Treasury Approves Risk Assessment Rules For Government Securities Broker/Dealers

Executive Summary

The Department of the Treasury (Treasury) recently approved amendments under the Government Securities Act of 1986 (GSA) that establish risk assessment rules for government securities broker/dealers registered under Section 15C (Section 15C broker/dealers) of the Securities Exchange Act of 1934. The rules parallel similar Securities and Exchange Commission (SEC) rules already in place for broker/dealers that conduct a general or municipal securities business. The effective date for the amendments is June 30, 1995, but the rules are being implemented on a multi-month phase-in schedule.

Background And General Description Of Amendments

Risk assessment rules are intended to provide greater warning of situations that can affect significantly the functioning of the markets and investors in general. The Market Reform Act of 1990 (the Reform Act) was passed by Congress to provide authorization for such rules.

Specifically, the Reform Act authorized the SEC to promulgate risk assessment rules for broker/dealers holding company structures and authorized Treasury to promulgate risk assessment rules for registered government securities broker/dealers. The SEC adopted its risk assessment rules in July 1992. Treasury's rules, which were recently approved, incorporate SEC Rules 17h-1T and 17h-2T, with minor modifications.

In general, the recordkeeping amendments require Section 15C broker/ dealers to maintain and preserve records concerning the financial and securities activities of affiliates whose business activities are reasonably likely to have a material impact on the financial or operational condition of the Section 15C broker/dealers. The reporting amendments require Section 15C broker/dealers to file with the SEC quarterly summary reports of this information. Treasury's rules also provide exemptions identical to those provided by the SEC. In addition, Treasury is adopting the SEC's special provisions for affiliates that are already subject to supervision by certain U.S. or foreign financial regulatory authorities.

Recordkeeping Requirements

Treasury's rules require that Section 15C broker/dealers keep two general categories of records:

• information concerning the holding company organization, risk management policies, and material legal proceedings; and
  
  
• financial and securities information pertinent to assessing risk in the holding company system (such as, consolidating and consolidated financial statements and positions in various financial instruments).

The information required under the recordkeeping rules will be subject to routine inspection by the SEC and self-regulatory organizations.

Reporting Requirements

Under the reporting rules, Section 15C broker/dealers must file with the SEC quarterly summaries of the information maintained under the recordkeeping rules. These quarterly summaries must be filed on SEC Form 17-H.

The information required to be maintained and reported by the firms pertains only to the firms' "material associated persons" (MAPs). Several factors that should be considered when determining which affiliates, or associated persons, might have a "material" impact on the broker/ dealer's financial or operational conditions are incorporated as guidelines in SEC Rule 17h-1T. The initial designation of MAPs will be made by the Section 15C broker/dealers. "Associated persons" is based on the definition at 3(a)(18) of the Exchange Act [(15 U.S.C. 78c(a)(18)], except that natural persons are excluded for the risk assessment rules (which automatically excludes natural persons from the definition of MAPs). Consistent with the SEC approach, partnerships will not be treated as natural persons and, depending on the circumstances, may be deemed to be MAPs. However, Subchapter S corporations may be treated as natural persons for the amendments if the Subchapter S corporation is owned by one natural person.

Exemptions

Treasury's rules exempt a Section 15C broker/dealer if it:

• does not carry customer accounts and maintains capital (equity capital plus subordinated debt) of less than $20 million;
  
  
• maintains capital of less than$250,000 (regardless of whether it carries customer accounts or not); and
  
  
• has an affiliated registered broker/ dealer that is subject to, and in compliance with, the SEC's risk assessment rules, provided that all of the MAPs of the Section 15C broker/ dealer are also MAPs of the registered broker/dealer.

A Section 15C broker/dealer that has no affiliates or holding company is not subject to Treasury's risk assessment rules.

Special Provisions

Treasury's rules allow affiliated Section 15C broker/dealers to request in writing that Treasury permit one of the firms (a "Reporting Registered Government Securities Broker/ Dealer") to maintain and report risk assessment information on behalf of the other firms.

Treasury also is adopting the SEC's special provisions for affiliates that are already subject to supervision by certain U.S. or foreign financial regulatory authorities. With respect to such affiliates, Section 15C broker/dealers are deemed in compliance with the financial and securities recordkeeping requirements by maintaining copies of reports that such affiliates already submit to other regulators; however, they are required to maintain organizational charts, risk management policies, and records of legal proceedings, and submit that information on Form 17-H to the SEC.

Implementation Schedule

Recordkeeping Requirements

Effective June 30, 1995, Section 15C broker/dealers must maintain records of an organizational chart, written risk management procedures, and a description of material legal or arbitration proceedings. The entire recordkeeping provisions are effective September 30, 1995.

Reporting Requirements

Section 15C broker/dealers must file the organizational chart, the written risk management procedures, and the description of material legal or arbitration proceedings (Part I, Item 1-3 of Form 17-H) by July 1, 1995.

The entire reporting provisions (that is, the remaining portion of Form 17-H) are effective for the period ending September 30, 1995. Firms have 60 calendar days after September 30, 1995, to file the remaining portions of Form 17-H. Firms have 60 calendar days after each subsequent fiscal quarter to file Form 17-H.

Members should note that following the first filing of the organizational chart, the written risk management procedures, and the description of material legal or arbitration proceedings, they are not required to include this information in subsequent quarterly filings unless a material change in the information has occurred, except that the organizational chart is required in each year-end filing.

The cumulative year-end financial statements required pursuant to Section 404.2(b)(4) must be filed within 105 calendar days of the end of the fiscal year.

Members interested in reviewing Treasury's release in its entirety should refer to the April 26, 1995, Federal Register. Questions concerning this Notice may be directed to Janet Marsh, District Coordinator, NASD^® Regulation Department, at (202) 728-8228.