Broker-dealers: New FOCUS on financial responsibility

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09/12/2013 by Financial services regulatory practice
Broker-dealers: New FOCUS on financial responsibility

At a glance

The SEC finalized two new rules for tightening controls over broker-dealers holding customer funds and securities.

The Securities and Exchange Commission (SEC) adopted two new sets of rules this summer that, taken together, tighten the controls required for broker-dealers holding customer funds and securities. The new rules amend (1) various financial responsibility requirements for broker-dealers (the “financial responsibility requirements”) and (2) several reporting and audit rules for broker-dealers and their auditors (the “custody-related requirements”). While most of the amendments impact those broker-dealer firms that carry customer accounts or provide clearing services, all broker-dealers will be required to submit new reports to the SEC.

The SEC’s final rules largely implement its proposals from 2007 and 2011, with certain modifications in response to public comments. The SEC approved the amendments to the financial responsibility requirements unanimously, while the amendments to the custody-related requirements generated some disagreement and were approved by a 3-2 vote.

The amendments to the financial responsibility requirements were initially proposed in 2007, before the financial crisis, and are intended to address the SEC’s concerns about the safety of customer assets in the event of the failure of a broker-dealer. They amend the customer protection, net capital, books and records, and notification rules (including protections associated with “sweep programs” for customer free credit balances, proprietary accounts of broker-dealers that are held at other broker-dealers, and limitations on banks eligible to hold special reserve accounts). These rules were subject to significant industry and public input (almost 100 comment letters were submitted to the SEC).

The amendments to the custody-related requirements were initially proposed in 2011 following frauds involving broker-dealers, particularly the Bernard Madoff case. They are intended to be the corollary to the SEC’s custody-related rules for investment advisers adopted in 2010. Broker-dealers will be required to submit new types of reports to the SEC concerning the custody of customer funds and securities. Clearing and carrying broker-dealers will also be required to permit their independent public accountants to make audit workpapers available to the SEC and their designated examining authority (DEA), and to permit auditors to discuss the audit with examiners.

The new rules will significantly impact broker-dealers’ current compliance with the existing regulatory framework.

The amendments to the financial responsibility requirements become effective October 21, 2013. The new Form Custody filing requirement becomes effective December 31, 2013, with an initial filing date of January 17, 2014. The requirements relating to annual reports become effective for all broker-dealers with fiscal years ending on or after June 1, 2014.

This Financial Services Regulatory Brief analyzes the key changes to the financial responsibility and custody-related requirements, and suggests actions that broker-dealers should begin taking.