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Directive of the Securities Supervisory Board of 26 May 1997 under §§ 31, 32 Securities Trading Act – Excerpts

Translation and annotations by Thorsten Schlüter.

§ 1 Scope of application

This Directive illustrates the duties arising under §§ 31 and 32 ‘WpHG’. It applies to the securities services provided by the following securities services companies:

(a) credit institutions whose seat is within the country,

(b) branches of companies in the meaning of § 53 section 1 sentence 1 and § 53b section 1 sentence 1 of Banking Act in the version of 30 June 1993 (BGBl. I S.1082), amended through the Act of 28 September 1994 (BGBl. I S.1082), amended through the Act of 28 October 1994 (BGBl. I S.3210),

(c) branches of companies which are given an equal status or are exempted according to a
statutory instrument based on § 53c of the Banking Act.

This Directive also applies to companies having their seat in a foreign state and which offer securities services towards customers whose ordinary residence or whose business management is within the country, unless primary securities services including related and supplementary services are exclusively rendered within a foreign country.

Securities services in the meaning of this Directive are the transactions on a commission basis, dealings for one’s own account for the benefit of others (Fixed Price Dealings), and procurement dealings, insofar as they relate to securities and derivatives in the sense of § 2 section 1 or 2 ‘WpHG’. Additionally, transactions where securities services companies pass their customers’ orders on to other securities services companies are also covered, provided that the rendered services are not restricted to the mere forwarding of the orders.

According to § 37 section 1 ‘WpHG’ this Directive does not bind

(a) companies which carry out securities services exclusively for their parent firm or their subsidiaries in the sense of § 1 section 6 and 7 of the Banking Act or for other subsidiaries of of their parent firm;

(b) the Federal Debt Administration, one of its Special Funds, the Debt Administration of one of the Federal States, a member state of the European Communities or a signatories to the Treaty on the European Economic Area, the German Federal Bank as well aas the central banks of theother member states or signatories.

This Directive does not apply to dealings which are done between two securities services companies in the stock market (see § 37 section 2 ‘WpHG’).

§ 2 General information to be given before the rendering of the securities services

2.1. Information on the firm

On demand, the securities services firm has to provide the customer with information on the nature and scope of the offered securities services, especially on range of services available.

2.2. Information on costs and collateral securities (‘margins’)

Before the supply of the services, the securities services firm has to enable its customer to obtain information on the calculation, extent and type of the costs, and to realize, where necessary, the need for collateral securities (‘margins’), or the existence of other liabilities such as costs for statements of account or deposit account, and, explain them on demand. Particular attention must also be drawn to minimum fees.

If the securities services firm arranges with brokers or other involved companies the partial reimbursement of third party costs which are billed to the customer as incurred expenses (‘kick-back-agreements’), the securities services firm has to inform the customer about the obligation under the commission arrangement to pay back these sums. Insofar as this information has not already been given when the business relationship was established, it must be provided before the supply of the securities services at the latest. The customer is also to be told, in an appropriate maner, about changes in the way prices are calculated.

2.3. Verification

The securities services firm has to comply with the duties to inform as they are laid down in this section in such a way that its compliance can be verified trhough an inspection under § 35 section 1 or § 36 section 1 ‘WpHG’.

§ 3 Collection of customer details and provision of adequate information

At latest before the placing of the order, the securities services firm must, insofar as necessary, provide its customer with all appropriate information on the type of the envisaged dealings (‘disclosure’), i.e. it must explain to the customer especially the nature and risks of single forms investment.

Insofar as the securities services firm only executes orders (‘execution-only’), either through a separate distribution channel or generally, in an individual case or commonly, meaning that the firm’s disclosure is not followed by a recommendation taking into account its customer’s personal situation, the customer must be informed about this fact explicitly at latest before the customer’s order is executed. In these cases, the rules as set out in third part of this Directive apply subject to the provisions of 3.6.

3.1 Collection of information from the customer

The securities services firm is obliged, insofar as necessary, to ask its customer about his investment objectives, his knowledge of and experience in specific forms of investment and about his financial situation. In this context, it must be pointed out to the customer that the giving of this kind of information, which is on a voluntary basis, is in the customer’s own interest. The scope of the gathered information should be brought into line with the customer’s interests as well as to the type and extent of his envisaged dealings. No collection of information is necessary insofar as the securities services firm has already sufficent knowledge of the customer’s affairs. If, with a view to the provisons of this Directive, individual information on specific forms of investmens is not required and it is only collected within the ordinary course of the business relationship for the purpose of streamlining business procedures, the customer must be informed about this beforehand. It must be safeguarded that the given information is exclusively used for the purpose of disclosure and advice to the customer unless the customer consents to any other use.

The disclosure undertaken by the securities services firm are founded on the customer’s statements. Therefore, the customer’s attention is to be drawn to the fact that he should inform the securities services firm about any substantial change in his affairs that form the basis for his statements. As soon as a change in the situation underlying the customer’s statements is noticeable, the securities services firm must approach and ask the customer again. With regard to derivatives and options, statements by customers are, insofar as necessary, to be obtained again within a period of three years.

The securities services firm must, insofar as necessary, ask the customer with regard to the following points:

(a) Investment objectives
The securities services firm is to question the customer about his investment objectives. The customer is especially to be asked about his interest in long term or short term forms of investment (e.g. for the purpose of his old age provision or eduction), single or recurrent returns (profits) and about the extent of his willingness to take risks.

(b) Knowledge or experience
The securities services firm must also ask the customer of which forms of investments (e.g. debenture bonds, shares, investment certificates, derivatives) he has knowledge and in which of them he has already invested money in the past (extent, frequency and time).

(c) Financial affairs
The securities services firm must also ask the customer with reference to his financial affairs insofar as this is necessary with regard to his envisaged dealings, his investment objectives as well as his knowledge and experience. Insofar as the customer gives information on deposit accounts or derivatives dealings with other credit institutions, this information must also be taken into account by the firm.

With regard to the scope of these questions, the securities services firm is to consider whether the envisaged dealings are to be paid for by the customers’s own means or through loans and what kind of risks concerning loss, additional payments or other risks exist with regard to these transactions. Customers who use their own existing funds to invest in securities of issuers having a particularly high credit standing such as the bonds or special funds of the Federal Republic of Germany or the Republic’s Federal States or equivalent bonds of member states of the European Economic Area, which are members of the Organization for Economic Cooperation and Development (OECD) need not make any statements as to their financial situation.

3.2. Extent of the information 2

At latest before the acceptance of the customer’s order, the customer is, insofar as necessary and with regard to his statements, to be informed about the nature and risks of the forms of investment as well as other relevant facts, for example about the possibility of putting a limit on an order, especially in markets of low liquidity and a minimum number of orders. This can be done through standardized brochures.

The customer must be told that he has the right to give instructions concerning the execution of his order, especially with regard to at which stock exchange the transaction is to be completed.

On demand, and insofar as known to the securities services firm, the firm must inform the customer at which stock exchange or in which markets the order is to be executed and which mediators, traders, market makers, depositary banks or clearing organizations are involved in the transaction. If there are specific risks concerning the involved parties or with regard to particular markets, especially with a view to insolvency or transactions, this must be disclosed to the customer by the securities services firm. This particularly applies to cross border securities services.

The information must be correct, complete and unequivocal as well as structured and is to be presented in an appropriate manner. With regard to the content and form of the information, the securities services firm shall take into account the customer’s knowledge of and experience in the relevant form of investment. The information is to be repeated if this appears to be necessary, for example, if the customer does only show a limited trading activity.

If the customer’s statements are used to place the customer into a specific risk category and he is told about this, then this categorization is to be considered when his orders are being executed by the securities services firm. Additionally, the customer must be told about the criteria which are used for the categorization.

If, on consultation, the customer wishes to have one specific order executed which does not fall into his risk category, the order can be carried out if it is ensured that the customer has received the necessary information before the execution of his order.

3.2.1. Information concerning debenture bonds

Information concerning the risks of debenture bonds should especially include information on the revenue, the credit rating, and, if necessary, the country risk, the price and interest rate risk, the insolvency risk, the currency risk as well as the termination and drawing rights risk.

3.2.2. Information concerning shares

Information regarding to shares should especially include information on the revenue (dividend), the price risk, the credit rating, the insolvency risk, the trade cycle risks as well as the currency risk.

Information on risks with regard to shares which are not traded at a national or foreign stock exchange (e.g. US-American ‘Penny Stocks’) should contain information on the market (especially on the market liquitity) and the specific risk of loss of this form of investment as well as on the origin of the price statements, on the difference between bid and book price (‘spread’) and on the fees charged by the securities services companies involved in the execution of the order.

3.2.3. Information concerning investment certificates

Information on risks of investment certificates should include information on the composition of the funds, the investment strategy, the utilization of the revenue, the issuing price (issuing top up fee etc.), the price risk and the assessment procedures.

3.2.4. Information on derivatives and options warrants

Information on the risks of derivatives must especially contain information on the intrinsic value, the economic context and function of the products (particularly the importance of duration of premium, the type of execution, the leverage effect, the liquidity, the volatility of the markets and, if necessary, the standstill risk), the revenue, the price risk, the currency risk and the credit risk.

If the customer is requested to bring a collateral security (‘margin’) for his envisaged transactions, he, on demand, must be informed in writing about the methods of how the collateral security is being calculated. In this respect, it must be disclosed to him which involved party demands the collateral security and in what form this security can be given (e.g. money, securities) and whether the securities services firm asks for more securities than the stock exchange itself. Additionally, the customer must be told, if necessary, about his obligation to produce further means of collateral securities (‘additional payments’) where necessary. Furthermore, attention should be drawn to the possibility of the passing on of collateral securities to the material stock exchange or clearing organization. The securities services firm must also inform the customer in which circumstances he has the right to even up or liquidate a position. In this context, the customer is also especially to be told at which intervals the requirements for collateral securities are revised by the securities services firm and what time limit the customer is granted to fulfill his obligation to present additional payments or to liquidate his position.

Moreover, the securities services firm has to notify the customer in which forms the given collateral securities are usually administered and whether the customer is, provided that the market situation allows it, entitled to reduce a surplus of collateral securities.

3.3 Agency

If a customer is represented by an agent, the agent’s knowledge of and experience in the form of investment in question is relevant in respect of the obligation to collect information and also with regard to the obligation to give appropriate information.

3.4 Procedure in cases where customers do not give information

The securities services firm must undertake serious efforts to obtain the relevant information from the customer. Where a customer excercises his right to refrain from giving information, this must be documented by the securities services firm. However, the possibility of not giving any information must not be part of a questionnaire used by the firm. In case a customer does not provide the requested information to the firm, the customer’s specific order can be executed if it is ensured that the customer has been offered to to get information on the nature and risks of the forms of investments before his order is being accepted.

3.5 Procedure where the customers are unattainable

Where the customer is unattainable for the purpose of the provision of information to him and where the immediate execution of the order is obviously within his interests, it is sufficient if the relevant pieces of information are given to him without undue delay after the execution of his order.

3.6 Provisions for securities services companies which only execute their customers’ orders (‘execution-only’)

If a securities services firm only executes orders (‘execution-only’), possibly through a separate distribution channel, individually or typically, it must inform its customer about this fact at latest before the acceptance of an order by him. The information that is to be given to the customer must be brought in line with his knowledge of and experience in his envisaged forms of investment. Insofar as the firm provides the customer with information which exceeds the type of information regulated in this section, such as market reports, charts or analysis, it must make it clear to its customer that this information does not amount to the supply of investment advice but is only meant to facilitate the customer’s own investment decision. At latest before the acceptance of the order, the securities services firm typically has only to ask its customer about his knowledge and experience. Statements by the customer concerning his investment objectives and financial affairs are only then required insofar as the securities services firm grants the customer a loan for the execution of his envisaged dealings or requests him to present collateral securities. In other respects, the rules of section 3 apply.

4.3 Execution in the customer’s best interest

Orders must be executed in the customer’s best interest. In this respect, those interests of the customer which are noticable to the securities services firm are material. Orders, which are obviously not in the interest of the customer, must only then be carried out by the securities services firm if it explains to the customer the risks of these orders before their execution. Insofar as there are no specific directions given by the customer, the securities services firm has, with the standard of care usually exercised in the ordinary course of business, to undertake to obtain with a view to the costs the most favourable price on the most favourable market as it is defined by the provisions of § 10 Stock Exchange Act. If necessary, the securities services firm must also inquire about the liquidity of the markets (e.g. so-called ‘emerging markets’).

In case the securities services firm uses a third party for the execution of the order, it must exercise due care when selecting this third party in order to ensure the best excecution of the order.

The splitting up of one single order into several partial orders is only then allowed if this is economically feasible as well as in the customer’s interest considering the thereby created extra costs. However, this does not apply where the customer explicitly requests the splitting up of the order.

With regard to orders which are passed on via an order routing systems of the respective stock exchange, it must be ensured that there are no delays caused by the forwarding of these orders. If delays cannot be avoided, other ways of communication (e.g. telephone or telefax) are to be used.

Where the securities services firm agrees with the customer on a fixed price for a single transaction (dealing for one’s own account or, as the case maybe, fixed price dealings), it must inform the customer about the fact that this agreement leads to the conclusion of a contract of sale. The price with regard to fixed price dealings is to calculated by periodical reference to the market price.

5. Not permitted dealings

5.1 Not permitted recommendations

The securities services firm is not permitted to recommend to the customer a transaction of which it assumes or should reasonably assume that is disadvantageous to the customer’s interests. Especially it must not recommend to the customer transactions which are not in line with his interests.

The customer’s interest is especially impaired if the recommendations result in a unreasonably high number of transactions in his current or deposit account leading to costs which are unreasonably high in proportion to the capital employed and the profit gained.

The securities services firm is also not permitted to recommend to the customer transactions in order to influence the price with a view to dealings in the firm’s own account or in the account of one of the firm’s associated companies in the sense of § 15 Company Act. Especially misleading influence on the forming of the customer’s opinion or deceit of the customer (e.g. through fictitious transactions or arranged dealings) are not allowed.

5.2 Not permitted transactions on the firm’s own behalf which are detrimental to the customer

The securities services firm is not allowed to undertake transactions on its own behalf on the basis of the knowledge of or expectation of a customer’s order and which can result in disadvantages to the customer (prohibition of front, parallel or counter running).

It is especially not permitted to acquire securities or derivatives with regard to a future recommendation in order to sell them with a profit after the recommendation. The same applies to sales. Where the publication of written recommendations for customers or research results of the securities services firm or one of its associated companies are impending, no tradings in the affected securities or derivatives on one’s own behalf are to be carried out before the customers have had reasonable time to react. Such a reasonable time to react can usually be assumed if, at the time of the written recommendation to the customer, the information has been made known to the interested public (so-called ‘Bereichsöffentlichkeit’) by publication of the information through an electronic information processing system that is recognized by the stock exchanges and commonly used by credit institutions, listed companies and insurance companies. There are exceptions to this rule in the following situations:

  • there is obviously no substantial impact on the price or rate to be expected;
  • the transactions are carried out as part of a ‘market maker’ activity;
  • the transaction is made in order to execute a customer’s order and where the securities services firm neither acts as an adviser nor as a portfolio manager;
  • the transaction is made in order to lay in a stock with a view to be able to accept orders after a publication and, thus, there is no influence on the price that is detrimental to the customer;
  • the publication includes a reference to possible transactions on the firm’s own behalf.

The provisons of the number 5.1 and 5.2 do not apply insofar as the securities services firm has implemented sufficient organizational messures to ensure that such conflicts of interest are avoided.

  1. Full name in German: Richtlinie des Bundesaufsichtsamtes für den Wertpapierhandel gemäß § 35 Abs. 2 des Gesetzes über den Wertpapierhandel (WpHG) zur Konkretisierung der §§ 31 und 32 WpHG für das Kommissions-, Festpreis- und Vermittlungsgeschäft der Kreditinstitute’.
  2. The German term used in the Directive is ‘Aufklärung’ which could also be translated as ‘disclosure’. However, the phrase ‘disclosure’ appears to have a slightly different meaning in English in the context of financial services in the UK. In the UK., the word ‘disclosure’ usually seems to characterize a situation where one party is obliged to disclose facts that are (more or less) exclusively known to him or her to another party. In contrast to this, in the German Directive, the term ‘Aufklärung’ is meant to describe the duties of a securities services firm to explain to a (not very experienced) customer facts that are of common knowledge to professionals in the area of financial services.

Translation and annotations © 1998 Thorsten Schlüter. HTML edition © 1998 Gerhard Dannemann. This document may be copied for teaching purposes.

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