United States: SEC Proposes To Amend Broker-Dealer Customer Protection Rule Reserve Account Calculation Requirements

The U.S. Securities and Exchange Commission (SEC) proposed to amend Exchange Act Rule 15c3-3 (the Customer Protection Rule) ¹ on July 12, 2023. If adopted, the proposed amendments would increase the frequency with which certain "carrying broker-dealers" compute their customer and broker-dealer proprietary reserve account requirements and make deposits into those accounts. The comment period ends on September 11, 2023.

The Customer Protection Rule

The Customer Protection Rule is designed to help safeguard customer securities and funds held by a broker-dealer, prevent investor loss or harm in the wake of a broker-dealer's failure, and improve the SEC's ability to monitor broker-dealer business practices. To achieve this objective, carrying broker-dealers must segregate customer securities and funds from the carrying broker-dealer's proprietary business activities. Specifically, the Customer Protection Rule requires that carrying broker-dealers: (1) maintain physical possession or control over customers' fully paid and excess margin securities, and (2) have special reserve accounts at a bank to hold cash and/or qualified securities in an amount determined by a computation of the net cash owed to the carrying broker-dealer's customers (reserve computation).² If a customer's credit items exceed their debit items, the net amount must be deposited in the customer reserve bank account in the form of cash and/or qualified securities.³ While broker-dealers are generally not considered customers under the Customer Protection Rule, carrying broker-dealers are required to maintain separate special reserve accounts for the proprietary securities accounts of its broker-dealer clients (PAB accounts).

Currently, the Customer Protection Rule requires that a carrying broker-dealer compute its customer and PAB account reserve requirements and make any required deposits into its reserve bank accounts on a weekly basis. This frequency, however, may result in large intra-week mismatches between the customer or PAB reserve bank account balances and actual net cash owed to customers or PAB account holders.⁴ According to the SEC, "[t]his mismatch poses a risk to the carrying broker-dealer's customers and PAB account holders that the carrying broker-dealer could fail financially and be unable to return all the securities and cash owed to the customers and PAB account holders."⁵

Proposed Amendments

The SEC is proposing to increase the frequency of reserve account computations from weekly to daily for certain carrying broker-dealers with large total credits.⁶ Specifically, the proposed amendments would require the following:

• A carrying broker-dealer with average total credits equal to or greater than $250 million to compute its customer and PAB account reserve requirements daily, as of the close of the previous business day.
• Any cash and/or securities that are required to be deposited into customer and PAB reserve accounts must be deposited no later than one hour after the opening of banking business on the following business day.
• A carrying broker-dealer's average total credits is based on the total credits reported in a carrying broker-dealer's customer and PAB reserve computations in its 12 most recently filed month-end FOCUS reports.
• A carrying broker-dealer must comply with the daily computation requirement no later than six months after having exceeded the $250 million threshold.
• If a carrying broker-dealer's average total credits subsequently falls below the $250 million threshold, the carrying broker-dealer must continue performing daily computations and provide written notification to its designated examining authority of its election to perform weekly computations 60 days before reverting to weekly computations.

The SEC believes that the proposed amendments will help safeguard customers and PAB account holders by reducing the potential for large mismatches to build over time and increasing the likelihood that customers and PAB account holders will be made whole if a broker-dealer fails. In addition to protecting customers and PAB account holders, the proposed amendments may "reduce the risk of disorderly liquidation and unnecessary withdrawals" from SIPC.⁷ Almost all registered broker-dealers are SIPC members.⁸ If a broker-dealer fails and does not have sufficient funds to satisfy customer claims, SIPC will oversee the liquidation of the broker-dealer.⁹

Reserve Account Requirements for Security-Based Swaps (SBSs)

The SEC is also soliciting comments regarding whether the security-based swap customer reserve computation and deposit requirements should be daily rather than weekly.¹⁰ Broker-dealers and security-based swap dealers (SBSDs) are required to segregate customer money, securities, and property related to SBSs.¹¹ Pursuant to the SBS segregation requirements, broker-dealers and SBSDs must perform separate weekly SBS customer reserve account computations and hold the net amount of cash owed to SBS customers in segregated accounts. The SEC, however, is not proposing to alter the existing SBS segregation requirements because "amending Rule 15c3-3 to require a daily security-based swap customer reserve computation for broker-dealers, including those also registered as SBSDs, would have virtually no impact because the credits related to security-based swap activity for security-based swap customers generally are being included in the customer reserve computation."¹² The proposing release also notes that SBSDs registered with the SEC that are not dually registered as broker-dealers (other than as OTC derivatives dealers) operate pursuant to an exemption from the SEC's SBS segregation rule and are not required to have an SBS customer reserve account.¹³

Conclusion

If the proposed amendments to the Customer Protection Rule are adopted, approximately 63 carrying broker-dealers would be required to perform the daily customer reserve account computation.¹⁴ According to the proposing release, 11 carrying broker-dealers already elect to compute their reserve account requirements on a daily basis.¹⁵ Therefore, approximately 52 carrying broker-dealers would need to change the frequency with which they calculate their customer and PAB account reserve requirements.¹⁶ This group of carrying broker-dealers could experience increased costs related to operational changes, staff increases, upgrades necessary for daily computing, and related record-keeping requirements.¹⁷ Carrying broker-dealers that currently have total credits close to or exceeding the proposed $250 million threshold should consider the impact the proposed amendments could have on their business practices. Please contact experienced securities regulatory counsel with any questions about these developments.

Footnotes

1. See Daily Computation of Customer and Broker-Dealer Reserve Requirements under the Broker-Dealer Customer Protection Rule, Exchange Act Release No. 34-97877, (July12, 2023) ("Proposing Release").

2. 17 C.F.R. 240.15c3-3(b)-(e).

3. See Proposing Release at 8-10.

4. According to 2022 FOCUS data, the largest required additional deposit into customer reserve bank accounts of carrying broker-dealers ranged from $1.6 billion to over $6.0 billion following the customer reserve computation. The largest required additional deposits carrying broker dealers PAB reserve bank accounts ranged from approximately $350 million to over $4.0 billion. See Proposing Release at 23.

5. See Proposing Release at 21-22.

6. Id. at 26-32.

7. See Statement on Proposed Amendments to Exchange Act Rule 15c3-3, Commissioner Hester M. Peirce, (July 12, 2023) (available here)

8. See Proposing Release at 16, note 40 ("With some limited exceptions set forth in SIPA, all registered broker-dealers are SIPC members. 15 U.S.C. 78ccc(a)(2)).

9. See Id. at 16.

10. Id. at 38-40.

11. See Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major-Security-Based Swap Participants and Capital and Segregation Requirements for Broker-Dealers, Exchange Act Release No. 86175 (June 21, 2019), 84 FR 43872, 43930-43 (Aug. 22, 2019).

12. See Proposing Release at 40.

13. Id.

14. According to 2022 FOCUS data, 63 carrying broker-dealers exceeded the proposed $250 Million threshold.

15. See Proposing Release at 25.

16. Rule 15c3-3 currently permits carrying broker-dealers to perform the reserve computation on a daily basis, and in limited circumstances to perform monthly computations.

17. See Proposing Release at 61.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.