Customer Protection Rule Initiative
Division of Trading and Markets and Division of Enforcement
U.S. Securities and Exchange Commission
The Customer Protection Rule Initiative (“CPR Initiative”) is intended to address historical or ongoing violations of Section 15(c)(3) of the Securities Exchange Act of 1934 and Rule 15c3-3 thereunder.
As described below, under the CPR Initiative, broker-dealers that have failed to comply with the Customer Protection Rule may self-report to the Division of Trading and Markets and the Division of Enforcement of the U.S. Securities and Exchange Commission (the “Commission”). If an enforcement action is warranted, the Division of Enforcement will recommend favorable settlement terms for self-reporting broker-dealers.
The Customer Protection Rule seeks to avoid, in the event of a broker-dealer failure, a delay in returning customer securities or worse, a shortfall in which customers are not made whole, by requiring broker-dealers to safeguard both the cash and securities of their customers. Its requirements work to achieve this objective by “eliminat[ing] the use by broker-dealers of customer funds and securities to finance firm overhead and such firm activities as trading and underwriting through the separation of customer related activities from other broker-dealer operations.” Rule 15c3-3 Adopting Release, Exch. Rel. No. 9775, 1972 WL 125434, at *1 (Sept. 14, 1972).
For customer cash, Rule 15c3-3(e) requires a broker-dealer to maintain a reserve of funds or qualified securities in an account at a bank that is at least equal in value to the net cash owed to customers. The amount of net cash owed to customers is computed pursuant to a formula contained in Exhibit A to Rule 15c3-3. While the formula itself is somewhat complex, it embodies a simple concept for the responsible stewardship of customer cash: if a broker-dealer owes more to its customers than its customers owe to it, the broker-dealer must set aside at least an amount equal to that difference so that it is readily available to repay customers.
As stated by the Commission staff and reiterated by the Commission in its Order Instituting Proceedings against Merrill Lynch for unprecedented violations of the Customer Protection Rule, any “device, window dressing or restructuring of transactions made solely to reduce an excess of credits over debits in the Rule 15c3-3 formula computation and not otherwise a normal business transaction” may be considered a circumvention of the Rule.
The Rule also requires a broker-dealer to maintain physical possession or control over customers’ fully paid and excess margin securities. Physical possession or control generally means that the broker-dealer must hold these securities in one of several locations specified in the Rule and that they be held free of liens or any other interest that could be exercised by a third-party to secure an obligation of the broker-dealer. Rule 15c3-3(c).
Broker-dealers are required to provide accurate information to the SEC on their compliance with Rule 15c3-3 and are required to self-report certain failures to comply or material weaknesses in controls that hinder a broker-dealer’s efforts at compliance. If a broker-dealer fails to maintain the minimum required amount in its customer reserve account, Rule 15c3-3(i) states that the broker-dealer must immediately notify the Commission and FINRA of this failure. Rules promulgated under Section 17(a)(1) of the Exchange Act impose additional reporting requirements.
The significant relief imposed in the Merrill Lynch Order reflects the seriousness with which the Commission views failures to comply with Rule 15c3-3’s provisions.
During the Financial Crisis, compliance with the Customer Protection Rule played a critical role in the orderly liquidation of Lehman Brothers. Compliance with Rule 15c3-3 served to protect customer assets and facilitate their prompt return to customers. Given the substantial risks posed to broker-dealer customers and to the industry generally by failures to comply with the Customer Protection Rule, the Division of Trading and Markets and the Division of Enforcement seek to incentivize broker-dealers to examine their adherence to the Customer Protection Rule’s requirements to ensure there is robust compliance.
III. CPR Initiative
A. Who Should Consider Self-Reporting?
Broker-dealers with any historical or ongoing instances of noncompliance with Rule 15c3-3 should consider participating in the CPR Initiative by self-reporting.
In conjunction with the CPR Initiative, the Division of Enforcement, in coordination with the Division of Trading and Markets and the Office of Compliance Inspections and Examinations, will be conducting a risk-based sweep of certain broker-dealers that will seek documents and data from those broker-dealers for the purpose of assessing their compliance with the Customer Protection Rule. After the Commission staff reviews the information provided by each firm in response to the sweep, the staff will consider whether additional information is necessary to ensure the firm’s compliance with the Rule, including whether to schedule an examination of the firm or to initiate an Enforcement investigation.
Broker-dealers that have already been contacted by the Division of Enforcement, either as part of the risk-based sweep or otherwise, regarding possible past or continuing noncompliance with Rule 15c3-3, but against which no enforcement action has yet been taken, may still be eligible for the CPR Initiative and should contact the Enforcement staff to discuss eligibility.
B. When and What Should Broker-Dealers Self Report?
To be eligible for the CPR Initiative, a broker-dealer must self-report to the Division of Trading and Markets and the Division of Enforcement by accurately providing the following information by November 1, 2016:
- Name of the broker-dealer;
- Provision of Rule 15c3-3 implicated in the self-report;
- The period during which the noncompliance has occurred and whether it is ongoing;
- Description of the possible noncompliance;
- Amount of customer cash and/or customer securities implicated in possible noncompliance;
- Remedial efforts, if any, undertaken to address possible noncompliance; and
- Any other facts that the self-reporting entity would like to provide to assist the staff in understanding the circumstances that may have led to the possible noncompliance.
Submissions may be made by email to CPRInitiative@sec.gov.
Self-reporting as part of the CPR Initiative does not satisfy any existing self-reporting requirements under the Exchange Act. Broker-dealers must fulfill those requirements separately.
C. Process for Reviewing Self-Reports
The Division of Trading and Markets and the Division of Enforcement will jointly review the submissions received. These Divisions, in coordination with the Office of Compliance Inspections and Examinations, will assess the submissions, consult with the broker-dealers, and determine appropriate responses. If there appears to be noncompliance with the Customer Protection Rule, this response may take the form of guidance from the Division of Trading and Markets, an examination of the firm by the Office of Compliance Inspections and Examinations, or an investigation by the Division of Enforcement.
D. Favorable Settlement Terms the Division of Enforcement Will Recommend
If the Division of Enforcement decides to recommend enforcement action for any violation reported, it will recommend that the Commission accept a settlement pursuant to which the broker-dealer consents to the institution of a cease-and-desist proceeding. The recommendation will include the following terms:
- The broker-dealer neither admits nor denies the findings of the Commission.
- The Commission finds that the broker-dealer violated Rule 15c3-3 and any applicable books and records and reporting charges.
- The broker-dealer undertakes to (i) establish appropriate policies and procedures and training, (ii) cooperate with any subsequent investigation concerning the violation, including the roles of individuals and other parties, and (iii) if warranted, retain an independent consultant to conduct a compliance review.
- The broker-dealer will pay disgorgement of any ill-gotten gains and penalties. Meaningful cooperation credit, including in the form of reduced penalties, will be given.
E. No Assurances Offered with Respect to Individual Liability
The CPR Initiative covers only broker-dealers. The Division of Enforcement provides no assurance that individuals associated with those entities will be offered similar terms if they have engaged in violations of the federal securities laws. The Division of Enforcement may recommend an enforcement action against such individuals and may seek remedies beyond those available through the CPR Initiative. Assessing whether to recommend an enforcement action against an individual for violations of the federal securities laws necessarily involves a case-by-case assessment of specific facts and circumstances, including evidence regarding the level of intent and other factors such as cooperation by the individual.
F. No Assurances for Entities That Do Not Take Advantage of CPR Initiative
For broker-dealers that would be eligible for the terms of the CPR Initiative but that do not self-report pursuant to the terms of the CPR Initiative, the Division of Enforcement offers no assurances that it will recommend the above terms in any subsequent enforcement recommendation. As noted above, assessing whether to recommend enforcement action necessarily involves a case-by-case assessment of specific facts and circumstances, but entities are cautioned that enforcement actions outside of the CPR initiative could result in the Division of Enforcement or the Commission seeking remedies beyond those described in the initiative.
Questions regarding the CPR Initiative may be directed to CPRInquiries@sec.gov.
 Rule 17a-5(a) requires broker-dealers to file monthly Financial and Operational Combined Uniform Single (“FOCUS”) Reports concerning, among other things, customer reserve account requirements and the proper segregation of customer securities. Rule 17a-5(d)(3)(i)(B) requires broker-dealers to annually file compliance reports that contain a description of “each material weakness in the Internal Control Over Compliance” of the broker-dealers, and Rule 17a-11(e) requires a broker-dealer to notify the SEC when it learns of a material weakness that could result in a Rule 15c3-3 violation. Rule 17a-5(d)(2)(ii) requires a broker-dealer to file supporting schedules to its annual financial reports and FOCUS Reports related to the Rule 15c3-3 possession and control requirements.