Segregation of Assets and Customer Protection

Regulatory Obligations and Related Considerations

Regulatory Obligations

Exchange Act Rule 15c3-3 (Customer Protection Rule) imposes requirements on member firms that are designed to protect customer funds and securities. Member firms are obligated to maintain custody of customers’ fully paid and excess margin securities, and safeguard customer funds by segregating these assets from the firm’s proprietary business activities and promptly delivering them to the customer upon request. Member firms can satisfy these requirements by keeping customer funds in a special reserve bank account and by maintaining customer securities in their physical possession or in a good control location, as specified in Rule 15c3-3. Member firms are required to maintain a reserve of cash or qualified securities in the special reserve bank account that is at least equal in value to the net cash owed to customers, including cash obtained from the use of customer securities. The amount of net cash owed to customers is computed pursuant to the formula set forth in Exhibit A to Rule 15c3-3.

Related Considerations

• What is your firm’s process to prevent, identify, escalate and resolve new or increased possession or control deficits that are in violation of the Customer Protection Rule?
• What controls does your firm have in place to identify and monitor its possession or control deficits, including their creation, cause and resolution?
• If your firm claims an exemption from the Customer Protection Rule under paragraph (k)(2)(ii) thereunder, in accordance with the requirements of that rule it is required to promptly forward any customer checks it receives to its clearing firm.
• Has your firm implemented an effective process for forwarding customers’ checks, and does your firm maintain accurate records to evidence that customer checks were promptly forwarded?
• How does your firm train its staff on the requirements of the Customer Protection Rule?
• What are your firm’s processes to confirm that it correctly computes its customer and PAB¹ reserve formula computations and maintains the amounts that must be deposited into its special reserve bank account(s)?

Findings and Effective Practices

Findings

• Inaccurate Reserve Formula Computations: Failing to complete accurate reserve formula computations, due to factors such as:
  • inadequate supervisory procedures and processes;
  • limited coordination between various internal departments;
  • inaccurate account coding; and
  • adjustments to the initial reserve formula components that are inaccurate, incomplete or both.
• Improper Withdrawals From Reserve Bank Account: Not preparing a reserve formula computation prior to making a withdrawal from the reserve bank account.
• Inaccurate Segregation of Customer Securities: Failing to maintain possession or control of customer fully paid or excess margin securities due to inadequate supervisory procedures and processes to identify, monitor and resolve possession or control deficits, and inaccurate coding of good control locations.

Effective Practices

• Confirming Control Location Agreements: Collaborating with legal and compliance departments to confirm that all agreements supporting control locations are finalized and executed before the accounts are established and accurately coded as good control location accounts on the firms’ books and records.
• Addressing Conflicts of Interest: Confirming which staff have system access to establish a new good control location, and that they are independent from the business areas to avoid potential conflicts of interest, as well as conducting ongoing review to address emerging conflicts of interest.
• Reviews and Exception Reports for Good Control Locations: Conducting periodic review of and implementing exception reports for existing control locations for potential miscoding, out-of-date paperwork or inactivity.
• Check Forwarding Blotter Review: Creating and reviewing your firm’s checks received and forwarded blotters to confirm that they are accurately maintained and include the information required to evidence compliance with the Customer Protection Rule exemption.
• Periodic Evaluation of Reserve Formula Computation Process: Performing variance analysis to review material fluctuations and new items to identify potential inaccuracies, and establishing a process to identify system or operational changes that could impact the customer or PAB reserve formula computations.

Additional Resource

• Interpretations to the SEC’s Financial and Operational Rules