. d SESTA and Art. 2 and 3 SESTO as well as the subordination of the introducing broker as a foreign securities dealer in accordance with Art. 38 and following of the SESTO. 2 Table of contents I. Title page pg. 2 II. Circular 08/5 pg. 3 3 Other languages DE: FINMA-RS 08/5 Effektenhändler vom 01. Januar 2009 FR: Circ.-FINMA 08/5 Commentaires du terme de négociant en valeurs mobilières du 01 janvier 2009 Unofficial translation issued in June 2010

Financial Market Supervisory Authority (FINMA) Circular 2008/5 Securities Dealers Explanatory Notes regarding Definition of Securities Dealers Reference: FINMA-Circ. 08/5 Issued: 20 November 2008 Effective: 1 January 2009 Last amendment: 20 November 2008 Concordance: SFBC-Circ. 98/2 Securities Dealers of 1 July 1998 Legal bases: FINMASA Art. 7 Para. 1 lit. b SESTA Art. 1, 2 lit. d SESTO Art. 2-5, 19 Para. 2, 38 et seq. Addressees BA ISA SESTA CISA AMLA Other Banks Fin. groups & conglomerates Other intermediaries Insurers Ins. groups & conglomerates Intermediaries Stock exchanges & participants Securities Dealers Fund management company SICAV Limited partnerships for CIS SICAF Custodian banks Managers domestic CIS Distributors Representative of foreign CIS Other intermediaries SRO DUFI SRO Supervised Audit companies Rating agencies x

Table of Content I. Purpose Margin nos. 1-2 II. Background Margin nos. 3-6 III. Main Activity in the Financial Sector (Art. 2 Para. 1 and 2, Art. 19 Para. 2 SESTO) IV. Trading in a Professional Capacity (Art. 3 Para. 1-5 SESTO) V. Public Offering (Art. 3 Para. 2-4, 6 and 7, Art. 4 SESTO) Margin nos. 7-10 Margin nos. 11-13 Margin nos. 14-16 VI. Own Account Dealers (Art. 3 Para. 1 SESTO) Margin nos. 17-23 A. Trading in a Professional Capacity Margin nos. 18-20 B. Trading for Own Account Margin no. 21 C. Short-term Basis Margin no. 22 D. Minimum Gross Volume of CHF 5 billion per annum Margin no. 23 VII. Issuing Houses (Art. 3 Para. 2 SESTO) Margin nos. 24-31 A. Trading in a Professional Capacity Margin no. 25 B. Public Offering Margin nos. 26-28 C. Issuing Houses with Banking Status Margin nos. 29-31 VIII. Derivative Houses (Art. 3 Para. 3 SESTO) Margin nos. 32-38 A. Trading in a professional capacity Margin no. 33 B. Public offering Margin nos. 34-36 C. Derivatives Margin no. 37 D. Spot Transactions Margin no. 38 IX. Market Makers (Art. 3 Para. 4 SESTO) Margin nos. 39-45 A. Trading in a Professional Capacity Margin no. 40 B. Public Offering Margin nos. 41-42 C. Trading for Own Account Margin no. 43 D. Short-term Basis Margin no. 44 3

E. Legal Segregation of Securities Trading Margin no. 45 X. Dealers Trading on behalf of Customers (Art. 3 Para. 5 SESTO) Margin nos. 46-53 A. Trading in a Professional Capacity Margin nos. 48-49 B. In Own Name and for the Account of Customers Margin no. 50 C. Maintenance of Accounts or Custody of Securities Margin no. 51 D. Asset Managers or Investment Advisors Not Subordinated to the Law Margin no. 52 E. Legal segregation of securities trading Margin no. 53 XI. Introducing Brokers (Art. 39 Para. 1 lit. a fig. 2 SESTO) Margin nos. 64-63 4

I. Purpose The present Circular explains in general the definition of securities dealer according to Art. 2 lit. d SESTA and Art. 2 and 3 SESTO as well as the subordination of the introducing broker as a foreign securities dealer in accordance with Art. 38 et seq. SESTO. The Circular will be adapted to the future amendments and developments in the practice to the above-named provisions of the Stock Exchange Act and Stock Exchange Ordinance. 1 2 II. Background The term securities dealer is defined in Art. 2 lit. d SESTA as follows: Securities dealers: natural persons, legal entities or partnerships who, in a professional capacity, trade for their own account on a short term basis or who buy and sell securities on the secondary market for the account of third parties, who offer securities to the public on the primary market, or who create and offer derivatives to the public. The implementing provisions regarding the term "securities dealer" in Art. 2 SESTO establish the following dealer categories: own-account dealers, issuing houses, derivative houses, market makers and client dealers, which for their part are set out in Art. 3 SESTO. These categories of dealers result in distinctive attributes that are useful for distinguishing securities dealers requiring a license from those not subject to the Act. These categories of dealers will be dealt with in more detail in Sections VI through X below. Companies with registered office in Switzerland that, as domestic securities dealers, fall under one of these categories require a license pursuant to Art. 10 SESTA and Art. 17 et seq. SESTO. In accordance with Art. 38 Para. 1 SESTO, foreign securities dealers shall be deemed to be companies that (a) possess an equivalent license abroad; (b) apply the expression "securities dealer" or an expression of similar meaning in their corporate name, business purpose or documents; or (c) conduct trading in securities within the sense of Art. 2 lit. d SESTA. They require a license pursuant to Art. 39 Para. 1 SESTO if they (a) maintain a branch or representative office in Switzerland or (b) are member of a stock exchange with registered office in Switzerland or plan to do become one. 3 4 5 6 III. Main Activity in the Financial Sector (Art. 2 Para. 1 and 2, Art. 19 Para. 2 SESTO) Own account dealers, issuing houses and derivative houses are subject to the Stock Exchange Act only if they are mainly active in the financial sector (Art. 2 Para. 1 SESTO). Mainly implies that the activity in the financial sector clearly predominates over any other activities (of an industrial or commercial nature). The condition main activity in the financial sector prevents industrial and commercial companies from being subordinated to the Stock Exchange Act based on the activity of their finance departments. Furthermore, the definition is to be observed in terms of consolidation. Group companies that assume treasury operation tasks of industrial and trading companies or groups are not subordinated to the Stock Exchange Act if their financial activity is closely connected with the normal business of the group. On the other hand, "market makers" and "dealers acting on behalf of customers" are securities dealers within the sense of the Stock Exchange Act even if they are not mainly active in the financial sector (Art. 2 Para. 2 SESTO). Companies deemed by the Stock Exchange Act to be "market makers" or "dealers acting on behalf of 7 8 9 10 5

customers" that are not mainly active in the financial sector must therefore make their securities trading business a legally autonomous entity (Art. 19 Para. 2 SESTO). IV. Trading in a Professional Capacity (Art. 3 Para. 1-5 SESTO) The common requirement for all dealer categories is that the specific activity must be undertaken in a professional capacity. Trading in a professional capacity implies that securities trading constitutes both a separate and independent economic activity that is designed to achieve regular revenues (see also the definition in Art. 2 lit. b Commercial Register Ordinance CRO). This definition of trading in a professional capacity applies to the following dealer categories: "own-account dealers", "issuing houses", "derivative houses" and "market makers"; an additional criteria is applicable for "dealers acting on behalf of customers" (see Margin no. 49 below). 11 12 13 V. Public Offering (Art. 3 Para. 2-4, 6 and 7, Art. 4 SESTO) An offering is deemed to be public if it is addressed to an unlimited number of persons, i.e. is disseminated, in particular, through advertisements, prospectuses, circulars or electronic media (see also Art. 3 BO). In accordance with Art. 3 Para. 7 SESTO, however, offers from issuing houses, derivative houses and market makers are not deemed to be public if they are addressed exclusively to the following persons (see Art. 3 Para. 6 SESTO): 14 15 a. domestic and foreign banks and securities dealers or other state supervised companies; b. shareholders or partners with a significant interest in the debtor (note: i.e. in the company which is not a securities dealer within the sense of the Stock Exchange Act) and persons with business or family ties to them; c. institutional investors with a professional treasury. For example, pension funds, "communes", industrial or trading companies are deemed to be institutional investors with a professional treasury. Professional treasury management exists if the enterprise entrusts at least one person with proven professional qualifications and experience in the financial sector with the responsibility of managing the financial resources of the company on an on-going basis (cf. also FINMA-Circ. 08/3 "Public Deposits with Non-banks", Margin no. 25). 16 VI. Own Account Dealers (Art. 3 Para. 1 SESTO) Own account dealers trade, by definition, in securities in a professional capacity for their own account on a short-term basis (Art. 3 Para. 1 SESTO). 17 A. Trading in a Professional Capacity See Margin nos. 11-13 above 18 Individuals and legal entities who only administer their own assets do not trade in a professional capacity within the sense of this interpretation. 19 6

On the other hand, investment companies trade in a professional capacity because the administration of their investment assets constitutes a service which is provided for the benefit of their shareholders (and is charged to them). 20 B. Trading for Own Account The own-account dealer trades for own account if he settles securities transactions in his own name without order or instructions of third parties and he also bears the risks arising therefrom i.e. the profits therefrom accrue to him or he bears the losses. The exercising of clearing functions for securities transactions of third parties is also deemed to be trading for own account as long as the own-account dealer assumes the related risks and as long as third parties do not advance monies to him for the settlement of the securities transactions; otherwise he would become a dealer acting on behalf of customers (see Margin nos. 46 et seq. below). 21 C. Short-term Basis The meaning of "short-term basis" relates to the aim pursued with the purchase of securities, i.e. the active management thereof in order to achieve profits from changes in prices or interest rates within a short period (trading portfolio, cf. definition of trading activities in FINMA-Circ. 08/2 "Accounting Banks", Margin no. 236). Those who acquire securities for the purpose of financial investment or a share participation (e.g. holding companies) are not trading on a short-term basis. 22 D. Minimum Gross Volume of CHF 5 billion per annum Because the own-account dealer only trades in his own name and for his own account, he has, by definition, no customers. Thus, his subordination to the Stock Exchange Act is not for reasons of investor protection. Such subordination is justified only for the protection of the market. However, he is capable of endangering the market function only if he undertakes a significant volume of securities transactions. Thus, an own-account dealer is only subject to the Stock Exchange Act if he settles securities trades with a gross turnover of more than CHF 5 billion per annum. For the calculation of turnover, the prices paid or realized are to be applied to both spot and derivative transactions. 23 VII. Issuing Houses (Art. 3 Para. 2 SESTO) Issuing houses, by definition, professionally underwrite securities issued by third parties at a fixed rate or on commission and offer them to the public on the primary market (Art. 3 Para. 2 SESTO). 24 A. Trading in a Professional Capacity See Margin nos. 11-13 above 25 B. Public Offering See Margin nos. 14-16 above 26 Should securities be placed with less than 20 customers subsequent to a public offering (cf. Art. 4 SESTO), an activity as an issuing house is deemed to have taken place. On the other hand, those who place securities with less than 20 customers without a public offering shall not be deemed to be an issuing house. 27 28 7

C. Issuing Houses with Banking Status Art. 2a lit. c BO, which subordinated issuing houses to the Banking Act, was repealed through Art. 57 SESTO because issuing houses no longer fall under the Banking Act but are covered by the Stock Exchange Act. Issuing houses, which until now fell under the Banking Act in accordance with Art. 2a lit. c BO, do not necessarily lose their banking status as a result. As previously, the core activities may be continued as a bank in accordance with the provisions of the Banking Act, subject to the timely compliance with the licensing requirements set out in Art. 58 Para. 2 SESTO. Upon request, a change may also be made from subordination to the Banking Act to that of the Stock Exchange Act. However, for such cases, the requirements of the Stock Exchange Act imposed upon securities dealers must be complied with as of the date of change and a new license must be granted. Existing securities dealers without banking status, as allowed by the transitional rules set out in Art. 50 SESTA, may continue their core activities but are not allowed to expand their activities during the transitional period into the business area of an issuing house without a corresponding securities dealer license. 29 30 31 VIII. Derivative Houses (Art. 3 Para. 3 SESTO) Derivative houses, by definition, create derivatives on a professional basis and offer them to the public on the primary market for their own account or that of third parties (Art. 3 Para. 3 SESTO). 32 A. Trading in a Professional Capacity See Margin nos. 11-13 above 33 B. Public Offering See Margin nos. 14-16 above 34 Should derivatives be placed with less than 20 customers subsequent to a public offering (cf. Art. 4 SESTO), activity as a derivative house is nevertheless deemed to have occurred. On the other hand, those who place derivatives with less than 20 customers without a public offering shall not be deemed to be a derivative house. 35 36 C. Derivatives According to the definition in Art. 5 SESTO, derivatives are financial contracts whose prices are derived from assets such as shares, bonds, commodities and precious metals as well as reference rates such as currencies, interest rates and indexes. It is irrelevant whether these financial contracts are quoted or stock-exchange traded or traded over-the-counter. Conversely, the derivatives must be widely standardized, i.e. issued on a uniform basis and suitable for mass trading within the sense of Art. 4 SESTO. If individual parameters can be freely fixed, standardization does not exist, as a rule, within the sense of Art. 4 SESTO. 37 D. Spot Transactions In contrast, dealers who only conduct spot transactions in underlying values that in their own right do not represent securities within the sense of Art. 2 lit. a SESTA or Art. 4 SESTO (raw materials, precious metals, foreign currencies) do not fall under the Stock Exchange Act; in other words, dealers in raw materials, precious metals and foreign currencies whose activities are limited to such spot transactions are not subject to the 38 8

Stock Exchange Act. IX. Market Makers (Art. 3 Para. 4 SESTO) Market makers trade, by definition, securities in a professional capacity on a short-term basis for their own account and quote prices to the public for single securities either on a regular basis or upon request (Art. 3 Para. 4 SESTO). 39 A. Trading in a Professional Capacity See Margin nos. 11-13 above 40 B. Public Offering See Margin nos. 14-16 above 41 Quoting prices to the public, continuously or upon request constitutes by analogy a public offering within the sense of Art. 3 Para. 7 and Art. 4 SESTO. 42 C. Trading for Own Account See Margin no. 21 above 43 D. Short-term Basis See Margin no. 22 above 44 E. Legal Segregation of Securities Trading Market makers also fall under the law even if they are not principally active within the financial sector (Art. 2 Para. 2 SESTO, cf. fig. III). Companies whose finance departments satisfy the definition as market makers must thus legally segregate their securities trading business and the new company must apply for a license as securities dealer under the Stock Exchange Act (Art. 19 Para. 2 SESTO). 45 X. Dealers Trading on behalf of Customers (Art. 3 Para. 5 SESTO) Dealers acting on behalf of customers trade, by definition, in securities on a professional basis for the account of customers and 46 a. operate accounts for these customers for the settlement of securities transactions either themselves or with third parties; or b. themselves hold securities of these customers in safekeeping or in their own name with third parties (Art. 3 Para. 5 SESTO). In accordance with Art. 3 Para. 6 SESTO, the following are not deemed customers: 47 a. domestic and foreign banks and securities dealers or other enterprises subject to state supervision; b. shareholders or partners with a significant participation in the equity capital of the debtor (note: in a company that is not a securities dealer within the sense of the Stock Exchange Act) and persons with economic or family ties thereto; 9

c. institutional investors whose treasury is managed professionally. A. Trading on a Professional Basis See Margin nos. 11-13 above 48 A dealer acting on behalf of customers, in addition, trades on a professional basis if he directly or indirectly maintains accounts or acts as custodian of securities for more than 20 customers (cf. Art. 3a Para. 2 SESTO). 49 B. In Own Name and for the Account of Customers The dealer acting on behalf of customers acts, vis-à-vis third parties (banks, securities dealers, brokers, stock exchanges etc.), in his own name, but the economic risk underlying the securities trades executed by him or given by him to be executed, however, is carried by his customer. The dealer acting on behalf of customers also acts in his own name, in particular, whenever he maintains with third parties an account or securities deposit for each individual customer ("mirror accounts"). Dealers acting on behalf of customers are also those who, based upon related powers-of-attorney, use their own accounts or custodians to purchase and sell securities for customers (cf. also Margin no. 52). 50 C. Maintenance of Accounts or Custody of Securities These requirements are satisfied whenever the dealer acting on behalf of customers and his customer have concluded a custody agreement, an account-opening contract or a fiduciary contract and the dealer acting on behalf of customers thereby becomes the custodian or fiduciary owner of the related assets, or, based on the factual activities, an equivalent legal situation is given. Based upon these contractual or factual relations, the dealer acting on behalf of customers maintains accounts for the customer himself or with third parties or holds for the latter securities in safekeeping himself or with third parties. 51 D. Asset Managers or Investment Advisors not Subordinated to the Law Asset managers or investment advisors who manage the assets of third parties solely on the basis of powersof-attorney, i.e. who do not maintain accounts or securities deposits in their own name for the account of these third parties, do not fall under the Stock Exchange Act. However, should the asset manager or investment advisor additionally purchase or sell securities to his customers using his own account or securities deposit, he is a dealer acting on behalf of customers (see Margin no. 50 in fine). 52 E. Legal Segregation of Securities Trading Dealers acting on behalf of customers also fall under the law even if they are not principally active in the financial sector (Art. 2 Para. 2 SESTO, cf. fig. III). Companies that offer services of a dealer acting on behalf of customers through their finance departments must therefore legally segregate the securities trading business and the new company must apply for a license as securities dealer under the Stock Exchange Act (Art. 19 Para. 2 SESTO). 53 XI. Introducing Brokers (Art. 39 Para. 1 lit. a fig. 2 SESTO) The activity of the introducing broker encompasses in short the transmission of securities trades in Switzerland for foreign securities dealers. In doing so, the conditions set out in Art. 39 Para. 1 lit. a fig. 2 SESTO requiring a license for the activity as representative of a foreign securities dealer in Switzerland are satisfied. 54 10

The activities of introducing brokers in Switzerland are nevertheless strongly influenced by the links to the foreign securities dealer they represent so that differing rules are thus required regarding their subordination to the Stock Exchange Act. Thus, within the sense of Art. 39 Para. 1 lit. a fig. 2 SESTO, the activities below of a representative of a foreign securities dealer are addressed by the Stock Exchange Act. In these cases, the license is granted not to the representative in Switzerland, but to the foreign securities dealer. a. The foreign securities dealer employs persons in Switzerland who are fully integrated into his organization and who both transmit securities trades and forward orders for him. b. The foreign securities dealer possesses a subsidiary in Switzerland (which itself does not have the status of a domestic securities dealer) that carries the same or a similar corporate name and which both transmits securities trades and forwards orders for the foreign securities dealer. c. The foreign securities dealer concludes exclusive contracts with individuals or legal entities in Switzerland for the transmittal of securities trades. The representative in Switzerland acts as exclusive representative of the foreign securities dealer and is compensated for each trade (mostly retrocessions). d. The foreign securities dealer concludes non-exclusive contracts with individuals or legal entities in Switzerland for the transmittal of trades but authorizes the representative to use his corporate name. The representative is also compensated in this case for each trade. In contrast to the preceding structures of the relationship between the foreign securities dealer and the representative in Switzerland, the following constructions do not fall under Art. 39 Para. 1 lit. a fig. 2 SESTO: e. The foreign securities dealer concludes contracts with individuals or legal entities in Switzerland without a clause of exclusivity and does not authorize the intermediary to use his corporate name. f. No particular legal agreements within the sense of letters a-e exist between the intermediary in Switzerland and the foreign securities dealer to whom he transmits securities trades and forwards orders. 55 56 57 58 59 60 61 62 63 11

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