SEC Grants Limited Exemptive Relief to Broker-Dealer for Custody Rule

Steven Lofchie Commentary by Steven Lofchie

The SEC Division of Trading and Markets (the "Division") granted limited exemptive relief to a broker-dealer from the custodial requirements of Exchange Act Rule 15c3-3 (the "custody rule") with respect to the custody of cash held in connection with the coordinated sale of mutual fund purchases and whole life insurance policies.

The relief came in response to a request from NIS Financial Services ("NIS") and its affiliate, Ozark National Life ("Ozark"). NIS asked the Division not to recommend an SEC enforcement action based on the broker-dealer's reliance on the Exchange Act Rule 15c3-3(k)(1) exemption from the requirements of the custody rule. To rely on the exemption, a broker-dealer must, inter alia, "promptly transmit" customer funds and securities (the SEC interprets this requirement to mean that broker-dealers must transmit securities and funds no later than noon of the business day after the receipt of such funds or securities).

According to the request for relief, NIS, acting through Ozark in its capacity as the processing agent for NIS, may rely on the Rule 15c3-3(k)(1) exemption in connection with the sale of mutual fund shares to customers regardless of the requirement to "promptly transmit" customer funds. This exemption applies in the following three scenarios:

  • if a customer mutual fund account has not yet reached the minimum investment balance required by the applicable mutual fund;

  • if a customer's check has not been cleared yet through normal banking cycles by the appropriate financial institution; and

  • if mutual fund transactions could not be processed because NIS was removed as the broker-dealer on a customer account.

The Division agreed to grant the request for exemptive relief as long as NIS (i) delivers certain disclosures to customers, (ii) returns funds to customers in the event the funds cannot be processed because a customer has removed NIS as the broker-dealer for its account, and (iii) maintains a "special reserve account" for the purpose of protecting customer funds that must hold an amount of funds equal to the funds not "promptly transmitted," plus a safety margin of approximately $200,000 in excess of such funds held in suspense.

Commentary

The relief goes to the procedures associated with the custody rule (for example, the procedures to release assets from the reserve account), as opposed to the substantive requirement to segregate customer assets.

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