Financial Responsibility Rules for Broker-Dealers, 51823-51907 [2013-18734]
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Vol. 78
Wednesday,
No. 162
August 21, 2013
Part II
Securities and Exchange Commission
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17 CFR Part 240
Financial Responsibility Rules for Broker-Dealers; Final Rule
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Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 / Rules and Regulations
SECURITIES AND EXCHANGE
COMMISSION
17 CFR Part 240
[Release No. 34–70072; File No. S7–08–07]
RIN 3235–AJ85
Financial Responsibility Rules for
Broker-Dealers
Securities and Exchange
Commission.
ACTION: Final rule.
AGENCY:
The Securities and Exchange
Commission (‘‘Commission’’) is
adopting amendments to the net capital,
customer protection, books and records,
and notification rules for broker-dealers
promulgated under the Securities
Exchange Act of 1934 (‘‘Exchange Act’’).
These amendments are designed to
address several areas of concern
regarding the financial responsibility
requirements for broker-dealers. The
amendments also update certain
financial responsibility requirements
and make certain technical
amendments.
SUMMARY:
DATES:
Effective Date: October 21, 2013.
FOR FURTHER INFORMATION CONTACT:
Michael A. Macchiaroli, Associate
Director, at (202) 551–5525; Thomas K.
McGowan, Deputy Associate Director, at
(202) 551–5521; Randall Roy, Assistant
Director, at (202) 551–5522; Raymond
Lombardo, Branch Chief, at (202) 551–
5755; Sheila Dombal Swartz, Special
Counsel, (202) 551–5545; Carrie A.
O’Brien, Special Counsel, (202) 551–
5640; or Kimberly N. Chehardy,
Attorney Advisor, (202) 551–5791;
Division of Trading and Markets,
Securities and Exchange Commission,
100 F Street NE., Washington, DC
20549–7010.
SUPPLEMENTARY INFORMATION:
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Table of Contents
I. Background
II. Amendments
A. Amendments to the Customer
Protection Rule
1. Background
2. Proprietary Accounts of Broker-Dealers
i. Definition of ‘‘PAB Account’’ under Rule
15c3–3(a)(16)
ii. Written Permission To Use PAB
Account Securities
iii. PAB Reserve Bank Accounts
iv. Other PAB Issues Raised by
Commenters
v. Amendment to Rule 15c3–1(c)(2)(iv)(E)
Related to PAB Accounts
3. Banks Where Special Reserve Deposits
May Be Held
4. Allocation of Customers’ Fully Paid and
Excess Margin Securities to Short
Positions
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5. Importation of Rule 15c3–2
Requirements Into Rule 15c3–3 and
Treatment of Free Credit Balances
i. Importation of Rule 15c3–2
ii. Treatment of Free Credit Balances
a. Treatment of Free Credit Balances
Outside of a Sweep Program
b. Treatment of Free Credit Balances in a
Sweep Program
6. ‘‘Proprietary Accounts’’ Under the
Commodity Exchange Act
7. Expansion of the Definition of
‘‘Qualified Securities’’ To Include
Certain Money Market Funds
B. Holding Futures Positions in a
Securities Portfolio Margin Account
C. Amendments With Respect to Securities
Lending and Borrowing and Repurchase/
Reverse Repurchase Transactions
D. Documentation of Risk Management
Procedures
E. Amendments to the Net Capital Rule
1. Requirement To Deduct From Net Worth
Certain Liabilities or Expenses Assumed
by Third Parties
2. Requirement To Subtract From Net
Worth Certain Non-Permanent Capital
Contributions
3. Requirement To Deduct the Amount by
Which a Fidelity Bond Deductible
Exceeds SRO Limits
4. Broker-Dealer Solvency Requirement
5. Amendment to Rule Governing Orders
Restricting Withdrawal of Capital From a
Broker-Dealer
6. Adjusted Net Capital Requirements
i. Amendment to Appendix A of Rule
15c3–1
ii. Money Market Funds
a. Clarification
b. Proposed Haircut Reduction From 2% to
1%
c. Aggregate Debit Items Charge
F. Technical Amendments
III. Responses to Specific Requests for
Comment
IV. Paperwork Reduction Act
A. Summary of the Collection of
Information Requirements
B. Use of Information
C. Respondents
D. Total Annual Reporting and
Recordkeeping Burden
1. Securities Lending Agreements and
Disclosures
2. DEA Permission To Withdraw Capital
Within One Year of Contribution
3. Written Subordination Agreements
Under Rule 15c3–3
4. PAB Reserve Bank Account
Recordkeeping Requirements
5. Adequate Procedures Required Under
Paragraph (j)(1) of Rule 15c3–3
6. Treatment of Free Credit Balances
7. Documentation of Risk Management
Procedures
8. Notice Requirements
E. Collection of Information Is Mandatory
F. Confidentiality
G. Record Retention Period
V. Economic Analysis
A. Introduction
B. Economic Baseline
C. Discussion of General Comments
Received
D. Economic Analysis of the Amendments
and Alternatives
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1. Amendments to the Customer Protection
Rule
i. Economic Analysis
a. Proprietary Accounts of Broker-Dealers
(I). Summary of Amendments
(II). Baseline and Incremental Economic
Effects
(III). Alternatives
(IV). Compliance Cost Estimates
b. Banks Where Special Reserve Deposits
May Be Held
(I). Summary of Amendments
(II). Baseline and Incremental Economic
Effects
(III). Alternatives
(IV). Compliance Cost Estimates
c. Allocation of Customers’ Fully Paid and
Excess Margin Securities to Short
Positions
d. Importation of Rule 15c3–2
Requirements Into Rule 15c3–3
e. Treatment of Free Credit Balances
(I). Summary of Amendments
(II). Baseline and Incremental Economic
Effects
(III). Alternatives
(IV). Compliance Cost Estimates
f. ‘‘Proprietary Accounts’’ Under the
Commodity Exchange Act
ii. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
2. Holding Futures Positions in a Securities
Portfolio Margining Account
i. Economic Analysis
ii. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
3. Amendments With Respect to Securities
Lending and Borrowing and Repurchase/
Reverse Repurchase Transactions
i. Economic Analysis
ii. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
4. Documentation of Risk Management
Procedures
i. Economic Analysis
ii. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
5. Amendments to the Net Capital Rule
i. Economic Analysis
a. Requirement To Deduct From Net Worth
Certain Liabilities or Expenses Assumed
By Third Parties
(I). Summary of Amendments
(II). Baseline and Incremental Economic
Effects
(III). Alternatives
b. Requirement To Subtract From Net
Worth Certain Non-Permanent Capital
Contributions
(I). Summary of Amendments
(II). Baseline and Incremental Economic
Effects
(III). Alternatives
c. Requirement To Deduct the Amount by
Which a Fidelity Bond Exceeds SRO
Limits
d. Broker-Dealer Solvency Requirement
e. Amendment to Rule Governing
Restrictions of Withdrawals of Capital
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f. Amendment to Rule 15c3–1 Appendix A
ii. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
VI. Final Regulatory Flexibility Analysis
A. General Issues Raised by Public
Comments
B. Amendments to the Customer Protection
Rule
1. Need for and Objectives of the Rule
Amendments
2. Significant Issues Raised by Public
Comment
3. Small Entities Subject to the Rules
4. Reporting, Recordkeeping, and Other
Compliance Requirements
5. Agency Action To Minimize Effect on
Small Entities
D. Securities Lending and Borrowing and
Repurchase/Reverse Repurchase
Transactions
1. Need for and Objectives of the
Amendments
2. Significant Issues Raised by the Public
Comments
3. Small Entities Subject to the Rule
4. Reporting, Recordkeeping, and Other
Compliance Requirements
5. Agency Action To Minimize Effect on
Small Entities
E. Documentation of Risk Management
Procedures
1. Need for and Objectives of the
Amendments
2. Significant Issues Raised by Public
Comments
3. Small Entities Subject to the Rule
4. Reporting, Recordkeeping, and Other
Compliance Requirements
5. Agency Action To Minimize Effect on
Small Entities
F. Amendments to the Net Capital Rule
1. Need for and Objectives of the
Amendments
2. Significant Issues Raised by Public
Comments
3. Small Entities Subject to the Rule
4. Reporting, Recordkeeping, and Other
Compliance Requirements
5. Agency Action to Minimize Effect on
Small Entities
VII. Statutory Authority
I. Background
The Commission is adopting
amendments to the broker-dealer net
capital rule (Rule 15c3–1),1 customer
protection rule (Rule 15c3–3),2 books
and records rules (Rules 17a–3 and 17a–
4), and notification rule (Rule 17a–11).3
The Commission proposed these rule
changes on March 9, 2007.4 The
1 17
CFR 240.15c3–1.
CFR 240.15c3–3.
3 17 CFR 240.17a–3; 17 CFR 240.17a–4; and 17
CFR 240.17a–11.
4 See Amendments to Financial Responsibility
Rules for Broker-Dealers, Exchange Act Release No.
55431 (Mar. 9, 2007), 72 FR 12862 (Mar. 19, 2007)
(‘‘Amendments to Financial Responsibility Rules’’).
As part of this release, the Commission also
requested comment on three additional matters:
reducing the Rule 17a–11 (17 CFR 240.17a–11)
early warning level for broker-dealers that carry
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2 17
Commission re-opened the public
comment period on May 3, 2012.5 The
Commission received a total of 97
comment letters on the proposed
amendments.6 Sixty comment letters
over $10 billion in debits; harmonization of the net
capital deductions required by paragraph
(c)(2)(iv)(B) of Rule 15c3–1 for securities lending
and borrowing transactions with the deductions
required under paragraph (c)(2)(iv)(F) for securities
repurchase and reverse repurchase agreement
transactions (17 CFR 240 240.15c3–1(c)(2)(iv)(B)
and (c)(2)(iv)(F), respectively); and accounting for
third-party liens on customer securities held at a
broker-dealer. As discussed below in section III. of
this release, the Commission received comments in
response to these requests but has determined to
defer consideration of actions with respect to these
specific matters at this time.
5 Amendments to Financial Responsibility Rules
for Broker-Dealers, Exchange Act Release No. 66910
(May 3, 2012), 77 FR 27150 (May 9, 2012).
6 Comments on the amendments are available at
https://www.sec.gov/comments/s7-08-07/
s70807.shtml. See also letter dated April 22, 2007
from Peter G. Crane, President, Crane Data LLC
(‘‘Crane Data Letter’’); letter dated April 22, 2007
from David Michael Bishop (‘‘Bishop Letter’’); letter
dated April 27, 2007 from Ted Beer, Broker/Dealer
Principal (‘‘Beer Letter’’); letter dated April 28, 2007
from Ted Beer, Broker/Dealer Principal (‘‘Beer 2
Letter’’); letter dated April 29, 2007 from R.A.
Lowenstein, FinOps Compliance Consultant
(‘‘Lowenstein Letter’’); letter dated April 29, 2007
from G. Kirk Ellis (‘‘Ellis Letter’’); letter dated May
1, 2007 from Stuart J. Kaswell and David J. Harris,
Dechert LLP on behalf of Federated Investors
(‘‘Federated Letter’’); letter dated May 2, 2007 from
Daniel R. Levene, President, small NASD brokerdealer (‘‘Levene Letter’’); letter dated May 4, 2007
from Gerard J. Quinn, Vice President and Associate
General Counsel, SIFMA (‘‘SIFMA Letter’’); letter
dated May 7, 2007 from Michael Bell, President and
CEO, Curian Clearing, LLC (‘‘Curian Clearing
Letter’’); letter dated May 10, 2007 from Richard B.
Franz II, Senior Vice-President, Treasurer and Chief
Financial Officer, Raymond James & Associates
(‘‘Raymond James Letter’’); letter dated May 16,
2007 from Steven R. Gerbel, Chicago Capital
Management LP (‘‘Chicago Capital Letter’’); letter
dated May 17, 2007 from Jeffrey L. Kiss, Principal,
PackerKiss Securities, Inc. (‘‘PackerKiss Letter’’);
letter dated May 17, 2007 from Josephine Wang,
General Counsel, SIPC (‘‘SIPC Letter’’); letter dated
May 18, 2007 from Kimberly Taylor, Managing
Director and Clearing House President, Chicago
Mercantile Exchange Inc. (‘‘CME Letter’’); letter
dated May 18, 2007 from Diane V. Esheleman,
Executive Vice President, JP Morgan Chase Bank,
N.A. (‘‘JP Morgan Letter’’); letter dated May 21, 2007
from Faith Colish, Carter Ledyard Milburn LLP
(‘‘Colish Letter’’); letter dated May 23, 2007 from
Charles R. Manzoni, Jr., General Counsel, FAF
Advisors, Inc. (‘‘FAF Advisors Letter’’); letter dated
May 27, 2007 from Joyce Glenn (‘‘Glenn Letter’’);
letter dated May 28, 2007 from William Bare (‘‘Bare
Letter’’); letter dated May 29, 2007 from Robert
Keenan, CEO, St. Bernard Financial Services, Inc.
(‘‘St. Bernard Financial Services Letter’’); letter
dated May 31, 2007 from John C. Melton, Sr.,
Executive Vice President, Coastal Securities
(‘‘Coastal Letter’’); letter dated June 3, 2007 from
Anonymous (‘‘Anonymous Letter’’); letter dated
June 5, 2007 from Kelly S. McEntire, Executor,
Retired State Administrator/Executor of Janus
Capital Investments (‘‘McEntire Letter’’); letter dated
June 13, 2007 from Bruce Bent, Chairman, The
Reserve (‘‘Reserve Letter’’); letter dated June 14,
2007 from Amal El Said, Accounting and
Regulatory, Abbey National (‘‘Abbey National
Letter’’); letter dated June 14, 2007 from Frank A.
Perrone, Senior Vice President, Brown Brothers
Harriman & Co. (‘‘Brown Brothers Harriman
51825
Letter’’); letter dated June 15, 2007 from James J.
Angel, Ph.D., CFA, Associate Professor of Finance,
McDonough School of Business, Georgetown
University (‘‘Angel Letter’’); letter dated June 15,
2007 from Matthew M. Hughey, Chief Financial
Officer, First Clearing, LLC (‘‘First Clearing Letter’’);
letter dated June 15, 2007 from Marshall J.
Levinson, Senior Managing Director, Bear, Stearns
& Co. Inc., Chair, SIFMA Capital Committee
(‘‘SIFMA 2 Letter’’); letter dated June 15, 2007 from
Christopher Williams, Director and Senior Counsel,
and Barbara Brooks, Principal Financial Officer,
Dresdner Kleinwort (‘‘Dresdner Kleinwort Letter’’);
letter dated June 18, 2007 from Michael Dworkin
(‘‘Dworkin Letter’’); letter dated June 18, 2007 from
Keith Weller, Executive Director and Senior
Associate General Counsel, UBS Global Asset
Management (Americas) Inc. (‘‘UBS Letter’’); letter
dated June 18, 2007 from Marcelo Riffaud,
Managing Director, Legal Department, Deutsche
Bank Securities Inc. (‘‘Deutsche Bank Securities
Letter’’); letter dated June 18, 2007 from Jill Gross
and Rahat Sarmast, Pace Investor Rights Project
(‘‘Pace Letter’’); letter dated June 18, 2007 from
Robert E. Putney, III, Director and Senior Counsel,
BlackRock, Inc. (‘‘BlackRock Letter’’); letter dated
June 18, 2007 from James S. Keller, Chief
Regulatory, the PNC Financial Services Group, Inc.
(‘‘PNC Letter’’); letter dated June 18, 2007 from
Sarah A. Miller, General Counsel, American ABA
Securities Association (‘‘ABASA Letter’’); letter
dated June 18, 2007 from David Hirschmann,
Executive Vice President, National Chamber
Foundation of U.S. Chamber of Commerce
(‘‘National Chamber Foundation Letter’’); letter
dated June 18, 2007 from Michael W. Fields, Chief
Fixed Income Officers, American Beacon Advisors
(‘‘American Beacon Letter’’); letter dated June 18,
2007 from David Lonergan, Head of U.S. Cash
Management, Barclays Global Investors (‘‘Barclays
Letter’’); letter dated June 18, 2007 from Howard
Spindel, Senior Managing Directors, Integrated
Management Solutions (‘‘Integrated Management
Letter’’); letter dated June 18, 2007 from Jane G.
Heinrichs, Associate Counsel, Investment Company
Institute (‘‘ICI Letter’’); letter dated June 18, 2007
from Jeffrey P. Neubert, CEO, Clearinghouse
Association L.L.C. (‘‘Clearing House Letter’’); letter
dated June 19, 2007 from James T. McHale,
Associate General Counsel, E*Trade Brokerage
Holdings, Inc. (‘‘E*Trade Letter’’); letter dated June
25, 2007 from Cliff Verron, Managing Director,
Deputy Chief Financial Officers and John Ramsay,
Managing Director, Deputy General Counsel,
Citigroup Global Markets Inc. (‘‘Citigroup Letter’’);
letter dated June 25, 2007 from AMEX, CBOE, ISE,
OCC, and NYSE/ARCA (‘‘AMEX Letter’’); letter
dated July 3, 2007 from Keith F. Higgins, Chair,
Committee on Federal Regulation of Securities,
American Bar Association (‘‘American Bar
Association Letter’’); letter dated July 23, 2007 from
Charles S. Morrison, Senior Vice President and
Money Market Group Leader, Fidelity Management
& Research Company, and John Valenti, Vice
President, National Financial Securities LLC
(‘‘Fidelity/NFS Letter’’); letter dated August 6, 2007
from Stuart Kaswell, Dechert LLP, on behalf of
Federated Investors, Inc. (‘‘Federated 2 Letter’’);
letter dated October 9, 2007 from Stuart Kaswell,
Dechert LLP on behalf of Federated Investors, Inc.
(‘‘Federated 3 Letter’’); letter dated November 16,
2007 from Marshall J. Levinson, Chair, Capital
Committee, SIFMA (‘‘SIFMA 3 Letter’’); letter dated
January 7, 2008 from Stuart J. Kaswell, Dechert LLP,
on behalf of Federated Investors, Inc. (‘‘Federated
4 Letter’’); letter dated August 7, 2008 from Stuart
J. Kaswell, Bryan Cave LLP, on behalf of Federated
Investors, Inc. (‘‘Federated 5 Letter’’); letter dated
November 10, 2008 from Lee A. Pickard, Pickard &
Djinis LLP on behalf of Federated Investors
(‘‘Federated 6 Letter’’); letter dated November 25,
2008 from Lee A. Pickard, Pickard & Djinis LLP on
behalf of Federated Investors (‘‘Federated 7 Letter’’);
Continued
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Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 / Rules and Regulations
emcdonald on DSK67QTVN1PROD with RULES2
were received prior to the re-opening of
the comment period, and 37 were
received after it. The Commission
carefully considered all of the comment
letter dated December 18, 2008 from Lee A. Pickard,
Pickard & Djinis LLP on behalf of Federated
Investors (‘‘Federated 8 Letter’’); letter dated July
28, 2009 from Richard J. McDonald, Chief
Regulatory Counsel, Susquehanna International
Group LLP (‘‘SIG Letter’’); letter dated June 8, 2010
from The Honorable Gregory W. Meeks (‘‘Meeks
Letter’’); letter dated October 14, 2011 from The
Honorable Gregory W. Meeks (‘‘Meeks 2 Letter’’);
letter dated May 5, 2012 from Edward P. Cernocky
(‘‘Cernocky Letter’’); letter dated May 11, 2012 from
Chris Barnard (‘‘Barnard Letter’’); letter dated May
15, 2012 from Helen M. Saarinen (‘‘Saarinen
Letter’’); letter dated May 18, 2012 from Laura H.
Hearne (‘‘Hearne Letter’’); letter dated May 24, 2012
from Dick Fuld (‘‘Fuld Letter’’); letter dated May 30,
2012 from Bruce J. Womack (‘‘Womack Letter’’);
letter dated June 1, 2012 from Lee A. Pickard,
Pickard & Djinis LLP, on behalf of Federated
Investors (‘‘Federated 9 Letter’’); letter dated June 4,
2012 from Michael Scillia, Director, National
Investment Banking Association (‘‘NIBA Letter’’);
letter dated June 7, 2012 from Anthony Fitzgerald
(‘‘Fitzgerald Letter’’); letter dated June 7, 2012 from
Tom Vincent, Senior V.P., Corporate Governance
and Wealth Management Compliance, BOK
Financial Corporation (‘‘BOK Letter’’); letter dated
June 8, 2012 from Denise Dolphin (‘‘Dolphin
Letter’’); letter dated June 8, 2012 from Colin W.
McKechnie, Managing Director, JP Morgan Chase
Bank, N. A (‘‘JP Morgan 2 Letter’’); letter dated June
8, 2012 from William A. Jacobson, Associate
Clinical Professor, Cornell Law School, and
Director, Cornell Securities Law Clinic, Ithaca, New
York (‘‘Cornell Letter’’); letter dated June 8, 2012
from Ryan K. Bakhtiari, Aidikoff, Uhl & Bakhtiari,
on behalf of the Public Investors Arbitration Bar
Association (‘‘PIABA Letter’’); letter dated June 8,
2012 from Kenneth E. Bentsen, Jr., Executive Vice
President, Public Policy and Advocacy, SIFMA
(‘‘SIFMA 4 Letter’’); letter dated June 8, 2012 from
Sarah A. Miller, Chief Executive Officer, Institute of
International Bankers (‘‘IIB Letter’’); letter dated
June 8, 2012 from James T. McHale, Global Head
of Compliance, E*TRADE Financial Corporation
(‘‘E*Trade 2 Letter’’); letter dated June 11, 2012
from Steve M. Brewer, Sr., ASG Securities, LLC,
Houston, Texas (‘‘ASG Securities Letter’’); letter
dated June 25, 2012 from Gene L. Finn (‘‘Finn
Letter’’); letter dated June 26, 2012 from Cindy
Walsh (‘‘Walsh Letter’’); letter dated July 12, 2012
from Michael Scillia, Director, National Investment
Banking Association (‘‘NIBA 2 Letter’’); letter dated
July 18, 2012 from Gene L. Finn (‘‘Finn 2 Letter’’);
letter dated July 30, 2012 from David Waddell
(‘‘Waddell Letter’’); letter dated August 6, 2012 from
Gene Finn (‘‘Finn 3 Letter’’); letter dated August 15,
2012 from Echeal R. Sigan (‘‘Sigan Letter’’); letter
dated August 26, 2012 from Mark Irwin (‘‘Irwin
Letter’’); letter dated September 17, 2012 from Gene
L. Finn (‘‘Finn 4 Letter’’); letter dated September 27,
2012 from Jeff S. Clark (‘‘Clark Letter’’); letter dated
September 28, 2012 from Robert LaPlante, M.P.A.
(‘‘LaPlante Letter’’); letter dated October 19, 2012
from Rick Louderbough (‘‘Louderbough Letter’’);
letter dated October 24, 2012 from Paul L. Matecki,
Senior Vice President, General Counsel, Raymond
James Financial, Inc. (‘‘Raymond James 2 Letter’’);
letter dated October 25, 2012 from Eric Gamble,
Ph.D. (‘‘Gamble Letter’’); letter dated November 1,
2012 from Percy R. Moorman, Esq. (‘‘Moorman
Letter’’); letter dated January 4, 2013 from Marquis
Wilkins (‘‘Wilkins Letter’’); letter dated January 5,
2013 from Anonymous SEC Fan (‘‘Anonymous SEC
Letter’’); letter dated January 24, 2013 from Robert
Fournier (‘‘Fournier Letter’’); and letter dated
January 28, 2013 from Scott E. Shjefte (‘‘Shjefte
Letter’’). Comment letters and specific comments
outside the scope of this rulemaking are not
addressed in this release.
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letters, and as discussed in detail below,
modified the amendments in certain
respects in light of the comments
received. In addition, the Commission
has determined to defer consideration of
action at this time with respect to
certain of the proposed amendments.
II. Amendments
A. Amendments to the Customer
Protection Rule
1. Background
The Commission adopted Rule 15c3–
3 in 1972 in response to a congressional
directive to strengthen the financial
responsibility requirements for brokerdealers that hold securities and cash for
customers.7 In particular, Rule 15c3–3 is
designed ‘‘to give more specific
protection to customer funds and
securities, in effect forbidding brokers
and dealers from using customer assets
to finance any part of their businesses
unrelated to servicing securities
customers; e.g., a firm is virtually
precluded from using customer funds to
buy securities for its own account.’’ 8 To
meet this objective, Rule 15c3–3
requires a broker-dealer that maintains
custody of customer securities and cash
(a ‘‘carrying broker-dealer’’) to take two
primary steps to safeguard these assets.
The steps are designed to protect
customers 9 by segregating their
securities and cash from the brokerdealer’s proprietary business activities.
If the broker-dealer fails financially, the
securities and cash should be readily
available to be returned to the
customers. In addition, if the failed
broker-dealer is liquidated in a formal
proceeding under the Securities Investor
Protection Act of 1970 (‘‘SIPA’’), the
securities and cash would be isolated
and readily identifiable as ‘‘customer
property’’ and, consequently, available
7 See Broker-dealers; Maintenance of Certain
Basic Reserves, Exchange Act Release No. 9856
(Nov. 10, 1972), 37 FR 25224 (Nov. 29, 1972).
8 See Net Capital Requirements for Brokers and
Dealers, Exchange Act Release No. 21651 (Jan. 11,
1985), 50 FR 2690, 2690 (Jan. 18, 1985). See also
Broker-Dealers; Maintenance of Certain Basic
Reserves, Exchange Act Release No. 9856 (Nov. 10,
1972), 37 FR 25224, 25224 (Nov. 29, 1972).
9 Rule 15c3–3 defines customer as ‘‘any person
from whom or on whose behalf a broker or dealer
has received or acquired or holds funds or
securities for the account of that person.’’ The rule
excludes certain categories of persons from the
definition, including broker-dealers, municipal
securities dealers, and government securities
broker-dealers. It also excludes general partners,
directors, and principal officers of the broker-dealer
and any other person to the extent that the person
has a claim for property or funds which by contract,
agreement or understanding, or by operation of law,
is part of the capital of the broker-dealer or is
subordinated to the claims of creditors of the
broker-dealer. 17 CFR 240.15c3–3(a)(1).
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to be distributed to customers ahead of
other creditors.10
The first step required by Rule 15c3–
3 is that a carrying broker-dealer must
maintain physical possession or control
over customers’ fully paid and excess
margin securities.11 Physical possession
or control means the broker-dealer must
hold these securities in one of several
locations specified in Rule 15c3–3 and
free of liens or any other interest that
could be exercised by a third party to
secure an obligation of the brokerdealer.12 Permissible locations include a
bank, as defined in section 3(a)(6) of the
Exchange Act, and a clearing agency.13
The second step is that a carrying
broker-dealer must maintain a reserve of
cash or qualified securities in an
account at a bank that is at least equal
in value to the net cash owed to
customers, including cash obtained
from the use of customer securities.14
The account must be titled ‘‘Special
Reserve Bank Account for the Exclusive
10 See
15 U.S.C. 78aaa et seq.
17 CFR 240.15c3–3(b) and (d). The term
fully paid securities includes all securities carried
for the account of a customer in a special cash
account as defined in Regulation T promulgated by
the Board of Governors of the Federal Reserve
System, as well as margin equity securities within
the meaning of Regulation T which are carried for
the account of a customer in a general account or
any special account under Regulation T during any
period when section 8 of Regulation T (12 CFR
220.8) specifies that margin equity securities shall
have no loan value in a general account or special
convertible debt security account, and all such
margin equity securities in such account if they are
fully paid: provided, however, that the term fully
paid securities shall not apply to any securities
which are purchased in transactions for which the
customer has not made full payment. 17 CFR
240.15c3–3(a)(3). The term margin securities means
those securities carried for the account of a
customer in a general account as defined in
Regulation T, as well as securities carried in any
special account other than the securities referred to
in paragraph (a)(3) of Rule 15c3–3. 17 CFR
240.15c3–3(a)(4). The term excess margin securities
means those securities referred to in paragraph
(a)(4) of Rule 15c3–3 carried for the account of a
customer having a market value in excess of 140
percent of the total of the debit balances in the
customer’s account or accounts encompassed by
paragraph (a)(4) of Rule 15c3–3 which the brokerdealer identifies as not constituting margin
securities. 17 CFR 240.15c3–3(a)(5). As discussed in
section II.F. of this release, the Commission is
adopting technical amendments to the definitions
of the terms fully paid securities and margin
securities under Rule 15c3–3. See paragraphs (a)(3)
and (4) of Rule 15c3–3, as adopted.
12 See 17 CFR 240.15c3–3(c). Customer securities
held by the carrying broker-dealer are not assets of
the firm. Rather, the carrying broker-dealer holds
them in a custodial capacity and the possession and
control requirement is designed to ensure that the
carrying broker-dealer treats them in a manner that
allows for their prompt return.
13 Id.
14 17 CFR 240.15c3–3(e). The term qualified
security is defined in Rule 15c3–3 to mean a
security issued by the United States or a security
in respect of which the principal and interest are
guaranteed by the United States. See 17 CFR
240.15c3–3(a)(6).
11 See
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Benefit of Customers.’’ 15 The amount of
net cash owed to customers is computed
pursuant to a formula set forth in
Exhibit A to Rule 15c3–3.16 Under the
customer reserve formula, the brokerdealer adds up customer credit items
(e.g., cash in customer securities
accounts and cash obtained through the
use of customer margin securities) and
then subtracts from that amount
customer debit items (e.g., margin
loans).17 If credit items exceed debit
items, the net amount must be on
deposit in the customer reserve account
in the form of cash and/or qualified
securities.18 A broker-dealer cannot
make a withdrawal from the customer
reserve account until the next
computation and even then only if the
computation shows that the reserve
requirement has decreased.19 The
broker-dealer must make a deposit into
the customer reserve account if the
computation shows an increase in the
reserve requirement.
In addition, the customer reserve
formula permits the broker-dealer to
offset customer credit items only with
customer debit items.20 This means the
broker-dealer can use customer cash to
facilitate customer transactions such as
financing customer margin loans and
borrowing securities to make deliveries
of securities that customers have sold
15 See 17 CFR 240.15c3–3(e)(1). The purpose of
giving the account this title is to alert the bank and
creditors of the broker-dealer that this account is to
be used to meet the broker-dealer’s obligations to
customers (and not the claims of general creditors)
in the event the broker-dealer must be liquidated in
a formal proceeding.
16 17 CFR 240.15c3–3a.
17 Id.
18 17 CFR 240.15c3–3(e). Customer cash is a
balance sheet item of the carrying broker-dealer
(i.e., the amount of cash received from a customer
increases the amount of the carrying broker-dealer’s
assets and creates a corresponding liability to the
customer). The customer reserve formula is
designed to isolate these broker-dealer assets so that
an amount equal to the net liabilities to customers
is held as a reserve in the form of cash or qualified
securities. The requirement to establish this reserve
is designed to effectively prevent the carrying
broker-dealer from using customer funds for
proprietary business activities such as investing in
securities. The goal is to put the carrying brokerdealer in a position to be able to readily meet its
cash obligations to customers by requiring the firm
to make deposits of cash and/or qualified securities
into the customer reserve account in the amount of
the net cash owed to customers. Capital, Margin,
and Segregation Requirements for Security-Based
Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for BrokerDealers, Exchange Act Release No. 68071 (Oct. 18,
2012), 77 FR 70213, 70277 n.671 (Nov. 23, 2012).
19 See 17 CFR 240.15c3–3(e). Under paragraph (e),
broker-dealers are generally required to perform the
customer reserve computation as of the close of
business on the last business day of the week.
Broker-dealers from time to time may perform a
mid-week computation if it would permit them to
make a withdrawal. 17 CFR 240.15c3–3(g).
20 See 17 CFR 240.15c3–3a.
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short.21 Broker-dealer margin rules
require securities customers to maintain
a minimum level of equity in their
securities accounts.22 In addition to
protecting the broker-dealer from the
consequences of a customer default, this
equity serves to over-collateralize the
customers’ obligations to the brokerdealer and thereby protect customers
whose cash was used to facilitate the
broker-dealer’s financing of securities
purchases and short sales by other
customers. For example, if the brokerdealer fails, the customer debits,
because they generally are overcollateralized, should be attractive
assets for another broker-dealer to
purchase or, if not purchased by another
broker-dealer, they should be able to be
liquidated to a net positive equity.23 The
proceeds of the debits sale or
liquidation can be used to repay the
customer cash used to finance the
customer obligations. This cash plus the
funds and/or qualified securities held in
the customer reserve account should
equal or exceed the total amount of
customer credit items (i.e., the total
amount owed by the broker-dealer to its
customers).24
2. Proprietary Accounts of BrokerDealers
A carrying broker-dealer may carry
accounts that hold proprietary securities
and cash of other broker-dealers (‘‘PAB
21 For example, if a broker-dealer holds $100 for
customer A, the broker-dealer can use that $100 to
finance a security purchase of customer B. The $100
the broker-dealer owes customer A is a credit in the
formula and the $100 customer B owes the brokerdealer is a debit in the formula. Therefore, under
the customer reserve formula there would be no
requirement to maintain cash and/or U.S.
government securities in the customer reserve
account. However, if the broker-dealer did not use
the $100 held in customer A’s account for this
purpose, there would be no offsetting debit and,
consequently, the broker-dealer would need to have
on deposit in the customer reserve account cash
and/or qualified securities in an amount at least
equal to $100.
22 Broker-dealers are subject to margin
requirements in Regulation T promulgated by the
Federal Reserve (see 12 CFR 220.1, et seq.), in rules
promulgated by the self-regulatory organizations
(‘‘SROs’’) (see, e.g., FINRA Rules 4210–4240), and
with respect to security futures, in rules jointly
promulgated by the Commission and the CFTC (see
17 CFR 242.400–406).
23 The attractiveness of the over-collateralized
debits facilitates the bulk transfer of customer
accounts from a failing or failed broker-dealer to
another broker-dealer.
24 See Net Capital Requirements for BrokerDealers; Amended Rules, Exchange Act Release No.
18417 (Jan. 13, 1982), 47 FR 3512, 3513 (Jan. 25,
1982) (‘‘The alternative method is founded on the
concept that if the debit items in the Reserve
Formula can be liquidated at or near their contract
values, these assets, along with any cash required
to be on deposit under the [customer protection]
rule, will be sufficient to satisfy all customer-related
liabilities (which are represented as credit items in
the Reserve Formula’’).
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51827
accounts’’). As noted above, brokerdealers are not within the definition of
customer for purposes of Rule 15c3–3.25
Accordingly, a carrying broker-dealer
that carries PAB accounts is not
required to treat these accounts as
customer accounts for the purposes of
Rule 15c3–3. This means the carrying
broker-dealer is not required to maintain
possession or control of the securities of
PAB account holders that are not
securing margin loans to the account
holders (‘‘non-margin securities’’) or
include credit and debit items
associated with those accounts in its
customer reserve computation. The
definition of customer in SIPA,
however, is broader than the definition
in Rule 15c3–3 in that the SIPA
definition does not exclude brokerdealers.26 Customers under SIPA (‘‘SIPA
customers’’) generally are entitled to a
number of protections, including the
right to share pro rata with other SIPA
customers in the customer property held
by the broker-dealer and, if the customer
property is insufficient to make each
SIPA customer whole, the entitlement to
receive an advance from the Securities
Investor Protection Corporation
(‘‘SIPC’’) of up to $500,000 (of which
$250,000 currently can be used to cover
cash claims).27 Broker-dealers as SIPA
customers have the right to a pro rata
share of the customer property, but are
not entitled to receive an advance from
the SIPC fund.28 Consequently, when a
carrying broker-dealer is liquidated in a
SIPA proceeding, each customer
(including a SIPA customer that is a
broker-dealer) has a claim on the
customer property. Because the
possession and control and customer
reserve account provisions of Rule
15c3–3 do not apply to PAB account
holders by virtue of the definition of
customer in the rule, the carrying
broker-dealer is not restricted by Rule
15c3–3 from using the securities and
cash in these accounts for its own
business purposes.
The treatment of PAB account holders
as SIPA customers but not as customers
for the purposes of Rule 15c3–3
25 17
CFR 240.15c3–3(a)(1).
15 U.S.C. 78lll(2).
27 See 15 U.S.C. 78fff–2(c) and 15 U.S.C. 78fff–
3(a), respectively. Under SIPA, customer property
includes ‘‘cash and securities (except customer
name securities delivered to the customer) at any
time received, acquired, or held by or for the
account of the debtor from or for the securities
accounts of a customer, and the proceeds of any
such property transferred by the debtor, including
property unlawfully converted.’’ 15 U.S.C. 78lll(4).
Therefore, customer property includes those
securities positions that are held for customers and
the cash that is owed to customers.
28 See 15 U.S.C. 78fff–2(c); see also 15 U.S.C.
78fff–3(a).
26 See
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increases the risk that, in the event a
carrying broker-dealer is liquidated
under SIPA, the claims of SIPA
customers (i.e., customers and PAB
account holders) will exceed the
amount of customer property available
and, thereby, expose the SIPC fund and
potentially SIPA customers to losses. In
addition, if the customer property is
insufficient to fully satisfy all SIPA
customer claims and losses are incurred,
the PAB account holders could be
placed in financial distress causing
adverse impacts to the securities
markets beyond those resulting from the
failure of the carrying broker-dealer.29
To address the disparity in treatment
between customers and PAB account
holders, the Commission proposed
amendments to Rules 15c3–3 and 15c3–
3a that would have required a brokerdealer that carries PAB accounts to
perform a PAB reserve computation
with respect to those accounts, generally
as of the close of business on the last
business day of the week.30 The
amendments, as proposed, would have
required the carrying broker-dealer to
add up the debits and credits relating to
PAB accounts—including credits arising
from the use of securities held in PAB
accounts—and maintain cash or
qualified securities in a PAB reserve
account in an amount equal to or greater
than the amount that the credits exceed
the debits.
Seven commenters responded to the
Commission’s request for comment on
the proposed amendments.31 As
discussed below, the Commission has
modified the final rule in certain
respects to address, among other things,
issues raised by commenters. As
adopted, the Commission’s amendments
to Rules 15c3–3 and 15c3–3a require
carrying broker-dealers to: (1) Perform a
separate reserve computation for PAB
accounts (in addition to the customer
reserve computation currently required
for Rule 15c3–3 customer accounts); (2)
establish and fund a separate reserve
account for the benefit of PAB account
holders; and (3) obtain and maintain
physical possession or control of nonmargin securities carried for PAB
29 As noted above, while broker-dealers are
customers for the purposes of SIPA, they are not
entitled to the advances from the SIPC fund to make
up for shortfalls after the pro rata distribution of
customer property. 15 U.S.C. 78fff–3(a)(5).
30 See Amendments to Financial Responsibility
Rules, 72 FR at 12863. A broker-dealer that does not
carry an account of a customer as defined under
Rule 15c3–3 or conduct a proprietary trading
business would be permitted to make the
computation monthly rather than weekly. See
paragraph (e)(3)(iii) of Rule 15c3–3, as adopted.
31 See SIFMA 2 Letter; SIFMA 4 Letter; Dresdner
Kleinwort Letter; Deutsche Bank Securities Letter;
SIPC Letter; Abbey National Letter; First Clearing
Letter; Cornell Letter.
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accounts unless the carrying broker has
provided written notice to the PAB
account holders that it will use those
securities in the ordinary course of its
securities business, and has provided
opportunity for the PAB account holder
to object to such use.32
These amendments, in part,
incorporate many of the provisions of a
no-action letter regarding PAB accounts
issued by Commission staff in 1998.33
The PAIB Letter stated that the staff
would not recommend enforcement
action to the Commission if a brokerdealer did not take a net capital
deduction under Rule 15c3–1 for cash
held in a securities account at another
broker-dealer,34 provided the other
broker-dealer agrees to: (1) Perform a
reserve computation for PAB
accounts; 35 (2) establish a separate
special reserve bank account; and (3)
maintain cash or qualified securities in
the reserve account equal to the
computed reserve requirement (‘‘PAIB
agreement’’). Broker-dealers that carry
PAB accounts have the incentive to
enter into PAIB agreements to prevent
their PAB account holders from
choosing to open an account or enter
into a clearing agreement with another
broker-dealer. Because many of the
provisions in the PAIB Letter are being
incorporated in this rulemaking, the
Commission is directing the
Commission staff to withdraw the PAIB
Letter as of the effective date of these
rule amendments.
i. Definition of ‘‘PAB Account’’ Under
Rule 15c3–3(a)(16)
The Commission proposed, among
other things, to add paragraph (a)(16) to
Rule 15c3–3 that would have defined
the term PAB account as ‘‘a proprietary
32 See infra section II.A.2.ii. of this release for a
discussion of the Commission’s rationale for the
change in the final rule to require a carrying brokerdealer provide notice to, rather than obtain written
permission from, a PAB account holder in order for
its securities to be used in the ordinary course of
the carrying firm’s securities business.
33 See Letter from Michael A. Macchiaroli,
Associate Director, Division of Market Regulation,
Commission, to Raymond J. Hennessy, Vice
President, NYSE, and Thomas Cassella, Vice
President, NASD Regulation, Inc. (Nov. 3, 1998)
(‘‘PAIB Letter’’).
34 Under Rule 15c3–1, broker-dealers are
generally required to deduct unsecured receivables
from their net worth when computing their net
capital.
35 Under new paragraph (e)(3), broker-dealers will
be required to perform the PAB reserve account
computation (and its customer reserve account
computation, if applicable) on a weekly basis, as of
the close of business on the last business day of the
week. With regard to PAB accounts, a broker-dealer
that does not carry an account of a customer as
defined under Rule 15c3–3 or conduct a proprietary
trading business may make the PAB reserve account
computation monthly rather than weekly. See new
paragraph (e)(3)(iii) of Rule 15c3–3.
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securities account of a broker or dealer
(which includes a foreign broker or
dealer, or a foreign bank acting as a
broker or dealer), but shall not include
an account where the account owner is
a guaranteed subsidiary of the carrying
broker or dealer, the account owner
guarantees all liabilities and obligations
of the carrying broker or dealer, or the
account is a delivery-versus-payment
account or receipt-versus-payment
account.’’ 36 Two commenters raised
concerns about the proposed definition
because—by including proprietary
accounts of foreign broker-dealers and
foreign banks acting as broker-dealers
within the term PAB account—it
differed from provisions in the PAIB
Letter, which excluded such accounts
from a PAIB computation.37 One of
these commenters stated that brokerdealers (including foreign banks acting
as broker-dealers) should be allowed to
opt-out of PAB account treatment
because they do not require the same
protections as customers as defined in
Rule 15c3–3.38 The commenter stated
that broker-dealers are able to
understand the insolvency risk of the
broker-dealers at which they maintain
proprietary accounts.39 This commenter
noted that broker-dealer customers often
self-insure or otherwise account for
such exposure regardless of their status
under SIPA.40 The second commenter
stated that foreign broker-dealers and
foreign banks acting as broker-dealers
should be allowed to subordinate their
claims to customers and creditors of the
broker-dealer in order to remove their
accounts from PAB account treatment
because under SIPA foreign brokerdealers and foreign banks acting as
broker-dealers, under certain
circumstances, will not be deemed
customers and, therefore, would not be
entitled to a pro rata share of the estate
of customer property in a SIPA
liquidation.41 More specifically, the
commenter suggested that the
Commission modify the definition of
PAB account, to exclude ‘‘any foreign
broker-dealer and foreign bank to the
extent that such entity has a claim for
cash or securities that is subordinated to
the claims of creditors of the carrying
broker-dealer’’ in order to parallel the
36 See Amendments to Financial Responsibility
Rules, 72 FR at 12895.
37 See Dresdner Kleinwort Letter; Deutsche Bank
Securities Letter. Though SIFMA initially raised
concerns about the proposed definition, it later
withdrew its recommendation that proprietary
accounts of affiliated non-U.S. broker-dealers and
non-U.S. banks be excluded from the PAB account
definition. See SIFMA 2 Letter; SIFMA 4 Letter.
38 See Dresdner Kleinwort Letter.
39 Id.
40 See Dresdner Kleinwort Letter.
41 See Deutsche Bank Securities Letter.
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language in SIPA.42 This commenter
also recommended requiring the
‘‘subordinating’’ broker-dealer to follow
the requirements for non-conforming
subordinated loans to remove an
account from PAB account treatment.43
Another commenter stated that the
Commission’s desire to close the gap
between Rule 15c3–3 and SIPA must be
balanced against the potentially
significant practical issues the
Commission’s proposal would raise in
the case of accounts carried for affiliated
entities operating in non-U.S.
jurisdictions.44 In a subsequent letter,
this commenter stated that while it
would prefer a more flexible solution
that would allow broker-dealers and
non-U.S. banks acting as broker-dealers
(especially non-U.S. affiliates) to opt to
have their accounts treated as neither
customer accounts under SIPA nor PAB
accounts, the commenter recognized
that there is a clear need for an
immediate solution that cannot be
delayed until appropriate amendments
to SIPA are adopted.45 Consequently,
the commenter withdrew its
recommendation that the proprietary
accounts of affiliated non-U.S. brokerdealers and affiliated non-U.S. banks be
excluded from the ‘‘PAB account’’
definition, but continued to endorse its
previous comments to achieve the goal
of correcting the gap between Rule
15c3–3 and SIPA without creating
undue or unintended burdens.46
42 The definition of customer in SIPA excludes
any person, to the extent that ‘‘such person has a
claim for cash or securities which by contract,
agreement, or understanding, or by operation of
law, is part of the capital of the debtor, or is
subordinated to the claims of any and all creditors
of the debtor, notwithstanding that some grounds
exist for declaring such contract, agreement, or
understanding void or voidable in a suit between
the claimant and the debtor.’’ See 15 U.S.C.
78lll(2)(C)(iii).
43 See Deutsche Bank Securities Letter. See also
SIFMA 4 Letter. Under Rule 15c3–1, a broker-dealer
can exclude liabilities that are subordinated to the
claims of creditors pursuant to a satisfactory
subordination agreement, as defined in Appendix D
to Rule 15c3–1, for purposes determining its net
capital. See 17 CFR 240.15c3–1(c)(2)(ii) and 17 CFR
240.15c3–1d. See also 17 CFR 240.15c3–1(c)(i)(x).
A non-conforming subordination agreement
generally would not meet all the requirements of
Appendix D to Rule 15c3–1, and, therefore, a
broker-dealer could not exclude the liability
resulting from the loan agreement in computing its
net capital. See 17 CFR 240.15c3–1(c)(2)(ii).
44 See SIFMA 2 Letter. This commenter
specifically raised concerns that it would be
cumbersome to subject transactions between a
carrying broker-dealer and its foreign affiliates to
the proposed PAB requirements because of the
integrated securities processing and settlement
activities of these entities, which would limit the
ability of the group as a whole to provide
competitive services to U.S. investors.
45 See SIFMA 4 Letter.
46 See SIFMA 4 Letter. Among other things, the
commenter suggested that the Commission modify
the proposed definition of PAB account to exclude
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The goal of the proposed amendments
is to create a process that protects Rule
15c3–3 customers and PAB account
holders of a failed carrying brokerdealer. The amendments are designed to
provide such protection by mitigating
the risk that there will be insufficient
customer property to fully satisfy all
customer claims in a SIPA liquidation.
The entitlement of PAB account holders
to a pro rata share of the fund of
customer property places all SIPA
customers at risk if the carrying firm
does not establish a PAB reserve
account for excess credits owed to PAB
account holders.
At the same time, the Commission
appreciates the need to consider both
the practical issues raised by
commenters and its objective to
eliminate the inconsistency between
Rule 15c3–3 and SIPA.47 Accordingly,
in response to commenters, the final
rule adopted by the Commission
excludes from the definition of PAB
account in paragraph (a)(16) of Rule
15c3–3 ‘‘an account that has been
subordinated to the claims of creditors
of the carrying broker or dealer.’’ 48 A
PAB account holder that has
subordinated its claims with respect to
that account to claims of creditors of the
carrying broker-dealer will not be
entitled to SIPA protection for that
account.49 Consequently, this provision
will provide flexibility to carrying
broker-dealers and their broker-dealer
affiliates to structure their PAB account
relationships in a manner that permits
operational efficiencies (i.e., the ability
to exclude these accounts from the PAB
reserve computation) while still
promoting the goal of the amendments
to have a consistent treatment of these
accounts under Rule 15c3–3 and SIPA,
and thereby protect accounts holders
that are ‘‘customers’’ under SIPA.50 If a
U.S. broker-dealer, however, chooses to
subordinate its claims to assets in that
account to the claims of other creditors
any customer as defined in Rule 15c3–3 and also
to exclude the other types of persons who are
specifically excluded from the definition of
customer. This suggestion included excluding
accounts whose claims are subordinated to the
claims of other creditors of the carrying brokerdealer. Id.
47 See Amendments to Financial Responsibility
Rules, 72 FR at 12863.
48 The agreement would not need to be
conforming for purposes of Exchange Act Rule
15c3–1d (Satisfactory Subordination Agreements).
49 See 15 U.S.C. 78lll(2).
50 See 17 CFR 240.15c3–3(a)(1) and 15 U.S.C.
78lll(2)(C)(ii). These accounts will be excluded from
both the definition of PAB account, as well from the
definition of customer under SIPA. See
Amendments to Financial Responsibility Rules, 72
FR at 12863. Consequently, these account holders
will not be entitled to the protections in SIPA
applicable to customers.
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51829
of the carrying broker-dealer, it will not
be able to include those assets as
allowable for its own net capital
computation.51
Further, as was proposed, the
definition of PAB account in the final
rule excludes accounts that operate on
a delivery-versus-payment or a receiptversus-payment basis, or ‘‘DVP/RVP’’
basis, because these accounts generally
hold securities and cash for short
durations.52 The provision relating to
DVP/RVP accounts is being adopted
substantially as proposed, though
paragraph (a)(16), as adopted, has been
modified by splitting the text into two
sentences. As adopted, the reference to
the DVP/RVP accounts provision was
moved to the first sentence. The
Commission is not adopting the
proposed exclusions from the PAB
reserve computation requirement
related to accounts established by a PAB
account holder that fully guarantee the
obligations of, or whose accounts are
fully guaranteed by, the carrying brokerdealer. Rather than create a specific
exemption for such account holders, the
Commission believes the better
approach is to allow these accounts to
enter into subordination agreements
with the carrying broker-dealer, in order
for these accounts to be excluded from
the definition of PAB account. This
approach simplifies the final rule, while
continuing to provide a means for these
account holders to be excluded from its
scope. Consequently, as adopted,
paragraph (a)(16) to Rule 15c3–3 defines
the term PAB account to mean ‘‘a
proprietary securities account of a
broker or dealer (which includes a
foreign broker or dealer, or a foreign
bank acting as a broker or dealer) other
than a delivery-versus-payment account
or a receipt-versus-payment account.’’ 53
The definition of PAB Account does not
include accounts that have been
subordinated to the claims of a carrying
broker-dealer’s creditors.54
ii. Written Permission To Use PAB
Account Securities
Because PAB account holders are not
customers for purposes of Rule 15c3–3,
a carrying broker-dealer is not required
to maintain possession or control of
their non-margin securities.
Consequently, it has been a long51 See
17 CFR 240.15c3–1(c)(2)(iv)(E).
Amendments to Financial Responsibility
Rules, 72 FR at 12863, n.17 (‘‘[T]he amendment
would exclude delivery-versus-payment and
receipt-versus-payment accounts. These types of
accounts pose little risk of reducing the estate of
customer property in a SIPA liquidation since they
only hold assets for short periods of time.’’).
53 See paragraph (a)(16) to Rule 15c3–3, as
adopted.
54 Id.
52 See
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standing industry practice for carrying
broker-dealers to use these PAB
securities in their business activities.
Under the final rule, a carrying brokerdealer that uses these PAB securities
will need to include the market value of
the securities as a credit in the formula
when performing the PAB reserve
computation. Thus, the amount that the
carrying broker-dealer must maintain in
its PAB reserve account will increase by
the amount of these credits because
there would be no corresponding debit
item.55
Using non-margin securities of PAB
account holders presents the risk that
securities may increase in market value
between PAB reserve computations and,
therefore, the amount of the credit items
in the formula may be less than the
value of the securities for a short period
of time. To accommodate industry
practice, however, the Commission did
not propose amending Rule 15c3–3 to
apply the possession or control
requirements to PAB accounts. The
Commission proposed adding paragraph
(b)(5) to Rule 15c3–3 that would have
required the carrying broker-dealer to
obtain written permission from a PAB
account holder before it could use the
PAB account holder’s securities in the
ordinary course of its securities
business. In this way, the Commission
proposed increasing the protections for
PAB account holders without interfering
with long-standing industry practice of
carrying broker-dealers using the
securities of their broker-dealer account
holders. However, securities not being
used by the broker-dealer must be
maintained in accordance with the
possession or control requirements of
Rule 15c3–3.
One commenter stated that this
provision should be eliminated from the
proposed amendments, arguing that
‘‘[t]he proposal interferes unnecessarily
in the contractual arrangements between
broker-dealers, which are capable of
understanding the terms of standard
industry custodial relationships.’’ 56 The
commenter also noted that the PAIB
Letter did not contain any such
requirement.57 The Commission agrees
with the commenter that broker-dealers
should be able to understand the
implications of granting another brokerdealer the ability to use their nonmargin securities and, therefore, the
final rule requires written notice rather
than written permission. An appropriate
level of protection for the PAB account
holder may be achieved without
requiring the carrying broker-dealer to
55 17
CFR 240.15c–3–3a.
SIFMA 2 Letter.
56 See
57 Id.
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maintain possession or control of
securities carried for a PAB account,
provided that the carrying broker-dealer
gives written notice to its PAB account
holders that it may use their non-margin
securities.58
The Commission acknowledges that
this change, as compared to the
proposed rule, will shift the burden to
the PAB account holder to proactively
object to the carrying broker-dealer
using the account holder’s securities.
However, the new written notice
requirement increases the protections
for PAB account holders from the status
quo without imposing substantial
burdens on existing account
relationships. The revised rule is
intended to provide to the PAB account
holders the opportunity to negotiate
different terms if they do not want their
securities used, while eliminating the
need for, and the costs that would result
from, carrying broker-dealers reworking
existing contracts.
As adopted, the Commission is
modifying the final rule to add the
phrase ‘‘and has provided an
opportunity for the account holder to
object’’ following the phrase ‘‘ordinary
course of its securities business.’’ 59 This
language was added to the final rule to
impose a requirement that the carrying
broker-dealer provide the PAB account
holders an opportunity to object to the
use of their non-margin securities after
they receive the written notice from the
carrying broker-dealer. The rule does
not prescribe the form in which a PAB
account holder must provide notice to
the carrying broker-dealer of its
objection. This will provide the PAB
account holder with flexibility to
communicate the objection in a manner
the account holder determines is most
effective in terms of conveying such
objection to the carrying broker-dealer.
If the PAB account holder objects, the
carrying broker-dealer could not use the
securities. Further, the PAB account
holder could seek to move the account
to another carrying broker-dealer or
negotiate different terms with the
carrying broker-dealer with regard to the
use of its securities.
Finally, the Commission has modified
proposed paragraph (b)(5) to clarify in
the final rule that a broker-dealer is
affirmatively required to maintain
58 The Commission has deleted the phrase
‘‘obtained the written permission of the account
owner to use the securities in the ordinary course
of its securities business’’ from paragraph (b)(5) of
the final rule and replaced it with ‘‘provided
written notice to the account holder that the
securities may be used in the ordinary course of its
securities business, and has provided an
opportunity for the account holder to object.’’
59 See paragraph (b)(5) of Rule 15c3–3, as
adopted.
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possession and control of non-margin
securities unless the broker-dealer has
provided written notice to the PAB
account holder.60 As modified,
paragraph (b)(5) reads: ‘‘A broker or
dealer is required to obtain and
thereafter maintain the physical
possession or control of securities
carried for a PAB account, unless the
broker or dealer has provided written
notice to the account holder that the
securities may be used in the ordinary
course of its securities business, and has
provided an opportunity for the account
holder to object.’’ 61
iii. PAB Reserve Bank Accounts
The Commission proposed
amendments to paragraph (e) of Rule
15c3–3 to require a carrying broker with
PAB accounts to establish and maintain
a PAB reserve account for PAB
accounts, perform a separate PAB
reserve computation for PAB accounts,
and maintain cash or qualified
securities in the PAB reserve account in
an amount equal to the PAB reserve
requirement.62 The Commission also
proposed amendments to paragraph (f)
of Rule 15c3–3 to require carrying
broker-dealers with PAB accounts to
notify the bank about the status of the
PAB reserve account and obtain an
agreement and notification from the
bank that the PAB reserve account will
be maintained for the benefit of the PAB
account holders.63 The Commission is
adopting these amendments to
paragraphs (e) and (f) of Rule 15c3–3
substantially as proposed, with some
technical modifications suggested by
one commenter, including making
terminology consistent throughout the
paragraphs.64 In addition, the
Commission is adopting substantially as
proposed the amendments to paragraph
(g) of Rule 15c3–3 which specifies when
the carrying broker-dealer can make
withdrawals from a PAB reserve
account.65 Finally, the Commission is
60 The modifications replaced the phrase ‘‘shall
not be required’’ with the phrase ‘‘is required’’ and
replaced the phrase ‘‘provided that’’ with the word
‘‘unless.’’
61 See paragraph (b)(5) of Rule 15c3–3, as
adopted.
62 See section II.A.3. of this release for a
discussion of changes to paragraph (e)(5) of Rule
15c3–3 with respect to banks where customer or
PAB reserve accounts may be held.
63 17 CFR 240.15c3–3(f).
64 See SIFMA 2 Letter.
65 17 CFR 240.15c3–3(g). In this paragraph, the
Commission deleted the phrase ‘‘his Reserve Bank
Accounts’’ and replaced it with the phrase ‘‘a
Customer Reserve Bank Account and PAB Reserve
Bank Account.’’ The Commission also deleted the
phrase ‘‘each Reserve Bank Account’’ and replaced
it with the phrase ‘‘the Customer Reserve Bank
Account and PAB Reserve Bank Account.’’ These
were the only changes made to the final rule in
paragraph (g) of Rule 15c3–3.
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adopting, as proposed, new paragraph
(e)(4) to Rule 15c3–3, which allows a
carrying broker-dealer to use credits
related to PAB accounts to finance Rule
15c3–3 customer debits, but does not
allow a carrying broker-dealer to use
Rule 15c3–3 customer credits to finance
PAB debits.
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iv. Other PAB Issues Raised by
Commenters
In addition to specific comments on
the proposed rule language, one
commenter had other interpretive
questions and comments about the
proposed PAB requirements.66 The
commenter requested that the
Commission clarify whether PAB
account holders must obtain from their
carrying broker-dealers a written
agreement to perform the calculation as
required by the PAIB Letter.67 Under the
amendments, there is no requirement
that PAB account holders obtain a
written agreement from the carrying
firm that it will perform the PAB reserve
computation. Rule 15c3–3, as amended,
requires the carrying firm to perform the
PAB reserve computation. As stated
above, Rule 15c3–3 prescribes the
requirements for carrying firms with
respect to PAB accounts, and the PAIB
Letter is being withdrawn.68
In addition, the commenter requested
the Commission to clarify that existing
PAIB reserve accounts need not be retitled to comply with the proposed
amendments.69 Item 4 of the PAIB Letter
required that a carrying broker-dealer,
‘‘establish and maintain a separate
‘Special Reserve Account for the
Exclusive Benefit of Customers’ with a
bank in conformity with the standards
of paragraph (f) of Rule 15c3–3.’’
Paragraph (e)(1) of Rule 15c3–3,
however, requires that a carrying brokerdealer establish and maintain a ‘‘Special
Reserve Bank Account for Brokers and
Dealers.’’ Given the small differences in
nomenclature and the time and expense
associated with broker-dealers re-titling
these accounts, a carrying broker-dealer
that has properly established PAB
reserve account in the manner described
in Item 4 of the PAIB Letter need not retitle the account and obtain a new
notification from the bank.70 However,
all PAB reserve accounts established on
or after the effective date of these
amendments must title the account in
66 See
SIMFA 2 Letter.
67 Id.
68 As discussed above in this section II.A.2., the
Commission is directing the staff to withdraw the
PAIB Letter as of the effective date of these rules.
69 See SIFMA 2 Letter.
70 See PAIB Letter.
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accordance with paragraph (e)(1) of Rule
15c3–3.
Finally, the commenter urged the
Commission to clarify whether, for
purposes of Rule 15c3–1, the term
aggregate debit items means total
aggregate debit items computed in
accordance with the customer reserve
formula or the total aggregate debit
items computed in accordance with
both the customer reserve formula and
the PAB reserve formula.71 Aggregate
debit items are used in the net capital
rule to determine the minimum net
capital requirement for broker-dealers
that elect to use the alternative standard
in computing their minimum net capital
requirement. Specifically, the net
capital rule requires broker-dealers
using the alternative standard to
maintain net capital of at least the
greater of $250,000 or 2% of aggregate
debit items.72 Including PAB aggregate
debit items in this computation would
significantly increase net capital
requirements for broker-dealers that use
the alternative method. The intended
purpose of this rule change is to address
the inconsistencies between Rule 15c3–
3 and SIPA—not to increase net capital
requirements. Consequently, the
requirements in Rules 15c3–1, 15c3–1d,
and 17a–11 that refer to aggregate debit
items continue to be based only on
aggregate debit items computed in
accordance with the customer reserve
computation, and do not include
aggregate debit items computed in
accordance with the PAB reserve
computation.73
v. Amendment to Rule 15c3–
1(c)(2)(iv)(E) Related to PAB Accounts
Finally, the Commission proposed an
amendment to Rule 15c3–1 74 that
would have required a broker-dealer,
when calculating net capital, to deduct
from net worth cash and securities held
in a securities account at another
broker-dealer if the other broker-dealer
does not treat the account, and the
71 See
SIFMA 2 Letter; SIFMA 4 Letter.
CFR 240.15c3–1(a)(1)(ii). In addition, certain
other financial responsibility rules require that a
broker-dealer that computes net capital pursuant to
the alternative method either report to the
Commission, limit its ability to obtain, pre-pay, or
repay subordinated debt, or limit its business if its
net capital falls below a certain level based on a
percentage of aggregate debit items (see, e.g., Rules
15c3–1(e)(2)(vi), 15c3–1d(b)(6)(iii), 15c3–1d(b)(7),
15c3–1d(b)(8)(i)(A), 15c3–1d(b)(10)(ii)(B), 15c3–
1d(c)(2), 15c3–1d(c)(5)(ii)(A), and 17a–11(c)(2)).
73 Under paragraph (e)(4) to Rule 15c3–3, a
carrying broker-dealer will be permitted to use
credits related to PAB accounts to finance Rule
15c3–3 customer debits. This rule, however, does
not affect the use of aggregate debit items in
computing a broker-dealer’s net capital under the
alternative standard pursuant to paragraph (a)(1)(ii)
of Rule 15c3–1.
74 17 CFR 240.15c3–1(c)(2)(iv)(E).
72 17
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51831
assets therein, in compliance with the
applicable PAB reserve account
requirements of Rules 15c3–3 and 15c3–
3a.75 A commenter suggested modifying
this proposed amendment,76 arguing
that ‘‘[a]lthough the Proposing Release
states that the Commission ‘would not
expect broker-dealers to audit or
examine their carrying broker-dealers to
determine whether the carrying brokerdealer is in compliance with [the
proposed rules],’ the text of the
proposed amendment suggests that they
in fact would have such an
obligation.’’ 77 The commenter also
stated that a broker-dealer should not be
deemed to have violated Rule 15c3–1
merely because its carrying firm fails to
properly perform requirements solely
applicable to the carrying firm and that
paragraph (c)(2)(iv)(E) under Rule 15c3–
1 should be explicitly modified to
clarify that cash and securities held in
a securities account at another brokerdealer are not subject to the deduction
specified in that paragraph.78
While the Commission did not intend
to impose any monitoring requirement
on the PAB account holder, the
Commission recognizes that the
language, as proposed, could have
implied such a requirement and agrees
with the commenter that a broker-dealer
should not be deemed to have violated
Rule 15c3–1 with respect to
requirements that are solely applicable
to the carrying broker-dealer. To address
this concern, the Commission has
modified the language in paragraph
(c)(2)(iv)(E) under Rule 15c3–1 to
eliminate the proposed capital charge of
Rule 15c3–1 that would have resulted
from a failure of a carrying broker-dealer
to comply with the PAB requirements in
Rule 15c3–3.79
Instead, the Commission has adopted
amendments to Rule 15c3–1 providing
that a broker-dealer need not deduct
cash and securities held in a securities
account at a carrying broker-dealer
except where the account has been
subordinated to the claims of creditors
of the carrying broker-dealer.80 This
provision is intended to prevent brokerdealers from including assets in their
net capital that may not be readily
available to be returned because they
75 See Amendments to Financial Responsibility
Rules, 72 FR at 12864.
76 See SIFMA 2 Letter.
77 Id.
78 Id.
79 More specifically, the Commission has deleted
the proposed language referring to ‘‘cash and
securities held in a securities account at another
broker-dealer if the other broker-dealer does not
treat the account, and the assets therein in
compliance with paragraphs (b)(5) and (e) of
§ 240.15c3–3. . . .’’
80 17 CFR 240.15c3–1(c)(2)(iv)(E).
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would not be subject to the PAB account
provisions discussed above.
Accordingly, the amendments to
paragraph (c)(2)(iv)(E) of Rule 15c3–1
are consistent with the exclusions from
the definition of PAB account in
paragraph (a)(16) of Rule 15c3–3.81
3. Banks Where Special Reserve
Deposits May Be Held
As amended, paragraph (e) of Rule
15c3–3 requires a broker-dealer to
deposit cash or qualified securities into
the customer or PAB reserve account,82
which must be maintained at a bank.83
While cash deposits at a bank are
fungible and may be used by the bank
in its lending and investment activities,
paragraph (f) of Rule 15c3–3 requires
that a broker-dealer obtain a written
contract from the bank wherein the bank
agrees not to re-lend or hypothecate
securities deposited into the reserve
account.84 This means the bank cannot
use the securities in its business, which
provides a measure of protection by
requiring that the securities will be
available to the broker-dealer if the bank
falls into financial difficulty. Cash
deposits, however, may be freely used
in the course of the bank’s commercial
activities.85 Therefore, to the extent a
broker-dealer deposits cash in a reserve
account, there is a risk the cash could
become inaccessible if the bank
experiences financial difficulties.86 This
could adversely impact the brokerdealer and its customers.87 To limit
these risks, the Commission proposed
amendments to Rule 15c3–3 that would
have: (1) Prohibited a broker-dealer from
maintaining cash deposits in the reserve
accounts for customers and PAB
account holders if the bank was
affiliated; and (2) limited the amount of
cash that could be deposited in both
types of reserve accounts at nonaffiliated banks.88 These restrictions
would not have applied to securities
held in the reserve accounts because, as
noted above, the bank must agree not to
use the securities in its business. The
goal of the proposals was to limit cash
81 17
CFR 15c3–3(a)(16).
PAB reserve account and the customer
reserve account are collectively referred to as the
‘‘reserve accounts’’ or a ‘‘reserve account.’’
83 The term bank is defined in paragraph (a)(7) of
Rule 15c3–3 as a ‘‘bank as defined in section 3(a)(6)
of the Exchange Act and will also mean any
building and loan, savings and loan or similar
banking institution subject to the supervision by a
Federal banking authority.’’ See paragraph (a)(7) to
Rule 15c3–3, as adopted.
84 See 17 CFR 240.15c3–3(f).
85 See Amendments to Financial Responsibility
Rules, 72 FR at 12864.
86 Id.
87 Id.
88 Id.
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82 The
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reserve account deposits to reasonably
safe amounts as measured against the
capitalization of the broker-dealer and
the bank.89
Specifically, as proposed, paragraph
(e)(5) of 15c3–3 provided that a carrying
broker-dealer would have been required
to exclude the amount of cash deposited
into reserve accounts at affiliated banks
when determining whether it
maintained the minimum amount
required to be on deposit in the reserve
accounts for its customers and PAB
account holders. In addition, the
proposed amendment would have
required a carrying broker-dealer to
exclude cash deposited in a reserve
account at an unaffiliated bank to the
extent the amount of the cash deposited
exceeded: (1) 50% of the broker-dealer’s
excess net capital (based on the brokerdealer’s most recently filed FOCUS
Report); 90 or (2) 10% of the bank’s
equity capital (based on the bank’s most
recently filed Call Report or Thrift
Financial Report).91
The Commission is adopting the
amendments with modifications
designed to address issues identified by
commenters. Twenty-three commenters
addressed the proposed amendments.92
Fifteen commenters urged the
89 Id.
90 Under Rule 17a–5, broker-dealers must file
periodic reports on Form X–17a–5 (Financial and
Operational Combined Uniform Single Reports)
(‘‘FOCUS Reports’’). See 17 CFR 240.17a–5(a). The
FOCUS Report requires, among other financial
information, a balance sheet, income statement, and
net capital and customer reserve computations.
Excess net capital is the amount that a brokerdealer’s net capital exceeds its minimum
requirement.
91 See Amendments to Financial Responsibility
Rules, 72 FR at 12864. On July 21, 2011,
supervisory responsibility for federal savings
associations was transferred from the Office of
Thrift Supervision (‘‘OTS’’) to the Office of the
Comptroller of the Currency (‘‘OCC’’). As of the
quarter ending March 31, 2012, savings associations
were required to file a Call Report in lieu of a Thrift
Financial Report. See Proposed Agency Information
Collection Activities; Comment Request, 76 FR 7082
(Feb. 8, 2011). The Call Report includes a line item
for total bank equity capital. A report for a specific
institution is available at https://cdr.ffiec.gov/
public/. See also, FINRA, Interpretations of
Financial and Operational Rules, Interpretations
15c3–3(e)(1)/01 and/011 (establishing similar
threshold restrictions on using money market
deposit accounts or time deposits, respectively, to
meet customer reserve account requirements), and
Interpretation 15c3–3(e)(3)/051 (establishing similar
threshold restrictions with respect to meeting the
customer reserve requirement by depositing cash at
an affiliated bank).
92 See Federated Letter; Curian Clearing Letter;
Raymond James Letter; JP Morgan Letter; Reserve
Letter; Dresdner Kleinwort Letter; SIFMA 2 Letter;
SIFMA 4 Letter; First Clearing Letter; Clearing
House Letter; ICI Letter; Barclays Letter; ABASA
Letter; PNC Letter; BlackRock Letter; Deutsche Bank
Securities Letter; E*Trade Letter; Citigroup Letter;
American Bar Association Letter; Fidelity/NFS
Letter; BOK Letter; JP Morgan 3 Letter; IIB Letter;
Raymond James 2 Letter.
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Commission not to adopt the proposed
prohibition on broker-dealers
maintaining cash in reserve accounts at
affiliated banks.93 These commenters
generally stated that, with regard to cash
in reserve accounts, affiliated banks
should be treated the same as
unaffiliated banks because both groups
are subject to the same financial
regulation.94 These commenters noted
that banks are subject to safety and
soundness requirements of their
respective banking regulators and,
therefore, the commenters argued that
the proposed restriction with respect to
affiliated banks is unwarranted.
One commenter also stated that the
Commission’s distinction between
affiliated and unaffiliated banks was not
sufficiently supported in the proposing
release.95 More specifically, this
commenter stated that the Commission’s
‘‘bare statement that a broker-dealer
‘may not exercise due diligence with the
same degree of impartiality when
assessing the soundness of an affiliate
bank as it would with a non-affiliate
. . .’ does not suffice to justify the
disparate treatment’’ with regard to the
treatment of affiliated banks under the
proposed rule.96 This commenter also
stated that it is just as easy to argue that
broker-dealers are in a much better
position to know about the soundness of
an affiliated bank then to learn about the
soundness of a unaffiliated bank, which
may not be willing to provide complete
and accurate information.97 In addition,
another commenter stated that the
Commission cited no empirical or
anecdotal evidence to support its
reasons for prohibiting cash reserve
deposits at an affiliated bank.98 This
commenter also stated that the
Commission’s concerns discount the
operational efficiencies to be gained
between an affiliated broker-dealer and
its bank, including: Commonality
between certain policies and
procedures; greater ease in
communication internally; and greater
operational efficiencies leading to
reduced operational risk in the transfer
of funds to and from the bank.99
One commenter stated that it took no
issue with the proposed restriction on
93 See Federated Letter; JP Morgan Letter;
Dresdner Kleinwort Letter; SIFMA 4 Letter; First
Clearing Letter; ICI Letter; ABASA Letter; E*Trade
Letter; Citigroup Letter; American Bar Association
Letter; Fidelity/NFS Letter; Curian Letter; BOK
Letter; JP Morgan 2 Letter; IIB Letter.
94 Id.
95 See Dresdner Kleinwort Letter.
96 Id.
97 Id.
98 See Citigroup Letter.
99 Id.
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affiliated banks.100 Another commenter
noted that the financial industry has
seen a remarkable consolidation of the
banking and securities industries, and,
as a result, the number of broker dealers
affiliated with banks has increased,
along with the number of those brokerdealers maintaining deposits at
affiliated banks.101 This commenter
stated that broker-dealers would be
required to move deposits from one
institution and divide that amount
among several banks, resulting in credit
risk to the broker-dealer, as well as an
increase in operational risk.102 Finally,
the commenter observed that the
Commission did not provide any
specific examples of bank failures
impacting affiliated broker-dealers,
which led the commenter to question
whether there is any realistic benefit to
offset the increased risk that brokerdealers would be required to take on as
a result of the proposal to place
restrictions on cash deposits in reserve
accounts at affiliated and unaffiliated
banks.103
The Commission recognizes that all
banks, whether or not affiliated with a
broker-dealer, are subject to regulation
by their respective banking regulators.
The Commission’s continuing concern,
however, is that a carrying broker-dealer
may not exercise due diligence with the
same degree of impartiality and care
when assessing the financial soundness
of an affiliated bank as it would with an
unaffiliated bank.104 Moreover, the goal
of protecting the carrying brokerdealer’s customers through the Rule
15c3–3 reserve requirement may be
undermined in the event a holding
company becomes insolvent, with
corresponding adverse consequences to
both the bank and broker-dealer
subsidiaries.
In some cases, a broker-dealer may
have access to more information about
an affiliated bank in comparison to an
unaffiliated bank for purposes of
conducting due diligence. However,
having more information would not be
of benefit if the individuals making the
decision on where to maintain the
reserve account are not objective in their
decision making. The Commission is
concerned that a broker-dealer’s
decision to hold cash in a reserve
100 See Raymond James Letter. In a subsequent
comment letter, this commenter stated that if this
proposal is adopted, registered broker-dealers
holding customer funds may be required to move
their reserve accounts if those accounts are
currently held at affiliated banks, which would
increase costs. See Raymond James 2 Letter.
101 See BOK Letter.
102 Id.
103 Id.
104 See Amendments to Financial Responsibility
Rules, 72 FR at 12864.
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account at an affiliated bank may be
driven in part by profit or reasons based
on the affiliation, regardless of any due
diligence it may conduct or the overall
safety and soundness of the bank.
In addition, in response to the
comments regarding affiliated banks, the
Commission notes that substantial
numbers of banks have failed or
required government assistance in
recent years.105 While a particular bank
failure may not have materially
impacted an affiliated broker-dealer to
date,106 the risk remains that the
financial difficulty of an entity that is
part of a holding company structure
may adversely impact other affiliated
entities, including affiliated brokerdealers and banks.107 Therefore, the
final rule retains the prohibition on
maintaining customer reserve cash
deposits at an affiliated bank.108
This prohibition does not apply to
securities on deposit at an affiliated
bank, but only cash deposits because, as
noted above, the latter are fungible with
other deposits carried by the bank and
may be freely used in the course of the
bank’s commercial activities.109
Consequently, to the extent that
operational or other efficiencies can be
achieved through the use of an affiliated
bank, the carrying broker-dealer can use
qualified securities held at an affiliated
bank to meet its reserve deposit
requirements.110 The ability to use
qualified securities alleviates concerns
that a broker-dealer would be required
to take deposits from one institution and
divide that amount among several
banks, resulting in credit risk to the
105 According to the FDIC, the number of FDICinsured institutions that failed in the U.S. over the
last four years are: (1) 140 in 2009; (2) 157 in 2010;
(3) 92 in 2011; and (4) 51 in 2012. A complete list
of failed banks since October 1, 2000, is available
at www.fdic.gov/bank/individual/failed/
banklist.html.
106 See BOK Letter; Dresdner Kleinwort Letter.
107 See, e.g., Lehman Brothers Inc.—Trustee’s
Preliminary Investigation Report and
Recommendations (Case No. 08–01420 (JMP) SIPA),
available at https://bankrupt.com/misc/
sipareport0904.pdf.
108 Id.
109 See Federal Reserve, Division of Banking
Supervision and Regulation, Commercial Bank
Examination Manual, Section 3000.1, Deposit
Accounts (stating that deposits are the primary
funding source for most banks and that banks use
deposits in a variety of ways, primarily to fund
loans and investments), available at https://
www.federalreserve.gov/boarddocs/supmanual/
cbem/3000.pdf. See also OCC Banking Circular
(BC–196), Securities Lending (May 7, 1985) (stating
securities should be lent only pursuant to a written
agreement between the lender institution and the
owner of the securities specifically authorizing the
institution to offer the securities for loan), available
at https://www.occ.gov/static/news-issuances/
bulletins/pre-1994/banking-circulars/bc-1985196.pdf.
110 See Citigroup Letter.
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51833
broker-dealer, as well as an increase in
operational risk.111
In summary, while the Commission
acknowledges concerns raised by
commenters, the Commission continues
to believe that it is appropriate to
exclude cash deposited in affiliated
banks from the calculation to determine
whether a broker-dealer has met its
reserve account requirements.
Therefore, the final rule excludes the
amount of any cash on deposit in an
affiliated bank of the broker-dealer from
being used to meet the reserve
requirements.112 Broker-dealers that use
affiliated banks for holding cash
customer reserve accounts will need to
either deposit qualified securities into
the accounts or move their accounts to
non-affiliated banks.
As for the limits on the amounts of
cash that could be deposited in one
unaffiliated bank, some commenters
argued that the proposed thresholds
were too restrictive. One commenter
urged the Commission to reconsider the
proposed limits, noting that the
proposed amendment will impose
significant costs on broker-dealers and
potentially adversely impact the brokerdealers’ customers.113 Several
commenters suggested that the
Commission allow cash reserve deposits
without the percentage restrictions at
unaffiliated banks that are wellcapitalized or for which the brokerdealer has performed due diligence.114
One commenter suggested that the
Commission consider higher
percentages for cash deposits at large
money-center banks.115 This commenter
stated that this would strike a better
balance between the Commission’s
concerns regarding the safety of cash
deposits and the costs imposed on
broker-dealers arising from having to
use qualified securities (as opposed to
cash) to meet deposit requirements or
having to maintain reserve accounts at
multiple banks.116 This commenter also
stated that the percentage thresholds
would negatively impact smaller brokerdealers because they would exceed the
50% of excess net capital threshold at
lower deposit levels.117 Two
111 See BOK Letter. Based on FOCUS Report data,
as of December 31, 2011, 79% of the total customer
reserve requirement across all carrying brokerdealers was met using qualified securities.
112 See paragraph (e)(5) of Rule 15c3–3, as
adopted.
113 See Raymond James 2 Letter.
114 See Raymond James Letter; JP Morgan Letter;
Clearing House Letter; ABASA Letter; PNC Letter;
Deutsche Bank Securities Letter; E*Trade Letter; JP
Morgan 2 Letter.
115 See SIFMA 2 Letter; SIFMA 4 Letter.
116 See SIFMA 2 Letter.
117 Id.
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commenters noted that the proposed
10% bank equity capital limitation
appears to be derived from a 1988 NYSE
staff interpretation, which stated that
customer reserve accounts may be
maintained in money market deposit
accounts if the total of such deposits in
any one bank does not exceed 50% of
the broker-dealer’s excess net capital or
10% of the bank’s equity capital.118
These commenters pointed out that
significant changes have taken place
with respect to federal bank regulatory
agency oversight of the safety and
soundness of banks since 1988,
including the imposition of prompt
corrective action provisions.119 These
commenters stated that the concerns
that gave rise to the 1988 interpretation
have been mitigated by current statutes
and regulations requiring prompt
corrective action in the event that a
bank’s capital position deteriorates.120
As stated above, substantial numbers
of banks have failed or required
government assistance in recent
years.121 Consequently, the rule, as
adopted, establishes requirements
designed to avoid the situation where a
carrying broker-dealer’s cash deposits
constitute a substantial portion of the
bank’s deposits. At the same time, the
proposal has been modified to mitigate
concerns raised by commenters that
broker-dealers would have to maintain
reserve accounts at multiple banks.
First, the Commission has eliminated
the provision that would have excluded
the amount of a cash deposit that
exceeds 50% of the broker-dealer’s
excess net capital. As noted by
comments, this provision likely would
have disproportionately impacted small
and mid-size broker-dealers when they
deposited cash into large commercial
banks since they would exceed the
excess net capital threshold well before
exceeding the bank equity capital
threshold.122 Also, based on staff
experience monitoring larger brokerdealers, firms that maintain large
amounts of cash in their customer
reserve accounts generally use more
than one non-affiliated bank to maintain
these accounts.
The bank equity capital threshold is
the more important metric since it
relates directly to the financial strength
of the bank, which is the entity holding
the account. Thus, this metric more
directly addresses the risk at issue: The
potential impairment of the bank’s
118 See
119 See
PNC Letter; ABASA Letter.
PNC Letter; ABASA Letter.
120 Id.
121 See www.fdic.gov/bank/individual/failed/
banklist.html.
122 See SIFMA 2 Letter; JP Morgan 2 Letter.
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ability to quickly return the customer
reserve deposit to the broker-dealer.
Second, with respect to the bank
equity capital threshold, in response to
comments, the Commission has
increased the threshold from 10% to
15% of the bank’s equity capital. The
increase of the threshold to 15% is
designed to address concerns raised by
commenters that the proposed
percentage tests were unduly restrictive
in certain respects and should be
modified, particularly with respect to
large broker-dealers with large deposit
requirements. Consequently, the
increase from 10% to 15% is designed
to mitigate commenters’ concerns that
the 10% threshold would require
broker-dealers to spread out cash
deposits over a number of banks, while
still providing adequate protection
against the risk that arises when a
bank’s deposit base is overly reliant on
a single depositor.
The elimination of the 50% of excess
net capital threshold and increase in the
bank capital threshold from 10% to 15%
is intended to address concerns raised
by commenters that they would have to
substantially alter their current cash
deposit practices in light of the goal of
the rule to promote the broker-dealer’s
ability to have quick access to the
deposit.
As proposed, the equity capital
threshold would have been based on
equity capital ‘‘as reported by the bank
in its most recent Call Report or Thrift
Financial Report.’’ Under the DoddFrank Wall Street Reform and Consumer
Protection Act (‘‘Dodd-Frank Act’’),123
the supervision of savings associations
was transferred from the OTS to the
OCC (for federal savings associations)
and the FDIC (for state savings
associations).124 Also, beginning in the
period ending March 31, 2012, savings
associations began to file a Call Report
in lieu of a Thrift Financial Report,
thereby ending the use of the Thrift
Financial Report.125 Therefore, due to
the passage of the Dodd-Frank Act and
the elimination of the Thrift Financial
Report, as well as to provide more
flexibility with regard to any successor
reports that may be required to be filed
by a bank, the Commission is modifying
the phrase ‘‘Call Report or Thrift
123 Public
Law 111–203, 124 Stat. 1376 (2010).
at §§ 300–378. See also List of OTS
Regulations to be Enforced by the OCC and the
FDIC Pursuant to the Dodd-Frank Act, OCC, FDIC,
(June 14, 2011), 76 FR 39246 (July 6, 2011).
Supervision of savings and loan holding companies
and their subsidiaries (other than depository
institutions) was transferred from the OTS to the
Federal Reserve.
125 See Proposed Agency Information Collection
Activities; Comment Request, 76 FR 7082 (Feb. 8,
2011).
124 Id.
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Financial Report’’ to read ‘‘Call Report
or any successor form the bank is
required to file by its appropriate
Federal banking agency (as defined by
section 3 of the Federal Deposit
Insurance Act (12 U.S.C. 1813))’’.
Two commenters expressed concern
about the use of a Call Report to
determine a bank’s ‘‘equity capital’’
under the rule.126 These commenters
noted that there is no equity capital line
item in the Call Reports of U.S. branches
of foreign banks due to these branches
not being separately incorporated legal
entities.127 Therefore, the proposed Call
Report provision potentially excluded
U.S. branches of foreign banks from
holding reserve accounts. The
commenters stated that for foreign
banks, the equity capital can be found
in other forms, such as Form FR Y–7,
Form FR Y–70, Form 6–K, and Form F–
20, among other financial statements
filed with U.S. regulators.128 One
commenter suggested the Commission
revise the proposed provision to read:
‘‘The amount of the deposit exceeds
10% of the bank’s equity capital (as
reported by the bank in its most recent
Call Report or Thrift Financial Report if
such report includes a line item for
‘equity capital’).’’ 129 Alternatively,
these commenters suggested that in lieu
of a Call Report a U.S. branch of a
foreign bank could periodically obtain a
certificate from the bank stating its
equity capital (or stating that its equity
capital exceeds a specified level).130
The Commission recognizes that the
U.S. branches of some foreign banks
may meet the definition of bank under
section (3)(a)(6) of the Exchange Act
and, therefore, also under paragraph
(a)(7) of Rule 15c3–3.131 However, the
126 See
IIB Letter; SIFMA 4 Letter.
127 Id.
128 Id.
129 See
IIB Letter.
IIB Letter; SIFMA 4 Letter.
131 The term bank as defined in section 3(a)(6) of
the Exchange Act is limited to banks directly
regulated by U.S. state or federal bank regulators.
The determination whether any particular financial
institution meets the requirements of section 3(a)(6)
is the responsibility of the financial institution and
its counsel. See 15 U.S.C. 78c(a)(6); cf. Securities
Issued Or Guaranteed By United States Branches Or
Agencies of Foreign Banks; Interpretive Release,
Securities Act Release No. 6661 (Sept. 23, 1986), 51
FR 34460 (Sept. 29, 1986) (determination as to
whether branch or agency of foreign bank falls
within the definition of bank under section 3(a)(2)
of Securities Act of 1933, 15 U.S.C. 77c(a)(2), is
responsibility of issuers and their counsel).
However, section 4(d) of the International Banking
Act, 12 U.S.C. 3102(d), expressly prohibits agencies
of foreign banks established under federal law from
receiving deposits or exercising fiduciary powers,
criteria necessary for qualification as a bank under
section 3(a)(6)(C) of the Exchange Act. See 12 U.S.C.
3102(d); see also Conference of State Bank
Supervisors v. Conover, 715 F.2d 604 (D.C. Cir.
1983), cert. denied, 466 U.S. 927 (1984) (stating that
130 See
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Commission is retaining the
requirement that the bank’s equity be
determined using its most recent Call
Report because U.S. branches of foreign
banks generally are not FDIC-insured.132
Consequently, deposits at these
institutions would not receive the
protections of FDIC insurance in the
event of a bank failure. FDIC insurance
provides additional protections to cash
deposited in a reserve account at a bank
in the event of a bank failure that would
not be available at an uninsured
bank.133 The Commission, however,
will consider requests for exemptive
relief from broker-dealers that wish to
hold a reserve account at a U.S. branch
of a foreign bank.
For these reasons, the Commission is
adopting the final rule to exclude, when
determining whether a broker-dealer
maintains the minimum deposits
required under paragraph (e) of Rule
15c3–3, cash deposited with an
affiliated bank as well as cash deposited
with an unaffiliated bank ‘‘to the extent
that the amount of the deposit exceeds
15% of the bank’s equity capital as
reported by the bank in its most recent
Call Report or any successor form the
bank is required to file by its
appropriate Federal banking agency (as
defined by section 3 of the Federal
Deposit Insurance Act (12 U.S.C.
1813)).’’ 134 As discussed above, the
Commission is deleting from the final
rule the provision that would have
excluded the amount of cash on deposit
that exceeds 50% of the broker-dealer’s
excess net capital.
federally-chartered agencies of foreign banks are
prohibited from receiving deposits from foreign, as
well as domestic, sources).
132 The FDIC protects depositors’ funds in the
event of the financial failure of their bank or savings
institution. FDIC deposit insurance covers the
balance of each depositor’s account, dollar-fordollar, up to the insurance limit, including
principal and any accrued interest through the date
of the insured bank’s closing. No depositor has
suffered a loss of insured deposits since the FDIC
was created in 1933. See FDIC, When a Bank
Fails—Facts for Depositors, Creditors, and
Borrowers, available at https://fdic.gov/consumers/
banking/facts/. See also Federal Reserve,
Structure and Share Data for U.S. Offices of Foreign
Banks, available at https://www.federalreserve.gov/
releases/iba/.
133 Id. Therefore, the availability of FDIC
insurance could also be a contributing factor to
mitigating the risk that an impairment of the reserve
deposit at an unaffiliated bank will have a material
negative impact on the broker-dealer’s ability to
meet its obligations to customers and PAB account
holders. See Amendments to Financial
Responsibility Rules, 72 FR at 12864.
134 See paragraph (e)(5) of Rule 15c3–3, as
adopted.
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4. Allocation of Customers’ Fully Paid
and Excess Margin Securities to Short
Positions
Paragraph (d) of Rule 15c3–3
currently sets forth steps a broker-dealer
must take to retrieve securities from
non-control locations if there is a
shortfall in the fully paid or excess
margin securities it is required to hold
for its customers. The actions prescribed
in the rule do not include a requirement
that the broker-dealer obtain possession
or control of a fully paid or excess
margin security that is reflected on the
broker-dealer’s stock record as a long
position of a customer that allocates to
a broker-dealer or non-customer short
position. In the simplest case, this
occurs when the carrying broker-dealer
as principal sells short a security to its
own customer. Currently, in such a case,
the broker-dealer is not required to have
possession or control of the security
even though its customer has paid for
the security in full. Rather, the brokerdealer must include the mark-to-market
value of the security as a credit item in
the reserve formula. The broker-dealer
can use the cash paid by the customer
to purchase the security to make any
increased deposit requirement caused
by the credit item.135 As the
Commission stated in the proposing
release, this permits the broker-dealer,
in effect, to partially monetize the
customer’s security.136 This result is
contrary to the customer protection
goals of Rule 15c3–3, which seek to
ensure that broker-dealers do not use
customer assets for proprietary
purposes.137
To address these concerns, the
Commission proposed an amendment to
Rule 15c3–3 that would have required a
broker-dealer to obtain physical
possession or control of customer fully
paid and excess margin securities that
allocate to a broker-dealer short
position.138 Specifically, the proposed
amendment would have added a fifth
step to take when a deficit arose in the
amount of securities the broker-dealer
was required to maintain in possession
or control; namely that for ‘‘[s]ecurities
included on [the broker-dealer’s] books
or records as a proprietary short
position or as a short position for
another person, excluding positions
135 In effect, the broker-dealer has monetized the
customer’s security and has to purchase or borrow
it, at a future date, to return the customer’s fully
paid securities.
136 See Amendments to Financial Responsibility
Rules, 72 FR at 12865.
137 See, e.g., Customer Protection Rule, Exchange
Act Release No. 22499 (Oct. 3, 1985), 50 FR 41337
(Oct. 10, 1985).
138 See Amendments to Financial Responsibility
Rules, 72 FR at 12865.
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51835
covered by paragraph (m) of this
section, for more than 10 business days
(or more than 30 calendar days if the
broker or dealer is a market maker in the
securities), [. . .] the broker or dealer
shall, not later than the business day
following the day on which the
determination is made, take prompt
steps to obtain physical possession or
control of such securities.’’ 139
Eleven commenters addressed this
proposed amendment.140 Three
commenters urged the Commission to
disallow naked short selling of
securities and one argued that the
Commission should force short sellers
to pre-borrow.141 Three commenters
generally opposed the proposed rule.
They argued that the credit item added
to the reserve formula computation
when a customer’s fully paid or excess
margin security allocates to a short
position provides the customer with
adequate protection.142 Two of these
commenters requested that the 30
calendar days allowed for a brokerdealer acting as a market maker to
obtain possession or control over
securities allocating to a short position
be expanded to include all situations
where a broker-dealer must act pursuant
to the rule (i.e., not be limited to market
maker positions).143 These commenters
argued that it would be difficult to
distinguish between market maker and
non-market maker positions in
complying with the proposed rule.
Another commenter requested that the
Commission reevaluate the proposed
amendment because of its potential
effects on investment and hedging
strategies in addition to the heavy
139 Id.
at 12895.
Glenn Letter; Bare Letter; Anonymous
Letter; SIFMA 2 Letter; First Clearing Letter; Hearne
Letter; Deutsche Bank Securities Letter; Citigroup
Letter; AMEX Letter; SIFMA 4 Letter; Federated 6
Letter; Raymond James 2 Letter.
141 See Glenn Letter; Bare Letter; Anonymous
Letter; Hearne Letter. The Commission has taken a
number of measures to strengthen investor
protections against potentially abusive ‘‘naked’’
short selling, including adopting rules requiring
that fails to deliver resulting from short sales
immediately be closed-out and expressly targeting
fraud in short selling transactions. See Amendments
to Regulation SHO, Exchange Act Release No.
60388 (July 27, 2009), 74 FR 38266 (July 31, 2009);
‘‘Naked’’ Short Selling Antifraud Rule, Exchange
Act Release No. 58774 (Oct. 14, 2008), 73 FR 61666
(Oct. 17, 2008). In addition, the Commission
adopted a short sale-related price test that, if
triggered, imposes a restriction on the prices at
which securities may be sold short. See
Amendments to Regulation SHO, Exchange Act
Release No. 61595 (Feb. 26, 2010), 75 FR 11232
(Mar. 10, 2010).
142 See First Clearing Letter; Deutsche Bank
Securities Letter; Citigroup Letter.
143 See Citigroup Letter; Deutsche Bank Securities
Letter.
140 See
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burden it will impose on short sales.144
One commenter supported the
amendments noting that it had ‘‘come to
believe . . . that the Commission’s
proposal is consistent with the direction
of the Commission’s other short sale
regulations. . . .’’ 145
As discussed above in section
II.A.2.ii. of this release, the Commission
has determined that a credit item is
sufficient to protect PAB account
holders if the carrying broker-dealer
provides them with notice that it may be
using their non-margin securities, as
well as the opportunity to object to such
use. The use of the non-margin
securities of PAB account holders is a
long-standing industry practice. In
contrast, customers under Rule 15c3–3,
which include the carrying brokerdealer’s retail customers, have an
expectation that the fully paid and
excess margin securities reflected on
their account statements are, in fact, in
the possession or control of the carrying
broker-dealer. However, as described
above, this expectation may be
frustrated where the securities are
allocated to a short position carried by
the broker-dealer, as the securities are
not in the possession or control of the
broker-dealer.
This gap in the existing rule, in effect,
permits the broker-dealer to partially
monetize the customer’s security. Also,
under some circumstances (e.g., a
change in the market value of the
securities), the amount the broker-dealer
may have on deposit in the customer
reserve account as a consequence of the
credit item may be less than the value
of the securities. Consequently, if the
broker-dealer fails, sufficient funds may
not be readily available to purchase the
securities to return them to customers.
The use of customer securities in this
manner is contrary to the customer
protection goals of Rule 15c3–3 and the
expectations of a broker-dealer’s
customers.146 For these reasons, the
Commission is adopting the
amendment.147 The Commission agrees,
however, that the proposed distinction
based upon a broker-dealer’s market
maker status could present operational
challenges and, consequently, the final
rule has been modified to allow a
uniform period of 30 calendar days
before the possession and control
requirement is triggered.
Specifically, as adopted, paragraph
(d)(4) of Rule 15c3–3 requires a broker144 See
Raymond James 2 Letter.
SIFMA 4 Letter. SIFMA originally opposed
the proposed amendments. See SIFMA 2 Letter.
146 See supra notes 12 and 18, and accompanying
text.
147 Current paragraph (d)(4) of Rule 15c3–3 is
being re-designated paragraph (d)(5), as proposed.
145 See
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dealer to take prompt steps to obtain
physical possession or control over
securities of the same issue and class as
those included ‘‘on the broker’s or
dealer’s books or records that allocate to
a short position of the broker or dealer
or a short position for another person,
excluding positions covered by
paragraph (m) of this section, for more
than 30 calendar days. . . .’’ 148 The
Commission does not believe that
lengthening the time from 10 business
days to 30 calendar days for non-market
maker positions will significantly
diminish the protections provided by
the new rule.149 Therefore, the
Commission is adopting a uniform 30
calendar day time period in the final
rule.
Three commenters requested that the
Commission clarify that the aging
process begins when the Rule 15c3–3
possession and control deficit arises and
not when the short transaction is
executed.150 The proposed amendment
was designed to require that the aging
process commence at the time a deficit
in securities allocating to a short
position arises. One commenter 151 also
requested that the Commission modify
the proposed amendment to specifically
exclude an underwriter’s short position
created in connection with a
distribution of securities until after the
later of the completion of such
underwriter’s participation in the
distribution (as defined in Rule 100 of
Regulation M) 152 or the delivery date
148 See Amendments to Financial Responsibility
Rules, 72 FR at 12865–12866. The amendment will
not apply to securities that are sold long for a
customer but not obtained from the customer
within ten days after the settlement date. This
circumstance is addressed by paragraph (m) of Rule
15c3–3, which requires the broker-dealer to close
the transaction by purchasing securities of like kind
and quantity. 17 CFR 240.15c3–3(m).
149 For example, the rule currently has a thirty
calendar day time period for securities failed to
receive and a forty-five calendar day time period for
securities receivable as a result of corporate actions
(e.g., stock splits) before the broker-dealer must take
prompt steps to obtain possession or control of such
securities. See 17 CFR 240.15c3–3(d)(2)–(3).
150 See Deutsche Bank Securities Letter; Citigroup
Letter; SIFMA 2 Letter.
151 See SIFMA 2 Letter. The commenter stated:
‘‘Regulation M embodies a carefully crafted scheme
for the regulation of secondary market transactions
by underwriters and other distribution participants,
including the regulation of ‘syndicate covering
transactions,’ which should not be disrupted by
proposed paragraph (d)(4).’’ Id. In addition, SIFMA
commented that where an underwriter sells short to
a customer in anticipation of obtaining the
securities through the exercise of an overallotment
option, paragraph (d)(4) should not require the
premature exercise of the overallotment option or
the use of secondary market purchases instead of
the overallotment option. Id.
152 17 CFR 242.100 through 242.105. More
specifically, Rule 100 of Regulation M provides:
‘‘For purposes of regulation M . . . the following
definitions shall apply: . . . Completion of
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for securities acquired in the exercise of
any overallotment option (or ‘‘Green
Shoe’’).153 The Commission agrees with
the commenter that there should be
consistency between the final rule and
Regulation M.154 Consequently, the
Commission has added a sentence to the
final rule to clarify that the 30 calendar
day period with respect to a syndicate
short position established in connection
with an offering does not begin to run
until the underwriter’s participation in
the distribution is complete as
determined pursuant to Rule 100(b) of
Regulation M.155 Finally, the
Commission is adopting the revision to
paragraph (n) as proposed to permit
broker-dealers to apply to their
designated examining authority
(‘‘DEA’’) for extensions of time related
to paragraph (d)(4).156
5. Importation of Rule 15c3–2
Requirements Into Rule 15c3–3 and
Treatment of Free Credit Balances
i. Importation of Rule 15c3–2
Rule 15c3–2 requires a broker-dealer
holding free credit balances to provide
its customers (defined as any person
other than a broker-dealer) at least once
every three months with a statement of
the amount due the customer and a
notice that: (1) the funds are not being
segregated, but rather are being used in
the broker-dealer’s business; and (2) the
funds are payable on demand. The rule
was adopted in 1964, before the
participation in a distribution. . . . A person shall
be deemed to have completed its participation in
a distribution as follows: . . . (2) [a]n underwriter,
when such person’s participation has been
distributed, including all other securities of the
same class that are acquired in connection with the
distribution, and any stabilization arrangements
and trading restrictions in connection with the
distribution have been terminated; Provided,
however, that an underwriter’s participation will
not be deemed to have been completed if a
syndicate overallotment option is exercised in an
amount that exceeds the net syndicate short
position at the time of such exercise. . . .’’ 17 CFR
242.100(b).
153 A green shoe or overallotment option is a
provision contained in an underwriting agreement
that gives the underwriting syndicate the right to
purchase additional shares from the issuer or
selling security holders (in addition to those
initially underwritten by the syndicate) for the
purpose of covering any overallotments that are
made on behalf of the syndicate in connection with
an offering of securities.
154 Rule 100 of Regulation M also provides that
an underwriter’s participation will not be deemed
to have been completed if a syndicate overallotment
option is exercised in an amount that exceeds the
net syndicate short position at the time of exercise.
17 CFR 242.100(b).
155 17 CFR 242.100(b).
156 SROs generally have procedures in place for
broker-dealers to apply for extensions of time under
paragraph (n) of Rule 15c3–3. See, e.g., FINRA Rule
4230.
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adoption of Rule 15c3–3 in 1972.157
Since the adoption of Rule 15c3–3,
broker-dealers have been limited in
their use of customer free credit
balances. The Commission proposed
importing requirements in Rule 15c3–
2 158 into Rule 15c3–3 and eliminating
Rule 15c3–2 as a separate rule in the
Code of Federal Regulations.159 The
Commission received two comments
supporting the proposal.160
The Commission is adopting the
amendments substantially as
proposed—deleting Rule 15c3–2 and
adding paragraph (j)(1) to Rule 15c3–3.
The Commission believes it is
appropriate to eliminate Rule 15c3–2 as
a separate rule because it is largely
irrelevant in light of the requirements in
Rule 15c3–3. Further, the provisions in
Rule 15c3–2 that the Commission
wishes to retain are being re-codified in
Rule 15c3–3. These provisions include
the requirement that broker-dealers
inform customers of the amounts due to
them and that such amounts are payable
on demand.161 Consequently, the
Commission is amending Rule 15c3–3
to add new paragraph (j)(1), which
provides that ‘‘[a] broker or dealer must
not accept or use any free credit balance
carried for the account of any customer
of the broker or dealer unless such
broker or dealer has established
adequate procedures pursuant to which
each customer for whom a free credit
balance is carried will be given or sent,
together with or as part of the
customer’s statement of account,
whenever sent but not less frequently
than once every three months, a written
statement informing the customer of the
amount due to the customer by the
broker or dealer on the date of the
statement, and that the funds are
payable on demand of the customer.’’ 162
157 See Customers’ Free Credit Balances,
Exchange Act Release No. 7266 (Mar. 12, 1964), 29
FR 7239 (June 3, 1964).
158 17 CFR 240.15c3–2.
159 See Amendments to Financial Responsibility
Rules, 72 FR at 12867.
160 See SIFMA 2 Letter; SIFMA 4 Letter.
161 Rule 15c3–2 contains an exemption for brokerdealers that also are banking institutions supervised
by a Federal authority. This exemption will not be
imported into Rule 15c3–3 because there are no
broker-dealers left that fit within the exemption.
Further, the definition of customer for purposes of
the imported 15c3–2 requirements will be the
definition of customer in Rule 15c3–3, which is
somewhat narrower than the definition in Rule
15c3–2.
162 See paragraph (j)(1) of Rule 15c3–3, as
adopted. The Commission also modified the phrase
‘‘[i]t shall be unlawful for a broker or dealer to’’ to
the phrase ‘‘[a] broker or dealer must not’’ in order
to avoid using the term ‘‘unlawful.’’ Any violation
of the rules and regulations promulgated under the
Exchange Act is unlawful and therefore it is
unnecessary to use this phrase in the final rule.
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ii. Treatment of Free Credit Balances
Free credit balances are funds payable
by a broker-dealer to its customers on
demand.163 They may result from cash
deposited by the customer to purchase
securities, proceeds from the sale of
securities or other assets held in the
customer’s account, or earnings from
dividends and interest on securities and
other assets held in the customer’s
account. Broker-dealers may, among
other things, pay interest to customers
on their free credit balances or offer to
routinely transfer (‘‘sweep’’) them to a
money market fund or bank account. On
occasion, broker-dealers have changed
the product to which a customer’s free
credit balances are swept—in recent
years, most frequently from a money
market fund to an interest bearing bank
account. Because of differences in these
two types of products, including the
type of protection afforded the customer
in the event of insolvency, there may be
investment consequences to the
customer when changing from one
product to the other. The money market
shares—as securities—would receive up
to $500,000 in SIPA protection in the
event the broker-dealer failed. The bank
deposits—as cash—would receive up to
$250,000 in protection from the FDIC in
the event the bank failed. On the other
hand, the money market fund shares
may incur market losses; whereas, the
full amount of the bank deposit would
be guaranteed up to the FDIC’s $250,000
limit. There also may be differences in
the amount of interest earned from the
two products. In short, there may be
consequences to moving a customer’s
free credit balances from one product to
another, and, accordingly, customers
should have a sufficient opportunity to
make an informed decision.164
The Commission proposed
amendments to Rule 15c3–3 that would
have established conditions required to
be met in order for a broker-dealer to
use or transfer free credit balances in a
customer’s securities account.165 More
specifically, as initially proposed, the
amendments would have structured the
new rule to make it unlawful for a
broker-dealer to convert, invest, or
otherwise transfer to another account or
institution free credit balances held in a
customer’s account except as provided
in the proposed rule.166 The proposed
rule then prescribed three conditions to
address three different scenarios
involving the use or transfer of customer
free credit balances. The first scenario
163 See
17 CFR 240.15c3–3(a)(8).
Amendments to Financial Responsibility
Rules, 72 FR at 12866.
165 Id. at 12866–12867.
166 Id. at 12866.
164 See
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51837
involved the use or transfer of free
credit balances outside the context of a
routine sweep to a money market fund
or bank. As discussed below, proposed
paragraph (j)(2)(i) would have
prohibited the use or transfer of free
credit balances in this scenario unless
the customer had specifically ordered or
authorized the transaction. The second
and third scenarios involved the use or
transfer of free credit balances in the
context of a program to routinely sweep
them to a money market fund or bank
account (a ‘‘sweep program’’). As
discussed below, proposed paragraph
(j)(2)(ii) would have addressed sweep
program requirements for accounts
opened after the effective date of the
rule (‘‘new accounts’’) and proposed
paragraph (j)(2)(iii) would have
addressed sweep program requirements
for accounts existing as of the effective
date of the rule (existing accounts). The
Commission is adopting new paragraph
(j)(2) to Rule 15c3–3 with substantial
modifications from the proposed rule in
response to comments and to clarify
certain portions of the rule.167
As proposed, the first sentence of
paragraph (j)(2) of the rule would have
established the prohibition with respect
to the treatment of free credit balances
by providing that ‘‘[i]t shall be unlawful
for a broker or dealer to convert, invest,
or otherwise transfer to another account
or institution, free credit balances held
in a customer’s account except as
provided in paragraphs (j)(2)(i), (ii) and
(iii).’’ 168 The Commission received one
comment in response to the proposed
text of this first sentence.169 The
commenter expressed concern that the
proposed text in the first sentence of
paragraph (j)(2) could be construed
broadly, in effect, to prohibit a brokerdealer from using, investing, or
transferring cash deposits that are not
swept to other investments or products
(and are included as credits in the
reserve formula) in the normal course of
the broker-dealer’s business, as is
currently permitted by Rule 15c3–3. The
commenter suggested that the text be
167 In 2005, the NYSE addressed the issue of
disclosure in a sweep program context by issuing
an information memo to its members discussing,
among other things, the disclosure responsibilities
of a broker-dealer offering a sweep program to its
customers. See Information Memo 05–11 (Feb. 15,
2005). The memo stated that broker-dealers should
disclose material differences in interest rates
between the different sweep products and, with
respect to the bank sweep program, further disclose
the terms and conditions, risks and features,
conflicts of interest, current interest rates, manner
by which future interest rates will be determined,
and the nature and extent of FDIC and SIPC
protection.
168 See Amendments to Financial Responsibility
Rules, 72 FR at 12896.
169 See SIFMA 2 Letter.
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revised to clarify the scope of the
proposed rule by prohibiting a brokerdealer from deducting a free credit
balance from the customer’s account at
the broker-dealer and transferring it to
another institution and investing it in
another instrument on behalf of the
customer, except as permitted under
paragraph (j)(2).170
In response to the comment, as a
preliminary matter, cash balances in
customer securities accounts must be
included as credits in the customer
reserve formula. Further, the net amount
of the credits over debits must be
deposited in a customer reserve account
in the form of cash or qualified
securities. However, cash credit items
that are net of debit items can be used
by the broker-dealer for the limited
purpose of facilitating transactions of its
customers.171 The commenter suggested
that proposed paragraph (j)(2) of Rule
15c3–3 could be interpreted to impose
new limits on a broker-dealer’s ability to
use cash that is an asset on the firm’s
balance sheet. In response to this
concern, the Commission notes that the
prohibition in the first sentence of
proposed paragraph (j)(2) of Rule 15c3–
3 is intended to place conditions only
on the broker-dealer’s ability to convert
the cash asset of the customer (i.e., a
receivable from the broker-dealer) into a
different type of asset (e.g., a security or
an obligation of another institution
outside the context of a sweep program)
or to transfer the customer’s cash asset
to another account.
The Commission is adopting
paragraph (j)(2) of Rule 15c3–3 with
certain technical modifications.172 As
adopted paragraph (j)(2) reads: ‘‘A
broker or dealer must not convert,
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170 Id.
171 See 17 CFR 240.15c3–3(e)(2) (‘‘It shall be
unlawful for any broker or dealer to accept or use
any of the amounts under items comprising Total
Credits under the formula referred to in paragraph
(e)(1) of this section except for the specified
purposes indicated under items comprising Total
Debits under the formula, and, to the extent Total
Credits exceed Total Debits, at least the net amount
thereof shall be maintained in the Reserve Bank
Account pursuant to paragraph (e)(1) of this
section.’’).
172 Specifically, the Commission is replacing the
phrase ‘‘[i]t shall be unlawful for a broker or dealer
to’’ with the phrase ‘‘[a] broker or dealer must not’’
because—as noted above—any violation of the rules
and regulations promulgated under the Exchange
Act is unlawful and therefore it is unnecessary to
use this phrase in the final rule. The Commission
also is replacing the phrase ‘‘free credit balance’’
with the phrase ‘‘credit balances’’ to clarify that this
provision covers both free credit balances and other
credit balances. See 17 CFR 240.15c3–3(a)(8)–(9)
(defining free credit balances and other credit
balances). The Commission is deleting the word
‘‘otherwise’’ because it would be redundant.
Finally, the rule text does not include a reference
to paragraph (j)(2)(iii), as proposed, because this
paragraph was deleted from the final rule text.
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invest, or transfer to another account or
institution, credit balances held in a
customer’s account except as provided
in paragraphs (j)(2)(i) and (ii) of this
section.’’ 173
a. Treatment of Free Credit Balances
Outside of a Sweep Program
As proposed, paragraph (j)(2)(i) of
Rule 15c3–3 would have permitted a
broker-dealer to convert, invest or
otherwise transfer to another account or
institution free credit balances held in a
customer’s account only upon a specific
order, authorization, or draft from the
customer, and only in the manner, and
under the terms and conditions,
specified in the order, authorization, or
draft.174 This catchall provision would
have applied to any use or transfer of
customer free credit balances outside
the context of a sweep program.
The Commission proposed paragraph
(j)(2)(i) in order to comprehensively
cover the range of possibilities with
respect to the disposition of free credit
balances in a customer account other
than pursuant to a sweep program. The
Commission received two comments
recommending that proposed paragraph
(j)(2)(i) be clarified to permit a brokerdealer to obtain a one-time consent to
ongoing transfers of any free credit
balances to a customer to another
account, entity or product (outside of a
sweep program).175 The commenters
noted that customers, for example, may
prefer that free credit balances be
regularly transferred to a linked account
in their name at another broker-dealer or
bank that is not part of a sweep
program, and that this clarification
would enable a broker-dealer to
efficiently handle such customer
requests by eliminating the need to
obtain individual ‘‘specific orders’’ for
repeated transfers that are substantially
identical.176 The Commission agrees
with the commenters that a customer
may consent to ongoing routine
transfers from the customer’s account
outside of a sweep program without
obtaining the customer’s specific
consent for each individual transfer,
provided the customer has consented to
the ongoing transfers under paragraph
(j)(2)(i) of Rule 15c3–3. This scenario
would already be covered by the
proposed rule, and, therefore, the
Commission is adopting paragraph
(j)(2)(i) substantially as proposed, with
173 See paragraph (j)(2) of Rule 15c3–3, as
adopted.
174 See Amendments to Financial Responsibility
Rules, 72 FR at 12866.
175 See SIFMA 2 Letter; E*Trade 2 Letter.
176 Id.
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certain technical modifications.177 As
adopted, paragraph (j)(2)(i) of Rule
15c3–3 reads: ‘‘A broker or dealer is
permitted to invest or transfer to another
account or institution, free credit
balances in a customer’s account only
upon a specific order, authorization, or
draft from the customer, and only in the
manner, and under the terms and
conditions, specified in the order,
authorization, or draft.’’ 178
Finally, one commenter stated that
both regulators and firms need the
flexibility to remove funds from a
reserve account to cover extraordinary
requests for payment of customer free
credit balances.179 However, the
commenter noted that ‘‘in light of recent
market events, we withdraw our earlier
proposal to allow such withdrawals
under specified conditions and instead
recommend that such withdrawals be
permitted only by approval of
Commission staff or a broker-dealer’s
[DEA].’’ 180 Broker-dealers currently
may make withdrawals under paragraph
(g) of Rule 15c3–3.181 In light of the
risks that could arise to customer funds,
the Commission does not believe it
would be appropriate at this time to
expand a firm’s ability to make
additional withdrawals from its reserve
account.
b. Treatment of Free Credit Balances in
a Sweep Program
The second and third set of
conditions in the proposed rules
addressed using or transferring free
credit balances in the context of a sweep
program.182 In particular, the
Commission proposed four conditions
with respect to using or transferring free
credit balances in a sweep program. A
broker-dealer would have been required
to meet: (1) all four conditions with
respect to free credit balances in new
accounts; 183 and (2) the second, third,
and fourth conditions with respect to
177 See paragraph (j)(2)(i) of Rule 15c3–3, as
adopted. The technical changes delete the words
‘‘convert’’ and ‘‘otherwise’’ from the final rule
because a broker-dealer would be prohibited from
‘‘converting’’ a customer’s free credit balances and,
therefore, it is not necessary to include the word in
the final rule. The word ‘‘otherwise’’ is redundant.
178 Id.
179 See SIFMA 4 Letter.
180 Id. In its June 15, 2007 comment letter, SIFMA
urged ‘‘the Commission to consider allowing a
broker-dealer to remove funds from a reserve
account to cover a large same-day request for
payment of a free credit balance, as long as the free
credit balance was included in the latest Rule 15c3–
3 reserve computation and the broker-dealer begins
a new reserve computation as of that date.’’ See
SIFMA 2 Letter.
181 17 CFR 240.15c3–3(g).
182 See Amendments to Financial Responsibility
Rules, 72 FR at 12866.
183 See paragraph (j)(2)(ii)(A)–(D) of Rule 15c3–3,
as adopted.
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Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 / Rules and Regulations
free credit balances in existing
accounts.184 The four conditions were:
1. The customer has previously
affirmatively consented to such
treatment of the free credit balances
after being notified of the different
general types of money market mutual
fund and bank account products in
which the broker or dealer may transfer
the free credit balances and the
applicable terms and conditions that
would apply if the broker or dealer
changes the product or type of product
in which free credit balances are
transferred;
2. The broker or dealer provides the
customer on an ongoing basis with all
disclosures and notices regarding the
investment and deposit of free credit
balances as required by the selfregulatory organizations for which the
broker or dealer is a member;
3. The broker or dealer provides
notice to the customer as part of the
customer’s quarterly statement of
account that the money market mutual
funds or bank deposits to which the free
credit balances have been transferred
can be liquidated on the customer’s
demand and held as free credit
balances; and
4. The broker or dealer provides the
customer with at least 30 calendar days
notice before the free credit balances
would begin being transferred to a
different product, different product
type, or into the same product but under
materially different terms and
conditions. The notice must describe
the new money market fund, bank
deposit type, or terms and conditions,
and how the customer can notify the
broker or dealer if the customer chooses
not to have the free credit balances
transferred to the new product or
product type, or under the new terms
and conditions.
Commenters generally agreed with the
fundamental principle embodied in the
proposal—that customer free credit
balances should not be transferred from
an obligation of the broker-dealer to an
obligation of another entity without the
customer’s authorization.185 Other
commenters supported the proposed
disclosures but suggested additional
disclosures be made to customers,
including clarification with respect to
other protections available to the
customer.186 Two commenters stated
that the practice of sweep programs
should be banned entirely or that the
Commission should adopt a ‘‘harder
184 See paragraph (j)(2)(iii)(A)–(C) of Rule 15c3–
3, as adopted.
185 See SIFMA 2 Letter; First Clearing Letter; Pace
Letter.
186 See SIPC Letter.
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stance’’ and require more than just
disclosure.187 One commenter
responded to the Commission’s request
for comment as to the cost burdens that
would result if the first condition (set
forth in proposed paragraph (j)(2)(ii)(A))
to obtain a new customer’s prior
agreement were to be applied to existing
customers. The commenter stated that
such costs would be substantial because
broker-dealers would be required to
amend their agreements with all
existing customers.188 One commenter
stated that the amendments in the
proposing release did not adequately
address situations in which brokerdealers change customer account
elections without first obtaining
customer authorization.189
In adopting the final rule, the
Commission has made some
modifications to the language in the
proposed rule in response to
commenters and to clarify its
application. For clarification and in
response to comments, the Commission
has defined the term Sweep Program in
paragraph (a)(17) of Rule 15c3–3 to
identify the types of transactions and
products to which the new provisions
apply.
Commenters raised concerns about
limitations on the types of products
broker-dealers could use for sweep
arrangements under the proposed
amendments. Three commenters
suggested that the Commission should
not limit the types of products brokerdealers can use for sweep arrangements
to money market funds and bank
deposit products.190
Sweep programs provide a
mechanism for excess cash in a
customer’s securities account to be held
in a manner that allows the customer to
earn interest on the funds but retain the
flexibility to quickly access that cash to
purchase securities or withdraw it.191 In
effect, transferring this excess cash to a
bank account or money market fund is
an alternative to retaining a credit
balance in the customer’s securities
187 See Ellis Letter; Dworkin Letter. One
commenter stated that broker-dealers profit from
‘‘excessive’’ fees charged to clients who opt out of
the sweep programs. See Ellis Letter. The second
commenter suggested that the broker-dealer’s
‘‘customer has been effectively denied the
opportunity to opt out of bank account sweeps by
[the broker-dealer] preventing him or her from
utilizing any other vehicle to park his or her free
credit balances. . . .’’ See Dworkin Letter. The
commenter noted that by opting out of the sweep,
the customer is ‘‘confined to a situation where the
free credit balance cannot earn any kind of return
at all[.]’’ Id.
188 See SIFMA 2 Letter.
189 See Waddell Letter.
190 See SIFMA 2 Letter; First Clearing Letter;
Raymond James 2 Letter.
191 See Ellis Letter; Dworkin Letter.
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51839
account. The final rule is designed to
accommodate this alternative by
providing broker-dealers with flexibility
in the operation of sweep programs. The
Commission believes it is appropriate to
confine this flexibility to products that
approximate the holding of a customer’s
excess cash in a securities account. The
Commission does not view sweep
accounts as a mechanism for investing
customers’ excess cash without their
specific consent in longer term or more
volatile assets. For these reasons, the
Commission does not believe it would
be appropriate to expand the products
covered by the final rule beyond money
market funds as described in Rule 2a–
7 under the Investment Company Act of
1940 or an account at an insured bank
as described in paragraph (a)(17) of Rule
15c3–3.
Consequently, paragraph (a)(17) of
Rule 15c3–3, as adopted, states ‘‘[t]he
term Sweep Program means a service
provided by a broker or dealer where it
offers to its customers the option to
automatically transfer free credit
balances in the securities account of the
customer to either a money market
mutual fund product as described in
[Rule 2a–7] or an account at a bank
whose deposits are insured by the
Federal Deposit Insurance
Corporation.’’ 192 The Commission
intended that the definition of Sweep
Program provide that the bank to which
free credits are swept be insured by the
FDIC.193 The revised text of the rule
makes this explicit. Finally, under this
definition, a one-time or other special
transfer of a customer’s free credit
balances would not qualify as a Sweep
Program.
Three commenters raised the issue of
bulk transfers.194 They argued that the
rule should allow broker-dealers to
process bulk transfers of customer assets
between, for instance, one money
market fund and another money market
fund or a bank deposit product and a
money market fund. These commenters
identify a potential ambiguity in the
rule as proposed; namely, how transfers
from one Sweep Program product to
another Sweep Program product are to
be handled under the rule if they do not
involve passing funds through the
192 See paragraph (a)(17) of Rule 15c3–3, as
adopted.
193 See Amendments to Financial Responsibility
Rules, 72 FR at 12866 (‘‘[T]he bank deposit would
be guaranteed up to the FDIC’s $100,000 limit.’’).
FDIC insurance covers all deposit accounts,
including checking and savings accounts, money
market deposit accounts and certificates of deposit.
The standard insurance amount is currently
$250,000 per depositor, per insured bank, for each
account ownership category. 12 CFR 330.1(o).
194 See SIFMA 2 Letter; First Clearing Letter;
E*Trade 2 Letter.
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customer’s securities account. To
address this issue, paragraph (j)(2)(ii) of
Rule 15c3–3 is being modified from the
proposal to clarify that the conditions
for operating a Sweep Program (which
are set forth in paragraphs (j)(2)(ii)(A)
and (B)) will apply to: (1) The transfer
of free credit balances from a customer’s
securities account to a product in a
Sweep Program; and (2) the transfer of
a customer’s interest in one Sweep
Program product to another Sweep
Program product. This will address both
bulk transfers 195 of customer positions
from one product (e.g., a money market
fund) to another (e.g., a bank deposit
product) and transfers of individual
customer positions from one product to
another.
The Commission is modifying
paragraph (j)(2)(ii) of Rule 15c3–3 from
the proposal to delete the phrase ‘‘to
either a money market mutual fund as
described in § 270.2a–7 of this chapter
or an interest bearing account at a bank
without a specific order, authorization
or draft for each such transfer,
provided’’ and instead to use the term
Sweep Program as defined in paragraph
(a)(17) of the final rule. The Commission
also replaced the phrase ‘‘the account of
a customer’’ with the phrase ‘‘a
customer’s securities account’’ to clarify
that paragraph (j)(2)(ii) and its required
conditions apply to the transfer of free
credit balances in connection with a
customer’s securities account, in
addition to the bulk transfers described
above.196 As adopted, paragraph (j)(2)(ii)
to Rule 15c3–3 reads, in pertinent part:
‘‘[a] broker or dealer is permitted to
transfer free credit balances held in a
customer’s securities account to a
product in its Sweep Program or to
transfer a customer’s interest in one
product in a Sweep Program to another
product in a Sweep Program, provided’’
the conditions set forth in paragraphs
(j)(2)(ii)(A) and (B) are met.197
195 See
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also NASD Rule 2510 (Discretionary
Accounts) (providing an exception from the NASD
rule for ‘‘bulk exchanges at net asset value of money
market mutual funds . . . utilizing negative
response letters provided: (A) The bulk exchange is
limited to situations involving mergers and
acquisitions of funds, changes of clearing members
and exchanges of funds used in sweep accounts; (B)
The negative response letter contains a tabular
comparison of the nature and amount of the fees
charged by each fund; (C) The negative response
letter contains a comparative description of the
investment objectives of each fund and a prospectus
of the fund to be purchased; and (D) The negative
response feature will not be activated until at least
30 days after the date on which the letter was
mailed.’’).
196 The final rule also deletes the phrase ‘‘opened
on or after the effective date of this paragraph’’ from
paragraph (j)(2)(ii) and moves it to paragraph
(j)(2)(ii)(A), as described below.
197 See paragraph (j)(2)(ii) of Rule 15c3–3, as
adopted.
As adopted, paragraphs (j)(2)(ii)(A)
and (B) establish four conditions that
must be met to lawfully transfer a
customer’s free credit balances to a
product in a Sweep Program or to
transfer a customer’s interest directly
from one product in a Sweep Program
to another product in a Sweep Program.
The first condition—set forth in
paragraph (j)(2)(ii)(A)—applies only
with respect to accounts opened on or
after the effective date of the rule. This
addresses the burden that would have
been associated with having brokerdealers re-document existing accounts.
The remaining three conditions—set
forth in paragraph (j)(2)(ii)(B)(1) through
(3)—apply to both existing and new
accounts.
Paragraph (j)(2)(ii)(A), as adopted,
provides that for an account opened on
or after the effective date of the rule, the
customer must give prior written
affirmative consent to having free credit
balances in the customer’s securities
account included in the Sweep Program
after being notified: (1) Of the general
terms and conditions of the products
available through the Sweep Program;
and (2) that the broker or dealer may
change the products available under the
Sweep Program.198
As stated above, the Commission has
modified paragraph (j)(2)(ii)(A) in the
final rule to read ‘‘the customer gives
prior written affirmative consent to
having free credit balances in the
customer’s securities account included
in the Sweep Program after being
notified. . . .’’ 199 The Commission
modified this paragraph to incorporate
the term Sweep Program as defined in
paragraph (a)(17) of the rule and the
reference to the ‘‘customer’s securities
account’’ to make this paragraph
consistent with other modifications to
paragraph (j)(2) of the final rule.
Additionally, the Commission modified
this paragraph to clarify that the
customer’s consent must be written,
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198 See paragraph (j)(2)(ii)(A) of Rule 15c3–3, as
adopted.
199 Id. The proposed rule stated the ‘‘customer has
previously affirmatively consented to such
treatment of the free credit balances after being
notified of . . . .’’ In addition, as noted above, the
phrase ‘‘accounts opened on or after the effective
date of this paragraph’’ was deleted from proposed
paragraph (j)(2)(ii) and moved to paragraph
(j)(2)(ii)(A), with the reference to specific paragraph
(j)(2)(ii) inserted after the word ‘‘paragraph.’’
Moving this phrase to paragraph (j)(2)(ii)(A)
simplifies the final rule by eliminating the necessity
of codifying two largely overlapping sets of
conditions, with three of the conditions being
repeated in both paragraphs. The effect of this
change is to make the first condition only
applicable to new accounts and the remaining
conditions (paragraph (j)(2)(ii)(B)(1) through (3))
applicable to both new and existing accounts. The
word ‘‘accounts’’ also has been replaced with the
phrase ‘‘an account.’’
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consistent with the discussion in the
proposing release, which noted
customer consent could be given in an
account opening agreement.200
The Commission received one
comment stating that the text of
proposed paragraph (j)(2)(ii)(A) that
would have required the disclosure of
‘‘applicable terms and conditions that
will apply if the broker or dealer
changes the product or type of product’’
could be read to require highly specific
disclosure about product terms and
conditions that may only be established
or modified in the future and, therefore,
are unknown at the time the customer
opens an account with the brokerdealer.201 In addition, the commenter
stated that under proposed paragraph
(j)(2)(ii)(D), a broker-dealer would
already be required to describe any
changes to the terms and conditions it
makes contemporaneously with such
changes. Given this type of notice, the
commenter stated that there is no need
for the type of generalized (and
therefore less effective) disclosure that
would have been required by paragraph
(j)(2)(ii)(A). The Commission agrees
with the commenter and, therefore, has
deleted the phrase ‘‘transfer the free
credit balances and the applicable terms
and conditions that will apply if the
broker or dealer changes the product or
type of product in which the free credit
balances are transferred. . . .’’ In its
place, the Commission is adopting
language in paragraph (j)(2)(ii)(A)(2) of
Rule 15c3–3 under which the brokerdealer must notify the customer that the
broker or dealer may change the
products available under the Sweep
Program.202
Paragraph (j)(2)(ii)(B), as adopted,
prescribes the following three
conditions to sweeping the customer’s
free credit balances in a new or existing
account:
• The broker-dealer provides the customer
with the disclosures and notices regarding
the Sweep Program required by each SRO of
which the broker-dealer is a member; 203
• The broker-dealer provides notice to the
customer, as part of the customer’s quarterly
statement of account, that the balance in the
bank deposit account or shares of the money
market mutual fund in which the customer
has a beneficial interest can be liquidated on
the customer’s order and the proceeds
200 See Amendments to Financial Responsibility
Rules, 72 FR at 12866 (‘‘[T]he customer would need
to agree prior to the change (e.g., in the account
opening agreement) that the broker-dealer could
switch the sweep option between those two types
of products.’’).
201 See SIFMA 2 Letter.
202 See paragraph (j)(2)(ii)(A)(2) of Rule 15c3–3, as
adopted.
203 See paragraph (j)(2)(ii)(B) of Rule 15c3–3, as
adopted.
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returned to the securities account or remitted
to the customer; 204 and
• The broker-dealer provides the customer
with written notice at least 30 calendar days
before: (1) Making changes to the terms and
conditions of the Sweep Program; (2) making
changes to the terms and conditions of a
product currently available through the
Sweep Program; (3) changing, adding or
deleting products available through the
Sweep Program; or (4) changing the
customer’s investment through the Sweep
Program from one product to another; and
the notice describes the new terms and
conditions of the Sweep Program or product
or the new product, and the options available
to the customer if the customer does not
accept the new terms and conditions or
product.205
As proposed, paragraph (j)(2)(ii)(B) of
Rule 15c3–3 would have required that
the broker-dealer provide these
disclosures and notices ‘‘on an ongoing
basis.’’ Three commenters stated that
there are no current SRO requirements
that broker-dealers make disclosures
concerning sweep arrangements on an
‘‘ongoing basis’’ and that the
Commission should clarify the source
and meaning of this requirement.206 The
Commission has deleted the phrase
‘‘ongoing basis’’ from the final rule. As
adopted, the Commission has also
modified the text in paragraph
(j)(2)(ii)(B), now paragraph
(j)(2)(ii)(B)(1), to delete the phrase
‘‘investment and deposit of free credit
balances as’’ and inserted the phrase
‘‘Sweep Program’’ to incorporate the
definition in paragraph (a)(17). Finally,
the Commission has modified the
phrase ‘‘the self-regulatory
organizations’’ to read ‘‘each selfregulatory organization of’’ to clarify
that the broker-dealer must provide the
notices and disclosures required by each
SRO of which it is a member (including
an SRO that is not its DEA).207
As adopted, paragraph (j)(2)(ii)(B)(2)
states that the broker-dealer must
provide information on a quarterly basis
with respect to the customer’s balance
in an account or fund ‘‘in which the
customer has a beneficial interest.’’ 208
The rule text has been modified to
account for the fact that customers can
have a beneficial interest in accounts in
their name and in omnibus accounts in
204 Id.
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205 Id.
206 See SIFMA 2 Letter; First Clearing Letter;
Raymond James 2 Letter.
207 See 17 CFR 240.17d–1.
208 See paragraph (j)(2)(ii)(B)(2) of Rule 15c3–3, as
adopted. More specifically, the Commission
modified the phrase ‘‘that the money market mutual
funds or bank deposits to which the free credit
balances have been transferred’’ to read ‘‘that the
balance in the bank deposit account or shares of the
money market mutual fund in which the customer
has a beneficial interest. . . .’’
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the name of a custodian in which the
assets of multiple customers are
commingled.
The Commission also modified
language in paragraph (j)(2)(ii)(B)(2) of
Rule 15c3–3 to replace the phrase ‘‘on
the customer’s demand’’ with the phrase
‘‘on the customer’s order’’ to address
concerns by two commenters that the
former phrase could lead customers to
believe that they will receive immediate
re-payment of those funds, or they could
revert to holding those funds as free
credit balances at the broker-dealer.209
These commenters pointed out that the
disclosed terms of most sweep programs
allow the money market fund or bank
up to seven days to meet requests for
withdrawals. Further, there are some
broker-dealers that do not allow
customers to maintain free credit
balances in securities accounts. In
response to these comments, the
Commission has deleted the phrase
‘‘demand and held as free credit
balances’’ and replaced it with the
phrase ‘‘and the proceeds returned to
the securities account or remitted to the
customer.’’ This language is designed to
account for broker-dealers that do not
offer customers the option of having
their funds held as free credit balances.
In such cases, the broker-dealer would
remit the funds withdrawn from the
bank or derived from redeeming money
market shares directly to the customer
(e.g., by transferring them to the
customer’s bank account).
Proposed paragraphs (j)(2)(ii)(D) and
(iii)(C)—now paragraph (j)(2)(ii)(B)(3)—
would have required the broker-dealer
to provide the customer with notice at
least thirty days before the broker-dealer
begins transferring the customer’s free
credit balances to a different product or
product type, or into the same product
but under materially different terms and
conditions.210 As adopted, paragraph
(j)(2)(ii)(B)(3) will require broker-dealers
to provide customers written notice at
least 30 calendar days before the brokerdealer: (1) Makes changes to the terms
and conditions of the Sweep Program;
(2) makes changes to the terms and
conditions of a product currently
available through the Sweep Program;
(3) changes, adds, or deletes products
available through the Sweep Program; or
(4) changes the customer’s investment
through the Sweep Program from one
product to another.211 This modification
209 See
SIFMA 2 Letter.
Amendments to Financial Responsibility
Rules, 72 FR at 12896.
211 A broker-dealer could request exemptive relief
from the rule in unusual or emergency cases where
it may be impractical or contrary to investor
protection for a broker-dealer to first provide
customers 30 days’ written notice under the rule
210 See
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51841
to the final rule is in response to
commenters’ requests that the
Commission provide clarity with
respect to when the thirty day notice
requirement would be triggered.212 In
response to comments, the final rule is
designed to make clear that the
triggering event for the thirty day notice
is not exclusively related to the transfer
of the customer’s free credit balances,
but rather changes relating to the terms
and conditions of the Sweep Program,
as well as, the products available
through the Sweep Program. This
greater specificity should enhance the
protections under the final rule by
providing greater certainty that the
customer will have time to evaluate
available options before a change to the
Sweep Program is put into effect.
In addition, paragraphs
(j)(2)(ii)(B)(3)(i)(A)–(D) of Rule 15c3–3
require the broker-dealer to provide the
customer with written notice at least 30
calendar days before: (1) Making
changes to the terms and conditions of
the Sweep Program; (2) making changes
to the terms and conditions of a product
currently available through the Sweep
Program; (3) changing, adding or
deleting products available through the
Sweep Program; or (4) changing the
customer’s investment through the
Sweep Program from one product to
another.213 Collectively, these
provisions provide more specificity
about the types of disclosures and
notices required under the final rule
than under the proposal. Further, the
final rule includes the word ‘‘written’’
before the word ‘‘notice’’ to make
explicit that a written notice is required.
As adopted, paragraph
(j)(2)(ii)(B)(3)(ii) requires that ‘‘[t]he
notice must describe the new terms and
conditions of the Sweep Program or
product or the new product, and the
options available to the customer if the
customer does not accept the new terms
and conditions or product.’’ 214 The
Commission modified the final rule in
response to a comment regarding the
text of proposed paragraphs (j)(2)(ii)(D)
and (iii)(C).215 The commenter stated
that, as drafted, proposed paragraphs
(j)(2)(ii)(D) and (iii)(C) would have
required a broker-dealer to disclose
before taking one of these actions. See, e.g.,
paragraph (k)(3) to Rule 15c3–3.
212 See SIFMA 2 Letter; First Clearing Letter;
Cornell Letter; E*Trade Letter.
213 See paragraph (j)(2)(ii)(B)(3)(i) of Rule 15c3–3,
as adopted. The requirements set forth in final
paragraph (j)(2)(ii)(B)(3)(i) were proposed as
paragraphs (j)(2)(ii)(D) and (iii)(C).
214 See paragraph (j)(2)(ii)(B)(ii) of Rule 15c3–3, as
adopted. The final rule codifies this text in a
separate paragraph in order to emphasize the
specific items the notice must contain.
215 See SIFMA 2 Letter.
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‘‘how the customer can notify the
[broker-dealer] if the customer chooses
not to have the free credit balances
transferred to the new product or
product type, or under new terms and
conditions.’’ 216 The commenter stated
that these paragraphs appear to assume
that the customer will have the option
of continuing to have free credit
balances treated as they were prior to
the change to the sweep arrangement.217
The commenter pointed out that, in fact,
the broker-dealer may elect not to
continue offering the prior sweep
options and not to offer another sweep
product.218 To account for this
possibility, the Commission has revised
the text in paragraph (j)(2)(ii)(B)(3)(ii) 219
to require the broker-dealer to provide
the customer with a notice that contains
a description of the options available to
the customer if the customer does not
wish to accept the new terms and
conditions or product.220 This is
intended to give customers sufficient
opportunity to make an informed
decision in connection with a Sweep
Program.
6. ‘‘Proprietary Accounts’’ Under the
Commodity Exchange Act
Some broker-dealers also are
registered as futures commission
merchants under the Commodity
Exchange Act (‘‘CEA’’). These firms
carry both securities and commodities
accounts for customers. The definition
of free credit balances in paragraph
(a)(8) of Rule 15c3–3 does not include
funds carried in commodities accounts
that are segregated in accordance with
the requirements of the CEA.221
However, regulations promulgated
under the CEA exclude certain types of
accounts (‘‘proprietary accounts’’) from
the CEA’s segregation requirements.222
216 Id.
217 Id.
emcdonald on DSK67QTVN1PROD with RULES2
218 Id.
219 More specifically, paragraph (j)(2)(ii)(B)(3)(ii)
provides that ‘‘the notice must describe the new
terms and conditions of the Sweep Program or
product or the new product, and the options
available to the customer if the customer does not
accept the new terms and conditions or product.’’
A customer that does not accept the new terms and
conditions or product would need to change how
free credit balances are treated by, for example,
selecting investments outside the Sweep Program or
having the balances transferred to an account at
another financial institution.
220 See Dworkin Letter.
221 17 CFR 240.15c3–3(a)(8).
222 Rule 1.20 requires a futures commission
merchant to segregate customer funds. See 17 CFR
1.20. Rule 1.3(k) defines the term customer for this
purpose. See 17 CFR 1.3(k). The definition of
customer excludes persons who own or hold a
proprietary account as that term is defined in Rule
1.3(y). See 17 CFR 1.3(y). Generally, the definition
of proprietary account refers to persons who have
an ownership interest in the futures commission
merchant. Id.
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This exclusion from the segregation
requirements under the CEA has raised
a question as to whether a broker-dealer
must treat payables to customers in
proprietary commodities accounts as
‘‘free credit balances’’ when performing
a customer reserve computation.223
In response to this question, the
Commission notes that the objective of
the customer reserve requirement in
Rule 15c3–3 is to require broker-dealers
to hold sufficient funds or qualified
securities to facilitate the prompt return
of customer property to customers either
before or during a liquidation
proceeding if the firm fails.224 Under
SIPA, customer property generally does
not include funds held in a
commodities account.225 Therefore,
funds held in a proprietary commodities
account generally would not constitute
customer property and persons having
223 See Part 241-Interpretive Releases Relating to
the Securities Exchange Act of 1934 and General
Rules and Regulations Thereunder, Exchange Act
Release No. 9922 (Jan. 2, 1973), 38 FR 1737 (Jan.
18, 1973) (interpreting the credit balance used in
Item 1 of the Rule 15c3–3a formula ‘‘to include the
net balance due to customers in non-regulated
commodities accounts reduced by any deposits of
cash or securities with any clearing organization or
clearing broker in connection with the open
contracts in such accounts’’).
224 See Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and
Major Security-Based Swap Participants and
Capital Requirements for Broker-Dealers, Exchange
Act Release No. 68071 (Oct. 18, 2012), 77 FR 70214,
70274 (Nov. 23, 2012) (describing rationale and
requirements of Rule 15c3–3 segregation
requirements). See also Broker-Dealers;
Maintenance of Certain Basic Reserves, Exchange
Act Release No. 9856 (Nov. 10, 1972), 37 FR 25224,
25225 (Nov. 29, 1972) (stating that the intent of
Rule 15c3–3 is, among other things, to ‘‘facilitate
the liquidations of insolvent broker-dealers and to
protect customer assets in the event of a SIPC
liquidation through a clear delineation in Exchange
Act Rule 15c3–3 of specifically identifiable
property of customers.’’); Amendments to Financial
Responsibility Rules, 72 FR at 12862, 12868.
225 As noted above, customer property under
SIPA includes ‘‘cash and securities (except
customer name securities delivered to the customer)
at any time received, acquired, or held by or for the
account of the debtor from or for the securities
accounts of a customer, and the proceeds of any
such property transferred by the debtor, including
property unlawfully converted.’’ 15 U.S.C. 78lll(4).
To receive protection under SIPA, a claimant must
first qualify as a customer as that term is defined
in the statute. Generally, a customer is any person
who has: (1) ‘‘a claim on account of securities
received, acquired, or held by the [broker-dealer];’’
(2) ‘‘deposited cash with the debtor for the purposes
of purchasing securities;’’ (3) ‘‘a claim against the
debtor for. . .[positions]. . .received, acquired, or
held in a portfolio margin account carried as a
securities account pursuant to a portfolio margining
program approved by the Commission;’’ or (4) ‘‘a
claim against the [broker-dealer] arising out of sales
or conversions of such securities.’’ See 15 U.S.C.
78lll(2)(A)–(B). The definition of security in SIPA
specifically excludes commodities and nonsecurities futures contracts and, thus, a person with
a claim for such assets (not held in a portfolio
margin account carried as a securities account)
would not meet the definition of customer. See 15
U.S.C. 78lll(14).
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claims to those funds would not be
customers under SIPA.226 Moreover, the
regulations under the CEA similarly
provide the persons having claims to
funds in proprietary commodities
accounts are not customers for purposes
of those regulations.227 For these
reasons, the Commission proposed a
specific amendment to the definition of
the term free credit balances in
paragraph (a)(8) of Rule 15c3–3 that
would have clarified that funds held in
a commodities account meeting the
definition of a proprietary account
under CEA regulations are not to be
included as free credit balances in the
customer reserve formula.228 As
discussed below, the Commission is
adopting the amendment substantially
as proposed.
The Commission received three
comments in support of the proposed
rule change.229 One commenter
requested that the Commission clarify
that the relevant definition of
proprietary account for these purposes
is the definition contained in Rule 1.3(y)
under the CEA. While Rule 1.3(y) under
the CEA currently contains the relevant
definition of proprietary account for the
purpose of the amendment, the
definition could be codified in a
different rule in the future.
Consequently, the Commission is
adopting the final rule amendment to
paragraph (a)(8) of Rule 15c3–3, as
proposed. Thus, the final rule does not
include specific references to a specific
rule. Rather, the amendment to
paragraph (a)(8) to Rule 15c3–3, as
adopted, more generally refers to a
‘‘proprietary account as that term is
defined in regulations under the
Commodity Exchange Act.’’
As stated above, this amendment to
paragraph (a)(8) of Rule 15c3–3 is
designed to clarify that funds held in a
commodities account meeting the
definition of a proprietary account
under CEA regulations are not to be
included as ‘‘free credit balances’’ in the
customer reserve formula. Under Item 1
of Rule 15c3–3a, however, cash balances
that do not meet the definition of free
credit balances (e.g., because they are
not subject to immediate payment) are
included in the customer reserve
formula if they meet the definition of
other credit balances under paragraph
226 Id.
227 See
17 CFR 1.3(k).
Amendments to Financial Responsibility
Rules, 72 FR at 12868. The Commission proposed
additional amendments to paragraph (a)(8) of Rule
15c3–3 related to portfolio margining. See also
discussion below in section II.B. of this release.
229 See SIPC Letter; SIFMA 2 Letter; SIFMA 4
Letter.
228 See
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emcdonald on DSK67QTVN1PROD with RULES2
(a)(9) of Rule 15c3–3.230 Therefore, in
order to remove any ambiguity as to the
proper exclusion of proprietary
accounts under the CEA from Rule
15c3–3, the Commission also is
amending the definition of the term
other credit balances in the final rule to
delete the words ‘‘as aforesaid’’ and
insert the phrase ‘‘in accordance with
the Commodity Exchange Act or in a
similar manner, or funds carried in a
proprietary account as that term is
defined in regulations under the
Commodity Exchange Act.’’ 231
Consequently, the amendments clarify
that both free credit balances and other
credit balances as defined in Rule 15c3–
3 do not include funds carried in
proprietary accounts under the CEA.
One commenter also suggested that
due to the changes to the swap markets
mandated by Title VII of the DoddFrank Act, swap accounts (in addition
to commodities accounts) are now
subject to customer protection rules
under the CEA.232 This commenter
suggested that the Commission make it
clear that funds in swap accounts also
do not constitute free credit balances,
whether those funds are required to be
segregated by rules under the CEA (e.g.,
cleared swap accounts or uncleared
swap accounts that have opted for
segregation) or excepted from
segregation under the CEA (e.g., cleared
swaps proprietary accounts or uncleared
swap accounts that have not opted for
segregation). The commenter noted this
treatment ‘‘would be consistent with the
treatment of funds in commodities
accounts and with the regulation of
swap accounts under the CEA.’’ 233 The
Commission agrees there may be
additional accounts under the CEA, as
amended by the Dodd-Frank Act, that
should explicitly be excluded from the
definition of free credit balances under
Rule 15c3–3. However, the amendments
today are designed to clarify the specific
question raised with respect to the
treatment of funds in proprietary
commodities accounts under the CEA
and, consequently, the suggestions by
230 Item 1 of Rule 15c3–3a requires a brokerdealer to include in the customer reserve formula
‘‘free credit balances and other credit balances in
customers’ security accounts.’’ Paragraph (a)(9) of
Rule 15c3–3 defines other credit balances as ‘‘cash
liabilities of a broker or dealer to customers other
than free credit balances and funds in commodities
accounts segregated as aforesaid.’’ 17 CFR
240.15c3–3(a)(9).
231 See paragraph (a)(9) to Rule 15c3–3. See also
comments and additional amendments to paragraph
(a)(9) of Rule 15c3–3 discussed in section II.B. of
this release.
232 See SIFMA 4 Letter.
233 Id.
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the commenter are beyond the scope of
this rulemaking.
7. Expansion of the Definition of
‘‘Qualified Securities’’ To Include
Certain Money Market Funds
A broker-dealer is limited to
depositing cash or qualified securities
into the bank account it maintains to
meet its customer (and now PAB
account) reserve deposit requirements
under Rule 15c3–3. Paragraph (a)(6) of
Rule 15c3–3 defines qualified securities
to mean securities issued by the United
States or guaranteed by the United
States with respect to principal and
interest.234 This strictly limits the types
of assets that can be used to fund a
broker-dealer’s customer or PAB reserve
account. The strict limitation is
designed to further the purpose of Rule
15c3–3; namely, that customer assets be
segregated and held in a manner that
makes them readily available to be
returned to the customer. As the
Commission noted when first proposing
Rule 15c3–3:
The operative procedures of the Special
[Reserve] Account are designed to protect the
integrity of customer-generated funds by
insulating them against inroads from the
broker-dealer’s firm activities, whether they
be underwriting, market making, other
trading, investing, or mere speculation in
securities, meeting overhead or any other
nature whatever. The Special [Reserve]
Account should achieve a virtual 100%
protection to customers with respect to the
carrying and use of customers’ deposits or
credit balances which is mandated by
Section 7(d) of the SIPC Act.235
In response to a petition for
rulemaking,236 the Commission
234 17
CFR 240.15c3–3(a)(6).
and Related Measures Respecting the
Financial Responsibility of Brokers and Dealers,
Exchange Act Release No. 9388 (Nov. 8, 1971), 36
FR 22312 (Nov. 24, 1971).
236 As discussed in the proposing release,
Federated submitted a petition for rulemaking on
April 3, 2003, which it later amended on April 4,
2005. See Amendments to Financial Responsibility
Rules, 72 FR at 12865, 12874. More specifically,
Federated’s petition requested that the Commission
amend: (i) Rule 15c3–1 to lower the haircut for
certain money market funds to 0%; and (ii) Rule
15c3–3 to: (a) permit a broker-dealer to pledge such
money market funds when borrowing fully paid or
excess margin securities from a customer under
paragraph (b)(3); and (b) treat such money market
funds as ‘‘qualified securities’’ that may be
deposited into a broker-dealer’s customer reserve
account. On February 9, 2009, Federated submitted
another request for rulemaking (Petition 4–577),
reiterating its first petition with respect to
amending Rule 15c3–3 to allow a broker-dealer to
treat certain money market funds as ‘‘qualified
securities’’ that may be deposited into a reserve
account. However, this new petition changed the
definition of the types of funds that could be treated
as qualified securities. More specifically, the new
petition proposed amending Rule 15c3–3(a)(6) to
define the term qualified securities to include, ‘‘a
redeemable security of an investment company
registered under the Investment Company Act of
235 Reserves
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51843
proposed a limited expansion of the
definition of qualified security to
include shares of an unaffiliated money
market fund that: (1) Is described in
Rule 2a–7 under the Investment
Company Act of 1940; (2) invests solely
in securities issued by the United States
or guaranteed by the United States as to
interest and principal; (3) agrees to
redeem fund shares in cash no later than
the business day following a redemption
request by a shareholder; and (4) has net
assets equal to at least 10 times the
value of the shares deposited by the
broker-dealer in its customer reserve
account.237 Twenty commenters
addressed the proposed amendment.238
A majority of commenters supported the
proposal and generally argued that the
definition of qualified security should
be expanded further to include more
types of instruments. One commenter
noted that permitting the use of certain
money market funds to make up the
required reserve account deposit would
introduce ‘‘an intermediary (namely, the
holding company or money market
fund) at which problems might
arise.’’ 239 The commenter also noted
that a number of SIPA liquidations have
involved the mishandling of money
market or mutual fund shares or the
confirmations of purchases of
nonexistent ‘‘money market funds.’’ 240
The Commission recently has
proposed substantial amendments to its
rules on money market funds.241 In light
1940 and described in 17 CFR 270.2a–7,
unaffiliated with the broker-dealer and which limits
its investments to securities issued or guaranteed by
the United States Government or its agencies or
instrumentalities (including repurchase
transactions).’’ See Amendments to Financial
Responsibility Rules, 72 FR at 12874 and n.112; see
also Public Petitions for Rulemaking No. 4–478
(Apr. 3, 2003) (available at https://www.sec.gov/
rules/petitions/petn4-478.htm), as amended (Apr. 4,
2005) (amendment available at https://www.sec.gov/
rules/petitions/petn4-478a.pdf), and No. 4–577
(Feb. 3, 2009) (available at https://www.sec.gov/
rules/petitions/2009/petn4-577.pdf).
237 See Amendments to Financial Responsibility
Rules, 72 FR at 12865.
238 See Federated Letter; Federated 2 Letter;
Federated 3 Letter; Federated 4 Letter; Federated 5
Letter; Federated 6 Letter; Federated 7 Letter;
Federated 8 Letter; Meeks Letter; Meeks 2 Letter;
Crane Data Letter; SIPC Letter; Curian Letter; FAF
Letter; Reserve Letter; Brown Brothers Letter; SIFMA
Letter; First Clearing Letter; ICI Letter; Barclays
Letter; American Beacon Letter; Chamber of
Commerce Letter; ABASA Letter; UBS Letter;
Fidelity/NFS Letter; Barnard Letter; Federated 9
Letter; BOK Letter; Cornell Letter.
239 See SIPC Letter.
240 Id.
241 Money Market Fund Reform; Amendments to
Form PF, Release No. IC–30551 (June 5, 2013), 78
FR 36834 (June 19, 2013) (The rule proposal
includes two principal alternative reforms that
could be adopted alone or in combination. One
alternative would require a floating net asset value
or ‘‘NAV’’ for prime institutional money market
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of these proposed amendments,242 the
Commission is deferring consideration
of any further expansion of the
definition of qualified security in Rule
15c3–3 at this time. This will allow the
Commission to assess the potential
impact of any money market fund
reforms it may adopt and whether any
such impact would have consequences
for the customer protection objective of
the reserve account requirement in Rule
15c3–3.
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B. Holding Futures Positions in a
Securities Portfolio Margin Account
Under SRO portfolio margin rules
(‘‘portfolio margin rules’’),243 a brokerdealer can combine securities and
futures positions in a portfolio margin
securities account to compute margin
requirements based on the net market
risk of all positions in the account.244
Until the passage of the Dodd-Frank
Act, however, SIPA only protected
customer claims for securities and cash,
and specifically excluded from
protection futures contracts that are not
also securities. This fact created a
potential ambiguity as to how futures
positions in a portfolio margin securities
account would be treated in a SIPA
liquidation. Consequently, the
Commission proposed amendments to
funds. The other alternative would allow the use of
liquidity fees and redemption gates in times of
stress. The proposal also includes additional
diversification and disclosure measures that would
apply under either alternative.). See also Division
of Risk, Strategy, and Financial Innovation,
Commission, Responses to Questions Posed by
Commissioners Aguilar, Paredes, and Gallagher
(Nov. 30, 2012) (responding to questions posed by
Commissioners Aguilar, Paredes, and Gallagher
regarding effectiveness of the 2010 money market
fund reforms, as well as how future reforms might
affect demand for investments in money market
fund substitutes and the implications for investors,
financial institutions, corporate borrowers,
municipalities, and states that sell their debt to
money market funds), available at https://
www.sec.gov/news/studies/2012/money-marketfunds-memo-2012.pdf.
242 Money Market Fund Reform; Amendments to
Form PF, Release No. IC–30551 (June 5, 2013), 78
FR 36834 (June 19, 2013).
243 See Exchange Act Release No. 55471 (Mar. 14,
2007), 72 FR 13149 (Mar. 20, 2007) (SR–NASD–
2007–013); Exchange Act Release No. 54918 (Dec.
12, 2006), 72 FR 1044 (Jan. 9, 2007) (SR–NYSE–
2006–13); Exchange Act Release No. 54919 (Dec. 12,
2006), (SR–CBOE–2006–14); Exchange Act Release
No. 54125 (July 11, 2006), 71 FR 40766 (July 18,
2006) (SR–NYSE–2005–93); Exchange Act Release
No. 52031 (July 14, 2005), 70 FR 42130 (July 21,
2005) (SR–NYSE–2002–19); Exchange Act Release
No. 52032 (July 14, 2005), 70 FR 42118 (July 21,
2005) (SR–CBOE–2002–03); see also Exchange Act
Release No. 58251 (July 30, 2008), 73 FR 46111
(Aug. 7, 2008) (SR–FINRA–2008–041); Exchange
Act Release No. 58243 (July 28, 2008), 73 FR 45505
(Aug. 5, 2008) (SR–CBOE–2008–73); and Exchange
Act Release No. 58261 (July 30, 2008), 73 FR 46116
(Aug. 7, 2008) (SR–NYSE–2008–66) (making
portfolio margin rules permanent).
244 See, e.g., FINRA Rule 4210(g) and CBOE Rule
12.4.
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Rule 15c3–3 to accommodate the
holding of futures positions in a
securities account that is margined on a
portfolio basis.245
Subsequent to the Commission’s
proposals, the Dodd-Frank Act amended
the definitions of customer, customer
property, and net equity in section 16 of
SIPA to take into account futures and
options on futures held in a portfolio
margin account carried as a securities
account pursuant to a Commissionapproved portfolio margining
program.246 As a result, persons who
hold futures positions in a portfolio
margining account carried as a
securities account are now entitled to
SIPA protection.
While the Dodd-Frank Act addressed
the protection under SIPA of futures
and futures options held in a securities
portfolio margin account, the
Commission’s proposed amendments to
Rule 15c3–3 and 15c3–3a will still serve
an important purpose. In particular,
they complement the Dodd-Frank SIPA
amendments, and will provide
additional protections to customers by
requiring broker-dealers to treat these
futures positions in accordance with the
segregation requirements in Rules 15c3–
3 and 15c3–3a. Consequently, the
Commission is adopting the
amendments with modifications to
address, in part, comments.
To accommodate securities and
futures portfolio margining, the
Commission’s proposals included
several amendments. First, the
Commission proposed amending the
definition of free credit balance in
paragraph (a)(8) of Rule 15c3–3 to
provide that the term shall also include
such liabilities carried in a securities
account pursuant to an SRO portfolio
margining rule approved by the
Commission under section 19(b) of the
Act (‘‘SRO portfolio margining rule’’),
including daily marks to market, and
proceeds resulting from closing out
futures contracts and options thereon,
and, in the event the broker-dealer is the
subject of a proceeding under SIPA, the
market value as of the filing date as that
term is defined in SIPA (15 U.S.C.
78lll(7)) of any long options on futures
contracts.
In addition, the Commission proposed
amendments to treat the unrealized
value of a futures option in a portfolio
margin account on the SIPA filing
date 247 as a free credit balance for
purposes of Rule 15c3–3. This
245 See Amendments to Financial Responsibility
Rules, 72 FR at 12868–12870.
246 See Public Law 111–203 § 983.
247 The term filing date is defined in SIPA as,
generally, being the date a SIPA proceeding is
commenced. See 15 U.S.C. 78lll(7).
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amendment was designed to clarify that
the market value of such assets should
be included in determining a customer’s
net equity claim in a SIPA proceeding.
Unlike futures contracts, futures options
do not generate cash balances on a daily
basis in the account (i.e., they have
unrealized market value at the end of a
trading day). Since the broker-dealer is
not holding cash for the customer, there
is no need to treat the futures options as
a free credit balance for purposes of the
reserve formula. However, if the brokerdealer was liquidated under SIPA, the
unrealized gains or losses of the futures
options should be included in
calculating the customer’s net equity in
the account (along with the securities
positions and all futures-related and
securities-related cash balances).248 The
proposed amendments were designed to
provide for this outcome by defining the
market value of the futures options as a
free credit balance as of the filing date
of a SIPA liquidation of the brokerdealer. As free credit balances, funds
originating from futures transactions
(e.g., margin deposits and daily marks to
market) and the market value of futures
options as of the SIPA filing date would
constitute claims for cash in a SIPA
proceeding and, therefore, become a
part of a customer’s net equity claim
entitling the customer to up to $250,000
in advances to make up for shortfalls.
The Commission received six
comments on the proposed
amendments.249 Three commenters
generally supported the amendments.250
One commenter stated that the
amendments represent a positive step
forward in resolving certain regulatory
obstacles in connection with the
inclusion of futures contracts in a
portfolio margin account.251 Another
commenter stated that it supported the
Commission’s efforts to facilitate the
cross-margining of futures and securities
in the portfolio margin account by
clarifying the treatment of futures and
options positions under SIPA.252 A
commenter expressed support for the
development of rules for portfolio
margining, and supported the
248 See 15 U.S.C 78lll(11); see also Public Law
111–203 § 983 (revising definition of net equity).
249 See SIFMA 2 Letter; CME Letter; SIPC Letter;
Citigroup Letter; American Bar Association Letter;
SIFMA 4 Letter. The comment letters received as a
result of the original solicitation of comment predate the Dodd-Frank Act. As such, these comment
letters address the proposed amendments prior to
the enactment of the Dodd-Frank SIPA amendments
related to portfolio margining. The comment letters
received subsequent to the passage of the DoddFrank Act address the SIPA amendments.
250 See SIFMA 2 Letter; Citigroup Letter;
American Bar Association Letter.
251 See Citigroup Letter.
252 See American Bar Association Letter.
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Commission’s effort to provide greater
legal certainty regarding the SIPA
treatment of futures positions in a
portfolio margin account.253 In a
subsequent comment letter, however,
this commenter stated that this
amendment is no longer necessary in
light of the Dodd-Frank Act
amendments, and recommended the
Commission withdraw it.254 Another
commenter stated that the Commission’s
proposal is premature in that including
futures in a portfolio margin account,
which is a securities account, would
conflict with the segregation provisions
under the CEA 255 and that SIPC has not
determined that protection should be
extended to futures.256
The Commission agrees, in part, with
the commenter who stated that the
Dodd-Frank Act SIPA amendments
make the Commission’s proposed
amendments to Rules 15c3–3 and 15c3–
3a unnecessary.257 As noted above, the
definitions of customer, customer
property, and net equity in section 16 of
SIPA were amended by the Dodd-Frank
Act to take into account futures and
options on futures held in a portfolio
margin account carried as a securities
account pursuant to a Commissionapproved portfolio margining
program.258 Consequently, in a
proceeding under SIPA, futures and
options on futures positions held in a
portfolio margin account carried as a
securities account would be included in
determining a customer’s net equity
claim.259 Therefore, the proposed
amendment relating to the unrealized
value of a futures option is not
necessary to achieve the objective of
providing SIPA protection for such
positions. As a result, the Commission
is modifying the final rule to delete the
proposed language in paragraph (a)(8) of
253 See
SIFMA 2 Letter.
SIFMA 4 Letter.
255 See, e.g., 17 CFR 1.20–1.29.
256 See CME Letter. See also SIPC Letter
(expressing ‘‘grave concerns’’ about potential
conflict between the proposed amendments and
SIPA).
257 See SIFMA 4 Letter.
258 See Public Law 111–203 § 983.
259 Under the Dodd-Frank Act SIPA amendments,
a customer’s net equity now includes all positions
in futures contracts and options on futures contracts
held in a portfolio margining account carried as a
securities account pursuant to a portfolio margining
program approved by the Commission, including all
property collateralizing such positions, to the extent
that such property is not otherwise included herein.
See 15 U.S.C. 78lll(11)(A)(ii). Further, the
amendment provided that a claim for a commodity
futures contract received, acquired, or held in a
portfolio margining account pursuant to a portfolio
margining program approved by the Commission or
a claim for a security futures contract, shall be
deemed to be a claim with respect to such contract
as of the filing date, and such claim shall be treated
as a claim for cash. See 15 U.S.C. 78lll(11).
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254 See
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Rule 15c3–3 that would have treated the
unrealized value of a futures option in
a portfolio margin account on the filing
date of a SIPA proceeding as a free
credit balance for purposes of Rule
15c3–3.260
As stated above, however, the
remaining rule amendments to Rules
15c3–3 and 15c3–3a complement the
amendments to SIPA and provide
additional protections to customers.
Consequently, the Commission is
adopting them with some technical
modifications in response to suggestions
offered by commenters.
One commenter suggested a change to
paragraph (a)(8) of Rule 15c3–3 that
would expand the definition of free
credit balances to include cash balances
related to futures positions and the
value of futures options positions on the
SIPA filing date.261 First, the commenter
noted that paragraph (a)(8) of Rule
15c3–3 concerns free credit balances,
which are funds subject to immediate
payment (among other limitations).262
The commenter expressed concern that
the Commission’s proposal could have
been construed as excluding cash
balances in a portfolio margin account
that are not subject to immediate
payment. The Commission agrees that
the proposal could have been
interpreted as requiring that futuresrelated cash balances be treated
differently depending on whether or not
they are subject to immediate payment.
The amendments to Rule 15c3–3 are
designed to provide the same treatment
to futures-related cash balances in a
portfolio margin account as applies to
securities-related cash balances. As
discussed above, under Item 1 of Rule
15c3–3a, cash balances that do not meet
the definition of free credit balances
(e.g., because they are not subject to
immediate payment) are included in the
customer reserve formula if they meet
the definition of other credit balances
under paragraph (a)(9) of Rule
15c3–3.263
Consequently, to remove any
ambiguity as to the effect of the rule
changes in response to the comments
260 Specifically, the final rule does not include
the proposed language: ‘‘, and, in the event the
broker-dealer is the subject of a proceeding under
SIPA, the market value as of the ‘‘filing date’’ as that
term is defined in SIPA (15 U.S.C. 78lll(7)) of any
long options on futures contracts.’’
261 See SIFMA 2 Letter.
262 Id.
263 Item 1 of Rule 15c3–3a requires a brokerdealer to include in the customer reserve formula
free credit balances and other credit balances in
customers’ securities accounts. Paragraph (a)(9) of
Rule 15c3–3 defines other credit balances as ‘‘cash
liabilities of a broker or dealer to customers other
than free credit balances and funds in commodities
accounts segregated as aforesaid.’’ 17 CFR
240.15c3–3(a)(9).
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51845
noted above, the Commission is
amending paragraph (a)(9) of Rule 15c3–
3—which defines other credit
balances—to include futures-related
cash balances other than free credit
balances. In addition, the Commission
has deleted the phrase ‘‘shall include
such liabilities,’’ in the amendment to
proposed paragraph (a)(8) and replaced
it with ‘‘includes, if subject to
immediate cash payment to customers
on demand, funds . . .’’ to clarify that
this paragraph relates to cash balances
in a portfolio margin account that are
subject to immediate payment and,
hence, that paragraph (a)(9) relates to
other cash balances in a portfolio
margin account.
One commenter suggested changes
with respect to the marks to market
language in the rule, stating that the
phrase relating to daily marks to market
be modified to read ‘‘variation margin or
initial margin marks to market’’ and the
phrase in the proposal that read
‘‘proceeds resulting from closing out
futures contracts and options thereon’’
be modified to read ‘‘proceeds resulting
from margin paid or released in
connection with closing out, settling or
exercising futures contracts and options
thereon.’’ 264 The Commission agrees
with these technical suggestions
because they clarify the rule by
incorporating appropriate futures
terminology.
Consequently, as adopted, the text in
paragraphs (a)(8) and (a)(9) of Rule
15c3–3 expands the terms free credit
balance and other credit balances to
include ‘‘funds carried in a securities
account pursuant to a self-regulatory
organization portfolio margin rule
approved by the Commission . . .
including variation margin or initial
margin, marks to market, and proceeds
resulting from margin paid or released
in connection with closing out, settling
or exercising futures contracts and
options thereon.’’ 265 The amendments,
as adopted, more precisely capture the
Commission’s intent in terms of
identifying the types of futures-related
cash balances that may be held in a
portfolio margin account than the
language in the proposed rule.
On the debit side of the customer
reserve formula, the Commission is
adopting, substantially as proposed, an
amendment to Rule 15c3–3a Item 14
that permits a broker-dealer to include
as a debit item the amount of customer
margin required and on deposit at a
derivatives clearing organization related
to futures positions carried in a portfolio
264 See
265 See
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margin account.266 Under SIPA, the
term customer property includes,
‘‘resources provided through the use or
realization of customers’ debit cash
balances and other customer-related
debit items as defined by the
Commission by rule,’’ as well as, ‘‘in the
case of a portfolio margining account of
a customer that is carried as a securities
account pursuant to a portfolio
margining program approved by the
Commission, a futures contract or an
option on a futures contract received,
acquired, or held by or for the account
of a debtor from or for such portfolio
margining account, and the proceeds
thereof.’’ 267 Under this provision of
SIPA, this amendment to Rule 15c3–3
makes the margin required and on
deposit at a derivatives clearing
organization part of the ‘‘customer
property’’ in the event the broker-dealer
is placed in a SIPA liquidation. Thus, it
would be available for distribution to
the failed firm’s customers.
Finally, one commenter suggested
changes to Commission rules beyond
those in the proposing release. This
commenter urged the Commission to
consider amending Rules 8c–1, 15c2–1,
and 15c3–3 to provide that their
provisions could be waived by
customers that are entitled to engage in
derivative transactions in a portfolio
margin account, provided the customer
agrees in writing to waive SIPA
protection.268 According to the
commenter, a customer executing such
a waiver would not be entitled to the
protections under SIPA for customers
and would be deemed a general creditor
of the broker-dealer with respect to
claims arising from their portfolio
margin accounts. At this time, the
Commission does not believe it would
be appropriate to amend the rules as
C. Amendments With Respect to
Securities Lending and Borrowing and
Repurchase/Reverse Repurchase
Transactions
In the proposing release, the
Commission noted two concerns about
stock lending that arose from the failure
of the registered broker-dealer MJK
Clearing, Inc. (‘‘MJK’’); 269 namely: (1)
That broker-dealers with principal
liability in a stock loan transaction may
purport to be acting in an agency
capacity and, consequently, not taking
appropriate capital charges; and (2) that
broker-dealers that historically have not
been active in stock loan activities may
rapidly expand their balance sheets
with such transactions and, thereby,
increase leverage to a level that poses
significant financial risk to the firm and
its counterparties. In response, the
Commission proposed, and is now
adopting, amendments to Rules 15c3–1
and 17a–11.
With respect to the Rule 15c3–1
proposal, the Commission is adopting
the amendment, as proposed. This
amendment to subparagraph (c)(2)(iv)(B)
of Rule 15c3–1 clarifies that brokerdealers providing securities lending and
borrowing settlement services are
deemed, for purposes of the rule, to be
acting as principal and are subject to
applicable capital deductions.270 Under
the amendment, these deductions can
be avoided if a broker-dealer takes
certain steps to disclaim principal
liability. In particular, the final rule
provides that ‘‘a broker or dealer that
participates in a loan of securities by
one party to another party will be
deemed a principal for the purpose of
266 The Commission also is amending Item 14 of
Rule 15c3–3a to replace the phrase ‘‘Security
futures products’’ with the phrase ‘‘security futures
products.’’ In addition, the Commission adopting
some non-substantive amendments to Note G to
Item 14, including: (1) In paragraph (a) replacing
the word ‘‘shall’’ with the word ‘‘must’’; (2) in
paragraph (b) replacing the word ‘‘shall’’ with the
word ‘‘will’’; in the second line in paragraph (b)(2)
inserting the phrase ‘‘futures in a’’ before the phrase
‘‘portfolio margin account’’ and deleting the word
‘‘margin’’; (3) in paragraph (b)(2) replacing the word
‘‘shall’’ with the word ‘‘will’’ in three places; (4) in
the sixth and seventh lines of paragraph (b)(2),
inserting the phrase ‘‘futures in a’’ before the phrase
‘‘portfolio margin account’’ and deleting the phrase
‘‘futures margin’’; in paragraph (b)(3)(iv) replacing
the word ‘‘securities’’ with the word ‘‘security’’,
inserting the phrase ‘‘futures in a’’ before the phrase
‘‘portfolio margin account’’ and deleting the word
‘‘futures’’; and (4) in paragraph (c), replacing the
word ‘‘shall’’ with the word ‘‘will’’, inserting the
phrase ‘‘futures in a’’ before the phrase ‘‘portfolio
margin account’’ and deleting the word ‘‘futures.’’
267 15 U.S.C. 78lll(4)(B) and (D); see also DoddFrank Act Section 983.
268 See American Bar Association Letter.
269 See Amendments to Financial Responsibility
Rules, 72 FR at 12869. The failure of MJK raised
several concerns regarding securities lending
transactions. As explained in more detail in the
proposing release, at the time of its failure, MJK
owed cash collateral to several borrowing brokerdealers. Id. at 12862, 12869–12870. These brokerdealers suffered losses caused by MJK’s failures
and, in later proceedings related to these losses,
questions arose as to whether these broker-dealers
were acting as principal or agent.
270 A broker-dealer is required to deduct from net
worth most unsecured receivables, including the
amount that the market value of a securities loan
exceeds the value of collateral obtained for the loan.
See 17 CFR 240.15c3–1(c)(2)(iv)(B). Similarly, with
respect to repo transactions, a broker-dealer
obligated to resell securities must, in computing net
capital, deduct the amount that the market value of
the securities is less than the resale price. See 17
CFR 240.15c3–1(c)(2)(iv)(F). A broker-dealer
obligated to repurchase securities must, in
computing net capital, deduct the amount that the
market value of the securities is greater than the
repurchase price to the extent the excess is greater
than certain percentages. See 17 CFR 240.15c3–
1(c)(2)(iv)(F).
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recommended by the commenter
because such changes are beyond the
scope of this rulemaking.
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the deductions required under this
section, [i.e., deductions from net
worth] unless the broker or dealer has
fully disclosed the identity of each party
to the other and each party has
expressly agreed in writing that the
obligations of the broker or dealer do
not include a guarantee of performance
by the other party and that such party’s
remedies in the event of a default by the
other party do not include a right of
setoff against obligations, if any, of the
broker or dealer.’’ 271
The Commission received five
comments on the proposed
amendment.272 Two commenters
objected to this amendment, stating that
they believed the standard legal
documents used in securities lending
transactions provide sufficient legal
certainty on the status of the parties.273
The Commission, in recognition of
standard stock loan agreement
templates, designed the amendment to
accommodate the continued use of these
industry model agreements by
incorporating their use into the rule’s
requirements. For the purposes of
establishing a broker-dealer’s status as
agent or lender, these agreements may
be sufficiently detailed to satisfy the
new requirements. However, it would
be the broker-dealer’s responsibility to
ensure that any ‘‘standard’’ agreement
contains the necessary provisions to
comply with this amendment, and that
such provisions are not weakened by
any other language in the agreement or
any subsequent amendment. The goal is
to avoid ambiguity about a brokerdealer’s status as agent or principal
regarding the applicability of the stock
loan charges in the net capital rule. As
the failure of MJK illustrated, disputes
can arise over whether a broker-dealer is
acting as a principal or agent in a stock
loan transaction.274 Under the
formulation of the rule, a broker-dealer
is presumed to be acting in a principal
capacity unless it can demonstrate
through its agreements with the other
participants in the transaction that it is
acting as agent. In this regard, a broker271 See paragraph (c)(2)(iv)(B) of Rule 15c3–1, as
adopted. Standard master securities loan
agreements (including the annexes thereto)
commonly used by the parties to a securities
lending transaction contain provisions for
establishing agent (as opposed to principal) status
in a securities lending and borrowing transaction
that are consistent with the requirements in
paragraph (c)(2)(iv)(B) of Rule 15c3–1, as amended.
See, e.g., 2000 Master Securities Loan Agreement,
Annex I, published by SIFMA, available at
www.sifma.org.
272 See Abbey National Letter; Dresdner Kleinwort
Letter; SIFMA 2 Letter; Citigroup Letter; Cornell
Letter.
273 See SIFMA 2 Letter; Citigroup Letter.
274 See, e.g., Nomura v. E*Trade, 280 F.Supp.2d
184 (S.D.N.Y. 2003).
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dealer will be responsible for
determining that its agreements are fully
consistent with the standards of the
rule.
One commenter asked for clarification
on the timing of when the agent lender
must disclose the principal parties to
one another in order to disclaim
principal liability under the rule.275
This commenter stated that the
amendment should be modified so as
not to require pre-trade disclosure of the
identity of the principal, since under the
agency annex to standardized master
lending agreements such disclosure can
be made on the next business day.276
The amendment is intended to
accommodate the continued use of these
industry model agreements by
incorporating their use into the rule’s
requirements. Consequently, disclosure
of principals in conformance with the
requirements of the ‘‘standard’’ stock
loan agreement templates would be
consistent with the requirements of the
rule (as long as the identity of the
borrower and the lender is disclosed
within one business day after the trade
date), which is designed to ensure that
firms are taking the required net capital
charges related to the securities lending
activity to the extent they have principal
liability.
The Commission also is adding new
paragraph (c)(5) to Rule 17a–11 to help
identify broker-dealers with highly
leveraged non-government securities
lending and borrowing and repurchase
operations.277 This new provision
requires a broker-dealer to notify the
Commission whenever the total amount
of money payable against all securities
loaned or subject to a repurchase
agreement, or the total contract value of
all securities borrowed or subject to a
reverse repurchase agreement, exceeds
2,500 percent of tentative net capital;
provided that, for purposes of this
leverage threshold, transactions
involving government securities as
defined in section 3(a)(42) of the
Exchange Act, are excluded from the
calculation.278 The amendment is
designed to alert regulators to a sudden
increase in a broker-dealer’s stock loan
and repo positions, which could
indicate that the broker-dealer is taking
275 See
SIFMA 2 Letter.
e.g., www.sifma.org for sample Master
Securities Loan Agreements (and annex).
277 See paragraph (c)(5) of Rule 17a–11, as
adopted.
278 15 U.S.C. 78c(a)(42). ‘‘Government securities’’
generally present less market risk than other types
of securities used in securities lending and repo
transactions. Consequently, they are excluded from
the scope of the rule.
276 See,
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on new risk that it may have limited
experience in managing.
One commenter supported the
proposed amendment and believes the
notification could serve as ‘‘an early
warning’’ that a firm is approaching
insolvency and generally supports the
Commission’s efforts to protect
customers from broker-dealers who
recklessly rely on excessively leveraged
transactions.279
In the proposing release, the
Commission estimated that a leverage
threshold of 25 times tentative net
capital would be triggered by 21 brokerdealers on a regular basis.280 The
Commission stated that this establishes
a threshold high enough to only capture
on a regular basis those few firms highly
active in securities lending and repo
transactions. The Commission did not
receive any comments regarding the
2,500% tentative net capital threshold
in the proposing release. Based on
FOCUS Report data, as of December 31,
2011, there were six broker-dealers
whose securities loaned and securities
borrowed transactions exceeded 25
times their tentative net capital. The
Commission continues to believe that
the 2,500% threshold is an appropriate
notice trigger for a firm that historically
has not been as active in these
transactions but rapidly leverages up its
securities lending and repo positions.
Given the updated estimates of how
many broker-dealers would trigger this
threshold, the Commission believes the
proposed threshold is high enough to
capture on a regular basis only those
few firms highly active in securities
lending and repo transactions.
Therefore, the Commission is retaining
this 2,500% threshold in the final rule
without revision.
As proposed, the amendment to Rule
17a–11 also would have provided that a
broker-dealer that submitted a monthly
report of its stock loan and repo activity
to its DEA need not file the notices. This
provision was designed to accommodate
large broker-dealers that are active in
this business and regularly maintain
stock loan and repo balances that
exceed the threshold. The Commission
expects that these broker-dealers have
experience in managing the risks
specific to these types of transactions
and have established controls to address
those risks. Consequently, a notice
under paragraph (c)(5) from these
broker-dealers might not be as useful in
providing risk assessment information
to regulators. Instead, the monthly
279 See
Cornell Letter.
Amendments to Financial Responsibility
Rules, 72 FR at 12870 (providing rationale for
2,500% threshold).
280 See
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reports will provide the Commission
and other financial regulators with
information with which to develop
trend analysis, when deemed
appropriate. They could use this
analysis to identify leverage levels that
are outside the normal trend range, and
which may be indicative of a material
change in the firm’s business model that
could indicate it was taking on higher
levels of leverage, branching into new
products, or experiencing operational or
financial difficulties (e.g., the firm could
be reducing leverage rapidly because
creditors were not willing to enter into
new transactions).
Three commenters addressed the
proposed monthly notification
requirement.281 They stated that the
monthly report in lieu of the
notification should be provided as part
of the monthly FOCUS report many
broker-dealers file with their DEA.282
The Commission agrees that the FOCUS
report may be an appropriate
mechanism for reporting stock loan and
repo positions in lieu of the proposed
monthly notification requirement.283
Consequently, the Commission has
modified the final rule to delete the
phrase ‘‘submits a monthly report of’’
and replace it with ‘‘reports
monthly.’’ 284 In addition, as adopted, in
order to provide that the monthly report
be sent to a broker-dealer’s DEA, the
Commission added the phrase ‘‘to its
designated examining authority in a
form acceptable’’ before ‘‘to its
designated examining authority.’’ 285
This language, as adopted, will provide
each DEA with the flexibility to
prescribe how the monthly reports are
to be made and will accommodate a
DEA that opts to use the FOCUS report
as the reporting mechanism.286 In
summary, as adopted, the notice
exemption in paragraph (c)(5) will state
‘‘provided further, however, that a
broker or dealer will not be required to
send the notice required by this
paragraph (c)(5) if it reports monthly its
securities lending and borrowing and
repurchase and reverse repurchase
activity (including the total amount of
money payable against securities loaned
or subject to a repurchase agreement
and the total contract value of securities
borrowed or subject to a reverse
repurchase agreement) to its designated
281 See Abbey National Letter; Citigroup Letter;
SIFMA 2 Letter; SIFMA 4 Letter.
282 See Abbey National Letter; Citigroup Letter;
SIFMA 2 Letter.
283 Carrying broker-dealers generally are required
to submit FOCUS reports on a monthly basis.
284 See paragraph (c)(5) of Rule 17a–11, as
adopted.
285 Id.
286 See also SIFMA 4 Letter.
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examining authority in a form
acceptable to its designated examining
authority.’’ 287
A commenter asked the Commission
to clarify that the new reporting
provision of paragraph (c)(5) of Rule
17a–11 is triggered only by principal
activity meeting or exceeding stated
thresholds.288 The notification
provision applies when a broker-dealer
is acting as principal and exceeds the
stated thresholds, and a broker-dealer
will not need to include transactions for
which it does not have principal
liability in determining whether the
notification threshold has been
triggered.
D. Documentation of Risk Management
Procedures
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It is important for broker-dealers to
document the controls they establish for
managing the material risk exposures
that arise from their business activities.
For example, a broker-dealer active in
securities lending is exposed to a variety
of risks, including market risk,289 credit
risk,290 and liquidity risk.291 Other
broker-dealer activities give rise to these
risks as well, including managing a repo
book, dealing in OTC derivatives,
trading proprietary positions, and
lending on margin. A well-documented
system of internal controls designed to
manage material risk exposures reflects
the determination of a firm’s
management as to how its business
activities should be conducted in light
of such exposures. It also enables
management to better identify, analyze,
and manage the risks inherent in the
firm’s business activities with a view to
preventing material losses and to review
whether the firm’s activities are being
conducted in a manner that is consistent
with such procedures and controls as
well as in accordance with the Federal
securities laws. Risk management
controls are particularly important for
the largest broker-dealers, which
generally engage in a wide range of
highly complex activities across many
287 See paragraph (c)(5) of Rule 17a–11, as
adopted. The Commission also inserted the text
‘‘(c)(5)’’ in the final rule before the phrase ‘‘if it
reports monthly’’ to make the paragraph reference
more explicit.
288 See Dresdner Kleinwort Letter.
289 Generally, market risk is the risk that prices,
values, or rates will adversely change.
290 Generally, credit risk is the risk of loss
resulting from a counterparty or other type of
obligor failing to meet an obligation, including an
obligation with respect to a loan, security, swap,
option, or settlement.
291 Generally, funding liquidity risk is the risk
that a firm will not be able to meet cash demands
as they become due and asset liquidity risk is the
risk that an asset will not be able to be sold quickly
at its market value.
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different markets and geographical
locations.
While most broker-dealers already
have well-documented procedures and
controls for managing risks as a matter
of business practice, it is important to
reinforce the practice and make it easier
for regulators to understand a brokerdealer’s procedures and controls so that
they can review whether the brokerdealer is adhering to them.
Consequently, the Commission
proposed an amendment to Rule 17a-3
that would have required a brokerdealer to create a record documenting
its ‘‘internal risk management
controls.’’ 292
Commenters raised concerns that the
proposed amendment would be ‘‘overly
broad and ambiguous’’ 293 and ‘‘so broad
as to create uncertainty.’’ 294 Three
commenters argued that the
requirement, if adopted, should be
limited to market, credit, and liquidity
risk management.295 Another
commenter recommended that the
Commission propose the minimum
elements required to be documented,
such as market risk, credit risk, liquidity
risk, and operational risk.296 While
market, credit, and liquidity risk were
among the specific examples of risk
identified in the proposed rule,297 the
Commission agrees that the phrase ‘‘risk
controls’’ could be interpreted very
broadly. To address this concern, the
Commission has modified the final rule
to clarify its application. The final rule
requires the documentation of controls
established specifically to manage
market, credit, and liquidity risk,
‘‘which have more commonly
understood meanings within the
industry.’’ 298 This also focuses the rule
on the key risks inherent in conducting
a securities business.
Commenters also requested that the
Commission clarify that, when a brokerdealer is part of a corporate family, risk
management controls could be
applicable to multiple entities within
the corporate family, including the
broker-dealer.299 In response, the final
rule does not specify the type of
controls a broker-dealer must establish
to manage these risks. It simply requires
292 See Amendments to Financial Responsibility
Rules, 72 FR at 12899.
293 See E*Trade Letter.
294 See Citigroup Letter.
295 See E*Trade Letter; SIFMA 2 Letter; Citigroup
Letter.
296 See Barnard Letter.
297 See Amendments to Financial Responsibility
Rules, 72 FR at 12870.
298 E*Trade Letter. The final rule also deletes the
term ‘‘internal’’ because it would be redundant.
299 See E*Trade Letter; SIFMA 2 Letter; Citigroup
Letter.
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the documentation of the procedures the
broker-dealer has established. Brokerdealers that are part of holding
companies may be subject to procedures
that are used globally throughout the
organization. As long as the brokerdealer maintains documented
procedures of controls pertaining to the
designated entity, the requirements of
the rule would be met.
Other commenters requested that the
Commission clarify that the risk
management controls do not have to
include any minimum elements 300 and
that the rule does not impose any
qualitative requirements.301 Two
commenters suggested that because
there were no stated content
requirements for the risk management
controls, it would be difficult for a firm
to prove that their risk management
procedures were adequate, which could
lead to a ‘‘subjective process’’ 302 or to
examiners applying a ‘‘one size fits all’’
best practices standard.303 One
commenter suggested that to address
this issue, the Commission should
articulate the process that examiners
will follow when examining risk
management controls.304 Finally, one
commenter encouraged the Commission
to consider strengthening this
requirement in terms of both its scope
and applicability.305
The Commission is not mandating
any specific controls, procedures, or
policies that must be established by a
broker-dealer to manage market, credit,
or liquidity risk, nor is it requiring any
minimum elements or specifying any
procedures that would be required to be
included in a firm’s market, credit, and
liquidity risk management policies.
Rather, the Commission is requiring that
a control, procedure, or policy be
documented if it is in place. Based on
staff experience monitoring large brokerdealers, the Commission anticipates that
most brokers-dealers that will be subject
to this rule already have documented
controls, procedures, and policies as
part of their overall risk management
processes. The purpose of this
amendment is not to change the
controls, procedures, and policies that
are in place, but to require that they be
adequately documented.
For the foregoing reasons, paragraph
(a)(23) to Rule 17a–3, as adopted,
requires certain broker-dealers to make
and keep current a record documenting
the credit, market, and liquidity risk
300 See
SIFMA 2 Letter.
Citigroup Letter.
302 See Coastal Securities Letter.
303 See American Bar Association Letter.
304 Id.
305 See Cornell Letter.
301 See
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management controls established and
maintained by the broker-dealer to assist
it in analyzing and managing the risks
associated with its business
activities.306 This documentation
requirement applies only to brokerdealers that have more than (1)
$1,000,000 in aggregate credit items as
computed under the customer reserve
formula of Rule 15c3–3, or (2)
$20,000,000 in capital, including debt
subordinated in accordance with
Appendix D to Rule 15c3–1.307
The Commission also proposed
adding paragraph (e)(9) to Rule 17a–4 to
require a broker-dealer to retain the
documented risk management controls
or procedures until three years after the
broker-dealer terminates the use of the
system of controls or procedures
documented therein. One commenter
stated that given the minimal cost of
electronic storage, the commenter
believes that the retention period could
be extended beyond three years.308
Conversely, two commenters suggested
that Rule 17a–4 be revised so that a
broker-dealer would not be required to
maintain outdated versions of its risk
management controls.309
The Commission is adding paragraph
(e)(9) to Rule 17a–4, with a minor
modification from the proposed
amendment. Specifically, the final rule
is modified to require retention of the
records until three years after
termination of the use of the risk
management controls documented
therein by replacing the phrase
‘‘systems of controls or procedures’’
with the phrase ‘‘risk management
controls.’’ 310 This modification
maintains consistency with the
terminology in paragraph (a)(23) of Rule
17a–3, as adopted, which requires
broker-dealers to make and keep current
a ‘‘record documenting the credit,
market, and liquidity risk management
controls established and maintained by
the broker or dealer.’’ 311 Finally, the
three year retention period is designed
to establish an audit trail between the
risk management controls that have
306 See paragraph (a)(23) of Rule 17a–3, as
adopted.
307 The Commission also has modified paragraph
(a)(23) of Rule 17a–3 from the proposed rule to
delete the reference to the term ‘‘member’’ in two
places in the final rule because the reference to
‘‘member’’ is unnecessary. Id.
308 Id.
309 See E*Trade Letter; SIFMA 2 Letter.
310 See paragraph (e)(9) of Rule 17a–4, as adopted.
The Commission also modified the final rule to
delete the phrase ‘‘paragraph (a)(23) of’’ and insert
‘‘(a)(23)’’ immediately following ‘‘17a–3’’ to make
the referenced citation consistent with other parts
of the rule.
311 See paragraph (a)(23) of Rule 17a–3, as
adopted.
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most recently been made inoperative
and the risk management controls
currently in effect to provide sufficient
opportunity to review the former during
the broker-dealer’s exam cycle. Three
years also is consistent with the
retention period for many of the records
required to be preserved under Rule
17a–4.312
Finally, one commenter noted that the
proposed amendment does not impose
any requirements beyond those
applicable under Rule 15c3–4.313
Accordingly, the commenter urged the
Commission to create an exception from
the proposed amendment to Rule 17a–
3 for a broker-dealer that is effectively
subject to Rule 15c3–4. With the
modifications to the final rule to include
only market, credit, and liquidity risk, a
broker-dealer subject to the conditions
of Rule 15c3–4 would already comply
with this amendment given that these
risks are included in the risks a brokerdealer would be required to address
under Rule 15c3–4. Therefore, an
exception from the rule is unnecessary.
E. Amendments to the Net Capital Rule
Under Rule 15c3–1, broker-dealers are
required to maintain, at all times, a
minimum amount of net capital.314 The
capital standard in Rule 15c3–1 is a net
liquid assets test. This standard is
designed to allow a broker-dealer the
flexibility to engage in activities that are
part of conducting a securities business
(e.g., taking securities into inventory)
but in a manner that places the firm in
the position of holding at all times more
than one dollar of highly liquid assets
for each dollar of unsubordinated
liabilities (e.g., money owed to
customers, counterparties, and
creditors).315 For example, Rule 15c3–1
312 See
17 CFR 240.17a–4(b).
SIFMA 2 Letter. See also 17 CFR
240.15c3–4.
314 See 17 CFR 240.15c3–1.
315 See, e.g., Interpretation Guide to Net Capital
Computation for Brokers and Dealers, Exchange Act
Release No. 8024 (Jan. 18, 1967), 32 FR 856 (Jan.
25, 1967) (‘‘Rule 15c3–1 (17 CFR 240.15c3–1) was
adopted to provide safeguards for public investors
by setting standards of financial responsibility to be
met by brokers and dealers. The basic concept of
the rule is liquidity; its object being to require a
broker-dealer to have at all times sufficient liquid
assets to cover his current indebtedness.’’)
(Footnotes omitted); Net Capital Treatment of
Securities Positions, Obligations and Transactions
in Suspended Securities, Exchange Act Release No.
10209 (June 8, 1973), 38 FR 16774 (June 26, 1973)
(Commission release of a letter from the Division of
Market Regulation) (‘‘The purpose of the net capital
rule is to require a broker or dealer to have at all
times sufficient liquid assets to cover its current
indebtedness. The need for liquidity has long been
recognized as vital to the public interest and for the
protection of investors and is predicated on the
belief that accounts are not opened and maintained
with broker-dealers in anticipation of relying upon
suit, judgment and execution to collect claims but
313 See
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51849
allows securities positions to count as
allowable net capital, subject to
standardized or model-based deductions
(‘‘haircuts’’).316 The rule, however, does
not permit most unsecured receivables
to count as allowable net capital.317
This aspect of the rule severely limits
the ability of broker-dealers to engage in
activities that generate unsecured
receivables (e.g., lending money without
obtaining collateral). The rule also does
not permit fixed assets or other illiquid
assets to count as allowable net capital,
which creates disincentives for brokerdealers to own real estate and other
fixed assets that cannot be readily
converted into cash.318 For these
reasons, Rule 15c3–1 incentivizes
broker-dealers to confine their business
activities and devote capital to activities
such as underwriting, market making,
and advising on and facilitating
customer securities transactions.319
Rule 15c3–1 requires broker-dealers to
maintain a minimum level of net capital
(meaning highly liquid capital) at all
times.320 The rule requires that a brokerdealer perform two calculations: (1) A
computation of the minimum amount of
net capital the broker-dealer must
maintain; 321 and (2) a computation of
the amount of net capital the brokerdealer is maintaining.322 The minimum
net capital requirement is the greater of
a fixed-dollar amount specified in the
rule and an amount determined by
applying one of two financial ratios: The
15-to-1 aggregate indebtedness to net
rather on a reasonable demand one can liquidate his
cash or securities positions.’’); Net Capital
Requirements for Brokers and Dealers, Exchange
Act Release No. 15426 (Dec. 21, 1978), 44 FR 1754
(Jan. 8, 1979) (‘‘The rule requires brokers or dealers
to have sufficient cash or liquid assets to protect the
cash or securities positions carried in their
customers’ accounts. The thrust of the rule is to
insure that a broker or dealer has sufficient liquid
assets to cover current indebtedness.’’); Net Capital
Requirements for Brokers and Dealers, Exchange
Act Release No. 26402 (Dec. 28, 1989), 54 FR 315
(Jan. 5, 1989) (‘‘The rule’s design is that brokerdealers maintain liquid assets in sufficient amounts
to enable them to satisfy promptly their liabilities.
The rule accomplishes this by requiring brokerdealers to maintain liquid assets in excess of their
liabilities to protect against potential market and
credit risks.’’) (Footnote omitted).
316 See 17 CFR 240.15c3–1(c)(2)(vi); 17 CFR
240.15c3–1e; 17 CFR 240.15c3–1f .
317 See 17 CFR 240.15c3–1(c)(2)(iv).
318 See, e.g., 17 CFR 240.15c3–1(c)(2)(iv)(A).
319 See Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and
Major Security-Based Swap Participants and
Capital Requirements for Broker-Dealers, Exchange
Act Release No. 68071 (Oct. 18, 2012), 77 FR 70214,
70219 (Nov. 23, 2012).
320 See 17 CFR 240.15c3–1.
321 See 17 CFR 240.15c3–1(a).
322 See 17 CFR 240.15c3–1(c)(2). The computation
of net capital is based on the definition of net
capital in paragraph (c)(2) of Rule 15c3–1. Id.
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capital ratio or the 2% of aggregate debit
items ratio.323
In computing net capital, the brokerdealer must, among other things, make
certain adjustments to net worth such as
deducting illiquid assets, taking other
capital charges, and adding qualifying
subordinated loans.324 The amount
remaining after these adjustments is
defined as tentative net capital.325 The
final step in computing net capital is to
take prescribed percentage deductions
(‘‘standardized haircuts’’) from the
mark-to-market value of the proprietary
positions (e.g., securities, money market
instruments, and commodities) that are
included in its tentative net capital.326
The standardized haircuts are designed
to account for the market risk inherent
in these positions and to create a buffer
of liquidity to protect against other risks
associated with the securities
business.327 Alternative Net Capital or
‘‘ANC’’ broker-dealers and a type of
limited purpose broker-dealer that deals
solely in OTC derivatives (‘‘OTC
derivative dealers’’) are permitted, with
Commission approval, to, among other
things, use internal models as the basis
for taking market risk charges as an
alternative approach in lieu of the
standardized haircuts for classes of
positions for which they have been
approved to use models.328 Rule 15c3–
1 imposes substantially higher
minimum capital requirements for ANC
broker-dealers and OTC derivatives
dealers, as compared to other types of
broker-dealers, because, among other
reasons, the use of internal models to
compute net capital can substantially
reduce the deductions for securities and
money market positions as compared
with the standardized haircuts.329
323 See
17 CFR 240.15c3–1(a).
17 CFR 240.15c3–1(c)(2)(i)–(xiii).
325 See 17 CFR 240.15c3–1(c)(15).
326 See 17 CFR 240.15c3–1(c)(2)(vi).
327 See, e.g., Uniform Net Capital Rule, Exchange
Act Release No. 13635 (June 16, 1977), 42 FR 31778
(June 23, 1977) (‘‘[Haircuts] are intended to enable
net capital computations to reflect the market risk
inherent in the positioning of the particular types
of securities enumerated in [the rule]’’); Net Capital
Rule, Exchange Act Release No. 22532 (Oct. 15,
1985), 50 FR 42961 (Oct. 23, 1985) (‘‘These
percentage deductions, or ‘haircuts’, take into
account elements of market and credit risk that the
broker-dealer is exposed to when holding a
particular position.’’); Net Capital Rule, Exchange
Act Release No. 39455 (Dec. 17, 1997), 62 FR 67996
(Dec. 30, 1997) (‘‘Reducing the value of securities
owned by broker-dealers for net capital purposes
provides a capital cushion against adverse market
movements and other risks faced by the firms,
including liquidity and operational risks.’’)
(Footnote omitted).
328 See 17 CFR 240.15c3–1(a)(5) and (a)(7); 17
CFR 240.15c3–1e; 17 CFR 240.15c3–1f.
329 See 17 CFR 240.15c3–1(a)(5) and (a)(7). See
also Capital, Margin, and Segregation Requirements
for Security-Based Swap Dealers and Major
Security-Based Swap Participants and Capital
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324 See
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1. Requirement To Deduct From Net
Worth Certain Liabilities or Expenses
Assumed by Third Parties
In the proposing release, the
Commission expressed concern that
some broker-dealers may be excluding
from their calculations of net worth
certain liabilities that relate directly to
expenses or debts incurred by the
broker-dealer.330 The accounting
justification for the exclusion is that a
third party (usually a parent or affiliate)
has assumed responsibility for these
expenses and debts through an expense
sharing agreement.331 In some cases,
however, the third party does not have
the resources —independent of the
broker-dealer’s revenues and assets—to
assume these liabilities. Thus, the third
party is dependent on the resources of
the broker-dealer to pay the expenses
and debts. Excluding liabilities from the
broker-dealer’s net worth calculation in
these situations may misrepresent the
firm’s actual financial condition,
deceive the firm’s customers, and
hamper the ability of regulators to
monitor the firm’s financial
condition.332
To address this issue, the Commission
proposed—and is now adopting
substantially as proposed—an
amendment to Rule 15c3–1 to add a
new paragraph (c)(2)(i)(F) that will
require a broker-dealer, in calculating
net capital, to take into account any
liabilities that are assumed by a third
party if the broker-dealer cannot
demonstrate that the third party has the
resources—independent of the brokerdealer’s income and assets—to pay the
liabilities.333
Requirements for Broker-Dealers, Exchange Act
Release No. 68071, 77 FR at 70219 (‘‘[T]he use of
internal models to compute net capital can
substantially reduce the deductions for securities
and money market positions as compared with the
standardized haircuts.’’); Alternative Net Capital
Requirements for Broker-Dealers that are Part of
Consolidated Supervised Entities, Exchange Act
Release No. 49830 (June 8, 2004), 69 FR 34428,
34431 (June 21, 2004) (‘‘We expect that use of the
alternative net capital computation will reduce
deductions for market and credit risk substantially
for broker-dealers that use that method.’’).
330 See Amendments to Financial Responsibility
Rules, 72 FR at 12871.
331 See, e.g., Letter from Michael A. Macchiaroli,
Associate Director, Division of Market Regulation,
Commission, to Elaine Michitsch, Member Firm
Operations, NYSE, and Susan DeMando, Director,
Financial Operations, NASD Regulation, Inc. (July
11, 2003) (‘‘Third Party Expense Letter’’); see also
FINRA Notice to Members 03–63, Expense-Sharing
Agreements (Oct. 2003) (discussing the issuance of
the Third Party Expense Letter).
332 See Amendments to Financial Responsibility
Rules, 72 FR at 12871.
333 As adopted, the final rule does not include the
‘‘-’’ in the phrase ‘‘third-party.’’ In addition, the
final rule uses the phrase ‘‘broker or dealer’’ in the
place of the phrase ‘‘broker-dealer’’ (which
appeared in two places) to maintain consistency
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The Commission received five
comments regarding this proposal.334
Two commenters stated that the
amendment was overly burdensome and
that it would not result in a more
accurate picture of a broker-dealer’s
financial condition than obtained
through current requirements.335 One of
these commenters added that any
implementation and enforcement of the
amendments ‘‘should not be made
retroactive.’’336 This commenter stated
that it is unclear how, and unlikely that,
this amendment would achieve any of
the desired results and argued that it
could conversely impair a firm’s ability
to continue as a going concern.337
Finally, this commenter also argued that
this amendment would affect capital
transactions that originate at the holding
company level.338 Two commenters
agreed in principle with the
amendments but urged the Commission
to carefully consider the potential
consequences of implementation and to
provide clarification on the standard for
demonstrating that the third party has
adequate financial resources, including
factors beyond those referred to in the
proposing release that they believed
would be potentially relevant.339 One
commenter supported the Commission’s
goal of clarifying disclosures relating to
expense sharing or obligations.340
As with the proposal, the amendment,
as adopted, is designed to prohibit a
practice that could misrepresent a
broker-dealer’s actual financial
condition, deceive the firm’s customers,
and hamper the ability of regulators to
monitor the firm’s financial condition.
Moreover, the amendment, as adopted,
should not impose undue burdens or
present serious implementation
difficulties because the requirement is
consistent with prior staff guidance
regarding the treatment of broker-dealer
expenses assumed by a third party.341
Finally, as compared to staff guidance,
a federal regulation offers broker-dealers
greater certainty as to how to treat
expense sharing agreements under Rule
15c3–1.
In response to the comments
discussed above, and as the Commission
explained in the proposing release, a
broker-dealer can demonstrate the
adequacy of the third party’s financial
throughout Rule 15c3–1, which uses the phrase
‘‘broker or dealer.’’
334 See Beer Letter; Levene Letter; Lowenstein
Letter; SIFMA 2 Letter; NIBA 2 Letter.
335 See Beer Letter; Levene Letter.
336 See Levene Letter.
337 Id.
338 Id.
339 See Lowenstein Letter; SIFMA 2 Letter.
340 See NIBA 2 Letter.
341 See, e.g., Third Party Expense Letter.
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resources by maintaining records such
as the third party’s most recent (i.e., as
of a date within the previous twelve
months) audited financial statements,
tax returns, or regulatory filings
containing financial reports.342 Given
that the entity to which the brokerdealer is seeking to shift one or more
liabilities typically is an affiliate, the
staff’s experience is that such records
should be available to the broker-dealer.
Further, because the proposed rule
change is consistent with prior staff
guidance regarding the need to be able
to demonstrate the third party’s
financial adequacy,343 a broker-dealer
seeking to shift a liability to a third
party already would be expected to
provide such evidence of the third
party’s financial resources. For these
reasons, the change from staff guidance
to Commission rule should not result in
implementation and burden concerns of
the magnitude raised by the two
commenters.344
Finally, one commenter noted it
would be helpful if the Commission
would clarify whether this amendment
supersedes the Commission staff
guidance in the Third Party Expense
Letter.345 Unlike the PAIB Letter
discussed above, the Commission is not
directing the staff to withdraw the Third
Party Expense Letter on the effective
date of these amendments. The Third
Party Expense Letter will still be
relevant as staff guidance,
notwithstanding that it contains a
condition that has been codified into
Rule 15c3–1 (i.e., that an expense of the
broker-dealer assumed by a third party
will be considered a liability for net
capital purposes unless the brokerdealer can demonstrate that the third
party has adequate resources
independent of the broker-dealer to pay
the liability or expense).346 In
particular, the letter contains additional
staff guidance not incorporated into the
rule that will be relevant as staff
guidance with respect to complying
with the amendment to Rule 15c3–1
being adopted today. For example, the
letter contains staff guidance with
respect to the records a broker-dealer
would be expected to make, keep
current, and preserve under Rules 17a–
3 and 17a–4 with respect to brokerdealer liabilities and expenses assumed
342 See Amendments to Financial Responsibility
Rules, 72 FR at 12872. The Commission specifically
requested comment regarding the records by which
a broker-dealer could demonstrate financial
resources. It received no comments in response to
this request.
343 See, e.g., Third Party Expense Letter.
344 See Lowenstein Letter; SIFMA 2 Letter.
345 See SIFMA 2 Letter.
346 See Third Party Expense Letter, at 2–3.
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by a third party, as well as requirements
regarding written expense sharing
agreements.347 Broker-dealers can
continue to rely on the guidance in the
Third Party Expense Letter with respect
to these matters in complying with
today’s amendment.
2. Requirement To Subtract From Net
Worth Certain Non-Permanent Capital
Contributions
In the proposing release, the
Commission noted its concern that
broker-dealers may be receiving capital
contributions from investors that are
subsequently withdrawn after a short
period of time (often less than a year).348
In some cases, the capital may be
contributed under an agreement giving
the investor the option to withdraw it at
the investor’s discretion. In the past, the
Commission has emphasized that
capital contributions to broker-dealers
should not be temporary,349 and the
Commission staff has explained that a
capital contribution should be treated as
a liability if it is made with the
understanding that the contribution can
be withdrawn at the option of the
investor.350
Consistent with these Commission
and staff positions that capital is not
temporary,351 and given the importance
of this issue and the Commission’s
concern that broker-dealers may not be
properly treating short-term capital
contributions as liabilities, the
347 Id.
348 See Amendments to Financial Responsibility
Rules, 72 FR at 12873.
349 See Net Capital Rule, Exchange Act Release
No. 28927 (Feb. 28, 1991), 56 FR 9124 (Mar. 5,
1991). See also Study of Unsafe and Unsound
Practices of Broker-Dealers, Report and
Recommendations of the Securities and Exchange
Commission, H.R. Doc. No. 92–231 (1971), at 17, 42
(recommending improvement of adequacy and
permanency of capital) (‘‘During the 1967–1970
period under review, many broker-dealers, some of
them large retail houses, were found to have
inadequate and impermanent capital in relation to
their business.’’).
350 Letter from Michael A. Macchiaroli, Associate
Director, Division of Market Regulation,
Commission, to Raymond J. Hennessy, Vice
President, NYSE, and Susan DeMando, Vice
President, NASD Regulation, Inc. (Feb. 23, 2000)
(‘‘Temporary Capital Letter’’) (‘‘It is the view of the
Division that, for net capital purposes, if an
individual investor contributes capital to a brokerdealer with an understanding that the contribution
can be withdrawn at the option of the individual
investor, the contribution may not be included in
the firm’s net capital computation and must be recharacterized as a liability. Any withdrawal of
capital as to that investor within a period of one
year, other than a withdrawal described in
paragraph (e)(4)(iii) of Rule 15c3–1, shall be
presumed to have been contemplated at the time of
the contribution.’’) (footnote omitted); see also Net
Capital Rule, Exchange Act Release No. 28927 (Feb.
28, 1991), 56 FR 9124 (Mar. 5, 1991).
351 See Net Capital Rule, Exchange Act Release
No. 28927 (Feb. 28, 1991), 56 FR 9124 (Mar. 5,
1991).
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51851
Commission proposed amending Rule
15c3–1 to add paragraph (c)(2)(i)(G) to
further incorporate these positions into
the rule.352 The proposed change would
require a broker-dealer to treat as a
liability any capital that is contributed
under an agreement giving the investor
the option to withdraw it or that is
contributed with the intent to withdraw
the capital within one year. The
Commission further proposed that
capital withdrawn within one year
would be presumptively subject to
treatment as a liability (i.e., it would be
presumed to have been contributed with
the intent to withdraw within one
year).353
The Commission is adopting the final
rule amendment with certain
modifications. As adopted, the rule
requires that a broker-dealer treat as a
liability any capital that is contributed
under an agreement giving the investor
the option to withdraw it. The rule, as
adopted, also requires that a brokerdealer treat as a liability any capital
contribution that is intended to be
withdrawn within one year of its
contribution. In addition, the final rule
provides that capital withdrawn within
one year of contribution is deemed to
have been intended to be withdrawn
within one year unless the broker-dealer
receives permission in writing for the
withdrawal from its DEA.354 The ability
of a broker-dealer to seek permission in
writing from its DEA to withdraw
capital contributed within one year will
provide a means for firms to seek to
withdraw capital in limited
circumstances after review by its DEA
without having to reclassify the
withdrawn capital as a liability for net
capital purposes.355
In the final rule, the Commission has
modified the proposed language by
moving the qualifier that the DEA can
approve a withdrawal so that it modifies
this presumption. Specifically, as
proposed, the rule provided that a
contribution of capital had to be
subtracted from net worth if it ‘‘is
352 See Amendments to Financial Responsibility
Rules, 74 FR at 12871–12872.
353 Id.
354 These requirements will not apply to
withdrawals covered by paragraph (e)(4)(iii) of Rule
15c3–1, namely, withdrawals used to make tax
payments or to pay reasonable compensation to
partners. See 17 CFR 240.15c3–1(e)(4)(iii). These
types of payments are ordinary business
expenditures and do not raise the types of concerns
the proposed rule is designed to address. One
commenter suggested that the rule be amended to
explicitly exclude any withdrawals that would fall
under paragraph (e)(4)(iii) of Rule 15c3–1.
355 See FINRA Rule 4110(c)(1) (providing, in part,
that no equity capital of a member may be
withdrawn for a period of one year from the date
such equity capital is contributed, unless otherwise
permitted by FINRA in writing).
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intended to be withdrawn within a
period of one year unless the
withdrawal has been approved in
writing by the Examining Authority for
the broker or dealer.’’ As adopted, the
rule provides that ‘‘[a]ny withdrawal of
capital made within one year of its
contribution is deemed to have been
intended to be withdrawn within a
period of one year, unless the
withdrawal has been approved in
writing by the Examining Authority for
the broker or dealer.’’ 356 The change is
intended to eliminate a potential
ambiguity in the proposal as to whether
a withdrawal of capital within one year
could ever be approved by the firm’s
DEA and, therefore, afford the intended
relief from the deduction.357
The Commission received five
comments regarding the amendment to
paragraph (c)(2)(i)(G)(2) of Rule 15c3–
1.358 In addition to the general request
for comment included in the proposing
release, the Commission also requested
specific comment on whether the time
period within which withdrawn and
intended-to-be-withdrawn contributions
must be treated as liabilities should be
longer than one year.359 While the
commenters agreed in principle that
contributions of capital to brokerdealers should not be subject to
withdrawal at will, they expressed
concerns regarding the negative effect
that overly restrictive limitations on
withdrawals of capital could have on
obtaining capital contributions and,
therefore, on the financial health of
broker-dealers. One commenter, a
registered broker-dealer, stated that it
believed that the amendment would
raise its cost of capital to the point
where it would be impossible to obtain
capital from unrelated third parties at
all.360 Two commenters also expressed
concerns about the potential burden
posed by the amendment to brokerdealers in need of capital.361 One
suggested the addition of exceptions to
the rule for de minimis withdrawals and
dividends or distributions.362 Another
commenter suggested that the proposal
should be amended to exclude a
356 See paragraph (c)(2)(i)(G)(2) of Rule 15c3–1, as
adopted.
357 The phrase ‘‘to the broker or dealer’’ following
‘‘one year of its contribution’’ is not included in the
final rule because it would be redundant, as the
contributions covered in the amendment all involve
contributions to the broker-dealer.
358 See Chicago Capital Management Letter;
SIFMA 2 Letter; American Bar Association Letter;
SIG Letter; NIBA 2 Letter.
359 See Amendments to Financial Responsibility
Rules, 72 FR at 12871–12872.
360 See Chicago Capital Management Letter.
361 See American Bar Association Letter; SIFMA
2 Letter.
362 See SIFMA 2 Letter.
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redemption right—a form of option—
provided to the investor in connection
with the investor’s capital contribution
to the broker-dealer, where (i) the
redemption right may only be exercised
by the investor commencing more than
one year following the date of the
capital contribution to the broker-dealer
and (ii) the redemption right would not
be mandatorily redeemable.363
Another commenter opposed the rule,
stating that it contravenes pertinent
legal and accounting standards and is
unnecessary in view of existing capital
withdrawal limitations and notification
requirements.364 This commenter stated
that neither GAAP nor Rule 15c3–1
contain a requirement that capital must
be permanent, and the word ‘‘capital’’
has no intrinsic meaning that requires it
to be permanent.365 This commenter
stated that if any further limitations on
capital withdrawals are adopted beyond
the current provisions of the net capital
rule, they should be designed to allow
for the ability of broker-dealer holding
companies to withdraw excess net
capital at their option for legitimate
purposes.366
The fifth commenter agreed that there
should be no circumstance in which a
broker-dealer accepted a capital
contribution for net capital purposes
that could be withdrawn at the option
of the investor.367 This commenter,
however, also stated that the standard
for withdrawals should be shortened
from one year to nine or six months to
increase the availability of funds from
investors and owners, allowing more
broker-dealers to raise capital and
strengthen their financial stability.368
The commenter requested that the
Commission consider the needs of small
firms that it said likely will require
additional net capital over the next
decade.369
In response to the commenters’
concerns about firms’ ability to obtain
capital and that the amendment
contravenes pertinent legal and
accounting standards, the amended rule
merely clarifies what constitutes a
broker-dealer’s permanent capital under
Rule 15c3–1 and further emphasizes the
requirement that capital contributions
363 See
364 See
American Bar Association Letter.
SIG Letter.
365 Id.
366 Id.
367 See
NIBA 2 Letter.
368 Id.
369 Id. The commenter also stated that rules that
‘‘restrict small broker-dealers from raising capital as
a result of uncertainty of investors or owneroperators related to the return of their capital in a
reasonable time frame will create a disproportionate
and impossible hurdle for small broker-dealers to
overcome.’’ Id.
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cannot be temporary.370 Rule 15c3–1
imposes a capital standard that is
distinct from the use of the term
‘‘capital’’ in other legal and accounting
contexts, and the rule amendments
under paragraph (c)(2)(i)(G) of Rule
15c3–1 are consistent with the
Commission’s and staff’s views that
capital under Rule 15c3–1 should not be
temporary.371
370 See Net Capital Rule, Exchange Act Release
No. 28927 (Feb. 28, 1991) (‘‘The Commission
wishes to emphasize that the net capital maintained
in a broker-dealer should be permanent capital and
not merely a temporary infusion of funds from an
affiliate or other sources. For example, there are
instances where a broker-dealer receives funds from
an affiliate in an amount that would enable the
broker-dealer to engage in a transaction that it
would otherwise be prohibited from doing because
of minimum net capital requirements. If the funds
are transferred back to the affiliate within a
relatively short period of time after the transaction,
the Commission questions whether the funds
transferred into the broker-dealer entity could
properly be characterized as capital of the firm.
Instead, the transaction could be viewed as a loan
by the affiliate to the broker-dealer, with the result
that the broker-dealer would have to treat the
transaction as a liability.’’). See also Net Capital
Requirements for Brokers and Dealers, Exchange
Act Release No. 18417 (Jan. 13, 1982), 47 FR 3512
(Jan. 25, 1982) (describing subordination agreement
requirements under Appendix D to Rule 15c3–1,
including that, among other things, no prepayment
may be made (except under the strictly defined
limitations of paragraph (c)(5) of Appendix D)
before the expiration of one year from the effective
date of the subordination agreement, and noting
this provision was designed to insure the adequacy
as well as the permanence of capital in the
industry.); Temporary Capital Letter; Study of
Unsafe and Unsound Practices of Broker-Dealers,
Report and Recommendations of the Securities and
Exchange Commission, H.R. Doc. No. 92–231 (1971)
(recommending improvement of adequacy and
permanency of capital); and Letter from Nelson
Kibler, Assistant Director, Division of Market
Regulation to John Pinto, National Association of
Securities Dealers, Inc. (Sept. 8, 1980).
371 See Study of Unsafe and Unsound Practices of
Broker-Dealers, Report and Recommendations of
the Securities and Exchange Commission, H.R. Doc.
No. 92–231 (1971), at p. 15 (‘‘The unfortunate use
of the term ‘‘net capital’’ in the financial
responsibility rules of the Commission and the
various exchanges resulted in a semantic confusion
which too frequently has led to the mistaken belief
that a broker-dealer’s net capital is the equivalent
of or has some relationship to the concept of
‘‘capital’’, as that term is commonly understood.
‘‘Net Capital’’ applies only to a hard core residue
of net liquid assets designed to enable a brokerdealer to meet all rightful current demands of
customers for their funds and securities.’’). See also
Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major SecurityBased Swap Participants and Capital Requirements
for Broker-Dealers, 77 FR at 70230 (‘‘The net liquid
assets test is imposed through the mechanics of
how a broker-dealer is required to compute net
capital pursuant to Rule 15c3–1. These
requirements are set forth in paragraph (c)(2) of
Rule 15c3–1, which defines the term net capital.
The first step is to compute the broker-dealer’s net
worth under GAAP. Next, the broker-dealer must
make certain adjustments to its net worth to
calculate net capital. These adjustments are
designed to leave the firm in a position where each
dollar of unsubordinated liabilities is matched by
more than a dollar of highly liquid assets. There are
thirteen categories of net worth adjustments
required by the rule.’’) (footnotes omitted).
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The Commission also considered the
commenter’s suggestion that there be
exceptions for de minimis withdrawals,
dividends, or distributions. As
previously stated, however, the
Commission has emphasized that
capital contributions should not be
temporary.372 Moreover, paragraph (e)
of Rule 15c3–1 already contains
mechanisms to permit a broker-dealer to
make capital withdrawals for specified
purposes.373 Finally, if a broker-dealer
believes it has a basis to appropriately
withdraw capital within one year of
contribution because, for example, the
withdrawal would be de minimis, the
final rule provides a mechanism for the
broker-dealer to seek permission in
writing from its DEA to make such a
withdrawal.374
With respect to a commenter’s view
that the standard for withdrawal should
be less than one year (e.g., six or nine
months), the Commission continues to
believe that one year is an appropriate
amount of time that a broker-dealer
must retain a contribution in order to
classify it as capital and not a liability.
This is the standard that the
Commission staff and FINRA have
applied for a number of years and there
is no compelling reason to change it.375
Because the final rule change is an
incorporation of, among other things,
existing Commission staff guidance into
Rule 15c3–1, the requirement should
not significantly alter current practice.
Moreover, with respect to
commenters’ concerns about the ability
to obtain capital, the rule does not
prohibit an investor from withdrawing
capital at any time. It prohibits a broker372 See Study of Unsafe and Unsound Practices of
Broker-Dealers, Report and Recommendations of
the Securities and Exchange Commission, H.R. Doc.
No. 92–231 (1971), at p. 15; Capital, Margin, and
Segregation Requirements for Security-Based Swap
Dealers and Major Security-Based Swap
Participants and Capital Requirements for BrokerDealers, 77 FR at 70230.
373 See 17 CFR 240.15c3–1(e)(1)(iii)(B) and
(e)(4)(iii). See also Amendments to Financial
Responsibility Rules, 72 FR at 12872, n.79 (‘‘These
requirements would not apply to withdrawals
covered by paragraph (e)(4)(iii) of Rule 15c3–1,
namely, withdrawals used to make tax payments or
pay reasonable compensation to partners. These
types of payments are ordinary business
expenditures and do not raise the types of concerns
the proposed rule is designed to address.’’).
374 See paragraph (c)(2)(i)(G)(2) of Rule 15c3–1, as
adopted.
375 See Temporary Capital Letter; FINRA Rule
4110(c)(1) (‘‘No equity capital of a member may be
withdrawn for a period of one year from the date
such equity capital is contributed, unless otherwise
permitted by FINRA in writing.’’). See also
Exchange Act Release No. 60933 (Nov. 4, 2009), 74
FR 58334 (Nov. 12, 2009) (SR–FINRA–2008–067);
Net Capital Rule, Exchange Act Release No. 28927
(Feb. 28, 1991) (emphasizing ‘‘that the net capital
maintained in a broker-dealer should be permanent
capital and not merely a temporary infusion of
funds from an affiliate or other sources’’).
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dealer from treating temporary cash
infusions as capital for purposes of Rule
15c3–1. Finally, as stated above, the
final rule provides a mechanism for a
broker-dealer to apply to its DEA to
make a withdrawal without triggering
the deduction.376 This provides a
process for firms to affect withdrawals
within one year where appropriate.
In summary, the Commission is
adding paragraph (c)(2)(i)(G) to Rule
15c3–1 to require a broker-dealer to
subtract from net worth any
contribution of capital to the broker or
dealer: ‘‘(1) [u]nder an agreement that
provides the investor with the option to
withdraw the capital; or (2) [t]hat is
intended to be withdrawn within a
period of one year of contribution.’’ 377
The final rule further provides that
‘‘[a]ny withdrawal of capital made
within one year of its contribution is
deemed to have been intended to be
withdrawn within a period of one year,
unless the withdrawal has been
approved in writing by the Examining
Authority for the broker or dealer.’’ 378
3. Requirement To Deduct the Amount
by Which a Fidelity Bond Deductible
Exceeds SRO Limits
Under SRO rules, certain brokerdealers that do business with the public
or that are required to become members
of SIPC must comply with mandatory
fidelity bonding requirements.379 SRO
rules typically permit a broker-dealer to
have a deductible provision included in
the bond; however, such rules provide
that the deductible may not exceed
certain amounts. With regard to firms
that maintain deductible amounts over
the maximum amount specified, several
SRO rules provide that the broker-dealer
must deduct this excess amount from its
net worth when calculating net capital
376 The final rule does not distinguish between
complete and partial withdrawals of capital and,
consequently, the deduction could be triggered in
either event. Moreover, a partial withdrawal would
require a deduction of the full amount of the
original contribution as it would indicate that the
contribution was merely temporary in nature.
377 See paragraph (c)(2)(i)(G) of Rule 15c3–1, as
adopted.
378 Id.
379 See, e.g., FINRA Rule 4360, CBOE Rule 9.22,
and NASDAQ OMX PHLX Rule 705. SRO fidelity
bonding requirements typically contain agreements
covering areas such as: a ‘‘Fidelity’’ insuring clause
to indemnify against loss of property through
dishonest or fraudulent acts of employees; an ‘‘On
Premises’’ agreement insuring against losses
resulting from crimes such as burglary and theft and
from misplacement of property of the insured; an
‘‘In Transit’’ clause indemnifying against losses
occurring while property is in transit; a ‘‘Forgery
and Alteration’’ agreement insuring against loss due
to forgery or alteration of various kinds of
negotiable instruments; and a ‘‘Securities Loss’’
clause protecting against losses incurred through
forgery and alteration of securities. Id.
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under Rule 15c3–1.380 Other SROs
require that any deductible amount
elected by a broker-dealer that is greater
than 10% of the coverage purchased by
the broker-dealer must be deducted
from the broker-dealer’s net worth when
calculating net capital under Rule 15c3–
1.381
Rule 15c3–1, however, does not
specifically reference the SRO
deductible requirements as a charge to
net worth. Therefore, a broker-dealer
would not be required to account for the
deduction required by an SRO rule in
computing net capital under Rule 15c3–
1 or in the net capital computation
reflected on the broker-dealer’s FOCUS
report. To address this inconsistency,
the Commission proposed to amend
Rule 15c3–1 to add paragraph (c)(2)(xiv)
to require a broker-dealer to deduct,
with regard to fidelity bonding
requirements, the amount required by
the rules of the broker-dealer’s DEA, i.e.,
the amount in excess of the deductible
prescribed in the applicable DEA’s
fidelity bond rule.382 The Commission
received one comment supporting the
proposal and one opposing it.383 The
commenter opposing the amendment
noted that amending Rule 15c3–1 to
conform to FINRA Rule 4360 would
create an increase in minimum net
capital requirements for some brokerdealers.384
SRO rules prescribing fidelity bond
deductibles, and capital charges for
deductibles in excess of a certain
amount, are designed to incentivize
broker-dealers to carry fidelity bonds
with a deductible low enough to help
ensure customer protection. Moreover,
in response to the comment that this
amendment would increase minimum
net capital requirements, the
Commission notes that broker-dealers
that are members of an SRO with such
a fidelity bonding rule already must
account for the deduction in complying
with the net capital requirements of the
SROs and nothing in the Commission’s
amendment to paragraph (c)(2)(xiv) of
Rule 15c3–1 would alter this status quo.
Rather, the proposed rule change would
conform the capital calculation under
paragraph (c)(2)(xiv) of Rule 15c3–1 to
that required by the broker-dealer’s
SRO.
For these reasons, the Commission is
adopting paragraph (c)(2)(xiv) to Rule
15c3–1 with technical revisions to the
proposed rule text to make the text of
380 See,
e.g., CBOE Rule 9.22.
e.g., FINRA Rule 4360.
17 CFR 240.15c3–1(c)(12) (defining
examining authority for purposes of Exchange Act
Rule 15c3–1).
383 See SIFMA 2 Letter; NIBA 2 Letter.
384 See NIBA 2 Letter.
381 See,
382 See
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the final rule, as adopted, a more
generic cross reference to SRO fidelity
bond requirements. The technical
changes are designed to increase the
flexibility of the final rule so that
revisions to SRO fidelity bond
requirements pursuant to section 19(b)
of the Exchange Act 385 will not require
conforming amendments to paragraph
(c)(2)(xiv) of Rule 15c3–1.386 More
specifically, the proposed rule text, as
set forth in the proposing release, would
have required the broker-dealer to
deduct ‘‘with respect to fidelity bond
coverage, the excess of any deductible
amount over the maximum deductible
amount permitted by the Examining
Authority for the broker or dealer.’’ 387
The final rule, as adopted, provides that
the broker-dealer must deduct ‘‘the
amount specified by rule of the
Examining Authority for the broker or
dealer with respect to a requirement to
maintain fidelity bond coverage.’’ 388
Thus, the final rule does not include the
phrase ‘‘maximum permissible
deductible amounts.’’ This phrase was
borrowed from SRO fidelity bond rules.
Because the construction of the SRO
rules may change over time, the
Commission is making the crossreference to the SRO rules more
general.389
4. Broker-Dealer Solvency Requirement
The Commission is adopting an
amendment to paragraph (a) of Rule
15c3–1 to require a broker-dealer to
cease conducting a securities business if
certain insolvency events were to occur.
Specifically, as adopted, amended
paragraph (a) of Rule 15c3–1 provides
that a broker-dealer must not be
insolvent as that term is defined in new
paragraph (c)(16) of the rule.390 By
making solvency a requirement of Rule
15c3–1, this amendment will require an
insolvent 391 broker-dealer to cease
conducting a securities business
pursuant to section 15(c)(3) of the
Exchange Act, which generally prohibits
a broker-dealer from effecting any
transaction in, or inducing or attempting
385 15
U.S.C. 78s(b).
e.g., FINRA Rule 4360.
387 See, e.g., Amendments to Financial
Responsibility Rules, 72 FR at 12872.
388 See paragraph (c)(2)(xiv) of Rule 15c3–1, as
adopted.
389 See, e.g., FINRA Rule 4360. See also Exchange
Act Release No. 63961 (Feb. 24, 2011), 76 FR 11542
(Mar. 2, 2011).
390 The final rule also has been modified by
replacing the word ‘‘shall’’ with the word ‘‘must.’’
391 The definition of insolvent is intended to be
broad enough to encompass any type of insolvency
proceeding or condition of insolvency; for example,
the proposed definition incorporates concepts of
insolvency in the U.S. Bankruptcy Code and SIPA.
See 11 U.S.C. 101; 15 U.S.C. 78eee(b)(1).
to induce the purchase or sale of, any
security in contravention of the
Commission’s financial responsibility
rules (which include Rule 15c3–1).392
As proposed, paragraph (c)(16) of
Rule 15c3–1 would have defined the
term insolvent as, among other things, a
broker-dealer’s placement in a voluntary
or involuntary bankruptcy or similar
proceeding; the appointment of a
trustee, receiver, or similar official; a
general assignment by the broker-dealer
for the benefit of its creditors; an
admission of insolvency; or the inability
to make computations necessary to
establish compliance with Rule 15c3–
1.393 As discussed more specifically
below, the Commission modified
paragraph (c)(16) of Rule 15c3–1 in the
final rule in response to concerns raised
by commenters.
In the proposing release, the
Commission solicited comment on
whether there are other insolvency
events that should be captured in the
proposed definition.394 One commenter
noted that involuntary insolvency
proceedings do not necessarily indicate
that the broker-dealer is insolvent, as
such proceedings can be frivolous,
malicious, or otherwise lacking in
merit.395 The commenter also noted that
industry standard contract forms
generally provide a grace period for a
party to such a proceeding to obtain a
stay or dismissal before an event of
default is deemed to occur.396 In
response to this comment, the
Commission notes that the number of
broker-dealer bankruptcy filings
(voluntary or involuntary) is small, and
therefore, the institution of a frivolous
involuntary proceeding involving a
broker-dealer likely is a very rare event.
Thus, the Commission must consider
the potential need for an automatic
grace period to address the potential for
a frivolous involuntary bankruptcy as
well as the harm that could result from
allowing a broker-dealer to continue to
effect securities transactions for a period
of time even though it is properly the
subject of a bankruptcy proceeding. The
Commission believes the more
appropriate approach is to address
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386 See,
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392 15
U.S.C. 78o.
Amendments to Financial Responsibility
Rules, 72 FR at 12872–12873. A broker-dealer’s
inability to make computations necessary to
establish compliance with Rule 15c3–1 may also
impact the broker-dealer’s ability to make the
computations necessary to establish compliance
with Rule 15c3–3 and vice versa. See, e.g., Rule
15c3–1(a)(1)(ii) (incorporating computations under
Rule 15c3–3 into the minimum net capital
requirement).
394 See Amendments to Financial Responsibility
Rules, 72 FR at 12873.
395 See SIFMA 2 Letter.
396 Id.
393 See
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potentially frivolous proceedings on a
case-by-case basis. In the event that a
case arises where there would be a need
to fashion relief for a broker-dealer that
was the subject of a frivolous or
meritless involuntary petition, the
Commission’s existing authority permits
it sufficient flexibility to fashion
exemptions under appropriate
circumstances.397
In addition to the comment discussed
above, the Commission received four
other comment letters that addressed
these amendments.398 One commenter
objected to the amendments as
unnecessary, citing the Rule 15c3–1
prohibition on broker-dealers effecting
securities transactions if their net
capital is below certain minimums and
noting that a broker-dealer that was
insolvent would ‘‘by definition’’ be
below those minimums.399 In response
to this comment, the Commission notes
that the purpose of the amendment is to
address cases where a broker-dealer is
subject to an insolvency event but takes
the position that it is in compliance
with the net capital rule. While such
instances may be rare, an insolvent
broker-dealer could seek the protection
of the bankruptcy laws but continue to
effect transactions with the public,
potentially jeopardizing customers and
other creditors of the broker-dealer,
including counterparties.
Another commenter requested that
the Commission modify the definition
of insolvent to carve out market-wide
disruptions that prevent the
computation of net capital but are
unrelated to the solvency of the brokerdealer.400 In response to this suggestion,
the Commission notes that if
appropriate and necessary, such an
event can be addressed through the
Commission’s exemptive authority,
rather than by a specific exception in
the rule.
One commenter, while supporting the
amendment, objected to the
incorporation of the definition of
insolvent from section 101 of the
Bankruptcy Code.401 This commenter
argued a bankruptcy-based standard for
insolvency was appropriate for a notice
requirement but that the proper
standard for determining whether a
broker-dealer should be prohibited from
continuing to conduct a securities
business is its amount of net capital. As
noted above, allowing an insolvent
397 See 15 U.S.C. 78mm(a). See also 17 CFR
240.15c3–1(b)(3).
398 See SIPC Letter; St. Bernard Financial Services
Letter; American Bar Association Letter; Cornell
Letter.
399 See St. Bernard Financial Services Letter.
400 See American Bar Association Letter.
401 See SIFMA 2 Letter.
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broker-dealer to continue conducting a
securities business during the period of
its insolvency, notwithstanding its net
capital position, could jeopardize
customers and other market participants
because a broker-dealer that has made
an admission of insolvency, or is
otherwise deemed insolvent or entitled
to protection from creditors, does not
possess the financial resources
necessary to operate a securities
business.402 Continuing to operate in
such circumstances poses a significant
credit risk to counterparties and to the
clearance and settlement system, and, in
the event the firm subsequently is
placed in a liquidation proceeding
under SIPA, may impair the ability of
the SIPA trustee to make customers of
the broker-dealer whole and satisfy
claims of other creditors out of the
assets of the general estate.403
In addition, this commenter also was
concerned that under the proposed
amendment a firm would be prevented
from effecting hedging or liquidating
transactions intended to reduce the risk
the firm poses to the financial markets
and its customers. The commenter
noted that such limitations also would
be at odds with section 5(a)(2) of SIPA,
which contemplates that a broker-dealer
that is in, or approaching, financial
difficulty may undertake to liquidate or
reduce its business either voluntarily or
pursuant to the direction of an SRO.404
The final rule amendment is not
intended to affect in any a brokerdealer’s ability to act under section
5(a)(2) of SIPA.405
In addition, the Commission is
amending the final rule to incorporate
within the term insolvency the
circumstance in which a broker-dealer
is unable to make such computations as
may be necessary to establish
compliance with Rule 15c3–3.406 In the
proposing release, the Commission
402 See Amendments to Financial Responsibility
Rules, 72 FR at 12872.
403 Id.
404 See SIFMA 2 Letter; SIPC Letter. See also 15
U.S.C. 78eee(a)(5).
405 See15 U.S.C. 78eee(a)(5). Further, the
amendment is not intended to affect in any way a
SIPA trustee’s ability to liquidate a broker-dealer.
Effectively, a SIPA trustee steps into the shoes of
the debtor broker-dealer in order to liquidate the
broker-dealer and protect its customers’ interests.
406 The final rule adds the phrase ‘‘or with
§ 240.15c3–3’’ to follow the phrase ‘‘[i]s unable to
make such computations as may be necessary to
establish compliance with this section.’’ See
paragraph (c)(16)(iv) of Rule 15c3–1. See also
generally, SIPC Letter (favoring an amendment
requiring broker-dealers to cease doing business if
insolvent as defined under proposed Rule 15c3l(c)(16) and noting that the circumstances under
which the broker would be required to cease doing
business are consistent with the circumstances
under which SIPC may seek to place a firm in
liquidation).
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stated that the ‘‘proposed definition of
‘insolvent’ is intended to be broad
enough to encompass any type of
insolvency proceeding or condition of
insolvency,’’ 407 and noted that the
proposed definition incorporates
concepts of insolvency from the U.S.
Bankruptcy Code and SIPA.408
Consequently, consistent with the
discussion in the proposing release, the
modification in the final rule will more
closely align the definition of insolvent
under paragraph (c)(16) of Rule 15c3–1
with the grounds for the commencement
of a proceeding under SIPA,409 which
includes the circumstance that a brokerdealer is unable to make computations
necessary to establish compliance with
the financial responsibility or
hypothecation rules.410 Rule 3a40–1
defines the term financial responsibility
rules to include, among others, any rule
adopted by the Commission pursuant to
section 15(c)(3) of the Exchange Act—
Rules 15c3–1 and 15c3–3 were adopted
under section 15(c)(3). As a financial
responsibility rule, the inability of a
broker-dealer to make a computation
necessary to establish compliance with
Rule 15c3–3 constitutes a basis for
commencing a SIPA proceeding.
Consequently, this modification to the
proposed definition of insolvency under
paragraph (c)(16) of Rule 15c3–1 will
more closely align the definition with
SIPA.411
The Commission also is adopting an
amendment to the first sentence of
paragraph (b)(1) of Rule 17a–11 to
require that a broker-dealer meeting the
definition of insolvent must provide
immediate notice to the Commission,
the firm’s DEA and, if applicable, the
CFTC. One commenter specifically
favored this amendment.412 This notice
will assist regulators in taking steps to
protect the insolvent firm’s customers,
including, if appropriate, notifying SIPC
of the need to commence a SIPA
407 See Amendments to Financial Responsibility
Rules, 72 FR at 12872.
408 Id. at n.85.
409 See 15 U.S.C. 78eee(b).
410 See 15 U.S.C. 78eee(b)(l)(D). See also 17 CFR
240.3a40–1 (defining the term financial
responsibility rules for purposes of SIPA to include
Rule 15c3–3).
411 The Commission also has made three
technical modifications to the text of the insolvency
definition. In response to a comment, the phrase
‘‘broker-dealer’’ was replaced with the phrase
‘‘broker or dealer’’ to be consistent with the use of
the phrase in Rule 15c3–1. In addition, the phrase
‘‘for purposes of this section’’ was moved to the
beginning of paragraph (c)(16) in order to clarify
that the term insolvency is defined for purposes of
Rule 15c3–1 in its entirety. Finally, the final rule
does not include the phrase ‘‘whether commenced
voluntarily or involuntarily’’ because the phrase
would be redundant.
412 See SIPC Letter.
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51855
proceeding. The Commission is
adopting the amendment to paragraph
(b)(1) of Rule 17a–11, with one technical
modification.413
5. Amendment To Rule Governing
Orders Restricting Withdrawal of
Capital From a Broker-Dealer
Paragraph (e) of Rule 15c3–1, which
places certain conditions on a brokerdealer when withdrawing capital,414
also allows the Commission to issue an
order temporarily restricting a brokerdealer from withdrawing capital or
making loans or advances to
stockholders, insiders, and affiliates
under certain circumstances.415 The
rule, however, limits such orders to
withdrawals, advances, or loans that,
when aggregated with all other
withdrawals, advances, or loans on a net
basis during a 30 calendar day period,
exceed 30 percent of the firm’s excess
net capital.416 When the Commission
adopted this paragraph of Rule 15c3–1
more than 20 years ago, the Commission
stated that it intended this section to be
applied only where the continued
viability of a broker-dealer appeared to
be at stake.417 In the ensuing years, the
Commission has utilized this provision
only one time.418 The Commission has
determined that the requirement is
difficult to enforce, as it generally
would not be clear when the 30%
threshold had been reached, due to the
inherent unreliability of a troubled
broker-dealer’s books and records.
Consequently, the Commission
proposed, and is adopting, a change to
delete this provision and instead to
allow the Commission to restrict all
withdrawals, advances, and loans so
long as the other conditions under the
rule (all of which remain unchanged)
are met.419
The Commission received three
comment letters addressing this
proposal.420 One commenter supported
the deletion of the 30% threshold, but
believed its removal reflected the
413 The Commission is deleting the phrase
‘‘paragraph (c)(16) of’’ and inserting ‘‘(c)(16)’’
immediately following the second ‘‘15c3–1’’.
414 See 17 CFR 240.15c3–1(e).
415 See 17 CFR 240.15c3–1(e)(3).
416 Id.
417 Net Capital Rule, Exchange Act Release No.
28927 (Feb. 28, 1991), 56 FR 9124, 9128 (Mar. 5,
1991).
418 Order Regarding Withdrawals, Unsecured
Loans or Advances from Refco Securities, LLC and
Refco Clearing, LLC, Exchange Act Release No.
52606 (Oct. 13, 2005).
419 The Commission also proposed revising the
second sentence in paragraph (e)(3)(ii) to remove
the text ‘‘The hearing’’ and in its place adding the
text ‘‘A hearing on an order temporarily prohibiting
the withdrawal of capital.’’
420 See NIBA 2 Letter; SIFMA 2 Letter; Raymond
James 2 Letter.
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Commission’s desire to regulate large
firms with complex capitalization
without considering the needs of
smaller firms.421 This commenter
recommended the Commission set forth
all conditions required for a firm to
withdraw, repay, or redeem any amount
that affects its overall capitalization.422
Specifically, the commenter suggested
the following non-exclusive list of
conditions for consideration: (1)
‘‘[r]egulatory minimum capital
requirement related to all lines of
business’’; (2) ‘‘[e]xcess mandated by
that firms’ accruals for that period’’; (3)
‘‘[e]xcess mandated by the firms’
upcoming one-time non-recurring costs
within that quarter’’; (4) ‘‘[e]xcess
mandated by operating costs expected[,]
but not related to accruals for that
period’’; (5) [c]osts related to increased
personnel coverage or recruitment
within that quarter’’; and (6)
‘‘[d]etermination of the Board of the
firm that there is no reasonable
expectation at the time of its approval
of the capital withdrawal, repayment or
redemption, that the firm would be
required to, or advisable to, increase its
net capital excess.’’
The second commenter recommended
several modifications to the
amendment, including: (1) Clarifying
that in addition to ordering complete
restrictions on withdrawals, advances,
and loans, the Commission may also
issue orders imposing partial or
conditional restrictions; (2) explicitly
permitting certain types of withdrawals,
advances, or loans, such as those in
paragraphs (e)(4)(ii) and (iii) of Rule
15c3–1 (e.g., required tax payments or
payments to partners for reasonable
compensation) even after the issuance of
a temporary restrictive order; and (3)
clarifying that the provision in
paragraph (e)(3)(ii) of the rule allowing
a broker-dealer to request and receive a
hearing on an order temporarily
restricting withdrawals also applies to
orders temporarily restricting advances
and loans (in addition to
withdrawals).423
Finally, the third commenter noted
that the proposed amendment would
eliminate the 30% requirement limit
and allow the Commission to restrict all
withdrawals, advances, and loans under
specific circumstances.424 The
commenter believes this action will
impose an additional compliance
421 See NIBA 2 Letter. As noted above, the 30%
threshold provision only applied in emergency
situations and has only been used once before. As
such, its deletion should only affect a limited
number of broker-dealers.
422 Id.
423 See SIFMA 2 Letter.
424 See Raymond James 2 Letter.
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burden on broker-dealers and will
significantly limit the flexibility of
broker-dealers in the event of a liquidity
crisis.425
In response to these comments, the
Commission notes that the 30%
threshold pertains only to paragraph
(e)(3)(i) of Rule 15c3–1, which relates to
the Commission’s authority to
temporarily restrict withdrawals of net
capital. The Commission cannot impose
these restrictions without concluding
under subparagraph (e)(3)(i) that ‘‘such
withdrawal, advance or loan may be
detrimental to the financial integrity of
the broker or dealer, or may unduly
jeopardize the broker or dealer’s ability
to repay its customer claims or other
liabilities which may cause a significant
impact on the markets or expose the
customers or creditors of the broker or
dealer to loss without taking into
account the application of the Securities
Investor Protection Act of 1970.’’ 426
While paragraph (e)(3)(i) of Rule 15c3–
1 would apply to all broker-dealers, the
conditions under which the
Commission may exercise its authority
under the rule apply only to
circumstances where the continued
viability of the broker-dealer appears to
be at stake.427 As noted above, the
Commission has only utilized this
provision once.428
The Commission, however, agrees
with the importance of maintaining
flexibility in the context of ordering
restrictions on withdrawals, advances,
and loans. Therefore, the Commission is
modifying the amendment, as adopted,
to add language to paragraph (e)(3)(i) to
state (following the phrase ‘‘employee or
affiliate’’) that such orders will be
issued, ‘‘under such terms and
conditions as the Commission deems
necessary or appropriate in the public
interest or consistent with the
protection of investors. . . .’’ 429 With
respect to the suggestion that the
Commission explicitly permit certain
types of withdrawals, advances, or loans
even after the issuance of a temporary
order, the Commission does not believe
that it would be appropriate to permit—
by codifying in the rule—a broker-dealer
to take the actions described if the
Commission has issued an order placing
425 Id.
426 See paragraph (e)(3)(i) of Rule 15c3–1, as
adopted.
427 Net Capital Rule, Exchange Act Release No.
28927 (Feb. 28, 1991), 56 FR 9124, 9128 (Mar. 5,
1991).
428 Order Regarding Withdrawals, Unsecured
Loans or Advances from Refco Securities, LLC and
Refco Clearing, LLC, Exchange Act Release No.
52606 (Oct. 13, 2005).
429 See paragraph (e)(3)(i) of Rule 15c3–1, as
adopted. See also 17 CFR 15c3–1(e). See generally,
15 U.S.C. 78mm(a)(1).
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temporary restrictions on a brokerdealer’s ability to withdraw net capital
under paragraph (e)(3) of the rule. The
order would be intended to protect the
customers and creditors of the brokerdealer, and permitting the actions by
rule could undermine those protections.
Moreover, there is no need to explicitly
permit certain types of withdrawals,
advances or loans because if there were
circumstances that merited the brokerdealer making such payments, the
Commission order could be fashioned as
appropriate to permit those payments.
With respect to the suggestion that the
Commission clarify in paragraph
(e)(3)(ii) of Rule 15c3–1 that a brokerdealer may request and receive a
hearing on orders temporarily restricting
advances and loans (in addition to
withdrawals), under the existing rule, a
broker-dealer may request a hearing if
the Commission has issued an order
temporarily restricting advances and
loans by a broker-dealer, in addition to
withdrawals, and the Commission is
therefore adopting the amendment to
paragraph (e)(3)(ii), as proposed.430
6. Adjusted Net Capital Requirements
i. Amendment to Appendix A of Rule
15c3–1
The Commission is adopting an
amendment to Appendix A of Rule
15c3–1, which permits broker-dealers to
employ theoretical option pricing
models to calculate haircuts for listed
options and related positions that hedge
those options.431 The amendment makes
permanent a temporary amendment the
Commission originally adopted in
1997.432 The temporary amendment
expired on September 1, 1997, unless it
was otherwise extended by the
Commission.433 The Commission staff
subsequently issued a no-action letter
on January 13, 2000, which stated that
the staff would not recommend
enforcement action if broker-dealers
continued to rely on the temporary
amendment.434
430 17 CFR 240.15c3–1(e)(3)(ii). The Commission
also is adopting revisions to the second sentence of
paragraph (e)(3)(ii), replacing the phrase ‘‘The
hearing’’ with the phrase ‘‘A hearing on an order
temporarily prohibiting the withdrawal of capital.’’
431 17 CFR 240.15c3–1a.
432 See Net Capital Rule, Exchange Act Release
No. 38248 (Feb. 6, 1997), 62 FR 6474 (Feb. 12,
1997).
433 See 17 CFR 15c3–1a(b)(1)(iv)(B).
434 Letter from Michael Macchiaroli, Associate
Director, Division of Market Regulation,
Commission, to Richard Lewandowski, Vice
President, Regulatory Division, The Chicago Board
Options Exchange, Inc. (Jan. 13, 2000) (stating that
the Division of Market Regulation ‘‘will not
recommend . . . enforcement action if non-clearing
option specialists and market-makers continue to
rely on subparagraph (b)(1)(iv) of Appendix A to
Rule 15c3–1 under the Exchange Act until such
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The temporary amendment decreased
the range of pricing inputs to the
approved option pricing models, which
effectively reduced the haircuts applied
by the carrying firm with respect to nonclearing option specialist and market
maker accounts.435 The temporary
amendment, which applied only to
these types of accounts, was limited to
major market foreign currencies and
diversified indexes. Even during periods
of substantial volatility, there have been
no significant increases in the number
of deficits in non-clearing option
specialist and market-maker accounts,
nor did the lower capital charges under
paragraph (b)(1)(iv) result in excessive
leverage. Consequently, this amendment
appropriately aligns the net capital
requirements of affected firms with the
risks Rule 15c3–1 seeks to mitigate. The
Commission received one comment
letter regarding this aspect of the
proposing release. The commenter
concurred with the Commission’s
conclusions as to the effect of the
temporary amendment and supported
the proposal to make it permanent.436
Accordingly, the Commission is
amending paragraph (b)(1)(iv) of
Appendix A to Rule 15c3–1, as
proposed, to make the temporary
amendment permanent.437
ii. Money Market Funds
a. Clarification
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The Commission is adopting an
amendment to paragraph (c)(2)(vi)(D)(1)
of Rule 15c3–1 to clarify that a money
market fund, for the purposes of
paragraph (c)(2)(vi)(D)(1), is a fund
described in Rule 2a–7 under the
Investment Company Act of 1940 (‘‘Rule
2a–7’’).438 The Commission did not
time as the Commission has determined whether it
should be extended’’). The letter did not grant any
other relief.
435 See Net Capital Rule, Exchange Act Release
No. 38248 (Feb. 6, 1997), 62 FR 6474 (Feb. 12,
1997). Under Appendix A to Rule 15c3–1, a brokerdealer calculating net capital charges for its options
portfolios shocks the products in each portfolio
(grouped by underlying instrument) at ten
equidistant points along a potential market move
range. The market move ranges for major market
foreign currencies, high-capitalization diversified
indexes, and non-high-capitalization diversified
indexes are, respectively: +(¥) 6%, +(¥) 10% and
+(¥) 15%. The temporary rule lowered these
market move ranges to respectively: +(¥) 4c%, +
6% (¥) 8% and +(¥) 10% in terms of calculating
haircuts for positions of non-clearing options
specialists and market makers. Id.
436 See SIFMA 2 Letter.
437 As a result, the Commission also is
redesignating paragraphs (b)(1)(iv)(A),
(b)(1)(iv)(A)(1), (b)(1)(iv)(A)(2), and (b)(1)(iv)(A)(3)
as paragraphs (b)(1)(iv), (b)(1)(iv)(A), (b)(1)(iv)(B),
and (b)(1)(iv)(C), respectively.
438 See 17 CFR 270.2a–7.
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receive any comments on this proposal
and is adopting it, as proposed.
b. Proposed Haircut Reduction From 2%
to 1%
The Commission proposed an
amendment to reduce the ‘‘haircut’’ that
broker-dealers apply under Rule 15c3–
1 for money market funds.439 In 1982,
the Commission adopted a 2% haircut
requirement for redeemable securities of
money market funds.440 In 1991, the
Commission adopted certain
amendments to Rule 2a–7 that
strengthened the risk-limiting
investment restrictions for money
market funds.441 Based on the
enhancements to Rule 2a–7, the
Commission proposed to amend
paragraph (c)(2)(vi)(D)(1) of Rule 15c3–
1 to reduce the haircut on such funds
from 2% to 1% in order to better align
the net capital charge with the risk
associated with holding shares of a
money market fund.442 In addition to
the general request for comments in the
proposing release, the Commission also
specifically requested comments
regarding whether the haircut for certain
types of money market funds should be
reduced to 0% as suggested in a petition
for rulemaking submitted to the
Commission.443
The Commission received a total of 14
responses from 12 different commenters
regarding this proposed amendment. All
of the commenters supported a
reduction in the haircut for money
market funds and urged that the haircut
be reduced below the proposed 1%,
with the majority proposing a haircut of
0% for ‘‘top-rated’’ money market funds
(i.e., those with the highest ratings).444
Commenters cited the safety record of
money market funds, in particular AAArated money market funds, in support of
439 See Amendments to Financial Responsibility
Rules, 72 FR at 12874.
440 Net Capital Requirements for Brokers and
Dealers, Exchange Act Release No. 18737 (May 13,
1982), 47 FR 21759 (May 20, 1982). See 17 CFR
240.15c3–1(c)(2)(vi)(D)(1).
441 Revisions to Rules Regulating Money Market
Funds, Investment Company Act Release No. 18005
(Feb. 20, 1991), 56 FR 8113 (Feb. 27, 1991).
442 See Amendments to Financial Responsibility
Rules, 72 FR at 12874.
443 See Public Petitions for Rulemaking No. 4–478
(Apr. 3, 2003) (available at https://www.sec.gov/
rules/petitions/petn4–478.htm), as amended (Apr.
4, 2005) (available at https://www.sec.gov/rules/
petitions/petn4–478a.pdf), and No. 4–577 (Feb. 3,
2009) (available at https://www.sec.gov/rules/
petitions/2009/petn4–577.pdf).
444 See Federated Letter; Federated 3 Letter;
Curion Clearing Letter; FAF Advisors Letter; Brown
Brothers Harriman Letter; SIFMA 2 Letter; ICI
Letter; Barclays Letter; National Chamber
Foundation Letter; Blackrock Letter; Deutsche Bank
Securities Letter; UBS Letter; SIFMA 4 Letter; NIBA
2 Letter.
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51857
imposing lower haircuts.445 Several
commenters argued that top-rated
money market funds were more liquid
and posed less credit and interest rate
risk than other instruments and
suggested haircuts of 1/8 of 1% or even
0%.446 One commenter argued that
since broker-dealers (like investors)
view money market funds as cash
equivalents, they would view a 1%
haircut as a significant cost and would
therefore avoid using money market
funds.447 Two commenters suggested
that if the Commission determined it
necessary to impose a haircut on some
Rule 2a–7 money market funds, it
should implement a bifurcated scheme
under which money market funds that
qualify for deposit into a broker-dealer’s
reserve account under Rule 15c3–3
would be subject to a 0% haircut,448
with one arguing that such qualifying
money market funds should in any case
receive a haircut no greater than 1/8 of
1%.449 Another commenter suggested
that the proposed amendments to
reduce the haircut for money market
funds should be deferred until the
results of the Commission’s money
market reforms are known.450 Another
commenter suggested a haircut of 5/8 of
1%, based on a combination of the 1/8
of 1% haircut applied to highly rated
shorter-term (at least 30 but less than 91
days to maturity) commercial paper and
municipal securities and an additional
charge of 1/2 of 1% to account for any
minimal risk associated with the nature
or operation of mutual funds.451 Finally,
one commenter supported a 0% haircut
for applied to money market funds that:
(1) Do not hold investments in their
affiliates or holding companies; and (2)
are not affiliated with the bank in which
the broker-dealer holds its cash reserves
and operating funds.452
As discussed above in section II.E.6.ii.
of this release, the Commission recently
proposed substantial amendments to its
money market fund rules.453 In light of
these proposed amendments,454 the
Commission is deferring consideration
of a reduction of the haircut for money
market funds in Rule 15c3–1 at this
time. Therefore, the haircut that brokerdealers apply for money market funds
will remain at 2% under paragraph
445 See,
e.g., Barclays Letter.
e.g., FAF Advisors Letter.
447 See Federated Letter.
448 See Blackrock Letter; ICI Letter.
449 See Blackrock Letter.
450 See SIFMA 4 Letter.
451 See SIFMA 2 Letter.
452 See NIBA 2 Letter.
453 See Money Market Fund Reform; Amendments
to Form PF, Release No. IC–30551 (June 5, 2013),
78 FR 36834 (June 19, 2013).
454 Id.
446 See,
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(c)(2)(vi)(D)(1) of Rule 15c3–1. Deferring
action will allow the Commission to
assess the potential impact of any
money market fund reforms it may
adopt and whether any such impact
would have consequences for the net
liquid asset standard of Rule 15c3–1.
c. Aggregate Debit Items Charge
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The Commission proposed
amendments to Rule 15c3–1 that would
have eliminated a reduction to aggregate
debit items that certain broker-dealers
must take when computing their reserve
requirements under Rule 15c3–3.455
Under paragraph (a)(1)(ii)(A) of Rule
15c3–1, a broker-dealer using the
‘‘alternative standard’’ 456 to compute its
minimum net capital requirement must
reduce aggregate debit items by 3%
when computing its customer reserve
requirement under Rule 15c3–3.
Conversely, Note E(3) to the customer
reserve formula (Rule 15c3–3a) requires
a broker-dealer using the ‘‘basic
method’’ of computing net capital under
Rule 15c3–1 to reduce by 1% the total
debits in Item 10 of the formula (i.e.,
debit balances in customer cash and
margin accounts).457 Both of these
provisions serve to increase the amount
of funds a broker-dealer must deposit
into its customer reserve account;
however, the deduction applicable to
alternative standard firms can result in
an even larger reserve deposit
requirement.
The Commission received four
comment letters regarding these
amendments and all were supportive.458
However, recent market turmoil has
highlighted the importance of
maintaining adequate amounts of funds
and qualified securities in the customer
reserve account under Rule 15c3–3 to
protect customers. Consequently, it
would be imprudent to lower the debit
reduction requirement for brokerdealers using the alternative standard at
this time (especially given the fact that
this standard is primarily used by firms
with a substantial customer business).
Therefore, the Commission has
determined to defer consideration of
action on this amendment at this time.
455 See Amendments to Financial Responsibility
Rules, 72 FR at 12867.
456 Under the ‘‘alternative standard,’’ a brokerdealer’s minimum net capital requirement is equal
to 2% of the firm’s aggregate debit items. 17 CFR
240.15c3–1(a)(1)(ii).
457 Under the ‘‘basic method,’’ a broker-dealer
cannot permit its aggregate indebtedness (generally
total money liabilities) to exceed 1500% of its net
capital. 17 CFR 15c3–1(a)(1)(i).
458 See Curian Clearing Letter; SIFMA 2 Letter;
Deutsche Bank Securities Letter; Citigroup Letter.
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F. Technical Amendments
The Commission proposed a number
of technical amendments to these rules,
including changes to the definitions of
fully paid securities, margin securities,
and bank in Rule 15c3–3.459 These
proposed technical amendments were
not designed to substantively change the
meanings of these defined terms but,
rather, to amend out-of-date citations
and remove text that the Commission
believed to be superfluous or redundant.
Two commenters 460 opposed the
proposed technical amendments to the
Rule 15c3–3 definition of fully paid
securities. As proposed, the definition of
fully paid securities would have
included ‘‘all securities carried for the
account of a customer unless such
securities are purchased in a transaction
for which the customer has not made
full payment.’’ 461 The commenters
contend that the amendments to the
definition of fully paid securities would
significantly expand the universe of
fully paid securities because these
securities generally are carried in a cash
account, and under the proposed
definition any security, in any account,
including a margin account, could be
considered a fully paid security (and
subject to possession and control
requirements) if it has been paid for in
full. As such, the commenter noted that
the term fully paid securities, as
proposed, would require broker-dealers
to determine whether securities in a
margin account are fully paid (in which
case they could not be hypothecated
even if they are not excess margin
securities). As a result, the commenter
suggested that this definition should be
limited to include only securities in a
cash account that have been paid for in
full. After careful consideration, and in
response to the comment, the
Commission has modified the text of
paragraph (a)(3) to Rule 15c3–3 to more
closely follow the original definition,
while still adopting the updated
references and terminology to reflect
changes made to Regulation T since
1972. As adopted, the term fully paid
securities includes ‘‘all securities
carried for the account of a customer in
a cash account as defined in Regulation
T (12 CFR 220.1 et seq.), as well as
securities carried for the account of a
customer in a margin account or any
special account under Regulation T that
have no loan value for margin purposes,
and all margin equity securities in such
459 17 CFR 240.15c3–3(a)(3), (4), and (7),
respectively.
460 See SIFMA 2 Letter; Angel Letter.
461 See Amendments to Financial Responsibility
Rules, 72 FR at 12894.
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account if they are fully paid. . . .’’ 462
The definition also states that, ‘‘the term
‘‘fully paid securities’’ does not apply to
any securities purchased in transactions
for which the customer has not made
full payment.’’
The Commission did not receive any
comments on the proposed amendments
to the definition of margin securities
under paragraph (a)(4) of Rule 15c3–3.
The Commission is adopting this
definition as proposed. In addition, the
Commission did not receive any
comments to the proposed amendments
to the definition of bank under
paragraph (a)(7) of Rule 15c3–3. The
Commission, however, has modified the
language in this paragraph to make the
paragraph gender neutral by replacing
the phrase ‘‘who maintains his principal
place of business’’ with the phrase ‘‘that
maintains its principal place of
business.’’
The Commission also has amended
other provisions of Rule 15c3–3 to make
the rule gender neutral. Finally, the
Commission has replaced the word
‘‘shall’’ throughout the rule, as
amended, with clearer words, such as
‘‘will’’ or ‘‘must.’’ This change will not
change either the nature or substance of
the affected rule provisions.
III. Responses to Specific Requests for
Comment
In the proposing release, the
Commission requested comment on
certain specific matters, in addition to
the proposed rule amendments.463
These matters included: (1) A proposal
to reduce the Rule 17a–11 notice
requirement for broker-dealers that carry
over $10 billion in debits; (2) whether
to harmonize the net capital deductions
required under paragraph (c)(2)(iv)(B) of
Rule 15c3–1 for securities lending and
borrowing transactions with the
deductions required under paragraph
(c)(2)(iv)(F) for securities repo
transactions; and (3) solicitation of
comment on how third-party liens
against customer fully paid securities
carried by a broker-dealer should be
treated under the financial
responsibility rules, including Rule
15c3–3, Rule 17a–3 and Rule 17a–4.
The Commission received seven
comment letters that addressed the
solicitation of comments for these
matters.464 With respect to the early
warning level proposal, one commenter
proposed modifying the Commission’s
462 See paragraph (a)(3) of Rule 15c3–3, as
adopted.
463 Id. at 12874.
464 See SIFMA 2 Letter; SIFMA 4 Letter; First
Clearing Letter; Citigroup Letter; American Bar
Association Letter; Cornell Letter; Raymond James
2 Letter.
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early warning levels for very large
‘‘alternative standard’’ firms with more
than $10 billion in debits.465 The
commenter recommended this approach
because of the increase in debit items at
large broker-dealers and the increased
focus on effective risk management
practices.466 Another comment
supported the amendment, suggesting
that the notification could serve as an
early warning if a firm is approaching
insolvency.467
In addition, the Commission received
three comments with respect to
harmonizing the net capital deductions
required under paragraph (c)(2)(iv)(B) of
Rule 15c3–1 for securities lending and
borrowing transactions with the
deductions required under paragraph
(c)(2)(iv)(F) for securities repo
transactions.468 These commenters
stated that the Commission should
consider the potential disruption to the
marketplace that may arise in
connection with any effort to harmonize
capital charges.469
The Commission also received seven
comments in response to the solicitation
of comment on how third-party liens
against customer fully paid securities
carried by a broker-dealer should be
treated under the financial
responsibility rules, including Rule
15c3–3, Rule 17a–3 and Rule 17a–4.470
Two commenters stated that the
Commission should not require that a
broker-dealer include third party liens
as a credit in the reserve formula and
stated that this is an area in which it
would be productive to have a detailed
discussion between Commission staff
and the industry before any
amendments are proposed.471 Another
commenter stated that each of the
suggested approaches in the proposing
release imposes burdens and
requirements on broker-dealers that do
not serve to address the concerns noted
by the Commission.472 Two commenters
stated that the most effective way to
avoid confusion regarding third party
liens in a SIPC liquidation would be to
segregate securities subject to a lien to
a separate pledge account in the name
of the pledgee.473 Finally, one
465 See
466 Id.
467 See
Cornell Letter.
SIFMA 2 Letter; Citigroup Letter; Raymond
James 2 Letter.
469 Id.
470 See SIFMA 2 Letter; SIFMA 4 Letter; First
Clearing Letter; Citigroup Letter; American Bar
Association Letter; NIBA 2 Letter; Raymond James
2 Letter.
471 See SIFMA 2 Letter; SIFMA 4 Letter; Citigroup
Letter.
472 See First Clearing Letter.
473 See American Bar Association Letter; NIBA 2
Letter.
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468 See
17:54 Aug 20, 2013
IV. Paperwork Reduction Act
Certain provisions of the amendments
contain ‘‘collection of information’’
requirements within the meaning of the
Paperwork Reduction Act of 1995
(‘‘PRA’’).475 The Commission published
a notice requesting comment on the
collection of information requirements
in the proposing release 476 and
submitted the amendments to the Office
of Management and Budget (‘‘OMB’’) for
review in accordance with the PRA.477
An agency may not conduct or sponsor,
and a person is not required to respond
to, a collection of information unless it
displays a currently valid control
number. The amended rules—Rule
15c3–1, Rule 15c3–3, Rule 17a–3, Rule
17a–4 and Rule 17a–11—contain
currently approved collections of
information under, respectively, OMB
control numbers 3235–0200, 3235–0078,
3235–0033, 3235–0279 and 3235–0085.
In response to comments received
regarding the proposed amendments in
the proposing release, the Commission
has modified the language in the final
rules being adopted, as discussed above.
These comments and their impact on
PRA estimates are discussed below. In
addition, the initial burden estimates in
the proposing release have been
adjusted,478 as discussed below, to
reflect updated information used to
make the current estimates, including
updated FOCUS Report data.479
Finally, one commenter specifically
stated that the estimates the
Commission provided utilized only that
number of broker-dealers in its
estimates that the Commission
474 See
Raymond James 2 Letter.
U.S.C. 3501, et seq.
476 See Amendments to Financial Responsibility
Rules, 72 FR at 12875.
477 44 U.S.C. 3507(d); 5 CFR 1320.11.
478 See Amendments to Financial Responsibility
Rules, 72 FR at 12875.
479 The PRA estimates derived from FOCUS
Reports filed by broker-dealers pursuant to Section
17 of the Exchange Act and Rule 17a–5 have been
updated in this final release to reflect more recently
available information, including FOCUS Report
data as of December 31, 2011. The PRA estimates
in the proposing release derived from FOCUS
reports were from 2004 year end data. See
Amendments to Financial Responsibility Rules, 72
FR at 12875.
475 44
SIFMA 2 Letter.
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commenter argued that requiring brokerdealers to include the amount of liens
as a credit item in the reserve formula
was not necessary to achieve customer
protection and would impose significant
costs and burdens on the brokerdealers.474
The Commission will consider the
comments received in developing any
proposals should the Commission
decide to take further action in any of
these areas.
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51859
‘‘justifiably considers to be affected by
the proposals.’’ 480 The commenter,
however, believes that most, if not all,
broker-dealers will spend over 90 hours
each analyzing the effects of the rules as
implemented, will spend many more
than 90 hours each in implementing
procedures and modifying their written
supervisory procedures to comply with
the new rules, will spend in excess of
240 hours each in the monitoring of
such rules, and will spend in excess of
$15,000 each for outside counsel and
auditor opinions or work product.481
This commenter did not provide
additional detail about the basis for its
view that the Commission’s estimates
were too low. The Commission agrees
with the commenter that broker-dealers
directly affected by the rule
amendments may be required to
implement procedures or modify their
written supervisory procedures in order
to comply with the rule amendments. In
cases where the rule amendments are
requiring a broker-dealer to implement
or document certain policies and
procedures, these hour burdens are
already included in the final hour
estimates discussed below.482 In
addition, the Commission acknowledges
that a broker-dealer may need to review
its operations to determine whether or
not it has any obligations under the rule
amendments. Even if a broker-dealer is
not directly affected by the rule
amendments, such a review may result
in an indirect effect on its operations.
These indirect effects or costs, however,
are more appropriately addressed in the
Economic Analysis in section V. of this
release because they relate to the overall
impact of the amendments, rather than
to the specific collections of information
discussed below. Consequently, the
Commission addresses the commenter’s
concerns that directly relate to the
collections of information below, and
the indirect burdens and costs in the
Economic Analysis in section V. of this
release.
A. Summary of the Collection of
Information Requirements
The rule amendments contain
recordkeeping and disclosure
requirements that are subject to the
PRA. In summary, the amendments may
require a broker-dealer, under certain
circumstances, to: (1) Disclose the
principals and obtain certain
agreements from the principals in a
securities lending transaction where it
performs settlement services if it is to be
480 See
NIBA 2 Letter.
481 Id.
482 See, e.g., paragraph (j)(1) of Rule 15c3–3 and
paragraph (a)(23) of Rule 17a–3, as adopted.
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considered an agent (as opposed to a
principal) for the purposes of the net
capital rule 483; (2) obtain permission in
writing from its DEA to withdraw
capital within one year of
contribution 484; (3) enter into a
subordination agreement with an
account holder in order to exclude such
account holder from the definition of
PAB account 485; (4) provide written
notice to PAB account holders that their
securities may be used in the ordinary
course of its securities business 486; (5)
perform a PAB reserve computation 487;
(6) obtain written notification from each
bank with which it maintains a PAB
reserve account that the bank was
informed that all cash and/or qualified
securities being held by the bank are
being held for the exclusive benefit of
brokers and dealers 488; (7) enter into a
written contract with a bank with which
it maintains its PAB reserve accounts
providing that the cash and/or qualified
securities shall at no time be used
directly or indirectly as security for a
loan to the broker-dealer by the bank,
and shall be subject to no right, charge,
security interest, lien, or claim of any
kind in favor of the bank or any person
claiming through the bank 489; (8)
develop adequate procedures to ensure
a customer for whom a free credit
balance is carried is sent a written
statement regarding the customer’s free
credit balances, including information
regarding the amount due to the
customer and that the funds are payable
on demand, prior to using funds arising
from free credit balances in the brokerdealer’s operations 490; (9) obtain the
written affirmative consent of a new
customer before including the
customer’s free credit balances in a
Sweep Program, as well as provide
certain disclosures and notices to all
customers with regard to the brokerdealer’s Sweep Program 491; (10) make
and maintain records documenting its
credit, market, and liquidity risk
management controls to assist the
broker-dealer in analyzing the risks
associated with its business
483 See paragraph (c)(2)(iv)(B) of Rule 15c3–1, as
adopted.
484 See paragraph (c)(2)(i)(G) to Rule 15c3–1, as
adopted.
485 See paragraph (a)(16) to Rule 15c3–3, as
adopted.
486 See paragraph (b)(5) to Rule 15c3–3, as
adopted.
487 See paragraph (e)(1) and (e)(3) of Rule 15c3–
3, as adopted.
488 See paragraph (f) of Rule 15c3–3, as adopted.
489 Id.
490 See paragraph (j)(1) to Rule 15c3–3, as
adopted.
491 See paragraph (j)(2) to Rule 15c3–3, as
adopted.
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activities 492; (11) provide notice to the
Commission and other regulatory
authorities if the broker-dealer becomes
insolvent 493; and (12) provide notice to
the Commission and other regulatory
authorities if the broker-dealer’s
securities borrowed and loaned or
securities repurchase/reverse
repurchase activity reaches a certain
threshold or, alternatively, report
monthly its securities borrowed and
loan or securities repurchase/reverse
repurchase activity to its DEA in a form
acceptable to its DEA.494
B. Use of Information
The Commission, its staff, and SROs
will use the information collected under
the amendments to Rule 15c3–1 and
Rule 15c3–3 to determine whether the
broker-dealer is in compliance with
each rule and to help fulfill their
oversight responsibilities. The
collections of information would also
help to ensure that broker-dealers are
meeting their obligations under the rule
amendments and have any required
policies and procedures in place.
In particular, the record with respect
to acting as agent in a securities loan
transaction will assist examiners in
verifying that the broker-dealer is
properly accounting for securities loan
deficits under Rule 15c3–1. The records
with respect to obtaining DEA approval
prior to withdrawing capital within one
year of contribution under Rule 15c3–1
will assist examiners in determining if
a broker-dealer is computing its net
capital accurately with regard to the
proper classification of its capital
contributions, and will help to ensure
the DEA only approves capital
withdrawals which are appropriate in
light of the firm’s current financial
condition at the time of the requested
withdrawal. The amendments to Rule
15c3–1 also will facilitate the
monitoring of the financial condition of
broker-dealers by the Commission and
its staff, as well as by SROs.
The records with respect to the PAB
accounts will assist examiners in
verifying that: (1) A carrying brokerdealer has properly excluded certain
accounts from being treated as PAB
accounts by entering into subordination
agreements with particular account
holders; (2) a carrying broker-dealer sent
written notices to PAB accountholders
to use their PAB securities; (3) the
broker-dealer performed the PAB
reserve computation; and (4) the bank
492 See paragraph (a)(23) to Rule 17a–3 and
paragraph (e)(9) of Rule 17a–4, as adopted.
493 See paragraph (b)(1) of Rule 17a–11, as
adopted.
494 See paragraph (c)(5) to Rule 17a–11, as
adopted.
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holding the PAB reserve account agreed
to do so free of lien by entering into a
written contract with the broker-dealer.
The records with respect to
customer’s free credit balances will
assist examiners in verifying that: (1) A
carrying broker-dealer has obtained the
written affirmative consent of a new
customer before including a customer’s
free credit balances in a Sweep Program;
(2) a carrying broker-dealer has
provided the required disclosures and
notices to all customers with regard to
the broker-dealer’s Sweep Program; and
(3) the broker-dealer has maintained
adequate procedures with regard to the
use of a customer’s free credit balances
prior to using such customer’s free
credit balances in its operations. The
amendments to Rule 15c3–3 will
facilitate the process by which the
Commission, its staff, and SROs monitor
how broker-dealers are fulfilling the
customer protection requirements of the
rule. The written affirmative consent,
disclosures and notices required to be
provided to customers also will alert
customers to the alternatives available
to them with respect to their free credit
balances.
The Commission, its staff, and SROs
will use the information collected under
the amendments to Rules 17a–3 and
17a–4 to determine whether the brokerdealer is adhering to its documented
credit, market, and liquidity risk
management controls, as well as to
evaluate the effectiveness of these
controls.
The Commission, its staff, and SROs
will use the information collected under
the amendments to Rule 17a–11 to
identify a broker-dealer experiencing
financial difficulty. This information
will assist the Commission and other
regulators in promptly taking
appropriate steps to protect customers,
creditors, and counterparties. In
particular, a notice of insolvency will
assist regulators in responding more
quickly to protect customers of a failing
institution. The notices and reports with
respect to securities lending and repos
will assist regulators in identifying
broker-dealers that are active in these
transactions or suddenly take on large
positions and thereby assist in
monitoring systemic risk.
C. Respondents
The final estimates of respondents
below have been updated to reflect more
recent information.495 The amendment
495 The final estimates of respondents derived
from FOCUS Reports filed by broker-dealers
pursuant to Section 17 of the Exchange Act and
Rule 17a–5 have been updated in this final release
to reflect more recently available information,
including FOCUS Report data as of December 31,
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to Rule 15c3–1 requiring a broker-dealer
to make disclosures to, and obtain
certain agreements from, securities
lending principals will apply only to
those firms that participate in the
settlement of securities lending
transactions as agents. The Commission
estimates that approximately 122
broker-dealers will be affected by this
requirement.496 This estimate has been
updated from the estimate of 170
broker-dealers in the proposing
release.497 No comments were received
on this estimate.
The amendment to Rule 15c3–1 with
respect to a broker-dealer obtaining
permission in writing from its DEA
prior to withdrawing capital within one
year of contribution under Rule 15c3–1
will apply to any broker-dealer who
wishes to withdraw such capital.
Because most broker-dealers already
comply with existing interpretations
regarding the treatment of temporary
capital contributions and similar SRO
requirements, or are familiar with such
interpretations and requirements, this
part of the amendment to Rule 15c3–1
regarding temporary capital
contributions likely will impact only a
small number of the approximately
4,709 broker-dealers registered with the
Commission, as of December 31, 2011
(based on FOCUS Report data).498
Therefore, the Commission estimates
that approximately 90 broker-dealers
will seek permission from their DEA in
writing to withdraw capital within one
year of its contribution under the
amendment.499
The amendments to Rule 15c3–3
requiring a broker-dealer to perform a
PAB reserve computation and to obtain
certain agreements and notices related
to its PAB accounts will affect only
those firms that carry such accounts.
2011. The estimates of respondents in the proposing
release derived from FOCUS reports were from
2004 year end data. See Amendments to Financial
Responsibility Rules, 72 FR at 12876.
496 This estimate is derived from FOCUS Reports.
497 See Amendments to Financial Responsibility
Rules, 72 FR at 12876.
498 Temporary Capital Letter; see also Net Capital
Rule, Exchange Act Release No. 28927 (Feb. 28,
1991), 56 FR 9124 (Mar. 5, 1991); and FINRA Rule
4110(c).
499 The Commission received 900 broker-dealer
capital withdrawal notices under paragraph (e) of
Rule 15c3–1 in 2012. Because this amendment is
consistent with prior Commission and staff
positions that capital is not temporary, as well as
current SRO requirements, it is likely that only a
small number of these notices are capital
withdrawals made within one year of contribution,
and therefore, based on staff experience with the
application of Rule 15c3–1, the Commission
estimates that approximately 90 broker-dealers
(10% of 900) will seek permission from their DEA
in writing to withdraw capital under the
amendment. See Net Capital Rule, Exchange Act
Release No. 28927 (Feb. 28, 1991); Temporary
Capital Letter; and FINRA Rule 4110.
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Based on FOCUS Report data, as of
December 31, 2011, the Commission
estimates that approximately 61 brokerdealers will carry such accounts.500 The
amendment to Rule 15c3–3 requiring a
broker-dealer to obtain the affirmative
consent of a new customer before
changing the terms under which the
customer’s free credit balances are
maintained will apply only to firms that
carry free credit balances for customers.
Based on FOCUS Report data, as of
December 31, 2011, the Commission
estimates that approximately 189
broker-dealers carry free credit
balances.501
The Commission estimates that the
amendment to Rule 15c3–3 permitting a
broker-dealer to exclude certain
accounts from being treated as PAB
accounts under Rule 15c3–3 by entering
into subordination agreements with
certain account holders will apply to all
61 broker-dealers that will carry such
accounts. The Commission estimates
that these 61 broker-dealers each will
enter into an average of 11
subordination agreements.502
The amendments to Rules 17a–3 and
17a–4 requiring a broker-dealer to make
and maintain records documenting the
credit, market and liquidity risk
management control for analyzing and
managing risks will apply only to firms
that have more than $1,000,000 in
aggregate credit items, or $20,000,000 in
capital. Thus, its impact will be limited
to larger broker-dealers. Accordingly,
the number of respondents will equal
the number of broker-dealers meeting
the thresholds set forth in the
amendment. The Commission estimates
that approximately 490 broker-dealers
will meet at least one of these
thresholds.503
500 This estimate has been updated from our
estimate of 75 broker-dealers in the proposing
release. See Amendments to Financial
Responsibility Rules, 72 FR at 12876. No comments
were received on this estimate.
501 In the proposing release, the Commission
estimated approximately 256 broker-dealers carried
free credit balances. See Amendments to Financial
Responsibility Rules, 72 FR at 12876. No comments
were received on this estimate.
502 See Order Granting Conditional Exemption
Under the Securities Exchange Act of 1934 in
Connection with Portfolio Margining of Swaps and
Security-Based Swaps, Exchange Act Release No.
68433 (Dec. 14, 2012), 77 FR 75211, 75222 n.69
(Dec. 19, 2012). (‘‘FINRA CRD data indicate that the
17 largest broker-dealers (i.e., those with total assets
of $50 billion or more) reported a total of 188
affiliates that are themselves registered with the
SEC (i.e., they have their own CRD numbers),
representing approximately 11 affiliates per brokerdealer.’’). Carrying firms likely will enter into
subordination agreements with affiliates, including
foreign banks or foreign broker-dealers affiliated
with the carrying broker-dealer to exclude such
accounts from the rule. See SIFMA 2 Letter.
503 This estimate has been updated from the
proposing release estimate of 517 broker-dealers.
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51861
One amendment to Rule 17a–11 will
require a broker-dealer to provide the
Commission with notice if it becomes
subject to certain insolvency events. The
Commission estimates that
approximately two broker-dealers will
become subject to one of these events in
a given year.504 Another amendment to
Rule 17a–11 will require a broker-dealer
to provide notice to the Commission if
its securities borrowed or loaned, or its
securities repurchase or reverse
repurchase activity reaches a certain
threshold or, alternatively, provide
monthly reports to its DEA about such
activities. This amendment will only
affect a limited number of firms per
year. The Commission estimates that
approximately one broker-dealer 505 will
provide notice and six broker-dealers 506
will opt to send the monthly reports in
a given year.
D. Total Annual Reporting and
Recordkeeping Burden
1. Securities Lending Agreements and
Disclosures
The amendments to paragraph
(c)(2)(iv)(B) of Rule 15c3–1 will require
a broker-dealer to make disclosures to,
See Amendments to Financial Responsibility Rules,
72 FR at 12876. No comments were received on this
estimate.
504 This estimate is based on the 2012 SIPC
Annual Report, which indicates that over the last
ten-year-period, the annual average of new
customer protection proceedings was two. A copy
of the 2012 Annual Report is available at https://
www.sipc.org/. This estimate has been updated
from our proposing release estimate of 6, which was
based on the SIPC 2005 Annual Report. See
Amendments to Financial Responsibility Rules, 72
FR at 12876. No comments were received on this
estimate.
505 This estimate is derived from information filed
by broker-dealers in their FOCUS Reports. This
estimate has been updated from the proposing
release estimate of 11. See Amendments to
Financial Responsibility Rules, 72 FR at 12876. No
comments were received on this estimate. Based on
FOCUS Report data, as of December 31, 2011, there
were seven broker-dealers whose securities
borrowed or securities loaned exceeded 80% of 25
times their tentative net capital, and there were six
broker-dealers whose securities borrowed or
securities loaned exceeded 25 times their tentative
net capital. Therefore, the Commission assumes for
purposes of the PRA that six broker-dealers would
chose to file monthly reports in lieu of the notice
requirements, and that one would file a notice.
506 This estimate is derived from information filed
by broker-dealers in their FOCUS Reports. Based on
FOCUS Report data, as of December 31, 2011, there
were six broker-dealers whose securities borrowed
or securities loaned exceeded 25 times their
tentative net capital. These firms likely will opt to
file the monthly report under the proposed
amendments to Rule 17a–11. This estimate has been
updated from our proposing release estimate of 21
broker-dealers. See Amendments to Financial
Responsibility Rules, 72 FR at 12876. No comments
were received on this estimate. The estimated
number of firms filing notices and monthly reports
has decreased largely due to an overall decrease in
the number of broker-dealers. See also id. at 12870
(discussing rationale for 2,500% threshold).
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and obtain certain agreements from,
securities lending principals in
situations where the firm participates in
the settlement of a securities lending
transaction but wants to be deemed an
agent for purposes of Rule 15c3–1.507
The Commission has adopted the final
rule substantially as proposed, and
consequently, there were no changes to
the final rule amendments that would
affect the Commission’s PRA estimates.
In addition, the Commission did not
receive any comments on the estimates
in the proposing release,508 and is
therefore is retaining the amendment’s
PRA hour burden estimates without
revision. The Commission, however, is
updating the number of respondents to
reflect more recently-available data from
broker-dealer FOCUS Reports.
As discussed above in section II.C. of
this release, the Commission, in
recognition of standard stock loan
agreements, designed the amendment to
accommodate the continued use of these
industry model agreements by
incorporating their use into the rule’s
requirements. For the purpose of
establishing a broker-dealer’s status as
agent or lender, these agreements may
be sufficiently detailed to satisfy the
new requirements. Thus, the standard
agreement used by the vast majority of
broker-dealers may contain the
representations and disclosures required
by the amendment. Nevertheless, based
on staff experience with securities
lending agreements and disclosure and
the application of Rule 15c3–1, the
Commission continues to believe that a
small percentage of broker-dealers may
need to modify their standard
agreements. In the proposing release,
the Commission estimated that 5% 509 of
broker-dealers may need to modify their
standard agreements. No comments
were received on this estimate and the
Commission believes 5% continues to
be an appropriate estimate for the final
rule amendments. Thus, the
Commission estimates that 5% of the
approximately 122 firms engaged in this
business, or approximately 6 firms, will
not have used the standard
agreements.510 The Commission
estimates each of these firms will spend
approximately 20 hours of employee
resources updating their standard
agreement template.511 Therefore, the
507 17
CFR 240.15c3–1(c)(2)(iv)(B).
Amendments to Financial Responsibility
Rules, 72 FR at 12876.
509 Id.
510 This estimate is updated from the estimate of
9 firms (5% of 170 firms) in the proposing release.
Id.
511 Because these firms are already engaging in
stock loan and repo activities, these functions likely
508 See
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Commission estimates that the total onetime burden to broker-dealers as a result
of this requirement will be
approximately 120 hours.512
2. DEA Permission To Withdraw Capital
within One Year of Contribution
The amendment to paragraph
(c)(2)(i)(G)(2) of Rule 15c3–1 will
require that a broker-dealer treat as a
liability any capital contribution that is
intended to be withdrawn within one
year of its contribution.513 The rule
amendment also includes the
presumption that capital withdrawn
within one year of contribution is
presumed to have been intended to be
withdrawn within one year, unless the
broker-dealer receives permission in
writing for the withdrawal from its DEA.
This amendment likely will impose
annual recordkeeping burdens on
broker-dealers making the request.
The Commission estimates that 90
broker-dealers will seek to obtain
permission from their DEA in writing to
withdraw capital within one year of its
contribution, and that it will take a
broker-dealer approximately one hour to
prepare and submit the request to its
DEA to withdraw capital.514 Therefore,
the Commission estimates that the total
annual hour burden with respect to the
rule amendment will be approximately
90 hours.515
3. Written Subordination Agreements
under Rule 15c3–3
As discussed above in section II.A.2.
of this release, in response to comments,
the final rule amendment adopted by
the Commission excludes from the
definition of PAB account in paragraph
(a)(16) of Rule 15c3–3, an account that
‘‘has been subordinated to the claims of
creditors of the carrying broker or
dealer.’’ 516 This modification to the
final rule will result in one-time
burdens under the collection of
information for Rule 15c3–3.517
In light of comments received 518 and
based on staff experience, the
Commission understands most PAB
account holders that enter into a
subordinated loan agreement with a
carrying broker-dealer in order to not be
will be performed by in-house employees, rather
than outside counsel.
512 6 broker-dealers × 20 hours per firm = 120
hours. This is an update from the proposing release
estimate of 9 broker-dealers × 20 hours = 180 hours.
Id.
513 17 CFR 240.15c3–1(c)(2)(i)(G)(2).
514 See section IV.C. of this release.
515 90 broker-dealers × 1 hour = 90 hours.
516 17 CFR 240.15c3–3(a)(16).
517 The proposing release did not contain any
proposals with regard to subordination agreements.
518 See SIFMA 2 Letter; SIFMA 4 Letter; Deutsche
Bank Securities Letter.
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treated as PAB accounts under
paragraph (a)(16) likely will be affiliates
of the broker-dealer.519 The Commission
estimates that the 61 broker-dealers that
carry PAB accounts will enter into an
average of 11 subordination agreements
as a result of the rule amendment.520
The Commission estimates that it will
take a carrying broker-dealer
approximately 20 hours to develop a
subordination agreement, based on the
Commission’s prior experience with the
development of subordination
agreements.521 Therefore, the
Commission estimates that the total onetime hour burden resulting from this
requirement will be 13,420 hours.522
4. PAB Reserve Bank Account
Recordkeeping Requirements
The amendments to Rules 15c3–3 and
15c3–3a require carrying broker-dealers
to: (1) Perform a separate reserve
computation for PAB accounts (in
addition to the reserve computation
currently required for Rule 15c3–3
customer accounts); (2) establish and
fund a separate PAB reserve account;
and (3) obtain and maintain physical
possession or control of non-margin
securities carried in PAB accounts
unless the carrying broker-dealer has
provided written notice to the PAB
account holders that it will use those
securities in the ordinary course of its
securities business, and has provided
opportunity for the PAB account holder
to object to such use.
In the proposing release, the
Commission proposed to require that
the carrying broker-dealer obtain written
permission from a PAB account holder
before it could use the securities of the
PAB account holder in the ordinary
course of its securities business. The
Commission estimated that, based on
FOCUS Report data, there were
approximately 2,533 existing PAB
customers, and therefore, broker-dealers
would have to amend approximately
2,533 existing PAB agreements.523 The
Commission further estimated that, on
average, a firm would spend
approximately 10 hours of employee
519 See
Deutsche Bank Letter; SIFMA 2 Letter.
section IV.C. of this release.
521 See Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and
Major Security-Based Swap Participants and
Capital Requirements for Broker-Dealers, Exchange
Act Release No. 68071, 77 FR at 70299. See also
Order Granting Conditional Exemption Under the
Securities Exchange Act of 1934 in Connection with
Portfolio Margining of Swaps and Security-Based
Swaps, Exchange Act Release No. 68433 (Dec. 14,
2012), 77 FR 75211 (Dec. 19, 2012).
522 61 broker-dealers × 11 accounts × 20 hours =
13,420 hours.
523 See Amendments to Financial Responsibility
Rules, 72 FR at 12877.
520 See
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resources amending each agreement and
that 75 firms would spend 20 hours
amending their standard PAB agreement
template, for a total of 26,830 hours.524
The Commission did not receive any
comments regarding these estimates in
the proposing release.
In response to comments, as
discussed above, the Commission
determined not to adopt the
requirement, as proposed. Instead,
paragraph (b)(5) of Rule 15c3–3 requires
the carrying broker-dealer to provide
PAB account holders with written
notice that the account holder’s nonmargin securities may be used in the
ordinary course of its business.525
Therefore, the Commission is revising
the final one-time hour burden in light
of the change in the rule to a notice
requirement, which is expected to be
less burdensome than the proposed
customer consent provision while still
providing customers with necessary
information. The Commission estimates,
based on FOCUS Report data, that
approximately 61 broker-dealers carry
PAB accounts.526 The Commission
further estimates, based on similar
collections of information and the fact
that these firms already carry PAB
accounts, and on average, a firm will
spend approximately 10 hours of
employee resources drafting a standard
notice template, for a total one-time
burden of 610 hours.527 In addition,
based on FOCUS Report data, the
Commission estimates that there are
approximately 1,551 existing PAB
customers and, therefore, broker-dealers
will have to send approximately 1,551
written notices.528 The Commission
estimates, based on staff experience,
that a firm will spend approximately 10
minutes per account sending out the
PAB customers × 10 hours per
customer) + (75 firms × 20 hours per firm) = 26,830.
Id.
525 17 CFR 240.15c3–3(b)(5).
526 This estimate is based on the number of
broker-dealers carrying PAB accounts as of
December 31, 2011. This is an update from the
proposing release estimate of approximately 75
broker-dealers that carry PAB accounts. See
Amendments to Financial Responsibility Rules, 72
FR at 12877.
527 61 firms × 10 hours = 610 hours. See also
Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major SecurityBased Swap Participants and Capital Requirements
for Broker-Dealers, Exchange Act Release No.
68071, 77 FR at 70298 (estimating that the notice
required to be sent by a security based swap dealer
to a counterparty pursuant to section 3E(f) of the
Exchange Act would take an outside counsel 10
hours to draft).
528 The number of customers also is updated from
the proposing release estimate of 2,533 customers.
See Amendments to Financial Responsibility Rules,
72 FR at 12877.
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524 (2,533
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51863
required written notice, for a total onetime burden of 259 hours.529
The Commission estimates that a
broker-dealer will incur postage costs
sending out the required written notice
to customers. These carrying brokerdealers likely will use the least cost
method to comply with this requirement
and may include this notification with
other mailings sent to PAB account
holders. The Commission, however,
conservatively estimates that the
postage cost of for each notification,
using the current price of first class
postage, will be approximately $.46 per
document sent. Therefore, the staff
estimates that the cost of sending the
required written notification to PAB
account holders will be approximately
$713.530
Based on FOCUS Report data, the
Commission also estimates that
approximately 61 broker-dealers carry
PAB accounts, and based upon
differences between the PAIB Letter and
the final rule, these 61 firms would have
to amend their standard PAB agreement
template. The Commission estimates a
firm will spend, on average,
approximately 20 hours of employee
resources on this task, for a total of
1,220 hours.531
In light of the changes to the final rule
amendments which require a brokerdealer to send a written notice, rather
than obtain a customer’s consent
regarding the use of a PAB account
holder’s securities, the 61 broker-dealers
carrying PAB accounts likely will
engage outside counsel 532 to review the
required notice,533 as well as the
standard PAB template agreement under
the final rule amendments to Rule 15c3–
3. As a result, the Commission estimates
that these 61 broker-dealers will likely
incur $2,000 in legal costs,534 or
$122,000 535 in aggregate initial burden
to review and comment on these
materials.
The requirements to perform a PAB
reserve computation and obtain
agreements and notices from banks
holding PAB accounts will result in
annual burdens based on the number of
broker-dealers that hold PAB accounts
and the number of times per year these
broker-dealers open new PAB reserve
accounts. Currently, to obtain the relief
provided in the PAIB Letter, brokerdealers are required to obtain the
agreements and notices from the
banks.536 The Commission understands
that broker-dealers generally already
obtain these agreements and notices.
Therefore, the Commission estimates
there will be no additional burden
imposed by this requirement.537 The
Commission did not receive any
comments on this estimate from the
proposing release.
The amendment requiring a PAB
reserve computation will produce a onetime burden. Based on FOCUS Report
data, as of December 31, 2011, the
Commission estimates that
approximately 61 broker-dealers will
perform a PAB reserve computation.538
These firms already perform a reserve
computation for domestic broker-dealer
customers under the PAIB Letter.
Nonetheless, the Commission estimates
these firms will spend, on average,
approximately 30 hours of employee
resources per firm updating their
systems to implement changes that will
be necessitated by the amendment.
Therefore, consistent with the hour
estimates in the proposing release, the
Commission estimates that the total onetime burden to broker-dealers arising
from updating their systems to comply
529 1,551 PAB account holders × 10 minutes =
15,510 minutes/60 minutes = 258.5 hours (rounded
to 259 hours). See generally, Exchange Act Release
No. 68071, 77 FR at 70298 (estimating that the
notice required to be sent by a security based swap
dealer to a counterparty pursuant to section 3E(f)
of the Exchange Act would take 10 minutes to
send).
530 1,551 notices × $0.46 = $713.46.
531 61 firms × 20 hours = 1,220.
532 See NIBA 2 Letter.
533 17 CFR 240.15c3–3(b)(5).
534 5 hours × $400 per hour = $2,000. The
Commission estimates the review of the notice and
standard PAB template would require 5 hours of
outside counsel time, which is the same estimate
used for outside counsel review in another recent
release. Based on staff experience with the PAIB
Letter and the application of Rule 15c3–3, the
Commission estimates the outside counsel review
related to the PAB amendments will take a
comparable amount of time. See Capital, Margin,
and Segregation Requirements for Security-Based
Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for BrokerDealers, Exchange Act Release 68071, 77 FR at
70297, n.904. The Commission estimates that the
outside counsel would cost $400 per hour, which
is the same estimate used by the Commission in
other recent releases. See Capital, Margin, and
Segregation Requirements for Security-Based Swap
Dealers and Major Security-Based Swap
Participants and Capital Requirements for BrokerDealers, Exchange Act Release 68071, 77 FR at
70297; Further Definition of ‘‘Swap,’’ ‘‘SecurityBased Swap,’’ and ‘‘Security-Based Swap
Agreement’’; Mixed Swaps; Security-Based Swap
Agreement Recordkeeping, Exchange Act Release
No. 67453 (July 18, 2012), 77 FR 48208 (Aug. 13,
2012).
535 61 firms × $2,000 legal cost = $122,000.
536 See PAIB Letter.
537 In addition, the hour burdens for brokerdealers to open new customer reserve bank account
under Rule 15c3–3 are already included within the
currently approved collection of information for
Rule 15c3–3.
538 This estimate is based on the number of
broker-dealers which currently perform a PAB
computation as of December 31, 2011. This is an
update from the estimate in the proposing release
of 75 broker-dealers.
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with this requirement will be
approximately 1,830 hours.539
The amendment requiring a PAB
reserve computation also will produce
an annual burden. Based on FOCUS
Report data, the Commission estimates
that of the 61 broker-dealers estimated
to perform a PAB reserve computation,
approximately 56 of the current PAB
filers will perform the PAB reserve
computation on a weekly basis, two
broker-dealers will perform it on a
monthly basis, and three broker-dealers
will perform the PAB reserve
computation on a daily basis.540 The
Commission further estimates that a
broker-dealer will spend, on average,
approximately 2.5 hours to complete the
PAB reserve computation in order to
make a record of such computation
under Rule 15c3–3 as a result of the
amendment.541 Therefore, consistent
with the hour burden estimates in the
proposing release, the Commission
estimates that the total annual burden to
broker-dealers from this requirement
will be approximately 9,215 hours.542
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5. Adequate Procedures Required Under
Paragraph (j)(1) of Rule 15c3–3
The Commission proposed importing
requirements in Rule 15c3–2 into Rule
15c3–3 and eliminating Rule 15c3–2 as
a stand-alone rule in the Code of Federal
Regulations, and adopting new
paragraph (j)(1) to Rule 15c3–3, which
includes a condition that a broker-dealer
must establish adequate procedures that
will impose a paperwork burden if a
broker-dealer wishes to accept or use
any free credit balance for the account
of any customer of the broker-dealer.
539 61 broker-dealers × 30 hours per firm = 1,830
hours. This is an update from the proposing release
estimate of 75 firms × 30 hours per firm = 2,250
hours. See Amendments to Financial Responsibility
Rules, 72 FR at 12877.
540 These estimates are based on the number of
broker-dealers performing a PAB reserve
computation monthly, weekly, and daily, as of
December 31, 2011. This is an update from the
estimate in the proposing release, which provided
that of the 75 broker-dealers estimated to perform
a PAB computation, 71 broker-dealers would prefer
PAB computations on a weekly basis and four
broker-dealers would perform it on a monthly basis.
See Amendments to Financial Responsibility Rules,
72 FR at 12877. No broker-dealers performed daily
PAB computations as of the date of the proposing
release. No comments were received on this
estimate.
541 This estimate is based on staff experience with
the current estimate of 2.5 hours under the current
collection of information for Rule 15c3–3 to make
a record of each reserve computation. See 17 CFR
240.15c3–3(e)(3).
542 (56 weekly filers × 52 weeks × 2.5 hours per
computation) + (2 monthly filers × 12 months × 2.5
hours per computation) + (3 daily filers × 250
business days per year × 2.5 hours per computation)
= 9,215 total hours. This is an update from the
proposing release estimate of 9,350 hours. See
Amendments to Financial Responsibility Rules, 72
FR at 12877, n.137.
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The Commission is adopting this
amendment substantially as proposed,
which provides, ‘‘[a] broker or dealer
must not accept or use any free credit
balance carried for the account of any
customer of the broker or dealer unless
such broker or dealer has established
adequate procedures pursuant to which
each customer for whom a free credit
balance is carried will be given or sent,
together with or as part of the
customer’s statement of account,
whenever sent but not less frequently
than once every three months, a written
statement informing the customer of the
amount due to the customer by the
broker or dealer on the date of the
statement, and that the funds are
payable on demand of the customer.’’ 543
The requirement that broker-dealers
establish adequate procedures with
regard to free credit balances will result
in one-time and annual hours burdens
for broker-dealers subject to the
requirements of new paragraph (j)(1) to
Rule 15c3–3. Based on FOCUS Report
data, the Commission estimates that 189
broker-dealers carry free credit balances.
Most firms may already have such
procedures in place with regard to the
requirements of the rule, because these
provisions are being imported from
current Rule 15c3–2, which is being
eliminated as a result of these
amendments. Therefore, the
Commission estimates that a brokerdealer will spend approximately 25
additional hours reviewing and
updating its procedures to ensure it is
in compliance with new paragraph (j)(1)
to Rule 15c3–3 and approximately 10
additional hours per year reviewing and
updating its procedures, for a total onetime and annual hour burden of 4,725
hours 544 and 1,890 hours,545
respectively.546
6. Treatment of Free Credit Balances
New paragraph (j)(2) to Rule 15c3–3
will require a broker-dealer to obtain the
written affirmative consent of a new
customer before including a customer’s
free credit balances in a Sweep Program,
as well as to provide certain disclosures
543 17
CFR 240.15c3–3(j)(1).
broker-dealers × 25 hours = 4,725 hours.
The 25 and 10 hour estimates are based on similar
collections of information and the Commission’s
belief that many of these broker-dealers already
have procedures in place and, therefore, most
broker-dealers will only be revising and updating
their current policies and procedures to ensure
compliance with the rule. See Removal of Certain
References to Credit Ratings Under the Securities
Exchange Act of 1934, Exchange Act Release No.
64532 (Apr. 27, 2011), 76 FR 26550, 26568 (May 6,
2011).
545 189 broker-dealers × 10 hours = 1,890 hours.
546 See NIBA 2 Letter.
544 189
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and notices to all customers with regard
to the broker-dealer’s Sweep Program.
These requirements will result in onetime and annual burdens to brokerdealers subject to its provisions.
However, these requirements will apply
only to a firm that carries customer free
credit balances and opts to have the
ability to change how its customers’ free
credit balances are treated. The
Commission did not receive comments
regarding the hour burden estimates
relating to the treatment of free credit
balances in the proposing release.
In the proposing release, the
Commission estimated that
approximately 50 broker-dealers 547
would choose to provide new customers
with the disclosures and notices
required under the amendment in order
to have the ability to change how their
customers’ free credit balances were
treated. The Commission did not receive
any comments on this estimate. The
Commission, however, is revising this
estimate for the final rule to include all
189 broker-dealers that carry free credit
balances to reflect the fact that these
firms may have to update their systems
to comply with these new requirements.
The Commission further estimates these
firms will spend, on average,
approximately 200 hours of employee
resources per firm updating their
current systems (including processes for
generating customer account statements)
to incorporate changes that will be
necessitated by the amendment.
Therefore, the Commission estimates
that the total one-time burden to brokerdealers arising from this requirement
will be approximately 37,800 hours.548
The Commission also estimates that
these firms will consult with outside
counsel in making these systems
changes, particularly with respect to the
language in the disclosures and notices
under new paragraph (j)(2) to Rule
15c3–3. The Commission estimates that
an outside counsel will spend, on
average, approximately 50 hours
assisting a broker-dealer in updating its
systems 549 for a one-time aggregate
burden to broker-dealers of 9,450
hours.550 The Commission estimates
that the average hourly cost for an
outside counsel will be approximately
547 See Amendments to Financial Responsibility
Rules, 72 FR at 12877.
548 189 broker-dealers × 200 hours per firm =
37,800.
549 Because broker-dealers affected by these
amendments are likely to already have existing
sweep programs in place, a broker-dealer likely will
need to update its existing systems, rather than be
required to purchase additional hardware to comply
with these rule amendments.
550 189 broker-dealers × 50 hours per firm = 9,450
hours.
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$400 per hour.551 For these reasons,
consistent with its estimate in the
proposing release, the Commission
estimates that the average one-time cost
to a broker-dealer will be approximately
$20,000 552 and the one-time cost to
broker-dealers will be approximately
$3,780,000.553
As for the annual hour burden, the
Commission estimates, consistent with
its estimate in the proposing release,
these requirements will impact 5% 554
of the total broker-dealer customer
accounts per year. Based on FOCUS
Report data, the Commission estimates
there are approximately 110,493,215
customer accounts and, consequently,
5% of the accounts (5,524,661 accounts
per year) will be impacted.555 Based on
staff experience with similar
requirements under the existing PRA
collection for Rule 17a–3, the
Commission further estimates that a
broker-dealer will spend, on average,
four minutes 556 of employee resources
to process a written affirmative consent
for new customers, as well as
disclosures required under paragraph (j)
to Rule 15c3–3. Therefore, the
Commission estimates that the annual
burden to broker-dealers arising from
the requirement will be approximately
368,311 hours.557
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7. Documentation of Risk Management
Procedures
The amendments to Rules 17a–3 and
17a–4 will require certain large brokerdealers to make and keep current a
record documenting credit, market, and
liquidity risk management controls
established and maintained by the
broker-dealer to assist it in analyzing
and managing the risks associated with
its business activities. The amendment
551 Based on staff experience, the Commission
used the estimate of $400 per hour for legal services
provided by outside counsel, which is the same
estimate used by the Commission in other recent
releases. See Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and
Major Security-Based Swap Participants and
Capital Requirements for Broker-Dealers, Exchange
Act Release 68071, 77 FR at 70297; Further
Definition of ‘‘Swap,’’ ‘‘Security-Based Swap,’’ and
‘‘Security-Based Swap Agreement’’; Mixed Swaps;
Security-Based Swap Agreement Recordkeeping;
Final Rule, Exchange Act Release No. 67453 (July
18, 2012), 77 FR 48208 (Aug. 13, 2012).
552 $400 per hour × 50 hours = $20,000.
553 189 broker-dealers × $20,000 = $3,780,000.
554 See Amendments to Financial Responsibility
Rules, 72 FR at 12877.
555 These estimates have been updated from the
proposing release estimates of 109,300,000
customer accounts and 5% of the customer account
or 5,465,000 accounts. Id.
556 Id.
557 [5,524,661 accounts × 4 minutes/account]/60
minutes = 368,311 hours. This is an update from
our proposing release estimate of 5,465,000
accounts × 4 minutes/account = 364,333 hours. Id.
at 12878.
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only will apply to broker-dealers that
have more than (1) $1,000,000 in
aggregate credit items as computed
under the customer reserve formula of
Rule 15c3–3, or (2) $20,000,000 in
capital, including debt subordinated in
accordance with Appendix D to Rule
15c3–1.
As proposed, the amendment would
have required a broker-dealer to create
a record documenting its ‘‘internal risk
management controls.’’ 558 To address
commenters’ concerns that the proposed
rule language was ambiguous and that
the Commission should narrow the
application of the rule, the Commission
modified new paragraph (a)(23) to Rule
17a–3, as stated above, so that the final
rule requires certain broker-dealers to
document risk management controls
established to manage market, credit,
and liquidity risk, rather than all of its
‘‘internal risk management controls.’’
In the proposing release, the
Commission estimated that based on
FOCUS Report data, that there would be
approximately 517 broker-dealers that
would meet the applicability threshold
of this amendment ($1,000,000 in
credits or $20,000,000 in capital), and
therefore would be subject to the
proposed rule.559 The Commission also
estimated that this requirement would
result in a one-time burden to brokerdealers of approximately 62,040 hours,
based on the estimate that a brokerdealer would spend approximately 120
hours of employee resources
augmenting its procedures to comply
with the proposed rule.560 The
Commission did not receive any
comments on this estimate in the
proposing release.
In light of the change in the final rule
text to require the documentation of
controls established to manage market,
credit, and liquidity risk, rather than all
of its ‘‘internal risk management
controls,’’ the Commission is reducing
the final PRA estimate for Rule 17a–3
because the final rule narrows the scope
of internal risk management controls the
broker-dealer is required to document.
Consequently, the change to the final
rule should result in a reduction in the
one-time hour burden estimate. The rule
does not specify the type of controls a
broker-dealer must establish to manage
these risks. It simply requires the
documentation of the procedures the
broker-dealer has established. Brokerdealers that are part of holding
companies may be subject to procedures
that are used globally throughout the
organization. As long as the broker558 Id.
at 12899.
at 12878.
560 517 broker-dealers × 120 hours = 62,040 hours.
559 Id.
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51865
dealer maintains documented
procedures of controls pertaining to the
designated entity, the requirements of
the rule would be met. The one-time
hour burden to comply with the rule
will vary depending on the size and
complexity of a firm. In addition, some
larger broker-dealers required to comply
with Rule 15c3–4 (Internal Risk
Management Control Systems for OTC
Derivatives Dealers) already would be
required to document their internal risk
management control systems related to
market, credit, and liquidity risk.561
Taking this into account, as well as
based on staff experience monitoring
compliance of risk management controls
of broker-dealers, the Commission
estimates that a broker-dealer will
spend, on average, approximately 100
hours of employee resources to comply
with this amendment to ensure its
market, credit, and liquidity risk
controls are documented. For the
reasons discussed above, including
narrowing the scope of the final rule,
the estimate of 100 hours reflects a 20%
reduction from the estimate in the
proposing release of 120 hours. Based
on FOCUS Report data, as of December
31, 2011, the Commission estimates
there are approximately 490 brokerdealers that would be subject to the final
rule amendment (because the firm has
$1,000,000 in credits or $20,000,000 in
capital). Therefore, the Commission
estimates the total one-time burden to
broker-dealers will be approximately
49,000 hours.562
In addition to the one-time hour
burden discussed in the proposing
release,563 based on similar collections
of information requiring the
documentation of risk management
controls,564 large broker-dealers
required to comply with the amendment
as adopted likely will incur annual hour
burdens.565 Consequently, the
Commission is incorporating annual
hour burdens for this collection of
information in the final rule
amendments.566 Therefore, the
Commission estimates that a broker561 See
17 CFR 240.15c3–4(a).
broker-dealers × 100 hours = 49,000 hours.
563 See Amendments to Financial Responsibility
Rules, 72 FR at 12878.
564 See Risk Management Controls for Brokers or
Dealers with Market Access; Final Rule, Exchange
Act Release No. 63241 (Nov. 3, 2010), 75 FR 69792,
69815 (Nov. 15, 2013). See also Capital, Margin,
and Segregation Requirements for Security-Based
Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for BrokerDealers, Exchange Act Release 68071, 77 FR at
70295 and 70297.
565 See NIBA 2 Letter.
566 The proposing release did not contain annual
hour burden estimates for this collection of
information.
562 490
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dealer would spend approximately 45
hours per year to ensure its compliance
with the amendment to Rule 17a–3, for
a total annual hour burden to the
industry of 22,050 hours.567
Additionally, the proposing release
did not specifically allocate the
estimated hour burdens with respect to
the amendments to Rule 17a–3 and 17a–
4 between these two rules.568 As
discussed above, and based on staff
experience with the application of Rule
17a–4, the Commission estimates that
broker-dealers meeting the threshold
requirements of paragraph (a)(23) of
Rule 17a–3 will already have
documented their established
procedures and controls to manage the
risks arising from their business.
Consequently, the amendment to Rule
17a–4 to require a broker-dealer to
preserve the records required pursuant
to paragraph (a)(23) of Rule 17a–3 until
three years after the termination of the
use of the risk management controls
documented therein should have a
minimal impact on the current annual
hour burden for Rule 17a–4 because the
paperwork burden associated with this
amendment derives from the substance
of the amendments to paragraph (a)(23)
of Rule 17a–3. Therefore, the
Commission is retaining the current
annual hour burden for Rule 17a–4
without change.
Because the final rule amendment
requires a broker-dealer to document its
liquidity, credit, and market risk
management controls, if it has
established such controls, these brokerdealers may incur one-time startup costs
to hire outside counsel to review the
documented controls to ensure the
broker-dealer is meeting the
requirements of the rule. Based on staff
experience with similar reviews, the
Commission estimates that these brokerdealers would incur $2,000 in legal
costs,569 or $980,000,570 in the
aggregate, initial one-time burden to
review and comment on the
567 490 broker-dealers × 45 hours = 22,050 hours.
The 45 per hour annual estimate is based on a
similar collection of information. See Risk
Management Controls for Brokers or Dealers with
Market Access; Final Rule, Exchange Act Release
No. 63241 (Nov. 3, 2010), 75 FR 69792, 69815 (Nov.
15, 2010).
568 See Amendments to Financial Responsibility
Rules, 72 FR at 12878.
569 The Commission staff estimates that the
review of the documented controls would require
5 hours of outside counsel time at a cost of $400
per hour. See also Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and
Major Security-Based Swap Participants and
Capital Requirements for Broker-Dealers, Exchange
Act Release 68071, 77 FR at 70297, n.904.
570 490 broker-dealers × $2,000 = $980,000.
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documented risk management
controls.571
8. Notice Requirements
The amendment to Rule 17a–11
requiring notice when a broker-dealer
becomes subject to certain insolvency
events will result in irregular filings
from a small number of broker-dealers.
As noted above, SIPC’s 2012 annual
report indicates that the average annual
number of broker-dealers which have
become subject to a liquidation
proceeding under SIPA over the last ten
years is two. Accordingly, the
Commission estimates that
approximately two insolvency notices
will be sent per year and that a brokerdealer will spend, on average,
approximately ten minutes of employee
resources to prepare and send the
notice.572 The Commission did not
receive any comments on its estimates
from the proposing release. Therefore,
the Commission estimates that the total
annual burden to broker-dealers arising
from this amendment will be
approximately 20 minutes.573
The amendment to Rule 17a–11
requires broker-dealers engaged in
securities lending or repurchase
activities to either: (1) File a notice with
the Commission and their DEA
whenever the total money payable
against all securities loaned, subject to
a reverse repurchase agreement or the
contract value of all securities borrowed
or subject to a repurchase agreement,
exceeds 2,500% of tentative net capital;
or, alternatively, (2) report monthly
their securities lending and repurchase
activities to their DEA in a form
acceptable to their DEA. The
Commission did not receive any
comments on these specific estimates in
the proposing release and continues to
believe they are appropriate. As such,
the Commission is adopting this
amendment with a minor modification
that does not impact the collection of
information.
In addition, based on FOCUS Report
data, as of December 31, 2011, the
Commission estimates that
approximately one stock loan/borrow
notice will be sent per year.574 The
571 See
NIBA 2 Letter.
is an update from the proposing release
estimate of an average of six broker-dealers per year
have become subject to a liquidation proceeding
under SIPA, based on SIPC’s 2005 annual report.
The proposing release also contained a 10 minute
estimate per broker-dealer (6 notices × 10 minutes
per notice = 1 hour). See Amendments to Financial
Responsibility Rules, 72 FR at 12878.
573 2 notices × 10 minutes per notice = 20
minutes.
574 This estimate is an update of the proposing
release estimate that twelve notices will be sent per
year based on FOCUS data. See Amendments to
572 This
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Commission further estimates that a
broker-dealer will spend, on average,
approximately ten minutes of employee
resources to prepare and send the
notice. Therefore, the Commission
estimates that the total annual burden to
broker-dealers arising from this
amendment will be approximately ten
minutes.575
Based on FOCUS Report data, as of
December 31, 2011, and staff
experience, the Commission estimates
that, annually, six broker-dealers will
submit the monthly stock loan/borrow
report.576 Based on staff experience, the
Commission estimates each firm will
spend, on average, approximately 100
hours of employee resources updating
its systems to generate the information
required in the monthly report.
Therefore, the Commission estimates
that the total one-time burden to brokerdealers arising from this requirement
will be approximately 600 hours.577
With respect to the annual hour burden,
the Commission estimates each firm
will spend, on average, approximately
one hour per month (or twelve hours
per year) of employee resources to
prepare and send the report or to
prepare the information for the FOCUS
report (as required by the firm’s DEA, if
applicable). Therefore, the Commission
estimates the total annual burden
arising from this amendment will be
approximately 72 hours.578
Financial Responsibility Rules, 72 FR at 12878. As
of December 31, 2011, there were seven brokerdealers whose securities borrowed or securities
loaned exceeded 80% of 25 times their tentative net
capital, and there were six broker-dealers whose
securities borrowed or securities loaned exceeded
25 times their tentative net capital. The
Commission assumes for purposes of the PRA that
six broker-dealers would chose to file monthly
reports in lieu of the notice requirements, and that
one would file a notice.
575 1 notice × 10 minutes per notice = 10 minutes.
This is an update of the proposing release estimate
of 2 hours (12 notices × 10 minutes per notice). See
Amendments to Financial Responsibility Rules, 72
FR at 12878. The Commission does not expect
broker-dealers to incur postage costs as a result of
this amendment because most broker-dealers file
these notices via facsimile or email. Therefore, any
incremental postages costs will likely be minimal.
576 This is an update from the proposing release
estimate that 21 broker-would submit a monthly
report. See Amendments to Financial Responsibility
Rules, 72 FR at 12878.
577 6 broker-dealers × 100 hours per firm = 600
hours. This is an update from our proposing release
estimate of 2,100 hours (21 broker-dealers × 100
hours per firm). See Amendments to Financial
Responsibility Rules, 72 FR at 12878.
578 6 broker-dealers × 12 hours per year = 72
hours. This is an update from the proposing release
estimate of 252 hours (21 broker-dealers × 12 hours
per year). See Amendments to Financial
Responsibility Rules, 72 FR at 12878.
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E. Collection of Information Is
Mandatory
These recordkeeping and notice
requirements are mandatory with the
exception of: (1) The option for a brokerdealer to report monthly its securities
lending activities to its DEA in lieu of
filing the notice required under
paragraph (c)(5) of Rule 17a–11; (2) the
option for a broker-dealer to request
written approval from its DEA in order
to withdraw capital that has been
contributed within one year under
paragraph (c)(2)(i)(G)(2) of Rule 15c3–1;
and (3) the option of a carrying brokerdealer to enter into a subordination
agreement with an account holder in
order to exclude such account holder’s
account from being treated as a PAB
account under paragraph (a)(16) of Rule
15c3–3.
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F. Confidentiality
Some of the information the
Commission expects to receive may be
confidential information. The
information collected under the
amendments to Rules 15c3–1, 15c3–3,
17a–3, and 17a–4 would be stored by
the broker-dealers and made available to
the Commission, Commission staff, and
SROs, as required in connection with
examinations, investigations, and
enforcement proceedings. The
information collected under the
amendments to Rule 17a–11 would be
generated from the internal records of
the broker-dealers. It would be provided
to the Commission, its staff, and SROs
but not on a regular basis (except for the
optional monthly reports).
To the extent that the Commission
receives confidential information
pursuant to these collections of
information, the Commission is
committed to protecting the
confidentiality of such information to
the extent permitted by law.579
Broker-dealers will send required
written notices regarding use of a PAB
account holder’s securities to its
customers, as required by Rule 15c3–
3.580 In addition, broker-dealers will
579 See, e.g., Exchange Act Section 24, 15 U.S.C.
78x (governing the public availability of
information obtained by the Commission) and 5
U.S.C. 552 et seq. (Freedom of Information Act—
‘‘FOIA’’). FOIA provides at least two pertinent
exemptions under which the Commission has
authority to withhold certain information. FOIA
Exemption 4 provides an exemption for ‘‘trade
secrets and commercial or financial information
obtained from a person and privileged or
confidential.’’ 5 U.S.C. 552(b)(4). FOIA Exemption
8 provides an exemption for matters that are
‘‘contained in or related to examination, operating,
or condition reports prepared by, on behalf of, or
for the use of an agency responsible for the
regulation or supervision of financial institutions.’’
5 U.S.C. 552(b)(8).
580 See 17 CFR 15c3–3(b)(5).
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send certain notices and disclosures to
customers regarding the treatment of
their free credit balances under new
paragraph (j)(2) to Rule 15c3–3. To the
extent these standard notices and
disclosures are made available to the
Commission, they may not be kept
confidential.
G. Record Retention Period
One amendment to Rule 15c3–1 will
require broker-dealers to make
disclosures to principals and obtain
agreements from principals with respect
to securities lending transactions where
the broker-dealer acts as agent. In
addition, the amendment to Rule 15c3–
3 to define the term PAB account will
require carrying broker-dealers to enter
into subordination agreements with
certain account holders if they wish
their account to be excluded from the
definition. These records will have to be
maintained for not less than three years
under paragraph (b)(7) of Rule 17a–4.581
The amendments to Rule 15c3–3
require broker-dealers to provide PAB
account holders with written notice that
the securities may be used in the
ordinary course of its business, obtain
the written affirmative consent of a new
customer before including a customer’s
free credit balances in a Sweep Program,
and provide certain disclosures and
notices to all customers with regard to
the broker-dealer’s Sweep Program.
These agreements relate to the terms
and conditions of the maintenance of
the customer’s account and,
accordingly, fall within the record
retention requirements of paragraph (c)
of Rule 17a–4.582 Under this paragraph,
the records must be retained until six
years after the closing of the customer’s
account. The amendments to Rule 15c3–
3 also require broker-dealers to obtain
notices and contracts from the banks
holding their PAB reserve accounts. In
order to comply with Rule 15c3–3,
broker-dealers must have these notices
and contracts in place and documented.
These records will have to be
maintained for not less than three years
under the requirements of Rule 17a–
4.583
The amendments to Rules 17a–3 and
17a–4 require broker-dealers to
document credit, market, and liquidity
risk management controls. The
amendments to Rule 17a–4 include the
establishment of a retention period for
these records, which will be until three
years after the termination of the use of
the risk management controls
documented therein under new
581 17
CFR 240.17a–4(b)(7).
CFR 240.17a–4(c).
583 17 CFR 240.17a–4.
582 17
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51867
paragraph (e)(9) of Rule 17a–4. The
three-year retention period is designed
to document former and current
procedures and to provide sufficient
opportunity to review the records
during the broker-dealer’s normal exam
cycle.
The amendments to Rule 17a–11 will
require broker-dealers to provide notice
or report monthly to the Commission
and other regulatory authorities under
certain circumstances. These notices
and reports will constitute
communications relating to a brokerdealer’s ‘‘business as such’’ and,
therefore, will need to be retained for
three years.584
V. Economic Analysis
A. Introduction
The Commission is sensitive to the
costs and benefits of its rules. When
engaging in rulemaking that requires the
Commission to consider or determine
whether an action is necessary or
appropriate in the public interest,
section 3(f) of the Exchange Act requires
that the Commission consider, in
addition to the protection of investors,
whether the action will promote
efficiency, competition, and capital
formation.585 In addition, section
23(a)(2) of the Exchange Act requires the
Commission to consider the effects on
competition of any rules the
Commission adopts under the Exchange
Act, and prohibits the Commission from
adopting any rule that would impose a
burden on competition not necessary or
appropriate in furtherance of the
purposes of the Exchange Act.586
In the proposing release,587 the
Commission solicited comment on the
costs and benefits of the proposed
amendments including whether these
costs and benefits were accurate.588 The
584 17
CFR 240.17a–4(b)(4).
U.S.C. 78c(f).
586 15 U.S.C. 78w(a)(2).
587 See Amendments to Financial Responsibility
Rules, 72 FR at 12879; see also Amendments to
Financial Responsibility Rules for Broker-Dealers,
Exchange Act Release No. 66910 (May 3, 2012), 77
FR 27150 (May 9, 2012) (re-opening of comment
period).
588 For the purposes of this final economic
analysis, the Commission is using salary data from
the SIFMA Management & Professional Earnings in
the Securities Industry 2012, which provides base
salary and bonus information for middlemanagement and professional positions within the
securities industry. The salary costs derived from
the report and referenced in this cost/benefit
section, are modified to account for an 1800-hour
work year and multiplied by 5.35 to account for
bonuses, firm size, employee benefits and overhead.
Hereinafter, references to data derived from the
report as modified in the manner described above
will be cited as ‘‘SIFMA 2012 Report as Modified.’’
The proposing release used salary information for
New York based employees derived from the SIA
585 15
Continued
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Commission also requested that
commenters identify and assess any
costs and benefits not discussed in the
proposing release. The Commission
further encouraged commenters to
provide specific data and analysis in
support of their views.589 The
Commission also requested comment on
whether the proposed amendments
would place a burden on competition,
and promote efficiency, competition,
and capital formation.590 In May 2012,
the Commission re-opened the comment
period to permit commenters additional
opportunity to address these, and any
other, issues raised by the proposed rule
amendments.591 The general comments
received, as well as comments received
relating to specific rule amendments,
are discussed below.
In adopting the rule amendments, the
Commission has been mindful of the
associated costs and benefits. The
discussion focuses on the Commission’s
reasons for adopting these amendments,
the affected parties, the costs and
benefits of the amendments compared to
a baseline, and alternative courses of
action. The discussion of the costs of the
rule amendments includes a discussion
of certain implementation burdens and
related costs,592 which may include
assessment costs, personnel costs, and
other costs (e.g., technology costs).593
The cost estimates and related data
derived from FOCUS Reports discussed
in the proposing release have also been
updated in this final release to reflect
more recently available data.594
Many of the benefits and costs
discussed below are difficult to
quantify, in particular when discussing
enhancements in investor protection.
For example, it is unknown how much
the amendments to the financial
responsibility rules will result in
enhanced compliance with those rules.
Therefore, much of the discussion is
qualitative in nature but, where
Report on Management and Professional Earnings
in the Securities Industry 2005. See Amendments to
Financial Responsibility Rules, 72 FR at 12879,
n.151.
589 Id. at 12879.
590 Id.
591 Amendments to Financial Responsibility Rules
for Broker-Dealers, Exchange Act Release No. 66910
(May 3, 2012), 77 FR 27150 (May 9, 2012).
592 In the proposing release, the Commission
estimated that the one-time and annual costs to
broker-dealers would be $32,814,454 and
$39,651,716, respectively. See Amendments to
Financial Responsibility Rules, 72 FR at 12887.
593 As discussed in section IV. of this release, the
Commission has estimated certain indirect burdens
and related costs of these implementation
requirements.
594 See Amendments to Financial Responsibility
Rules, 72 FR at 12887. The FOCUS Report data from
the proposing release was derived from 2004 year
end numbers.
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possible, the Commission has attempted
to quantify the costs. However, the
inability to quantify these costs and
benefits does not mean that the costs
and benefits of these rule amendments
are any less significant.
As discussed throughout this release,
in part in response to comments, the
Commission has modified the proposed
rules to reduce compliance burdens
where consistent with investor
protection. In addition, where
commenters identified additional costs,
the Commission has revised its
economic analysis of the final rules to
take these costs into account. Finally,
the Commission has considered all
comment letters received related to the
impact of the proposed amendments on
efficiency, competition, and capital
formation, and responds to these
comments in the sections below
discussing individual rule amendments.
B. Economic Baseline
The regulatory changes adopted today
amend requirements that apply to
broker-dealers registered with the
Commission. The discussion below
includes the approximate numbers of
broker-dealers that will be affected by
today’s amendments and a description
of the economic baseline against which
the costs and benefits, as well as the
impact on efficiency, competition, and
capital formation, of today’s
amendments are measured.
The broker-dealers registered with the
Commission vary significantly in terms
of their size, business activities, and the
complexities of their operations. For
example, carrying broker-dealers hold
customer securities and funds.595
Clearing broker-dealers clear
transactions as members of security
exchanges, the Depository Trust &
Clearing Corporation and the Options
Clearing Corporation.596 Many clearing
595 Rule 15c3–1 specifies that a broker-dealer
shall be deemed to carry customer accounts ‘‘if, in
connection with its activities as a broker or dealer,
it receives checks, drafts, or other evidences of
indebtedness made payable to itself or persons
other than the requisite registered broker or dealer
carrying the account of a customer, escrow agent,
issuer, underwriter, sponsor, or other distributor of
securities’’ or ‘‘if it does not promptly forward or
promptly deliver all of the securities of customers
or of other brokers or dealers received by the firm
in connection with its activities as a broker or
dealer.’’ 17 CFR 240.15c3–1(a)(2)(i). Rule 15c3–3
defines the term securities carried for the account
of a customer to mean ‘‘securities received by or on
behalf of a broker or dealer for the account of any
customer and securities carried long by a broker or
dealer for the account of any customer,’’ as well as
securities sold to, or bought for, a customer by a
broker-dealer. 17 CFR 240.15c3–3(a)(2).
596 See Definitions of Terms and Exemptions
Relating to the ‘‘Broker’’ Exceptions for Banks,
Exchange Act Release No. 56501 (Sept. 24, 2007),
72 FR 56514 (Oct. 3, 2007), at n.269.
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broker-dealers are carrying brokerdealers, but some clearing brokerdealers clear only their own transactions
and do not hold customer securities and
cash.
In addition, a broker-dealer that does
not hold customer securities and/or
cash is generally referred to as a ‘‘noncarrying broker-dealer.’’ Non-carrying
broker-dealers include ‘‘introducing
brokers.’’ 597 These introducing brokerdealers accept customer orders and
introduce their customers to carrying
broker-dealers that hold the securities
and cash of the customers of the
introducing broker-dealers along with
the securities and cash of their direct
customers. A carrying broker-dealer
generally receives and executes orders
of the introducing broker-dealers’
customers.598 Carrying broker-dealers
generally also prepare trade
confirmations, settle trades, and
organize book entries of the securities
purchased and sold.599 Introducing
broker-dealers also may use carrying
broker-dealers to clear the introducing
firm’s proprietary trades and carry the
firm’s securities. Another group of noncarrying broker-dealers effects
transactions in securities like mutual
funds on a subscription-way basis,
where customers generally purchase the
securities by providing the funds
directly to the issuer.600 Finally, some
non-carrying broker-dealers act as
finders by referring prospective
purchasers of securities to issuers.601
597 Id. at ¶ 1.15; see also Net Capital Rule,
Exchange Act Release No. 31511 (Nov. 24, 1992),
57 FR 56973 (Dec. 2, 1992) (describing role of
introducing broker-dealers).
598 Net Capital Rule, Exchange Act Release No.
31511 (Nov. 24, 1992), 57 FR 56973 (Dec. 2, 1992).
599 See, e.g., FINRA Rule 4311 (Carrying
Agreements). This FINRA rule governs the
requirements applicable to FINRA members when
entering into agreements for the carrying of any
customer accounts in which securities transactions
can be effected. Historically, the purpose of this
rule has been to ensure that certain functions and
responsibilities are clearly allocated to either the
introducing or carrying firm, consistent with the
requirements of the SRO’s and Commission’s
financial responsibility and other rules and
regulations, as applicable. See also Notice of Filing
of Amendment No. 1 and Order Granting
Accelerated Approval of a Proposed Rule Change
Adopting, as Modified by Amendment No. 1, Rules
Governing Guarantees, Carrying Agreements,
Security Counts and Supervision of General Ledger
Accounts in the Consolidated FINRA Rulebook,
Exchange Act Release No. 63999 (Mar. 7, 2011), 76
FR 12380 (Mar. 7, 2011).
600 See Books and Records Requirement for
Brokers and Dealers Under the Securities Exchange
Act of 1934, Exchange Act Release No. 44992 (Nov.
2, 2001) (‘‘[T]he Commission recognizes that for
some types of transactions, such as purchases of
mutual funds or variable annuities, the customer
may simply fill out an application or a subscription
agreement that the broker-dealer then forwards
directly to the issuer.’’).
601 See American Bar Association, Report and
Recommendations of the Task Force on Private
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While these amendments will impact
investors and markets more generally,
the broker-dealer industry is the
primary industry directly affected by the
rule amendments. In some cases, the
amendments impose requirements on
certain types of broker-dealers that
engage in specific activities. For
example, only carrying broker-dealers
that carry free credit balances would be
subject to the requirements regarding
the treatment of free credit balances
under paragraph (j) of Rule 15c3–3. All
broker-dealers would be subject to the
requirements to deduct from net worth
certain liabilities or expenses assumed
by third parties under Rule 15c3–1.
51869
To establish a baseline for
competition among broker-dealers, the
Commission looked at the status of the
broker-dealer industry detailed below.
In terms of size, the following table
provides the distribution of brokerdealers by total capital levels and the
aggregate total capital within each
capital bracket.
BROKER-DEALER CAPITAL AT CALENDAR YEAR END 2011 602
[$ millions]
Number of
firms
Capital
Aggregate
total capital
Less than $500,000 .................................................................................................................................................
Greater than or equal to $500,000 and less than $5 million ..................................................................................
Greater than or equal to $5 million and less than $50 million ................................................................................
Greater than or equal to $50 million and less than $100 million ............................................................................
Greater than or equal to $100 million and less than $500 million ..........................................................................
Greater than or equal to $500 million and less than $1 billion ...............................................................................
Greater than or equal to $1 billion and less than $5 billion ....................................................................................
Greater than or equal to $5 billion and less than $10 billion ..................................................................................
Greater than or equal to $10 billion ........................................................................................................................
2,506
1,320
608
80
125
28
27
6
9
$347
2,212
10,520
5,672
26,655
19,248
61,284
41,175
175,585
Total ..................................................................................................................................................................
4,709
342,698
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According to FOCUS Report data, as
of December 31, 2011, there were
approximately 4,709 broker-dealers
registered with the Commission. Nine
broker-dealers hold over half of brokerdealers’ total capital. Further, based on
FOCUS Report data, as of December 31,
2011, the Commission also estimates
that there are approximately 287 brokerdealers that are clearing or carrying
firms that do not claim exemptions
pursuant to paragraph (k) of Rule 15c3–
3. Based on FOCUS Report data, as of
December 31, 2011, approximately 189
of these broker-dealers carry free credit
balances, while 61 broker-dealers carry
PAB accounts.
For the purposes of this economic
analysis, the baseline is the current
customer protection, net capital, books
and records, and notification
requirements for broker-dealers
promulgated under the Exchange Act
and existing interpretations thereunder,
and how they affect broker-dealers.
As discussed above in section II.A.1.
of this release, Rule 15c3–3—the
customer protection rule—in effect
mandates a separation of customer
assets from broker-dealer assets through
two fundamental requirements: (1) That
a carrying broker-dealer must maintain
Placement Broker-Dealers 23–24 (2005); see also
Net Capital Rule, Exchange Act Release No. 31511
(Nov. 24, 1992), 57 FR 56973 (Dec. 2, 1992).
602 The information in this chart is based on
FOCUS Report data filed by broker-dealers in 2011.
The information in the ‘‘Aggregate Total Capital’’
column is based on data reported on line 3530 of
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physical possession or control over
customers’ fully paid and excess margin
securities; and (2) that a carrying brokerdealer must maintain a reserve of cash
or qualified securities 603 in an account
at a bank that is at least equal in value
to the net cash owed to customers,
including cash obtained from the use of
customer securities. These provisions
are designed to require the broker-dealer
to hold customer securities and cash in
a manner that enables the prompt return
of these assets in the event that the firm
falls into financial difficulty or becomes
insolvent. The goal of the rule is to
place a broker-dealer in a position
where it is able to wind down in an
orderly self-liquidation without the
need for financial assistance from SIPC
through a formal proceeding under
SIPA.604
As discussed above in section II.E. of
this release, Rule 15c3–1—the net
capital rule—requires broker-dealers to
maintain a minimum level of net capital
(meaning highly liquid capital) at all
times.605 The rule requires that a brokerdealer perform two calculations: (1) A
computation of the minimum amount of
net capital the broker-dealer must
maintain; 606 and (2) a computation of
the amount of net capital the brokerthe FOCUS Report, which includes total capital and
allowable subordinated liabilities.
603 Rule 15c3–3 defines qualified securities as
securities issued by the United States or guaranteed
by the United States with respect to principal and
interest. 17 CFR 240.15c3–3(a)(6).
604 15 U.S.C. 78aaa et seq.
605 See 17 CFR 240.15c3–1.
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dealer is maintaining.607 The minimum
net capital requirement is the greater of
a fixed-dollar amount specified in the
rule and an amount determined by
applying one of two financial ratios: the
15-to-1 aggregate indebtedness to net
capital ratio or the 2% of aggregate debit
items ratio.608 In computing net capital,
the broker-dealer must, among other
things, make certain adjustments to net
worth, such as deducting illiquid assets,
taking other capital charges, and adding
qualifying subordinated loans.609 The
amount remaining after these
adjustments is defined as tentative net
capital.610 The final step in computing
net capital is to take prescribed
percentage deductions (‘‘standardized
haircuts’’) from the mark-to-market
value of the proprietary positions (e.g.,
securities, money market instruments,
and commodities) that are included in
its tentative net capital.611
As discussed above in section II.D. of
this release, Rule 17a–3 and 17a–4—the
books and records rules—require
broker-dealers to make and keep current
certain records (e.g., trade blotters, asset
and liability ledgers, income ledgers,
customer account ledgers, etc.), which
must be maintained in a specific
manner for required retention
606 See
17 CFR 240.15c3–1(a).
17 CFR 240.15c3–1(c)(2). The computation
of net capital is based on the definition of net
capital in paragraph (c)(2) of Rule 15c3–1. Id.
608 See 17 CFR 240.15c3–1(a).
609 See 17 CFR 240.15c3–1(c)(2)(i)–(xiii).
610 See 17 CFR 240.15c3–1(c)(15).
611 See 17 CFR 240.15c3–1(c)(2)(vi).
607 See
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periods.612 Finally, Rule 17a–11—the
notification rule—requires a brokerdealer to notify the Commission and its
DEA when certain events occur, such as
if it fails to maintain certain levels of net
capital.613
The specific requirements as well as
the benefits and costs of each
amendment and how broker-dealers will
be affected are discussed in more detail
in the sections below.
C. Discussion of General Comments
Received
As stated above, in the proposing
release, the Commission requested
comment on estimates and views
regarding the costs and benefits for
particular types of market participants,
as well as any other costs and benefits
that may result from the adoption of the
proposed rules.614 In response to this
specific request, the Commission
received two comment letters.615 The
first commenter who was explicitly
addressing the Commission’s Initial
Regulatory Flexibility Analysis stated
that the Commission should pay
‘‘explicit attention to regulatory trends
in the rest of the world’’ because doing
so ‘‘benefits not only small entities [the
focus of the Initial Regulatory Flexibility
Analysis] (by reducing their regulatory
burden) but all entities, as larger entities
can experience more consistent
regulatory procedures around the
world.’’ 616 The commenter suggested
that the Commission consider a ‘‘Basel
II type approach to net capital
requirements.’’ 617 The second
commenter requested that the
Commission publish an update to all
statistics and costs referenced in the
proposing release.618 The commenter
further requested that, once published,
the Commission reopen the comment
period so that comments could be
provided based on ‘‘current conditions
and statistics.’’ 619
In response to the first commenter’s
request that the Commission should
explicitly examine the alternatives used
by regulators in other jurisdictions,620 in
adopting the final rule amendments
today, as discussed throughout this
section, the Commission considered
reasonable alternatives, including
alternatives in other jurisdictions, as
well as the costs and benefits of the
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612 17
CFR 240.17a–3; 17 CFR 240.17a–4.
CFR 240.17a–11.
614 See Amendments to Financial Responsibility
Rules, 72 FR at 12879.
615 See Angel Letter; NIBA 2 Letter.
616 See Angel Letter.
617 Id.
618 See NIBA 2 Letter.
619 Id.
620 See Angel Letter.
613 17
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amendments. Moreover, the
amendments relate to discrete areas of
the broker-dealer financial
responsibility rules (i.e., they do not
establish new financial responsibility
standards such as would be the case if
the Commission were to adopt a ‘‘Basel
II type approach to net capital
requirements.’’). Consequently, the
commenter’s suggestion is beyond the
scope of this rulemaking.621
In response to the second commenter,
the Commission is publishing updated
costs and statistics in this release. The
Commission, however, believes that it is
unnecessary to reopen the comment
period to obtain comment on the
updated statistics for several reasons.
First, in proposing the rule changes, the
Commission included then current
estimates in the proposing release.
Second, as noted above, the
Commission reopened the comment
period in 2012.622 The reopening of the
comment period afforded commenters
an additional opportunity to comment
on the proposed rules (including
estimated costs and benefits), given the
economic events since the rule
amendments were proposed, the
regulatory developments, the comments
received on the proposed amendments,
the continuing public interest in the
proposed amendments, and the passage
of time.623 The Commission received a
total of 97 comment letters on the
proposed amendments.624 As discussed
below, in many cases, the revised data
included in this release reflects a
decrease in overall costs because of the
decline in the total number of brokerdealers (including the number of brokerdealers that will be affected by each of
these rule amendments). As of the 2004
year end, the number of registered
broker-dealers was 6,339. As of the 2011
year end, the number of registered
broker-dealers was 4,709, reflecting a
net decrease of 1,630 (or 26%) in the
number of registered broker-dealers.
Consequently, many of the aggregate
costs included in the proposing release
have declined due to the decrease in the
number of registered broker-dealers.
Further, the costs incurred by a
broker-dealer to comply with the rule
621 The commenter cited the JP Morgan Letter in
support of the suggestion to ‘‘consider regulatory
trends in the rest of the world.’’ Id. The JP Morgan
Letter recommends that the Commission adopt a
due diligence standard—citing a U.K. regulation—
with respect to the amendments regarding customer
reserve account cash deposits. See JP Morgan Letter.
The Commission addresses this comment below in
section V.D.1.i.b.(III) of this release.
622 Amendments to Financial Responsibility Rules
for Broker-Dealers, Exchange Act Release No. 66910
(May 3, 2012), 77 FR 27150 (May 9, 2012).
623 Id.
624 See supra note 6.
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amendments will generally depend,
among other factors, on the size and
complexity of its business activities.
Because the size and complexity of
broker-dealers varies significantly, their
costs also could vary significantly. In
some cases, the Commission provided
in the proposing release, and is
providing here, estimates of the average
cost per broker-dealer, taking into
consideration the variance in size and
complexity of the business activities of
broker-dealers. In other cases, the cost
impact to broker-dealers will depend on
whether the broker-dealer is conducting
activities that are subject to the rule
amendments. For example, the
amendments to Rule 15c3–3 will apply,
for the most part, only to broker-dealers
that carry PAB accounts (e.g., PAB
account amendment), have a reserve
deposit requirement (e.g., reserve bank
account amendments), or carry free
credit balances (e.g., free credit balance
amendments). These amendments
would have no direct cost impact on
non-carrying broker-dealers, many of
which are small broker-dealers.
Moreover, given that some amendments
are largely codifications of existing
Commission and staff guidance (e.g.,
amendments related to PAB accounts,
third parties assuming broker-dealer
liabilities, temporary capital
contributions, and fidelity bond
deductions), any economic effects,
including costs and benefits, should be
compared to the baseline of current
practice. Broker-dealers that are already
complying with these requirements
would not be expected to incur
substantial costs to comply with these
amendments.
The second commenter also stated
that broker-dealers are dealing with
relatively static commission and fee
schedules in comparison to what they
might charge customers, and, as such,
broker-dealers will be unable to pass on
any cost increases resulting from these
rule amendments directly to
customers.625 The commenter stated
that these cost increases over a
relatively short period of time threaten
the viability of all small broker-dealers,
irrespective of their business line types
or classes.626 The commenter noted that
the estimates provided by the
Commission utilized only the number of
broker-dealers in its estimate that the
Commission justifiably considered to be
affected by the proposals.627 In contrast,
the commenter believes that most, if not
all broker-dealers will spend over 90
hours each analyzing the effects of these
625 See
NIBA 2 Letter.
626 Id.
627 Id.
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proposals and, if the rules are
implemented, will spend much more
than 90 hours each in implementing
procedures to comply with the new
rules. The commenter also believes that
implementation will require brokerdealers to modify their written
supervisory procedures and supervisory
controls, and broker-dealers will spend
in excess of 240 hours each in the
monitoring of such rules on an ongoing
basis. Consequently, the commenter
believes that each broker-dealer will
spend in excess of $15,000 for outside
counsel and auditor opinions or work
product.628 This commenter did not
provide additional detail about the basis
for its view that the Commission’s
estimates were too low.
As stated above in section IV. of this
release, the Commission agrees with the
commenter that the broker-dealers
directly affected by the rule
amendments may be required to
implement procedures or modify their
written supervisory procedures to
comply with the rule amendments. In
cases where the rule amendments
require a broker-dealer to directly
implement or document certain policies
and procedures, these hour burdens and
costs already are incorporated into the
PRA costs discussed above in section
IV. of this release, and incorporated into
the discussion below.629 In response to
the commenter, the Commission also
acknowledges that a broker-dealer may
need to review its operations to
determine whether it has any
obligations under the rule amendments.
Even if the broker-dealer is not affected
by the rule amendments, such a review
may result in an indirect effect on its
operations. These indirect costs are
discussed in more detail below. In
adopting these final rules, as discussed
throughout the release, including this
economic analysis, the Commission has
sought to take into account the costs and
benefits associated with each particular
rule amendment. The Commission has
also considered the indirect costs that a
broker-dealer would incur to assess the
impact of these final rule amendments.
The Commission estimates that a
broker-dealer likely will hire outside
counsel to assess the impact of the final
rules on the broker-dealer’s operations
because all broker-dealers may be
affected by the final rules, including
non-carrying broker-dealers that may be
affected by certain amendments, such as
the Rule 15c3–1 amendments regarding
third party liabilities or temporary
capital contributions. Whether a broker628 Id.
629 See, e.g., paragraph (j)(1) of Rule 15c3–3 and
paragraph (a)(23) of Rule 17a–3, as adopted.
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dealer determines to incur such
assessment costs will depend on the
nature and size of the broker-dealer’s
business and the range of activities the
broker-dealer conducts. Therefore,
while the Commission cannot estimate
an aggregate assessment cost for all
broker-dealers, the Commission
estimates that these assessment costs
would range approximately from $2,000
to $30,000 630 per broker-dealer.631
D. Economic Analysis of the
Amendments and Alternatives
This section discusses costs and
benefits of the rule amendments for the
affected parties against the economic
baseline identified above, both in terms
of each of the specific changes from the
baseline and in terms of the overall
impact. In considering costs, benefits,
and overall impact, this discussion
addresses comments received,
modifications made to the proposed
amendments, and reasonable
alternatives, where applicable.
This section also discusses the
Commission’s considerations on the
burden on competition, and the
promotion of efficiency, competition,
and capital formation.632 In significant
part, the effects of the final rules on
630 These costs estimates include hour estimates
in the range of 5 hours to 75 hours for outside
counsel assessment review. A small broker-dealer
may hire outside counsel to review only 1 or 2 of
the final rule amendments for approximately 5
hours × $400 per hour = $2,000. See Business
Conduct Standards for Security-Based Swap
Dealers and Major Security-Based Swap
Participants, Exchange Act Release No. 64766, 76
FR 42396 (June 29, 2011), 76 FR 42396 (July 18,
2011) (applying the estimated cost of $400 for legal
services by outside counsel). See also Further
Definition of ‘‘Swap Dealer,’’ ‘‘Security-Based Swap
Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major
Security-Based Swap Participant’’ and ‘‘Eligible
Contract Participant’’, Exchange Act Release No.
66868 (Apr. 27, 2012), 77 FR 30596 (May 23, 2012)
(noting that the review of the final rules by outside
counsel for a large firm would generally cost more
because the review would be more complex).
631 As discussed above, and in section IV. of this
release, broker-dealers directly affected by a specific
rule amendment may be required to implement
procedures or modify their written supervisory
procedures in order to comply with the rule
amendments. The hours and related costs are
discussed in section IV. of this release, and are
incorporated into the specific sections below
discussing each rule amendment. Therefore, while
the range of hours is less than 90 hours (as
suggested by the commenter), the Commission has
adjusted other specific hour and cost estimates (in
sections IV. and V. of this release) in response to
the commenter’s concerns, and believes these
adjusted estimates, in totality, for the reasons
discussed above, adequately address the estimated
costs as well as the commenter’s concerns. See
NIBA 2 Letter.
632 In the proposing release, the Commission
stated that its preliminary view was that the
proposed amendments promote efficiency,
competition, and capital formation and would not
have any anti-competitive effects. See Amendments
to Financial Responsibility Rules, 72 FR at 12887.
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51871
efficiency and capital formation are
linked to the effects of these rules on
competition. Competitive markets are
generally expected to promote an
efficient allocation of capital. Rules that
promote, or do not unduly restrict,
investor participation and competition
in the broker-dealer industry can be
accompanied by regulatory benefits that
may reduce the risk of market failure
and thus promote market efficiency and
capital formation.
1. Amendments to the Customer
Protection Rule
i. Economic Analysis
a. Proprietary Accounts of BrokerDealers
(I). Summary of Amendments
Today’s amendments to Rules 15c3–3
and 15c3–3a require carrying brokerdealers to: (1) Perform a separate reserve
computation for PAB accounts (in
addition to the customer reserve
computation currently required under
Rule 15c3–3); 633 (2) establish and fund
a separate reserve account for the
benefit of the PAB account holders; 634
and (3) obtain and maintain physical
possession or control of securities
carried for a PAB account, unless the
carrying broker-dealer has provided
written notice to the PAB account
holder that the securities may be used
in the ordinary course of its securities
business, and has provided opportunity
for the PAB account holder to object.635
In addition to the amendments to Rules
15c3–3 and 15c3–3a, the Commission is
adopting amendments to Rule 15c3–1
that will require a broker-dealer to
deduct from net capital cash and
securities held in a securities account at
a carrying broker-dealer except where
the account has been subordinated to
the claims of creditors of the carrying
broker-dealer.636
As discussed above in section II.A.2.
of this release, there is a disparity
between the customer reserve
requirements in Rule 15c3–3 and the
treatment of customers in a liquidation
proceeding under SIPA.637 Brokerdealers are not within the definition of
customer for the purposes of Rule 15c3–
3.638 Accordingly, a carrying brokerdealer that carries PAB accounts is not
required to treat these accounts as
customer accounts for the purposes of
Rule 15c3–3. However, the definition of
customer in SIPA is broader than the
633 17
CFR 250.15c3–3(e)(3).
CFR 240.15c3–3(e)(1).
635 17 CFR 240.15c3–3(b)(5).
636 17 CFR 240.15c3–1(c)(2)(iv)(E).
637 15 U.S.C. 78aaa et seq.
638 17 CFR 240.15c3–3(a)(1).
634 17
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definition in Rule 15c3–3 in that the
SIPA definition does not exclude
broker-dealers.639
SIPA customers are entitled to a
number of protections if their brokerdealer fails and is liquidated in a SIPA
proceeding, including the right to share
pro rata with other SIPA customers in
the customer property held by the
broker-dealer and, if the fund of
customer property is insufficient to
make each SIPA customer whole, the
entitlement to receive an advance from
the SIPC fund of up to $500,000 (of
which only $250,000 can be used to
cover cash claims).640 Broker-dealers
that are SIPA customers have the right
to share pro rata in customer
property.641 Consequently, when a
carrying broker-dealer is liquidated in a
SIPA proceeding, each customer
(including a SIPA customer that is a
broker-dealer) has a claim on the
customer property. However, because
the possession and control and
customer reserve account provisions of
Rule 15c3–3 do not apply to PAB
account holders by virtue of the
definition of customer in the rule, the
carrying broker-dealer is not restricted
from using the securities and cash in
these accounts for its business purposes.
The treatment of PAB account holders
as customers for the purposes of SIPA
but not as customers for the purposes of
Rule 15c3–3 increases the risk that, in
the event that a carrying broker-dealer is
liquidated under SIPA, the claims of all
SIPA customers will exceed the amount
of customer property available and,
thereby, expose the SIPC fund and
potentially SIPA customers to losses. In
addition, if the customer property is
insufficient to satisfy fully all SIPA
customer claims, and losses are
incurred, the broker-dealer SIPA
customers could be potentially placed
in financial distress causing adverse
effects to the securities markets, in
addition to the adverse effects resulting
from the failure of the carrying brokerdealer.642
639 See
15 U.S.C. 78lll(a).
15 U.S.C. 78fff–2(c) and 15 U.S.C. 78fff–
3(a), respectively. Under SIPA, the term customer
property includes ‘‘cash and securities . . . at any
time received, acquired, or held by or for the
account of the debtor from or for the securities
accounts of a customer, and the proceeds of any
such property transferred by the debtor, including
property unlawfully converted.’’ Therefore,
customer property includes those securities
positions that are held for customers and the cash
that is owed to customers. 15 U.S.C. 78lll(4).
641 See 15 U.S.C. 78fff–2(c). Broker-dealers,
however, are not entitled to receive an advance
from the SIPC fund. 15 U.S.C. 78fff–3(a).
642 As noted above, while broker-dealers are
customers for the purposes of SIPA, they are not
entitled to the advances from the SIPC fund of up
to $500,000 (limited to $250,000 for cash claims)
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The amendments address the
disparity between the customer reserve
requirements in Rule 15c3–3 and the
treatment of customers in a liquidation
proceeding under SIPA by requiring
broker-dealers to reserve for the amount
that credits exceed debits with respect
to broker-dealer accounts. The
amendments create a process that
protects customers and PAB account
holders of a failed carrying brokerdealer, and are designed to provide such
protection by mitigating the risk that
there will be insufficient customer
property to fully satisfy all customer
claims in a SIPA liquidation. By
requiring the protection of PAB account
holders (who qualify as customers
under SIPA), the amendments to Rule
15c3–3 also reduce the risk that
advances from the SIPC fund would be
necessary to protect customer claims.
The amendments to Rule 15c3–1 are
intended to prevent broker-dealers from
including in their net capital amount
assets that may not be readily available
to be returned to such broker-dealer
account holders because the assets
would not be subject to the PAB account
provisions under Rules 15c3–3 and
15c3–3a. The amendments to Rule
15c3–1 also provide consistency with
the exclusions from the definition of
PAB account in paragraph (a)(16) of
Rule 15c3–3.
Overall, the PAB-related amendments
to Rules 15c3–3, 15c3–3a, and 15c3–1
should serve to reduce certain risks to
investors and PAB account holders and,
thereby, strengthen customer protection.
The Commission requested comment on
available metrics to quantify these
benefits and any other benefits a
commenter may identify. The
Commission did not receive any
comments in response to this request.
(II). Baseline and Incremental Economic
Effects
Under the no-action relief set forth in
the PAIB Letter,643 discussed in section
II.A.2 of this release, broker-dealers
currently perform a reserve computation
for domestic broker-dealer accounts and
have obtained the necessary agreements
and notices from the banks holding their
PAIB reserve deposits. Therefore, as
compared to the baseline of current Rule
15c3–1 and existing interpretations and
guidance thereunder, including the noaction relief set forth in the PAIB Letter,
the amendments will likely result only
in small incremental benefits and costs
allowed under SIPA to make up for potential
shortfalls after the pro rata distribution of customer
property. 15 U.S.C. 78fff–3(a).
643 See PAIB Letter.
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because the final rule codifies many of
the provisions of the PAIB Letter.644
Incorporation of certain aspects of the
PAIB Letter into Rule 15c3–3 is
intended to provide broker-dealers with
more certainty with respect to the PAB
requirements because these
requirements will be expressly stated in
a Commission rule. Moreover, the PAB
final rule amendments will not impose
a significant additional burden on
broker-dealers presently utilizing the
interpretive relief provided in the PAIB
Letter since the provisions of the final
rule amendments are substantially
similar. Relative to the baseline, there
will be economic differences to the
extent that carrying broker-dealers are
currently not following the PAIB Letter,
as compliance with conditions of the
PAIB Letter are voluntary, while the
PAB amendments to Rule 15c3–3 will
be mandatory for the carrying brokerdealers subject to its requirements.
Consequently, to the extent that carrying
broker-dealers are not currently
complying with the PAIB Letter, and to
the extent the amendments as adopted
differ from the PAIB Letter, they may
incur incremental costs, including
possible costs of capital as firms
reallocate capital to comply with the
rule amendments.
(III). Alternatives
In adopting these amendments, the
Commission considered alternatives
suggested by commenters on specific
provisions of the rule, and incorporated
some of these alternative approaches
into the final rule amendments.
Two commenters raised concerns
about the proposed definition of the
term PAB account, because by including
proprietary accounts of foreign brokerdealers and foreign banks acting as
broker-dealers within the definition, the
definition would differ from provisions
in the PAIB Letter, which excluded such
accounts from a PAIB computation.645
The first commenter suggested allowing
broker-dealers to ‘‘opt out’’ of the
rule.646 The second commenter stated
that foreign broker-dealers and foreign
banks acting as broker-dealers should be
allowed to subordinate their claims to
customers and creditors of the brokerdealer to remove their accounts from
PAB account treatment because under
SIPA foreign broker-dealers and foreign
banks acting as broker-dealers, under
certain circumstances, will not be
deemed customers and, therefore,
644 See section II.B. of this release. The PAIB
Letter is being withdrawn as of the effective date of
these rule amendments.
645 See Dresdner Kleinwort Letter; Deutsche Bank
Securities Letter.
646 See Dresdner Kleinwort Letter.
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would not be entitled to a pro rata share
of the estate of customer property in a
SIPA liquidation.647 More specifically,
the commenter suggested that, to
parallel the language in SIPA,648 the
Commission modify the definition of
PAB account to exclude ‘‘any foreign
broker-dealer and foreign bank, to the
extent that such entity has a claim for
cash or securities that is subordinated to
the claims of creditors of the carrying
broker-dealer.’’ This commenter also
recommended that the subordinating
broker-dealer would need to follow the
requirements for non-conforming
subordinated loans to remove an
account from being treated as a PAB
account.649
In response to commenters’ concerns
and suggested alternatives, the
Commission is excluding from the PAB
account definition accounts that have
been subordinated to the claims of
creditors of the carrying broker-dealer.
Consequently, this provision will
provide flexibility to carrying brokerdealers and their broker-dealer affiliates
to structure their PAB account
relationships in a manner that permits
operational efficiencies (i.e., the ability
to exclude these accounts from the PAB
reserve computation) while still
promoting the goal of the amendments
to have a consistent treatment of these
accounts under Rule 15c3–3 and SIPA,
and thereby protect accounts holders
that are customers under SIPA. As
discussed below, however, the
requirement to enter into a
subordination agreement with certain
account holders to exclude them from
the definition of PAB account may
result in a one-time cost to brokerdealers.
In addition, in the proposing release,
the Commission proposed to require
that a carrying broker-dealer obtain
written permission from a PAB account
holder before it could use the securities
of the PAB account holder in the
ordinary course of its securities
business. One commenter stated that
this provision should be eliminated
from the proposed amendments, arguing
that it interferes unnecessarily in the
contractual arrangements between
broker-dealers, which are capable of
647 See
Deutsche Bank Securities Letter.
The definition of customer in SIPA
excludes any person, to the extent that ‘‘such
person has a claim for cash or securities which by
contract, agreement, or understanding, or by
operation of law, is part of the capital of the debtor,
or is subordinated to the claims of any or all
creditors of the debtor, notwithstanding that some
ground exists for declaring such contract,
agreement, or understanding void or voidable in a
suit between the claimant and the debtor.’’ 15
U.S.C. 78lll(2)(C)(ii).
649 See Deutsche Bank Securities Letter.
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understanding the terms of standard
industry custodial relationships and
that the PAIB Letter did not contain any
such requirements. The Commission
considered this alternative and believes
that an appropriate level of protection
for PAB account holders will be
achieved by requiring the carrying
broker-dealer to provide written notice
to the PAB account holders that the firm
may use their non-margin securities in
the ordinary course of its securities
business. The written notice
requirement in the final rule will
increase protection for PAB account
holders from the status quo without
imposing substantial burdens on
existing account relationships. The
revised rule will alert PAB account
holders to the fact that the carrying
broker-dealer may use their securities in
its business for its own benefit, thereby
reducing possible contractual ambiguity
between the PAB account holder and
the broker-dealer. The revised rule also
will provide a PAB account holder the
opportunity to seek to move the account
to another broker-dealer or to negotiate
different terms with regard to the use of
its securities. Finally, this amendment
will eliminate the need for, and the
costs that would result from, carrying
broker-dealers reworking existing
contracts.
An alternative considered in adopting
the PAB-related amendments to Rule
15c3–1 would have required a brokerdealer, when calculating net capital, to
deduct from net worth cash and
securities held in a securities account at
another broker-dealer, if the other
broker-dealer does not treat the account,
and the assets in the account, in
compliance with the applicable PAB
requirements of the rule.650 Although
the proposing release stated that the
Commission did not expect brokerdealers to audit or examine their
carrying broker-dealers to determine
whether such firms were in compliance
with the proposed rule, commenters
expressed concern that the proposed
rule text suggested that broker-dealers in
fact would have such an obligation.651
There were also concerns expressed that
a broker-dealer should not be deemed to
have violated the net capital rule
because its carrying firm fails to
properly perform requirements solely
applicable to the carrying firm and that
Rule 15c3–1 should be modified to
clarify that cash and securities held in
a securities account at another brokerdealer are not subject to the deduction
specified in paragraph (c)(2)(iv)(E) of
650 See
651 See
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51873
Rule 15c3–1.652 In response to these
concerns, the Commission has modified
the language in the Rule 15c3–1 to
eliminate the proposed capital charge
that would have resulted from a failure
of a carrying broker-dealer to comply
with the PAB requirements. Instead, the
Commission has adopted amendments
providing that a broker-dealer need not
deduct cash and securities held in a
securities account at another brokerdealer, with one exception. As
discussed in section II.A.2. of this
release, the exception generally parallels
the exclusions from the definition of
PAB account in Rule 15c3–3.
(IV). Compliance Cost Estimates
The Commission is mindful of the
compliance costs associated with the
final PAB rule amendments. In
particular, the Commission recognizes
that, though many requirements of the
PAB rule amendments being adopted by
the Commission today are incorporated
from the PAIB Letter, there may be
incremental imposed costs. For
example, as discussed above in section
II.A.2. of this release, because the
possession and control and customer
reserve account provisions of Rule
15c3–3 do not apply to PAB account
holders by virtue of the definition of
customer in the rule, the carrying
broker-dealer is not restricted from
using the securities and cash in those
accounts for its own business purposes.
Broker-dealers carrying PAB accounts
will be required to comply with the
final PAB rule amendments, in contrast
to the provisions of the PAIB Letter,
which are voluntary.653 To the extent
that carrying broker-dealers are not
currently complying with the PAIB
Letter, or to the extent the amendments
as adopted differ from the PAIB Letter,
they may incur incremental costs,
including possible costs of capital as
firms reallocate capital to comply with
the rule amendments.
The requirement to enter into a
subordination agreement with certain
account holders to exclude them from
the definition of PAB account,654 the
requirement to provide written notice to
PAB account holders that their
securities may be used in the ordinary
course of the carrying broker-dealer’s
securities business,655 the requirement
652 Id.
653 See
PAIB Letter.
internal hours for this requirement would
likely be performed by an in-house Attorney at $379
per hour. Therefore the estimated internal cost
would be calculated as follows: $379 per hour ×
13,420 hours = $5,086,180. See also section IV.D.3.
of this release.
655 The internal hours required to draft the notice
would likely be performed by an in-house Attorney
654 The
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to amend the standard PAB agreement
templates,656 and the need to update
systems to implement the necessary
changes 657 may also impose one-time
costs. In addition, a carrying brokerdealer will incur postage costs as a
result of the requirement to send written
notices to PAB account holders
regarding the use of their non-margin
securities, as well as outside counsel
fees to review the notice and standard
PAB agreement template.658 Finally, the
requirements to compute and establish
a separate reserve for PAB accounts will
result in annual costs to carrying brokerdealers to the extent that these
requirements will lengthen the time
needed to compute and establish the
PAB reserve account under the PAIB
Letter. The Commission estimates that
these requirements would impose onetime and annual costs in the aggregate
of approximately $6,434,840 659 and
$2,709,210,660 respectively.
As noted above, the Commission
requested comment on the proposed
cost estimates.661 In particular, the
Commission requested comment on
whether there would be additional costs
to broker-dealers as a consequence of
these proposals. The Commission
requested comment on whether these
requirements would result in such costs
and, if so, how to quantify the costs. The
Commission also requested comment on
whether these proposals would impose
costs on other market participants,
at $379 per hour. The estimated internal cost would
be calculated as follows: $379 per hour × 610 hours
= $231,190. The internal hours required to send out
the notices would likely be performed by a
Compliance Clerk at $63 per hour, resulting in an
internal estimated cost calculated as follows: $63
per hour × 259 hours = $16,317. See also section
IV.D.4. of this release.
656 The internal hours would likely be performed
by an in-house Attorney at $379 per hour, resulting
in an internal estimated cost calculated as follows:
$379 per hour × 1,220 hours = $462,380. See also
section IV.D.4. of this release.
657 The internal hours would likely be performed
by a Senior Programmer at $282 per hour, resulting
in the estimated internal cost calculated as follows:
$282 per hour × 1,830 hours = $516,060. See also
section IV.D.4. of this release.
658 The estimated postage costs are calculated as
follows: 1,551 notices × $0.46 = $713.46. To review
and comment on the notice and PAB templates, the
estimated outside counsel burden is $122,000, in
aggregate. See also section IV.D.4. of this release.
659 See section IV.D.3 and 4. of this release
($5,086,180 + $231,190 + $16,317 + $462,380 +
$516,060 + $713.46 + $122,000 = $6,434,840.46).
660 The internal hours would likely be performed
by a Financial Reporting Manager at $294 per hour,
resulting in the estimated internal cost calculated
as follows: $294 per hour × 9,215 hours =
$2,709,210. See also section IV.D.4. of this release.
661 See Amendments to Financial Responsibility
Rules, 72 FR at 12880. In the proposing release, the
Commission estimated that the one-time and annual
costs to broker-dealers resulting from these
proposed amendments would be $603,000 and
$2,599,399. Id.
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including broker-dealer customers.
Commenters were also asked to identify
the metrics and sources of any empirical
data that support their cost estimates.
The Commission did not receive any
comments in response to these requests.
b. Banks Where Special Reserve
Deposits May Be Held
(I). Summary of Amendments
As amended, paragraph (e) of Rule
15c3–3 requires carrying broker-dealers
to deposit cash or qualified securities
into their customer or PAB reserve
account, which must be maintained at a
‘‘bank.’’ 662 As adopted, the final rule
excludes when determining whether a
broker-dealer maintains the minimum
deposits required under paragraph (e) of
Rule 15c3–3: (1) Cash deposited with an
affiliated bank; and (2) cash deposited at
a ‘‘non-affiliated bank to the extent that
the amount of the deposit exceeds 15%
of the bank’s equity capital as reported
by the bank in its most recent Call
Report or any successor form the bank
is required to file by its appropriate
Federal banking agency (as defined by
Section 3 of the Federal Deposit
Insurance Act (12 U.S.C. 1813)).’’
Under paragraph (f) of Rule 15c3–3, a
broker-dealer is currently required to
obtain a written contract from the bank
wherein the bank agrees not to re-lend
or hypothecate the qualified securities
deposited into the reserve account.663
This means that the bank cannot use the
qualified securities in its business,
which provides a measure of protection
by requiring that the securities will be
available to the broker-dealer if the bank
falls into financial difficulty. Cash
deposits, however, may be freely used
in the course of the bank’s commercial
activities. Therefore, because they do
not have that same type of protection,
the amendments to Rule 15c3–3
enhance customer protection by
prohibiting a carrying broker-dealer
from holding customer cash deposits at
its affiliated bank and establishing
requirements designed to avoid the
situation where a carrying brokerdealer’s cash deposits constitute a
substantial portion of the bank’s
deposits.
Customer cash deposits may be at risk
if a carrying broker-dealer does not
662 The term qualified securities is defined in
paragraph (a)(6) of Rule 15c3–3 to mean securities
issued by the United States or guaranteed by the
United States with respect to principal and interest.
17 CFR 240.15c3–3(a)(6). The term bank is defined
in paragraph (a)(7) of Rule 15c3–3 as a ‘‘bank as
defined in section 3(a)(6) of the Act and will also
mean any building and loan, savings and loan or
similar banking institution subject to the
supervision by a Federal banking authority.’’ See
paragraph (a)(7) to Rule 15c3–3, as adopted.
663 17 CFR 240.15c3–3(f).
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exercise due diligence when assessing
the financial soundness of an affiliated
bank with the same degree of
impartiality and care as it would with
an unaffiliated bank. The situation
where a broker-dealer’s cash constitutes
a substantial portion of a bank’s
deposits also poses a risk that some or
all of the cash deposits may not be
readily available for quick withdrawal
by the broker-dealer. Depending on the
relative size of the deposit, a lost
deposit that is large relative to the
broker-dealer’s capital could cause the
firm to fail.664 If the broker-dealer fails
and the deposit is not recovered, the
SIPC fund may not recover advances
that it has made for the purpose of
returning customer assets. To the extent
that customer losses exceed the SIPA
advance limits, customers may suffer
permanent losses.
The amendment to Rule 15c3–3
should serve to reduce certain risks to
investors in the event of a bank’s failure
and, thereby, enhance customer
protection. The Commission requested
comment on available metrics to
quantify these benefits and any other
benefits a commenter may identify.
Commenters were also requested to
identify sources of empirical data that
could be used for the proposed metrics.
The Commission did not receive any
comments in response to these requests.
(II). Baseline and Incremental Economic
Effects
The current baseline for the
amendment to paragraph (e) of Rule
15c3–3 is the existing customer
protection requirements under Rule
15c3–3 and interpretations of the rule.
Under paragraph (e) of Rule 15c3–3,
broker-dealers are currently required to
deposit cash or qualified securities into
the customer reserve account, which
must be maintained at a ‘‘bank.’’ Under
current interpretations, broker-dealers
are limited in their reserve account cash
deposits at parent or affiliated banks to
50% of the broker-dealer’s excess net
capital or 10% of the bank’s equity
capital.665 Current interpretations also
place similar restrictions on certain
types of products at unaffiliated banks,
including restrictions on concentration
in money market deposit accounts and
time deposits.666
As compared to the baseline, the
Commission estimates that the
incremental costs resulting from this
amendment will be limited. Using
664 See Amendment to the Financial
Responsibility Rules for Broker-Dealers, 72 FR at
12880.
665 FINRA Interpretation 15c3–3(e)(3)/051.
666 See FINRA Interpretation 15c3–3(e)(1)/01 and
/011.
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FOCUS Report data, as of December 31,
2011, the Commission estimates that
approximately 224 broker-dealers report
reserve deposits.667 A considerable
proportion of these broker-dealers,
including some of the largest firms,
meet their deposit requirements using
mostly qualified securities as opposed
to cash and, therefore, will be
marginally impacted by this
amendment. For example, based on
FOCUS Report data, as of December 31,
2011, for the 224 broker-dealers with
reserve deposits, 79% of the total
customer reserve requirement was met
using qualified securities that could still
be deposited at affiliated banks to meet
customer reserve requirements, under
the rule, as adopted. The remaining
customer reserve requirement could be
met by using qualified securities (as
opposed to cash) and/or opening one or
more accounts at unaffiliated banks,
which would hold the cash within the
limits permitted under the rule.
Relative to the current baseline,
broker-dealers may incur two types of
costs. The first type of cost relates to the
costs of opening a new account at an
unaffiliated bank for broker-dealers that
currently hold cash in a reserve account
at an affiliated bank. It is difficult to
estimate the number of broker-dealers
that hold cash reserve deposits at an
affiliated bank because FOCUS Report
data does not include the names of
banks at which broker-dealers maintain
their reserve accounts. Therefore, this
data is not readily available to the
Commission and commenters did not
provide it. Based on an analysis of
FOCUS Report data as of December 31,
2011, as well as available bank data,668
the Commission, however, estimates
that there are approximately 50 brokerdealers 669 that have an affiliated bank
and cash in their customer reserve
accounts.
The second type of cost relates to the
costs of opening and maintaining
multiple bank accounts if the cash
deposit exceeds the 15% bank equity
capital threshold as defined in the final
rule, the likelihood of which the
Commission expects to decrease
because, with the relaxation of the bank
equity capital threshold in the final rule,
fewer broker-dealers will be required to
667 This estimate is based on FOCUS Report
filings the 2011 year end. It is an update from the
proposing release estimate of 216 broker-dealers.
See Amendments to Financial Responsibility Rules,
72 FR at 12881.
668 Data regarding a bank’s equity capital as of the
2011 year end is publicly available at https://
www2.fdic.gov/sdi/.
669 This estimate is based on a review of brokerdealers and affiliated banks based on legal names,
as well as customer reserve account data, from
FOCUS Report data.
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open multiple accounts, relative to the
current baseline. Broker-dealers,
however, may replace these types of
cost with the costs of converting cash
into qualified securities to meet some or
all of their reserve deposit requirements
under Rule 15c3–3.
Moreover, in an attempt to reduce
search costs, the potential exists that
broker-dealers will select one or a few
large unaffiliated banks or create
networks on the basis of reciprocity
between broker-dealers and banks. This
could result in a potential concentration
of reserve cash deposits at a few banks.
If as a result of such concentration, the
carrying broker-dealer’s deposit
constitutes a substantial portion of the
bank’s total deposits, the risk increases
that the bank may not have the liquidity
to quickly return the deposit to the
broker-dealer. Finally, the affiliated
banks that are currently holding and
using broker-dealer reserve cash
deposits in the course of their business
may incur funding costs, resulting from
the possible transfer of cash deposits in
the reserve account by broker-dealers to
unaffiliated banks. These incremental
funding costs to the affiliated banks may
potentially be offset by the benefit of
receiving cash deposits from
unaffiliated broker-dealers.
(III). Alternatives
In adopting the final rule, the
Commission considered several
alternative approaches suggested by
commenters. For example, commenters
urged the Commission not to adopt the
proposed prohibition on broker-dealers
maintaining cash in reserve accounts at
banks that are affiliates, stating that
affiliated banks should be treated the
same as unaffiliated banks because both
groups are subject to the same financial
regulation. One commenter noted that if
a broker-dealer must move their reserve
accounts to an unaffiliated bank this
may require the broker-dealer to enter
into new or additional banking
relationships to comply with the
amendment, which would increase the
costs and administrative burdens of
those reserve account funds.670
Several commenters suggested that
the Commission allow cash reserve
deposits without percentage restrictions
at unaffiliated banks that are wellcapitalized or for which a broker-dealer
has performed due diligence.671 One of
these commenters cited a U.K.
regulation that requires a firm selecting
a bank to hold customer deposits to
670 See
Raymond James 2 Letter.
671 See Raymond James Letter; JP Morgan Letter;
The Clearing House Letter; ABASA Letter; PNC
Letter; Deutsche Bank Securities Letter; E*Trade
Letter; JP Morgan 2 Letter.
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51875
undertake due diligence on the bank
taking into consideration a number of
factors including: (1) The capital of the
bank; (2) the amount of client money
placed, as a proportion of the bank’s
capital and deposits; (3) the credit rating
of the bank (if available); and (4) to the
extent the information is available, the
level of risk in the investment and loan
activities undertaken by the bank and its
affiliated companies.672
One commenter suggested that the
Commission consider higher
percentages for cash deposits at large
money-center banks.673 This commenter
also stated that the percentage
thresholds would negatively impact
small broker-dealers because they
would cross the 50% of excess net
capital threshold at lower deposit
levels.674 Another commenter suggested
that the Commission reconsider the
proposed limitation on the amount of
reserve account cash deposits that may
be held at any one bank because the
limitation would result in significant
costs for broker-dealers and could
potentially adversely impact the
customers of broker-dealers.675
In the final rule, the language
excluding customer and PAB reserve
cash deposits at affiliated banks from
counting towards a broker-dealer’s
reserve requirement is being adopted as
proposed. As discussed further below,
relative to the proposed rule, in the final
rule, the Commission eliminated the
proposed language that would have
excluded the amount of the deposit at
an unaffiliated bank that exceeded 50%
of a broker-dealer’s excess net capital
and based on the Commission’s expert
judgment, increased the bank equity
capital threshold from 10% to 15%.676
In response to comments on the
proposed rule (including comments
suggesting a due diligence standard
instead of an objective threshold), the
Commission modified the final rule text
in ways that are designed to
substantially mitigate the costs
identified by commenters. While the
final rule amendment excludes the
amount of any cash on deposit at an
affiliated bank from being used to meet
a broker-dealer’s reserve requirement,
the Commission eliminated the
provision that would have excluded the
amount of a deposit that exceeds 50%
of a broker-dealer’s excess net capital.
This provision would have impacted
small and mid-size broker-dealers when
672 See
JP Morgan Letter.
SIFMA 2 Letter; see also NIBA Letter.
674 See SIFMA 2 Letter.
675 See Raymond James 2 Letter.
676 See Amendments to Financial Responsibility
Rules, 72 FR at 12864.
673 See
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they deposited cash into large
commercial banks since the cash
deposits of these firms would exceed
the broker-dealer excess net capital
threshold before exceeding the bank
equity capital threshold.
The elimination of the broker-dealer
excess net capital threshold, combined
with the increase of the bank equity
capital threshold from 10% to 15%, is
intended to substantially mitigate the
costs, burdens and inefficiencies that
commenters believed would be imposed
on small and mid-size broker-dealers if
such firms had to open multiple bank
accounts as a result of the proposed
rule. The rule, as adopted, will allow
small and mid-size broker-dealers to
maintain reserve accounts at one bank if
they so choose, provided that the bank
equity capital threshold is not exceeded.
In contrast to the proposed thresholds,
the final rule amendments should
reduce the costs associated with
implementing the necessary changes to
systems, operations, and contractual
agreements related to a broker-dealer’s
reserve bank accounts.
Further, in response to comments,
increasing the threshold from 10% to
15% of the bank’s equity capital is
intended to address concerns raised by
large broker-dealers with large deposit
requirements that the 10% threshold
would have resulted in increased costs
of having to spread out deposits over a
number of banks. The decrease in the
cost of opening and maintaining
multiple accounts resulting from the
increased threshold to 15% of the
bank’s equity capital may
counterbalance the increase in the cost
of transferring cash deposits to an
unaffiliated bank. In summary, the rule,
as adopted, with an increase to a 15%
threshold will, in the Commission’s
expert judgment, substantially mitigate
the cost concerns raised by commenters,
while still providing adequate customer
protection consistent with the goal of
the rule to promote the broker-dealer’s
ability to have quick access to the
deposit.
With respect to qualified securities,
one commenter argued that if a brokerdealer elects to use qualified securities
as opposed to cash to meet its reserve
requirement, the broker-dealer will
likely have a significant amount of
additional operational and transactional
costs.677 In addition, this commenter
677 See JP Morgan Letter. The commenter noted
that ‘‘[c]ertain broker-dealers may be required to
hire additional staff to manage and maintain a
securities portfolio.’’ Id. ‘‘Managing a pool of
qualified securities involves a myriad of tasks such
as monitoring income collection, redemption
processing, marking the securities to market,
collateral substitutions and collateral segregation
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In the proposing release, in
quantifying costs, the Commission
estimated that, of the 216 firms with
reserve deposit requirements, only 11
broker-dealers would need to open new
bank accounts or substitute cash for
qualified securities in an existing
reserve account,680 and that this would
result in an estimated total one-time
cost of approximately $2,630 per brokerdealer 681 and approximately $28,930 in
the aggregate.682 As noted above, the
Commission requested comment on the
proposed cost estimates. Commenters
were asked to identify the metrics and
sources of any empirical data that
support their cost estimates. The
Commission received seven comment
letters in response to the proposed cost
estimates.683
One commenter stated that the
estimate is inaccurate and arbitrary, and
does not take into account situations
where a broker-dealer will need to
establish numerous banking
relationships.684 Commenters also
stated that the Commission failed to
consider the ongoing costs of
maintaining and monitoring multiple
bank accounts.685 One commenter
believes that limiting Rule 15c3–3
deposits at a single bank to 50% of a
broker-dealer’s excess net capital will
require a significant number of brokerdealers to open a number of additional
cash and/or securities accounts and
devote ongoing operational resources to
the management of such accounts.686
This commenter stated that at any one
time, approximately 10% to 15% of
broker-dealer customers could be
impacted by the proposed rule change
and many of those customers would be
required to open accounts at multiple
institutions.687
Commenters also stated that the
proposed amendments would impose
requirements whose costs are not
adequately justified by their benefits
and that the Commission substantially
underestimated the costs.688 One
commenter noted that there are
significant costs associated with
implementing the necessary changes to
systems, operations, and contractual
agreements that the Commission did not
appear to take into account.689 Another
commenter stated that the proposal also
fails to quantify the inherent
inefficiency of forcing broker-dealers to
set up numerous bank accounts to
satisfy the restrictive broker-dealer net
capital and bank equity capital
requirements.690 Another commenter
suggested that the Commission consider
higher percentage limits for cash
deposits held at very large money center
banks, stating that a higher percentage
limit would strike a better balance
between the Commission’s concerns
regarding the safety of cash deposits and
the substantial costs imposed on brokerdealers by overly restrictive deposit
limitations.691 Two commenters
amongst other tasks.’’ Id. The commenter did not
quantify the costs of managing a pool of qualified
securities or the costs of additional staff to manage
the securities portfolio.
678 Id.
679 See JP Morgan Letter.
680 The Commission estimated in the proposing
release that it would take approximately 10 hours
to implement these changes. See Amendments to
Financial Responsibility Rules, 72 FR at 12881.
681 Id.
682 11 broker-dealers × $2,630 = $28,930. Id. at
12881.
683 See Curian Clearing Letter; SIFMA 2 Letter;
Clearing House Letter; ABASA Letter; Deutsche
Bank Letter; E*Trade Letter; P Morgan Letter.
684 See Curian Clearing Letter.
685 See Curian Clearing Letter; SIFMA 2 Letter;
ABASA Letter; The Clearing House Letter; E*Trade
Letter; JP Morgan Letter.
686 See JP Morgan Letter.
687 Id.
688 See SIFMA 2 Letter; ABASA Letter.
689 See SIFMA 2 Letter.
690 See ABASA Letter.
691 See SIFMA 2 Letter.
stated that while large broker-dealers
may be able to reallocate existing
trading desk, operational, regulatory
reporting, and treasury functions to
assist in ongoing maintenance activities,
small and mid-sized broker-dealers may
be required to hire additional staff to
manage and maintain a securities
portfolio.678 In response to the
commenter, many large broker-dealers
already hold large amounts of their
reserve deposits in qualified securities.
As the commenter noted, if a large
broker-dealer needed to shift more of its
reserve deposits into qualified securities
as opposed to cash, then these firms
would most likely reallocate existing
functions to assist in ongoing
maintenance activities, thus offsetting
any costs associated with the shift of
reserve deposits into qualified
securities. Finally, with the elimination
of the 50% excess net capital threshold
in the rule as amended, most small and
mid-sized firms likely would not have
ongoing costs, because under the final
rules, all firms will now only have to
comply with the bank equity capital
threshold, which as confirmed by
comments, would be of concern
primarily for the large firms. Therefore,
under the final rule, broker-dealers
should not incur significant operational
or transactional costs in complying with
the amendment.679
(IV). Compliance Cost Estimates
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believed that the upfront and ongoing
cost to each broker-dealer is far higher
than the one-time estimate of $2,630
that the Commission estimated in the
proposing release.692 One commenter
stated that conducting due diligence
and opening new accounts and the
ongoing monitoring and periodic reevaluation of such additional accounts
would require much more time than the
10 hours originally estimated by the
Commission.693 One commenter,
referencing the SIFMA 2 Letter, stated
that it agreed with SIFMA that the
Commission significantly
underestimated the cost of the proposal
to smaller firms.694 Finally, commenters
did not provide the Commission with
revised cost estimates or data related to
these amendments.
In quantifying costs, the Commission
is increasing its estimate of the number
of broker-dealers that will likely incur
the cost of opening a new account at an
unaffiliated bank (or substituting cash
for qualified securities in their reserve
accounts) from the estimated 11 brokerdealers in the proposing release to 50
broker-dealers, as described above.695 In
addition, in response to the
commenter’s concern that conducting
due diligence and opening new
accounts would require much more time
than the 10 hours originally estimated
by the Commission,696 the Commission
also is increasing the one-time hour
estimates discussed in the proposing
release from 10 to 25 hours.697 In
response to the commenters pointing
that the amendments would require
ongoing monitoring of bank equity
capital levels,698 the Commission is
including an annual cost estimate in
this release (in addition to the estimated
one-time costs) to account for
incremental ongoing costs to monitor
compliance with the rule.699 The
692 See
JP Morgan Letter; E*Trade Letter.
SIFMA 2 Letter.
694 See NIBA Letter.
695 The Commission estimates that the
responsibility for the one-time opening a new
reserve bank account or substituting qualified
securities for cash in an existing account likely
would be undertaken by a Senior Treasury/Cash
Management Manager at $197 per hour. See
Amendments to Financial Responsibility Rules, 72
FR at 12881.
696 See SIFMA 2 Letter.
697 See Amendments to Financial Responsibility
Rules, 72 FR at 12881. The Commission estimates
that the Senior Treasury/Cash Management
Manager will spend approximately 25 hours
performing these changes on a one-time basis.
698 See SIFMA 2 Letter.
699 The Commission estimates that the
responsibility for the annual compliance review of
these rule amendments likely would be split
between a Senior Treasury/Cash Management
Manager at $197 per hour and a Compliance
Attorney at $310 per hour, and will likely take 50
hours per year.
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693 See
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Commission further estimates that the
average cost per firm to make these
changes will be approximately $4,925
on a one-time basis and $12,675 on an
annual basis.700 For these reasons, the
Commission estimates that the total cost
to broker-dealers will be approximately
$246,250 on a one-time basis and
$633,750 on an annual basis.701
Finally, using FOCUS Report data and
top decile bank equity capital data at
year end 2011,702 the Commission
estimates that approximately 30 brokerdealers are no longer required to sustain
the cost of maintaining multiple bank
accounts, as a result of removing the
50% excess net capital threshold and
increasing the bank equity capital
threshold to 15%. This change to the
final rule may result in potential cost
savings to broker-dealers, which may
have been required to maintain multiple
bank accounts under the rule, as
proposed.
c. Allocation of Customers’ Fully Paid
and Excess Margin Securities to Short
Positions
The amendment to paragraph (d)(4) of
Rule 15c3–3 requires broker-dealers to
take prompt steps to obtain possession
or control over fully paid and excess
margin securities on the broker-dealer’s
books or records that allocate to a short
position of the broker-dealer or a short
position for another person, excluding
positions covered by paragraph (m) of
Rule 15c3–3, for more than 30 calendar
days.703 This amendment protects
broker-dealer customers by helping to
ensure that customer securities are
available to be returned in the event of
a broker-dealer failure. Therefore, in
addition to broker-dealer customers, the
amendment benefits the SIPC fund to
the extent that it mitigates potential
outlays from the fund to make advances
to customers of a failed broker-dealer
that cannot return all customer
securities.
The Commission requested comment
on available metrics to quantify these
benefits and any other benefits a
commenter may identify. In particular,
the Commission requested comment on
whether there would be additional costs
to broker-dealers as a consequence of
these proposals and whether these
proposals would impose costs on other
market participants, including brokerdealer customers. The Commission also
requested that commenters identify
sources of empirical data that could be
700 $197 per hour × 25 hours = $4,925; ($197 per
hour × 25 hours) + ($310 × 25 hours) = $12,675.
701 50 broker-dealers × $4,925 = $246,250; 50
broker-dealers × $12,675 = $633,750.
702 See https://cdr.ffiec.gov/public/.
703 17 CFR 240.15c3–3(d)(4).
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51877
used for the metrics they proposed. The
Commission received one comment in
response to these requests.704 The
commenter stated that the proposed
amendments would ‘‘greatly increase
the cost of proprietary and customer
short positions that were established
and maintained in accordance with all
applicable short sale regulations at the
time entered.’’ 705 However, this
commenter did not quantify its cost
estimates in terms of dollars, nor did it
provide data to support its conclusion.
In response to this comment,
modifications were made to the final
rule that should mitigate the
commenter’s concern because the
changes were designed to reduce
operational burdens and to more closely
align the final rule with current
regulations related to short sales. More
specifically, as discussed in section
II.A.4., as adopted, final paragraph (d)(4)
of Rule 15c3–3 contains a uniform 30
calendar day period and clarifies that
the 30 calendar day period with respect
to a syndicate short position established
in connection with an offering does not
begin to run until the underwriter’s
participation in the distribution is
complete as determined pursuant to
Rule 100(b) of Regulation M. In
addition, the proposed amendment was
designed to require that the aging
process commence at the time a deficit
in securities allocating to a short
position arises. These modifications
clarify the rule amendment, while
continuing to strengthen customer
protections under Rule 15c3–3.
Three commenters argued that the
credit item added to the reserve formula
computation when a customer’s fully
paid or excess margin securities are
allocated to a short position provides
the customer with adequate
protection.706 The Commission
considered this alternative, as well as
the cost concerns raised above, in
adopting these final rule amendments. It
has been a long-standing industry
practice for carrying broker-dealers to
use securities of PAB account holders in
their business activities. In contrast, as
stated above in section II.A.4. of this
release, customers under Rule 15c3–3,
which include the carrying brokerdealer’s retail customers, have an
expectation that the fully paid and
excess margin securities reflected on
their account statements are, in fact, in
the possession or control of the carrying
broker-dealer. However, as described
above, this expectation may be
704 See
Raymond James 2 Letter.
705 Id.
706 See First Clearing Letter; Deutsche Bank
Securities Letter; Citigroup Letter.
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frustrated where the securities are
allocated to a short position carried by
the broker-dealer, as the securities are
not in the possession or control of the
carrying broker-dealer. This gap in the
existing rule, in effect, permits the
broker-dealer to partially monetize the
Rule 15c3–3 customer’s securities. Also,
under some circumstances (e.g., a
change in the market value of the
securities), the amount the broker-dealer
may have on deposit in the reserve
account as a consequence of the credit
item may be less than the value of the
securities. Consequently, if the brokerdealer fails, sufficient funds may not be
readily available to purchase the
securities to return them to customers.
The use of customer securities in this
manner is contrary to the customer
protection goals of Rule 15c3–3 and the
expectations of a broker-dealer’s
customers.707 Therefore, the
Commission believes that any increased
costs related to this final rule
amendment are justified by the
enhancements to the customer
protection goals of Rule 15c3–3. For
these reasons, and those discussed
throughout this release, the Commission
is adopting the amendment.
The Commission estimates this
requirement will result in a one-time
cost to firms that carry customer
securities to update systems for
complying with the possession or
control requirements in Rule 15c3–3.
Based on FOCUS Report data, as of
December 31, 2011, the Commission
estimates that approximately 287
broker-dealers carry customer
accounts.708 The Commission further
estimates these firms will spend, on
average, approximately 40 hours of
employee resources per firm updating
their systems to implement changes that
will be necessitated by the
amendment.709 Therefore, the
Commission estimates that the average
cost per firm to make these changes will
be approximately $11,280.710 The
Commission estimates that the total onetime cost to broker-dealers will be
approximately $3,237,360.711
In addition to systems costs, brokerdealers may incur other costs to comply
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707 See
section II.A.1. of this release.
708 This is an update of the proposing release
estimate of 350 broker-dealers. See Amendments to
Financial Responsibility Rules, 72 FR at 12881.
709 For the purposes of this cost analysis, the
Commission estimates that this work will be
undertaken by a Senior Programmer at $282 per
hour.
710 $282 per hour × 40 hours = $11,280.
711 287 broker-dealers × $11,280 = $3,237,360. In
the proposing release, the Commission estimated
that the total one-time cost to broker-dealers would
be $3,752,000. See Amendments to Financial
Responsibility Rules, 72 FR at 12881.
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with the rule amendment because they
may be required to change their existing
practices. For example, the amendment
could result in some broker-dealers
borrowing securities to cover
proprietary short positions rather than
using customer securities, resulting in
increased borrowing costs. However,
under the current baseline, when
broker-dealers use customer securities
to cover short positions they are
required to add a credit item in the Rule
15c3–3 reserve formula equal to the
value of the securities. This credit item
can result in higher reserve deposit
requirements, which must be made
using the broker-dealer’s own capital.
Thus, in response to commenters
concerns regarding the costs of this
amendments,712 the increased costs
associated with having to borrow
securities to cover a short position likely
will be offset by decreased costs
associated with devoting capital to
customer reserve requirements.
d. Importation of Rule 15c3–2
Requirements Into Rule 15c3–3
Today’s amendment to Rules 15c3–2
and 15c3–3 imports requirements in
Rule 15c3–2 713 to Rule 15c3–3 and
eliminates Rule 15c3–2 as a separate
rule in the Code of Federal
Regulations.714 Rule 15c3–2 requires a
broker-dealer holding free credit
balances to provide its customers
(defined as any person other than a
broker-dealer) at least once every three
months with a statement of the amount
due the customer and a notice that the
funds are not being segregated, but
rather are being used in the brokerdealer’s business and that the funds are
payable on demand. The Commission
believes it is appropriate to eliminate
Rule 15c3–2 because it is largely
irrelevant in light of the requirements of
Rule 15c3–3 (which was adopted after
Rule 15c3–2).
This amendment will benefit brokerdealers by streamlining and
consolidating relevant provisions of
Rule 15c3–2 into Rule 15c3–3,
promoting efficiency in the rulemaking
process while not modifying the legal
requirements. These provisions include
the requirements that broker-dealers
inform customers of the amounts due to
them and that such amounts are payable
on demand, which have been moved to
new paragraph (j)(1) of Rule 15c3–3.715
712 See First Clearing Letter; Deutsche Bank
Securities Letter; Citigroup Letter.
713 17 CFR 240.15c3–2.
714 See Amendments to Financial Responsibility
Rules, 72 FR at 12867.
715 The provisions in Rule 15c3–2 that are being
re-codified in Rule 15c3–3, include the
requirements that broker-dealers inform customers
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Finally, the definition of customer for
purposes of the imported Rule 15c3–2
requirements will be the definition of
customer in Rule 15c3–3,716 which is
somewhat narrower than the definition
in Rule 15c3–2. The application of the
narrower definition of customer in Rule
15c3–3 should not increase related
costs. Alternatively, it may result in
decreased costs because the narrowing
of the rule’s scope may reduce the
compliance burden on broker-dealers.
The Commission considered
reasonable alternatives with regard to
the proposed deletion of Rule 15c3–2
and the importation of certain
requirements into paragraph (j)(1) of
Rule 15c3–3. Not adopting the rule
amendment and thus leaving Rule
15c3–2 in the Code of Federal
Regulations was a considered
alternative. The Commission, however,
believes consolidating the relevant
provisions in Rule 15c3–3 is a more
appropriate alternative because it
promotes efficiency in the rulemaking
process, and streamlines the
Commission’s customer protection
rules.
The amendments—because they only
re-codify provisions of Rule 15c3–2 into
Rule 15c3–3 717—should not be a new
source of costs as compared to the
baseline because these provisions are
continuations of existing requirements.
However, the re-codification and
placement of these provisions into Rule
15c3–3 may cause broker-dealers to
review and update their existing
procedures from time-to-time and,
therefore, could result in incremental
costs.718
e. Treatment of Free Credit Balances
(I). Summary of Amendments
Today, the Commission is adopting
the amendment to add new paragraph
(j)(2) to Rule 15c3–3 that prohibits a
broker-dealer from converting,
investing, or transferring to another
account or institution, free credit
balances held in a customer’s account
except as provided in paragraphs (j)(2)(i)
and (ii) of the rule. As adopted, the
amendment defines a Sweep Program as
of the amounts due to them and that such amounts
be payable on demand. In addition, Rule 15c3–2
contains an exemption for broker-dealers that are
also banking institutions supervised by a Federal
authority. This exemption will not be imported into
Rule 15c3–3 because there are no broker-dealers
that fit within this exemption.
716 17 CFR 240.15c3–3(a)(1).
717 See paragraph (j)(1) of Rule 15c3–3.
718 Based on the estimated hour burdens in
section IV.D.5. of this release, there could be onetime internal costs of $1,464,750 and annual
internal costs of $585,900, if the review and update
is performed by a Compliance Attorney at $310 per
hour.
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‘‘a service provided by a broker or
dealer where it offers to its customer the
option to automatically transfer free
credit balances in the securities account
of the customer to either a money
market mutual fund product as
described in § 270.2a–7 of this chapter
or an account at a bank whose deposits
are insured by the Federal Deposit
Insurance Corporation.’’ 719
With regard to the treatment of free
credit balances outside the context of a
Sweep Program, paragraph (j)(2)(i) of
Rule 15c3–3 permits a broker-dealer to
invest or transfer to another account or
institution free credit balances held in a
customer’s account only upon a specific
order, authorization, or draft from the
customer, and only in the manner, and
under the terms and conditions,
specified in the order, authorization, or
draft.720 Two commenters suggested
that the proposal should be clarified to
permit a broker-dealer to obtain a onetime consent to ongoing transfers of any
free credit balances to a customer to
another account, entity or product
(outside of a Sweep Program). As
discussed above, this scenario was
covered by the proposed rule and is
being adopted under paragraph (j)(2)(i)
of Rule 15c3–3.
With regard to the treatment of free
credit balances in the context of a
Sweep Program, new paragraph (j)(2)(ii)
of Rule 15c3–3 requires broker-dealers
to meet conditions that vary depending
on the date when a customer’s account
was opened. For accounts opened on or
after the effective date of the rule, a
broker-dealer must meet the conditions
of (j)(2)(ii)(A) and (B) of the rule. For
any account, the broker-dealer must
meet the conditions in paragraphs
(j)(2)(ii)(B) of the rule. Under paragraph
(j)(2)(ii)(A), for accounts opened on or
after the effective date of the rule, the
amendment to Rule 15c3–3 requires a
broker-dealer to obtain the written
affirmative consent of a new customer to
have free credit balances in the
customer’s securities account included
in the Sweep Program. Under paragraph
(j)(2)(ii)(B), a broker-dealer must comply
with the remaining three conditions for
any account: (1) Providing the customer
with the disclosures and notices
regarding the Sweep Program required
by each SRO of which the broker-dealer
is a member; (2) providing notice to the
customer, as part of the customer’s
quarterly statement of account, that the
balance in the bank deposit account or
shares of the money market mutual
funds in which the customer has a
719 See
paragraph (a)(17) of Rule 15c3–3.
Amendments to Financial Responsibility
Rules, 72 FR at 12866.
720 See
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beneficial interest can be liquidated on
the customer’s order and the proceeds
returned to the securities account or
remitted to the customer; and (3)
providing the customer written notice at
least 30 calendar days before the brokerdealer makes certain changes to the
Sweep Program and describes the
options available to the customer if the
customer does not accept the new terms
and conditions or product.721
Free credit balances constitute money
that a broker-dealer owes its customers.
Customers may maintain these balances
at the broker-dealer in anticipation of
future stock purchases. Under current
practices, customer account agreements
set forth how the broker-dealer will
invest these balances. For example, the
broker-dealer may sweep them into a
money market fund or, alternatively,
pay an amount of interest on the funds.
On occasion, broker-dealers may change
the product to which a customer’s free
credit balances are swept—most
frequently from a money market fund to
an interest bearing bank account.
Because of differences in these two
types of products, there may be
investment consequences when
changing from one to the other.722
New paragraph (j)(2) to Rule 15c3–3
should serve to enhance customer
protection by prohibiting a brokerdealer from transforming the credit risk
faced by a customer through transfer of
the broker-dealer’s obligation to another
entity without the required notice to, or
approval from, the customer.
(II). Baseline and Incremental Economic
Effects
In the absence of new paragraph (j)(2)
of Rule 15c3–3, current practices
represent the existing baseline. As
compared to the baseline, new
paragraph (j)(2) to Rule 15c3–3 will
enhance customer protection by
requiring broker-dealers to obtain the
written affirmative consent of a new
customer before including a customer’s
free credit balances in a Sweep Program,
as well as to provide certain disclosures
and notices to all customers with regard
to the broker-dealer’s Sweep Program.
The Commission requested comment on
available metrics to quantify these
benefits and any other benefits a
commenter may identify. The
Commission did not receive any
comments in response to this request.
721 See new paragraph (j)(ii)(B)(1)–(3) of Rule
15c3–3, as adopted.
722 Differences include the type of protection
afforded the customer in the event of an insolvency,
and the amount of interest or dividends earned on
the product. See Amendments to Financial
Responsibility Rules, 72 FR at 12866.
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Relative to the baseline, brokerdealers carrying free credit balances will
incur incremental one-time and periodic
costs (e.g., systems changes, outside
counsel, and notification costs) to
comply with new paragraph (j)(2) of
Rule 15c3–3. The Commission
requested comment on whether there
would be additional costs to brokerdealers as a consequence of the
proposals. The Commission also
requested comment on whether the
proposals would impose costs on other
market participants, including brokerdealer customers. Commenters were
requested to identify sources of
empirical data that could be used for the
metrics they proposed. The Commission
did not receive any comments in
response to these requests.
(III). Alternatives
As stated above in section II.A.5.ii. of
this release, the Commission is adopting
new paragraph (j)(2) to Rule 15c3–3
with substantial modifications from the
proposed rule in response to comments
and to clarify certain portions of the
rule.
Commenters generally agreed with the
fundamental principle embodied in the
proposal—that customer free credit
balances should not be transferred from
an obligation of the broker-dealer to an
obligation of another entity without the
customer’s authorization.723 Other
commenters supported the proposed
disclosures but suggested additional
disclosures be made to customers
including clarification with respect to
other protections available to the
customer.724 Two commenters stated
that the practice of sweep programs
should be banned entirely or that the
Commission should adopt a ‘‘harder
stance’’ and require more than just
disclosure.725 One commenter
responded to the Commission’s request
for comment as to the cost burdens that
would result if the first condition (set
forth in proposed paragraph (j)(2)(ii)(A))
to obtain a new customer’s prior
agreement were to be applied to existing
customers. The commenter stated that
such costs would be substantial because
broker-dealers would be required to
amend their agreements with all
723 See SIFMA 2 Letter; First Clearing Letter; Pace
Letter.
724 See SIPC Letter.
725 See Ellis Letter; Dworkin Letter. One
commenter stated that broker-dealers profit from
‘‘excessive’’ fees charged to customers who opt out
of the sweep programs. See Ellis Letter. The second
commenter suggested that the broker-dealer’s
‘‘customer has been effectively denied the
opportunity to opt out of bank account sweeps by
[the broker-dealer] preventing him or her from
utilizing any other vehicle to park his or her free
credit balances . . . .’’ See Dworkin Letter.
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existing customers.726 One commenter
stated that the amendments in the
proposing release did not adequately
address situations in which brokerdealers change customer account
elections without first obtaining
customer authorization.727 Commenters
also raised concerns about limitations
on the types of products broker-dealers
can use for sweep arrangements.728
The Commission considered
alternatives, including whether to adopt
the amendments and, in adopting the
final rule, the Commission modified the
language in the final rule in response to
commenters and to clarify its
application. In response to comments
that the Commission should ban sweep
programs or adopt a ‘‘harder stance,’’
the Commission notes that sweep
programs provide a mechanism for
excess cash in a customer’s securities
account to be held in a manner that
allows the customer to earn interest on
the funds but retain the flexibility to
quickly access that cash to purchase
securities or withdraw it.729 In effect,
transferring this excess cash to a bank
account or money market fund is an
alternative to retaining a credit balance
in the customer’s securities account.
The final rule is intended to
appropriately balance commenters’
concerns while providing broker-dealers
with flexibility in the operation of
sweep programs.730
In addition, in response to the
comments that the Commission should
not limit the types of products brokerdealers can use for sweep accounts to
money market funds and bank deposit
products,731 as discussed above in
section II.A.5.ii. of this release, the
Commission does not view sweep
accounts as a mechanism for investing
customers’ excess cash in longer term or
more volatile assets without specific
consent from customers. Therefore, the
Commission believes that it is not
appropriate to modify the final rule
amendments to expand the permitted
products for Sweep Programs.
In response to commenters’ concern
regarding cost burdens resulting from
the application of the affirmative
consent requirement to existing
accounts, the final rule retains the
proposed requirement to require a
broker-dealer to obtain a customer’s
prior affirmative consent for accounts
726 See
SIFMA 2 Letter.
Waddell Letter.
728 See SIFMA 2 Letter; First Clearing Letter;
Raymond James 2 Letter.
729 See Ellis Letter; Dworkin Letter.
730 See Ellis Letter; Dworkin Letter; Waddell
Letter.
731 See SIFMA 2 Letter; First Clearing Letter;
Raymond James 2 Letter.
727 See
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opened on or after the effective date of
the rule before transferring the
customer’s free credit balance to a
product in the firm’s Sweep Program,
and makes explicit that the consent
must be in writing. This will provide
new customers with the opportunity to
evaluate the broker-dealer’s Sweep
Program before consenting to the
transfer of the customer’s free credit
balances into such program. In the
proposing release, the Commission
requested comment as to the cost
burdens that would result if the
condition to obtain a new customer’s
prior agreement were to be applied to
existing customers. One commenter
stated that such costs would be
substantial because broker-dealers
would be required to amend their
agreements with existing customers.
The Commission considered this
alternative and agrees with the
commenter that requiring a brokerdealer to amend its existing agreements
with customers would be substantial.
Therefore, to address the burden that
would have been associated with having
broker-dealers re-paper existing account
documentation, the prior affirmative
consent requirement will continue to
apply only to accounts opened on or
after the effective date of the rule.
However, as discussed above in
section II.A.5.ii. of this release, all
customers will be provided written
notice at least 30 days before a brokerdealer changes certain terms and
conditions or products of its Sweep
Program. This notice must also contain
a description of the options available to
the customer if the customer does not
accept the new terms and conditions or
product. This is intended to benefit new
and existing customers by giving them
sufficient opportunity to make an
informed decision and evaluate the
effects of changes in the terms and
conditions or product of the sweep
program and the options available.
(IV). Compliance Cost Estimates
Broker-dealers will incur one-time
and periodic costs to implement the
changes necessitated by the amendment.
These changes include providing
customers with the disclosures and
notices (including the description of the
options available if a customer does not
accept the new terms or conditions or
product) in order to have the flexibility
to change the treatment of customers’
free credit balances. This would require
that broker-dealers update their systems
(including processes for generating
customer account statements) to
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incorporate the necessary changes.732
Additionally, broker-dealers may incur
one-time costs of outside counsel in
implementing these system changes,
particularly with respect to the language
in the disclosures and notices required
by paragraph (j)(2) of the rule.
The Commission further estimates
that broker-dealers will incur costs to
process an affirmative consent for new
customers.733 Specifically, the
Commission estimates that brokerdealers may incur aggregate one-time
and annual costs of approximately $14.4
million 734 and $23.2 million,735
respectively related to the changes
necessitated by these rule
amendments.736
f. ‘‘Proprietary Accounts’’ Under the
Commodity Exchange Act
Some broker-dealers also are
registered as futures commission
merchants under the CEA. These firms
carry both securities and commodities
accounts for customers. The definition
of free credit balances in paragraph
(a)(8) of Rule 15c3–3 does not include
funds carried in commodities accounts
that are segregated in accordance with
the requirements of the CEA.737
However, regulations promulgated
under the CEA exclude proprietary
accounts from the CEA’s segregation
requirements.738 This exclusion from
the segregation requirements under the
CEA has raised a question as to whether
a broker-dealer must treat payables to
customers in proprietary commodities
accounts as ‘‘free credit balances’’ when
732 The internal hours would likely be performed
by a senior programmer. Therefore, the estimated
internal costs for this hour burden would be
calculated as follows: Senior Programmer at $282
per hours × 37,800 hours = $10,659,600. See section
IV.D.6. of this release.
733 The internal hours would likely be performed
by a compliance clerk. Therefore, the estimated
internal costs for this hour burden would be
calculated as follows: Compliance Clerk at $63 per
hour × 368,311 hours = $23,203,593. See section
IV.D.6. of this release.
734 See section IV.D.6. of this release.
($10,659,600 + $3,780,000 (outside counsel costs) =
$14,439,600).
735 Id. ($23,203,593).
736 In the proposing release, the Commission
estimated that broker-dealers would incur one-time
costs of approximately $3.68 million ($2.68 million
internal costs and $1.0 million for outside counsel)
and annual costs of approximately $24.6 million.
See Amendments to Financial Responsibility Rules,
72 FR at 12882.
737 17 CFR 240.15c3–3(a)(8).
738 Rule 1.20 requires a futures commission
merchant to segregate customer funds. See 17 CFR
1.20. Rule 1.3(k) defines the term customer for this
purpose. See 17 CFR 1.3(k). The definition of
customer excludes persons who own or hold a
proprietary account as that term is defined in Rule
1.3(y). See 17 CFR 1.3(y). Generally, the definition
of proprietary account refers to persons who have
an ownership interest in the futures commission
merchant. Id.
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performing a customer reserve
computation.739 For these reasons, the
specific amendment to the definition of
the term free credit balances in
paragraph (a)(8) of Rule 15c3–3 clarifies
that funds held in a commodities
account meeting the definition of a
proprietary account under CEA
regulations are not to be included as free
credit balances in the customer reserve
formula.
One commenter requested that the
Commission clarify that the relevant
definition of proprietary account for
purposes of this amendment will be the
definition contained in 17 CFR 1.3(y).740
The Commission considered this
alternative suggested by the commenter.
While Rule 1.3(y) under the CEA
currently contains the relevant
definition of proprietary account for the
purpose of the amendment, the
definition could be codified in a
different rule in the future.
Consequently, the Commission is
adopting the final rule amendment to
paragraph (a)(8) of Rule 15c3–3, as
proposed. Thus, the final rule does not
include specific references to a specific
rule. Rather, the amendment to
paragraph (a)(8) to Rule 15c3–3, as
adopted, more generally refers to a
‘‘proprietary account as that term is
defined in regulations under the
Commodity Exchange Act.’’
In addition, one commenter stated
that, due to the changes to the swap
markets mandated by Title VII of the
Dodd-Frank Act, swap accounts (in
addition to commodities accounts) are
now subject to customer protection
rules under the CEA. This commenter
suggested that the Commission make it
clear that funds in swap accounts also
do not constitute free credit balances,
whether those funds are required to be
segregated by rules under the CEA (e.g.,
cleared swap accounts or uncleared
swap accounts that have opted for
segregation) or excepted from
segregation under the CEA (e.g., cleared
swaps proprietary accounts or uncleared
swap accounts that have not opted for
segregation). The commenter noted this
treatment ‘‘would be consistent with the
treatment of funds in commodities
accounts and with the regulation of
739 See Part 241-Interpretive Releases Relating to
the Securities Exchange Act of 1934 and General
Rules and Regulations Thereunder, Exchange Act
Release No. 9922 (Jan. 2, 1973), 38 FR 1737 (Jan.
18, 1973) (interpreting the credit balance used in
Item 1 of the Rule 15c3–3a formula ‘‘to include the
net balance due to customers in non-regulated
commodities accounts reduced by any deposits of
cash or securities with any clearing organization or
clearing broker in connection with the open
contracts in such accounts’’).
740 See SIFMA 2 Letter.
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swap accounts under the CEA.’’ 741 The
Commission agrees there may be
additional accounts under the CEA, as
amended by the Dodd-Frank Act that
should explicitly be excluded from the
definition of free credit balances under
Rule 15c3–3. However, the amendments
today are designed to clarify the specific
question raised with respect to the
treatment of funds in proprietary
commodities accounts under the CEA
and, consequently, the suggestions by
this commenter are beyond the scope of
this rulemaking.
The Commission considered
reasonable alternatives in adopting the
final rule amendment. These
alternatives included adopting the
proposed rule, with modifications
suggested by commenters described
above, as well as leaving the current
rule in place without the amendments.
The Commission believes that the
adoption of the final rule is the more
appropriate approach at this time
because the final rule amendment will
benefit broker-dealers that are registered
as futures commission merchants by
eliminating any ambiguity with respect
to such accounts and avoiding
situations where they unnecessarily
increase reserve amounts.
The Commission does not anticipate
that the amendments will result in any
costs to broker-dealers and, as funds in
certain commodities accounts are not
protected under SIPA, will not expose
the SIPC fund to increased liabilities.
Because this amendment is intended to
be a clarification of existing
interpretations, broker-dealers are not
expected to incur additional costs
against the baseline of current Rule
15c3–3 and its existing interpretations.
This clarification is designed to provide
broker-dealers with more certainty as to
the Commission’s stated legal
requirements.
ii. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
The amendments to the customer
protection rule (Rule 15c3–3) regarding
PAB accounts,742 cash deposits at
special reserve bank accounts,743
allocation of short positions,744 the
treatment of free credit balances,745 and
the clarification of the treatment of
proprietary accounts under the CEA are
designed to protect and preserve
customer property held at broker741 Id.
742 See
section II.A.2. of this release.
section II.A.3. of this release.
744 See section II.A.4. of this release.
745 See section II.A.5.ii. of this release.
743 See
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51881
dealers.746 These protections are
primarily intended to reduce the risks
borne by investors.
In particular, first, the final rule
amendment on PAB accounts is
intended to fill a gap in the definition
of customer between Rule 15c3–3 and
SIPA, reducing the risk that customers
could face losses in the case of a
liquidation of a carrying broker-dealer.
The final rule codifies many of the
provisions of the PAIB Letter. The
Commission believes that it is prudent,
and will provide greater regulatory
clarity, to incorporate into Rule 15c3–3
specified provisions of the PAIB Letter.
Further, the Commission understands
that the relief in the PAIB Letter has
been widely, if not universally, utilized
by broker-dealers that carry customer
accounts. Thus, the benefits associated
with codifying specified provisions of
the PAIB Letter will continue to provide
SIPA customers with the protections
currently provided by broker-dealers
complying with the PAIB Letter. Setting
forth these requirements in a
Commission rule will benefit the
securities markets by helping to
diminish the risks and incidences of
non-compliance.
Second, the final rule amendments
regarding the banks where reserve
deposits may be held are intended to
protect customers’ cash deposits by
mitigating the risk that the funds in the
customer reserve account will not be
readily available to be withdrawn by the
broker-dealer.
Third, the final rule amendments
regarding the allocation of customers’
fully paid and excess margin securities
to a broker-dealer short position are
designed to enhance the customer
protection goals of Rule 15c3–3, which
seek to ensure that broker-dealers do not
use customer assets for proprietary
activities.
Fourth, the final rule amendments
regarding the importation of Rule 15c3–
2 requirements into paragraph (j)(1) of
Rule 15c3–3 and the elimination of Rule
15c3–2 streamline the regulatory
requirements for broker-dealers. Also,
the addition of new paragraph (j)(2) to
Rule 15c3–3 is intended to protect a
customer’s free credit balances from
being swept to products or programs
without the appropriate approval, notice
or disclosure.
Fifth, the final rule amendment
establishing that the funds in certain
commodities accounts need not be
treated as free credit balances or other
credit balances may enhance efficiency
at the broker-dealers by freeing up cash
that may have been required to be
746 See
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deposited into a broker-dealer’s
customer reserve account, and clarifying
an ambiguity in Rule 15c3–3.
By strengthening requirements
designed to protect customer assets,
these amendments will mitigate
potential exposure to the SIPC fund that
is used to make advances to customers
whose securities or cash are unable to
be returned by a failed broker-dealer. To
the extent that the amendments to Rule
15c3–3 achieve this goal, investors
might be more willing to transact
business in securities with brokerdealers. The possible positive effects on
investor participation in the securities
markets may promote capital formation
as investor assets are able to be allocated
more efficiently across the opportunity
set.
As discussed above, the Commission
recognizes that the amendments to Rule
15c3–3 adopted today may impose
certain costs on broker-dealers that
might place a burden on competition
among broker-dealers. However, the
Commission is of the opinion that these
costs are justified by the significant
benefits described in this economic
analysis, as well as in the discussion of
the rule amendments above.
Amendments to Rule 15c3–3 should not
place a burden on competition for noncarrying broker-dealers, which are
generally small broker-dealers, because
the amendments primarily affect brokerdealers that perform PAB and customer
reserve computations, carry customer
accounts, and carry free credit balances.
In addition, for those carrying brokerdealers that already follow the PAIB
Letter, any difference from the baseline
with regard to cost burdens should be
marginal. In sum, the costs of
compliance resulting from the
requirements in the amendments to
Rule 15c3–3 should not impose a
burden on competition not necessary or
appropriate in furtherance of the
purposes of the Exchange Act in light of
the benefits discussed above.
2. Holding Futures Positions in a
Securities Portfolio Margining Account
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i. Economic Analysis
As discussed in section II.B. of this
release, the Commission is adopting
amendments to Rule 15c3–3 to
accommodate futures positions in a
securities account that is margined on a
portfolio basis. The amendments revise
the definition of free credit balances and
other credit balances in paragraphs
(a)(8) and (a)(9) of Rule 15c3–3,
respectively, by expanding these
definitions to include funds in a
portfolio margin account relating to
certain futures and futures options
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positions. Consequently, as part of free
credit balances and other credit
balances, these funds will be included
as a credit item on the credit side of the
customer reserve formula. The
Commission is also adopting, as
proposed, an amendment to Rule 15c3–
3a Item 14 that permits a broker-dealer
to include as a debit item, on the debit
side of the customer reserve formula,
the amount of customer margin required
and on deposit at a derivatives clearing
organization related to futures positions
carried in a portfolio margin account.
The amendments are designed to
provide greater protection to customers
with portfolio margin accounts, through
the reserve requirements of Rule 15c3–
3 and SIPA, by requiring a broker-dealer
to include all cash balances (including
portfolio margin cash balances) of its
customers’ securities accounts in the
computation of the customer reserve.
The customer reserve computation
under Rule 15c3–3 is designed to ensure
that the funds a broker-dealer owes to
customers are available to be returned to
customers in the event the broker-dealer
fails.
Subsequent to the Commission’s
proposals, the Dodd-Frank Act amended
the definitions of customer, customer
property, and net equity in section 16 of
SIPA to take into account futures and
options on futures held in a portfolio
margin account carried as a securities
account pursuant to a Commissionapproved portfolio margining
program.747 As a result, persons who
hold futures positions in a portfolio
margining account carried as a
securities account are now entitled to
SIPA protection.
While the Dodd-Frank Act addressed
the protection under SIPA of futures
and futures options held in a securities
portfolio margin account, the
Commission’s amendments to Rule
15c3–3 and 15c3–3a will still serve an
important purpose. In particular, they
complement the Dodd-Frank SIPA
amendments, and will provide
additional protections to customers by
requiring broker-dealers to treat these
futures positions in accordance with the
segregation requirements in Rules 15c3–
3 and 15c3–3a. Consequently, the
Commission is adopting the
amendments with modifications to
address, in part, comments. As noted
above, the requirements of Rule 15c3–3
and Rule 15c3–3a are designed to enable
the prompt return of customer securities
and cash in the event the broker-dealer
falls into financial difficulty or becomes
insolvent. The goal is to place a brokerdealer in a position where it is able to
747 See
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wind down in an orderly selfliquidation without the need for
financial assistance from SIPC.
The Commission received six
comments on the proposed
amendments.748 Three commenters
generally supported the amendments.749
One commenter supported the
development of rules for portfolio
margining and the Commission’s effort
to provide greater legal certainty
regarding the SIPA treatment of futures
positions in a portfolio margin
account.750 This commenter, however,
in a subsequent comment letter, stated
that this amendment is no longer
necessary in light of the Dodd-Frank Act
amendments, and recommended that
the Commission withdraw it.751
Another commenter stated that the
Commission’s proposal is premature in
that the inclusion of futures in a
portfolio margin account, which is a
securities account, would conflict with
the segregation provisions under the
CEA752 and that SIPC has not
determined that protection should be
extended to futures.753 Commenting in
2007 before the adoption of the DoddFrank Act, SIPC stated that the proposed
rules seek to extend SIPC protection to
all positions in the portfolio margin
account, irrespective of whether the
positions are securities under SIPA or
are on deposit in connection with a
securities transaction.754
The Commission agrees, in part, with
the commenter who stated that the
Dodd-Frank Act SIPA amendments
make the Commission’s proposed
amendments to Rules 15c3–3 and 15c3–
3a unnecessary.755 As noted above, the
definitions of customer, customer
property, and net equity in section 16 of
SIPA were amended by the Dodd-Frank
Act to take into account futures and
options on futures held in a portfolio
margin account carried as a securities
account pursuant to a Commissionapproved portfolio margining
program.756 Consequently, in a
748 See SIFMA 2 Letter; CME Letter; SIPC Letter;
Citigroup Letter; American Bar Association Letter;
SIFMA 4 Letter.
749 See SIFMA 2 Letter; Citigroup Letter;
American Bar Association Letter.
750 See SIFMA 2 Letter.
751 See SIFMA 4 Letter.
752 See, e.g., 17 CFR 1.20–1.29.
753 See CME Letter; see also SIPC Letter
(expressing ‘‘grave concerns’’ about potential
conflict between the proposed amendments and
SIPA).
754 See SIPC Letter. SIPC also urged the
Commission to reconsider its adoption of the
portfolio margin proposals, stating that if the
changes are in order, the Commission should seek
to have them made by legislative amendment and
not rulemaking.
755 See SIFMA 4 Letter.
756 See Public Law 111–203 § 983.
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proceeding under SIPA, futures and
options on futures positions held in a
portfolio margin account carried as a
securities account would be included in
determining a customer’s net equity
claim.757 Therefore, the proposed
amendment relating to the unrealized
value of a futures option is not
necessary to achieve the objective of
providing SIPA protection for such
positions. As a result, the Commission
is modifying the final rule to delete the
proposed language in paragraph (a)(8) of
Rule 15c3–3 that would have treated the
unrealized value of a futures option in
a portfolio margin account on the filing
date of a SIPA proceeding as a free
credit balance for purposes of Rule
15c3–3.758
While the legislation provides
additional certainty with respect to how
futures in a portfolio margin account
would be treated in a SIPA liquidation,
the Commission’s amendments will
require that positions are subject to the
protections of Rule 15c3–3, thus
enhancing customer protection.
Therefore, while the Commission has
considered the suggested alternatives in
developing the final rule amendments
(including not adopting the
amendments), the Commission has
determined that adopting the portfolio
margining amendments was a more
appropriate approach in furtherance of
enhancing customer protection.
The Commission requested comment
on available metrics to quantify these
benefits and any other benefits a
commenter may identify, including the
identification of sources of empirical
data that could be used for such metrics.
The Commission did not receive any
comments in response to these requests.
Current SRO portfolio margin rules
permit futures to be held in a securities
portfolio margin account.759 However,
pending further regulatory action by the
757 Under the Dodd-Frank Act SIPA amendments,
a customer’s net equity now includes all positions
in futures contracts and options on futures contracts
held in a portfolio margining account carried as a
securities account pursuant to a portfolio margining
program approved by the Commission, including all
property collateralizing such positions, to the extent
that such property is not otherwise included herein.
See 15 U.S.C. 78lll(11)(A)(ii). Further, the
amendments provided that a claim for a commodity
futures contract received, acquired, or held in a
portfolio margining account pursuant to a portfolio
margining program approved by the Commission or
a claim for a security futures contract, shall be
deemed to be a claim with respect to such contract
as of the filing date, and such claim shall be treated
as a claim for cash. See 15 U.S.C. 78lll(11).
758 Specifically, the final rule does not include
the proposed language: ‘‘, and, in the event the
broker-dealer is the subject of a proceeding under
SIPA, the market value as of the ‘‘filing date’’ as that
term is defined in SIPA (15 U.S.C. 78lll(7)) of any
long options on futures contracts.’’
759 See, e.g., FINRA Rule 4210.
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Commission and the CFTC, the ability
to combine securities and futures
products into a single portfolio margin
account will be unavailable.760
Therefore, under the current baseline of
SRO portfolio margin rules, with the
inclusion of only securities positions in
the securities account, this amendment
would have no effect as compared to the
baseline until the Commission and
CFTC take such further action with
respect to portfolio margining.761
The requirements imposed by the
portfolio margin amendments will be
elective. The requirements will apply
only to broker-dealers choosing to offer
their customers portfolio margin
accounts. The Commission estimates
that approximately 35 broker-dealers
will elect to offer their customers
portfolio margin accounts that will
include futures and futures options.762
The amendment to the definition of free
credit balances in Rule 15c3–3 will
require broker-dealers to include in the
reserve formula credit balances related
to futures positions in a portfolio margin
account. The amendment to Rule 15c3–
3a Item 14 in the reserve formula will
enable broker-dealers to include as a
debit item the amount of customer
margin required and on deposit at a
derivatives clearing organization.
Accordingly, these amendments will
require changes to the systems brokerdealers use to compute and account for
their reserve requirements. Consistent
with the proposing release,763 the
Commission assumes that the
responsibility for updating these
systems will be undertaken by a Senior
Programmer.764 Therefore, the
760 See Section 713 of the Dodd-Frank Act.
Section 713 of the Dodd-Frank Act amends the
Exchange Act and CEA to facilitate portfolio
margining by allowing cash and securities to be
held in a futures account and futures and options
on futures and related collateral to be held in a
securities account by a dually-registered brokerdealer and futures commission merchant pursuant
to an approved portfolio margin program, subject to
certain requirements, including regulatory action by
the Commission and CFTC (pursuant to an
exemption, or by rule or regulation). See generally,
A Joint Report of the SEC and the CFTC on
Harmonization of Regulation (Oct. 19, 2009).
761 See generally, A Joint Report of the SEC and
the CFTC on Harmonization of Regulation (Oct. 19,
2009).
762 This estimate is based on OCUS Report data.
This is an update from the estimate in the
proposing release of 33 broker-dealers. See
Amendments to Financial Responsibility Rules, 72
FR at 12883.
763 See Amendments to Financial Responsibility
Rules, 72 FR at 12883.
764 The SIFMA 2012 Report as Modified indicates
the average hourly cost of this position is
approximately $282. Consistent with the proposing
release, the Commission estimates the Senior
Programmer will spend approximately 130 hours
modifying software to conform it to the
requirements of the amendments. See Amendments
to Financial Responsibility Rules, 72 FR at 12883.
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51883
Commission estimates that the program
and systems changes would result, on
average, in a one-time cost of
approximately $36,660 per brokerdealer.765 Thus, the Commission
estimates the total one-time cost to
broker-dealers will be approximately
$1,283,100.766
The Commission requested comment
on the proposed cost estimates. In
particular, the Commission requested
comment on additional costs to brokerdealers that would arise from the
proposals, such as system costs in
addition to those discussed above (e.g.,
costs associated with purchasing new
software and updates to existing
software). The Commission also
requested comment on whether these
proposals would impose costs on other
market participants, including brokerdealer customers. Commenters were
asked to identify the metrics and
sources of any empirical data that
supported their costs estimates. The
Commission did not receive any
comments in response to these requests.
ii. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
The final rule amendments to Rule
15c3–3 to accommodate futures
positions in a securities account
margined on a portfolio basis 767 should
complement the Congressional
amendments and provide additional
protections to portfolio margin
customers through the strengthened
reserve requirements of Rule 15c3–3.
These additional protections may
reduce the risk of loss of collateral to
securities customers, promote
participation in the securities markets,
and enhance competition and price
discovery. Moreover, these additional
protections may make portfolio
margining more attractive to investors.
Portfolio margining may significantly
reduce customer margin requirements
by offsetting positions involving
securities and futures products, which
in turn reduces the costs of trading such
products and enhances efficiency.
Portfolio margining may also promote
better price discovery across securities
and futures products by allowing
customers to offset a position assumed
in one market with a product traded in
765 130 hours × $282 = $36,660. In the proposing
release, the Commission estimated this cost would
be $34,840. See Amendments to Financial
Responsibility Rules, 72 FR at 12883.
766 35 broker-dealers × $36,660 = $1,283,100. In
the proposing release, the Commission estimated
this cost would be $1,149,720. See Amendments to
Financial Responsibility Rules, 72 FR at 12883.
767 See section II.B. of this release.
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another market. The enhanced
efficiencies as a result of increases in
the use of portfolio margin accounts
may facilitate capital formation through
the availability of additional capital for
customers as a result of reduced margin
costs.
While today’s amendments promote
efficiency within the securities markets,
the increased costs associated with the
rule amendments may impose a burden
on competition among broker-dealers.
However, the Commission is of the
opinion that these costs are justified by
the significant benefits described in this
economic analysis. In sum, the costs of
compliance resulting from the
requirements in the portfolio margining
amendments to Rule 15c3–3 should not
impose a burden on competition not
necessary or appropriate in furtherance
of the purposes of the Exchange Act in
light of the benefits discussed above.
3. Amendments With Respect to
Securities Lending and Borrowing and
Repurchase/Reverse Repurchase
Transactions
emcdonald on DSK67QTVN1PROD with RULES2
i. Economic Analysis
The Commission is adopting
amendments to Rules 15c3–1 and 17a–
11 to strengthen the financial
responsibility of broker-dealers engaging
in a securities lending business. First,
the amendment to subparagraph
(c)(2)(iv)(B) of Rule 15c3–1 clarifies that
broker-dealers providing securities
lending and borrowing settlement
services are deemed, for purposes of the
rule, to be acting as principals and are
subject to applicable capital deductions.
Under the amendment, these deductions
could be avoided if a broker-dealer takes
certain steps to disclaim principal
liability. Second, the amendment to
paragraph (c)(5) of Rule 17a–11 requires
a broker-dealer to: (1) File a notice with
the Commission and its DEA whenever
the total money payable against all
securities loaned, subject to a reverse
repurchase agreement or the contract
value of all securities borrowed or
subject to a repurchase agreement
exceeds 2,500% of tentative net capital;
or, alternatively, (2) report monthly its
securities lending and repurchase
activities to its DEA in a form acceptable
to its DEA.
Both amendments are intended to
strengthen the financial responsibility of
broker-dealers engaged in a securities
lending or repurchase business. The
first amendment to subparagraph
(c)(2)(iv)(B) of Rule 15c3–1 will help
eliminate the legal uncertainty among
counterparties as to the role played by
broker-dealers in such transactions and
clarify the nature of the services that
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securities lending intermediaries
provide their counterparties.
Thus, a broker-dealer will be
considered a principal unless the
broker-dealer has disclosed the identity
of each party to the other, and the
parties have agreed in writing that the
obligations of the broker-dealer do not
include a guarantee of performance by
the other party and that in the event of
default, neither party shall have the
right of setoff against the obligations, if
any, of the broker-dealer. In addition,
this amendment will help avoid
ambiguity regarding the applicability to
a particular broker-dealer of the stock
loan charges in the net capital rule.
In response to comments that
standard legal documents currently
used in securities lending transactions
provide sufficient legal certainty with
respect to the status of the parties,768 the
Commission considered whether to
adopt the proposed approach or
whether to rely on existing industry
practice. The Commission considered
the alternatives and believes that the
rule as adopted appropriately balances
the commenters’ objections to the
proposal with the Commission’s
concerns about stock lending practices,
particularly with regard to the failure of
MJK.769 In recognition of standard stock
loan agreement templates, the
Commission designed the amendment
to accommodate the continued use of
these industry model agreements by
incorporating their use into the rule’s
requirements.
The second amendment to paragraph
(c)(5) of Rule 17a–11 will help identify
broker-dealers with highly leveraged
non-government securities lending and
borrowing and repo activity.770 This
new provision requires that a brokerdealer notify the Commission whenever
the total amount of money payable
against all securities loaned or subject to
a repurchase agreement, or the total
contract value of all securities borrowed
or subject to a reverse repurchase
agreement exceeds 2,500% of tentative
net capital; provided that, for purposes
of this leverage threshold, transactions
involving government securities, as
defined in Section 3(a)(42) of the
Exchange Act, are excluded from the
calculation.771 The notice provision is
designed to alert regulators to a sudden
increase in a broker-dealer’s stock loan
768 See section II.C. of this release. See also
SIFMA 2 Letter; Citigroup Letter.
769 See section II.C. of this release.
770 17 CFR 240.17a–11(c)(5).
771 15 U.S.C. 78c(a)(42). Government securities
generally present less market risk than other types
of securities used in securities lending and repo
transactions. Consequently, they are excluded from
the scope of this rule.
PO 00000
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and repo positions, which could
indicate that the broker-dealer is taking
on new or additional risk that it may
have limited experience or increased
difficulty in managing. This amendment
will assist securities regulators in
monitoring such activities and
responding to situations where a brokerdealer experiences financial difficulty
due to a large securities lending or repo
position. This may help prevent
significant losses to the broker-dealer’s
customers and other broker-dealers, and
reduce systemic financial risk.
As adopted, new paragraph (c)(5) of
Rule 17a–11 also permits a brokerdealer to report monthly its stock loan
and repo activity to its DEA in a form
acceptable to its DEA in lieu of the
notices required by paragraph (c)(5).
This approach will provide each DEA
with the flexibility to prescribe how the
monthly reports are to be made and will
accommodate a DEA that opts to use the
FOCUS report as the reporting
mechanism.772 This provision will also
accommodate large broker-dealers that
are active in this business and regularly
maintain stock loan and repo balances
that exceed the threshold. The
Commission expects that these brokerdealers have experience in managing the
risks associated with these types of
transactions and have established
controls to address those risks.
Consequently, notice under Rule 17a–11
from these broker-dealers will not be as
useful to regulators. On the other hand,
the monthly reports will provide
securities regulators with information
useful, for example, to develop trend
analysis, if deemed appropriate. This
analysis can be used to identify leverage
levels that are outside the normal trend
range and that may be indicative of a
material change in the firm’s business
model (e.g., taking on higher levels of
leverage, branching into new products,
or experiencing operational or financial
difficulties).
The Commission requested comment
on available metrics to quantify these
benefits and any other benefits a
commenter may identify. Commenters
were requested to identify sources of
empirical data that could be used for the
metrics they propose. The Commission
did not receive any comments in
response to these requests.
The Commission expects that brokerdealers may incur costs related to the
implementation of the rule
772 As proposed, the amendment to Rule 17a–11
would have provided that a broker-dealer that
submitted a monthly report of its stock loan and
repo activity to its DEA not be required to file the
Rule 17a–11 notices required by paragraph (c)(5).
See Amendments to Financial Responsibility Rules,
72 FR at 12870.
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emcdonald on DSK67QTVN1PROD with RULES2
amendments. Using current Rule 15c3–
1 and Rule 17a–11 as a baseline, the
Commission expects that some brokerdealers may incur costs in connection
with the implementation of these rule
amendments.
With regard to the amendment to
subparagraph (c)(2)(iv)(B) of Rule 15c3–
1, the Commission understands that
most existing standard securities
lending master agreements in use today
already contain language requiring agent
lenders to disclose principals and for
principals to agree not to hold the
agents liable for a counterparty default.
Thus, the standard agreement used by
the vast majority of broker-dealers
should contain the representations and
disclosures required by the proposed
amendment. However, a small
percentage of broker-dealers may need
to modify their standard agreements.
The Commission estimates that the total
one-time cost to broker-dealers for this
change will be approximately
$45,480.773
The Commission requested comment
on the cost estimates. In particular, the
Commission requested comment on
additional costs to broker-dealers that
would arise from the proposals, such as
costs arising from making systems
changes. The Commission also
requested comment on whether these
proposals would impose costs on other
market participants, including brokerdealer customers. Commenters were
also asked to identify the metrics and
sources of any empirical data that
support their costs estimates. The
Commission did not receive any
comments in response to these requests.
With regard to the amendment to Rule
17a–11, the Commission received
several suggested alternatives from
commenters which contributed to the
modification of the final rule from the
proposal. Three commenters addressed
the proposed monthly notification
requirement. They stated that the
monthly report in lieu of the
notification should be provided as part
of the monthly FOCUS report many
broker-dealers file with their DEA.774
The Commission agrees that the FOCUS
report may be an appropriate
mechanism for reporting stock loan and
repo positions in lieu of the proposed
773 In the proposing release, the Commission
estimated that the total one-time cost to brokerdealers would be approximately $62,604. See
Amendments to Financial Responsibility Rules, 72
FR at 12884. The internal hours would likely be
performed by an in-house Attorney at $379 per
hour, resulting in the estimated internal cost
calculated as follows: 120 hours at $379 per hour
= $45,480. See section IV.D.1. of this release.
774 See Abbey National Letter; Citigroup Letter;
SIFMA 2 Letter.
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monthly notification requirement.775
Consequently, the Commission
modified the final rule amendment to
delete the phrase ‘‘submits a monthly
report of’’ and replace it with the phrase
‘‘reports monthly.’’ In addition, as
adopted, in order to provide that the
monthly report shall be sent to a brokerdealer’s DEA, the Commission added
the phrase ‘‘to its designated examining
authority in a form acceptable’’ before
‘‘to its designated examining authority.’’
This approach, as adopted, is intended
to provide each DEA with the flexibility
to tailor the reporting requirements.
Based on FOCUS Report data, the
Commission estimates that
approximately one notice per year will
be sent pursuant to this amendment.776
Therefore, approximately one brokerdealer per year will incur costs to
prepare and send the notice.777
Consequently, the Commission
estimates that the costs to broker-dealers
associated with this requirement will be
de minimis.
In addition, the Commission estimates
that six broker-dealers will choose the
option of reporting monthly 778 and will
incur a one-time cost to update their
systems to generate the information for
the report.779 The Commission also
estimates that these broker-dealers will
incur annual costs generating and filing
the monthly reports or preparing the
information to include in monthly
FOCUS Reports (as applicable).780
Therefore, the Commission estimates
that the total one-time cost and annual
costs to broker-dealers will be
775 Carrying broker-dealers are generally required
to submit FOCUS reports on a monthly basis.
776 This estimate is derived from FOCUS Report
data, and adjusted based on staff experience. This
estimate has been updated from the proposing
release estimate of 11. No comments were received
on this estimate.
777 The internal hours would likely be performed
by junior stock loan manager for 10 minutes at $134
per hour × 1 notice = $22.33. See section IV.D.8.
of this release.
778 This is an update from the proposing release
estimate of 21 broker-dealers. See Amendments to
Financial Responsibility Rules, 72 FR at 12884.
779 The internal hours would likely be performed
by a senior programmer. Therefore, the estimated
internal costs for this hour burden would be
calculated as follows: Senior Programmer for 100
hours at $282 per hour = $28,200. See section
IV.D.8. of this release. This is an update from the
proposing release estimate of $26,800. See
Amendments to Financial Responsibility Rules, 72
FR at 12884.
780 The internal hours would likely be performed
by a junior stock loan manager. Therefore, the
estimated internal costs for this hour burden would
be calculated as follows: Junior Stock Loan Manager
for 12 hours at $134 per hour = $1,608. See section
IV.D.8. of this release. This is an update from the
proposing release estimate of $2,496 per firm. See
Amendments to Financial Responsibility Rules, 72
FR at 12884.
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51885
approximately $169,200 781 and
$9,648 782 respectively. The
Commission’s total one-time and annual
cost estimates have decreased from the
proposing release primarily due to an
overall decrease in the number of
broker-dealers.
As noted above, the Commission
requested comment on the proposed
cost estimates. In particular, the
Commission requested comment on
additional costs to broker-dealers that
would arise from the proposals. The
Commission also requested comment on
whether these proposals would impose
costs on other market participants,
including market participants active in
the securities lending and repurchase
markets. Commenters were asked to
identify the metrics and sources of any
empirical data that supported their cost
estimates. The Commission did not
receive any comments in response to
these requests.
ii. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
As described above, the amendment
to subparagraph (c)(2)(iv)(B) of Rule
15c3–1 and new paragraph (c)(5) of Rule
17a–11 are designed to address two
areas of concern that emerged from the
Commission’s experience with the
failure of MJK.783 First, broker-dealers
with principal liability in a stock loan
transaction may be deemed to be acting
in an agency capacity and therefore not
taking appropriate capital charges.
Second, broker-dealers that historically
have not been very active in stock loan
activities may rapidly expand their
balance sheets and increase leverage to
a level that poses significant financial
risk to the firm and counterparties.
Either potential event could result in
significant, adverse consequences for
customers and counterparties of the
broker-dealer. For the customers, the
fact that the broker-dealer could avoid
taking appropriate capital charges
would imperil the broker-dealer’s ability
to self-liquidate, thereby impeding the
ability of customers to be promptly paid
in full. For the counterparties, the fact
that the broker-dealer could rapidly
escalate its leverage increases the
likelihood that the broker-dealer could
fail and its counterparties could
781 6 firms × $28,200 = $169,200. This is an
update from the proposing release estimate of
$562,800. See Amendments to Financial
Responsibility Rules, 72 FR at 12884.
782 6 firms × $1,608 = $9,648. This is an update
from the proposing release estimate of $52,416. See
Amendments to Financial Responsibility Rules, 72
FR at 12884.
783 See section II.C. of this release.
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experience, losses of value associated
with the rapid unwinding of positions
with the failing broker-dealer.
Overall, the amendments to Rule
15c3–1 and Rule 17a–11 will help
enhance the monitoring of securities
lending or repurchase activities by
securities regulators, thereby reducing
the effect on customers and
counterparties of the potential impact of
a financial collapse of the brokerdealer.784 This will strengthen the
securities markets and make them more
attractive to investors, thereby
enhancing efficiency and capital
formation. Moreover, the language in
the final rule that provides each DEA
with the flexibility to prescribe how the
monthly reports are to be made may
enhance efficiencies for broker-dealers
by providing the ability for a DEA to
tailor the reporting requirements.
Finally, the costs of compliance with
the amendments to Rules 15c3–1 and
17a–11 should not impose a burden on
competition not necessary or
appropriate in the furtherance of the
purposes of the Exchange Act in light of
the benefits discussed above.
emcdonald on DSK67QTVN1PROD with RULES2
4. Documentation of Risk Management
Procedures
i. Economic Analysis
As discussed in section II.D. of this
release, the Commission is adopting
new paragraph (a)(23) to Rule 17a–3 to
require certain broker-dealers to make
and keep current a record documenting
the credit, market, and liquidity risk
management controls established and
maintained by certain broker-dealers to
assist them in analyzing and managing
the risks associated with their business
activities, including, for example,
securities lending and repo transactions,
OTC derivative transactions, proprietary
trading, and margin lending.785 The
amendment will apply only to brokerdealers that have more than $1,000,000
in aggregate credit items as computed
under the customer reserve formula of
Rule 15c3–3, or $20,000,000 in capital
including debt subordinated in
accordance with Appendix D to Rule
15c3–1.
These amendments require large
broker-dealers to document the controls
they have implemented to address the
risks they face as a result of their
business activities. As proposed, the
amendment would have required a
broker-dealer to create a record
documenting its ‘‘internal risk
management controls,’’ rather than its
market, credit, and liquidity risk
controls. Commenters generally raised
786 See
784 Id.
785 17
concerns with the proposed amendment
stating, for example, that the proposed
documentation of internal management
controls over risks arising from the
broker-dealer’s business activities was
overly broad and ambiguous.786 The
Commission considered the proposed
approach and, as discussed above, in
part in response to comments, the
Commission narrowed the application
of the amendment so that the final rule
now requires the documentation of
internal risk management controls
established to manage market, credit,
and liquidity risk.787 The final rule
benefits firms and their customers by
mitigating the risk of losses associated
with a firm’s normal activities, while at
the same time placing an increased
recordkeeping burden on broker-dealers
by requiring them to document certain
risks in writing.
A well-documented system of internal
controls designed to manage material
risk exposures related to market, credit,
and liquidity risk reflects the
expectations of a firm’s management as
to how its business activities should be
conducted in light of such exposures.
Written risk management procedures
enable management to better identify,
analyze, and manage the risks inherent
in the firm’s business activities with a
view to preventing material losses and
to review whether the firm’s activities
are being conducted in a manner that is
consistent with such procedures and
controls. This will likely benefit market
participants and reduce systemic
financial risk.
In addition, by making the
documented controls a required record
under Rule 17a–3, a broker-dealer’s
regulator likely will have better access
to them, as this benefit will only be
realized to the extent that a brokerdealer has existing market, credit, and
liquidity risk management controls in
place because the rule does not specify
the type of controls a broker-dealer must
establish to manage these risks. It
simply requires documentation of the
procedures that the broker-dealer has
established. The final rule amendment
will require any such records of the
market, credit, and liquidity risk
management controls to be available to
the broker-dealer’s regulators so that
they can review whether the brokerdealer is adhering to these controls.
The Commission requested comment
on available metrics to quantify these
benefits and any other benefits a
commenter may identify. Commenters
were requested to identify sources of
empirical data that could be used for the
CFR 240.17a–3(a)(23).
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787 See
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metrics they proposed. The Commission
did not receive any comments in
response to these requests.
These amendments apply to a limited
number of broker-dealers, namely, those
firms with more than $1 million in
customer credits or $20 million in
capital and amend recordkeeping
requirements in Rules 17a–3 and 17a–4.
Therefore, against the existing baseline
of these current rules, the Commission
expects that the requirement will result
in a one-time cost to some of these firms
to the extent that they have established
controls that have not been
documented. However, since most firms
are expected to be already compliant,
the incremental costs are expected to be
small. For example, broker-dealers that
are approved to compute capital using
internal models are already subject to
Rule 15c3–4, which requires these firms
to establish, document, and maintain a
system of internal risk controls to assist
them in managing the risks associated
with its business activities, including
market, credit, leverage, liquidity, legal,
and operational risks.788 These firms
would most likely incur no or minimal
costs to comply with the final rule. In
addition, this rule amendment does not
mandate any specific control,
procedure, or policy be established;
rather, the Commission is requiring that
a control, procedure, or policy be
documented if it is in place. For these
reasons, the Commission estimates that
the one-time hourly burden to meet the
requirements of these rules will range
from zero hours for some firms to
hundreds of hours for other firms.
Taking this into account, the
Commission estimates that the total onetime cost to broker-dealers to document
controls in compliance with this
amendment will be approximately
$13,783,700.789 The Commission also
estimates that the annual cost to brokerdealers to ensure compliance with the
788 17 CFR 240.15c3–4; 17 CFR 240.15c3–
1(a)(7)(iii). Based on staff experience monitoring
broker-dealer risk management procedures, the
internal hours would likely be coordinated by a
broker-dealer’s in-house attorney (19,600 hours),
working with operation specialists (24,500 hours),
and overseen by an associate general counsel (4,900
hours). Therefore, the estimated internal costs for
this hour burden would be calculated as follows:
[(Attorney for 19,600 hours at $379 per hour) +
(Operations Specialist for 24,500 hours at $126 per
hour) + (Associate General Counsel for 4,900 hours
at $467) = $12,803,700. Broker-dealers are also
expected to incur one-time outside counsel costs of
$980,000 for a total one-time cost of $13,783,700.
See section IV.D.7. of this release.
789 See section IV.D.7. of this release. In the
proposing release, the Commission estimated this
cost would be approximately $14,201,990. See
Amendments to Financial Responsibility Rules, 72
FR at 12885.
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amendment to Rule 17a–3 will be
approximately $8,356,950.790
As noted above, the Commission
requested comment on the proposed
cost estimates. In particular, the
Commission requested comment on
additional costs to broker-dealers that
would arise from the proposals, such as
costs arising from making changes to
systems and costs associated with
maintaining these records. The
Commission also requested comment on
whether the proposals would impose
costs on other market participants,
including broker-dealer customers.
Commenters were also asked to identify
the metrics and sources of any empirical
data that support their cost estimates.
The Commission did not receive any
comments in response to these requests.
emcdonald on DSK67QTVN1PROD with RULES2
ii. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
The amendments to Rules 17a–3 and
17a–4 require firms to document their
market, credit, and liquidity risk
management controls. The amendments
will help strengthen broker-dealer
internal controls. Documenting internal
controls will encourage enhanced
consideration of, and thus a firmer grasp
upon, the risks attendant to a brokerdealer’s business activities. This is
designed to reduce the risks inherent to
the business of operating as a brokerdealer. The final approach the
Commission has taken with these rule
amendments—encouraging effective
internal controls while preserving
flexibility—will enhance a brokerdealer’s financial soundness and,
consequently, may help to reduce the
likelihood of broker-dealer failures with
possible positive effects on investor
participation, competition, and capital
formation. The amendments may also
increase efficiencies in broker-dealer
examinations through the ready
availability of records for examiners.
Finally, the Rule 17a–3 and 17a–4
amendments are not expected to place
a burden on competition for small noncarrying broker-dealers because such
firms would not be subject to these
amendments.791 As discussed above,
there will be some incremental costs to
790 The internal hours would likely be performed
by a broker-dealer’s in-house attorney. Therefore,
the estimated internal costs for this hour burden
would be calculated as follows: Attorney at $379
per hour × 22,050 hours = $8,356,950. See section
IV.D.7. of this release.
791 The amendments only apply to broker-dealers
that have more than $1,000,000 in aggregate credit
items as computed under the customer reserve
formula of Rule 15c3–3, or $20,000,000 in capital
including debt subordinated in accordance with
Appendix D to Rule 15c3–1.
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compliance related to these
amendments for carrying broker-dealers
but the costs of compliance should not
impose a burden on competition not
necessary or appropriate in furtherance
of the purposes of the Exchange Act and
in light of the benefits discussed above.
5. Amendments to the Net Capital Rule
i. Economic Analysis
a. Requirement To Deduct From Net
Worth Certain Liabilities or Expenses
Assumed by Third Parties
(I). Summary of Amendments
The amendments to Rule 15c3–1 add
a new paragraph (c)(2)(i)(F) requiring a
broker-dealer to adjust its net worth
when calculating net capital by
including any liabilities that are
assumed by a third party if the brokerdealer cannot demonstrate that the third
party has the resources, independent of
the broker-dealer’s income and assets, to
pay the liabilities. This amendment is
intended to assist investors and
regulators by requiring broker-dealers to
provide a more accurate picture of their
financial condition. This should help
regulators react more quickly if a brokerdealer experiences financial difficulty
and benefit customers of the troubled
broker-dealer as well as its
counterparties.
The purpose of the requirement in
new paragraph (c)(2)(i)(F) of Rule 15c3–
1 is to address the practices of a brokerdealer that raise concerns when a
broker-dealer shifts liabilities to an
entity with no revenue or assets
independent of the broker-dealer to
inappropriately increase its reported net
capital, by excluding the liability from
the calculation of net worth. The final
rule is designed to prohibit a practice
that could misrepresent a brokerdealer’s actual financial condition,
mislead the firm’s customers, and
hamper the ability of regulators to
monitor the firm’s financial condition.
The Commission requested comment
on available metrics to quantify these
benefits and any other benefits a
commenter may identify. Commenters
were requested to identify sources of
empirical data that could be used for the
metrics they proposed. The Commission
did not receive any comments in
response to these requests.
(II). Baseline and Incremental Economic
Effects
As discussed in section II.E.1. of this
release, the baseline of this rule
amendment is current Rule 15c3–1 and
existing guidance and interpretations.
The Commission staff has provided
guidance with respect to the treatment
and recording of certain broker-dealer
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51887
expenses and liabilities that is
consistent with the rule amendment.792
Consequently, as against the current
baseline, the Commission does not
expect significant incremental benefits
and costs to the extent that they already
comply with existing guidance and
interpretations.793
While the amendments apply to all
broker-dealers, they will impact only
those few that shift liabilities to entities
with no revenue or assets independent
of the broker-dealer (i.e., shell
corporations) to boost the brokerdealer’s reported net capital. Based on
staff experience in supervising brokerdealer compliance with Rule 15c3–1,
the vast majority of broker-dealers likely
either do not seek to transfer
responsibility for their liabilities to a
third party or, if they do so, rely on a
third party that has the financial
resources—independent of the assets
and revenue of the broker-dealer—to
pay the obligations as they become due.
Because of this, it is difficult to quantify
the benefits and costs impact of this rule
amendment.
The Commission conservatively
estimates that the amendment may
impact all broker-dealers that do not
report any liabilities. FOCUS Report
data, as of December 31, 2011, indicates
that approximately 289 broker-dealers
report having no liabilities. While this
number is likely at the upper boundary
of the total number of broker-dealers
affected by this amendment, the number
of broker-dealers reporting no liabilities
likely represents a reasonable sample of
broker-dealers on which to base the cost
estimates.
Requiring these broker-dealers to book
liabilities will decrease the amount of
equity capital held by the firms and in
some cases may require them to obtain
additional capital. The majority of
broker-dealers reporting no liabilities
are introducing broker-dealers that have
a $5,000 minimum net capital
requirement, while the reported average
of total liabilities is approximately
$491,355 per broker-dealer. Therefore,
conservatively estimating that each of
the 289 broker-dealers will have to raise
$491,355 in additional capital as result
of the requirement, the total aggregate
792 See, e.g., Third Party Expense Letter; see also
FINRA Notice to Members 03–6, Expense Sharing
Agreements.
793 Under this amendment, some broker-dealers
may request permission in writing from their DEA
to withdraw capital within one year of contribution
under the rule, resulting in annual costs to brokerdealers of approximately $144,150 (465 hours ×
$310 per hour for a Compliance Attorney). See
section IV.D.2. of this release.
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amount of additional capital that will
need to be raised is $142 million.794
Further, relative to the proposing
release, the Commission is revising the
cost of capital from approximately 5%,
which was determined based on
historical interest rates published by the
Federal Reserve, to 12% as the average
cost of equity capital determined using
the capital asset pricing model
(‘‘CAPM’’).795 Therefore, the
Commission conservatively estimates
that the total annual cost to brokerdealers will be approximately $17
million,796 which is an increased
estimate relative to the proposing
release. For the broker-dealers to whom
this increased estimate applies, the
Commission expects that there would be
greater costs imposed. However, the
Commission expects that the benefits
outlined above would also accrue to the
customers of these broker-dealers.
The Commission requested comment
on the proposed cost estimates. In
particular, the Commission requested
comment on additional costs to brokerdealers that would arise from the
proposals. The Commission also
requested comment on whether these
proposals would impose costs on other
market participants, including brokerdealer customers. Commenters were
also asked to identify the metrics and
sources of any empirical data that
support their costs estimates. The
Commission received five comments in
response to this request for comment.797
One commenter noted that the
Commission has provided no evidence
that the public has been endangered or
has been left financially unprotected as
a result of the practice of having another
entity book some or all of a member’s
liabilities.798 This commenter asserted
794 289 broker-dealers × $491,355 = $142,001,595.
This is an update from the proposing release
estimate of 702 broker-dealers with aggregate
liabilities of $280,354 per firm, resulting in an
estimated amount of additional capital that would
have to be raised in the amount of $196,808,508
(702 broker-dealers × $280,354 = $196,808,508). See
Amendments to Financial Responsibility Rules, 72
FR at 12885, n.189 and accompanying text.
795 The CAPM is a central model in modern
financial theory and is widely used in applications,
such as estimating the cost of capital for firms and
evaluating the performance of managed portfolios.
Based on conventional assumptions and historical
stock price data available on Bloomberg, the
Commission estimates a risk-free rate of 2.5% and
an equity risk premium of 7.8%. Using, five-year,
as well as two-year, monthly returns for a sample
of listed broker-dealers, the Commission estimates
an adjusted beta of approximately 1.25.
796 $142,001,595 × 12.25% = $17,395,195. In the
proposing release, the Commission estimated that
this cost would be approximately $10 million. See
Amendments to Financial Responsibilities Rules. 72
FR at 12995.
797 See Beer Letter; Beer 2 Letter; Lowenstein
Letter; Levene Letter; NIBA 2 Letter.
798 See Lowenstein Letter.
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that the amendment will affect 14% of
total member firms and that member
firms may be shut down, sold or merged
as an unintended consequence of the
amendment.799 The commenter
questioned how many member firms
will fail as a result of this proposal.800
Another commenter stated that the
true costs of the amendment should be
calculated and verified before a
proposed amendment is offered and that
the true costs of these amendments were
given little time, research, and
consideration.801 This commenter also
argued that the estimated 5% cost of
capital has no basis and a firm would be
fortunate to borrow funds for double the
estimate of 5%.802 This same
commenter also stated that the proposal
would require 702 debt-free introducing
broker-dealers to needlessly take on
debt of approximately $280,354.803
Another commenter stated that it is
unclear and unlikely how this
amendment would achieve any of the
desired results and may conversely
impair a firm’s ability to continue as a
going concern.804 None of the
commenters provided the Commission
with revised cost estimates.
One commenter stated that if small
firms were required to raise over
$300,000 in capital each, there would be
the largest dissolution of small brokerdealers in the history of the regulated
securities industry.805 This commenter
also stated that the Commission’s
estimate of a gross cost of capital of
7.5% (5% + 2.5%) is a totally unrealistic
cost of capital for small broker-dealers
and that these broker-dealers will
categorically have costs significantly
higher than 7.5%.806 Finally, the
commenter stated that, until the
Commission convenes a small brokerdealer representative panel to assist it
with establishing such costs, the
Commission is speculating on such
costs, and is therefore without adequate
information to consider the effects of
such costs and changes on small
firms.807
(III). Alternatives
The Commission considered all
comments received 808 and the
alternative of not adopting the rule, and
decided to adopt the amendments
800 Id.
Beer 2 Letter.
802 Id.
803 See
Beer Letter; Lowenstein Letter.
Levene Letter.
805 See NIBA 2 Letter.
806 Id.
807 Id.
808 See Beer Letter; Beer 2 Letter; Lowenstein
Letter; Levene Letter; NIBA 2 Letter.
804 See
PO 00000
809 See
NIBA 2 Letter.
e.g., Third Party Expense Letter; see also
FINRA Notice to Members 03–6, Expense Sharing
Agreements.
811 17 CFR 240.17a–3; 17 CFR 240.17a–4.
812 17 CFR 240.17a–3(a)(2).
813 See Beer Letter; Beer 2 Letter; Lowenstein
Letter; Levene Letter; NIBA 2 Letter.
814 See Levene Letter.
815 See NIBA 2 Letter.
816 See, e.g., Third Party Expense Letter; see also
FINRA Notice to Members 03–6, Expense Sharing
Agreements.
810 See,
799 Id.
801 See
substantially as proposed. In response to
the comment regarding the unrealistic
cost of capital,809 the Commission has
increased the cost of capital to 12% as
an average cost of equity capital for
broker-dealers. As discussed in section
II.E.1 of this release, the baseline of this
amendment is current Rule 15c3–1 and
existing guidance and interpretations.
The Commission staff has provided
guidance with respect to the treatment
and recording of certain broker-dealer
expenses and liabilities that is
consistent with the rule amendment.810
Existing broker-dealer recordkeeping
rules require a broker-dealer to record
its income and expenses.811 For
example, paragraph (a)(2) of Rule 17a–
3 requires a broker-dealer to make and
keep current ledgers (or other records)
reflecting all assets and liabilities,
income and expense and capital
accounts.812 Consequently, as against
the current baseline, the above estimates
are intended to be conservative. The
Commission expects that broker-dealers
will incur costs to comply with this
amendment, including costs to obtain
additional capital, only to the extent
they are not currently complying with
existing guidance and interpretations.
In response to comments,813 the
Commission does not expect brokerdealers to incur significant costs to
comply with this amendment to the
extent that they are appropriately
recording their assets and liabilities
under current Commission rules and
interpretive guidance, because these
items will already appear on a brokerdealer’s balance sheet and be included
in its net capital computation.
Consequently, the rule amendment, as
adopted, should not: (1) Cause firms to
be classified as ‘‘a going concern;’’ 814
(2) cause firms to fail, dissolve, or
otherwise close; 815 (3) impose undue
burdens; or (4) present serious
implementation difficulties to firms
(small or large) if they are appropriately
recording their assets and liabilities
under current Commission rules and
interpretive guidance.816 Further, as
stated above, the estimates are intended
to be conservative, and therefore, the
Commission expects that the ‘‘true’’
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costs 817 that may be incurred by brokerdealers should be less than the
maximum estimated. Therefore, the
Commission does not believe a longer
time period for compliance or the
formation of a small broker-dealer
advisory cost committee is necessary.818
b. Requirement To Subtract From Net
Worth Certain Non-Permanent Capital
Contributions
(I). Summary of Amendments
As discussed in section II.E.2. of this
release, the amendment adds paragraph
(c)(2)(i)(G) to Rule 15c3–1, requiring a
broker-dealer to treat as a liability any
capital that is contributed under an
agreement giving the investor the option
to withdraw it. The rule, as adopted,
also requires that a broker-dealer treat as
a liability any capital contribution that
is withdrawn within a year of its
contribution unless the broker-dealer
receives permission in writing from its
DEA.819 The amendment to Rule 15c3–
1 is intended to assist investors and
regulators by requiring broker-dealers to
provide a more accurate picture of their
financial condition. This amendment
will help regulators react more quickly
if a broker-dealer experiences financial
difficulty and benefits customers of a
troubled broker-dealer as well as its
counterparties.
The Commission requested comment
on available metrics to quantify these
benefits and any other benefits a
commenter may identify. Commenters
were requested to identify sources of
empirical data that could be used for the
metrics they proposed. The Commission
did not receive any comments in
response to these requests.
(II). Baseline and Incremental Economic
Effects
As discussed in section II.E.2. of this
release, the baseline of this rule
amendment is current Rule 15c3–1 and
existing guidance and interpretations.
The Commission estimates that the
amendments requiring broker-dealers to
treat certain capital contributions as
liabilities should not result in
817 See
Beer 2 Letter.
NIBA 2 Letter.
819 One commenter suggested that the rule be
amended to explicitly exclude any withdrawals that
would fall under paragraph (e)(4)(iii) of Rule 15c3–
1. See American Bar Association Letter. It is
unnecessary to explicitly exclude any withdrawals
that would fall under paragraph (e)(4)(iii) of Rule
15c3–1 because these requirements will not apply
to withdrawals covered by paragraph (e)(4)(iii) of
Rule 15c3–1, namely, withdrawals used to make tax
payments or to pay reasonable compensation to
partners. 17 CFR 240.15c3–1(e)(4)(iii). These types
of payments are ordinary business expenditures and
do not raise the types of concerns the proposed rule
is designed to address. See Amendments to
Financial Responsibility Rules, 74 FR at12872, n.79.
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818 See
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significant incremental benefits and
costs, as compared to the baseline.
Because of existing Commission and
staff guidance regarding the permanency
of capital,820 broker-dealers typically do
not enter into agreements permitting an
owner to withdraw capital at any time.
To the extent some firms may have
engaged in this practice, they may need
to raise capital to meet the rule
requirement.
While the amendments apply to all
broker-dealers, they will impact only
the few broker-dealers that provide
investors with the option to withdraw
capital at any time or within one year.
Because of existing Commission and
staff interpretations related to temporary
capital contributions,821 most brokerdealers likely do not accept capital
contributions under agreements
permitting the investor to withdraw the
capital at any time or within one year.
Therefore, it is difficult to quantify the
cost impact of this rule amendment.
Based on staff experience with the
treatment of capital contributions and
the application of Rule 15c3–1, the
Commission estimates that no more
than $100 million in capital at brokerdealers is subject to such agreements.822
Further, with regard to the treatment of
temporary capital contributions, in the
proposing release, the Commission
assumed an incremental cost of capital
of 2.5%,823 and estimated that the
amendment would result in an annual
cost of approximately $2.5 million.824
The Commission requested comment
on the proposed cost estimates. In
particular, the Commission requested
comment on additional costs to brokerdealers that would arise from the
proposals. The Commission also
requested comment on whether these
proposals would impose costs on other
market participants, including brokerdealer customers. Commenters were
also asked to identify the metrics and
sources of any empirical data that
support their costs estimates.
820 See Net Capital Rule, Exchange Act Release
No. 28927 (Feb. 28, 1991). See also Net Capital
Requirements for Brokers and Dealers Exchange Act
Release No. 18417 (Jan. 13, 1982), 47 FR 3512 (Jan.
25, 1982). See also Temporary Capital Letter; Study
of Unsafe and Unsound Practices of Broker-Dealers,
Report and Recommendations of the Securities and
Exchange Commission, H.R. Doc. No. 92–231 (1971)
(recommending improvement of adequacy and
permanency of capital); and Letter from Nelson
Kibler, Assistant Director, Division of Market
Regulation to John Pinto, National Association of
Securities Dealers, Inc. (Sept. 8, 1980).
821 See Net Capital Rule, Exchange Act Release
No. 28927 (Feb. 28, 1991), 56 FR 9124 (Mar. 5,
1991); and Temporary Capital Letter.
822 See Amendments to Financial Responsibility
Rules, 72 FR at 12885.
823 Id. at 12886–12887.
824 $100,000,000 × 2.5% = $2,500,000.
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51889
The Commission received three
comments.825 One commenter stated
that the Commission’s estimate that no
more than $100 million of capital at
broker-dealers is subject to agreements
permitting an owner to withdraw capital
at any time greatly underestimates the
impact of the proposed rule.826 The
commenter stated that the Commission
makes no case for deviating from the
already established standards.827
Another commenter believed that the
proposal would raise its cost of capital
to such an extent that it would be
impossible for the firm to raise capital
from unrelated third parties.828
One commenter stated that the
Commission’s estimate of a gross cost of
capital of 7.5% (5% + 2.5%) is a totally
unrealistic cost of capital for small
broker-dealers and that these brokerdealers will categorically have costs
significantly higher than 7.5%.829
Finally, the commenter stated that, until
the Commission convenes a small
broker-dealer representative panel to
assist it with establishing such costs, the
Commission is ‘‘speculating’’ on such
costs, and is therefore without adequate
information to consider the effects of
such costs and changes on small
firms.830
In response to comments,831 the
Commission is revising this estimate in
the final rule to an estimated cost of
capital of approximately 12%, which is
determined as the average cost of equity
capital of broker-dealers using the
CAPM. The overall estimated cost of
capital is not incremental to the
amendment discussed above regarding
third party liabilities. The estimated
cost of capital would be 12% for a
broker-dealer seeking additional equity
capital. Therefore, with regard to the
treatment of temporary capital
contributions, the Commission
estimates the amendment will result in
an annual cost of approximately $12.0
million,832 which is an increased
estimate relative to the proposing
release. For the broker-dealers to whom
this increased estimate applies, and who
may not be complying with the rule
amendments, the Commission expects
that there would be greater costs
imposed. However, the Commission
expects that the benefits outlined above
825 See Chicago Capital Management Letter; SIG
Letter; NIBA 2 Letter.
826 See SIG Letter.
827 Id.
828 See Chicago Capital Management Letter.
829 See NIBA 2 Letter.
830 Id.
831 See NIBA 2 Letter.
832 $100,000,000 × 12.25% = $12,250,000.
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would also accrue to the customers of
these broker-dealers.833
(III). Alternatives
The Commission considered all
comments discussed above and the
alternative of not adopting the rule, and
decided to adopt the amendments
substantially as proposed. In response to
commenters’ concerns about the impact
on capital and the $100 million
estimate,834 as discussed above, the
final rule amendment is a codification
of existing Commission staff
guidance,835 and thus should not
represent a change for broker-dealers
with respect to capital withdrawals.
Moreover, with respect to commenters’
concerns about obtaining capital,836 the
rule does not prohibit an investor from
withdrawing capital at any time. Rather,
it prohibits a broker-dealer from treating
temporary cash infusions as capital for
purposes of the net capital rule. Finally,
the final rule amendment provides a
mechanism for a broker-dealer to apply
to its DEA to make a withdrawal within
one year of the capital contribution
without triggering the deduction under
certain circumstances.
In the final rule, the Commission has
increased the estimated cost of capital
from 2.5% to 12%, in response to
comments regarding the unrealistic cost
of capital, and because the estimated
cost of capital is not incremental to the
estimated cost of capital to the
amendment to Rule 15c3–1 regarding
third party liabilities.837 The estimated
cost of capital would be 12% for a
broker-dealer seeking a loan for any
additional capital. In addition, based on
staff experience with the treatment of
capital contributions and for the reasons
discussed above, the Commission
continues to believe that the estimate of
$100 million regarding the temporary
capital contributions is reasonable.838
Further, the final rule amendments
relating to temporary capital
contributions have been revised to
clarify that a withdrawal of capital made
within one year of its contribution to the
broker-dealer is deemed to have been
intended to be withdrawn within one
year, unless the withdrawal has been
approved in writing by the brokerdealer’s DEA.839 The Commission made
this change to eliminate a potential
× 12.25% = $12,250,000.
Chicago Capital Management Letter; SIG
Letter; NIBA 2 Letter.
835 See Temporary Capital Letter. See also section
II.E.2. of this release.
836 See Chicago Capital Management Letter; SIG
Letter; NIBA 2 Letter.
837 See NIBA 2 Letter.
838 See SIG Letter.
839 See section II.E.2. of this release.
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833 $100,000,000
834 See
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ambiguity as to whether a withdrawal of
capital within one year could ever be
approved by a broker-dealer’s DEA. The
final rule amendment clarifies the intent
to provide a mechanism for brokerdealers to apply for approval to
withdraw capital within one year and to
be granted such approval where
appropriate.
While owners of most broker-dealers
have the option of withdrawing capital,
most owners likely do not have
agreements that provide the option of
withdrawing capital at any time.840
Paragraph (e) of Rule 15c3–1 contains
mechanisms to permit a broker-dealer to
make capital withdrawals for specified
purposes.841 If there is a specific need
for a broker-dealer to seek permission to
make a capital withdrawal within one
year of contribution, the final rule
already provides a mechanism for the
broker-dealer to seek permission in
writing from its DEA to make such a
withdrawal.842 Based on the discussion
above, the Commission believes the
final cost estimates are appropriate.843
c. Requirement To Deduct the Amount
by Which a Fidelity Bond Exceeds SRO
Limits
As discussed in section II.E.3. of this
release, this amendment requires
broker-dealers to deduct from net
capital, with regard to fidelity bonding
requirements prescribed by a brokerdealer’s examining authority, the excess
of any deductible amount over the
amount permitted by SRO rules.
Under SRO rules, certain brokerdealers that do business with the public
or are required to become SIPC members
must comply with mandatory fidelity
bonding requirements.844 SRO rules
840 See
SIG Letter.
paragraphs (e)(1)(iii)(B) and (e)(4)(iii) of
Rule 15c3–1. See also Amendments to Financial
Responsibility Rules, 72 FR at 12872, n.79 (‘‘These
requirements would not apply to withdrawals
covered by paragraph (e)(4)(iii) of Rule 15c3–1,
namely, withdrawals used to make tax payments or
pay reasonable compensation to partners. These
types of payments are ordinary business
expenditures and do not raise the types of concerns
the proposed rule is designed to address.’’)
842 See paragraph (c)(2)(i)(G)(2) of Rule 15c3–1.
843 See NIBA 2 Letter.
844 See, e.g., FINRA Rule 4360, CBOE Rule 9.22,
and NASDAQ OMX PHLX Rule 705. SRO fidelity
bonding requirements typically contain agreements
covering the following areas: A ‘‘Fidelity’’ insuring
clause to indemnify against loss of property through
dishonest or fraudulent acts of employees; an ‘‘On
Premises’’ agreement insuring against losses
resulting from crimes such as burglary and theft and
from misplacement of property of the insured; an
‘‘In Transit’’ clause indemnifying against losses
occurring while property is in transit; a ‘‘Forgery
and Alteration’’ agreement insuring against loss due
to forgery or alteration of various kinds of
negotiable instruments; and a ‘‘Securities Loss’’
clause protecting against losses incurred through
forgery and alteration of securities. Id.
841 See
PO 00000
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typically permit a broker-dealer to have
a deductible provision included in the
bond; however, such rules provide that
the deductible must not exceed certain
amounts. With regard to firms that
maintain deductible amounts over
certain specified amounts, a number of
SRO rules provide that the broker-dealer
must deduct this specified amount from
net worth when calculating net capital
under Rule 15c3–1.845
Rule 15c3–1, however, does not
specifically reference the SRO
deductible requirements as a charge to
net worth, meaning that a broker-dealer
would not be required for the purposes
of Commission rules to show the impact
of the deduction in the net capital
computation required by an SRO on the
FOCUS Report.846 To address the
reporting inconsistency, the
Commission is amending Rule 15c3–1
to add paragraph (c)(2)(xiv), which will
require broker-dealers to deduct the
amount specified by rule of the
Examining Authority of the brokerdealer with respect to a requirement to
maintain fidelity bond coverage. This
rule amendment will provide
consistency in broker-dealer reporting
requirements.847
This amendment will also codify in a
Commission rule capital charges that
broker-dealers are currently required to
take pursuant to the rules of various
SROs. Consequently, any economic
effects, including costs and benefits,
should be compared to a baseline of
current practices. The amendment
should not impose additional costs on
broker-dealers with respect to the
purchasing or carrying of fidelity bond
coverage. Nor will the amendment cause
broker-dealers to incur additional costs
in determining or reporting excess
deductible amounts over the deductible
permitted. Broker-dealers already make
such determinations under SROs rules,
and the manner in which such excesses
are typically reported (i.e., through
periodic FOCUS Reports and other
reports) would remain the same.
The Commission received one
comment opposing the fidelity bond
amendment, stating that FINRA Rule
4360 and the Commission’s amendment
would result in a de facto increase in
minimum net capital requirements for
some broker-dealers.848 Any increase in
net capital cited by the commenter
845 See,
e.g., FINRA Rule 4360 and CBOE Rule
9.22.
846 See
17 CFR 240.17a–5.
not adopting this rule amendment
would have resulted in continued inconsistency
among existing SRO rules and Rule 15c3–1.
848 See NIBA 2 Letter.
847 Conversely,
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would result from existing SRO rules.849
Stated differently, broker-dealers that
are members of an SRO with such a
fidelity bonding rule must already
account for the deduction in complying
with the net capital requirements of
SROs and nothing in the Commission’s
amendment to paragraph (c)(2)(xiv) of
Rule 15c3–1 would alter this status quo.
Consequently, while there is currently
no deduction required under the
baseline of current Rule 15c3–1 relating
to fidelity bond deductibles, because
SRO rules currently require this
deduction, the adoption of this
amendment under Rule 15c3–1 should
not impose any additional costs on
broker-dealers that they are not already
incurring under existing SRO rules.
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d. Broker-Dealer Solvency Requirement
As discussed in section II.E.4., the
amendment to paragraph (a) of Rule
15c3–1 states that no broker-dealer shall
be ‘‘insolvent’’ as that term is defined
under paragraph (c)(16) of the rule. The
companion amendment to paragraph
(b)(1) of Rule 17a–11 requires insolvent
broker-dealers to provide notice to
regulatory authorities.
Allowing an insolvent broker-dealer
to continue conducting a securities
business during the period of its
insolvency, notwithstanding its net
capital position, could jeopardize
customers and other market participants
because a broker-dealer that has made
an admission of insolvency, or is
otherwise deemed insolvent or entitled
to protection from creditors, does not
possess the financial resources
necessary to operate a securities
business. Continuing to operate in such
circumstances poses a significant credit
risk to counterparties and to the
clearance and settlement system, and, in
the event the firm ends up in a
liquidation proceeding under SIPA, may
impair the ability of the SIPA trustee to
make the customers of the broker-dealer
whole and satisfy the claims of other
creditors out of the assets of the general
estate.850
Consequently, the amendment to Rule
15c3–1 benefits the securities markets,
849 For example, the Commission approved
FINRA Rule 4360 through the SRO rule filing
process. See Order Approving Proposed Rule
Change to Adopt FINRA Rule 4360 (Fidelity Bonds)
in the Consolidated FINRA Rulebook, Exchange Act
Release No. 63961 (Feb. 24, 2011), 76 FR 11542
(Mar. 2, 2011). Pursuant to Section 19(b)(1) of the
Exchange Act, each SRO must file with the
Commission any proposed change in, addition to,
or deletion from the rules of the exchange
electronically on a Form 19b–4 through the
Electronic Form 19b–4 Filing System, which is a
secure Web site operated by the Commission. 15
U.S.C. 78s(b)(1) and 17 CFR 240.19b–4.
850 See Amendments to Financial Responsibility
Rules, 72 FR at 12872.
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and indirectly, all other market
participants, by removing risks
associated with the continued operation
of a financially unstable firm. For
example, the amendment will limit the
potential that an insolvent firm would
take on new customers and place their
assets at risk. Furthermore, the brokerdealer will not be able to enter into
proprietary transactions with other
broker-dealers and place them or
clearing agencies at further risk of
counterparty default. The brokerdealer’s existing customers also will
benefit from preservation of any
remaining capital of the firm, which
could be used to facilitate an orderly
liquidation.
The amendment to Rule 17a-11 also
benefits the securities markets in that it
will provide regulators with the
opportunity to more quickly take steps
to protect customers and counterparties
at the onset of the insolvency,
including, if appropriate, notifying SIPC
of the need to commence a SIPA
liquidation.
The baseline for this proposed
amendment is current Rules 15c3–1 and
17a–11, which currently do not contain
requirements to cease conducting a
securities business (or to notify the
Commission) if certain insolvency
events were to occur. The amendments
generally will have no impact on brokerdealers when compared to the current
baseline. Should a broker-dealer become
subject to an insolvency proceeding, it
will incur the cost of sending notice of
that fact to the Commission and its DEA.
The Commission estimated in the PRA
that it will occur approximately two 851
times a year for all broker-dealers.852
For these reasons, the Commission
estimates that any costs arising from this
amendment will be de minimis.
One commenter stated that
involuntary bankruptcy proceedings do
not necessarily indicate that the brokerdealer is insolvent, as such proceedings
can be frivolous, malicious, or otherwise
lacking in merit, and noted standard
industry forms generally provide a grace
period for a party to such a proceeding
to obtain a stay or dismissal before an
event of default is deemed to have
occurred. The Commission considered
this alternative approach and notes that
851 This estimate is based on the 2012 SIPC
Annual Report, which indicates that over the last
ten year-period, the annual average of new
customer protection proceedings was three. A copy
of the 2012 Annual Report is available at https://
www.sipc.org/.
852 The internal hours would likely be performed
by a compliance clerk. Therefore, the estimated
internal costs for this hour burden would be
calculated as follows: Compliance Clerk at $63 per
hour × 20 minutes = $21.00. See section IV.D.8. of
this release.
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if a firm believes that it is the subject of
an unwarranted involuntary bankruptcy
proceeding and that its case will not be
dismissed within the 30 day timeframe,
as is the case with existing net capital
requirements, pursuant to Rule 15c3–
1(b)(3), the Commission may, upon
written application, exempt the brokerdealer from the requirement.
In addition, one commenter objected
to the amendments as unnecessary,
citing the Rule 15c3–1 prohibition on
broker-dealers effecting securities
transactions if their net capital is below
certain minimums.853 The commenter
stated that the net capital of an
insolvent broker-dealer would, by
definition, be below those
minimums.854 The Commission
considered the commenter’s view and
the alternative of not adopting the
amendments. The purpose of the
amendment is to address cases where
the broker-dealer is subject to an
insolvency event but maintains that it is
in compliance with the net capital rule.
Therefore, the Commission is adopting
this amendment, because, while such
instances may be rare, an insolvent
broker-dealer could seek the protection
of the bankruptcy laws but continue to
effect transactions with the public,
potentially jeopardizing customers and
other creditors of the broker-dealer,
including counterparties.
As noted above, the Commission
requested comment on this cost
estimate. In particular, the Commission
requested comment on whether there
would be costs to broker-dealers as a
consequence of the proposal. The
Commission also requested comment on
whether this proposal would impose
costs on other market participants,
including broker-dealer customers.
Commenters were asked to identify the
metrics and sources of any empirical
data that supported their costs
estimates. The Commission did not
receive any comments in response to
these requests.
e. Amendment To Rule Governing
Restrictions of Withdrawals of Capital
As discussed in section II.E.5. of this
release, paragraph (e) of Rule 15c3–1,
which places certain conditions on a
broker-dealer when withdrawing
capital,855 also allows the Commission
to issue an order temporarily restricting
a broker-dealer from withdrawing
capital or making loans or advances to
stockholders, insiders, and affiliates
853 See
St. Bernard Financial Services Letter.
854 Id.
855 See
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under certain circumstances.856 The
rule, however, limits such orders to
withdrawals, advances, or loans that,
when aggregated with all other
withdrawals, advances, or loans on a net
basis during a 30 calendar day period,
exceed 30% of the firm’s excess net
capital.857
The Commission has determined that
the requirement is difficult to enforce,
as it generally would not be clear when
the 30% threshold had been reached,
due to the inherent unreliability of a
troubled broker-dealer’s books and
records. The Commission considered
retaining the 30% threshold, but
determined that a more appropriate
approach would be to eliminate the
30% threshold requirement from the
rule, rather than retain a provision that
is difficult to enforce. Consequently, the
Commission proposed, and is adopting,
a change to delete this provision and
instead to allow the Commission to
restrict all withdrawals, advances, and
loans so long as the other conditions
under the rule (all of which remain
unchanged) were met.
The amendment to paragraph (e) of
Rule 15c3–1 benefits the securities
markets by protecting customers and
counterparties of a financially stressed
broker-dealer. For example, by
prohibiting unsecured loans to a
stockholder or withdrawal of equity
capital while the order is outstanding,
the amendment will help to preserve the
assets and liquidity of the broker-dealer
and enable the Commission and its staff,
as well as other regulators, to examine
the broker-dealer’s financial condition,
net capital position, and the risk
exposure to the customers and creditors
of the broker-dealer.
The current rule permitting the
Commission to restrict withdrawals of
capital from a financially distressed
broker-dealer was adopted in 1991.858
This rule is the baseline for purposes of
this economic analysis. When the
Commission adopted this paragraph of
Rule 15c3–1 more than twenty years
ago, the Commission stated that it was
intended to be an emergency provision,
applicable only to the most exigent of
circumstances where the continued
viability of the broker-dealer appears to
be at stake.859 In the ensuing years, the
Commission has only utilized this
provision one time.860 Based on this
856 See
17 CFR 240.15c3–1(e)(3).
857 Id.
858 See Net Capital Rule, Exchange Act Release
No. 28927 (Feb. 28, 1991), 56 FR 9124 (Mar. 5,
1991).
859 Net Capital Rule, Exchange Act Release No.
28927, 56 FR 9124, 9128.
860 Order Regarding Withdrawals, Unsecured
Loans or Advances from Refco Securities, LLC and
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experience with the rule, and the fact
that the rule is intended as an
emergency provision only, as compared
to the current baseline, the Commission
estimates that the amendment will
result in no or de minimis costs to
broker-dealers.
As noted above, the Commission
requested comment on this cost
estimate. The Commission also
requested comment on whether the
proposal would impose costs on other
market participants. Commenters were
asked to identify the metrics and
sources of any empirical data that
support their cost estimates. One
commenter supported the amendment
but believed that the rule is intended to
protect the capitalization of large firms
while ignoring small firms, and
proposed that the Commission state all
the conditions that need to exist for a
firm to withdraw, repay or redeem any
amount that does not endanger the firm
or its customers.861 The commenter also
stated that it opposes regulation that
arbitrarily reduces the value of small
broker-dealers and their competitive
position relative to larger broker-dealers.
A second commenter noted that the
proposed amendment would impose
additional compliance burdens on
broker-dealers and would significantly
limit broker-dealers’ flexibility in the
event of a liquidity crisis.862
In adopting the final rule, the
Commission considered the alternatives
and modifications suggested by
commenters. In response to these
comments, the Commission notes that
the amendment would eliminate the
30% threshold from paragraph (e)(3)(i)
of Rule 15c3–1, which relates to the
Commission’s authority to temporarily
restrict withdrawals of net capital. It
cannot impose these restrictions
without concluding that ‘‘such
withdrawal, advance or loan may be
detrimental to the financial integrity of
the broker or dealer, or may unduly
jeopardize the broker or dealer’s ability
to repay its customer claims or other
liabilities which may cause a significant
impact on the markets or expose the
customers or creditors of the broker or
dealer to loss without taking into
account the application of the Securities
Investor Protection Act of 1970.’’ 863
While paragraph (e)(3)(i) of Rule 15c3–
1 would apply to all broker-dealers, the
stringent conditions under which the
Commission may exert its authority
under the rule to temporarily restrict a
Refco Clearing, LLC, Exchange Act Release No.
52606 (Oct. 13, 2005).
861 See NIBA 2 Letter.
862 See Raymond James 2 Letter.
863 See 17 CFR 240.15c3–1(e)(3)(i).
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broker-dealer’s withdrawals of net
capital would apply to only the
circumstances where the continued
viability of the broker-dealer appears to
be at stake.864 The Commission,
however, agrees with the importance of
maintaining flexibility in the context of
ordering restrictions on withdrawals,
advances, and loans. Therefore, the
Commission modified the amendment,
as adopted, to add language to
paragraph (e)(3)(i) to state (following the
phrase ‘‘employee or affiliate’’) that
such orders will be issued, ‘‘under such
terms and conditions as the Commission
deems necessary or appropriate in the
public interest or consistent with the
protection of investors . . . .’’ 865
In summary, the Commission does not
believe that the deletion of the 30%
threshold will affect the
competitiveness or unduly restrict the
ongoing business operations of small
broker-dealers as compared to larger
firms. All broker-dealers remain subject
to the other notice and withdrawal
limitations on equity capital set forth in
paragraphs (e)(1) and (e)(2) of Rule
15c3–1, which are not the subject of this
rule amendment.
f. Amendment to Rule 15c3–1
Appendix A
As discussed in section II.E.6.i. of this
release, the amendment to paragraph
(b)(1)(vi) of Rule 15c3–1a will make
permanent the reduced net capital
requirements that apply to listed option
positions in major market foreign
currencies and high-capitalization and
non-high-capitalization diversified
indexes in non-clearing option
specialist and market maker accounts.
This change will benefit the brokerdealers that have been calculating
charges under a temporary amendment
the Commission originally adopted in
1997.866 The temporary amendment
expired on September 1, 1997, subject to
extension.867 The Commission staff
subsequently issued a no-action letter
on January 13, 2000, which stated that
the staff would not recommend
enforcement action if broker-dealers
continued to rely on the temporary
amendment.868 The Commission
864 Net Capital Rule, Exchange Act Release No.
28927, 56 FR 9124, 9128.
865 See paragraph (e) of Rule 17a–3, as adopted.
See generally, 15 U.S.C. 78mm(a)(1).
866 See Net Capital Rule, Exchange Act Release
No. 38248 (Feb. 6, 1997), 62 FR 6474 (Feb. 12,
1997).
867 See 17 CFR 15c3–1a(b)(1)(iv)(B).
868 Letter from Michael Macchiaroli, Associate
Director, Division of Market Regulation,
Commission, to Richard Lewandowski, Vice
President, Regulatory Division, The Chicago Board
Options Exchange, Inc. (Jan. 13, 2000) (stating that
the Division of Trading and Markets ‘‘will not
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considered whether to keep the
amendment temporary but determined
that making the temporary amendment
permanent, as proposed, was the more
appropriate alternative because it
creates certainty for broker-dealers
relying on the rule.
Because this amendment seeks to
match capital requirements with actual
risks, it should not have an adverse
impact on the financial strength of
broker-dealers. Moreover, because
broker-dealers are already operating
under the temporary relief, which is the
current baseline, the amendment should
not result in any costs for broker-dealers
as compared to the current baseline.
The Commission requested comment
on available metrics to quantify the
benefits identified above and any other
benefits the commenter may identify. In
addition, the Commission requested
comment on whether the proposal
would result in any costs. Commenters
were asked to identify the metrics and
sources of any empirical data that
support their cost estimates. The
Commission did not receive any
comments in response to these requests.
ii. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
Rule 15c3–1 is designed to help
ensure that a broker-dealer holds at all
times liquid assets sufficient to pay its
non-subordinated liabilities and retain a
‘‘cushion’’ of liquid assets used to pay
customers without delay in the event
that the broker-dealer fails. For example,
a broker-dealer that inappropriately
excludes certain liabilities when
presenting its financial position 869 or
includes non-permanent capital
contributions in its financial
statements 870 distorts the view of the
firm’s financial condition and
undermines the rule. In either event,
such practices jeopardize the brokerdealer’s ability to self-liquidate and
promptly pay customers.
The Commission’s experience with
the broker-dealer financial
responsibility rules, underscored by the
2008 financial crisis, highlights the
effects that the failure of a broker-dealer,
particularly a large carrying brokerdealer, could have on customers and
other market participants. Losses
resulting from the disorderly winding
recommend . . . enforcement action if non-clearing
option specialists and market-makers continue to
rely on subparagraph (b)(1)(iv) of Appendix A to
Rule 15c3–1 under the Exchange Act until such
time as the Commission has determined whether it
should be extended’’).
869 See section II.E.1. of this release.
870 See section II.E.2. of this release.
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down of a broker-dealer may often
undermine the participation of investors
in the U.S. capital markets, with
possible negative effects on capital
formation and market efficiency. Thus,
it is imperative that broker-dealers
operate in compliance with Rule 15c3–
1 and that the Commission takes the
necessary steps to help ensure that
broker-dealers are prohibited from
engaging in practices that obscure
noncompliance.
The amendments to Rule 15c3–1 are
designed to reduce the risk of a
disorderly failure of a broker-dealer and
lessen the potential that market
participants may seek to rapidly
withdraw assets and financing from
broker-dealers during a time of market
stress. These Rule 15c3–1 amendments
may affect efficiency and capital
formation through their positive impact
on competition among broker-dealers.
Specifically, markets that are
competitive can, all other things equal,
be expected to promote an efficient
allocation of capital.871
The amendments to Rule 15c3–1—(1)
Requiring a broker-dealer to account for
certain liabilities or treat certain capital
contributions as liabilities,872 (2)
requiring a broker-dealer to deduct
certain fidelity bond deductibles,873 (3)
requiring an insolvent broker-dealer to
cease conducting a securities business
and provide notice under the
amendment to Rule 17a–11,874 (4)
eliminating the qualification on
Commission orders restricting
withdrawals, advances, and unsecured
loans to instances where recent
withdrawals, advances or loans, in the
aggregate, exceed 30% of the brokerdealer’s excess net capital,875 and (5)
making permanent the reduced net
capital requirements under Appendix A
for market makers 876—are consistent
with promoting efficiency, competition,
and capital formation in the market
place.
First, a broker-dealer that fails to
include liabilities that depend on the
broker-dealer’s assets and revenues and
accepts temporary capital contributions
is obscuring its true financial condition.
This also interferes with the process by
which regulators monitor the financial
condition of broker-dealers and,
871 See Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and
Major Security-Based Swap Participants and
Capital Requirements for Broker-Dealers, Exchange
Act Release No. 68071 (Oct. 18, 2012), 77 FR 70213,
70315 (Nov. 23, 2012).
872 See sections II.E.1. and 2. of this release.
873 See section II.E.3. of this release.
874 See section II.E.4. of this release.
875 See section II.E.5. of this release.
876 See section II.E.6.i. of this release.
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51893
thereby, impedes their ability to take
proactive steps to minimize the harm
resulting from a broker-dealer failure to
customers, counterparties, and clearing
agencies.
Second, requiring broker-dealers to
take net capital charges for excess
fidelity bond deductibles imposed
under SRO rules will promote efficiency
by providing consistency among Rule
15c3–1 and SRO rules. Because fidelity
bond requirements provide a safeguard
with regard to broker-dealer financial
responsibility, the amendment will
enhance competition through the
operation of more financially sound
firms.
Third, the continued operation of an
insolvent broker-dealer or the
withdrawal of capital from a brokerdealer that may jeopardize such brokerdealer’s financial integrity poses
financial risk to its customers,
counterparties, and the registered
clearing agencies. These risks increase
costs and decrease efficiency of the
marketplace.
Fourth, the elimination of the
limitation on Commission orders
restricting capital withdrawals under
paragraph (e)(3) of Rule 15c3–1 from a
financially troubled broker-dealer will
provide greater protection to customers
and counterparties of the firm and
registered clearing agencies. While such
orders are expected to be infrequent,
when issued they should lower costs to
these entities associated with having an
outstanding obligation from the troubled
broker-dealer, thereby promoting
efficiency and facilitating capital
formation.
One commenter expressed concern
that the proposed amendments to Rule
15c3–1 would be particularly
burdensome on small broker-dealers,
negatively impacting capital formation
for small issuers and increasing the cost
of capital for small broker-dealers.877
For example, the commenter stated that
it believed that the proposed changes
requiring a broker-dealer to subtract
from net worth certain non-permanent
capital contributions and to deduct from
net worth certain liabilities or expenses
assumed by third parties would
negatively impact capital formation for
small issuers and increase the cost of
capital for small broker-dealers.878
While the Commission is cognizant
that the Rule 15c3–1 amendments may
impose burdens on broker-dealers,
including non-carrying broker-dealers,
the commenter is treating the
amendments as entirely new additions
to the net capital rule. Yet, as discussed
877 See
NIBA 2 Letter.
878 Id.
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in section II.E. of this release, the
Commission has emphasized that
capital contributions to broker-dealers
should not be temporary. Further, the
Commission staff has explained that a
capital contribution should be treated as
a liability if it is made with the
understanding that such contribution
can be withdrawn at the option of the
investor.879 Based on the Commission’s
experience with the application of Rule
15c3–1, the majority of broker-dealers
operate consistent with past
Commission and staff rules and
guidance regarding the nature of capital
and, thus, the Rule 15c3–1 amendments
should not represent a substantial
change for most broker-dealers.
Therefore, the final rule should not
negatively impact capital formation for
small issuers, nor increase the cost of
capital for small broker-dealers, to the
extent that these firms already comply
with current guidance and
interpretations.880 For those firms that
will need to raise capital to comply with
the amendments to Rule 15c3–1, the
rule amendments potentially may
negatively impact capital formation.
However, the potential costs to some
broker-dealers could be offset by the
aggregate increase in capital formation
related to heightened confidence in
broker-dealer financial requirements.
Finally, the Commission recognizes
that, as discussed above, the
amendments to Rule 15c3–3 adopted
today impose certain costs on brokerdealers that could affect competition
among broker-dealers. However, the
Commission is of the opinion that these
costs are justified by the significant
benefits described in this economic
analysis. In sum, the costs of
compliance resulting from the
requirements in the amendments to
Rule 15c3–3 should not impose a
burden on competition not necessary or
appropriate in furtherance of the
purposes of the Exchange Act in light of
the benefits discussed above.
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VI. Final Regulatory Flexibility
Analysis
The Commission proposed
amendments to Rules 15c3–1, 15c3–1a,
15c3–2, 15c3–3, 15c3–3a, 17a–3, 17a–4,
and 17a–11 under the Exchange Act. An
Initial Regulatory Flexibility Analysis
(‘‘IRFA’’) was included in the proposing
release.881 This Final Regulatory
Flexibility Analysis (‘‘FRFA’’) has been
879 See
section II.E.2. of this release.
NIBA 2 Letter.
881 See Amendments to Financial Responsibility
Rules, 72 FR 12862.
880 See
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prepared in accordance with the
provisions of the RFA.882
The Commission requested comment
with regard to matters discussed in the
IRFA, including comments with respect
to the number of small entities that may
be affected by the proposed rule
amendments.883 The Commission also
requested that commenters specify the
costs of compliance with the proposed
amendments, and suggest alternatives
that would accomplish the goals of the
amendments.884 The Commission
received one general comment on the
IRFA.885 In addition, the Commission
received a number of comments
regarding the impact on small entities
with respect to specific aspects of the
proposed rule amendments, including
comments relating to amendments
under Rule 15c3–3 with respect to
where special reserve deposits may be
held, and amendments under Rule
15c3–1 relating to the requirement to
subtract from net worth certain
liabilities or expenses assumed by third
parties.886 The general comment on the
IRFA is discussed directly below. The
specific comments are discussed in the
applicable sections below.
A. General Issues Raised by Public
Comments
The commenter stated that the
Commission should pay ‘‘explicit
attention to regulatory trends in the rest
of the world’’ because doing so ‘‘benefits
not only small entities (by reducing
their regulatory burden) but all entities,
as larger entities can experience more
consistent regulatory procedures around
the world.’’ 887 The commenter
suggested that the Commission consider
a ‘‘Basel II type approach to net capital
requirements.’’ 888 In response to the
commenter, the Commission notes that
the amendments relate to discrete areas
of the broker-dealer financial
responsibility rules (i.e., they do not
establish new financial responsibility
standards such as would be the case if
the Commission were to adopt a ‘‘Basel
II type approach to net capital
requirements.’’). As noted above, the
commenter’s suggestion is beyond the
scope of this rulemaking.889
882 5
U.S.C. 604(a).
Amendments to Financial Responsibility
Rules, 72 FR at 12888.
884 Id.
885 See Angel Letter.
886 These comments are discussed in the
applicable section below.
887 See Angel Letter.
888 Id.
889 The commenter cited the JP Morgan Letter in
support of the suggestion to ‘‘consider regulatory
trends in the rest of the world.’’ Id. The JP Morgan
Letter recommends that the Commission adopt a
due diligence standard—citing a U.K. regulation—
883 See
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B. Amendments to the Customer
Protection Rule
1. Need for and Objectives of the Rule
Amendments
The final rule amends certain
provisions of Rule 15c3–3.890 The
amendment that requires broker-dealers
to perform a PAB reserve computation
is designed to address a disparity
between Rule 15c3–3 and the SIPA, and
to incorporate provisions of the PAIB
Letter into Commission rules.891 The
amendment that will require brokerdealers to exclude cash deposited at an
affiliated bank and cash deposited with
an unaffiliated bank to the extent that
the amount exceeds 15% of the bank’s
equity capital from being used to meet
a broker-dealer’s reserve requirements is
designed to avoid the situation where a
carrying broker-dealer’s cash deposits
constitute a substantial portion of the
bank’s deposits.892 The amendment that
will require broker-dealers to obtain
possession and control of customers’
fully paid and excess margin securities
allocated to a short position is designed
to address the fact that Rule 15c3–3
currently permits a broker-dealer to
monetize customer securities, which is
contrary to the customer protection
goals of Rule 15c3–3, which seeks to
ensure that broker-dealer’s do not use
customer assets for proprietary
purposes.893 The amendment that will
require broker-dealers to provide certain
notices and disclosures before changing
the terms and conditions under which
the broker-dealer treats customer free
credit balances is intended to help
ensure that the use of customer free
credit balances accords with customer
preferences.894 The importation of
certain provisions of Rule 15c3–2 into
Rule 15c3–3 streamlines the customer
protection rules and eliminates
irrelevant provisions in Rule 15c3–2
due to Rule 15c3–3.895 The amendments
clarifying that funds in certain
commodities accounts are not to be
treated as free credit balances or other
credit balances are intended to remove
uncertainty with respect to their
treatment under Rule 15c3–3.896
The amendments to Rule 15c3–3 are
intended to strengthen the protections
afforded to customer assets held at a
with respect to the amendments regarding customer
reserve account cash deposits. See JP Morgan Letter.
The Commission addresses this comment above in
section V.D.1.i.b.(III) of this release.
890 17 CFR 240.15c3–3.
891 See section II.A.2. of this release.
892 See section II.A.3. of this release.
893 See section II.A.4. of this release.
894 See section II.A.5. of this release.
895 Id.
896 See section II.A.6. of this release.
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broker-dealer. The amendments are
designed to minimize the risk that
customer assets will be lost, tied-up in
a liquidation proceeding, or held in a
manner that is inconsistent with a
customer’s expectations.
2. Significant Issues Raised by Public
Comment
The Commission received numerous
comments with respect to the
amendment under paragraph (e)(5) of
Rule 15c3–3 that will require brokerdealers to exclude cash deposited at an
affiliated bank and cash deposited with
an unaffiliated bank to the extent that
the amount exceeds 15% of the bank’s
equity capital from being used to meet
a broker-dealer’s reserve
requirements.897 As proposed, new
paragraph (e)(5) of 15c3–3 would have
provided that, in determining whether a
broker-dealer maintains the minimum
reserve deposits required (customer and
PAB), the broker-dealer must exclude
any cash deposited at an affiliated bank.
In addition, the proposed amendment
would have required a broker-dealer to
also exclude cash deposited at an
unaffiliated bank to the extent the cash
deposited exceeds (1) 50% of the
broker-dealer’s excess net capital (based
on the broker-dealer’s most recently
filed FOCUS Report),898 or (2) 10% of
the bank’s equity capital (based on the
bank’s most recently filed Call Report or
Thrift Financial Report).899
With respect to the proposed limits on
the amounts that could be deposited in
unaffiliated banks, some commenters
argued that the percentages were too
restrictive while other commenters
suggested alternative approaches to the
proposed percentage limitations.900 One
commenter stated that the percentage
thresholds would negatively impact
smaller broker-dealers because these
firms would still be required under the
proposed rule to maintain at least two
reserve bank accounts at different
banks.901 This commenter noted that
limiting Rule 15c3–3 deposits at a single
bank to 50% of a broker-dealer’s excess
897 See
section II.A.3. of this release.
Rule 17a–5 broker-dealers must file
FOCUS Reports. 17 CFR 240.17a–5.
899 See Amendments to Financial Responsibility
Rules, 72 FR at 12864.
900 See Deutsche Bank Securities Letter; SIFMA 2
Letter; First Clearing Letter; ICI Letter; BlackRock
Letter.
901 See SIFMA 2 Letter (‘‘[T]he [percentage] tests
could prevent a smaller firm from maintaining
reserve account deposits at any single bank, even
though those deposits are relatively small compared
to the size of the bank—e.g., a broker-dealer with
excess net capital of $500,000 could not maintain
more than $250,000 in reserve account cash
deposits at any one bank, regardless of the ratio
between such bash deposits and the overall size or
equity capital of the bank.’’).
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898 Under
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net capital could impact 10 to 15% of
its broker-dealer customers in that many
of these customers would be required to
open accounts at multiple
institutions.902 This commenter
suggested the Commission consider
higher percentages for cash deposits at
large money-centered banks, since the
proposed percentage thresholds would
negatively impact small broker-dealers
because they would exceed the 50% of
excess net capital threshold at lower
deposit levels.903 This commenter also
noted that conducting due diligence and
opening new accounts and the ongoing
monitoring and periodic re-evaluation
of such additional accounts would
require much more time than the 10
hours originally estimated by the
Commission.904 A second commenter
concurred with this cost assessment,
stating that the Commission
significantly underestimated the cost of
the proposal to smaller firms.905
With respect to the use of qualified
securities to meet reserve requirements,
one commenter noted that brokerdealers will ‘‘likely have a significant
amount of additional operational and
transactional costs.’’ 906 The commenter
believes that ‘‘[w]hile larger brokerdealers may be able to reallocate
existing trading desk, operational,
regulatory reporting and treasury
functions to assist in ongoing
maintenance activities, midsized and
smaller broker-dealers may be required
to hire additional staff to manage and
maintain a securities portfolio.’’ 907
In response to commenters concerns,
the Commission has eliminated the
provision that would have excluded the
amount of a deposit that exceeds 50%
of the broker-dealer’s excess net capital.
After review of the comment letters, the
Commission believes that this provision
likely would have disproportionately
impacted small and mid-size brokerdealers when they deposited cash into
large commercial banks since they
would exceed the excess net capital
threshold well before exceeding the
bank equity capital threshold.908 The
bank equity capital threshold is the
more important metric since it relates
directly to the financial strength of the
bank, which is the entity holding the
902 Id.
903 Id.;
see also SIFMA 4 Letter.
SIFMA 2 Letter.
905 See NIBA 2 Letter.
906 See JP Morgan Letter.
907 Id. The commenter noted that managing pools
of qualified securities involves various tasks, such
as ‘‘monitoring income collection, redemption
processing, marking the securities to market,
collateral substitutions and collateral segregation
amongst other tasks.’’ Id.
908 See SIFMA 2 Letter; JP Morgan 2 Letter.
904 See
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account. In particular, if the carrying
broker-dealer’s deposit constitutes a
substantial portion of the bank’s total
deposits, the bank may not have the
liquidity to quickly return the deposit to
the broker-dealer. The elimination of the
excess net capital threshold should
mitigate concerns expressed by small
broker-dealers that they would need to
open multiple bank accounts to make
cash deposits or hire additional staff, if
they sought to deposit qualified
securities in a reserve account in order
to avoid opening multiple accounts.
This is because the excess net capital
threshold likely would have impacted
smaller broker-dealers, which—
consistent with their size—maintain less
net capital than larger firms.
Second, with respect to the bank
equity capital threshold, in response to
comments, the Commission has
increased the trigger level from 10% to
15% of the bank’s equity capital. The
increase of the threshold to 15% is
designed to address concerns raised by
commenters that the proposed
percentage tests were unduly restrictive
in certain respects and should be
modified, particularly with respect to
large broker-dealers with large deposit
requirements. Consequently, the
increase from 10% to 15% is designed
to mitigate commenters concerns that
the 10% threshold would require
broker-dealers to spread out deposits
over an excessive number of banks,
while still providing adequate
protection against undue concentrations
of deposits, particularly where smaller
banks are concerned.
The elimination of the 50% of excess
net capital threshold and increase of the
bank capital threshold from 10% to 15%
is designed to appropriately address
concerns raised by commenters that
they would have to substantially alter
their current cash deposit practices in
light of the goal of the rule to promote
the broker-dealer’s ability to have quick
access to the deposit.
With the elimination of the brokerdealer excess net capital threshold, and
the increase in the bank equity capital
threshold, it is likely that very few
broker-dealers (including small brokerdealers) would be required to maintain
reserve accounts at multiple banks,
unless they chose to do so for
operational, business or other reasons.
Therefore for the reasons discussed
above, as adopted, paragraph (e)(5) of
Rule 15c3–3, should not significantly
impact a substantial number of small
entities.
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3. Small Entities Subject to the Rule
Paragraph (c)(1) of Rule 0–10 909 states
that the term small business or small
organization, when referring to a brokerdealer, means a broker or dealer that
had total capital (net worth plus
subordinated liabilities) of less than
$500,000 on the date in the prior fiscal
year as of which its audited financial
statements were prepared pursuant to
Rule 17a–5(d); 910 and is not affiliated
with any person (other than a natural
person) that is not a small business or
small organization.
Based on FOCUS Report data, as of
December 31, 2011, the Commission
estimates there are approximately 5
broker-dealers that performed a
customer reserve computation pursuant
to Rule 15c3–3 and were ‘‘small’’ for the
purposes Rule 0–10.
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4. Reporting, Recordkeeping, and Other
Compliance Requirements
The amendments (1) Require brokerdealers to perform a PAB reserve
computation, (2) limit the amount that
a broker-dealer may deposit in a reserve
account at any individual bank in the
form of cash, (3) require broker-dealers
to obtain possession and control of
customers’ fully paid and excess margin
securities allocated to a short position
by borrowing equivalent securities or
through other means within a specified
period of time, and (4) require brokerdealers to obtain the written affirmative
consent of a new customer before
including a customer’s free credit
balances in a Sweep Program, as well as
provide certain disclosures and notices
to all customers with regard to the
broker-dealer’s Sweep Program.
5. Agency Action To Minimize Effect on
Small Entities
The RFA directs the Commission to
consider significant alternatives that
would accomplish the stated objectives,
while minimizing any significant
adverse impact on small entities. In
connection with adopting the final
rules, the Commission considered, as
alternatives, establishing different
compliance or reporting requirements
that take into account the resources
available to smaller entities, exempting
smaller entities from coverage of the
disclosure requirements, and clarifying,
consolidating, or simplifying disclosure
for small entities.911
As discussed above, the impact on
individual small broker-dealers, as well
as all small broker-dealers, should be
minimal, and thus the Commission is
CFR 240.0–10(c)(1).
CFR 240.17a–5(d).
911 5 U.S.C. 604(a)(5).
not establishing different compliance or
reporting requirements or timetables;
clarifying, consolidating, or simplifying
compliance and reporting requirements
under the rule for small entities; or
exempting small entities from coverage
of the rule, or any part thereof. The
amendments impose performance
standards and do not dictate for entities
of any size any particular design
standards (e.g., technology) that must be
employed to achieve the objectives of
the amendments.
4. Reporting, Recordkeeping, and Other
Compliance Requirements
C. Holding Futures Positions in a
Securities Portfolio Margining Account
5. Agency Action To Minimize Effect on
Small Entities
1. Need for and Objectives of the
Amendments
As stated above, the Commission does
not believe that any of the brokerdealers that will elect to offer portfolio
margining are ‘‘small’’ for purposes of
Rule 0–10. Further, the requirements
imposed by the portfolio margin
amendments will be elective. Therefore,
the Commission does not believe it is
necessary or appropriate to establish
different compliance or reporting
requirements or timetables; clarify,
consolidate, or simplify compliance and
reporting requirements under the rule
for small entities; or exempting small
entities from coverage of the rule, or any
part thereof. The amendments also
contain performance standards and do
not dictate for entities of any size any
particular design standards (e.g.,
technology) that must be employed to
achieve the objectives of the proposed
amendments.
The amendments to Rule 15c3–3 and
15c3–3a are designed to accommodate
futures positions in a securities account
that is margined on a portfolio basis.912
Under SRO portfolio margin rules, a
broker-dealer can combine securities
and futures positions in a portfolio
margin securities account to compute
margin requirements based on the net
market risk of all positions in the
account. The amendments to Rule 15c3–
3 and 15c3–3a complement the
amendments to SIPA in the Dodd-Frank
Act, as well as provide additional
protections to customers through the
strengthened reserve requirements of
Rule 15c3–3. In particular, the changes
will apply the protections in Rules
15c3–3 and Rule 15c3–3a to all
positions in a portfolio margin account.
These additional protections should
make portfolio margining more
attractive to investors. Portfolio
margining can significantly reduce
customer margin requirements for
offsetting positions involving securities
and futures products, which in turn
reduces the costs of trading such
products.
2. Significant Issues Raised by Public
Comments
The Commission did not receive any
specific comments with respect to this
portion of the IRFA.
3. Small Entities Subject to the Rules
As discussed above in section V.D.2.
of this release, based on FOCUS Report
data, as of December 31, 2011, the
Commission estimates that
approximately 35 broker-dealers will
elect to offer their customers portfolio
margin accounts that will include
futures and futures options. None of
these broker-dealers are ‘‘small’’ for
purposes of Rule 0–10.
These amendments (1) revise the
definition of free credit balances and
other credit balances in Rule 15c3–3 to
include funds in a portfolio margin
account relating to certain futures and
futures options positions, and (2) add a
debit line item to the customer reserve
formula in Rule 15c3–3a consisting of
margin posted by a broker-dealer to a
derivatives clearing organization.
D. Securities Lending and Borrowing
and Repurchase/Reverse Repurchase
Transactions
1. Need for and Objectives of the
Amendments
These rules amend subparagraph
(c)(2)(iv)(B) of Rule 15c3–3 to clarify
that broker-dealers providing securities
lending and borrowing settlement
services are deemed, for purposes of the
rule, to be acting as principals and are
subject to applicable capital deductions,
unless the broker-dealer takes certain
steps to disclaim principal liability.913
In addition, the Commission is adopting
paragraph (c)(5) to Rule 17a–11 to
require that a broker-dealer notify the
Commission whenever the total amount
of money payable against all securities
loaned or subject to a repurchase
agreement exceeds 2,500 percent of
tentative net capital.914 The final rule
also exempts a broker-dealer from this
17a–11 notice requirement if it reports
monthly its securities lending and
borrowing and repurchase and reverse
909 17
910 17
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912 See Amendments to Financial Responsibility
Rules, 72 FR at 12868–12870.
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913 See
section II.C. of this release.
914 Id.
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repurchase activity to its DEA in a form
acceptable to its DEA.
In 2001, MJK Clearing, a broker-dealer
with a substantial number of customer
accounts, failed when it could not meet
its securities lending obligations. This
failure has highlighted the risks
associated with securities lending and
repurchase and reverse repurchase
agreements and the need to manage
those risks. More specifically, two
concerns arose from the failure of MJK,
namely, (1) that broker-dealers with
principal liability in a stock loan
transaction may erroneously be
considering themselves as acting in an
agency capacity and, consequently, not
taking appropriate capital charges; and
(2) that broker-dealers that have
historically not been very active in stock
loan transactions may be rapidly
expanding their balance sheets with
such transactions, and thereby, increase
leverage to a level that poses significant
financial risk to the firm and its
counterparties.
These amendments are intended to
strengthen the documentation controls
broker-dealers employ to manage their
securities lending and borrowing and
securities repurchase and reverse
repurchase activities and to enhance
regulatory monitoring. The intended
result of the amendments is to avoid
ambiguity regarding the applicability of
the stock loan charges in the net capital
rule to a particular broker-dealer. As the
failure of MJK illustrated, disputes can
arise over whether a broker-dealer is
acting as a principal or agent in a stock
loan transaction.915
The amendments to paragraph (c)(5)
to Rule 17a–11 will help identify
broker-dealers with highly leveraged
non-government securities lending and
borrowing and repo operations and
make it easier for regulators to respond
more quickly and protect customers in
the event a firm is approaching
insolvency.916 This notice provision is
designed to alert regulators to a sudden
increase in a broker-dealer’s stock loan
and repo positions, which could
indicate that the broker-dealer is taking
on new risk that it may have limited
experience in managing, as well as to
help identify those broker-dealers
highly active in securities lending and
repos. Finally, the objective of the
exemption from the notice provision of
paragraph (c)(5) of Rule 17a–11 through
monthly reporting is designed to
accommodate large broker-dealers that
are active in this business and regularly
915 See, e.g., Nomura v. E*Trade, 280 F.Supp.2d
184 (S.D.N.Y. 2003).
916 17 CFR 240.17a–11(c)(5).
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maintain stock loan and repo balances
that exceed the threshold.
2. Significant Issues Raised by Public
Comments
The Commission did not receive any
specific comments with respect to this
portion of the IRFA.
3. Small Entities Subject to the Rule
Based on FOCUS Report data, as of
December 31, 2011, the Commission
estimates that none of the broker-dealers
that engage in securities lending and
borrowing or securities repurchase and
reverse repurchase activity are ‘‘small’’
for the purposes Rule 0–10. Therefore,
the amendments should not affect
‘‘small’’ broker-dealers.
4. Reporting, Recordkeeping, and Other
Compliance Requirements
These amendments require brokerdealers to (1) disclose the principals and
obtain certain agreements from the
principals in a transaction where they
provide settlement services in order to
be considered an agent (as opposed to
a principal) for the purposes of the net
capital rule, and (2) provide notice to
the Commission and other regulatory
authorities if the broker-dealer’s
securities lending or repo activity
reaches a certain threshold or,
alternatively, report monthly the brokerdealer’s securities lending and repo
activity to the broker-dealer’s DEA, in a
form acceptable to the DEA.
5. Agency Action To Minimize Effect on
Small Entities
As noted above, the Commission
estimates that this amendment will have
no impact on small entities. Thus, the
Commission does not believe it is
necessary or appropriate to establish
different compliance or reporting
requirements or timetables, nor is it
clarifying, consolidating, or simplifying
compliance and reporting requirements
under the rule for small entities; or
exempt small entities from coverage of
the rule, or any part thereof. The
amendments also use performance
standards and do not dictate for entities
of any size any particular design
standards (e.g., technology) that must be
employed to achieve the objectives of
the proposed amendments.
E. Documentation of Risk Management
Procedures
1. Need for and Objectives of the
Amendments
Requiring certain large broker-dealers
to document and preserve their internal
credit, market, and liquidity risk
management controls under paragraph
(a)(23) to Rule 17a–3 and (e)(9) to Rule
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51897
17a–4 will assist firms in evaluating and
adhering to their established internal
risk management controls and regulators
in reviewing such controls.917
These amendments are intended to
strengthen the controls certain large
broker-dealers employ to manage risk.
These amendments are designed to
lower systemic risk primarily in the
securities markets by enhancing risk
management through reinforcement of
documentation practices and making it
easier for regulators to access a brokerdealer’s procedures and controls, to
ensure a broker-dealer is adhering to
such documented controls.
Additionally, by making the
documented controls a required record
under Rule 17a–3, a broker-dealer’s
regulator likely will have better access
to them, as this benefit will only be
realized to the extent a broker-dealer has
existing market, credit and liquidity risk
management controls in place because
the rule does not specify the type of
controls a broker-dealer must establish
to manage these risks. It simply requires
the documentation of the procedures the
broker-dealer has established. The final
rule amendment will require any such
records of the market, credit, and
liquidity risk management controls be
available to the broker-dealer’s
regulators so they can review whether
the broker-dealer is adhering to these
controls.
2. Significant Issues Raised by Public
Comments
The Commission did not receive any
specific comments with respect to this
portion of the IRFA.
3. Small Entities Subject to the Rule
These amendments apply to a limited
number of broker-dealers, namely, those
firms with more than $1 million in
customer credits or $20 million in
capital. Based on FOCUS Report data, as
of December 31, 2011, the Commission
estimates that none of the broker-dealers
that will be subject to this amendment
will be ‘‘small’’ for the purposes Rule 0–
10.
4. Reporting, Recordkeeping, and Other
Compliance Requirements
These amendments will require
broker-dealers to document any credit,
market, and liquidity risk management
controls established and maintained by
the broker-dealer to assist it in analyzing
and managing the risks associated with
its business activities. The Commission
is not mandating any specific controls,
procedures, or policies that must be
established by a broker-dealer to manage
917 See
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market, credit, or liquidity risk. Rather,
the Commission is requiring that a
control, procedure, or policy be
documented if it is in place.
5. Agency Action To Minimize Effect on
Small Entities
As noted above, these amendments
will have no impact on ‘‘small’’ brokerdealers. Thus, the Commission is not
establishing different compliance or
reporting requirements or timetables;
clarifying, consolidating, or simplifying
compliance and reporting requirements
under the rule for small entities; nor
exempting small entities from coverage
of the rule, or any part thereof.
The amendments also use
performance standards and do not
dictate for entities of any size any
particular design standards (e.g.,
technology) that must be employed to
achieve the objectives of the
amendments.
F. Amendments to the Net Capital Rule
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1. Need for and Objectives of the
Amendments
The amendments to Rule 15c3–1 are
designed to address several areas of
concern regarding the financial
responsibility requirements for brokerdealers. Some broker-dealers have
excluded from their regulatory financial
reports certain liabilities that have been
shifted to third parties that lack the
resources—independent of the assets
and revenue of the broker-dealer—to
pay the liabilities, or have utilized
infusions of temporary capital. These
practices may misrepresent the true
financial condition of the broker-dealer
and, thereby, impede the ability of
regulators to take proactive steps to
reduce the harm to customers,
counterparties and clearing agencies
that may result from the broker-dealer’s
failure. To address these issues, the
Commission is adopting an amendment
to Rule 15c3–1 to add a new paragraph
(c)(2)(i)(F) requiring a broker-dealer to
adjust its net worth when calculating
net capital by including any liability or
expense for which a third party has
assumed the responsibility, unless the
broker-dealer can demonstrate that the
third party has adequate resources,
independent of the broker-dealer to pay
the liability or expense.918 In addition,
the Commission is adopting
amendments to paragraph (c)(2)(i)(G)(2)
of Rule 15c3–1, to require a brokerdealer to subtract from net worth any
contribution of capital to the brokerdealer: (1) Under an agreement that
provides the investor with the option to
918 See
section II.E.1. of this release.
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withdraw the capital; or (2) that is
intended to be withdrawn within a
period of one year of its contribution.
Under the final rule, any withdrawal of
capital made within one year of its
contribution is deemed to have been
intended to be withdrawn within a
period of one year, unless the
withdrawal has been approved in
writing by the broker-dealer’s DEA.919
Further, currently, broker-dealers are
required to take net capital charges
pursuant to SRO rules relating to
fidelity bond deductibles, but Rule
15c3–1 does not explicitly incorporate
such charges for purposes of computing
net capital. To address this
inconsistency, the Commission is
adopting paragraph (c)(2)(xiv) to Rule
15c3–1.920
In addition, a number of brokerdealers have sought to obtain protection
under the bankruptcy laws while still
engaging in a securities business.
Permitting an insolvent broker-dealer to
continue to transact a securities
business endangers its customers and
counterparties and places securities
clearing agencies at risk. To address this
concern, the Commission is adopting an
amendment to paragraph (a) of Rule
15c3–1 to require a broker-dealer to
cease its securities business activities if
certain insolvency events were to occur,
as defined in new paragraph (c)(16) to
Rule 15c3–1.921
Finally, an important goal of the
Commission is to protect the financial
integrity of the broker-dealer so that if
the firm must liquidate it may do so in
an orderly fashion. Allowing a capital
withdrawal that may jeopardize the
financial integrity of a broker-dealer
exposes customers and creditors of the
broker-dealer to unnecessary risk.
Paragraph (e) of Rule 15c3–1, which
places certain conditions on a brokerdealer when withdrawing capital,922
allows the Commission to issue an order
temporarily restricting a broker-dealer
from withdrawing capital or making
loans or advances to stockholders,
insiders, and affiliates under certain
circumstances.923 The rule, however,
limits such orders to withdrawals,
advances, or loans that, when
aggregated with all other withdrawals,
advances, or loans on a net basis during
a thirty calendar day period, exceed
30% of the firm’s excess net capital. The
Commission is amending paragraph (e)
to remove the 30% of excess net capital
limitation because the Commission has
919 See
section II.E.2. of this release.
section II.E.4. of this release.
921 See section II.E.5. of this release.
922 See 17 CFR 240.15c3–1(e).
923 See 17 CFR 240.15c3–1(e)(3).
920 See
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determined that the requirement is
difficult to enforce, as it generally
would not be clear when the 30%
threshold had been reached, due to the
inherent unreliability of a troubled
broker-dealer’s books and records.924
Finally, the Commission is making
permanent a temporary amendment to
Appendix A of Rule 15c3–1, which
permits broker-dealers to employ
theoretical option pricing models to
calculate haircuts for listed options and
related positions that hedge those
options.925 The temporary amendment
decreased the range of pricing inputs to
the approved option pricing models,
which effectively reduced the haircuts
applied by the carrying firm with
respect to non-clearing option specialist
and market maker accounts.926 The
amendment is intended to better align
the capital requirements with the risks
these requirements are designed to
address.
2. Significant Issues Raised by Public
Comments
The Commission received three
comments in response to requests for
comment related to the amendments to
the net capital rule requiring brokerdealers to add back to its net worth
certain liabilities assumed by third
parties and treat certain temporary
capital contributions as liabilities.927
One commenter noted that there
should be no circumstance in which a
broker-dealer accepted a capital
contribution for net capital purposes
that could be withdrawn at the option
of the investor.928 This commenter also
noted that if small firms were required
to raise over $300,000 in capital each,
there will be the largest dissolution of
small broker-dealers in the history of the
regulated securities industry.929 The
commenter requested that the
Commission state a reasonable time
period for broker-dealers to raise capital
924 See
section II.E.6. of this release.
CFR 240.15c3–1a; See Net Capital Rule,
Exchange Act Release No. 38248 (Feb. 6, 1997), 62
FR 6474 (Feb. 12, 1997). See also Letter from
Michael Macchiaroli, Associate Director, Division
of Market Regulation, Commission, to Richard
Lewandowski, Vice President, Regulatory Division,
The Chicago Board Options Exchange, Inc. (Jan. 13,
2000) (stating that the Division of Market
Regulation ‘‘will not recommend . . . enforcement
action if non-clearing option specialists and marketmakers continue to rely on subparagraph (b)(1)(iv)
of Appendix A to Rule 15c3–1 under the Exchange
Act until such time as the Commission has
determined whether it should be extended’’). The
letter did not grant any other relief.
926 See Net Capital Rule, Exchange Act Release
No. 38248 (Feb. 6, 1997), 62 FR 6474 (Feb. 12,
1997).
927 See Beer Letter; Levene Letter; NIBA 2 Letter.
928 See NIBA 2 Letter.
929 Id.
925 17
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to meet these new standards.930 This
commenter also stated that the
Commission’s estimate of a gross cost of
capital of 7.5% (5% + 2.5%) is a totally
unrealistic cost of capital for small
broker-dealers and that these brokerdealers will categorically have costs
significantly higher than 7.5%.931
Further, the commenter stated that,
until the Commission convenes a small
broker-dealer representative panel to
assist it with establishing such costs, the
Commission is ‘‘speculating’’ on such
costs, and is therefore without adequate
information to consider the effects of
such costs and changes on small
firms.932 This commenter specifically
requested the Commission consider the
needs of small firms that will likely
require additional net capital over the
next decade.933
Additionally, this commenter
believed that the rule is intended to
protect the capitalization of large firms
while ignoring small firms. The
commenter also noted that it opposes
regulation that arbitrarily reduces the
value of small broker-dealers and their
competitive position relative to larger
broker-dealers.934 Finally, the
commenter expressed concern that the
proposed amendments to Rule 15c3–1
would be particularly burdensome on
small broker-dealers, negatively
impacting capital formation for small
issuers and increasing the cost of capital
for small broker-dealers.935
Another commenter stated that this
proposal will require the 702 mentioned
debt-free introducing broker-dealers to
needlessly take on debt of
approximately $280,354.936 Further, the
commenter stated that, if the proposed
is approved, it would force the majority
of small firms out of business and
ultimately deny investors the right and
opportunity to deal with smaller, more
930 Id.
931 Id.
emcdonald on DSK67QTVN1PROD with RULES2
932 Id.
933 Id. The commenter stated that any rule that
would ‘‘restrict small broker-dealers from raising
capital as a result of uncertainty of investors or
owner-operators related to the return of their capital
in a reasonable time frame will create a
disproportionate and impossible hurdle for small
broker-dealers to overcome.’’ See NIBA 2 Letter.
934 See NIBA 2 Letter.
935 Id. The commenter noted that broker-dealers
‘‘are dealing with a relatively static commission and
fees matrix versus what they may charge
customers.’’ Consequently, the commenter believes
‘‘broker-dealers will be unable to pass any of these
costs increases directly to customers, irrespective of
the type of customer or type of business that they
are conducting with small broker-dealers, which
further threatens the financial profit potential and
return on equity of small broker-dealers.’’ Id. The
commenter further believes that the cost increases
over a short period of time will threaten the
viability of all small broker-dealers. Id.
936 See Beer Letter.
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personalized and debt-free member
firms.937 One commenter stated that it
also must be considered that any
implementation and enforcement of
these proposed changes should not be
made retroactive, because to subject
firms to a new set of rules and
guidelines will effectively penalize
small firms that have been in full
compliance with the rules and
regulations.938
The Commission considered all
comments discussed above and the
potential impact on small brokerdealers.939 The Commission continues
to believe that the estimated cost of
capital is not unrealistic for small
broker-dealers. However, as discussed
above in section V. of this release, in
response to comments, the Commission
increased the estimated cost of capital
for these amendments is 12%.
Moreover, as discussed in section
II.E.1 and 2. of this release, the baseline
of these rules is current Rule 15c3–1
and existing guidance and
interpretations. The Commission staff
has provided guidance with respect to
the treatment and recording of certain
broker-dealer expenses and liabilities
that is consistent with the rule
amendment.940 In addition, existing
broker-dealer recordkeeping rules
require that a broker-dealer record its
income and expenses.941 For example,
paragraph (a)(2) of Rule 17a–3, requires
a broker-dealer to make and keep
current ledgers (or other records)
reflecting all assets and liabilities,
income and expense and capital
accounts.942 Therefore, the Commission
does not expect small broker-dealers to
incur significant costs or burdens to
comply with the amendment regarding
broker-dealers and payment of expenses
by third parties.943
At the same time, the purpose of the
requirement in new paragraph
(c)(2)(i)(F) of Rule 15c3–1 is to address
the practices of a broker-dealer that raise
concerns when a broker-dealer shifts
liabilities to an entity with no revenue
or assets independent of the brokerdealer to inappropriately increase its
reported net capital, by excluding the
liability from the calculation of net
worth. Therefore, the final rule, as
discussed above in section II.E.1. of this
release, is designed to prohibit a
practice that could misrepresent a
51899
broker-dealer’s actual financial
condition, deceive the firm’s customers,
and hamper the ability of regulators to
monitor the firm’s financial condition.
Moreover, in response to
comments,944 the rule amendment, as
adopted, should not impose burdens or
present serious implementation
difficulties to small broker-dealers 945
that are appropriately recording their
assets and liabilities under current
Commission rules and interpretive
guidance.946 These broker-dealers also
should not be required to obtain loans
to increase their capital as a result of the
Rule 15c3–1 amendments. Therefore,
the Commission does not believe a
longer time period for compliance or the
formation of a small broker-dealer
advisory cost committee is necessary.947
In response to the commenters’
concerns about the negative impact of
the rule amendments on the capital of
small broker-dealers,948 as discussed
above, the final rule amendment is a
codification of existing Commission
staff guidance,949 and thus should not
represent a change for small brokerdealers with respect to capital
withdrawals. Moreover, with respect to
commenters’ concerns about obtaining
capital,950 the rule does not prohibit an
investor from withdrawing capital at
any time. Rather, it prohibits a brokerdealer from treating temporary cash
infusions as capital for purposes of the
net capital rule. Finally, the final rule
amendments provide a mechanism for a
broker-dealer to apply to its DEA to
make a withdrawal within one year of
the capital contribution without
triggering the deduction under certain
circumstances (e.g., de minimis
withdrawals).
3. Small Entities Subject to the Rule
Based on FOCUS Report data, as of
December 31, 2011, the Commission
estimates that there are approximately
2,506 introducing and carrying brokerdealers that are ‘‘small’’ for the purposes
Rule 0–10. The amendments relating to
certain subtractions from net worth and
the restrictions on the withdrawal of
capital will apply to all ‘‘small’’ brokerdealers in that they will be subject to the
requirements in the amendments. The
amendment to Appendix A of Rule
15c3–1 likely should have no, or little,
impact on ‘‘small’’ broker-dealers,
because based on staff experience, most,
937 Id.
938 See
944 Id.
939 See
945 See
Levene Letter.
Beer Letter; Levene Letter; NIBA 2 Letter.
940 See, e.g., Third Party Expense Letter; see also
FINRA Notice to Members 03–6, Expense Sharing
Agreements.
941 17 CFR 240.17a–3; 17 CFR 240.17a–4.
942 17 CFR 240.17a–3(a)(2).
943 See NIBA 2 Letter.
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Beer Letter; Levene Letter; NIBA 2 Letter.
e.g., Third Party Expense Letter.
947 See NIBA 2 Letter.
948 See Beer Letter; Levene Letter; NIBA 2 Letter.
949 See Temporary Capital Letter. See also section
II.E.2. of this release.
950 See Beer Letter; NIBA 2 Letter.
946 See,
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if not all, of these firms do not carry
non-clearing option specialist or market
maker accounts.
4. Reporting, Recordkeeping, and Other
Compliance Requirements
The amendments will require an
‘‘insolvent’’ broker-dealer to cease
conducting a securities business and
provide the securities regulators with
notice of its insolvency. The
amendments also will require brokerdealers to deduct from net worth certain
liabilities and certain temporary capital
contributions, as well as require brokerdealers to deduct from net capital,
certain specified amounts as required by
SRO fidelity bond rules. Finally, under
the amendment to the rule on
Commission orders restricting
withdrawals of capital, a broker-dealer
subject to an order will not be permitted
to withdraw capital. Finally, the
amendments will make permanent a
temporary rule that reduced the haircut
for non-clearing options specialist and
market maker accounts under Appendix
A to Rule 15c3–1.
emcdonald on DSK67QTVN1PROD with RULES2
5. Agency Action To Minimize Effect on
Small Entities
As discussed in detail above, the
Commission considered all comments
received and adopted the amendment
substantially as proposed.951 The
Commission understands the concerns
relating to small broker-dealers raised
by commenters 952 and reiterates that
the rule is designed to address
situations where there is no legitimate
reason to book liabilities to a separate
legal entity that otherwise would accrue
to the broker-dealer. Moreover, the final
rule is consistent with current staff
interpretations regarding third-party
expense sharing and thus should not
represent a change for broker-dealers.
The Commission also notes that the
final rule is designed to prohibit a
practice that could misrepresent a
broker-dealer’s actual financial
condition, deceive the firm’s customers,
and hamper the ability of regulators to
monitor the firm’s financial condition.
Moreover, the rule change, as adopted,
should not impose undue burdens or
present serious implementation
difficulties for large or small brokerdealers. As the Commission explained
in the proposing release, a broker-dealer
can demonstrate the adequacy of the
third party’s financial resources by
maintaining records such as the third
party’s most recent (i.e., as of a date
951 See
section II.E.1. of this release.
Beer Letter; Beer 2 Letter; Levene Letter;
Lowenstein Letter; NIBA 2 Letter. See also
discussion in section II.E.1. of this release.
952 See
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within the previous twelve months)
audited financial statements, tax
returns, or regulatory filings containing
financial reports.953 Given that the
entity to which the broker-dealer is
seeking to shift one or more liabilities
typically is an affiliate, the staff’s
experience is that such records should
be available to the broker-dealer.
Further, because the proposed rule
change is consistent with prior staff
guidance regarding the need to be able
to demonstrate the third party’s
financial adequacy, the broker-dealer
seeking to shift a liability to a third
party already would, under existing staff
interpretations, expect to be ready to
provide such evidence of the third
party’s financial resources. Taken
together, these realities should mitigate
the implementation and burden
concerns raised by commenters as they
relate to small broker-dealers.
One or more of these record types are
generally readily available. The general
availability of a satisfactory measure of
financial resources should mitigate the
implementation and burden concerns
raised by the commenters.
As discussed above, given the
minimal impact these amendments will
have on small entities, the Commission
is not establishing different compliance
or reporting requirements or timetables;
clarifying, consolidating, or simplifying
compliance and reporting requirements
under the rule for small entities; nor
exempting small entities from coverage
of the rule, or any part thereof.
The amendments use performance
standards and do not dictate for entities
of any size any particular design
standards (e.g., technology) that must be
employed to achieve the objectives of
the amendments.
VII. Statutory Authority
The Commission is adopting
amendments to Rules 15c3–1, 15c3–3,
17a–3, 17a–4 and 17a–11 under the
Exchange Act pursuant to the authority
conferred by the Exchange Act,
including Sections 15, 17, 23(a) and
36.954
Text of Final Rules
List of Subjects in 17 CFR Part 240
Brokers, Reporting and recordkeeping
requirements, Securities.
In accordance with the foregoing, the
Commission hereby amends Title 17,
953 Amendments to Financial Responsibility
Rules, 72 FR at 12872. The Commission specifically
requested comment regarding the records by which
a broker-dealer could demonstrate financial
resources. It received no comments in response to
this request.
954 15 U.S.C. 78o, 78q, 78w and 78mm.
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Chapter II of the Code of Federal
Regulation as follows.
PART 240—GENERAL RULES AND
REGULATIONS, SECURITIES
EXCHANGE ACT OF 1934
1. The general authority for Part 240
continues to read as follows:
■
Authority: 15 U.S.C. 77c, 77d, 77g, 77j,
77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn,
77sss, 77ttt, 78c, 78c–3, 78c–5, 78d, 78e, 78f,
78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m,
78n, 78n–1, 78o, 78o–4, 78o–10, 78p, 78q,
78q–1, 78s, 78u–5, 78w, 78x, 78ll, 78mm,
80a–20, 80a–23, 80a–29, 80a–37, 80b–3, 80b–
4, 80b–11, 7201 et. seq., and 8302; 7 U.S.C.
2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C.
1350; and Pub. L. 111–203, 939A, 124 Stat.
1376, (2010), unless otherwise noted.
*
*
*
*
*
2. Section 240.15c3–1 is amended by:
a. Revising the first sentence of
paragraph (a) introductory text;
■ b. Removing from paragraph
(a)(6)(iii)(A) the phrase ‘‘paragraph
(c)(2)(x)(A)(1) through (9) of this
section’’ and in its place adding the
phrase ‘‘Appendix A (§ 240.15c3–1a)’’;
■ c. Revising the paragraph (c)(2)(i)
heading;
■ d. Adding paragraphs (c)(2)(i)(F) and
(G);
■ e. Revising paragraphs (c)(2)(iv)(B),
(c)(2)(iv)(E), and (c)(2)(vi)(D)(1);
■ f. Adding paragraph (c)(2)(xiv);
■ g. Adding paragraph (c)(16) and an
undesignated center heading;
■ h. Revising paragraph (e)(3)(i); and
■ i. Removing from the second sentence
in paragraph (e)(3)(ii) the text ‘‘The
hearing’’ and in its place adding the
phrase ‘‘A hearing on an order
temporarily prohibiting the withdrawal
of capital’’.
The revisions and additions read as
follows:
■
■
§ 240.15c3–1 Net capital requirements for
brokers or dealers.
(a) Every broker or dealer must at all
times have and maintain net capital no
less than the greater of the highest
minimum requirement applicable to its
ratio requirement under paragraph (a)(1)
of this section, or to any of its activities
under paragraph (a)(2) of this section,
and must otherwise not be ‘‘insolvent’’
as that term is defined in paragraph
(c)(16) of this section. * * *
*
*
*
*
*
(c) * * *
(2) * * *
(i) Adjustments to net worth related to
unrealized profit or loss, deferred tax
provisions, and certain liabilities.* * *
*
*
*
*
*
(F) Subtracting from net worth any
liability or expense relating to the
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business of the broker or dealer for
which a third party has assumed the
responsibility, unless the broker or
dealer can demonstrate that the third
party has adequate resources
independent of the broker or dealer to
pay the liability or expense.
(G) Subtracting from net worth any
contribution of capital to the broker or
dealer:
(1) Under an agreement that provides
the investor with the option to
withdraw the capital; or
(2) That is intended to be withdrawn
within a period of one year of
contribution. Any withdrawal of capital
made within one year of its contribution
is deemed to have been intended to be
withdrawn within a period of one year,
unless the withdrawal has been
approved in writing by the Examining
Authority for the broker or dealer.
*
*
*
*
*
(iv) * * *
(B) All unsecured advances and loans;
deficits in customers’ and noncustomers’ unsecured and partly
secured notes; deficits in omnibus credit
accounts maintained in compliance
with the requirements of 12 CFR
220.7(f) of Regulation T under the Act,
or similar accounts carried on behalf of
another broker or dealer, after
application of calls for margin, marks to
the market or other required deposits
that are outstanding 5 business days or
less; deficits in customers’ and noncustomers’ unsecured and partly
secured accounts after application of
calls for margin, marks to market or
other required deposits that are
outstanding 5 business days or less,
except deficits in cash accounts as
defined in 12 CFR 220.8 of Regulation
T under the Act for which not more
than one extension respecting a
specified securities transaction has been
requested and granted, and deducting
for securities carried in any of such
accounts the percentages specified in
paragraph (c)(2)(vi) of this section or
Appendix A, § 240.15c3–1a; the market
value of stock loaned in excess of the
value of any collateral received therefor;
receivables arising out of free shipments
of securities (other than mutual fund
redemptions) in excess of $5,000 per
shipment and all free shipments (other
than mutual fund redemptions)
outstanding more than 7 business days,
and mutual fund redemptions
outstanding more than 16 business days;
and any collateral deficiencies in
secured demand notes as defined in
Appendix D, § 240.15c3–1d; a broker or
dealer that participates in a loan of
securities by one party to another party
will be deemed a principal for the
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purpose of the deductions required
under this section, unless the broker or
dealer has fully disclosed the identity of
each party to the other and each party
has expressly agreed in writing that the
obligations of the broker or dealer do
not include a guarantee of performance
by the other party and that such party’s
remedies in the event of a default by the
other party do not include a right of
setoff against obligations, if any, of the
broker or dealer.
*
*
*
*
*
(E) Other Deductions. All other
unsecured receivables; all assets
doubtful of collection less any reserves
established therefor; the amount by
which the market value of securities
failed to receive outstanding longer than
thirty (30) calendar days exceeds the
contract value of such fails to receive;
and the funds on deposit in a
‘‘segregated trust account’’ in
accordance with 17 CFR 270.27d–1
under the Investment Company Act of
1940, but only to the extent that the
amount on deposit in such segregated
trust account exceeds the amount of
liability reserves established and
maintained for refunds of charges
required by sections 27(d) and 27(f) of
the Investment Company Act of 1940;
Provided, That the following need not
be deducted:
(1) Any amounts deposited in a
Customer Reserve Bank Account or PAB
Reserve Bank Account pursuant to
§ 240.15c3–3(e),
(2) Cash and securities held in a
securities account at a carrying broker or
dealer (except where the account has
been subordinated to the claims of
creditors of the carrying broker or
dealer), and
(3) Clearing deposits.
*
*
*
*
*
(vi) * * *
(D)(1) In the case of redeemable
securities of an investment company
registered under the Investment
Company Act of 1940, which assets
consist of cash or money market
instruments and which is described in
§ 270.2a–7 of this chapter, the deduction
will be 2% of the market value of the
greater of the long or short position.
*
*
*
*
*
(xiv) Deduction from net worth for
excess deductible amounts related to
fidelity bond coverage. Deducting the
amount specified by rule of the
Examining Authority for the broker or
dealer with respect to a requirement to
maintain fidelity bond coverage.
*
*
*
*
*
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51901
Insolvent
(16) For the purposes of this section,
a broker or dealer is insolvent if the
broker or dealer:
(i) Is the subject of any bankruptcy,
equity receivership proceeding or any
other proceeding to reorganize,
conserve, or liquidate such broker or
dealer or its property or is applying for
the appointment or election of a
receiver, trustee, or liquidator or similar
official for such broker or dealer or its
property;
(ii) Has made a general assignment for
the benefit of creditors;
(iii) Is insolvent within the meaning
of section 101 of title 11 of the United
States Code, or is unable to meet its
obligations as they mature, and has
made an admission to such effect in
writing or in any court or before any
agency of the United States or any State;
or
(iv) Is unable to make such
computations as may be necessary to
establish compliance with this section
or with § 240.15c3–3.
*
*
*
*
*
(e) * * *
(3)(i) Temporary restrictions on
withdrawal of net capital. The
Commission may by order restrict, for a
period of up to twenty business days,
any withdrawal by the broker or dealer
of equity capital or unsecured loan or
advance to a stockholder, partner, sole
proprietor, member, employee or
affiliate under such terms and
conditions as the Commission deems
necessary or appropriate in the public
interest or consistent with the
protection of investors if the
Commission, based on the information
available, concludes that such
withdrawal, advance or loan may be
detrimental to the financial integrity of
the broker or dealer, or may unduly
jeopardize the broker or dealer’s ability
to repay its customer claims or other
liabilities which may cause a significant
impact on the markets or expose the
customers or creditors of the broker or
dealer to loss without taking into
account the application of the Securities
Investor Protection Act of 1970.
*
*
*
*
*
§ 240.15c3–1a
[Amended]
3. Section 240.15c3–1a is amended
by:
■ a. Removing paragraph (b)(1)(iv)(B);
and
■ b. Redesignating paragraphs
(b)(1)(iv)(A) introductory text,
(b)(1)(iv)(A)(1), (b)(1)(iv)(A)(2), and
(b)(1)(iv)(A)(3) as paragraphs (b)(1)(iv)
introductory text, (b)(1)(iv)(A),
■
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(b)(1)(iv)(B), and (b)(1)(iv)(C)
respectively.
§ 240.15c3–2
[Removed and Reserved]
4. Section 240.15c3–2 is removed and
reserved.
■ 5. Section 240.15c3–3 is amended by:
■ a. Removing from paragraph (a)(1)
introductory text, third sentence, the
citation ‘‘220.19’’ and in its place
adding the citation ‘‘220.12’’;
■ b. In paragraph (a)(1)(iii), after the
phrase ‘‘(15 U.S.C. 78aaa et seq.)’’
adding ‘‘(SIPA)’’;
■ c. Removing the ‘‘;’’ at the end of
paragraph (a)(1)(iv) and adding a period
in its place;
■ d. Revising paragraphs (a)(3), (4), (7),
(8), and (9);
■ e. Adding paragraphs (a)(16) and (17);
■ f. In paragraph (b)(2):
■ i. In the first sentence, removing the
phrase ‘‘his physical possession or
under his control’’ and in its place
adding ‘‘the broker’s or dealer’s physical
possession or under its control’’;
■ ii. In the second sentence, removing
the word ‘‘he’’ and in its place adding
‘‘it’’; and
■ iii. In the second sentence, removing
the word ‘‘his’’ and in its place adding
‘‘its’’;
■ g. Removing from paragraphs (b)(3)(iv)
and (b)(4)(i)(C) the phrase ‘‘the
Securities Investor Protection Act of
1970’’ and in its place adding ‘‘SIPA’’;
■ h. At the end of paragraph (b)(4)(i)(C)
adding the word ‘‘and,’’;
■ i. In paragraph (b)(4)(v), removing the
word ‘‘his’’ and adding in its place ‘‘the
person’s’’;
■ j. Adding paragraph (b)(5);
■ k. In paragraph (c)(2):
■ i. Removing ‘‘a special omnibus’’ and
in its place adding ‘‘an omnibus credit’’;
■ ii. Removing the text ‘‘section 4(b) of
Regulation T under the Act (12 CFR
220.4(b))’’ and in its place adding
‘‘section 7(f) of Regulation T (12 CFR
220.7(f))’’; and
■ iii. Removing the word ‘‘he’’ and in its
place adding ‘‘it’’;
■ l. In paragraph (c)(3), removing the
words ‘‘him’’ and ‘‘he’’ wherever they
appear and in their place adding ‘‘the
broker or dealer’’;
■ m. In the first sentence of paragraph
(d) introductory text, removing the word
‘‘his’’ wherever it appears and in its
place adding ‘‘its’’;
■ n. In paragraph (d)(2), removing the
word ‘‘his’’ and in its place adding ‘‘the
broker’s or dealer’s’’;
■ o. Removing the period at the end of
paragraph (d)(3) and in its place adding
‘‘; or’’;
■ p. Redesignating paragraph (d)(4) as
paragraph (d)(5);
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■
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q. Adding a new paragraph (d)(4);
r. Revising paragraphs (e) and (f);
s. Revising the first sentence of
paragraph (g);
■ t. Removing from paragraph (i) the
text ‘‘his reserve bank account’’ and in
its place adding ‘‘its Customer Reserve
Bank Account, PAB Reserve Bank
Account’’;
■ u. Adding paragraph (j);
■ v. In paragraph (k)(1)(i), removing the
phrase ‘‘His dealer transactions’’ and in
its place adding ‘‘The broker’s or
dealer’s transactions as dealer’’, and
removing the word ‘‘his’’ the second
and third time the word ‘‘his’’ appears
and in its place adding ‘‘its’’;
■ w. In paragraph (k)(1)(ii), removing
the word ‘‘His’’ and in its place adding
‘‘The broker’s or dealer’s’’;
■ x. In paragraph (k)(1)(iii), removing
the word ‘‘He’’ and in its place adding
‘‘The broker or dealer’’ and removing
the word ‘‘his’’ and in its place adding
‘‘its’’;
■ y. In paragraph (k)(2)(i), removing the
word ‘‘his’’ and in its place adding ‘‘its’’
wherever it appears;
■ z. Revising paragraph (l)(2);
■ aa. Removing from the last sentence in
paragraph (m) before the Note, the text
‘‘a special omnibus’’ and in its place
adding ‘‘an omnibus credit’’ and
removing the text ‘‘section 4(b) of
Regulation T [12 CFR 220.4(b)]’’ and in
its place adding ‘‘section 7(f) of
Regulation T (12 CFR 220.7(f))’’;
■ bb. Redesignate the Note following
paragraph (m) as ‘‘Note to paragraph
(m).’’;
■ cc. Removing from the first sentence
in paragraph (n) the phrase ‘‘paragraphs
(d)(2) and (3)’’ and in its place adding
‘‘paragraphs (d)(2) through (4)’’; and
■ dd. Removing from paragraph
(o)(2)(i)(A) the phrase ‘‘the Securities
Investor Protection Act of 1970 (15
U.S.C. 78aaa et seq.)’’ and in its place
adding ‘‘SIPA’’;
The revisions and additions read as
follows:
■
■
■
§ 240.15c3–3 Customer protection—
reserves and custody of securities.
(a) * * *
(3) The term fully paid securities
means all securities carried for the
account of a customer in a cash account
as defined in Regulation T (12 CFR
220.1 et seq.), as well as securities
carried for the account of a customer in
a margin account or any special account
under Regulation T that have no loan
value for margin purposes, and all
margin equity securities in such
accounts if they are fully paid: Provided,
however, that the term fully paid
securities does not apply to any
securities purchased in transactions for
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which the customer has not made full
payment.
(4) The term margin securities means
those securities carried for the account
of a customer in a margin account as
defined in section 4 of Regulation T (12
CFR 220.4), as well as securities carried
in any other account (such accounts
hereinafter referred to as ‘‘margin
accounts’’) other than the securities
referred to in paragraph (a)(3) of this
section.
*
*
*
*
*
(7) The term bank means a bank as
defined in section 3(a)(6) of the Act and
will also mean any building and loan,
savings and loan or similar banking
institution subject to supervision by a
Federal banking authority. With respect
to a broker or dealer that maintains its
principal place of business in Canada,
the term ‘‘bank’’ also means a Canadian
bank subject to supervision by a
Canadian authority.
(8) The term free credit balances
means liabilities of a broker or dealer to
customers which are subject to
immediate cash payment to customers
on demand, whether resulting from
sales of securities, dividends, interest,
deposits or otherwise, excluding,
however, funds in commodity accounts
which are segregated in accordance with
the Commodity Exchange Act or in a
similar manner, or which are funds
carried in a proprietary account as that
term is defined in regulations under the
Commodity Exchange Act. The term
‘‘free credit balances’’ also includes, if
subject to immediate cash payment to
customers on demand, funds carried in
a securities account pursuant to a selfregulatory organization portfolio
margining rule approved by the
Commission under section 19(b) of the
Act (15 U.S.C. 78s(b)) (‘‘SRO portfolio
margining rule’’), including variation
margin or initial margin, marks to
market, and proceeds resulting from
margin paid or released in connection
with closing out, settling or exercising
futures contracts and options thereon.
(9) The term other credit balances
means cash liabilities of a broker or
dealer to customers other than free
credit balances and funds in commodity
accounts which are segregated in
accordance with the Commodity
Exchange Act or in a similar manner, or
funds carried in a proprietary account as
that term is defined in regulations under
the Commodity Exchange Act. The term
‘‘other credit balances’’ also includes
funds that are cash liabilities of a broker
or dealer to customers other than free
credit balances and are carried in a
securities account pursuant to an SRO
portfolio margining rule, including
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variation margin or initial margin,
marks to market, and proceeds resulting
from margin paid or released in
connection with closing out, settling or
exercising futures contracts and options
thereon.
*
*
*
*
*
(16) The term PAB account means a
proprietary securities account of a
broker or dealer (which includes a
foreign broker or dealer, or a foreign
bank acting as a broker or dealer) other
than a delivery-versus-payment account
or a receipt-versus-payment account.
The term does not include an account
that has been subordinated to the claims
of creditors of the carrying broker or
dealer.
(17) The term Sweep Program means
a service provided by a broker or dealer
where it offers to its customer the option
to automatically transfer free credit
balances in the securities account of the
customer to either a money market
mutual fund product as described in
§ 270.2a–7 of this chapter or an account
at a bank whose deposits are insured by
the Federal Deposit Insurance
Corporation.
(b) * * *
(5) A broker or dealer is required to
obtain and thereafter maintain the
physical possession or control of
securities carried for a PAB account,
unless the broker or dealer has provided
written notice to the account holder that
the securities may be used in the
ordinary course of its securities
business, and has provided an
opportunity for the account holder to
object.
*
*
*
*
*
(d) * * *
(4) Securities included on the broker’s
or dealer’s books or records that allocate
to a short position of the broker or
dealer or a short position for another
person, excluding positions covered by
paragraph (m) of this section, for more
than 30 calendar days, then the broker
or dealer must, not later than the
business day following the day on
which the determination is made, take
prompt steps to obtain physical
possession or control of such securities.
For the purposes of this paragraph
(d)(4), the 30 day time period will not
begin to run with respect to a syndicate
short position established in connection
with an offering of securities until the
completion of the underwriter’s
participation in the distribution as
determined pursuant to § 242.100(b) of
Regulation M of this chapter (17 CFR
242.100 through 242.105); or
*
*
*
*
*
(e) Special reserve bank accounts for
the exclusive benefit of customers and
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PAB accounts. (1) Every broker or dealer
must maintain with a bank or banks at
all times when deposits are required or
hereinafter specified a ‘‘Special Reserve
Bank Account for the Exclusive Benefit
of Customers’’ (hereinafter referred to as
the Customer Reserve Bank Account)
and a ‘‘Special Reserve Bank Account
for Brokers and Dealers’’ (hereinafter
referred to as the PAB Reserve Bank
Account), each of which will be separate
from the other and from any other bank
account of the broker or dealer. Such
broker or dealer must at all times
maintain in the Customer Reserve Bank
Account and the PAB Reserve Bank
Account, through deposits made
therein, cash and/or qualified securities
in amounts computed in accordance
with the formula attached as Exhibit A
(17 CFR 240.15c3–3a), as applied to
customer and PAB accounts
respectively.
(2) With respect to each computation
required pursuant to paragraph (e)(1) of
this section, a broker or dealer must not
accept or use any of the amounts under
items comprising Total Credits under
the formula referred to in paragraph
(e)(1) of this section except for the
specified purposes indicated under
items comprising Total Debits under the
formula, and, to the extent Total Credits
exceed Total Debits, at least the net
amount thereof must be maintained in
the Customer Reserve Bank Account
and PAB Reserve Bank Account
pursuant to paragraph (e)(1) of this
section.
(3) Reserve Bank Account
computations. (i) Computations
necessary to determine the amount
required to be deposited in the
Customer Reserve Bank Account and
PAB Reserve Bank Account as specified
in paragraph (e)(1) of this section must
be made weekly, as of the close of the
last business day of the week, and the
deposit so computed must be made no
later than one hour after the opening of
banking business on the second
following business day; provided,
however, a broker or dealer which has
aggregate indebtedness not exceeding
800 percent of net capital (as defined in
§ 240.15c3–1) and which carries
aggregate customer funds (as defined in
paragraph (a)(10) of this section), as
computed at the last required
computation pursuant to this section,
not exceeding $1,000,000, may in the
alternative make the Customer Reserve
Bank Account computation monthly, as
of the close of the last business day of
the month, and, in such event, must
deposit not less than 105 percent of the
amount so computed no later than one
hour after the opening of banking
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51903
business on the second following
business day.
(ii) If a broker or dealer, computing on
a monthly basis, has, at the time of any
required computation, aggregate
indebtedness in excess of 800 percent of
net capital, such broker or dealer must
thereafter compute weekly as aforesaid
until four successive weekly Customer
Reserve Bank Account computations are
made, none of which were made at a
time when its aggregate indebtedness
exceeded 800 percent of its net capital.
(iii) A broker or dealer that does not
carry the accounts of a ‘‘customer’’ as
defined by this section or conduct a
proprietary trading business may make
the computation to be performed with
respect to PAB accounts under
paragraph (e)(1) of this section monthly
rather than weekly. If a broker or dealer
performing the computation with
respect to PAB accounts under
paragraph (e)(1) of this section on a
monthly basis is, at the time of any
required computation, required to
deposit additional cash or qualified
securities in the PAB Reserve Bank
Account, the broker or dealer must
thereafter perform the computation
required with respect to PAB accounts
under paragraph (e)(1) of this section
weekly until four successive weekly
computations are made, none of which
is made at a time when the broker or
dealer was required to deposit
additional cash or qualified securities in
the PAB Reserve Bank Account.
(iv) Computations in addition to the
computations required in this paragraph
(e)(3), may be made as of the close of
any business day, and the deposits so
computed must be made no later than
one hour after the opening of banking
business on the second following
business day.
(v) The broker or dealer must make
and maintain a record of each such
computation made pursuant to this
paragraph (e)(3) or otherwise and
preserve each such record in accordance
with § 240.17a–4.
(4) If the computation performed
under paragraph (e)(3) of this section
with respect to PAB accounts results in
a deposit requirement, the requirement
may be satisfied to the extent of any
excess debit in the computation
performed under paragraph (e)(3) of this
section with respect to customer
accounts of the same date. However, a
deposit requirement resulting from the
computation performed under
paragraph (e)(3) of this section with
respect to customer accounts cannot be
satisfied with excess debits from the
computation performed under
paragraph (e)(3) of this section with
respect to PAB accounts.
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Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 / Rules and Regulations
(5) In determining whether a broker or
dealer maintains the minimum deposits
required under this section, the broker
or dealer must exclude the total amount
of any cash deposited with an affiliated
bank. The broker or dealer also must
exclude cash deposited with a nonaffiliated bank to the extent that the
amount of the deposit exceeds 15% of
the bank’s equity capital as reported by
the bank in its most recent Call Report
or any successor form the bank is
required to file by its appropriate
Federal banking agency (as defined by
section 3 of the Federal Deposit
Insurance Act (12 U.S.C. 1813)).
(f) Notification of banks. A broker or
dealer required to maintain a Customer
Reserve Bank Account and PAB Reserve
Bank Account prescribed by paragraph
(e)(1) of this section or who maintains
a Special Account referred to in
paragraph (k) of this section must obtain
and preserve in accordance with
§ 240.17a–4 a written notification from
each bank with which it maintains a
Customer Reserve Bank Account, a PAB
Reserve Bank Account, or a Special
Account that the bank was informed
that all cash and/or qualified securities
deposited therein are being held by the
bank for the exclusive benefit of the
customers and account holders of the
broker or dealer in accordance with the
regulations of the Commission, and are
being kept separate from any other
accounts maintained by the broker or
dealer with the bank, and the broker or
dealer must have a written contract with
the bank which provides that the cash
and/or qualified securities will at no
time be used directly or indirectly as
security for a loan to the broker or
dealer by the bank and will not be
subject to any right, charge, security
interest, lien, or claim of any kind in
favor of the bank or any person claiming
through the bank.
(g) Withdrawals from the reserve bank
accounts. A broker or dealer may make
withdrawals from a Customer Reserve
Bank Account and a PAB Reserve Bank
Account if and to the extent that at the
time of the withdrawal the amount
remaining in the Customer Reserve
Bank Account and PAB Reserve Bank
Account is not less than the amount
then required by paragraph (e) of this
section. * * *
*
*
*
*
*
(j) Treatment of free credit balances.
(1) A broker or dealer must not accept
or use any free credit balance carried for
the account of any customer of the
broker or dealer unless such broker or
dealer has established adequate
procedures pursuant to which each
customer for whom a free credit balance
is carried will be given or sent, together
with or as part of the customer’s
statement of account, whenever sent but
not less frequently than once every three
months, a written statement informing
the customer of the amount due to the
customer by the broker or dealer on the
date of the statement, and that the funds
are payable on demand of the customer.
(2) A broker or dealer must not
convert, invest, or transfer to another
account or institution, credit balances
held in a customer’s account except as
provided in paragraphs (j)(2)(i) and (ii)
of this section.
(i) A broker or dealer is permitted to
invest or transfer to another account or
institution, free credit balances in a
customer’s account only upon a specific
order, authorization, or draft from the
customer, and only in the manner, and
under the terms and conditions,
specified in the order, authorization, or
draft.
(ii) A broker or dealer is permitted to
transfer free credit balances held in a
customer’s securities account to a
product in its Sweep Program or to
transfer a customer’s interest in one
product in a Sweep Program to another
product in a Sweep Program, provided:
(A) For an account opened on or after
the effective date of this paragraph
(j)(2)(ii), the customer gives prior
written affirmative consent to having
free credit balances in the customer’s
securities account included in the
Sweep Program after being notified:
(1) Of the general terms and
conditions of the products available
through the Sweep Program; and
(2) That the broker or dealer may
change the products available under the
Sweep Program.
(B) For any account:
(1) The broker or dealer provides the
customer with the disclosures and
notices regarding the Sweep Program
required by each self-regulatory
organization of which the broker or
dealer is a member;
(2) The broker or dealer provides
notice to the customer, as part of the
customer’s quarterly statement of
account, that the balance in the bank
deposit account or shares of the money
market mutual fund in which the
customer has a beneficial interest can be
liquidated on the customer’s order and
the proceeds returned to the securities
account or remitted to the customer; and
(3)(i) The broker or dealer provides
the customer with written notice at least
30 calendar days before:
(A) Making changes to the terms and
conditions of the Sweep Program;
(B) Making changes to the terms and
conditions of a product currently
available through the Sweep Program;
(C) Changing, adding or deleting
products available through the Sweep
Program; or
(D) Changing the customer’s
investment through the Sweep Program
from one product to another.
(ii) The notice must describe the new
terms and conditions of the Sweep
Program or product or the new product,
and the options available to the
customer if the customer does not
accept the new terms and conditions or
product.
*
*
*
*
*
(l) Delivery of securities. * * *
(2) Margin securities upon full
payment by such customer to the broker
or dealer of the customer’s indebtedness
to the broker or dealer; and, subject to
the right of the broker or dealer under
Regulation T (12 CFR 220) to retain
collateral for its own protection beyond
the requirements of Regulation T, excess
margin securities not reasonably
required to collateralize such customer’s
indebtedness to the broker or dealer.
*
*
*
*
*
■ 6. Section 240.15c3–3a is revised to
read as follows:
§ 240.15c3–3a Exhibit A—Formula for
determination of customer and PAB
account reserve requirements of brokers
and dealers under § 240.15c3–3.
emcdonald on DSK67QTVN1PROD with RULES2
Credits
1.
2.
3.
4.
5.
6.
Free credit balances and other credit balances in customers’ security accounts. (See Note A) ......................
Monies borrowed collateralized by securities carried for the accounts of customers (See Note B) ..................
Monies payable against customers’ securities loaned (See Note C) .................................................................
Customers’ securities failed to receive (See Note D) .........................................................................................
Credit balances in firm accounts which are attributable to principal sales to customers. ..................................
Market value of stock dividends, stock splits and similar distributions receivable outstanding over 30 calendar days ...........................................................................................................................................................
7. Market value of short security count differences over 30 calendar days old .....................................................
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Debits
XXX
XXX
XXX
XXX
XXX
........................
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XXX
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51905
Credits
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8. Market value of short securities and credits (not to be offset by longs or by debits) in all suspense accounts
over 30 calendar days .........................................................................................................................................
9. Market value of securities which are in transfer in excess of 40 calendar days and have not been confirmed
to be in transfer by the transfer agent or the issuer during the 40 days ............................................................
10. Debit balances in customers’ cash and margin accounts excluding unsecured accounts and accounts
doubtful of collection. (See Note E) .....................................................................................................................
11. Securities borrowed to effectuate short sales by customers and securities borrowed to make delivery on
customers’ securities failed to deliver ..................................................................................................................
12. Failed to deliver of customers’ securities not older than 30 calendar days .....................................................
13. Margin required and on deposit with the Options Clearing Corporation for all option contracts written or
purchased in customer accounts. (See Note F) ..................................................................................................
14. Margin required and on deposit with a clearing agency registered with the Commission under section 17A
of the Act (15 U.S.C. 78q–1) or a derivatives clearing organization registered with the Commodity Futures
Trading Commission under section 5b of the Commodity Exchange Act (7 U.S.C. 7a–1) related to the following types of positions written, purchased or sold in customer accounts: (1) security futures products and
(2) futures contracts (and options thereon) carried in a securities account pursuant to an SRO portfolio margining rule (See Note G) ......................................................................................................................................
Total credits ......................................................................................................................................................
Total debits .......................................................................................................................................................
15. Excess of total credits (sum of items 1–9) over total debits (sum of items 10–14) required to be on deposit
in the ‘‘Reserve Bank Account’’ (§ 240.15c3–3(e)). If the computation is made monthly as permitted by this
section, the deposit must be not less than 105% of the excess of total credits over total debits. .....................
Notes Regarding the Customer Reserve
Bank Account Computation
Note A. Item 1 must include all
outstanding drafts payable to customers
which have been applied against free
credit balances or other credit balances
and must also include checks drawn in
excess of bank balances per the records
of the broker or dealer.
Note B. Item 2 must include the
amount of options-related or security
futures product-related Letters of Credit
obtained by a member of a registered
clearing agency or a derivatives clearing
organization which are collateralized by
customers’ securities, to the extent of
the member’s margin requirement at the
registered clearing agency or derivatives
clearing organization. Item 2 must also
include the amount of Letters of Credit
which are collateralized by customers’
securities and related to other futures
contracts (and options thereon) carried
in a securities account pursuant to an
SRO portfolio margining rule.
Note C. Item 3 must include in
addition to monies payable against
customers’ securities loaned the amount
by which the market value of securities
loaned exceeds the collateral value
received from the lending of such
securities.
Note D. Item 4 must include in
addition to customers’ securities failed
to receive the amount by which the
market value of securities failed to
receive and outstanding more than
thirty (30) calendar days exceeds their
contract value.
Note E. (1) Debit balances in margin
accounts must be reduced by the
amount by which a specific security
(other than an exempted security) which
is collateral for margin accounts exceeds
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in aggregate value 15 percent of the
aggregate value of all securities which
collateralize all margin accounts
receivable; provided, however, the
required reduction must not be in
excess of the amounts of the debit
balance required to be excluded because
of this concentration rule. A specified
security is deemed to be collateral for a
margin account only to the extent it
represents in value not more than 140
percent of the customer debit balance in
a margin account.
(2) Debit balances in special omnibus
accounts, maintained in compliance
with the requirements of Section 7(f) of
Regulation T (12 CFR 220.7(f)) or similar
accounts carried on behalf of another
broker or dealer, must be reduced by
any deficits in such accounts (or if a
credit, such credit must be increased)
less any calls for margin, mark to the
market, or other required deposits
which are outstanding 5 business days
or less.
(3) Debit balances in customers’ cash
and margin accounts included in the
formula under Item 10 must be reduced
by an amount equal to 1 percent of their
aggregate value.
(4) Debit balances in cash and margin
accounts of household members and
other persons related to principals of a
broker or dealer and debit balances in
cash and margin accounts of affiliated
persons of a broker or dealer must be
excluded from the Reserve Formula,
unless the broker or dealer can
demonstrate that such debit balances are
directly related to credit items in the
formula.
(5) Debit balances in margin accounts
(other than omnibus accounts) must be
reduced by the amount by which any
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XXX
........................
XXX
........................
........................
XXX
........................
........................
XXX
XXX
........................
XXX
........................
........................
........................
XXX
........................
........................
........................
XXX
single customer’s debit balance exceeds
25% (to the extent such amount is
greater than $50,000) of the brokerdealer’s tentative net capital (i.e., net
capital prior to securities haircuts)
unless the broker or dealer can
demonstrate that the debit balance is
directly related to credit items in the
Reserve Formula. Related accounts (e.g.,
the separate accounts of an individual,
accounts under common control or
subject to cross guarantees) will be
deemed to be a single customer’s
accounts for purposes of this provision.
If the registered national securities
exchange or the registered national
securities association having
responsibility for examining the broker
or dealer (‘‘designated examining
authority’’) is satisfied, after taking into
account the circumstances of the
concentrated account including the
quality, diversity, and marketability of
the collateral securing the debit
balances or margin accounts subject to
this provision, that the concentration of
debit balances is appropriate, then such
designated examining authority may
grant a partial or plenary exception from
this provision. The debit balance may be
included in the reserve formula
computation for five business days from
the day the request is made.
(6) Debit balances in joint accounts,
custodian accounts, participation in
hedge funds or limited partnerships or
similar type accounts or arrangements
that include both assets of a person or
persons who would be excluded from
the definition of customer
(‘‘noncustomer’’) and assets of a person
or persons who would be included in
the definition of customer must be
included in the Reserve Formula in the
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following manner: If the percentage
ownership of the non-customer is less
than 5 percent then the entire debit
balance shall be included in the
formula; if such percentage ownership
is between 5 percent and 50 percent
then the portion of the debit balance
attributable to the non-customer must be
excluded from the formula unless the
broker or dealer can demonstrate that
the debit balance is directly related to
credit items in the formula; or if such
percentage ownership is greater than 50
percent, then the entire debit balance
must be excluded from the formula
unless the broker or dealer can
demonstrate that the debit balance is
directly related to credit items in the
formula.
Note F. Item 13 must include the
amount of margin required and on
deposit with the Options Clearing
Corporation to the extent such margin is
represented by cash, proprietary
qualified securities and letters of credit
collateralized by customers’ securities.
Note G. (a) Item 14 must include the
amount of margin required and on
deposit with a clearing agency
registered with the Commission under
section 17A of the Act (15 U.S.C. 78q–
1) or a derivatives clearing organization
registered with the Commodity Futures
Trading Commission under section 5b
of the Commodity Exchange Act (7
U.S.C. 7a–1) for customer accounts to
the extent that the margin is represented
by cash, proprietary qualified securities,
and letters of credit collateralized by
customers’ securities.
(b) Item 14 will apply only if the
broker or dealer has the margin related
to security futures products, or futures
(and options thereon) carried in a
securities account pursuant to an
approved SRO portfolio margining
program on deposit with:
(1) A registered clearing agency or
derivatives clearing organization that:
(i) Maintains the highest investmentgrade rating from a nationally
recognized statistical rating
organization; or
(ii) Maintains security deposits from
clearing members in connection with
regulated options or futures transactions
and assessment power over member
firms that equal a combined total of at
least $2 billion, at least $500 million of
which must be in the form of security
deposits. For the purposes of this Note
G, the term ‘‘security deposits’’ refers to
a general fund, other than margin
deposits or their equivalent, that
consists of cash or securities held by a
registered clearing agency or derivative
clearing organization; or
(iii) Maintains at least $3 billion in
margin deposits; or
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(iv) Does not meet the requirements of
paragraphs (b)(1)(i) through (b)(1)(iii) of
this Note G, if the Commission has
determined, upon a written request for
exemption by or for the benefit of the
broker or dealer, that the broker or
dealer may utilize such a registered
clearing agency or derivatives clearing
organization. The Commission may, in
its sole discretion, grant such an
exemption subject to such conditions as
are appropriate under the
circumstances, if the Commission
determines that such conditional or
unconditional exemption is necessary or
appropriate in the public interest, and is
consistent with the protection of
investors; and
(2) A registered clearing agency or
derivatives clearing organization that, if
it holds funds or securities deposited as
margin for security futures products or
futures in a portfolio margin account in
a bank, as defined in section 3(a)(6) of
the Act (15 U.S.C. 78c(a)(6)), obtains
and preserves written notification from
the bank at which it holds such funds
and securities or at which such funds
and securities are held on its behalf. The
written notification will state that all
funds and/or securities deposited with
the bank as margin (including customer
security futures products and futures in
a portfolio margin account), or held by
the bank and pledged to such registered
clearing agency or derivatives clearing
agency as margin, are being held by the
bank for the exclusive benefit of clearing
members of the registered clearing
agency or derivatives clearing
organization (subject to the interest of
such registered clearing agency or
derivatives clearing organization
therein), and are being kept separate
from any other accounts maintained by
the registered clearing agency or
derivatives clearing organization with
the bank. The written notification also
will provide that such funds and/or
securities will at no time be used
directly or indirectly as security for a
loan to the registered clearing agency or
derivatives clearing organization by the
bank, and will be subject to no right,
charge, security interest, lien, or claim
of any kind in favor of the bank or any
person claiming through the bank. This
provision, however, will not prohibit a
registered clearing agency or derivatives
clearing organization from pledging
customer funds or securities as
collateral to a bank for any purpose that
the rules of the Commission or the
registered clearing agency or derivatives
clearing organization otherwise permit;
and
(3) A registered clearing agency or
derivatives clearing organization
establishes, documents, and maintains:
PO 00000
Frm 00084
Fmt 4701
Sfmt 4700
(i) Safeguards in the handling,
transfer, and delivery of cash and
securities;
(ii) Fidelity bond coverage for its
employees and agents who handle
customer funds or securities. In the case
of agents of a registered clearing agency
or derivatives clearing organization, the
agent may provide the fidelity bond
coverage; and
(iii) Provisions for periodic
examination by independent public
accountants; and
(iv) A derivatives clearing
organization that, if it is not otherwise
registered with the Commission, has
provided the Commission with a written
undertaking, in a form acceptable to the
Commission, executed by a duly
authorized person at the derivatives
clearing organization, to the effect that,
with respect to the clearance and
settlement of the customer security
futures products and futures in a
portfolio margin account of the broker
or dealer, the derivatives clearing
organization will permit the
Commission to examine the books and
records of the derivatives clearing
organization for compliance with the
requirements set forth in § 240.15c3–3a,
Note G (b)(1) through (3).
(c) Item 14 will apply only if a broker
or dealer determines, at least annually,
that the registered clearing agency or
derivatives clearing organization with
which the broker or dealer has on
deposit margin related to securities
future products or futures in a portfolio
margin account meets the conditions of
this Note G.
Notes Regarding the PAB Reserve Bank
Account Computation
Note 1. Broker-dealers should use the
formula in Exhibit A for the purposes of
computing the PAB reserve
requirement, except that references to
‘‘accounts,’’ ‘‘customer accounts, or
‘‘customers’’ will be treated as
references to PAB accounts.
Note 2. Any credit (including a credit
applied to reduce a debit) that is
included in the computation required
by § 240.15c3–3 with respect to
customer accounts (the ‘‘customer
reserve computation’’) may not be
included as a credit in the computation
required by § 240.15c3–3 with respect to
PAB accounts (the ‘‘PAB reserve
computation’’).
Note 3. Note E(1) to § 240.15c3–3a
does not apply to the PAB reserve
computation.
Note 4. Note E(3) to § 240.15c3–3a
which reduces debit balances by 1%
does not apply to the PAB reserve
computation.
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Federal Register / Vol. 78, No. 162 / Wednesday, August 21, 2013 / Rules and Regulations
Note 5. Interest receivable, floor
brokerage, and commissions receivable
of another broker or dealer from the
broker or dealer (excluding clearing
deposits) that are otherwise allowable
assets under § 240.15c3–1 need not be
included in the PAB reserve
computation, provided the amounts
have been clearly identified as payables
on the books of the broker or dealer.
Commissions receivable and other
receivables of another broker or dealer
from the broker or dealer that are
otherwise non-allowable assets under
§ 240.15c3–1 and clearing deposits of
another broker or dealer may be
included as ‘‘credit balances’’ for
purposes of the PAB reserve
computation, provided the commissions
receivable and other receivables are
subject to immediate cash payment to
the other broker or dealer and the
clearing deposit is subject to payment
within 30 days.
Note 6. Credits included in the PAB
reserve computation that result from the
use of securities held for a PAB account
(‘‘PAB securities’’) that are pledged to
meet intra-day margin calls in a crossmargin account established between the
Options Clearing Corporation and any
regulated derivatives clearing
organization may be reduced to the
extent that the excess margin held by
the other clearing corporation in the
cross-margin relationship is used the
following business day to replace the
PAB securities that were previously
pledged. In addition, balances resulting
from a portfolio margin account that are
segregated pursuant to Commodity
Futures Trading Commission
regulations need not be included in the
PAB Reserve Bank Account
computation.
Note 7. Deposits received prior to a
transaction pending settlement which
are $5 million or greater for any single
transaction or $10 million in aggregate
may be excluded as credits from the
PAB reserve computation if such
balances are placed and maintained in
a separate PAB Reserve Bank Account
by 12 p.m. Eastern Time on the
following business day. Thereafter, the
money representing any such deposits
may be withdrawn to complete the
related transactions without performing
a new PAB reserve computation.
Note 8. A credit balance resulting
from a PAB reserve computation may be
reduced by the amount that items
representing such credits are swept into
money market funds or mutual funds of
an investment company registered
under the Investment Company Act of
1940 on or prior to 10 a.m. Eastern Time
on the deposit date provided that the
credits swept into any such fund are not
VerDate Mar<15>2010
17:54 Aug 20, 2013
Jkt 229001
subject to any right, charge, security
interest, lien, or claim of any kind in
favor of the investment company or the
broker or dealer. Any credits that have
been swept into money market funds or
mutual funds must be maintained in the
name of a particular broker or for the
benefit of another broker.
Note 9. Clearing deposits required to
be maintained at registered clearing
agencies may be included as debits in
the PAB reserve computation to the
extent the percentage of the deposit,
which is based upon the clearing
agency’s aggregate deposit requirements
(e.g., dollar trading volume), that relates
to the proprietary business of other
brokers and dealers can be identified.
Note 10. A broker or dealer that clears
PAB accounts through an affiliate or
third party clearing broker must include
these PAB account balances and the
omnibus PAB account balance in its
PAB reserve computation.
■ 7. Section 240.17a–3 is amended by
adding paragraph (a)(23) to read as
follows:
§ 240.17a–3 Records to be made by certain
exchange members, brokers and dealers.
(a) * * *
(23) A record documenting the credit,
market, and liquidity risk management
controls established and maintained by
the broker or dealer to assist it in
analyzing and managing the risks
associated with its business activities,
Provided, that the records required by
this paragraph (a)(23) need only be
made if the broker or dealer has more
than:
(i) $1,000,000 in aggregate credit
items as computed under § 240.15c3–3a;
or
(ii) $20,000,000 in capital, which
includes debt subordinated in
accordance with § 240.15c3–1d.
*
*
*
*
*
■ 8. Section 240.17a–4 is amended by:
■ a. Removing from paragraph (b)(1) the
citation ‘‘§ 240.17a–3(f)’’ and its place
adding the citation ‘‘§ 240.17a–3(g)’’;
■ b. Removing from paragraph (b)(9) the
citation ‘‘§ 240.15c3–3(d)(4)’’ and in its
place adding the citation ‘‘§ 240.15c3–
3(d)(5)’’; and
■ c. Adding paragraph (e)(9).
The addition reads as follows:
§ 240.17a–4 Records to be preserved by
certain exchange members, brokers and
dealers.
*
*
*
*
*
(e) * * *
(9) All records required pursuant to
§ 240.17a–3(a)(23) until three years after
the termination of the use of the risk
PO 00000
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Fmt 4701
Sfmt 9990
51907
management controls documented
therein.
*
*
*
*
*
9. Section 240.17a–11 is amended by:
a. Revising the first sentence of
paragraph (b)(1);
■ b. Removing from paragraph (c)
introductory text ‘‘or (c)(4)’’ and in its
place adding ‘‘, (c)(4) or (c)(5)’’; and
■ c. Adding paragraph (c)(5).
The revision and addition read as
follows:
■
■
§ 240.17a–11 Notification provisions for
brokers and dealers
*
*
*
*
*
(b)(1) Every broker or dealer whose
net capital declines below the minimum
amount required pursuant to
§ 240.15c3–1, or is insolvent as that
term is defined in § 240.15c3–1(c)(16),
must give notice of such deficiency that
same day in accordance with paragraph
(g) of this section. * * *
*
*
*
*
*
(c) * * *
(5) If a computation made by a broker
or dealer pursuant to § 240.15c3–1
shows that the total amount of money
payable against all securities loaned or
subject to a repurchase agreement or the
total contract value of all securities
borrowed or subject to a reverse
repurchase agreement is in excess of
2500 percent of its tentative net capital;
provided, however, that for purposes of
this leverage test transactions involving
government securities, as defined in
section 3(a)(42) of the Act (15 U.S.C.
78c(a)(42)), must be excluded from the
calculation; provided further, however,
that a broker or dealer will not be
required to send the notice required by
this paragraph (c)(5) if it reports
monthly its securities lending and
borrowing and repurchase and reverse
repurchase activity (including the total
amount of money payable against
securities loaned or subject to a
repurchase agreement and the total
contract value of securities borrowed or
subject to a reverse repurchase
agreement) to its designated examining
authority in a form acceptable to its
designated examining authority.
*
*
*
*
*
By the Commission.
Dated: July 30, 2013.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2013–18734 Filed 8–20–13; 8:45 am]
BILLING CODE 8011–01–P
E:\FR\FM\21AUR2.SGM
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Agencies
[Federal Register Volume 78, Number 162 (Wednesday, August 21, 2013)]
[Rules and Regulations]
[Pages 51823-51907]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-18734]
[[Page 51823]]
Vol. 78
Wednesday,
No. 162
August 21, 2013
Part II
Securities and Exchange Commission
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17 CFR Part 240
Financial Responsibility Rules for Broker-Dealers; Final Rule
Federal Register / Vol. 78 , No. 162 / Wednesday, August 21, 2013 /
Rules and Regulations
[[Page 51824]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-70072; File No. S7-08-07]
RIN 3235-AJ85
Financial Responsibility Rules for Broker-Dealers
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting amendments to the net capital, customer protection, books and
records, and notification rules for broker-dealers promulgated under
the Securities Exchange Act of 1934 (``Exchange Act''). These
amendments are designed to address several areas of concern regarding
the financial responsibility requirements for broker-dealers. The
amendments also update certain financial responsibility requirements
and make certain technical amendments.
DATES: Effective Date: October 21, 2013.
FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate
Director, at (202) 551-5525; Thomas K. McGowan, Deputy Associate
Director, at (202) 551-5521; Randall Roy, Assistant Director, at (202)
551-5522; Raymond Lombardo, Branch Chief, at (202) 551-5755; Sheila
Dombal Swartz, Special Counsel, (202) 551-5545; Carrie A. O'Brien,
Special Counsel, (202) 551-5640; or Kimberly N. Chehardy, Attorney
Advisor, (202) 551-5791; Division of Trading and Markets, Securities
and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
II. Amendments
A. Amendments to the Customer Protection Rule
1. Background
2. Proprietary Accounts of Broker-Dealers
i. Definition of ``PAB Account'' under Rule 15c3-3(a)(16)
ii. Written Permission To Use PAB Account Securities
iii. PAB Reserve Bank Accounts
iv. Other PAB Issues Raised by Commenters
v. Amendment to Rule 15c3-1(c)(2)(iv)(E) Related to PAB Accounts
3. Banks Where Special Reserve Deposits May Be Held
4. Allocation of Customers' Fully Paid and Excess Margin
Securities to Short Positions
5. Importation of Rule 15c3-2 Requirements Into Rule 15c3-3 and
Treatment of Free Credit Balances
i. Importation of Rule 15c3-2
ii. Treatment of Free Credit Balances
a. Treatment of Free Credit Balances Outside of a Sweep Program
b. Treatment of Free Credit Balances in a Sweep Program
6. ``Proprietary Accounts'' Under the Commodity Exchange Act
7. Expansion of the Definition of ``Qualified Securities'' To
Include Certain Money Market Funds
B. Holding Futures Positions in a Securities Portfolio Margin
Account
C. Amendments With Respect to Securities Lending and Borrowing
and Repurchase/Reverse Repurchase Transactions
D. Documentation of Risk Management Procedures
E. Amendments to the Net Capital Rule
1. Requirement To Deduct From Net Worth Certain Liabilities or
Expenses Assumed by Third Parties
2. Requirement To Subtract From Net Worth Certain Non-Permanent
Capital Contributions
3. Requirement To Deduct the Amount by Which a Fidelity Bond
Deductible Exceeds SRO Limits
4. Broker-Dealer Solvency Requirement
5. Amendment to Rule Governing Orders Restricting Withdrawal of
Capital From a Broker-Dealer
6. Adjusted Net Capital Requirements
i. Amendment to Appendix A of Rule 15c3-1
ii. Money Market Funds
a. Clarification
b. Proposed Haircut Reduction From 2% to 1%
c. Aggregate Debit Items Charge
F. Technical Amendments
III. Responses to Specific Requests for Comment
IV. Paperwork Reduction Act
A. Summary of the Collection of Information Requirements
B. Use of Information
C. Respondents
D. Total Annual Reporting and Recordkeeping Burden
1. Securities Lending Agreements and Disclosures
2. DEA Permission To Withdraw Capital Within One Year of
Contribution
3. Written Subordination Agreements Under Rule 15c3-3
4. PAB Reserve Bank Account Recordkeeping Requirements
5. Adequate Procedures Required Under Paragraph (j)(1) of Rule
15c3-3
6. Treatment of Free Credit Balances
7. Documentation of Risk Management Procedures
8. Notice Requirements
E. Collection of Information Is Mandatory
F. Confidentiality
G. Record Retention Period
V. Economic Analysis
A. Introduction
B. Economic Baseline
C. Discussion of General Comments Received
D. Economic Analysis of the Amendments and Alternatives
1. Amendments to the Customer Protection Rule
i. Economic Analysis
a. Proprietary Accounts of Broker-Dealers
(I). Summary of Amendments
(II). Baseline and Incremental Economic Effects
(III). Alternatives
(IV). Compliance Cost Estimates
b. Banks Where Special Reserve Deposits May Be Held
(I). Summary of Amendments
(II). Baseline and Incremental Economic Effects
(III). Alternatives
(IV). Compliance Cost Estimates
c. Allocation of Customers' Fully Paid and Excess Margin
Securities to Short Positions
d. Importation of Rule 15c3-2 Requirements Into Rule 15c3-3
e. Treatment of Free Credit Balances
(I). Summary of Amendments
(II). Baseline and Incremental Economic Effects
(III). Alternatives
(IV). Compliance Cost Estimates
f. ``Proprietary Accounts'' Under the Commodity Exchange Act
ii. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
2. Holding Futures Positions in a Securities Portfolio Margining
Account
i. Economic Analysis
ii. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
3. Amendments With Respect to Securities Lending and Borrowing
and Repurchase/Reverse Repurchase Transactions
i. Economic Analysis
ii. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
4. Documentation of Risk Management Procedures
i. Economic Analysis
ii. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
5. Amendments to the Net Capital Rule
i. Economic Analysis
a. Requirement To Deduct From Net Worth Certain Liabilities or
Expenses Assumed By Third Parties
(I). Summary of Amendments
(II). Baseline and Incremental Economic Effects
(III). Alternatives
b. Requirement To Subtract From Net Worth Certain Non-Permanent
Capital Contributions
(I). Summary of Amendments
(II). Baseline and Incremental Economic Effects
(III). Alternatives
c. Requirement To Deduct the Amount by Which a Fidelity Bond
Exceeds SRO Limits
d. Broker-Dealer Solvency Requirement
e. Amendment to Rule Governing Restrictions of Withdrawals of
Capital
[[Page 51825]]
f. Amendment to Rule 15c3-1 Appendix A
ii. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
VI. Final Regulatory Flexibility Analysis
A. General Issues Raised by Public Comments
B. Amendments to the Customer Protection Rule
1. Need for and Objectives of the Rule Amendments
2. Significant Issues Raised by Public Comment
3. Small Entities Subject to the Rules
4. Reporting, Recordkeeping, and Other Compliance Requirements
5. Agency Action To Minimize Effect on Small Entities
D. Securities Lending and Borrowing and Repurchase/Reverse
Repurchase Transactions
1. Need for and Objectives of the Amendments
2. Significant Issues Raised by the Public Comments
3. Small Entities Subject to the Rule
4. Reporting, Recordkeeping, and Other Compliance Requirements
5. Agency Action To Minimize Effect on Small Entities
E. Documentation of Risk Management Procedures
1. Need for and Objectives of the Amendments
2. Significant Issues Raised by Public Comments
3. Small Entities Subject to the Rule
4. Reporting, Recordkeeping, and Other Compliance Requirements
5. Agency Action To Minimize Effect on Small Entities
F. Amendments to the Net Capital Rule
1. Need for and Objectives of the Amendments
2. Significant Issues Raised by Public Comments
3. Small Entities Subject to the Rule
4. Reporting, Recordkeeping, and Other Compliance Requirements
5. Agency Action to Minimize Effect on Small Entities
VII. Statutory Authority
I. Background
The Commission is adopting amendments to the broker-dealer net
capital rule (Rule 15c3-1),\1\ customer protection rule (Rule 15c3-
3),\2\ books and records rules (Rules 17a-3 and 17a-4), and
notification rule (Rule 17a-11).\3\ The Commission proposed these rule
changes on March 9, 2007.\4\ The Commission re-opened the public
comment period on May 3, 2012.\5\ The Commission received a total of 97
comment letters on the proposed amendments.\6\ Sixty comment letters
[[Page 51826]]
were received prior to the re-opening of the comment period, and 37
were received after it. The Commission carefully considered all of the
comment letters, and as discussed in detail below, modified the
amendments in certain respects in light of the comments received. In
addition, the Commission has determined to defer consideration of
action at this time with respect to certain of the proposed amendments.
---------------------------------------------------------------------------
\1\ 17 CFR 240.15c3-1.
\2\ 17 CFR 240.15c3-3.
\3\ 17 CFR 240.17a-3; 17 CFR 240.17a-4; and 17 CFR 240.17a-11.
\4\ See Amendments to Financial Responsibility Rules for Broker-
Dealers, Exchange Act Release No. 55431 (Mar. 9, 2007), 72 FR 12862
(Mar. 19, 2007) (``Amendments to Financial Responsibility Rules'').
As part of this release, the Commission also requested comment on
three additional matters: reducing the Rule 17a-11 (17 CFR 240.17a-
11) early warning level for broker-dealers that carry over $10
billion in debits; harmonization of the net capital deductions
required by paragraph (c)(2)(iv)(B) of Rule 15c3-1 for securities
lending and borrowing transactions with the deductions required
under paragraph (c)(2)(iv)(F) for securities repurchase and reverse
repurchase agreement transactions (17 CFR 240 240.15c3-
1(c)(2)(iv)(B) and (c)(2)(iv)(F), respectively); and accounting for
third-party liens on customer securities held at a broker-dealer. As
discussed below in section III. of this release, the Commission
received comments in response to these requests but has determined
to defer consideration of actions with respect to these specific
matters at this time.
\5\ Amendments to Financial Responsibility Rules for Broker-
Dealers, Exchange Act Release No. 66910 (May 3, 2012), 77 FR 27150
(May 9, 2012).
\6\ Comments on the amendments are available at https://www.sec.gov/comments/s7-08-07/s70807.shtml. See also letter dated
April 22, 2007 from Peter G. Crane, President, Crane Data LLC
(``Crane Data Letter''); letter dated April 22, 2007 from David
Michael Bishop (``Bishop Letter''); letter dated April 27, 2007 from
Ted Beer, Broker/Dealer Principal (``Beer Letter''); letter dated
April 28, 2007 from Ted Beer, Broker/Dealer Principal (``Beer 2
Letter''); letter dated April 29, 2007 from R.A. Lowenstein, FinOps
Compliance Consultant (``Lowenstein Letter''); letter dated April
29, 2007 from G. Kirk Ellis (``Ellis Letter''); letter dated May 1,
2007 from Stuart J. Kaswell and David J. Harris, Dechert LLP on
behalf of Federated Investors (``Federated Letter''); letter dated
May 2, 2007 from Daniel R. Levene, President, small NASD broker-
dealer (``Levene Letter''); letter dated May 4, 2007 from Gerard J.
Quinn, Vice President and Associate General Counsel, SIFMA (``SIFMA
Letter''); letter dated May 7, 2007 from Michael Bell, President and
CEO, Curian Clearing, LLC (``Curian Clearing Letter''); letter dated
May 10, 2007 from Richard B. Franz II, Senior Vice-President,
Treasurer and Chief Financial Officer, Raymond James & Associates
(``Raymond James Letter''); letter dated May 16, 2007 from Steven R.
Gerbel, Chicago Capital Management LP (``Chicago Capital Letter'');
letter dated May 17, 2007 from Jeffrey L. Kiss, Principal,
PackerKiss Securities, Inc. (``PackerKiss Letter''); letter dated
May 17, 2007 from Josephine Wang, General Counsel, SIPC (``SIPC
Letter''); letter dated May 18, 2007 from Kimberly Taylor, Managing
Director and Clearing House President, Chicago Mercantile Exchange
Inc. (``CME Letter''); letter dated May 18, 2007 from Diane V.
Esheleman, Executive Vice President, JP Morgan Chase Bank, N.A.
(``JP Morgan Letter''); letter dated May 21, 2007 from Faith Colish,
Carter Ledyard Milburn LLP (``Colish Letter''); letter dated May 23,
2007 from Charles R. Manzoni, Jr., General Counsel, FAF Advisors,
Inc. (``FAF Advisors Letter''); letter dated May 27, 2007 from Joyce
Glenn (``Glenn Letter''); letter dated May 28, 2007 from William
Bare (``Bare Letter''); letter dated May 29, 2007 from Robert
Keenan, CEO, St. Bernard Financial Services, Inc. (``St. Bernard
Financial Services Letter''); letter dated May 31, 2007 from John C.
Melton, Sr., Executive Vice President, Coastal Securities (``Coastal
Letter''); letter dated June 3, 2007 from Anonymous (``Anonymous
Letter''); letter dated June 5, 2007 from Kelly S. McEntire,
Executor, Retired State Administrator/Executor of Janus Capital
Investments (``McEntire Letter''); letter dated June 13, 2007 from
Bruce Bent, Chairman, The Reserve (``Reserve Letter''); letter dated
June 14, 2007 from Amal El Said, Accounting and Regulatory, Abbey
National (``Abbey National Letter''); letter dated June 14, 2007
from Frank A. Perrone, Senior Vice President, Brown Brothers
Harriman & Co. (``Brown Brothers Harriman Letter''); letter dated
June 15, 2007 from James J. Angel, Ph.D., CFA, Associate Professor
of Finance, McDonough School of Business, Georgetown University
(``Angel Letter''); letter dated June 15, 2007 from Matthew M.
Hughey, Chief Financial Officer, First Clearing, LLC (``First
Clearing Letter''); letter dated June 15, 2007 from Marshall J.
Levinson, Senior Managing Director, Bear, Stearns & Co. Inc., Chair,
SIFMA Capital Committee (``SIFMA 2 Letter''); letter dated June 15,
2007 from Christopher Williams, Director and Senior Counsel, and
Barbara Brooks, Principal Financial Officer, Dresdner Kleinwort
(``Dresdner Kleinwort Letter''); letter dated June 18, 2007 from
Michael Dworkin (``Dworkin Letter''); letter dated June 18, 2007
from Keith Weller, Executive Director and Senior Associate General
Counsel, UBS Global Asset Management (Americas) Inc. (``UBS
Letter''); letter dated June 18, 2007 from Marcelo Riffaud, Managing
Director, Legal Department, Deutsche Bank Securities Inc.
(``Deutsche Bank Securities Letter''); letter dated June 18, 2007
from Jill Gross and Rahat Sarmast, Pace Investor Rights Project
(``Pace Letter''); letter dated June 18, 2007 from Robert E. Putney,
III, Director and Senior Counsel, BlackRock, Inc. (``BlackRock
Letter''); letter dated June 18, 2007 from James S. Keller, Chief
Regulatory, the PNC Financial Services Group, Inc. (``PNC Letter'');
letter dated June 18, 2007 from Sarah A. Miller, General Counsel,
American ABA Securities Association (``ABASA Letter''); letter dated
June 18, 2007 from David Hirschmann, Executive Vice President,
National Chamber Foundation of U.S. Chamber of Commerce (``National
Chamber Foundation Letter''); letter dated June 18, 2007 from
Michael W. Fields, Chief Fixed Income Officers, American Beacon
Advisors (``American Beacon Letter''); letter dated June 18, 2007
from David Lonergan, Head of U.S. Cash Management, Barclays Global
Investors (``Barclays Letter''); letter dated June 18, 2007 from
Howard Spindel, Senior Managing Directors, Integrated Management
Solutions (``Integrated Management Letter''); letter dated June 18,
2007 from Jane G. Heinrichs, Associate Counsel, Investment Company
Institute (``ICI Letter''); letter dated June 18, 2007 from Jeffrey
P. Neubert, CEO, Clearinghouse Association L.L.C. (``Clearing House
Letter''); letter dated June 19, 2007 from James T. McHale,
Associate General Counsel, E*Trade Brokerage Holdings, Inc.
(``E*Trade Letter''); letter dated June 25, 2007 from Cliff Verron,
Managing Director, Deputy Chief Financial Officers and John Ramsay,
Managing Director, Deputy General Counsel, Citigroup Global Markets
Inc. (``Citigroup Letter''); letter dated June 25, 2007 from AMEX,
CBOE, ISE, OCC, and NYSE/ARCA (``AMEX Letter''); letter dated July
3, 2007 from Keith F. Higgins, Chair, Committee on Federal
Regulation of Securities, American Bar Association (``American Bar
Association Letter''); letter dated July 23, 2007 from Charles S.
Morrison, Senior Vice President and Money Market Group Leader,
Fidelity Management & Research Company, and John Valenti, Vice
President, National Financial Securities LLC (``Fidelity/NFS
Letter''); letter dated August 6, 2007 from Stuart Kaswell, Dechert
LLP, on behalf of Federated Investors, Inc. (``Federated 2
Letter''); letter dated October 9, 2007 from Stuart Kaswell, Dechert
LLP on behalf of Federated Investors, Inc. (``Federated 3 Letter'');
letter dated November 16, 2007 from Marshall J. Levinson, Chair,
Capital Committee, SIFMA (``SIFMA 3 Letter''); letter dated January
7, 2008 from Stuart J. Kaswell, Dechert LLP, on behalf of Federated
Investors, Inc. (``Federated 4 Letter''); letter dated August 7,
2008 from Stuart J. Kaswell, Bryan Cave LLP, on behalf of Federated
Investors, Inc. (``Federated 5 Letter''); letter dated November 10,
2008 from Lee A. Pickard, Pickard & Djinis LLP on behalf of
Federated Investors (``Federated 6 Letter''); letter dated November
25, 2008 from Lee A. Pickard, Pickard & Djinis LLP on behalf of
Federated Investors (``Federated 7 Letter''); letter dated December
18, 2008 from Lee A. Pickard, Pickard & Djinis LLP on behalf of
Federated Investors (``Federated 8 Letter''); letter dated July 28,
2009 from Richard J. McDonald, Chief Regulatory Counsel, Susquehanna
International Group LLP (``SIG Letter''); letter dated June 8, 2010
from The Honorable Gregory W. Meeks (``Meeks Letter''); letter dated
October 14, 2011 from The Honorable Gregory W. Meeks (``Meeks 2
Letter''); letter dated May 5, 2012 from Edward P. Cernocky
(``Cernocky Letter''); letter dated May 11, 2012 from Chris Barnard
(``Barnard Letter''); letter dated May 15, 2012 from Helen M.
Saarinen (``Saarinen Letter''); letter dated May 18, 2012 from Laura
H. Hearne (``Hearne Letter''); letter dated May 24, 2012 from Dick
Fuld (``Fuld Letter''); letter dated May 30, 2012 from Bruce J.
Womack (``Womack Letter''); letter dated June 1, 2012 from Lee A.
Pickard, Pickard & Djinis LLP, on behalf of Federated Investors
(``Federated 9 Letter''); letter dated June 4, 2012 from Michael
Scillia, Director, National Investment Banking Association (``NIBA
Letter''); letter dated June 7, 2012 from Anthony Fitzgerald
(``Fitzgerald Letter''); letter dated June 7, 2012 from Tom Vincent,
Senior V.P., Corporate Governance and Wealth Management Compliance,
BOK Financial Corporation (``BOK Letter''); letter dated June 8,
2012 from Denise Dolphin (``Dolphin Letter''); letter dated June 8,
2012 from Colin W. McKechnie, Managing Director, JP Morgan Chase
Bank, N. A (``JP Morgan 2 Letter''); letter dated June 8, 2012 from
William A. Jacobson, Associate Clinical Professor, Cornell Law
School, and Director, Cornell Securities Law Clinic, Ithaca, New
York (``Cornell Letter''); letter dated June 8, 2012 from Ryan K.
Bakhtiari, Aidikoff, Uhl & Bakhtiari, on behalf of the Public
Investors Arbitration Bar Association (``PIABA Letter''); letter
dated June 8, 2012 from Kenneth E. Bentsen, Jr., Executive Vice
President, Public Policy and Advocacy, SIFMA (``SIFMA 4 Letter'');
letter dated June 8, 2012 from Sarah A. Miller, Chief Executive
Officer, Institute of International Bankers (``IIB Letter''); letter
dated June 8, 2012 from James T. McHale, Global Head of Compliance,
E*TRADE Financial Corporation (``E*Trade 2 Letter''); letter dated
June 11, 2012 from Steve M. Brewer, Sr., ASG Securities, LLC,
Houston, Texas (``ASG Securities Letter''); letter dated June 25,
2012 from Gene L. Finn (``Finn Letter''); letter dated June 26, 2012
from Cindy Walsh (``Walsh Letter''); letter dated July 12, 2012 from
Michael Scillia, Director, National Investment Banking Association
(``NIBA 2 Letter''); letter dated July 18, 2012 from Gene L. Finn
(``Finn 2 Letter''); letter dated July 30, 2012 from David Waddell
(``Waddell Letter''); letter dated August 6, 2012 from Gene Finn
(``Finn 3 Letter''); letter dated August 15, 2012 from Echeal R.
Sigan (``Sigan Letter''); letter dated August 26, 2012 from Mark
Irwin (``Irwin Letter''); letter dated September 17, 2012 from Gene
L. Finn (``Finn 4 Letter''); letter dated September 27, 2012 from
Jeff S. Clark (``Clark Letter''); letter dated September 28, 2012
from Robert LaPlante, M.P.A. (``LaPlante Letter''); letter dated
October 19, 2012 from Rick Louderbough (``Louderbough Letter'');
letter dated October 24, 2012 from Paul L. Matecki, Senior Vice
President, General Counsel, Raymond James Financial, Inc. (``Raymond
James 2 Letter''); letter dated October 25, 2012 from Eric Gamble,
Ph.D. (``Gamble Letter''); letter dated November 1, 2012 from Percy
R. Moorman, Esq. (``Moorman Letter''); letter dated January 4, 2013
from Marquis Wilkins (``Wilkins Letter''); letter dated January 5,
2013 from Anonymous SEC Fan (``Anonymous SEC Letter''); letter dated
January 24, 2013 from Robert Fournier (``Fournier Letter''); and
letter dated January 28, 2013 from Scott E. Shjefte (``Shjefte
Letter''). Comment letters and specific comments outside the scope
of this rulemaking are not addressed in this release.
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II. Amendments
A. Amendments to the Customer Protection Rule
1. Background
The Commission adopted Rule 15c3-3 in 1972 in response to a
congressional directive to strengthen the financial responsibility
requirements for broker-dealers that hold securities and cash for
customers.\7\ In particular, Rule 15c3-3 is designed ``to give more
specific protection to customer funds and securities, in effect
forbidding brokers and dealers from using customer assets to finance
any part of their businesses unrelated to servicing securities
customers; e.g., a firm is virtually precluded from using customer
funds to buy securities for its own account.'' \8\ To meet this
objective, Rule 15c3-3 requires a broker-dealer that maintains custody
of customer securities and cash (a ``carrying broker-dealer'') to take
two primary steps to safeguard these assets. The steps are designed to
protect customers \9\ by segregating their securities and cash from the
broker-dealer's proprietary business activities. If the broker-dealer
fails financially, the securities and cash should be readily available
to be returned to the customers. In addition, if the failed broker-
dealer is liquidated in a formal proceeding under the Securities
Investor Protection Act of 1970 (``SIPA''), the securities and cash
would be isolated and readily identifiable as ``customer property''
and, consequently, available to be distributed to customers ahead of
other creditors.\10\
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\7\ See Broker-dealers; Maintenance of Certain Basic Reserves,
Exchange Act Release No. 9856 (Nov. 10, 1972), 37 FR 25224 (Nov. 29,
1972).
\8\ See Net Capital Requirements for Brokers and Dealers,
Exchange Act Release No. 21651 (Jan. 11, 1985), 50 FR 2690, 2690
(Jan. 18, 1985). See also Broker-Dealers; Maintenance of Certain
Basic Reserves, Exchange Act Release No. 9856 (Nov. 10, 1972), 37 FR
25224, 25224 (Nov. 29, 1972).
\9\ Rule 15c3-3 defines customer as ``any person from whom or on
whose behalf a broker or dealer has received or acquired or holds
funds or securities for the account of that person.'' The rule
excludes certain categories of persons from the definition,
including broker-dealers, municipal securities dealers, and
government securities broker-dealers. It also excludes general
partners, directors, and principal officers of the broker-dealer and
any other person to the extent that the person has a claim for
property or funds which by contract, agreement or understanding, or
by operation of law, is part of the capital of the broker-dealer or
is subordinated to the claims of creditors of the broker-dealer. 17
CFR 240.15c3-3(a)(1).
\10\ See 15 U.S.C. 78aaa et seq.
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The first step required by Rule 15c3-3 is that a carrying broker-
dealer must maintain physical possession or control over customers'
fully paid and excess margin securities.\11\ Physical possession or
control means the broker-dealer must hold these securities in one of
several locations specified in Rule 15c3-3 and free of liens or any
other interest that could be exercised by a third party to secure an
obligation of the broker-dealer.\12\ Permissible locations include a
bank, as defined in section 3(a)(6) of the Exchange Act, and a clearing
agency.\13\
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\11\ See 17 CFR 240.15c3-3(b) and (d). The term fully paid
securities includes all securities carried for the account of a
customer in a special cash account as defined in Regulation T
promulgated by the Board of Governors of the Federal Reserve System,
as well as margin equity securities within the meaning of Regulation
T which are carried for the account of a customer in a general
account or any special account under Regulation T during any period
when section 8 of Regulation T (12 CFR 220.8) specifies that margin
equity securities shall have no loan value in a general account or
special convertible debt security account, and all such margin
equity securities in such account if they are fully paid: provided,
however, that the term fully paid securities shall not apply to any
securities which are purchased in transactions for which the
customer has not made full payment. 17 CFR 240.15c3-3(a)(3). The
term margin securities means those securities carried for the
account of a customer in a general account as defined in Regulation
T, as well as securities carried in any special account other than
the securities referred to in paragraph (a)(3) of Rule 15c3-3. 17
CFR 240.15c3-3(a)(4). The term excess margin securities means those
securities referred to in paragraph (a)(4) of Rule 15c3-3 carried
for the account of a customer having a market value in excess of 140
percent of the total of the debit balances in the customer's account
or accounts encompassed by paragraph (a)(4) of Rule 15c3-3 which the
broker-dealer identifies as not constituting margin securities. 17
CFR 240.15c3-3(a)(5). As discussed in section II.F. of this release,
the Commission is adopting technical amendments to the definitions
of the terms fully paid securities and margin securities under Rule
15c3-3. See paragraphs (a)(3) and (4) of Rule 15c3-3, as adopted.
\12\ See 17 CFR 240.15c3-3(c). Customer securities held by the
carrying broker-dealer are not assets of the firm. Rather, the
carrying broker-dealer holds them in a custodial capacity and the
possession and control requirement is designed to ensure that the
carrying broker-dealer treats them in a manner that allows for their
prompt return.
\13\ Id.
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The second step is that a carrying broker-dealer must maintain a
reserve of cash or qualified securities in an account at a bank that is
at least equal in value to the net cash owed to customers, including
cash obtained from the use of customer securities.\14\ The account must
be titled ``Special Reserve Bank Account for the Exclusive
[[Page 51827]]
Benefit of Customers.'' \15\ The amount of net cash owed to customers
is computed pursuant to a formula set forth in Exhibit A to Rule 15c3-
3.\16\ Under the customer reserve formula, the broker-dealer adds up
customer credit items (e.g., cash in customer securities accounts and
cash obtained through the use of customer margin securities) and then
subtracts from that amount customer debit items (e.g., margin
loans).\17\ If credit items exceed debit items, the net amount must be
on deposit in the customer reserve account in the form of cash and/or
qualified securities.\18\ A broker-dealer cannot make a withdrawal from
the customer reserve account until the next computation and even then
only if the computation shows that the reserve requirement has
decreased.\19\ The broker-dealer must make a deposit into the customer
reserve account if the computation shows an increase in the reserve
requirement.
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\14\ 17 CFR 240.15c3-3(e). The term qualified security is
defined in Rule 15c3-3 to mean a security issued by the United
States or a security in respect of which the principal and interest
are guaranteed by the United States. See 17 CFR 240.15c3-3(a)(6).
\15\ See 17 CFR 240.15c3-3(e)(1). The purpose of giving the
account this title is to alert the bank and creditors of the broker-
dealer that this account is to be used to meet the broker-dealer's
obligations to customers (and not the claims of general creditors)
in the event the broker-dealer must be liquidated in a formal
proceeding.
\16\ 17 CFR 240.15c3-3a.
\17\ Id.
\18\ 17 CFR 240.15c3-3(e). Customer cash is a balance sheet item
of the carrying broker-dealer (i.e., the amount of cash received
from a customer increases the amount of the carrying broker-dealer's
assets and creates a corresponding liability to the customer). The
customer reserve formula is designed to isolate these broker-dealer
assets so that an amount equal to the net liabilities to customers
is held as a reserve in the form of cash or qualified securities.
The requirement to establish this reserve is designed to effectively
prevent the carrying broker-dealer from using customer funds for
proprietary business activities such as investing in securities. The
goal is to put the carrying broker-dealer in a position to be able
to readily meet its cash obligations to customers by requiring the
firm to make deposits of cash and/or qualified securities into the
customer reserve account in the amount of the net cash owed to
customers. Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for Broker-Dealers, Exchange
Act Release No. 68071 (Oct. 18, 2012), 77 FR 70213, 70277 n.671
(Nov. 23, 2012).
\19\ See 17 CFR 240.15c3-3(e). Under paragraph (e), broker-
dealers are generally required to perform the customer reserve
computation as of the close of business on the last business day of
the week. Broker-dealers from time to time may perform a mid-week
computation if it would permit them to make a withdrawal. 17 CFR
240.15c3-3(g).
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In addition, the customer reserve formula permits the broker-dealer
to offset customer credit items only with customer debit items.\20\
This means the broker-dealer can use customer cash to facilitate
customer transactions such as financing customer margin loans and
borrowing securities to make deliveries of securities that customers
have sold short.\21\ Broker-dealer margin rules require securities
customers to maintain a minimum level of equity in their securities
accounts.\22\ In addition to protecting the broker-dealer from the
consequences of a customer default, this equity serves to over-
collateralize the customers' obligations to the broker-dealer and
thereby protect customers whose cash was used to facilitate the broker-
dealer's financing of securities purchases and short sales by other
customers. For example, if the broker-dealer fails, the customer
debits, because they generally are over-collateralized, should be
attractive assets for another broker-dealer to purchase or, if not
purchased by another broker-dealer, they should be able to be
liquidated to a net positive equity.\23\ The proceeds of the debits
sale or liquidation can be used to repay the customer cash used to
finance the customer obligations. This cash plus the funds and/or
qualified securities held in the customer reserve account should equal
or exceed the total amount of customer credit items (i.e., the total
amount owed by the broker-dealer to its customers).\24\
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\20\ See 17 CFR 240.15c3-3a.
\21\ For example, if a broker-dealer holds $100 for customer A,
the broker-dealer can use that $100 to finance a security purchase
of customer B. The $100 the broker-dealer owes customer A is a
credit in the formula and the $100 customer B owes the broker-dealer
is a debit in the formula. Therefore, under the customer reserve
formula there would be no requirement to maintain cash and/or U.S.
government securities in the customer reserve account. However, if
the broker-dealer did not use the $100 held in customer A's account
for this purpose, there would be no offsetting debit and,
consequently, the broker-dealer would need to have on deposit in the
customer reserve account cash and/or qualified securities in an
amount at least equal to $100.
\22\ Broker-dealers are subject to margin requirements in
Regulation T promulgated by the Federal Reserve (see 12 CFR 220.1,
et seq.), in rules promulgated by the self-regulatory organizations
(``SROs'') (see, e.g., FINRA Rules 4210-4240), and with respect to
security futures, in rules jointly promulgated by the Commission and
the CFTC (see 17 CFR 242.400-406).
\23\ The attractiveness of the over-collateralized debits
facilitates the bulk transfer of customer accounts from a failing or
failed broker-dealer to another broker-dealer.
\24\ See Net Capital Requirements for Broker-Dealers; Amended
Rules, Exchange Act Release No. 18417 (Jan. 13, 1982), 47 FR 3512,
3513 (Jan. 25, 1982) (``The alternative method is founded on the
concept that if the debit items in the Reserve Formula can be
liquidated at or near their contract values, these assets, along
with any cash required to be on deposit under the [customer
protection] rule, will be sufficient to satisfy all customer-related
liabilities (which are represented as credit items in the Reserve
Formula'').
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2. Proprietary Accounts of Broker-Dealers
A carrying broker-dealer may carry accounts that hold proprietary
securities and cash of other broker-dealers (``PAB accounts''). As
noted above, broker-dealers are not within the definition of customer
for purposes of Rule 15c3-3.\25\ Accordingly, a carrying broker-dealer
that carries PAB accounts is not required to treat these accounts as
customer accounts for the purposes of Rule 15c3-3. This means the
carrying broker-dealer is not required to maintain possession or
control of the securities of PAB account holders that are not securing
margin loans to the account holders (``non-margin securities'') or
include credit and debit items associated with those accounts in its
customer reserve computation. The definition of customer in SIPA,
however, is broader than the definition in Rule 15c3-3 in that the SIPA
definition does not exclude broker-dealers.\26\ Customers under SIPA
(``SIPA customers'') generally are entitled to a number of protections,
including the right to share pro rata with other SIPA customers in the
customer property held by the broker-dealer and, if the customer
property is insufficient to make each SIPA customer whole, the
entitlement to receive an advance from the Securities Investor
Protection Corporation (``SIPC'') of up to $500,000 (of which $250,000
currently can be used to cover cash claims).\27\ Broker-dealers as SIPA
customers have the right to a pro rata share of the customer property,
but are not entitled to receive an advance from the SIPC fund.\28\
Consequently, when a carrying broker-dealer is liquidated in a SIPA
proceeding, each customer (including a SIPA customer that is a broker-
dealer) has a claim on the customer property. Because the possession
and control and customer reserve account provisions of Rule 15c3-3 do
not apply to PAB account holders by virtue of the definition of
customer in the rule, the carrying broker-dealer is not restricted by
Rule 15c3-3 from using the securities and cash in these accounts for
its own business purposes.
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\25\ 17 CFR 240.15c3-3(a)(1).
\26\ See 15 U.S.C. 78lll(2).
\27\ See 15 U.S.C. 78fff-2(c) and 15 U.S.C. 78fff-3(a),
respectively. Under SIPA, customer property includes ``cash and
securities (except customer name securities delivered to the
customer) at any time received, acquired, or held by or for the
account of the debtor from or for the securities accounts of a
customer, and the proceeds of any such property transferred by the
debtor, including property unlawfully converted.'' 15 U.S.C.
78lll(4). Therefore, customer property includes those securities
positions that are held for customers and the cash that is owed to
customers.
\28\ See 15 U.S.C. 78fff-2(c); see also 15 U.S.C. 78fff-3(a).
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The treatment of PAB account holders as SIPA customers but not as
customers for the purposes of Rule 15c3-3
[[Page 51828]]
increases the risk that, in the event a carrying broker-dealer is
liquidated under SIPA, the claims of SIPA customers (i.e., customers
and PAB account holders) will exceed the amount of customer property
available and, thereby, expose the SIPC fund and potentially SIPA
customers to losses. In addition, if the customer property is
insufficient to fully satisfy all SIPA customer claims and losses are
incurred, the PAB account holders could be placed in financial distress
causing adverse impacts to the securities markets beyond those
resulting from the failure of the carrying broker-dealer.\29\
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\29\ As noted above, while broker-dealers are customers for the
purposes of SIPA, they are not entitled to the advances from the
SIPC fund to make up for shortfalls after the pro rata distribution
of customer property. 15 U.S.C. 78fff-3(a)(5).
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To address the disparity in treatment between customers and PAB
account holders, the Commission proposed amendments to Rules 15c3-3 and
15c3-3a that would have required a broker-dealer that carries PAB
accounts to perform a PAB reserve computation with respect to those
accounts, generally as of the close of business on the last business
day of the week.\30\ The amendments, as proposed, would have required
the carrying broker-dealer to add up the debits and credits relating to
PAB accounts--including credits arising from the use of securities held
in PAB accounts--and maintain cash or qualified securities in a PAB
reserve account in an amount equal to or greater than the amount that
the credits exceed the debits.
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\30\ See Amendments to Financial Responsibility Rules, 72 FR at
12863. A broker-dealer that does not carry an account of a customer
as defined under Rule 15c3-3 or conduct a proprietary trading
business would be permitted to make the computation monthly rather
than weekly. See paragraph (e)(3)(iii) of Rule 15c3-3, as adopted.
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Seven commenters responded to the Commission's request for comment
on the proposed amendments.\31\ As discussed below, the Commission has
modified the final rule in certain respects to address, among other
things, issues raised by commenters. As adopted, the Commission's
amendments to Rules 15c3-3 and 15c3-3a require carrying broker-dealers
to: (1) Perform a separate reserve computation for PAB accounts (in
addition to the customer reserve computation currently required for
Rule 15c3-3 customer accounts); (2) establish and fund a separate
reserve account for the benefit of PAB account holders; and (3) obtain
and maintain physical possession or control of non-margin securities
carried for PAB accounts unless the carrying broker has provided
written notice to the PAB account holders that it will use those
securities in the ordinary course of its securities business, and has
provided opportunity for the PAB account holder to object to such
use.\32\
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\31\ See SIFMA 2 Letter; SIFMA 4 Letter; Dresdner Kleinwort
Letter; Deutsche Bank Securities Letter; SIPC Letter; Abbey National
Letter; First Clearing Letter; Cornell Letter.
\32\ See infra section II.A.2.ii. of this release for a
discussion of the Commission's rationale for the change in the final
rule to require a carrying broker-dealer provide notice to, rather
than obtain written permission from, a PAB account holder in order
for its securities to be used in the ordinary course of the carrying
firm's securities business.
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These amendments, in part, incorporate many of the provisions of a
no-action letter regarding PAB accounts issued by Commission staff in
1998.\33\ The PAIB Letter stated that the staff would not recommend
enforcement action to the Commission if a broker-dealer did not take a
net capital deduction under Rule 15c3-1 for cash held in a securities
account at another broker-dealer,\34\ provided the other broker-dealer
agrees to: (1) Perform a reserve computation for PAB accounts; \35\ (2)
establish a separate special reserve bank account; and (3) maintain
cash or qualified securities in the reserve account equal to the
computed reserve requirement (``PAIB agreement''). Broker-dealers that
carry PAB accounts have the incentive to enter into PAIB agreements to
prevent their PAB account holders from choosing to open an account or
enter into a clearing agreement with another broker-dealer. Because
many of the provisions in the PAIB Letter are being incorporated in
this rulemaking, the Commission is directing the Commission staff to
withdraw the PAIB Letter as of the effective date of these rule
amendments.
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\33\ See Letter from Michael A. Macchiaroli, Associate Director,
Division of Market Regulation, Commission, to Raymond J. Hennessy,
Vice President, NYSE, and Thomas Cassella, Vice President, NASD
Regulation, Inc. (Nov. 3, 1998) (``PAIB Letter'').
\34\ Under Rule 15c3-1, broker-dealers are generally required to
deduct unsecured receivables from their net worth when computing
their net capital.
\35\ Under new paragraph (e)(3), broker-dealers will be required
to perform the PAB reserve account computation (and its customer
reserve account computation, if applicable) on a weekly basis, as of
the close of business on the last business day of the week. With
regard to PAB accounts, a broker-dealer that does not carry an
account of a customer as defined under Rule 15c3-3 or conduct a
proprietary trading business may make the PAB reserve account
computation monthly rather than weekly. See new paragraph
(e)(3)(iii) of Rule 15c3-3.
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i. Definition of ``PAB Account'' Under Rule 15c3-3(a)(16)
The Commission proposed, among other things, to add paragraph
(a)(16) to Rule 15c3-3 that would have defined the term PAB account as
``a proprietary securities account of a broker or dealer (which
includes a foreign broker or dealer, or a foreign bank acting as a
broker or dealer), but shall not include an account where the account
owner is a guaranteed subsidiary of the carrying broker or dealer, the
account owner guarantees all liabilities and obligations of the
carrying broker or dealer, or the account is a delivery-versus-payment
account or receipt-versus-payment account.'' \36\ Two commenters raised
concerns about the proposed definition because--by including
proprietary accounts of foreign broker-dealers and foreign banks acting
as broker-dealers within the term PAB account--it differed from
provisions in the PAIB Letter, which excluded such accounts from a PAIB
computation.\37\ One of these commenters stated that broker-dealers
(including foreign banks acting as broker-dealers) should be allowed to
opt-out of PAB account treatment because they do not require the same
protections as customers as defined in Rule 15c3-3.\38\ The commenter
stated that broker-dealers are able to understand the insolvency risk
of the broker-dealers at which they maintain proprietary accounts.\39\
This commenter noted that broker-dealer customers often self-insure or
otherwise account for such exposure regardless of their status under
SIPA.\40\ The second commenter stated that foreign broker-dealers and
foreign banks acting as broker-dealers should be allowed to subordinate
their claims to customers and creditors of the broker-dealer in order
to remove their accounts from PAB account treatment because under SIPA
foreign broker-dealers and foreign banks acting as broker-dealers,
under certain circumstances, will not be deemed customers and,
therefore, would not be entitled to a pro rata share of the estate of
customer property in a SIPA liquidation.\41\ More specifically, the
commenter suggested that the Commission modify the definition of PAB
account, to exclude ``any foreign broker-dealer and foreign bank to the
extent that such entity has a claim for cash or securities that is
subordinated to the claims of creditors of the carrying broker-dealer''
in order to parallel the
[[Page 51829]]
language in SIPA.\42\ This commenter also recommended requiring the
``subordinating'' broker-dealer to follow the requirements for non-
conforming subordinated loans to remove an account from PAB account
treatment.\43\
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\36\ See Amendments to Financial Responsibility Rules, 72 FR at
12895.
\37\ See Dresdner Kleinwort Letter; Deutsche Bank Securities
Letter. Though SIFMA initially raised concerns about the proposed
definition, it later withdrew its recommendation that proprietary
accounts of affiliated non-U.S. broker-dealers and non-U.S. banks be
excluded from the PAB account definition. See SIFMA 2 Letter; SIFMA
4 Letter.
\38\ See Dresdner Kleinwort Letter.
\39\ Id.
\40\ See Dresdner Kleinwort Letter.
\41\ See Deutsche Bank Securities Letter.
\42\ The definition of customer in SIPA excludes any person, to
the extent that ``such person has a claim for cash or securities
which by contract, agreement, or understanding, or by operation of
law, is part of the capital of the debtor, or is subordinated to the
claims of any and all creditors of the debtor, notwithstanding that
some grounds exist for declaring such contract, agreement, or
understanding void or voidable in a suit between the claimant and
the debtor.'' See 15 U.S.C. 78lll(2)(C)(iii).
\43\ See Deutsche Bank Securities Letter. See also SIFMA 4
Letter. Under Rule 15c3-1, a broker-dealer can exclude liabilities
that are subordinated to the claims of creditors pursuant to a
satisfactory subordination agreement, as defined in Appendix D to
Rule 15c3-1, for purposes determining its net capital. See 17 CFR
240.15c3-1(c)(2)(ii) and 17 CFR 240.15c3-1d. See also 17 CFR
240.15c3-1(c)(i)(x). A non-conforming subordination agreement
generally would not meet all the requirements of Appendix D to Rule
15c3-1, and, therefore, a broker-dealer could not exclude the
liability resulting from the loan agreement in computing its net
capital. See 17 CFR 240.15c3-1(c)(2)(ii).
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Another commenter stated that the Commission's desire to close the
gap between Rule 15c3-3 and SIPA must be balanced against the
potentially significant practical issues the Commission's proposal
would raise in the case of accounts carried for affiliated entities
operating in non-U.S. jurisdictions.\44\ In a subsequent letter, this
commenter stated that while it would prefer a more flexible solution
that would allow broker-dealers and non-U.S. banks acting as broker-
dealers (especially non-U.S. affiliates) to opt to have their accounts
treated as neither customer accounts under SIPA nor PAB accounts, the
commenter recognized that there is a clear need for an immediate
solution that cannot be delayed until appropriate amendments to SIPA
are adopted.\45\ Consequently, the commenter withdrew its
recommendation that the proprietary accounts of affiliated non-U.S.
broker-dealers and affiliated non-U.S. banks be excluded from the ``PAB
account'' definition, but continued to endorse its previous comments to
achieve the goal of correcting the gap between Rule 15c3-3 and SIPA
without creating undue or unintended burdens.\46\
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\44\ See SIFMA 2 Letter. This commenter specifically raised
concerns that it would be cumbersome to subject transactions between
a carrying broker-dealer and its foreign affiliates to the proposed
PAB requirements because of the integrated securities processing and
settlement activities of these entities, which would limit the
ability of the group as a whole to provide competitive services to
U.S. investors.
\45\ See SIFMA 4 Letter.
\46\ See SIFMA 4 Letter. Among other things, the commenter
suggested that the Commission modify the proposed definition of PAB
account to exclude any customer as defined in Rule 15c3-3 and also
to exclude the other types of persons who are specifically excluded
from the definition of customer. This suggestion included excluding
accounts whose claims are subordinated to the claims of other
creditors of the carrying broker-dealer. Id.
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The goal of the proposed amendments is to create a process that
protects Rule 15c3-3 customers and PAB account holders of a failed
carrying broker-dealer. The amendments are designed to provide such
protection by mitigating the risk that there will be insufficient
customer property to fully satisfy all customer claims in a SIPA
liquidation. The entitlement of PAB account holders to a pro rata share
of the fund of customer property places all SIPA customers at risk if
the carrying firm does not establish a PAB reserve account for excess
credits owed to PAB account holders.
At the same time, the Commission appreciates the need to consider
both the practical issues raised by commenters and its objective to
eliminate the inconsistency between Rule 15c3-3 and SIPA.\47\
Accordingly, in response to commenters, the final rule adopted by the
Commission excludes from the definition of PAB account in paragraph
(a)(16) of Rule 15c3-3 ``an account that has been subordinated to the
claims of creditors of the carrying broker or dealer.'' \48\ A PAB
account holder that has subordinated its claims with respect to that
account to claims of creditors of the carrying broker-dealer will not
be entitled to SIPA protection for that account.\49\ Consequently, this
provision will provide flexibility to carrying broker-dealers and their
broker-dealer affiliates to structure their PAB account relationships
in a manner that permits operational efficiencies (i.e., the ability to
exclude these accounts from the PAB reserve computation) while still
promoting the goal of the amendments to have a consistent treatment of
these accounts under Rule 15c3-3 and SIPA, and thereby protect accounts
holders that are ``customers'' under SIPA.\50\ If a U.S. broker-dealer,
however, chooses to subordinate its claims to assets in that account to
the claims of other creditors of the carrying broker-dealer, it will
not be able to include those assets as allowable for its own net
capital computation.\51\
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\47\ See Amendments to Financial Responsibility Rules, 72 FR at
12863.
\48\ The agreement would not need to be conforming for purposes
of Exchange Act Rule 15c3-1d (Satisfactory Subordination
Agreements).
\49\ See 15 U.S.C. 78lll(2).
\50\ See 17 CFR 240.15c3-3(a)(1) and 15 U.S.C. 78lll(2)(C)(ii).
These accounts will be excluded from both the definition of PAB
account, as well from the definition of customer under SIPA. See
Amendments to Financial Responsibility Rules, 72 FR at 12863.
Consequently, these account holders will not be entitled to the
protections in SIPA applicable to customers.
\51\ See 17 CFR 240.15c3-1(c)(2)(iv)(E).
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Further, as was proposed, the definition of PAB account in the
final rule excludes accounts that operate on a delivery-versus-payment
or a receipt-versus-payment basis, or ``DVP/RVP'' basis, because these
accounts generally hold securities and cash for short durations.\52\
The provision relating to DVP/RVP accounts is being adopted
substantially as proposed, though paragraph (a)(16), as adopted, has
been modified by splitting the text into two sentences. As adopted, the
reference to the DVP/RVP accounts provision was moved to the first
sentence. The Commission is not adopting the proposed exclusions from
the PAB reserve computation requirement related to accounts established
by a PAB account holder that fully guarantee the obligations of, or
whose accounts are fully guaranteed by, the carrying broker-dealer.
Rather than create a specific exemption for such account holders, the
Commission believes the better approach is to allow these accounts to
enter into subordination agreements with the carrying broker-dealer, in
order for these accounts to be excluded from the definition of PAB
account. This approach simplifies the final rule, while continuing to
provide a means for these account holders to be excluded from its
scope. Consequently, as adopted, paragraph (a)(16) to Rule 15c3-3
defines the term PAB account to mean ``a proprietary securities account
of a broker or dealer (which includes a foreign broker or dealer, or a
foreign bank acting as a broker or dealer) other than a delivery-
versus-payment account or a receipt-versus-payment account.'' \53\ The
definition of PAB Account does not include accounts that have been
subordinated to the claims of a carrying broker-dealer's creditors.\54\
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\52\ See Amendments to Financial Responsibility Rules, 72 FR at
12863, n.17 (``[T]he amendment would exclude delivery-versus-payment
and receipt-versus-payment accounts. These types of accounts pose
little risk of reducing the estate of customer property in a SIPA
liquidation since they only hold assets for short periods of
time.'').
\53\ See paragraph (a)(16) to Rule 15c3-3, as adopted.
\54\ Id.
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ii. Written Permission To Use PAB Account Securities
Because PAB account holders are not customers for purposes of Rule
15c3-3, a carrying broker-dealer is not required to maintain possession
or control of their non-margin securities. Consequently, it has been a
long-
[[Page 51830]]
standing industry practice for carrying broker-dealers to use these PAB
securities in their business activities. Under the final rule, a
carrying broker-dealer that uses these PAB securities will need to
include the market value of the securities as a credit in the formula
when performing the PAB reserve computation. Thus, the amount that the
carrying broker-dealer must maintain in its PAB reserve account will
increase by the amount of these credits because there would be no
corresponding debit item.\55\
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\55\ 17 CFR 240.15c-3-3a.
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Using non-margin securities of PAB account holders presents the
risk that securities may increase in market value between PAB reserve
computations and, therefore, the amount of the credit items in the
formula may be less than the value of the securities for a short period
of time. To accommodate industry practice, however, the Commission did
not propose amending Rule 15c3-3 to apply the possession or control
requirements to PAB accounts. The Commission proposed adding paragraph
(b)(5) to Rule 15c3-3 that would have required the carrying broker-
dealer to obtain written permission from a PAB account holder before it
could use the PAB account holder's securities in the ordinary course of
its securities business. In this way, the Commission proposed
increasing the protections for PAB account holders without interfering
with long-standing industry practice of carrying broker-dealers using
the securities of their broker-dealer account holders. However,
securities not being used by the broker-dealer must be maintained in
accordance with the possession or control requirements of Rule 15c3-3.
One commenter stated that this provision should be eliminated from
the proposed amendments, arguing that ``[t]he proposal interferes
unnecessarily in the contractual arrangements between broker-dealers,
which are capable of understanding the terms of standard industry
custodial relationships.'' \56\ The commenter also noted that the PAIB
Letter did not contain any such requirement.\57\ The Commission agrees
with the commenter that broker-dealers should be able to understand the
implications of granting another broker-dealer the ability to use their
non-margin securities and, therefore, the final rule requires written
notice rather than written permission. An appropriate level of
protection for the PAB account holder may be achieved without requiring
the carrying broker-dealer to maintain possession or control of
securities carried for a PAB account, provided that the carrying
broker-dealer gives written notice to its PAB account holders that it
may use their non-margin securities.\58\
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\56\ See SIFMA 2 Letter.
\57\ Id.
\58\ The Commission has deleted the phrase ``obtained the
written permission of the account owner to use the securities in the
ordinary course of its securities business'' from paragraph (b)(5)
of the final rule and replaced it with ``provided written notice to
the account holder that the securities may be used in the ordinary
course of its securities business, and has provided an opportunity
for the account holder to object.''
---------------------------------------------------------------------------
The Commission acknowledges that this change, as compared to the
proposed rule, will shift the burden to the PAB account holder to
proactively object to the carrying broker-dealer using the account
holder's securities. However, the new written notice requirement
increases the protections for PAB account holders from the status quo
without imposing substantial burdens on existing account relationships.
The revised rule is intended to provide to the PAB account holders the
opportunity to negotiate different terms if they do not want their
securities used, while eliminating the need for, and the costs that
would result from, carrying broker-dealers reworking existing
contracts.
As adopted, the Commission is modifying the final rule to add the
phrase ``and has provided an opportunity for the account holder to
object'' following the phrase ``ordinary course of its securities
business.'' \59\ This language was added to the final rule to impose a
requirement that the carrying broker-dealer provide the PAB account
holders an opportunity to object to the use of their non-margin
securities after they receive the written notice from the carrying
broker-dealer. The rule does not prescribe the form in which a PAB
account holder must provide notice to the carrying broker-dealer of its
objection. This will provide the PAB account holder with flexibility to
communicate the objection in a manner the account holder determines is
most effective in terms of conveying such objection to the carrying
broker-dealer. If the PAB account holder objects, the carrying broker-
dealer could not use the securities. Further, the PAB account holder
could seek to move the account to another carrying broker-dealer or
negotiate different terms with the carrying broker-dealer with regard
to the use of its securities.
---------------------------------------------------------------------------
\59\ See paragraph (b)(5) of Rule 15c3-3, as adopted.
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Finally, the Commission has modified proposed paragraph (b)(5) to
clarify in the final rule that a broker-dealer is affirmatively
required to maintain possession and control of non-margin securities
unless the broker-dealer has provided written notice to the PAB account
holder.\60\ As modified, paragraph (b)(5) reads: ``A broker or dealer
is required to obtain and thereafter maintain the physical possession
or control of securities carried for a PAB account, unless the broker
or dealer has provided written notice to the account holder that the
securities may be used in the ordinary course of its securities
business, and has provided an opportunity for the account holder to
object.'' \61\
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\60\ The modifications replaced the phrase ``shall not be
required'' with the phrase ``is required'' and replaced the phrase
``provided that'' with the word ``unless.''
\61\ See paragraph (b)(5) of Rule 15c3-3, as adopted.
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iii. PAB Reserve Bank Accounts
The Commission proposed amendments to paragraph (e) of Rule 15c3-3
to require a carrying broker with PAB accounts to establish and
maintain a PAB reserve account for PAB accounts, perform a separate PAB
reserve computation for PAB accounts, and maintain cash or qualified
securities in the PAB reserve account in an amount equal to the PAB
reserve requirement.\62\ The Commission also proposed amendments to
paragraph (f) of Rule 15c3-3 to require carrying broker-dealers with
PAB accounts to notify the bank about the status of the PAB reserve
account and obtain an agreement and notification from the bank that the
PAB reserve account will be maintained for the benefit of the PAB
account holders.\63\ The Commission is adopting these amendments to
paragraphs (e) and (f) of Rule 15c3-3 substantially as proposed, with
some technical modifications suggested by one commenter, including
making terminology consistent throughout the paragraphs.\64\ In
addition, the Commission is adopting substantially as proposed the
amendments to paragraph (g) of Rule 15c3-3 which specifies when the
carrying broker-dealer can make withdrawals from a PAB reserve
account.\65\ Finally, the Commission is
[[Page 51831]]
adopting, as proposed, new paragraph (e)(4) to Rule 15c3-3, which
allows a carrying broker-dealer to use credits related to PAB accounts
to finance Rule 15c3-3 customer debits, but does not allow a carrying
broker-dealer to use Rule 15c3-3 customer credits to finance PAB
debits.
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\62\ See section II.A.3. of this release for a discussion of
changes to paragraph (e)(5) of Rule 15c3-3 with respect to banks
where customer or PAB reserve accounts may be held.
\63\ 17 CFR 240.15c3-3(f).
\64\ See SIFMA 2 Letter.
\65\ 17 CFR 240.15c3-3(g). In this paragraph, the Commission
deleted the phrase ``his Reserve Bank Accounts'' and replaced it
with the phrase ``a Customer Reserve Bank Account and PAB Reserve
Bank Account.'' The Commission also deleted the phrase ``each
Reserve Bank Account'' and replaced it with the phrase ``the
Customer Reserve Bank Account and PAB Reserve Bank Account.'' These
were the only changes made to the final rule in paragraph (g) of
Rule 15c3-3.
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iv. Other PAB Issues Raised by Commenters
In addition to specific comments on the proposed rule language, one
commenter had other interpretive questions and comments about the
proposed PAB requirements.\66\ The commenter requested that the
Commission clarify whether PAB account holders must obtain from their
carrying broker-dealers a written agreement to perform the calculation
as required by the PAIB Letter.\67\ Under the amendments, there is no
requirement that PAB account holders obtain a written agreement from
the carrying firm that it will perform the PAB reserve computation.
Rule 15c3-3, as amended, requires the carrying firm to perform the PAB
reserve computation. As stated above, Rule 15c3-3 prescribes the
requirements for carrying firms with respect to PAB accounts, and the
PAIB Letter is being withdrawn.\68\
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\66\ See SIMFA 2 Letter.
\67\ Id.
\68\ As discussed above in this section II.A.2., the Commission
is directing the staff to withdraw the PAIB Letter as of the
effective date of these rules.
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In addition, the commenter requested the Commission to clarify that
existing PAIB reserve accounts need not be re-titled to comply with the
proposed amendments.\69\ Item 4 of the PAIB Letter required that a
carrying broker-dealer, ``establish and maintain a separate `Special
Reserve Account for the Exclusive Benefit of Customers' with a bank in
conformity with the standards of paragraph (f) of Rule 15c3-3.''
Paragraph (e)(1) of Rule 15c3-3, however, requires that a carrying
broker-dealer establish and maintain a ``Special Reserve Bank Account
for Brokers and Dealers.'' Given the small differences in nomenclature
and the time and expense associated with broker-dealers re-titling
these accounts, a carrying broker-dealer that has properly established
PAB reserve account in the manner described in Item 4 of the PAIB
Letter need not re-title the account and obtain a new notification from
the bank.\70\ However, all PAB reserve accounts established on or after
the effective date of these amendments must title the account in
accordance with paragraph (e)(1) of Rule 15c3-3.
---------------------------------------------------------------------------
\69\ See SIFMA 2 Letter.
\70\ See PAIB Letter.
---------------------------------------------------------------------------
Finally, the commenter urged the Commission to clarify whether, for
purposes of Rule 15c3-1, the term aggregate debit items means total
aggregate debit items computed in accordance with the customer reserve
formula or the total aggregate debit items computed in accordance with
both the customer reserve formula and the PAB reserve formula.\71\
Aggregate debit items are used in the net capital rule to determine the
minimum net capital requirement for broker-dealers that elect to use
the alternative standard in computing their minimum net capital
requirement. Specifically, the net capital rule requires broker-dealers
using the alternative standard to maintain net capital of at least the
greater of $250,000 or 2% of aggregate debit items.\72\ Including PAB
aggregate debit items in this computation would significantly increase
net capital requirements for broker-dealers that use the alternative
method. The intended purpose of this rule change is to address the
inconsistencies between Rule 15c3-3 and SIPA--not to increase net
capital requirements. Consequently, the requirements in Rules 15c3-1,
15c3-1d, and 17a-11 that refer to aggregate debit items continue to be
based only on aggregate debit items computed in accordance with the
customer reserve computation, and do not include aggregate debit items
computed in accordance with the PAB reserve computation.\73\
---------------------------------------------------------------------------
\71\ See SIFMA 2 Letter; SIFMA 4 Letter.
\72\ 17 CFR 240.15c3-1(a)(1)(ii). In addition, certain other
financial responsibility rules require that a broker-dealer that
computes net capital pursuant to the alternative method either
report to the Commission, limit its ability to obtain, pre-pay, or
repay subordinated debt, or limit its business if its net capital
falls below a certain level based on a percentage of aggregate debit
items (see, e.g., Rules 15c3-1(e)(2)(vi), 15c3-1d(b)(6)(iii), 15c3-
1d(b)(7), 15c3-1d(b)(8)(i)(A), 15c3-1d(b)(10)(ii)(B), 15c3-1d(c)(2),
15c3-1d(c)(5)(ii)(A), and 17a-11(c)(2)).
\73\ Under paragraph (e)(4) to Rule 15c3-3, a carrying broker-
dealer will be permitted to use credits related to PAB accounts to
finance Rule 15c3-3 customer debits. This rule, however, does not
affect the use of aggregate debit items in computing a broker-
dealer's net capital under the alternative standard pursuant to
paragraph (a)(1)(ii) of Rule 15c3-1.
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v. Amendment to Rule 15c3-1(c)(2)(iv)(E) Related to PAB Accounts
Finally, the Commission proposed an amendment to Rule 15c3-1 \74\
that would have required a broker-dealer, when calculating net capital,
to deduct from net worth cash and securities held in a securities
account at another broker-dealer if the other broker-dealer does not
treat the account, and the assets therein, in compliance with the
applicable PAB reserve account requirements of Rules 15c3-3 and 15c3-
3a.\75\ A commenter suggested modifying this proposed amendment,\76\
arguing that ``[a]lthough the Proposing Release states that the
Commission `would not expect broker-dealers to audit or examine their
carrying broker-dealers to determine whether the carrying broker-dealer
is in compliance with [the proposed rules],' the text of the proposed
amendment suggests that they in fact would have such an obligation.''
\77\ The commenter also stated that a broker-dealer should not be
deemed to have violated Rule 15c3-1 merely because its carrying firm
fails to properly perform requirements solely applicable to the
carrying firm and that paragraph (c)(2)(iv)(E) under Rule 15c3-1 should
be explicitly modified to clarify that cash and securities held in a
securities account at another broker-dealer are not subject to the
deduction specified in that paragraph.\78\
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\74\ 17 CFR 240.15c3-1(c)(2)(iv)(E).
\75\ See Amendments to Financial Responsibility Rules, 72 FR at
12864.
\76\ See SIFMA 2 Letter.
\77\ Id.
\78\ Id.
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While the Commission did not intend to impose any monitoring
requirement on the PAB account holder, the Commission recognizes that
the language, as proposed, could have implied such a requirement and
agrees with the commenter that a broker-dealer should not be deemed to
have violated Rule 15c3-1 with respect to requirements that are solely
applicable to the carrying broker-dealer. To address this concern, the
Commission has modified the language in paragraph (c)(2)(iv)(E) under
Rule 15c3-1 to eliminate the proposed capital charge of Rule 15c3-1
that would have resulted from a failure of a carrying broker-dealer to
comply with the PAB requirements in Rule 15c3-3.\79\
---------------------------------------------------------------------------
\79\ More specifically, the Commission has deleted the proposed
language referring to ``cash and securities held in a securities
account at another broker-dealer if the other broker-dealer does not
treat the account, and the assets therein in compliance with
paragraphs (b)(5) and (e) of Sec. 240.15c3-3. . . .''
---------------------------------------------------------------------------
Instead, the Commission has adopted amendments to Rule 15c3-1
providing that a broker-dealer need not deduct cash and securities held
in a securities account at a carrying broker-dealer except where the
account has been subordinated to the claims of creditors of the
carrying broker-dealer.\80\ This provision is intended to prevent
broker-dealers from including assets in their net capital that may not
be readily available to be returned because they
[[Page 51832]]
would not be subject to the PAB account provisions discussed above.
Accordingly, the amendments to paragraph (c)(2)(iv)(E) of Rule 15c3-1
are consistent with the exclusions from the definition of PAB account
in paragraph (a)(16) of Rule 15c3-3.\81\
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\80\ 17 CFR 240.15c3-1(c)(2)(iv)(E).
\81\ 17 CFR 15c3-3(a)(16).
---------------------------------------------------------------------------
3. Banks Where Special Reserve Deposits May Be Held
As amended, paragraph (e) of Rule 15c3-3 requires a broker-dealer
to deposit cash or qualified securities into the customer or PAB
reserve account,\82\ which must be maintained at a bank.\83\ While cash
deposits at a bank are fungible and may be used by the bank in its
lending and investment activities, paragraph (f) of Rule 15c3-3
requires that a broker-dealer obtain a written contract from the bank
wherein the bank agrees not to re-lend or hypothecate securities
deposited into the reserve account.\84\ This means the bank cannot use
the securities in its business, which provides a measure of protection
by requiring that the securities will be available to the broker-dealer
if the bank falls into financial difficulty. Cash deposits, however,
may be freely used in the course of the bank's commercial
activities.\85\ Therefore, to the extent a broker-dealer deposits cash
in a reserve account, there is a risk the cash could become
inaccessible if the bank experiences financial difficulties.\86\ This
could adversely impact the broker-dealer and its customers.\87\ To
limit these risks, the Commission proposed amendments to Rule 15c3-3
that would have: (1) Prohibited a broker-dealer from maintaining cash
deposits in the reserve accounts for customers and PAB account holders
if the bank was affiliated; and (2) limited the amount of cash that
could be deposited in both types of reserve accounts at non-affiliated
banks.\88\ These restrictions would not have applied to securities held
in the reserve accounts because, as noted above, the bank must agree
not to use the securities in its business. The goal of the proposals
was to limit cash reserve account deposits to reasonably safe amounts
as measured against the capitalization of the broker-dealer and the
bank.\89\
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\82\ The PAB reserve account and the customer reserve account
are collectively referred to as the ``reserve accounts'' or a
``reserve account.''
\83\ The term bank is defined in paragraph (a)(7) of Rule 15c3-3
as a ``bank as defined in section 3(a)(6) of the Exchange Act and
will also mean any building and loan, savings and loan or similar
banking institution subject to the supervision by a Federal banking
authority.'' See paragraph (a)(7) to Rule 15c3-3, as adopted.
\84\ See 17 CFR 240.15c3-3(f).
\85\ See Amendments to Financial Responsibility Rules, 72 FR at
12864.
\86\ Id.
\87\ Id.
\88\ Id.
\89\ Id.
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Specifically, as proposed, paragraph (e)(5) of 15c3-3 provided that
a carrying broker-dealer would have been required to exclude the amount
of cash deposited into reserve accounts at affiliated banks when
determining whether it maintained the minimum amount required to be on
deposit in the reserve accounts for its customers and PAB account
holders. In addition, the proposed amendment would have required a
carrying broker-dealer to exclude cash deposited in a reserve account
at an unaffiliated bank to the extent the amount of the cash deposited
exceeded: (1) 50% of the broker-dealer's excess net capital (based on
the broker-dealer's most recently filed FOCUS Report); \90\ or (2) 10%
of the bank's equity capital (based on the bank's most recently filed
Call Report or Thrift Financial Report).\91\
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\90\ Under Rule 17a-5, broker-dealers must file periodic reports
on Form X-17a-5 (Financial and Operational Combined Uniform Single
Reports) (``FOCUS Reports''). See 17 CFR 240.17a-5(a). The FOCUS
Report requires, among other financial information, a balance sheet,
income statement, and net capital and customer reserve computations.
Excess net capital is the amount that a broker-dealer's net capital
exceeds its minimum requirement.
\91\ See Amendments to Financial Responsibility Rules, 72 FR at
12864. On July 21, 2011, supervisory responsibility for federal
savings associations was transferred from the Office of Thrift
Supervision (``OTS'') to the Office of the Comptroller of the
Currency (``OCC''). As of the quarter ending March 31, 2012, savings
associations were required to file a Call Report in lieu of a Thrift
Financial Report. See Proposed Agency Information Collection
Activities; Comment Request, 76 FR 7082 (Feb. 8, 2011). The Call
Report includes a line item for total bank equity capital. A report
for a specific institution is available at https://cdr.ffiec.gov/public/. See also, FINRA, Interpretations of Financial and
Operational Rules, Interpretations 15c3-3(e)(1)/01 and/011
(establishing similar threshold restrictions on using money market
deposit accounts or time deposits, respectively, to meet customer
reserve account requirements), and Interpretation 15c3-3(e)(3)/051
(establishing similar threshold restrictions with respect to meeting
the customer reserve requirement by depositing cash at an affiliated
bank).
---------------------------------------------------------------------------
The Commission is adopting the amendments with modifications
designed to address issues identified by commenters. Twenty-three
commenters addressed the proposed amendments.\92\ Fifteen commenters
urged the Commission not to adopt the proposed prohibition on broker-
dealers maintaining cash in reserve accounts at affiliated banks.\93\
These commenters generally stated that, with regard to cash in reserve
accounts, affiliated banks should be treated the same as unaffiliated
banks because both groups are subject to the same financial
regulation.\94\ These commenters noted that banks are subject to safety
and soundness requirements of their respective banking regulators and,
therefore, the commenters argued that the proposed restriction with
respect to affiliated banks is unwarranted.
---------------------------------------------------------------------------
\92\ See Federated Letter; Curian Clearing Letter; Raymond James
Letter; JP Morgan Letter; Reserve Letter; Dresdner Kleinwort Letter;
SIFMA 2 Letter; SIFMA 4 Letter; First Clearing Letter; Clearing
House Letter; ICI Letter; Barclays Letter; ABASA Letter; PNC Letter;
BlackRock Letter; Deutsche Bank Securities Letter; E*Trade Letter;
Citigroup Letter; American Bar Association Letter; Fidelity/NFS
Letter; BOK Letter; JP Morgan 3 Letter; IIB Letter; Raymond James 2
Letter.
\93\ See Federated Letter; JP Morgan Letter; Dresdner Kleinwort
Letter; SIFMA 4 Letter; First Clearing Letter; ICI Letter; ABASA
Letter; E*Trade Letter; Citigroup Letter; American Bar Association
Letter; Fidelity/NFS Letter; Curian Letter; BOK Letter; JP Morgan 2
Letter; IIB Letter.
\94\ Id.
---------------------------------------------------------------------------
One commenter also stated that the Commission's distinction between
affiliated and unaffiliated banks was not sufficiently supported in the
proposing release.\95\ More specifically, this commenter stated that
the Commission's ``bare statement that a broker-dealer `may not
exercise due diligence with the same degree of impartiality when
assessing the soundness of an affiliate bank as it would with a non-
affiliate . . .' does not suffice to justify the disparate treatment''
with regard to the treatment of affiliated banks under the proposed
rule.\96\ This commenter also stated that it is just as easy to argue
that broker-dealers are in a much better position to know about the
soundness of an affiliated bank then to learn about the soundness of a
unaffiliated bank, which may not be willing to provide complete and
accurate information.\97\ In addition, another commenter stated that
the Commission cited no empirical or anecdotal evidence to support its
reasons for prohibiting cash reserve deposits at an affiliated
bank.\98\ This commenter also stated that the Commission's concerns
discount the operational efficiencies to be gained between an
affiliated broker-dealer and its bank, including: Commonality between
certain policies and procedures; greater ease in communication
internally; and greater operational efficiencies leading to reduced
operational risk in the transfer of funds to and from the bank.\99\
---------------------------------------------------------------------------
\95\ See Dresdner Kleinwort Letter.
\96\ Id.
\97\ Id.
\98\ See Citigroup Letter.
\99\ Id.
---------------------------------------------------------------------------
One commenter stated that it took no issue with the proposed
restriction on
[[Page 51833]]
affiliated banks.\100\ Another commenter noted that the financial
industry has seen a remarkable consolidation of the banking and
securities industries, and, as a result, the number of broker dealers
affiliated with banks has increased, along with the number of those
broker-dealers maintaining deposits at affiliated banks.\101\ This
commenter stated that broker-dealers would be required to move deposits
from one institution and divide that amount among several banks,
resulting in credit risk to the broker-dealer, as well as an increase
in operational risk.\102\ Finally, the commenter observed that the
Commission did not provide any specific examples of bank failures
impacting affiliated broker-dealers, which led the commenter to
question whether there is any realistic benefit to offset the increased
risk that broker-dealers would be required to take on as a result of
the proposal to place restrictions on cash deposits in reserve accounts
at affiliated and unaffiliated banks.\103\
---------------------------------------------------------------------------
\100\ See Raymond James Letter. In a subsequent comment letter,
this commenter stated that if this proposal is adopted, registered
broker-dealers holding customer funds may be required to move their
reserve accounts if those accounts are currently held at affiliated
banks, which would increase costs. See Raymond James 2 Letter.
\101\ See BOK Letter.
\102\ Id.
\103\ Id.
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The Commission recognizes that all banks, whether or not affiliated
with a broker-dealer, are subject to regulation by their respective
banking regulators. The Commission's continuing concern, however, is
that a carrying broker-dealer may not exercise due diligence with the
same degree of impartiality and care when assessing the financial
soundness of an affiliated bank as it would with an unaffiliated
bank.\104\ Moreover, the goal of protecting the carrying broker-
dealer's customers through the Rule 15c3-3 reserve requirement may be
undermined in the event a holding company becomes insolvent, with
corresponding adverse consequences to both the bank and broker-dealer
subsidiaries.
---------------------------------------------------------------------------
\104\ See Amendments to Financial Responsibility Rules, 72 FR at
12864.
---------------------------------------------------------------------------
In some cases, a broker-dealer may have access to more information
about an affiliated bank in comparison to an unaffiliated bank for
purposes of conducting due diligence. However, having more information
would not be of benefit if the individuals making the decision on where
to maintain the reserve account are not objective in their decision
making. The Commission is concerned that a broker-dealer's decision to
hold cash in a reserve account at an affiliated bank may be driven in
part by profit or reasons based on the affiliation, regardless of any
due diligence it may conduct or the overall safety and soundness of the
bank.
In addition, in response to the comments regarding affiliated
banks, the Commission notes that substantial numbers of banks have
failed or required government assistance in recent years.\105\ While a
particular bank failure may not have materially impacted an affiliated
broker-dealer to date,\106\ the risk remains that the financial
difficulty of an entity that is part of a holding company structure may
adversely impact other affiliated entities, including affiliated
broker-dealers and banks.\107\ Therefore, the final rule retains the
prohibition on maintaining customer reserve cash deposits at an
affiliated bank.\108\
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\105\ According to the FDIC, the number of FDIC-insured
institutions that failed in the U.S. over the last four years are:
(1) 140 in 2009; (2) 157 in 2010; (3) 92 in 2011; and (4) 51 in
2012. A complete list of failed banks since October 1, 2000, is
available at www.fdic.gov/bank/individual/failed/banklist.html.
\106\ See BOK Letter; Dresdner Kleinwort Letter.
\107\ See, e.g., Lehman Brothers Inc.--Trustee's Preliminary
Investigation Report and Recommendations (Case No. 08-01420 (JMP)
SIPA), available at https://bankrupt.com/misc/sipareport0904.pdf.
\108\ Id.
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This prohibition does not apply to securities on deposit at an
affiliated bank, but only cash deposits because, as noted above, the
latter are fungible with other deposits carried by the bank and may be
freely used in the course of the bank's commercial activities.\109\
Consequently, to the extent that operational or other efficiencies can
be achieved through the use of an affiliated bank, the carrying broker-
dealer can use qualified securities held at an affiliated bank to meet
its reserve deposit requirements.\110\ The ability to use qualified
securities alleviates concerns that a broker-dealer would be required
to take deposits from one institution and divide that amount among
several banks, resulting in credit risk to the broker-dealer, as well
as an increase in operational risk.\111\
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\109\ See Federal Reserve, Division of Banking Supervision and
Regulation, Commercial Bank Examination Manual, Section 3000.1,
Deposit Accounts (stating that deposits are the primary funding
source for most banks and that banks use deposits in a variety of
ways, primarily to fund loans and investments), available at https://www.federalreserve.gov/boarddocs/supmanual/cbem/3000.pdf. See also
OCC Banking Circular (BC-196), Securities Lending (May 7, 1985)
(stating securities should be lent only pursuant to a written
agreement between the lender institution and the owner of the
securities specifically authorizing the institution to offer the
securities for loan), available at https://www.occ.gov/static/news-issuances/bulletins/pre-1994/banking-circulars/bc-1985-196.pdf.
\110\ See Citigroup Letter.
\111\ See BOK Letter. Based on FOCUS Report data, as of December
31, 2011, 79% of the total customer reserve requirement across all
carrying broker-dealers was met using qualified securities.
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In summary, while the Commission acknowledges concerns raised by
commenters, the Commission continues to believe that it is appropriate
to exclude cash deposited in affiliated banks from the calculation to
determine whether a broker-dealer has met its reserve account
requirements. Therefore, the final rule excludes the amount of any cash
on deposit in an affiliated bank of the broker-dealer from being used
to meet the reserve requirements.\112\ Broker-dealers that use
affiliated banks for holding cash customer reserve accounts will need
to either deposit qualified securities into the accounts or move their
accounts to non-affiliated banks.
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\112\ See paragraph (e)(5) of Rule 15c3-3, as adopted.
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As for the limits on the amounts of cash that could be deposited in
one unaffiliated bank, some commenters argued that the proposed
thresholds were too restrictive. One commenter urged the Commission to
reconsider the proposed limits, noting that the proposed amendment will
impose significant costs on broker-dealers and potentially adversely
impact the broker-dealers' customers.\113\ Several commenters suggested
that the Commission allow cash reserve deposits without the percentage
restrictions at unaffiliated banks that are well-capitalized or for
which the broker-dealer has performed due diligence.\114\ One commenter
suggested that the Commission consider higher percentages for cash
deposits at large money-center banks.\115\ This commenter stated that
this would strike a better balance between the Commission's concerns
regarding the safety of cash deposits and the costs imposed on broker-
dealers arising from having to use qualified securities (as opposed to
cash) to meet deposit requirements or having to maintain reserve
accounts at multiple banks.\116\ This commenter also stated that the
percentage thresholds would negatively impact smaller broker-dealers
because they would exceed the 50% of excess net capital threshold at
lower deposit levels.\117\ Two
[[Page 51834]]
commenters noted that the proposed 10% bank equity capital limitation
appears to be derived from a 1988 NYSE staff interpretation, which
stated that customer reserve accounts may be maintained in money market
deposit accounts if the total of such deposits in any one bank does not
exceed 50% of the broker-dealer's excess net capital or 10% of the
bank's equity capital.\118\ These commenters pointed out that
significant changes have taken place with respect to federal bank
regulatory agency oversight of the safety and soundness of banks since
1988, including the imposition of prompt corrective action
provisions.\119\ These commenters stated that the concerns that gave
rise to the 1988 interpretation have been mitigated by current statutes
and regulations requiring prompt corrective action in the event that a
bank's capital position deteriorates.\120\
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\113\ See Raymond James 2 Letter.
\114\ See Raymond James Letter; JP Morgan Letter; Clearing House
Letter; ABASA Letter; PNC Letter; Deutsche Bank Securities Letter;
E*Trade Letter; JP Morgan 2 Letter.
\115\ See SIFMA 2 Letter; SIFMA 4 Letter.
\116\ See SIFMA 2 Letter.
\117\ Id.
\118\ See PNC Letter; ABASA Letter.
\119\ See PNC Letter; ABASA Letter.
\120\ Id.
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As stated above, substantial numbers of banks have failed or
required government assistance in recent years.\121\ Consequently, the
rule, as adopted, establishes requirements designed to avoid the
situation where a carrying broker-dealer's cash deposits constitute a
substantial portion of the bank's deposits. At the same time, the
proposal has been modified to mitigate concerns raised by commenters
that broker-dealers would have to maintain reserve accounts at multiple
banks. First, the Commission has eliminated the provision that would
have excluded the amount of a cash deposit that exceeds 50% of the
broker-dealer's excess net capital. As noted by comments, this
provision likely would have disproportionately impacted small and mid-
size broker-dealers when they deposited cash into large commercial
banks since they would exceed the excess net capital threshold well
before exceeding the bank equity capital threshold.\122\ Also, based on
staff experience monitoring larger broker-dealers, firms that maintain
large amounts of cash in their customer reserve accounts generally use
more than one non-affiliated bank to maintain these accounts.
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\121\ See www.fdic.gov/bank/individual/failed/banklist.html.
\122\ See SIFMA 2 Letter; JP Morgan 2 Letter.
---------------------------------------------------------------------------
The bank equity capital threshold is the more important metric
since it relates directly to the financial strength of the bank, which
is the entity holding the account. Thus, this metric more directly
addresses the risk at issue: The potential impairment of the bank's
ability to quickly return the customer reserve deposit to the broker-
dealer.
Second, with respect to the bank equity capital threshold, in
response to comments, the Commission has increased the threshold from
10% to 15% of the bank's equity capital. The increase of the threshold
to 15% is designed to address concerns raised by commenters that the
proposed percentage tests were unduly restrictive in certain respects
and should be modified, particularly with respect to large broker-
dealers with large deposit requirements. Consequently, the increase
from 10% to 15% is designed to mitigate commenters' concerns that the
10% threshold would require broker-dealers to spread out cash deposits
over a number of banks, while still providing adequate protection
against the risk that arises when a bank's deposit base is overly
reliant on a single depositor.
The elimination of the 50% of excess net capital threshold and
increase in the bank capital threshold from 10% to 15% is intended to
address concerns raised by commenters that they would have to
substantially alter their current cash deposit practices in light of
the goal of the rule to promote the broker-dealer's ability to have
quick access to the deposit.
As proposed, the equity capital threshold would have been based on
equity capital ``as reported by the bank in its most recent Call Report
or Thrift Financial Report.'' Under the Dodd-Frank Wall Street Reform
and Consumer Protection Act (``Dodd-Frank Act''),\123\ the supervision
of savings associations was transferred from the OTS to the OCC (for
federal savings associations) and the FDIC (for state savings
associations).\124\ Also, beginning in the period ending March 31,
2012, savings associations began to file a Call Report in lieu of a
Thrift Financial Report, thereby ending the use of the Thrift Financial
Report.\125\ Therefore, due to the passage of the Dodd-Frank Act and
the elimination of the Thrift Financial Report, as well as to provide
more flexibility with regard to any successor reports that may be
required to be filed by a bank, the Commission is modifying the phrase
``Call Report or Thrift Financial Report'' to read ``Call Report or any
successor form the bank is required to file by its appropriate Federal
banking agency (as defined by section 3 of the Federal Deposit
Insurance Act (12 U.S.C. 1813))''.
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\123\ Public Law 111-203, 124 Stat. 1376 (2010).
\124\ Id. at Sec. Sec. 300-378. See also List of OTS
Regulations to be Enforced by the OCC and the FDIC Pursuant to the
Dodd-Frank Act, OCC, FDIC, (June 14, 2011), 76 FR 39246 (July 6,
2011). Supervision of savings and loan holding companies and their
subsidiaries (other than depository institutions) was transferred
from the OTS to the Federal Reserve.
\125\ See Proposed Agency Information Collection Activities;
Comment Request, 76 FR 7082 (Feb. 8, 2011).
---------------------------------------------------------------------------
Two commenters expressed concern about the use of a Call Report to
determine a bank's ``equity capital'' under the rule.\126\ These
commenters noted that there is no equity capital line item in the Call
Reports of U.S. branches of foreign banks due to these branches not
being separately incorporated legal entities.\127\ Therefore, the
proposed Call Report provision potentially excluded U.S. branches of
foreign banks from holding reserve accounts. The commenters stated that
for foreign banks, the equity capital can be found in other forms, such
as Form FR Y-7, Form FR Y-70, Form 6-K, and Form F-20, among other
financial statements filed with U.S. regulators.\128\ One commenter
suggested the Commission revise the proposed provision to read: ``The
amount of the deposit exceeds 10% of the bank's equity capital (as
reported by the bank in its most recent Call Report or Thrift Financial
Report if such report includes a line item for `equity capital').''
\129\ Alternatively, these commenters suggested that in lieu of a Call
Report a U.S. branch of a foreign bank could periodically obtain a
certificate from the bank stating its equity capital (or stating that
its equity capital exceeds a specified level).\130\
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\126\ See IIB Letter; SIFMA 4 Letter.
\127\ Id.
\128\ Id.
\129\ See IIB Letter.
\130\ See IIB Letter; SIFMA 4 Letter.
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The Commission recognizes that the U.S. branches of some foreign
banks may meet the definition of bank under section (3)(a)(6) of the
Exchange Act and, therefore, also under paragraph (a)(7) of Rule 15c3-
3.\131\ However, the
[[Page 51835]]
Commission is retaining the requirement that the bank's equity be
determined using its most recent Call Report because U.S. branches of
foreign banks generally are not FDIC-insured.\132\ Consequently,
deposits at these institutions would not receive the protections of
FDIC insurance in the event of a bank failure. FDIC insurance provides
additional protections to cash deposited in a reserve account at a bank
in the event of a bank failure that would not be available at an
uninsured bank.\133\ The Commission, however, will consider requests
for exemptive relief from broker-dealers that wish to hold a reserve
account at a U.S. branch of a foreign bank.
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\131\ The term bank as defined in section 3(a)(6) of the
Exchange Act is limited to banks directly regulated by U.S. state or
federal bank regulators. The determination whether any particular
financial institution meets the requirements of section 3(a)(6) is
the responsibility of the financial institution and its counsel. See
15 U.S.C. 78c(a)(6); cf. Securities Issued Or Guaranteed By United
States Branches Or Agencies of Foreign Banks; Interpretive Release,
Securities Act Release No. 6661 (Sept. 23, 1986), 51 FR 34460 (Sept.
29, 1986) (determination as to whether branch or agency of foreign
bank falls within the definition of bank under section 3(a)(2) of
Securities Act of 1933, 15 U.S.C. 77c(a)(2), is responsibility of
issuers and their counsel). However, section 4(d) of the
International Banking Act, 12 U.S.C. 3102(d), expressly prohibits
agencies of foreign banks established under federal law from
receiving deposits or exercising fiduciary powers, criteria
necessary for qualification as a bank under section 3(a)(6)(C) of
the Exchange Act. See 12 U.S.C. 3102(d); see also Conference of
State Bank Supervisors v. Conover, 715 F.2d 604 (D.C. Cir. 1983),
cert. denied, 466 U.S. 927 (1984) (stating that federally-chartered
agencies of foreign banks are prohibited from receiving deposits
from foreign, as well as domestic, sources).
\132\ The FDIC protects depositors' funds in the event of the
financial failure of their bank or savings institution. FDIC deposit
insurance covers the balance of each depositor's account, dollar-
for-dollar, up to the insurance limit, including principal and any
accrued interest through the date of the insured bank's closing. No
depositor has suffered a loss of insured deposits since the FDIC was
created in 1933. See FDIC, When a Bank Fails--Facts for Depositors,
Creditors, and Borrowers, available at https://fdic.gov/consumers/banking/facts/. See also Federal Reserve, Structure and
Share Data for U.S. Offices of Foreign Banks, available at https://www.federalreserve.gov/releases/iba/.
\133\ Id. Therefore, the availability of FDIC insurance could
also be a contributing factor to mitigating the risk that an
impairment of the reserve deposit at an unaffiliated bank will have
a material negative impact on the broker-dealer's ability to meet
its obligations to customers and PAB account holders. See Amendments
to Financial Responsibility Rules, 72 FR at 12864.
---------------------------------------------------------------------------
For these reasons, the Commission is adopting the final rule to
exclude, when determining whether a broker-dealer maintains the minimum
deposits required under paragraph (e) of Rule 15c3-3, cash deposited
with an affiliated bank as well as cash deposited with an unaffiliated
bank ``to the extent that the amount of the deposit exceeds 15% of the
bank's equity capital as reported by the bank in its most recent Call
Report or any successor form the bank is required to file by its
appropriate Federal banking agency (as defined by section 3 of the
Federal Deposit Insurance Act (12 U.S.C. 1813)).'' \134\ As discussed
above, the Commission is deleting from the final rule the provision
that would have excluded the amount of cash on deposit that exceeds 50%
of the broker-dealer's excess net capital.
---------------------------------------------------------------------------
\134\ See paragraph (e)(5) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------
4. Allocation of Customers' Fully Paid and Excess Margin Securities to
Short Positions
Paragraph (d) of Rule 15c3-3 currently sets forth steps a broker-
dealer must take to retrieve securities from non-control locations if
there is a shortfall in the fully paid or excess margin securities it
is required to hold for its customers. The actions prescribed in the
rule do not include a requirement that the broker-dealer obtain
possession or control of a fully paid or excess margin security that is
reflected on the broker-dealer's stock record as a long position of a
customer that allocates to a broker-dealer or non-customer short
position. In the simplest case, this occurs when the carrying broker-
dealer as principal sells short a security to its own customer.
Currently, in such a case, the broker-dealer is not required to have
possession or control of the security even though its customer has paid
for the security in full. Rather, the broker-dealer must include the
mark-to-market value of the security as a credit item in the reserve
formula. The broker-dealer can use the cash paid by the customer to
purchase the security to make any increased deposit requirement caused
by the credit item.\135\ As the Commission stated in the proposing
release, this permits the broker-dealer, in effect, to partially
monetize the customer's security.\136\ This result is contrary to the
customer protection goals of Rule 15c3-3, which seek to ensure that
broker-dealers do not use customer assets for proprietary
purposes.\137\
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\135\ In effect, the broker-dealer has monetized the customer's
security and has to purchase or borrow it, at a future date, to
return the customer's fully paid securities.
\136\ See Amendments to Financial Responsibility Rules, 72 FR at
12865.
\137\ See, e.g., Customer Protection Rule, Exchange Act Release
No. 22499 (Oct. 3, 1985), 50 FR 41337 (Oct. 10, 1985).
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To address these concerns, the Commission proposed an amendment to
Rule 15c3-3 that would have required a broker-dealer to obtain physical
possession or control of customer fully paid and excess margin
securities that allocate to a broker-dealer short position.\138\
Specifically, the proposed amendment would have added a fifth step to
take when a deficit arose in the amount of securities the broker-dealer
was required to maintain in possession or control; namely that for
``[s]ecurities included on [the broker-dealer's] books or records as a
proprietary short position or as a short position for another person,
excluding positions covered by paragraph (m) of this section, for more
than 10 business days (or more than 30 calendar days if the broker or
dealer is a market maker in the securities), [. . .] the broker or
dealer shall, not later than the business day following the day on
which the determination is made, take prompt steps to obtain physical
possession or control of such securities.'' \139\
---------------------------------------------------------------------------
\138\ See Amendments to Financial Responsibility Rules, 72 FR at
12865.
\139\ Id. at 12895.
---------------------------------------------------------------------------
Eleven commenters addressed this proposed amendment.\140\ Three
commenters urged the Commission to disallow naked short selling of
securities and one argued that the Commission should force short
sellers to pre-borrow.\141\ Three commenters generally opposed the
proposed rule. They argued that the credit item added to the reserve
formula computation when a customer's fully paid or excess margin
security allocates to a short position provides the customer with
adequate protection.\142\ Two of these commenters requested that the 30
calendar days allowed for a broker-dealer acting as a market maker to
obtain possession or control over securities allocating to a short
position be expanded to include all situations where a broker-dealer
must act pursuant to the rule (i.e., not be limited to market maker
positions).\143\ These commenters argued that it would be difficult to
distinguish between market maker and non-market maker positions in
complying with the proposed rule. Another commenter requested that the
Commission reevaluate the proposed amendment because of its potential
effects on investment and hedging strategies in addition to the heavy
[[Page 51836]]
burden it will impose on short sales.\144\ One commenter supported the
amendments noting that it had ``come to believe . . . that the
Commission's proposal is consistent with the direction of the
Commission's other short sale regulations. . . .'' \145\
---------------------------------------------------------------------------
\140\ See Glenn Letter; Bare Letter; Anonymous Letter; SIFMA 2
Letter; First Clearing Letter; Hearne Letter; Deutsche Bank
Securities Letter; Citigroup Letter; AMEX Letter; SIFMA 4 Letter;
Federated 6 Letter; Raymond James 2 Letter.
\141\ See Glenn Letter; Bare Letter; Anonymous Letter; Hearne
Letter. The Commission has taken a number of measures to strengthen
investor protections against potentially abusive ``naked'' short
selling, including adopting rules requiring that fails to deliver
resulting from short sales immediately be closed-out and expressly
targeting fraud in short selling transactions. See Amendments to
Regulation SHO, Exchange Act Release No. 60388 (July 27, 2009), 74
FR 38266 (July 31, 2009); ``Naked'' Short Selling Antifraud Rule,
Exchange Act Release No. 58774 (Oct. 14, 2008), 73 FR 61666 (Oct.
17, 2008). In addition, the Commission adopted a short sale-related
price test that, if triggered, imposes a restriction on the prices
at which securities may be sold short. See Amendments to Regulation
SHO, Exchange Act Release No. 61595 (Feb. 26, 2010), 75 FR 11232
(Mar. 10, 2010).
\142\ See First Clearing Letter; Deutsche Bank Securities
Letter; Citigroup Letter.
\143\ See Citigroup Letter; Deutsche Bank Securities Letter.
\144\ See Raymond James 2 Letter.
\145\ See SIFMA 4 Letter. SIFMA originally opposed the proposed
amendments. See SIFMA 2 Letter.
---------------------------------------------------------------------------
As discussed above in section II.A.2.ii. of this release, the
Commission has determined that a credit item is sufficient to protect
PAB account holders if the carrying broker-dealer provides them with
notice that it may be using their non-margin securities, as well as the
opportunity to object to such use. The use of the non-margin securities
of PAB account holders is a long-standing industry practice. In
contrast, customers under Rule 15c3-3, which include the carrying
broker-dealer's retail customers, have an expectation that the fully
paid and excess margin securities reflected on their account statements
are, in fact, in the possession or control of the carrying broker-
dealer. However, as described above, this expectation may be frustrated
where the securities are allocated to a short position carried by the
broker-dealer, as the securities are not in the possession or control
of the broker-dealer.
This gap in the existing rule, in effect, permits the broker-dealer
to partially monetize the customer's security. Also, under some
circumstances (e.g., a change in the market value of the securities),
the amount the broker-dealer may have on deposit in the customer
reserve account as a consequence of the credit item may be less than
the value of the securities. Consequently, if the broker-dealer fails,
sufficient funds may not be readily available to purchase the
securities to return them to customers. The use of customer securities
in this manner is contrary to the customer protection goals of Rule
15c3-3 and the expectations of a broker-dealer's customers.\146\ For
these reasons, the Commission is adopting the amendment.\147\ The
Commission agrees, however, that the proposed distinction based upon a
broker-dealer's market maker status could present operational
challenges and, consequently, the final rule has been modified to allow
a uniform period of 30 calendar days before the possession and control
requirement is triggered.
---------------------------------------------------------------------------
\146\ See supra notes 12 and 18, and accompanying text.
\147\ Current paragraph (d)(4) of Rule 15c3-3 is being re-
designated paragraph (d)(5), as proposed.
---------------------------------------------------------------------------
Specifically, as adopted, paragraph (d)(4) of Rule 15c3-3 requires
a broker-dealer to take prompt steps to obtain physical possession or
control over securities of the same issue and class as those included
``on the broker's or dealer's books or records that allocate to a short
position of the broker or dealer or a short position for another
person, excluding positions covered by paragraph (m) of this section,
for more than 30 calendar days. . . .'' \148\ The Commission does not
believe that lengthening the time from 10 business days to 30 calendar
days for non-market maker positions will significantly diminish the
protections provided by the new rule.\149\ Therefore, the Commission is
adopting a uniform 30 calendar day time period in the final rule.
---------------------------------------------------------------------------
\148\ See Amendments to Financial Responsibility Rules, 72 FR at
12865-12866. The amendment will not apply to securities that are
sold long for a customer but not obtained from the customer within
ten days after the settlement date. This circumstance is addressed
by paragraph (m) of Rule 15c3-3, which requires the broker-dealer to
close the transaction by purchasing securities of like kind and
quantity. 17 CFR 240.15c3-3(m).
\149\ For example, the rule currently has a thirty calendar day
time period for securities failed to receive and a forty-five
calendar day time period for securities receivable as a result of
corporate actions (e.g., stock splits) before the broker-dealer must
take prompt steps to obtain possession or control of such
securities. See 17 CFR 240.15c3-3(d)(2)-(3).
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Three commenters requested that the Commission clarify that the
aging process begins when the Rule 15c3-3 possession and control
deficit arises and not when the short transaction is executed.\150\ The
proposed amendment was designed to require that the aging process
commence at the time a deficit in securities allocating to a short
position arises. One commenter \151\ also requested that the Commission
modify the proposed amendment to specifically exclude an underwriter's
short position created in connection with a distribution of securities
until after the later of the completion of such underwriter's
participation in the distribution (as defined in Rule 100 of Regulation
M) \152\ or the delivery date for securities acquired in the exercise
of any overallotment option (or ``Green Shoe'').\153\ The Commission
agrees with the commenter that there should be consistency between the
final rule and Regulation M.\154\ Consequently, the Commission has
added a sentence to the final rule to clarify that the 30 calendar day
period with respect to a syndicate short position established in
connection with an offering does not begin to run until the
underwriter's participation in the distribution is complete as
determined pursuant to Rule 100(b) of Regulation M.\155\ Finally, the
Commission is adopting the revision to paragraph (n) as proposed to
permit broker-dealers to apply to their designated examining authority
(``DEA'') for extensions of time related to paragraph (d)(4).\156\
---------------------------------------------------------------------------
\150\ See Deutsche Bank Securities Letter; Citigroup Letter;
SIFMA 2 Letter.
\151\ See SIFMA 2 Letter. The commenter stated: ``Regulation M
embodies a carefully crafted scheme for the regulation of secondary
market transactions by underwriters and other distribution
participants, including the regulation of `syndicate covering
transactions,' which should not be disrupted by proposed paragraph
(d)(4).'' Id. In addition, SIFMA commented that where an underwriter
sells short to a customer in anticipation of obtaining the
securities through the exercise of an overallotment option,
paragraph (d)(4) should not require the premature exercise of the
overallotment option or the use of secondary market purchases
instead of the overallotment option. Id.
\152\ 17 CFR 242.100 through 242.105. More specifically, Rule
100 of Regulation M provides: ``For purposes of regulation M . . .
the following definitions shall apply: . . . Completion of
participation in a distribution. . . . A person shall be deemed to
have completed its participation in a distribution as follows: . . .
(2) [a]n underwriter, when such person's participation has been
distributed, including all other securities of the same class that
are acquired in connection with the distribution, and any
stabilization arrangements and trading restrictions in connection
with the distribution have been terminated; Provided, however, that
an underwriter's participation will not be deemed to have been
completed if a syndicate overallotment option is exercised in an
amount that exceeds the net syndicate short position at the time of
such exercise. . . .'' 17 CFR 242.100(b).
\153\ A green shoe or overallotment option is a provision
contained in an underwriting agreement that gives the underwriting
syndicate the right to purchase additional shares from the issuer or
selling security holders (in addition to those initially
underwritten by the syndicate) for the purpose of covering any
overallotments that are made on behalf of the syndicate in
connection with an offering of securities.
\154\ Rule 100 of Regulation M also provides that an
underwriter's participation will not be deemed to have been
completed if a syndicate overallotment option is exercised in an
amount that exceeds the net syndicate short position at the time of
exercise. 17 CFR 242.100(b).
\155\ 17 CFR 242.100(b).
\156\ SROs generally have procedures in place for broker-dealers
to apply for extensions of time under paragraph (n) of Rule 15c3-3.
See, e.g., FINRA Rule 4230.
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5. Importation of Rule 15c3-2 Requirements Into Rule 15c3-3 and
Treatment of Free Credit Balances
i. Importation of Rule 15c3-2
Rule 15c3-2 requires a broker-dealer holding free credit balances
to provide its customers (defined as any person other than a broker-
dealer) at least once every three months with a statement of the amount
due the customer and a notice that: (1) the funds are not being
segregated, but rather are being used in the broker-dealer's business;
and (2) the funds are payable on demand. The rule was adopted in 1964,
before the
[[Page 51837]]
adoption of Rule 15c3-3 in 1972.\157\ Since the adoption of Rule 15c3-
3, broker-dealers have been limited in their use of customer free
credit balances. The Commission proposed importing requirements in Rule
15c3-2 \158\ into Rule 15c3-3 and eliminating Rule 15c3-2 as a separate
rule in the Code of Federal Regulations.\159\ The Commission received
two comments supporting the proposal.\160\
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\157\ See Customers' Free Credit Balances, Exchange Act Release
No. 7266 (Mar. 12, 1964), 29 FR 7239 (June 3, 1964).
\158\ 17 CFR 240.15c3-2.
\159\ See Amendments to Financial Responsibility Rules, 72 FR at
12867.
\160\ See SIFMA 2 Letter; SIFMA 4 Letter.
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The Commission is adopting the amendments substantially as
proposed--deleting Rule 15c3-2 and adding paragraph (j)(1) to Rule
15c3-3. The Commission believes it is appropriate to eliminate Rule
15c3-2 as a separate rule because it is largely irrelevant in light of
the requirements in Rule 15c3-3. Further, the provisions in Rule 15c3-2
that the Commission wishes to retain are being re-codified in Rule
15c3-3. These provisions include the requirement that broker-dealers
inform customers of the amounts due to them and that such amounts are
payable on demand.\161\ Consequently, the Commission is amending Rule
15c3-3 to add new paragraph (j)(1), which provides that ``[a] broker or
dealer must not accept or use any free credit balance carried for the
account of any customer of the broker or dealer unless such broker or
dealer has established adequate procedures pursuant to which each
customer for whom a free credit balance is carried will be given or
sent, together with or as part of the customer's statement of account,
whenever sent but not less frequently than once every three months, a
written statement informing the customer of the amount due to the
customer by the broker or dealer on the date of the statement, and that
the funds are payable on demand of the customer.'' \162\
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\161\ Rule 15c3-2 contains an exemption for broker-dealers that
also are banking institutions supervised by a Federal authority.
This exemption will not be imported into Rule 15c3-3 because there
are no broker-dealers left that fit within the exemption. Further,
the definition of customer for purposes of the imported 15c3-2
requirements will be the definition of customer in Rule 15c3-3,
which is somewhat narrower than the definition in Rule 15c3-2.
\162\ See paragraph (j)(1) of Rule 15c3-3, as adopted. The
Commission also modified the phrase ``[i]t shall be unlawful for a
broker or dealer to'' to the phrase ``[a] broker or dealer must
not'' in order to avoid using the term ``unlawful.'' Any violation
of the rules and regulations promulgated under the Exchange Act is
unlawful and therefore it is unnecessary to use this phrase in the
final rule.
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ii. Treatment of Free Credit Balances
Free credit balances are funds payable by a broker-dealer to its
customers on demand.\163\ They may result from cash deposited by the
customer to purchase securities, proceeds from the sale of securities
or other assets held in the customer's account, or earnings from
dividends and interest on securities and other assets held in the
customer's account. Broker-dealers may, among other things, pay
interest to customers on their free credit balances or offer to
routinely transfer (``sweep'') them to a money market fund or bank
account. On occasion, broker-dealers have changed the product to which
a customer's free credit balances are swept--in recent years, most
frequently from a money market fund to an interest bearing bank
account. Because of differences in these two types of products,
including the type of protection afforded the customer in the event of
insolvency, there may be investment consequences to the customer when
changing from one product to the other. The money market shares--as
securities--would receive up to $500,000 in SIPA protection in the
event the broker-dealer failed. The bank deposits--as cash--would
receive up to $250,000 in protection from the FDIC in the event the
bank failed. On the other hand, the money market fund shares may incur
market losses; whereas, the full amount of the bank deposit would be
guaranteed up to the FDIC's $250,000 limit. There also may be
differences in the amount of interest earned from the two products. In
short, there may be consequences to moving a customer's free credit
balances from one product to another, and, accordingly, customers
should have a sufficient opportunity to make an informed decision.\164\
---------------------------------------------------------------------------
\163\ See 17 CFR 240.15c3-3(a)(8).
\164\ See Amendments to Financial Responsibility Rules, 72 FR at
12866.
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The Commission proposed amendments to Rule 15c3-3 that would have
established conditions required to be met in order for a broker-dealer
to use or transfer free credit balances in a customer's securities
account.\165\ More specifically, as initially proposed, the amendments
would have structured the new rule to make it unlawful for a broker-
dealer to convert, invest, or otherwise transfer to another account or
institution free credit balances held in a customer's account except as
provided in the proposed rule.\166\ The proposed rule then prescribed
three conditions to address three different scenarios involving the use
or transfer of customer free credit balances. The first scenario
involved the use or transfer of free credit balances outside the
context of a routine sweep to a money market fund or bank. As discussed
below, proposed paragraph (j)(2)(i) would have prohibited the use or
transfer of free credit balances in this scenario unless the customer
had specifically ordered or authorized the transaction. The second and
third scenarios involved the use or transfer of free credit balances in
the context of a program to routinely sweep them to a money market fund
or bank account (a ``sweep program''). As discussed below, proposed
paragraph (j)(2)(ii) would have addressed sweep program requirements
for accounts opened after the effective date of the rule (``new
accounts'') and proposed paragraph (j)(2)(iii) would have addressed
sweep program requirements for accounts existing as of the effective
date of the rule (existing accounts). The Commission is adopting new
paragraph (j)(2) to Rule 15c3-3 with substantial modifications from the
proposed rule in response to comments and to clarify certain portions
of the rule.\167\
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\165\ Id. at 12866-12867.
\166\ Id. at 12866.
\167\ In 2005, the NYSE addressed the issue of disclosure in a
sweep program context by issuing an information memo to its members
discussing, among other things, the disclosure responsibilities of a
broker-dealer offering a sweep program to its customers. See
Information Memo 05-11 (Feb. 15, 2005). The memo stated that broker-
dealers should disclose material differences in interest rates
between the different sweep products and, with respect to the bank
sweep program, further disclose the terms and conditions, risks and
features, conflicts of interest, current interest rates, manner by
which future interest rates will be determined, and the nature and
extent of FDIC and SIPC protection.
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As proposed, the first sentence of paragraph (j)(2) of the rule
would have established the prohibition with respect to the treatment of
free credit balances by providing that ``[i]t shall be unlawful for a
broker or dealer to convert, invest, or otherwise transfer to another
account or institution, free credit balances held in a customer's
account except as provided in paragraphs (j)(2)(i), (ii) and (iii).''
\168\ The Commission received one comment in response to the proposed
text of this first sentence.\169\ The commenter expressed concern that
the proposed text in the first sentence of paragraph (j)(2) could be
construed broadly, in effect, to prohibit a broker-dealer from using,
investing, or transferring cash deposits that are not swept to other
investments or products (and are included as credits in the reserve
formula) in the normal course of the broker-dealer's business, as is
currently permitted by Rule 15c3-3. The commenter suggested that the
text be
[[Page 51838]]
revised to clarify the scope of the proposed rule by prohibiting a
broker-dealer from deducting a free credit balance from the customer's
account at the broker-dealer and transferring it to another institution
and investing it in another instrument on behalf of the customer,
except as permitted under paragraph (j)(2).\170\
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\168\ See Amendments to Financial Responsibility Rules, 72 FR at
12896.
\169\ See SIFMA 2 Letter.
\170\ Id.
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In response to the comment, as a preliminary matter, cash balances
in customer securities accounts must be included as credits in the
customer reserve formula. Further, the net amount of the credits over
debits must be deposited in a customer reserve account in the form of
cash or qualified securities. However, cash credit items that are net
of debit items can be used by the broker-dealer for the limited purpose
of facilitating transactions of its customers.\171\ The commenter
suggested that proposed paragraph (j)(2) of Rule 15c3-3 could be
interpreted to impose new limits on a broker-dealer's ability to use
cash that is an asset on the firm's balance sheet. In response to this
concern, the Commission notes that the prohibition in the first
sentence of proposed paragraph (j)(2) of Rule 15c3-3 is intended to
place conditions only on the broker-dealer's ability to convert the
cash asset of the customer (i.e., a receivable from the broker-dealer)
into a different type of asset (e.g., a security or an obligation of
another institution outside the context of a sweep program) or to
transfer the customer's cash asset to another account.
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\171\ See 17 CFR 240.15c3-3(e)(2) (``It shall be unlawful for
any broker or dealer to accept or use any of the amounts under items
comprising Total Credits under the formula referred to in paragraph
(e)(1) of this section except for the specified purposes indicated
under items comprising Total Debits under the formula, and, to the
extent Total Credits exceed Total Debits, at least the net amount
thereof shall be maintained in the Reserve Bank Account pursuant to
paragraph (e)(1) of this section.'').
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The Commission is adopting paragraph (j)(2) of Rule 15c3-3 with
certain technical modifications.\172\ As adopted paragraph (j)(2)
reads: ``A broker or dealer must not convert, invest, or transfer to
another account or institution, credit balances held in a customer's
account except as provided in paragraphs (j)(2)(i) and (ii) of this
section.'' \173\
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\172\ Specifically, the Commission is replacing the phrase
``[i]t shall be unlawful for a broker or dealer to'' with the phrase
``[a] broker or dealer must not'' because--as noted above--any
violation of the rules and regulations promulgated under the
Exchange Act is unlawful and therefore it is unnecessary to use this
phrase in the final rule. The Commission also is replacing the
phrase ``free credit balance'' with the phrase ``credit balances''
to clarify that this provision covers both free credit balances and
other credit balances. See 17 CFR 240.15c3-3(a)(8)-(9) (defining
free credit balances and other credit balances). The Commission is
deleting the word ``otherwise'' because it would be redundant.
Finally, the rule text does not include a reference to paragraph
(j)(2)(iii), as proposed, because this paragraph was deleted from
the final rule text.
\173\ See paragraph (j)(2) of Rule 15c3-3, as adopted.
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a. Treatment of Free Credit Balances Outside of a Sweep Program
As proposed, paragraph (j)(2)(i) of Rule 15c3-3 would have
permitted a broker-dealer to convert, invest or otherwise transfer to
another account or institution free credit balances held in a
customer's account only upon a specific order, authorization, or draft
from the customer, and only in the manner, and under the terms and
conditions, specified in the order, authorization, or draft.\174\ This
catchall provision would have applied to any use or transfer of
customer free credit balances outside the context of a sweep program.
---------------------------------------------------------------------------
\174\ See Amendments to Financial Responsibility Rules, 72 FR at
12866.
---------------------------------------------------------------------------
The Commission proposed paragraph (j)(2)(i) in order to
comprehensively cover the range of possibilities with respect to the
disposition of free credit balances in a customer account other than
pursuant to a sweep program. The Commission received two comments
recommending that proposed paragraph (j)(2)(i) be clarified to permit a
broker-dealer to obtain a one-time consent to ongoing transfers of any
free credit balances to a customer to another account, entity or
product (outside of a sweep program).\175\ The commenters noted that
customers, for example, may prefer that free credit balances be
regularly transferred to a linked account in their name at another
broker-dealer or bank that is not part of a sweep program, and that
this clarification would enable a broker-dealer to efficiently handle
such customer requests by eliminating the need to obtain individual
``specific orders'' for repeated transfers that are substantially
identical.\176\ The Commission agrees with the commenters that a
customer may consent to ongoing routine transfers from the customer's
account outside of a sweep program without obtaining the customer's
specific consent for each individual transfer, provided the customer
has consented to the ongoing transfers under paragraph (j)(2)(i) of
Rule 15c3-3. This scenario would already be covered by the proposed
rule, and, therefore, the Commission is adopting paragraph (j)(2)(i)
substantially as proposed, with certain technical modifications.\177\
As adopted, paragraph (j)(2)(i) of Rule 15c3-3 reads: ``A broker or
dealer is permitted to invest or transfer to another account or
institution, free credit balances in a customer's account only upon a
specific order, authorization, or draft from the customer, and only in
the manner, and under the terms and conditions, specified in the order,
authorization, or draft.'' \178\
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\175\ See SIFMA 2 Letter; E*Trade 2 Letter.
\176\ Id.
\177\ See paragraph (j)(2)(i) of Rule 15c3-3, as adopted. The
technical changes delete the words ``convert'' and ``otherwise''
from the final rule because a broker-dealer would be prohibited from
``converting'' a customer's free credit balances and, therefore, it
is not necessary to include the word in the final rule. The word
``otherwise'' is redundant.
\178\ Id.
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Finally, one commenter stated that both regulators and firms need
the flexibility to remove funds from a reserve account to cover
extraordinary requests for payment of customer free credit
balances.\179\ However, the commenter noted that ``in light of recent
market events, we withdraw our earlier proposal to allow such
withdrawals under specified conditions and instead recommend that such
withdrawals be permitted only by approval of Commission staff or a
broker-dealer's [DEA].'' \180\ Broker-dealers currently may make
withdrawals under paragraph (g) of Rule 15c3-3.\181\ In light of the
risks that could arise to customer funds, the Commission does not
believe it would be appropriate at this time to expand a firm's ability
to make additional withdrawals from its reserve account.
---------------------------------------------------------------------------
\179\ See SIFMA 4 Letter.
\180\ Id. In its June 15, 2007 comment letter, SIFMA urged ``the
Commission to consider allowing a broker-dealer to remove funds from
a reserve account to cover a large same-day request for payment of a
free credit balance, as long as the free credit balance was included
in the latest Rule 15c3-3 reserve computation and the broker-dealer
begins a new reserve computation as of that date.'' See SIFMA 2
Letter.
\181\ 17 CFR 240.15c3-3(g).
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b. Treatment of Free Credit Balances in a Sweep Program
The second and third set of conditions in the proposed rules
addressed using or transferring free credit balances in the context of
a sweep program.\182\ In particular, the Commission proposed four
conditions with respect to using or transferring free credit balances
in a sweep program. A broker-dealer would have been required to meet:
(1) all four conditions with respect to free credit balances in new
accounts; \183\ and (2) the second, third, and fourth conditions with
respect to
[[Page 51839]]
free credit balances in existing accounts.\184\ The four conditions
were:
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\182\ See Amendments to Financial Responsibility Rules, 72 FR at
12866.
\183\ See paragraph (j)(2)(ii)(A)-(D) of Rule 15c3-3, as
adopted.
\184\ See paragraph (j)(2)(iii)(A)-(C) of Rule 15c3-3, as
adopted.
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1. The customer has previously affirmatively consented to such
treatment of the free credit balances after being notified of the
different general types of money market mutual fund and bank account
products in which the broker or dealer may transfer the free credit
balances and the applicable terms and conditions that would apply if
the broker or dealer changes the product or type of product in which
free credit balances are transferred;
2. The broker or dealer provides the customer on an ongoing basis
with all disclosures and notices regarding the investment and deposit
of free credit balances as required by the self-regulatory
organizations for which the broker or dealer is a member;
3. The broker or dealer provides notice to the customer as part of
the customer's quarterly statement of account that the money market
mutual funds or bank deposits to which the free credit balances have
been transferred can be liquidated on the customer's demand and held as
free credit balances; and
4. The broker or dealer provides the customer with at least 30
calendar days notice before the free credit balances would begin being
transferred to a different product, different product type, or into the
same product but under materially different terms and conditions. The
notice must describe the new money market fund, bank deposit type, or
terms and conditions, and how the customer can notify the broker or
dealer if the customer chooses not to have the free credit balances
transferred to the new product or product type, or under the new terms
and conditions.
Commenters generally agreed with the fundamental principle embodied in
the proposal--that customer free credit balances should not be
transferred from an obligation of the broker-dealer to an obligation of
another entity without the customer's authorization.\185\ Other
commenters supported the proposed disclosures but suggested additional
disclosures be made to customers, including clarification with respect
to other protections available to the customer.\186\ Two commenters
stated that the practice of sweep programs should be banned entirely or
that the Commission should adopt a ``harder stance'' and require more
than just disclosure.\187\ One commenter responded to the Commission's
request for comment as to the cost burdens that would result if the
first condition (set forth in proposed paragraph (j)(2)(ii)(A)) to
obtain a new customer's prior agreement were to be applied to existing
customers. The commenter stated that such costs would be substantial
because broker-dealers would be required to amend their agreements with
all existing customers.\188\ One commenter stated that the amendments
in the proposing release did not adequately address situations in which
broker-dealers change customer account elections without first
obtaining customer authorization.\189\
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\185\ See SIFMA 2 Letter; First Clearing Letter; Pace Letter.
\186\ See SIPC Letter.
\187\ See Ellis Letter; Dworkin Letter. One commenter stated
that broker-dealers profit from ``excessive'' fees charged to
clients who opt out of the sweep programs. See Ellis Letter. The
second commenter suggested that the broker-dealer's ``customer has
been effectively denied the opportunity to opt out of bank account
sweeps by [the broker-dealer] preventing him or her from utilizing
any other vehicle to park his or her free credit balances. . . .''
See Dworkin Letter. The commenter noted that by opting out of the
sweep, the customer is ``confined to a situation where the free
credit balance cannot earn any kind of return at all[.]'' Id.
\188\ See SIFMA 2 Letter.
\189\ See Waddell Letter.
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In adopting the final rule, the Commission has made some
modifications to the language in the proposed rule in response to
commenters and to clarify its application. For clarification and in
response to comments, the Commission has defined the term Sweep Program
in paragraph (a)(17) of Rule 15c3-3 to identify the types of
transactions and products to which the new provisions apply.
Commenters raised concerns about limitations on the types of
products broker-dealers could use for sweep arrangements under the
proposed amendments. Three commenters suggested that the Commission
should not limit the types of products broker-dealers can use for sweep
arrangements to money market funds and bank deposit products.\190\
---------------------------------------------------------------------------
\190\ See SIFMA 2 Letter; First Clearing Letter; Raymond James 2
Letter.
---------------------------------------------------------------------------
Sweep programs provide a mechanism for excess cash in a customer's
securities account to be held in a manner that allows the customer to
earn interest on the funds but retain the flexibility to quickly access
that cash to purchase securities or withdraw it.\191\ In effect,
transferring this excess cash to a bank account or money market fund is
an alternative to retaining a credit balance in the customer's
securities account. The final rule is designed to accommodate this
alternative by providing broker-dealers with flexibility in the
operation of sweep programs. The Commission believes it is appropriate
to confine this flexibility to products that approximate the holding of
a customer's excess cash in a securities account. The Commission does
not view sweep accounts as a mechanism for investing customers' excess
cash without their specific consent in longer term or more volatile
assets. For these reasons, the Commission does not believe it would be
appropriate to expand the products covered by the final rule beyond
money market funds as described in Rule 2a-7 under the Investment
Company Act of 1940 or an account at an insured bank as described in
paragraph (a)(17) of Rule 15c3-3.
---------------------------------------------------------------------------
\191\ See Ellis Letter; Dworkin Letter.
---------------------------------------------------------------------------
Consequently, paragraph (a)(17) of Rule 15c3-3, as adopted, states
``[t]he term Sweep Program means a service provided by a broker or
dealer where it offers to its customers the option to automatically
transfer free credit balances in the securities account of the customer
to either a money market mutual fund product as described in [Rule 2a-
7] or an account at a bank whose deposits are insured by the Federal
Deposit Insurance Corporation.'' \192\ The Commission intended that the
definition of Sweep Program provide that the bank to which free credits
are swept be insured by the FDIC.\193\ The revised text of the rule
makes this explicit. Finally, under this definition, a one-time or
other special transfer of a customer's free credit balances would not
qualify as a Sweep Program.
---------------------------------------------------------------------------
\192\ See paragraph (a)(17) of Rule 15c3-3, as adopted.
\193\ See Amendments to Financial Responsibility Rules, 72 FR at
12866 (``[T]he bank deposit would be guaranteed up to the FDIC's
$100,000 limit.''). FDIC insurance covers all deposit accounts,
including checking and savings accounts, money market deposit
accounts and certificates of deposit. The standard insurance amount
is currently $250,000 per depositor, per insured bank, for each
account ownership category. 12 CFR 330.1(o).
---------------------------------------------------------------------------
Three commenters raised the issue of bulk transfers.\194\ They
argued that the rule should allow broker-dealers to process bulk
transfers of customer assets between, for instance, one money market
fund and another money market fund or a bank deposit product and a
money market fund. These commenters identify a potential ambiguity in
the rule as proposed; namely, how transfers from one Sweep Program
product to another Sweep Program product are to be handled under the
rule if they do not involve passing funds through the
[[Page 51840]]
customer's securities account. To address this issue, paragraph
(j)(2)(ii) of Rule 15c3-3 is being modified from the proposal to
clarify that the conditions for operating a Sweep Program (which are
set forth in paragraphs (j)(2)(ii)(A) and (B)) will apply to: (1) The
transfer of free credit balances from a customer's securities account
to a product in a Sweep Program; and (2) the transfer of a customer's
interest in one Sweep Program product to another Sweep Program product.
This will address both bulk transfers \195\ of customer positions from
one product (e.g., a money market fund) to another (e.g., a bank
deposit product) and transfers of individual customer positions from
one product to another.
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\194\ See SIFMA 2 Letter; First Clearing Letter; E*Trade 2
Letter.
\195\ See also NASD Rule 2510 (Discretionary Accounts)
(providing an exception from the NASD rule for ``bulk exchanges at
net asset value of money market mutual funds . . . utilizing
negative response letters provided: (A) The bulk exchange is limited
to situations involving mergers and acquisitions of funds, changes
of clearing members and exchanges of funds used in sweep accounts;
(B) The negative response letter contains a tabular comparison of
the nature and amount of the fees charged by each fund; (C) The
negative response letter contains a comparative description of the
investment objectives of each fund and a prospectus of the fund to
be purchased; and (D) The negative response feature will not be
activated until at least 30 days after the date on which the letter
was mailed.'').
---------------------------------------------------------------------------
The Commission is modifying paragraph (j)(2)(ii) of Rule 15c3-3
from the proposal to delete the phrase ``to either a money market
mutual fund as described in Sec. 270.2a-7 of this chapter or an
interest bearing account at a bank without a specific order,
authorization or draft for each such transfer, provided'' and instead
to use the term Sweep Program as defined in paragraph (a)(17) of the
final rule. The Commission also replaced the phrase ``the account of a
customer'' with the phrase ``a customer's securities account'' to
clarify that paragraph (j)(2)(ii) and its required conditions apply to
the transfer of free credit balances in connection with a customer's
securities account, in addition to the bulk transfers described
above.\196\ As adopted, paragraph (j)(2)(ii) to Rule 15c3-3 reads, in
pertinent part: ``[a] broker or dealer is permitted to transfer free
credit balances held in a customer's securities account to a product in
its Sweep Program or to transfer a customer's interest in one product
in a Sweep Program to another product in a Sweep Program, provided''
the conditions set forth in paragraphs (j)(2)(ii)(A) and (B) are
met.\197\
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\196\ The final rule also deletes the phrase ``opened on or
after the effective date of this paragraph'' from paragraph
(j)(2)(ii) and moves it to paragraph (j)(2)(ii)(A), as described
below.
\197\ See paragraph (j)(2)(ii) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------
As adopted, paragraphs (j)(2)(ii)(A) and (B) establish four
conditions that must be met to lawfully transfer a customer's free
credit balances to a product in a Sweep Program or to transfer a
customer's interest directly from one product in a Sweep Program to
another product in a Sweep Program. The first condition--set forth in
paragraph (j)(2)(ii)(A)--applies only with respect to accounts opened
on or after the effective date of the rule. This addresses the burden
that would have been associated with having broker-dealers re-document
existing accounts. The remaining three conditions--set forth in
paragraph (j)(2)(ii)(B)(1) through (3)--apply to both existing and new
accounts.
Paragraph (j)(2)(ii)(A), as adopted, provides that for an account
opened on or after the effective date of the rule, the customer must
give prior written affirmative consent to having free credit balances
in the customer's securities account included in the Sweep Program
after being notified: (1) Of the general terms and conditions of the
products available through the Sweep Program; and (2) that the broker
or dealer may change the products available under the Sweep
Program.\198\
---------------------------------------------------------------------------
\198\ See paragraph (j)(2)(ii)(A) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------
As stated above, the Commission has modified paragraph
(j)(2)(ii)(A) in the final rule to read ``the customer gives prior
written affirmative consent to having free credit balances in the
customer's securities account included in the Sweep Program after being
notified. . . .'' \199\ The Commission modified this paragraph to
incorporate the term Sweep Program as defined in paragraph (a)(17) of
the rule and the reference to the ``customer's securities account'' to
make this paragraph consistent with other modifications to paragraph
(j)(2) of the final rule. Additionally, the Commission modified this
paragraph to clarify that the customer's consent must be written,
consistent with the discussion in the proposing release, which noted
customer consent could be given in an account opening agreement.\200\
---------------------------------------------------------------------------
\199\ Id. The proposed rule stated the ``customer has previously
affirmatively consented to such treatment of the free credit
balances after being notified of . . . .'' In addition, as noted
above, the phrase ``accounts opened on or after the effective date
of this paragraph'' was deleted from proposed paragraph (j)(2)(ii)
and moved to paragraph (j)(2)(ii)(A), with the reference to specific
paragraph (j)(2)(ii) inserted after the word ``paragraph.'' Moving
this phrase to paragraph (j)(2)(ii)(A) simplifies the final rule by
eliminating the necessity of codifying two largely overlapping sets
of conditions, with three of the conditions being repeated in both
paragraphs. The effect of this change is to make the first condition
only applicable to new accounts and the remaining conditions
(paragraph (j)(2)(ii)(B)(1) through (3)) applicable to both new and
existing accounts. The word ``accounts'' also has been replaced with
the phrase ``an account.''
\200\ See Amendments to Financial Responsibility Rules, 72 FR at
12866 (``[T]he customer would need to agree prior to the change
(e.g., in the account opening agreement) that the broker-dealer
could switch the sweep option between those two types of
products.'').
---------------------------------------------------------------------------
The Commission received one comment stating that the text of
proposed paragraph (j)(2)(ii)(A) that would have required the
disclosure of ``applicable terms and conditions that will apply if the
broker or dealer changes the product or type of product'' could be read
to require highly specific disclosure about product terms and
conditions that may only be established or modified in the future and,
therefore, are unknown at the time the customer opens an account with
the broker-dealer.\201\ In addition, the commenter stated that under
proposed paragraph (j)(2)(ii)(D), a broker-dealer would already be
required to describe any changes to the terms and conditions it makes
contemporaneously with such changes. Given this type of notice, the
commenter stated that there is no need for the type of generalized (and
therefore less effective) disclosure that would have been required by
paragraph (j)(2)(ii)(A). The Commission agrees with the commenter and,
therefore, has deleted the phrase ``transfer the free credit balances
and the applicable terms and conditions that will apply if the broker
or dealer changes the product or type of product in which the free
credit balances are transferred. . . .'' In its place, the Commission
is adopting language in paragraph (j)(2)(ii)(A)(2) of Rule 15c3-3 under
which the broker-dealer must notify the customer that the broker or
dealer may change the products available under the Sweep Program.\202\
---------------------------------------------------------------------------
\201\ See SIFMA 2 Letter.
\202\ See paragraph (j)(2)(ii)(A)(2) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------
Paragraph (j)(2)(ii)(B), as adopted, prescribes the following three
conditions to sweeping the customer's free credit balances in a new or
existing account:
The broker-dealer provides the customer with the
disclosures and notices regarding the Sweep Program required by each
SRO of which the broker-dealer is a member; \203\
---------------------------------------------------------------------------
\203\ See paragraph (j)(2)(ii)(B) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------
The broker-dealer provides notice to the customer, as
part of the customer's quarterly statement of account, that the
balance in the bank deposit account or shares of the money market
mutual fund in which the customer has a beneficial interest can be
liquidated on the customer's order and the proceeds
[[Page 51841]]
returned to the securities account or remitted to the customer;
\204\ and
---------------------------------------------------------------------------
\204\ Id.
---------------------------------------------------------------------------
The broker-dealer provides the customer with written
notice at least 30 calendar days before: (1) Making changes to the
terms and conditions of the Sweep Program; (2) making changes to the
terms and conditions of a product currently available through the
Sweep Program; (3) changing, adding or deleting products available
through the Sweep Program; or (4) changing the customer's investment
through the Sweep Program from one product to another; and the
notice describes the new terms and conditions of the Sweep Program
or product or the new product, and the options available to the
customer if the customer does not accept the new terms and
conditions or product.\205\
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\205\ Id.
As proposed, paragraph (j)(2)(ii)(B) of Rule 15c3-3 would have
required that the broker-dealer provide these disclosures and notices
``on an ongoing basis.'' Three commenters stated that there are no
current SRO requirements that broker-dealers make disclosures
concerning sweep arrangements on an ``ongoing basis'' and that the
Commission should clarify the source and meaning of this
requirement.\206\ The Commission has deleted the phrase ``ongoing
basis'' from the final rule. As adopted, the Commission has also
modified the text in paragraph (j)(2)(ii)(B), now paragraph
(j)(2)(ii)(B)(1), to delete the phrase ``investment and deposit of free
credit balances as'' and inserted the phrase ``Sweep Program'' to
incorporate the definition in paragraph (a)(17). Finally, the
Commission has modified the phrase ``the self-regulatory
organizations'' to read ``each self-regulatory organization of'' to
clarify that the broker-dealer must provide the notices and disclosures
required by each SRO of which it is a member (including an SRO that is
not its DEA).\207\
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\206\ See SIFMA 2 Letter; First Clearing Letter; Raymond James 2
Letter.
\207\ See 17 CFR 240.17d-1.
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As adopted, paragraph (j)(2)(ii)(B)(2) states that the broker-
dealer must provide information on a quarterly basis with respect to
the customer's balance in an account or fund ``in which the customer
has a beneficial interest.'' \208\ The rule text has been modified to
account for the fact that customers can have a beneficial interest in
accounts in their name and in omnibus accounts in the name of a
custodian in which the assets of multiple customers are commingled.
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\208\ See paragraph (j)(2)(ii)(B)(2) of Rule 15c3-3, as adopted.
More specifically, the Commission modified the phrase ``that the
money market mutual funds or bank deposits to which the free credit
balances have been transferred'' to read ``that the balance in the
bank deposit account or shares of the money market mutual fund in
which the customer has a beneficial interest. . . .''
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The Commission also modified language in paragraph (j)(2)(ii)(B)(2)
of Rule 15c3-3 to replace the phrase ``on the customer's demand'' with
the phrase ``on the customer's order'' to address concerns by two
commenters that the former phrase could lead customers to believe that
they will receive immediate re-payment of those funds, or they could
revert to holding those funds as free credit balances at the broker-
dealer.\209\ These commenters pointed out that the disclosed terms of
most sweep programs allow the money market fund or bank up to seven
days to meet requests for withdrawals. Further, there are some broker-
dealers that do not allow customers to maintain free credit balances in
securities accounts. In response to these comments, the Commission has
deleted the phrase ``demand and held as free credit balances'' and
replaced it with the phrase ``and the proceeds returned to the
securities account or remitted to the customer.'' This language is
designed to account for broker-dealers that do not offer customers the
option of having their funds held as free credit balances. In such
cases, the broker-dealer would remit the funds withdrawn from the bank
or derived from redeeming money market shares directly to the customer
(e.g., by transferring them to the customer's bank account).
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\209\ See SIFMA 2 Letter.
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Proposed paragraphs (j)(2)(ii)(D) and (iii)(C)--now paragraph
(j)(2)(ii)(B)(3)--would have required the broker-dealer to provide the
customer with notice at least thirty days before the broker-dealer
begins transferring the customer's free credit balances to a different
product or product type, or into the same product but under materially
different terms and conditions.\210\ As adopted, paragraph
(j)(2)(ii)(B)(3) will require broker-dealers to provide customers
written notice at least 30 calendar days before the broker-dealer: (1)
Makes changes to the terms and conditions of the Sweep Program; (2)
makes changes to the terms and conditions of a product currently
available through the Sweep Program; (3) changes, adds, or deletes
products available through the Sweep Program; or (4) changes the
customer's investment through the Sweep Program from one product to
another.\211\ This modification to the final rule is in response to
commenters' requests that the Commission provide clarity with respect
to when the thirty day notice requirement would be triggered.\212\ In
response to comments, the final rule is designed to make clear that the
triggering event for the thirty day notice is not exclusively related
to the transfer of the customer's free credit balances, but rather
changes relating to the terms and conditions of the Sweep Program, as
well as, the products available through the Sweep Program. This greater
specificity should enhance the protections under the final rule by
providing greater certainty that the customer will have time to
evaluate available options before a change to the Sweep Program is put
into effect.
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\210\ See Amendments to Financial Responsibility Rules, 72 FR at
12896.
\211\ A broker-dealer could request exemptive relief from the
rule in unusual or emergency cases where it may be impractical or
contrary to investor protection for a broker-dealer to first provide
customers 30 days' written notice under the rule before taking one
of these actions. See, e.g., paragraph (k)(3) to Rule 15c3-3.
\212\ See SIFMA 2 Letter; First Clearing Letter; Cornell Letter;
E*Trade Letter.
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In addition, paragraphs (j)(2)(ii)(B)(3)(i)(A)-(D) of Rule 15c3-3
require the broker-dealer to provide the customer with written notice
at least 30 calendar days before: (1) Making changes to the terms and
conditions of the Sweep Program; (2) making changes to the terms and
conditions of a product currently available through the Sweep Program;
(3) changing, adding or deleting products available through the Sweep
Program; or (4) changing the customer's investment through the Sweep
Program from one product to another.\213\ Collectively, these
provisions provide more specificity about the types of disclosures and
notices required under the final rule than under the proposal. Further,
the final rule includes the word ``written'' before the word ``notice''
to make explicit that a written notice is required.
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\213\ See paragraph (j)(2)(ii)(B)(3)(i) of Rule 15c3-3, as
adopted. The requirements set forth in final paragraph
(j)(2)(ii)(B)(3)(i) were proposed as paragraphs (j)(2)(ii)(D) and
(iii)(C).
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As adopted, paragraph (j)(2)(ii)(B)(3)(ii) requires that ``[t]he
notice must describe the new terms and conditions of the Sweep Program
or product or the new product, and the options available to the
customer if the customer does not accept the new terms and conditions
or product.'' \214\ The Commission modified the final rule in response
to a comment regarding the text of proposed paragraphs (j)(2)(ii)(D)
and (iii)(C).\215\ The commenter stated that, as drafted, proposed
paragraphs (j)(2)(ii)(D) and (iii)(C) would have required a broker-
dealer to disclose
[[Page 51842]]
``how the customer can notify the [broker-dealer] if the customer
chooses not to have the free credit balances transferred to the new
product or product type, or under new terms and conditions.'' \216\ The
commenter stated that these paragraphs appear to assume that the
customer will have the option of continuing to have free credit
balances treated as they were prior to the change to the sweep
arrangement.\217\ The commenter pointed out that, in fact, the broker-
dealer may elect not to continue offering the prior sweep options and
not to offer another sweep product.\218\ To account for this
possibility, the Commission has revised the text in paragraph
(j)(2)(ii)(B)(3)(ii) \219\ to require the broker-dealer to provide the
customer with a notice that contains a description of the options
available to the customer if the customer does not wish to accept the
new terms and conditions or product.\220\ This is intended to give
customers sufficient opportunity to make an informed decision in
connection with a Sweep Program.
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\214\ See paragraph (j)(2)(ii)(B)(ii) of Rule 15c3-3, as
adopted. The final rule codifies this text in a separate paragraph
in order to emphasize the specific items the notice must contain.
\215\ See SIFMA 2 Letter.
\216\ Id.
\217\ Id.
\218\ Id.
\219\ More specifically, paragraph (j)(2)(ii)(B)(3)(ii) provides
that ``the notice must describe the new terms and conditions of the
Sweep Program or product or the new product, and the options
available to the customer if the customer does not accept the new
terms and conditions or product.'' A customer that does not accept
the new terms and conditions or product would need to change how
free credit balances are treated by, for example, selecting
investments outside the Sweep Program or having the balances
transferred to an account at another financial institution.
\220\ See Dworkin Letter.
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6. ``Proprietary Accounts'' Under the Commodity Exchange Act
Some broker-dealers also are registered as futures commission
merchants under the Commodity Exchange Act (``CEA''). These firms carry
both securities and commodities accounts for customers. The definition
of free credit balances in paragraph (a)(8) of Rule 15c3-3 does not
include funds carried in commodities accounts that are segregated in
accordance with the requirements of the CEA.\221\ However, regulations
promulgated under the CEA exclude certain types of accounts
(``proprietary accounts'') from the CEA's segregation
requirements.\222\ This exclusion from the segregation requirements
under the CEA has raised a question as to whether a broker-dealer must
treat payables to customers in proprietary commodities accounts as
``free credit balances'' when performing a customer reserve
computation.\223\
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\221\ 17 CFR 240.15c3-3(a)(8).
\222\ Rule 1.20 requires a futures commission merchant to
segregate customer funds. See 17 CFR 1.20. Rule 1.3(k) defines the
term customer for this purpose. See 17 CFR 1.3(k). The definition of
customer excludes persons who own or hold a proprietary account as
that term is defined in Rule 1.3(y). See 17 CFR 1.3(y). Generally,
the definition of proprietary account refers to persons who have an
ownership interest in the futures commission merchant. Id.
\223\ See Part 241-Interpretive Releases Relating to the
Securities Exchange Act of 1934 and General Rules and Regulations
Thereunder, Exchange Act Release No. 9922 (Jan. 2, 1973), 38 FR 1737
(Jan. 18, 1973) (interpreting the credit balance used in Item 1 of
the Rule 15c3-3a formula ``to include the net balance due to
customers in non-regulated commodities accounts reduced by any
deposits of cash or securities with any clearing organization or
clearing broker in connection with the open contracts in such
accounts'').
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In response to this question, the Commission notes that the
objective of the customer reserve requirement in Rule 15c3-3 is to
require broker-dealers to hold sufficient funds or qualified securities
to facilitate the prompt return of customer property to customers
either before or during a liquidation proceeding if the firm
fails.\224\ Under SIPA, customer property generally does not include
funds held in a commodities account.\225\ Therefore, funds held in a
proprietary commodities account generally would not constitute customer
property and persons having claims to those funds would not be
customers under SIPA.\226\ Moreover, the regulations under the CEA
similarly provide the persons having claims to funds in proprietary
commodities accounts are not customers for purposes of those
regulations.\227\ For these reasons, the Commission proposed a specific
amendment to the definition of the term free credit balances in
paragraph (a)(8) of Rule 15c3-3 that would have clarified that funds
held in a commodities account meeting the definition of a proprietary
account under CEA regulations are not to be included as free credit
balances in the customer reserve formula.\228\ As discussed below, the
Commission is adopting the amendment substantially as proposed.
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\224\ See Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for Broker-Dealers, Exchange
Act Release No. 68071 (Oct. 18, 2012), 77 FR 70214, 70274 (Nov. 23,
2012) (describing rationale and requirements of Rule 15c3-3
segregation requirements). See also Broker-Dealers; Maintenance of
Certain Basic Reserves, Exchange Act Release No. 9856 (Nov. 10,
1972), 37 FR 25224, 25225 (Nov. 29, 1972) (stating that the intent
of Rule 15c3-3 is, among other things, to ``facilitate the
liquidations of insolvent broker-dealers and to protect customer
assets in the event of a SIPC liquidation through a clear
delineation in Exchange Act Rule 15c3-3 of specifically identifiable
property of customers.''); Amendments to Financial Responsibility
Rules, 72 FR at 12862, 12868.
\225\ As noted above, customer property under SIPA includes
``cash and securities (except customer name securities delivered to
the customer) at any time received, acquired, or held by or for the
account of the debtor from or for the securities accounts of a
customer, and the proceeds of any such property transferred by the
debtor, including property unlawfully converted.'' 15 U.S.C.
78lll(4). To receive protection under SIPA, a claimant must first
qualify as a customer as that term is defined in the statute.
Generally, a customer is any person who has: (1) ``a claim on
account of securities received, acquired, or held by the [broker-
dealer];'' (2) ``deposited cash with the debtor for the purposes of
purchasing securities;'' (3) ``a claim against the debtor for. .
.[positions]. . .received, acquired, or held in a portfolio margin
account carried as a securities account pursuant to a portfolio
margining program approved by the Commission;'' or (4) ``a claim
against the [broker-dealer] arising out of sales or conversions of
such securities.'' See 15 U.S.C. 78lll(2)(A)-(B). The definition of
security in SIPA specifically excludes commodities and non-
securities futures contracts and, thus, a person with a claim for
such assets (not held in a portfolio margin account carried as a
securities account) would not meet the definition of customer. See
15 U.S.C. 78lll(14).
\226\ Id.
\227\ See 17 CFR 1.3(k).
\228\ See Amendments to Financial Responsibility Rules, 72 FR at
12868. The Commission proposed additional amendments to paragraph
(a)(8) of Rule 15c3-3 related to portfolio margining. See also
discussion below in section II.B. of this release.
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The Commission received three comments in support of the proposed
rule change.\229\ One commenter requested that the Commission clarify
that the relevant definition of proprietary account for these purposes
is the definition contained in Rule 1.3(y) under the CEA. While Rule
1.3(y) under the CEA currently contains the relevant definition of
proprietary account for the purpose of the amendment, the definition
could be codified in a different rule in the future. Consequently, the
Commission is adopting the final rule amendment to paragraph (a)(8) of
Rule 15c3-3, as proposed. Thus, the final rule does not include
specific references to a specific rule. Rather, the amendment to
paragraph (a)(8) to Rule 15c3-3, as adopted, more generally refers to a
``proprietary account as that term is defined in regulations under the
Commodity Exchange Act.''
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\229\ See SIPC Letter; SIFMA 2 Letter; SIFMA 4 Letter.
---------------------------------------------------------------------------
As stated above, this amendment to paragraph (a)(8) of Rule 15c3-3
is designed to clarify that funds held in a commodities account meeting
the definition of a proprietary account under CEA regulations are not
to be included as ``free credit balances'' in the customer reserve
formula. Under Item 1 of Rule 15c3-3a, however, cash balances that do
not meet the definition of free credit balances (e.g., because they are
not subject to immediate payment) are included in the customer reserve
formula if they meet the definition of other credit balances under
paragraph
[[Page 51843]]
(a)(9) of Rule 15c3-3.\230\ Therefore, in order to remove any ambiguity
as to the proper exclusion of proprietary accounts under the CEA from
Rule 15c3-3, the Commission also is amending the definition of the term
other credit balances in the final rule to delete the words ``as
aforesaid'' and insert the phrase ``in accordance with the Commodity
Exchange Act or in a similar manner, or funds carried in a proprietary
account as that term is defined in regulations under the Commodity
Exchange Act.'' \231\ Consequently, the amendments clarify that both
free credit balances and other credit balances as defined in Rule 15c3-
3 do not include funds carried in proprietary accounts under the CEA.
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\230\ Item 1 of Rule 15c3-3a requires a broker-dealer to include
in the customer reserve formula ``free credit balances and other
credit balances in customers' security accounts.'' Paragraph (a)(9)
of Rule 15c3-3 defines other credit balances as ``cash liabilities
of a broker or dealer to customers other than free credit balances
and funds in commodities accounts segregated as aforesaid.'' 17 CFR
240.15c3-3(a)(9).
\231\ See paragraph (a)(9) to Rule 15c3-3. See also comments and
additional amendments to paragraph (a)(9) of Rule 15c3-3 discussed
in section II.B. of this release.
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One commenter also suggested that due to the changes to the swap
markets mandated by Title VII of the Dodd-Frank Act, swap accounts (in
addition to commodities accounts) are now subject to customer
protection rules under the CEA.\232\ This commenter suggested that the
Commission make it clear that funds in swap accounts also do not
constitute free credit balances, whether those funds are required to be
segregated by rules under the CEA (e.g., cleared swap accounts or
uncleared swap accounts that have opted for segregation) or excepted
from segregation under the CEA (e.g., cleared swaps proprietary
accounts or uncleared swap accounts that have not opted for
segregation). The commenter noted this treatment ``would be consistent
with the treatment of funds in commodities accounts and with the
regulation of swap accounts under the CEA.'' \233\ The Commission
agrees there may be additional accounts under the CEA, as amended by
the Dodd-Frank Act, that should explicitly be excluded from the
definition of free credit balances under Rule 15c3-3. However, the
amendments today are designed to clarify the specific question raised
with respect to the treatment of funds in proprietary commodities
accounts under the CEA and, consequently, the suggestions by the
commenter are beyond the scope of this rulemaking.
---------------------------------------------------------------------------
\232\ See SIFMA 4 Letter.
\233\ Id.
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7. Expansion of the Definition of ``Qualified Securities'' To Include
Certain Money Market Funds
A broker-dealer is limited to depositing cash or qualified
securities into the bank account it maintains to meet its customer (and
now PAB account) reserve deposit requirements under Rule 15c3-3.
Paragraph (a)(6) of Rule 15c3-3 defines qualified securities to mean
securities issued by the United States or guaranteed by the United
States with respect to principal and interest.\234\ This strictly
limits the types of assets that can be used to fund a broker-dealer's
customer or PAB reserve account. The strict limitation is designed to
further the purpose of Rule 15c3-3; namely, that customer assets be
segregated and held in a manner that makes them readily available to be
returned to the customer. As the Commission noted when first proposing
Rule 15c3-3:
\234\ 17 CFR 240.15c3-3(a)(6).
The operative procedures of the Special [Reserve] Account are
designed to protect the integrity of customer-generated funds by
insulating them against inroads from the broker-dealer's firm
activities, whether they be underwriting, market making, other
trading, investing, or mere speculation in securities, meeting
overhead or any other nature whatever. The Special [Reserve] Account
should achieve a virtual 100% protection to customers with respect
to the carrying and use of customers' deposits or credit balances
which is mandated by Section 7(d) of the SIPC Act.\235\
---------------------------------------------------------------------------
\235\ Reserves and Related Measures Respecting the Financial
Responsibility of Brokers and Dealers, Exchange Act Release No. 9388
(Nov. 8, 1971), 36 FR 22312 (Nov. 24, 1971).
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In response to a petition for rulemaking,\236\ the Commission
proposed a limited expansion of the definition of qualified security to
include shares of an unaffiliated money market fund that: (1) Is
described in Rule 2a-7 under the Investment Company Act of 1940; (2)
invests solely in securities issued by the United States or guaranteed
by the United States as to interest and principal; (3) agrees to redeem
fund shares in cash no later than the business day following a
redemption request by a shareholder; and (4) has net assets equal to at
least 10 times the value of the shares deposited by the broker-dealer
in its customer reserve account.\237\ Twenty commenters addressed the
proposed amendment.\238\ A majority of commenters supported the
proposal and generally argued that the definition of qualified security
should be expanded further to include more types of instruments. One
commenter noted that permitting the use of certain money market funds
to make up the required reserve account deposit would introduce ``an
intermediary (namely, the holding company or money market fund) at
which problems might arise.'' \239\ The commenter also noted that a
number of SIPA liquidations have involved the mishandling of money
market or mutual fund shares or the confirmations of purchases of
nonexistent ``money market funds.'' \240\
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\236\ As discussed in the proposing release, Federated submitted
a petition for rulemaking on April 3, 2003, which it later amended
on April 4, 2005. See Amendments to Financial Responsibility Rules,
72 FR at 12865, 12874. More specifically, Federated's petition
requested that the Commission amend: (i) Rule 15c3-1 to lower the
haircut for certain money market funds to 0%; and (ii) Rule 15c3-3
to: (a) permit a broker-dealer to pledge such money market funds
when borrowing fully paid or excess margin securities from a
customer under paragraph (b)(3); and (b) treat such money market
funds as ``qualified securities'' that may be deposited into a
broker-dealer's customer reserve account. On February 9, 2009,
Federated submitted another request for rulemaking (Petition 4-577),
reiterating its first petition with respect to amending Rule 15c3-3
to allow a broker-dealer to treat certain money market funds as
``qualified securities'' that may be deposited into a reserve
account. However, this new petition changed the definition of the
types of funds that could be treated as qualified securities. More
specifically, the new petition proposed amending Rule 15c3-3(a)(6)
to define the term qualified securities to include, ``a redeemable
security of an investment company registered under the Investment
Company Act of 1940 and described in 17 CFR 270.2a-7, unaffiliated
with the broker-dealer and which limits its investments to
securities issued or guaranteed by the United States Government or
its agencies or instrumentalities (including repurchase
transactions).'' See Amendments to Financial Responsibility Rules,
72 FR at 12874 and n.112; see also Public Petitions for Rulemaking
No. 4-478 (Apr. 3, 2003) (available at https://www.sec.gov/rules/petitions/petn4-478.htm), as amended (Apr. 4, 2005) (amendment
available at https://www.sec.gov/rules/petitions/petn4-478a.pdf), and
No. 4-577 (Feb. 3, 2009) (available at https://www.sec.gov/rules/petitions/2009/petn4-577.pdf).
\237\ See Amendments to Financial Responsibility Rules, 72 FR at
12865.
\238\ See Federated Letter; Federated 2 Letter; Federated 3
Letter; Federated 4 Letter; Federated 5 Letter; Federated 6 Letter;
Federated 7 Letter; Federated 8 Letter; Meeks Letter; Meeks 2
Letter; Crane Data Letter; SIPC Letter; Curian Letter; FAF Letter;
Reserve Letter; Brown Brothers Letter; SIFMA Letter; First Clearing
Letter; ICI Letter; Barclays Letter; American Beacon Letter; Chamber
of Commerce Letter; ABASA Letter; UBS Letter; Fidelity/NFS Letter;
Barnard Letter; Federated 9 Letter; BOK Letter; Cornell Letter.
\239\ See SIPC Letter.
\240\ Id.
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The Commission recently has proposed substantial amendments to its
rules on money market funds.\241\ In light
[[Page 51844]]
of these proposed amendments,\242\ the Commission is deferring
consideration of any further expansion of the definition of qualified
security in Rule 15c3-3 at this time. This will allow the Commission to
assess the potential impact of any money market fund reforms it may
adopt and whether any such impact would have consequences for the
customer protection objective of the reserve account requirement in
Rule 15c3-3.
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\241\ Money Market Fund Reform; Amendments to Form PF, Release
No. IC-30551 (June 5, 2013), 78 FR 36834 (June 19, 2013) (The rule
proposal includes two principal alternative reforms that could be
adopted alone or in combination. One alternative would require a
floating net asset value or ``NAV'' for prime institutional money
market funds. The other alternative would allow the use of liquidity
fees and redemption gates in times of stress. The proposal also
includes additional diversification and disclosure measures that
would apply under either alternative.). See also Division of Risk,
Strategy, and Financial Innovation, Commission, Responses to
Questions Posed by Commissioners Aguilar, Paredes, and Gallagher
(Nov. 30, 2012) (responding to questions posed by Commissioners
Aguilar, Paredes, and Gallagher regarding effectiveness of the 2010
money market fund reforms, as well as how future reforms might
affect demand for investments in money market fund substitutes and
the implications for investors, financial institutions, corporate
borrowers, municipalities, and states that sell their debt to money
market funds), available at https://www.sec.gov/news/studies/2012/money-market-funds-memo-2012.pdf.
\242\ Money Market Fund Reform; Amendments to Form PF, Release
No. IC-30551 (June 5, 2013), 78 FR 36834 (June 19, 2013).
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B. Holding Futures Positions in a Securities Portfolio Margin Account
Under SRO portfolio margin rules (``portfolio margin rules''),\243\
a broker-dealer can combine securities and futures positions in a
portfolio margin securities account to compute margin requirements
based on the net market risk of all positions in the account.\244\
Until the passage of the Dodd-Frank Act, however, SIPA only protected
customer claims for securities and cash, and specifically excluded from
protection futures contracts that are not also securities. This fact
created a potential ambiguity as to how futures positions in a
portfolio margin securities account would be treated in a SIPA
liquidation. Consequently, the Commission proposed amendments to Rule
15c3-3 to accommodate the holding of futures positions in a securities
account that is margined on a portfolio basis.\245\
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\243\ See Exchange Act Release No. 55471 (Mar. 14, 2007), 72 FR
13149 (Mar. 20, 2007) (SR-NASD-2007-013); Exchange Act Release No.
54918 (Dec. 12, 2006), 72 FR 1044 (Jan. 9, 2007) (SR-NYSE-2006-13);
Exchange Act Release No. 54919 (Dec. 12, 2006), (SR-CBOE-2006-14);
Exchange Act Release No. 54125 (July 11, 2006), 71 FR 40766 (July
18, 2006) (SR-NYSE-2005-93); Exchange Act Release No. 52031 (July
14, 2005), 70 FR 42130 (July 21, 2005) (SR-NYSE-2002-19); Exchange
Act Release No. 52032 (July 14, 2005), 70 FR 42118 (July 21, 2005)
(SR-CBOE-2002-03); see also Exchange Act Release No. 58251 (July 30,
2008), 73 FR 46111 (Aug. 7, 2008) (SR-FINRA-2008-041); Exchange Act
Release No. 58243 (July 28, 2008), 73 FR 45505 (Aug. 5, 2008) (SR-
CBOE-2008-73); and Exchange Act Release No. 58261 (July 30, 2008),
73 FR 46116 (Aug. 7, 2008) (SR-NYSE-2008-66) (making portfolio
margin rules permanent).
\244\ See, e.g., FINRA Rule 4210(g) and CBOE Rule 12.4.
\245\ See Amendments to Financial Responsibility Rules, 72 FR at
12868-12870.
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Subsequent to the Commission's proposals, the Dodd-Frank Act
amended the definitions of customer, customer property, and net equity
in section 16 of SIPA to take into account futures and options on
futures held in a portfolio margin account carried as a securities
account pursuant to a Commission-approved portfolio margining
program.\246\ As a result, persons who hold futures positions in a
portfolio margining account carried as a securities account are now
entitled to SIPA protection.
---------------------------------------------------------------------------
\246\ See Public Law 111-203 Sec. 983.
---------------------------------------------------------------------------
While the Dodd-Frank Act addressed the protection under SIPA of
futures and futures options held in a securities portfolio margin
account, the Commission's proposed amendments to Rule 15c3-3 and 15c3-
3a will still serve an important purpose. In particular, they
complement the Dodd-Frank SIPA amendments, and will provide additional
protections to customers by requiring broker-dealers to treat these
futures positions in accordance with the segregation requirements in
Rules 15c3-3 and 15c3-3a. Consequently, the Commission is adopting the
amendments with modifications to address, in part, comments.
To accommodate securities and futures portfolio margining, the
Commission's proposals included several amendments. First, the
Commission proposed amending the definition of free credit balance in
paragraph (a)(8) of Rule 15c3-3 to provide that the term shall also
include such liabilities carried in a securities account pursuant to an
SRO portfolio margining rule approved by the Commission under section
19(b) of the Act (``SRO portfolio margining rule''), including daily
marks to market, and proceeds resulting from closing out futures
contracts and options thereon, and, in the event the broker-dealer is
the subject of a proceeding under SIPA, the market value as of the
filing date as that term is defined in SIPA (15 U.S.C. 78lll(7)) of any
long options on futures contracts.
In addition, the Commission proposed amendments to treat the
unrealized value of a futures option in a portfolio margin account on
the SIPA filing date \247\ as a free credit balance for purposes of
Rule 15c3-3. This amendment was designed to clarify that the market
value of such assets should be included in determining a customer's net
equity claim in a SIPA proceeding. Unlike futures contracts, futures
options do not generate cash balances on a daily basis in the account
(i.e., they have unrealized market value at the end of a trading day).
Since the broker-dealer is not holding cash for the customer, there is
no need to treat the futures options as a free credit balance for
purposes of the reserve formula. However, if the broker-dealer was
liquidated under SIPA, the unrealized gains or losses of the futures
options should be included in calculating the customer's net equity in
the account (along with the securities positions and all futures-
related and securities-related cash balances).\248\ The proposed
amendments were designed to provide for this outcome by defining the
market value of the futures options as a free credit balance as of the
filing date of a SIPA liquidation of the broker-dealer. As free credit
balances, funds originating from futures transactions (e.g., margin
deposits and daily marks to market) and the market value of futures
options as of the SIPA filing date would constitute claims for cash in
a SIPA proceeding and, therefore, become a part of a customer's net
equity claim entitling the customer to up to $250,000 in advances to
make up for shortfalls.
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\247\ The term filing date is defined in SIPA as, generally,
being the date a SIPA proceeding is commenced. See 15 U.S.C.
78lll(7).
\248\ See 15 U.S.C 78lll(11); see also Public Law 111-203 Sec.
983 (revising definition of net equity).
---------------------------------------------------------------------------
The Commission received six comments on the proposed
amendments.\249\ Three commenters generally supported the
amendments.\250\ One commenter stated that the amendments represent a
positive step forward in resolving certain regulatory obstacles in
connection with the inclusion of futures contracts in a portfolio
margin account.\251\ Another commenter stated that it supported the
Commission's efforts to facilitate the cross-margining of futures and
securities in the portfolio margin account by clarifying the treatment
of futures and options positions under SIPA.\252\ A commenter expressed
support for the development of rules for portfolio margining, and
supported the
[[Page 51845]]
Commission's effort to provide greater legal certainty regarding the
SIPA treatment of futures positions in a portfolio margin account.\253\
In a subsequent comment letter, however, this commenter stated that
this amendment is no longer necessary in light of the Dodd-Frank Act
amendments, and recommended the Commission withdraw it.\254\ Another
commenter stated that the Commission's proposal is premature in that
including futures in a portfolio margin account, which is a securities
account, would conflict with the segregation provisions under the CEA
\255\ and that SIPC has not determined that protection should be
extended to futures.\256\
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\249\ See SIFMA 2 Letter; CME Letter; SIPC Letter; Citigroup
Letter; American Bar Association Letter; SIFMA 4 Letter. The comment
letters received as a result of the original solicitation of comment
pre-date the Dodd-Frank Act. As such, these comment letters address
the proposed amendments prior to the enactment of the Dodd-Frank
SIPA amendments related to portfolio margining. The comment letters
received subsequent to the passage of the Dodd-Frank Act address the
SIPA amendments.
\250\ See SIFMA 2 Letter; Citigroup Letter; American Bar
Association Letter.
\251\ See Citigroup Letter.
\252\ See American Bar Association Letter.
\253\ See SIFMA 2 Letter.
\254\ See SIFMA 4 Letter.
\255\ See, e.g., 17 CFR 1.20-1.29.
\256\ See CME Letter. See also SIPC Letter (expressing ``grave
concerns'' about potential conflict between the proposed amendments
and SIPA).
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The Commission agrees, in part, with the commenter who stated that
the Dodd-Frank Act SIPA amendments make the Commission's proposed
amendments to Rules 15c3-3 and 15c3-3a unnecessary.\257\ As noted
above, the definitions of customer, customer property, and net equity
in section 16 of SIPA were amended by the Dodd-Frank Act to take into
account futures and options on futures held in a portfolio margin
account carried as a securities account pursuant to a Commission-
approved portfolio margining program.\258\ Consequently, in a
proceeding under SIPA, futures and options on futures positions held in
a portfolio margin account carried as a securities account would be
included in determining a customer's net equity claim.\259\ Therefore,
the proposed amendment relating to the unrealized value of a futures
option is not necessary to achieve the objective of providing SIPA
protection for such positions. As a result, the Commission is modifying
the final rule to delete the proposed language in paragraph (a)(8) of
Rule 15c3-3 that would have treated the unrealized value of a futures
option in a portfolio margin account on the filing date of a SIPA
proceeding as a free credit balance for purposes of Rule 15c3-3.\260\
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\257\ See SIFMA 4 Letter.
\258\ See Public Law 111-203 Sec. 983.
\259\ Under the Dodd-Frank Act SIPA amendments, a customer's net
equity now includes all positions in futures contracts and options
on futures contracts held in a portfolio margining account carried
as a securities account pursuant to a portfolio margining program
approved by the Commission, including all property collateralizing
such positions, to the extent that such property is not otherwise
included herein. See 15 U.S.C. 78lll(11)(A)(ii). Further, the
amendment provided that a claim for a commodity futures contract
received, acquired, or held in a portfolio margining account
pursuant to a portfolio margining program approved by the Commission
or a claim for a security futures contract, shall be deemed to be a
claim with respect to such contract as of the filing date, and such
claim shall be treated as a claim for cash. See 15 U.S.C. 78lll(11).
\260\ Specifically, the final rule does not include the proposed
language: ``, and, in the event the broker-dealer is the subject of
a proceeding under SIPA, the market value as of the ``filing date''
as that term is defined in SIPA (15 U.S.C. 78lll(7)) of any long
options on futures contracts.''
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As stated above, however, the remaining rule amendments to Rules
15c3-3 and 15c3-3a complement the amendments to SIPA and provide
additional protections to customers. Consequently, the Commission is
adopting them with some technical modifications in response to
suggestions offered by commenters.
One commenter suggested a change to paragraph (a)(8) of Rule 15c3-3
that would expand the definition of free credit balances to include
cash balances related to futures positions and the value of futures
options positions on the SIPA filing date.\261\ First, the commenter
noted that paragraph (a)(8) of Rule 15c3-3 concerns free credit
balances, which are funds subject to immediate payment (among other
limitations).\262\ The commenter expressed concern that the
Commission's proposal could have been construed as excluding cash
balances in a portfolio margin account that are not subject to
immediate payment. The Commission agrees that the proposal could have
been interpreted as requiring that futures-related cash balances be
treated differently depending on whether or not they are subject to
immediate payment.
---------------------------------------------------------------------------
\261\ See SIFMA 2 Letter.
\262\ Id.
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The amendments to Rule 15c3-3 are designed to provide the same
treatment to futures-related cash balances in a portfolio margin
account as applies to securities-related cash balances. As discussed
above, under Item 1 of Rule 15c3-3a, cash balances that do not meet the
definition of free credit balances (e.g., because they are not subject
to immediate payment) are included in the customer reserve formula if
they meet the definition of other credit balances under paragraph
(a)(9) of Rule 15c3-3.\263\
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\263\ Item 1 of Rule 15c3-3a requires a broker-dealer to include
in the customer reserve formula free credit balances and other
credit balances in customers' securities accounts. Paragraph (a)(9)
of Rule 15c3-3 defines other credit balances as ``cash liabilities
of a broker or dealer to customers other than free credit balances
and funds in commodities accounts segregated as aforesaid.'' 17 CFR
240.15c3-3(a)(9).
---------------------------------------------------------------------------
Consequently, to remove any ambiguity as to the effect of the rule
changes in response to the comments noted above, the Commission is
amending paragraph (a)(9) of Rule 15c3-3--which defines other credit
balances--to include futures-related cash balances other than free
credit balances. In addition, the Commission has deleted the phrase
``shall include such liabilities,'' in the amendment to proposed
paragraph (a)(8) and replaced it with ``includes, if subject to
immediate cash payment to customers on demand, funds . . .'' to clarify
that this paragraph relates to cash balances in a portfolio margin
account that are subject to immediate payment and, hence, that
paragraph (a)(9) relates to other cash balances in a portfolio margin
account.
One commenter suggested changes with respect to the marks to market
language in the rule, stating that the phrase relating to daily marks
to market be modified to read ``variation margin or initial margin
marks to market'' and the phrase in the proposal that read ``proceeds
resulting from closing out futures contracts and options thereon'' be
modified to read ``proceeds resulting from margin paid or released in
connection with closing out, settling or exercising futures contracts
and options thereon.'' \264\ The Commission agrees with these technical
suggestions because they clarify the rule by incorporating appropriate
futures terminology.
---------------------------------------------------------------------------
\264\ See SIFMA 2 Letter.
---------------------------------------------------------------------------
Consequently, as adopted, the text in paragraphs (a)(8) and (a)(9)
of Rule 15c3-3 expands the terms free credit balance and other credit
balances to include ``funds carried in a securities account pursuant to
a self-regulatory organization portfolio margin rule approved by the
Commission . . . including variation margin or initial margin, marks to
market, and proceeds resulting from margin paid or released in
connection with closing out, settling or exercising futures contracts
and options thereon.'' \265\ The amendments, as adopted, more precisely
capture the Commission's intent in terms of identifying the types of
futures-related cash balances that may be held in a portfolio margin
account than the language in the proposed rule.
---------------------------------------------------------------------------
\265\ See also section II.A.6. of this release.
---------------------------------------------------------------------------
On the debit side of the customer reserve formula, the Commission
is adopting, substantially as proposed, an amendment to Rule 15c3-3a
Item 14 that permits a broker-dealer to include as a debit item the
amount of customer margin required and on deposit at a derivatives
clearing organization related to futures positions carried in a
portfolio
[[Page 51846]]
margin account.\266\ Under SIPA, the term customer property includes,
``resources provided through the use or realization of customers' debit
cash balances and other customer-related debit items as defined by the
Commission by rule,'' as well as, ``in the case of a portfolio
margining account of a customer that is carried as a securities account
pursuant to a portfolio margining program approved by the Commission, a
futures contract or an option on a futures contract received, acquired,
or held by or for the account of a debtor from or for such portfolio
margining account, and the proceeds thereof.'' \267\ Under this
provision of SIPA, this amendment to Rule 15c3-3 makes the margin
required and on deposit at a derivatives clearing organization part of
the ``customer property'' in the event the broker-dealer is placed in a
SIPA liquidation. Thus, it would be available for distribution to the
failed firm's customers.
---------------------------------------------------------------------------
\266\ The Commission also is amending Item 14 of Rule 15c3-3a to
replace the phrase ``Security futures products'' with the phrase
``security futures products.'' In addition, the Commission adopting
some non-substantive amendments to Note G to Item 14, including: (1)
In paragraph (a) replacing the word ``shall'' with the word
``must''; (2) in paragraph (b) replacing the word ``shall'' with the
word ``will''; in the second line in paragraph (b)(2) inserting the
phrase ``futures in a'' before the phrase ``portfolio margin
account'' and deleting the word ``margin''; (3) in paragraph (b)(2)
replacing the word ``shall'' with the word ``will'' in three places;
(4) in the sixth and seventh lines of paragraph (b)(2), inserting
the phrase ``futures in a'' before the phrase ``portfolio margin
account'' and deleting the phrase ``futures margin''; in paragraph
(b)(3)(iv) replacing the word ``securities'' with the word
``security'', inserting the phrase ``futures in a'' before the
phrase ``portfolio margin account'' and deleting the word
``futures''; and (4) in paragraph (c), replacing the word ``shall''
with the word ``will'', inserting the phrase ``futures in a'' before
the phrase ``portfolio margin account'' and deleting the word
``futures.''
\267\ 15 U.S.C. 78lll(4)(B) and (D); see also Dodd-Frank Act
Section 983.
---------------------------------------------------------------------------
Finally, one commenter suggested changes to Commission rules beyond
those in the proposing release. This commenter urged the Commission to
consider amending Rules 8c-1, 15c2-1, and 15c3-3 to provide that their
provisions could be waived by customers that are entitled to engage in
derivative transactions in a portfolio margin account, provided the
customer agrees in writing to waive SIPA protection.\268\ According to
the commenter, a customer executing such a waiver would not be entitled
to the protections under SIPA for customers and would be deemed a
general creditor of the broker-dealer with respect to claims arising
from their portfolio margin accounts. At this time, the Commission does
not believe it would be appropriate to amend the rules as recommended
by the commenter because such changes are beyond the scope of this
rulemaking.
---------------------------------------------------------------------------
\268\ See American Bar Association Letter.
---------------------------------------------------------------------------
C. Amendments With Respect to Securities Lending and Borrowing and
Repurchase/Reverse Repurchase Transactions
In the proposing release, the Commission noted two concerns about
stock lending that arose from the failure of the registered broker-
dealer MJK Clearing, Inc. (``MJK''); \269\ namely: (1) That broker-
dealers with principal liability in a stock loan transaction may
purport to be acting in an agency capacity and, consequently, not
taking appropriate capital charges; and (2) that broker-dealers that
historically have not been active in stock loan activities may rapidly
expand their balance sheets with such transactions and, thereby,
increase leverage to a level that poses significant financial risk to
the firm and its counterparties. In response, the Commission proposed,
and is now adopting, amendments to Rules 15c3-1 and 17a-11.
---------------------------------------------------------------------------
\269\ See Amendments to Financial Responsibility Rules, 72 FR at
12869. The failure of MJK raised several concerns regarding
securities lending transactions. As explained in more detail in the
proposing release, at the time of its failure, MJK owed cash
collateral to several borrowing broker-dealers. Id. at 12862, 12869-
12870. These broker-dealers suffered losses caused by MJK's failures
and, in later proceedings related to these losses, questions arose
as to whether these broker-dealers were acting as principal or
agent.
---------------------------------------------------------------------------
With respect to the Rule 15c3-1 proposal, the Commission is
adopting the amendment, as proposed. This amendment to subparagraph
(c)(2)(iv)(B) of Rule 15c3-1 clarifies that broker-dealers providing
securities lending and borrowing settlement services are deemed, for
purposes of the rule, to be acting as principal and are subject to
applicable capital deductions.\270\ Under the amendment, these
deductions can be avoided if a broker-dealer takes certain steps to
disclaim principal liability. In particular, the final rule provides
that ``a broker or dealer that participates in a loan of securities by
one party to another party will be deemed a principal for the purpose
of the deductions required under this section, [i.e., deductions from
net worth] unless the broker or dealer has fully disclosed the identity
of each party to the other and each party has expressly agreed in
writing that the obligations of the broker or dealer do not include a
guarantee of performance by the other party and that such party's
remedies in the event of a default by the other party do not include a
right of setoff against obligations, if any, of the broker or dealer.''
\271\
---------------------------------------------------------------------------
\270\ A broker-dealer is required to deduct from net worth most
unsecured receivables, including the amount that the market value of
a securities loan exceeds the value of collateral obtained for the
loan. See 17 CFR 240.15c3-1(c)(2)(iv)(B). Similarly, with respect to
repo transactions, a broker-dealer obligated to resell securities
must, in computing net capital, deduct the amount that the market
value of the securities is less than the resale price. See 17 CFR
240.15c3-1(c)(2)(iv)(F). A broker-dealer obligated to repurchase
securities must, in computing net capital, deduct the amount that
the market value of the securities is greater than the repurchase
price to the extent the excess is greater than certain percentages.
See 17 CFR 240.15c3-1(c)(2)(iv)(F).
\271\ See paragraph (c)(2)(iv)(B) of Rule 15c3-1, as adopted.
Standard master securities loan agreements (including the annexes
thereto) commonly used by the parties to a securities lending
transaction contain provisions for establishing agent (as opposed to
principal) status in a securities lending and borrowing transaction
that are consistent with the requirements in paragraph (c)(2)(iv)(B)
of Rule 15c3-1, as amended. See, e.g., 2000 Master Securities Loan
Agreement, Annex I, published by SIFMA, available at www.sifma.org.
---------------------------------------------------------------------------
The Commission received five comments on the proposed
amendment.\272\ Two commenters objected to this amendment, stating that
they believed the standard legal documents used in securities lending
transactions provide sufficient legal certainty on the status of the
parties.\273\ The Commission, in recognition of standard stock loan
agreement templates, designed the amendment to accommodate the
continued use of these industry model agreements by incorporating their
use into the rule's requirements. For the purposes of establishing a
broker-dealer's status as agent or lender, these agreements may be
sufficiently detailed to satisfy the new requirements. However, it
would be the broker-dealer's responsibility to ensure that any
``standard'' agreement contains the necessary provisions to comply with
this amendment, and that such provisions are not weakened by any other
language in the agreement or any subsequent amendment. The goal is to
avoid ambiguity about a broker-dealer's status as agent or principal
regarding the applicability of the stock loan charges in the net
capital rule. As the failure of MJK illustrated, disputes can arise
over whether a broker-dealer is acting as a principal or agent in a
stock loan transaction.\274\ Under the formulation of the rule, a
broker-dealer is presumed to be acting in a principal capacity unless
it can demonstrate through its agreements with the other participants
in the transaction that it is acting as agent. In this regard, a
broker-
[[Page 51847]]
dealer will be responsible for determining that its agreements are
fully consistent with the standards of the rule.
---------------------------------------------------------------------------
\272\ See Abbey National Letter; Dresdner Kleinwort Letter;
SIFMA 2 Letter; Citigroup Letter; Cornell Letter.
\273\ See SIFMA 2 Letter; Citigroup Letter.
\274\ See, e.g., Nomura v. E*Trade, 280 F.Supp.2d 184 (S.D.N.Y.
2003).
---------------------------------------------------------------------------
One commenter asked for clarification on the timing of when the
agent lender must disclose the principal parties to one another in
order to disclaim principal liability under the rule.\275\ This
commenter stated that the amendment should be modified so as not to
require pre-trade disclosure of the identity of the principal, since
under the agency annex to standardized master lending agreements such
disclosure can be made on the next business day.\276\ The amendment is
intended to accommodate the continued use of these industry model
agreements by incorporating their use into the rule's requirements.
Consequently, disclosure of principals in conformance with the
requirements of the ``standard'' stock loan agreement templates would
be consistent with the requirements of the rule (as long as the
identity of the borrower and the lender is disclosed within one
business day after the trade date), which is designed to ensure that
firms are taking the required net capital charges related to the
securities lending activity to the extent they have principal
liability.
---------------------------------------------------------------------------
\275\ See SIFMA 2 Letter.
\276\ See, e.g., www.sifma.org for sample Master Securities Loan
Agreements (and annex).
---------------------------------------------------------------------------
The Commission also is adding new paragraph (c)(5) to Rule 17a-11
to help identify broker-dealers with highly leveraged non-government
securities lending and borrowing and repurchase operations.\277\ This
new provision requires a broker-dealer to notify the Commission
whenever the total amount of money payable against all securities
loaned or subject to a repurchase agreement, or the total contract
value of all securities borrowed or subject to a reverse repurchase
agreement, exceeds 2,500 percent of tentative net capital; provided
that, for purposes of this leverage threshold, transactions involving
government securities as defined in section 3(a)(42) of the Exchange
Act, are excluded from the calculation.\278\ The amendment is designed
to alert regulators to a sudden increase in a broker-dealer's stock
loan and repo positions, which could indicate that the broker-dealer is
taking on new risk that it may have limited experience in managing.
---------------------------------------------------------------------------
\277\ See paragraph (c)(5) of Rule 17a-11, as adopted.
\278\ 15 U.S.C. 78c(a)(42). ``Government securities'' generally
present less market risk than other types of securities used in
securities lending and repo transactions. Consequently, they are
excluded from the scope of the rule.
---------------------------------------------------------------------------
One commenter supported the proposed amendment and believes the
notification could serve as ``an early warning'' that a firm is
approaching insolvency and generally supports the Commission's efforts
to protect customers from broker-dealers who recklessly rely on
excessively leveraged transactions.\279\
---------------------------------------------------------------------------
\279\ See Cornell Letter.
---------------------------------------------------------------------------
In the proposing release, the Commission estimated that a leverage
threshold of 25 times tentative net capital would be triggered by 21
broker-dealers on a regular basis.\280\ The Commission stated that this
establishes a threshold high enough to only capture on a regular basis
those few firms highly active in securities lending and repo
transactions. The Commission did not receive any comments regarding the
2,500% tentative net capital threshold in the proposing release. Based
on FOCUS Report data, as of December 31, 2011, there were six broker-
dealers whose securities loaned and securities borrowed transactions
exceeded 25 times their tentative net capital. The Commission continues
to believe that the 2,500% threshold is an appropriate notice trigger
for a firm that historically has not been as active in these
transactions but rapidly leverages up its securities lending and repo
positions. Given the updated estimates of how many broker-dealers would
trigger this threshold, the Commission believes the proposed threshold
is high enough to capture on a regular basis only those few firms
highly active in securities lending and repo transactions. Therefore,
the Commission is retaining this 2,500% threshold in the final rule
without revision.
---------------------------------------------------------------------------
\280\ See Amendments to Financial Responsibility Rules, 72 FR at
12870 (providing rationale for 2,500% threshold).
---------------------------------------------------------------------------
As proposed, the amendment to Rule 17a-11 also would have provided
that a broker-dealer that submitted a monthly report of its stock loan
and repo activity to its DEA need not file the notices. This provision
was designed to accommodate large broker-dealers that are active in
this business and regularly maintain stock loan and repo balances that
exceed the threshold. The Commission expects that these broker-dealers
have experience in managing the risks specific to these types of
transactions and have established controls to address those risks.
Consequently, a notice under paragraph (c)(5) from these broker-dealers
might not be as useful in providing risk assessment information to
regulators. Instead, the monthly reports will provide the Commission
and other financial regulators with information with which to develop
trend analysis, when deemed appropriate. They could use this analysis
to identify leverage levels that are outside the normal trend range,
and which may be indicative of a material change in the firm's business
model that could indicate it was taking on higher levels of leverage,
branching into new products, or experiencing operational or financial
difficulties (e.g., the firm could be reducing leverage rapidly because
creditors were not willing to enter into new transactions).
Three commenters addressed the proposed monthly notification
requirement.\281\ They stated that the monthly report in lieu of the
notification should be provided as part of the monthly FOCUS report
many broker-dealers file with their DEA.\282\ The Commission agrees
that the FOCUS report may be an appropriate mechanism for reporting
stock loan and repo positions in lieu of the proposed monthly
notification requirement.\283\ Consequently, the Commission has
modified the final rule to delete the phrase ``submits a monthly report
of'' and replace it with ``reports monthly.'' \284\ In addition, as
adopted, in order to provide that the monthly report be sent to a
broker-dealer's DEA, the Commission added the phrase ``to its
designated examining authority in a form acceptable'' before ``to its
designated examining authority.'' \285\ This language, as adopted, will
provide each DEA with the flexibility to prescribe how the monthly
reports are to be made and will accommodate a DEA that opts to use the
FOCUS report as the reporting mechanism.\286\ In summary, as adopted,
the notice exemption in paragraph (c)(5) will state ``provided further,
however, that a broker or dealer will not be required to send the
notice required by this paragraph (c)(5) if it reports monthly its
securities lending and borrowing and repurchase and reverse repurchase
activity (including the total amount of money payable against
securities loaned or subject to a repurchase agreement and the total
contract value of securities borrowed or subject to a reverse
repurchase agreement) to its designated
[[Page 51848]]
examining authority in a form acceptable to its designated examining
authority.'' \287\
---------------------------------------------------------------------------
\281\ See Abbey National Letter; Citigroup Letter; SIFMA 2
Letter; SIFMA 4 Letter.
\282\ See Abbey National Letter; Citigroup Letter; SIFMA 2
Letter.
\283\ Carrying broker-dealers generally are required to submit
FOCUS reports on a monthly basis.
\284\ See paragraph (c)(5) of Rule 17a-11, as adopted.
\285\ Id.
\286\ See also SIFMA 4 Letter.
\287\ See paragraph (c)(5) of Rule 17a-11, as adopted. The
Commission also inserted the text ``(c)(5)'' in the final rule
before the phrase ``if it reports monthly'' to make the paragraph
reference more explicit.
---------------------------------------------------------------------------
A commenter asked the Commission to clarify that the new reporting
provision of paragraph (c)(5) of Rule 17a-11 is triggered only by
principal activity meeting or exceeding stated thresholds.\288\ The
notification provision applies when a broker-dealer is acting as
principal and exceeds the stated thresholds, and a broker-dealer will
not need to include transactions for which it does not have principal
liability in determining whether the notification threshold has been
triggered.
---------------------------------------------------------------------------
\288\ See Dresdner Kleinwort Letter.
---------------------------------------------------------------------------
D. Documentation of Risk Management Procedures
It is important for broker-dealers to document the controls they
establish for managing the material risk exposures that arise from
their business activities. For example, a broker-dealer active in
securities lending is exposed to a variety of risks, including market
risk,\289\ credit risk,\290\ and liquidity risk.\291\ Other broker-
dealer activities give rise to these risks as well, including managing
a repo book, dealing in OTC derivatives, trading proprietary positions,
and lending on margin. A well-documented system of internal controls
designed to manage material risk exposures reflects the determination
of a firm's management as to how its business activities should be
conducted in light of such exposures. It also enables management to
better identify, analyze, and manage the risks inherent in the firm's
business activities with a view to preventing material losses and to
review whether the firm's activities are being conducted in a manner
that is consistent with such procedures and controls as well as in
accordance with the Federal securities laws. Risk management controls
are particularly important for the largest broker-dealers, which
generally engage in a wide range of highly complex activities across
many different markets and geographical locations.
---------------------------------------------------------------------------
\289\ Generally, market risk is the risk that prices, values, or
rates will adversely change.
\290\ Generally, credit risk is the risk of loss resulting from
a counterparty or other type of obligor failing to meet an
obligation, including an obligation with respect to a loan,
security, swap, option, or settlement.
\291\ Generally, funding liquidity risk is the risk that a firm
will not be able to meet cash demands as they become due and asset
liquidity risk is the risk that an asset will not be able to be sold
quickly at its market value.
---------------------------------------------------------------------------
While most broker-dealers already have well-documented procedures
and controls for managing risks as a matter of business practice, it is
important to reinforce the practice and make it easier for regulators
to understand a broker-dealer's procedures and controls so that they
can review whether the broker-dealer is adhering to them. Consequently,
the Commission proposed an amendment to Rule 17a-3 that would have
required a broker-dealer to create a record documenting its ``internal
risk management controls.'' \292\
---------------------------------------------------------------------------
\292\ See Amendments to Financial Responsibility Rules, 72 FR at
12899.
---------------------------------------------------------------------------
Commenters raised concerns that the proposed amendment would be
``overly broad and ambiguous'' \293\ and ``so broad as to create
uncertainty.'' \294\ Three commenters argued that the requirement, if
adopted, should be limited to market, credit, and liquidity risk
management.\295\ Another commenter recommended that the Commission
propose the minimum elements required to be documented, such as market
risk, credit risk, liquidity risk, and operational risk.\296\ While
market, credit, and liquidity risk were among the specific examples of
risk identified in the proposed rule,\297\ the Commission agrees that
the phrase ``risk controls'' could be interpreted very broadly. To
address this concern, the Commission has modified the final rule to
clarify its application. The final rule requires the documentation of
controls established specifically to manage market, credit, and
liquidity risk, ``which have more commonly understood meanings within
the industry.'' \298\ This also focuses the rule on the key risks
inherent in conducting a securities business.
---------------------------------------------------------------------------
\293\ See E*Trade Letter.
\294\ See Citigroup Letter.
\295\ See E*Trade Letter; SIFMA 2 Letter; Citigroup Letter.
\296\ See Barnard Letter.
\297\ See Amendments to Financial Responsibility Rules, 72 FR at
12870.
\298\ E*Trade Letter. The final rule also deletes the term
``internal'' because it would be redundant.
---------------------------------------------------------------------------
Commenters also requested that the Commission clarify that, when a
broker-dealer is part of a corporate family, risk management controls
could be applicable to multiple entities within the corporate family,
including the broker-dealer.\299\ In response, the final rule does not
specify the type of controls a broker-dealer must establish to manage
these risks. It simply requires the documentation of the procedures the
broker-dealer has established. Broker-dealers that are part of holding
companies may be subject to procedures that are used globally
throughout the organization. As long as the broker-dealer maintains
documented procedures of controls pertaining to the designated entity,
the requirements of the rule would be met.
---------------------------------------------------------------------------
\299\ See E*Trade Letter; SIFMA 2 Letter; Citigroup Letter.
---------------------------------------------------------------------------
Other commenters requested that the Commission clarify that the
risk management controls do not have to include any minimum elements
\300\ and that the rule does not impose any qualitative
requirements.\301\ Two commenters suggested that because there were no
stated content requirements for the risk management controls, it would
be difficult for a firm to prove that their risk management procedures
were adequate, which could lead to a ``subjective process'' \302\ or to
examiners applying a ``one size fits all'' best practices
standard.\303\ One commenter suggested that to address this issue, the
Commission should articulate the process that examiners will follow
when examining risk management controls.\304\ Finally, one commenter
encouraged the Commission to consider strengthening this requirement in
terms of both its scope and applicability.\305\
---------------------------------------------------------------------------
\300\ See SIFMA 2 Letter.
\301\ See Citigroup Letter.
\302\ See Coastal Securities Letter.
\303\ See American Bar Association Letter.
\304\ Id.
\305\ See Cornell Letter.
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The Commission is not mandating any specific controls, procedures,
or policies that must be established by a broker-dealer to manage
market, credit, or liquidity risk, nor is it requiring any minimum
elements or specifying any procedures that would be required to be
included in a firm's market, credit, and liquidity risk management
policies. Rather, the Commission is requiring that a control,
procedure, or policy be documented if it is in place. Based on staff
experience monitoring large broker-dealers, the Commission anticipates
that most brokers-dealers that will be subject to this rule already
have documented controls, procedures, and policies as part of their
overall risk management processes. The purpose of this amendment is not
to change the controls, procedures, and policies that are in place, but
to require that they be adequately documented.
For the foregoing reasons, paragraph (a)(23) to Rule 17a-3, as
adopted, requires certain broker-dealers to make and keep current a
record documenting the credit, market, and liquidity risk
[[Page 51849]]
management controls established and maintained by the broker-dealer to
assist it in analyzing and managing the risks associated with its
business activities.\306\ This documentation requirement applies only
to broker-dealers that have more than (1) $1,000,000 in aggregate
credit items as computed under the customer reserve formula of Rule
15c3-3, or (2) $20,000,000 in capital, including debt subordinated in
accordance with Appendix D to Rule 15c3-1.\307\
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\306\ See paragraph (a)(23) of Rule 17a-3, as adopted.
\307\ The Commission also has modified paragraph (a)(23) of Rule
17a-3 from the proposed rule to delete the reference to the term
``member'' in two places in the final rule because the reference to
``member'' is unnecessary. Id.
---------------------------------------------------------------------------
The Commission also proposed adding paragraph (e)(9) to Rule 17a-4
to require a broker-dealer to retain the documented risk management
controls or procedures until three years after the broker-dealer
terminates the use of the system of controls or procedures documented
therein. One commenter stated that given the minimal cost of electronic
storage, the commenter believes that the retention period could be
extended beyond three years.\308\ Conversely, two commenters suggested
that Rule 17a-4 be revised so that a broker-dealer would not be
required to maintain outdated versions of its risk management
controls.\309\
---------------------------------------------------------------------------
\308\ Id.
\309\ See E*Trade Letter; SIFMA 2 Letter.
---------------------------------------------------------------------------
The Commission is adding paragraph (e)(9) to Rule 17a-4, with a
minor modification from the proposed amendment. Specifically, the final
rule is modified to require retention of the records until three years
after termination of the use of the risk management controls documented
therein by replacing the phrase ``systems of controls or procedures''
with the phrase ``risk management controls.'' \310\ This modification
maintains consistency with the terminology in paragraph (a)(23) of Rule
17a-3, as adopted, which requires broker-dealers to make and keep
current a ``record documenting the credit, market, and liquidity risk
management controls established and maintained by the broker or
dealer.'' \311\ Finally, the three year retention period is designed to
establish an audit trail between the risk management controls that have
most recently been made inoperative and the risk management controls
currently in effect to provide sufficient opportunity to review the
former during the broker-dealer's exam cycle. Three years also is
consistent with the retention period for many of the records required
to be preserved under Rule 17a-4.\312\
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\310\ See paragraph (e)(9) of Rule 17a-4, as adopted. The
Commission also modified the final rule to delete the phrase
``paragraph (a)(23) of'' and insert ``(a)(23)'' immediately
following ``17a-3'' to make the referenced citation consistent with
other parts of the rule.
\311\ See paragraph (a)(23) of Rule 17a-3, as adopted.
\312\ See 17 CFR 240.17a-4(b).
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Finally, one commenter noted that the proposed amendment does not
impose any requirements beyond those applicable under Rule 15c3-4.\313\
Accordingly, the commenter urged the Commission to create an exception
from the proposed amendment to Rule 17a-3 for a broker-dealer that is
effectively subject to Rule 15c3-4. With the modifications to the final
rule to include only market, credit, and liquidity risk, a broker-
dealer subject to the conditions of Rule 15c3-4 would already comply
with this amendment given that these risks are included in the risks a
broker-dealer would be required to address under Rule 15c3-4.
Therefore, an exception from the rule is unnecessary.
---------------------------------------------------------------------------
\313\ See SIFMA 2 Letter. See also 17 CFR 240.15c3-4.
---------------------------------------------------------------------------
E. Amendments to the Net Capital Rule
Under Rule 15c3-1, broker-dealers are required to maintain, at all
times, a minimum amount of net capital.\314\ The capital standard in
Rule 15c3-1 is a net liquid assets test. This standard is designed to
allow a broker-dealer the flexibility to engage in activities that are
part of conducting a securities business (e.g., taking securities into
inventory) but in a manner that places the firm in the position of
holding at all times more than one dollar of highly liquid assets for
each dollar of unsubordinated liabilities (e.g., money owed to
customers, counterparties, and creditors).\315\ For example, Rule 15c3-
1 allows securities positions to count as allowable net capital,
subject to standardized or model-based deductions (``haircuts'').\316\
The rule, however, does not permit most unsecured receivables to count
as allowable net capital.\317\ This aspect of the rule severely limits
the ability of broker-dealers to engage in activities that generate
unsecured receivables (e.g., lending money without obtaining
collateral). The rule also does not permit fixed assets or other
illiquid assets to count as allowable net capital, which creates
disincentives for broker-dealers to own real estate and other fixed
assets that cannot be readily converted into cash.\318\ For these
reasons, Rule 15c3-1 incentivizes broker-dealers to confine their
business activities and devote capital to activities such as
underwriting, market making, and advising on and facilitating customer
securities transactions.\319\
---------------------------------------------------------------------------
\314\ See 17 CFR 240.15c3-1.
\315\ See, e.g., Interpretation Guide to Net Capital Computation
for Brokers and Dealers, Exchange Act Release No. 8024 (Jan. 18,
1967), 32 FR 856 (Jan. 25, 1967) (``Rule 15c3-1 (17 CFR 240.15c3-1)
was adopted to provide safeguards for public investors by setting
standards of financial responsibility to be met by brokers and
dealers. The basic concept of the rule is liquidity; its object
being to require a broker-dealer to have at all times sufficient
liquid assets to cover his current indebtedness.'') (Footnotes
omitted); Net Capital Treatment of Securities Positions, Obligations
and Transactions in Suspended Securities, Exchange Act Release No.
10209 (June 8, 1973), 38 FR 16774 (June 26, 1973) (Commission
release of a letter from the Division of Market Regulation) (``The
purpose of the net capital rule is to require a broker or dealer to
have at all times sufficient liquid assets to cover its current
indebtedness. The need for liquidity has long been recognized as
vital to the public interest and for the protection of investors and
is predicated on the belief that accounts are not opened and
maintained with broker-dealers in anticipation of relying upon suit,
judgment and execution to collect claims but rather on a reasonable
demand one can liquidate his cash or securities positions.''); Net
Capital Requirements for Brokers and Dealers, Exchange Act Release
No. 15426 (Dec. 21, 1978), 44 FR 1754 (Jan. 8, 1979) (``The rule
requires brokers or dealers to have sufficient cash or liquid assets
to protect the cash or securities positions carried in their
customers' accounts. The thrust of the rule is to insure that a
broker or dealer has sufficient liquid assets to cover current
indebtedness.''); Net Capital Requirements for Brokers and Dealers,
Exchange Act Release No. 26402 (Dec. 28, 1989), 54 FR 315 (Jan. 5,
1989) (``The rule's design is that broker-dealers maintain liquid
assets in sufficient amounts to enable them to satisfy promptly
their liabilities. The rule accomplishes this by requiring broker-
dealers to maintain liquid assets in excess of their liabilities to
protect against potential market and credit risks.'') (Footnote
omitted).
\316\ See 17 CFR 240.15c3-1(c)(2)(vi); 17 CFR 240.15c3-1e; 17
CFR 240.15c3-1f .
\317\ See 17 CFR 240.15c3-1(c)(2)(iv).
\318\ See, e.g., 17 CFR 240.15c3-1(c)(2)(iv)(A).
\319\ See Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for Broker-Dealers, Exchange
Act Release No. 68071 (Oct. 18, 2012), 77 FR 70214, 70219 (Nov. 23,
2012).
---------------------------------------------------------------------------
Rule 15c3-1 requires broker-dealers to maintain a minimum level of
net capital (meaning highly liquid capital) at all times.\320\ The rule
requires that a broker-dealer perform two calculations: (1) A
computation of the minimum amount of net capital the broker-dealer must
maintain; \321\ and (2) a computation of the amount of net capital the
broker-dealer is maintaining.\322\ The minimum net capital requirement
is the greater of a fixed-dollar amount specified in the rule and an
amount determined by applying one of two financial ratios: The 15-to-1
aggregate indebtedness to net
[[Page 51850]]
capital ratio or the 2% of aggregate debit items ratio.\323\
---------------------------------------------------------------------------
\320\ See 17 CFR 240.15c3-1.
\321\ See 17 CFR 240.15c3-1(a).
\322\ See 17 CFR 240.15c3-1(c)(2). The computation of net
capital is based on the definition of net capital in paragraph
(c)(2) of Rule 15c3-1. Id.
\323\ See 17 CFR 240.15c3-1(a).
---------------------------------------------------------------------------
In computing net capital, the broker-dealer must, among other
things, make certain adjustments to net worth such as deducting
illiquid assets, taking other capital charges, and adding qualifying
subordinated loans.\324\ The amount remaining after these adjustments
is defined as tentative net capital.\325\ The final step in computing
net capital is to take prescribed percentage deductions (``standardized
haircuts'') from the mark-to-market value of the proprietary positions
(e.g., securities, money market instruments, and commodities) that are
included in its tentative net capital.\326\ The standardized haircuts
are designed to account for the market risk inherent in these positions
and to create a buffer of liquidity to protect against other risks
associated with the securities business.\327\ Alternative Net Capital
or ``ANC'' broker-dealers and a type of limited purpose broker-dealer
that deals solely in OTC derivatives (``OTC derivative dealers'') are
permitted, with Commission approval, to, among other things, use
internal models as the basis for taking market risk charges as an
alternative approach in lieu of the standardized haircuts for classes
of positions for which they have been approved to use models.\328\ Rule
15c3-1 imposes substantially higher minimum capital requirements for
ANC broker-dealers and OTC derivatives dealers, as compared to other
types of broker-dealers, because, among other reasons, the use of
internal models to compute net capital can substantially reduce the
deductions for securities and money market positions as compared with
the standardized haircuts.\329\
---------------------------------------------------------------------------
\324\ See 17 CFR 240.15c3-1(c)(2)(i)-(xiii).
\325\ See 17 CFR 240.15c3-1(c)(15).
\326\ See 17 CFR 240.15c3-1(c)(2)(vi).
\327\ See, e.g., Uniform Net Capital Rule, Exchange Act Release
No. 13635 (June 16, 1977), 42 FR 31778 (June 23, 1977) (``[Haircuts]
are intended to enable net capital computations to reflect the
market risk inherent in the positioning of the particular types of
securities enumerated in [the rule]''); Net Capital Rule, Exchange
Act Release No. 22532 (Oct. 15, 1985), 50 FR 42961 (Oct. 23, 1985)
(``These percentage deductions, or `haircuts', take into account
elements of market and credit risk that the broker-dealer is exposed
to when holding a particular position.''); Net Capital Rule,
Exchange Act Release No. 39455 (Dec. 17, 1997), 62 FR 67996 (Dec.
30, 1997) (``Reducing the value of securities owned by broker-
dealers for net capital purposes provides a capital cushion against
adverse market movements and other risks faced by the firms,
including liquidity and operational risks.'') (Footnote omitted).
\328\ See 17 CFR 240.15c3-1(a)(5) and (a)(7); 17 CFR 240.15c3-
1e; 17 CFR 240.15c3-1f.
\329\ See 17 CFR 240.15c3-1(a)(5) and (a)(7). See also Capital,
Margin, and Segregation Requirements for Security-Based Swap Dealers
and Major Security-Based Swap Participants and Capital Requirements
for Broker-Dealers, Exchange Act Release No. 68071, 77 FR at 70219
(``[T]he use of internal models to compute net capital can
substantially reduce the deductions for securities and money market
positions as compared with the standardized haircuts.'');
Alternative Net Capital Requirements for Broker-Dealers that are
Part of Consolidated Supervised Entities, Exchange Act Release No.
49830 (June 8, 2004), 69 FR 34428, 34431 (June 21, 2004) (``We
expect that use of the alternative net capital computation will
reduce deductions for market and credit risk substantially for
broker-dealers that use that method.'').
---------------------------------------------------------------------------
1. Requirement To Deduct From Net Worth Certain Liabilities or Expenses
Assumed by Third Parties
In the proposing release, the Commission expressed concern that
some broker-dealers may be excluding from their calculations of net
worth certain liabilities that relate directly to expenses or debts
incurred by the broker-dealer.\330\ The accounting justification for
the exclusion is that a third party (usually a parent or affiliate) has
assumed responsibility for these expenses and debts through an expense
sharing agreement.\331\ In some cases, however, the third party does
not have the resources --independent of the broker-dealer's revenues
and assets--to assume these liabilities. Thus, the third party is
dependent on the resources of the broker-dealer to pay the expenses and
debts. Excluding liabilities from the broker-dealer's net worth
calculation in these situations may misrepresent the firm's actual
financial condition, deceive the firm's customers, and hamper the
ability of regulators to monitor the firm's financial condition.\332\
---------------------------------------------------------------------------
\330\ See Amendments to Financial Responsibility Rules, 72 FR at
12871.
\331\ See, e.g., Letter from Michael A. Macchiaroli, Associate
Director, Division of Market Regulation, Commission, to Elaine
Michitsch, Member Firm Operations, NYSE, and Susan DeMando,
Director, Financial Operations, NASD Regulation, Inc. (July 11,
2003) (``Third Party Expense Letter''); see also FINRA Notice to
Members 03-63, Expense-Sharing Agreements (Oct. 2003) (discussing
the issuance of the Third Party Expense Letter).
\332\ See Amendments to Financial Responsibility Rules, 72 FR at
12871.
---------------------------------------------------------------------------
To address this issue, the Commission proposed--and is now adopting
substantially as proposed--an amendment to Rule 15c3-1 to add a new
paragraph (c)(2)(i)(F) that will require a broker-dealer, in
calculating net capital, to take into account any liabilities that are
assumed by a third party if the broker-dealer cannot demonstrate that
the third party has the resources--independent of the broker-dealer's
income and assets--to pay the liabilities.\333\
---------------------------------------------------------------------------
\333\ As adopted, the final rule does not include the ``-'' in
the phrase ``third-party.'' In addition, the final rule uses the
phrase ``broker or dealer'' in the place of the phrase ``broker-
dealer'' (which appeared in two places) to maintain consistency
throughout Rule 15c3-1, which uses the phrase ``broker or dealer.''
---------------------------------------------------------------------------
The Commission received five comments regarding this proposal.\334\
Two commenters stated that the amendment was overly burdensome and that
it would not result in a more accurate picture of a broker-dealer's
financial condition than obtained through current requirements.\335\
One of these commenters added that any implementation and enforcement
of the amendments ``should not be made retroactive.''\336\ This
commenter stated that it is unclear how, and unlikely that, this
amendment would achieve any of the desired results and argued that it
could conversely impair a firm's ability to continue as a going
concern.\337\ Finally, this commenter also argued that this amendment
would affect capital transactions that originate at the holding company
level.\338\ Two commenters agreed in principle with the amendments but
urged the Commission to carefully consider the potential consequences
of implementation and to provide clarification on the standard for
demonstrating that the third party has adequate financial resources,
including factors beyond those referred to in the proposing release
that they believed would be potentially relevant.\339\ One commenter
supported the Commission's goal of clarifying disclosures relating to
expense sharing or obligations.\340\
---------------------------------------------------------------------------
\334\ See Beer Letter; Levene Letter; Lowenstein Letter; SIFMA 2
Letter; NIBA 2 Letter.
\335\ See Beer Letter; Levene Letter.
\336\ See Levene Letter.
\337\ Id.
\338\ Id.
\339\ See Lowenstein Letter; SIFMA 2 Letter.
\340\ See NIBA 2 Letter.
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As with the proposal, the amendment, as adopted, is designed to
prohibit a practice that could misrepresent a broker-dealer's actual
financial condition, deceive the firm's customers, and hamper the
ability of regulators to monitor the firm's financial condition.
Moreover, the amendment, as adopted, should not impose undue burdens or
present serious implementation difficulties because the requirement is
consistent with prior staff guidance regarding the treatment of broker-
dealer expenses assumed by a third party.\341\ Finally, as compared to
staff guidance, a federal regulation offers broker-dealers greater
certainty as to how to treat expense sharing agreements under Rule
15c3-1.
---------------------------------------------------------------------------
\341\ See, e.g., Third Party Expense Letter.
---------------------------------------------------------------------------
In response to the comments discussed above, and as the Commission
explained in the proposing release, a broker-dealer can demonstrate the
adequacy of the third party's financial
[[Page 51851]]
resources by maintaining records such as the third party's most recent
(i.e., as of a date within the previous twelve months) audited
financial statements, tax returns, or regulatory filings containing
financial reports.\342\ Given that the entity to which the broker-
dealer is seeking to shift one or more liabilities typically is an
affiliate, the staff's experience is that such records should be
available to the broker-dealer. Further, because the proposed rule
change is consistent with prior staff guidance regarding the need to be
able to demonstrate the third party's financial adequacy,\343\ a
broker-dealer seeking to shift a liability to a third party already
would be expected to provide such evidence of the third party's
financial resources. For these reasons, the change from staff guidance
to Commission rule should not result in implementation and burden
concerns of the magnitude raised by the two commenters.\344\
---------------------------------------------------------------------------
\342\ See Amendments to Financial Responsibility Rules, 72 FR at
12872. The Commission specifically requested comment regarding the
records by which a broker-dealer could demonstrate financial
resources. It received no comments in response to this request.
\343\ See, e.g., Third Party Expense Letter.
\344\ See Lowenstein Letter; SIFMA 2 Letter.
---------------------------------------------------------------------------
Finally, one commenter noted it would be helpful if the Commission
would clarify whether this amendment supersedes the Commission staff
guidance in the Third Party Expense Letter.\345\ Unlike the PAIB Letter
discussed above, the Commission is not directing the staff to withdraw
the Third Party Expense Letter on the effective date of these
amendments. The Third Party Expense Letter will still be relevant as
staff guidance, notwithstanding that it contains a condition that has
been codified into Rule 15c3-1 (i.e., that an expense of the broker-
dealer assumed by a third party will be considered a liability for net
capital purposes unless the broker-dealer can demonstrate that the
third party has adequate resources independent of the broker-dealer to
pay the liability or expense).\346\ In particular, the letter contains
additional staff guidance not incorporated into the rule that will be
relevant as staff guidance with respect to complying with the amendment
to Rule 15c3-1 being adopted today. For example, the letter contains
staff guidance with respect to the records a broker-dealer would be
expected to make, keep current, and preserve under Rules 17a-3 and 17a-
4 with respect to broker-dealer liabilities and expenses assumed by a
third party, as well as requirements regarding written expense sharing
agreements.\347\ Broker-dealers can continue to rely on the guidance in
the Third Party Expense Letter with respect to these matters in
complying with today's amendment.
---------------------------------------------------------------------------
\345\ See SIFMA 2 Letter.
\346\ See Third Party Expense Letter, at 2-3.
\347\ Id.
---------------------------------------------------------------------------
2. Requirement To Subtract From Net Worth Certain Non-Permanent Capital
Contributions
In the proposing release, the Commission noted its concern that
broker-dealers may be receiving capital contributions from investors
that are subsequently withdrawn after a short period of time (often
less than a year).\348\ In some cases, the capital may be contributed
under an agreement giving the investor the option to withdraw it at the
investor's discretion. In the past, the Commission has emphasized that
capital contributions to broker-dealers should not be temporary,\349\
and the Commission staff has explained that a capital contribution
should be treated as a liability if it is made with the understanding
that the contribution can be withdrawn at the option of the
investor.\350\
---------------------------------------------------------------------------
\348\ See Amendments to Financial Responsibility Rules, 72 FR at
12873.
\349\ See Net Capital Rule, Exchange Act Release No. 28927 (Feb.
28, 1991), 56 FR 9124 (Mar. 5, 1991). See also Study of Unsafe and
Unsound Practices of Broker-Dealers, Report and Recommendations of
the Securities and Exchange Commission, H.R. Doc. No. 92-231 (1971),
at 17, 42 (recommending improvement of adequacy and permanency of
capital) (``During the 1967-1970 period under review, many broker-
dealers, some of them large retail houses, were found to have
inadequate and impermanent capital in relation to their
business.'').
\350\ Letter from Michael A. Macchiaroli, Associate Director,
Division of Market Regulation, Commission, to Raymond J. Hennessy,
Vice President, NYSE, and Susan DeMando, Vice President, NASD
Regulation, Inc. (Feb. 23, 2000) (``Temporary Capital Letter'')
(``It is the view of the Division that, for net capital purposes, if
an individual investor contributes capital to a broker-dealer with
an understanding that the contribution can be withdrawn at the
option of the individual investor, the contribution may not be
included in the firm's net capital computation and must be re-
characterized as a liability. Any withdrawal of capital as to that
investor within a period of one year, other than a withdrawal
described in paragraph (e)(4)(iii) of Rule 15c3-1, shall be presumed
to have been contemplated at the time of the contribution.'')
(footnote omitted); see also Net Capital Rule, Exchange Act Release
No. 28927 (Feb. 28, 1991), 56 FR 9124 (Mar. 5, 1991).
---------------------------------------------------------------------------
Consistent with these Commission and staff positions that capital
is not temporary,\351\ and given the importance of this issue and the
Commission's concern that broker-dealers may not be properly treating
short-term capital contributions as liabilities, the Commission
proposed amending Rule 15c3-1 to add paragraph (c)(2)(i)(G) to further
incorporate these positions into the rule.\352\ The proposed change
would require a broker-dealer to treat as a liability any capital that
is contributed under an agreement giving the investor the option to
withdraw it or that is contributed with the intent to withdraw the
capital within one year. The Commission further proposed that capital
withdrawn within one year would be presumptively subject to treatment
as a liability (i.e., it would be presumed to have been contributed
with the intent to withdraw within one year).\353\
---------------------------------------------------------------------------
\351\ See Net Capital Rule, Exchange Act Release No. 28927 (Feb.
28, 1991), 56 FR 9124 (Mar. 5, 1991).
\352\ See Amendments to Financial Responsibility Rules, 74 FR at
12871-12872.
\353\ Id.
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The Commission is adopting the final rule amendment with certain
modifications. As adopted, the rule requires that a broker-dealer treat
as a liability any capital that is contributed under an agreement
giving the investor the option to withdraw it. The rule, as adopted,
also requires that a broker-dealer treat as a liability any capital
contribution that is intended to be withdrawn within one year of its
contribution. In addition, the final rule provides that capital
withdrawn within one year of contribution is deemed to have been
intended to be withdrawn within one year unless the broker-dealer
receives permission in writing for the withdrawal from its DEA.\354\
The ability of a broker-dealer to seek permission in writing from its
DEA to withdraw capital contributed within one year will provide a
means for firms to seek to withdraw capital in limited circumstances
after review by its DEA without having to reclassify the withdrawn
capital as a liability for net capital purposes.\355\
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\354\ These requirements will not apply to withdrawals covered
by paragraph (e)(4)(iii) of Rule 15c3-1, namely, withdrawals used to
make tax payments or to pay reasonable compensation to partners. See
17 CFR 240.15c3-1(e)(4)(iii). These types of payments are ordinary
business expenditures and do not raise the types of concerns the
proposed rule is designed to address. One commenter suggested that
the rule be amended to explicitly exclude any withdrawals that would
fall under paragraph (e)(4)(iii) of Rule 15c3-1.
\355\ See FINRA Rule 4110(c)(1) (providing, in part, that no
equity capital of a member may be withdrawn for a period of one year
from the date such equity capital is contributed, unless otherwise
permitted by FINRA in writing).
---------------------------------------------------------------------------
In the final rule, the Commission has modified the proposed
language by moving the qualifier that the DEA can approve a withdrawal
so that it modifies this presumption. Specifically, as proposed, the
rule provided that a contribution of capital had to be subtracted from
net worth if it ``is
[[Page 51852]]
intended to be withdrawn within a period of one year unless the
withdrawal has been approved in writing by the Examining Authority for
the broker or dealer.'' As adopted, the rule provides that ``[a]ny
withdrawal of capital made within one year of its contribution is
deemed to have been intended to be withdrawn within a period of one
year, unless the withdrawal has been approved in writing by the
Examining Authority for the broker or dealer.'' \356\ The change is
intended to eliminate a potential ambiguity in the proposal as to
whether a withdrawal of capital within one year could ever be approved
by the firm's DEA and, therefore, afford the intended relief from the
deduction.\357\
---------------------------------------------------------------------------
\356\ See paragraph (c)(2)(i)(G)(2) of Rule 15c3-1, as adopted.
\357\ The phrase ``to the broker or dealer'' following ``one
year of its contribution'' is not included in the final rule because
it would be redundant, as the contributions covered in the amendment
all involve contributions to the broker-dealer.
---------------------------------------------------------------------------
The Commission received five comments regarding the amendment to
paragraph (c)(2)(i)(G)(2) of Rule 15c3-1.\358\ In addition to the
general request for comment included in the proposing release, the
Commission also requested specific comment on whether the time period
within which withdrawn and intended-to-be-withdrawn contributions must
be treated as liabilities should be longer than one year.\359\ While
the commenters agreed in principle that contributions of capital to
broker-dealers should not be subject to withdrawal at will, they
expressed concerns regarding the negative effect that overly
restrictive limitations on withdrawals of capital could have on
obtaining capital contributions and, therefore, on the financial health
of broker-dealers. One commenter, a registered broker-dealer, stated
that it believed that the amendment would raise its cost of capital to
the point where it would be impossible to obtain capital from unrelated
third parties at all.\360\ Two commenters also expressed concerns about
the potential burden posed by the amendment to broker-dealers in need
of capital.\361\ One suggested the addition of exceptions to the rule
for de minimis withdrawals and dividends or distributions.\362\ Another
commenter suggested that the proposal should be amended to exclude a
redemption right--a form of option--provided to the investor in
connection with the investor's capital contribution to the broker-
dealer, where (i) the redemption right may only be exercised by the
investor commencing more than one year following the date of the
capital contribution to the broker-dealer and (ii) the redemption right
would not be mandatorily redeemable.\363\
---------------------------------------------------------------------------
\358\ See Chicago Capital Management Letter; SIFMA 2 Letter;
American Bar Association Letter; SIG Letter; NIBA 2 Letter.
\359\ See Amendments to Financial Responsibility Rules, 72 FR at
12871-12872.
\360\ See Chicago Capital Management Letter.
\361\ See American Bar Association Letter; SIFMA 2 Letter.
\362\ See SIFMA 2 Letter.
\363\ See American Bar Association Letter.
---------------------------------------------------------------------------
Another commenter opposed the rule, stating that it contravenes
pertinent legal and accounting standards and is unnecessary in view of
existing capital withdrawal limitations and notification
requirements.\364\ This commenter stated that neither GAAP nor Rule
15c3-1 contain a requirement that capital must be permanent, and the
word ``capital'' has no intrinsic meaning that requires it to be
permanent.\365\ This commenter stated that if any further limitations
on capital withdrawals are adopted beyond the current provisions of the
net capital rule, they should be designed to allow for the ability of
broker-dealer holding companies to withdraw excess net capital at their
option for legitimate purposes.\366\
---------------------------------------------------------------------------
\364\ See SIG Letter.
\365\ Id.
\366\ Id.
---------------------------------------------------------------------------
The fifth commenter agreed that there should be no circumstance in
which a broker-dealer accepted a capital contribution for net capital
purposes that could be withdrawn at the option of the investor.\367\
This commenter, however, also stated that the standard for withdrawals
should be shortened from one year to nine or six months to increase the
availability of funds from investors and owners, allowing more broker-
dealers to raise capital and strengthen their financial stability.\368\
The commenter requested that the Commission consider the needs of small
firms that it said likely will require additional net capital over the
next decade.\369\
---------------------------------------------------------------------------
\367\ See NIBA 2 Letter.
\368\ Id.
\369\ Id. The commenter also stated that rules that ``restrict
small broker-dealers from raising capital as a result of uncertainty
of investors or owner-operators related to the return of their
capital in a reasonable time frame will create a disproportionate
and impossible hurdle for small broker-dealers to overcome.'' Id.
---------------------------------------------------------------------------
In response to the commenters' concerns about firms' ability to
obtain capital and that the amendment contravenes pertinent legal and
accounting standards, the amended rule merely clarifies what
constitutes a broker-dealer's permanent capital under Rule 15c3-1 and
further emphasizes the requirement that capital contributions cannot be
temporary.\370\ Rule 15c3-1 imposes a capital standard that is distinct
from the use of the term ``capital'' in other legal and accounting
contexts, and the rule amendments under paragraph (c)(2)(i)(G) of Rule
15c3-1 are consistent with the Commission's and staff's views that
capital under Rule 15c3-1 should not be temporary.\371\
---------------------------------------------------------------------------
\370\ See Net Capital Rule, Exchange Act Release No. 28927 (Feb.
28, 1991) (``The Commission wishes to emphasize that the net capital
maintained in a broker-dealer should be permanent capital and not
merely a temporary infusion of funds from an affiliate or other
sources. For example, there are instances where a broker-dealer
receives funds from an affiliate in an amount that would enable the
broker-dealer to engage in a transaction that it would otherwise be
prohibited from doing because of minimum net capital requirements.
If the funds are transferred back to the affiliate within a
relatively short period of time after the transaction, the
Commission questions whether the funds transferred into the broker-
dealer entity could properly be characterized as capital of the
firm. Instead, the transaction could be viewed as a loan by the
affiliate to the broker-dealer, with the result that the broker-
dealer would have to treat the transaction as a liability.''). See
also Net Capital Requirements for Brokers and Dealers, Exchange Act
Release No. 18417 (Jan. 13, 1982), 47 FR 3512 (Jan. 25, 1982)
(describing subordination agreement requirements under Appendix D to
Rule 15c3-1, including that, among other things, no prepayment may
be made (except under the strictly defined limitations of paragraph
(c)(5) of Appendix D) before the expiration of one year from the
effective date of the subordination agreement, and noting this
provision was designed to insure the adequacy as well as the
permanence of capital in the industry.); Temporary Capital Letter;
Study of Unsafe and Unsound Practices of Broker-Dealers, Report and
Recommendations of the Securities and Exchange Commission, H.R. Doc.
No. 92-231 (1971) (recommending improvement of adequacy and
permanency of capital); and Letter from Nelson Kibler, Assistant
Director, Division of Market Regulation to John Pinto, National
Association of Securities Dealers, Inc. (Sept. 8, 1980).
\371\ See Study of Unsafe and Unsound Practices of Broker-
Dealers, Report and Recommendations of the Securities and Exchange
Commission, H.R. Doc. No. 92-231 (1971), at p. 15 (``The unfortunate
use of the term ``net capital'' in the financial responsibility
rules of the Commission and the various exchanges resulted in a
semantic confusion which too frequently has led to the mistaken
belief that a broker-dealer's net capital is the equivalent of or
has some relationship to the concept of ``capital'', as that term is
commonly understood. ``Net Capital'' applies only to a hard core
residue of net liquid assets designed to enable a broker-dealer to
meet all rightful current demands of customers for their funds and
securities.''). See also Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and Major Security-
Based Swap Participants and Capital Requirements for Broker-Dealers,
77 FR at 70230 (``The net liquid assets test is imposed through the
mechanics of how a broker-dealer is required to compute net capital
pursuant to Rule 15c3-1. These requirements are set forth in
paragraph (c)(2) of Rule 15c3-1, which defines the term net capital.
The first step is to compute the broker-dealer's net worth under
GAAP. Next, the broker-dealer must make certain adjustments to its
net worth to calculate net capital. These adjustments are designed
to leave the firm in a position where each dollar of unsubordinated
liabilities is matched by more than a dollar of highly liquid
assets. There are thirteen categories of net worth adjustments
required by the rule.'') (footnotes omitted).
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[[Page 51853]]
The Commission also considered the commenter's suggestion that
there be exceptions for de minimis withdrawals, dividends, or
distributions. As previously stated, however, the Commission has
emphasized that capital contributions should not be temporary.\372\
Moreover, paragraph (e) of Rule 15c3-1 already contains mechanisms to
permit a broker-dealer to make capital withdrawals for specified
purposes.\373\ Finally, if a broker-dealer believes it has a basis to
appropriately withdraw capital within one year of contribution because,
for example, the withdrawal would be de minimis, the final rule
provides a mechanism for the broker-dealer to seek permission in
writing from its DEA to make such a withdrawal.\374\
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\372\ See Study of Unsafe and Unsound Practices of Broker-
Dealers, Report and Recommendations of the Securities and Exchange
Commission, H.R. Doc. No. 92-231 (1971), at p. 15; Capital, Margin,
and Segregation Requirements for Security-Based Swap Dealers and
Major Security-Based Swap Participants and Capital Requirements for
Broker-Dealers, 77 FR at 70230.
\373\ See 17 CFR 240.15c3-1(e)(1)(iii)(B) and (e)(4)(iii). See
also Amendments to Financial Responsibility Rules, 72 FR at 12872,
n.79 (``These requirements would not apply to withdrawals covered by
paragraph (e)(4)(iii) of Rule 15c3-1, namely, withdrawals used to
make tax payments or pay reasonable compensation to partners. These
types of payments are ordinary business expenditures and do not
raise the types of concerns the proposed rule is designed to
address.'').
\374\ See paragraph (c)(2)(i)(G)(2) of Rule 15c3-1, as adopted.
---------------------------------------------------------------------------
With respect to a commenter's view that the standard for withdrawal
should be less than one year (e.g., six or nine months), the Commission
continues to believe that one year is an appropriate amount of time
that a broker-dealer must retain a contribution in order to classify it
as capital and not a liability. This is the standard that the
Commission staff and FINRA have applied for a number of years and there
is no compelling reason to change it.\375\ Because the final rule
change is an incorporation of, among other things, existing Commission
staff guidance into Rule 15c3-1, the requirement should not
significantly alter current practice.
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\375\ See Temporary Capital Letter; FINRA Rule 4110(c)(1) (``No
equity capital of a member may be withdrawn for a period of one year
from the date such equity capital is contributed, unless otherwise
permitted by FINRA in writing.''). See also Exchange Act Release No.
60933 (Nov. 4, 2009), 74 FR 58334 (Nov. 12, 2009) (SR-FINRA-2008-
067); Net Capital Rule, Exchange Act Release No. 28927 (Feb. 28,
1991) (emphasizing ``that the net capital maintained in a broker-
dealer should be permanent capital and not merely a temporary
infusion of funds from an affiliate or other sources'').
---------------------------------------------------------------------------
Moreover, with respect to commenters' concerns about the ability to
obtain capital, the rule does not prohibit an investor from withdrawing
capital at any time. It prohibits a broker-dealer from treating
temporary cash infusions as capital for purposes of Rule 15c3-1.
Finally, as stated above, the final rule provides a mechanism for a
broker-dealer to apply to its DEA to make a withdrawal without
triggering the deduction.\376\ This provides a process for firms to
affect withdrawals within one year where appropriate.
---------------------------------------------------------------------------
\376\ The final rule does not distinguish between complete and
partial withdrawals of capital and, consequently, the deduction
could be triggered in either event. Moreover, a partial withdrawal
would require a deduction of the full amount of the original
contribution as it would indicate that the contribution was merely
temporary in nature.
---------------------------------------------------------------------------
In summary, the Commission is adding paragraph (c)(2)(i)(G) to Rule
15c3-1 to require a broker-dealer to subtract from net worth any
contribution of capital to the broker or dealer: ``(1) [u]nder an
agreement that provides the investor with the option to withdraw the
capital; or (2) [t]hat is intended to be withdrawn within a period of
one year of contribution.'' \377\ The final rule further provides that
``[a]ny withdrawal of capital made within one year of its contribution
is deemed to have been intended to be withdrawn within a period of one
year, unless the withdrawal has been approved in writing by the
Examining Authority for the broker or dealer.'' \378\
---------------------------------------------------------------------------
\377\ See paragraph (c)(2)(i)(G) of Rule 15c3-1, as adopted.
\378\ Id.
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3. Requirement To Deduct the Amount by Which a Fidelity Bond Deductible
Exceeds SRO Limits
Under SRO rules, certain broker-dealers that do business with the
public or that are required to become members of SIPC must comply with
mandatory fidelity bonding requirements.\379\ SRO rules typically
permit a broker-dealer to have a deductible provision included in the
bond; however, such rules provide that the deductible may not exceed
certain amounts. With regard to firms that maintain deductible amounts
over the maximum amount specified, several SRO rules provide that the
broker-dealer must deduct this excess amount from its net worth when
calculating net capital under Rule 15c3-1.\380\ Other SROs require that
any deductible amount elected by a broker-dealer that is greater than
10% of the coverage purchased by the broker-dealer must be deducted
from the broker-dealer's net worth when calculating net capital under
Rule 15c3-1.\381\
---------------------------------------------------------------------------
\379\ See, e.g., FINRA Rule 4360, CBOE Rule 9.22, and NASDAQ OMX
PHLX Rule 705. SRO fidelity bonding requirements typically contain
agreements covering areas such as: a ``Fidelity'' insuring clause to
indemnify against loss of property through dishonest or fraudulent
acts of employees; an ``On Premises'' agreement insuring against
losses resulting from crimes such as burglary and theft and from
misplacement of property of the insured; an ``In Transit'' clause
indemnifying against losses occurring while property is in transit;
a ``Forgery and Alteration'' agreement insuring against loss due to
forgery or alteration of various kinds of negotiable instruments;
and a ``Securities Loss'' clause protecting against losses incurred
through forgery and alteration of securities. Id.
\380\ See, e.g., CBOE Rule 9.22.
\381\ See, e.g., FINRA Rule 4360.
---------------------------------------------------------------------------
Rule 15c3-1, however, does not specifically reference the SRO
deductible requirements as a charge to net worth. Therefore, a broker-
dealer would not be required to account for the deduction required by
an SRO rule in computing net capital under Rule 15c3-1 or in the net
capital computation reflected on the broker-dealer's FOCUS report. To
address this inconsistency, the Commission proposed to amend Rule 15c3-
1 to add paragraph (c)(2)(xiv) to require a broker-dealer to deduct,
with regard to fidelity bonding requirements, the amount required by
the rules of the broker-dealer's DEA, i.e., the amount in excess of the
deductible prescribed in the applicable DEA's fidelity bond rule.\382\
The Commission received one comment supporting the proposal and one
opposing it.\383\ The commenter opposing the amendment noted that
amending Rule 15c3-1 to conform to FINRA Rule 4360 would create an
increase in minimum net capital requirements for some broker-
dealers.\384\
---------------------------------------------------------------------------
\382\ See 17 CFR 240.15c3-1(c)(12) (defining examining authority
for purposes of Exchange Act Rule 15c3-1).
\383\ See SIFMA 2 Letter; NIBA 2 Letter.
\384\ See NIBA 2 Letter.
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SRO rules prescribing fidelity bond deductibles, and capital
charges for deductibles in excess of a certain amount, are designed to
incentivize broker-dealers to carry fidelity bonds with a deductible
low enough to help ensure customer protection. Moreover, in response to
the comment that this amendment would increase minimum net capital
requirements, the Commission notes that broker-dealers that are members
of an SRO with such a fidelity bonding rule already must account for
the deduction in complying with the net capital requirements of the
SROs and nothing in the Commission's amendment to paragraph (c)(2)(xiv)
of Rule 15c3-1 would alter this status quo. Rather, the proposed rule
change would conform the capital calculation under paragraph
(c)(2)(xiv) of Rule 15c3-1 to that required by the broker-dealer's SRO.
For these reasons, the Commission is adopting paragraph (c)(2)(xiv)
to Rule 15c3-1 with technical revisions to the proposed rule text to
make the text of
[[Page 51854]]
the final rule, as adopted, a more generic cross reference to SRO
fidelity bond requirements. The technical changes are designed to
increase the flexibility of the final rule so that revisions to SRO
fidelity bond requirements pursuant to section 19(b) of the Exchange
Act \385\ will not require conforming amendments to paragraph
(c)(2)(xiv) of Rule 15c3-1.\386\ More specifically, the proposed rule
text, as set forth in the proposing release, would have required the
broker-dealer to deduct ``with respect to fidelity bond coverage, the
excess of any deductible amount over the maximum deductible amount
permitted by the Examining Authority for the broker or dealer.'' \387\
The final rule, as adopted, provides that the broker-dealer must deduct
``the amount specified by rule of the Examining Authority for the
broker or dealer with respect to a requirement to maintain fidelity
bond coverage.'' \388\ Thus, the final rule does not include the phrase
``maximum permissible deductible amounts.'' This phrase was borrowed
from SRO fidelity bond rules. Because the construction of the SRO rules
may change over time, the Commission is making the cross-reference to
the SRO rules more general.\389\
---------------------------------------------------------------------------
\385\ 15 U.S.C. 78s(b).
\386\ See, e.g., FINRA Rule 4360.
\387\ See, e.g., Amendments to Financial Responsibility Rules,
72 FR at 12872.
\388\ See paragraph (c)(2)(xiv) of Rule 15c3-1, as adopted.
\389\ See, e.g., FINRA Rule 4360. See also Exchange Act Release
No. 63961 (Feb. 24, 2011), 76 FR 11542 (Mar. 2, 2011).
---------------------------------------------------------------------------
4. Broker-Dealer Solvency Requirement
The Commission is adopting an amendment to paragraph (a) of Rule
15c3-1 to require a broker-dealer to cease conducting a securities
business if certain insolvency events were to occur. Specifically, as
adopted, amended paragraph (a) of Rule 15c3-1 provides that a broker-
dealer must not be insolvent as that term is defined in new paragraph
(c)(16) of the rule.\390\ By making solvency a requirement of Rule
15c3-1, this amendment will require an insolvent \391\ broker-dealer to
cease conducting a securities business pursuant to section 15(c)(3) of
the Exchange Act, which generally prohibits a broker-dealer from
effecting any transaction in, or inducing or attempting to induce the
purchase or sale of, any security in contravention of the Commission's
financial responsibility rules (which include Rule 15c3-1).\392\
---------------------------------------------------------------------------
\390\ The final rule also has been modified by replacing the
word ``shall'' with the word ``must.''
\391\ The definition of insolvent is intended to be broad enough
to encompass any type of insolvency proceeding or condition of
insolvency; for example, the proposed definition incorporates
concepts of insolvency in the U.S. Bankruptcy Code and SIPA. See 11
U.S.C. 101; 15 U.S.C. 78eee(b)(1).
\392\ 15 U.S.C. 78o.
---------------------------------------------------------------------------
As proposed, paragraph (c)(16) of Rule 15c3-1 would have defined
the term insolvent as, among other things, a broker-dealer's placement
in a voluntary or involuntary bankruptcy or similar proceeding; the
appointment of a trustee, receiver, or similar official; a general
assignment by the broker-dealer for the benefit of its creditors; an
admission of insolvency; or the inability to make computations
necessary to establish compliance with Rule 15c3-1.\393\ As discussed
more specifically below, the Commission modified paragraph (c)(16) of
Rule 15c3-1 in the final rule in response to concerns raised by
commenters.
---------------------------------------------------------------------------
\393\ See Amendments to Financial Responsibility Rules, 72 FR at
12872-12873. A broker-dealer's inability to make computations
necessary to establish compliance with Rule 15c3-1 may also impact
the broker-dealer's ability to make the computations necessary to
establish compliance with Rule 15c3-3 and vice versa. See, e.g.,
Rule 15c3-1(a)(1)(ii) (incorporating computations under Rule 15c3-3
into the minimum net capital requirement).
---------------------------------------------------------------------------
In the proposing release, the Commission solicited comment on
whether there are other insolvency events that should be captured in
the proposed definition.\394\ One commenter noted that involuntary
insolvency proceedings do not necessarily indicate that the broker-
dealer is insolvent, as such proceedings can be frivolous, malicious,
or otherwise lacking in merit.\395\ The commenter also noted that
industry standard contract forms generally provide a grace period for a
party to such a proceeding to obtain a stay or dismissal before an
event of default is deemed to occur.\396\ In response to this comment,
the Commission notes that the number of broker-dealer bankruptcy
filings (voluntary or involuntary) is small, and therefore, the
institution of a frivolous involuntary proceeding involving a broker-
dealer likely is a very rare event. Thus, the Commission must consider
the potential need for an automatic grace period to address the
potential for a frivolous involuntary bankruptcy as well as the harm
that could result from allowing a broker-dealer to continue to effect
securities transactions for a period of time even though it is properly
the subject of a bankruptcy proceeding. The Commission believes the
more appropriate approach is to address potentially frivolous
proceedings on a case-by-case basis. In the event that a case arises
where there would be a need to fashion relief for a broker-dealer that
was the subject of a frivolous or meritless involuntary petition, the
Commission's existing authority permits it sufficient flexibility to
fashion exemptions under appropriate circumstances.\397\
---------------------------------------------------------------------------
\394\ See Amendments to Financial Responsibility Rules, 72 FR at
12873.
\395\ See SIFMA 2 Letter.
\396\ Id.
\397\ See 15 U.S.C. 78mm(a). See also 17 CFR 240.15c3-1(b)(3).
---------------------------------------------------------------------------
In addition to the comment discussed above, the Commission received
four other comment letters that addressed these amendments.\398\ One
commenter objected to the amendments as unnecessary, citing the Rule
15c3-1 prohibition on broker-dealers effecting securities transactions
if their net capital is below certain minimums and noting that a
broker-dealer that was insolvent would ``by definition'' be below those
minimums.\399\ In response to this comment, the Commission notes that
the purpose of the amendment is to address cases where a broker-dealer
is subject to an insolvency event but takes the position that it is in
compliance with the net capital rule. While such instances may be rare,
an insolvent broker-dealer could seek the protection of the bankruptcy
laws but continue to effect transactions with the public, potentially
jeopardizing customers and other creditors of the broker-dealer,
including counterparties.
---------------------------------------------------------------------------
\398\ See SIPC Letter; St. Bernard Financial Services Letter;
American Bar Association Letter; Cornell Letter.
\399\ See St. Bernard Financial Services Letter.
---------------------------------------------------------------------------
Another commenter requested that the Commission modify the
definition of insolvent to carve out market-wide disruptions that
prevent the computation of net capital but are unrelated to the
solvency of the broker-dealer.\400\ In response to this suggestion, the
Commission notes that if appropriate and necessary, such an event can
be addressed through the Commission's exemptive authority, rather than
by a specific exception in the rule.
---------------------------------------------------------------------------
\400\ See American Bar Association Letter.
---------------------------------------------------------------------------
One commenter, while supporting the amendment, objected to the
incorporation of the definition of insolvent from section 101 of the
Bankruptcy Code.\401\ This commenter argued a bankruptcy-based standard
for insolvency was appropriate for a notice requirement but that the
proper standard for determining whether a broker-dealer should be
prohibited from continuing to conduct a securities business is its
amount of net capital. As noted above, allowing an insolvent
[[Page 51855]]
broker-dealer to continue conducting a securities business during the
period of its insolvency, notwithstanding its net capital position,
could jeopardize customers and other market participants because a
broker-dealer that has made an admission of insolvency, or is otherwise
deemed insolvent or entitled to protection from creditors, does not
possess the financial resources necessary to operate a securities
business.\402\ Continuing to operate in such circumstances poses a
significant credit risk to counterparties and to the clearance and
settlement system, and, in the event the firm subsequently is placed in
a liquidation proceeding under SIPA, may impair the ability of the SIPA
trustee to make customers of the broker-dealer whole and satisfy claims
of other creditors out of the assets of the general estate.\403\
---------------------------------------------------------------------------
\401\ See SIFMA 2 Letter.
\402\ See Amendments to Financial Responsibility Rules, 72 FR at
12872.
\403\ Id.
---------------------------------------------------------------------------
In addition, this commenter also was concerned that under the
proposed amendment a firm would be prevented from effecting hedging or
liquidating transactions intended to reduce the risk the firm poses to
the financial markets and its customers. The commenter noted that such
limitations also would be at odds with section 5(a)(2) of SIPA, which
contemplates that a broker-dealer that is in, or approaching, financial
difficulty may undertake to liquidate or reduce its business either
voluntarily or pursuant to the direction of an SRO.\404\ The final rule
amendment is not intended to affect in any a broker-dealer's ability to
act under section 5(a)(2) of SIPA.\405\
---------------------------------------------------------------------------
\404\ See SIFMA 2 Letter; SIPC Letter. See also 15 U.S.C.
78eee(a)(5).
\405\ See15 U.S.C. 78eee(a)(5). Further, the amendment is not
intended to affect in any way a SIPA trustee's ability to liquidate
a broker-dealer. Effectively, a SIPA trustee steps into the shoes of
the debtor broker-dealer in order to liquidate the broker-dealer and
protect its customers' interests.
---------------------------------------------------------------------------
In addition, the Commission is amending the final rule to
incorporate within the term insolvency the circumstance in which a
broker-dealer is unable to make such computations as may be necessary
to establish compliance with Rule 15c3-3.\406\ In the proposing
release, the Commission stated that the ``proposed definition of
`insolvent' is intended to be broad enough to encompass any type of
insolvency proceeding or condition of insolvency,'' \407\ and noted
that the proposed definition incorporates concepts of insolvency from
the U.S. Bankruptcy Code and SIPA.\408\ Consequently, consistent with
the discussion in the proposing release, the modification in the final
rule will more closely align the definition of insolvent under
paragraph (c)(16) of Rule 15c3-1 with the grounds for the commencement
of a proceeding under SIPA,\409\ which includes the circumstance that a
broker-dealer is unable to make computations necessary to establish
compliance with the financial responsibility or hypothecation
rules.\410\ Rule 3a40-1 defines the term financial responsibility rules
to include, among others, any rule adopted by the Commission pursuant
to section 15(c)(3) of the Exchange Act--Rules 15c3-1 and 15c3-3 were
adopted under section 15(c)(3). As a financial responsibility rule, the
inability of a broker-dealer to make a computation necessary to
establish compliance with Rule 15c3-3 constitutes a basis for
commencing a SIPA proceeding. Consequently, this modification to the
proposed definition of insolvency under paragraph (c)(16) of Rule 15c3-
1 will more closely align the definition with SIPA.\411\
---------------------------------------------------------------------------
\406\ The final rule adds the phrase ``or with Sec. 240.15c3-
3'' to follow the phrase ``[i]s unable to make such computations as
may be necessary to establish compliance with this section.'' See
paragraph (c)(16)(iv) of Rule 15c3-1. See also generally, SIPC
Letter (favoring an amendment requiring broker-dealers to cease
doing business if insolvent as defined under proposed Rule 15c3-
l(c)(16) and noting that the circumstances under which the broker
would be required to cease doing business are consistent with the
circumstances under which SIPC may seek to place a firm in
liquidation).
\407\ See Amendments to Financial Responsibility Rules, 72 FR at
12872.
\408\ Id. at n.85.
\409\ See 15 U.S.C. 78eee(b).
\410\ See 15 U.S.C. 78eee(b)(l)(D). See also 17 CFR 240.3a40-1
(defining the term financial responsibility rules for purposes of
SIPA to include Rule 15c3-3).
\411\ The Commission also has made three technical modifications
to the text of the insolvency definition. In response to a comment,
the phrase ``broker-dealer'' was replaced with the phrase ``broker
or dealer'' to be consistent with the use of the phrase in Rule
15c3-1. In addition, the phrase ``for purposes of this section'' was
moved to the beginning of paragraph (c)(16) in order to clarify that
the term insolvency is defined for purposes of Rule 15c3-1 in its
entirety. Finally, the final rule does not include the phrase
``whether commenced voluntarily or involuntarily'' because the
phrase would be redundant.
---------------------------------------------------------------------------
The Commission also is adopting an amendment to the first sentence
of paragraph (b)(1) of Rule 17a-11 to require that a broker-dealer
meeting the definition of insolvent must provide immediate notice to
the Commission, the firm's DEA and, if applicable, the CFTC. One
commenter specifically favored this amendment.\412\ This notice will
assist regulators in taking steps to protect the insolvent firm's
customers, including, if appropriate, notifying SIPC of the need to
commence a SIPA proceeding. The Commission is adopting the amendment to
paragraph (b)(1) of Rule 17a-11, with one technical modification.\413\
---------------------------------------------------------------------------
\412\ See SIPC Letter.
\413\ The Commission is deleting the phrase ``paragraph (c)(16)
of'' and inserting ``(c)(16)'' immediately following the second
``15c3-1''.
---------------------------------------------------------------------------
5. Amendment To Rule Governing Orders Restricting Withdrawal of Capital
From a Broker-Dealer
Paragraph (e) of Rule 15c3-1, which places certain conditions on a
broker-dealer when withdrawing capital,\414\ also allows the Commission
to issue an order temporarily restricting a broker-dealer from
withdrawing capital or making loans or advances to stockholders,
insiders, and affiliates under certain circumstances.\415\ The rule,
however, limits such orders to withdrawals, advances, or loans that,
when aggregated with all other withdrawals, advances, or loans on a net
basis during a 30 calendar day period, exceed 30 percent of the firm's
excess net capital.\416\ When the Commission adopted this paragraph of
Rule 15c3-1 more than 20 years ago, the Commission stated that it
intended this section to be applied only where the continued viability
of a broker-dealer appeared to be at stake.\417\ In the ensuing years,
the Commission has utilized this provision only one time.\418\ The
Commission has determined that the requirement is difficult to enforce,
as it generally would not be clear when the 30% threshold had been
reached, due to the inherent unreliability of a troubled broker-
dealer's books and records. Consequently, the Commission proposed, and
is adopting, a change to delete this provision and instead to allow the
Commission to restrict all withdrawals, advances, and loans so long as
the other conditions under the rule (all of which remain unchanged) are
met.\419\
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\414\ See 17 CFR 240.15c3-1(e).
\415\ See 17 CFR 240.15c3-1(e)(3).
\416\ Id.
\417\ Net Capital Rule, Exchange Act Release No. 28927 (Feb. 28,
1991), 56 FR 9124, 9128 (Mar. 5, 1991).
\418\ Order Regarding Withdrawals, Unsecured Loans or Advances
from Refco Securities, LLC and Refco Clearing, LLC, Exchange Act
Release No. 52606 (Oct. 13, 2005).
\419\ The Commission also proposed revising the second sentence
in paragraph (e)(3)(ii) to remove the text ``The hearing'' and in
its place adding the text ``A hearing on an order temporarily
prohibiting the withdrawal of capital.''
---------------------------------------------------------------------------
The Commission received three comment letters addressing this
proposal.\420\ One commenter supported the deletion of the 30%
threshold, but believed its removal reflected the
[[Page 51856]]
Commission's desire to regulate large firms with complex capitalization
without considering the needs of smaller firms.\421\ This commenter
recommended the Commission set forth all conditions required for a firm
to withdraw, repay, or redeem any amount that affects its overall
capitalization.\422\ Specifically, the commenter suggested the
following non-exclusive list of conditions for consideration: (1)
``[r]egulatory minimum capital requirement related to all lines of
business''; (2) ``[e]xcess mandated by that firms' accruals for that
period''; (3) ``[e]xcess mandated by the firms' upcoming one-time non-
recurring costs within that quarter''; (4) ``[e]xcess mandated by
operating costs expected[,] but not related to accruals for that
period''; (5) [c]osts related to increased personnel coverage or
recruitment within that quarter''; and (6) ``[d]etermination of the
Board of the firm that there is no reasonable expectation at the time
of its approval of the capital withdrawal, repayment or redemption,
that the firm would be required to, or advisable to, increase its net
capital excess.''
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\420\ See NIBA 2 Letter; SIFMA 2 Letter; Raymond James 2 Letter.
\421\ See NIBA 2 Letter. As noted above, the 30% threshold
provision only applied in emergency situations and has only been
used once before. As such, its deletion should only affect a limited
number of broker-dealers.
\422\ Id.
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The second commenter recommended several modifications to the
amendment, including: (1) Clarifying that in addition to ordering
complete restrictions on withdrawals, advances, and loans, the
Commission may also issue orders imposing partial or conditional
restrictions; (2) explicitly permitting certain types of withdrawals,
advances, or loans, such as those in paragraphs (e)(4)(ii) and (iii) of
Rule 15c3-1 (e.g., required tax payments or payments to partners for
reasonable compensation) even after the issuance of a temporary
restrictive order; and (3) clarifying that the provision in paragraph
(e)(3)(ii) of the rule allowing a broker-dealer to request and receive
a hearing on an order temporarily restricting withdrawals also applies
to orders temporarily restricting advances and loans (in addition to
withdrawals).\423\
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\423\ See SIFMA 2 Letter.
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Finally, the third commenter noted that the proposed amendment
would eliminate the 30% requirement limit and allow the Commission to
restrict all withdrawals, advances, and loans under specific
circumstances.\424\ The commenter believes this action will impose an
additional compliance burden on broker-dealers and will significantly
limit the flexibility of broker-dealers in the event of a liquidity
crisis.\425\
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\424\ See Raymond James 2 Letter.
\425\ Id.
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In response to these comments, the Commission notes that the 30%
threshold pertains only to paragraph (e)(3)(i) of Rule 15c3-1, which
relates to the Commission's authority to temporarily restrict
withdrawals of net capital. The Commission cannot impose these
restrictions without concluding under subparagraph (e)(3)(i) that
``such withdrawal, advance or loan may be detrimental to the financial
integrity of the broker or dealer, or may unduly jeopardize the broker
or dealer's ability to repay its customer claims or other liabilities
which may cause a significant impact on the markets or expose the
customers or creditors of the broker or dealer to loss without taking
into account the application of the Securities Investor Protection Act
of 1970.'' \426\ While paragraph (e)(3)(i) of Rule 15c3-1 would apply
to all broker-dealers, the conditions under which the Commission may
exercise its authority under the rule apply only to circumstances where
the continued viability of the broker-dealer appears to be at
stake.\427\ As noted above, the Commission has only utilized this
provision once.\428\
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\426\ See paragraph (e)(3)(i) of Rule 15c3-1, as adopted.
\427\ Net Capital Rule, Exchange Act Release No. 28927 (Feb. 28,
1991), 56 FR 9124, 9128 (Mar. 5, 1991).
\428\ Order Regarding Withdrawals, Unsecured Loans or Advances
from Refco Securities, LLC and Refco Clearing, LLC, Exchange Act
Release No. 52606 (Oct. 13, 2005).
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The Commission, however, agrees with the importance of maintaining
flexibility in the context of ordering restrictions on withdrawals,
advances, and loans. Therefore, the Commission is modifying the
amendment, as adopted, to add language to paragraph (e)(3)(i) to state
(following the phrase ``employee or affiliate'') that such orders will
be issued, ``under such terms and conditions as the Commission deems
necessary or appropriate in the public interest or consistent with the
protection of investors. . . .'' \429\ With respect to the suggestion
that the Commission explicitly permit certain types of withdrawals,
advances, or loans even after the issuance of a temporary order, the
Commission does not believe that it would be appropriate to permit--by
codifying in the rule--a broker-dealer to take the actions described if
the Commission has issued an order placing temporary restrictions on a
broker-dealer's ability to withdraw net capital under paragraph (e)(3)
of the rule. The order would be intended to protect the customers and
creditors of the broker-dealer, and permitting the actions by rule
could undermine those protections. Moreover, there is no need to
explicitly permit certain types of withdrawals, advances or loans
because if there were circumstances that merited the broker-dealer
making such payments, the Commission order could be fashioned as
appropriate to permit those payments.
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\429\ See paragraph (e)(3)(i) of Rule 15c3-1, as adopted. See
also 17 CFR 15c3-1(e). See generally, 15 U.S.C. 78mm(a)(1).
---------------------------------------------------------------------------
With respect to the suggestion that the Commission clarify in
paragraph (e)(3)(ii) of Rule 15c3-1 that a broker-dealer may request
and receive a hearing on orders temporarily restricting advances and
loans (in addition to withdrawals), under the existing rule, a broker-
dealer may request a hearing if the Commission has issued an order
temporarily restricting advances and loans by a broker-dealer, in
addition to withdrawals, and the Commission is therefore adopting the
amendment to paragraph (e)(3)(ii), as proposed.\430\
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\430\ 17 CFR 240.15c3-1(e)(3)(ii). The Commission also is
adopting revisions to the second sentence of paragraph (e)(3)(ii),
replacing the phrase ``The hearing'' with the phrase ``A hearing on
an order temporarily prohibiting the withdrawal of capital.''
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6. Adjusted Net Capital Requirements
i. Amendment to Appendix A of Rule 15c3-1
The Commission is adopting an amendment to Appendix A of Rule 15c3-
1, which permits broker-dealers to employ theoretical option pricing
models to calculate haircuts for listed options and related positions
that hedge those options.\431\ The amendment makes permanent a
temporary amendment the Commission originally adopted in 1997.\432\ The
temporary amendment expired on September 1, 1997, unless it was
otherwise extended by the Commission.\433\ The Commission staff
subsequently issued a no-action letter on January 13, 2000, which
stated that the staff would not recommend enforcement action if broker-
dealers continued to rely on the temporary amendment.\434\
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\431\ 17 CFR 240.15c3-1a.
\432\ See Net Capital Rule, Exchange Act Release No. 38248 (Feb.
6, 1997), 62 FR 6474 (Feb. 12, 1997).
\433\ See 17 CFR 15c3-1a(b)(1)(iv)(B).
\434\ Letter from Michael Macchiaroli, Associate Director,
Division of Market Regulation, Commission, to Richard Lewandowski,
Vice President, Regulatory Division, The Chicago Board Options
Exchange, Inc. (Jan. 13, 2000) (stating that the Division of Market
Regulation ``will not recommend . . . enforcement action if non-
clearing option specialists and market-makers continue to rely on
subparagraph (b)(1)(iv) of Appendix A to Rule 15c3-1 under the
Exchange Act until such time as the Commission has determined
whether it should be extended''). The letter did not grant any other
relief.
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[[Page 51857]]
The temporary amendment decreased the range of pricing inputs to
the approved option pricing models, which effectively reduced the
haircuts applied by the carrying firm with respect to non-clearing
option specialist and market maker accounts.\435\ The temporary
amendment, which applied only to these types of accounts, was limited
to major market foreign currencies and diversified indexes. Even during
periods of substantial volatility, there have been no significant
increases in the number of deficits in non-clearing option specialist
and market-maker accounts, nor did the lower capital charges under
paragraph (b)(1)(iv) result in excessive leverage. Consequently, this
amendment appropriately aligns the net capital requirements of affected
firms with the risks Rule 15c3-1 seeks to mitigate. The Commission
received one comment letter regarding this aspect of the proposing
release. The commenter concurred with the Commission's conclusions as
to the effect of the temporary amendment and supported the proposal to
make it permanent.\436\ Accordingly, the Commission is amending
paragraph (b)(1)(iv) of Appendix A to Rule 15c3-1, as proposed, to make
the temporary amendment permanent.\437\
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\435\ See Net Capital Rule, Exchange Act Release No. 38248 (Feb.
6, 1997), 62 FR 6474 (Feb. 12, 1997). Under Appendix A to Rule 15c3-
1, a broker-dealer calculating net capital charges for its options
portfolios shocks the products in each portfolio (grouped by
underlying instrument) at ten equidistant points along a potential
market move range. The market move ranges for major market foreign
currencies, high-capitalization diversified indexes, and non-high-
capitalization diversified indexes are, respectively: +(-) 6%, +(-)
10% and +(-) 15%. The temporary rule lowered these market move
ranges to respectively: +(-) 4[frac12]%, + 6% (-) 8% and +(-) 10% in
terms of calculating haircuts for positions of non-clearing options
specialists and market makers. Id.
\436\ See SIFMA 2 Letter.
\437\ As a result, the Commission also is redesignating
paragraphs (b)(1)(iv)(A), (b)(1)(iv)(A)(1), (b)(1)(iv)(A)(2), and
(b)(1)(iv)(A)(3) as paragraphs (b)(1)(iv), (b)(1)(iv)(A),
(b)(1)(iv)(B), and (b)(1)(iv)(C), respectively.
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ii. Money Market Funds
a. Clarification
The Commission is adopting an amendment to paragraph
(c)(2)(vi)(D)(1) of Rule 15c3-1 to clarify that a money market fund,
for the purposes of paragraph (c)(2)(vi)(D)(1), is a fund described in
Rule 2a-7 under the Investment Company Act of 1940 (``Rule 2a-
7'').\438\ The Commission did not receive any comments on this proposal
and is adopting it, as proposed.
---------------------------------------------------------------------------
\438\ See 17 CFR 270.2a-7.
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b. Proposed Haircut Reduction From 2% to 1%
The Commission proposed an amendment to reduce the ``haircut'' that
broker-dealers apply under Rule 15c3-1 for money market funds.\439\ In
1982, the Commission adopted a 2% haircut requirement for redeemable
securities of money market funds.\440\ In 1991, the Commission adopted
certain amendments to Rule 2a-7 that strengthened the risk-limiting
investment restrictions for money market funds.\441\ Based on the
enhancements to Rule 2a-7, the Commission proposed to amend paragraph
(c)(2)(vi)(D)(1) of Rule 15c3-1 to reduce the haircut on such funds
from 2% to 1% in order to better align the net capital charge with the
risk associated with holding shares of a money market fund.\442\ In
addition to the general request for comments in the proposing release,
the Commission also specifically requested comments regarding whether
the haircut for certain types of money market funds should be reduced
to 0% as suggested in a petition for rulemaking submitted to the
Commission.\443\
---------------------------------------------------------------------------
\439\ See Amendments to Financial Responsibility Rules, 72 FR at
12874.
\440\ Net Capital Requirements for Brokers and Dealers, Exchange
Act Release No. 18737 (May 13, 1982), 47 FR 21759 (May 20, 1982).
See 17 CFR 240.15c3-1(c)(2)(vi)(D)(1).
\441\ Revisions to Rules Regulating Money Market Funds,
Investment Company Act Release No. 18005 (Feb. 20, 1991), 56 FR 8113
(Feb. 27, 1991).
\442\ See Amendments to Financial Responsibility Rules, 72 FR at
12874.
\443\ See Public Petitions for Rulemaking No. 4-478 (Apr. 3,
2003) (available at https://www.sec.gov/rules/petitions/petn4-478.htm), as amended (Apr. 4, 2005) (available at https://www.sec.gov/rules/petitions/petn4-478a.pdf), and No. 4-577 (Feb. 3,
2009) (available at https://www.sec.gov/rules/petitions/2009/petn4-577.pdf).
---------------------------------------------------------------------------
The Commission received a total of 14 responses from 12 different
commenters regarding this proposed amendment. All of the commenters
supported a reduction in the haircut for money market funds and urged
that the haircut be reduced below the proposed 1%, with the majority
proposing a haircut of 0% for ``top-rated'' money market funds (i.e.,
those with the highest ratings).\444\ Commenters cited the safety
record of money market funds, in particular AAA-rated money market
funds, in support of imposing lower haircuts.\445\ Several commenters
argued that top-rated money market funds were more liquid and posed
less credit and interest rate risk than other instruments and suggested
haircuts of 1/8 of 1% or even 0%.\446\ One commenter argued that since
broker-dealers (like investors) view money market funds as cash
equivalents, they would view a 1% haircut as a significant cost and
would therefore avoid using money market funds.\447\ Two commenters
suggested that if the Commission determined it necessary to impose a
haircut on some Rule 2a-7 money market funds, it should implement a
bifurcated scheme under which money market funds that qualify for
deposit into a broker-dealer's reserve account under Rule 15c3-3 would
be subject to a 0% haircut,\448\ with one arguing that such qualifying
money market funds should in any case receive a haircut no greater than
1/8 of 1%.\449\ Another commenter suggested that the proposed
amendments to reduce the haircut for money market funds should be
deferred until the results of the Commission's money market reforms are
known.\450\ Another commenter suggested a haircut of 5/8 of 1%, based
on a combination of the 1/8 of 1% haircut applied to highly rated
shorter-term (at least 30 but less than 91 days to maturity) commercial
paper and municipal securities and an additional charge of 1/2 of 1% to
account for any minimal risk associated with the nature or operation of
mutual funds.\451\ Finally, one commenter supported a 0% haircut for
applied to money market funds that: (1) Do not hold investments in
their affiliates or holding companies; and (2) are not affiliated with
the bank in which the broker-dealer holds its cash reserves and
operating funds.\452\
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\444\ See Federated Letter; Federated 3 Letter; Curion Clearing
Letter; FAF Advisors Letter; Brown Brothers Harriman Letter; SIFMA 2
Letter; ICI Letter; Barclays Letter; National Chamber Foundation
Letter; Blackrock Letter; Deutsche Bank Securities Letter; UBS
Letter; SIFMA 4 Letter; NIBA 2 Letter.
\445\ See, e.g., Barclays Letter.
\446\ See, e.g., FAF Advisors Letter.
\447\ See Federated Letter.
\448\ See Blackrock Letter; ICI Letter.
\449\ See Blackrock Letter.
\450\ See SIFMA 4 Letter.
\451\ See SIFMA 2 Letter.
\452\ See NIBA 2 Letter.
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As discussed above in section II.E.6.ii. of this release, the
Commission recently proposed substantial amendments to its money market
fund rules.\453\ In light of these proposed amendments,\454\ the
Commission is deferring consideration of a reduction of the haircut for
money market funds in Rule 15c3-1 at this time. Therefore, the haircut
that broker-dealers apply for money market funds will remain at 2%
under paragraph
[[Page 51858]]
(c)(2)(vi)(D)(1) of Rule 15c3-1. Deferring action will allow the
Commission to assess the potential impact of any money market fund
reforms it may adopt and whether any such impact would have
consequences for the net liquid asset standard of Rule 15c3-1.
---------------------------------------------------------------------------
\453\ See Money Market Fund Reform; Amendments to Form PF,
Release No. IC-30551 (June 5, 2013), 78 FR 36834 (June 19, 2013).
\454\ Id.
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c. Aggregate Debit Items Charge
The Commission proposed amendments to Rule 15c3-1 that would have
eliminated a reduction to aggregate debit items that certain broker-
dealers must take when computing their reserve requirements under Rule
15c3-3.\455\ Under paragraph (a)(1)(ii)(A) of Rule 15c3-1, a broker-
dealer using the ``alternative standard'' \456\ to compute its minimum
net capital requirement must reduce aggregate debit items by 3% when
computing its customer reserve requirement under Rule 15c3-3.
Conversely, Note E(3) to the customer reserve formula (Rule 15c3-3a)
requires a broker-dealer using the ``basic method'' of computing net
capital under Rule 15c3-1 to reduce by 1% the total debits in Item 10
of the formula (i.e., debit balances in customer cash and margin
accounts).\457\ Both of these provisions serve to increase the amount
of funds a broker-dealer must deposit into its customer reserve
account; however, the deduction applicable to alternative standard
firms can result in an even larger reserve deposit requirement.
---------------------------------------------------------------------------
\455\ See Amendments to Financial Responsibility Rules, 72 FR at
12867.
\456\ Under the ``alternative standard,'' a broker-dealer's
minimum net capital requirement is equal to 2% of the firm's
aggregate debit items. 17 CFR 240.15c3-1(a)(1)(ii).
\457\ Under the ``basic method,'' a broker-dealer cannot permit
its aggregate indebtedness (generally total money liabilities) to
exceed 1500% of its net capital. 17 CFR 15c3-1(a)(1)(i).
---------------------------------------------------------------------------
The Commission received four comment letters regarding these
amendments and all were supportive.\458\ However, recent market turmoil
has highlighted the importance of maintaining adequate amounts of funds
and qualified securities in the customer reserve account under Rule
15c3-3 to protect customers. Consequently, it would be imprudent to
lower the debit reduction requirement for broker-dealers using the
alternative standard at this time (especially given the fact that this
standard is primarily used by firms with a substantial customer
business). Therefore, the Commission has determined to defer
consideration of action on this amendment at this time.
---------------------------------------------------------------------------
\458\ See Curian Clearing Letter; SIFMA 2 Letter; Deutsche Bank
Securities Letter; Citigroup Letter.
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F. Technical Amendments
The Commission proposed a number of technical amendments to these
rules, including changes to the definitions of fully paid securities,
margin securities, and bank in Rule 15c3-3.\459\ These proposed
technical amendments were not designed to substantively change the
meanings of these defined terms but, rather, to amend out-of-date
citations and remove text that the Commission believed to be
superfluous or redundant.
---------------------------------------------------------------------------
\459\ 17 CFR 240.15c3-3(a)(3), (4), and (7), respectively.
---------------------------------------------------------------------------
Two commenters \460\ opposed the proposed technical amendments to
the Rule 15c3-3 definition of fully paid securities. As proposed, the
definition of fully paid securities would have included ``all
securities carried for the account of a customer unless such securities
are purchased in a transaction for which the customer has not made full
payment.'' \461\ The commenters contend that the amendments to the
definition of fully paid securities would significantly expand the
universe of fully paid securities because these securities generally
are carried in a cash account, and under the proposed definition any
security, in any account, including a margin account, could be
considered a fully paid security (and subject to possession and control
requirements) if it has been paid for in full. As such, the commenter
noted that the term fully paid securities, as proposed, would require
broker-dealers to determine whether securities in a margin account are
fully paid (in which case they could not be hypothecated even if they
are not excess margin securities). As a result, the commenter suggested
that this definition should be limited to include only securities in a
cash account that have been paid for in full. After careful
consideration, and in response to the comment, the Commission has
modified the text of paragraph (a)(3) to Rule 15c3-3 to more closely
follow the original definition, while still adopting the updated
references and terminology to reflect changes made to Regulation T
since 1972. As adopted, the term fully paid securities includes ``all
securities carried for the account of a customer in a cash account as
defined in Regulation T (12 CFR 220.1 et seq.), as well as securities
carried for the account of a customer in a margin account or any
special account under Regulation T that have no loan value for margin
purposes, and all margin equity securities in such account if they are
fully paid. . . .'' \462\ The definition also states that, ``the term
``fully paid securities'' does not apply to any securities purchased in
transactions for which the customer has not made full payment.''
---------------------------------------------------------------------------
\460\ See SIFMA 2 Letter; Angel Letter.
\461\ See Amendments to Financial Responsibility Rules, 72 FR at
12894.
\462\ See paragraph (a)(3) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------
The Commission did not receive any comments on the proposed
amendments to the definition of margin securities under paragraph
(a)(4) of Rule 15c3-3. The Commission is adopting this definition as
proposed. In addition, the Commission did not receive any comments to
the proposed amendments to the definition of bank under paragraph
(a)(7) of Rule 15c3-3. The Commission, however, has modified the
language in this paragraph to make the paragraph gender neutral by
replacing the phrase ``who maintains his principal place of business''
with the phrase ``that maintains its principal place of business.''
The Commission also has amended other provisions of Rule 15c3-3 to
make the rule gender neutral. Finally, the Commission has replaced the
word ``shall'' throughout the rule, as amended, with clearer words,
such as ``will'' or ``must.'' This change will not change either the
nature or substance of the affected rule provisions.
III. Responses to Specific Requests for Comment
In the proposing release, the Commission requested comment on
certain specific matters, in addition to the proposed rule
amendments.\463\ These matters included: (1) A proposal to reduce the
Rule 17a-11 notice requirement for broker-dealers that carry over $10
billion in debits; (2) whether to harmonize the net capital deductions
required under paragraph (c)(2)(iv)(B) of Rule 15c3-1 for securities
lending and borrowing transactions with the deductions required under
paragraph (c)(2)(iv)(F) for securities repo transactions; and (3)
solicitation of comment on how third-party liens against customer fully
paid securities carried by a broker-dealer should be treated under the
financial responsibility rules, including Rule 15c3-3, Rule 17a-3 and
Rule 17a-4.
---------------------------------------------------------------------------
\463\ Id. at 12874.
---------------------------------------------------------------------------
The Commission received seven comment letters that addressed the
solicitation of comments for these matters.\464\ With respect to the
early warning level proposal, one commenter proposed modifying the
Commission's
[[Page 51859]]
early warning levels for very large ``alternative standard'' firms with
more than $10 billion in debits.\465\ The commenter recommended this
approach because of the increase in debit items at large broker-dealers
and the increased focus on effective risk management practices.\466\
Another comment supported the amendment, suggesting that the
notification could serve as an early warning if a firm is approaching
insolvency.\467\
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\464\ See SIFMA 2 Letter; SIFMA 4 Letter; First Clearing Letter;
Citigroup Letter; American Bar Association Letter; Cornell Letter;
Raymond James 2 Letter.
\465\ See SIFMA 2 Letter.
\466\ Id.
\467\ See Cornell Letter.
---------------------------------------------------------------------------
In addition, the Commission received three comments with respect to
harmonizing the net capital deductions required under paragraph
(c)(2)(iv)(B) of Rule 15c3-1 for securities lending and borrowing
transactions with the deductions required under paragraph (c)(2)(iv)(F)
for securities repo transactions.\468\ These commenters stated that the
Commission should consider the potential disruption to the marketplace
that may arise in connection with any effort to harmonize capital
charges.\469\
---------------------------------------------------------------------------
\468\ See SIFMA 2 Letter; Citigroup Letter; Raymond James 2
Letter.
\469\ Id.
---------------------------------------------------------------------------
The Commission also received seven comments in response to the
solicitation of comment on how third-party liens against customer fully
paid securities carried by a broker-dealer should be treated under the
financial responsibility rules, including Rule 15c3-3, Rule 17a-3 and
Rule 17a-4.\470\ Two commenters stated that the Commission should not
require that a broker-dealer include third party liens as a credit in
the reserve formula and stated that this is an area in which it would
be productive to have a detailed discussion between Commission staff
and the industry before any amendments are proposed.\471\ Another
commenter stated that each of the suggested approaches in the proposing
release imposes burdens and requirements on broker-dealers that do not
serve to address the concerns noted by the Commission.\472\ Two
commenters stated that the most effective way to avoid confusion
regarding third party liens in a SIPC liquidation would be to segregate
securities subject to a lien to a separate pledge account in the name
of the pledgee.\473\ Finally, one commenter argued that requiring
broker-dealers to include the amount of liens as a credit item in the
reserve formula was not necessary to achieve customer protection and
would impose significant costs and burdens on the broker-dealers.\474\
---------------------------------------------------------------------------
\470\ See SIFMA 2 Letter; SIFMA 4 Letter; First Clearing Letter;
Citigroup Letter; American Bar Association Letter; NIBA 2 Letter;
Raymond James 2 Letter.
\471\ See SIFMA 2 Letter; SIFMA 4 Letter; Citigroup Letter.
\472\ See First Clearing Letter.
\473\ See American Bar Association Letter; NIBA 2 Letter.
\474\ See Raymond James 2 Letter.
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The Commission will consider the comments received in developing
any proposals should the Commission decide to take further action in
any of these areas.
IV. Paperwork Reduction Act
Certain provisions of the amendments contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\475\ The Commission published a notice
requesting comment on the collection of information requirements in the
proposing release \476\ and submitted the amendments to the Office of
Management and Budget (``OMB'') for review in accordance with the
PRA.\477\ An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid control number. The amended rules--Rule 15c3-1, Rule
15c3-3, Rule 17a-3, Rule 17a-4 and Rule 17a-11--contain currently
approved collections of information under, respectively, OMB control
numbers 3235-0200, 3235-0078, 3235-0033, 3235-0279 and 3235-0085.
---------------------------------------------------------------------------
\475\ 44 U.S.C. 3501, et seq.
\476\ See Amendments to Financial Responsibility Rules, 72 FR at
12875.
\477\ 44 U.S.C. 3507(d); 5 CFR 1320.11.
---------------------------------------------------------------------------
In response to comments received regarding the proposed amendments
in the proposing release, the Commission has modified the language in
the final rules being adopted, as discussed above. These comments and
their impact on PRA estimates are discussed below. In addition, the
initial burden estimates in the proposing release have been
adjusted,\478\ as discussed below, to reflect updated information used
to make the current estimates, including updated FOCUS Report
data.\479\
---------------------------------------------------------------------------
\478\ See Amendments to Financial Responsibility Rules, 72 FR at
12875.
\479\ The PRA estimates derived from FOCUS Reports filed by
broker-dealers pursuant to Section 17 of the Exchange Act and Rule
17a-5 have been updated in this final release to reflect more
recently available information, including FOCUS Report data as of
December 31, 2011. The PRA estimates in the proposing release
derived from FOCUS reports were from 2004 year end data. See
Amendments to Financial Responsibility Rules, 72 FR at 12875.
---------------------------------------------------------------------------
Finally, one commenter specifically stated that the estimates the
Commission provided utilized only that number of broker-dealers in its
estimates that the Commission ``justifiably considers to be affected by
the proposals.'' \480\ The commenter, however, believes that most, if
not all, broker-dealers will spend over 90 hours each analyzing the
effects of the rules as implemented, will spend many more than 90 hours
each in implementing procedures and modifying their written supervisory
procedures to comply with the new rules, will spend in excess of 240
hours each in the monitoring of such rules, and will spend in excess of
$15,000 each for outside counsel and auditor opinions or work
product.\481\ This commenter did not provide additional detail about
the basis for its view that the Commission's estimates were too low.
The Commission agrees with the commenter that broker-dealers directly
affected by the rule amendments may be required to implement procedures
or modify their written supervisory procedures in order to comply with
the rule amendments. In cases where the rule amendments are requiring a
broker-dealer to implement or document certain policies and procedures,
these hour burdens are already included in the final hour estimates
discussed below.\482\ In addition, the Commission acknowledges that a
broker-dealer may need to review its operations to determine whether or
not it has any obligations under the rule amendments. Even if a broker-
dealer is not directly affected by the rule amendments, such a review
may result in an indirect effect on its operations. These indirect
effects or costs, however, are more appropriately addressed in the
Economic Analysis in section V. of this release because they relate to
the overall impact of the amendments, rather than to the specific
collections of information discussed below. Consequently, the
Commission addresses the commenter's concerns that directly relate to
the collections of information below, and the indirect burdens and
costs in the Economic Analysis in section V. of this release.
---------------------------------------------------------------------------
\480\ See NIBA 2 Letter.
\481\ Id.
\482\ See, e.g., paragraph (j)(1) of Rule 15c3-3 and paragraph
(a)(23) of Rule 17a-3, as adopted.
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A. Summary of the Collection of Information Requirements
The rule amendments contain recordkeeping and disclosure
requirements that are subject to the PRA. In summary, the amendments
may require a broker-dealer, under certain circumstances, to: (1)
Disclose the principals and obtain certain agreements from the
principals in a securities lending transaction where it performs
settlement services if it is to be
[[Page 51860]]
considered an agent (as opposed to a principal) for the purposes of the
net capital rule \483\; (2) obtain permission in writing from its DEA
to withdraw capital within one year of contribution \484\; (3) enter
into a subordination agreement with an account holder in order to
exclude such account holder from the definition of PAB account \485\;
(4) provide written notice to PAB account holders that their securities
may be used in the ordinary course of its securities business \486\;
(5) perform a PAB reserve computation \487\; (6) obtain written
notification from each bank with which it maintains a PAB reserve
account that the bank was informed that all cash and/or qualified
securities being held by the bank are being held for the exclusive
benefit of brokers and dealers \488\; (7) enter into a written contract
with a bank with which it maintains its PAB reserve accounts providing
that the cash and/or qualified securities shall at no time be used
directly or indirectly as security for a loan to the broker-dealer by
the bank, and shall be subject to no right, charge, security interest,
lien, or claim of any kind in favor of the bank or any person claiming
through the bank \489\; (8) develop adequate procedures to ensure a
customer for whom a free credit balance is carried is sent a written
statement regarding the customer's free credit balances, including
information regarding the amount due to the customer and that the funds
are payable on demand, prior to using funds arising from free credit
balances in the broker-dealer's operations \490\; (9) obtain the
written affirmative consent of a new customer before including the
customer's free credit balances in a Sweep Program, as well as provide
certain disclosures and notices to all customers with regard to the
broker-dealer's Sweep Program \491\; (10) make and maintain records
documenting its credit, market, and liquidity risk management controls
to assist the broker-dealer in analyzing the risks associated with its
business activities \492\; (11) provide notice to the Commission and
other regulatory authorities if the broker-dealer becomes insolvent
\493\; and (12) provide notice to the Commission and other regulatory
authorities if the broker-dealer's securities borrowed and loaned or
securities repurchase/reverse repurchase activity reaches a certain
threshold or, alternatively, report monthly its securities borrowed and
loan or securities repurchase/reverse repurchase activity to its DEA in
a form acceptable to its DEA.\494\
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\483\ See paragraph (c)(2)(iv)(B) of Rule 15c3-1, as adopted.
\484\ See paragraph (c)(2)(i)(G) to Rule 15c3-1, as adopted.
\485\ See paragraph (a)(16) to Rule 15c3-3, as adopted.
\486\ See paragraph (b)(5) to Rule 15c3-3, as adopted.
\487\ See paragraph (e)(1) and (e)(3) of Rule 15c3-3, as
adopted.
\488\ See paragraph (f) of Rule 15c3-3, as adopted.
\489\ Id.
\490\ See paragraph (j)(1) to Rule 15c3-3, as adopted.
\491\ See paragraph (j)(2) to Rule 15c3-3, as adopted.
\492\ See paragraph (a)(23) to Rule 17a-3 and paragraph (e)(9)
of Rule 17a-4, as adopted.
\493\ See paragraph (b)(1) of Rule 17a-11, as adopted.
\494\ See paragraph (c)(5) to Rule 17a-11, as adopted.
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B. Use of Information
The Commission, its staff, and SROs will use the information
collected under the amendments to Rule 15c3-1 and Rule 15c3-3 to
determine whether the broker-dealer is in compliance with each rule and
to help fulfill their oversight responsibilities. The collections of
information would also help to ensure that broker-dealers are meeting
their obligations under the rule amendments and have any required
policies and procedures in place.
In particular, the record with respect to acting as agent in a
securities loan transaction will assist examiners in verifying that the
broker-dealer is properly accounting for securities loan deficits under
Rule 15c3-1. The records with respect to obtaining DEA approval prior
to withdrawing capital within one year of contribution under Rule 15c3-
1 will assist examiners in determining if a broker-dealer is computing
its net capital accurately with regard to the proper classification of
its capital contributions, and will help to ensure the DEA only
approves capital withdrawals which are appropriate in light of the
firm's current financial condition at the time of the requested
withdrawal. The amendments to Rule 15c3-1 also will facilitate the
monitoring of the financial condition of broker-dealers by the
Commission and its staff, as well as by SROs.
The records with respect to the PAB accounts will assist examiners
in verifying that: (1) A carrying broker-dealer has properly excluded
certain accounts from being treated as PAB accounts by entering into
subordination agreements with particular account holders; (2) a
carrying broker-dealer sent written notices to PAB accountholders to
use their PAB securities; (3) the broker-dealer performed the PAB
reserve computation; and (4) the bank holding the PAB reserve account
agreed to do so free of lien by entering into a written contract with
the broker-dealer.
The records with respect to customer's free credit balances will
assist examiners in verifying that: (1) A carrying broker-dealer has
obtained the written affirmative consent of a new customer before
including a customer's free credit balances in a Sweep Program; (2) a
carrying broker-dealer has provided the required disclosures and
notices to all customers with regard to the broker-dealer's Sweep
Program; and (3) the broker-dealer has maintained adequate procedures
with regard to the use of a customer's free credit balances prior to
using such customer's free credit balances in its operations. The
amendments to Rule 15c3-3 will facilitate the process by which the
Commission, its staff, and SROs monitor how broker-dealers are
fulfilling the customer protection requirements of the rule. The
written affirmative consent, disclosures and notices required to be
provided to customers also will alert customers to the alternatives
available to them with respect to their free credit balances.
The Commission, its staff, and SROs will use the information
collected under the amendments to Rules 17a-3 and 17a-4 to determine
whether the broker-dealer is adhering to its documented credit, market,
and liquidity risk management controls, as well as to evaluate the
effectiveness of these controls.
The Commission, its staff, and SROs will use the information
collected under the amendments to Rule 17a-11 to identify a broker-
dealer experiencing financial difficulty. This information will assist
the Commission and other regulators in promptly taking appropriate
steps to protect custome