The US Securities and Exchange Commission proposed changes to the Customer Protection Rule, which would impact about 63 carrying broker-dealers and potentially require more frequent deposits into customer and PAB reserve bank accounts.

The Securities and Exchange Commission (SEC) on July 12 proposed amendments to Rule 15c3-3 under the Securities Exchange Act of 1934 to require certain broker-dealers to increase the frequency with which they perform computations of the net cash they owe to customers and other broker-dealers from weekly to daily (Proposal). The Proposal would apply to carrying broker-dealers with average total credits (the amount of cash they owe customers and PAB account holders) equal to or greater than $250 million.

The public comment period will remain open for 60 days following publication of Proposal the SEC website or 30 days following publication in the Federal Register, whichever period is longer.

KEY TAKEAWAYS

• The Proposal requires a carrying broker-dealer with average total credits that are equal to or greater than $250 million to make a daily customer and PAB reserve calculations.
• Average total credits would be defined as the arithmetic mean of the sum of total credits in the customer reserve computation and PAB reserve computation reported in the 12 most recently filed month-end FOCUS Reports.
• Any required deposits would have to be made no later than one hour after the opening of banking business on the second following business day.
• Broker-dealers would have to start daily calculations six months after reaching $250 million in average total credits.
• A daily computing broker-dealer falling below $250 million in average total credits can revert to weekly computations after notifying its designated examining authority and waiting 60 days.

BACKGROUND

Rule 15c3-3—the Customer Protection Rule—protects customer cash and securities through two requirements: the cash reserve requirement and the possession or control requirement.

The first step, the possession or control requirement, requires broker-dealers to promptly obtain and maintain the physical possession or control of all fully paid and excess margin customer securities.

The second step, the cash reserve requirement, requires carrying broker-dealers to segregate all customer cash or money obtained from the use of customer property that has not been used to finance transactions of other customers.

This step further requires that a carrying broker-dealer maintain a reserve of cash or qualified securities in an account at a bank that is at least equal in value to the net cash owed to customers, including cash obtained from the use of customer securities. The account must be titled “Special Reserve Bank Account for the Exclusive Benefit of Customers.” The amount of net cash owed to customers is computed pursuant to a formula set forth in Rule 15c3-3a. Under that formula, the broker-dealer adds up customer credit items (e.g., cash in customer securities accounts and cash obtained through the use of customer margin securities) and then subtracts from that amount customer debit items (e.g., margin loans).

If credit items exceed debit items, the net amount must be on deposit in the customer reserve account in the form of cash and/or qualified securities. A carrying broker-dealer cannot make a withdrawal from the customer reserve account until the next computation and then only if the computation shows that the reserve requirement has decreased.

The carrying broker-dealer must make a deposit into the customer reserve bank account by 10:00 am of the second business day following the “as of” date of the new computation if the computation shows that the amount required to be on deposit in the customer reserve bank account is greater than the amount currently on deposit in the account.

If the computation shows the amount required to be on deposit in the customer reserve bank account is less than the amount currently on deposit in the account, the carrying broker-dealer can withdraw the difference.

A carrying broker-dealer also is required to make and maintain a record of each computation and permitted to offset customer credit items only with customer debit items.

PAB ACCOUNTS

Carrying broker-dealers also may carry PAB accounts—that is, accounts that hold proprietary securities and cash of other broker-dealers. Because broker-dealers are entitled to a pro rata share of customer property under the Securities Investor Protection Act of 1970, Rules 15c3-3 and 15c3-3a require carrying broker-dealers to

1. perform a separate reserve computation for PAB accounts (PAB reserve computation);
2. establish and fund a separate bank account titled “Special Reserve Bank Account for Brokers and Dealers” (PAB reserve bank account); and
3. obtain and maintain physical possession or control of non-margin securities carried for a PAB account holder unless the carrying broker-dealer has provided written notice to the PAB account holder that it may use those securities in the ordinary course of its securities business, and has provided opportunity for the PAB account holder to object to such use.

The amount of net cash owed to PAB account holders is computed weekly as of the close of the last business day of the week.

REASONS FOR PROPOSED AMENDMENTS

The SEC is proposing amendments to Rule 15c3-3 to address a mismatch risk in funds owed and funds reserved under the rule. To illustrate the issue, the SEC noted that under a weekly computation schedule, carrying broker-dealers receive customer- and PAB-related cash inflows and that cash credited to customers and PAB account holders often is quickly reinvested into other instruments and/or subject to a sweep program (whether bank sweep or money market fund sweep).

These outflows generally reduce the amount of cash and/or qualified securities the broker-dealer needs to deposit into the customer or PAB reserve bank account. However, the SEC notes that carrying broker-dealers may also receive large cash inflows that are not deployed for or on behalf of the customers or PAB account holders prior to the next required customer and PAB reserve computations and deposits into the customer and PAB reserve bank accounts.

The SEC states that this may result in the value of the cash and/or qualified securities in the customer and PAB reserve bank accounts not equaling the net cash owed to customers and PAB account holders for a period of time.

This mismatch, according to the SEC, poses a risk to the carrying broker-dealer’s customers and PAB account holders if the carrying broker-dealer fails financially because it may be unable to meet its obligations to customers and PAB account holders.

PROPOSED AMENDMENTS

To address this mismatch, the SEC would amend Rule 15c3-3 to add paragraph (e)(3)(i)(B) to the rule. In summary, the Proposal would implement the following:

• Daily Calculation: A carrying broker-dealer with average total credits that are equal to or greater than $250 million must make the computation necessary to determine the amounts required to be deposited in the customer and PAB reserve bank accounts daily as of the close of the previous business day.
• Deposit Requirement: Any required deposit would have to be made no later than one hour after the opening of banking business on the second following business day.
• Average Total Credits: Average total credits would be defined as the arithmetic mean of the sum of total credits in the customer reserve computation and PAB reserve computation reported in the 12 most recently filed month-end FOCUS Reports ($250 Million Threshold).
  • By way of example, a carrying broker-dealer performing the computation on Tuesday as of the close of business on Monday, would be required to make the deposit on Wednesday, assuming all three days are business days. On Wednesday, the carrying broker-dealer would perform the computation as of the close of business Tuesday and be required to make the deposit on Thursday (assuming Thursday is a business day).
  • Based on regulatory filings for the period of January 2022 through December 2022, the $250 Million Threshold would apply the proposed daily computation requirement to approximately 63 carrying broker-dealers.
• Timeline: A carrying broker-dealer must comply with the daily computation requirement for the customer and PAB reserve bank accounts no later than six months after having average total credits that equal or are greater than $250 million.
• Falling Below the $250 Million Threshold: Once a carrying broker-dealer begins to perform daily customer and PAB reserve computations, it would have to continue performing daily computations for at least 60 days after it falls below the $250 Million Threshold. A carrying broker-dealer performing daily computations, whose average total credits falls below the $250 Million Threshold, could elect to perform weekly computations by notifying its designated examining authority in writing, but would then need to wait 60 calendar days after this notification before it could switch to performing weekly computations.
• Reaching the $250 Million Threshold Again: If a carrying broker-dealer that provided the 60-day notice reverts to a weekly (rather than daily) customer and PAB reserve computation and subsequently exceeds the $250 Million Threshold once again, the Proposal would require the carrying broker-dealer to comply with the daily computation requirement no later than six months after having average total credits equal to or greater than $250 million.

OBSERVATIONS

While a number of broker-dealers already calculate their customer reserve and PAB reserve account computation requirement on a daily basis, a number of firms that would fall under the Proposal would have to undergo significant systems upgrades in order to meet the daily calculation requirements.

In addition, the potential increase in daily inflows and outflows of cash and qualified securities between broker-dealers and banks could further operational implications that may need more vetting.

In this respect, while supportive of the Proposal because of its narrow and tailored approach, Commissioner Peirce did highlight that the Proposal “urges commenters to review the Treasury clearing proposal to determine whether it is relevant to their comments on this release.”

To this end, she asks why that proposal is not being reopened and whether the proposed Rule 15c3-3 changes are likely not to have an effect on that clearing proposal. In any event, while the Proposal may not seem overtly controversial or complicated, there will be a back office operational build required of broker-dealers, and a relatively short time frame to build out the necessary systems when the $250 Million Threshold is met.

[View source.]