SEC Amends Capital and Custody Rules for Broker-Dealers (with Lofchie Coment)
The SEC has adopted amendments to the net capital, customer protection, books and records, and notification rules for broker-dealers promulgated under the Exchange Act.The amendments (commonly called the "Onig Amendments" in the industry, named after one of the SEC staffers who had been heavily involved in their initial development when they were first proposed in 2007) are designed to address areas of concern regarding financial responsibility requirements for broker-dealers, including updating the requirements and enhancing the SEC's ability to monitor business practices. The rule amendments were approved by a unanimous Commission vote and will become effective 60 days after their publication in the Federal Register.
The principal amendments are as follows:
- An SEC-registered broker-dealer is required to treat the accounts of ALL broker-dealers (both U.S. and foreign) in a manner similar to the way it treats ordinary customer accounts, unless the broker-dealer whose account it carries agrees that its account can be "subordinated to the claims of creditors of the carrying broker-dealer." Note that this requirement is broader than the one that applies under the so-called PAIB letter in that it will govern the treatment of non-U.S. broker-dealers. When the new rule comes into effect, the PAIB letter will be withdrawn. (For background on the PAIB letter, see theCustody Chapter of the Broker-Dealer Guide.)
- Customer reserves (including reserves held for other brokers) can NOT be held in CASH at a bank affiliated with the broker-dealer. A broker-dealer can continue to maintain securities, including "qualified securities" held in lieu of cash, at an affiliated bank.
- Certain additional buy-in requirements that prevent a customer's long positions from being allocated against a firm's short positions.
- The new rule imposes additional customer consent requirements in regard to sweeps of customer cash.
- The amendments make clear that customer assets held in futures accounts are governed by the rules of the CFTC and are not protected by SIPA. Conversely, the SEC also made clear that security futures held in a securities account are protected by SIPA and that a broker-dealer's deposits of margin at a futures clearing agency reduce its obligations to segregate cash on behalf of customers.
- The amendments expand the types of "qualified securities" (that a broker-dealer can segregate on behalf of customers rather than segregating cash) to include certain money market funds.
- Broker-dealers that have "highly leveraged" securities lending and repo businesses (other than those relating to U.S. government securities) are required to identify themselves to the SEC.
- Broker-dealers are required to document their procedures to manage "market, credit, and liquidity risk". (Small broker-dealers are not subject to this requirement.)
- The rule formalizes the limitations on broker-dealers that treat some of their liabilities as being that of their affiliates for purposes of determining their capital requirements. According to the release, these formal requirements are generally similar to the informal staff guidance that currently applies. (See the discussion of "Expenses Paid by a Third Party" in the Capital Chapter of the Broker-Dealer Guide.)
- The rule imposes limitations on a broker-dealer treating as "equity" any investment in the broker-dealer that may be withdrawn in less than one year.
- The rule generally expands the authority of the SEC to limit capital withdrawals from a broker-dealer.
Lofchie Comment: For the most part, these amendments had been expected by the industry. Some are extensions or affirmations of existing SEC staff positions. That is not to say that all of them have been implemented or are ready to be implemented. Certain of the new requirements will require technology changes and revisions to customer or broker-dealer agreements. Firms may be hard pressed to complete these revisions within the time schedule (particularly given everything else that must be done to comply with Dodd-Frank).In addition, many firms do use affiliated banks to hold customers' cash. The ban on holding cash at affiliated banks is a significant rule change.