SEC customer classification

The SEC requires broker dealers to adhere to strict financial responsibility rules. These rules include the customer protection rule 15c3-3 and the net capital rule 15c3-1. The net capital rules have always been part of the Securities Exchange Act of 1934 and require broker-dealers to maintain a minimum level of financial solvency.  The more complex the broker-dealers’ business is, the greater the financial requirements imposed upon the broker-dealer. For example, a general securities broker-dealer carrying customer accounts has a minimum financial requirement of $250,000. While an introducing broker dealer has a minimum Financial requirement of $50,000. A general securities broker-dealer must clearly define the difference between customers who are retail customers and  introducing broker dealers or correspondent broker-dealers who use the services of the general securities broker-dealer to provide custody and other services to their clients.

The Customer Protection Rule attempts to align the definition of “customer” in Rule 15c3-3, which excludes broker-dealers, with the definition of “customer” under the Securities Investor Protection Act, which includes broker-dealers. In making this change, the rule now requires “carrying broker-dealers” maintaining customer securities and funds to create and maintain a new segregated reserve account for account holders that are broker-dealers.

This means that large clearing/carrying broker-dealers will likely have two customer reserve accounts: one for their customers and one for the customers of its correspondent broker-dealers.

This means potential coding and programming changes to automated allocation software and systems. Most large clearing operations attach specific account numbers that define whether it is a customer or not and these systems have changed very little since the inception of the rule in the 1970s. This amendment means these clearing/carrying broker-dealers must adopt procedures and software to account for this definition of a customer.

The commission also incorporates in the Net Capital Rule net worth adjustments based on liabilities assumed by a third party when the broker-dealer cannot demonstrate the third party’s ability to pay the liabilities without any revenues from the broker-dealer. This will require additional due diligence on the part of the broker-dealer when entering into expense sharing agreements and on an ongoing basis. The change also permits FINRA to examine the records of the payer by allowing the regulators to reach beyond Rule 8210 to any third party who assumes a liability.

the SEC requires that broker-dealers treat contributed capital as a liability if an agreement exists granting the contributor the option to withdraw it. Broker-dealers will undoubtedly need to review their operating agreements along with related entity meeting minutes and charters to ensure they do not contain such agreements. This rule is not intended to stifle an owner’s ability to withdraw capital, but merely defines the intent of the contribution itself. Simply put, a capital contribution cannot be deposited with ”strings’ attached.

In conjunction with the rules related to the intent of contributed capital, the SEC’s position that capital that is withdrawn within 12 months of its contribution must be reclassified as a loan and capital would be required to be recalculated from the date of contribution. Most broker-dealers have operated under this requirement for some time but the rules make it a formal part of the net capital rules. Another point  clarified by the commission requires that broker-dealers deduct from net capital any excess deductible of fidelity bond coverage over the deductible amount permitted by the examining authority for the broker-dealer.

Pass your exam guaranteed or your money back with our Greenlight Pass guarantee.

 Good luck on your exam!

 The Securities Institute of America

Preparing for an Exam?

Receive 15% off all your Securities Exam Prep materials

Please wait....

Your Cart