SEC Allows BD to Use Modified Securities Count Framework for "Capital Balance Funds"
Commentary by Steven Lofchie
The SEC Division of Trading and Markets ("Division") permitted a broker-dealer to use a modified securities count framework for "capital balance funds" that reports ownership by dollar value rather than by number of shares.
In a no-action letter, the Division said that the relief responds to the unique characteristics of "capital balance funds," a type of uncertificated alternative investment where ownership is recorded solely as a total dollar value—representing the customer's ending capital account balance in the fund—rather than as a specific number of shares or units owned. The Division said granting the relief addresses the practical challenges arising when issuers provide position statements in arrears due to valuation delays, provided the broker-dealer operates under specific protocols, including: (i) recognizing that ownership in these funds is expressed purely as a dollar-denominated capital balance and (ii) addressing the impracticability of complying with standard seven-day reconciliation timeframes when statements are received months after the fact.
The Division required that certain safeguards be met, including: (i) "maintain[ing] a record [of the] position statement reporting schedule for each ... issuer," (ii) promptly requesting explanations from issuers for any reporting delays, (iii) comparing and reconciling position statements "within five business days of receipt" to update customer records, (iv) "identify[ing] on customer statements the last known value reported" and the date of that report, and (v) including a disclosure that the value is based on issuer information that "may not be currently priced [or] realized" upon liquidation.
Under the no-action position, the Division said that it would not recommend enforcement action against the broker-dealer under Rule 17a-13 ("Quarterly security counts to be made by certain exchange members, brokers, and dealers") regarding the failure to record unresolved differences within seven business days of a securities count, provided the relief is applied only to capital balance funds denominated in dollars where the issuer commits to providing value statements at least quarterly.
Commentary
Note that the relief given applies to the conduct of securities counts, an internal audit function. It does not directly address the sending of statements to customers, which is pursuant to FINRA, not SEC, rules. Presumably, FINRA has also signed off on the procedures.