Division of Trading and Markets

March 6, 2014 (UPDATED July 1, 2020)

The Division of Trading and Markets (“Division”), U.S. Securities and Exchange Commission (“Commission”), is providing guidance concerning the amendments to certain of the broker-dealer financial responsibility rules that were adopted on July 30, 2013.¹ This guidance represents the views of the staff of the Division of Trading and Markets (“staff”). It is not a rule, regulation, or statement of the Commission. The Commission has neither approved nor disapproved its content. This guidance, like all staff guidance, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person. Additional information is available at: http://www.sec.gov/rules/final/2013/34-70072.pdf; and http://www.sec.gov/info/smallbus/secg/bd-financial-resp-secg.htm.

The staff may update this guidance periodically. Updates will be marked “MODIFIED” or “NEW.”

For Further Information Contact: Michael A. Macchiaroli, Associate Director, at (202) 551-5525; Thomas K. McGowan, Associate Director, at (202) 551-5521; Randall W. Roy, Assistant Director, at (202) 551-5522; Raymond Lombardo, Branch Chief, at (202) 551-5755; Sheila Dombal Swartz, Special Counsel, at (202) 551-5545; or Valentina Minak Deng, Special Counsel, at (202) 551-5778, Office of Financial Responsibility, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, NE, Washington DC 20549-7010.

Background

On July 30, 2013, the Commission amended the net capital, customer protection, books and records, and notification rules for broker-dealers (“amendments to the broker-dealer financial responsibility rules”).² The amendments to the broker-dealer financial responsibility rules were designed to better protect the customers of broker-dealers and enhance the Commission’s ability to monitor and prevent unsound business practices. The amendments to the broker-dealer financial responsibility rules also updated certain financial responsibility requirements and made certain technical amendments.

Responses to Frequently Asked Questions

Effective Dates

Question 1.

What are the effective dates for the amendments to the broker-dealer financial responsibility rules?

Answer 1:

On October 17, 2013, the Commission extended the effective date for certain amendments to the broker-dealer financial responsibility rules.³ Specifically, the effective date for the following amendments was extended from October 21, 2013 to March 3, 2014: (1) all amendments to Rule 15c3-3, with the exception of new paragraph (j)(1); (2) the amendments to Rule 15c3-3a; (3) the amendments to Rule 17a-3; (4) the amendments to Rule 17a-4; and (5) the amendment to paragraph (c)(2)(iv)(E)(2) of Rule 15c3-1. The remaining amendments became effective on October 21, 2013, 60 days after the release’s publication in the Federal Register.

Amendments to Rule 15c3-1

Question 2.

Paragraph (c)(2)(i)(F) of Rule 15c3-1 requires a broker-dealer to subtract from net worth any liability or expense relating to the business of the broker-dealer for which a third party has assumed 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. Do the guidelines set forth in the staff’s July 11, 2003 letter relating to third party expense sharing agreements (“Third Party Expense Letter”)⁴ still apply?

Answer 2:

Yes. The Third Party Expense Letter sets forth nine points concerning the application of the financial responsibility rules when a third party, which may include, but is not limited to, a parent, holding company, or affiliate of a broker-dealer, agrees to assume responsibility for payment of the broker-dealer’s expenses. These nine points are still relevant staff guidance, notwithstanding that they contain 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). For example, the letter contains staff guidance with respect to the records that 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. A broker-dealer may continue to rely on the guidance in the Third Party Expense Letter with respect to these matters in complying with the amendment to paragraph (c)(2)(i)(F) of Rule 15c3-1. A broker-dealer for which FINRA is the designated examining authority (“DEA”) must demonstrate to FINRA that the third party has adequate resources independent of the broker-dealer as set forth in FINRA Regulatory Notice 03-63 (Expense-Sharing Agreements).

Amendments to Rule 15c3-3

Banks Where Special Reserve Deposits May Be Held

Question 3.

Paragraph (e)(5) of Rule 15c3-3 requires a broker-dealer to exclude the total amount of any cash deposited with an affiliated bank when determining whether the broker-dealer maintains the minimum reserve account deposits under Rule 15c3-3. For purposes of paragraph (e)(5) of Rule 15c3-3, is there a definition of the term “affiliated” that should be used when determining whether a bank is “affiliated” with a broker-dealer?

Answer 3:

A bank that meets the definition of “affiliated person” under paragraph (a)(13) of Rule 15c3-3 will be deemed to be “affiliated” for purposes of paragraph (e)(5). Paragraph (a)(13) of Rule 15c3-3 defines an “affiliated person” to include: “[a]ny person who directly or indirectly controls a broker or dealer or any person who is directly or indirectly controlled by or under common control with the broker or dealer. Ownership of 10% or more of the common stock of the relevant entity will be deemed prima facie control of that entity for purposes of [paragraph (a)(13)].”

Allocation of Customers’ Fully Paid and Excess Margin Securities to Short Positions

Question 4.

Paragraph (d)(4) of Rule 15c3-3 requires a broker-dealer to take prompt steps to obtain physical possession or control of a customer’s fully paid and excess margin securities of the same issue and same class as those included on the broker-dealer’s books and records that allocate to a short position for more than 30-calendar days. For purposes of paragraph (d)(4) of Rule 15c3-3, when does the 30-calendar day period begin to run?

Answer 4:

The 30-calendar day period begins to run when a broker-dealer identifies a segregation deficit in fully paid and excess margin securities that allocates to a short position (e.g., when the deficit is created). Paragraph (d)(4) is triggered if the segregation deficit persists for 30 consecutive calendar days without cure. For purposes of aging deficits that began on or prior to March 3, 2014, broker-dealers may consider March 3, 2014 as “Day 1.”

Question 5.

Is a broker-dealer required to buy-in securities to meet the requirements of paragraph (d)(4) of Rule 15c3-3?

Answer 5:

No. Firms are not required to buy-in securities and, instead, may borrow securities to meet the requirements of paragraph (d)(4).

Proprietary Accounts of Broker-Dealers (“PAB”)

Question 6.

Paragraph (b)(5) of Rule 15c3-3 states: “[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.” When must a carrying broker-dealer provide written notice to the account holder that the securities in a PAB account may be used in the ordinary course of the broker-dealer’s securities business? How long must the carrying broker-dealer wait after providing the notice before it can use the PAB account holder’s securities?

Answer 6:

On or after March 3, 2014, a broker-dealer should provide the notice to new PAB account holders at the time a PAB account is opened. On or after March 3, 2014, if a broker-dealer has not yet sent the written notice to a PAB account holder, then the carrying broker-dealer must treat the PAB account holder’s securities in accordance with the possession or control requirements of Rule 15c3-3 until such time as the carrying broker-dealer provides the notice to the account holder and affords the account holder an opportunity to object. Finally, the carrying broker-dealer can rely on notices sent prior to March 3, 2014 for purposes of compliance with paragraph (b)(5) of Rule 15c3-3.

The rule requires the carrying broker-dealer to provide a PAB account holder an opportunity to object to the use of the account holder’s securities. The rule does not specify the period of time a carrying broker-dealer must provide the PAB account holder to object. A period of 15-calendar days from the date the PAB account holder is provided the notice should provide the account holder with a reasonable opportunity to object.

Question 7.

Are the requirements in paragraph (b)(5) of Rule 15c3-3 applicable to all securities carried for a PAB account holder?

Answer 7:

Yes. The possession and control requirements in paragraph (b)(5) are applicable to all securities carried for a PAB account, unless the account holder has not objected to the use of its securities by the carrying broker-dealer. Broker-dealers should treat securities carried for a PAB account as “customer” securities for this purpose, including for determining which securities are fully paid and excess margin securities. The definition of “customer” under paragraph (a)(1) of Rule 15c3-3 should be applied when determining whether to treat securities as customer securities.

Question 8.

If a carrying broker-dealer is using a PAB account holder’s fully paid and excess margin securities under an existing account agreement and, on or after the effective date of the rule, the PAB account holder objects to the use of such securities, what must the carrying broker-dealer do to be in compliance with the possession or control requirements of Rule 15c3-3?

Answer 8.

If a PAB account holder whose fully paid and excess margin securities are being used by the carrying broker-dealer under an existing account agreement objects to the continued use of such securities, the carrying broker-dealer should take immediate steps to retrieve the securities, in accordance with the requirements of paragraph (d) of Rule 15c3-3, and maintain them in accordance with the possession or control requirements of paragraph (b) of Rule 15c3-3.

Treatment of Free Credit Balances Outside a Sweep Program

Question 9.

Paragraph (j)(2)(i) of Rule 15c3-3 provides that a broker-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. For purposes of paragraph (j)(2)(i) of Rule 15c3-3, may a customer orally communicate a specific order, authorization, or draft for a broker-dealer to transfer a free credit balance from a customer’s securities account?

Answer 9:

A customer’s oral communication could meet the requirements of paragraph (j)(2)(i) of Rule 15c3-3 with respect to transferring free credit balances, provided it constitutes a specific order or authorization. In this regard, the communication (for both a one-time transfer and transfers to be made on a continuing basis) should specify the account from which the customer’s cash is to be transferred and the account or institution to which the cash is to be transferred.⁵

Broker-dealers are reminded that, consistent with other Commission financial responsibility rules, they will bear the burden of demonstrating compliance with paragraph (j)(2)(i) of Rule 15c3-3. It may be difficult to demonstrate compliance with the rule if the customer’s consent is not in writing or documented.

Question 10.

Some customers grant control, via a written authorization, over their accounts to an agent or pledgee and order or authorize their broker-dealer to act on orders of the agent or pledgee. Under paragraph (j)(2)(i) of Rule 15c3-3, may the broker-dealer invest or transfer to another account or institution the customer’s free credit balances pursuant to an order from such agent or pledgee?

Answer 10:

Yes. In this circumstance, the broker-dealer can accept an order, authorization, or draft from the agent or pledgee.

Sweep Program Questions

Question 11.

Can a broker-dealer satisfy paragraph (j)(2)(ii)(A)(2) of Rule 15c3-3 by providing a general statement that the broker-dealer “may change the products available under the Sweep Program” upon advance written notice (under paragraph (j)(2)(ii)(B)(3), if applicable), or must the broker-dealer specify all changes it can make upon such notice (i.e., changes to terms and conditions, changing an investment, etc.)?

Answer 11:

A broker-dealer may satisfy paragraph (j)(2)(ii)(A)(2) by providing a general statement that the broker-dealer “may change the products available under the Sweep Program.” However, a broker-dealer also must comply with paragraph (j)(2)(ii)(B)(3) which requires a broker-dealer to provide a customer with written notice at least 30-calendar days before making certain specified changes to its Sweep Program.

Paragraph (j)(2)(ii)(B)(3)(ii) requires that the notice 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. For example, if the broker-dealer changes the money market mutual fund product to which free credit balances are swept, it must notify its customers of these changes in compliance with the requirements of paragraph (j)(2)(ii)(B)(3).

Question 12.

If a FINRA Rule 4311-compliant carrying agreement allocates to the fully disclosed introducing firm responsibility for obtaining written affirmative consent for a customer’s free credit balances to be included in a Sweep Program under paragraph (j)(2)(ii)(A) of Rule 15c3-3, may the carrying firm include a customer’s free credit balances in a Sweep Program based on a representation from the introducing firm that it has obtained the customer’s written affirmative consent?

Answer 12:

Yes. In a fully disclosed carrying arrangement where responsibility for obtaining the written consent is allocated to the introducing broker in compliance with FINRA Rule 4311, the carrying firm may rely on a representation from the introducing broker that the customer has given the introducing broker the required written consent.

Question 13.

New paragraph (j)(2)(ii)(B)(2) of Rule 15c3-3 requires a broker-dealer to provide notice to a 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. Is this requirement inconsistent with money market mutual fund documents that allow the fund a specified period of time to pay redemption proceeds or any applicable rules that would permit money market mutual funds to limit redemptions in certain circumstances?

Answer 13:

No. A broker-dealer that sweeps a customer’s free credit balances to a money market mutual fund must instruct the fund to redeem the customer’s investment when ordered to do so by the customer and, when the broker-dealer receives the proceeds, return them to the customer’s account or remit them to the customer. The redemption itself, however, is subject to the terms and conditions of the money market mutual fund and to applicable law and regulation.

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Note: Broker-dealers also are directed to the Division’s no-action letter to Thomas F. Price, Operations, Technology & BCP, Securities Industry and Financial Markets Association, dated February 26, 2014 regarding conditional temporary relief granted related to paragraph (j)(2)(ii)(A) of Rule 15c3-3.

Bulk Transfer Questions

Question 14.

FINRA Notice to Members (“FINRA NTM”) 02-57 (Bulk Transfer of Customer Accounts) (September 2002) identifies specific situations in which the use of negative response letters by members of FINRA could be appropriate for the bulk transfer of customers’ accounts.⁶ A bulk transfer of customers’ accounts in the identified situations may involve a transfer of free credit balances in the securities accounts of customers at one broker-dealer (“delivering firm”) to another broker-dealer (“receiving firm”), including the transfer of free credit balances that result from the liquidation of products in a Sweep Program (either a money market mutual fund or a bank deposit account that is insured by the Federal Deposit Insurance Corporation (“FDIC”)) offered by the delivering firm that are held in customer accounts at the delivering firm. May a delivering firm that is a member of FINRA transfer free credit balances in the securities accounts of customers to a receiving firm as part of a bulk transfer of accounts in reliance on the guidance provided in FINRA NTM 02-57 (for bulk transfers that occur on or after March 3, 2014) without being deemed in violation of paragraph (j)(2)(i) of Rule 15c3-3?

Answer 14:

Yes, broker-dealers that are FINRA members may continue to rely on the guidance provided in FINRA NTM 02-57 to effect a bulk transfer of customers’ accounts, including the transfer of free credit balances in the securities accounts of customers at the delivering firm to the receiving firm, without being deemed in violation of paragraph (j)(2)(i) of Rule 15c3-3.

Question 15.

Further to Question 14 above, following the bulk transfer of customers’ accounts to a receiving firm in accordance with FINRA NTM 02-57, the receiving firm may immediately invest customers’ free credit balances in products (either a money market mutual fund or an FDIC-insured bank deposit account) offered through a Sweep Program at the receiving firm. In such circumstances, may the receiving firm also rely on the negative response letters that were used to effect the bulk transfer of customers’ accounts as permitted by FINRA NTM 02-57 (for bulk transfers that occur on or after March 3, 2014) without being deemed in violation of paragraph (j)(2)(ii) of Rule 15c3-3?

Answer 15:

Under the circumstances described above, the staff will not object to the receiving firm relying on the negative response letters that were used to effect the bulk transfer of customers’ accounts as permitted by FINRA NTM 02-57 (for bulk transfers that occur on or after March 3, 2014), provided that the negative response letter used to effect the bulk transfer of such accounts, in addition to satisfying the requirements outlined in FINRA NTM 02-57, contains the information and disclosures required by paragraphs (j)(2)(ii)(A)(1) and (2), and (j)(2)(ii)(B)(1) of Rule 15c3-3 and: (1) if the customers’ free credit balances are invested in a different money market mutual fund at the receiving firm than the one available through the Sweep Program of the delivering firm, the negative response letters also must comply with the disclosure and notice requirements of NASD Rule 2510(d)(2); and (2) if the customers’ free credit balances were previously invested in a product (either a money market mutual fund or an FDIC-insured bank deposit account) in the Sweep Program of the delivering firm, the receiving firm must reinvest customers’ free credit balances in a substantially similar product in its Sweep Program to the extent practicable.

Question 16.

NASD Rule 2510(d)(2) provides that FINRA members also may use negative response letters for the bulk exchange at net asset value of money market mutual funds where there is a merger or acquisition of money market mutual funds, provided that (1) the negative response letter contains a tabular comparison of the nature and amount of the fees charged by each fund, (2) 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 (3) the negative response feature will not be activated until at least 30 days after the date on which the letter was mailed. May broker-dealers that are FINRA members continue to rely on NASD Rule 2510(d)(2) when making bulk exchanges at net asset value of money market mutual funds, either outside of a Sweep Program or in a Sweep Program, as a result of a merger or acquisition of the money market mutual funds that occurs on or after March 3, 2014 without being deemed in violation of paragraphs (j)(2)(i) or (ii) of Rule 15c3-3, as applicable?

Answer 16:

Where there is a bulk exchange at net asset value of money market mutual funds, either outside of a Sweep Program or in a Sweep Program, as a result of a merger or acquisition of the money market mutual funds, broker-dealers that are FINRA members may continue to rely on NASD Rule 2510(d)(2) without being deemed in violation of paragraph (j)(2)(i) or (ii) of Rule 15c3-3, provided that, where the bulk exchange involves money market mutual funds in a Sweep Program, the negative response letter used to effect such bulk exchange, in addition to satisfying the requirements of NASD Rule 2510(d)(2), also contains the information required by paragraph (j)(2)(ii)(B)(3) of Rule 15c3-3.

Amendments to Rule 17a-11

Question 17.

New paragraph (c)(5) of Rule 17a-11 establishes new notification requirements for when a broker-dealer’s repurchase and securities lending activities exceed a certain threshold. In lieu of the notification requirement, the final rule provides that a broker-dealer may report monthly its stock loan and repurchase activity to its DEA, in a form acceptable to its DEA. Is new paragraph (c)(5) of Rule 17a-11 intended to include non-cash transactions (collateral-for-collateral) too, or was it just meant to cover cash transactions only (cash-for-collateral)?

Answer 17:

Paragraph (c)(5) of Rule 17a-11 covers only cash (cash-for collateral) transactions. It does not include non-cash (collateral-to-collateral) transactions.

Reserve Formula Computation and Possession or Control

Question 18. (NEW, July 1, 2020)

Is a broker-dealer required to make the daily possession or control determination required by paragraph (d) of Rule 15c3-3 and the customer reserve and PAB reserve account computations required by paragraph (e) of Rule 15c3-3 if the broker-dealer does not meet any of the exemption conditions of paragraph (k) of Rule 15c3-3 (i.e., paragraph (k)(1), (k)(2)(i) or (k)(2)(ii)), but also (1) does not directly or indirectly receive, hold, or otherwise owe funds or securities for or to customers, other than money or other consideration received and promptly transmitted in compliance with paragraph (a) or (b)(2) of Exchange Act Rule 15c2-4; (2) does not carry accounts of or for customers; and (3) does not carry PAB accounts (as defined in Rule 15c3-3) (“Non-Covered Firm”)?

Answer 18: (NEW, July 1, 2020)

No. A Non-Covered Firm is not required to make the daily possession or control determination because the requirement applies only to broker-dealers that carry accounts of or for customers. In addition, a Non-Covered Firm is not required to make the customer reserve or PAB reserve account computations because a broker-dealer is only required to make these computations to the extent it has amounts required to be deposited in the customer reserve account or the PAB reserve account. Only broker-dealers that (1) directly or indirectly receive, hold, or otherwise owe funds or securities for or to customers; (2) carry accounts of or for customers; or (3) carry PAB accounts may have amounts required to be deposited in the customer reserve account or the PAB reserve account.

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¹See Financial Responsibility Rules for Broker-Dealers, Exchange Act Release No. 70072 (July 30, 2013), 78 FR 51824 (Aug. 21, 2013).

²See Financial Responsibility Rules for Broker-Dealers, 78 FR 51824.

³ Order Providing Broker-Dealers a Temporary Exemption from the Requirements of Certain New Amendments to the Financial Responsibility Rules for Broker-Dealers under the Securities Exchange Act of 1934, Exchange Act Release No. 70701 (Oct. 17, 2013), 78 FR 62930 (Oct. 22, 2013), available at http://www.sec.gov/rules/exorders/2013/34-70701.pdf.

⁴ 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), available at http://www.sec.gov/divisions/marketreg/mr-noaction/macchiaroli071103.pdf.

⁵ Broker-dealers are responsible for compliance with the requirements of Rule 17a-3, which requires, among other things, that a broker-dealer make and keep current blotters (or other records of original entry) containing an itemized daily record of all receipts and disbursements of cash and all other debits and credits, as well as ledger accounts itemizing separately as to each margin and cash account of every customer all other debits and credits to such account. See 17 CFR 240.17a-3.

⁶ FINRA NTM 02-57 provides that the use of negative response letters to facilitate the bulk transfer of customer accounts in the specified situations is appropriate, given the potential risks to investors and costs to firms that could result if firms were required to solicit individual transfer instructions from each customer. The bulk transfer of accounts through the use of negative response letters in these situations also helps minimize interruptions to customers’ access to their accounts and the trading markets.

Also, as discussed in FINRA NTM 02-57, a firm seeking to transfer customer accounts using negative response letters is expected to provide account holders, consistent with just and equitable principles of trade under FINRA Rule 2010 (then NASD Rule 2110), with adequate time and information to decide whether to object to the transfer. FINRA NTM 02-57 advises firms seeking to transfer customer accounts using negative response letters as permitted under the NTM to provide each customer with the following information in the negative response letter: (1) a brief description of the circumstances necessitating the transfer; (2) a statement that the customer has the right to object to the transfer; (3) information on how a customer can effectuate a transfer to another firm; (4) a sufficient time period for the customer to respond to the letter (at least 30 days from the receipt of the letter unless exigent circumstances exist that warrant a shorter time period); (5) disclosure of any cost that will be imposed on the customer as a result of the transfer, including costs to the customer if the customer initiates a transfer of the account after the account is moved pursuant to the negative response letter; and (6) a statement regarding the firm’s compliance with SEC Regulation S-P (Privacy of Consumer Financial Information) in connection with the transfer.