Segregation of Assets and Customer Protection
Regulatory Obligations
SEA Rule 15c3-3 (Customer Protection Rule) imposes requirements on firms that are designed to protect customer funds and securities. Firms are obligated to maintain custody of customers’ fully paid and excess margin securities and safeguard customer funds. Firms 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. 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.
SEC Adopts Rule Amendments to the Broker-Dealer Customer Protection Rule
- The SEC adopted amendments to Rule 15c3-3 to require certain firms 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.
- The SEC also adopted amendments to Rule 15c3-3 and Rule 15c3-1 to permit certain broker-dealers that perform a daily customer reserve computation to decrease the required 3 percent “buffer” in the customer reserve bank account by reducing the customer-related receivables, or “aggregate debit items,” charge from 3 percent to 2 percent in the computation.
- For additional information, please see the SEC’s Daily Computation of Customer and Broker-Dealer Reserve Requirements under the Broker-Dealer Customer Protection Rule.
Findings and Effective Practices
Findings
- Inadequate Supervision: Failing to establish and maintain a reasonably designed supervisory system for reserves, resulting in issues including:
- incorrectly designating customer accounts as noncustomer accounts for purposes of the reserve formula computation;
- failing to identify, track or age suspense items; and
- failing to ensure bank sweep programs are compliant.
- Inaccurate Reserve Formula Computations: Failing to complete accurate reserve formula computations due to factors including:
- inadequate supervisory procedures and processes;
- limited coordination between various internal departments;
- inaccurate account coding;
- inadequate understanding of the relevant requirements under the Customer Protection Rule; and
- not detecting or resolving coding errors in firm systems that resulted in inaccurate credit and debit balances being included in the computation.
- Insufficient 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.
- Inadequate Handling of Customer Checks: Firms accepting customer checks as part of their business practice, but failing to establish an adequate process to promptly forward them (e.g., not maintaining a checks received and forwarded blotter, not having a procedure for handling customer checks written payable to the firm).
Effective Practices
- Periodic Evaluation of the Reserve Formula Computation Process: Performing variance analysis to review for material fluctuations, anomalies and new items to identify potential inaccuracies; establishing a process to identify system or operational changes that could impact the customer or PAB reserve formula computations; and reviewing adjustments to the reserve formula computations to ensure they are accurate and compliant with the Customer Protection Rule.
- Good Control Locations: Ensure that all relevant documents are maintained to support the treatment of accounts as good control locations and perform periodic reviews to identify newly established accounts, 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.
- Supervision: Ensuring experienced individuals perform and supervise reserve formula computations and possession or control processes (who also hold the proper registrations).
Additional Resources
- FINRA
- SEC
FINRA Reminds Firms of Their Obligations to Designate FINOPs
- FINRA reminds firms of the requirement to designate a qualified Financial and Operations Principal (FINOP) and such FINOP’s responsibilities under FINRA Rule 1220(a)(4) (Registration Categories).
- Among other things, FINRA Rule 1220(a)(4) requires each firm subject to SEA Rule 15c3-1 to designate either an appropriately registered Financial and Operations Principal (Series 27) or an Introducing Broker-Dealer Financial and Operations Principal (Series 28) and to also designate a Principal Financial Officer (PFO) and Principal Operations Officer (POO), who must be qualified as a FINOP. The rule specifies the duties for which the FINOP is responsible and the responsibilities of the PFO and POO.
- In addition to responsibility for the final approval and the accuracy of financial reports, a FINOP’s duties and responsibilities under Rule 1220 include, among other things, supervision of and responsibility for individuals who are involved in the creation and maintenance of the firm’s books and records from which such reports are derived and overall supervision of and responsibility for the individuals who are involved in the administration and maintenance of the firm’s back office operations.
- The responsibilities noted above and in Rule 1220(a)(4) are applicable regardless of whether a FINOP is employed full-time or part-time with a firm, holds registrations with multiple firms, or performs his or her duties on-site or off-site of the firm.
- Notice to Members 06-23 (NASD Reminds FINOPs of their Obligations under NASD Rule 1022 and Issues Guidance to FINOPS who Work Part-Time, Work Off-Site or Hold Multiple Registrations) was published to remind FINOPs and firms of their obligations when a FINOP is employed part-time.
- Part-time FINOPs and firms that employ them should review their procedures to ensure that they encompass the duties outlined in Rule 1220 and thoroughly outline the part-time FINOP's responsibilities.
- Further, firms must ensure that the part-time FINOP has complete access to all of the firm's books and records and all relevant information about the firm’s business activities necessary to enable the FINOP to carry out his or her duties and responsibilities. Firms are required to supervise their part-time FINOPs and assess whether they are fulfilling their duties and responsibilities.
- FINRA reminds firms and their FINOPs that the failure to meet their responsibilities under the rules can result in disciplinary actions against both the FINOP and the firm employing the FINOP. While firms must also designate a PFO and POO, these designations do not relieve a firm’s FINOP from their obligations to fulfill their duties under 1220(a)(4).1
- During recent examinations, FINRA observed recurring themes concerning certain firms’ use of part-time FINOPs (e.g., not having access to books and records; not adequately performing reconciliations).
- For additional guidance in this area, please see:
- Regulatory Notice 17-30 (SEC Approves Consolidated FINRA Registration Rules, Restructured Representative-Level Qualification Examinations and Changes to Continuing Education Requirements)
- Notice to Members 06-23 (NASD Reminds FINOPs of their Obligations under NASD Rule 1022 and Issues Guidance to FINOPS who Work Part-Time, Work Off-Site or Hold Multiple Registrations)
1 Firms that neither self-clear nor provide clearing services may designate the same person as the Principal Financial Officer, Principal Operations Officer and Financial and Operations Principal or Introducing Broker-Dealer Financial and Operations Principal (that is, such firms are not required to designate different persons to function in these capacities). See FINRA Rule 1220(a)(4).