Statement on Daily Computation of Customer and Broker-Dealer Reserve Requirements under an Amended Broker-Dealer Customer Protection Rule

Under the Broker-Dealer Customer Protection Rule, carrying broker-dealers—i.e., those broker-dealers that maintain custody of customer securities and cash—must have a special reserve bank account that holds “qualified securities” and/or cash in an amount determined by a weekly computation.[1]  The idea is that if the broker-dealer fails, the securities and cash it holds for customers can be promptly returned.[2]  A firm must hold an amount of cash or U.S. Treasury securities in the reserve account equal in value to the net amount of cash owed to customers, which is the amount by which total cash owed to customers (e.g., cash balances in securities accounts) exceeds total amount of cash customers owed to the broker-dealer (such as through margin loans to customers).[3]  On July 12, 2023, the Commission proposed to amend this rule to require certain broker-dealers to compute their customer and reserve deposit requirements, and make any required deposits into their reserve accounts on a daily basis rather than a weekly basis.[4]

There were some modifications to the final amendments in response to public comments, such as increasing the threshold for application of the daily calculation requirement from an average total credits of $250 million to $500 million and reducing the 3% aggregate debit items charge that certain carrying broker-dealers must take in performing a customer reserve computation to 2% when they perform a daily customer reserve computation.[5]  However, the final amendments do not adequately address a number of thoughtful public comments on the proposal and appropriately consider the trade-offs between costs and benefits.  In my view, the Commission has not yet fully explored potentially more cost-effective means of achieving the sought-after risk amelioration.  Indeed, many sensible suggestions in the public comment file appear to have been brushed aside in an attempt to rush it across the finish line.  By failing to address these concerns, these final amendments may do more harm than good.  As one commenter opined, “the Commission has gravely underestimated the staffing and time that will be needed in order to transition to daily calculations and deposits”.[6]

Our markets are characterized by different types of broker-dealer business models, some of which present greater risk than others in terms of customer protection concerns.  The amended rule could have been more narrowly targeted to those riskier business models.  For example, the final amendments could have utilized a hybrid calculation that included both average total credits and the broker-dealer’s overall net credit position as thresholds.  One comment letter suggested, in addition to the total credit threshold, that an “average excess of credits over debits of at least $10 million or more” across the previous year would be also required as a threshold.[7]  Such ideas are worthy of further consideration before proceeding with the final amendments as is.

In the adopting release, the Commission appears to have looked past many suggestions from commentators that might potentially lower cost while still reducing risk.  These suggestions include: (1) permitting the calculation and adjustments to be omitted on days in which markets close early;[8] (2) permitting a broker-dealer to not conduct the calculation on given days if there are disruptions beyond the control of the broker-dealer that affect the execution of the calculation so long as the broker-dealer informs and works with their designated regulatory authority,[9] and (3) codifying and simplifying “previous guidance making clear that firms need not deposit or maintain in special reserve bank accounts customer inflows that firms deposit into sweep programs or special reserve bank accounts on a same or next day basis.”[10]  There may be unintended negative consequences to the market as a result of ignoring the opportunity to further explore these alternatives.  For example, in the third suggestion above—what might be labelled the “cash in motion issue”—the danger is that, as one commenter described it, “firms might limit business with clients whose transactions involve large transitory credits, leading to a situation where only the largest firms (with substantial liquidity) can handle ultra-high net worth clients with large transitory credits … creat[ing] an anti-competitive landscape.”[11]  The Commission has a statutory obligation to take a close look at such possible anti-competitive effects.[12]

The adoption of the final amendments has been rushed in an apparent attempt to be promulgated prior to the end of the Biden Administration.  A rushed rulemaking process can be particularly troubling when the proposed rules, like those being considered today, involve a more nuanced and less obvious balance of costs against speculative benefits.  The Commission should have taken the additional time to consider comments, gather evidence and data, and interact with the public.  However, the Commission is not proceeding in that fashion and may end up leaving yet another mess for its successors to clean up.  Therefore, I dissent.