[Federal Register Volume 78, Number 162 (Wednesday, August 21, 2013)]
[Rules and Regulations]
[Pages 51823-51907]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-18734]



[[Page 51823]]

Vol. 78

Wednesday,

No. 162

August 21, 2013

Part II





Securities and Exchange Commission





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17 CFR Part 240





 Financial Responsibility Rules for Broker-Dealers; Final Rule

Federal Register / Vol. 78 , No. 162 / Wednesday, August 21, 2013 / 
Rules and Regulations

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-70072; File No. S7-08-07]
RIN 3235-AJ85


Financial Responsibility Rules for Broker-Dealers

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
adopting amendments to the net capital, customer protection, books and 
records, and notification rules for broker-dealers promulgated under 
the Securities Exchange Act of 1934 (``Exchange Act''). These 
amendments are designed to address several areas of concern regarding 
the financial responsibility requirements for broker-dealers. The 
amendments also update certain financial responsibility requirements 
and make certain technical amendments.

DATES: Effective Date: October 21, 2013.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate 
Director, at (202) 551-5525; Thomas K. McGowan, Deputy Associate 
Director, at (202) 551-5521; Randall Roy, Assistant Director, at (202) 
551-5522; Raymond Lombardo, Branch Chief, at (202) 551-5755; Sheila 
Dombal Swartz, Special Counsel, (202) 551-5545; Carrie A. O'Brien, 
Special Counsel, (202) 551-5640; or Kimberly N. Chehardy, Attorney 
Advisor, (202) 551-5791; Division of Trading and Markets, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
II. Amendments
    A. Amendments to the Customer Protection Rule
    1. Background
    2. Proprietary Accounts of Broker-Dealers
    i. Definition of ``PAB Account'' under Rule 15c3-3(a)(16)
    ii. Written Permission To Use PAB Account Securities
    iii. PAB Reserve Bank Accounts
    iv. Other PAB Issues Raised by Commenters
    v. Amendment to Rule 15c3-1(c)(2)(iv)(E) Related to PAB Accounts
    3. Banks Where Special Reserve Deposits May Be Held
    4. Allocation of Customers' Fully Paid and Excess Margin 
Securities to Short Positions
    5. Importation of Rule 15c3-2 Requirements Into Rule 15c3-3 and 
Treatment of Free Credit Balances
    i. Importation of Rule 15c3-2
    ii. Treatment of Free Credit Balances
    a. Treatment of Free Credit Balances Outside of a Sweep Program
    b. Treatment of Free Credit Balances in a Sweep Program
    6. ``Proprietary Accounts'' Under the Commodity Exchange Act
    7. Expansion of the Definition of ``Qualified Securities'' To 
Include Certain Money Market Funds
    B. Holding Futures Positions in a Securities Portfolio Margin 
Account
    C. Amendments With Respect to Securities Lending and Borrowing 
and Repurchase/Reverse Repurchase Transactions
    D. Documentation of Risk Management Procedures
    E. Amendments to the Net Capital Rule
    1. Requirement To Deduct From Net Worth Certain Liabilities or 
Expenses Assumed by Third Parties
    2. Requirement To Subtract From Net Worth Certain Non-Permanent 
Capital Contributions
    3. Requirement To Deduct the Amount by Which a Fidelity Bond 
Deductible Exceeds SRO Limits
    4. Broker-Dealer Solvency Requirement
    5. Amendment to Rule Governing Orders Restricting Withdrawal of 
Capital From a Broker-Dealer
    6. Adjusted Net Capital Requirements
    i. Amendment to Appendix A of Rule 15c3-1
    ii. Money Market Funds
    a. Clarification
    b. Proposed Haircut Reduction From 2% to 1%
    c. Aggregate Debit Items Charge
    F. Technical Amendments
III. Responses to Specific Requests for Comment
IV. Paperwork Reduction Act
    A. Summary of the Collection of Information Requirements
    B. Use of Information
    C. Respondents
    D. Total Annual Reporting and Recordkeeping Burden
    1. Securities Lending Agreements and Disclosures
    2. DEA Permission To Withdraw Capital Within One Year of 
Contribution
    3. Written Subordination Agreements Under Rule 15c3-3
    4. PAB Reserve Bank Account Recordkeeping Requirements
    5. Adequate Procedures Required Under Paragraph (j)(1) of Rule 
15c3-3
    6. Treatment of Free Credit Balances
    7. Documentation of Risk Management Procedures
    8. Notice Requirements
    E. Collection of Information Is Mandatory
    F. Confidentiality
    G. Record Retention Period
V. Economic Analysis
    A. Introduction
    B. Economic Baseline
    C. Discussion of General Comments Received
    D. Economic Analysis of the Amendments and Alternatives
    1. Amendments to the Customer Protection Rule
    i. Economic Analysis
    a. Proprietary Accounts of Broker-Dealers
    (I). Summary of Amendments
    (II). Baseline and Incremental Economic Effects
    (III). Alternatives
    (IV). Compliance Cost Estimates
    b. Banks Where Special Reserve Deposits May Be Held
    (I). Summary of Amendments
    (II). Baseline and Incremental Economic Effects
    (III). Alternatives
    (IV). Compliance Cost Estimates
    c. Allocation of Customers' Fully Paid and Excess Margin 
Securities to Short Positions
    d. Importation of Rule 15c3-2 Requirements Into Rule 15c3-3
    e. Treatment of Free Credit Balances
    (I). Summary of Amendments
    (II). Baseline and Incremental Economic Effects
    (III). Alternatives
    (IV). Compliance Cost Estimates
    f. ``Proprietary Accounts'' Under the Commodity Exchange Act
    ii. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation
    2. Holding Futures Positions in a Securities Portfolio Margining 
Account
    i. Economic Analysis
    ii. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation
    3. Amendments With Respect to Securities Lending and Borrowing 
and Repurchase/Reverse Repurchase Transactions
    i. Economic Analysis
    ii. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation
    4. Documentation of Risk Management Procedures
    i. Economic Analysis
    ii. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation
    5. Amendments to the Net Capital Rule
    i. Economic Analysis
    a. Requirement To Deduct From Net Worth Certain Liabilities or 
Expenses Assumed By Third Parties
    (I). Summary of Amendments
    (II). Baseline and Incremental Economic Effects
    (III). Alternatives
    b. Requirement To Subtract From Net Worth Certain Non-Permanent 
Capital Contributions
    (I). Summary of Amendments
    (II). Baseline and Incremental Economic Effects
    (III). Alternatives
    c. Requirement To Deduct the Amount by Which a Fidelity Bond 
Exceeds SRO Limits
    d. Broker-Dealer Solvency Requirement
    e. Amendment to Rule Governing Restrictions of Withdrawals of 
Capital

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    f. Amendment to Rule 15c3-1 Appendix A
    ii. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation
VI. Final Regulatory Flexibility Analysis
    A. General Issues Raised by Public Comments
    B. Amendments to the Customer Protection Rule
    1. Need for and Objectives of the Rule Amendments
    2. Significant Issues Raised by Public Comment
    3. Small Entities Subject to the Rules
    4. Reporting, Recordkeeping, and Other Compliance Requirements
    5. Agency Action To Minimize Effect on Small Entities
    D. Securities Lending and Borrowing and Repurchase/Reverse 
Repurchase Transactions
    1. Need for and Objectives of the Amendments
    2. Significant Issues Raised by the Public Comments
    3. Small Entities Subject to the Rule
    4. Reporting, Recordkeeping, and Other Compliance Requirements
    5. Agency Action To Minimize Effect on Small Entities
    E. Documentation of Risk Management Procedures
    1. Need for and Objectives of the Amendments
    2. Significant Issues Raised by Public Comments
    3. Small Entities Subject to the Rule
    4. Reporting, Recordkeeping, and Other Compliance Requirements
    5. Agency Action To Minimize Effect on Small Entities
    F. Amendments to the Net Capital Rule
    1. Need for and Objectives of the Amendments
    2. Significant Issues Raised by Public Comments
    3. Small Entities Subject to the Rule
    4. Reporting, Recordkeeping, and Other Compliance Requirements
    5. Agency Action to Minimize Effect on Small Entities
VII. Statutory Authority

I. Background

    The Commission is adopting amendments to the broker-dealer net 
capital rule (Rule 15c3-1),\1\ customer protection rule (Rule 15c3-
3),\2\ books and records rules (Rules 17a-3 and 17a-4), and 
notification rule (Rule 17a-11).\3\ The Commission proposed these rule 
changes on March 9, 2007.\4\ The Commission re-opened the public 
comment period on May 3, 2012.\5\ The Commission received a total of 97 
comment letters on the proposed amendments.\6\ Sixty comment letters

[[Page 51826]]

were received prior to the re-opening of the comment period, and 37 
were received after it. The Commission carefully considered all of the 
comment letters, and as discussed in detail below, modified the 
amendments in certain respects in light of the comments received. In 
addition, the Commission has determined to defer consideration of 
action at this time with respect to certain of the proposed amendments.
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    \1\ 17 CFR 240.15c3-1.
    \2\ 17 CFR 240.15c3-3.
    \3\ 17 CFR 240.17a-3; 17 CFR 240.17a-4; and 17 CFR 240.17a-11.
    \4\ See Amendments to Financial Responsibility Rules for Broker-
Dealers, Exchange Act Release No. 55431 (Mar. 9, 2007), 72 FR 12862 
(Mar. 19, 2007) (``Amendments to Financial Responsibility Rules''). 
As part of this release, the Commission also requested comment on 
three additional matters: reducing the Rule 17a-11 (17 CFR 240.17a-
11) early warning level for broker-dealers that carry over $10 
billion in debits; harmonization of the net capital deductions 
required by paragraph (c)(2)(iv)(B) of Rule 15c3-1 for securities 
lending and borrowing transactions with the deductions required 
under paragraph (c)(2)(iv)(F) for securities repurchase and reverse 
repurchase agreement transactions (17 CFR 240 240.15c3-
1(c)(2)(iv)(B) and (c)(2)(iv)(F), respectively); and accounting for 
third-party liens on customer securities held at a broker-dealer. As 
discussed below in section III. of this release, the Commission 
received comments in response to these requests but has determined 
to defer consideration of actions with respect to these specific 
matters at this time.
    \5\ Amendments to Financial Responsibility Rules for Broker-
Dealers, Exchange Act Release No. 66910 (May 3, 2012), 77 FR 27150 
(May 9, 2012).
    \6\ Comments on the amendments are available at http://www.sec.gov/comments/s7-08-07/s70807.shtml. See also letter dated 
April 22, 2007 from Peter G. Crane, President, Crane Data LLC 
(``Crane Data Letter''); letter dated April 22, 2007 from David 
Michael Bishop (``Bishop Letter''); letter dated April 27, 2007 from 
Ted Beer, Broker/Dealer Principal (``Beer Letter''); letter dated 
April 28, 2007 from Ted Beer, Broker/Dealer Principal (``Beer 2 
Letter''); letter dated April 29, 2007 from R.A. Lowenstein, FinOps 
Compliance Consultant (``Lowenstein Letter''); letter dated April 
29, 2007 from G. Kirk Ellis (``Ellis Letter''); letter dated May 1, 
2007 from Stuart J. Kaswell and David J. Harris, Dechert LLP on 
behalf of Federated Investors (``Federated Letter''); letter dated 
May 2, 2007 from Daniel R. Levene, President, small NASD broker-
dealer (``Levene Letter''); letter dated May 4, 2007 from Gerard J. 
Quinn, Vice President and Associate General Counsel, SIFMA (``SIFMA 
Letter''); letter dated May 7, 2007 from Michael Bell, President and 
CEO, Curian Clearing, LLC (``Curian Clearing Letter''); letter dated 
May 10, 2007 from Richard B. Franz II, Senior Vice-President, 
Treasurer and Chief Financial Officer, Raymond James & Associates 
(``Raymond James Letter''); letter dated May 16, 2007 from Steven R. 
Gerbel, Chicago Capital Management LP (``Chicago Capital Letter''); 
letter dated May 17, 2007 from Jeffrey L. Kiss, Principal, 
PackerKiss Securities, Inc. (``PackerKiss Letter''); letter dated 
May 17, 2007 from Josephine Wang, General Counsel, SIPC (``SIPC 
Letter''); letter dated May 18, 2007 from Kimberly Taylor, Managing 
Director and Clearing House President, Chicago Mercantile Exchange 
Inc. (``CME Letter''); letter dated May 18, 2007 from Diane V. 
Esheleman, Executive Vice President, JP Morgan Chase Bank, N.A. 
(``JP Morgan Letter''); letter dated May 21, 2007 from Faith Colish, 
Carter Ledyard Milburn LLP (``Colish Letter''); letter dated May 23, 
2007 from Charles R. Manzoni, Jr., General Counsel, FAF Advisors, 
Inc. (``FAF Advisors Letter''); letter dated May 27, 2007 from Joyce 
Glenn (``Glenn Letter''); letter dated May 28, 2007 from William 
Bare (``Bare Letter''); letter dated May 29, 2007 from Robert 
Keenan, CEO, St. Bernard Financial Services, Inc. (``St. Bernard 
Financial Services Letter''); letter dated May 31, 2007 from John C. 
Melton, Sr., Executive Vice President, Coastal Securities (``Coastal 
Letter''); letter dated June 3, 2007 from Anonymous (``Anonymous 
Letter''); letter dated June 5, 2007 from Kelly S. McEntire, 
Executor, Retired State Administrator/Executor of Janus Capital 
Investments (``McEntire Letter''); letter dated June 13, 2007 from 
Bruce Bent, Chairman, The Reserve (``Reserve Letter''); letter dated 
June 14, 2007 from Amal El Said, Accounting and Regulatory, Abbey 
National (``Abbey National Letter''); letter dated June 14, 2007 
from Frank A. Perrone, Senior Vice President, Brown Brothers 
Harriman & Co. (``Brown Brothers Harriman Letter''); letter dated 
June 15, 2007 from James J. Angel, Ph.D., CFA, Associate Professor 
of Finance, McDonough School of Business, Georgetown University 
(``Angel Letter''); letter dated June 15, 2007 from Matthew M. 
Hughey, Chief Financial Officer, First Clearing, LLC (``First 
Clearing Letter''); letter dated June 15, 2007 from Marshall J. 
Levinson, Senior Managing Director, Bear, Stearns & Co. Inc., Chair, 
SIFMA Capital Committee (``SIFMA 2 Letter''); letter dated June 15, 
2007 from Christopher Williams, Director and Senior Counsel, and 
Barbara Brooks, Principal Financial Officer, Dresdner Kleinwort 
(``Dresdner Kleinwort Letter''); letter dated June 18, 2007 from 
Michael Dworkin (``Dworkin Letter''); letter dated June 18, 2007 
from Keith Weller, Executive Director and Senior Associate General 
Counsel, UBS Global Asset Management (Americas) Inc. (``UBS 
Letter''); letter dated June 18, 2007 from Marcelo Riffaud, Managing 
Director, Legal Department, Deutsche Bank Securities Inc. 
(``Deutsche Bank Securities Letter''); letter dated June 18, 2007 
from Jill Gross and Rahat Sarmast, Pace Investor Rights Project 
(``Pace Letter''); letter dated June 18, 2007 from Robert E. Putney, 
III, Director and Senior Counsel, BlackRock, Inc. (``BlackRock 
Letter''); letter dated June 18, 2007 from James S. Keller, Chief 
Regulatory, the PNC Financial Services Group, Inc. (``PNC Letter''); 
letter dated June 18, 2007 from Sarah A. Miller, General Counsel, 
American ABA Securities Association (``ABASA Letter''); letter dated 
June 18, 2007 from David Hirschmann, Executive Vice President, 
National Chamber Foundation of U.S. Chamber of Commerce (``National 
Chamber Foundation Letter''); letter dated June 18, 2007 from 
Michael W. Fields, Chief Fixed Income Officers, American Beacon 
Advisors (``American Beacon Letter''); letter dated June 18, 2007 
from David Lonergan, Head of U.S. Cash Management, Barclays Global 
Investors (``Barclays Letter''); letter dated June 18, 2007 from 
Howard Spindel, Senior Managing Directors, Integrated Management 
Solutions (``Integrated Management Letter''); letter dated June 18, 
2007 from Jane G. Heinrichs, Associate Counsel, Investment Company 
Institute (``ICI Letter''); letter dated June 18, 2007 from Jeffrey 
P. Neubert, CEO, Clearinghouse Association L.L.C. (``Clearing House 
Letter''); letter dated June 19, 2007 from James T. McHale, 
Associate General Counsel, E*Trade Brokerage Holdings, Inc. 
(``E*Trade Letter''); letter dated June 25, 2007 from Cliff Verron, 
Managing Director, Deputy Chief Financial Officers and John Ramsay, 
Managing Director, Deputy General Counsel, Citigroup Global Markets 
Inc. (``Citigroup Letter''); letter dated June 25, 2007 from AMEX, 
CBOE, ISE, OCC, and NYSE/ARCA (``AMEX Letter''); letter dated July 
3, 2007 from Keith F. Higgins, Chair, Committee on Federal 
Regulation of Securities, American Bar Association (``American Bar 
Association Letter''); letter dated July 23, 2007 from Charles S. 
Morrison, Senior Vice President and Money Market Group Leader, 
Fidelity Management & Research Company, and John Valenti, Vice 
President, National Financial Securities LLC (``Fidelity/NFS 
Letter''); letter dated August 6, 2007 from Stuart Kaswell, Dechert 
LLP, on behalf of Federated Investors, Inc. (``Federated 2 
Letter''); letter dated October 9, 2007 from Stuart Kaswell, Dechert 
LLP on behalf of Federated Investors, Inc. (``Federated 3 Letter''); 
letter dated November 16, 2007 from Marshall J. Levinson, Chair, 
Capital Committee, SIFMA (``SIFMA 3 Letter''); letter dated January 
7, 2008 from Stuart J. Kaswell, Dechert LLP, on behalf of Federated 
Investors, Inc. (``Federated 4 Letter''); letter dated August 7, 
2008 from Stuart J. Kaswell, Bryan Cave LLP, on behalf of Federated 
Investors, Inc. (``Federated 5 Letter''); letter dated November 10, 
2008 from Lee A. Pickard, Pickard & Djinis LLP on behalf of 
Federated Investors (``Federated 6 Letter''); letter dated November 
25, 2008 from Lee A. Pickard, Pickard & Djinis LLP on behalf of 
Federated Investors (``Federated 7 Letter''); letter dated December 
18, 2008 from Lee A. Pickard, Pickard & Djinis LLP on behalf of 
Federated Investors (``Federated 8 Letter''); letter dated July 28, 
2009 from Richard J. McDonald, Chief Regulatory Counsel, Susquehanna 
International Group LLP (``SIG Letter''); letter dated June 8, 2010 
from The Honorable Gregory W. Meeks (``Meeks Letter''); letter dated 
October 14, 2011 from The Honorable Gregory W. Meeks (``Meeks 2 
Letter''); letter dated May 5, 2012 from Edward P. Cernocky 
(``Cernocky Letter''); letter dated May 11, 2012 from Chris Barnard 
(``Barnard Letter''); letter dated May 15, 2012 from Helen M. 
Saarinen (``Saarinen Letter''); letter dated May 18, 2012 from Laura 
H. Hearne (``Hearne Letter''); letter dated May 24, 2012 from Dick 
Fuld (``Fuld Letter''); letter dated May 30, 2012 from Bruce J. 
Womack (``Womack Letter''); letter dated June 1, 2012 from Lee A. 
Pickard, Pickard & Djinis LLP, on behalf of Federated Investors 
(``Federated 9 Letter''); letter dated June 4, 2012 from Michael 
Scillia, Director, National Investment Banking Association (``NIBA 
Letter''); letter dated June 7, 2012 from Anthony Fitzgerald 
(``Fitzgerald Letter''); letter dated June 7, 2012 from Tom Vincent, 
Senior V.P., Corporate Governance and Wealth Management Compliance, 
BOK Financial Corporation (``BOK Letter''); letter dated June 8, 
2012 from Denise Dolphin (``Dolphin Letter''); letter dated June 8, 
2012 from Colin W. McKechnie, Managing Director, JP Morgan Chase 
Bank, N. A (``JP Morgan 2 Letter''); letter dated June 8, 2012 from 
William A. Jacobson, Associate Clinical Professor, Cornell Law 
School, and Director, Cornell Securities Law Clinic, Ithaca, New 
York (``Cornell Letter''); letter dated June 8, 2012 from Ryan K. 
Bakhtiari, Aidikoff, Uhl & Bakhtiari, on behalf of the Public 
Investors Arbitration Bar Association (``PIABA Letter''); letter 
dated June 8, 2012 from Kenneth E. Bentsen, Jr., Executive Vice 
President, Public Policy and Advocacy, SIFMA (``SIFMA 4 Letter''); 
letter dated June 8, 2012 from Sarah A. Miller, Chief Executive 
Officer, Institute of International Bankers (``IIB Letter''); letter 
dated June 8, 2012 from James T. McHale, Global Head of Compliance, 
E*TRADE Financial Corporation (``E*Trade 2 Letter''); letter dated 
June 11, 2012 from Steve M. Brewer, Sr., ASG Securities, LLC, 
Houston, Texas (``ASG Securities Letter''); letter dated June 25, 
2012 from Gene L. Finn (``Finn Letter''); letter dated June 26, 2012 
from Cindy Walsh (``Walsh Letter''); letter dated July 12, 2012 from 
Michael Scillia, Director, National Investment Banking Association 
(``NIBA 2 Letter''); letter dated July 18, 2012 from Gene L. Finn 
(``Finn 2 Letter''); letter dated July 30, 2012 from David Waddell 
(``Waddell Letter''); letter dated August 6, 2012 from Gene Finn 
(``Finn 3 Letter''); letter dated August 15, 2012 from Echeal R. 
Sigan (``Sigan Letter''); letter dated August 26, 2012 from Mark 
Irwin (``Irwin Letter''); letter dated September 17, 2012 from Gene 
L. Finn (``Finn 4 Letter''); letter dated September 27, 2012 from 
Jeff S. Clark (``Clark Letter''); letter dated September 28, 2012 
from Robert LaPlante, M.P.A. (``LaPlante Letter''); letter dated 
October 19, 2012 from Rick Louderbough (``Louderbough Letter''); 
letter dated October 24, 2012 from Paul L. Matecki, Senior Vice 
President, General Counsel, Raymond James Financial, Inc. (``Raymond 
James 2 Letter''); letter dated October 25, 2012 from Eric Gamble, 
Ph.D. (``Gamble Letter''); letter dated November 1, 2012 from Percy 
R. Moorman, Esq. (``Moorman Letter''); letter dated January 4, 2013 
from Marquis Wilkins (``Wilkins Letter''); letter dated January 5, 
2013 from Anonymous SEC Fan (``Anonymous SEC Letter''); letter dated 
January 24, 2013 from Robert Fournier (``Fournier Letter''); and 
letter dated January 28, 2013 from Scott E. Shjefte (``Shjefte 
Letter''). Comment letters and specific comments outside the scope 
of this rulemaking are not addressed in this release.
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II. Amendments

A. Amendments to the Customer Protection Rule

1. Background
    The Commission adopted Rule 15c3-3 in 1972 in response to a 
congressional directive to strengthen the financial responsibility 
requirements for broker-dealers that hold securities and cash for 
customers.\7\ In particular, Rule 15c3-3 is designed ``to give more 
specific protection to customer funds and securities, in effect 
forbidding brokers and dealers from using customer assets to finance 
any part of their businesses unrelated to servicing securities 
customers; e.g., a firm is virtually precluded from using customer 
funds to buy securities for its own account.'' \8\ To meet this 
objective, Rule 15c3-3 requires a broker-dealer that maintains custody 
of customer securities and cash (a ``carrying broker-dealer'') to take 
two primary steps to safeguard these assets. The steps are designed to 
protect customers \9\ by segregating their securities and cash from the 
broker-dealer's proprietary business activities. If the broker-dealer 
fails financially, the securities and cash should be readily available 
to be returned to the customers. In addition, if the failed broker-
dealer is liquidated in a formal proceeding under the Securities 
Investor Protection Act of 1970 (``SIPA''), the securities and cash 
would be isolated and readily identifiable as ``customer property'' 
and, consequently, available to be distributed to customers ahead of 
other creditors.\10\
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    \7\ See Broker-dealers; Maintenance of Certain Basic Reserves, 
Exchange Act Release No. 9856 (Nov. 10, 1972), 37 FR 25224 (Nov. 29, 
1972).
    \8\ See Net Capital Requirements for Brokers and Dealers, 
Exchange Act Release No. 21651 (Jan. 11, 1985), 50 FR 2690, 2690 
(Jan. 18, 1985). See also Broker-Dealers; Maintenance of Certain 
Basic Reserves, Exchange Act Release No. 9856 (Nov. 10, 1972), 37 FR 
25224, 25224 (Nov. 29, 1972).
    \9\ Rule 15c3-3 defines customer as ``any person from whom or on 
whose behalf a broker or dealer has received or acquired or holds 
funds or securities for the account of that person.'' The rule 
excludes certain categories of persons from the definition, 
including broker-dealers, municipal securities dealers, and 
government securities broker-dealers. It also excludes general 
partners, directors, and principal officers of the broker-dealer and 
any other person to the extent that the person has a claim for 
property or funds which by contract, agreement or understanding, or 
by operation of law, is part of the capital of the broker-dealer or 
is subordinated to the claims of creditors of the broker-dealer. 17 
CFR 240.15c3-3(a)(1).
    \10\ See 15 U.S.C. 78aaa et seq.
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    The first step required by Rule 15c3-3 is that a carrying broker-
dealer must maintain physical possession or control over customers' 
fully paid and excess margin securities.\11\ Physical possession or 
control means the broker-dealer must hold these securities in one of 
several locations specified in Rule 15c3-3 and free of liens or any 
other interest that could be exercised by a third party to secure an 
obligation of the broker-dealer.\12\ Permissible locations include a 
bank, as defined in section 3(a)(6) of the Exchange Act, and a clearing 
agency.\13\
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    \11\ See 17 CFR 240.15c3-3(b) and (d). The term fully paid 
securities includes all securities carried for the account of a 
customer in a special cash account as defined in Regulation T 
promulgated by the Board of Governors of the Federal Reserve System, 
as well as margin equity securities within the meaning of Regulation 
T which are carried for the account of a customer in a general 
account or any special account under Regulation T during any period 
when section 8 of Regulation T (12 CFR 220.8) specifies that margin 
equity securities shall have no loan value in a general account or 
special convertible debt security account, and all such margin 
equity securities in such account if they are fully paid: provided, 
however, that the term fully paid securities shall not apply to any 
securities which are purchased in transactions for which the 
customer has not made full payment. 17 CFR 240.15c3-3(a)(3). The 
term margin securities means those securities carried for the 
account of a customer in a general account as defined in Regulation 
T, as well as securities carried in any special account other than 
the securities referred to in paragraph (a)(3) of Rule 15c3-3. 17 
CFR 240.15c3-3(a)(4). The term excess margin securities means those 
securities referred to in paragraph (a)(4) of Rule 15c3-3 carried 
for the account of a customer having a market value in excess of 140 
percent of the total of the debit balances in the customer's account 
or accounts encompassed by paragraph (a)(4) of Rule 15c3-3 which the 
broker-dealer identifies as not constituting margin securities. 17 
CFR 240.15c3-3(a)(5). As discussed in section II.F. of this release, 
the Commission is adopting technical amendments to the definitions 
of the terms fully paid securities and margin securities under Rule 
15c3-3. See paragraphs (a)(3) and (4) of Rule 15c3-3, as adopted.
    \12\ See 17 CFR 240.15c3-3(c). Customer securities held by the 
carrying broker-dealer are not assets of the firm. Rather, the 
carrying broker-dealer holds them in a custodial capacity and the 
possession and control requirement is designed to ensure that the 
carrying broker-dealer treats them in a manner that allows for their 
prompt return.
    \13\ Id.
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    The second step is that a carrying broker-dealer must maintain a 
reserve of cash or qualified securities in an account at a bank that is 
at least equal in value to the net cash owed to customers, including 
cash obtained from the use of customer securities.\14\ The account must 
be titled ``Special Reserve Bank Account for the Exclusive

[[Page 51827]]

Benefit of Customers.'' \15\ The amount of net cash owed to customers 
is computed pursuant to a formula set forth in Exhibit A to Rule 15c3-
3.\16\ Under the customer reserve formula, the broker-dealer adds up 
customer credit items (e.g., cash in customer securities accounts and 
cash obtained through the use of customer margin securities) and then 
subtracts from that amount customer debit items (e.g., margin 
loans).\17\ If credit items exceed debit items, the net amount must be 
on deposit in the customer reserve account in the form of cash and/or 
qualified securities.\18\ A broker-dealer cannot make a withdrawal from 
the customer reserve account until the next computation and even then 
only if the computation shows that the reserve requirement has 
decreased.\19\ The broker-dealer must make a deposit into the customer 
reserve account if the computation shows an increase in the reserve 
requirement.
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    \14\ 17 CFR 240.15c3-3(e). The term qualified security is 
defined in Rule 15c3-3 to mean a security issued by the United 
States or a security in respect of which the principal and interest 
are guaranteed by the United States. See 17 CFR 240.15c3-3(a)(6).
    \15\ See 17 CFR 240.15c3-3(e)(1). The purpose of giving the 
account this title is to alert the bank and creditors of the broker-
dealer that this account is to be used to meet the broker-dealer's 
obligations to customers (and not the claims of general creditors) 
in the event the broker-dealer must be liquidated in a formal 
proceeding.
    \16\ 17 CFR 240.15c3-3a.
    \17\ Id.
    \18\ 17 CFR 240.15c3-3(e). Customer cash is a balance sheet item 
of the carrying broker-dealer (i.e., the amount of cash received 
from a customer increases the amount of the carrying broker-dealer's 
assets and creates a corresponding liability to the customer). The 
customer reserve formula is designed to isolate these broker-dealer 
assets so that an amount equal to the net liabilities to customers 
is held as a reserve in the form of cash or qualified securities. 
The requirement to establish this reserve is designed to effectively 
prevent the carrying broker-dealer from using customer funds for 
proprietary business activities such as investing in securities. The 
goal is to put the carrying broker-dealer in a position to be able 
to readily meet its cash obligations to customers by requiring the 
firm to make deposits of cash and/or qualified securities into the 
customer reserve account in the amount of the net cash owed to 
customers. Capital, Margin, and Segregation Requirements for 
Security-Based Swap Dealers and Major Security-Based Swap 
Participants and Capital Requirements for Broker-Dealers, Exchange 
Act Release No. 68071 (Oct. 18, 2012), 77 FR 70213, 70277 n.671 
(Nov. 23, 2012).
    \19\ See 17 CFR 240.15c3-3(e). Under paragraph (e), broker-
dealers are generally required to perform the customer reserve 
computation as of the close of business on the last business day of 
the week. Broker-dealers from time to time may perform a mid-week 
computation if it would permit them to make a withdrawal. 17 CFR 
240.15c3-3(g).
---------------------------------------------------------------------------

    In addition, the customer reserve formula permits the broker-dealer 
to offset customer credit items only with customer debit items.\20\ 
This means the broker-dealer can use customer cash to facilitate 
customer transactions such as financing customer margin loans and 
borrowing securities to make deliveries of securities that customers 
have sold short.\21\ Broker-dealer margin rules require securities 
customers to maintain a minimum level of equity in their securities 
accounts.\22\ In addition to protecting the broker-dealer from the 
consequences of a customer default, this equity serves to over-
collateralize the customers' obligations to the broker-dealer and 
thereby protect customers whose cash was used to facilitate the broker-
dealer's financing of securities purchases and short sales by other 
customers. For example, if the broker-dealer fails, the customer 
debits, because they generally are over-collateralized, should be 
attractive assets for another broker-dealer to purchase or, if not 
purchased by another broker-dealer, they should be able to be 
liquidated to a net positive equity.\23\ The proceeds of the debits 
sale or liquidation can be used to repay the customer cash used to 
finance the customer obligations. This cash plus the funds and/or 
qualified securities held in the customer reserve account should equal 
or exceed the total amount of customer credit items (i.e., the total 
amount owed by the broker-dealer to its customers).\24\
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    \20\ See 17 CFR 240.15c3-3a.
    \21\ For example, if a broker-dealer holds $100 for customer A, 
the broker-dealer can use that $100 to finance a security purchase 
of customer B. The $100 the broker-dealer owes customer A is a 
credit in the formula and the $100 customer B owes the broker-dealer 
is a debit in the formula. Therefore, under the customer reserve 
formula there would be no requirement to maintain cash and/or U.S. 
government securities in the customer reserve account. However, if 
the broker-dealer did not use the $100 held in customer A's account 
for this purpose, there would be no offsetting debit and, 
consequently, the broker-dealer would need to have on deposit in the 
customer reserve account cash and/or qualified securities in an 
amount at least equal to $100.
    \22\ Broker-dealers are subject to margin requirements in 
Regulation T promulgated by the Federal Reserve (see 12 CFR 220.1, 
et seq.), in rules promulgated by the self-regulatory organizations 
(``SROs'') (see, e.g., FINRA Rules 4210-4240), and with respect to 
security futures, in rules jointly promulgated by the Commission and 
the CFTC (see 17 CFR 242.400-406).
    \23\ The attractiveness of the over-collateralized debits 
facilitates the bulk transfer of customer accounts from a failing or 
failed broker-dealer to another broker-dealer.
    \24\ See Net Capital Requirements for Broker-Dealers; Amended 
Rules, Exchange Act Release No. 18417 (Jan. 13, 1982), 47 FR 3512, 
3513 (Jan. 25, 1982) (``The alternative method is founded on the 
concept that if the debit items in the Reserve Formula can be 
liquidated at or near their contract values, these assets, along 
with any cash required to be on deposit under the [customer 
protection] rule, will be sufficient to satisfy all customer-related 
liabilities (which are represented as credit items in the Reserve 
Formula'').
---------------------------------------------------------------------------

2. Proprietary Accounts of Broker-Dealers
    A carrying broker-dealer may carry accounts that hold proprietary 
securities and cash of other broker-dealers (``PAB accounts''). As 
noted above, broker-dealers are not within the definition of customer 
for purposes of Rule 15c3-3.\25\ Accordingly, a carrying broker-dealer 
that carries PAB accounts is not required to treat these accounts as 
customer accounts for the purposes of Rule 15c3-3. This means the 
carrying broker-dealer is not required to maintain possession or 
control of the securities of PAB account holders that are not securing 
margin loans to the account holders (``non-margin securities'') or 
include credit and debit items associated with those accounts in its 
customer reserve computation. The definition of customer in SIPA, 
however, is broader than the definition in Rule 15c3-3 in that the SIPA 
definition does not exclude broker-dealers.\26\ Customers under SIPA 
(``SIPA customers'') generally are entitled to a number of protections, 
including the right to share pro rata with other SIPA customers in the 
customer property held by the broker-dealer and, if the customer 
property is insufficient to make each SIPA customer whole, the 
entitlement to receive an advance from the Securities Investor 
Protection Corporation (``SIPC'') of up to $500,000 (of which $250,000 
currently can be used to cover cash claims).\27\ Broker-dealers as SIPA 
customers have the right to a pro rata share of the customer property, 
but are not entitled to receive an advance from the SIPC fund.\28\ 
Consequently, when a carrying broker-dealer is liquidated in a SIPA 
proceeding, each customer (including a SIPA customer that is a broker-
dealer) has a claim on the customer property. Because the possession 
and control and customer reserve account provisions of Rule 15c3-3 do 
not apply to PAB account holders by virtue of the definition of 
customer in the rule, the carrying broker-dealer is not restricted by 
Rule 15c3-3 from using the securities and cash in these accounts for 
its own business purposes.
---------------------------------------------------------------------------

    \25\ 17 CFR 240.15c3-3(a)(1).
    \26\ See 15 U.S.C. 78lll(2).
    \27\ See 15 U.S.C. 78fff-2(c) and 15 U.S.C. 78fff-3(a), 
respectively. Under SIPA, customer property includes ``cash and 
securities (except customer name securities delivered to the 
customer) at any time received, acquired, or held by or for the 
account of the debtor from or for the securities accounts of a 
customer, and the proceeds of any such property transferred by the 
debtor, including property unlawfully converted.'' 15 U.S.C. 
78lll(4). Therefore, customer property includes those securities 
positions that are held for customers and the cash that is owed to 
customers.
    \28\ See 15 U.S.C. 78fff-2(c); see also 15 U.S.C. 78fff-3(a).
---------------------------------------------------------------------------

    The treatment of PAB account holders as SIPA customers but not as 
customers for the purposes of Rule 15c3-3

[[Page 51828]]

increases the risk that, in the event a carrying broker-dealer is 
liquidated under SIPA, the claims of SIPA customers (i.e., customers 
and PAB account holders) will exceed the amount of customer property 
available and, thereby, expose the SIPC fund and potentially SIPA 
customers to losses. In addition, if the customer property is 
insufficient to fully satisfy all SIPA customer claims and losses are 
incurred, the PAB account holders could be placed in financial distress 
causing adverse impacts to the securities markets beyond those 
resulting from the failure of the carrying broker-dealer.\29\
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    \29\ As noted above, while broker-dealers are customers for the 
purposes of SIPA, they are not entitled to the advances from the 
SIPC fund to make up for shortfalls after the pro rata distribution 
of customer property. 15 U.S.C. 78fff-3(a)(5).
---------------------------------------------------------------------------

    To address the disparity in treatment between customers and PAB 
account holders, the Commission proposed amendments to Rules 15c3-3 and 
15c3-3a that would have required a broker-dealer that carries PAB 
accounts to perform a PAB reserve computation with respect to those 
accounts, generally as of the close of business on the last business 
day of the week.\30\ The amendments, as proposed, would have required 
the carrying broker-dealer to add up the debits and credits relating to 
PAB accounts--including credits arising from the use of securities held 
in PAB accounts--and maintain cash or qualified securities in a PAB 
reserve account in an amount equal to or greater than the amount that 
the credits exceed the debits.
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    \30\ See Amendments to Financial Responsibility Rules, 72 FR at 
12863. A broker-dealer that does not carry an account of a customer 
as defined under Rule 15c3-3 or conduct a proprietary trading 
business would be permitted to make the computation monthly rather 
than weekly. See paragraph (e)(3)(iii) of Rule 15c3-3, as adopted.
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    Seven commenters responded to the Commission's request for comment 
on the proposed amendments.\31\ As discussed below, the Commission has 
modified the final rule in certain respects to address, among other 
things, issues raised by commenters. As adopted, the Commission's 
amendments to Rules 15c3-3 and 15c3-3a require carrying broker-dealers 
to: (1) Perform a separate reserve computation for PAB accounts (in 
addition to the customer reserve computation currently required for 
Rule 15c3-3 customer accounts); (2) establish and fund a separate 
reserve account for the benefit of PAB account holders; and (3) obtain 
and maintain physical possession or control of non-margin securities 
carried for PAB accounts unless the carrying broker has provided 
written notice to the PAB account holders that it will use those 
securities in the ordinary course of its securities business, and has 
provided opportunity for the PAB account holder to object to such 
use.\32\
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    \31\ See SIFMA 2 Letter; SIFMA 4 Letter; Dresdner Kleinwort 
Letter; Deutsche Bank Securities Letter; SIPC Letter; Abbey National 
Letter; First Clearing Letter; Cornell Letter.
    \32\ See infra section II.A.2.ii. of this release for a 
discussion of the Commission's rationale for the change in the final 
rule to require a carrying broker-dealer provide notice to, rather 
than obtain written permission from, a PAB account holder in order 
for its securities to be used in the ordinary course of the carrying 
firm's securities business.
---------------------------------------------------------------------------

    These amendments, in part, incorporate many of the provisions of a 
no-action letter regarding PAB accounts issued by Commission staff in 
1998.\33\ The PAIB Letter stated that the staff would not recommend 
enforcement action to the Commission if a broker-dealer did not take a 
net capital deduction under Rule 15c3-1 for cash held in a securities 
account at another broker-dealer,\34\ provided the other broker-dealer 
agrees to: (1) Perform a reserve computation for PAB accounts; \35\ (2) 
establish a separate special reserve bank account; and (3) maintain 
cash or qualified securities in the reserve account equal to the 
computed reserve requirement (``PAIB agreement''). Broker-dealers that 
carry PAB accounts have the incentive to enter into PAIB agreements to 
prevent their PAB account holders from choosing to open an account or 
enter into a clearing agreement with another broker-dealer. Because 
many of the provisions in the PAIB Letter are being incorporated in 
this rulemaking, the Commission is directing the Commission staff to 
withdraw the PAIB Letter as of the effective date of these rule 
amendments.
---------------------------------------------------------------------------

    \33\ See Letter from Michael A. Macchiaroli, Associate Director, 
Division of Market Regulation, Commission, to Raymond J. Hennessy, 
Vice President, NYSE, and Thomas Cassella, Vice President, NASD 
Regulation, Inc. (Nov. 3, 1998) (``PAIB Letter'').
    \34\ Under Rule 15c3-1, broker-dealers are generally required to 
deduct unsecured receivables from their net worth when computing 
their net capital.
    \35\ Under new paragraph (e)(3), broker-dealers will be required 
to perform the PAB reserve account computation (and its customer 
reserve account computation, if applicable) on a weekly basis, as of 
the close of business on the last business day of the week. With 
regard to PAB accounts, a broker-dealer that does not carry an 
account of a customer as defined under Rule 15c3-3 or conduct a 
proprietary trading business may make the PAB reserve account 
computation monthly rather than weekly. See new paragraph 
(e)(3)(iii) of Rule 15c3-3.
---------------------------------------------------------------------------

i. Definition of ``PAB Account'' Under Rule 15c3-3(a)(16)
    The Commission proposed, among other things, to add paragraph 
(a)(16) to Rule 15c3-3 that would have defined the term PAB account as 
``a proprietary securities account of a broker or dealer (which 
includes a foreign broker or dealer, or a foreign bank acting as a 
broker or dealer), but shall not include an account where the account 
owner is a guaranteed subsidiary of the carrying broker or dealer, the 
account owner guarantees all liabilities and obligations of the 
carrying broker or dealer, or the account is a delivery-versus-payment 
account or receipt-versus-payment account.'' \36\ Two commenters raised 
concerns about the proposed definition because--by including 
proprietary accounts of foreign broker-dealers and foreign banks acting 
as broker-dealers within the term PAB account--it differed from 
provisions in the PAIB Letter, which excluded such accounts from a PAIB 
computation.\37\ One of these commenters stated that broker-dealers 
(including foreign banks acting as broker-dealers) should be allowed to 
opt-out of PAB account treatment because they do not require the same 
protections as customers as defined in Rule 15c3-3.\38\ The commenter 
stated that broker-dealers are able to understand the insolvency risk 
of the broker-dealers at which they maintain proprietary accounts.\39\ 
This commenter noted that broker-dealer customers often self-insure or 
otherwise account for such exposure regardless of their status under 
SIPA.\40\ The second commenter stated that foreign broker-dealers and 
foreign banks acting as broker-dealers should be allowed to subordinate 
their claims to customers and creditors of the broker-dealer in order 
to remove their accounts from PAB account treatment because under SIPA 
foreign broker-dealers and foreign banks acting as broker-dealers, 
under certain circumstances, will not be deemed customers and, 
therefore, would not be entitled to a pro rata share of the estate of 
customer property in a SIPA liquidation.\41\ More specifically, the 
commenter suggested that the Commission modify the definition of PAB 
account, to exclude ``any foreign broker-dealer and foreign bank to the 
extent that such entity has a claim for cash or securities that is 
subordinated to the claims of creditors of the carrying broker-dealer'' 
in order to parallel the

[[Page 51829]]

language in SIPA.\42\ This commenter also recommended requiring the 
``subordinating'' broker-dealer to follow the requirements for non-
conforming subordinated loans to remove an account from PAB account 
treatment.\43\
---------------------------------------------------------------------------

    \36\ See Amendments to Financial Responsibility Rules, 72 FR at 
12895.
    \37\ See Dresdner Kleinwort Letter; Deutsche Bank Securities 
Letter. Though SIFMA initially raised concerns about the proposed 
definition, it later withdrew its recommendation that proprietary 
accounts of affiliated non-U.S. broker-dealers and non-U.S. banks be 
excluded from the PAB account definition. See SIFMA 2 Letter; SIFMA 
4 Letter.
    \38\ See Dresdner Kleinwort Letter.
    \39\ Id.
    \40\ See Dresdner Kleinwort Letter.
    \41\ See Deutsche Bank Securities Letter.
    \42\ The definition of customer in SIPA excludes any person, to 
the extent that ``such person has a claim for cash or securities 
which by contract, agreement, or understanding, or by operation of 
law, is part of the capital of the debtor, or is subordinated to the 
claims of any and all creditors of the debtor, notwithstanding that 
some grounds exist for declaring such contract, agreement, or 
understanding void or voidable in a suit between the claimant and 
the debtor.'' See 15 U.S.C. 78lll(2)(C)(iii).
    \43\ See Deutsche Bank Securities Letter. See also SIFMA 4 
Letter. Under Rule 15c3-1, a broker-dealer can exclude liabilities 
that are subordinated to the claims of creditors pursuant to a 
satisfactory subordination agreement, as defined in Appendix D to 
Rule 15c3-1, for purposes determining its net capital. See 17 CFR 
240.15c3-1(c)(2)(ii) and 17 CFR 240.15c3-1d. See also 17 CFR 
240.15c3-1(c)(i)(x). A non-conforming subordination agreement 
generally would not meet all the requirements of Appendix D to Rule 
15c3-1, and, therefore, a broker-dealer could not exclude the 
liability resulting from the loan agreement in computing its net 
capital. See 17 CFR 240.15c3-1(c)(2)(ii).
---------------------------------------------------------------------------

    Another commenter stated that the Commission's desire to close the 
gap between Rule 15c3-3 and SIPA must be balanced against the 
potentially significant practical issues the Commission's proposal 
would raise in the case of accounts carried for affiliated entities 
operating in non-U.S. jurisdictions.\44\ In a subsequent letter, this 
commenter stated that while it would prefer a more flexible solution 
that would allow broker-dealers and non-U.S. banks acting as broker-
dealers (especially non-U.S. affiliates) to opt to have their accounts 
treated as neither customer accounts under SIPA nor PAB accounts, the 
commenter recognized that there is a clear need for an immediate 
solution that cannot be delayed until appropriate amendments to SIPA 
are adopted.\45\ Consequently, the commenter withdrew its 
recommendation that the proprietary accounts of affiliated non-U.S. 
broker-dealers and affiliated non-U.S. banks be excluded from the ``PAB 
account'' definition, but continued to endorse its previous comments to 
achieve the goal of correcting the gap between Rule 15c3-3 and SIPA 
without creating undue or unintended burdens.\46\
---------------------------------------------------------------------------

    \44\ See SIFMA 2 Letter. This commenter specifically raised 
concerns that it would be cumbersome to subject transactions between 
a carrying broker-dealer and its foreign affiliates to the proposed 
PAB requirements because of the integrated securities processing and 
settlement activities of these entities, which would limit the 
ability of the group as a whole to provide competitive services to 
U.S. investors.
    \45\ See SIFMA 4 Letter.
    \46\ See SIFMA 4 Letter. Among other things, the commenter 
suggested that the Commission modify the proposed definition of PAB 
account to exclude any customer as defined in Rule 15c3-3 and also 
to exclude the other types of persons who are specifically excluded 
from the definition of customer. This suggestion included excluding 
accounts whose claims are subordinated to the claims of other 
creditors of the carrying broker-dealer. Id.
---------------------------------------------------------------------------

    The goal of the proposed amendments is to create a process that 
protects Rule 15c3-3 customers and PAB account holders of a failed 
carrying broker-dealer. The amendments are designed to provide such 
protection by mitigating the risk that there will be insufficient 
customer property to fully satisfy all customer claims in a SIPA 
liquidation. The entitlement of PAB account holders to a pro rata share 
of the fund of customer property places all SIPA customers at risk if 
the carrying firm does not establish a PAB reserve account for excess 
credits owed to PAB account holders.
    At the same time, the Commission appreciates the need to consider 
both the practical issues raised by commenters and its objective to 
eliminate the inconsistency between Rule 15c3-3 and SIPA.\47\ 
Accordingly, in response to commenters, the final rule adopted by the 
Commission excludes from the definition of PAB account in paragraph 
(a)(16) of Rule 15c3-3 ``an account that has been subordinated to the 
claims of creditors of the carrying broker or dealer.'' \48\ A PAB 
account holder that has subordinated its claims with respect to that 
account to claims of creditors of the carrying broker-dealer will not 
be entitled to SIPA protection for that account.\49\ Consequently, this 
provision will provide flexibility to carrying broker-dealers and their 
broker-dealer affiliates to structure their PAB account relationships 
in a manner that permits operational efficiencies (i.e., the ability to 
exclude these accounts from the PAB reserve computation) while still 
promoting the goal of the amendments to have a consistent treatment of 
these accounts under Rule 15c3-3 and SIPA, and thereby protect accounts 
holders that are ``customers'' under SIPA.\50\ If a U.S. broker-dealer, 
however, chooses to subordinate its claims to assets in that account to 
the claims of other creditors of the carrying broker-dealer, it will 
not be able to include those assets as allowable for its own net 
capital computation.\51\
---------------------------------------------------------------------------

    \47\ See Amendments to Financial Responsibility Rules, 72 FR at 
12863.
    \48\ The agreement would not need to be conforming for purposes 
of Exchange Act Rule 15c3-1d (Satisfactory Subordination 
Agreements).
    \49\ See 15 U.S.C. 78lll(2).
    \50\ See 17 CFR 240.15c3-3(a)(1) and 15 U.S.C. 78lll(2)(C)(ii). 
These accounts will be excluded from both the definition of PAB 
account, as well from the definition of customer under SIPA. See 
Amendments to Financial Responsibility Rules, 72 FR at 12863. 
Consequently, these account holders will not be entitled to the 
protections in SIPA applicable to customers.
    \51\ See 17 CFR 240.15c3-1(c)(2)(iv)(E).
---------------------------------------------------------------------------

    Further, as was proposed, the definition of PAB account in the 
final rule excludes accounts that operate on a delivery-versus-payment 
or a receipt-versus-payment basis, or ``DVP/RVP'' basis, because these 
accounts generally hold securities and cash for short durations.\52\ 
The provision relating to DVP/RVP accounts is being adopted 
substantially as proposed, though paragraph (a)(16), as adopted, has 
been modified by splitting the text into two sentences. As adopted, the 
reference to the DVP/RVP accounts provision was moved to the first 
sentence. The Commission is not adopting the proposed exclusions from 
the PAB reserve computation requirement related to accounts established 
by a PAB account holder that fully guarantee the obligations of, or 
whose accounts are fully guaranteed by, the carrying broker-dealer. 
Rather than create a specific exemption for such account holders, the 
Commission believes the better approach is to allow these accounts to 
enter into subordination agreements with the carrying broker-dealer, in 
order for these accounts to be excluded from the definition of PAB 
account. This approach simplifies the final rule, while continuing to 
provide a means for these account holders to be excluded from its 
scope. Consequently, as adopted, paragraph (a)(16) to Rule 15c3-3 
defines the term PAB account to mean ``a proprietary securities account 
of a broker or dealer (which includes a foreign broker or dealer, or a 
foreign bank acting as a broker or dealer) other than a delivery-
versus-payment account or a receipt-versus-payment account.'' \53\ The 
definition of PAB Account does not include accounts that have been 
subordinated to the claims of a carrying broker-dealer's creditors.\54\
---------------------------------------------------------------------------

    \52\ See Amendments to Financial Responsibility Rules, 72 FR at 
12863, n.17 (``[T]he amendment would exclude delivery-versus-payment 
and receipt-versus-payment accounts. These types of accounts pose 
little risk of reducing the estate of customer property in a SIPA 
liquidation since they only hold assets for short periods of 
time.'').
    \53\ See paragraph (a)(16) to Rule 15c3-3, as adopted.
    \54\ Id.
---------------------------------------------------------------------------

ii. Written Permission To Use PAB Account Securities
    Because PAB account holders are not customers for purposes of Rule 
15c3-3, a carrying broker-dealer is not required to maintain possession 
or control of their non-margin securities. Consequently, it has been a 
long-

[[Page 51830]]

standing industry practice for carrying broker-dealers to use these PAB 
securities in their business activities. Under the final rule, a 
carrying broker-dealer that uses these PAB securities will need to 
include the market value of the securities as a credit in the formula 
when performing the PAB reserve computation. Thus, the amount that the 
carrying broker-dealer must maintain in its PAB reserve account will 
increase by the amount of these credits because there would be no 
corresponding debit item.\55\
---------------------------------------------------------------------------

    \55\ 17 CFR 240.15c-3-3a.
---------------------------------------------------------------------------

    Using non-margin securities of PAB account holders presents the 
risk that securities may increase in market value between PAB reserve 
computations and, therefore, the amount of the credit items in the 
formula may be less than the value of the securities for a short period 
of time. To accommodate industry practice, however, the Commission did 
not propose amending Rule 15c3-3 to apply the possession or control 
requirements to PAB accounts. The Commission proposed adding paragraph 
(b)(5) to Rule 15c3-3 that would have required the carrying broker-
dealer to obtain written permission from a PAB account holder before it 
could use the PAB account holder's securities in the ordinary course of 
its securities business. In this way, the Commission proposed 
increasing the protections for PAB account holders without interfering 
with long-standing industry practice of carrying broker-dealers using 
the securities of their broker-dealer account holders. However, 
securities not being used by the broker-dealer must be maintained in 
accordance with the possession or control requirements of Rule 15c3-3.
    One commenter stated that this provision should be eliminated from 
the proposed amendments, arguing that ``[t]he proposal interferes 
unnecessarily in the contractual arrangements between broker-dealers, 
which are capable of understanding the terms of standard industry 
custodial relationships.'' \56\ The commenter also noted that the PAIB 
Letter did not contain any such requirement.\57\ The Commission agrees 
with the commenter that broker-dealers should be able to understand the 
implications of granting another broker-dealer the ability to use their 
non-margin securities and, therefore, the final rule requires written 
notice rather than written permission. An appropriate level of 
protection for the PAB account holder may be achieved without requiring 
the carrying broker-dealer to maintain possession or control of 
securities carried for a PAB account, provided that the carrying 
broker-dealer gives written notice to its PAB account holders that it 
may use their non-margin securities.\58\
---------------------------------------------------------------------------

    \56\ See SIFMA 2 Letter.
    \57\ Id.
    \58\ The Commission has deleted the phrase ``obtained the 
written permission of the account owner to use the securities in the 
ordinary course of its securities business'' from paragraph (b)(5) 
of the final rule and replaced it with ``provided written notice to 
the account holder that the securities may be used in the ordinary 
course of its securities business, and has provided an opportunity 
for the account holder to object.''
---------------------------------------------------------------------------

    The Commission acknowledges that this change, as compared to the 
proposed rule, will shift the burden to the PAB account holder to 
proactively object to the carrying broker-dealer using the account 
holder's securities. However, the new written notice requirement 
increases the protections for PAB account holders from the status quo 
without imposing substantial burdens on existing account relationships. 
The revised rule is intended to provide to the PAB account holders the 
opportunity to negotiate different terms if they do not want their 
securities used, while eliminating the need for, and the costs that 
would result from, carrying broker-dealers reworking existing 
contracts.
    As adopted, the Commission is modifying the final rule to add the 
phrase ``and has provided an opportunity for the account holder to 
object'' following the phrase ``ordinary course of its securities 
business.'' \59\ This language was added to the final rule to impose a 
requirement that the carrying broker-dealer provide the PAB account 
holders an opportunity to object to the use of their non-margin 
securities after they receive the written notice from the carrying 
broker-dealer. The rule does not prescribe the form in which a PAB 
account holder must provide notice to the carrying broker-dealer of its 
objection. This will provide the PAB account holder with flexibility to 
communicate the objection in a manner the account holder determines is 
most effective in terms of conveying such objection to the carrying 
broker-dealer. If the PAB account holder objects, the carrying broker-
dealer could not use the securities. Further, the PAB account holder 
could seek to move the account to another carrying broker-dealer or 
negotiate different terms with the carrying broker-dealer with regard 
to the use of its securities.
---------------------------------------------------------------------------

    \59\ See paragraph (b)(5) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------

    Finally, the Commission has modified proposed paragraph (b)(5) to 
clarify in the final rule that a broker-dealer is affirmatively 
required to maintain possession and control of non-margin securities 
unless the broker-dealer has provided written notice to the PAB account 
holder.\60\ As modified, paragraph (b)(5) reads: ``A broker or dealer 
is required to obtain and thereafter maintain the physical possession 
or control of securities carried for a PAB account, unless the broker 
or dealer has provided written notice to the account holder that the 
securities may be used in the ordinary course of its securities 
business, and has provided an opportunity for the account holder to 
object.'' \61\
---------------------------------------------------------------------------

    \60\ The modifications replaced the phrase ``shall not be 
required'' with the phrase ``is required'' and replaced the phrase 
``provided that'' with the word ``unless.''
    \61\ See paragraph (b)(5) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------

iii. PAB Reserve Bank Accounts
    The Commission proposed amendments to paragraph (e) of Rule 15c3-3 
to require a carrying broker with PAB accounts to establish and 
maintain a PAB reserve account for PAB accounts, perform a separate PAB 
reserve computation for PAB accounts, and maintain cash or qualified 
securities in the PAB reserve account in an amount equal to the PAB 
reserve requirement.\62\ The Commission also proposed amendments to 
paragraph (f) of Rule 15c3-3 to require carrying broker-dealers with 
PAB accounts to notify the bank about the status of the PAB reserve 
account and obtain an agreement and notification from the bank that the 
PAB reserve account will be maintained for the benefit of the PAB 
account holders.\63\ The Commission is adopting these amendments to 
paragraphs (e) and (f) of Rule 15c3-3 substantially as proposed, with 
some technical modifications suggested by one commenter, including 
making terminology consistent throughout the paragraphs.\64\ In 
addition, the Commission is adopting substantially as proposed the 
amendments to paragraph (g) of Rule 15c3-3 which specifies when the 
carrying broker-dealer can make withdrawals from a PAB reserve 
account.\65\ Finally, the Commission is

[[Page 51831]]

adopting, as proposed, new paragraph (e)(4) to Rule 15c3-3, which 
allows a carrying broker-dealer to use credits related to PAB accounts 
to finance Rule 15c3-3 customer debits, but does not allow a carrying 
broker-dealer to use Rule 15c3-3 customer credits to finance PAB 
debits.
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    \62\ See section II.A.3. of this release for a discussion of 
changes to paragraph (e)(5) of Rule 15c3-3 with respect to banks 
where customer or PAB reserve accounts may be held.
    \63\ 17 CFR 240.15c3-3(f).
    \64\ See SIFMA 2 Letter.
    \65\ 17 CFR 240.15c3-3(g). In this paragraph, the Commission 
deleted the phrase ``his Reserve Bank Accounts'' and replaced it 
with the phrase ``a Customer Reserve Bank Account and PAB Reserve 
Bank Account.'' The Commission also deleted the phrase ``each 
Reserve Bank Account'' and replaced it with the phrase ``the 
Customer Reserve Bank Account and PAB Reserve Bank Account.'' These 
were the only changes made to the final rule in paragraph (g) of 
Rule 15c3-3.
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iv. Other PAB Issues Raised by Commenters
    In addition to specific comments on the proposed rule language, one 
commenter had other interpretive questions and comments about the 
proposed PAB requirements.\66\ The commenter requested that the 
Commission clarify whether PAB account holders must obtain from their 
carrying broker-dealers a written agreement to perform the calculation 
as required by the PAIB Letter.\67\ Under the amendments, there is no 
requirement that PAB account holders obtain a written agreement from 
the carrying firm that it will perform the PAB reserve computation. 
Rule 15c3-3, as amended, requires the carrying firm to perform the PAB 
reserve computation. As stated above, Rule 15c3-3 prescribes the 
requirements for carrying firms with respect to PAB accounts, and the 
PAIB Letter is being withdrawn.\68\
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    \66\ See SIMFA 2 Letter.
    \67\ Id.
    \68\ As discussed above in this section II.A.2., the Commission 
is directing the staff to withdraw the PAIB Letter as of the 
effective date of these rules.
---------------------------------------------------------------------------

    In addition, the commenter requested the Commission to clarify that 
existing PAIB reserve accounts need not be re-titled to comply with the 
proposed amendments.\69\ Item 4 of the PAIB Letter required that a 
carrying broker-dealer, ``establish and maintain a separate `Special 
Reserve Account for the Exclusive Benefit of Customers' with a bank in 
conformity with the standards of paragraph (f) of Rule 15c3-3.'' 
Paragraph (e)(1) of Rule 15c3-3, however, requires that a carrying 
broker-dealer establish and maintain a ``Special Reserve Bank Account 
for Brokers and Dealers.'' Given the small differences in nomenclature 
and the time and expense associated with broker-dealers re-titling 
these accounts, a carrying broker-dealer that has properly established 
PAB reserve account in the manner described in Item 4 of the PAIB 
Letter need not re-title the account and obtain a new notification from 
the bank.\70\ However, all PAB reserve accounts established on or after 
the effective date of these amendments must title the account in 
accordance with paragraph (e)(1) of Rule 15c3-3.
---------------------------------------------------------------------------

    \69\ See SIFMA 2 Letter.
    \70\ See PAIB Letter.
---------------------------------------------------------------------------

    Finally, the commenter urged the Commission to clarify whether, for 
purposes of Rule 15c3-1, the term aggregate debit items means total 
aggregate debit items computed in accordance with the customer reserve 
formula or the total aggregate debit items computed in accordance with 
both the customer reserve formula and the PAB reserve formula.\71\ 
Aggregate debit items are used in the net capital rule to determine the 
minimum net capital requirement for broker-dealers that elect to use 
the alternative standard in computing their minimum net capital 
requirement. Specifically, the net capital rule requires broker-dealers 
using the alternative standard to maintain net capital of at least the 
greater of $250,000 or 2% of aggregate debit items.\72\ Including PAB 
aggregate debit items in this computation would significantly increase 
net capital requirements for broker-dealers that use the alternative 
method. The intended purpose of this rule change is to address the 
inconsistencies between Rule 15c3-3 and SIPA--not to increase net 
capital requirements. Consequently, the requirements in Rules 15c3-1, 
15c3-1d, and 17a-11 that refer to aggregate debit items continue to be 
based only on aggregate debit items computed in accordance with the 
customer reserve computation, and do not include aggregate debit items 
computed in accordance with the PAB reserve computation.\73\
---------------------------------------------------------------------------

    \71\ See SIFMA 2 Letter; SIFMA 4 Letter.
    \72\ 17 CFR 240.15c3-1(a)(1)(ii). In addition, certain other 
financial responsibility rules require that a broker-dealer that 
computes net capital pursuant to the alternative method either 
report to the Commission, limit its ability to obtain, pre-pay, or 
repay subordinated debt, or limit its business if its net capital 
falls below a certain level based on a percentage of aggregate debit 
items (see, e.g., Rules 15c3-1(e)(2)(vi), 15c3-1d(b)(6)(iii), 15c3-
1d(b)(7), 15c3-1d(b)(8)(i)(A), 15c3-1d(b)(10)(ii)(B), 15c3-1d(c)(2), 
15c3-1d(c)(5)(ii)(A), and 17a-11(c)(2)).
    \73\ Under paragraph (e)(4) to Rule 15c3-3, a carrying broker-
dealer will be permitted to use credits related to PAB accounts to 
finance Rule 15c3-3 customer debits. This rule, however, does not 
affect the use of aggregate debit items in computing a broker-
dealer's net capital under the alternative standard pursuant to 
paragraph (a)(1)(ii) of Rule 15c3-1.
---------------------------------------------------------------------------

v. Amendment to Rule 15c3-1(c)(2)(iv)(E) Related to PAB Accounts
    Finally, the Commission proposed an amendment to Rule 15c3-1 \74\ 
that would have required a broker-dealer, when calculating net capital, 
to deduct from net worth cash and securities held in a securities 
account at another broker-dealer if the other broker-dealer does not 
treat the account, and the assets therein, in compliance with the 
applicable PAB reserve account requirements of Rules 15c3-3 and 15c3-
3a.\75\ A commenter suggested modifying this proposed amendment,\76\ 
arguing that ``[a]lthough the Proposing Release states that the 
Commission `would not expect broker-dealers to audit or examine their 
carrying broker-dealers to determine whether the carrying broker-dealer 
is in compliance with [the proposed rules],' the text of the proposed 
amendment suggests that they in fact would have such an obligation.'' 
\77\ The commenter also stated that a broker-dealer should not be 
deemed to have violated Rule 15c3-1 merely because its carrying firm 
fails to properly perform requirements solely applicable to the 
carrying firm and that paragraph (c)(2)(iv)(E) under Rule 15c3-1 should 
be explicitly modified to clarify that cash and securities held in a 
securities account at another broker-dealer are not subject to the 
deduction specified in that paragraph.\78\
---------------------------------------------------------------------------

    \74\ 17 CFR 240.15c3-1(c)(2)(iv)(E).
    \75\ See Amendments to Financial Responsibility Rules, 72 FR at 
12864.
    \76\ See SIFMA 2 Letter.
    \77\ Id.
    \78\ Id.
---------------------------------------------------------------------------

    While the Commission did not intend to impose any monitoring 
requirement on the PAB account holder, the Commission recognizes that 
the language, as proposed, could have implied such a requirement and 
agrees with the commenter that a broker-dealer should not be deemed to 
have violated Rule 15c3-1 with respect to requirements that are solely 
applicable to the carrying broker-dealer. To address this concern, the 
Commission has modified the language in paragraph (c)(2)(iv)(E) under 
Rule 15c3-1 to eliminate the proposed capital charge of Rule 15c3-1 
that would have resulted from a failure of a carrying broker-dealer to 
comply with the PAB requirements in Rule 15c3-3.\79\
---------------------------------------------------------------------------

    \79\ More specifically, the Commission has deleted the proposed 
language referring to ``cash and securities held in a securities 
account at another broker-dealer if the other broker-dealer does not 
treat the account, and the assets therein in compliance with 
paragraphs (b)(5) and (e) of Sec.  240.15c3-3. . . .''
---------------------------------------------------------------------------

    Instead, the Commission has adopted amendments to Rule 15c3-1 
providing that a broker-dealer need not deduct cash and securities held 
in a securities account at a carrying broker-dealer except where the 
account has been subordinated to the claims of creditors of the 
carrying broker-dealer.\80\ This provision is intended to prevent 
broker-dealers from including assets in their net capital that may not 
be readily available to be returned because they

[[Page 51832]]

would not be subject to the PAB account provisions discussed above. 
Accordingly, the amendments to paragraph (c)(2)(iv)(E) of Rule 15c3-1 
are consistent with the exclusions from the definition of PAB account 
in paragraph (a)(16) of Rule 15c3-3.\81\
---------------------------------------------------------------------------

    \80\ 17 CFR 240.15c3-1(c)(2)(iv)(E).
    \81\ 17 CFR 15c3-3(a)(16).
---------------------------------------------------------------------------

3. Banks Where Special Reserve Deposits May Be Held
    As amended, paragraph (e) of Rule 15c3-3 requires a broker-dealer 
to deposit cash or qualified securities into the customer or PAB 
reserve account,\82\ which must be maintained at a bank.\83\ While cash 
deposits at a bank are fungible and may be used by the bank in its 
lending and investment activities, paragraph (f) of Rule 15c3-3 
requires that a broker-dealer obtain a written contract from the bank 
wherein the bank agrees not to re-lend or hypothecate securities 
deposited into the reserve account.\84\ This means the bank cannot use 
the securities in its business, which provides a measure of protection 
by requiring that the securities will be available to the broker-dealer 
if the bank falls into financial difficulty. Cash deposits, however, 
may be freely used in the course of the bank's commercial 
activities.\85\ Therefore, to the extent a broker-dealer deposits cash 
in a reserve account, there is a risk the cash could become 
inaccessible if the bank experiences financial difficulties.\86\ This 
could adversely impact the broker-dealer and its customers.\87\ To 
limit these risks, the Commission proposed amendments to Rule 15c3-3 
that would have: (1) Prohibited a broker-dealer from maintaining cash 
deposits in the reserve accounts for customers and PAB account holders 
if the bank was affiliated; and (2) limited the amount of cash that 
could be deposited in both types of reserve accounts at non-affiliated 
banks.\88\ These restrictions would not have applied to securities held 
in the reserve accounts because, as noted above, the bank must agree 
not to use the securities in its business. The goal of the proposals 
was to limit cash reserve account deposits to reasonably safe amounts 
as measured against the capitalization of the broker-dealer and the 
bank.\89\
---------------------------------------------------------------------------

    \82\ The PAB reserve account and the customer reserve account 
are collectively referred to as the ``reserve accounts'' or a 
``reserve account.''
    \83\ The term bank is defined in paragraph (a)(7) of Rule 15c3-3 
as a ``bank as defined in section 3(a)(6) of the Exchange Act and 
will also mean any building and loan, savings and loan or similar 
banking institution subject to the supervision by a Federal banking 
authority.'' See paragraph (a)(7) to Rule 15c3-3, as adopted.
    \84\ See 17 CFR 240.15c3-3(f).
    \85\ See Amendments to Financial Responsibility Rules, 72 FR at 
12864.
    \86\ Id.
    \87\ Id.
    \88\ Id.
    \89\ Id.
---------------------------------------------------------------------------

    Specifically, as proposed, paragraph (e)(5) of 15c3-3 provided that 
a carrying broker-dealer would have been required to exclude the amount 
of cash deposited into reserve accounts at affiliated banks when 
determining whether it maintained the minimum amount required to be on 
deposit in the reserve accounts for its customers and PAB account 
holders. In addition, the proposed amendment would have required a 
carrying broker-dealer to exclude cash deposited in a reserve account 
at an unaffiliated bank to the extent the amount of the cash deposited 
exceeded: (1) 50% of the broker-dealer's excess net capital (based on 
the broker-dealer's most recently filed FOCUS Report); \90\ or (2) 10% 
of the bank's equity capital (based on the bank's most recently filed 
Call Report or Thrift Financial Report).\91\
---------------------------------------------------------------------------

    \90\ Under Rule 17a-5, broker-dealers must file periodic reports 
on Form X-17a-5 (Financial and Operational Combined Uniform Single 
Reports) (``FOCUS Reports''). See 17 CFR 240.17a-5(a). The FOCUS 
Report requires, among other financial information, a balance sheet, 
income statement, and net capital and customer reserve computations. 
Excess net capital is the amount that a broker-dealer's net capital 
exceeds its minimum requirement.
    \91\ See Amendments to Financial Responsibility Rules, 72 FR at 
12864. On July 21, 2011, supervisory responsibility for federal 
savings associations was transferred from the Office of Thrift 
Supervision (``OTS'') to the Office of the Comptroller of the 
Currency (``OCC''). As of the quarter ending March 31, 2012, savings 
associations were required to file a Call Report in lieu of a Thrift 
Financial Report. See Proposed Agency Information Collection 
Activities; Comment Request, 76 FR 7082 (Feb. 8, 2011). The Call 
Report includes a line item for total bank equity capital. A report 
for a specific institution is available at https://cdr.ffiec.gov/public/. See also, FINRA, Interpretations of Financial and 
Operational Rules, Interpretations 15c3-3(e)(1)/01 and/011 
(establishing similar threshold restrictions on using money market 
deposit accounts or time deposits, respectively, to meet customer 
reserve account requirements), and Interpretation 15c3-3(e)(3)/051 
(establishing similar threshold restrictions with respect to meeting 
the customer reserve requirement by depositing cash at an affiliated 
bank).
---------------------------------------------------------------------------

    The Commission is adopting the amendments with modifications 
designed to address issues identified by commenters. Twenty-three 
commenters addressed the proposed amendments.\92\ Fifteen commenters 
urged the Commission not to adopt the proposed prohibition on broker-
dealers maintaining cash in reserve accounts at affiliated banks.\93\ 
These commenters generally stated that, with regard to cash in reserve 
accounts, affiliated banks should be treated the same as unaffiliated 
banks because both groups are subject to the same financial 
regulation.\94\ These commenters noted that banks are subject to safety 
and soundness requirements of their respective banking regulators and, 
therefore, the commenters argued that the proposed restriction with 
respect to affiliated banks is unwarranted.
---------------------------------------------------------------------------

    \92\ See Federated Letter; Curian Clearing Letter; Raymond James 
Letter; JP Morgan Letter; Reserve Letter; Dresdner Kleinwort Letter; 
SIFMA 2 Letter; SIFMA 4 Letter; First Clearing Letter; Clearing 
House Letter; ICI Letter; Barclays Letter; ABASA Letter; PNC Letter; 
BlackRock Letter; Deutsche Bank Securities Letter; E*Trade Letter; 
Citigroup Letter; American Bar Association Letter; Fidelity/NFS 
Letter; BOK Letter; JP Morgan 3 Letter; IIB Letter; Raymond James 2 
Letter.
    \93\ See Federated Letter; JP Morgan Letter; Dresdner Kleinwort 
Letter; SIFMA 4 Letter; First Clearing Letter; ICI Letter; ABASA 
Letter; E*Trade Letter; Citigroup Letter; American Bar Association 
Letter; Fidelity/NFS Letter; Curian Letter; BOK Letter; JP Morgan 2 
Letter; IIB Letter.
    \94\ Id.
---------------------------------------------------------------------------

    One commenter also stated that the Commission's distinction between 
affiliated and unaffiliated banks was not sufficiently supported in the 
proposing release.\95\ More specifically, this commenter stated that 
the Commission's ``bare statement that a broker-dealer `may not 
exercise due diligence with the same degree of impartiality when 
assessing the soundness of an affiliate bank as it would with a non-
affiliate . . .' does not suffice to justify the disparate treatment'' 
with regard to the treatment of affiliated banks under the proposed 
rule.\96\ This commenter also stated that it is just as easy to argue 
that broker-dealers are in a much better position to know about the 
soundness of an affiliated bank then to learn about the soundness of a 
unaffiliated bank, which may not be willing to provide complete and 
accurate information.\97\ In addition, another commenter stated that 
the Commission cited no empirical or anecdotal evidence to support its 
reasons for prohibiting cash reserve deposits at an affiliated 
bank.\98\ This commenter also stated that the Commission's concerns 
discount the operational efficiencies to be gained between an 
affiliated broker-dealer and its bank, including: Commonality between 
certain policies and procedures; greater ease in communication 
internally; and greater operational efficiencies leading to reduced 
operational risk in the transfer of funds to and from the bank.\99\
---------------------------------------------------------------------------

    \95\ See Dresdner Kleinwort Letter.
    \96\ Id.
    \97\ Id.
    \98\ See Citigroup Letter.
    \99\ Id.
---------------------------------------------------------------------------

    One commenter stated that it took no issue with the proposed 
restriction on

[[Page 51833]]

affiliated banks.\100\ Another commenter noted that the financial 
industry has seen a remarkable consolidation of the banking and 
securities industries, and, as a result, the number of broker dealers 
affiliated with banks has increased, along with the number of those 
broker-dealers maintaining deposits at affiliated banks.\101\ This 
commenter stated that broker-dealers would be required to move deposits 
from one institution and divide that amount among several banks, 
resulting in credit risk to the broker-dealer, as well as an increase 
in operational risk.\102\ Finally, the commenter observed that the 
Commission did not provide any specific examples of bank failures 
impacting affiliated broker-dealers, which led the commenter to 
question whether there is any realistic benefit to offset the increased 
risk that broker-dealers would be required to take on as a result of 
the proposal to place restrictions on cash deposits in reserve accounts 
at affiliated and unaffiliated banks.\103\
---------------------------------------------------------------------------

    \100\ See Raymond James Letter. In a subsequent comment letter, 
this commenter stated that if this proposal is adopted, registered 
broker-dealers holding customer funds may be required to move their 
reserve accounts if those accounts are currently held at affiliated 
banks, which would increase costs. See Raymond James 2 Letter.
    \101\ See BOK Letter.
    \102\ Id.
    \103\ Id.
---------------------------------------------------------------------------

    The Commission recognizes that all banks, whether or not affiliated 
with a broker-dealer, are subject to regulation by their respective 
banking regulators. The Commission's continuing concern, however, is 
that a carrying broker-dealer may not exercise due diligence with the 
same degree of impartiality and care when assessing the financial 
soundness of an affiliated bank as it would with an unaffiliated 
bank.\104\ Moreover, the goal of protecting the carrying broker-
dealer's customers through the Rule 15c3-3 reserve requirement may be 
undermined in the event a holding company becomes insolvent, with 
corresponding adverse consequences to both the bank and broker-dealer 
subsidiaries.
---------------------------------------------------------------------------

    \104\ See Amendments to Financial Responsibility Rules, 72 FR at 
12864.
---------------------------------------------------------------------------

    In some cases, a broker-dealer may have access to more information 
about an affiliated bank in comparison to an unaffiliated bank for 
purposes of conducting due diligence. However, having more information 
would not be of benefit if the individuals making the decision on where 
to maintain the reserve account are not objective in their decision 
making. The Commission is concerned that a broker-dealer's decision to 
hold cash in a reserve account at an affiliated bank may be driven in 
part by profit or reasons based on the affiliation, regardless of any 
due diligence it may conduct or the overall safety and soundness of the 
bank.
    In addition, in response to the comments regarding affiliated 
banks, the Commission notes that substantial numbers of banks have 
failed or required government assistance in recent years.\105\ While a 
particular bank failure may not have materially impacted an affiliated 
broker-dealer to date,\106\ the risk remains that the financial 
difficulty of an entity that is part of a holding company structure may 
adversely impact other affiliated entities, including affiliated 
broker-dealers and banks.\107\ Therefore, the final rule retains the 
prohibition on maintaining customer reserve cash deposits at an 
affiliated bank.\108\
---------------------------------------------------------------------------

    \105\ According to the FDIC, the number of FDIC-insured 
institutions that failed in the U.S. over the last four years are: 
(1) 140 in 2009; (2) 157 in 2010; (3) 92 in 2011; and (4) 51 in 
2012. A complete list of failed banks since October 1, 2000, is 
available at www.fdic.gov/bank/individual/failed/banklist.html.
    \106\ See BOK Letter; Dresdner Kleinwort Letter.
    \107\ See, e.g., Lehman Brothers Inc.--Trustee's Preliminary 
Investigation Report and Recommendations (Case No. 08-01420 (JMP) 
SIPA), available at http://bankrupt.com/misc/sipareport0904.pdf.
    \108\ Id.
---------------------------------------------------------------------------

    This prohibition does not apply to securities on deposit at an 
affiliated bank, but only cash deposits because, as noted above, the 
latter are fungible with other deposits carried by the bank and may be 
freely used in the course of the bank's commercial activities.\109\ 
Consequently, to the extent that operational or other efficiencies can 
be achieved through the use of an affiliated bank, the carrying broker-
dealer can use qualified securities held at an affiliated bank to meet 
its reserve deposit requirements.\110\ The ability to use qualified 
securities alleviates concerns that a broker-dealer would be required 
to take deposits from one institution and divide that amount among 
several banks, resulting in credit risk to the broker-dealer, as well 
as an increase in operational risk.\111\
---------------------------------------------------------------------------

    \109\ See Federal Reserve, Division of Banking Supervision and 
Regulation, Commercial Bank Examination Manual, Section 3000.1, 
Deposit Accounts (stating that deposits are the primary funding 
source for most banks and that banks use deposits in a variety of 
ways, primarily to fund loans and investments), available at http://www.federalreserve.gov/boarddocs/supmanual/cbem/3000.pdf. See also 
OCC Banking Circular (BC-196), Securities Lending (May 7, 1985) 
(stating securities should be lent only pursuant to a written 
agreement between the lender institution and the owner of the 
securities specifically authorizing the institution to offer the 
securities for loan), available at http://www.occ.gov/static/news-issuances/bulletins/pre-1994/banking-circulars/bc-1985-196.pdf.
    \110\ See Citigroup Letter.
    \111\ See BOK Letter. Based on FOCUS Report data, as of December 
31, 2011, 79% of the total customer reserve requirement across all 
carrying broker-dealers was met using qualified securities.
---------------------------------------------------------------------------

    In summary, while the Commission acknowledges concerns raised by 
commenters, the Commission continues to believe that it is appropriate 
to exclude cash deposited in affiliated banks from the calculation to 
determine whether a broker-dealer has met its reserve account 
requirements. Therefore, the final rule excludes the amount of any cash 
on deposit in an affiliated bank of the broker-dealer from being used 
to meet the reserve requirements.\112\ Broker-dealers that use 
affiliated banks for holding cash customer reserve accounts will need 
to either deposit qualified securities into the accounts or move their 
accounts to non-affiliated banks.
---------------------------------------------------------------------------

    \112\ See paragraph (e)(5) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------

    As for the limits on the amounts of cash that could be deposited in 
one unaffiliated bank, some commenters argued that the proposed 
thresholds were too restrictive. One commenter urged the Commission to 
reconsider the proposed limits, noting that the proposed amendment will 
impose significant costs on broker-dealers and potentially adversely 
impact the broker-dealers' customers.\113\ Several commenters suggested 
that the Commission allow cash reserve deposits without the percentage 
restrictions at unaffiliated banks that are well-capitalized or for 
which the broker-dealer has performed due diligence.\114\ One commenter 
suggested that the Commission consider higher percentages for cash 
deposits at large money-center banks.\115\ This commenter stated that 
this would strike a better balance between the Commission's concerns 
regarding the safety of cash deposits and the costs imposed on broker-
dealers arising from having to use qualified securities (as opposed to 
cash) to meet deposit requirements or having to maintain reserve 
accounts at multiple banks.\116\ This commenter also stated that the 
percentage thresholds would negatively impact smaller broker-dealers 
because they would exceed the 50% of excess net capital threshold at 
lower deposit levels.\117\ Two

[[Page 51834]]

commenters noted that the proposed 10% bank equity capital limitation 
appears to be derived from a 1988 NYSE staff interpretation, which 
stated that customer reserve accounts may be maintained in money market 
deposit accounts if the total of such deposits in any one bank does not 
exceed 50% of the broker-dealer's excess net capital or 10% of the 
bank's equity capital.\118\ These commenters pointed out that 
significant changes have taken place with respect to federal bank 
regulatory agency oversight of the safety and soundness of banks since 
1988, including the imposition of prompt corrective action 
provisions.\119\ These commenters stated that the concerns that gave 
rise to the 1988 interpretation have been mitigated by current statutes 
and regulations requiring prompt corrective action in the event that a 
bank's capital position deteriorates.\120\
---------------------------------------------------------------------------

    \113\ See Raymond James 2 Letter.
    \114\ See Raymond James Letter; JP Morgan Letter; Clearing House 
Letter; ABASA Letter; PNC Letter; Deutsche Bank Securities Letter; 
E*Trade Letter; JP Morgan 2 Letter.
    \115\ See SIFMA 2 Letter; SIFMA 4 Letter.
    \116\ See SIFMA 2 Letter.
    \117\ Id.
    \118\ See PNC Letter; ABASA Letter.
    \119\ See PNC Letter; ABASA Letter.
    \120\ Id.
---------------------------------------------------------------------------

    As stated above, substantial numbers of banks have failed or 
required government assistance in recent years.\121\ Consequently, the 
rule, as adopted, establishes requirements designed to avoid the 
situation where a carrying broker-dealer's cash deposits constitute a 
substantial portion of the bank's deposits. At the same time, the 
proposal has been modified to mitigate concerns raised by commenters 
that broker-dealers would have to maintain reserve accounts at multiple 
banks. First, the Commission has eliminated the provision that would 
have excluded the amount of a cash deposit that exceeds 50% of the 
broker-dealer's excess net capital. As noted by comments, this 
provision likely would have disproportionately impacted small and mid-
size broker-dealers when they deposited cash into large commercial 
banks since they would exceed the excess net capital threshold well 
before exceeding the bank equity capital threshold.\122\ Also, based on 
staff experience monitoring larger broker-dealers, firms that maintain 
large amounts of cash in their customer reserve accounts generally use 
more than one non-affiliated bank to maintain these accounts.
---------------------------------------------------------------------------

    \121\ See www.fdic.gov/bank/individual/failed/banklist.html.
    \122\ See SIFMA 2 Letter; JP Morgan 2 Letter.
---------------------------------------------------------------------------

    The bank equity capital threshold is the more important metric 
since it relates directly to the financial strength of the bank, which 
is the entity holding the account. Thus, this metric more directly 
addresses the risk at issue: The potential impairment of the bank's 
ability to quickly return the customer reserve deposit to the broker-
dealer.
    Second, with respect to the bank equity capital threshold, in 
response to comments, the Commission has increased the threshold from 
10% to 15% of the bank's equity capital. The increase of the threshold 
to 15% is designed to address concerns raised by commenters that the 
proposed percentage tests were unduly restrictive in certain respects 
and should be modified, particularly with respect to large broker-
dealers with large deposit requirements. Consequently, the increase 
from 10% to 15% is designed to mitigate commenters' concerns that the 
10% threshold would require broker-dealers to spread out cash deposits 
over a number of banks, while still providing adequate protection 
against the risk that arises when a bank's deposit base is overly 
reliant on a single depositor.
    The elimination of the 50% of excess net capital threshold and 
increase in the bank capital threshold from 10% to 15% is intended to 
address concerns raised by commenters that they would have to 
substantially alter their current cash deposit practices in light of 
the goal of the rule to promote the broker-dealer's ability to have 
quick access to the deposit.
    As proposed, the equity capital threshold would have been based on 
equity capital ``as reported by the bank in its most recent Call Report 
or Thrift Financial Report.'' Under the Dodd-Frank Wall Street Reform 
and Consumer Protection Act (``Dodd-Frank Act''),\123\ the supervision 
of savings associations was transferred from the OTS to the OCC (for 
federal savings associations) and the FDIC (for state savings 
associations).\124\ Also, beginning in the period ending March 31, 
2012, savings associations began to file a Call Report in lieu of a 
Thrift Financial Report, thereby ending the use of the Thrift Financial 
Report.\125\ Therefore, due to the passage of the Dodd-Frank Act and 
the elimination of the Thrift Financial Report, as well as to provide 
more flexibility with regard to any successor reports that may be 
required to be filed by a bank, the Commission is modifying the phrase 
``Call Report or Thrift Financial Report'' to read ``Call Report or any 
successor form the bank is required to file by its appropriate Federal 
banking agency (as defined by section 3 of the Federal Deposit 
Insurance Act (12 U.S.C. 1813))''.
---------------------------------------------------------------------------

    \123\ Public Law 111-203, 124 Stat. 1376 (2010).
    \124\ Id. at Sec. Sec.  300-378. See also List of OTS 
Regulations to be Enforced by the OCC and the FDIC Pursuant to the 
Dodd-Frank Act, OCC, FDIC, (June 14, 2011), 76 FR 39246 (July 6, 
2011). Supervision of savings and loan holding companies and their 
subsidiaries (other than depository institutions) was transferred 
from the OTS to the Federal Reserve.
    \125\ See Proposed Agency Information Collection Activities; 
Comment Request, 76 FR 7082 (Feb. 8, 2011).
---------------------------------------------------------------------------

    Two commenters expressed concern about the use of a Call Report to 
determine a bank's ``equity capital'' under the rule.\126\ These 
commenters noted that there is no equity capital line item in the Call 
Reports of U.S. branches of foreign banks due to these branches not 
being separately incorporated legal entities.\127\ Therefore, the 
proposed Call Report provision potentially excluded U.S. branches of 
foreign banks from holding reserve accounts. The commenters stated that 
for foreign banks, the equity capital can be found in other forms, such 
as Form FR Y-7, Form FR Y-70, Form 6-K, and Form F-20, among other 
financial statements filed with U.S. regulators.\128\ One commenter 
suggested the Commission revise the proposed provision to read: ``The 
amount of the deposit exceeds 10% of the bank's equity capital (as 
reported by the bank in its most recent Call Report or Thrift Financial 
Report if such report includes a line item for `equity capital').'' 
\129\ Alternatively, these commenters suggested that in lieu of a Call 
Report a U.S. branch of a foreign bank could periodically obtain a 
certificate from the bank stating its equity capital (or stating that 
its equity capital exceeds a specified level).\130\
---------------------------------------------------------------------------

    \126\ See IIB Letter; SIFMA 4 Letter.
    \127\ Id.
    \128\ Id.
    \129\ See IIB Letter.
    \130\ See IIB Letter; SIFMA 4 Letter.
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    The Commission recognizes that the U.S. branches of some foreign 
banks may meet the definition of bank under section (3)(a)(6) of the 
Exchange Act and, therefore, also under paragraph (a)(7) of Rule 15c3-
3.\131\ However, the

[[Page 51835]]

Commission is retaining the requirement that the bank's equity be 
determined using its most recent Call Report because U.S. branches of 
foreign banks generally are not FDIC-insured.\132\ Consequently, 
deposits at these institutions would not receive the protections of 
FDIC insurance in the event of a bank failure. FDIC insurance provides 
additional protections to cash deposited in a reserve account at a bank 
in the event of a bank failure that would not be available at an 
uninsured bank.\133\ The Commission, however, will consider requests 
for exemptive relief from broker-dealers that wish to hold a reserve 
account at a U.S. branch of a foreign bank.
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    \131\ The term bank as defined in section 3(a)(6) of the 
Exchange Act is limited to banks directly regulated by U.S. state or 
federal bank regulators. The determination whether any particular 
financial institution meets the requirements of section 3(a)(6) is 
the responsibility of the financial institution and its counsel. See 
15 U.S.C. 78c(a)(6); cf. Securities Issued Or Guaranteed By United 
States Branches Or Agencies of Foreign Banks; Interpretive Release, 
Securities Act Release No. 6661 (Sept. 23, 1986), 51 FR 34460 (Sept. 
29, 1986) (determination as to whether branch or agency of foreign 
bank falls within the definition of bank under section 3(a)(2) of 
Securities Act of 1933, 15 U.S.C. 77c(a)(2), is responsibility of 
issuers and their counsel). However, section 4(d) of the 
International Banking Act, 12 U.S.C. 3102(d), expressly prohibits 
agencies of foreign banks established under federal law from 
receiving deposits or exercising fiduciary powers, criteria 
necessary for qualification as a bank under section 3(a)(6)(C) of 
the Exchange Act. See 12 U.S.C. 3102(d); see also Conference of 
State Bank Supervisors v. Conover, 715 F.2d 604 (D.C. Cir. 1983), 
cert. denied, 466 U.S. 927 (1984) (stating that federally-chartered 
agencies of foreign banks are prohibited from receiving deposits 
from foreign, as well as domestic, sources).
    \132\ The FDIC protects depositors' funds in the event of the 
financial failure of their bank or savings institution. FDIC deposit 
insurance covers the balance of each depositor's account, dollar-
for-dollar, up to the insurance limit, including principal and any 
accrued interest through the date of the insured bank's closing. No 
depositor has suffered a loss of insured deposits since the FDIC was 
created in 1933. See FDIC, When a Bank Fails--Facts for Depositors, 
Creditors, and Borrowers, available at http://fdic.gov/consumers/banking/facts/index.html. See also Federal Reserve, Structure and 
Share Data for U.S. Offices of Foreign Banks, available at http://www.federalreserve.gov/releases/iba/.
    \133\ Id. Therefore, the availability of FDIC insurance could 
also be a contributing factor to mitigating the risk that an 
impairment of the reserve deposit at an unaffiliated bank will have 
a material negative impact on the broker-dealer's ability to meet 
its obligations to customers and PAB account holders. See Amendments 
to Financial Responsibility Rules, 72 FR at 12864.
---------------------------------------------------------------------------

    For these reasons, the Commission is adopting the final rule to 
exclude, when determining whether a broker-dealer maintains the minimum 
deposits required under paragraph (e) of Rule 15c3-3, cash deposited 
with an affiliated bank as well as cash deposited with an unaffiliated 
bank ``to the extent that the amount of the deposit exceeds 15% of the 
bank's equity capital as reported by the bank in its most recent Call 
Report or any successor form the bank is required to file by its 
appropriate Federal banking agency (as defined by section 3 of the 
Federal Deposit Insurance Act (12 U.S.C. 1813)).'' \134\ As discussed 
above, the Commission is deleting from the final rule the provision 
that would have excluded the amount of cash on deposit that exceeds 50% 
of the broker-dealer's excess net capital.
---------------------------------------------------------------------------

    \134\ See paragraph (e)(5) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------

4. Allocation of Customers' Fully Paid and Excess Margin Securities to 
Short Positions
    Paragraph (d) of Rule 15c3-3 currently sets forth steps a broker-
dealer must take to retrieve securities from non-control locations if 
there is a shortfall in the fully paid or excess margin securities it 
is required to hold for its customers. The actions prescribed in the 
rule do not include a requirement that the broker-dealer obtain 
possession or control of a fully paid or excess margin security that is 
reflected on the broker-dealer's stock record as a long position of a 
customer that allocates to a broker-dealer or non-customer short 
position. In the simplest case, this occurs when the carrying broker-
dealer as principal sells short a security to its own customer. 
Currently, in such a case, the broker-dealer is not required to have 
possession or control of the security even though its customer has paid 
for the security in full. Rather, the broker-dealer must include the 
mark-to-market value of the security as a credit item in the reserve 
formula. The broker-dealer can use the cash paid by the customer to 
purchase the security to make any increased deposit requirement caused 
by the credit item.\135\ As the Commission stated in the proposing 
release, this permits the broker-dealer, in effect, to partially 
monetize the customer's security.\136\ This result is contrary to the 
customer protection goals of Rule 15c3-3, which seek to ensure that 
broker-dealers do not use customer assets for proprietary 
purposes.\137\
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    \135\ In effect, the broker-dealer has monetized the customer's 
security and has to purchase or borrow it, at a future date, to 
return the customer's fully paid securities.
    \136\ See Amendments to Financial Responsibility Rules, 72 FR at 
12865.
    \137\ See, e.g., Customer Protection Rule, Exchange Act Release 
No. 22499 (Oct. 3, 1985), 50 FR 41337 (Oct. 10, 1985).
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    To address these concerns, the Commission proposed an amendment to 
Rule 15c3-3 that would have required a broker-dealer to obtain physical 
possession or control of customer fully paid and excess margin 
securities that allocate to a broker-dealer short position.\138\ 
Specifically, the proposed amendment would have added a fifth step to 
take when a deficit arose in the amount of securities the broker-dealer 
was required to maintain in possession or control; namely that for 
``[s]ecurities included on [the broker-dealer's] books or records as a 
proprietary short position or as a short position for another person, 
excluding positions covered by paragraph (m) of this section, for more 
than 10 business days (or more than 30 calendar days if the broker or 
dealer is a market maker in the securities), [. . .] the broker or 
dealer shall, not later than the business day following the day on 
which the determination is made, take prompt steps to obtain physical 
possession or control of such securities.'' \139\
---------------------------------------------------------------------------

    \138\ See Amendments to Financial Responsibility Rules, 72 FR at 
12865.
    \139\ Id. at 12895.
---------------------------------------------------------------------------

    Eleven commenters addressed this proposed amendment.\140\ Three 
commenters urged the Commission to disallow naked short selling of 
securities and one argued that the Commission should force short 
sellers to pre-borrow.\141\ Three commenters generally opposed the 
proposed rule. They argued that the credit item added to the reserve 
formula computation when a customer's fully paid or excess margin 
security allocates to a short position provides the customer with 
adequate protection.\142\ Two of these commenters requested that the 30 
calendar days allowed for a broker-dealer acting as a market maker to 
obtain possession or control over securities allocating to a short 
position be expanded to include all situations where a broker-dealer 
must act pursuant to the rule (i.e., not be limited to market maker 
positions).\143\ These commenters argued that it would be difficult to 
distinguish between market maker and non-market maker positions in 
complying with the proposed rule. Another commenter requested that the 
Commission reevaluate the proposed amendment because of its potential 
effects on investment and hedging strategies in addition to the heavy

[[Page 51836]]

burden it will impose on short sales.\144\ One commenter supported the 
amendments noting that it had ``come to believe . . . that the 
Commission's proposal is consistent with the direction of the 
Commission's other short sale regulations. . . .'' \145\
---------------------------------------------------------------------------

    \140\ See Glenn Letter; Bare Letter; Anonymous Letter; SIFMA 2 
Letter; First Clearing Letter; Hearne Letter; Deutsche Bank 
Securities Letter; Citigroup Letter; AMEX Letter; SIFMA 4 Letter; 
Federated 6 Letter; Raymond James 2 Letter.
    \141\ See Glenn Letter; Bare Letter; Anonymous Letter; Hearne 
Letter. The Commission has taken a number of measures to strengthen 
investor protections against potentially abusive ``naked'' short 
selling, including adopting rules requiring that fails to deliver 
resulting from short sales immediately be closed-out and expressly 
targeting fraud in short selling transactions. See Amendments to 
Regulation SHO, Exchange Act Release No. 60388 (July 27, 2009), 74 
FR 38266 (July 31, 2009); ``Naked'' Short Selling Antifraud Rule, 
Exchange Act Release No. 58774 (Oct. 14, 2008), 73 FR 61666 (Oct. 
17, 2008). In addition, the Commission adopted a short sale-related 
price test that, if triggered, imposes a restriction on the prices 
at which securities may be sold short. See Amendments to Regulation 
SHO, Exchange Act Release No. 61595 (Feb. 26, 2010), 75 FR 11232 
(Mar. 10, 2010).
    \142\ See First Clearing Letter; Deutsche Bank Securities 
Letter; Citigroup Letter.
    \143\ See Citigroup Letter; Deutsche Bank Securities Letter.
    \144\ See Raymond James 2 Letter.
    \145\ See SIFMA 4 Letter. SIFMA originally opposed the proposed 
amendments. See SIFMA 2 Letter.
---------------------------------------------------------------------------

    As discussed above in section II.A.2.ii. of this release, the 
Commission has determined that a credit item is sufficient to protect 
PAB account holders if the carrying broker-dealer provides them with 
notice that it may be using their non-margin securities, as well as the 
opportunity to object to such use. The use of the non-margin securities 
of PAB account holders is a long-standing industry practice. In 
contrast, customers under Rule 15c3-3, which include the carrying 
broker-dealer's retail customers, have an expectation that the fully 
paid and excess margin securities reflected on their account statements 
are, in fact, in the possession or control of the carrying broker-
dealer. However, as described above, this expectation may be frustrated 
where the securities are allocated to a short position carried by the 
broker-dealer, as the securities are not in the possession or control 
of the broker-dealer.
    This gap in the existing rule, in effect, permits the broker-dealer 
to partially monetize the customer's security. Also, under some 
circumstances (e.g., a change in the market value of the securities), 
the amount the broker-dealer may have on deposit in the customer 
reserve account as a consequence of the credit item may be less than 
the value of the securities. Consequently, if the broker-dealer fails, 
sufficient funds may not be readily available to purchase the 
securities to return them to customers. The use of customer securities 
in this manner is contrary to the customer protection goals of Rule 
15c3-3 and the expectations of a broker-dealer's customers.\146\ For 
these reasons, the Commission is adopting the amendment.\147\ The 
Commission agrees, however, that the proposed distinction based upon a 
broker-dealer's market maker status could present operational 
challenges and, consequently, the final rule has been modified to allow 
a uniform period of 30 calendar days before the possession and control 
requirement is triggered.
---------------------------------------------------------------------------

    \146\ See supra notes 12 and 18, and accompanying text.
    \147\ Current paragraph (d)(4) of Rule 15c3-3 is being re-
designated paragraph (d)(5), as proposed.
---------------------------------------------------------------------------

    Specifically, as adopted, paragraph (d)(4) of Rule 15c3-3 requires 
a broker-dealer to take prompt steps to obtain physical possession or 
control over securities of the same issue and class as those included 
``on the broker's or dealer's books or records that allocate to a short 
position of the broker or dealer or a short position for another 
person, excluding positions covered by paragraph (m) of this section, 
for more than 30 calendar days. . . .'' \148\ The Commission does not 
believe that lengthening the time from 10 business days to 30 calendar 
days for non-market maker positions will significantly diminish the 
protections provided by the new rule.\149\ Therefore, the Commission is 
adopting a uniform 30 calendar day time period in the final rule.
---------------------------------------------------------------------------

    \148\ See Amendments to Financial Responsibility Rules, 72 FR at 
12865-12866. The amendment will not apply to securities that are 
sold long for a customer but not obtained from the customer within 
ten days after the settlement date. This circumstance is addressed 
by paragraph (m) of Rule 15c3-3, which requires the broker-dealer to 
close the transaction by purchasing securities of like kind and 
quantity. 17 CFR 240.15c3-3(m).
    \149\ For example, the rule currently has a thirty calendar day 
time period for securities failed to receive and a forty-five 
calendar day time period for securities receivable as a result of 
corporate actions (e.g., stock splits) before the broker-dealer must 
take prompt steps to obtain possession or control of such 
securities. See 17 CFR 240.15c3-3(d)(2)-(3).
---------------------------------------------------------------------------

    Three commenters requested that the Commission clarify that the 
aging process begins when the Rule 15c3-3 possession and control 
deficit arises and not when the short transaction is executed.\150\ The 
proposed amendment was designed to require that the aging process 
commence at the time a deficit in securities allocating to a short 
position arises. One commenter \151\ also requested that the Commission 
modify the proposed amendment to specifically exclude an underwriter's 
short position created in connection with a distribution of securities 
until after the later of the completion of such underwriter's 
participation in the distribution (as defined in Rule 100 of Regulation 
M) \152\ or the delivery date for securities acquired in the exercise 
of any overallotment option (or ``Green Shoe'').\153\ The Commission 
agrees with the commenter that there should be consistency between the 
final rule and Regulation M.\154\ Consequently, the Commission has 
added a sentence to the final rule to clarify that the 30 calendar day 
period with respect to a syndicate short position established in 
connection with an offering does not begin to run until the 
underwriter's participation in the distribution is complete as 
determined pursuant to Rule 100(b) of Regulation M.\155\ Finally, the 
Commission is adopting the revision to paragraph (n) as proposed to 
permit broker-dealers to apply to their designated examining authority 
(``DEA'') for extensions of time related to paragraph (d)(4).\156\
---------------------------------------------------------------------------

    \150\ See Deutsche Bank Securities Letter; Citigroup Letter; 
SIFMA 2 Letter.
    \151\ See SIFMA 2 Letter. The commenter stated: ``Regulation M 
embodies a carefully crafted scheme for the regulation of secondary 
market transactions by underwriters and other distribution 
participants, including the regulation of `syndicate covering 
transactions,' which should not be disrupted by proposed paragraph 
(d)(4).'' Id. In addition, SIFMA commented that where an underwriter 
sells short to a customer in anticipation of obtaining the 
securities through the exercise of an overallotment option, 
paragraph (d)(4) should not require the premature exercise of the 
overallotment option or the use of secondary market purchases 
instead of the overallotment option. Id.
    \152\ 17 CFR 242.100 through 242.105. More specifically, Rule 
100 of Regulation M provides: ``For purposes of regulation M . . . 
the following definitions shall apply: . . . Completion of 
participation in a distribution. . . . A person shall be deemed to 
have completed its participation in a distribution as follows: . . . 
(2) [a]n underwriter, when such person's participation has been 
distributed, including all other securities of the same class that 
are acquired in connection with the distribution, and any 
stabilization arrangements and trading restrictions in connection 
with the distribution have been terminated; Provided, however, that 
an underwriter's participation will not be deemed to have been 
completed if a syndicate overallotment option is exercised in an 
amount that exceeds the net syndicate short position at the time of 
such exercise. . . .'' 17 CFR 242.100(b).
    \153\ A green shoe or overallotment option is a provision 
contained in an underwriting agreement that gives the underwriting 
syndicate the right to purchase additional shares from the issuer or 
selling security holders (in addition to those initially 
underwritten by the syndicate) for the purpose of covering any 
overallotments that are made on behalf of the syndicate in 
connection with an offering of securities.
    \154\ Rule 100 of Regulation M also provides that an 
underwriter's participation will not be deemed to have been 
completed if a syndicate overallotment option is exercised in an 
amount that exceeds the net syndicate short position at the time of 
exercise. 17 CFR 242.100(b).
    \155\ 17 CFR 242.100(b).
    \156\ SROs generally have procedures in place for broker-dealers 
to apply for extensions of time under paragraph (n) of Rule 15c3-3. 
See, e.g., FINRA Rule 4230.
---------------------------------------------------------------------------

5. Importation of Rule 15c3-2 Requirements Into Rule 15c3-3 and 
Treatment of Free Credit Balances
i. Importation of Rule 15c3-2
    Rule 15c3-2 requires a broker-dealer holding free credit balances 
to provide its customers (defined as any person other than a broker-
dealer) at least once every three months with a statement of the amount 
due the customer and a notice that: (1) the funds are not being 
segregated, but rather are being used in the broker-dealer's business; 
and (2) the funds are payable on demand. The rule was adopted in 1964, 
before the

[[Page 51837]]

adoption of Rule 15c3-3 in 1972.\157\ Since the adoption of Rule 15c3-
3, broker-dealers have been limited in their use of customer free 
credit balances. The Commission proposed importing requirements in Rule 
15c3-2 \158\ into Rule 15c3-3 and eliminating Rule 15c3-2 as a separate 
rule in the Code of Federal Regulations.\159\ The Commission received 
two comments supporting the proposal.\160\
---------------------------------------------------------------------------

    \157\ See Customers' Free Credit Balances, Exchange Act Release 
No. 7266 (Mar. 12, 1964), 29 FR 7239 (June 3, 1964).
    \158\ 17 CFR 240.15c3-2.
    \159\ See Amendments to Financial Responsibility Rules, 72 FR at 
12867.
    \160\ See SIFMA 2 Letter; SIFMA 4 Letter.
---------------------------------------------------------------------------

    The Commission is adopting the amendments substantially as 
proposed--deleting Rule 15c3-2 and adding paragraph (j)(1) to Rule 
15c3-3. The Commission believes it is appropriate to eliminate Rule 
15c3-2 as a separate rule because it is largely irrelevant in light of 
the requirements in Rule 15c3-3. Further, the provisions in Rule 15c3-2 
that the Commission wishes to retain are being re-codified in Rule 
15c3-3. These provisions include the requirement that broker-dealers 
inform customers of the amounts due to them and that such amounts are 
payable on demand.\161\ Consequently, the Commission is amending Rule 
15c3-3 to add new paragraph (j)(1), which provides that ``[a] broker or 
dealer must not accept or use any free credit balance carried for the 
account of any customer of the broker or dealer unless such broker or 
dealer has established adequate procedures pursuant to which each 
customer for whom a free credit balance is carried will be given or 
sent, together with or as part of the customer's statement of account, 
whenever sent but not less frequently than once every three months, a 
written statement informing the customer of the amount due to the 
customer by the broker or dealer on the date of the statement, and that 
the funds are payable on demand of the customer.'' \162\
---------------------------------------------------------------------------

    \161\ Rule 15c3-2 contains an exemption for broker-dealers that 
also are banking institutions supervised by a Federal authority. 
This exemption will not be imported into Rule 15c3-3 because there 
are no broker-dealers left that fit within the exemption. Further, 
the definition of customer for purposes of the imported 15c3-2 
requirements will be the definition of customer in Rule 15c3-3, 
which is somewhat narrower than the definition in Rule 15c3-2.
    \162\ See paragraph (j)(1) of Rule 15c3-3, as adopted. The 
Commission also modified the phrase ``[i]t shall be unlawful for a 
broker or dealer to'' to the phrase ``[a] broker or dealer must 
not'' in order to avoid using the term ``unlawful.'' Any violation 
of the rules and regulations promulgated under the Exchange Act is 
unlawful and therefore it is unnecessary to use this phrase in the 
final rule.
---------------------------------------------------------------------------

ii. Treatment of Free Credit Balances
    Free credit balances are funds payable by a broker-dealer to its 
customers on demand.\163\ They may result from cash deposited by the 
customer to purchase securities, proceeds from the sale of securities 
or other assets held in the customer's account, or earnings from 
dividends and interest on securities and other assets held in the 
customer's account. Broker-dealers may, among other things, pay 
interest to customers on their free credit balances or offer to 
routinely transfer (``sweep'') them to a money market fund or bank 
account. On occasion, broker-dealers have changed the product to which 
a customer's free credit balances are swept--in recent years, most 
frequently from a money market fund to an interest bearing bank 
account. Because of differences in these two types of products, 
including the type of protection afforded the customer in the event of 
insolvency, there may be investment consequences to the customer when 
changing from one product to the other. The money market shares--as 
securities--would receive up to $500,000 in SIPA protection in the 
event the broker-dealer failed. The bank deposits--as cash--would 
receive up to $250,000 in protection from the FDIC in the event the 
bank failed. On the other hand, the money market fund shares may incur 
market losses; whereas, the full amount of the bank deposit would be 
guaranteed up to the FDIC's $250,000 limit. There also may be 
differences in the amount of interest earned from the two products. In 
short, there may be consequences to moving a customer's free credit 
balances from one product to another, and, accordingly, customers 
should have a sufficient opportunity to make an informed decision.\164\
---------------------------------------------------------------------------

    \163\ See 17 CFR 240.15c3-3(a)(8).
    \164\ See Amendments to Financial Responsibility Rules, 72 FR at 
12866.
---------------------------------------------------------------------------

    The Commission proposed amendments to Rule 15c3-3 that would have 
established conditions required to be met in order for a broker-dealer 
to use or transfer free credit balances in a customer's securities 
account.\165\ More specifically, as initially proposed, the amendments 
would have structured the new rule to make it unlawful for a broker-
dealer to convert, invest, or otherwise transfer to another account or 
institution free credit balances held in a customer's account except as 
provided in the proposed rule.\166\ The proposed rule then prescribed 
three conditions to address three different scenarios involving the use 
or transfer of customer free credit balances. The first scenario 
involved the use or transfer of free credit balances outside the 
context of a routine sweep to a money market fund or bank. As discussed 
below, proposed paragraph (j)(2)(i) would have prohibited the use or 
transfer of free credit balances in this scenario unless the customer 
had specifically ordered or authorized the transaction. The second and 
third scenarios involved the use or transfer of free credit balances in 
the context of a program to routinely sweep them to a money market fund 
or bank account (a ``sweep program''). As discussed below, proposed 
paragraph (j)(2)(ii) would have addressed sweep program requirements 
for accounts opened after the effective date of the rule (``new 
accounts'') and proposed paragraph (j)(2)(iii) would have addressed 
sweep program requirements for accounts existing as of the effective 
date of the rule (existing accounts). The Commission is adopting new 
paragraph (j)(2) to Rule 15c3-3 with substantial modifications from the 
proposed rule in response to comments and to clarify certain portions 
of the rule.\167\
---------------------------------------------------------------------------

    \165\ Id. at 12866-12867.
    \166\ Id. at 12866.
    \167\ In 2005, the NYSE addressed the issue of disclosure in a 
sweep program context by issuing an information memo to its members 
discussing, among other things, the disclosure responsibilities of a 
broker-dealer offering a sweep program to its customers. See 
Information Memo 05-11 (Feb. 15, 2005). The memo stated that broker-
dealers should disclose material differences in interest rates 
between the different sweep products and, with respect to the bank 
sweep program, further disclose the terms and conditions, risks and 
features, conflicts of interest, current interest rates, manner by 
which future interest rates will be determined, and the nature and 
extent of FDIC and SIPC protection.
---------------------------------------------------------------------------

    As proposed, the first sentence of paragraph (j)(2) of the rule 
would have established the prohibition with respect to the treatment of 
free credit balances by providing that ``[i]t shall be unlawful for a 
broker or dealer to convert, invest, or otherwise transfer to another 
account or institution, free credit balances held in a customer's 
account except as provided in paragraphs (j)(2)(i), (ii) and (iii).'' 
\168\ The Commission received one comment in response to the proposed 
text of this first sentence.\169\ The commenter expressed concern that 
the proposed text in the first sentence of paragraph (j)(2) could be 
construed broadly, in effect, to prohibit a broker-dealer from using, 
investing, or transferring cash deposits that are not swept to other 
investments or products (and are included as credits in the reserve 
formula) in the normal course of the broker-dealer's business, as is 
currently permitted by Rule 15c3-3. The commenter suggested that the 
text be

[[Page 51838]]

revised to clarify the scope of the proposed rule by prohibiting a 
broker-dealer from deducting a free credit balance from the customer's 
account at the broker-dealer and transferring it to another institution 
and investing it in another instrument on behalf of the customer, 
except as permitted under paragraph (j)(2).\170\
---------------------------------------------------------------------------

    \168\ See Amendments to Financial Responsibility Rules, 72 FR at 
12896.
    \169\ See SIFMA 2 Letter.
    \170\ Id.
---------------------------------------------------------------------------

    In response to the comment, as a preliminary matter, cash balances 
in customer securities accounts must be included as credits in the 
customer reserve formula. Further, the net amount of the credits over 
debits must be deposited in a customer reserve account in the form of 
cash or qualified securities. However, cash credit items that are net 
of debit items can be used by the broker-dealer for the limited purpose 
of facilitating transactions of its customers.\171\ The commenter 
suggested that proposed paragraph (j)(2) of Rule 15c3-3 could be 
interpreted to impose new limits on a broker-dealer's ability to use 
cash that is an asset on the firm's balance sheet. In response to this 
concern, the Commission notes that the prohibition in the first 
sentence of proposed paragraph (j)(2) of Rule 15c3-3 is intended to 
place conditions only on the broker-dealer's ability to convert the 
cash asset of the customer (i.e., a receivable from the broker-dealer) 
into a different type of asset (e.g., a security or an obligation of 
another institution outside the context of a sweep program) or to 
transfer the customer's cash asset to another account.
---------------------------------------------------------------------------

    \171\ See 17 CFR 240.15c3-3(e)(2) (``It shall be unlawful for 
any broker or dealer to accept or use any of the amounts under items 
comprising Total Credits under the formula referred to in paragraph 
(e)(1) of this section except for the specified purposes indicated 
under items comprising Total Debits under the formula, and, to the 
extent Total Credits exceed Total Debits, at least the net amount 
thereof shall be maintained in the Reserve Bank Account pursuant to 
paragraph (e)(1) of this section.'').
---------------------------------------------------------------------------

    The Commission is adopting paragraph (j)(2) of Rule 15c3-3 with 
certain technical modifications.\172\ As adopted paragraph (j)(2) 
reads: ``A broker or dealer must not convert, invest, or transfer to 
another account or institution, credit balances held in a customer's 
account except as provided in paragraphs (j)(2)(i) and (ii) of this 
section.'' \173\
---------------------------------------------------------------------------

    \172\ Specifically, the Commission is replacing the phrase 
``[i]t shall be unlawful for a broker or dealer to'' with the phrase 
``[a] broker or dealer must not'' because--as noted above--any 
violation of the rules and regulations promulgated under the 
Exchange Act is unlawful and therefore it is unnecessary to use this 
phrase in the final rule. The Commission also is replacing the 
phrase ``free credit balance'' with the phrase ``credit balances'' 
to clarify that this provision covers both free credit balances and 
other credit balances. See 17 CFR 240.15c3-3(a)(8)-(9) (defining 
free credit balances and other credit balances). The Commission is 
deleting the word ``otherwise'' because it would be redundant. 
Finally, the rule text does not include a reference to paragraph 
(j)(2)(iii), as proposed, because this paragraph was deleted from 
the final rule text.
    \173\ See paragraph (j)(2) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------

a. Treatment of Free Credit Balances Outside of a Sweep Program
    As proposed, paragraph (j)(2)(i) of Rule 15c3-3 would have 
permitted a broker-dealer to convert, invest or otherwise transfer to 
another account or institution free credit balances held in a 
customer's account only upon a specific order, authorization, or draft 
from the customer, and only in the manner, and under the terms and 
conditions, specified in the order, authorization, or draft.\174\ This 
catchall provision would have applied to any use or transfer of 
customer free credit balances outside the context of a sweep program.
---------------------------------------------------------------------------

    \174\ See Amendments to Financial Responsibility Rules, 72 FR at 
12866.
---------------------------------------------------------------------------

    The Commission proposed paragraph (j)(2)(i) in order to 
comprehensively cover the range of possibilities with respect to the 
disposition of free credit balances in a customer account other than 
pursuant to a sweep program. The Commission received two comments 
recommending that proposed paragraph (j)(2)(i) be clarified to permit a 
broker-dealer to obtain a one-time consent to ongoing transfers of any 
free credit balances to a customer to another account, entity or 
product (outside of a sweep program).\175\ The commenters noted that 
customers, for example, may prefer that free credit balances be 
regularly transferred to a linked account in their name at another 
broker-dealer or bank that is not part of a sweep program, and that 
this clarification would enable a broker-dealer to efficiently handle 
such customer requests by eliminating the need to obtain individual 
``specific orders'' for repeated transfers that are substantially 
identical.\176\ The Commission agrees with the commenters that a 
customer may consent to ongoing routine transfers from the customer's 
account outside of a sweep program without obtaining the customer's 
specific consent for each individual transfer, provided the customer 
has consented to the ongoing transfers under paragraph (j)(2)(i) of 
Rule 15c3-3. This scenario would already be covered by the proposed 
rule, and, therefore, the Commission is adopting paragraph (j)(2)(i) 
substantially as proposed, with certain technical modifications.\177\ 
As adopted, paragraph (j)(2)(i) of Rule 15c3-3 reads: ``A broker or 
dealer is permitted to invest or transfer to another account or 
institution, free credit balances in a customer's account only upon a 
specific order, authorization, or draft from the customer, and only in 
the manner, and under the terms and conditions, specified in the order, 
authorization, or draft.'' \178\
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    \175\ See SIFMA 2 Letter; E*Trade 2 Letter.
    \176\ Id.
    \177\ See paragraph (j)(2)(i) of Rule 15c3-3, as adopted. The 
technical changes delete the words ``convert'' and ``otherwise'' 
from the final rule because a broker-dealer would be prohibited from 
``converting'' a customer's free credit balances and, therefore, it 
is not necessary to include the word in the final rule. The word 
``otherwise'' is redundant.
    \178\ Id.
---------------------------------------------------------------------------

    Finally, one commenter stated that both regulators and firms need 
the flexibility to remove funds from a reserve account to cover 
extraordinary requests for payment of customer free credit 
balances.\179\ However, the commenter noted that ``in light of recent 
market events, we withdraw our earlier proposal to allow such 
withdrawals under specified conditions and instead recommend that such 
withdrawals be permitted only by approval of Commission staff or a 
broker-dealer's [DEA].'' \180\ Broker-dealers currently may make 
withdrawals under paragraph (g) of Rule 15c3-3.\181\ In light of the 
risks that could arise to customer funds, the Commission does not 
believe it would be appropriate at this time to expand a firm's ability 
to make additional withdrawals from its reserve account.
---------------------------------------------------------------------------

    \179\ See SIFMA 4 Letter.
    \180\ Id. In its June 15, 2007 comment letter, SIFMA urged ``the 
Commission to consider allowing a broker-dealer to remove funds from 
a reserve account to cover a large same-day request for payment of a 
free credit balance, as long as the free credit balance was included 
in the latest Rule 15c3-3 reserve computation and the broker-dealer 
begins a new reserve computation as of that date.'' See SIFMA 2 
Letter.
    \181\ 17 CFR 240.15c3-3(g).
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b. Treatment of Free Credit Balances in a Sweep Program
    The second and third set of conditions in the proposed rules 
addressed using or transferring free credit balances in the context of 
a sweep program.\182\ In particular, the Commission proposed four 
conditions with respect to using or transferring free credit balances 
in a sweep program. A broker-dealer would have been required to meet: 
(1) all four conditions with respect to free credit balances in new 
accounts; \183\ and (2) the second, third, and fourth conditions with 
respect to

[[Page 51839]]

free credit balances in existing accounts.\184\ The four conditions 
were:
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    \182\ See Amendments to Financial Responsibility Rules, 72 FR at 
12866.
    \183\ See paragraph (j)(2)(ii)(A)-(D) of Rule 15c3-3, as 
adopted.
    \184\ See paragraph (j)(2)(iii)(A)-(C) of Rule 15c3-3, as 
adopted.
---------------------------------------------------------------------------

    1. The customer has previously affirmatively consented to such 
treatment of the free credit balances after being notified of the 
different general types of money market mutual fund and bank account 
products in which the broker or dealer may transfer the free credit 
balances and the applicable terms and conditions that would apply if 
the broker or dealer changes the product or type of product in which 
free credit balances are transferred;
    2. The broker or dealer provides the customer on an ongoing basis 
with all disclosures and notices regarding the investment and deposit 
of free credit balances as required by the self-regulatory 
organizations for which the broker or dealer is a member;
    3. The broker or dealer provides notice to the customer as part of 
the customer's quarterly statement of account that the money market 
mutual funds or bank deposits to which the free credit balances have 
been transferred can be liquidated on the customer's demand and held as 
free credit balances; and
    4. The broker or dealer provides the customer with at least 30 
calendar days notice before the free credit balances would begin being 
transferred to a different product, different product type, or into the 
same product but under materially different terms and conditions. The 
notice must describe the new money market fund, bank deposit type, or 
terms and conditions, and how the customer can notify the broker or 
dealer if the customer chooses not to have the free credit balances 
transferred to the new product or product type, or under the new terms 
and conditions.
Commenters generally agreed with the fundamental principle embodied in 
the proposal--that customer free credit balances should not be 
transferred from an obligation of the broker-dealer to an obligation of 
another entity without the customer's authorization.\185\ Other 
commenters supported the proposed disclosures but suggested additional 
disclosures be made to customers, including clarification with respect 
to other protections available to the customer.\186\ Two commenters 
stated that the practice of sweep programs should be banned entirely or 
that the Commission should adopt a ``harder stance'' and require more 
than just disclosure.\187\ One commenter responded to the Commission's 
request for comment as to the cost burdens that would result if the 
first condition (set forth in proposed paragraph (j)(2)(ii)(A)) to 
obtain a new customer's prior agreement were to be applied to existing 
customers. The commenter stated that such costs would be substantial 
because broker-dealers would be required to amend their agreements with 
all existing customers.\188\ One commenter stated that the amendments 
in the proposing release did not adequately address situations in which 
broker-dealers change customer account elections without first 
obtaining customer authorization.\189\
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    \185\ See SIFMA 2 Letter; First Clearing Letter; Pace Letter.
    \186\ See SIPC Letter.
    \187\ See Ellis Letter; Dworkin Letter. One commenter stated 
that broker-dealers profit from ``excessive'' fees charged to 
clients who opt out of the sweep programs. See Ellis Letter. The 
second commenter suggested that the broker-dealer's ``customer has 
been effectively denied the opportunity to opt out of bank account 
sweeps by [the broker-dealer] preventing him or her from utilizing 
any other vehicle to park his or her free credit balances. . . .'' 
See Dworkin Letter. The commenter noted that by opting out of the 
sweep, the customer is ``confined to a situation where the free 
credit balance cannot earn any kind of return at all[.]'' Id.
    \188\ See SIFMA 2 Letter.
    \189\ See Waddell Letter.
---------------------------------------------------------------------------

    In adopting the final rule, the Commission has made some 
modifications to the language in the proposed rule in response to 
commenters and to clarify its application. For clarification and in 
response to comments, the Commission has defined the term Sweep Program 
in paragraph (a)(17) of Rule 15c3-3 to identify the types of 
transactions and products to which the new provisions apply.
    Commenters raised concerns about limitations on the types of 
products broker-dealers could use for sweep arrangements under the 
proposed amendments. Three commenters suggested that the Commission 
should not limit the types of products broker-dealers can use for sweep 
arrangements to money market funds and bank deposit products.\190\
---------------------------------------------------------------------------

    \190\ See SIFMA 2 Letter; First Clearing Letter; Raymond James 2 
Letter.
---------------------------------------------------------------------------

    Sweep programs provide a mechanism for excess cash in a customer's 
securities account to be held in a manner that allows the customer to 
earn interest on the funds but retain the flexibility to quickly access 
that cash to purchase securities or withdraw it.\191\ In effect, 
transferring this excess cash to a bank account or money market fund is 
an alternative to retaining a credit balance in the customer's 
securities account. The final rule is designed to accommodate this 
alternative by providing broker-dealers with flexibility in the 
operation of sweep programs. The Commission believes it is appropriate 
to confine this flexibility to products that approximate the holding of 
a customer's excess cash in a securities account. The Commission does 
not view sweep accounts as a mechanism for investing customers' excess 
cash without their specific consent in longer term or more volatile 
assets. For these reasons, the Commission does not believe it would be 
appropriate to expand the products covered by the final rule beyond 
money market funds as described in Rule 2a-7 under the Investment 
Company Act of 1940 or an account at an insured bank as described in 
paragraph (a)(17) of Rule 15c3-3.
---------------------------------------------------------------------------

    \191\ See Ellis Letter; Dworkin Letter.
---------------------------------------------------------------------------

    Consequently, paragraph (a)(17) of Rule 15c3-3, as adopted, states 
``[t]he term Sweep Program means a service provided by a broker or 
dealer where it offers to its customers the option to automatically 
transfer free credit balances in the securities account of the customer 
to either a money market mutual fund product as described in [Rule 2a-
7] or an account at a bank whose deposits are insured by the Federal 
Deposit Insurance Corporation.'' \192\ The Commission intended that the 
definition of Sweep Program provide that the bank to which free credits 
are swept be insured by the FDIC.\193\ The revised text of the rule 
makes this explicit. Finally, under this definition, a one-time or 
other special transfer of a customer's free credit balances would not 
qualify as a Sweep Program.
---------------------------------------------------------------------------

    \192\ See paragraph (a)(17) of Rule 15c3-3, as adopted.
    \193\ See Amendments to Financial Responsibility Rules, 72 FR at 
12866 (``[T]he bank deposit would be guaranteed up to the FDIC's 
$100,000 limit.''). FDIC insurance covers all deposit accounts, 
including checking and savings accounts, money market deposit 
accounts and certificates of deposit. The standard insurance amount 
is currently $250,000 per depositor, per insured bank, for each 
account ownership category. 12 CFR 330.1(o).
---------------------------------------------------------------------------

    Three commenters raised the issue of bulk transfers.\194\ They 
argued that the rule should allow broker-dealers to process bulk 
transfers of customer assets between, for instance, one money market 
fund and another money market fund or a bank deposit product and a 
money market fund. These commenters identify a potential ambiguity in 
the rule as proposed; namely, how transfers from one Sweep Program 
product to another Sweep Program product are to be handled under the 
rule if they do not involve passing funds through the

[[Page 51840]]

customer's securities account. To address this issue, paragraph 
(j)(2)(ii) of Rule 15c3-3 is being modified from the proposal to 
clarify that the conditions for operating a Sweep Program (which are 
set forth in paragraphs (j)(2)(ii)(A) and (B)) will apply to: (1) The 
transfer of free credit balances from a customer's securities account 
to a product in a Sweep Program; and (2) the transfer of a customer's 
interest in one Sweep Program product to another Sweep Program product. 
This will address both bulk transfers \195\ of customer positions from 
one product (e.g., a money market fund) to another (e.g., a bank 
deposit product) and transfers of individual customer positions from 
one product to another.
---------------------------------------------------------------------------

    \194\ See SIFMA 2 Letter; First Clearing Letter; E*Trade 2 
Letter.
    \195\ See also NASD Rule 2510 (Discretionary Accounts) 
(providing an exception from the NASD rule for ``bulk exchanges at 
net asset value of money market mutual funds . . . utilizing 
negative response letters provided: (A) The bulk exchange is limited 
to situations involving mergers and acquisitions of funds, changes 
of clearing members and exchanges of funds used in sweep accounts; 
(B) The negative response letter contains a tabular comparison of 
the nature and amount of the fees charged by each fund; (C) The 
negative response letter contains a comparative description of the 
investment objectives of each fund and a prospectus of the fund to 
be purchased; and (D) The negative response feature will not be 
activated until at least 30 days after the date on which the letter 
was mailed.'').
---------------------------------------------------------------------------

    The Commission is modifying paragraph (j)(2)(ii) of Rule 15c3-3 
from the proposal to delete the phrase ``to either a money market 
mutual fund as described in Sec.  270.2a-7 of this chapter or an 
interest bearing account at a bank without a specific order, 
authorization or draft for each such transfer, provided'' and instead 
to use the term Sweep Program as defined in paragraph (a)(17) of the 
final rule. The Commission also replaced the phrase ``the account of a 
customer'' with the phrase ``a customer's securities account'' to 
clarify that paragraph (j)(2)(ii) and its required conditions apply to 
the transfer of free credit balances in connection with a customer's 
securities account, in addition to the bulk transfers described 
above.\196\ As adopted, paragraph (j)(2)(ii) to Rule 15c3-3 reads, in 
pertinent part: ``[a] broker or dealer is permitted to transfer free 
credit balances held in a customer's securities account to a product in 
its Sweep Program or to transfer a customer's interest in one product 
in a Sweep Program to another product in a Sweep Program, provided'' 
the conditions set forth in paragraphs (j)(2)(ii)(A) and (B) are 
met.\197\
---------------------------------------------------------------------------

    \196\ The final rule also deletes the phrase ``opened on or 
after the effective date of this paragraph'' from paragraph 
(j)(2)(ii) and moves it to paragraph (j)(2)(ii)(A), as described 
below.
    \197\ See paragraph (j)(2)(ii) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------

    As adopted, paragraphs (j)(2)(ii)(A) and (B) establish four 
conditions that must be met to lawfully transfer a customer's free 
credit balances to a product in a Sweep Program or to transfer a 
customer's interest directly from one product in a Sweep Program to 
another product in a Sweep Program. The first condition--set forth in 
paragraph (j)(2)(ii)(A)--applies only with respect to accounts opened 
on or after the effective date of the rule. This addresses the burden 
that would have been associated with having broker-dealers re-document 
existing accounts. The remaining three conditions--set forth in 
paragraph (j)(2)(ii)(B)(1) through (3)--apply to both existing and new 
accounts.
    Paragraph (j)(2)(ii)(A), as adopted, provides that for an account 
opened on or after the effective date of the rule, the customer must 
give prior written affirmative consent to having free credit balances 
in the customer's securities account included in the Sweep Program 
after being notified: (1) Of the general terms and conditions of the 
products available through the Sweep Program; and (2) that the broker 
or dealer may change the products available under the Sweep 
Program.\198\
---------------------------------------------------------------------------

    \198\ See paragraph (j)(2)(ii)(A) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------

    As stated above, the Commission has modified paragraph 
(j)(2)(ii)(A) in the final rule to read ``the customer gives prior 
written affirmative consent to having free credit balances in the 
customer's securities account included in the Sweep Program after being 
notified. . . .'' \199\ The Commission modified this paragraph to 
incorporate the term Sweep Program as defined in paragraph (a)(17) of 
the rule and the reference to the ``customer's securities account'' to 
make this paragraph consistent with other modifications to paragraph 
(j)(2) of the final rule. Additionally, the Commission modified this 
paragraph to clarify that the customer's consent must be written, 
consistent with the discussion in the proposing release, which noted 
customer consent could be given in an account opening agreement.\200\
---------------------------------------------------------------------------

    \199\ Id. The proposed rule stated the ``customer has previously 
affirmatively consented to such treatment of the free credit 
balances after being notified of . . . .'' In addition, as noted 
above, the phrase ``accounts opened on or after the effective date 
of this paragraph'' was deleted from proposed paragraph (j)(2)(ii) 
and moved to paragraph (j)(2)(ii)(A), with the reference to specific 
paragraph (j)(2)(ii) inserted after the word ``paragraph.'' Moving 
this phrase to paragraph (j)(2)(ii)(A) simplifies the final rule by 
eliminating the necessity of codifying two largely overlapping sets 
of conditions, with three of the conditions being repeated in both 
paragraphs. The effect of this change is to make the first condition 
only applicable to new accounts and the remaining conditions 
(paragraph (j)(2)(ii)(B)(1) through (3)) applicable to both new and 
existing accounts. The word ``accounts'' also has been replaced with 
the phrase ``an account.''
    \200\ See Amendments to Financial Responsibility Rules, 72 FR at 
12866 (``[T]he customer would need to agree prior to the change 
(e.g., in the account opening agreement) that the broker-dealer 
could switch the sweep option between those two types of 
products.'').
---------------------------------------------------------------------------

    The Commission received one comment stating that the text of 
proposed paragraph (j)(2)(ii)(A) that would have required the 
disclosure of ``applicable terms and conditions that will apply if the 
broker or dealer changes the product or type of product'' could be read 
to require highly specific disclosure about product terms and 
conditions that may only be established or modified in the future and, 
therefore, are unknown at the time the customer opens an account with 
the broker-dealer.\201\ In addition, the commenter stated that under 
proposed paragraph (j)(2)(ii)(D), a broker-dealer would already be 
required to describe any changes to the terms and conditions it makes 
contemporaneously with such changes. Given this type of notice, the 
commenter stated that there is no need for the type of generalized (and 
therefore less effective) disclosure that would have been required by 
paragraph (j)(2)(ii)(A). The Commission agrees with the commenter and, 
therefore, has deleted the phrase ``transfer the free credit balances 
and the applicable terms and conditions that will apply if the broker 
or dealer changes the product or type of product in which the free 
credit balances are transferred. . . .'' In its place, the Commission 
is adopting language in paragraph (j)(2)(ii)(A)(2) of Rule 15c3-3 under 
which the broker-dealer must notify the customer that the broker or 
dealer may change the products available under the Sweep Program.\202\
---------------------------------------------------------------------------

    \201\ See SIFMA 2 Letter.
    \202\ See paragraph (j)(2)(ii)(A)(2) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------

    Paragraph (j)(2)(ii)(B), as adopted, prescribes the following three 
conditions to sweeping the customer's free credit balances in a new or 
existing account:

     The broker-dealer provides the customer with the 
disclosures and notices regarding the Sweep Program required by each 
SRO of which the broker-dealer is a member; \203\
---------------------------------------------------------------------------

    \203\ See paragraph (j)(2)(ii)(B) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------

     The broker-dealer provides notice to the customer, as 
part of the customer's quarterly statement of account, that the 
balance in the bank deposit account or shares of the money market 
mutual fund in which the customer has a beneficial interest can be 
liquidated on the customer's order and the proceeds

[[Page 51841]]

returned to the securities account or remitted to the customer; 
\204\ and
---------------------------------------------------------------------------

    \204\ Id.
---------------------------------------------------------------------------

     The broker-dealer provides the customer with written 
notice at least 30 calendar days before: (1) Making changes to the 
terms and conditions of the Sweep Program; (2) making changes to the 
terms and conditions of a product currently available through the 
Sweep Program; (3) changing, adding or deleting products available 
through the Sweep Program; or (4) changing the customer's investment 
through the Sweep Program from one product to another; and the 
notice describes the new terms and conditions of the Sweep Program 
or product or the new product, and the options available to the 
customer if the customer does not accept the new terms and 
conditions or product.\205\
---------------------------------------------------------------------------

    \205\ Id.

    As proposed, paragraph (j)(2)(ii)(B) of Rule 15c3-3 would have 
required that the broker-dealer provide these disclosures and notices 
``on an ongoing basis.'' Three commenters stated that there are no 
current SRO requirements that broker-dealers make disclosures 
concerning sweep arrangements on an ``ongoing basis'' and that the 
Commission should clarify the source and meaning of this 
requirement.\206\ The Commission has deleted the phrase ``ongoing 
basis'' from the final rule. As adopted, the Commission has also 
modified the text in paragraph (j)(2)(ii)(B), now paragraph 
(j)(2)(ii)(B)(1), to delete the phrase ``investment and deposit of free 
credit balances as'' and inserted the phrase ``Sweep Program'' to 
incorporate the definition in paragraph (a)(17). Finally, the 
Commission has modified the phrase ``the self-regulatory 
organizations'' to read ``each self-regulatory organization of'' to 
clarify that the broker-dealer must provide the notices and disclosures 
required by each SRO of which it is a member (including an SRO that is 
not its DEA).\207\
---------------------------------------------------------------------------

    \206\ See SIFMA 2 Letter; First Clearing Letter; Raymond James 2 
Letter.
    \207\ See 17 CFR 240.17d-1.
---------------------------------------------------------------------------

    As adopted, paragraph (j)(2)(ii)(B)(2) states that the broker-
dealer must provide information on a quarterly basis with respect to 
the customer's balance in an account or fund ``in which the customer 
has a beneficial interest.'' \208\ The rule text has been modified to 
account for the fact that customers can have a beneficial interest in 
accounts in their name and in omnibus accounts in the name of a 
custodian in which the assets of multiple customers are commingled.
---------------------------------------------------------------------------

    \208\ See paragraph (j)(2)(ii)(B)(2) of Rule 15c3-3, as adopted. 
More specifically, the Commission modified the phrase ``that the 
money market mutual funds or bank deposits to which the free credit 
balances have been transferred'' to read ``that the balance in the 
bank deposit account or shares of the money market mutual fund in 
which the customer has a beneficial interest. . . .''
---------------------------------------------------------------------------

    The Commission also modified language in paragraph (j)(2)(ii)(B)(2) 
of Rule 15c3-3 to replace the phrase ``on the customer's demand'' with 
the phrase ``on the customer's order'' to address concerns by two 
commenters that the former phrase could lead customers to believe that 
they will receive immediate re-payment of those funds, or they could 
revert to holding those funds as free credit balances at the broker-
dealer.\209\ These commenters pointed out that the disclosed terms of 
most sweep programs allow the money market fund or bank up to seven 
days to meet requests for withdrawals. Further, there are some broker-
dealers that do not allow customers to maintain free credit balances in 
securities accounts. In response to these comments, the Commission has 
deleted the phrase ``demand and held as free credit balances'' and 
replaced it with the phrase ``and the proceeds returned to the 
securities account or remitted to the customer.'' This language is 
designed to account for broker-dealers that do not offer customers the 
option of having their funds held as free credit balances. In such 
cases, the broker-dealer would remit the funds withdrawn from the bank 
or derived from redeeming money market shares directly to the customer 
(e.g., by transferring them to the customer's bank account).
---------------------------------------------------------------------------

    \209\ See SIFMA 2 Letter.
---------------------------------------------------------------------------

    Proposed paragraphs (j)(2)(ii)(D) and (iii)(C)--now paragraph 
(j)(2)(ii)(B)(3)--would have required the broker-dealer to provide the 
customer with notice at least thirty days before the broker-dealer 
begins transferring the customer's free credit balances to a different 
product or product type, or into the same product but under materially 
different terms and conditions.\210\ As adopted, paragraph 
(j)(2)(ii)(B)(3) will require broker-dealers to provide customers 
written notice at least 30 calendar days before the broker-dealer: (1) 
Makes changes to the terms and conditions of the Sweep Program; (2) 
makes changes to the terms and conditions of a product currently 
available through the Sweep Program; (3) changes, adds, or deletes 
products available through the Sweep Program; or (4) changes the 
customer's investment through the Sweep Program from one product to 
another.\211\ This modification to the final rule is in response to 
commenters' requests that the Commission provide clarity with respect 
to when the thirty day notice requirement would be triggered.\212\ In 
response to comments, the final rule is designed to make clear that the 
triggering event for the thirty day notice is not exclusively related 
to the transfer of the customer's free credit balances, but rather 
changes relating to the terms and conditions of the Sweep Program, as 
well as, the products available through the Sweep Program. This greater 
specificity should enhance the protections under the final rule by 
providing greater certainty that the customer will have time to 
evaluate available options before a change to the Sweep Program is put 
into effect.
---------------------------------------------------------------------------

    \210\ See Amendments to Financial Responsibility Rules, 72 FR at 
12896.
    \211\ A broker-dealer could request exemptive relief from the 
rule in unusual or emergency cases where it may be impractical or 
contrary to investor protection for a broker-dealer to first provide 
customers 30 days' written notice under the rule before taking one 
of these actions. See, e.g., paragraph (k)(3) to Rule 15c3-3.
    \212\ See SIFMA 2 Letter; First Clearing Letter; Cornell Letter; 
E*Trade Letter.
---------------------------------------------------------------------------

    In addition, paragraphs (j)(2)(ii)(B)(3)(i)(A)-(D) of Rule 15c3-3 
require the broker-dealer to provide the customer with written notice 
at least 30 calendar days before: (1) Making changes to the terms and 
conditions of the Sweep Program; (2) making changes to the terms and 
conditions of a product currently available through the Sweep Program; 
(3) changing, adding or deleting products available through the Sweep 
Program; or (4) changing the customer's investment through the Sweep 
Program from one product to another.\213\ Collectively, these 
provisions provide more specificity about the types of disclosures and 
notices required under the final rule than under the proposal. Further, 
the final rule includes the word ``written'' before the word ``notice'' 
to make explicit that a written notice is required.
---------------------------------------------------------------------------

    \213\ See paragraph (j)(2)(ii)(B)(3)(i) of Rule 15c3-3, as 
adopted. The requirements set forth in final paragraph 
(j)(2)(ii)(B)(3)(i) were proposed as paragraphs (j)(2)(ii)(D) and 
(iii)(C).
---------------------------------------------------------------------------

    As adopted, paragraph (j)(2)(ii)(B)(3)(ii) requires that ``[t]he 
notice must describe the new terms and conditions of the Sweep Program 
or product or the new product, and the options available to the 
customer if the customer does not accept the new terms and conditions 
or product.'' \214\ The Commission modified the final rule in response 
to a comment regarding the text of proposed paragraphs (j)(2)(ii)(D) 
and (iii)(C).\215\ The commenter stated that, as drafted, proposed 
paragraphs (j)(2)(ii)(D) and (iii)(C) would have required a broker-
dealer to disclose

[[Page 51842]]

``how the customer can notify the [broker-dealer] if the customer 
chooses not to have the free credit balances transferred to the new 
product or product type, or under new terms and conditions.'' \216\ The 
commenter stated that these paragraphs appear to assume that the 
customer will have the option of continuing to have free credit 
balances treated as they were prior to the change to the sweep 
arrangement.\217\ The commenter pointed out that, in fact, the broker-
dealer may elect not to continue offering the prior sweep options and 
not to offer another sweep product.\218\ To account for this 
possibility, the Commission has revised the text in paragraph 
(j)(2)(ii)(B)(3)(ii) \219\ to require the broker-dealer to provide the 
customer with a notice that contains a description of the options 
available to the customer if the customer does not wish to accept the 
new terms and conditions or product.\220\ This is intended to give 
customers sufficient opportunity to make an informed decision in 
connection with a Sweep Program.
---------------------------------------------------------------------------

    \214\ See paragraph (j)(2)(ii)(B)(ii) of Rule 15c3-3, as 
adopted. The final rule codifies this text in a separate paragraph 
in order to emphasize the specific items the notice must contain.
    \215\ See SIFMA 2 Letter.
    \216\ Id.
    \217\ Id.
    \218\ Id.
    \219\ More specifically, paragraph (j)(2)(ii)(B)(3)(ii) provides 
that ``the notice must describe the new terms and conditions of the 
Sweep Program or product or the new product, and the options 
available to the customer if the customer does not accept the new 
terms and conditions or product.'' A customer that does not accept 
the new terms and conditions or product would need to change how 
free credit balances are treated by, for example, selecting 
investments outside the Sweep Program or having the balances 
transferred to an account at another financial institution.
    \220\ See Dworkin Letter.
---------------------------------------------------------------------------

6. ``Proprietary Accounts'' Under the Commodity Exchange Act
    Some broker-dealers also are registered as futures commission 
merchants under the Commodity Exchange Act (``CEA''). These firms carry 
both securities and commodities accounts for customers. The definition 
of free credit balances in paragraph (a)(8) of Rule 15c3-3 does not 
include funds carried in commodities accounts that are segregated in 
accordance with the requirements of the CEA.\221\ However, regulations 
promulgated under the CEA exclude certain types of accounts 
(``proprietary accounts'') from the CEA's segregation 
requirements.\222\ This exclusion from the segregation requirements 
under the CEA has raised a question as to whether a broker-dealer must 
treat payables to customers in proprietary commodities accounts as 
``free credit balances'' when performing a customer reserve 
computation.\223\
---------------------------------------------------------------------------

    \221\ 17 CFR 240.15c3-3(a)(8).
    \222\ Rule 1.20 requires a futures commission merchant to 
segregate customer funds. See 17 CFR 1.20. Rule 1.3(k) defines the 
term customer for this purpose. See 17 CFR 1.3(k). The definition of 
customer excludes persons who own or hold a proprietary account as 
that term is defined in Rule 1.3(y). See 17 CFR 1.3(y). Generally, 
the definition of proprietary account refers to persons who have an 
ownership interest in the futures commission merchant. Id.
    \223\ See Part 241-Interpretive Releases Relating to the 
Securities Exchange Act of 1934 and General Rules and Regulations 
Thereunder, Exchange Act Release No. 9922 (Jan. 2, 1973), 38 FR 1737 
(Jan. 18, 1973) (interpreting the credit balance used in Item 1 of 
the Rule 15c3-3a formula ``to include the net balance due to 
customers in non-regulated commodities accounts reduced by any 
deposits of cash or securities with any clearing organization or 
clearing broker in connection with the open contracts in such 
accounts'').
---------------------------------------------------------------------------

    In response to this question, the Commission notes that the 
objective of the customer reserve requirement in Rule 15c3-3 is to 
require broker-dealers to hold sufficient funds or qualified securities 
to facilitate the prompt return of customer property to customers 
either before or during a liquidation proceeding if the firm 
fails.\224\ Under SIPA, customer property generally does not include 
funds held in a commodities account.\225\ Therefore, funds held in a 
proprietary commodities account generally would not constitute customer 
property and persons having claims to those funds would not be 
customers under SIPA.\226\ Moreover, the regulations under the CEA 
similarly provide the persons having claims to funds in proprietary 
commodities accounts are not customers for purposes of those 
regulations.\227\ For these reasons, the Commission proposed a specific 
amendment to the definition of the term free credit balances in 
paragraph (a)(8) of Rule 15c3-3 that would have clarified that funds 
held in a commodities account meeting the definition of a proprietary 
account under CEA regulations are not to be included as free credit 
balances in the customer reserve formula.\228\ As discussed below, the 
Commission is adopting the amendment substantially as proposed.
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    \224\ See Capital, Margin, and Segregation Requirements for 
Security-Based Swap Dealers and Major Security-Based Swap 
Participants and Capital Requirements for Broker-Dealers, Exchange 
Act Release No. 68071 (Oct. 18, 2012), 77 FR 70214, 70274 (Nov. 23, 
2012) (describing rationale and requirements of Rule 15c3-3 
segregation requirements). See also Broker-Dealers; Maintenance of 
Certain Basic Reserves, Exchange Act Release No. 9856 (Nov. 10, 
1972), 37 FR 25224, 25225 (Nov. 29, 1972) (stating that the intent 
of Rule 15c3-3 is, among other things, to ``facilitate the 
liquidations of insolvent broker-dealers and to protect customer 
assets in the event of a SIPC liquidation through a clear 
delineation in Exchange Act Rule 15c3-3 of specifically identifiable 
property of customers.''); Amendments to Financial Responsibility 
Rules, 72 FR at 12862, 12868.
    \225\ As noted above, customer property under SIPA includes 
``cash and securities (except customer name securities delivered to 
the customer) at any time received, acquired, or held by or for the 
account of the debtor from or for the securities accounts of a 
customer, and the proceeds of any such property transferred by the 
debtor, including property unlawfully converted.'' 15 U.S.C. 
78lll(4). To receive protection under SIPA, a claimant must first 
qualify as a customer as that term is defined in the statute. 
Generally, a customer is any person who has: (1) ``a claim on 
account of securities received, acquired, or held by the [broker-
dealer];'' (2) ``deposited cash with the debtor for the purposes of 
purchasing securities;'' (3) ``a claim against the debtor for. . 
.[positions]. . .received, acquired, or held in a portfolio margin 
account carried as a securities account pursuant to a portfolio 
margining program approved by the Commission;'' or (4) ``a claim 
against the [broker-dealer] arising out of sales or conversions of 
such securities.'' See 15 U.S.C. 78lll(2)(A)-(B). The definition of 
security in SIPA specifically excludes commodities and non-
securities futures contracts and, thus, a person with a claim for 
such assets (not held in a portfolio margin account carried as a 
securities account) would not meet the definition of customer. See 
15 U.S.C. 78lll(14).
    \226\ Id.
    \227\ See 17 CFR 1.3(k).
    \228\ See Amendments to Financial Responsibility Rules, 72 FR at 
12868. The Commission proposed additional amendments to paragraph 
(a)(8) of Rule 15c3-3 related to portfolio margining. See also 
discussion below in section II.B. of this release.
---------------------------------------------------------------------------

    The Commission received three comments in support of the proposed 
rule change.\229\ One commenter requested that the Commission clarify 
that the relevant definition of proprietary account for these purposes 
is the definition contained in Rule 1.3(y) under the CEA. While Rule 
1.3(y) under the CEA currently contains the relevant definition of 
proprietary account for the purpose of the amendment, the definition 
could be codified in a different rule in the future. Consequently, the 
Commission is adopting the final rule amendment to paragraph (a)(8) of 
Rule 15c3-3, as proposed. Thus, the final rule does not include 
specific references to a specific rule. Rather, the amendment to 
paragraph (a)(8) to Rule 15c3-3, as adopted, more generally refers to a 
``proprietary account as that term is defined in regulations under the 
Commodity Exchange Act.''
---------------------------------------------------------------------------

    \229\ See SIPC Letter; SIFMA 2 Letter; SIFMA 4 Letter.
---------------------------------------------------------------------------

    As stated above, this amendment to paragraph (a)(8) of Rule 15c3-3 
is designed to clarify that funds held in a commodities account meeting 
the definition of a proprietary account under CEA regulations are not 
to be included as ``free credit balances'' in the customer reserve 
formula. Under Item 1 of Rule 15c3-3a, however, cash balances that do 
not meet the definition of free credit balances (e.g., because they are 
not subject to immediate payment) are included in the customer reserve 
formula if they meet the definition of other credit balances under 
paragraph

[[Page 51843]]

(a)(9) of Rule 15c3-3.\230\ Therefore, in order to remove any ambiguity 
as to the proper exclusion of proprietary accounts under the CEA from 
Rule 15c3-3, the Commission also is amending the definition of the term 
other credit balances in the final rule to delete the words ``as 
aforesaid'' and insert the phrase ``in accordance with the Commodity 
Exchange Act or in a similar manner, or funds carried in a proprietary 
account as that term is defined in regulations under the Commodity 
Exchange Act.'' \231\ Consequently, the amendments clarify that both 
free credit balances and other credit balances as defined in Rule 15c3-
3 do not include funds carried in proprietary accounts under the CEA.
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    \230\ Item 1 of Rule 15c3-3a requires a broker-dealer to include 
in the customer reserve formula ``free credit balances and other 
credit balances in customers' security accounts.'' Paragraph (a)(9) 
of Rule 15c3-3 defines other credit balances as ``cash liabilities 
of a broker or dealer to customers other than free credit balances 
and funds in commodities accounts segregated as aforesaid.'' 17 CFR 
240.15c3-3(a)(9).
    \231\ See paragraph (a)(9) to Rule 15c3-3. See also comments and 
additional amendments to paragraph (a)(9) of Rule 15c3-3 discussed 
in section II.B. of this release.
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    One commenter also suggested that due to the changes to the swap 
markets mandated by Title VII of the Dodd-Frank Act, swap accounts (in 
addition to commodities accounts) are now subject to customer 
protection rules under the CEA.\232\ This commenter suggested that the 
Commission make it clear that funds in swap accounts also do not 
constitute free credit balances, whether those funds are required to be 
segregated by rules under the CEA (e.g., cleared swap accounts or 
uncleared swap accounts that have opted for segregation) or excepted 
from segregation under the CEA (e.g., cleared swaps proprietary 
accounts or uncleared swap accounts that have not opted for 
segregation). The commenter noted this treatment ``would be consistent 
with the treatment of funds in commodities accounts and with the 
regulation of swap accounts under the CEA.'' \233\ The Commission 
agrees there may be additional accounts under the CEA, as amended by 
the Dodd-Frank Act, that should explicitly be excluded from the 
definition of free credit balances under Rule 15c3-3. However, the 
amendments today are designed to clarify the specific question raised 
with respect to the treatment of funds in proprietary commodities 
accounts under the CEA and, consequently, the suggestions by the 
commenter are beyond the scope of this rulemaking.
---------------------------------------------------------------------------

    \232\ See SIFMA 4 Letter.
    \233\ Id.
---------------------------------------------------------------------------

7. Expansion of the Definition of ``Qualified Securities'' To Include 
Certain Money Market Funds
    A broker-dealer is limited to depositing cash or qualified 
securities into the bank account it maintains to meet its customer (and 
now PAB account) reserve deposit requirements under Rule 15c3-3. 
Paragraph (a)(6) of Rule 15c3-3 defines qualified securities to mean 
securities issued by the United States or guaranteed by the United 
States with respect to principal and interest.\234\ This strictly 
limits the types of assets that can be used to fund a broker-dealer's 
customer or PAB reserve account. The strict limitation is designed to 
further the purpose of Rule 15c3-3; namely, that customer assets be 
segregated and held in a manner that makes them readily available to be 
returned to the customer. As the Commission noted when first proposing 
Rule 15c3-3:

    \234\ 17 CFR 240.15c3-3(a)(6).

The operative procedures of the Special [Reserve] Account are 
designed to protect the integrity of customer-generated funds by 
insulating them against inroads from the broker-dealer's firm 
activities, whether they be underwriting, market making, other 
trading, investing, or mere speculation in securities, meeting 
overhead or any other nature whatever. The Special [Reserve] Account 
should achieve a virtual 100% protection to customers with respect 
to the carrying and use of customers' deposits or credit balances 
which is mandated by Section 7(d) of the SIPC Act.\235\
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    \235\ Reserves and Related Measures Respecting the Financial 
Responsibility of Brokers and Dealers, Exchange Act Release No. 9388 
(Nov. 8, 1971), 36 FR 22312 (Nov. 24, 1971).
---------------------------------------------------------------------------

    In response to a petition for rulemaking,\236\ the Commission 
proposed a limited expansion of the definition of qualified security to 
include shares of an unaffiliated money market fund that: (1) Is 
described in Rule 2a-7 under the Investment Company Act of 1940; (2) 
invests solely in securities issued by the United States or guaranteed 
by the United States as to interest and principal; (3) agrees to redeem 
fund shares in cash no later than the business day following a 
redemption request by a shareholder; and (4) has net assets equal to at 
least 10 times the value of the shares deposited by the broker-dealer 
in its customer reserve account.\237\ Twenty commenters addressed the 
proposed amendment.\238\ A majority of commenters supported the 
proposal and generally argued that the definition of qualified security 
should be expanded further to include more types of instruments. One 
commenter noted that permitting the use of certain money market funds 
to make up the required reserve account deposit would introduce ``an 
intermediary (namely, the holding company or money market fund) at 
which problems might arise.'' \239\ The commenter also noted that a 
number of SIPA liquidations have involved the mishandling of money 
market or mutual fund shares or the confirmations of purchases of 
nonexistent ``money market funds.'' \240\
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    \236\ As discussed in the proposing release, Federated submitted 
a petition for rulemaking on April 3, 2003, which it later amended 
on April 4, 2005. See Amendments to Financial Responsibility Rules, 
72 FR at 12865, 12874. More specifically, Federated's petition 
requested that the Commission amend: (i) Rule 15c3-1 to lower the 
haircut for certain money market funds to 0%; and (ii) Rule 15c3-3 
to: (a) permit a broker-dealer to pledge such money market funds 
when borrowing fully paid or excess margin securities from a 
customer under paragraph (b)(3); and (b) treat such money market 
funds as ``qualified securities'' that may be deposited into a 
broker-dealer's customer reserve account. On February 9, 2009, 
Federated submitted another request for rulemaking (Petition 4-577), 
reiterating its first petition with respect to amending Rule 15c3-3 
to allow a broker-dealer to treat certain money market funds as 
``qualified securities'' that may be deposited into a reserve 
account. However, this new petition changed the definition of the 
types of funds that could be treated as qualified securities. More 
specifically, the new petition proposed amending Rule 15c3-3(a)(6) 
to define the term qualified securities to include, ``a redeemable 
security of an investment company registered under the Investment 
Company Act of 1940 and described in 17 CFR 270.2a-7, unaffiliated 
with the broker-dealer and which limits its investments to 
securities issued or guaranteed by the United States Government or 
its agencies or instrumentalities (including repurchase 
transactions).'' See Amendments to Financial Responsibility Rules, 
72 FR at 12874 and n.112; see also Public Petitions for Rulemaking 
No. 4-478 (Apr. 3, 2003) (available at http://www.sec.gov/rules/petitions/petn4-478.htm), as amended (Apr. 4, 2005) (amendment 
available at http://www.sec.gov/rules/petitions/petn4-478a.pdf), and 
No. 4-577 (Feb. 3, 2009) (available at http://www.sec.gov/rules/petitions/2009/petn4-577.pdf).
    \237\ See Amendments to Financial Responsibility Rules, 72 FR at 
12865.
    \238\ See Federated Letter; Federated 2 Letter; Federated 3 
Letter; Federated 4 Letter; Federated 5 Letter; Federated 6 Letter; 
Federated 7 Letter; Federated 8 Letter; Meeks Letter; Meeks 2 
Letter; Crane Data Letter; SIPC Letter; Curian Letter; FAF Letter; 
Reserve Letter; Brown Brothers Letter; SIFMA Letter; First Clearing 
Letter; ICI Letter; Barclays Letter; American Beacon Letter; Chamber 
of Commerce Letter; ABASA Letter; UBS Letter; Fidelity/NFS Letter; 
Barnard Letter; Federated 9 Letter; BOK Letter; Cornell Letter.
    \239\ See SIPC Letter.
    \240\ Id.
---------------------------------------------------------------------------

    The Commission recently has proposed substantial amendments to its 
rules on money market funds.\241\ In light

[[Page 51844]]

of these proposed amendments,\242\ the Commission is deferring 
consideration of any further expansion of the definition of qualified 
security in Rule 15c3-3 at this time. This will allow the Commission to 
assess the potential impact of any money market fund reforms it may 
adopt and whether any such impact would have consequences for the 
customer protection objective of the reserve account requirement in 
Rule 15c3-3.
---------------------------------------------------------------------------

    \241\ Money Market Fund Reform; Amendments to Form PF, Release 
No. IC-30551 (June 5, 2013), 78 FR 36834 (June 19, 2013) (The rule 
proposal includes two principal alternative reforms that could be 
adopted alone or in combination. One alternative would require a 
floating net asset value or ``NAV'' for prime institutional money 
market funds. The other alternative would allow the use of liquidity 
fees and redemption gates in times of stress. The proposal also 
includes additional diversification and disclosure measures that 
would apply under either alternative.). See also Division of Risk, 
Strategy, and Financial Innovation, Commission, Responses to 
Questions Posed by Commissioners Aguilar, Paredes, and Gallagher 
(Nov. 30, 2012) (responding to questions posed by Commissioners 
Aguilar, Paredes, and Gallagher regarding effectiveness of the 2010 
money market fund reforms, as well as how future reforms might 
affect demand for investments in money market fund substitutes and 
the implications for investors, financial institutions, corporate 
borrowers, municipalities, and states that sell their debt to money 
market funds), available at http://www.sec.gov/news/studies/2012/money-market-funds-memo-2012.pdf.
    \242\ Money Market Fund Reform; Amendments to Form PF, Release 
No. IC-30551 (June 5, 2013), 78 FR 36834 (June 19, 2013).
---------------------------------------------------------------------------

B. Holding Futures Positions in a Securities Portfolio Margin Account

    Under SRO portfolio margin rules (``portfolio margin rules''),\243\ 
a broker-dealer can combine securities and futures positions in a 
portfolio margin securities account to compute margin requirements 
based on the net market risk of all positions in the account.\244\ 
Until the passage of the Dodd-Frank Act, however, SIPA only protected 
customer claims for securities and cash, and specifically excluded from 
protection futures contracts that are not also securities. This fact 
created a potential ambiguity as to how futures positions in a 
portfolio margin securities account would be treated in a SIPA 
liquidation. Consequently, the Commission proposed amendments to Rule 
15c3-3 to accommodate the holding of futures positions in a securities 
account that is margined on a portfolio basis.\245\
---------------------------------------------------------------------------

    \243\ See Exchange Act Release No. 55471 (Mar. 14, 2007), 72 FR 
13149 (Mar. 20, 2007) (SR-NASD-2007-013); Exchange Act Release No. 
54918 (Dec. 12, 2006), 72 FR 1044 (Jan. 9, 2007) (SR-NYSE-2006-13); 
Exchange Act Release No. 54919 (Dec. 12, 2006), (SR-CBOE-2006-14); 
Exchange Act Release No. 54125 (July 11, 2006), 71 FR 40766 (July 
18, 2006) (SR-NYSE-2005-93); Exchange Act Release No. 52031 (July 
14, 2005), 70 FR 42130 (July 21, 2005) (SR-NYSE-2002-19); Exchange 
Act Release No. 52032 (July 14, 2005), 70 FR 42118 (July 21, 2005) 
(SR-CBOE-2002-03); see also Exchange Act Release No. 58251 (July 30, 
2008), 73 FR 46111 (Aug. 7, 2008) (SR-FINRA-2008-041); Exchange Act 
Release No. 58243 (July 28, 2008), 73 FR 45505 (Aug. 5, 2008) (SR-
CBOE-2008-73); and Exchange Act Release No. 58261 (July 30, 2008), 
73 FR 46116 (Aug. 7, 2008) (SR-NYSE-2008-66) (making portfolio 
margin rules permanent).
    \244\ See, e.g., FINRA Rule 4210(g) and CBOE Rule 12.4.
    \245\ See Amendments to Financial Responsibility Rules, 72 FR at 
12868-12870.
---------------------------------------------------------------------------

    Subsequent to the Commission's proposals, the Dodd-Frank Act 
amended the definitions of customer, customer property, and net equity 
in section 16 of SIPA to take into account futures and options on 
futures held in a portfolio margin account carried as a securities 
account pursuant to a Commission-approved portfolio margining 
program.\246\ As a result, persons who hold futures positions in a 
portfolio margining account carried as a securities account are now 
entitled to SIPA protection.
---------------------------------------------------------------------------

    \246\ See Public Law 111-203 Sec.  983.
---------------------------------------------------------------------------

    While the Dodd-Frank Act addressed the protection under SIPA of 
futures and futures options held in a securities portfolio margin 
account, the Commission's proposed amendments to Rule 15c3-3 and 15c3-
3a will still serve an important purpose. In particular, they 
complement the Dodd-Frank SIPA amendments, and will provide additional 
protections to customers by requiring broker-dealers to treat these 
futures positions in accordance with the segregation requirements in 
Rules 15c3-3 and 15c3-3a. Consequently, the Commission is adopting the 
amendments with modifications to address, in part, comments.
    To accommodate securities and futures portfolio margining, the 
Commission's proposals included several amendments. First, the 
Commission proposed amending the definition of free credit balance in 
paragraph (a)(8) of Rule 15c3-3 to provide that the term shall also 
include such liabilities carried in a securities account pursuant to an 
SRO portfolio margining rule approved by the Commission under section 
19(b) of the Act (``SRO portfolio margining rule''), including daily 
marks to market, and proceeds resulting from closing out futures 
contracts and options thereon, and, in the event the broker-dealer is 
the subject of a proceeding under SIPA, the market value as of the 
filing date as that term is defined in SIPA (15 U.S.C. 78lll(7)) of any 
long options on futures contracts.
    In addition, the Commission proposed amendments to treat the 
unrealized value of a futures option in a portfolio margin account on 
the SIPA filing date \247\ as a free credit balance for purposes of 
Rule 15c3-3. This amendment was designed to clarify that the market 
value of such assets should be included in determining a customer's net 
equity claim in a SIPA proceeding. Unlike futures contracts, futures 
options do not generate cash balances on a daily basis in the account 
(i.e., they have unrealized market value at the end of a trading day). 
Since the broker-dealer is not holding cash for the customer, there is 
no need to treat the futures options as a free credit balance for 
purposes of the reserve formula. However, if the broker-dealer was 
liquidated under SIPA, the unrealized gains or losses of the futures 
options should be included in calculating the customer's net equity in 
the account (along with the securities positions and all futures-
related and securities-related cash balances).\248\ The proposed 
amendments were designed to provide for this outcome by defining the 
market value of the futures options as a free credit balance as of the 
filing date of a SIPA liquidation of the broker-dealer. As free credit 
balances, funds originating from futures transactions (e.g., margin 
deposits and daily marks to market) and the market value of futures 
options as of the SIPA filing date would constitute claims for cash in 
a SIPA proceeding and, therefore, become a part of a customer's net 
equity claim entitling the customer to up to $250,000 in advances to 
make up for shortfalls.
---------------------------------------------------------------------------

    \247\ The term filing date is defined in SIPA as, generally, 
being the date a SIPA proceeding is commenced. See 15 U.S.C. 
78lll(7).
    \248\ See 15 U.S.C 78lll(11); see also Public Law 111-203 Sec.  
983 (revising definition of net equity).
---------------------------------------------------------------------------

    The Commission received six comments on the proposed 
amendments.\249\ Three commenters generally supported the 
amendments.\250\ One commenter stated that the amendments represent a 
positive step forward in resolving certain regulatory obstacles in 
connection with the inclusion of futures contracts in a portfolio 
margin account.\251\ Another commenter stated that it supported the 
Commission's efforts to facilitate the cross-margining of futures and 
securities in the portfolio margin account by clarifying the treatment 
of futures and options positions under SIPA.\252\ A commenter expressed 
support for the development of rules for portfolio margining, and 
supported the

[[Page 51845]]

Commission's effort to provide greater legal certainty regarding the 
SIPA treatment of futures positions in a portfolio margin account.\253\ 
In a subsequent comment letter, however, this commenter stated that 
this amendment is no longer necessary in light of the Dodd-Frank Act 
amendments, and recommended the Commission withdraw it.\254\ Another 
commenter stated that the Commission's proposal is premature in that 
including futures in a portfolio margin account, which is a securities 
account, would conflict with the segregation provisions under the CEA 
\255\ and that SIPC has not determined that protection should be 
extended to futures.\256\
---------------------------------------------------------------------------

    \249\ See SIFMA 2 Letter; CME Letter; SIPC Letter; Citigroup 
Letter; American Bar Association Letter; SIFMA 4 Letter. The comment 
letters received as a result of the original solicitation of comment 
pre-date the Dodd-Frank Act. As such, these comment letters address 
the proposed amendments prior to the enactment of the Dodd-Frank 
SIPA amendments related to portfolio margining. The comment letters 
received subsequent to the passage of the Dodd-Frank Act address the 
SIPA amendments.
    \250\ See SIFMA 2 Letter; Citigroup Letter; American Bar 
Association Letter.
    \251\ See Citigroup Letter.
    \252\ See American Bar Association Letter.
    \253\ See SIFMA 2 Letter.
    \254\ See SIFMA 4 Letter.
    \255\ See, e.g., 17 CFR 1.20-1.29.
    \256\ See CME Letter. See also SIPC Letter (expressing ``grave 
concerns'' about potential conflict between the proposed amendments 
and SIPA).
---------------------------------------------------------------------------

    The Commission agrees, in part, with the commenter who stated that 
the Dodd-Frank Act SIPA amendments make the Commission's proposed 
amendments to Rules 15c3-3 and 15c3-3a unnecessary.\257\ As noted 
above, the definitions of customer, customer property, and net equity 
in section 16 of SIPA were amended by the Dodd-Frank Act to take into 
account futures and options on futures held in a portfolio margin 
account carried as a securities account pursuant to a Commission-
approved portfolio margining program.\258\ Consequently, in a 
proceeding under SIPA, futures and options on futures positions held in 
a portfolio margin account carried as a securities account would be 
included in determining a customer's net equity claim.\259\ Therefore, 
the proposed amendment relating to the unrealized value of a futures 
option is not necessary to achieve the objective of providing SIPA 
protection for such positions. As a result, the Commission is modifying 
the final rule to delete the proposed language in paragraph (a)(8) of 
Rule 15c3-3 that would have treated the unrealized value of a futures 
option in a portfolio margin account on the filing date of a SIPA 
proceeding as a free credit balance for purposes of Rule 15c3-3.\260\
---------------------------------------------------------------------------

    \257\ See SIFMA 4 Letter.
    \258\ See Public Law 111-203 Sec.  983.
    \259\ Under the Dodd-Frank Act SIPA amendments, a customer's net 
equity now includes all positions in futures contracts and options 
on futures contracts held in a portfolio margining account carried 
as a securities account pursuant to a portfolio margining program 
approved by the Commission, including all property collateralizing 
such positions, to the extent that such property is not otherwise 
included herein. See 15 U.S.C. 78lll(11)(A)(ii). Further, the 
amendment provided that a claim for a commodity futures contract 
received, acquired, or held in a portfolio margining account 
pursuant to a portfolio margining program approved by the Commission 
or a claim for a security futures contract, shall be deemed to be a 
claim with respect to such contract as of the filing date, and such 
claim shall be treated as a claim for cash. See 15 U.S.C. 78lll(11).
    \260\ Specifically, the final rule does not include the proposed 
language: ``, and, in the event the broker-dealer is the subject of 
a proceeding under SIPA, the market value as of the ``filing date'' 
as that term is defined in SIPA (15 U.S.C. 78lll(7)) of any long 
options on futures contracts.''
---------------------------------------------------------------------------

    As stated above, however, the remaining rule amendments to Rules 
15c3-3 and 15c3-3a complement the amendments to SIPA and provide 
additional protections to customers. Consequently, the Commission is 
adopting them with some technical modifications in response to 
suggestions offered by commenters.
    One commenter suggested a change to paragraph (a)(8) of Rule 15c3-3 
that would expand the definition of free credit balances to include 
cash balances related to futures positions and the value of futures 
options positions on the SIPA filing date.\261\ First, the commenter 
noted that paragraph (a)(8) of Rule 15c3-3 concerns free credit 
balances, which are funds subject to immediate payment (among other 
limitations).\262\ The commenter expressed concern that the 
Commission's proposal could have been construed as excluding cash 
balances in a portfolio margin account that are not subject to 
immediate payment. The Commission agrees that the proposal could have 
been interpreted as requiring that futures-related cash balances be 
treated differently depending on whether or not they are subject to 
immediate payment.
---------------------------------------------------------------------------

    \261\ See SIFMA 2 Letter.
    \262\ Id.
---------------------------------------------------------------------------

    The amendments to Rule 15c3-3 are designed to provide the same 
treatment to futures-related cash balances in a portfolio margin 
account as applies to securities-related cash balances. As discussed 
above, under Item 1 of Rule 15c3-3a, cash balances that do not meet the 
definition of free credit balances (e.g., because they are not subject 
to immediate payment) are included in the customer reserve formula if 
they meet the definition of other credit balances under paragraph 
(a)(9) of Rule 15c3-3.\263\
---------------------------------------------------------------------------

    \263\ Item 1 of Rule 15c3-3a requires a broker-dealer to include 
in the customer reserve formula free credit balances and other 
credit balances in customers' securities accounts. Paragraph (a)(9) 
of Rule 15c3-3 defines other credit balances as ``cash liabilities 
of a broker or dealer to customers other than free credit balances 
and funds in commodities accounts segregated as aforesaid.'' 17 CFR 
240.15c3-3(a)(9).
---------------------------------------------------------------------------

    Consequently, to remove any ambiguity as to the effect of the rule 
changes in response to the comments noted above, the Commission is 
amending paragraph (a)(9) of Rule 15c3-3--which defines other credit 
balances--to include futures-related cash balances other than free 
credit balances. In addition, the Commission has deleted the phrase 
``shall include such liabilities,'' in the amendment to proposed 
paragraph (a)(8) and replaced it with ``includes, if subject to 
immediate cash payment to customers on demand, funds . . .'' to clarify 
that this paragraph relates to cash balances in a portfolio margin 
account that are subject to immediate payment and, hence, that 
paragraph (a)(9) relates to other cash balances in a portfolio margin 
account.
    One commenter suggested changes with respect to the marks to market 
language in the rule, stating that the phrase relating to daily marks 
to market be modified to read ``variation margin or initial margin 
marks to market'' and the phrase in the proposal that read ``proceeds 
resulting from closing out futures contracts and options thereon'' be 
modified to read ``proceeds resulting from margin paid or released in 
connection with closing out, settling or exercising futures contracts 
and options thereon.'' \264\ The Commission agrees with these technical 
suggestions because they clarify the rule by incorporating appropriate 
futures terminology.
---------------------------------------------------------------------------

    \264\ See SIFMA 2 Letter.
---------------------------------------------------------------------------

    Consequently, as adopted, the text in paragraphs (a)(8) and (a)(9) 
of Rule 15c3-3 expands the terms free credit balance and other credit 
balances to include ``funds carried in a securities account pursuant to 
a self-regulatory organization portfolio margin rule approved by the 
Commission . . . including variation margin or initial margin, marks to 
market, and proceeds resulting from margin paid or released in 
connection with closing out, settling or exercising futures contracts 
and options thereon.'' \265\ The amendments, as adopted, more precisely 
capture the Commission's intent in terms of identifying the types of 
futures-related cash balances that may be held in a portfolio margin 
account than the language in the proposed rule.
---------------------------------------------------------------------------

    \265\ See also section II.A.6. of this release.
---------------------------------------------------------------------------

    On the debit side of the customer reserve formula, the Commission 
is adopting, substantially as proposed, an amendment to Rule 15c3-3a 
Item 14 that permits a broker-dealer to include as a debit item the 
amount of customer margin required and on deposit at a derivatives 
clearing organization related to futures positions carried in a 
portfolio

[[Page 51846]]

margin account.\266\ Under SIPA, the term customer property includes, 
``resources provided through the use or realization of customers' debit 
cash balances and other customer-related debit items as defined by the 
Commission by rule,'' as well as, ``in the case of a portfolio 
margining account of a customer that is carried as a securities account 
pursuant to a portfolio margining program approved by the Commission, a 
futures contract or an option on a futures contract received, acquired, 
or held by or for the account of a debtor from or for such portfolio 
margining account, and the proceeds thereof.'' \267\ Under this 
provision of SIPA, this amendment to Rule 15c3-3 makes the margin 
required and on deposit at a derivatives clearing organization part of 
the ``customer property'' in the event the broker-dealer is placed in a 
SIPA liquidation. Thus, it would be available for distribution to the 
failed firm's customers.
---------------------------------------------------------------------------

    \266\ The Commission also is amending Item 14 of Rule 15c3-3a to 
replace the phrase ``Security futures products'' with the phrase 
``security futures products.'' In addition, the Commission adopting 
some non-substantive amendments to Note G to Item 14, including: (1) 
In paragraph (a) replacing the word ``shall'' with the word 
``must''; (2) in paragraph (b) replacing the word ``shall'' with the 
word ``will''; in the second line in paragraph (b)(2) inserting the 
phrase ``futures in a'' before the phrase ``portfolio margin 
account'' and deleting the word ``margin''; (3) in paragraph (b)(2) 
replacing the word ``shall'' with the word ``will'' in three places; 
(4) in the sixth and seventh lines of paragraph (b)(2), inserting 
the phrase ``futures in a'' before the phrase ``portfolio margin 
account'' and deleting the phrase ``futures margin''; in paragraph 
(b)(3)(iv) replacing the word ``securities'' with the word 
``security'', inserting the phrase ``futures in a'' before the 
phrase ``portfolio margin account'' and deleting the word 
``futures''; and (4) in paragraph (c), replacing the word ``shall'' 
with the word ``will'', inserting the phrase ``futures in a'' before 
the phrase ``portfolio margin account'' and deleting the word 
``futures.''
    \267\ 15 U.S.C. 78lll(4)(B) and (D); see also Dodd-Frank Act 
Section 983.
---------------------------------------------------------------------------

    Finally, one commenter suggested changes to Commission rules beyond 
those in the proposing release. This commenter urged the Commission to 
consider amending Rules 8c-1, 15c2-1, and 15c3-3 to provide that their 
provisions could be waived by customers that are entitled to engage in 
derivative transactions in a portfolio margin account, provided the 
customer agrees in writing to waive SIPA protection.\268\ According to 
the commenter, a customer executing such a waiver would not be entitled 
to the protections under SIPA for customers and would be deemed a 
general creditor of the broker-dealer with respect to claims arising 
from their portfolio margin accounts. At this time, the Commission does 
not believe it would be appropriate to amend the rules as recommended 
by the commenter because such changes are beyond the scope of this 
rulemaking.
---------------------------------------------------------------------------

    \268\ See American Bar Association Letter.
---------------------------------------------------------------------------

C. Amendments With Respect to Securities Lending and Borrowing and 
Repurchase/Reverse Repurchase Transactions

    In the proposing release, the Commission noted two concerns about 
stock lending that arose from the failure of the registered broker-
dealer MJK Clearing, Inc. (``MJK''); \269\ namely: (1) That broker-
dealers with principal liability in a stock loan transaction may 
purport to be acting in an agency capacity and, consequently, not 
taking appropriate capital charges; and (2) that broker-dealers that 
historically have not been active in stock loan activities may rapidly 
expand their balance sheets with such transactions and, thereby, 
increase leverage to a level that poses significant financial risk to 
the firm and its counterparties. In response, the Commission proposed, 
and is now adopting, amendments to Rules 15c3-1 and 17a-11.
---------------------------------------------------------------------------

    \269\ See Amendments to Financial Responsibility Rules, 72 FR at 
12869. The failure of MJK raised several concerns regarding 
securities lending transactions. As explained in more detail in the 
proposing release, at the time of its failure, MJK owed cash 
collateral to several borrowing broker-dealers. Id. at 12862, 12869-
12870. These broker-dealers suffered losses caused by MJK's failures 
and, in later proceedings related to these losses, questions arose 
as to whether these broker-dealers were acting as principal or 
agent.
---------------------------------------------------------------------------

    With respect to the Rule 15c3-1 proposal, the Commission is 
adopting the amendment, as proposed. This amendment to subparagraph 
(c)(2)(iv)(B) of Rule 15c3-1 clarifies that broker-dealers providing 
securities lending and borrowing settlement services are deemed, for 
purposes of the rule, to be acting as principal and are subject to 
applicable capital deductions.\270\ Under the amendment, these 
deductions can be avoided if a broker-dealer takes certain steps to 
disclaim principal liability. In particular, the final rule provides 
that ``a broker or dealer that participates in a loan of securities by 
one party to another party will be deemed a principal for the purpose 
of the deductions required under this section, [i.e., deductions from 
net worth] unless the broker or dealer has fully disclosed the identity 
of each party to the other and each party has expressly agreed in 
writing that the obligations of the broker or dealer do not include a 
guarantee of performance by the other party and that such party's 
remedies in the event of a default by the other party do not include a 
right of setoff against obligations, if any, of the broker or dealer.'' 
\271\
---------------------------------------------------------------------------

    \270\ A broker-dealer is required to deduct from net worth most 
unsecured receivables, including the amount that the market value of 
a securities loan exceeds the value of collateral obtained for the 
loan. See 17 CFR 240.15c3-1(c)(2)(iv)(B). Similarly, with respect to 
repo transactions, a broker-dealer obligated to resell securities 
must, in computing net capital, deduct the amount that the market 
value of the securities is less than the resale price. See 17 CFR 
240.15c3-1(c)(2)(iv)(F). A broker-dealer obligated to repurchase 
securities must, in computing net capital, deduct the amount that 
the market value of the securities is greater than the repurchase 
price to the extent the excess is greater than certain percentages. 
See 17 CFR 240.15c3-1(c)(2)(iv)(F).
    \271\ See paragraph (c)(2)(iv)(B) of Rule 15c3-1, as adopted. 
Standard master securities loan agreements (including the annexes 
thereto) commonly used by the parties to a securities lending 
transaction contain provisions for establishing agent (as opposed to 
principal) status in a securities lending and borrowing transaction 
that are consistent with the requirements in paragraph (c)(2)(iv)(B) 
of Rule 15c3-1, as amended. See, e.g., 2000 Master Securities Loan 
Agreement, Annex I, published by SIFMA, available at www.sifma.org.
---------------------------------------------------------------------------

    The Commission received five comments on the proposed 
amendment.\272\ Two commenters objected to this amendment, stating that 
they believed the standard legal documents used in securities lending 
transactions provide sufficient legal certainty on the status of the 
parties.\273\ The Commission, in recognition of standard stock loan 
agreement templates, designed the amendment to accommodate the 
continued use of these industry model agreements by incorporating their 
use into the rule's requirements. For the purposes of establishing a 
broker-dealer's status as agent or lender, these agreements may be 
sufficiently detailed to satisfy the new requirements. However, it 
would be the broker-dealer's responsibility to ensure that any 
``standard'' agreement contains the necessary provisions to comply with 
this amendment, and that such provisions are not weakened by any other 
language in the agreement or any subsequent amendment. The goal is to 
avoid ambiguity about a broker-dealer's status as agent or principal 
regarding the applicability of the stock loan charges in the net 
capital rule. As the failure of MJK illustrated, disputes can arise 
over whether a broker-dealer is acting as a principal or agent in a 
stock loan transaction.\274\ Under the formulation of the rule, a 
broker-dealer is presumed to be acting in a principal capacity unless 
it can demonstrate through its agreements with the other participants 
in the transaction that it is acting as agent. In this regard, a 
broker-

[[Page 51847]]

dealer will be responsible for determining that its agreements are 
fully consistent with the standards of the rule.
---------------------------------------------------------------------------

    \272\ See Abbey National Letter; Dresdner Kleinwort Letter; 
SIFMA 2 Letter; Citigroup Letter; Cornell Letter.
    \273\ See SIFMA 2 Letter; Citigroup Letter.
    \274\ See, e.g., Nomura v. E*Trade, 280 F.Supp.2d 184 (S.D.N.Y. 
2003).
---------------------------------------------------------------------------

    One commenter asked for clarification on the timing of when the 
agent lender must disclose the principal parties to one another in 
order to disclaim principal liability under the rule.\275\ This 
commenter stated that the amendment should be modified so as not to 
require pre-trade disclosure of the identity of the principal, since 
under the agency annex to standardized master lending agreements such 
disclosure can be made on the next business day.\276\ The amendment is 
intended to accommodate the continued use of these industry model 
agreements by incorporating their use into the rule's requirements. 
Consequently, disclosure of principals in conformance with the 
requirements of the ``standard'' stock loan agreement templates would 
be consistent with the requirements of the rule (as long as the 
identity of the borrower and the lender is disclosed within one 
business day after the trade date), which is designed to ensure that 
firms are taking the required net capital charges related to the 
securities lending activity to the extent they have principal 
liability.
---------------------------------------------------------------------------

    \275\ See SIFMA 2 Letter.
    \276\ See, e.g., www.sifma.org for sample Master Securities Loan 
Agreements (and annex).
---------------------------------------------------------------------------

    The Commission also is adding new paragraph (c)(5) to Rule 17a-11 
to help identify broker-dealers with highly leveraged non-government 
securities lending and borrowing and repurchase operations.\277\ This 
new provision requires a broker-dealer to notify the Commission 
whenever the total amount of money payable against all securities 
loaned or subject to a repurchase agreement, or the total contract 
value of all securities borrowed or subject to a reverse repurchase 
agreement, exceeds 2,500 percent of tentative net capital; provided 
that, for purposes of this leverage threshold, transactions involving 
government securities as defined in section 3(a)(42) of the Exchange 
Act, are excluded from the calculation.\278\ The amendment is designed 
to alert regulators to a sudden increase in a broker-dealer's stock 
loan and repo positions, which could indicate that the broker-dealer is 
taking on new risk that it may have limited experience in managing.
---------------------------------------------------------------------------

    \277\ See paragraph (c)(5) of Rule 17a-11, as adopted.
    \278\ 15 U.S.C. 78c(a)(42). ``Government securities'' generally 
present less market risk than other types of securities used in 
securities lending and repo transactions. Consequently, they are 
excluded from the scope of the rule.
---------------------------------------------------------------------------

    One commenter supported the proposed amendment and believes the 
notification could serve as ``an early warning'' that a firm is 
approaching insolvency and generally supports the Commission's efforts 
to protect customers from broker-dealers who recklessly rely on 
excessively leveraged transactions.\279\
---------------------------------------------------------------------------

    \279\ See Cornell Letter.
---------------------------------------------------------------------------

    In the proposing release, the Commission estimated that a leverage 
threshold of 25 times tentative net capital would be triggered by 21 
broker-dealers on a regular basis.\280\ The Commission stated that this 
establishes a threshold high enough to only capture on a regular basis 
those few firms highly active in securities lending and repo 
transactions. The Commission did not receive any comments regarding the 
2,500% tentative net capital threshold in the proposing release. Based 
on FOCUS Report data, as of December 31, 2011, there were six broker-
dealers whose securities loaned and securities borrowed transactions 
exceeded 25 times their tentative net capital. The Commission continues 
to believe that the 2,500% threshold is an appropriate notice trigger 
for a firm that historically has not been as active in these 
transactions but rapidly leverages up its securities lending and repo 
positions. Given the updated estimates of how many broker-dealers would 
trigger this threshold, the Commission believes the proposed threshold 
is high enough to capture on a regular basis only those few firms 
highly active in securities lending and repo transactions. Therefore, 
the Commission is retaining this 2,500% threshold in the final rule 
without revision.
---------------------------------------------------------------------------

    \280\ See Amendments to Financial Responsibility Rules, 72 FR at 
12870 (providing rationale for 2,500% threshold).
---------------------------------------------------------------------------

    As proposed, the amendment to Rule 17a-11 also would have provided 
that a broker-dealer that submitted a monthly report of its stock loan 
and repo activity to its DEA need not file the notices. This provision 
was designed to accommodate large broker-dealers that are active in 
this business and regularly maintain stock loan and repo balances that 
exceed the threshold. The Commission expects that these broker-dealers 
have experience in managing the risks specific to these types of 
transactions and have established controls to address those risks. 
Consequently, a notice under paragraph (c)(5) from these broker-dealers 
might not be as useful in providing risk assessment information to 
regulators. Instead, the monthly reports will provide the Commission 
and other financial regulators with information with which to develop 
trend analysis, when deemed appropriate. They could use this analysis 
to identify leverage levels that are outside the normal trend range, 
and which may be indicative of a material change in the firm's business 
model that could indicate it was taking on higher levels of leverage, 
branching into new products, or experiencing operational or financial 
difficulties (e.g., the firm could be reducing leverage rapidly because 
creditors were not willing to enter into new transactions).
    Three commenters addressed the proposed monthly notification 
requirement.\281\ They stated that the monthly report in lieu of the 
notification should be provided as part of the monthly FOCUS report 
many broker-dealers file with their DEA.\282\ The Commission agrees 
that the FOCUS report may be an appropriate mechanism for reporting 
stock loan and repo positions in lieu of the proposed monthly 
notification requirement.\283\ Consequently, the Commission has 
modified the final rule to delete the phrase ``submits a monthly report 
of'' and replace it with ``reports monthly.'' \284\ In addition, as 
adopted, in order to provide that the monthly report be sent to a 
broker-dealer's DEA, the Commission added the phrase ``to its 
designated examining authority in a form acceptable'' before ``to its 
designated examining authority.'' \285\ This language, as adopted, will 
provide each DEA with the flexibility to prescribe how the monthly 
reports are to be made and will accommodate a DEA that opts to use the 
FOCUS report as the reporting mechanism.\286\ In summary, as adopted, 
the notice exemption in paragraph (c)(5) will state ``provided further, 
however, that a broker or dealer will not be required to send the 
notice required by this paragraph (c)(5) if it reports monthly its 
securities lending and borrowing and repurchase and reverse repurchase 
activity (including the total amount of money payable against 
securities loaned or subject to a repurchase agreement and the total 
contract value of securities borrowed or subject to a reverse 
repurchase agreement) to its designated

[[Page 51848]]

examining authority in a form acceptable to its designated examining 
authority.'' \287\
---------------------------------------------------------------------------

    \281\ See Abbey National Letter; Citigroup Letter; SIFMA 2 
Letter; SIFMA 4 Letter.
    \282\ See Abbey National Letter; Citigroup Letter; SIFMA 2 
Letter.
    \283\ Carrying broker-dealers generally are required to submit 
FOCUS reports on a monthly basis.
    \284\ See paragraph (c)(5) of Rule 17a-11, as adopted.
    \285\ Id.
    \286\ See also SIFMA 4 Letter.
    \287\ See paragraph (c)(5) of Rule 17a-11, as adopted. The 
Commission also inserted the text ``(c)(5)'' in the final rule 
before the phrase ``if it reports monthly'' to make the paragraph 
reference more explicit.
---------------------------------------------------------------------------

    A commenter asked the Commission to clarify that the new reporting 
provision of paragraph (c)(5) of Rule 17a-11 is triggered only by 
principal activity meeting or exceeding stated thresholds.\288\ The 
notification provision applies when a broker-dealer is acting as 
principal and exceeds the stated thresholds, and a broker-dealer will 
not need to include transactions for which it does not have principal 
liability in determining whether the notification threshold has been 
triggered.
---------------------------------------------------------------------------

    \288\ See Dresdner Kleinwort Letter.
---------------------------------------------------------------------------

D. Documentation of Risk Management Procedures

    It is important for broker-dealers to document the controls they 
establish for managing the material risk exposures that arise from 
their business activities. For example, a broker-dealer active in 
securities lending is exposed to a variety of risks, including market 
risk,\289\ credit risk,\290\ and liquidity risk.\291\ Other broker-
dealer activities give rise to these risks as well, including managing 
a repo book, dealing in OTC derivatives, trading proprietary positions, 
and lending on margin. A well-documented system of internal controls 
designed to manage material risk exposures reflects the determination 
of a firm's management as to how its business activities should be 
conducted in light of such exposures. It also enables management to 
better identify, analyze, and manage the risks inherent in the firm's 
business activities with a view to preventing material losses and to 
review whether the firm's activities are being conducted in a manner 
that is consistent with such procedures and controls as well as in 
accordance with the Federal securities laws. Risk management controls 
are particularly important for the largest broker-dealers, which 
generally engage in a wide range of highly complex activities across 
many different markets and geographical locations.
---------------------------------------------------------------------------

    \289\ Generally, market risk is the risk that prices, values, or 
rates will adversely change.
    \290\ Generally, credit risk is the risk of loss resulting from 
a counterparty or other type of obligor failing to meet an 
obligation, including an obligation with respect to a loan, 
security, swap, option, or settlement.
    \291\ Generally, funding liquidity risk is the risk that a firm 
will not be able to meet cash demands as they become due and asset 
liquidity risk is the risk that an asset will not be able to be sold 
quickly at its market value.
---------------------------------------------------------------------------

    While most broker-dealers already have well-documented procedures 
and controls for managing risks as a matter of business practice, it is 
important to reinforce the practice and make it easier for regulators 
to understand a broker-dealer's procedures and controls so that they 
can review whether the broker-dealer is adhering to them. Consequently, 
the Commission proposed an amendment to Rule 17a-3 that would have 
required a broker-dealer to create a record documenting its ``internal 
risk management controls.'' \292\
---------------------------------------------------------------------------

    \292\ See Amendments to Financial Responsibility Rules, 72 FR at 
12899.
---------------------------------------------------------------------------

    Commenters raised concerns that the proposed amendment would be 
``overly broad and ambiguous'' \293\ and ``so broad as to create 
uncertainty.'' \294\ Three commenters argued that the requirement, if 
adopted, should be limited to market, credit, and liquidity risk 
management.\295\ Another commenter recommended that the Commission 
propose the minimum elements required to be documented, such as market 
risk, credit risk, liquidity risk, and operational risk.\296\ While 
market, credit, and liquidity risk were among the specific examples of 
risk identified in the proposed rule,\297\ the Commission agrees that 
the phrase ``risk controls'' could be interpreted very broadly. To 
address this concern, the Commission has modified the final rule to 
clarify its application. The final rule requires the documentation of 
controls established specifically to manage market, credit, and 
liquidity risk, ``which have more commonly understood meanings within 
the industry.'' \298\ This also focuses the rule on the key risks 
inherent in conducting a securities business.
---------------------------------------------------------------------------

    \293\ See E*Trade Letter.
    \294\ See Citigroup Letter.
    \295\ See E*Trade Letter; SIFMA 2 Letter; Citigroup Letter.
    \296\ See Barnard Letter.
    \297\ See Amendments to Financial Responsibility Rules, 72 FR at 
12870.
    \298\ E*Trade Letter. The final rule also deletes the term 
``internal'' because it would be redundant.
---------------------------------------------------------------------------

    Commenters also requested that the Commission clarify that, when a 
broker-dealer is part of a corporate family, risk management controls 
could be applicable to multiple entities within the corporate family, 
including the broker-dealer.\299\ In response, the final rule does not 
specify the type of controls a broker-dealer must establish to manage 
these risks. It simply requires the documentation of the procedures the 
broker-dealer has established. Broker-dealers that are part of holding 
companies may be subject to procedures that are used globally 
throughout the organization. As long as the broker-dealer maintains 
documented procedures of controls pertaining to the designated entity, 
the requirements of the rule would be met.
---------------------------------------------------------------------------

    \299\ See E*Trade Letter; SIFMA 2 Letter; Citigroup Letter.
---------------------------------------------------------------------------

    Other commenters requested that the Commission clarify that the 
risk management controls do not have to include any minimum elements 
\300\ and that the rule does not impose any qualitative 
requirements.\301\ Two commenters suggested that because there were no 
stated content requirements for the risk management controls, it would 
be difficult for a firm to prove that their risk management procedures 
were adequate, which could lead to a ``subjective process'' \302\ or to 
examiners applying a ``one size fits all'' best practices 
standard.\303\ One commenter suggested that to address this issue, the 
Commission should articulate the process that examiners will follow 
when examining risk management controls.\304\ Finally, one commenter 
encouraged the Commission to consider strengthening this requirement in 
terms of both its scope and applicability.\305\
---------------------------------------------------------------------------

    \300\ See SIFMA 2 Letter.
    \301\ See Citigroup Letter.
    \302\ See Coastal Securities Letter.
    \303\ See American Bar Association Letter.
    \304\ Id.
    \305\ See Cornell Letter.
---------------------------------------------------------------------------

    The Commission is not mandating any specific controls, procedures, 
or policies that must be established by a broker-dealer to manage 
market, credit, or liquidity risk, nor is it requiring any minimum 
elements or specifying any procedures that would be required to be 
included in a firm's market, credit, and liquidity risk management 
policies. Rather, the Commission is requiring that a control, 
procedure, or policy be documented if it is in place. Based on staff 
experience monitoring large broker-dealers, the Commission anticipates 
that most brokers-dealers that will be subject to this rule already 
have documented controls, procedures, and policies as part of their 
overall risk management processes. The purpose of this amendment is not 
to change the controls, procedures, and policies that are in place, but 
to require that they be adequately documented.
    For the foregoing reasons, paragraph (a)(23) to Rule 17a-3, as 
adopted, requires certain broker-dealers to make and keep current a 
record documenting the credit, market, and liquidity risk

[[Page 51849]]

management controls established and maintained by the broker-dealer to 
assist it in analyzing and managing the risks associated with its 
business activities.\306\ This documentation requirement applies only 
to broker-dealers that have more than (1) $1,000,000 in aggregate 
credit items as computed under the customer reserve formula of Rule 
15c3-3, or (2) $20,000,000 in capital, including debt subordinated in 
accordance with Appendix D to Rule 15c3-1.\307\
---------------------------------------------------------------------------

    \306\ See paragraph (a)(23) of Rule 17a-3, as adopted.
    \307\ The Commission also has modified paragraph (a)(23) of Rule 
17a-3 from the proposed rule to delete the reference to the term 
``member'' in two places in the final rule because the reference to 
``member'' is unnecessary. Id.
---------------------------------------------------------------------------

    The Commission also proposed adding paragraph (e)(9) to Rule 17a-4 
to require a broker-dealer to retain the documented risk management 
controls or procedures until three years after the broker-dealer 
terminates the use of the system of controls or procedures documented 
therein. One commenter stated that given the minimal cost of electronic 
storage, the commenter believes that the retention period could be 
extended beyond three years.\308\ Conversely, two commenters suggested 
that Rule 17a-4 be revised so that a broker-dealer would not be 
required to maintain outdated versions of its risk management 
controls.\309\
---------------------------------------------------------------------------

    \308\ Id.
    \309\ See E*Trade Letter; SIFMA 2 Letter.
---------------------------------------------------------------------------

    The Commission is adding paragraph (e)(9) to Rule 17a-4, with a 
minor modification from the proposed amendment. Specifically, the final 
rule is modified to require retention of the records until three years 
after termination of the use of the risk management controls documented 
therein by replacing the phrase ``systems of controls or procedures'' 
with the phrase ``risk management controls.'' \310\ This modification 
maintains consistency with the terminology in paragraph (a)(23) of Rule 
17a-3, as adopted, which requires broker-dealers to make and keep 
current a ``record documenting the credit, market, and liquidity risk 
management controls established and maintained by the broker or 
dealer.'' \311\ Finally, the three year retention period is designed to 
establish an audit trail between the risk management controls that have 
most recently been made inoperative and the risk management controls 
currently in effect to provide sufficient opportunity to review the 
former during the broker-dealer's exam cycle. Three years also is 
consistent with the retention period for many of the records required 
to be preserved under Rule 17a-4.\312\
---------------------------------------------------------------------------

    \310\ See paragraph (e)(9) of Rule 17a-4, as adopted. The 
Commission also modified the final rule to delete the phrase 
``paragraph (a)(23) of'' and insert ``(a)(23)'' immediately 
following ``17a-3'' to make the referenced citation consistent with 
other parts of the rule.
    \311\ See paragraph (a)(23) of Rule 17a-3, as adopted.
    \312\ See 17 CFR 240.17a-4(b).
---------------------------------------------------------------------------

    Finally, one commenter noted that the proposed amendment does not 
impose any requirements beyond those applicable under Rule 15c3-4.\313\ 
Accordingly, the commenter urged the Commission to create an exception 
from the proposed amendment to Rule 17a-3 for a broker-dealer that is 
effectively subject to Rule 15c3-4. With the modifications to the final 
rule to include only market, credit, and liquidity risk, a broker-
dealer subject to the conditions of Rule 15c3-4 would already comply 
with this amendment given that these risks are included in the risks a 
broker-dealer would be required to address under Rule 15c3-4. 
Therefore, an exception from the rule is unnecessary.
---------------------------------------------------------------------------

    \313\ See SIFMA 2 Letter. See also 17 CFR 240.15c3-4.
---------------------------------------------------------------------------

E. Amendments to the Net Capital Rule

    Under Rule 15c3-1, broker-dealers are required to maintain, at all 
times, a minimum amount of net capital.\314\ The capital standard in 
Rule 15c3-1 is a net liquid assets test. This standard is designed to 
allow a broker-dealer the flexibility to engage in activities that are 
part of conducting a securities business (e.g., taking securities into 
inventory) but in a manner that places the firm in the position of 
holding at all times more than one dollar of highly liquid assets for 
each dollar of unsubordinated liabilities (e.g., money owed to 
customers, counterparties, and creditors).\315\ For example, Rule 15c3-
1 allows securities positions to count as allowable net capital, 
subject to standardized or model-based deductions (``haircuts'').\316\ 
The rule, however, does not permit most unsecured receivables to count 
as allowable net capital.\317\ This aspect of the rule severely limits 
the ability of broker-dealers to engage in activities that generate 
unsecured receivables (e.g., lending money without obtaining 
collateral). The rule also does not permit fixed assets or other 
illiquid assets to count as allowable net capital, which creates 
disincentives for broker-dealers to own real estate and other fixed 
assets that cannot be readily converted into cash.\318\ For these 
reasons, Rule 15c3-1 incentivizes broker-dealers to confine their 
business activities and devote capital to activities such as 
underwriting, market making, and advising on and facilitating customer 
securities transactions.\319\
---------------------------------------------------------------------------

    \314\ See 17 CFR 240.15c3-1.
    \315\ See, e.g., Interpretation Guide to Net Capital Computation 
for Brokers and Dealers, Exchange Act Release No. 8024 (Jan. 18, 
1967), 32 FR 856 (Jan. 25, 1967) (``Rule 15c3-1 (17 CFR 240.15c3-1) 
was adopted to provide safeguards for public investors by setting 
standards of financial responsibility to be met by brokers and 
dealers. The basic concept of the rule is liquidity; its object 
being to require a broker-dealer to have at all times sufficient 
liquid assets to cover his current indebtedness.'') (Footnotes 
omitted); Net Capital Treatment of Securities Positions, Obligations 
and Transactions in Suspended Securities, Exchange Act Release No. 
10209 (June 8, 1973), 38 FR 16774 (June 26, 1973) (Commission 
release of a letter from the Division of Market Regulation) (``The 
purpose of the net capital rule is to require a broker or dealer to 
have at all times sufficient liquid assets to cover its current 
indebtedness. The need for liquidity has long been recognized as 
vital to the public interest and for the protection of investors and 
is predicated on the belief that accounts are not opened and 
maintained with broker-dealers in anticipation of relying upon suit, 
judgment and execution to collect claims but rather on a reasonable 
demand one can liquidate his cash or securities positions.''); Net 
Capital Requirements for Brokers and Dealers, Exchange Act Release 
No. 15426 (Dec. 21, 1978), 44 FR 1754 (Jan. 8, 1979) (``The rule 
requires brokers or dealers to have sufficient cash or liquid assets 
to protect the cash or securities positions carried in their 
customers' accounts. The thrust of the rule is to insure that a 
broker or dealer has sufficient liquid assets to cover current 
indebtedness.''); Net Capital Requirements for Brokers and Dealers, 
Exchange Act Release No. 26402 (Dec. 28, 1989), 54 FR 315 (Jan. 5, 
1989) (``The rule's design is that broker-dealers maintain liquid 
assets in sufficient amounts to enable them to satisfy promptly 
their liabilities. The rule accomplishes this by requiring broker-
dealers to maintain liquid assets in excess of their liabilities to 
protect against potential market and credit risks.'') (Footnote 
omitted).
    \316\ See 17 CFR 240.15c3-1(c)(2)(vi); 17 CFR 240.15c3-1e; 17 
CFR 240.15c3-1f .
    \317\ See 17 CFR 240.15c3-1(c)(2)(iv).
    \318\ See, e.g., 17 CFR 240.15c3-1(c)(2)(iv)(A).
    \319\ See Capital, Margin, and Segregation Requirements for 
Security-Based Swap Dealers and Major Security-Based Swap 
Participants and Capital Requirements for Broker-Dealers, Exchange 
Act Release No. 68071 (Oct. 18, 2012), 77 FR 70214, 70219 (Nov. 23, 
2012).
---------------------------------------------------------------------------

    Rule 15c3-1 requires broker-dealers to maintain a minimum level of 
net capital (meaning highly liquid capital) at all times.\320\ The rule 
requires that a broker-dealer perform two calculations: (1) A 
computation of the minimum amount of net capital the broker-dealer must 
maintain; \321\ and (2) a computation of the amount of net capital the 
broker-dealer is maintaining.\322\ The minimum net capital requirement 
is the greater of a fixed-dollar amount specified in the rule and an 
amount determined by applying one of two financial ratios: The 15-to-1 
aggregate indebtedness to net

[[Page 51850]]

capital ratio or the 2% of aggregate debit items ratio.\323\
---------------------------------------------------------------------------

    \320\ See 17 CFR 240.15c3-1.
    \321\ See 17 CFR 240.15c3-1(a).
    \322\ See 17 CFR 240.15c3-1(c)(2). The computation of net 
capital is based on the definition of net capital in paragraph 
(c)(2) of Rule 15c3-1. Id.
    \323\ See 17 CFR 240.15c3-1(a).
---------------------------------------------------------------------------

    In computing net capital, the broker-dealer must, among other 
things, make certain adjustments to net worth such as deducting 
illiquid assets, taking other capital charges, and adding qualifying 
subordinated loans.\324\ The amount remaining after these adjustments 
is defined as tentative net capital.\325\ The final step in computing 
net capital is to take prescribed percentage deductions (``standardized 
haircuts'') from the mark-to-market value of the proprietary positions 
(e.g., securities, money market instruments, and commodities) that are 
included in its tentative net capital.\326\ The standardized haircuts 
are designed to account for the market risk inherent in these positions 
and to create a buffer of liquidity to protect against other risks 
associated with the securities business.\327\ Alternative Net Capital 
or ``ANC'' broker-dealers and a type of limited purpose broker-dealer 
that deals solely in OTC derivatives (``OTC derivative dealers'') are 
permitted, with Commission approval, to, among other things, use 
internal models as the basis for taking market risk charges as an 
alternative approach in lieu of the standardized haircuts for classes 
of positions for which they have been approved to use models.\328\ Rule 
15c3-1 imposes substantially higher minimum capital requirements for 
ANC broker-dealers and OTC derivatives dealers, as compared to other 
types of broker-dealers, because, among other reasons, the use of 
internal models to compute net capital can substantially reduce the 
deductions for securities and money market positions as compared with 
the standardized haircuts.\329\
---------------------------------------------------------------------------

    \324\ See 17 CFR 240.15c3-1(c)(2)(i)-(xiii).
    \325\ See 17 CFR 240.15c3-1(c)(15).
    \326\ See 17 CFR 240.15c3-1(c)(2)(vi).
    \327\ See, e.g., Uniform Net Capital Rule, Exchange Act Release 
No. 13635 (June 16, 1977), 42 FR 31778 (June 23, 1977) (``[Haircuts] 
are intended to enable net capital computations to reflect the 
market risk inherent in the positioning of the particular types of 
securities enumerated in [the rule]''); Net Capital Rule, Exchange 
Act Release No. 22532 (Oct. 15, 1985), 50 FR 42961 (Oct. 23, 1985) 
(``These percentage deductions, or `haircuts', take into account 
elements of market and credit risk that the broker-dealer is exposed 
to when holding a particular position.''); Net Capital Rule, 
Exchange Act Release No. 39455 (Dec. 17, 1997), 62 FR 67996 (Dec. 
30, 1997) (``Reducing the value of securities owned by broker-
dealers for net capital purposes provides a capital cushion against 
adverse market movements and other risks faced by the firms, 
including liquidity and operational risks.'') (Footnote omitted).
    \328\ See 17 CFR 240.15c3-1(a)(5) and (a)(7); 17 CFR 240.15c3-
1e; 17 CFR 240.15c3-1f.
    \329\ See 17 CFR 240.15c3-1(a)(5) and (a)(7). See also Capital, 
Margin, and Segregation Requirements for Security-Based Swap Dealers 
and Major Security-Based Swap Participants and Capital Requirements 
for Broker-Dealers, Exchange Act Release No. 68071, 77 FR at 70219 
(``[T]he use of internal models to compute net capital can 
substantially reduce the deductions for securities and money market 
positions as compared with the standardized haircuts.''); 
Alternative Net Capital Requirements for Broker-Dealers that are 
Part of Consolidated Supervised Entities, Exchange Act Release No. 
49830 (June 8, 2004), 69 FR 34428, 34431 (June 21, 2004) (``We 
expect that use of the alternative net capital computation will 
reduce deductions for market and credit risk substantially for 
broker-dealers that use that method.'').
---------------------------------------------------------------------------

1. Requirement To Deduct From Net Worth Certain Liabilities or Expenses 
Assumed by Third Parties
    In the proposing release, the Commission expressed concern that 
some broker-dealers may be excluding from their calculations of net 
worth certain liabilities that relate directly to expenses or debts 
incurred by the broker-dealer.\330\ The accounting justification for 
the exclusion is that a third party (usually a parent or affiliate) has 
assumed responsibility for these expenses and debts through an expense 
sharing agreement.\331\ In some cases, however, the third party does 
not have the resources --independent of the broker-dealer's revenues 
and assets--to assume these liabilities. Thus, the third party is 
dependent on the resources of the broker-dealer to pay the expenses and 
debts. Excluding liabilities from the broker-dealer's net worth 
calculation in these situations may misrepresent the firm's actual 
financial condition, deceive the firm's customers, and hamper the 
ability of regulators to monitor the firm's financial condition.\332\
---------------------------------------------------------------------------

    \330\ See Amendments to Financial Responsibility Rules, 72 FR at 
12871.
    \331\ See, e.g., Letter from Michael A. Macchiaroli, Associate 
Director, Division of Market Regulation, Commission, to Elaine 
Michitsch, Member Firm Operations, NYSE, and Susan DeMando, 
Director, Financial Operations, NASD Regulation, Inc. (July 11, 
2003) (``Third Party Expense Letter''); see also FINRA Notice to 
Members 03-63, Expense-Sharing Agreements (Oct. 2003) (discussing 
the issuance of the Third Party Expense Letter).
    \332\ See Amendments to Financial Responsibility Rules, 72 FR at 
12871.
---------------------------------------------------------------------------

    To address this issue, the Commission proposed--and is now adopting 
substantially as proposed--an amendment to Rule 15c3-1 to add a new 
paragraph (c)(2)(i)(F) that will require a broker-dealer, in 
calculating net capital, to take into account any liabilities that are 
assumed by a third party if the broker-dealer cannot demonstrate that 
the third party has the resources--independent of the broker-dealer's 
income and assets--to pay the liabilities.\333\
---------------------------------------------------------------------------

    \333\ As adopted, the final rule does not include the ``-'' in 
the phrase ``third-party.'' In addition, the final rule uses the 
phrase ``broker or dealer'' in the place of the phrase ``broker-
dealer'' (which appeared in two places) to maintain consistency 
throughout Rule 15c3-1, which uses the phrase ``broker or dealer.''
---------------------------------------------------------------------------

    The Commission received five comments regarding this proposal.\334\ 
Two commenters stated that the amendment was overly burdensome and that 
it would not result in a more accurate picture of a broker-dealer's 
financial condition than obtained through current requirements.\335\ 
One of these commenters added that any implementation and enforcement 
of the amendments ``should not be made retroactive.''\336\ This 
commenter stated that it is unclear how, and unlikely that, this 
amendment would achieve any of the desired results and argued that it 
could conversely impair a firm's ability to continue as a going 
concern.\337\ Finally, this commenter also argued that this amendment 
would affect capital transactions that originate at the holding company 
level.\338\ Two commenters agreed in principle with the amendments but 
urged the Commission to carefully consider the potential consequences 
of implementation and to provide clarification on the standard for 
demonstrating that the third party has adequate financial resources, 
including factors beyond those referred to in the proposing release 
that they believed would be potentially relevant.\339\ One commenter 
supported the Commission's goal of clarifying disclosures relating to 
expense sharing or obligations.\340\
---------------------------------------------------------------------------

    \334\ See Beer Letter; Levene Letter; Lowenstein Letter; SIFMA 2 
Letter; NIBA 2 Letter.
    \335\ See Beer Letter; Levene Letter.
    \336\ See Levene Letter.
    \337\ Id.
    \338\ Id.
    \339\ See Lowenstein Letter; SIFMA 2 Letter.
    \340\ See NIBA 2 Letter.
---------------------------------------------------------------------------

    As with the proposal, the amendment, as adopted, is designed to 
prohibit a practice that could misrepresent a broker-dealer's actual 
financial condition, deceive the firm's customers, and hamper the 
ability of regulators to monitor the firm's financial condition. 
Moreover, the amendment, as adopted, should not impose undue burdens or 
present serious implementation difficulties because the requirement is 
consistent with prior staff guidance regarding the treatment of broker-
dealer expenses assumed by a third party.\341\ Finally, as compared to 
staff guidance, a federal regulation offers broker-dealers greater 
certainty as to how to treat expense sharing agreements under Rule 
15c3-1.
---------------------------------------------------------------------------

    \341\ See, e.g., Third Party Expense Letter.
---------------------------------------------------------------------------

    In response to the comments discussed above, and as the Commission 
explained in the proposing release, a broker-dealer can demonstrate the 
adequacy of the third party's financial

[[Page 51851]]

resources by maintaining records such as the third party's most recent 
(i.e., as of a date within the previous twelve months) audited 
financial statements, tax returns, or regulatory filings containing 
financial reports.\342\ Given that the entity to which the broker-
dealer is seeking to shift one or more liabilities typically is an 
affiliate, the staff's experience is that such records should be 
available to the broker-dealer. Further, because the proposed rule 
change is consistent with prior staff guidance regarding the need to be 
able to demonstrate the third party's financial adequacy,\343\ a 
broker-dealer seeking to shift a liability to a third party already 
would be expected to provide such evidence of the third party's 
financial resources. For these reasons, the change from staff guidance 
to Commission rule should not result in implementation and burden 
concerns of the magnitude raised by the two commenters.\344\
---------------------------------------------------------------------------

    \342\ See Amendments to Financial Responsibility Rules, 72 FR at 
12872. The Commission specifically requested comment regarding the 
records by which a broker-dealer could demonstrate financial 
resources. It received no comments in response to this request.
    \343\ See, e.g., Third Party Expense Letter.
    \344\ See Lowenstein Letter; SIFMA 2 Letter.
---------------------------------------------------------------------------

    Finally, one commenter noted it would be helpful if the Commission 
would clarify whether this amendment supersedes the Commission staff 
guidance in the Third Party Expense Letter.\345\ Unlike the PAIB Letter 
discussed above, the Commission is not directing the staff to withdraw 
the Third Party Expense Letter on the effective date of these 
amendments. The Third Party Expense Letter will still be relevant as 
staff guidance, notwithstanding that it contains a condition that has 
been codified into Rule 15c3-1 (i.e., that an expense of the broker-
dealer assumed by a third party will be considered a liability for net 
capital purposes unless the broker-dealer can demonstrate that the 
third party has adequate resources independent of the broker-dealer to 
pay the liability or expense).\346\ In particular, the letter contains 
additional staff guidance not incorporated into the rule that will be 
relevant as staff guidance with respect to complying with the amendment 
to Rule 15c3-1 being adopted today. For example, the letter contains 
staff guidance with respect to the records a broker-dealer would be 
expected to make, keep current, and preserve under Rules 17a-3 and 17a-
4 with respect to broker-dealer liabilities and expenses assumed by a 
third party, as well as requirements regarding written expense sharing 
agreements.\347\ Broker-dealers can continue to rely on the guidance in 
the Third Party Expense Letter with respect to these matters in 
complying with today's amendment.
---------------------------------------------------------------------------

    \345\ See SIFMA 2 Letter.
    \346\ See Third Party Expense Letter, at 2-3.
    \347\ Id.
---------------------------------------------------------------------------

2. Requirement To Subtract From Net Worth Certain Non-Permanent Capital 
Contributions
    In the proposing release, the Commission noted its concern that 
broker-dealers may be receiving capital contributions from investors 
that are subsequently withdrawn after a short period of time (often 
less than a year).\348\ In some cases, the capital may be contributed 
under an agreement giving the investor the option to withdraw it at the 
investor's discretion. In the past, the Commission has emphasized that 
capital contributions to broker-dealers should not be temporary,\349\ 
and the Commission staff has explained that a capital contribution 
should be treated as a liability if it is made with the understanding 
that the contribution can be withdrawn at the option of the 
investor.\350\
---------------------------------------------------------------------------

    \348\ See Amendments to Financial Responsibility Rules, 72 FR at 
12873.
    \349\ See Net Capital Rule, Exchange Act Release No. 28927 (Feb. 
28, 1991), 56 FR 9124 (Mar. 5, 1991). See also Study of Unsafe and 
Unsound Practices of Broker-Dealers, Report and Recommendations of 
the Securities and Exchange Commission, H.R. Doc. No. 92-231 (1971), 
at 17, 42 (recommending improvement of adequacy and permanency of 
capital) (``During the 1967-1970 period under review, many broker-
dealers, some of them large retail houses, were found to have 
inadequate and impermanent capital in relation to their 
business.'').
    \350\ Letter from Michael A. Macchiaroli, Associate Director, 
Division of Market Regulation, Commission, to Raymond J. Hennessy, 
Vice President, NYSE, and Susan DeMando, Vice President, NASD 
Regulation, Inc. (Feb. 23, 2000) (``Temporary Capital Letter'') 
(``It is the view of the Division that, for net capital purposes, if 
an individual investor contributes capital to a broker-dealer with 
an understanding that the contribution can be withdrawn at the 
option of the individual investor, the contribution may not be 
included in the firm's net capital computation and must be re-
characterized as a liability. Any withdrawal of capital as to that 
investor within a period of one year, other than a withdrawal 
described in paragraph (e)(4)(iii) of Rule 15c3-1, shall be presumed 
to have been contemplated at the time of the contribution.'') 
(footnote omitted); see also Net Capital Rule, Exchange Act Release 
No. 28927 (Feb. 28, 1991), 56 FR 9124 (Mar. 5, 1991).
---------------------------------------------------------------------------

    Consistent with these Commission and staff positions that capital 
is not temporary,\351\ and given the importance of this issue and the 
Commission's concern that broker-dealers may not be properly treating 
short-term capital contributions as liabilities, the Commission 
proposed amending Rule 15c3-1 to add paragraph (c)(2)(i)(G) to further 
incorporate these positions into the rule.\352\ The proposed change 
would require a broker-dealer to treat as a liability any capital that 
is contributed under an agreement giving the investor the option to 
withdraw it or that is contributed with the intent to withdraw the 
capital within one year. The Commission further proposed that capital 
withdrawn within one year would be presumptively subject to treatment 
as a liability (i.e., it would be presumed to have been contributed 
with the intent to withdraw within one year).\353\
---------------------------------------------------------------------------

    \351\ See Net Capital Rule, Exchange Act Release No. 28927 (Feb. 
28, 1991), 56 FR 9124 (Mar. 5, 1991).
    \352\ See Amendments to Financial Responsibility Rules, 74 FR at 
12871-12872.
    \353\ Id.
---------------------------------------------------------------------------

    The Commission is adopting the final rule amendment with certain 
modifications. As adopted, the rule requires that a broker-dealer treat 
as a liability any capital that is contributed under an agreement 
giving the investor the option to withdraw it. The rule, as adopted, 
also requires that a broker-dealer treat as a liability any capital 
contribution that is intended to be withdrawn within one year of its 
contribution. In addition, the final rule provides that capital 
withdrawn within one year of contribution is deemed to have been 
intended to be withdrawn within one year unless the broker-dealer 
receives permission in writing for the withdrawal from its DEA.\354\ 
The ability of a broker-dealer to seek permission in writing from its 
DEA to withdraw capital contributed within one year will provide a 
means for firms to seek to withdraw capital in limited circumstances 
after review by its DEA without having to reclassify the withdrawn 
capital as a liability for net capital purposes.\355\
---------------------------------------------------------------------------

    \354\ These requirements will not apply to withdrawals covered 
by paragraph (e)(4)(iii) of Rule 15c3-1, namely, withdrawals used to 
make tax payments or to pay reasonable compensation to partners. See 
17 CFR 240.15c3-1(e)(4)(iii). These types of payments are ordinary 
business expenditures and do not raise the types of concerns the 
proposed rule is designed to address. One commenter suggested that 
the rule be amended to explicitly exclude any withdrawals that would 
fall under paragraph (e)(4)(iii) of Rule 15c3-1.
    \355\ See FINRA Rule 4110(c)(1) (providing, in part, that no 
equity capital of a member may be withdrawn for a period of one year 
from the date such equity capital is contributed, unless otherwise 
permitted by FINRA in writing).
---------------------------------------------------------------------------

    In the final rule, the Commission has modified the proposed 
language by moving the qualifier that the DEA can approve a withdrawal 
so that it modifies this presumption. Specifically, as proposed, the 
rule provided that a contribution of capital had to be subtracted from 
net worth if it ``is

[[Page 51852]]

intended to be withdrawn within a period of one year unless the 
withdrawal has been approved in writing by the Examining Authority for 
the broker or dealer.'' As adopted, the rule provides that ``[a]ny 
withdrawal of capital made within one year of its contribution is 
deemed to have been intended to be withdrawn within a period of one 
year, unless the withdrawal has been approved in writing by the 
Examining Authority for the broker or dealer.'' \356\ The change is 
intended to eliminate a potential ambiguity in the proposal as to 
whether a withdrawal of capital within one year could ever be approved 
by the firm's DEA and, therefore, afford the intended relief from the 
deduction.\357\
---------------------------------------------------------------------------

    \356\ See paragraph (c)(2)(i)(G)(2) of Rule 15c3-1, as adopted.
    \357\ The phrase ``to the broker or dealer'' following ``one 
year of its contribution'' is not included in the final rule because 
it would be redundant, as the contributions covered in the amendment 
all involve contributions to the broker-dealer.
---------------------------------------------------------------------------

    The Commission received five comments regarding the amendment to 
paragraph (c)(2)(i)(G)(2) of Rule 15c3-1.\358\ In addition to the 
general request for comment included in the proposing release, the 
Commission also requested specific comment on whether the time period 
within which withdrawn and intended-to-be-withdrawn contributions must 
be treated as liabilities should be longer than one year.\359\ While 
the commenters agreed in principle that contributions of capital to 
broker-dealers should not be subject to withdrawal at will, they 
expressed concerns regarding the negative effect that overly 
restrictive limitations on withdrawals of capital could have on 
obtaining capital contributions and, therefore, on the financial health 
of broker-dealers. One commenter, a registered broker-dealer, stated 
that it believed that the amendment would raise its cost of capital to 
the point where it would be impossible to obtain capital from unrelated 
third parties at all.\360\ Two commenters also expressed concerns about 
the potential burden posed by the amendment to broker-dealers in need 
of capital.\361\ One suggested the addition of exceptions to the rule 
for de minimis withdrawals and dividends or distributions.\362\ Another 
commenter suggested that the proposal should be amended to exclude a 
redemption right--a form of option--provided to the investor in 
connection with the investor's capital contribution to the broker-
dealer, where (i) the redemption right may only be exercised by the 
investor commencing more than one year following the date of the 
capital contribution to the broker-dealer and (ii) the redemption right 
would not be mandatorily redeemable.\363\
---------------------------------------------------------------------------

    \358\ See Chicago Capital Management Letter; SIFMA 2 Letter; 
American Bar Association Letter; SIG Letter; NIBA 2 Letter.
    \359\ See Amendments to Financial Responsibility Rules, 72 FR at 
12871-12872.
    \360\ See Chicago Capital Management Letter.
    \361\ See American Bar Association Letter; SIFMA 2 Letter.
    \362\ See SIFMA 2 Letter.
    \363\ See American Bar Association Letter.
---------------------------------------------------------------------------

    Another commenter opposed the rule, stating that it contravenes 
pertinent legal and accounting standards and is unnecessary in view of 
existing capital withdrawal limitations and notification 
requirements.\364\ This commenter stated that neither GAAP nor Rule 
15c3-1 contain a requirement that capital must be permanent, and the 
word ``capital'' has no intrinsic meaning that requires it to be 
permanent.\365\ This commenter stated that if any further limitations 
on capital withdrawals are adopted beyond the current provisions of the 
net capital rule, they should be designed to allow for the ability of 
broker-dealer holding companies to withdraw excess net capital at their 
option for legitimate purposes.\366\
---------------------------------------------------------------------------

    \364\ See SIG Letter.
    \365\ Id.
    \366\ Id.
---------------------------------------------------------------------------

    The fifth commenter agreed that there should be no circumstance in 
which a broker-dealer accepted a capital contribution for net capital 
purposes that could be withdrawn at the option of the investor.\367\ 
This commenter, however, also stated that the standard for withdrawals 
should be shortened from one year to nine or six months to increase the 
availability of funds from investors and owners, allowing more broker-
dealers to raise capital and strengthen their financial stability.\368\ 
The commenter requested that the Commission consider the needs of small 
firms that it said likely will require additional net capital over the 
next decade.\369\
---------------------------------------------------------------------------

    \367\ See NIBA 2 Letter.
    \368\ Id.
    \369\ Id. The commenter also stated that rules that ``restrict 
small broker-dealers from raising capital as a result of uncertainty 
of investors or owner-operators related to the return of their 
capital in a reasonable time frame will create a disproportionate 
and impossible hurdle for small broker-dealers to overcome.'' Id.
---------------------------------------------------------------------------

    In response to the commenters' concerns about firms' ability to 
obtain capital and that the amendment contravenes pertinent legal and 
accounting standards, the amended rule merely clarifies what 
constitutes a broker-dealer's permanent capital under Rule 15c3-1 and 
further emphasizes the requirement that capital contributions cannot be 
temporary.\370\ Rule 15c3-1 imposes a capital standard that is distinct 
from the use of the term ``capital'' in other legal and accounting 
contexts, and the rule amendments under paragraph (c)(2)(i)(G) of Rule 
15c3-1 are consistent with the Commission's and staff's views that 
capital under Rule 15c3-1 should not be temporary.\371\
---------------------------------------------------------------------------

    \370\ See Net Capital Rule, Exchange Act Release No. 28927 (Feb. 
28, 1991) (``The Commission wishes to emphasize that the net capital 
maintained in a broker-dealer should be permanent capital and not 
merely a temporary infusion of funds from an affiliate or other 
sources. For example, there are instances where a broker-dealer 
receives funds from an affiliate in an amount that would enable the 
broker-dealer to engage in a transaction that it would otherwise be 
prohibited from doing because of minimum net capital requirements. 
If the funds are transferred back to the affiliate within a 
relatively short period of time after the transaction, the 
Commission questions whether the funds transferred into the broker-
dealer entity could properly be characterized as capital of the 
firm. Instead, the transaction could be viewed as a loan by the 
affiliate to the broker-dealer, with the result that the broker-
dealer would have to treat the transaction as a liability.''). See 
also Net Capital Requirements for Brokers and Dealers, Exchange Act 
Release No. 18417 (Jan. 13, 1982), 47 FR 3512 (Jan. 25, 1982) 
(describing subordination agreement requirements under Appendix D to 
Rule 15c3-1, including that, among other things, no prepayment may 
be made (except under the strictly defined limitations of paragraph 
(c)(5) of Appendix D) before the expiration of one year from the 
effective date of the subordination agreement, and noting this 
provision was designed to insure the adequacy as well as the 
permanence of capital in the industry.); Temporary Capital Letter; 
Study of Unsafe and Unsound Practices of Broker-Dealers, Report and 
Recommendations of the Securities and Exchange Commission, H.R. Doc. 
No. 92-231 (1971) (recommending improvement of adequacy and 
permanency of capital); and Letter from Nelson Kibler, Assistant 
Director, Division of Market Regulation to John Pinto, National 
Association of Securities Dealers, Inc. (Sept. 8, 1980).
    \371\ See Study of Unsafe and Unsound Practices of Broker-
Dealers, Report and Recommendations of the Securities and Exchange 
Commission, H.R. Doc. No. 92-231 (1971), at p. 15 (``The unfortunate 
use of the term ``net capital'' in the financial responsibility 
rules of the Commission and the various exchanges resulted in a 
semantic confusion which too frequently has led to the mistaken 
belief that a broker-dealer's net capital is the equivalent of or 
has some relationship to the concept of ``capital'', as that term is 
commonly understood. ``Net Capital'' applies only to a hard core 
residue of net liquid assets designed to enable a broker-dealer to 
meet all rightful current demands of customers for their funds and 
securities.''). See also Capital, Margin, and Segregation 
Requirements for Security-Based Swap Dealers and Major Security-
Based Swap Participants and Capital Requirements for Broker-Dealers, 
77 FR at 70230 (``The net liquid assets test is imposed through the 
mechanics of how a broker-dealer is required to compute net capital 
pursuant to Rule 15c3-1. These requirements are set forth in 
paragraph (c)(2) of Rule 15c3-1, which defines the term net capital. 
The first step is to compute the broker-dealer's net worth under 
GAAP. Next, the broker-dealer must make certain adjustments to its 
net worth to calculate net capital. These adjustments are designed 
to leave the firm in a position where each dollar of unsubordinated 
liabilities is matched by more than a dollar of highly liquid 
assets. There are thirteen categories of net worth adjustments 
required by the rule.'') (footnotes omitted).

---------------------------------------------------------------------------

[[Page 51853]]

    The Commission also considered the commenter's suggestion that 
there be exceptions for de minimis withdrawals, dividends, or 
distributions. As previously stated, however, the Commission has 
emphasized that capital contributions should not be temporary.\372\ 
Moreover, paragraph (e) of Rule 15c3-1 already contains mechanisms to 
permit a broker-dealer to make capital withdrawals for specified 
purposes.\373\ Finally, if a broker-dealer believes it has a basis to 
appropriately withdraw capital within one year of contribution because, 
for example, the withdrawal would be de minimis, the final rule 
provides a mechanism for the broker-dealer to seek permission in 
writing from its DEA to make such a withdrawal.\374\
---------------------------------------------------------------------------

    \372\ See Study of Unsafe and Unsound Practices of Broker-
Dealers, Report and Recommendations of the Securities and Exchange 
Commission, H.R. Doc. No. 92-231 (1971), at p. 15; Capital, Margin, 
and Segregation Requirements for Security-Based Swap Dealers and 
Major Security-Based Swap Participants and Capital Requirements for 
Broker-Dealers, 77 FR at 70230.
    \373\ See 17 CFR 240.15c3-1(e)(1)(iii)(B) and (e)(4)(iii). See 
also Amendments to Financial Responsibility Rules, 72 FR at 12872, 
n.79 (``These requirements would not apply to withdrawals covered by 
paragraph (e)(4)(iii) of Rule 15c3-1, namely, withdrawals used to 
make tax payments or pay reasonable compensation to partners. These 
types of payments are ordinary business expenditures and do not 
raise the types of concerns the proposed rule is designed to 
address.'').
    \374\ See paragraph (c)(2)(i)(G)(2) of Rule 15c3-1, as adopted.
---------------------------------------------------------------------------

    With respect to a commenter's view that the standard for withdrawal 
should be less than one year (e.g., six or nine months), the Commission 
continues to believe that one year is an appropriate amount of time 
that a broker-dealer must retain a contribution in order to classify it 
as capital and not a liability. This is the standard that the 
Commission staff and FINRA have applied for a number of years and there 
is no compelling reason to change it.\375\ Because the final rule 
change is an incorporation of, among other things, existing Commission 
staff guidance into Rule 15c3-1, the requirement should not 
significantly alter current practice.
---------------------------------------------------------------------------

    \375\ See Temporary Capital Letter; FINRA Rule 4110(c)(1) (``No 
equity capital of a member may be withdrawn for a period of one year 
from the date such equity capital is contributed, unless otherwise 
permitted by FINRA in writing.''). See also Exchange Act Release No. 
60933 (Nov. 4, 2009), 74 FR 58334 (Nov. 12, 2009) (SR-FINRA-2008-
067); Net Capital Rule, Exchange Act Release No. 28927 (Feb. 28, 
1991) (emphasizing ``that the net capital maintained in a broker-
dealer should be permanent capital and not merely a temporary 
infusion of funds from an affiliate or other sources'').
---------------------------------------------------------------------------

    Moreover, with respect to commenters' concerns about the ability to 
obtain capital, the rule does not prohibit an investor from withdrawing 
capital at any time. It prohibits a broker-dealer from treating 
temporary cash infusions as capital for purposes of Rule 15c3-1. 
Finally, as stated above, the final rule provides a mechanism for a 
broker-dealer to apply to its DEA to make a withdrawal without 
triggering the deduction.\376\ This provides a process for firms to 
affect withdrawals within one year where appropriate.
---------------------------------------------------------------------------

    \376\ The final rule does not distinguish between complete and 
partial withdrawals of capital and, consequently, the deduction 
could be triggered in either event. Moreover, a partial withdrawal 
would require a deduction of the full amount of the original 
contribution as it would indicate that the contribution was merely 
temporary in nature.
---------------------------------------------------------------------------

    In summary, the Commission is adding paragraph (c)(2)(i)(G) to Rule 
15c3-1 to require a broker-dealer to subtract from net worth any 
contribution of capital to the broker or dealer: ``(1) [u]nder an 
agreement that provides the investor with the option to withdraw the 
capital; or (2) [t]hat is intended to be withdrawn within a period of 
one year of contribution.'' \377\ The final rule further provides that 
``[a]ny withdrawal of capital made within one year of its contribution 
is deemed to have been intended to be withdrawn within a period of one 
year, unless the withdrawal has been approved in writing by the 
Examining Authority for the broker or dealer.'' \378\
---------------------------------------------------------------------------

    \377\ See paragraph (c)(2)(i)(G) of Rule 15c3-1, as adopted.
    \378\ Id.
---------------------------------------------------------------------------

3. Requirement To Deduct the Amount by Which a Fidelity Bond Deductible 
Exceeds SRO Limits
    Under SRO rules, certain broker-dealers that do business with the 
public or that are required to become members of SIPC must comply with 
mandatory fidelity bonding requirements.\379\ SRO rules typically 
permit a broker-dealer to have a deductible provision included in the 
bond; however, such rules provide that the deductible may not exceed 
certain amounts. With regard to firms that maintain deductible amounts 
over the maximum amount specified, several SRO rules provide that the 
broker-dealer must deduct this excess amount from its net worth when 
calculating net capital under Rule 15c3-1.\380\ Other SROs require that 
any deductible amount elected by a broker-dealer that is greater than 
10% of the coverage purchased by the broker-dealer must be deducted 
from the broker-dealer's net worth when calculating net capital under 
Rule 15c3-1.\381\
---------------------------------------------------------------------------

    \379\ See, e.g., FINRA Rule 4360, CBOE Rule 9.22, and NASDAQ OMX 
PHLX Rule 705. SRO fidelity bonding requirements typically contain 
agreements covering areas such as: a ``Fidelity'' insuring clause to 
indemnify against loss of property through dishonest or fraudulent 
acts of employees; an ``On Premises'' agreement insuring against 
losses resulting from crimes such as burglary and theft and from 
misplacement of property of the insured; an ``In Transit'' clause 
indemnifying against losses occurring while property is in transit; 
a ``Forgery and Alteration'' agreement insuring against loss due to 
forgery or alteration of various kinds of negotiable instruments; 
and a ``Securities Loss'' clause protecting against losses incurred 
through forgery and alteration of securities. Id.
    \380\ See, e.g., CBOE Rule 9.22.
    \381\ See, e.g., FINRA Rule 4360.
---------------------------------------------------------------------------

    Rule 15c3-1, however, does not specifically reference the SRO 
deductible requirements as a charge to net worth. Therefore, a broker-
dealer would not be required to account for the deduction required by 
an SRO rule in computing net capital under Rule 15c3-1 or in the net 
capital computation reflected on the broker-dealer's FOCUS report. To 
address this inconsistency, the Commission proposed to amend Rule 15c3-
1 to add paragraph (c)(2)(xiv) to require a broker-dealer to deduct, 
with regard to fidelity bonding requirements, the amount required by 
the rules of the broker-dealer's DEA, i.e., the amount in excess of the 
deductible prescribed in the applicable DEA's fidelity bond rule.\382\ 
The Commission received one comment supporting the proposal and one 
opposing it.\383\ The commenter opposing the amendment noted that 
amending Rule 15c3-1 to conform to FINRA Rule 4360 would create an 
increase in minimum net capital requirements for some broker-
dealers.\384\
---------------------------------------------------------------------------

    \382\ See 17 CFR 240.15c3-1(c)(12) (defining examining authority 
for purposes of Exchange Act Rule 15c3-1).
    \383\ See SIFMA 2 Letter; NIBA 2 Letter.
    \384\ See NIBA 2 Letter.
---------------------------------------------------------------------------

    SRO rules prescribing fidelity bond deductibles, and capital 
charges for deductibles in excess of a certain amount, are designed to 
incentivize broker-dealers to carry fidelity bonds with a deductible 
low enough to help ensure customer protection. Moreover, in response to 
the comment that this amendment would increase minimum net capital 
requirements, the Commission notes that broker-dealers that are members 
of an SRO with such a fidelity bonding rule already must account for 
the deduction in complying with the net capital requirements of the 
SROs and nothing in the Commission's amendment to paragraph (c)(2)(xiv) 
of Rule 15c3-1 would alter this status quo. Rather, the proposed rule 
change would conform the capital calculation under paragraph 
(c)(2)(xiv) of Rule 15c3-1 to that required by the broker-dealer's SRO.
    For these reasons, the Commission is adopting paragraph (c)(2)(xiv) 
to Rule 15c3-1 with technical revisions to the proposed rule text to 
make the text of

[[Page 51854]]

the final rule, as adopted, a more generic cross reference to SRO 
fidelity bond requirements. The technical changes are designed to 
increase the flexibility of the final rule so that revisions to SRO 
fidelity bond requirements pursuant to section 19(b) of the Exchange 
Act \385\ will not require conforming amendments to paragraph 
(c)(2)(xiv) of Rule 15c3-1.\386\ More specifically, the proposed rule 
text, as set forth in the proposing release, would have required the 
broker-dealer to deduct ``with respect to fidelity bond coverage, the 
excess of any deductible amount over the maximum deductible amount 
permitted by the Examining Authority for the broker or dealer.'' \387\ 
The final rule, as adopted, provides that the broker-dealer must deduct 
``the amount specified by rule of the Examining Authority for the 
broker or dealer with respect to a requirement to maintain fidelity 
bond coverage.'' \388\ Thus, the final rule does not include the phrase 
``maximum permissible deductible amounts.'' This phrase was borrowed 
from SRO fidelity bond rules. Because the construction of the SRO rules 
may change over time, the Commission is making the cross-reference to 
the SRO rules more general.\389\
---------------------------------------------------------------------------

    \385\ 15 U.S.C. 78s(b).
    \386\ See, e.g., FINRA Rule 4360.
    \387\ See, e.g., Amendments to Financial Responsibility Rules, 
72 FR at 12872.
    \388\ See paragraph (c)(2)(xiv) of Rule 15c3-1, as adopted.
    \389\ See, e.g., FINRA Rule 4360. See also Exchange Act Release 
No. 63961 (Feb. 24, 2011), 76 FR 11542 (Mar. 2, 2011).
---------------------------------------------------------------------------

4. Broker-Dealer Solvency Requirement
    The Commission is adopting an amendment to paragraph (a) of Rule 
15c3-1 to require a broker-dealer to cease conducting a securities 
business if certain insolvency events were to occur. Specifically, as 
adopted, amended paragraph (a) of Rule 15c3-1 provides that a broker-
dealer must not be insolvent as that term is defined in new paragraph 
(c)(16) of the rule.\390\ By making solvency a requirement of Rule 
15c3-1, this amendment will require an insolvent \391\ broker-dealer to 
cease conducting a securities business pursuant to section 15(c)(3) of 
the Exchange Act, which generally prohibits a broker-dealer from 
effecting any transaction in, or inducing or attempting to induce the 
purchase or sale of, any security in contravention of the Commission's 
financial responsibility rules (which include Rule 15c3-1).\392\
---------------------------------------------------------------------------

    \390\ The final rule also has been modified by replacing the 
word ``shall'' with the word ``must.''
    \391\ The definition of insolvent is intended to be broad enough 
to encompass any type of insolvency proceeding or condition of 
insolvency; for example, the proposed definition incorporates 
concepts of insolvency in the U.S. Bankruptcy Code and SIPA. See 11 
U.S.C. 101; 15 U.S.C. 78eee(b)(1).
    \392\ 15 U.S.C. 78o.
---------------------------------------------------------------------------

    As proposed, paragraph (c)(16) of Rule 15c3-1 would have defined 
the term insolvent as, among other things, a broker-dealer's placement 
in a voluntary or involuntary bankruptcy or similar proceeding; the 
appointment of a trustee, receiver, or similar official; a general 
assignment by the broker-dealer for the benefit of its creditors; an 
admission of insolvency; or the inability to make computations 
necessary to establish compliance with Rule 15c3-1.\393\ As discussed 
more specifically below, the Commission modified paragraph (c)(16) of 
Rule 15c3-1 in the final rule in response to concerns raised by 
commenters.
---------------------------------------------------------------------------

    \393\ See Amendments to Financial Responsibility Rules, 72 FR at 
12872-12873. A broker-dealer's inability to make computations 
necessary to establish compliance with Rule 15c3-1 may also impact 
the broker-dealer's ability to make the computations necessary to 
establish compliance with Rule 15c3-3 and vice versa. See, e.g., 
Rule 15c3-1(a)(1)(ii) (incorporating computations under Rule 15c3-3 
into the minimum net capital requirement).
---------------------------------------------------------------------------

    In the proposing release, the Commission solicited comment on 
whether there are other insolvency events that should be captured in 
the proposed definition.\394\ One commenter noted that involuntary 
insolvency proceedings do not necessarily indicate that the broker-
dealer is insolvent, as such proceedings can be frivolous, malicious, 
or otherwise lacking in merit.\395\ The commenter also noted that 
industry standard contract forms generally provide a grace period for a 
party to such a proceeding to obtain a stay or dismissal before an 
event of default is deemed to occur.\396\ In response to this comment, 
the Commission notes that the number of broker-dealer bankruptcy 
filings (voluntary or involuntary) is small, and therefore, the 
institution of a frivolous involuntary proceeding involving a broker-
dealer likely is a very rare event. Thus, the Commission must consider 
the potential need for an automatic grace period to address the 
potential for a frivolous involuntary bankruptcy as well as the harm 
that could result from allowing a broker-dealer to continue to effect 
securities transactions for a period of time even though it is properly 
the subject of a bankruptcy proceeding. The Commission believes the 
more appropriate approach is to address potentially frivolous 
proceedings on a case-by-case basis. In the event that a case arises 
where there would be a need to fashion relief for a broker-dealer that 
was the subject of a frivolous or meritless involuntary petition, the 
Commission's existing authority permits it sufficient flexibility to 
fashion exemptions under appropriate circumstances.\397\
---------------------------------------------------------------------------

    \394\ See Amendments to Financial Responsibility Rules, 72 FR at 
12873.
    \395\ See SIFMA 2 Letter.
    \396\ Id.
    \397\ See 15 U.S.C. 78mm(a). See also 17 CFR 240.15c3-1(b)(3).
---------------------------------------------------------------------------

    In addition to the comment discussed above, the Commission received 
four other comment letters that addressed these amendments.\398\ One 
commenter objected to the amendments as unnecessary, citing the Rule 
15c3-1 prohibition on broker-dealers effecting securities transactions 
if their net capital is below certain minimums and noting that a 
broker-dealer that was insolvent would ``by definition'' be below those 
minimums.\399\ In response to this comment, the Commission notes that 
the purpose of the amendment is to address cases where a broker-dealer 
is subject to an insolvency event but takes the position that it is in 
compliance with the net capital rule. While such instances may be rare, 
an insolvent broker-dealer could seek the protection of the bankruptcy 
laws but continue to effect transactions with the public, potentially 
jeopardizing customers and other creditors of the broker-dealer, 
including counterparties.
---------------------------------------------------------------------------

    \398\ See SIPC Letter; St. Bernard Financial Services Letter; 
American Bar Association Letter; Cornell Letter.
    \399\ See St. Bernard Financial Services Letter.
---------------------------------------------------------------------------

    Another commenter requested that the Commission modify the 
definition of insolvent to carve out market-wide disruptions that 
prevent the computation of net capital but are unrelated to the 
solvency of the broker-dealer.\400\ In response to this suggestion, the 
Commission notes that if appropriate and necessary, such an event can 
be addressed through the Commission's exemptive authority, rather than 
by a specific exception in the rule.
---------------------------------------------------------------------------

    \400\ See American Bar Association Letter.
---------------------------------------------------------------------------

    One commenter, while supporting the amendment, objected to the 
incorporation of the definition of insolvent from section 101 of the 
Bankruptcy Code.\401\ This commenter argued a bankruptcy-based standard 
for insolvency was appropriate for a notice requirement but that the 
proper standard for determining whether a broker-dealer should be 
prohibited from continuing to conduct a securities business is its 
amount of net capital. As noted above, allowing an insolvent

[[Page 51855]]

broker-dealer to continue conducting a securities business during the 
period of its insolvency, notwithstanding its net capital position, 
could jeopardize customers and other market participants because a 
broker-dealer that has made an admission of insolvency, or is otherwise 
deemed insolvent or entitled to protection from creditors, does not 
possess the financial resources necessary to operate a securities 
business.\402\ Continuing to operate in such circumstances poses a 
significant credit risk to counterparties and to the clearance and 
settlement system, and, in the event the firm subsequently is placed in 
a liquidation proceeding under SIPA, may impair the ability of the SIPA 
trustee to make customers of the broker-dealer whole and satisfy claims 
of other creditors out of the assets of the general estate.\403\
---------------------------------------------------------------------------

    \401\ See SIFMA 2 Letter.
    \402\ See Amendments to Financial Responsibility Rules, 72 FR at 
12872.
    \403\ Id.
---------------------------------------------------------------------------

    In addition, this commenter also was concerned that under the 
proposed amendment a firm would be prevented from effecting hedging or 
liquidating transactions intended to reduce the risk the firm poses to 
the financial markets and its customers. The commenter noted that such 
limitations also would be at odds with section 5(a)(2) of SIPA, which 
contemplates that a broker-dealer that is in, or approaching, financial 
difficulty may undertake to liquidate or reduce its business either 
voluntarily or pursuant to the direction of an SRO.\404\ The final rule 
amendment is not intended to affect in any a broker-dealer's ability to 
act under section 5(a)(2) of SIPA.\405\
---------------------------------------------------------------------------

    \404\ See SIFMA 2 Letter; SIPC Letter. See also 15 U.S.C. 
78eee(a)(5).
    \405\ See15 U.S.C. 78eee(a)(5). Further, the amendment is not 
intended to affect in any way a SIPA trustee's ability to liquidate 
a broker-dealer. Effectively, a SIPA trustee steps into the shoes of 
the debtor broker-dealer in order to liquidate the broker-dealer and 
protect its customers' interests.
---------------------------------------------------------------------------

    In addition, the Commission is amending the final rule to 
incorporate within the term insolvency the circumstance in which a 
broker-dealer is unable to make such computations as may be necessary 
to establish compliance with Rule 15c3-3.\406\ In the proposing 
release, the Commission stated that the ``proposed definition of 
`insolvent' is intended to be broad enough to encompass any type of 
insolvency proceeding or condition of insolvency,'' \407\ and noted 
that the proposed definition incorporates concepts of insolvency from 
the U.S. Bankruptcy Code and SIPA.\408\ Consequently, consistent with 
the discussion in the proposing release, the modification in the final 
rule will more closely align the definition of insolvent under 
paragraph (c)(16) of Rule 15c3-1 with the grounds for the commencement 
of a proceeding under SIPA,\409\ which includes the circumstance that a 
broker-dealer is unable to make computations necessary to establish 
compliance with the financial responsibility or hypothecation 
rules.\410\ Rule 3a40-1 defines the term financial responsibility rules 
to include, among others, any rule adopted by the Commission pursuant 
to section 15(c)(3) of the Exchange Act--Rules 15c3-1 and 15c3-3 were 
adopted under section 15(c)(3). As a financial responsibility rule, the 
inability of a broker-dealer to make a computation necessary to 
establish compliance with Rule 15c3-3 constitutes a basis for 
commencing a SIPA proceeding. Consequently, this modification to the 
proposed definition of insolvency under paragraph (c)(16) of Rule 15c3-
1 will more closely align the definition with SIPA.\411\
---------------------------------------------------------------------------

    \406\ The final rule adds the phrase ``or with Sec.  240.15c3-
3'' to follow the phrase ``[i]s unable to make such computations as 
may be necessary to establish compliance with this section.'' See 
paragraph (c)(16)(iv) of Rule 15c3-1. See also generally, SIPC 
Letter (favoring an amendment requiring broker-dealers to cease 
doing business if insolvent as defined under proposed Rule 15c3-
l(c)(16) and noting that the circumstances under which the broker 
would be required to cease doing business are consistent with the 
circumstances under which SIPC may seek to place a firm in 
liquidation).
    \407\ See Amendments to Financial Responsibility Rules, 72 FR at 
12872.
    \408\ Id. at n.85.
    \409\ See 15 U.S.C. 78eee(b).
    \410\ See 15 U.S.C. 78eee(b)(l)(D). See also 17 CFR 240.3a40-1 
(defining the term financial responsibility rules for purposes of 
SIPA to include Rule 15c3-3).
    \411\ The Commission also has made three technical modifications 
to the text of the insolvency definition. In response to a comment, 
the phrase ``broker-dealer'' was replaced with the phrase ``broker 
or dealer'' to be consistent with the use of the phrase in Rule 
15c3-1. In addition, the phrase ``for purposes of this section'' was 
moved to the beginning of paragraph (c)(16) in order to clarify that 
the term insolvency is defined for purposes of Rule 15c3-1 in its 
entirety. Finally, the final rule does not include the phrase 
``whether commenced voluntarily or involuntarily'' because the 
phrase would be redundant.
---------------------------------------------------------------------------

    The Commission also is adopting an amendment to the first sentence 
of paragraph (b)(1) of Rule 17a-11 to require that a broker-dealer 
meeting the definition of insolvent must provide immediate notice to 
the Commission, the firm's DEA and, if applicable, the CFTC. One 
commenter specifically favored this amendment.\412\ This notice will 
assist regulators in taking steps to protect the insolvent firm's 
customers, including, if appropriate, notifying SIPC of the need to 
commence a SIPA proceeding. The Commission is adopting the amendment to 
paragraph (b)(1) of Rule 17a-11, with one technical modification.\413\
---------------------------------------------------------------------------

    \412\ See SIPC Letter.
    \413\ The Commission is deleting the phrase ``paragraph (c)(16) 
of'' and inserting ``(c)(16)'' immediately following the second 
``15c3-1''.
---------------------------------------------------------------------------

5. Amendment To Rule Governing Orders Restricting Withdrawal of Capital 
From a Broker-Dealer
    Paragraph (e) of Rule 15c3-1, which places certain conditions on a 
broker-dealer when withdrawing capital,\414\ also allows the Commission 
to issue an order temporarily restricting a broker-dealer from 
withdrawing capital or making loans or advances to stockholders, 
insiders, and affiliates under certain circumstances.\415\ The rule, 
however, limits such orders to withdrawals, advances, or loans that, 
when aggregated with all other withdrawals, advances, or loans on a net 
basis during a 30 calendar day period, exceed 30 percent of the firm's 
excess net capital.\416\ When the Commission adopted this paragraph of 
Rule 15c3-1 more than 20 years ago, the Commission stated that it 
intended this section to be applied only where the continued viability 
of a broker-dealer appeared to be at stake.\417\ In the ensuing years, 
the Commission has utilized this provision only one time.\418\ The 
Commission has determined that the requirement is difficult to enforce, 
as it generally would not be clear when the 30% threshold had been 
reached, due to the inherent unreliability of a troubled broker-
dealer's books and records. Consequently, the Commission proposed, and 
is adopting, a change to delete this provision and instead to allow the 
Commission to restrict all withdrawals, advances, and loans so long as 
the other conditions under the rule (all of which remain unchanged) are 
met.\419\
---------------------------------------------------------------------------

    \414\ See 17 CFR 240.15c3-1(e).
    \415\ See 17 CFR 240.15c3-1(e)(3).
    \416\ Id.
    \417\ Net Capital Rule, Exchange Act Release No. 28927 (Feb. 28, 
1991), 56 FR 9124, 9128 (Mar. 5, 1991).
    \418\ Order Regarding Withdrawals, Unsecured Loans or Advances 
from Refco Securities, LLC and Refco Clearing, LLC, Exchange Act 
Release No. 52606 (Oct. 13, 2005).
    \419\ The Commission also proposed revising the second sentence 
in paragraph (e)(3)(ii) to remove the text ``The hearing'' and in 
its place adding the text ``A hearing on an order temporarily 
prohibiting the withdrawal of capital.''
---------------------------------------------------------------------------

    The Commission received three comment letters addressing this 
proposal.\420\ One commenter supported the deletion of the 30% 
threshold, but believed its removal reflected the

[[Page 51856]]

Commission's desire to regulate large firms with complex capitalization 
without considering the needs of smaller firms.\421\ This commenter 
recommended the Commission set forth all conditions required for a firm 
to withdraw, repay, or redeem any amount that affects its overall 
capitalization.\422\ Specifically, the commenter suggested the 
following non-exclusive list of conditions for consideration: (1) 
``[r]egulatory minimum capital requirement related to all lines of 
business''; (2) ``[e]xcess mandated by that firms' accruals for that 
period''; (3) ``[e]xcess mandated by the firms' upcoming one-time non-
recurring costs within that quarter''; (4) ``[e]xcess mandated by 
operating costs expected[,] but not related to accruals for that 
period''; (5) [c]osts related to increased personnel coverage or 
recruitment within that quarter''; and (6) ``[d]etermination of the 
Board of the firm that there is no reasonable expectation at the time 
of its approval of the capital withdrawal, repayment or redemption, 
that the firm would be required to, or advisable to, increase its net 
capital excess.''
---------------------------------------------------------------------------

    \420\ See NIBA 2 Letter; SIFMA 2 Letter; Raymond James 2 Letter.
    \421\ See NIBA 2 Letter. As noted above, the 30% threshold 
provision only applied in emergency situations and has only been 
used once before. As such, its deletion should only affect a limited 
number of broker-dealers.
    \422\ Id.
---------------------------------------------------------------------------

    The second commenter recommended several modifications to the 
amendment, including: (1) Clarifying that in addition to ordering 
complete restrictions on withdrawals, advances, and loans, the 
Commission may also issue orders imposing partial or conditional 
restrictions; (2) explicitly permitting certain types of withdrawals, 
advances, or loans, such as those in paragraphs (e)(4)(ii) and (iii) of 
Rule 15c3-1 (e.g., required tax payments or payments to partners for 
reasonable compensation) even after the issuance of a temporary 
restrictive order; and (3) clarifying that the provision in paragraph 
(e)(3)(ii) of the rule allowing a broker-dealer to request and receive 
a hearing on an order temporarily restricting withdrawals also applies 
to orders temporarily restricting advances and loans (in addition to 
withdrawals).\423\
---------------------------------------------------------------------------

    \423\ See SIFMA 2 Letter.
---------------------------------------------------------------------------

    Finally, the third commenter noted that the proposed amendment 
would eliminate the 30% requirement limit and allow the Commission to 
restrict all withdrawals, advances, and loans under specific 
circumstances.\424\ The commenter believes this action will impose an 
additional compliance burden on broker-dealers and will significantly 
limit the flexibility of broker-dealers in the event of a liquidity 
crisis.\425\
---------------------------------------------------------------------------

    \424\ See Raymond James 2 Letter.
    \425\ Id.
---------------------------------------------------------------------------

    In response to these comments, the Commission notes that the 30% 
threshold pertains only to paragraph (e)(3)(i) of Rule 15c3-1, which 
relates to the Commission's authority to temporarily restrict 
withdrawals of net capital. The Commission cannot impose these 
restrictions without concluding under subparagraph (e)(3)(i) that 
``such withdrawal, advance or loan may be detrimental to the financial 
integrity of the broker or dealer, or may unduly jeopardize the broker 
or dealer's ability to repay its customer claims or other liabilities 
which may cause a significant impact on the markets or expose the 
customers or creditors of the broker or dealer to loss without taking 
into account the application of the Securities Investor Protection Act 
of 1970.'' \426\ While paragraph (e)(3)(i) of Rule 15c3-1 would apply 
to all broker-dealers, the conditions under which the Commission may 
exercise its authority under the rule apply only to circumstances where 
the continued viability of the broker-dealer appears to be at 
stake.\427\ As noted above, the Commission has only utilized this 
provision once.\428\
---------------------------------------------------------------------------

    \426\ See paragraph (e)(3)(i) of Rule 15c3-1, as adopted.
    \427\ Net Capital Rule, Exchange Act Release No. 28927 (Feb. 28, 
1991), 56 FR 9124, 9128 (Mar. 5, 1991).
    \428\ Order Regarding Withdrawals, Unsecured Loans or Advances 
from Refco Securities, LLC and Refco Clearing, LLC, Exchange Act 
Release No. 52606 (Oct. 13, 2005).
---------------------------------------------------------------------------

    The Commission, however, agrees with the importance of maintaining 
flexibility in the context of ordering restrictions on withdrawals, 
advances, and loans. Therefore, the Commission is modifying the 
amendment, as adopted, to add language to paragraph (e)(3)(i) to state 
(following the phrase ``employee or affiliate'') that such orders will 
be issued, ``under such terms and conditions as the Commission deems 
necessary or appropriate in the public interest or consistent with the 
protection of investors. . . .'' \429\ With respect to the suggestion 
that the Commission explicitly permit certain types of withdrawals, 
advances, or loans even after the issuance of a temporary order, the 
Commission does not believe that it would be appropriate to permit--by 
codifying in the rule--a broker-dealer to take the actions described if 
the Commission has issued an order placing temporary restrictions on a 
broker-dealer's ability to withdraw net capital under paragraph (e)(3) 
of the rule. The order would be intended to protect the customers and 
creditors of the broker-dealer, and permitting the actions by rule 
could undermine those protections. Moreover, there is no need to 
explicitly permit certain types of withdrawals, advances or loans 
because if there were circumstances that merited the broker-dealer 
making such payments, the Commission order could be fashioned as 
appropriate to permit those payments.
---------------------------------------------------------------------------

    \429\ See paragraph (e)(3)(i) of Rule 15c3-1, as adopted. See 
also 17 CFR 15c3-1(e). See generally, 15 U.S.C. 78mm(a)(1).
---------------------------------------------------------------------------

    With respect to the suggestion that the Commission clarify in 
paragraph (e)(3)(ii) of Rule 15c3-1 that a broker-dealer may request 
and receive a hearing on orders temporarily restricting advances and 
loans (in addition to withdrawals), under the existing rule, a broker-
dealer may request a hearing if the Commission has issued an order 
temporarily restricting advances and loans by a broker-dealer, in 
addition to withdrawals, and the Commission is therefore adopting the 
amendment to paragraph (e)(3)(ii), as proposed.\430\
---------------------------------------------------------------------------

    \430\ 17 CFR 240.15c3-1(e)(3)(ii). The Commission also is 
adopting revisions to the second sentence of paragraph (e)(3)(ii), 
replacing the phrase ``The hearing'' with the phrase ``A hearing on 
an order temporarily prohibiting the withdrawal of capital.''
---------------------------------------------------------------------------

6. Adjusted Net Capital Requirements
i. Amendment to Appendix A of Rule 15c3-1
    The Commission is adopting an amendment to Appendix A of Rule 15c3-
1, which permits broker-dealers to employ theoretical option pricing 
models to calculate haircuts for listed options and related positions 
that hedge those options.\431\ The amendment makes permanent a 
temporary amendment the Commission originally adopted in 1997.\432\ The 
temporary amendment expired on September 1, 1997, unless it was 
otherwise extended by the Commission.\433\ The Commission staff 
subsequently issued a no-action letter on January 13, 2000, which 
stated that the staff would not recommend enforcement action if broker-
dealers continued to rely on the temporary amendment.\434\
---------------------------------------------------------------------------

    \431\ 17 CFR 240.15c3-1a.
    \432\ See Net Capital Rule, Exchange Act Release No. 38248 (Feb. 
6, 1997), 62 FR 6474 (Feb. 12, 1997).
    \433\ See 17 CFR 15c3-1a(b)(1)(iv)(B).
    \434\ Letter from Michael Macchiaroli, Associate Director, 
Division of Market Regulation, Commission, to Richard Lewandowski, 
Vice President, Regulatory Division, The Chicago Board Options 
Exchange, Inc. (Jan. 13, 2000) (stating that the Division of Market 
Regulation ``will not recommend . . . enforcement action if non-
clearing option specialists and market-makers continue to rely on 
subparagraph (b)(1)(iv) of Appendix A to Rule 15c3-1 under the 
Exchange Act until such time as the Commission has determined 
whether it should be extended''). The letter did not grant any other 
relief.

---------------------------------------------------------------------------

[[Page 51857]]

    The temporary amendment decreased the range of pricing inputs to 
the approved option pricing models, which effectively reduced the 
haircuts applied by the carrying firm with respect to non-clearing 
option specialist and market maker accounts.\435\ The temporary 
amendment, which applied only to these types of accounts, was limited 
to major market foreign currencies and diversified indexes. Even during 
periods of substantial volatility, there have been no significant 
increases in the number of deficits in non-clearing option specialist 
and market-maker accounts, nor did the lower capital charges under 
paragraph (b)(1)(iv) result in excessive leverage. Consequently, this 
amendment appropriately aligns the net capital requirements of affected 
firms with the risks Rule 15c3-1 seeks to mitigate. The Commission 
received one comment letter regarding this aspect of the proposing 
release. The commenter concurred with the Commission's conclusions as 
to the effect of the temporary amendment and supported the proposal to 
make it permanent.\436\ Accordingly, the Commission is amending 
paragraph (b)(1)(iv) of Appendix A to Rule 15c3-1, as proposed, to make 
the temporary amendment permanent.\437\
---------------------------------------------------------------------------

    \435\ See Net Capital Rule, Exchange Act Release No. 38248 (Feb. 
6, 1997), 62 FR 6474 (Feb. 12, 1997). Under Appendix A to Rule 15c3-
1, a broker-dealer calculating net capital charges for its options 
portfolios shocks the products in each portfolio (grouped by 
underlying instrument) at ten equidistant points along a potential 
market move range. The market move ranges for major market foreign 
currencies, high-capitalization diversified indexes, and non-high-
capitalization diversified indexes are, respectively: +(-) 6%, +(-) 
10% and +(-) 15%. The temporary rule lowered these market move 
ranges to respectively: +(-) 4[frac12]%, + 6% (-) 8% and +(-) 10% in 
terms of calculating haircuts for positions of non-clearing options 
specialists and market makers. Id.
    \436\ See SIFMA 2 Letter.
    \437\ As a result, the Commission also is redesignating 
paragraphs (b)(1)(iv)(A), (b)(1)(iv)(A)(1), (b)(1)(iv)(A)(2), and 
(b)(1)(iv)(A)(3) as paragraphs (b)(1)(iv), (b)(1)(iv)(A), 
(b)(1)(iv)(B), and (b)(1)(iv)(C), respectively.
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ii. Money Market Funds
a. Clarification
    The Commission is adopting an amendment to paragraph 
(c)(2)(vi)(D)(1) of Rule 15c3-1 to clarify that a money market fund, 
for the purposes of paragraph (c)(2)(vi)(D)(1), is a fund described in 
Rule 2a-7 under the Investment Company Act of 1940 (``Rule 2a-
7'').\438\ The Commission did not receive any comments on this proposal 
and is adopting it, as proposed.
---------------------------------------------------------------------------

    \438\ See 17 CFR 270.2a-7.
---------------------------------------------------------------------------

b. Proposed Haircut Reduction From 2% to 1%
    The Commission proposed an amendment to reduce the ``haircut'' that 
broker-dealers apply under Rule 15c3-1 for money market funds.\439\ In 
1982, the Commission adopted a 2% haircut requirement for redeemable 
securities of money market funds.\440\ In 1991, the Commission adopted 
certain amendments to Rule 2a-7 that strengthened the risk-limiting 
investment restrictions for money market funds.\441\ Based on the 
enhancements to Rule 2a-7, the Commission proposed to amend paragraph 
(c)(2)(vi)(D)(1) of Rule 15c3-1 to reduce the haircut on such funds 
from 2% to 1% in order to better align the net capital charge with the 
risk associated with holding shares of a money market fund.\442\ In 
addition to the general request for comments in the proposing release, 
the Commission also specifically requested comments regarding whether 
the haircut for certain types of money market funds should be reduced 
to 0% as suggested in a petition for rulemaking submitted to the 
Commission.\443\
---------------------------------------------------------------------------

    \439\ See Amendments to Financial Responsibility Rules, 72 FR at 
12874.
    \440\ Net Capital Requirements for Brokers and Dealers, Exchange 
Act Release No. 18737 (May 13, 1982), 47 FR 21759 (May 20, 1982). 
See 17 CFR 240.15c3-1(c)(2)(vi)(D)(1).
    \441\ Revisions to Rules Regulating Money Market Funds, 
Investment Company Act Release No. 18005 (Feb. 20, 1991), 56 FR 8113 
(Feb. 27, 1991).
    \442\ See Amendments to Financial Responsibility Rules, 72 FR at 
12874.
    \443\ See Public Petitions for Rulemaking No. 4-478 (Apr. 3, 
2003) (available at http://www.sec.gov/rules/petitions/petn4-478.htm), as amended (Apr. 4, 2005) (available at http://www.sec.gov/rules/petitions/petn4-478a.pdf), and No. 4-577 (Feb. 3, 
2009) (available at http://www.sec.gov/rules/petitions/2009/petn4-577.pdf).
---------------------------------------------------------------------------

    The Commission received a total of 14 responses from 12 different 
commenters regarding this proposed amendment. All of the commenters 
supported a reduction in the haircut for money market funds and urged 
that the haircut be reduced below the proposed 1%, with the majority 
proposing a haircut of 0% for ``top-rated'' money market funds (i.e., 
those with the highest ratings).\444\ Commenters cited the safety 
record of money market funds, in particular AAA-rated money market 
funds, in support of imposing lower haircuts.\445\ Several commenters 
argued that top-rated money market funds were more liquid and posed 
less credit and interest rate risk than other instruments and suggested 
haircuts of 1/8 of 1% or even 0%.\446\ One commenter argued that since 
broker-dealers (like investors) view money market funds as cash 
equivalents, they would view a 1% haircut as a significant cost and 
would therefore avoid using money market funds.\447\ Two commenters 
suggested that if the Commission determined it necessary to impose a 
haircut on some Rule 2a-7 money market funds, it should implement a 
bifurcated scheme under which money market funds that qualify for 
deposit into a broker-dealer's reserve account under Rule 15c3-3 would 
be subject to a 0% haircut,\448\ with one arguing that such qualifying 
money market funds should in any case receive a haircut no greater than 
1/8 of 1%.\449\ Another commenter suggested that the proposed 
amendments to reduce the haircut for money market funds should be 
deferred until the results of the Commission's money market reforms are 
known.\450\ Another commenter suggested a haircut of 5/8 of 1%, based 
on a combination of the 1/8 of 1% haircut applied to highly rated 
shorter-term (at least 30 but less than 91 days to maturity) commercial 
paper and municipal securities and an additional charge of 1/2 of 1% to 
account for any minimal risk associated with the nature or operation of 
mutual funds.\451\ Finally, one commenter supported a 0% haircut for 
applied to money market funds that: (1) Do not hold investments in 
their affiliates or holding companies; and (2) are not affiliated with 
the bank in which the broker-dealer holds its cash reserves and 
operating funds.\452\
---------------------------------------------------------------------------

    \444\ See Federated Letter; Federated 3 Letter; Curion Clearing 
Letter; FAF Advisors Letter; Brown Brothers Harriman Letter; SIFMA 2 
Letter; ICI Letter; Barclays Letter; National Chamber Foundation 
Letter; Blackrock Letter; Deutsche Bank Securities Letter; UBS 
Letter; SIFMA 4 Letter; NIBA 2 Letter.
    \445\ See, e.g., Barclays Letter.
    \446\ See, e.g., FAF Advisors Letter.
    \447\ See Federated Letter.
    \448\ See Blackrock Letter; ICI Letter.
    \449\ See Blackrock Letter.
    \450\ See SIFMA 4 Letter.
    \451\ See SIFMA 2 Letter.
    \452\ See NIBA 2 Letter.
---------------------------------------------------------------------------

    As discussed above in section II.E.6.ii. of this release, the 
Commission recently proposed substantial amendments to its money market 
fund rules.\453\ In light of these proposed amendments,\454\ the 
Commission is deferring consideration of a reduction of the haircut for 
money market funds in Rule 15c3-1 at this time. Therefore, the haircut 
that broker-dealers apply for money market funds will remain at 2% 
under paragraph

[[Page 51858]]

(c)(2)(vi)(D)(1) of Rule 15c3-1. Deferring action will allow the 
Commission to assess the potential impact of any money market fund 
reforms it may adopt and whether any such impact would have 
consequences for the net liquid asset standard of Rule 15c3-1.
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    \453\ See Money Market Fund Reform; Amendments to Form PF, 
Release No. IC-30551 (June 5, 2013), 78 FR 36834 (June 19, 2013).
    \454\ Id.
---------------------------------------------------------------------------

c. Aggregate Debit Items Charge
    The Commission proposed amendments to Rule 15c3-1 that would have 
eliminated a reduction to aggregate debit items that certain broker-
dealers must take when computing their reserve requirements under Rule 
15c3-3.\455\ Under paragraph (a)(1)(ii)(A) of Rule 15c3-1, a broker-
dealer using the ``alternative standard'' \456\ to compute its minimum 
net capital requirement must reduce aggregate debit items by 3% when 
computing its customer reserve requirement under Rule 15c3-3. 
Conversely, Note E(3) to the customer reserve formula (Rule 15c3-3a) 
requires a broker-dealer using the ``basic method'' of computing net 
capital under Rule 15c3-1 to reduce by 1% the total debits in Item 10 
of the formula (i.e., debit balances in customer cash and margin 
accounts).\457\ Both of these provisions serve to increase the amount 
of funds a broker-dealer must deposit into its customer reserve 
account; however, the deduction applicable to alternative standard 
firms can result in an even larger reserve deposit requirement.
---------------------------------------------------------------------------

    \455\ See Amendments to Financial Responsibility Rules, 72 FR at 
12867.
    \456\ Under the ``alternative standard,'' a broker-dealer's 
minimum net capital requirement is equal to 2% of the firm's 
aggregate debit items. 17 CFR 240.15c3-1(a)(1)(ii).
    \457\ Under the ``basic method,'' a broker-dealer cannot permit 
its aggregate indebtedness (generally total money liabilities) to 
exceed 1500% of its net capital. 17 CFR 15c3-1(a)(1)(i).
---------------------------------------------------------------------------

    The Commission received four comment letters regarding these 
amendments and all were supportive.\458\ However, recent market turmoil 
has highlighted the importance of maintaining adequate amounts of funds 
and qualified securities in the customer reserve account under Rule 
15c3-3 to protect customers. Consequently, it would be imprudent to 
lower the debit reduction requirement for broker-dealers using the 
alternative standard at this time (especially given the fact that this 
standard is primarily used by firms with a substantial customer 
business). Therefore, the Commission has determined to defer 
consideration of action on this amendment at this time.
---------------------------------------------------------------------------

    \458\ See Curian Clearing Letter; SIFMA 2 Letter; Deutsche Bank 
Securities Letter; Citigroup Letter.
---------------------------------------------------------------------------

F. Technical Amendments

    The Commission proposed a number of technical amendments to these 
rules, including changes to the definitions of fully paid securities, 
margin securities, and bank in Rule 15c3-3.\459\ These proposed 
technical amendments were not designed to substantively change the 
meanings of these defined terms but, rather, to amend out-of-date 
citations and remove text that the Commission believed to be 
superfluous or redundant.
---------------------------------------------------------------------------

    \459\ 17 CFR 240.15c3-3(a)(3), (4), and (7), respectively.
---------------------------------------------------------------------------

    Two commenters \460\ opposed the proposed technical amendments to 
the Rule 15c3-3 definition of fully paid securities. As proposed, the 
definition of fully paid securities would have included ``all 
securities carried for the account of a customer unless such securities 
are purchased in a transaction for which the customer has not made full 
payment.'' \461\ The commenters contend that the amendments to the 
definition of fully paid securities would significantly expand the 
universe of fully paid securities because these securities generally 
are carried in a cash account, and under the proposed definition any 
security, in any account, including a margin account, could be 
considered a fully paid security (and subject to possession and control 
requirements) if it has been paid for in full. As such, the commenter 
noted that the term fully paid securities, as proposed, would require 
broker-dealers to determine whether securities in a margin account are 
fully paid (in which case they could not be hypothecated even if they 
are not excess margin securities). As a result, the commenter suggested 
that this definition should be limited to include only securities in a 
cash account that have been paid for in full. After careful 
consideration, and in response to the comment, the Commission has 
modified the text of paragraph (a)(3) to Rule 15c3-3 to more closely 
follow the original definition, while still adopting the updated 
references and terminology to reflect changes made to Regulation T 
since 1972. As adopted, the term fully paid securities includes ``all 
securities carried for the account of a customer in a cash account as 
defined in Regulation T (12 CFR 220.1 et seq.), as well as securities 
carried for the account of a customer in a margin account or any 
special account under Regulation T that have no loan value for margin 
purposes, and all margin equity securities in such account if they are 
fully paid. . . .'' \462\ The definition also states that, ``the term 
``fully paid securities'' does not apply to any securities purchased in 
transactions for which the customer has not made full payment.''
---------------------------------------------------------------------------

    \460\ See SIFMA 2 Letter; Angel Letter.
    \461\ See Amendments to Financial Responsibility Rules, 72 FR at 
12894.
    \462\ See paragraph (a)(3) of Rule 15c3-3, as adopted.
---------------------------------------------------------------------------

    The Commission did not receive any comments on the proposed 
amendments to the definition of margin securities under paragraph 
(a)(4) of Rule 15c3-3. The Commission is adopting this definition as 
proposed. In addition, the Commission did not receive any comments to 
the proposed amendments to the definition of bank under paragraph 
(a)(7) of Rule 15c3-3. The Commission, however, has modified the 
language in this paragraph to make the paragraph gender neutral by 
replacing the phrase ``who maintains his principal place of business'' 
with the phrase ``that maintains its principal place of business.''
    The Commission also has amended other provisions of Rule 15c3-3 to 
make the rule gender neutral. Finally, the Commission has replaced the 
word ``shall'' throughout the rule, as amended, with clearer words, 
such as ``will'' or ``must.'' This change will not change either the 
nature or substance of the affected rule provisions.

III. Responses to Specific Requests for Comment

    In the proposing release, the Commission requested comment on 
certain specific matters, in addition to the proposed rule 
amendments.\463\ These matters included: (1) A proposal to reduce the 
Rule 17a-11 notice requirement for broker-dealers that carry over $10 
billion in debits; (2) whether to harmonize the net capital deductions 
required under paragraph (c)(2)(iv)(B) of Rule 15c3-1 for securities 
lending and borrowing transactions with the deductions required under 
paragraph (c)(2)(iv)(F) for securities repo transactions; and (3) 
solicitation of comment on how third-party liens against customer fully 
paid securities carried by a broker-dealer should be treated under the 
financial responsibility rules, including Rule 15c3-3, Rule 17a-3 and 
Rule 17a-4.
---------------------------------------------------------------------------

    \463\ Id. at 12874.
---------------------------------------------------------------------------

    The Commission received seven comment letters that addressed the 
solicitation of comments for these matters.\464\ With respect to the 
early warning level proposal, one commenter proposed modifying the 
Commission's

[[Page 51859]]

early warning levels for very large ``alternative standard'' firms with 
more than $10 billion in debits.\465\ The commenter recommended this 
approach because of the increase in debit items at large broker-dealers 
and the increased focus on effective risk management practices.\466\ 
Another comment supported the amendment, suggesting that the 
notification could serve as an early warning if a firm is approaching 
insolvency.\467\
---------------------------------------------------------------------------

    \464\ See SIFMA 2 Letter; SIFMA 4 Letter; First Clearing Letter; 
Citigroup Letter; American Bar Association Letter; Cornell Letter; 
Raymond James 2 Letter.
    \465\ See SIFMA 2 Letter.
    \466\ Id.
    \467\ See Cornell Letter.
---------------------------------------------------------------------------

    In addition, the Commission received three comments with respect to 
harmonizing the net capital deductions required under paragraph 
(c)(2)(iv)(B) of Rule 15c3-1 for securities lending and borrowing 
transactions with the deductions required under paragraph (c)(2)(iv)(F) 
for securities repo transactions.\468\ These commenters stated that the 
Commission should consider the potential disruption to the marketplace 
that may arise in connection with any effort to harmonize capital 
charges.\469\
---------------------------------------------------------------------------

    \468\ See SIFMA 2 Letter; Citigroup Letter; Raymond James 2 
Letter.
    \469\ Id.
---------------------------------------------------------------------------

    The Commission also received seven comments in response to the 
solicitation of comment on how third-party liens against customer fully 
paid securities carried by a broker-dealer should be treated under the 
financial responsibility rules, including Rule 15c3-3, Rule 17a-3 and 
Rule 17a-4.\470\ Two commenters stated that the Commission should not 
require that a broker-dealer include third party liens as a credit in 
the reserve formula and stated that this is an area in which it would 
be productive to have a detailed discussion between Commission staff 
and the industry before any amendments are proposed.\471\ Another 
commenter stated that each of the suggested approaches in the proposing 
release imposes burdens and requirements on broker-dealers that do not 
serve to address the concerns noted by the Commission.\472\ Two 
commenters stated that the most effective way to avoid confusion 
regarding third party liens in a SIPC liquidation would be to segregate 
securities subject to a lien to a separate pledge account in the name 
of the pledgee.\473\ Finally, one commenter argued that requiring 
broker-dealers to include the amount of liens as a credit item in the 
reserve formula was not necessary to achieve customer protection and 
would impose significant costs and burdens on the broker-dealers.\474\
---------------------------------------------------------------------------

    \470\ See SIFMA 2 Letter; SIFMA 4 Letter; First Clearing Letter; 
Citigroup Letter; American Bar Association Letter; NIBA 2 Letter; 
Raymond James 2 Letter.
    \471\ See SIFMA 2 Letter; SIFMA 4 Letter; Citigroup Letter.
    \472\ See First Clearing Letter.
    \473\ See American Bar Association Letter; NIBA 2 Letter.
    \474\ See Raymond James 2 Letter.
---------------------------------------------------------------------------

    The Commission will consider the comments received in developing 
any proposals should the Commission decide to take further action in 
any of these areas.

IV. Paperwork Reduction Act

    Certain provisions of the amendments contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').\475\ The Commission published a notice 
requesting comment on the collection of information requirements in the 
proposing release \476\ and submitted the amendments to the Office of 
Management and Budget (``OMB'') for review in accordance with the 
PRA.\477\ An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid control number. The amended rules--Rule 15c3-1, Rule 
15c3-3, Rule 17a-3, Rule 17a-4 and Rule 17a-11--contain currently 
approved collections of information under, respectively, OMB control 
numbers 3235-0200, 3235-0078, 3235-0033, 3235-0279 and 3235-0085.
---------------------------------------------------------------------------

    \475\ 44 U.S.C. 3501, et seq.
    \476\ See Amendments to Financial Responsibility Rules, 72 FR at 
12875.
    \477\ 44 U.S.C. 3507(d); 5 CFR 1320.11.
---------------------------------------------------------------------------

    In response to comments received regarding the proposed amendments 
in the proposing release, the Commission has modified the language in 
the final rules being adopted, as discussed above. These comments and 
their impact on PRA estimates are discussed below. In addition, the 
initial burden estimates in the proposing release have been 
adjusted,\478\ as discussed below, to reflect updated information used 
to make the current estimates, including updated FOCUS Report 
data.\479\
---------------------------------------------------------------------------

    \478\ See Amendments to Financial Responsibility Rules, 72 FR at 
12875.
    \479\ The PRA estimates derived from FOCUS Reports filed by 
broker-dealers pursuant to Section 17 of the Exchange Act and Rule 
17a-5 have been updated in this final release to reflect more 
recently available information, including FOCUS Report data as of 
December 31, 2011. The PRA estimates in the proposing release 
derived from FOCUS reports were from 2004 year end data. See 
Amendments to Financial Responsibility Rules, 72 FR at 12875.
---------------------------------------------------------------------------

    Finally, one commenter specifically stated that the estimates the 
Commission provided utilized only that number of broker-dealers in its 
estimates that the Commission ``justifiably considers to be affected by 
the proposals.'' \480\ The commenter, however, believes that most, if 
not all, broker-dealers will spend over 90 hours each analyzing the 
effects of the rules as implemented, will spend many more than 90 hours 
each in implementing procedures and modifying their written supervisory 
procedures to comply with the new rules, will spend in excess of 240 
hours each in the monitoring of such rules, and will spend in excess of 
$15,000 each for outside counsel and auditor opinions or work 
product.\481\ This commenter did not provide additional detail about 
the basis for its view that the Commission's estimates were too low. 
The Commission agrees with the commenter that broker-dealers directly 
affected by the rule amendments may be required to implement procedures 
or modify their written supervisory procedures in order to comply with 
the rule amendments. In cases where the rule amendments are requiring a 
broker-dealer to implement or document certain policies and procedures, 
these hour burdens are already included in the final hour estimates 
discussed below.\482\ In addition, the Commission acknowledges that a 
broker-dealer may need to review its operations to determine whether or 
not it has any obligations under the rule amendments. Even if a broker-
dealer is not directly affected by the rule amendments, such a review 
may result in an indirect effect on its operations. These indirect 
effects or costs, however, are more appropriately addressed in the 
Economic Analysis in section V. of this release because they relate to 
the overall impact of the amendments, rather than to the specific 
collections of information discussed below. Consequently, the 
Commission addresses the commenter's concerns that directly relate to 
the collections of information below, and the indirect burdens and 
costs in the Economic Analysis in section V. of this release.
---------------------------------------------------------------------------

    \480\ See NIBA 2 Letter.
    \481\ Id.
    \482\ See, e.g., paragraph (j)(1) of Rule 15c3-3 and paragraph 
(a)(23) of Rule 17a-3, as adopted.
---------------------------------------------------------------------------

A. Summary of the Collection of Information Requirements

    The rule amendments contain recordkeeping and disclosure 
requirements that are subject to the PRA. In summary, the amendments 
may require a broker-dealer, under certain circumstances, to: (1) 
Disclose the principals and obtain certain agreements from the 
principals in a securities lending transaction where it performs 
settlement services if it is to be

[[Page 51860]]

considered an agent (as opposed to a principal) for the purposes of the 
net capital rule \483\; (2) obtain permission in writing from its DEA 
to withdraw capital within one year of contribution \484\; (3) enter 
into a subordination agreement with an account holder in order to 
exclude such account holder from the definition of PAB account \485\; 
(4) provide written notice to PAB account holders that their securities 
may be used in the ordinary course of its securities business \486\; 
(5) perform a PAB reserve computation \487\; (6) obtain written 
notification from each bank with which it maintains a PAB reserve 
account that the bank was informed that all cash and/or qualified 
securities being held by the bank are being held for the exclusive 
benefit of brokers and dealers \488\; (7) enter into a written contract 
with a bank with which it maintains its PAB reserve accounts providing 
that the cash and/or qualified securities shall at no time be used 
directly or indirectly as security for a loan to the broker-dealer by 
the bank, and shall be subject to no right, charge, security interest, 
lien, or claim of any kind in favor of the bank or any person claiming 
through the bank \489\; (8) develop adequate procedures to ensure a 
customer for whom a free credit balance is carried is sent a written 
statement regarding the customer's free credit balances, including 
information regarding the amount due to the customer and that the funds 
are payable on demand, prior to using funds arising from free credit 
balances in the broker-dealer's operations \490\; (9) obtain the 
written affirmative consent of a new customer before including the 
customer's free credit balances in a Sweep Program, as well as provide 
certain disclosures and notices to all customers with regard to the 
broker-dealer's Sweep Program \491\; (10) make and maintain records 
documenting its credit, market, and liquidity risk management controls 
to assist the broker-dealer in analyzing the risks associated with its 
business activities \492\; (11) provide notice to the Commission and 
other regulatory authorities if the broker-dealer becomes insolvent 
\493\; and (12) provide notice to the Commission and other regulatory 
authorities if the broker-dealer's securities borrowed and loaned or 
securities repurchase/reverse repurchase activity reaches a certain 
threshold or, alternatively, report monthly its securities borrowed and 
loan or securities repurchase/reverse repurchase activity to its DEA in 
a form acceptable to its DEA.\494\
---------------------------------------------------------------------------

    \483\ See paragraph (c)(2)(iv)(B) of Rule 15c3-1, as adopted.
    \484\ See paragraph (c)(2)(i)(G) to Rule 15c3-1, as adopted.
    \485\ See paragraph (a)(16) to Rule 15c3-3, as adopted.
    \486\ See paragraph (b)(5) to Rule 15c3-3, as adopted.
    \487\ See paragraph (e)(1) and (e)(3) of Rule 15c3-3, as 
adopted.
    \488\ See paragraph (f) of Rule 15c3-3, as adopted.
    \489\ Id.
    \490\ See paragraph (j)(1) to Rule 15c3-3, as adopted.
    \491\ See paragraph (j)(2) to Rule 15c3-3, as adopted.
    \492\ See paragraph (a)(23) to Rule 17a-3 and paragraph (e)(9) 
of Rule 17a-4, as adopted.
    \493\ See paragraph (b)(1) of Rule 17a-11, as adopted.
    \494\ See paragraph (c)(5) to Rule 17a-11, as adopted.
---------------------------------------------------------------------------

B. Use of Information

    The Commission, its staff, and SROs will use the information 
collected under the amendments to Rule 15c3-1 and Rule 15c3-3 to 
determine whether the broker-dealer is in compliance with each rule and 
to help fulfill their oversight responsibilities. The collections of 
information would also help to ensure that broker-dealers are meeting 
their obligations under the rule amendments and have any required 
policies and procedures in place.
    In particular, the record with respect to acting as agent in a 
securities loan transaction will assist examiners in verifying that the 
broker-dealer is properly accounting for securities loan deficits under 
Rule 15c3-1. The records with respect to obtaining DEA approval prior 
to withdrawing capital within one year of contribution under Rule 15c3-
1 will assist examiners in determining if a broker-dealer is computing 
its net capital accurately with regard to the proper classification of 
its capital contributions, and will help to ensure the DEA only 
approves capital withdrawals which are appropriate in light of the 
firm's current financial condition at the time of the requested 
withdrawal. The amendments to Rule 15c3-1 also will facilitate the 
monitoring of the financial condition of broker-dealers by the 
Commission and its staff, as well as by SROs.
    The records with respect to the PAB accounts will assist examiners 
in verifying that: (1) A carrying broker-dealer has properly excluded 
certain accounts from being treated as PAB accounts by entering into 
subordination agreements with particular account holders; (2) a 
carrying broker-dealer sent written notices to PAB accountholders to 
use their PAB securities; (3) the broker-dealer performed the PAB 
reserve computation; and (4) the bank holding the PAB reserve account 
agreed to do so free of lien by entering into a written contract with 
the broker-dealer.
    The records with respect to customer's free credit balances will 
assist examiners in verifying that: (1) A carrying broker-dealer has 
obtained the written affirmative consent of a new customer before 
including a customer's free credit balances in a Sweep Program; (2) a 
carrying broker-dealer has provided the required disclosures and 
notices to all customers with regard to the broker-dealer's Sweep 
Program; and (3) the broker-dealer has maintained adequate procedures 
with regard to the use of a customer's free credit balances prior to 
using such customer's free credit balances in its operations. The 
amendments to Rule 15c3-3 will facilitate the process by which the 
Commission, its staff, and SROs monitor how broker-dealers are 
fulfilling the customer protection requirements of the rule. The 
written affirmative consent, disclosures and notices required to be 
provided to customers also will alert customers to the alternatives 
available to them with respect to their free credit balances.
    The Commission, its staff, and SROs will use the information 
collected under the amendments to Rules 17a-3 and 17a-4 to determine 
whether the broker-dealer is adhering to its documented credit, market, 
and liquidity risk management controls, as well as to evaluate the 
effectiveness of these controls.
    The Commission, its staff, and SROs will use the information 
collected under the amendments to Rule 17a-11 to identify a broker-
dealer experiencing financial difficulty. This information will assist 
the Commission and other regulators in promptly taking appropriate 
steps to protect customers, creditors, and counterparties. In 
particular, a notice of insolvency will assist regulators in responding 
more quickly to protect customers of a failing institution. The notices 
and reports with respect to securities lending and repos will assist 
regulators in identifying broker-dealers that are active in these 
transactions or suddenly take on large positions and thereby assist in 
monitoring systemic risk.

C. Respondents

    The final estimates of respondents below have been updated to 
reflect more recent information.\495\ The amendment

[[Page 51861]]

to Rule 15c3-1 requiring a broker-dealer to make disclosures to, and 
obtain certain agreements from, securities lending principals will 
apply only to those firms that participate in the settlement of 
securities lending transactions as agents. The Commission estimates 
that approximately 122 broker-dealers will be affected by this 
requirement.\496\ This estimate has been updated from the estimate of 
170 broker-dealers in the proposing release.\497\ No comments were 
received on this estimate.
---------------------------------------------------------------------------

    \495\ The final estimates of respondents derived from FOCUS 
Reports filed by broker-dealers pursuant to Section 17 of the 
Exchange Act and Rule 17a-5 have been updated in this final release 
to reflect more recently available information, including FOCUS 
Report data as of December 31, 2011. The estimates of respondents in 
the proposing release derived from FOCUS reports were from 2004 year 
end data. See Amendments to Financial Responsibility Rules, 72 FR at 
12876.
    \496\ This estimate is derived from FOCUS Reports.
    \497\ See Amendments to Financial Responsibility Rules, 72 FR at 
12876.
---------------------------------------------------------------------------

    The amendment to Rule 15c3-1 with respect to a broker-dealer 
obtaining permission in writing from its DEA prior to withdrawing 
capital within one year of contribution under Rule 15c3-1 will apply to 
any broker-dealer who wishes to withdraw such capital. Because most 
broker-dealers already comply with existing interpretations regarding 
the treatment of temporary capital contributions and similar SRO 
requirements, or are familiar with such interpretations and 
requirements, this part of the amendment to Rule 15c3-1 regarding 
temporary capital contributions likely will impact only a small number 
of the approximately 4,709 broker-dealers registered with the 
Commission, as of December 31, 2011 (based on FOCUS Report data).\498\ 
Therefore, the Commission estimates that approximately 90 broker-
dealers will seek permission from their DEA in writing to withdraw 
capital within one year of its contribution under the amendment.\499\
---------------------------------------------------------------------------

    \498\ Temporary Capital Letter; see also Net Capital Rule, 
Exchange Act Release No. 28927 (Feb. 28, 1991), 56 FR 9124 (Mar. 5, 
1991); and FINRA Rule 4110(c).
    \499\ The Commission received 900 broker-dealer capital 
withdrawal notices under paragraph (e) of Rule 15c3-1 in 2012. 
Because this amendment is consistent with prior Commission and staff 
positions that capital is not temporary, as well as current SRO 
requirements, it is likely that only a small number of these notices 
are capital withdrawals made within one year of contribution, and 
therefore, based on staff experience with the application of Rule 
15c3-1, the Commission estimates that approximately 90 broker-
dealers (10% of 900) will seek permission from their DEA in writing 
to withdraw capital under the amendment. See Net Capital Rule, 
Exchange Act Release No. 28927 (Feb. 28, 1991); Temporary Capital 
Letter; and FINRA Rule 4110.
---------------------------------------------------------------------------

    The amendments to Rule 15c3-3 requiring a broker-dealer to perform 
a PAB reserve computation and to obtain certain agreements and notices 
related to its PAB accounts will affect only those firms that carry 
such accounts. Based on FOCUS Report data, as of December 31, 2011, the 
Commission estimates that approximately 61 broker-dealers will carry 
such accounts.\500\ The amendment to Rule 15c3-3 requiring a broker-
dealer to obtain the affirmative consent of a new customer before 
changing the terms under which the customer's free credit balances are 
maintained will apply only to firms that carry free credit balances for 
customers. Based on FOCUS Report data, as of December 31, 2011, the 
Commission estimates that approximately 189 broker-dealers carry free 
credit balances.\501\
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    \500\ This estimate has been updated from our estimate of 75 
broker-dealers in the proposing release. See Amendments to Financial 
Responsibility Rules, 72 FR at 12876. No comments were received on 
this estimate.
    \501\ In the proposing release, the Commission estimated 
approximately 256 broker-dealers carried free credit balances. See 
Amendments to Financial Responsibility Rules, 72 FR at 12876. No 
comments were received on this estimate.
---------------------------------------------------------------------------

    The Commission estimates that the amendment to Rule 15c3-3 
permitting a broker-dealer to exclude certain accounts from being 
treated as PAB accounts under Rule 15c3-3 by entering into 
subordination agreements with certain account holders will apply to all 
61 broker-dealers that will carry such accounts. The Commission 
estimates that these 61 broker-dealers each will enter into an average 
of 11 subordination agreements.\502\
---------------------------------------------------------------------------

    \502\ See Order Granting Conditional Exemption Under the 
Securities Exchange Act of 1934 in Connection with Portfolio 
Margining of Swaps and Security-Based Swaps, Exchange Act Release 
No. 68433 (Dec. 14, 2012), 77 FR 75211, 75222 n.69 (Dec. 19, 2012). 
(``FINRA CRD data indicate that the 17 largest broker-dealers (i.e., 
those with total assets of $50 billion or more) reported a total of 
188 affiliates that are themselves registered with the SEC (i.e., 
they have their own CRD numbers), representing approximately 11 
affiliates per broker-dealer.''). Carrying firms likely will enter 
into subordination agreements with affiliates, including foreign 
banks or foreign broker-dealers affiliated with the carrying broker-
dealer to exclude such accounts from the rule. See SIFMA 2 Letter.
---------------------------------------------------------------------------

    The amendments to Rules 17a-3 and 17a-4 requiring a broker-dealer 
to make and maintain records documenting the credit, market and 
liquidity risk management control for analyzing and managing risks will 
apply only to firms that have more than $1,000,000 in aggregate credit 
items, or $20,000,000 in capital. Thus, its impact will be limited to 
larger broker-dealers. Accordingly, the number of respondents will 
equal the number of broker-dealers meeting the thresholds set forth in 
the amendment. The Commission estimates that approximately 490 broker-
dealers will meet at least one of these thresholds.\503\
---------------------------------------------------------------------------

    \503\ This estimate has been updated from the proposing release 
estimate of 517 broker-dealers. See Amendments to Financial 
Responsibility Rules, 72 FR at 12876. No comments were received on 
this estimate.
---------------------------------------------------------------------------

    One amendment to Rule 17a-11 will require a broker-dealer to 
provide the Commission with notice if it becomes subject to certain 
insolvency events. The Commission estimates that approximately two 
broker-dealers will become subject to one of these events in a given 
year.\504\ Another amendment to Rule 17a-11 will require a broker-
dealer to provide notice to the Commission if its securities borrowed 
or loaned, or its securities repurchase or reverse repurchase activity 
reaches a certain threshold or, alternatively, provide monthly reports 
to its DEA about such activities. This amendment will only affect a 
limited number of firms per year. The Commission estimates that 
approximately one broker-dealer \505\ will provide notice and six 
broker-dealers \506\ will opt to send the monthly reports in a given 
year.
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    \504\ This estimate is based on the 2012 SIPC Annual Report, 
which indicates that over the last ten-year-period, the annual 
average of new customer protection proceedings was two. A copy of 
the 2012 Annual Report is available at http://www.sipc.org/. This 
estimate has been updated from our proposing release estimate of 6, 
which was based on the SIPC 2005 Annual Report. See Amendments to 
Financial Responsibility Rules, 72 FR at 12876. No comments were 
received on this estimate.
    \505\ This estimate is derived from information filed by broker-
dealers in their FOCUS Reports. This estimate has been updated from 
the proposing release estimate of 11. See Amendments to Financial 
Responsibility Rules, 72 FR at 12876. No comments were received on 
this estimate. Based on FOCUS Report data, as of December 31, 2011, 
there were seven broker-dealers whose securities borrowed or 
securities loaned exceeded 80% of 25 times their tentative net 
capital, and there were six broker-dealers whose securities borrowed 
or securities loaned exceeded 25 times their tentative net capital. 
Therefore, the Commission assumes for purposes of the PRA that six 
broker-dealers would chose to file monthly reports in lieu of the 
notice requirements, and that one would file a notice.
    \506\ This estimate is derived from information filed by broker-
dealers in their FOCUS Reports. Based on FOCUS Report data, as of 
December 31, 2011, there were six broker-dealers whose securities 
borrowed or securities loaned exceeded 25 times their tentative net 
capital. These firms likely will opt to file the monthly report 
under the proposed amendments to Rule 17a-11. This estimate has been 
updated from our proposing release estimate of 21 broker-dealers. 
See Amendments to Financial Responsibility Rules, 72 FR at 12876. No 
comments were received on this estimate. The estimated number of 
firms filing notices and monthly reports has decreased largely due 
to an overall decrease in the number of broker-dealers. See also id. 
at 12870 (discussing rationale for 2,500% threshold).
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D. Total Annual Reporting and Recordkeeping Burden

1. Securities Lending Agreements and Disclosures
    The amendments to paragraph (c)(2)(iv)(B) of Rule 15c3-1 will 
require a broker-dealer to make disclosures to,

[[Page 51862]]

and obtain certain agreements from, securities lending principals in 
situations where the firm participates in the settlement of a 
securities lending transaction but wants to be deemed an agent for 
purposes of Rule 15c3-1.\507\ The Commission has adopted the final rule 
substantially as proposed, and consequently, there were no changes to 
the final rule amendments that would affect the Commission's PRA 
estimates. In addition, the Commission did not receive any comments on 
the estimates in the proposing release,\508\ and is therefore is 
retaining the amendment's PRA hour burden estimates without revision. 
The Commission, however, is updating the number of respondents to 
reflect more recently-available data from broker-dealer FOCUS Reports.
---------------------------------------------------------------------------

    \507\ 17 CFR 240.15c3-1(c)(2)(iv)(B).
    \508\ See Amendments to Financial Responsibility Rules, 72 FR at 
12876.
---------------------------------------------------------------------------

    As discussed above in section II.C. of this release, the 
Commission, in recognition of standard stock loan agreements, designed 
the amendment to accommodate the continued use of these industry model 
agreements by incorporating their use into the rule's requirements. For 
the purpose of establishing a broker-dealer's status as agent or 
lender, these agreements may be sufficiently detailed to satisfy the 
new requirements. Thus, the standard agreement used by the vast 
majority of broker-dealers may contain the representations and 
disclosures required by the amendment. Nevertheless, based on staff 
experience with securities lending agreements and disclosure and the 
application of Rule 15c3-1, the Commission continues to believe that a 
small percentage of broker-dealers may need to modify their standard 
agreements. In the proposing release, the Commission estimated that 5% 
\509\ of broker-dealers may need to modify their standard agreements. 
No comments were received on this estimate and the Commission believes 
5% continues to be an appropriate estimate for the final rule 
amendments. Thus, the Commission estimates that 5% of the approximately 
122 firms engaged in this business, or approximately 6 firms, will not 
have used the standard agreements.\510\ The Commission estimates each 
of these firms will spend approximately 20 hours of employee resources 
updating their standard agreement template.\511\ Therefore, the 
Commission estimates that the total one-time burden to broker-dealers 
as a result of this requirement will be approximately 120 hours.\512\
---------------------------------------------------------------------------

    \509\ Id.
    \510\ This estimate is updated from the estimate of 9 firms (5% 
of 170 firms) in the proposing release. Id.
    \511\ Because these firms are already engaging in stock loan and 
repo activities, these functions likely will be performed by in-
house employees, rather than outside counsel.
    \512\ 6 broker-dealers x 20 hours per firm = 120 hours. This is 
an update from the proposing release estimate of 9 broker-dealers x 
20 hours = 180 hours. Id.
---------------------------------------------------------------------------

2. DEA Permission To Withdraw Capital within One Year of Contribution
    The amendment to paragraph (c)(2)(i)(G)(2) of Rule 15c3-1 will 
require that a broker-dealer treat as a liability any capital 
contribution that is intended to be withdrawn within one year of its 
contribution.\513\ The rule amendment also includes the presumption 
that capital withdrawn within one year of contribution is presumed to 
have been intended to be withdrawn within one year, unless the broker-
dealer receives permission in writing for the withdrawal from its DEA. 
This amendment likely will impose annual recordkeeping burdens on 
broker-dealers making the request.
---------------------------------------------------------------------------

    \513\ 17 CFR 240.15c3-1(c)(2)(i)(G)(2).
---------------------------------------------------------------------------

    The Commission estimates that 90 broker-dealers will seek to obtain 
permission from their DEA in writing to withdraw capital within one 
year of its contribution, and that it will take a broker-dealer 
approximately one hour to prepare and submit the request to its DEA to 
withdraw capital.\514\ Therefore, the Commission estimates that the 
total annual hour burden with respect to the rule amendment will be 
approximately 90 hours.\515\
---------------------------------------------------------------------------

    \514\ See section IV.C. of this release.
    \515\ 90 broker-dealers x 1 hour = 90 hours.
---------------------------------------------------------------------------

3. Written Subordination Agreements under Rule 15c3-3
    As discussed above in section II.A.2. of this release, in response 
to comments, the final rule amendment adopted by the Commission 
excludes from the definition of PAB account in paragraph (a)(16) of 
Rule 15c3-3, an account that ``has been subordinated to the claims of 
creditors of the carrying broker or dealer.'' \516\ This modification 
to the final rule will result in one-time burdens under the collection 
of information for Rule 15c3-3.\517\
---------------------------------------------------------------------------

    \516\ 17 CFR 240.15c3-3(a)(16).
    \517\ The proposing release did not contain any proposals with 
regard to subordination agreements.
---------------------------------------------------------------------------

    In light of comments received \518\ and based on staff experience, 
the Commission understands most PAB account holders that enter into a 
subordinated loan agreement with a carrying broker-dealer in order to 
not be treated as PAB accounts under paragraph (a)(16) likely will be 
affiliates of the broker-dealer.\519\ The Commission estimates that the 
61 broker-dealers that carry PAB accounts will enter into an average of 
11 subordination agreements as a result of the rule amendment.\520\ The 
Commission estimates that it will take a carrying broker-dealer 
approximately 20 hours to develop a subordination agreement, based on 
the Commission's prior experience with the development of subordination 
agreements.\521\ Therefore, the Commission estimates that the total 
one-time hour burden resulting from this requirement will be 13,420 
hours.\522\
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    \518\ See SIFMA 2 Letter; SIFMA 4 Letter; Deutsche Bank 
Securities Letter.
    \519\ See Deutsche Bank Letter; SIFMA 2 Letter.
    \520\ See section IV.C. of this release.
    \521\ See Capital, Margin, and Segregation Requirements for 
Security-Based Swap Dealers and Major Security-Based Swap 
Participants and Capital Requirements for Broker-Dealers, Exchange 
Act Release No. 68071, 77 FR at 70299. See also Order Granting 
Conditional Exemption Under the Securities Exchange Act of 1934 in 
Connection with Portfolio Margining of Swaps and Security-Based 
Swaps, Exchange Act Release No. 68433 (Dec. 14, 2012), 77 FR 75211 
(Dec. 19, 2012).
    \522\ 61 broker-dealers x 11 accounts x 20 hours = 13,420 hours.
---------------------------------------------------------------------------

4. PAB Reserve Bank Account Recordkeeping Requirements
    The amendments to Rules 15c3-3 and 15c3-3a require carrying broker-
dealers to: (1) Perform a separate reserve computation for PAB accounts 
(in addition to the reserve computation currently required for Rule 
15c3-3 customer accounts); (2) establish and fund a separate PAB 
reserve account; and (3) obtain and maintain physical possession or 
control of non-margin securities carried in PAB accounts unless the 
carrying broker-dealer has provided written notice to the PAB account 
holders that it will use those securities in the ordinary course of its 
securities business, and has provided opportunity for the PAB account 
holder to object to such use.
    In the proposing release, the Commission proposed to require that 
the carrying broker-dealer obtain written permission from a PAB account 
holder before it could use the securities of the PAB account holder in 
the ordinary course of its securities business. The Commission 
estimated that, based on FOCUS Report data, there were approximately 
2,533 existing PAB customers, and therefore, broker-dealers would have 
to amend approximately 2,533 existing PAB agreements.\523\ The 
Commission further estimated that, on average, a firm would spend 
approximately 10 hours of employee

[[Page 51863]]

resources amending each agreement and that 75 firms would spend 20 
hours amending their standard PAB agreement template, for a total of 
26,830 hours.\524\ The Commission did not receive any comments 
regarding these estimates in the proposing release.
---------------------------------------------------------------------------

    \523\ See Amendments to Financial Responsibility Rules, 72 FR at 
12877.
    \524\ (2,533 PAB customers x 10 hours per customer) + (75 firms 
x 20 hours per firm) = 26,830. Id.
---------------------------------------------------------------------------

    In response to comments, as discussed above, the Commission 
determined not to adopt the requirement, as proposed. Instead, 
paragraph (b)(5) of Rule 15c3-3 requires the carrying broker-dealer to 
provide PAB account holders with written notice that the account 
holder's non-margin securities may be used in the ordinary course of 
its business.\525\ Therefore, the Commission is revising the final one-
time hour burden in light of the change in the rule to a notice 
requirement, which is expected to be less burdensome than the proposed 
customer consent provision while still providing customers with 
necessary information. The Commission estimates, based on FOCUS Report 
data, that approximately 61 broker-dealers carry PAB accounts.\526\ The 
Commission further estimates, based on similar collections of 
information and the fact that these firms already carry PAB accounts, 
and on average, a firm will spend approximately 10 hours of employee 
resources drafting a standard notice template, for a total one-time 
burden of 610 hours.\527\ In addition, based on FOCUS Report data, the 
Commission estimates that there are approximately 1,551 existing PAB 
customers and, therefore, broker-dealers will have to send 
approximately 1,551 written notices.\528\ The Commission estimates, 
based on staff experience, that a firm will spend approximately 10 
minutes per account sending out the required written notice, for a 
total one-time burden of 259 hours.\529\
---------------------------------------------------------------------------

    \525\ 17 CFR 240.15c3-3(b)(5).
    \526\ This estimate is based on the number of broker-dealers 
carrying PAB accounts as of December 31, 2011. This is an update 
from the proposing release estimate of approximately 75 broker-
dealers that carry PAB accounts. See Amendments to Financial 
Responsibility Rules, 72 FR at 12877.
    \527\ 61 firms x 10 hours = 610 hours. See also Capital, Margin, 
and Segregation Requirements for Security-Based Swap Dealers and 
Major Security-Based Swap Participants and Capital Requirements for 
Broker-Dealers, Exchange Act Release No. 68071, 77 FR at 70298 
(estimating that the notice required to be sent by a security based 
swap dealer to a counterparty pursuant to section 3E(f) of the 
Exchange Act would take an outside counsel 10 hours to draft).
    \528\ The number of customers also is updated from the proposing 
release estimate of 2,533 customers. See Amendments to Financial 
Responsibility Rules, 72 FR at 12877.
    \529\ 1,551 PAB account holders x 10 minutes = 15,510 minutes/60 
minutes = 258.5 hours (rounded to 259 hours). See generally, 
Exchange Act Release No. 68071, 77 FR at 70298 (estimating that the 
notice required to be sent by a security based swap dealer to a 
counterparty pursuant to section 3E(f) of the Exchange Act would 
take 10 minutes to send).
---------------------------------------------------------------------------

    The Commission estimates that a broker-dealer will incur postage 
costs sending out the required written notice to customers. These 
carrying broker-dealers likely will use the least cost method to comply 
with this requirement and may include this notification with other 
mailings sent to PAB account holders. The Commission, however, 
conservatively estimates that the postage cost of for each 
notification, using the current price of first class postage, will be 
approximately $.46 per document sent. Therefore, the staff estimates 
that the cost of sending the required written notification to PAB 
account holders will be approximately $713.\530\
---------------------------------------------------------------------------

    \530\ 1,551 notices x $0.46 = $713.46.
---------------------------------------------------------------------------

    Based on FOCUS Report data, the Commission also estimates that 
approximately 61 broker-dealers carry PAB accounts, and based upon 
differences between the PAIB Letter and the final rule, these 61 firms 
would have to amend their standard PAB agreement template. The 
Commission estimates a firm will spend, on average, approximately 20 
hours of employee resources on this task, for a total of 1,220 
hours.\531\
---------------------------------------------------------------------------

    \531\ 61 firms x 20 hours = 1,220.
---------------------------------------------------------------------------

    In light of the changes to the final rule amendments which require 
a broker-dealer to send a written notice, rather than obtain a 
customer's consent regarding the use of a PAB account holder's 
securities, the 61 broker-dealers carrying PAB accounts likely will 
engage outside counsel \532\ to review the required notice,\533\ as 
well as the standard PAB template agreement under the final rule 
amendments to Rule 15c3-3. As a result, the Commission estimates that 
these 61 broker-dealers will likely incur $2,000 in legal costs,\534\ 
or $122,000 \535\ in aggregate initial burden to review and comment on 
these materials.
---------------------------------------------------------------------------

    \532\ See NIBA 2 Letter.
    \533\ 17 CFR 240.15c3-3(b)(5).
    \534\ 5 hours x $400 per hour = $2,000. The Commission estimates 
the review of the notice and standard PAB template would require 5 
hours of outside counsel time, which is the same estimate used for 
outside counsel review in another recent release. Based on staff 
experience with the PAIB Letter and the application of Rule 15c3-3, 
the Commission estimates the outside counsel review related to the 
PAB amendments will take a comparable amount of time. See Capital, 
Margin, and Segregation Requirements for Security-Based Swap Dealers 
and Major Security-Based Swap Participants and Capital Requirements 
for Broker-Dealers, Exchange Act Release 68071, 77 FR at 70297, 
n.904. The Commission estimates that the outside counsel would cost 
$400 per hour, which is the same estimate used by the Commission in 
other recent releases. See Capital, Margin, and Segregation 
Requirements for Security-Based Swap Dealers and Major Security-
Based Swap Participants and Capital Requirements for Broker-Dealers, 
Exchange Act Release 68071, 77 FR at 70297; Further Definition of 
``Swap,'' ``Security-Based Swap,'' and ``Security-Based Swap 
Agreement''; Mixed Swaps; Security-Based Swap Agreement 
Recordkeeping, Exchange Act Release No. 67453 (July 18, 2012), 77 FR 
48208 (Aug. 13, 2012).
    \535\ 61 firms x $2,000 legal cost = $122,000.
---------------------------------------------------------------------------

    The requirements to perform a PAB reserve computation and obtain 
agreements and notices from banks holding PAB accounts will result in 
annual burdens based on the number of broker-dealers that hold PAB 
accounts and the number of times per year these broker-dealers open new 
PAB reserve accounts. Currently, to obtain the relief provided in the 
PAIB Letter, broker-dealers are required to obtain the agreements and 
notices from the banks.\536\ The Commission understands that broker-
dealers generally already obtain these agreements and notices. 
Therefore, the Commission estimates there will be no additional burden 
imposed by this requirement.\537\ The Commission did not receive any 
comments on this estimate from the proposing release.
---------------------------------------------------------------------------

    \536\ See PAIB Letter.
    \537\ In addition, the hour burdens for broker-dealers to open 
new customer reserve bank account under Rule 15c3-3 are already 
included within the currently approved collection of information for 
Rule 15c3-3.
---------------------------------------------------------------------------

    The amendment requiring a PAB reserve computation will produce a 
one-time burden. Based on FOCUS Report data, as of December 31, 2011, 
the Commission estimates that approximately 61 broker-dealers will 
perform a PAB reserve computation.\538\ These firms already perform a 
reserve computation for domestic broker-dealer customers under the PAIB 
Letter. Nonetheless, the Commission estimates these firms will spend, 
on average, approximately 30 hours of employee resources per firm 
updating their systems to implement changes that will be necessitated 
by the amendment. Therefore, consistent with the hour estimates in the 
proposing release, the Commission estimates that the total one-time 
burden to broker-dealers arising from updating their systems to comply

[[Page 51864]]

with this requirement will be approximately 1,830 hours.\539\
---------------------------------------------------------------------------

    \538\ This estimate is based on the number of broker-dealers 
which currently perform a PAB computation as of December 31, 2011. 
This is an update from the estimate in the proposing release of 75 
broker-dealers.
    \539\ 61 broker-dealers x 30 hours per firm = 1,830 hours. This 
is an update from the proposing release estimate of 75 firms x 30 
hours per firm = 2,250 hours. See Amendments to Financial 
Responsibility Rules, 72 FR at 12877.
---------------------------------------------------------------------------

    The amendment requiring a PAB reserve computation also will produce 
an annual burden. Based on FOCUS Report data, the Commission estimates 
that of the 61 broker-dealers estimated to perform a PAB reserve 
computation, approximately 56 of the current PAB filers will perform 
the PAB reserve computation on a weekly basis, two broker-dealers will 
perform it on a monthly basis, and three broker-dealers will perform 
the PAB reserve computation on a daily basis.\540\ The Commission 
further estimates that a broker-dealer will spend, on average, 
approximately 2.5 hours to complete the PAB reserve computation in 
order to make a record of such computation under Rule 15c3-3 as a 
result of the amendment.\541\ Therefore, consistent with the hour 
burden estimates in the proposing release, the Commission estimates 
that the total annual burden to broker-dealers from this requirement 
will be approximately 9,215 hours.\542\
---------------------------------------------------------------------------

    \540\ These estimates are based on the number of broker-dealers 
performing a PAB reserve computation monthly, weekly, and daily, as 
of December 31, 2011. This is an update from the estimate in the 
proposing release, which provided that of the 75 broker-dealers 
estimated to perform a PAB computation, 71 broker-dealers would 
prefer PAB computations on a weekly basis and four broker-dealers 
would perform it on a monthly basis. See Amendments to Financial 
Responsibility Rules, 72 FR at 12877. No broker-dealers performed 
daily PAB computations as of the date of the proposing release. No 
comments were received on this estimate.
    \541\ This estimate is based on staff experience with the 
current estimate of 2.5 hours under the current collection of 
information for Rule 15c3-3 to make a record of each reserve 
computation. See 17 CFR 240.15c3-3(e)(3).
    \542\ (56 weekly filers x 52 weeks x 2.5 hours per computation) 
+ (2 monthly filers x 12 months x 2.5 hours per computation) + (3 
daily filers x 250 business days per year x 2.5 hours per 
computation) = 9,215 total hours. This is an update from the 
proposing release estimate of 9,350 hours. See Amendments to 
Financial Responsibility Rules, 72 FR at 12877, n.137.
---------------------------------------------------------------------------

5. Adequate Procedures Required Under Paragraph (j)(1) of Rule 15c3-3
    The Commission proposed importing requirements in Rule 15c3-2 into 
Rule 15c3-3 and eliminating Rule 15c3-2 as a stand-alone rule in the 
Code of Federal Regulations, and adopting new paragraph (j)(1) to Rule 
15c3-3, which includes a condition that a broker-dealer must establish 
adequate procedures that will impose a paperwork burden if a broker-
dealer wishes to accept or use any free credit balance for the account 
of any customer of the broker-dealer. The Commission is adopting this 
amendment substantially as proposed, which provides, ``[a] broker or 
dealer must not accept or use any free credit balance carried for the 
account of any customer of the broker or dealer unless such broker or 
dealer has established adequate procedures pursuant to which each 
customer for whom a free credit balance is carried will be given or 
sent, together with or as part of the customer's statement of account, 
whenever sent but not less frequently than once every three months, a 
written statement informing the customer of the amount due to the 
customer by the broker or dealer on the date of the statement, and that 
the funds are payable on demand of the customer.'' \543\
---------------------------------------------------------------------------

    \543\ 17 CFR 240.15c3-3(j)(1).
---------------------------------------------------------------------------

    The requirement that broker-dealers establish adequate procedures 
with regard to free credit balances will result in one-time and annual 
hours burdens for broker-dealers subject to the requirements of new 
paragraph (j)(1) to Rule 15c3-3. Based on FOCUS Report data, the 
Commission estimates that 189 broker-dealers carry free credit 
balances. Most firms may already have such procedures in place with 
regard to the requirements of the rule, because these provisions are 
being imported from current Rule 15c3-2, which is being eliminated as a 
result of these amendments. Therefore, the Commission estimates that a 
broker-dealer will spend approximately 25 additional hours reviewing 
and updating its procedures to ensure it is in compliance with new 
paragraph (j)(1) to Rule 15c3-3 and approximately 10 additional hours 
per year reviewing and updating its procedures, for a total one-time 
and annual hour burden of 4,725 hours \544\ and 1,890 hours,\545\ 
respectively.\546\
---------------------------------------------------------------------------

    \544\ 189 broker-dealers x 25 hours = 4,725 hours. The 25 and 10 
hour estimates are based on similar collections of information and 
the Commission's belief that many of these broker-dealers already 
have procedures in place and, therefore, most broker-dealers will 
only be revising and updating their current policies and procedures 
to ensure compliance with the rule. See Removal of Certain 
References to Credit Ratings Under the Securities Exchange Act of 
1934, Exchange Act Release No. 64532 (Apr. 27, 2011), 76 FR 26550, 
26568 (May 6, 2011).
    \545\ 189 broker-dealers x 10 hours = 1,890 hours.
    \546\ See NIBA 2 Letter.
---------------------------------------------------------------------------

6. Treatment of Free Credit Balances
    New paragraph (j)(2) to Rule 15c3-3 will require a broker-dealer to 
obtain the written affirmative consent of a new customer before 
including a customer's free credit balances in a Sweep Program, as well 
as to provide certain disclosures and notices to all customers with 
regard to the broker-dealer's Sweep Program.
    These requirements will result in one-time and annual burdens to 
broker-dealers subject to its provisions. However, these requirements 
will apply only to a firm that carries customer free credit balances 
and opts to have the ability to change how its customers' free credit 
balances are treated. The Commission did not receive comments regarding 
the hour burden estimates relating to the treatment of free credit 
balances in the proposing release.
    In the proposing release, the Commission estimated that 
approximately 50 broker-dealers \547\ would choose to provide new 
customers with the disclosures and notices required under the amendment 
in order to have the ability to change how their customers' free credit 
balances were treated. The Commission did not receive any comments on 
this estimate. The Commission, however, is revising this estimate for 
the final rule to include all 189 broker-dealers that carry free credit 
balances to reflect the fact that these firms may have to update their 
systems to comply with these new requirements. The Commission further 
estimates these firms will spend, on average, approximately 200 hours 
of employee resources per firm updating their current systems 
(including processes for generating customer account statements) to 
incorporate changes that will be necessitated by the amendment. 
Therefore, the Commission estimates that the total one-time burden to 
broker-dealers arising from this requirement will be approximately 
37,800 hours.\548\
---------------------------------------------------------------------------

    \547\ See Amendments to Financial Responsibility Rules, 72 FR at 
12877.
    \548\ 189 broker-dealers x 200 hours per firm = 37,800.
---------------------------------------------------------------------------

    The Commission also estimates that these firms will consult with 
outside counsel in making these systems changes, particularly with 
respect to the language in the disclosures and notices under new 
paragraph (j)(2) to Rule 15c3-3. The Commission estimates that an 
outside counsel will spend, on average, approximately 50 hours 
assisting a broker-dealer in updating its systems \549\ for a one-time 
aggregate burden to broker-dealers of 9,450 hours.\550\ The Commission 
estimates that the average hourly cost for an outside counsel will be 
approximately

[[Page 51865]]

$400 per hour.\551\ For these reasons, consistent with its estimate in 
the proposing release, the Commission estimates that the average one-
time cost to a broker-dealer will be approximately $20,000 \552\ and 
the one-time cost to broker-dealers will be approximately 
$3,780,000.\553\
---------------------------------------------------------------------------

    \549\ Because broker-dealers affected by these amendments are 
likely to already have existing sweep programs in place, a broker-
dealer likely will need to update its existing systems, rather than 
be required to purchase additional hardware to comply with these 
rule amendments.
    \550\ 189 broker-dealers x 50 hours per firm = 9,450 hours.
    \551\ Based on staff experience, the Commission used the 
estimate of $400 per hour for legal services provided by outside 
counsel, which is the same estimate used by the Commission in other 
recent releases. See Capital, Margin, and Segregation Requirements 
for Security-Based Swap Dealers and Major Security-Based Swap 
Participants and Capital Requirements for Broker-Dealers, Exchange 
Act Release 68071, 77 FR at 70297; Further Definition of ``Swap,'' 
``Security-Based Swap,'' and ``Security-Based Swap Agreement''; 
Mixed Swaps; Security-Based Swap Agreement Recordkeeping; Final 
Rule, Exchange Act Release No. 67453 (July 18, 2012), 77 FR 48208 
(Aug. 13, 2012).
    \552\ $400 per hour x 50 hours = $20,000.
    \553\ 189 broker-dealers x $20,000 = $3,780,000.
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    As for the annual hour burden, the Commission estimates, consistent 
with its estimate in the proposing release, these requirements will 
impact 5% \554\ of the total broker-dealer customer accounts per year. 
Based on FOCUS Report data, the Commission estimates there are 
approximately 110,493,215 customer accounts and, consequently, 5% of 
the accounts (5,524,661 accounts per year) will be impacted.\555\ Based 
on staff experience with similar requirements under the existing PRA 
collection for Rule 17a-3, the Commission further estimates that a 
broker-dealer will spend, on average, four minutes \556\ of employee 
resources to process a written affirmative consent for new customers, 
as well as disclosures required under paragraph (j) to Rule 15c3-3. 
Therefore, the Commission estimates that the annual burden to broker-
dealers arising from the requirement will be approximately 368,311 
hours.\557\
---------------------------------------------------------------------------

    \554\ See Amendments to Financial Responsibility Rules, 72 FR at 
12877.
    \555\ These estimates have been updated from the proposing 
release estimates of 109,300,000 customer accounts and 5% of the 
customer account or 5,465,000 accounts. Id.
    \556\ Id.
    \557\ [5,524,661 accounts x 4 minutes/account]/60 minutes = 
368,311 hours. This is an update from our proposing release estimate 
of 5,465,000 accounts x 4 minutes/account = 364,333 hours. Id. at 
12878.
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7. Documentation of Risk Management Procedures
    The amendments to Rules 17a-3 and 17a-4 will require certain large 
broker-dealers to make and keep current a record documenting credit, 
market, and liquidity risk management controls established and 
maintained by the broker-dealer to assist it in analyzing and managing 
the risks associated with its business activities. The amendment only 
will apply to broker-dealers that have more than (1) $1,000,000 in 
aggregate credit items as computed under the customer reserve formula 
of Rule 15c3-3, or (2) $20,000,000 in capital, including debt 
subordinated in accordance with Appendix D to Rule 15c3-1.
    As proposed, the amendment would have required a broker-dealer to 
create a record documenting its ``internal risk management controls.'' 
\558\ To address commenters' concerns that the proposed rule language 
was ambiguous and that the Commission should narrow the application of 
the rule, the Commission modified new paragraph (a)(23) to Rule 17a-3, 
as stated above, so that the final rule requires certain broker-dealers 
to document risk management controls established to manage market, 
credit, and liquidity risk, rather than all of its ``internal risk 
management controls.''
---------------------------------------------------------------------------

    \558\ Id. at 12899.
---------------------------------------------------------------------------

    In the proposing release, the Commission estimated that based on 
FOCUS Report data, that there would be approximately 517 broker-dealers 
that would meet the applicability threshold of this amendment 
($1,000,000 in credits or $20,000,000 in capital), and therefore would 
be subject to the proposed rule.\559\ The Commission also estimated 
that this requirement would result in a one-time burden to broker-
dealers of approximately 62,040 hours, based on the estimate that a 
broker-dealer would spend approximately 120 hours of employee resources 
augmenting its procedures to comply with the proposed rule.\560\ The 
Commission did not receive any comments on this estimate in the 
proposing release.
---------------------------------------------------------------------------

    \559\ Id. at 12878.
    \560\ 517 broker-dealers x 120 hours = 62,040 hours.
---------------------------------------------------------------------------

    In light of the change in the final rule text to require the 
documentation of controls established to manage market, credit, and 
liquidity risk, rather than all of its ``internal risk management 
controls,'' the Commission is reducing the final PRA estimate for Rule 
17a-3 because the final rule narrows the scope of internal risk 
management controls the broker-dealer is required to document. 
Consequently, the change to the final rule should result in a reduction 
in the one-time hour burden estimate. The rule does not specify the 
type of controls a broker-dealer must establish to manage these risks. 
It simply requires the documentation of the procedures the broker-
dealer has established. Broker-dealers that are part of holding 
companies may be subject to procedures that are used globally 
throughout the organization. As long as the broker-dealer maintains 
documented procedures of controls pertaining to the designated entity, 
the requirements of the rule would be met. The one-time hour burden to 
comply with the rule will vary depending on the size and complexity of 
a firm. In addition, some larger broker-dealers required to comply with 
Rule 15c3-4 (Internal Risk Management Control Systems for OTC 
Derivatives Dealers) already would be required to document their 
internal risk management control systems related to market, credit, and 
liquidity risk.\561\
---------------------------------------------------------------------------

    \561\ See 17 CFR 240.15c3-4(a).
---------------------------------------------------------------------------

    Taking this into account, as well as based on staff experience 
monitoring compliance of risk management controls of broker-dealers, 
the Commission estimates that a broker-dealer will spend, on average, 
approximately 100 hours of employee resources to comply with this 
amendment to ensure its market, credit, and liquidity risk controls are 
documented. For the reasons discussed above, including narrowing the 
scope of the final rule, the estimate of 100 hours reflects a 20% 
reduction from the estimate in the proposing release of 120 hours. 
Based on FOCUS Report data, as of December 31, 2011, the Commission 
estimates there are approximately 490 broker-dealers that would be 
subject to the final rule amendment (because the firm has $1,000,000 in 
credits or $20,000,000 in capital). Therefore, the Commission estimates 
the total one-time burden to broker-dealers will be approximately 
49,000 hours.\562\
---------------------------------------------------------------------------

    \562\ 490 broker-dealers x 100 hours = 49,000 hours.
---------------------------------------------------------------------------

    In addition to the one-time hour burden discussed in the proposing 
release,\563\ based on similar collections of information requiring the 
documentation of risk management controls,\564\ large broker-dealers 
required to comply with the amendment as adopted likely will incur 
annual hour burdens.\565\ Consequently, the Commission is incorporating 
annual hour burdens for this collection of information in the final 
rule amendments.\566\ Therefore, the Commission estimates that a 
broker-

[[Page 51866]]

dealer would spend approximately 45 hours per year to ensure its 
compliance with the amendment to Rule 17a-3, for a total annual hour 
burden to the industry of 22,050 hours.\567\
---------------------------------------------------------------------------

    \563\ See Amendments to Financial Responsibility Rules, 72 FR at 
12878.
    \564\ See Risk Management Controls for Brokers or Dealers with 
Market Access; Final Rule, Exchange Act Release No. 63241 (Nov. 3, 
2010), 75 FR 69792, 69815 (Nov. 15, 2013). See also Capital, Margin, 
and Segregation Requirements for Security-Based Swap Dealers and 
Major Security-Based Swap Participants and Capital Requirements for 
Broker-Dealers, Exchange Act Release 68071, 77 FR at 70295 and 
70297.
    \565\ See NIBA 2 Letter.
    \566\ The proposing release did not contain annual hour burden 
estimates for this collection of information.
    \567\ 490 broker-dealers x 45 hours = 22,050 hours. The 45 per 
hour annual estimate is based on a similar collection of 
information. See Risk Management Controls for Brokers or Dealers 
with Market Access; Final Rule, Exchange Act Release No. 63241 (Nov. 
3, 2010), 75 FR 69792, 69815 (Nov. 15, 2010).
---------------------------------------------------------------------------

    Additionally, the proposing release did not specifically allocate 
the estimated hour burdens with respect to the amendments to Rule 17a-3 
and 17a-4 between these two rules.\568\ As discussed above, and based 
on staff experience with the application of Rule 17a-4, the Commission 
estimates that broker-dealers meeting the threshold requirements of 
paragraph (a)(23) of Rule 17a-3 will already have documented their 
established procedures and controls to manage the risks arising from 
their business. Consequently, the amendment to Rule 17a-4 to require a 
broker-dealer to preserve the records required pursuant to paragraph 
(a)(23) of Rule 17a-3 until three years after the termination of the 
use of the risk management controls documented therein should have a 
minimal impact on the current annual hour burden for Rule 17a-4 because 
the paperwork burden associated with this amendment derives from the 
substance of the amendments to paragraph (a)(23) of Rule 17a-3. 
Therefore, the Commission is retaining the current annual hour burden 
for Rule 17a-4 without change.
---------------------------------------------------------------------------

    \568\ See Amendments to Financial Responsibility Rules, 72 FR at 
12878.
---------------------------------------------------------------------------

    Because the final rule amendment requires a broker-dealer to 
document its liquidity, credit, and market risk management controls, if 
it has established such controls, these broker-dealers may incur one-
time startup costs to hire outside counsel to review the documented 
controls to ensure the broker-dealer is meeting the requirements of the 
rule. Based on staff experience with similar reviews, the Commission 
estimates that these broker-dealers would incur $2,000 in legal 
costs,\569\ or $980,000,\570\ in the aggregate, initial one-time burden 
to review and comment on the documented risk management controls.\571\
---------------------------------------------------------------------------

    \569\ The Commission staff estimates that the review of the 
documented controls would require 5 hours of outside counsel time at 
a cost of $400 per hour. See also Capital, Margin, and Segregation 
Requirements for Security-Based Swap Dealers and Major Security-
Based Swap Participants and Capital Requirements for Broker-Dealers, 
Exchange Act Release 68071, 77 FR at 70297, n.904.
    \570\ 490 broker-dealers x $2,000 = $980,000.
    \571\ See NIBA 2 Letter.
---------------------------------------------------------------------------

8. Notice Requirements
    The amendment to Rule 17a-11 requiring notice when a broker-dealer 
becomes subject to certain insolvency events will result in irregular 
filings from a small number of broker-dealers. As noted above, SIPC's 
2012 annual report indicates that the average annual number of broker-
dealers which have become subject to a liquidation proceeding under 
SIPA over the last ten years is two. Accordingly, the Commission 
estimates that approximately two insolvency notices will be sent per 
year and that a broker-dealer will spend, on average, approximately ten 
minutes of employee resources to prepare and send the notice.\572\ The 
Commission did not receive any comments on its estimates from the 
proposing release. Therefore, the Commission estimates that the total 
annual burden to broker-dealers arising from this amendment will be 
approximately 20 minutes.\573\
---------------------------------------------------------------------------

    \572\ This is an update from the proposing release estimate of 
an average of six broker-dealers per year have become subject to a 
liquidation proceeding under SIPA, based on SIPC's 2005 annual 
report. The proposing release also contained a 10 minute estimate 
per broker-dealer (6 notices x 10 minutes per notice = 1 hour). See 
Amendments to Financial Responsibility Rules, 72 FR at 12878.
    \573\ 2 notices x 10 minutes per notice = 20 minutes.
---------------------------------------------------------------------------

    The amendment to Rule 17a-11 requires broker-dealers engaged in 
securities lending or repurchase activities to either: (1) File a 
notice with the Commission and their DEA whenever the total money 
payable against all securities loaned, subject to a reverse repurchase 
agreement or the contract value of all securities borrowed or subject 
to a repurchase agreement, exceeds 2,500% of tentative net capital; or, 
alternatively, (2) report monthly their securities lending and 
repurchase activities to their DEA in a form acceptable to their DEA. 
The Commission did not receive any comments on these specific estimates 
in the proposing release and continues to believe they are appropriate. 
As such, the Commission is adopting this amendment with a minor 
modification that does not impact the collection of information.
    In addition, based on FOCUS Report data, as of December 31, 2011, 
the Commission estimates that approximately one stock loan/borrow 
notice will be sent per year.\574\ The Commission further estimates 
that a broker-dealer will spend, on average, approximately ten minutes 
of employee resources to prepare and send the notice. Therefore, the 
Commission estimates that the total annual burden to broker-dealers 
arising from this amendment will be approximately ten minutes.\575\
---------------------------------------------------------------------------

    \574\ This estimate is an update of the proposing release 
estimate that twelve notices will be sent per year based on FOCUS 
data. See Amendments to Financial Responsibility Rules, 72 FR at 
12878. As of December 31, 2011, there were seven broker-dealers 
whose securities borrowed or securities loaned exceeded 80% of 25 
times their tentative net capital, and there were six broker-dealers 
whose securities borrowed or securities loaned exceeded 25 times 
their tentative net capital. The Commission assumes for purposes of 
the PRA that six broker-dealers would chose to file monthly reports 
in lieu of the notice requirements, and that one would file a 
notice.
    \575\ 1 notice x 10 minutes per notice = 10 minutes. This is an 
update of the proposing release estimate of 2 hours (12 notices x 10 
minutes per notice). See Amendments to Financial Responsibility 
Rules, 72 FR at 12878. The Commission does not expect broker-dealers 
to incur postage costs as a result of this amendment because most 
broker-dealers file these notices via facsimile or email. Therefore, 
any incremental postages costs will likely be minimal.
---------------------------------------------------------------------------

    Based on FOCUS Report data, as of December 31, 2011, and staff 
experience, the Commission estimates that, annually, six broker-dealers 
will submit the monthly stock loan/borrow report.\576\ Based on staff 
experience, the Commission estimates each firm will spend, on average, 
approximately 100 hours of employee resources updating its systems to 
generate the information required in the monthly report. Therefore, the 
Commission estimates that the total one-time burden to broker-dealers 
arising from this requirement will be approximately 600 hours.\577\ 
With respect to the annual hour burden, the Commission estimates each 
firm will spend, on average, approximately one hour per month (or 
twelve hours per year) of employee resources to prepare and send the 
report or to prepare the information for the FOCUS report (as required 
by the firm's DEA, if applicable). Therefore, the Commission estimates 
the total annual burden arising from this amendment will be 
approximately 72 hours.\578\
---------------------------------------------------------------------------

    \576\ This is an update from the proposing release estimate that 
21 broker-would submit a monthly report. See Amendments to Financial 
Responsibility Rules, 72 FR at 12878.
    \577\ 6 broker-dealers x 100 hours per firm = 600 hours. This is 
an update from our proposing release estimate of 2,100 hours (21 
broker-dealers x 100 hours per firm). See Amendments to Financial 
Responsibility Rules, 72 FR at 12878.
    \578\ 6 broker-dealers x 12 hours per year = 72 hours. This is 
an update from the proposing release estimate of 252 hours (21 
broker-dealers x 12 hours per year). See Amendments to Financial 
Responsibility Rules, 72 FR at 12878.

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[[Page 51867]]

E. Collection of Information Is Mandatory

    These recordkeeping and notice requirements are mandatory with the 
exception of: (1) The option for a broker-dealer to report monthly its 
securities lending activities to its DEA in lieu of filing the notice 
required under paragraph (c)(5) of Rule 17a-11; (2) the option for a 
broker-dealer to request written approval from its DEA in order to 
withdraw capital that has been contributed within one year under 
paragraph (c)(2)(i)(G)(2) of Rule 15c3-1; and (3) the option of a 
carrying broker-dealer to enter into a subordination agreement with an 
account holder in order to exclude such account holder's account from 
being treated as a PAB account under paragraph (a)(16) of Rule 15c3-3.

F. Confidentiality

    Some of the information the Commission expects to receive may be 
confidential information. The information collected under the 
amendments to Rules 15c3-1, 15c3-3, 17a-3, and 17a-4 would be stored by 
the broker-dealers and made available to the Commission, Commission 
staff, and SROs, as required in connection with examinations, 
investigations, and enforcement proceedings. The information collected 
under the amendments to Rule 17a-11 would be generated from the 
internal records of the broker-dealers. It would be provided to the 
Commission, its staff, and SROs but not on a regular basis (except for 
the optional monthly reports).
    To the extent that the Commission receives confidential information 
pursuant to these collections of information, the Commission is 
committed to protecting the confidentiality of such information to the 
extent permitted by law.\579\
---------------------------------------------------------------------------

    \579\ See, e.g., Exchange Act Section 24, 15 U.S.C. 78x 
(governing the public availability of information obtained by the 
Commission) and 5 U.S.C. 552 et seq. (Freedom of Information Act--
``FOIA''). FOIA provides at least two pertinent exemptions under 
which the Commission has authority to withhold certain information. 
FOIA Exemption 4 provides an exemption for ``trade secrets and 
commercial or financial information obtained from a person and 
privileged or confidential.'' 5 U.S.C. 552(b)(4). FOIA Exemption 8 
provides an exemption for matters that are ``contained in or related 
to examination, operating, or condition reports prepared by, on 
behalf of, or for the use of an agency responsible for the 
regulation or supervision of financial institutions.'' 5 U.S.C. 
552(b)(8).
---------------------------------------------------------------------------

    Broker-dealers will send required written notices regarding use of 
a PAB account holder's securities to its customers, as required by Rule 
15c3-3.\580\ In addition, broker-dealers will send certain notices and 
disclosures to customers regarding the treatment of their free credit 
balances under new paragraph (j)(2) to Rule 15c3-3. To the extent these 
standard notices and disclosures are made available to the Commission, 
they may not be kept confidential.
---------------------------------------------------------------------------

    \580\ See 17 CFR 15c3-3(b)(5).
---------------------------------------------------------------------------

G. Record Retention Period

    One amendment to Rule 15c3-1 will require broker-dealers to make 
disclosures to principals and obtain agreements from principals with 
respect to securities lending transactions where the broker-dealer acts 
as agent. In addition, the amendment to Rule 15c3-3 to define the term 
PAB account will require carrying broker-dealers to enter into 
subordination agreements with certain account holders if they wish 
their account to be excluded from the definition. These records will 
have to be maintained for not less than three years under paragraph 
(b)(7) of Rule 17a-4.\581\
---------------------------------------------------------------------------

    \581\ 17 CFR 240.17a-4(b)(7).
---------------------------------------------------------------------------

    The amendments to Rule 15c3-3 require broker-dealers to provide PAB 
account holders with written notice that the securities may be used in 
the ordinary course of its business, obtain the written affirmative 
consent of a new customer before including a customer's free credit 
balances in a Sweep Program, and provide certain disclosures and 
notices to all customers with regard to the broker-dealer's Sweep 
Program. These agreements relate to the terms and conditions of the 
maintenance of the customer's account and, accordingly, fall within the 
record retention requirements of paragraph (c) of Rule 17a-4.\582\ 
Under this paragraph, the records must be retained until six years 
after the closing of the customer's account. The amendments to Rule 
15c3-3 also require broker-dealers to obtain notices and contracts from 
the banks holding their PAB reserve accounts. In order to comply with 
Rule 15c3-3, broker-dealers must have these notices and contracts in 
place and documented. These records will have to be maintained for not 
less than three years under the requirements of Rule 17a-4.\583\
---------------------------------------------------------------------------

    \582\ 17 CFR 240.17a-4(c).
    \583\ 17 CFR 240.17a-4.
---------------------------------------------------------------------------

    The amendments to Rules 17a-3 and 17a-4 require broker-dealers to 
document credit, market, and liquidity risk management controls. The 
amendments to Rule 17a-4 include the establishment of a retention 
period for these records, which will be until three years after the 
termination of the use of the risk management controls documented 
therein under new paragraph (e)(9) of Rule 17a-4. The three-year 
retention period is designed to document former and current procedures 
and to provide sufficient opportunity to review the records during the 
broker-dealer's normal exam cycle.
    The amendments to Rule 17a-11 will require broker-dealers to 
provide notice or report monthly to the Commission and other regulatory 
authorities under certain circumstances. These notices and reports will 
constitute communications relating to a broker-dealer's ``business as 
such'' and, therefore, will need to be retained for three years.\584\
---------------------------------------------------------------------------

    \584\ 17 CFR 240.17a-4(b)(4).
---------------------------------------------------------------------------

V. Economic Analysis

A. Introduction

    The Commission is sensitive to the costs and benefits of its rules. 
When engaging in rulemaking that requires the Commission to consider or 
determine whether an action is necessary or appropriate in the public 
interest, section 3(f) of the Exchange Act requires that the Commission 
consider, in addition to the protection of investors, whether the 
action will promote efficiency, competition, and capital 
formation.\585\ In addition, section 23(a)(2) of the Exchange Act 
requires the Commission to consider the effects on competition of any 
rules the Commission adopts under the Exchange Act, and prohibits the 
Commission from adopting any rule that would impose a burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Exchange Act.\586\
---------------------------------------------------------------------------

    \585\ 15 U.S.C. 78c(f).
    \586\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    In the proposing release,\587\ the Commission solicited comment on 
the costs and benefits of the proposed amendments including whether 
these costs and benefits were accurate.\588\ The

[[Page 51868]]

Commission also requested that commenters identify and assess any costs 
and benefits not discussed in the proposing release. The Commission 
further encouraged commenters to provide specific data and analysis in 
support of their views.\589\ The Commission also requested comment on 
whether the proposed amendments would place a burden on competition, 
and promote efficiency, competition, and capital formation.\590\ In May 
2012, the Commission re-opened the comment period to permit commenters 
additional opportunity to address these, and any other, issues raised 
by the proposed rule amendments.\591\ The general comments received, as 
well as comments received relating to specific rule amendments, are 
discussed below.
---------------------------------------------------------------------------

    \587\ See Amendments to Financial Responsibility Rules, 72 FR at 
12879; see also Amendments to Financial Responsibility Rules for 
Broker-Dealers, Exchange Act Release No. 66910 (May 3, 2012), 77 FR 
27150 (May 9, 2012) (re-opening of comment period).
    \588\ For the purposes of this final economic analysis, the 
Commission is using salary data from the SIFMA Management & 
Professional Earnings in the Securities Industry 2012, which 
provides base salary and bonus information for middle-management and 
professional positions within the securities industry. The salary 
costs derived from the report and referenced in this cost/benefit 
section, are modified to account for an 1800-hour work year and 
multiplied by 5.35 to account for bonuses, firm size, employee 
benefits and overhead. Hereinafter, references to data derived from 
the report as modified in the manner described above will be cited 
as ``SIFMA 2012 Report as Modified.'' The proposing release used 
salary information for New York based employees derived from the SIA 
Report on Management and Professional Earnings in the Securities 
Industry 2005. See Amendments to Financial Responsibility Rules, 72 
FR at 12879, n.151.
    \589\ Id. at 12879.
    \590\ Id.
    \591\ Amendments to Financial Responsibility Rules for Broker-
Dealers, Exchange Act Release No. 66910 (May 3, 2012), 77 FR 27150 
(May 9, 2012).
---------------------------------------------------------------------------

    In adopting the rule amendments, the Commission has been mindful of 
the associated costs and benefits. The discussion focuses on the 
Commission's reasons for adopting these amendments, the affected 
parties, the costs and benefits of the amendments compared to a 
baseline, and alternative courses of action. The discussion of the 
costs of the rule amendments includes a discussion of certain 
implementation burdens and related costs,\592\ which may include 
assessment costs, personnel costs, and other costs (e.g., technology 
costs).\593\ The cost estimates and related data derived from FOCUS 
Reports discussed in the proposing release have also been updated in 
this final release to reflect more recently available data.\594\
---------------------------------------------------------------------------

    \592\ In the proposing release, the Commission estimated that 
the one-time and annual costs to broker-dealers would be $32,814,454 
and $39,651,716, respectively. See Amendments to Financial 
Responsibility Rules, 72 FR at 12887.
    \593\ As discussed in section IV. of this release, the 
Commission has estimated certain indirect burdens and related costs 
of these implementation requirements.
    \594\ See Amendments to Financial Responsibility Rules, 72 FR at 
12887. The FOCUS Report data from the proposing release was derived 
from 2004 year end numbers.
---------------------------------------------------------------------------

    Many of the benefits and costs discussed below are difficult to 
quantify, in particular when discussing enhancements in investor 
protection. For example, it is unknown how much the amendments to the 
financial responsibility rules will result in enhanced compliance with 
those rules. Therefore, much of the discussion is qualitative in nature 
but, where possible, the Commission has attempted to quantify the 
costs. However, the inability to quantify these costs and benefits does 
not mean that the costs and benefits of these rule amendments are any 
less significant.
    As discussed throughout this release, in part in response to 
comments, the Commission has modified the proposed rules to reduce 
compliance burdens where consistent with investor protection. In 
addition, where commenters identified additional costs, the Commission 
has revised its economic analysis of the final rules to take these 
costs into account. Finally, the Commission has considered all comment 
letters received related to the impact of the proposed amendments on 
efficiency, competition, and capital formation, and responds to these 
comments in the sections below discussing individual rule amendments.

B. Economic Baseline

    The regulatory changes adopted today amend requirements that apply 
to broker-dealers registered with the Commission. The discussion below 
includes the approximate numbers of broker-dealers that will be 
affected by today's amendments and a description of the economic 
baseline against which the costs and benefits, as well as the impact on 
efficiency, competition, and capital formation, of today's amendments 
are measured.
    The broker-dealers registered with the Commission vary 
significantly in terms of their size, business activities, and the 
complexities of their operations. For example, carrying broker-dealers 
hold customer securities and funds.\595\ Clearing broker-dealers clear 
transactions as members of security exchanges, the Depository Trust & 
Clearing Corporation and the Options Clearing Corporation.\596\ Many 
clearing broker-dealers are carrying broker-dealers, but some clearing 
broker-dealers clear only their own transactions and do not hold 
customer securities and cash.
---------------------------------------------------------------------------

    \595\ Rule 15c3-1 specifies that a broker-dealer shall be deemed 
to carry customer accounts ``if, in connection with its activities 
as a broker or dealer, it receives checks, drafts, or other 
evidences of indebtedness made payable to itself or persons other 
than the requisite registered broker or dealer carrying the account 
of a customer, escrow agent, issuer, underwriter, sponsor, or other 
distributor of securities'' or ``if it does not promptly forward or 
promptly deliver all of the securities of customers or of other 
brokers or dealers received by the firm in connection with its 
activities as a broker or dealer.'' 17 CFR 240.15c3-1(a)(2)(i). Rule 
15c3-3 defines the term securities carried for the account of a 
customer to mean ``securities received by or on behalf of a broker 
or dealer for the account of any customer and securities carried 
long by a broker or dealer for the account of any customer,'' as 
well as securities sold to, or bought for, a customer by a broker-
dealer. 17 CFR 240.15c3-3(a)(2).
    \596\ See Definitions of Terms and Exemptions Relating to the 
``Broker'' Exceptions for Banks, Exchange Act Release No. 56501 
(Sept. 24, 2007), 72 FR 56514 (Oct. 3, 2007), at n.269.
---------------------------------------------------------------------------

    In addition, a broker-dealer that does not hold customer securities 
and/or cash is generally referred to as a ``non-carrying broker-
dealer.'' Non-carrying broker-dealers include ``introducing brokers.'' 
\597\ These introducing broker-dealers accept customer orders and 
introduce their customers to carrying broker-dealers that hold the 
securities and cash of the customers of the introducing broker-dealers 
along with the securities and cash of their direct customers. A 
carrying broker-dealer generally receives and executes orders of the 
introducing broker-dealers' customers.\598\ Carrying broker-dealers 
generally also prepare trade confirmations, settle trades, and organize 
book entries of the securities purchased and sold.\599\ Introducing 
broker-dealers also may use carrying broker-dealers to clear the 
introducing firm's proprietary trades and carry the firm's securities. 
Another group of non-carrying broker-dealers effects transactions in 
securities like mutual funds on a subscription-way basis, where 
customers generally purchase the securities by providing the funds 
directly to the issuer.\600\ Finally, some non-carrying broker-dealers 
act as finders by referring prospective purchasers of securities to 
issuers.\601\
---------------------------------------------------------------------------

    \597\ Id. at ] 1.15; see also Net Capital Rule, Exchange Act 
Release No. 31511 (Nov. 24, 1992), 57 FR 56973 (Dec. 2, 1992) 
(describing role of introducing broker-dealers).
    \598\ Net Capital Rule, Exchange Act Release No. 31511 (Nov. 24, 
1992), 57 FR 56973 (Dec. 2, 1992).
    \599\ See, e.g., FINRA Rule 4311 (Carrying Agreements). This 
FINRA rule governs the requirements applicable to FINRA members when 
entering into agreements for the carrying of any customer accounts 
in which securities transactions can be effected. Historically, the 
purpose of this rule has been to ensure that certain functions and 
responsibilities are clearly allocated to either the introducing or 
carrying firm, consistent with the requirements of the SRO's and 
Commission's financial responsibility and other rules and 
regulations, as applicable. See also Notice of Filing of Amendment 
No. 1 and Order Granting Accelerated Approval of a Proposed Rule 
Change Adopting, as Modified by Amendment No. 1, Rules Governing 
Guarantees, Carrying Agreements, Security Counts and Supervision of 
General Ledger Accounts in the Consolidated FINRA Rulebook, Exchange 
Act Release No. 63999 (Mar. 7, 2011), 76 FR 12380 (Mar. 7, 2011).
    \600\ See Books and Records Requirement for Brokers and Dealers 
Under the Securities Exchange Act of 1934, Exchange Act Release No. 
44992 (Nov. 2, 2001) (``[T]he Commission recognizes that for some 
types of transactions, such as purchases of mutual funds or variable 
annuities, the customer may simply fill out an application or a 
subscription agreement that the broker-dealer then forwards directly 
to the issuer.'').
    \601\ See American Bar Association, Report and Recommendations 
of the Task Force on Private Placement Broker-Dealers 23-24 (2005); 
see also Net Capital Rule, Exchange Act Release No. 31511 (Nov. 24, 
1992), 57 FR 56973 (Dec. 2, 1992).

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[[Page 51869]]

    While these amendments will impact investors and markets more 
generally, the broker-dealer industry is the primary industry directly 
affected by the rule amendments. In some cases, the amendments impose 
requirements on certain types of broker-dealers that engage in specific 
activities. For example, only carrying broker-dealers that carry free 
credit balances would be subject to the requirements regarding the 
treatment of free credit balances under paragraph (j) of Rule 15c3-3. 
All broker-dealers would be subject to the requirements to deduct from 
net worth certain liabilities or expenses assumed by third parties 
under Rule 15c3-1.
    To establish a baseline for competition among broker-dealers, the 
Commission looked at the status of the broker-dealer industry detailed 
below. In terms of size, the following table provides the distribution 
of broker-dealers by total capital levels and the aggregate total 
capital within each capital bracket.

          Broker-Dealer Capital at Calendar Year End 2011 \602\
                              [$ millions]
------------------------------------------------------------------------
                                             Number of       Aggregate
                 Capital                       firms       total capital
------------------------------------------------------------------------
Less than $500,000......................           2,506            $347
Greater than or equal to $500,000 and              1,320           2,212
 less than $5 million...................
Greater than or equal to $5 million and              608          10,520
 less than $50 million..................
Greater than or equal to $50 million and              80           5,672
 less than $100 million.................
Greater than or equal to $100 million                125          26,655
 and less than $500 million.............
Greater than or equal to $500 million                 28          19,248
 and less than $1 billion...............
Greater than or equal to $1 billion and               27          61,284
 less than $5 billion...................
Greater than or equal to $5 billion and                6          41,175
 less than $10 billion..................
Greater than or equal to $10 billion....               9         175,585
                                         -------------------------------
    Total...............................           4,709         342,698
------------------------------------------------------------------------

     
---------------------------------------------------------------------------

    \602\ The information in this chart is based on FOCUS Report 
data filed by broker-dealers in 2011. The information in the 
``Aggregate Total Capital'' column is based on data reported on line 
3530 of the FOCUS Report, which includes total capital and allowable 
subordinated liabilities.
---------------------------------------------------------------------------

    According to FOCUS Report data, as of December 31, 2011, there were 
approximately 4,709 broker-dealers registered with the Commission. Nine 
broker-dealers hold over half of broker-dealers' total capital. 
Further, based on FOCUS Report data, as of December 31, 2011, the 
Commission also estimates that there are approximately 287 broker-
dealers that are clearing or carrying firms that do not claim 
exemptions pursuant to paragraph (k) of Rule 15c3-3. Based on FOCUS 
Report data, as of December 31, 2011, approximately 189 of these 
broker-dealers carry free credit balances, while 61 broker-dealers 
carry PAB accounts.
    For the purposes of this economic analysis, the baseline is the 
current customer protection, net capital, books and records, and 
notification requirements for broker-dealers promulgated under the 
Exchange Act and existing interpretations thereunder, and how they 
affect broker-dealers.
    As discussed above in section II.A.1. of this release, Rule 15c3-
3--the customer protection rule--in effect mandates a separation of 
customer assets from broker-dealer assets through two fundamental 
requirements: (1) That a carrying broker-dealer must maintain physical 
possession or control over customers' fully paid and excess margin 
securities; and (2) that a carrying broker-dealer must maintain a 
reserve of cash or qualified securities \603\ in an account at a bank 
that is at least equal in value to the net cash owed to customers, 
including cash obtained from the use of customer securities. These 
provisions are designed to require the broker-dealer to hold customer 
securities and cash in a manner that enables the prompt return of these 
assets in the event that the firm falls into financial difficulty or 
becomes insolvent. The goal of the rule is to place a broker-dealer in 
a position where it is able to wind down in an orderly self-liquidation 
without the need for financial assistance from SIPC through a formal 
proceeding under SIPA.\604\
---------------------------------------------------------------------------

    \603\ Rule 15c3-3 defines qualified securities as securities 
issued by the United States or guaranteed by the United States with 
respect to principal and interest. 17 CFR 240.15c3-3(a)(6).
    \604\ 15 U.S.C. 78aaa et seq.
---------------------------------------------------------------------------

    As discussed above in section II.E. of this release, Rule 15c3-1--
the net capital rule--requires broker-dealers to maintain a minimum 
level of net capital (meaning highly liquid capital) at all times.\605\ 
The rule requires that a broker-dealer perform two calculations: (1) A 
computation of the minimum amount of net capital the broker-dealer must 
maintain; \606\ and (2) a computation of the amount of net capital the 
broker-dealer is maintaining.\607\ The minimum net capital requirement 
is the greater of a fixed-dollar amount specified in the rule and an 
amount determined by applying one of two financial ratios: the 15-to-1 
aggregate indebtedness to net capital ratio or the 2% of aggregate 
debit items ratio.\608\ In computing net capital, the broker-dealer 
must, among other things, make certain adjustments to net worth, such 
as deducting illiquid assets, taking other capital charges, and adding 
qualifying subordinated loans.\609\ The amount remaining after these 
adjustments is defined as tentative net capital.\610\ The final step in 
computing net capital is to take prescribed percentage deductions 
(``standardized haircuts'') from the mark-to-market value of the 
proprietary positions (e.g., securities, money market instruments, and 
commodities) that are included in its tentative net capital.\611\
---------------------------------------------------------------------------

    \605\ See 17 CFR 240.15c3-1.
    \606\ See 17 CFR 240.15c3-1(a).
    \607\ See 17 CFR 240.15c3-1(c)(2). The computation of net 
capital is based on the definition of net capital in paragraph 
(c)(2) of Rule 15c3-1. Id.
    \608\ See 17 CFR 240.15c3-1(a).
    \609\ See 17 CFR 240.15c3-1(c)(2)(i)-(xiii).
    \610\ See 17 CFR 240.15c3-1(c)(15).
    \611\ See 17 CFR 240.15c3-1(c)(2)(vi).
---------------------------------------------------------------------------

    As discussed above in section II.D. of this release, Rule 17a-3 and 
17a-4--the books and records rules--require broker-dealers to make and 
keep current certain records (e.g., trade blotters, asset and liability 
ledgers, income ledgers, customer account ledgers, etc.), which must be 
maintained in a specific manner for required retention

[[Page 51870]]

periods.\612\ Finally, Rule 17a-11--the notification rule--requires a 
broker-dealer to notify the Commission and its DEA when certain events 
occur, such as if it fails to maintain certain levels of net 
capital.\613\
---------------------------------------------------------------------------

    \612\ 17 CFR 240.17a-3; 17 CFR 240.17a-4.
    \613\ 17 CFR 240.17a-11.
---------------------------------------------------------------------------

    The specific requirements as well as the benefits and costs of each 
amendment and how broker-dealers will be affected are discussed in more 
detail in the sections below.

C. Discussion of General Comments Received

    As stated above, in the proposing release, the Commission requested 
comment on estimates and views regarding the costs and benefits for 
particular types of market participants, as well as any other costs and 
benefits that may result from the adoption of the proposed rules.\614\ 
In response to this specific request, the Commission received two 
comment letters.\615\ The first commenter who was explicitly addressing 
the Commission's Initial Regulatory Flexibility Analysis stated that 
the Commission should pay ``explicit attention to regulatory trends in 
the rest of the world'' because doing so ``benefits not only small 
entities [the focus of the Initial Regulatory Flexibility Analysis] (by 
reducing their regulatory burden) but all entities, as larger entities 
can experience more consistent regulatory procedures around the 
world.'' \616\ The commenter suggested that the Commission consider a 
``Basel II type approach to net capital requirements.'' \617\ The 
second commenter requested that the Commission publish an update to all 
statistics and costs referenced in the proposing release.\618\ The 
commenter further requested that, once published, the Commission reopen 
the comment period so that comments could be provided based on 
``current conditions and statistics.'' \619\
---------------------------------------------------------------------------

    \614\ See Amendments to Financial Responsibility Rules, 72 FR at 
12879.
    \615\ See Angel Letter; NIBA 2 Letter.
    \616\ See Angel Letter.
    \617\ Id.
    \618\ See NIBA 2 Letter.
    \619\ Id.
---------------------------------------------------------------------------

    In response to the first commenter's request that the Commission 
should explicitly examine the alternatives used by regulators in other 
jurisdictions,\620\ in adopting the final rule amendments today, as 
discussed throughout this section, the Commission considered reasonable 
alternatives, including alternatives in other jurisdictions, as well as 
the costs and benefits of the amendments. Moreover, the amendments 
relate to discrete areas of the broker-dealer financial responsibility 
rules (i.e., they do not establish new financial responsibility 
standards such as would be the case if the Commission were to adopt a 
``Basel II type approach to net capital requirements.''). Consequently, 
the commenter's suggestion is beyond the scope of this rulemaking.\621\
---------------------------------------------------------------------------

    \620\ See Angel Letter.
    \621\ The commenter cited the JP Morgan Letter in support of the 
suggestion to ``consider regulatory trends in the rest of the 
world.'' Id. The JP Morgan Letter recommends that the Commission 
adopt a due diligence standard--citing a U.K. regulation--with 
respect to the amendments regarding customer reserve account cash 
deposits. See JP Morgan Letter. The Commission addresses this 
comment below in section V.D.1.i.b.(III) of this release.
---------------------------------------------------------------------------

    In response to the second commenter, the Commission is publishing 
updated costs and statistics in this release. The Commission, however, 
believes that it is unnecessary to reopen the comment period to obtain 
comment on the updated statistics for several reasons. First, in 
proposing the rule changes, the Commission included then current 
estimates in the proposing release. Second, as noted above, the 
Commission reopened the comment period in 2012.\622\ The reopening of 
the comment period afforded commenters an additional opportunity to 
comment on the proposed rules (including estimated costs and benefits), 
given the economic events since the rule amendments were proposed, the 
regulatory developments, the comments received on the proposed 
amendments, the continuing public interest in the proposed amendments, 
and the passage of time.\623\ The Commission received a total of 97 
comment letters on the proposed amendments.\624\ As discussed below, in 
many cases, the revised data included in this release reflects a 
decrease in overall costs because of the decline in the total number of 
broker-dealers (including the number of broker-dealers that will be 
affected by each of these rule amendments). As of the 2004 year end, 
the number of registered broker-dealers was 6,339. As of the 2011 year 
end, the number of registered broker-dealers was 4,709, reflecting a 
net decrease of 1,630 (or 26%) in the number of registered broker-
dealers. Consequently, many of the aggregate costs included in the 
proposing release have declined due to the decrease in the number of 
registered broker-dealers.
---------------------------------------------------------------------------

    \622\ Amendments to Financial Responsibility Rules for Broker-
Dealers, Exchange Act Release No. 66910 (May 3, 2012), 77 FR 27150 
(May 9, 2012).
    \623\ Id.
    \624\ See supra note 6.
---------------------------------------------------------------------------

    Further, the costs incurred by a broker-dealer to comply with the 
rule amendments will generally depend, among other factors, on the size 
and complexity of its business activities. Because the size and 
complexity of broker-dealers varies significantly, their costs also 
could vary significantly. In some cases, the Commission provided in the 
proposing release, and is providing here, estimates of the average cost 
per broker-dealer, taking into consideration the variance in size and 
complexity of the business activities of broker-dealers. In other 
cases, the cost impact to broker-dealers will depend on whether the 
broker-dealer is conducting activities that are subject to the rule 
amendments. For example, the amendments to Rule 15c3-3 will apply, for 
the most part, only to broker-dealers that carry PAB accounts (e.g., 
PAB account amendment), have a reserve deposit requirement (e.g., 
reserve bank account amendments), or carry free credit balances (e.g., 
free credit balance amendments). These amendments would have no direct 
cost impact on non-carrying broker-dealers, many of which are small 
broker-dealers. Moreover, given that some amendments are largely 
codifications of existing Commission and staff guidance (e.g., 
amendments related to PAB accounts, third parties assuming broker-
dealer liabilities, temporary capital contributions, and fidelity bond 
deductions), any economic effects, including costs and benefits, should 
be compared to the baseline of current practice. Broker-dealers that 
are already complying with these requirements would not be expected to 
incur substantial costs to comply with these amendments.
    The second commenter also stated that broker-dealers are dealing 
with relatively static commission and fee schedules in comparison to 
what they might charge customers, and, as such, broker-dealers will be 
unable to pass on any cost increases resulting from these rule 
amendments directly to customers.\625\ The commenter stated that these 
cost increases over a relatively short period of time threaten the 
viability of all small broker-dealers, irrespective of their business 
line types or classes.\626\ The commenter noted that the estimates 
provided by the Commission utilized only the number of broker-dealers 
in its estimate that the Commission justifiably considered to be 
affected by the proposals.\627\ In contrast, the commenter believes 
that most, if not all broker-dealers will spend over 90 hours each 
analyzing the effects of these

[[Page 51871]]

proposals and, if the rules are implemented, will spend much more than 
90 hours each in implementing procedures to comply with the new rules. 
The commenter also believes that implementation will require broker-
dealers to modify their written supervisory procedures and supervisory 
controls, and broker-dealers will spend in excess of 240 hours each in 
the monitoring of such rules on an ongoing basis. Consequently, the 
commenter believes that each broker-dealer will spend in excess of 
$15,000 for outside counsel and auditor opinions or work product.\628\ 
This commenter did not provide additional detail about the basis for 
its view that the Commission's estimates were too low.
---------------------------------------------------------------------------

    \625\ See NIBA 2 Letter.
    \626\ Id.
    \627\ Id.
    \628\ Id.
---------------------------------------------------------------------------

    As stated above in section IV. of this release, the Commission 
agrees with the commenter that the broker-dealers directly affected by 
the rule amendments may be required to implement procedures or modify 
their written supervisory procedures to comply with the rule 
amendments. In cases where the rule amendments require a broker-dealer 
to directly implement or document certain policies and procedures, 
these hour burdens and costs already are incorporated into the PRA 
costs discussed above in section IV. of this release, and incorporated 
into the discussion below.\629\ In response to the commenter, the 
Commission also acknowledges that a broker-dealer may need to review 
its operations to determine whether it has any obligations under the 
rule amendments. Even if the broker-dealer is not affected by the rule 
amendments, such a review may result in an indirect effect on its 
operations. These indirect costs are discussed in more detail below. In 
adopting these final rules, as discussed throughout the release, 
including this economic analysis, the Commission has sought to take 
into account the costs and benefits associated with each particular 
rule amendment. The Commission has also considered the indirect costs 
that a broker-dealer would incur to assess the impact of these final 
rule amendments.
---------------------------------------------------------------------------

    \629\ See, e.g., paragraph (j)(1) of Rule 15c3-3 and paragraph 
(a)(23) of Rule 17a-3, as adopted.
---------------------------------------------------------------------------

    The Commission estimates that a broker-dealer likely will hire 
outside counsel to assess the impact of the final rules on the broker-
dealer's operations because all broker-dealers may be affected by the 
final rules, including non-carrying broker-dealers that may be affected 
by certain amendments, such as the Rule 15c3-1 amendments regarding 
third party liabilities or temporary capital contributions. Whether a 
broker-dealer determines to incur such assessment costs will depend on 
the nature and size of the broker-dealer's business and the range of 
activities the broker-dealer conducts. Therefore, while the Commission 
cannot estimate an aggregate assessment cost for all broker-dealers, 
the Commission estimates that these assessment costs would range 
approximately from $2,000 to $30,000 \630\ per broker-dealer.\631\
---------------------------------------------------------------------------

    \630\ These costs estimates include hour estimates in the range 
of 5 hours to 75 hours for outside counsel assessment review. A 
small broker-dealer may hire outside counsel to review only 1 or 2 
of the final rule amendments for approximately 5 hours x $400 per 
hour = $2,000. See Business Conduct Standards for Security-Based 
Swap Dealers and Major Security-Based Swap Participants, Exchange 
Act Release No. 64766, 76 FR 42396 (June 29, 2011), 76 FR 42396 
(July 18, 2011) (applying the estimated cost of $400 for legal 
services by outside counsel). See also Further Definition of ``Swap 
Dealer,'' ``Security-Based Swap Dealer,'' ``Major Swap 
Participant,'' ``Major Security-Based Swap Participant'' and 
``Eligible Contract Participant'', Exchange Act Release No. 66868 
(Apr. 27, 2012), 77 FR 30596 (May 23, 2012) (noting that the review 
of the final rules by outside counsel for a large firm would 
generally cost more because the review would be more complex).
    \631\ As discussed above, and in section IV. of this release, 
broker-dealers directly affected by a specific rule amendment may be 
required to implement procedures or modify their written supervisory 
procedures in order to comply with the rule amendments. The hours 
and related costs are discussed in section IV. of this release, and 
are incorporated into the specific sections below discussing each 
rule amendment. Therefore, while the range of hours is less than 90 
hours (as suggested by the commenter), the Commission has adjusted 
other specific hour and cost estimates (in sections IV. and V. of 
this release) in response to the commenter's concerns, and believes 
these adjusted estimates, in totality, for the reasons discussed 
above, adequately address the estimated costs as well as the 
commenter's concerns. See NIBA 2 Letter.
---------------------------------------------------------------------------

D. Economic Analysis of the Amendments and Alternatives

    This section discusses costs and benefits of the rule amendments 
for the affected parties against the economic baseline identified 
above, both in terms of each of the specific changes from the baseline 
and in terms of the overall impact. In considering costs, benefits, and 
overall impact, this discussion addresses comments received, 
modifications made to the proposed amendments, and reasonable 
alternatives, where applicable.
    This section also discusses the Commission's considerations on the 
burden on competition, and the promotion of efficiency, competition, 
and capital formation.\632\ In significant part, the effects of the 
final rules on efficiency and capital formation are linked to the 
effects of these rules on competition. Competitive markets are 
generally expected to promote an efficient allocation of capital. Rules 
that promote, or do not unduly restrict, investor participation and 
competition in the broker-dealer industry can be accompanied by 
regulatory benefits that may reduce the risk of market failure and thus 
promote market efficiency and capital formation.
---------------------------------------------------------------------------

    \632\ In the proposing release, the Commission stated that its 
preliminary view was that the proposed amendments promote 
efficiency, competition, and capital formation and would not have 
any anti-competitive effects. See Amendments to Financial 
Responsibility Rules, 72 FR at 12887.
---------------------------------------------------------------------------

1. Amendments to the Customer Protection Rule
i. Economic Analysis
a. Proprietary Accounts of Broker-Dealers
(I). Summary of Amendments
    Today's amendments to Rules 15c3-3 and 15c3-3a require carrying 
broker-dealers to: (1) Perform a separate reserve computation for PAB 
accounts (in addition to the customer reserve computation currently 
required under Rule 15c3-3); \633\ (2) establish and fund a separate 
reserve account for the benefit of the PAB account holders; \634\ and 
(3) obtain and maintain physical possession or control of securities 
carried for a PAB account, unless the carrying broker-dealer has 
provided written notice to the PAB account holder that the securities 
may be used in the ordinary course of its securities business, and has 
provided opportunity for the PAB account holder to object.\635\ In 
addition to the amendments to Rules 15c3-3 and 15c3-3a, the Commission 
is adopting amendments to Rule 15c3-1 that will require a broker-dealer 
to deduct from net capital cash and securities held in a securities 
account at a carrying broker-dealer except where the account has been 
subordinated to the claims of creditors of the carrying broker-
dealer.\636\
---------------------------------------------------------------------------

    \633\ 17 CFR 250.15c3-3(e)(3).
    \634\ 17 CFR 240.15c3-3(e)(1).
    \635\ 17 CFR 240.15c3-3(b)(5).
    \636\ 17 CFR 240.15c3-1(c)(2)(iv)(E).
---------------------------------------------------------------------------

    As discussed above in section II.A.2. of this release, there is a 
disparity between the customer reserve requirements in Rule 15c3-3 and 
the treatment of customers in a liquidation proceeding under SIPA.\637\ 
Broker-dealers are not within the definition of customer for the 
purposes of Rule 15c3-3.\638\ Accordingly, a carrying broker-dealer 
that carries PAB accounts is not required to treat these accounts as 
customer accounts for the purposes of Rule 15c3-3. However, the 
definition of customer in SIPA is broader than the

[[Page 51872]]

definition in Rule 15c3-3 in that the SIPA definition does not exclude 
broker-dealers.\639\
---------------------------------------------------------------------------

    \637\ 15 U.S.C. 78aaa et seq.
    \638\ 17 CFR 240.15c3-3(a)(1).
    \639\ See 15 U.S.C. 78lll(a).
---------------------------------------------------------------------------

    SIPA customers are entitled to a number of protections if their 
broker-dealer fails and is liquidated in a SIPA proceeding, including 
the right to share pro rata with other SIPA customers in the customer 
property held by the broker-dealer and, if the fund of customer 
property is insufficient to make each SIPA customer whole, the 
entitlement to receive an advance from the SIPC fund of up to $500,000 
(of which only $250,000 can be used to cover cash claims).\640\ Broker-
dealers that are SIPA customers have the right to share pro rata in 
customer property.\641\ Consequently, when a carrying broker-dealer is 
liquidated in a SIPA proceeding, each customer (including a SIPA 
customer that is a broker-dealer) has a claim on the customer property. 
However, because the possession and control and customer reserve 
account provisions of Rule 15c3-3 do not apply to PAB account holders 
by virtue of the definition of customer in the rule, the carrying 
broker-dealer is not restricted from using the securities and cash in 
these accounts for its business purposes.
---------------------------------------------------------------------------

    \640\ See 15 U.S.C. 78fff-2(c) and 15 U.S.C. 78fff-3(a), 
respectively. Under SIPA, the term customer property includes ``cash 
and securities . . . at any time received, acquired, or held by or 
for the account of the debtor from or for the securities accounts of 
a customer, and the proceeds of any such property transferred by the 
debtor, including property unlawfully converted.'' Therefore, 
customer property includes those securities positions that are held 
for customers and the cash that is owed to customers. 15 U.S.C. 
78lll(4).
    \641\ See 15 U.S.C. 78fff-2(c). Broker-dealers, however, are not 
entitled to receive an advance from the SIPC fund. 15 U.S.C. 78fff-
3(a).
---------------------------------------------------------------------------

    The treatment of PAB account holders as customers for the purposes 
of SIPA but not as customers for the purposes of Rule 15c3-3 increases 
the risk that, in the event that a carrying broker-dealer is liquidated 
under SIPA, the claims of all SIPA customers will exceed the amount of 
customer property available and, thereby, expose the SIPC fund and 
potentially SIPA customers to losses. In addition, if the customer 
property is insufficient to satisfy fully all SIPA customer claims, and 
losses are incurred, the broker-dealer SIPA customers could be 
potentially placed in financial distress causing adverse effects to the 
securities markets, in addition to the adverse effects resulting from 
the failure of the carrying broker-dealer.\642\
---------------------------------------------------------------------------

    \642\ As noted above, while broker-dealers are customers for the 
purposes of SIPA, they are not entitled to the advances from the 
SIPC fund of up to $500,000 (limited to $250,000 for cash claims) 
allowed under SIPA to make up for potential shortfalls after the pro 
rata distribution of customer property. 15 U.S.C. 78fff-3(a).
---------------------------------------------------------------------------

    The amendments address the disparity between the customer reserve 
requirements in Rule 15c3-3 and the treatment of customers in a 
liquidation proceeding under SIPA by requiring broker-dealers to 
reserve for the amount that credits exceed debits with respect to 
broker-dealer accounts. The amendments create a process that protects 
customers and PAB account holders of a failed carrying broker-dealer, 
and are designed to provide such protection by mitigating the risk that 
there will be insufficient customer property to fully satisfy all 
customer claims in a SIPA liquidation. By requiring the protection of 
PAB account holders (who qualify as customers under SIPA), the 
amendments to Rule 15c3-3 also reduce the risk that advances from the 
SIPC fund would be necessary to protect customer claims.
    The amendments to Rule 15c3-1 are intended to prevent broker-
dealers from including in their net capital amount assets that may not 
be readily available to be returned to such broker-dealer account 
holders because the assets would not be subject to the PAB account 
provisions under Rules 15c3-3 and 15c3-3a. The amendments to Rule 15c3-
1 also provide consistency with the exclusions from the definition of 
PAB account in paragraph (a)(16) of Rule 15c3-3.
    Overall, the PAB-related amendments to Rules 15c3-3, 15c3-3a, and 
15c3-1 should serve to reduce certain risks to investors and PAB 
account holders and, thereby, strengthen customer protection. The 
Commission requested comment on available metrics to quantify these 
benefits and any other benefits a commenter may identify. The 
Commission did not receive any comments in response to this request.
(II). Baseline and Incremental Economic Effects
    Under the no-action relief set forth in the PAIB Letter,\643\ 
discussed in section II.A.2 of this release, broker-dealers currently 
perform a reserve computation for domestic broker-dealer accounts and 
have obtained the necessary agreements and notices from the banks 
holding their PAIB reserve deposits. Therefore, as compared to the 
baseline of current Rule 15c3-1 and existing interpretations and 
guidance thereunder, including the no-action relief set forth in the 
PAIB Letter, the amendments will likely result only in small 
incremental benefits and costs because the final rule codifies many of 
the provisions of the PAIB Letter.\644\
---------------------------------------------------------------------------

    \643\ See PAIB Letter.
    \644\ See section II.B. of this release. The PAIB Letter is 
being withdrawn as of the effective date of these rule amendments.
---------------------------------------------------------------------------

    Incorporation of certain aspects of the PAIB Letter into Rule 15c3-
3 is intended to provide broker-dealers with more certainty with 
respect to the PAB requirements because these requirements will be 
expressly stated in a Commission rule. Moreover, the PAB final rule 
amendments will not impose a significant additional burden on broker-
dealers presently utilizing the interpretive relief provided in the 
PAIB Letter since the provisions of the final rule amendments are 
substantially similar. Relative to the baseline, there will be economic 
differences to the extent that carrying broker-dealers are currently 
not following the PAIB Letter, as compliance with conditions of the 
PAIB Letter are voluntary, while the PAB amendments to Rule 15c3-3 will 
be mandatory for the carrying broker-dealers subject to its 
requirements. Consequently, to the extent that carrying broker-dealers 
are not currently complying with the PAIB Letter, and to the extent the 
amendments as adopted differ from the PAIB Letter, they may incur 
incremental costs, including possible costs of capital as firms 
reallocate capital to comply with the rule amendments.
(III). Alternatives
    In adopting these amendments, the Commission considered 
alternatives suggested by commenters on specific provisions of the 
rule, and incorporated some of these alternative approaches into the 
final rule amendments.
    Two commenters raised concerns about the proposed definition of the 
term PAB account, because by including proprietary accounts of foreign 
broker-dealers and foreign banks acting as broker-dealers within the 
definition, the definition would differ from provisions in the PAIB 
Letter, which excluded such accounts from a PAIB computation.\645\ The 
first commenter suggested allowing broker-dealers to ``opt out'' of the 
rule.\646\ The second commenter stated that foreign broker-dealers and 
foreign banks acting as broker-dealers should be allowed to subordinate 
their claims to customers and creditors of the broker-dealer to remove 
their accounts from PAB account treatment because under SIPA foreign 
broker-dealers and foreign banks acting as broker-dealers, under 
certain circumstances, will not be deemed customers and, therefore,

[[Page 51873]]

would not be entitled to a pro rata share of the estate of customer 
property in a SIPA liquidation.\647\ More specifically, the commenter 
suggested that, to parallel the language in SIPA,\648\ the Commission 
modify the definition of PAB account to exclude ``any foreign broker-
dealer and foreign bank, to the extent that such entity has a claim for 
cash or securities that is subordinated to the claims of creditors of 
the carrying broker-dealer.'' This commenter also recommended that the 
subordinating broker-dealer would need to follow the requirements for 
non-conforming subordinated loans to remove an account from being 
treated as a PAB account.\649\
---------------------------------------------------------------------------

    \645\ See Dresdner Kleinwort Letter; Deutsche Bank Securities 
Letter.
    \646\ See Dresdner Kleinwort Letter.
    \647\ See Deutsche Bank Securities Letter.
    \648\ Id. The definition of customer in SIPA excludes any 
person, to the extent that ``such person has a claim for cash or 
securities which by contract, agreement, or understanding, or by 
operation of law, is part of the capital of the debtor, or is 
subordinated to the claims of any or all creditors of the debtor, 
notwithstanding that some ground exists for declaring such contract, 
agreement, or understanding void or voidable in a suit between the 
claimant and the debtor.'' 15 U.S.C. 78lll(2)(C)(ii).
    \649\ See Deutsche Bank Securities Letter.
---------------------------------------------------------------------------

    In response to commenters' concerns and suggested alternatives, the 
Commission is excluding from the PAB account definition accounts that 
have been subordinated to the claims of creditors of the carrying 
broker-dealer. Consequently, this provision will provide flexibility to 
carrying broker-dealers and their broker-dealer affiliates to structure 
their PAB account relationships in a manner that permits operational 
efficiencies (i.e., the ability to exclude these accounts from the PAB 
reserve computation) while still promoting the goal of the amendments 
to have a consistent treatment of these accounts under Rule 15c3-3 and 
SIPA, and thereby protect accounts holders that are customers under 
SIPA. As discussed below, however, the requirement to enter into a 
subordination agreement with certain account holders to exclude them 
from the definition of PAB account may result in a one-time cost to 
broker-dealers.
    In addition, in the proposing release, the Commission proposed to 
require that a carrying broker-dealer obtain written permission from a 
PAB account holder before it could use the securities of the PAB 
account holder in the ordinary course of its securities business. One 
commenter stated that this provision should be eliminated from the 
proposed amendments, arguing that it interferes unnecessarily in the 
contractual arrangements between broker-dealers, which are capable of 
understanding the terms of standard industry custodial relationships 
and that the PAIB Letter did not contain any such requirements. The 
Commission considered this alternative and believes that an appropriate 
level of protection for PAB account holders will be achieved by 
requiring the carrying broker-dealer to provide written notice to the 
PAB account holders that the firm may use their non-margin securities 
in the ordinary course of its securities business. The written notice 
requirement in the final rule will increase protection for PAB account 
holders from the status quo without imposing substantial burdens on 
existing account relationships. The revised rule will alert PAB account 
holders to the fact that the carrying broker-dealer may use their 
securities in its business for its own benefit, thereby reducing 
possible contractual ambiguity between the PAB account holder and the 
broker-dealer. The revised rule also will provide a PAB account holder 
the opportunity to seek to move the account to another broker-dealer or 
to negotiate different terms with regard to the use of its securities. 
Finally, this amendment will eliminate the need for, and the costs that 
would result from, carrying broker-dealers reworking existing 
contracts.
    An alternative considered in adopting the PAB-related amendments to 
Rule 15c3-1 would have required a broker-dealer, when calculating net 
capital, to deduct from net worth cash and securities held in a 
securities account at another broker-dealer, if the other broker-dealer 
does not treat the account, and the assets in the account, in 
compliance with the applicable PAB requirements of the rule.\650\ 
Although the proposing release stated that the Commission did not 
expect broker-dealers to audit or examine their carrying broker-dealers 
to determine whether such firms were in compliance with the proposed 
rule, commenters expressed concern that the proposed rule text 
suggested that broker-dealers in fact would have such an 
obligation.\651\ There were also concerns expressed that a broker-
dealer should not be deemed to have violated the net capital rule 
because its carrying firm fails to properly perform requirements solely 
applicable to the carrying firm and that Rule 15c3-1 should be modified 
to clarify that cash and securities held in a securities account at 
another broker-dealer are not subject to the deduction specified in 
paragraph (c)(2)(iv)(E) of Rule 15c3-1.\652\ In response to these 
concerns, the Commission has modified the language in the Rule 15c3-1 
to eliminate the proposed capital charge that would have resulted from 
a failure of a carrying broker-dealer to comply with the PAB 
requirements. Instead, the Commission has adopted amendments providing 
that a broker-dealer need not deduct cash and securities held in a 
securities account at another broker-dealer, with one exception. As 
discussed in section II.A.2. of this release, the exception generally 
parallels the exclusions from the definition of PAB account in Rule 
15c3-3.
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    \650\ See section II.A.2.v. of this release.
    \651\ See SIFMA 2 Letter.
    \652\ Id.
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(IV). Compliance Cost Estimates
    The Commission is mindful of the compliance costs associated with 
the final PAB rule amendments. In particular, the Commission recognizes 
that, though many requirements of the PAB rule amendments being adopted 
by the Commission today are incorporated from the PAIB Letter, there 
may be incremental imposed costs. For example, as discussed above in 
section II.A.2. of this release, because the possession and control and 
customer reserve account provisions of Rule 15c3-3 do not apply to PAB 
account holders by virtue of the definition of customer in the rule, 
the carrying broker-dealer is not restricted from using the securities 
and cash in those accounts for its own business purposes. Broker-
dealers carrying PAB accounts will be required to comply with the final 
PAB rule amendments, in contrast to the provisions of the PAIB Letter, 
which are voluntary.\653\ To the extent that carrying broker-dealers 
are not currently complying with the PAIB Letter, or to the extent the 
amendments as adopted differ from the PAIB Letter, they may incur 
incremental costs, including possible costs of capital as firms 
reallocate capital to comply with the rule amendments.
---------------------------------------------------------------------------

    \653\ See PAIB Letter.
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    The requirement to enter into a subordination agreement with 
certain account holders to exclude them from the definition of PAB 
account,\654\ the requirement to provide written notice to PAB account 
holders that their securities may be used in the ordinary course of the 
carrying broker-dealer's securities business,\655\ the requirement

[[Page 51874]]

to amend the standard PAB agreement templates,\656\ and the need to 
update systems to implement the necessary changes \657\ may also impose 
one-time costs. In addition, a carrying broker-dealer will incur 
postage costs as a result of the requirement to send written notices to 
PAB account holders regarding the use of their non-margin securities, 
as well as outside counsel fees to review the notice and standard PAB 
agreement template.\658\ Finally, the requirements to compute and 
establish a separate reserve for PAB accounts will result in annual 
costs to carrying broker-dealers to the extent that these requirements 
will lengthen the time needed to compute and establish the PAB reserve 
account under the PAIB Letter. The Commission estimates that these 
requirements would impose one-time and annual costs in the aggregate of 
approximately $6,434,840 \659\ and $2,709,210,\660\ respectively.
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    \654\ The internal hours for this requirement would likely be 
performed by an in-house Attorney at $379 per hour. Therefore the 
estimated internal cost would be calculated as follows: $379 per 
hour x 13,420 hours = $5,086,180. See also section IV.D.3. of this 
release.
    \655\ The internal hours required to draft the notice would 
likely be performed by an in-house Attorney at $379 per hour. The 
estimated internal cost would be calculated as follows: $379 per 
hour x 610 hours = $231,190. The internal hours required to send out 
the notices would likely be performed by a Compliance Clerk at $63 
per hour, resulting in an internal estimated cost calculated as 
follows: $63 per hour x 259 hours = $16,317. See also section 
IV.D.4. of this release.
    \656\ The internal hours would likely be performed by an in-
house Attorney at $379 per hour, resulting in an internal estimated 
cost calculated as follows: $379 per hour x 1,220 hours = $462,380. 
See also section IV.D.4. of this release.
    \657\ The internal hours would likely be performed by a Senior 
Programmer at $282 per hour, resulting in the estimated internal 
cost calculated as follows: $282 per hour x 1,830 hours = $516,060. 
See also section IV.D.4. of this release.
    \658\ The estimated postage costs are calculated as follows: 
1,551 notices x $0.46 = $713.46. To review and comment on the notice 
and PAB templates, the estimated outside counsel burden is $122,000, 
in aggregate. See also section IV.D.4. of this release.
    \659\ See section IV.D.3 and 4. of this release ($5,086,180 + 
$231,190 + $16,317 + $462,380 + $516,060 + $713.46 + $122,000 = 
$6,434,840.46).
    \660\ The internal hours would likely be performed by a 
Financial Reporting Manager at $294 per hour, resulting in the 
estimated internal cost calculated as follows: $294 per hour x 9,215 
hours = $2,709,210. See also section IV.D.4. of this release.
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    As noted above, the Commission requested comment on the proposed 
cost estimates.\661\ In particular, the Commission requested comment on 
whether there would be additional costs to broker-dealers as a 
consequence of these proposals. The Commission requested comment on 
whether these requirements would result in such costs and, if so, how 
to quantify the costs. The Commission also requested comment on whether 
these proposals would impose costs on other market participants, 
including broker-dealer customers. Commenters were also asked to 
identify the metrics and sources of any empirical data that support 
their cost estimates. The Commission did not receive any comments in 
response to these requests.
---------------------------------------------------------------------------

    \661\ See Amendments to Financial Responsibility Rules, 72 FR at 
12880. In the proposing release, the Commission estimated that the 
one-time and annual costs to broker-dealers resulting from these 
proposed amendments would be $603,000 and $2,599,399. Id.
---------------------------------------------------------------------------

b. Banks Where Special Reserve Deposits May Be Held
(I). Summary of Amendments
    As amended, paragraph (e) of Rule 15c3-3 requires carrying broker-
dealers to deposit cash or qualified securities into their customer or 
PAB reserve account, which must be maintained at a ``bank.'' \662\ As 
adopted, the final rule excludes when determining whether a broker-
dealer maintains the minimum deposits required under paragraph (e) of 
Rule 15c3-3: (1) Cash deposited with an affiliated bank; and (2) cash 
deposited at a ``non-affiliated bank to the extent that the amount of 
the deposit exceeds 15% of the bank's equity capital as reported by the 
bank in its most recent Call Report or any successor form the bank is 
required to file by its appropriate Federal banking agency (as defined 
by Section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813)).''
---------------------------------------------------------------------------

    \662\ The term qualified securities is defined in paragraph 
(a)(6) of Rule 15c3-3 to mean securities issued by the United States 
or guaranteed by the United States with respect to principal and 
interest. 17 CFR 240.15c3-3(a)(6). The term bank is defined in 
paragraph (a)(7) of Rule 15c3-3 as a ``bank as defined in section 
3(a)(6) of the Act and will also mean any building and loan, savings 
and loan or similar banking institution subject to the supervision 
by a Federal banking authority.'' See paragraph (a)(7) to Rule 15c3-
3, as adopted.
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    Under paragraph (f) of Rule 15c3-3, a broker-dealer is currently 
required to obtain a written contract from the bank wherein the bank 
agrees not to re-lend or hypothecate the qualified securities deposited 
into the reserve account.\663\ This means that the bank cannot use the 
qualified securities in its business, which provides a measure of 
protection by requiring that the securities will be available to the 
broker-dealer if the bank falls into financial difficulty. Cash 
deposits, however, may be freely used in the course of the bank's 
commercial activities. Therefore, because they do not have that same 
type of protection, the amendments to Rule 15c3-3 enhance customer 
protection by prohibiting a carrying broker-dealer from holding 
customer cash deposits at its affiliated bank and establishing 
requirements designed to avoid the situation where a carrying broker-
dealer's cash deposits constitute a substantial portion of the bank's 
deposits.
---------------------------------------------------------------------------

    \663\ 17 CFR 240.15c3-3(f).
---------------------------------------------------------------------------

    Customer cash deposits may be at risk if a carrying broker-dealer 
does not exercise due diligence when assessing the financial soundness 
of an affiliated bank with the same degree of impartiality and care as 
it would with an unaffiliated bank. The situation where a broker-
dealer's cash constitutes a substantial portion of a bank's deposits 
also poses a risk that some or all of the cash deposits may not be 
readily available for quick withdrawal by the broker-dealer. Depending 
on the relative size of the deposit, a lost deposit that is large 
relative to the broker-dealer's capital could cause the firm to 
fail.\664\ If the broker-dealer fails and the deposit is not recovered, 
the SIPC fund may not recover advances that it has made for the purpose 
of returning customer assets. To the extent that customer losses exceed 
the SIPA advance limits, customers may suffer permanent losses.
---------------------------------------------------------------------------

    \664\ See Amendment to the Financial Responsibility Rules for 
Broker-Dealers, 72 FR at 12880.
---------------------------------------------------------------------------

    The amendment to Rule 15c3-3 should serve to reduce certain risks 
to investors in the event of a bank's failure and, thereby, enhance 
customer protection. The Commission requested comment on available 
metrics to quantify these benefits and any other benefits a commenter 
may identify. Commenters were also requested to identify sources of 
empirical data that could be used for the proposed metrics. The 
Commission did not receive any comments in response to these requests.
(II). Baseline and Incremental Economic Effects
    The current baseline for the amendment to paragraph (e) of Rule 
15c3-3 is the existing customer protection requirements under Rule 
15c3-3 and interpretations of the rule. Under paragraph (e) of Rule 
15c3-3, broker-dealers are currently required to deposit cash or 
qualified securities into the customer reserve account, which must be 
maintained at a ``bank.'' Under current interpretations, broker-dealers 
are limited in their reserve account cash deposits at parent or 
affiliated banks to 50% of the broker-dealer's excess net capital or 
10% of the bank's equity capital.\665\ Current interpretations also 
place similar restrictions on certain types of products at unaffiliated 
banks, including restrictions on concentration in money market deposit 
accounts and time deposits.\666\
---------------------------------------------------------------------------

    \665\ FINRA Interpretation 15c3-3(e)(3)/051.
    \666\ See FINRA Interpretation 15c3-3(e)(1)/01 and /011.
---------------------------------------------------------------------------

    As compared to the baseline, the Commission estimates that the 
incremental costs resulting from this amendment will be limited. Using

[[Page 51875]]

FOCUS Report data, as of December 31, 2011, the Commission estimates 
that approximately 224 broker-dealers report reserve deposits.\667\ A 
considerable proportion of these broker-dealers, including some of the 
largest firms, meet their deposit requirements using mostly qualified 
securities as opposed to cash and, therefore, will be marginally 
impacted by this amendment. For example, based on FOCUS Report data, as 
of December 31, 2011, for the 224 broker-dealers with reserve deposits, 
79% of the total customer reserve requirement was met using qualified 
securities that could still be deposited at affiliated banks to meet 
customer reserve requirements, under the rule, as adopted. The 
remaining customer reserve requirement could be met by using qualified 
securities (as opposed to cash) and/or opening one or more accounts at 
unaffiliated banks, which would hold the cash within the limits 
permitted under the rule.
---------------------------------------------------------------------------

    \667\ This estimate is based on FOCUS Report filings the 2011 
year end. It is an update from the proposing release estimate of 216 
broker-dealers. See Amendments to Financial Responsibility Rules, 72 
FR at 12881.
---------------------------------------------------------------------------

    Relative to the current baseline, broker-dealers may incur two 
types of costs. The first type of cost relates to the costs of opening 
a new account at an unaffiliated bank for broker-dealers that currently 
hold cash in a reserve account at an affiliated bank. It is difficult 
to estimate the number of broker-dealers that hold cash reserve 
deposits at an affiliated bank because FOCUS Report data does not 
include the names of banks at which broker-dealers maintain their 
reserve accounts. Therefore, this data is not readily available to the 
Commission and commenters did not provide it. Based on an analysis of 
FOCUS Report data as of December 31, 2011, as well as available bank 
data,\668\ the Commission, however, estimates that there are 
approximately 50 broker-dealers \669\ that have an affiliated bank and 
cash in their customer reserve accounts.
---------------------------------------------------------------------------

    \668\ Data regarding a bank's equity capital as of the 2011 year 
end is publicly available at http://www2.fdic.gov/sdi/.
    \669\ This estimate is based on a review of broker-dealers and 
affiliated banks based on legal names, as well as customer reserve 
account data, from FOCUS Report data.
---------------------------------------------------------------------------

    The second type of cost relates to the costs of opening and 
maintaining multiple bank accounts if the cash deposit exceeds the 15% 
bank equity capital threshold as defined in the final rule, the 
likelihood of which the Commission expects to decrease because, with 
the relaxation of the bank equity capital threshold in the final rule, 
fewer broker-dealers will be required to open multiple accounts, 
relative to the current baseline. Broker-dealers, however, may replace 
these types of cost with the costs of converting cash into qualified 
securities to meet some or all of their reserve deposit requirements 
under Rule 15c3-3.
    Moreover, in an attempt to reduce search costs, the potential 
exists that broker-dealers will select one or a few large unaffiliated 
banks or create networks on the basis of reciprocity between broker-
dealers and banks. This could result in a potential concentration of 
reserve cash deposits at a few banks. If as a result of such 
concentration, the carrying broker-dealer's deposit constitutes a 
substantial portion of the bank's total deposits, the risk increases 
that the bank may not have the liquidity to quickly return the deposit 
to the broker-dealer. Finally, the affiliated banks that are currently 
holding and using broker-dealer reserve cash deposits in the course of 
their business may incur funding costs, resulting from the possible 
transfer of cash deposits in the reserve account by broker-dealers to 
unaffiliated banks. These incremental funding costs to the affiliated 
banks may potentially be offset by the benefit of receiving cash 
deposits from unaffiliated broker-dealers.
(III). Alternatives
    In adopting the final rule, the Commission considered several 
alternative approaches suggested by commenters. For example, commenters 
urged the Commission not to adopt the proposed prohibition on broker-
dealers maintaining cash in reserve accounts at banks that are 
affiliates, stating that affiliated banks should be treated the same as 
unaffiliated banks because both groups are subject to the same 
financial regulation. One commenter noted that if a broker-dealer must 
move their reserve accounts to an unaffiliated bank this may require 
the broker-dealer to enter into new or additional banking relationships 
to comply with the amendment, which would increase the costs and 
administrative burdens of those reserve account funds.\670\
---------------------------------------------------------------------------

    \670\ See Raymond James 2 Letter.
---------------------------------------------------------------------------

    Several commenters suggested that the Commission allow cash reserve 
deposits without percentage restrictions at unaffiliated banks that are 
well-capitalized or for which a broker-dealer has performed due 
diligence.\671\ One of these commenters cited a U.K. regulation that 
requires a firm selecting a bank to hold customer deposits to undertake 
due diligence on the bank taking into consideration a number of factors 
including: (1) The capital of the bank; (2) the amount of client money 
placed, as a proportion of the bank's capital and deposits; (3) the 
credit rating of the bank (if available); and (4) to the extent the 
information is available, the level of risk in the investment and loan 
activities undertaken by the bank and its affiliated companies.\672\
---------------------------------------------------------------------------

    \671\ See Raymond James Letter; JP Morgan Letter; The Clearing 
House Letter; ABASA Letter; PNC Letter; Deutsche Bank Securities 
Letter; E*Trade Letter; JP Morgan 2 Letter.
    \672\ See JP Morgan Letter.
---------------------------------------------------------------------------

    One commenter suggested that the Commission consider higher 
percentages for cash deposits at large money-center banks.\673\ This 
commenter also stated that the percentage thresholds would negatively 
impact small broker-dealers because they would cross the 50% of excess 
net capital threshold at lower deposit levels.\674\ Another commenter 
suggested that the Commission reconsider the proposed limitation on the 
amount of reserve account cash deposits that may be held at any one 
bank because the limitation would result in significant costs for 
broker-dealers and could potentially adversely impact the customers of 
broker-dealers.\675\
---------------------------------------------------------------------------

    \673\ See SIFMA 2 Letter; see also NIBA Letter.
    \674\ See SIFMA 2 Letter.
    \675\ See Raymond James 2 Letter.
---------------------------------------------------------------------------

    In the final rule, the language excluding customer and PAB reserve 
cash deposits at affiliated banks from counting towards a broker-
dealer's reserve requirement is being adopted as proposed. As discussed 
further below, relative to the proposed rule, in the final rule, the 
Commission eliminated the proposed language that would have excluded 
the amount of the deposit at an unaffiliated bank that exceeded 50% of 
a broker-dealer's excess net capital and based on the Commission's 
expert judgment, increased the bank equity capital threshold from 10% 
to 15%.\676\
---------------------------------------------------------------------------

    \676\ See Amendments to Financial Responsibility Rules, 72 FR at 
12864.
---------------------------------------------------------------------------

    In response to comments on the proposed rule (including comments 
suggesting a due diligence standard instead of an objective threshold), 
the Commission modified the final rule text in ways that are designed 
to substantially mitigate the costs identified by commenters. While the 
final rule amendment excludes the amount of any cash on deposit at an 
affiliated bank from being used to meet a broker-dealer's reserve 
requirement, the Commission eliminated the provision that would have 
excluded the amount of a deposit that exceeds 50% of a broker-dealer's 
excess net capital. This provision would have impacted small and mid-
size broker-dealers when

[[Page 51876]]

they deposited cash into large commercial banks since the cash deposits 
of these firms would exceed the broker-dealer excess net capital 
threshold before exceeding the bank equity capital threshold.
    The elimination of the broker-dealer excess net capital threshold, 
combined with the increase of the bank equity capital threshold from 
10% to 15%, is intended to substantially mitigate the costs, burdens 
and inefficiencies that commenters believed would be imposed on small 
and mid-size broker-dealers if such firms had to open multiple bank 
accounts as a result of the proposed rule. The rule, as adopted, will 
allow small and mid-size broker-dealers to maintain reserve accounts at 
one bank if they so choose, provided that the bank equity capital 
threshold is not exceeded. In contrast to the proposed thresholds, the 
final rule amendments should reduce the costs associated with 
implementing the necessary changes to systems, operations, and 
contractual agreements related to a broker-dealer's reserve bank 
accounts.
    Further, in response to comments, increasing the threshold from 10% 
to 15% of the bank's equity capital is intended to address concerns 
raised by large broker-dealers with large deposit requirements that the 
10% threshold would have resulted in increased costs of having to 
spread out deposits over a number of banks. The decrease in the cost of 
opening and maintaining multiple accounts resulting from the increased 
threshold to 15% of the bank's equity capital may counterbalance the 
increase in the cost of transferring cash deposits to an unaffiliated 
bank. In summary, the rule, as adopted, with an increase to a 15% 
threshold will, in the Commission's expert judgment, substantially 
mitigate the cost concerns raised by commenters, while still providing 
adequate customer protection consistent with the goal of the rule to 
promote the broker-dealer's ability to have quick access to the 
deposit.
    With respect to qualified securities, one commenter argued that if 
a broker-dealer elects to use qualified securities as opposed to cash 
to meet its reserve requirement, the broker-dealer will likely have a 
significant amount of additional operational and transactional 
costs.\677\ In addition, this commenter stated that while large broker-
dealers may be able to reallocate existing trading desk, operational, 
regulatory reporting, and treasury functions to assist in ongoing 
maintenance activities, small and mid-sized broker-dealers may be 
required to hire additional staff to manage and maintain a securities 
portfolio.\678\ In response to the commenter, many large broker-dealers 
already hold large amounts of their reserve deposits in qualified 
securities. As the commenter noted, if a large broker-dealer needed to 
shift more of its reserve deposits into qualified securities as opposed 
to cash, then these firms would most likely reallocate existing 
functions to assist in ongoing maintenance activities, thus offsetting 
any costs associated with the shift of reserve deposits into qualified 
securities. Finally, with the elimination of the 50% excess net capital 
threshold in the rule as amended, most small and mid-sized firms likely 
would not have ongoing costs, because under the final rules, all firms 
will now only have to comply with the bank equity capital threshold, 
which as confirmed by comments, would be of concern primarily for the 
large firms. Therefore, under the final rule, broker-dealers should not 
incur significant operational or transactional costs in complying with 
the amendment.\679\
---------------------------------------------------------------------------

    \677\ See JP Morgan Letter. The commenter noted that ``[c]ertain 
broker-dealers may be required to hire additional staff to manage 
and maintain a securities portfolio.'' Id. ``Managing a pool of 
qualified securities involves a myriad of tasks such as monitoring 
income collection, redemption processing, marking the securities to 
market, collateral substitutions and collateral segregation amongst 
other tasks.'' Id. The commenter did not quantify the costs of 
managing a pool of qualified securities or the costs of additional 
staff to manage the securities portfolio.
    \678\ Id.
    \679\ See JP Morgan Letter.
---------------------------------------------------------------------------

(IV). Compliance Cost Estimates
    In the proposing release, in quantifying costs, the Commission 
estimated that, of the 216 firms with reserve deposit requirements, 
only 11 broker-dealers would need to open new bank accounts or 
substitute cash for qualified securities in an existing reserve 
account,\680\ and that this would result in an estimated total one-time 
cost of approximately $2,630 per broker-dealer \681\ and approximately 
$28,930 in the aggregate.\682\ As noted above, the Commission requested 
comment on the proposed cost estimates. Commenters were asked to 
identify the metrics and sources of any empirical data that support 
their cost estimates. The Commission received seven comment letters in 
response to the proposed cost estimates.\683\
---------------------------------------------------------------------------

    \680\ The Commission estimated in the proposing release that it 
would take approximately 10 hours to implement these changes. See 
Amendments to Financial Responsibility Rules, 72 FR at 12881.
    \681\ Id.
    \682\ 11 broker-dealers x $2,630 = $28,930. Id. at 12881.
    \683\ See Curian Clearing Letter; SIFMA 2 Letter; Clearing House 
Letter; ABASA Letter; Deutsche Bank Letter; E*Trade Letter; P Morgan 
Letter.
---------------------------------------------------------------------------

    One commenter stated that the estimate is inaccurate and arbitrary, 
and does not take into account situations where a broker-dealer will 
need to establish numerous banking relationships.\684\ Commenters also 
stated that the Commission failed to consider the ongoing costs of 
maintaining and monitoring multiple bank accounts.\685\ One commenter 
believes that limiting Rule 15c3-3 deposits at a single bank to 50% of 
a broker-dealer's excess net capital will require a significant number 
of broker-dealers to open a number of additional cash and/or securities 
accounts and devote ongoing operational resources to the management of 
such accounts.\686\ This commenter stated that at any one time, 
approximately 10% to 15% of broker-dealer customers could be impacted 
by the proposed rule change and many of those customers would be 
required to open accounts at multiple institutions.\687\
---------------------------------------------------------------------------

    \684\ See Curian Clearing Letter.
    \685\ See Curian Clearing Letter; SIFMA 2 Letter; ABASA Letter; 
The Clearing House Letter; E*Trade Letter; JP Morgan Letter.
    \686\ See JP Morgan Letter.
    \687\ Id.
---------------------------------------------------------------------------

    Commenters also stated that the proposed amendments would impose 
requirements whose costs are not adequately justified by their benefits 
and that the Commission substantially underestimated the costs.\688\ 
One commenter noted that there are significant costs associated with 
implementing the necessary changes to systems, operations, and 
contractual agreements that the Commission did not appear to take into 
account.\689\ Another commenter stated that the proposal also fails to 
quantify the inherent inefficiency of forcing broker-dealers to set up 
numerous bank accounts to satisfy the restrictive broker-dealer net 
capital and bank equity capital requirements.\690\ Another commenter 
suggested that the Commission consider higher percentage limits for 
cash deposits held at very large money center banks, stating that a 
higher percentage limit would strike a better balance between the 
Commission's concerns regarding the safety of cash deposits and the 
substantial costs imposed on broker-dealers by overly restrictive 
deposit limitations.\691\ Two commenters

[[Page 51877]]

believed that the upfront and ongoing cost to each broker-dealer is far 
higher than the one-time estimate of $2,630 that the Commission 
estimated in the proposing release.\692\ One commenter stated that 
conducting due diligence and opening new accounts and the ongoing 
monitoring and periodic re-evaluation of such additional accounts would 
require much more time than the 10 hours originally estimated by the 
Commission.\693\ One commenter, referencing the SIFMA 2 Letter, stated 
that it agreed with SIFMA that the Commission significantly 
underestimated the cost of the proposal to smaller firms.\694\ Finally, 
commenters did not provide the Commission with revised cost estimates 
or data related to these amendments.
    In quantifying costs, the Commission is increasing its estimate of 
the number of broker-dealers that will likely incur the cost of opening 
a new account at an unaffiliated bank (or substituting cash for 
qualified securities in their reserve accounts) from the estimated 11 
broker-dealers in the proposing release to 50 broker-dealers, as 
described above.\695\ In addition, in response to the commenter's 
concern that conducting due diligence and opening new accounts would 
require much more time than the 10 hours originally estimated by the 
Commission,\696\ the Commission also is increasing the one-time hour 
estimates discussed in the proposing release from 10 to 25 hours.\697\ 
In response to the commenters pointing that the amendments would 
require ongoing monitoring of bank equity capital levels,\698\ the 
Commission is including an annual cost estimate in this release (in 
addition to the estimated one-time costs) to account for incremental 
ongoing costs to monitor compliance with the rule.\699\ The Commission 
further estimates that the average cost per firm to make these changes 
will be approximately $4,925 on a one-time basis and $12,675 on an 
annual basis.\700\ For these reasons, the Commission estimates that the 
total cost to broker-dealers will be approximately $246,250 on a one-
time basis and $633,750 on an annual basis.\701\
---------------------------------------------------------------------------

    \688\ See SIFMA 2 Letter; ABASA Letter.
    \689\ See SIFMA 2 Letter.
    \690\ See ABASA Letter.
    \691\ See SIFMA 2 Letter.
    \692\ See JP Morgan Letter; E*Trade Letter.
    \693\ See SIFMA 2 Letter.
    \694\ See NIBA Letter.
    \695\ The Commission estimates that the responsibility for the 
one-time opening a new reserve bank account or substituting 
qualified securities for cash in an existing account likely would be 
undertaken by a Senior Treasury/Cash Management Manager at $197 per 
hour. See Amendments to Financial Responsibility Rules, 72 FR at 
12881.
    \696\ See SIFMA 2 Letter.
    \697\ See Amendments to Financial Responsibility Rules, 72 FR at 
12881. The Commission estimates that the Senior Treasury/Cash 
Management Manager will spend approximately 25 hours performing 
these changes on a one-time basis.
    \698\ See SIFMA 2 Letter.
    \699\ The Commission estimates that the responsibility for the 
annual compliance review of these rule amendments likely would be 
split between a Senior Treasury/Cash Management Manager at $197 per 
hour and a Compliance Attorney at $310 per hour, and will likely 
take 50 hours per year.
    \700\ $197 per hour x 25 hours = $4,925; ($197 per hour x 25 
hours) + ($310 x 25 hours) = $12,675.
    \701\ 50 broker-dealers x $4,925 = $246,250; 50 broker-dealers x 
$12,675 = $633,750.
---------------------------------------------------------------------------

    Finally, using FOCUS Report data and top decile bank equity capital 
data at year end 2011,\702\ the Commission estimates that approximately 
30 broker-dealers are no longer required to sustain the cost of 
maintaining multiple bank accounts, as a result of removing the 50% 
excess net capital threshold and increasing the bank equity capital 
threshold to 15%. This change to the final rule may result in potential 
cost savings to broker-dealers, which may have been required to 
maintain multiple bank accounts under the rule, as proposed.
---------------------------------------------------------------------------

    \702\ See https://cdr.ffiec.gov/public/.
---------------------------------------------------------------------------

c. Allocation of Customers' Fully Paid and Excess Margin Securities to 
Short Positions
    The amendment to paragraph (d)(4) of Rule 15c3-3 requires broker-
dealers to take prompt steps to obtain possession or control over fully 
paid and excess margin securities on the broker-dealer's books or 
records that allocate to a short position of the broker-dealer or a 
short position for another person, excluding positions covered by 
paragraph (m) of Rule 15c3-3, for more than 30 calendar days.\703\ This 
amendment protects broker-dealer customers by helping to ensure that 
customer securities are available to be returned in the event of a 
broker-dealer failure. Therefore, in addition to broker-dealer 
customers, the amendment benefits the SIPC fund to the extent that it 
mitigates potential outlays from the fund to make advances to customers 
of a failed broker-dealer that cannot return all customer securities.
---------------------------------------------------------------------------

    \703\ 17 CFR 240.15c3-3(d)(4).
---------------------------------------------------------------------------

    The Commission requested comment on available metrics to quantify 
these benefits and any other benefits a commenter may identify. In 
particular, the Commission requested comment on whether there would be 
additional costs to broker-dealers as a consequence of these proposals 
and whether these proposals would impose costs on other market 
participants, including broker-dealer customers. The Commission also 
requested that commenters identify sources of empirical data that could 
be used for the metrics they proposed. The Commission received one 
comment in response to these requests.\704\ The commenter stated that 
the proposed amendments would ``greatly increase the cost of 
proprietary and customer short positions that were established and 
maintained in accordance with all applicable short sale regulations at 
the time entered.'' \705\ However, this commenter did not quantify its 
cost estimates in terms of dollars, nor did it provide data to support 
its conclusion.
---------------------------------------------------------------------------

    \704\ See Raymond James 2 Letter.
    \705\ Id.
---------------------------------------------------------------------------

    In response to this comment, modifications were made to the final 
rule that should mitigate the commenter's concern because the changes 
were designed to reduce operational burdens and to more closely align 
the final rule with current regulations related to short sales. More 
specifically, as discussed in section II.A.4., as adopted, final 
paragraph (d)(4) of Rule 15c3-3 contains a uniform 30 calendar day 
period and clarifies that the 30 calendar day period with respect to a 
syndicate short position established in connection with an offering 
does not begin to run until the underwriter's participation in the 
distribution is complete as determined pursuant to Rule 100(b) of 
Regulation M. In addition, the proposed amendment was designed to 
require that the aging process commence at the time a deficit in 
securities allocating to a short position arises. These modifications 
clarify the rule amendment, while continuing to strengthen customer 
protections under Rule 15c3-3.
    Three commenters argued that the credit item added to the reserve 
formula computation when a customer's fully paid or excess margin 
securities are allocated to a short position provides the customer with 
adequate protection.\706\ The Commission considered this alternative, 
as well as the cost concerns raised above, in adopting these final rule 
amendments. It has been a long-standing industry practice for carrying 
broker-dealers to use securities of PAB account holders in their 
business activities. In contrast, as stated above in section II.A.4. of 
this release, customers under Rule 15c3-3, which include the carrying 
broker-dealer's retail customers, have an expectation that the fully 
paid and excess margin securities reflected on their account statements 
are, in fact, in the possession or control of the carrying broker-
dealer. However, as described above, this expectation may be

[[Page 51878]]

frustrated where the securities are allocated to a short position 
carried by the broker-dealer, as the securities are not in the 
possession or control of the carrying broker-dealer. This gap in the 
existing rule, in effect, permits the broker-dealer to partially 
monetize the Rule 15c3-3 customer's securities. Also, under some 
circumstances (e.g., a change in the market value of the securities), 
the amount the broker-dealer may have on deposit in the reserve account 
as a consequence of the credit item may be less than the value of the 
securities. Consequently, if the broker-dealer fails, sufficient funds 
may not be readily available to purchase the securities to return them 
to customers. The use of customer securities in this manner is contrary 
to the customer protection goals of Rule 15c3-3 and the expectations of 
a broker-dealer's customers.\707\ Therefore, the Commission believes 
that any increased costs related to this final rule amendment are 
justified by the enhancements to the customer protection goals of Rule 
15c3-3. For these reasons, and those discussed throughout this release, 
the Commission is adopting the amendment.
---------------------------------------------------------------------------

    \706\ See First Clearing Letter; Deutsche Bank Securities 
Letter; Citigroup Letter.
    \707\ See section II.A.1. of this release.
---------------------------------------------------------------------------

    The Commission estimates this requirement will result in a one-time 
cost to firms that carry customer securities to update systems for 
complying with the possession or control requirements in Rule 15c3-3. 
Based on FOCUS Report data, as of December 31, 2011, the Commission 
estimates that approximately 287 broker-dealers carry customer 
accounts.\708\ The Commission further estimates these firms will spend, 
on average, approximately 40 hours of employee resources per firm 
updating their systems to implement changes that will be necessitated 
by the amendment.\709\ Therefore, the Commission estimates that the 
average cost per firm to make these changes will be approximately 
$11,280.\710\ The Commission estimates that the total one-time cost to 
broker-dealers will be approximately $3,237,360.\711\
---------------------------------------------------------------------------

    \708\ This is an update of the proposing release estimate of 350 
broker-dealers. See Amendments to Financial Responsibility Rules, 72 
FR at 12881.
    \709\ For the purposes of this cost analysis, the Commission 
estimates that this work will be undertaken by a Senior Programmer 
at $282 per hour.
    \710\ $282 per hour x 40 hours = $11,280.
    \711\ 287 broker-dealers x $11,280 = $3,237,360. In the 
proposing release, the Commission estimated that the total one-time 
cost to broker-dealers would be $3,752,000. See Amendments to 
Financial Responsibility Rules, 72 FR at 12881.
---------------------------------------------------------------------------

    In addition to systems costs, broker-dealers may incur other costs 
to comply with the rule amendment because they may be required to 
change their existing practices. For example, the amendment could 
result in some broker-dealers borrowing securities to cover proprietary 
short positions rather than using customer securities, resulting in 
increased borrowing costs. However, under the current baseline, when 
broker-dealers use customer securities to cover short positions they 
are required to add a credit item in the Rule 15c3-3 reserve formula 
equal to the value of the securities. This credit item can result in 
higher reserve deposit requirements, which must be made using the 
broker-dealer's own capital. Thus, in response to commenters concerns 
regarding the costs of this amendments,\712\ the increased costs 
associated with having to borrow securities to cover a short position 
likely will be offset by decreased costs associated with devoting 
capital to customer reserve requirements.
---------------------------------------------------------------------------

    \712\ See First Clearing Letter; Deutsche Bank Securities 
Letter; Citigroup Letter.
---------------------------------------------------------------------------

d. Importation of Rule 15c3-2 Requirements Into Rule 15c3-3
    Today's amendment to Rules 15c3-2 and 15c3-3 imports requirements 
in Rule 15c3-2 \713\ to Rule 15c3-3 and eliminates Rule 15c3-2 as a 
separate rule in the Code of Federal Regulations.\714\ Rule 15c3-2 
requires a broker-dealer holding free credit balances to provide its 
customers (defined as any person other than a broker-dealer) at least 
once every three months with a statement of the amount due the customer 
and a notice that the funds are not being segregated, but rather are 
being used in the broker-dealer's business and that the funds are 
payable on demand. The Commission believes it is appropriate to 
eliminate Rule 15c3-2 because it is largely irrelevant in light of the 
requirements of Rule 15c3-3 (which was adopted after Rule 15c3-2).
---------------------------------------------------------------------------

    \713\ 17 CFR 240.15c3-2.
    \714\ See Amendments to Financial Responsibility Rules, 72 FR at 
12867.
---------------------------------------------------------------------------

    This amendment will benefit broker-dealers by streamlining and 
consolidating relevant provisions of Rule 15c3-2 into Rule 15c3-3, 
promoting efficiency in the rulemaking process while not modifying the 
legal requirements. These provisions include the requirements that 
broker-dealers inform customers of the amounts due to them and that 
such amounts are payable on demand, which have been moved to new 
paragraph (j)(1) of Rule 15c3-3.\715\ Finally, the definition of 
customer for purposes of the imported Rule 15c3-2 requirements will be 
the definition of customer in Rule 15c3-3,\716\ which is somewhat 
narrower than the definition in Rule 15c3-2. The application of the 
narrower definition of customer in Rule 15c3-3 should not increase 
related costs. Alternatively, it may result in decreased costs because 
the narrowing of the rule's scope may reduce the compliance burden on 
broker-dealers.
---------------------------------------------------------------------------

    \715\ The provisions in Rule 15c3-2 that are being re-codified 
in Rule 15c3-3, include the requirements that broker-dealers inform 
customers of the amounts due to them and that such amounts be 
payable on demand. In addition, Rule 15c3-2 contains an exemption 
for broker-dealers that are also banking institutions supervised by 
a Federal authority. This exemption will not be imported into Rule 
15c3-3 because there are no broker-dealers that fit within this 
exemption.
    \716\ 17 CFR 240.15c3-3(a)(1).
---------------------------------------------------------------------------

    The Commission considered reasonable alternatives with regard to 
the proposed deletion of Rule 15c3-2 and the importation of certain 
requirements into paragraph (j)(1) of Rule 15c3-3. Not adopting the 
rule amendment and thus leaving Rule 15c3-2 in the Code of Federal 
Regulations was a considered alternative. The Commission, however, 
believes consolidating the relevant provisions in Rule 15c3-3 is a more 
appropriate alternative because it promotes efficiency in the 
rulemaking process, and streamlines the Commission's customer 
protection rules.
    The amendments--because they only re-codify provisions of Rule 
15c3-2 into Rule 15c3-3 \717\--should not be a new source of costs as 
compared to the baseline because these provisions are continuations of 
existing requirements. However, the re-codification and placement of 
these provisions into Rule 15c3-3 may cause broker-dealers to review 
and update their existing procedures from time-to-time and, therefore, 
could result in incremental costs.\718\
---------------------------------------------------------------------------

    \717\ See paragraph (j)(1) of Rule 15c3-3.
    \718\ Based on the estimated hour burdens in section IV.D.5. of 
this release, there could be one-time internal costs of $1,464,750 
and annual internal costs of $585,900, if the review and update is 
performed by a Compliance Attorney at $310 per hour.
---------------------------------------------------------------------------

e. Treatment of Free Credit Balances
(I). Summary of Amendments
    Today, the Commission is adopting the amendment to add new 
paragraph (j)(2) to Rule 15c3-3 that prohibits a broker-dealer from 
converting, investing, or transferring to another account or 
institution, free credit balances held in a customer's account except 
as provided in paragraphs (j)(2)(i) and (ii) of the rule. As adopted, 
the amendment defines a Sweep Program as

[[Page 51879]]

``a service provided by a broker or dealer where it offers to its 
customer the option to automatically transfer free credit balances in 
the securities account of the customer to either a money market mutual 
fund product as described in Sec.  270.2a-7 of this chapter or an 
account at a bank whose deposits are insured by the Federal Deposit 
Insurance Corporation.'' \719\
---------------------------------------------------------------------------

    \719\ See paragraph (a)(17) of Rule 15c3-3.
---------------------------------------------------------------------------

    With regard to the treatment of free credit balances outside the 
context of a Sweep Program, paragraph (j)(2)(i) of Rule 15c3-3 permits 
a broker-dealer to invest or transfer to another account or institution 
free credit balances held in a customer's account only upon a specific 
order, authorization, or draft from the customer, and only in the 
manner, and under the terms and conditions, specified in the order, 
authorization, or draft.\720\ Two commenters suggested that the 
proposal should be clarified to permit a broker-dealer to obtain a one-
time consent to ongoing transfers of any free credit balances to a 
customer to another account, entity or product (outside of a Sweep 
Program). As discussed above, this scenario was covered by the proposed 
rule and is being adopted under paragraph (j)(2)(i) of Rule 15c3-3.
---------------------------------------------------------------------------

    \720\ See Amendments to Financial Responsibility Rules, 72 FR at 
12866.
---------------------------------------------------------------------------

    With regard to the treatment of free credit balances in the context 
of a Sweep Program, new paragraph (j)(2)(ii) of Rule 15c3-3 requires 
broker-dealers to meet conditions that vary depending on the date when 
a customer's account was opened. For accounts opened on or after the 
effective date of the rule, a broker-dealer must meet the conditions of 
(j)(2)(ii)(A) and (B) of the rule. For any account, the broker-dealer 
must meet the conditions in paragraphs (j)(2)(ii)(B) of the rule. Under 
paragraph (j)(2)(ii)(A), for accounts opened on or after the effective 
date of the rule, the amendment to Rule 15c3-3 requires a broker-dealer 
to obtain the written affirmative consent of a new customer to have 
free credit balances in the customer's securities account included in 
the Sweep Program. Under paragraph (j)(2)(ii)(B), a broker-dealer must 
comply with the remaining three conditions for any account: (1) 
Providing the customer with the disclosures and notices regarding the 
Sweep Program required by each SRO of which the broker-dealer is a 
member; (2) providing notice to the customer, as part of the customer's 
quarterly statement of account, that the balance in the bank deposit 
account or shares of the money market mutual funds in which the 
customer has a beneficial interest can be liquidated on the customer's 
order and the proceeds returned to the securities account or remitted 
to the customer; and (3) providing the customer written notice at least 
30 calendar days before the broker-dealer makes certain changes to the 
Sweep Program and describes the options available to the customer if 
the customer does not accept the new terms and conditions or 
product.\721\
---------------------------------------------------------------------------

    \721\ See new paragraph (j)(ii)(B)(1)-(3) of Rule 15c3-3, as 
adopted.
---------------------------------------------------------------------------

    Free credit balances constitute money that a broker-dealer owes its 
customers. Customers may maintain these balances at the broker-dealer 
in anticipation of future stock purchases. Under current practices, 
customer account agreements set forth how the broker-dealer will invest 
these balances. For example, the broker-dealer may sweep them into a 
money market fund or, alternatively, pay an amount of interest on the 
funds. On occasion, broker-dealers may change the product to which a 
customer's free credit balances are swept--most frequently from a money 
market fund to an interest bearing bank account. Because of differences 
in these two types of products, there may be investment consequences 
when changing from one to the other.\722\
---------------------------------------------------------------------------

    \722\ Differences include the type of protection afforded the 
customer in the event of an insolvency, and the amount of interest 
or dividends earned on the product. See Amendments to Financial 
Responsibility Rules, 72 FR at 12866.
---------------------------------------------------------------------------

    New paragraph (j)(2) to Rule 15c3-3 should serve to enhance 
customer protection by prohibiting a broker-dealer from transforming 
the credit risk faced by a customer through transfer of the broker-
dealer's obligation to another entity without the required notice to, 
or approval from, the customer.
(II). Baseline and Incremental Economic Effects
    In the absence of new paragraph (j)(2) of Rule 15c3-3, current 
practices represent the existing baseline. As compared to the baseline, 
new paragraph (j)(2) to Rule 15c3-3 will enhance customer protection by 
requiring broker-dealers to obtain the written affirmative consent of a 
new customer before including a customer's free credit balances in a 
Sweep Program, as well as to provide certain disclosures and notices to 
all customers with regard to the broker-dealer's Sweep Program. The 
Commission requested comment on available metrics to quantify these 
benefits and any other benefits a commenter may identify. The 
Commission did not receive any comments in response to this request.
    Relative to the baseline, broker-dealers carrying free credit 
balances will incur incremental one-time and periodic costs (e.g., 
systems changes, outside counsel, and notification costs) to comply 
with new paragraph (j)(2) of Rule 15c3-3. The Commission requested 
comment on whether there would be additional costs to broker-dealers as 
a consequence of the proposals. The Commission also requested comment 
on whether the proposals would impose costs on other market 
participants, including broker-dealer customers. Commenters were 
requested to identify sources of empirical data that could be used for 
the metrics they proposed. The Commission did not receive any comments 
in response to these requests.
(III). Alternatives
    As stated above in section II.A.5.ii. of this release, the 
Commission is adopting new paragraph (j)(2) to Rule 15c3-3 with 
substantial modifications from the proposed rule in response to 
comments and to clarify certain portions of the rule.
    Commenters generally agreed with the fundamental principle embodied 
in the proposal--that customer free credit balances should not be 
transferred from an obligation of the broker-dealer to an obligation of 
another entity without the customer's authorization.\723\ Other 
commenters supported the proposed disclosures but suggested additional 
disclosures be made to customers including clarification with respect 
to other protections available to the customer.\724\ Two commenters 
stated that the practice of sweep programs should be banned entirely or 
that the Commission should adopt a ``harder stance'' and require more 
than just disclosure.\725\ One commenter responded to the Commission's 
request for comment as to the cost burdens that would result if the 
first condition (set forth in proposed paragraph (j)(2)(ii)(A)) to 
obtain a new customer's prior agreement were to be applied to existing 
customers. The commenter stated that such costs would be substantial 
because broker-dealers would be required to amend their agreements with 
all

[[Page 51880]]

existing customers.\726\ One commenter stated that the amendments in 
the proposing release did not adequately address situations in which 
broker-dealers change customer account elections without first 
obtaining customer authorization.\727\ Commenters also raised concerns 
about limitations on the types of products broker-dealers can use for 
sweep arrangements.\728\
---------------------------------------------------------------------------

    \723\ See SIFMA 2 Letter; First Clearing Letter; Pace Letter.
    \724\ See SIPC Letter.
    \725\ See Ellis Letter; Dworkin Letter. One commenter stated 
that broker-dealers profit from ``excessive'' fees charged to 
customers who opt out of the sweep programs. See Ellis Letter. The 
second commenter suggested that the broker-dealer's ``customer has 
been effectively denied the opportunity to opt out of bank account 
sweeps by [the broker-dealer] preventing him or her from utilizing 
any other vehicle to park his or her free credit balances . . . .'' 
See Dworkin Letter.
    \726\ See SIFMA 2 Letter.
    \727\ See Waddell Letter.
    \728\ See SIFMA 2 Letter; First Clearing Letter; Raymond James 2 
Letter.
---------------------------------------------------------------------------

    The Commission considered alternatives, including whether to adopt 
the amendments and, in adopting the final rule, the Commission modified 
the language in the final rule in response to commenters and to clarify 
its application. In response to comments that the Commission should ban 
sweep programs or adopt a ``harder stance,'' the Commission notes that 
sweep programs provide a mechanism for excess cash in a customer's 
securities account to be held in a manner that allows the customer to 
earn interest on the funds but retain the flexibility to quickly access 
that cash to purchase securities or withdraw it.\729\ In effect, 
transferring this excess cash to a bank account or money market fund is 
an alternative to retaining a credit balance in the customer's 
securities account. The final rule is intended to appropriately balance 
commenters' concerns while providing broker-dealers with flexibility in 
the operation of sweep programs.\730\
---------------------------------------------------------------------------

    \729\ See Ellis Letter; Dworkin Letter.
    \730\ See Ellis Letter; Dworkin Letter; Waddell Letter.
---------------------------------------------------------------------------

    In addition, in response to the comments that the Commission should 
not limit the types of products broker-dealers can use for sweep 
accounts to money market funds and bank deposit products,\731\ as 
discussed above in section II.A.5.ii. of this release, the Commission 
does not view sweep accounts as a mechanism for investing customers' 
excess cash in longer term or more volatile assets without specific 
consent from customers. Therefore, the Commission believes that it is 
not appropriate to modify the final rule amendments to expand the 
permitted products for Sweep Programs.
---------------------------------------------------------------------------

    \731\ See SIFMA 2 Letter; First Clearing Letter; Raymond James 2 
Letter.
---------------------------------------------------------------------------

    In response to commenters' concern regarding cost burdens resulting 
from the application of the affirmative consent requirement to existing 
accounts, the final rule retains the proposed requirement to require a 
broker-dealer to obtain a customer's prior affirmative consent for 
accounts opened on or after the effective date of the rule before 
transferring the customer's free credit balance to a product in the 
firm's Sweep Program, and makes explicit that the consent must be in 
writing. This will provide new customers with the opportunity to 
evaluate the broker-dealer's Sweep Program before consenting to the 
transfer of the customer's free credit balances into such program. In 
the proposing release, the Commission requested comment as to the cost 
burdens that would result if the condition to obtain a new customer's 
prior agreement were to be applied to existing customers. One commenter 
stated that such costs would be substantial because broker-dealers 
would be required to amend their agreements with existing customers. 
The Commission considered this alternative and agrees with the 
commenter that requiring a broker-dealer to amend its existing 
agreements with customers would be substantial. Therefore, to address 
the burden that would have been associated with having broker-dealers 
re-paper existing account documentation, the prior affirmative consent 
requirement will continue to apply only to accounts opened on or after 
the effective date of the rule.
    However, as discussed above in section II.A.5.ii. of this release, 
all customers will be provided written notice at least 30 days before a 
broker-dealer changes certain terms and conditions or products of its 
Sweep Program. This notice must also contain a description of the 
options available to the customer if the customer does not accept the 
new terms and conditions or product. This is intended to benefit new 
and existing customers by giving them sufficient opportunity to make an 
informed decision and evaluate the effects of changes in the terms and 
conditions or product of the sweep program and the options available.
(IV). Compliance Cost Estimates
    Broker-dealers will incur one-time and periodic costs to implement 
the changes necessitated by the amendment. These changes include 
providing customers with the disclosures and notices (including the 
description of the options available if a customer does not accept the 
new terms or conditions or product) in order to have the flexibility to 
change the treatment of customers' free credit balances. This would 
require that broker-dealers update their systems (including processes 
for generating customer account statements) to incorporate the 
necessary changes.\732\ Additionally, broker-dealers may incur one-time 
costs of outside counsel in implementing these system changes, 
particularly with respect to the language in the disclosures and 
notices required by paragraph (j)(2) of the rule.
---------------------------------------------------------------------------

    \732\ The internal hours would likely be performed by a senior 
programmer. Therefore, the estimated internal costs for this hour 
burden would be calculated as follows: Senior Programmer at $282 per 
hours x 37,800 hours = $10,659,600. See section IV.D.6. of this 
release.
---------------------------------------------------------------------------

    The Commission further estimates that broker-dealers will incur 
costs to process an affirmative consent for new customers.\733\ 
Specifically, the Commission estimates that broker-dealers may incur 
aggregate one-time and annual costs of approximately $14.4 million 
\734\ and $23.2 million,\735\ respectively related to the changes 
necessitated by these rule amendments.\736\
---------------------------------------------------------------------------

    \733\ The internal hours would likely be performed by a 
compliance clerk. Therefore, the estimated internal costs for this 
hour burden would be calculated as follows: Compliance Clerk at $63 
per hour x 368,311 hours = $23,203,593. See section IV.D.6. of this 
release.
    \734\ See section IV.D.6. of this release. ($10,659,600 + 
$3,780,000 (outside counsel costs) = $14,439,600).
    \735\ Id. ($23,203,593).
    \736\ In the proposing release, the Commission estimated that 
broker-dealers would incur one-time costs of approximately $3.68 
million ($2.68 million internal costs and $1.0 million for outside 
counsel) and annual costs of approximately $24.6 million. See 
Amendments to Financial Responsibility Rules, 72 FR at 12882.
---------------------------------------------------------------------------

f. ``Proprietary Accounts'' Under the Commodity Exchange Act
    Some broker-dealers also are registered as futures commission 
merchants under the CEA. These firms carry both securities and 
commodities accounts for customers. The definition of free credit 
balances in paragraph (a)(8) of Rule 15c3-3 does not include funds 
carried in commodities accounts that are segregated in accordance with 
the requirements of the CEA.\737\ However, regulations promulgated 
under the CEA exclude proprietary accounts from the CEA's segregation 
requirements.\738\ This exclusion from the segregation requirements 
under the CEA has raised a question as to whether a broker-dealer must 
treat payables to customers in proprietary commodities accounts as 
``free credit balances'' when

[[Page 51881]]

performing a customer reserve computation.\739\ For these reasons, the 
specific amendment to the definition of the term free credit balances 
in paragraph (a)(8) of Rule 15c3-3 clarifies that funds held in a 
commodities account meeting the definition of a proprietary account 
under CEA regulations are not to be included as free credit balances in 
the customer reserve formula.
---------------------------------------------------------------------------

    \737\ 17 CFR 240.15c3-3(a)(8).
    \738\ Rule 1.20 requires a futures commission merchant to 
segregate customer funds. See 17 CFR 1.20. Rule 1.3(k) defines the 
term customer for this purpose. See 17 CFR 1.3(k). The definition of 
customer excludes persons who own or hold a proprietary account as 
that term is defined in Rule 1.3(y). See 17 CFR 1.3(y). Generally, 
the definition of proprietary account refers to persons who have an 
ownership interest in the futures commission merchant. Id.
    \739\ See Part 241-Interpretive Releases Relating to the 
Securities Exchange Act of 1934 and General Rules and Regulations 
Thereunder, Exchange Act Release No. 9922 (Jan. 2, 1973), 38 FR 1737 
(Jan. 18, 1973) (interpreting the credit balance used in Item 1 of 
the Rule 15c3-3a formula ``to include the net balance due to 
customers in non-regulated commodities accounts reduced by any 
deposits of cash or securities with any clearing organization or 
clearing broker in connection with the open contracts in such 
accounts'').
---------------------------------------------------------------------------

    One commenter requested that the Commission clarify that the 
relevant definition of proprietary account for purposes of this 
amendment will be the definition contained in 17 CFR 1.3(y).\740\ The 
Commission considered this alternative suggested by the commenter. 
While Rule 1.3(y) under the CEA currently contains the relevant 
definition of proprietary account for the purpose of the amendment, the 
definition could be codified in a different rule in the future. 
Consequently, the Commission is adopting the final rule amendment to 
paragraph (a)(8) of Rule 15c3-3, as proposed. Thus, the final rule does 
not include specific references to a specific rule. Rather, the 
amendment to paragraph (a)(8) to Rule 15c3-3, as adopted, more 
generally refers to a ``proprietary account as that term is defined in 
regulations under the Commodity Exchange Act.''
---------------------------------------------------------------------------

    \740\ See SIFMA 2 Letter.
---------------------------------------------------------------------------

    In addition, one commenter stated that, due to the changes to the 
swap markets mandated by Title VII of the Dodd-Frank Act, swap accounts 
(in addition to commodities accounts) are now subject to customer 
protection rules under the CEA. This commenter suggested that the 
Commission make it clear that funds in swap accounts also do not 
constitute free credit balances, whether those funds are required to be 
segregated by rules under the CEA (e.g., cleared swap accounts or 
uncleared swap accounts that have opted for segregation) or excepted 
from segregation under the CEA (e.g., cleared swaps proprietary 
accounts or uncleared swap accounts that have not opted for 
segregation). The commenter noted this treatment ``would be consistent 
with the treatment of funds in commodities accounts and with the 
regulation of swap accounts under the CEA.'' \741\ The Commission 
agrees there may be additional accounts under the CEA, as amended by 
the Dodd-Frank Act that should explicitly be excluded from the 
definition of free credit balances under Rule 15c3-3. However, the 
amendments today are designed to clarify the specific question raised 
with respect to the treatment of funds in proprietary commodities 
accounts under the CEA and, consequently, the suggestions by this 
commenter are beyond the scope of this rulemaking.
---------------------------------------------------------------------------

    \741\ Id.
---------------------------------------------------------------------------

    The Commission considered reasonable alternatives in adopting the 
final rule amendment. These alternatives included adopting the proposed 
rule, with modifications suggested by commenters described above, as 
well as leaving the current rule in place without the amendments. The 
Commission believes that the adoption of the final rule is the more 
appropriate approach at this time because the final rule amendment will 
benefit broker-dealers that are registered as futures commission 
merchants by eliminating any ambiguity with respect to such accounts 
and avoiding situations where they unnecessarily increase reserve 
amounts.
    The Commission does not anticipate that the amendments will result 
in any costs to broker-dealers and, as funds in certain commodities 
accounts are not protected under SIPA, will not expose the SIPC fund to 
increased liabilities. Because this amendment is intended to be a 
clarification of existing interpretations, broker-dealers are not 
expected to incur additional costs against the baseline of current Rule 
15c3-3 and its existing interpretations. This clarification is designed 
to provide broker-dealers with more certainty as to the Commission's 
stated legal requirements.
ii. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation
    The amendments to the customer protection rule (Rule 15c3-3) 
regarding PAB accounts,\742\ cash deposits at special reserve bank 
accounts,\743\ allocation of short positions,\744\ the treatment of 
free credit balances,\745\ and the clarification of the treatment of 
proprietary accounts under the CEA are designed to protect and preserve 
customer property held at broker-dealers.\746\ These protections are 
primarily intended to reduce the risks borne by investors.
---------------------------------------------------------------------------

    \742\ See section II.A.2. of this release.
    \743\ See section II.A.3. of this release.
    \744\ See section II.A.4. of this release.
    \745\ See section II.A.5.ii. of this release.
    \746\ See section II.A.6.i. of this release.
---------------------------------------------------------------------------

    In particular, first, the final rule amendment on PAB accounts is 
intended to fill a gap in the definition of customer between Rule 15c3-
3 and SIPA, reducing the risk that customers could face losses in the 
case of a liquidation of a carrying broker-dealer. The final rule 
codifies many of the provisions of the PAIB Letter. The Commission 
believes that it is prudent, and will provide greater regulatory 
clarity, to incorporate into Rule 15c3-3 specified provisions of the 
PAIB Letter. Further, the Commission understands that the relief in the 
PAIB Letter has been widely, if not universally, utilized by broker-
dealers that carry customer accounts. Thus, the benefits associated 
with codifying specified provisions of the PAIB Letter will continue to 
provide SIPA customers with the protections currently provided by 
broker-dealers complying with the PAIB Letter. Setting forth these 
requirements in a Commission rule will benefit the securities markets 
by helping to diminish the risks and incidences of non-compliance.
    Second, the final rule amendments regarding the banks where reserve 
deposits may be held are intended to protect customers' cash deposits 
by mitigating the risk that the funds in the customer reserve account 
will not be readily available to be withdrawn by the broker-dealer.
    Third, the final rule amendments regarding the allocation of 
customers' fully paid and excess margin securities to a broker-dealer 
short position are designed to enhance the customer protection goals of 
Rule 15c3-3, which seek to ensure that broker-dealers do not use 
customer assets for proprietary activities.
    Fourth, the final rule amendments regarding the importation of Rule 
15c3-2 requirements into paragraph (j)(1) of Rule 15c3-3 and the 
elimination of Rule 15c3-2 streamline the regulatory requirements for 
broker-dealers. Also, the addition of new paragraph (j)(2) to Rule 
15c3-3 is intended to protect a customer's free credit balances from 
being swept to products or programs without the appropriate approval, 
notice or disclosure.
    Fifth, the final rule amendment establishing that the funds in 
certain commodities accounts need not be treated as free credit 
balances or other credit balances may enhance efficiency at the broker-
dealers by freeing up cash that may have been required to be

[[Page 51882]]

deposited into a broker-dealer's customer reserve account, and 
clarifying an ambiguity in Rule 15c3-3.
    By strengthening requirements designed to protect customer assets, 
these amendments will mitigate potential exposure to the SIPC fund that 
is used to make advances to customers whose securities or cash are 
unable to be returned by a failed broker-dealer. To the extent that the 
amendments to Rule 15c3-3 achieve this goal, investors might be more 
willing to transact business in securities with broker-dealers. The 
possible positive effects on investor participation in the securities 
markets may promote capital formation as investor assets are able to be 
allocated more efficiently across the opportunity set.
    As discussed above, the Commission recognizes that the amendments 
to Rule 15c3-3 adopted today may impose certain costs on broker-dealers 
that might place a burden on competition among broker-dealers. However, 
the Commission is of the opinion that these costs are justified by the 
significant benefits described in this economic analysis, as well as in 
the discussion of the rule amendments above. Amendments to Rule 15c3-3 
should not place a burden on competition for non-carrying broker-
dealers, which are generally small broker-dealers, because the 
amendments primarily affect broker-dealers that perform PAB and 
customer reserve computations, carry customer accounts, and carry free 
credit balances. In addition, for those carrying broker-dealers that 
already follow the PAIB Letter, any difference from the baseline with 
regard to cost burdens should be marginal. In sum, the costs of 
compliance resulting from the requirements in the amendments to Rule 
15c3-3 should not impose a burden on competition not necessary or 
appropriate in furtherance of the purposes of the Exchange Act in light 
of the benefits discussed above.
2. Holding Futures Positions in a Securities Portfolio Margining 
Account
i. Economic Analysis
    As discussed in section II.B. of this release, the Commission is 
adopting amendments to Rule 15c3-3 to accommodate futures positions in 
a securities account that is margined on a portfolio basis. The 
amendments revise the definition of free credit balances and other 
credit balances in paragraphs (a)(8) and (a)(9) of Rule 15c3-3, 
respectively, by expanding these definitions to include funds in a 
portfolio margin account relating to certain futures and futures 
options positions. Consequently, as part of free credit balances and 
other credit balances, these funds will be included as a credit item on 
the credit side of the customer reserve formula. The Commission is also 
adopting, as proposed, an amendment to Rule 15c3-3a Item 14 that 
permits a broker-dealer to include as a debit item, on the debit side 
of the customer reserve formula, the amount of customer margin required 
and on deposit at a derivatives clearing organization related to 
futures positions carried in a portfolio margin account.
    The amendments are designed to provide greater protection to 
customers with portfolio margin accounts, through the reserve 
requirements of Rule 15c3-3 and SIPA, by requiring a broker-dealer to 
include all cash balances (including portfolio margin cash balances) of 
its customers' securities accounts in the computation of the customer 
reserve. The customer reserve computation under Rule 15c3-3 is designed 
to ensure that the funds a broker-dealer owes to customers are 
available to be returned to customers in the event the broker-dealer 
fails.
    Subsequent to the Commission's proposals, the Dodd-Frank Act 
amended the definitions of customer, customer property, and net equity 
in section 16 of SIPA to take into account futures and options on 
futures held in a portfolio margin account carried as a securities 
account pursuant to a Commission-approved portfolio margining 
program.\747\ As a result, persons who hold futures positions in a 
portfolio margining account carried as a securities account are now 
entitled to SIPA protection.
---------------------------------------------------------------------------

    \747\ See Public Law 111-203 Sec.  983.
---------------------------------------------------------------------------

    While the Dodd-Frank Act addressed the protection under SIPA of 
futures and futures options held in a securities portfolio margin 
account, the Commission's amendments to Rule 15c3-3 and 15c3-3a will 
still serve an important purpose. In particular, they complement the 
Dodd-Frank SIPA amendments, and will provide additional protections to 
customers by requiring broker-dealers to treat these futures positions 
in accordance with the segregation requirements in Rules 15c3-3 and 
15c3-3a. Consequently, the Commission is adopting the amendments with 
modifications to address, in part, comments. As noted above, the 
requirements of Rule 15c3-3 and Rule 15c3-3a are designed to enable the 
prompt return of customer securities and cash in the event the broker-
dealer falls into financial difficulty or becomes insolvent. The goal 
is to place a broker-dealer in a position where it is able to wind down 
in an orderly self-liquidation without the need for financial 
assistance from SIPC.
    The Commission received six comments on the proposed 
amendments.\748\ Three commenters generally supported the 
amendments.\749\ One commenter supported the development of rules for 
portfolio margining and the Commission's effort to provide greater 
legal certainty regarding the SIPA treatment of futures positions in a 
portfolio margin account.\750\ This commenter, however, in a subsequent 
comment letter, stated that this amendment is no longer necessary in 
light of the Dodd-Frank Act amendments, and recommended that the 
Commission withdraw it.\751\ Another commenter stated that the 
Commission's proposal is premature in that the inclusion of futures in 
a portfolio margin account, which is a securities account, would 
conflict with the segregation provisions under the CEA\752\ and that 
SIPC has not determined that protection should be extended to 
futures.\753\ Commenting in 2007 before the adoption of the Dodd-Frank 
Act, SIPC stated that the proposed rules seek to extend SIPC protection 
to all positions in the portfolio margin account, irrespective of 
whether the positions are securities under SIPA or are on deposit in 
connection with a securities transaction.\754\
---------------------------------------------------------------------------

    \748\ See SIFMA 2 Letter; CME Letter; SIPC Letter; Citigroup 
Letter; American Bar Association Letter; SIFMA 4 Letter.
    \749\ See SIFMA 2 Letter; Citigroup Letter; American Bar 
Association Letter.
    \750\ See SIFMA 2 Letter.
    \751\ See SIFMA 4 Letter.
    \752\ See, e.g., 17 CFR 1.20-1.29.
    \753\ See CME Letter; see also SIPC Letter (expressing ``grave 
concerns'' about potential conflict between the proposed amendments 
and SIPA).
    \754\ See SIPC Letter. SIPC also urged the Commission to 
reconsider its adoption of the portfolio margin proposals, stating 
that if the changes are in order, the Commission should seek to have 
them made by legislative amendment and not rulemaking.
---------------------------------------------------------------------------

    The Commission agrees, in part, with the commenter who stated that 
the Dodd-Frank Act SIPA amendments make the Commission's proposed 
amendments to Rules 15c3-3 and 15c3-3a unnecessary.\755\ As noted 
above, the definitions of customer, customer property, and net equity 
in section 16 of SIPA were amended by the Dodd-Frank Act to take into 
account futures and options on futures held in a portfolio margin 
account carried as a securities account pursuant to a Commission-
approved portfolio margining program.\756\ Consequently, in a

[[Page 51883]]

proceeding under SIPA, futures and options on futures positions held in 
a portfolio margin account carried as a securities account would be 
included in determining a customer's net equity claim.\757\ Therefore, 
the proposed amendment relating to the unrealized value of a futures 
option is not necessary to achieve the objective of providing SIPA 
protection for such positions. As a result, the Commission is modifying 
the final rule to delete the proposed language in paragraph (a)(8) of 
Rule 15c3-3 that would have treated the unrealized value of a futures 
option in a portfolio margin account on the filing date of a SIPA 
proceeding as a free credit balance for purposes of Rule 15c3-3.\758\
---------------------------------------------------------------------------

    \755\ See SIFMA 4 Letter.
    \756\ See Public Law 111-203 Sec.  983.
    \757\ Under the Dodd-Frank Act SIPA amendments, a customer's net 
equity now includes all positions in futures contracts and options 
on futures contracts held in a portfolio margining account carried 
as a securities account pursuant to a portfolio margining program 
approved by the Commission, including all property collateralizing 
such positions, to the extent that such property is not otherwise 
included herein. See 15 U.S.C. 78lll(11)(A)(ii). Further, the 
amendments provided that a claim for a commodity futures contract 
received, acquired, or held in a portfolio margining account 
pursuant to a portfolio margining program approved by the Commission 
or a claim for a security futures contract, shall be deemed to be a 
claim with respect to such contract as of the filing date, and such 
claim shall be treated as a claim for cash. See 15 U.S.C. 78lll(11).
    \758\ Specifically, the final rule does not include the proposed 
language: ``, and, in the event the broker-dealer is the subject of 
a proceeding under SIPA, the market value as of the ``filing date'' 
as that term is defined in SIPA (15 U.S.C. 78lll(7)) of any long 
options on futures contracts.''
---------------------------------------------------------------------------

    While the legislation provides additional certainty with respect to 
how futures in a portfolio margin account would be treated in a SIPA 
liquidation, the Commission's amendments will require that positions 
are subject to the protections of Rule 15c3-3, thus enhancing customer 
protection. Therefore, while the Commission has considered the 
suggested alternatives in developing the final rule amendments 
(including not adopting the amendments), the Commission has determined 
that adopting the portfolio margining amendments was a more appropriate 
approach in furtherance of enhancing customer protection.
    The Commission requested comment on available metrics to quantify 
these benefits and any other benefits a commenter may identify, 
including the identification of sources of empirical data that could be 
used for such metrics. The Commission did not receive any comments in 
response to these requests.
    Current SRO portfolio margin rules permit futures to be held in a 
securities portfolio margin account.\759\ However, pending further 
regulatory action by the Commission and the CFTC, the ability to 
combine securities and futures products into a single portfolio margin 
account will be unavailable.\760\ Therefore, under the current baseline 
of SRO portfolio margin rules, with the inclusion of only securities 
positions in the securities account, this amendment would have no 
effect as compared to the baseline until the Commission and CFTC take 
such further action with respect to portfolio margining.\761\
---------------------------------------------------------------------------

    \759\ See, e.g., FINRA Rule 4210.
    \760\ See Section 713 of the Dodd-Frank Act. Section 713 of the 
Dodd-Frank Act amends the Exchange Act and CEA to facilitate 
portfolio margining by allowing cash and securities to be held in a 
futures account and futures and options on futures and related 
collateral to be held in a securities account by a dually-registered 
broker-dealer and futures commission merchant pursuant to an 
approved portfolio margin program, subject to certain requirements, 
including regulatory action by the Commission and CFTC (pursuant to 
an exemption, or by rule or regulation). See generally, A Joint 
Report of the SEC and the CFTC on Harmonization of Regulation (Oct. 
19, 2009).
    \761\ See generally, A Joint Report of the SEC and the CFTC on 
Harmonization of Regulation (Oct. 19, 2009).
---------------------------------------------------------------------------

    The requirements imposed by the portfolio margin amendments will be 
elective. The requirements will apply only to broker-dealers choosing 
to offer their customers portfolio margin accounts. The Commission 
estimates that approximately 35 broker-dealers will elect to offer 
their customers portfolio margin accounts that will include futures and 
futures options.\762\ The amendment to the definition of free credit 
balances in Rule 15c3-3 will require broker-dealers to include in the 
reserve formula credit balances related to futures positions in a 
portfolio margin account. The amendment to Rule 15c3-3a Item 14 in the 
reserve formula will enable broker-dealers to include as a debit item 
the amount of customer margin required and on deposit at a derivatives 
clearing organization. Accordingly, these amendments will require 
changes to the systems broker-dealers use to compute and account for 
their reserve requirements. Consistent with the proposing release,\763\ 
the Commission assumes that the responsibility for updating these 
systems will be undertaken by a Senior Programmer.\764\ Therefore, the 
Commission estimates that the program and systems changes would result, 
on average, in a one-time cost of approximately $36,660 per broker-
dealer.\765\ Thus, the Commission estimates the total one-time cost to 
broker-dealers will be approximately $1,283,100.\766\
---------------------------------------------------------------------------

    \762\ This estimate is based on OCUS Report data. This is an 
update from the estimate in the proposing release of 33 broker-
dealers. See Amendments to Financial Responsibility Rules, 72 FR at 
12883.
    \763\ See Amendments to Financial Responsibility Rules, 72 FR at 
12883.
    \764\ The SIFMA 2012 Report as Modified indicates the average 
hourly cost of this position is approximately $282. Consistent with 
the proposing release, the Commission estimates the Senior 
Programmer will spend approximately 130 hours modifying software to 
conform it to the requirements of the amendments. See Amendments to 
Financial Responsibility Rules, 72 FR at 12883.
    \765\ 130 hours x $282 = $36,660. In the proposing release, the 
Commission estimated this cost would be $34,840. See Amendments to 
Financial Responsibility Rules, 72 FR at 12883.
    \766\ 35 broker-dealers x $36,660 = $1,283,100. In the proposing 
release, the Commission estimated this cost would be $1,149,720. See 
Amendments to Financial Responsibility Rules, 72 FR at 12883.
---------------------------------------------------------------------------

    The Commission requested comment on the proposed cost estimates. In 
particular, the Commission requested comment on additional costs to 
broker-dealers that would arise from the proposals, such as system 
costs in addition to those discussed above (e.g., costs associated with 
purchasing new software and updates to existing software). The 
Commission also requested comment on whether these proposals would 
impose costs on other market participants, including broker-dealer 
customers. Commenters were asked to identify the metrics and sources of 
any empirical data that supported their costs estimates. The Commission 
did not receive any comments in response to these requests.
ii. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation
    The final rule amendments to Rule 15c3-3 to accommodate futures 
positions in a securities account margined on a portfolio basis \767\ 
should complement the Congressional amendments and provide additional 
protections to portfolio margin customers through the strengthened 
reserve requirements of Rule 15c3-3. These additional protections may 
reduce the risk of loss of collateral to securities customers, promote 
participation in the securities markets, and enhance competition and 
price discovery. Moreover, these additional protections may make 
portfolio margining more attractive to investors. Portfolio margining 
may significantly reduce customer margin requirements by offsetting 
positions involving securities and futures products, which in turn 
reduces the costs of trading such products and enhances efficiency. 
Portfolio margining may also promote better price discovery across 
securities and futures products by allowing customers to offset a 
position assumed in one market with a product traded in

[[Page 51884]]

another market. The enhanced efficiencies as a result of increases in 
the use of portfolio margin accounts may facilitate capital formation 
through the availability of additional capital for customers as a 
result of reduced margin costs.
---------------------------------------------------------------------------

    \767\ See section II.B. of this release.
---------------------------------------------------------------------------

    While today's amendments promote efficiency within the securities 
markets, the increased costs associated with the rule amendments may 
impose a burden on competition among broker-dealers. However, the 
Commission is of the opinion that these costs are justified by the 
significant benefits described in this economic analysis. In sum, the 
costs of compliance resulting from the requirements in the portfolio 
margining amendments to Rule 15c3-3 should not impose a burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Exchange Act in light of the benefits discussed above.
3. Amendments With Respect to Securities Lending and Borrowing and 
Repurchase/Reverse Repurchase Transactions
i. Economic Analysis
    The Commission is adopting amendments to Rules 15c3-1 and 17a-11 to 
strengthen the financial responsibility of broker-dealers engaging in a 
securities lending business. First, the amendment to subparagraph 
(c)(2)(iv)(B) of Rule 15c3-1 clarifies that broker-dealers providing 
securities lending and borrowing settlement services are deemed, for 
purposes of the rule, to be acting as principals and are subject to 
applicable capital deductions. Under the amendment, these deductions 
could be avoided if a broker-dealer takes certain steps to disclaim 
principal liability. Second, the amendment to paragraph (c)(5) of Rule 
17a-11 requires a broker-dealer to: (1) File a notice with the 
Commission and its DEA whenever the total money payable against all 
securities loaned, subject to a reverse repurchase agreement or the 
contract value of all securities borrowed or subject to a repurchase 
agreement exceeds 2,500% of tentative net capital; or, alternatively, 
(2) report monthly its securities lending and repurchase activities to 
its DEA in a form acceptable to its DEA.
    Both amendments are intended to strengthen the financial 
responsibility of broker-dealers engaged in a securities lending or 
repurchase business. The first amendment to subparagraph (c)(2)(iv)(B) 
of Rule 15c3-1 will help eliminate the legal uncertainty among 
counterparties as to the role played by broker-dealers in such 
transactions and clarify the nature of the services that securities 
lending intermediaries provide their counterparties.
    Thus, a broker-dealer will be considered a principal unless the 
broker-dealer has disclosed the identity of each party to the other, 
and the parties have agreed in writing that the obligations of the 
broker-dealer do not include a guarantee of performance by the other 
party and that in the event of default, neither party shall have the 
right of setoff against the obligations, if any, of the broker-dealer. 
In addition, this amendment will help avoid ambiguity regarding the 
applicability to a particular broker-dealer of the stock loan charges 
in the net capital rule.
    In response to comments that standard legal documents currently 
used in securities lending transactions provide sufficient legal 
certainty with respect to the status of the parties,\768\ the 
Commission considered whether to adopt the proposed approach or whether 
to rely on existing industry practice. The Commission considered the 
alternatives and believes that the rule as adopted appropriately 
balances the commenters' objections to the proposal with the 
Commission's concerns about stock lending practices, particularly with 
regard to the failure of MJK.\769\ In recognition of standard stock 
loan agreement templates, the Commission designed the amendment to 
accommodate the continued use of these industry model agreements by 
incorporating their use into the rule's requirements.
---------------------------------------------------------------------------

    \768\ See section II.C. of this release. See also SIFMA 2 
Letter; Citigroup Letter.
    \769\ See section II.C. of this release.
---------------------------------------------------------------------------

    The second amendment to paragraph (c)(5) of Rule 17a-11 will help 
identify broker-dealers with highly leveraged non-government securities 
lending and borrowing and repo activity.\770\ This new provision 
requires that a broker-dealer notify the Commission whenever the total 
amount of money payable against all securities loaned or subject to a 
repurchase agreement, or the total contract value of all securities 
borrowed or subject to a reverse repurchase agreement exceeds 2,500% of 
tentative net capital; provided that, for purposes of this leverage 
threshold, transactions involving government securities, as defined in 
Section 3(a)(42) of the Exchange Act, are excluded from the 
calculation.\771\ The notice provision is designed to alert regulators 
to a sudden increase in a broker-dealer's stock loan and repo 
positions, which could indicate that the broker-dealer is taking on new 
or additional risk that it may have limited experience or increased 
difficulty in managing. This amendment will assist securities 
regulators in monitoring such activities and responding to situations 
where a broker-dealer experiences financial difficulty due to a large 
securities lending or repo position. This may help prevent significant 
losses to the broker-dealer's customers and other broker-dealers, and 
reduce systemic financial risk.
---------------------------------------------------------------------------

    \770\ 17 CFR 240.17a-11(c)(5).
    \771\ 15 U.S.C. 78c(a)(42). Government securities generally 
present less market risk than other types of securities used in 
securities lending and repo transactions. Consequently, they are 
excluded from the scope of this rule.
---------------------------------------------------------------------------

    As adopted, new paragraph (c)(5) of Rule 17a-11 also permits a 
broker-dealer to report monthly its stock loan and repo activity to its 
DEA in a form acceptable to its DEA in lieu of the notices required by 
paragraph (c)(5). This approach will provide each DEA with the 
flexibility to prescribe how the monthly reports are to be made and 
will accommodate a DEA that opts to use the FOCUS report as the 
reporting mechanism.\772\ This provision will also accommodate large 
broker-dealers that are active in this business and regularly maintain 
stock loan and repo balances that exceed the threshold. The Commission 
expects that these broker-dealers have experience in managing the risks 
associated with these types of transactions and have established 
controls to address those risks. Consequently, notice under Rule 17a-11 
from these broker-dealers will not be as useful to regulators. On the 
other hand, the monthly reports will provide securities regulators with 
information useful, for example, to develop trend analysis, if deemed 
appropriate. This analysis can be used to identify leverage levels that 
are outside the normal trend range and that may be indicative of a 
material change in the firm's business model (e.g., taking on higher 
levels of leverage, branching into new products, or experiencing 
operational or financial difficulties).
---------------------------------------------------------------------------

    \772\ As proposed, the amendment to Rule 17a-11 would have 
provided that a broker-dealer that submitted a monthly report of its 
stock loan and repo activity to its DEA not be required to file the 
Rule 17a-11 notices required by paragraph (c)(5). See Amendments to 
Financial Responsibility Rules, 72 FR at 12870.
---------------------------------------------------------------------------

    The Commission requested comment on available metrics to quantify 
these benefits and any other benefits a commenter may identify. 
Commenters were requested to identify sources of empirical data that 
could be used for the metrics they propose. The Commission did not 
receive any comments in response to these requests.
    The Commission expects that broker-dealers may incur costs related 
to the implementation of the rule

[[Page 51885]]

amendments. Using current Rule 15c3-1 and Rule 17a-11 as a baseline, 
the Commission expects that some broker-dealers may incur costs in 
connection with the implementation of these rule amendments.
    With regard to the amendment to subparagraph (c)(2)(iv)(B) of Rule 
15c3-1, the Commission understands that most existing standard 
securities lending master agreements in use today already contain 
language requiring agent lenders to disclose principals and for 
principals to agree not to hold the agents liable for a counterparty 
default. Thus, the standard agreement used by the vast majority of 
broker-dealers should contain the representations and disclosures 
required by the proposed amendment. However, a small percentage of 
broker-dealers may need to modify their standard agreements. The 
Commission estimates that the total one-time cost to broker-dealers for 
this change will be approximately $45,480.\773\
---------------------------------------------------------------------------

    \773\ In the proposing release, the Commission estimated that 
the total one-time cost to broker-dealers would be approximately 
$62,604. See Amendments to Financial Responsibility Rules, 72 FR at 
12884. The internal hours would likely be performed by an in-house 
Attorney at $379 per hour, resulting in the estimated internal cost 
calculated as follows: 120 hours at $379 per hour = $45,480. See 
section IV.D.1. of this release.
---------------------------------------------------------------------------

    The Commission requested comment on the cost estimates. In 
particular, the Commission requested comment on additional costs to 
broker-dealers that would arise from the proposals, such as costs 
arising from making systems changes. The Commission also requested 
comment on whether these proposals would impose costs on other market 
participants, including broker-dealer customers. Commenters were also 
asked to identify the metrics and sources of any empirical data that 
support their costs estimates. The Commission did not receive any 
comments in response to these requests.
    With regard to the amendment to Rule 17a-11, the Commission 
received several suggested alternatives from commenters which 
contributed to the modification of the final rule from the proposal. 
Three commenters addressed the proposed monthly notification 
requirement. They stated that the monthly report in lieu of the 
notification should be provided as part of the monthly FOCUS report 
many broker-dealers file with their DEA.\774\ The Commission agrees 
that the FOCUS report may be an appropriate mechanism for reporting 
stock loan and repo positions in lieu of the proposed monthly 
notification requirement.\775\ Consequently, the Commission modified 
the final rule amendment to delete the phrase ``submits a monthly 
report of'' and replace it with the phrase ``reports monthly.'' In 
addition, as adopted, in order to provide that the monthly report shall 
be sent to a broker-dealer's DEA, the Commission added the phrase ``to 
its designated examining authority in a form acceptable'' before ``to 
its designated examining authority.'' This approach, as adopted, is 
intended to provide each DEA with the flexibility to tailor the 
reporting requirements.
---------------------------------------------------------------------------

    \774\ See Abbey National Letter; Citigroup Letter; SIFMA 2 
Letter.
    \775\ Carrying broker-dealers are generally required to submit 
FOCUS reports on a monthly basis.
---------------------------------------------------------------------------

    Based on FOCUS Report data, the Commission estimates that 
approximately one notice per year will be sent pursuant to this 
amendment.\776\ Therefore, approximately one broker-dealer per year 
will incur costs to prepare and send the notice.\777\ Consequently, the 
Commission estimates that the costs to broker-dealers associated with 
this requirement will be de minimis.
---------------------------------------------------------------------------

    \776\ This estimate is derived from FOCUS Report data, and 
adjusted based on staff experience. This estimate has been updated 
from the proposing release estimate of 11. No comments were received 
on this estimate.
    \777\ The internal hours would likely be performed by junior 
stock loan manager for 10 minutes at $134 per hour x 1 notice = 
$22.33. See section IV.D.8. of this release.
---------------------------------------------------------------------------

    In addition, the Commission estimates that six broker-dealers will 
choose the option of reporting monthly \778\ and will incur a one-time 
cost to update their systems to generate the information for the 
report.\779\ The Commission also estimates that these broker-dealers 
will incur annual costs generating and filing the monthly reports or 
preparing the information to include in monthly FOCUS Reports (as 
applicable).\780\ Therefore, the Commission estimates that the total 
one-time cost and annual costs to broker-dealers will be approximately 
$169,200 \781\ and $9,648 \782\ respectively. The Commission's total 
one-time and annual cost estimates have decreased from the proposing 
release primarily due to an overall decrease in the number of broker-
dealers.
---------------------------------------------------------------------------

    \778\ This is an update from the proposing release estimate of 
21 broker-dealers. See Amendments to Financial Responsibility Rules, 
72 FR at 12884.
    \779\ The internal hours would likely be performed by a senior 
programmer. Therefore, the estimated internal costs for this hour 
burden would be calculated as follows: Senior Programmer for 100 
hours at $282 per hour = $28,200. See section IV.D.8. of this 
release. This is an update from the proposing release estimate of 
$26,800. See Amendments to Financial Responsibility Rules, 72 FR at 
12884.
    \780\ The internal hours would likely be performed by a junior 
stock loan manager. Therefore, the estimated internal costs for this 
hour burden would be calculated as follows: Junior Stock Loan 
Manager for 12 hours at $134 per hour = $1,608. See section IV.D.8. 
of this release. This is an update from the proposing release 
estimate of $2,496 per firm. See Amendments to Financial 
Responsibility Rules, 72 FR at 12884.
    \781\ 6 firms x $28,200 = $169,200. This is an update from the 
proposing release estimate of $562,800. See Amendments to Financial 
Responsibility Rules, 72 FR at 12884.
    \782\ 6 firms x $1,608 = $9,648. This is an update from the 
proposing release estimate of $52,416. See Amendments to Financial 
Responsibility Rules, 72 FR at 12884.
---------------------------------------------------------------------------

    As noted above, the Commission requested comment on the proposed 
cost estimates. In particular, the Commission requested comment on 
additional costs to broker-dealers that would arise from the proposals. 
The Commission also requested comment on whether these proposals would 
impose costs on other market participants, including market 
participants active in the securities lending and repurchase markets. 
Commenters were asked to identify the metrics and sources of any 
empirical data that supported their cost estimates. The Commission did 
not receive any comments in response to these requests.
ii. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation
    As described above, the amendment to subparagraph (c)(2)(iv)(B) of 
Rule 15c3-1 and new paragraph (c)(5) of Rule 17a-11 are designed to 
address two areas of concern that emerged from the Commission's 
experience with the failure of MJK.\783\ First, broker-dealers with 
principal liability in a stock loan transaction may be deemed to be 
acting in an agency capacity and therefore not taking appropriate 
capital charges. Second, broker-dealers that historically have not been 
very active in stock loan activities may rapidly expand their balance 
sheets and increase leverage to a level that poses significant 
financial risk to the firm and counterparties. Either potential event 
could result in significant, adverse consequences for customers and 
counterparties of the broker-dealer. For the customers, the fact that 
the broker-dealer could avoid taking appropriate capital charges would 
imperil the broker-dealer's ability to self-liquidate, thereby impeding 
the ability of customers to be promptly paid in full. For the 
counterparties, the fact that the broker-dealer could rapidly escalate 
its leverage increases the likelihood that the broker-dealer could fail 
and its counterparties could

[[Page 51886]]

experience, losses of value associated with the rapid unwinding of 
positions with the failing broker-dealer.
---------------------------------------------------------------------------

    \783\ See section II.C. of this release.
---------------------------------------------------------------------------

    Overall, the amendments to Rule 15c3-1 and Rule 17a-11 will help 
enhance the monitoring of securities lending or repurchase activities 
by securities regulators, thereby reducing the effect on customers and 
counterparties of the potential impact of a financial collapse of the 
broker-dealer.\784\ This will strengthen the securities markets and 
make them more attractive to investors, thereby enhancing efficiency 
and capital formation. Moreover, the language in the final rule that 
provides each DEA with the flexibility to prescribe how the monthly 
reports are to be made may enhance efficiencies for broker-dealers by 
providing the ability for a DEA to tailor the reporting requirements. 
Finally, the costs of compliance with the amendments to Rules 15c3-1 
and 17a-11 should not impose a burden on competition not necessary or 
appropriate in the furtherance of the purposes of the Exchange Act in 
light of the benefits discussed above.
---------------------------------------------------------------------------

    \784\ Id.
---------------------------------------------------------------------------

4. Documentation of Risk Management Procedures
i. Economic Analysis
    As discussed in section II.D. of this release, the Commission is 
adopting new paragraph (a)(23) to Rule 17a-3 to require certain broker-
dealers to make and keep current a record documenting the credit, 
market, and liquidity risk management controls established and 
maintained by certain broker-dealers to assist them in analyzing and 
managing the risks associated with their business activities, 
including, for example, securities lending and repo transactions, OTC 
derivative transactions, proprietary trading, and margin lending.\785\ 
The amendment will apply only to broker-dealers that have more than 
$1,000,000 in aggregate credit items as computed under the customer 
reserve formula of Rule 15c3-3, or $20,000,000 in capital including 
debt subordinated in accordance with Appendix D to Rule 15c3-1.
---------------------------------------------------------------------------

    \785\ 17 CFR 240.17a-3(a)(23).
---------------------------------------------------------------------------

    These amendments require large broker-dealers to document the 
controls they have implemented to address the risks they face as a 
result of their business activities. As proposed, the amendment would 
have required a broker-dealer to create a record documenting its 
``internal risk management controls,'' rather than its market, credit, 
and liquidity risk controls. Commenters generally raised concerns with 
the proposed amendment stating, for example, that the proposed 
documentation of internal management controls over risks arising from 
the broker-dealer's business activities was overly broad and 
ambiguous.\786\ The Commission considered the proposed approach and, as 
discussed above, in part in response to comments, the Commission 
narrowed the application of the amendment so that the final rule now 
requires the documentation of internal risk management controls 
established to manage market, credit, and liquidity risk.\787\ The 
final rule benefits firms and their customers by mitigating the risk of 
losses associated with a firm's normal activities, while at the same 
time placing an increased recordkeeping burden on broker-dealers by 
requiring them to document certain risks in writing.
---------------------------------------------------------------------------

    \786\ See E*Trade Letter; Citigroup Letter.
    \787\ See section II.D. of this release.
---------------------------------------------------------------------------

    A well-documented system of internal controls designed to manage 
material risk exposures related to market, credit, and liquidity risk 
reflects the expectations of a firm's management as to how its business 
activities should be conducted in light of such exposures. Written risk 
management procedures enable management to better identify, analyze, 
and manage the risks inherent in the firm's business activities with a 
view to preventing material losses and to review whether the firm's 
activities are being conducted in a manner that is consistent with such 
procedures and controls. This will likely benefit market participants 
and reduce systemic financial risk.
    In addition, by making the documented controls a required record 
under Rule 17a-3, a broker-dealer's regulator likely will have better 
access to them, as this benefit will only be realized to the extent 
that a broker-dealer has existing market, credit, and liquidity risk 
management controls in place because the rule does not specify the type 
of controls a broker-dealer must establish to manage these risks. It 
simply requires documentation of the procedures that the broker-dealer 
has established. The final rule amendment will require any such records 
of the market, credit, and liquidity risk management controls to be 
available to the broker-dealer's regulators so that they can review 
whether the broker-dealer is adhering to these controls.
    The Commission requested comment on available metrics to quantify 
these benefits and any other benefits a commenter may identify. 
Commenters were requested to identify sources of empirical data that 
could be used for the metrics they proposed. The Commission did not 
receive any comments in response to these requests.
    These amendments apply to a limited number of broker-dealers, 
namely, those firms with more than $1 million in customer credits or 
$20 million in capital and amend recordkeeping requirements in Rules 
17a-3 and 17a-4. Therefore, against the existing baseline of these 
current rules, the Commission expects that the requirement will result 
in a one-time cost to some of these firms to the extent that they have 
established controls that have not been documented. However, since most 
firms are expected to be already compliant, the incremental costs are 
expected to be small. For example, broker-dealers that are approved to 
compute capital using internal models are already subject to Rule 15c3-
4, which requires these firms to establish, document, and maintain a 
system of internal risk controls to assist them in managing the risks 
associated with its business activities, including market, credit, 
leverage, liquidity, legal, and operational risks.\788\ These firms 
would most likely incur no or minimal costs to comply with the final 
rule. In addition, this rule amendment does not mandate any specific 
control, procedure, or policy be established; rather, the Commission is 
requiring that a control, procedure, or policy be documented if it is 
in place. For these reasons, the Commission estimates that the one-time 
hourly burden to meet the requirements of these rules will range from 
zero hours for some firms to hundreds of hours for other firms. Taking 
this into account, the Commission estimates that the total one-time 
cost to broker-dealers to document controls in compliance with this 
amendment will be approximately $13,783,700.\789\ The Commission also 
estimates that the annual cost to broker-dealers to ensure compliance 
with the

[[Page 51887]]

amendment to Rule 17a-3 will be approximately $8,356,950.\790\
---------------------------------------------------------------------------

    \788\ 17 CFR 240.15c3-4; 17 CFR 240.15c3-1(a)(7)(iii). Based on 
staff experience monitoring broker-dealer risk management 
procedures, the internal hours would likely be coordinated by a 
broker-dealer's in-house attorney (19,600 hours), working with 
operation specialists (24,500 hours), and overseen by an associate 
general counsel (4,900 hours). Therefore, the estimated internal 
costs for this hour burden would be calculated as follows: 
[(Attorney for 19,600 hours at $379 per hour) + (Operations 
Specialist for 24,500 hours at $126 per hour) + (Associate General 
Counsel for 4,900 hours at $467) = $12,803,700. Broker-dealers are 
also expected to incur one-time outside counsel costs of $980,000 
for a total one-time cost of $13,783,700. See section IV.D.7. of 
this release.
    \789\ See section IV.D.7. of this release. In the proposing 
release, the Commission estimated this cost would be approximately 
$14,201,990. See Amendments to Financial Responsibility Rules, 72 FR 
at 12885.
    \790\ The internal hours would likely be performed by a broker-
dealer's in-house attorney. Therefore, the estimated internal costs 
for this hour burden would be calculated as follows: Attorney at 
$379 per hour x 22,050 hours = $8,356,950. See section IV.D.7. of 
this release.
---------------------------------------------------------------------------

    As noted above, the Commission requested comment on the proposed 
cost estimates. In particular, the Commission requested comment on 
additional costs to broker-dealers that would arise from the proposals, 
such as costs arising from making changes to systems and costs 
associated with maintaining these records. The Commission also 
requested comment on whether the proposals would impose costs on other 
market participants, including broker-dealer customers. Commenters were 
also asked to identify the metrics and sources of any empirical data 
that support their cost estimates. The Commission did not receive any 
comments in response to these requests.
ii. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation
    The amendments to Rules 17a-3 and 17a-4 require firms to document 
their market, credit, and liquidity risk management controls. The 
amendments will help strengthen broker-dealer internal controls. 
Documenting internal controls will encourage enhanced consideration of, 
and thus a firmer grasp upon, the risks attendant to a broker-dealer's 
business activities. This is designed to reduce the risks inherent to 
the business of operating as a broker-dealer. The final approach the 
Commission has taken with these rule amendments--encouraging effective 
internal controls while preserving flexibility--will enhance a broker-
dealer's financial soundness and, consequently, may help to reduce the 
likelihood of broker-dealer failures with possible positive effects on 
investor participation, competition, and capital formation. The 
amendments may also increase efficiencies in broker-dealer examinations 
through the ready availability of records for examiners.
    Finally, the Rule 17a-3 and 17a-4 amendments are not expected to 
place a burden on competition for small non-carrying broker-dealers 
because such firms would not be subject to these amendments.\791\ As 
discussed above, there will be some incremental costs to compliance 
related to these amendments for carrying broker-dealers but the costs 
of compliance should not impose a burden on competition not necessary 
or appropriate in furtherance of the purposes of the Exchange Act and 
in light of the benefits discussed above.
---------------------------------------------------------------------------

    \791\ The amendments only apply to broker-dealers that have more 
than $1,000,000 in aggregate credit items as computed under the 
customer reserve formula of Rule 15c3-3, or $20,000,000 in capital 
including debt subordinated in accordance with Appendix D to Rule 
15c3-1.
---------------------------------------------------------------------------

5. Amendments to the Net Capital Rule
i. Economic Analysis
a. Requirement To Deduct From Net Worth Certain Liabilities or Expenses 
Assumed by Third Parties
(I). Summary of Amendments
    The amendments to Rule 15c3-1 add a new paragraph (c)(2)(i)(F) 
requiring a broker-dealer to adjust its net worth when calculating net 
capital by including any liabilities that are assumed by a third party 
if the broker-dealer cannot demonstrate that the third party has the 
resources, independent of the broker-dealer's income and assets, to pay 
the liabilities. This amendment is intended to assist investors and 
regulators by requiring broker-dealers to provide a more accurate 
picture of their financial condition. This should help regulators react 
more quickly if a broker-dealer experiences financial difficulty and 
benefit customers of the troubled broker-dealer as well as its 
counterparties.
    The purpose of the requirement in new paragraph (c)(2)(i)(F) of 
Rule 15c3-1 is to address the practices of a broker-dealer that raise 
concerns when a broker-dealer shifts liabilities to an entity with no 
revenue or assets independent of the broker-dealer to inappropriately 
increase its reported net capital, by excluding the liability from the 
calculation of net worth. The final rule is designed to prohibit a 
practice that could misrepresent a broker-dealer's actual financial 
condition, mislead the firm's customers, and hamper the ability of 
regulators to monitor the firm's financial condition.
    The Commission requested comment on available metrics to quantify 
these benefits and any other benefits a commenter may identify. 
Commenters were requested to identify sources of empirical data that 
could be used for the metrics they proposed. The Commission did not 
receive any comments in response to these requests.
(II). Baseline and Incremental Economic Effects
    As discussed in section II.E.1. of this release, the baseline of 
this rule amendment is current Rule 15c3-1 and existing guidance and 
interpretations. The Commission staff has provided guidance with 
respect to the treatment and recording of certain broker-dealer 
expenses and liabilities that is consistent with the rule 
amendment.\792\ Consequently, as against the current baseline, the 
Commission does not expect significant incremental benefits and costs 
to the extent that they already comply with existing guidance and 
interpretations.\793\
---------------------------------------------------------------------------

    \792\ See, e.g., Third Party Expense Letter; see also FINRA 
Notice to Members 03-6, Expense Sharing Agreements.
    \793\ Under this amendment, some broker-dealers may request 
permission in writing from their DEA to withdraw capital within one 
year of contribution under the rule, resulting in annual costs to 
broker-dealers of approximately $144,150 (465 hours x $310 per hour 
for a Compliance Attorney). See section IV.D.2. of this release.
---------------------------------------------------------------------------

    While the amendments apply to all broker-dealers, they will impact 
only those few that shift liabilities to entities with no revenue or 
assets independent of the broker-dealer (i.e., shell corporations) to 
boost the broker-dealer's reported net capital. Based on staff 
experience in supervising broker-dealer compliance with Rule 15c3-1, 
the vast majority of broker-dealers likely either do not seek to 
transfer responsibility for their liabilities to a third party or, if 
they do so, rely on a third party that has the financial resources--
independent of the assets and revenue of the broker-dealer--to pay the 
obligations as they become due. Because of this, it is difficult to 
quantify the benefits and costs impact of this rule amendment.
    The Commission conservatively estimates that the amendment may 
impact all broker-dealers that do not report any liabilities. FOCUS 
Report data, as of December 31, 2011, indicates that approximately 289 
broker-dealers report having no liabilities. While this number is 
likely at the upper boundary of the total number of broker-dealers 
affected by this amendment, the number of broker-dealers reporting no 
liabilities likely represents a reasonable sample of broker-dealers on 
which to base the cost estimates.
    Requiring these broker-dealers to book liabilities will decrease 
the amount of equity capital held by the firms and in some cases may 
require them to obtain additional capital. The majority of broker-
dealers reporting no liabilities are introducing broker-dealers that 
have a $5,000 minimum net capital requirement, while the reported 
average of total liabilities is approximately $491,355 per broker-
dealer. Therefore, conservatively estimating that each of the 289 
broker-dealers will have to raise $491,355 in additional capital as 
result of the requirement, the total aggregate

[[Page 51888]]

amount of additional capital that will need to be raised is $142 
million.\794\
---------------------------------------------------------------------------

    \794\ 289 broker-dealers x $491,355 = $142,001,595. This is an 
update from the proposing release estimate of 702 broker-dealers 
with aggregate liabilities of $280,354 per firm, resulting in an 
estimated amount of additional capital that would have to be raised 
in the amount of $196,808,508 (702 broker-dealers x $280,354 = 
$196,808,508). See Amendments to Financial Responsibility Rules, 72 
FR at 12885, n.189 and accompanying text.
---------------------------------------------------------------------------

    Further, relative to the proposing release, the Commission is 
revising the cost of capital from approximately 5%, which was 
determined based on historical interest rates published by the Federal 
Reserve, to 12% as the average cost of equity capital determined using 
the capital asset pricing model (``CAPM'').\795\ Therefore, the 
Commission conservatively estimates that the total annual cost to 
broker-dealers will be approximately $17 million,\796\ which is an 
increased estimate relative to the proposing release. For the broker-
dealers to whom this increased estimate applies, the Commission expects 
that there would be greater costs imposed. However, the Commission 
expects that the benefits outlined above would also accrue to the 
customers of these broker-dealers.
---------------------------------------------------------------------------

    \795\ The CAPM is a central model in modern financial theory and 
is widely used in applications, such as estimating the cost of 
capital for firms and evaluating the performance of managed 
portfolios. Based on conventional assumptions and historical stock 
price data available on Bloomberg, the Commission estimates a risk-
free rate of 2.5% and an equity risk premium of 7.8%. Using, five-
year, as well as two-year, monthly returns for a sample of listed 
broker-dealers, the Commission estimates an adjusted beta of 
approximately 1.25.
    \796\ $142,001,595 x 12.25% = $17,395,195. In the proposing 
release, the Commission estimated that this cost would be 
approximately $10 million. See Amendments to Financial 
Responsibilities Rules. 72 FR at 12995.
---------------------------------------------------------------------------

    The Commission requested comment on the proposed cost estimates. In 
particular, the Commission requested comment on additional costs to 
broker-dealers that would arise from the proposals. The Commission also 
requested comment on whether these proposals would impose costs on 
other market participants, including broker-dealer customers. 
Commenters were also asked to identify the metrics and sources of any 
empirical data that support their costs estimates. The Commission 
received five comments in response to this request for comment.\797\
---------------------------------------------------------------------------

    \797\ See Beer Letter; Beer 2 Letter; Lowenstein Letter; Levene 
Letter; NIBA 2 Letter.
---------------------------------------------------------------------------

    One commenter noted that the Commission has provided no evidence 
that the public has been endangered or has been left financially 
unprotected as a result of the practice of having another entity book 
some or all of a member's liabilities.\798\ This commenter asserted 
that the amendment will affect 14% of total member firms and that 
member firms may be shut down, sold or merged as an unintended 
consequence of the amendment.\799\ The commenter questioned how many 
member firms will fail as a result of this proposal.\800\
---------------------------------------------------------------------------

    \798\ See Lowenstein Letter.
    \799\ Id.
    \800\ Id.
---------------------------------------------------------------------------

    Another commenter stated that the true costs of the amendment 
should be calculated and verified before a proposed amendment is 
offered and that the true costs of these amendments were given little 
time, research, and consideration.\801\ This commenter also argued that 
the estimated 5% cost of capital has no basis and a firm would be 
fortunate to borrow funds for double the estimate of 5%.\802\ This same 
commenter also stated that the proposal would require 702 debt-free 
introducing broker-dealers to needlessly take on debt of approximately 
$280,354.\803\ Another commenter stated that it is unclear and unlikely 
how this amendment would achieve any of the desired results and may 
conversely impair a firm's ability to continue as a going concern.\804\ 
None of the commenters provided the Commission with revised cost 
estimates.
---------------------------------------------------------------------------

    \801\ See Beer 2 Letter.
    \802\ Id.
    \803\ See Beer Letter; Lowenstein Letter.
    \804\ See Levene Letter.
---------------------------------------------------------------------------

    One commenter stated that if small firms were required to raise 
over $300,000 in capital each, there would be the largest dissolution 
of small broker-dealers in the history of the regulated securities 
industry.\805\ This commenter also stated that the Commission's 
estimate of a gross cost of capital of 7.5% (5% + 2.5%) is a totally 
unrealistic cost of capital for small broker-dealers and that these 
broker-dealers will categorically have costs significantly higher than 
7.5%.\806\ Finally, the commenter stated that, until the Commission 
convenes a small broker-dealer representative panel to assist it with 
establishing such costs, the Commission is speculating on such costs, 
and is therefore without adequate information to consider the effects 
of such costs and changes on small firms.\807\
---------------------------------------------------------------------------

    \805\ See NIBA 2 Letter.
    \806\ Id.
    \807\ Id.
---------------------------------------------------------------------------

(III). Alternatives
    The Commission considered all comments received \808\ and the 
alternative of not adopting the rule, and decided to adopt the 
amendments substantially as proposed. In response to the comment 
regarding the unrealistic cost of capital,\809\ the Commission has 
increased the cost of capital to 12% as an average cost of equity 
capital for broker-dealers. As discussed in section II.E.1 of this 
release, the baseline of this amendment is current Rule 15c3-1 and 
existing guidance and interpretations. The Commission staff has 
provided guidance with respect to the treatment and recording of 
certain broker-dealer expenses and liabilities that is consistent with 
the rule amendment.\810\ Existing broker-dealer recordkeeping rules 
require a broker-dealer to record its income and expenses.\811\ For 
example, paragraph (a)(2) of Rule 17a-3 requires a broker-dealer to 
make and keep current ledgers (or other records) reflecting all assets 
and liabilities, income and expense and capital accounts.\812\ 
Consequently, as against the current baseline, the above estimates are 
intended to be conservative. The Commission expects that broker-dealers 
will incur costs to comply with this amendment, including costs to 
obtain additional capital, only to the extent they are not currently 
complying with existing guidance and interpretations.
---------------------------------------------------------------------------

    \808\ See Beer Letter; Beer 2 Letter; Lowenstein Letter; Levene 
Letter; NIBA 2 Letter.
    \809\ See NIBA 2 Letter.
    \810\ See, e.g., Third Party Expense Letter; see also FINRA 
Notice to Members 03-6, Expense Sharing Agreements.
    \811\ 17 CFR 240.17a-3; 17 CFR 240.17a-4.
    \812\ 17 CFR 240.17a-3(a)(2).
---------------------------------------------------------------------------

    In response to comments,\813\ the Commission does not expect 
broker-dealers to incur significant costs to comply with this amendment 
to the extent that they are appropriately recording their assets and 
liabilities under current Commission rules and interpretive guidance, 
because these items will already appear on a broker-dealer's balance 
sheet and be included in its net capital computation. Consequently, the 
rule amendment, as adopted, should not: (1) Cause firms to be 
classified as ``a going concern;'' \814\ (2) cause firms to fail, 
dissolve, or otherwise close; \815\ (3) impose undue burdens; or (4) 
present serious implementation difficulties to firms (small or large) 
if they are appropriately recording their assets and liabilities under 
current Commission rules and interpretive guidance.\816\ Further, as 
stated above, the estimates are intended to be conservative, and 
therefore, the Commission expects that the ``true''

[[Page 51889]]

costs \817\ that may be incurred by broker-dealers should be less than 
the maximum estimated. Therefore, the Commission does not believe a 
longer time period for compliance or the formation of a small broker-
dealer advisory cost committee is necessary.\818\
---------------------------------------------------------------------------

    \813\ See Beer Letter; Beer 2 Letter; Lowenstein Letter; Levene 
Letter; NIBA 2 Letter.
    \814\ See Levene Letter.
    \815\ See NIBA 2 Letter.
    \816\ See, e.g., Third Party Expense Letter; see also FINRA 
Notice to Members 03-6, Expense Sharing Agreements.
    \817\ See Beer 2 Letter.
    \818\ See NIBA 2 Letter.
---------------------------------------------------------------------------

b. Requirement To Subtract From Net Worth Certain Non-Permanent Capital 
Contributions
(I). Summary of Amendments
    As discussed in section II.E.2. of this release, the amendment adds 
paragraph (c)(2)(i)(G) to Rule 15c3-1, requiring a broker-dealer to 
treat as a liability any capital that is contributed under an agreement 
giving the investor the option to withdraw it. The rule, as adopted, 
also requires that a broker-dealer treat as a liability any capital 
contribution that is withdrawn within a year of its contribution unless 
the broker-dealer receives permission in writing from its DEA.\819\ The 
amendment to Rule 15c3-1 is intended to assist investors and regulators 
by requiring broker-dealers to provide a more accurate picture of their 
financial condition. This amendment will help regulators react more 
quickly if a broker-dealer experiences financial difficulty and 
benefits customers of a troubled broker-dealer as well as its 
counterparties.
---------------------------------------------------------------------------

    \819\ One commenter suggested that the rule be amended to 
explicitly exclude any withdrawals that would fall under paragraph 
(e)(4)(iii) of Rule 15c3-1. See American Bar Association Letter. It 
is unnecessary to explicitly exclude any withdrawals that would fall 
under paragraph (e)(4)(iii) of Rule 15c3-1 because these 
requirements will not apply to withdrawals covered by paragraph 
(e)(4)(iii) of Rule 15c3-1, namely, withdrawals used to make tax 
payments or to pay reasonable compensation to partners. 17 CFR 
240.15c3-1(e)(4)(iii). These types of payments are ordinary business 
expenditures and do not raise the types of concerns the proposed 
rule is designed to address. See Amendments to Financial 
Responsibility Rules, 74 FR at12872, n.79.
---------------------------------------------------------------------------

    The Commission requested comment on available metrics to quantify 
these benefits and any other benefits a commenter may identify. 
Commenters were requested to identify sources of empirical data that 
could be used for the metrics they proposed. The Commission did not 
receive any comments in response to these requests.
(II). Baseline and Incremental Economic Effects
    As discussed in section II.E.2. of this release, the baseline of 
this rule amendment is current Rule 15c3-1 and existing guidance and 
interpretations. The Commission estimates that the amendments requiring 
broker-dealers to treat certain capital contributions as liabilities 
should not result in significant incremental benefits and costs, as 
compared to the baseline. Because of existing Commission and staff 
guidance regarding the permanency of capital,\820\ broker-dealers 
typically do not enter into agreements permitting an owner to withdraw 
capital at any time. To the extent some firms may have engaged in this 
practice, they may need to raise capital to meet the rule requirement.
---------------------------------------------------------------------------

    \820\ See Net Capital Rule, Exchange Act Release No. 28927 (Feb. 
28, 1991). See also Net Capital Requirements for Brokers and Dealers 
Exchange Act Release No. 18417 (Jan. 13, 1982), 47 FR 3512 (Jan. 25, 
1982). See also Temporary Capital Letter; Study of Unsafe and 
Unsound Practices of Broker-Dealers, Report and Recommendations of 
the Securities and Exchange Commission, H.R. Doc. No. 92-231 (1971) 
(recommending improvement of adequacy and permanency of capital); 
and Letter from Nelson Kibler, Assistant Director, Division of 
Market Regulation to John Pinto, National Association of Securities 
Dealers, Inc. (Sept. 8, 1980).
---------------------------------------------------------------------------

    While the amendments apply to all broker-dealers, they will impact 
only the few broker-dealers that provide investors with the option to 
withdraw capital at any time or within one year. Because of existing 
Commission and staff interpretations related to temporary capital 
contributions,\821\ most broker-dealers likely do not accept capital 
contributions under agreements permitting the investor to withdraw the 
capital at any time or within one year. Therefore, it is difficult to 
quantify the cost impact of this rule amendment.
---------------------------------------------------------------------------

    \821\ See Net Capital Rule, Exchange Act Release No. 28927 (Feb. 
28, 1991), 56 FR 9124 (Mar. 5, 1991); and Temporary Capital Letter.
---------------------------------------------------------------------------

    Based on staff experience with the treatment of capital 
contributions and the application of Rule 15c3-1, the Commission 
estimates that no more than $100 million in capital at broker-dealers 
is subject to such agreements.\822\ Further, with regard to the 
treatment of temporary capital contributions, in the proposing release, 
the Commission assumed an incremental cost of capital of 2.5%,\823\ and 
estimated that the amendment would result in an annual cost of 
approximately $2.5 million.\824\
---------------------------------------------------------------------------

    \822\ See Amendments to Financial Responsibility Rules, 72 FR at 
12885.
    \823\ Id. at 12886-12887.
    \824\ $100,000,000 x 2.5% = $2,500,000.
---------------------------------------------------------------------------

    The Commission requested comment on the proposed cost estimates. In 
particular, the Commission requested comment on additional costs to 
broker-dealers that would arise from the proposals. The Commission also 
requested comment on whether these proposals would impose costs on 
other market participants, including broker-dealer customers. 
Commenters were also asked to identify the metrics and sources of any 
empirical data that support their costs estimates.
    The Commission received three comments.\825\ One commenter stated 
that the Commission's estimate that no more than $100 million of 
capital at broker-dealers is subject to agreements permitting an owner 
to withdraw capital at any time greatly underestimates the impact of 
the proposed rule.\826\ The commenter stated that the Commission makes 
no case for deviating from the already established standards.\827\ 
Another commenter believed that the proposal would raise its cost of 
capital to such an extent that it would be impossible for the firm to 
raise capital from unrelated third parties.\828\
---------------------------------------------------------------------------

    \825\ See Chicago Capital Management Letter; SIG Letter; NIBA 2 
Letter.
    \826\ See SIG Letter.
    \827\ Id.
    \828\ See Chicago Capital Management Letter.
---------------------------------------------------------------------------

    One commenter stated that the Commission's estimate of a gross cost 
of capital of 7.5% (5% + 2.5%) is a totally unrealistic cost of capital 
for small broker-dealers and that these broker-dealers will 
categorically have costs significantly higher than 7.5%.\829\ Finally, 
the commenter stated that, until the Commission convenes a small 
broker-dealer representative panel to assist it with establishing such 
costs, the Commission is ``speculating'' on such costs, and is 
therefore without adequate information to consider the effects of such 
costs and changes on small firms.\830\
---------------------------------------------------------------------------

    \829\ See NIBA 2 Letter.
    \830\ Id.
---------------------------------------------------------------------------

    In response to comments,\831\ the Commission is revising this 
estimate in the final rule to an estimated cost of capital of 
approximately 12%, which is determined as the average cost of equity 
capital of broker-dealers using the CAPM. The overall estimated cost of 
capital is not incremental to the amendment discussed above regarding 
third party liabilities. The estimated cost of capital would be 12% for 
a broker-dealer seeking additional equity capital. Therefore, with 
regard to the treatment of temporary capital contributions, the 
Commission estimates the amendment will result in an annual cost of 
approximately $12.0 million,\832\ which is an increased estimate 
relative to the proposing release. For the broker-dealers to whom this 
increased estimate applies, and who may not be complying with the rule 
amendments, the Commission expects that there would be greater costs 
imposed. However, the Commission expects that the benefits outlined 
above

[[Page 51890]]

would also accrue to the customers of these broker-dealers.\833\
---------------------------------------------------------------------------

    \831\ See NIBA 2 Letter.
    \832\ $100,000,000 x 12.25% = $12,250,000.
    \833\ $100,000,000 x 12.25% = $12,250,000.
---------------------------------------------------------------------------

(III). Alternatives
    The Commission considered all comments discussed above and the 
alternative of not adopting the rule, and decided to adopt the 
amendments substantially as proposed. In response to commenters' 
concerns about the impact on capital and the $100 million 
estimate,\834\ as discussed above, the final rule amendment is a 
codification of existing Commission staff guidance,\835\ and thus 
should not represent a change for broker-dealers with respect to 
capital withdrawals. Moreover, with respect to commenters' concerns 
about obtaining capital,\836\ the rule does not prohibit an investor 
from withdrawing capital at any time. Rather, it prohibits a broker-
dealer from treating temporary cash infusions as capital for purposes 
of the net capital rule. Finally, the final rule amendment provides a 
mechanism for a broker-dealer to apply to its DEA to make a withdrawal 
within one year of the capital contribution without triggering the 
deduction under certain circumstances.
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    \834\ See Chicago Capital Management Letter; SIG Letter; NIBA 2 
Letter.
    \835\ See Temporary Capital Letter. See also section II.E.2. of 
this release.
    \836\ See Chicago Capital Management Letter; SIG Letter; NIBA 2 
Letter.
---------------------------------------------------------------------------

    In the final rule, the Commission has increased the estimated cost 
of capital from 2.5% to 12%, in response to comments regarding the 
unrealistic cost of capital, and because the estimated cost of capital 
is not incremental to the estimated cost of capital to the amendment to 
Rule 15c3-1 regarding third party liabilities.\837\ The estimated cost 
of capital would be 12% for a broker-dealer seeking a loan for any 
additional capital. In addition, based on staff experience with the 
treatment of capital contributions and for the reasons discussed above, 
the Commission continues to believe that the estimate of $100 million 
regarding the temporary capital contributions is reasonable.\838\
---------------------------------------------------------------------------

    \837\ See NIBA 2 Letter.
    \838\ See SIG Letter.
---------------------------------------------------------------------------

    Further, the final rule amendments relating to temporary capital 
contributions have been revised to clarify that a withdrawal of capital 
made within one year of its contribution to the broker-dealer is deemed 
to have been intended to be withdrawn within one year, unless the 
withdrawal has been approved in writing by the broker-dealer's 
DEA.\839\ The Commission made this change to eliminate a potential 
ambiguity as to whether a withdrawal of capital within one year could 
ever be approved by a broker-dealer's DEA. The final rule amendment 
clarifies the intent to provide a mechanism for broker-dealers to apply 
for approval to withdraw capital within one year and to be granted such 
approval where appropriate.
---------------------------------------------------------------------------

    \839\ See section II.E.2. of this release.
---------------------------------------------------------------------------

    While owners of most broker-dealers have the option of withdrawing 
capital, most owners likely do not have agreements that provide the 
option of withdrawing capital at any time.\840\ Paragraph (e) of Rule 
15c3-1 contains mechanisms to permit a broker-dealer to make capital 
withdrawals for specified purposes.\841\ If there is a specific need 
for a broker-dealer to seek permission to make a capital withdrawal 
within one year of contribution, the final rule already provides a 
mechanism for the broker-dealer to seek permission in writing from its 
DEA to make such a withdrawal.\842\ Based on the discussion above, the 
Commission believes the final cost estimates are appropriate.\843\
---------------------------------------------------------------------------

    \840\ See SIG Letter.
    \841\ See paragraphs (e)(1)(iii)(B) and (e)(4)(iii) of Rule 
15c3-1. See also Amendments to Financial Responsibility Rules, 72 FR 
at 12872, n.79 (``These requirements would not apply to withdrawals 
covered by paragraph (e)(4)(iii) of Rule 15c3-1, namely, withdrawals 
used to make tax payments or pay reasonable compensation to 
partners. These types of payments are ordinary business expenditures 
and do not raise the types of concerns the proposed rule is designed 
to address.'')
    \842\ See paragraph (c)(2)(i)(G)(2) of Rule 15c3-1.
    \843\ See NIBA 2 Letter.
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c. Requirement To Deduct the Amount by Which a Fidelity Bond Exceeds 
SRO Limits
    As discussed in section II.E.3. of this release, this amendment 
requires broker-dealers to deduct from net capital, with regard to 
fidelity bonding requirements prescribed by a broker-dealer's examining 
authority, the excess of any deductible amount over the amount 
permitted by SRO rules.
    Under SRO rules, certain broker-dealers that do business with the 
public or are required to become SIPC members must comply with 
mandatory fidelity bonding requirements.\844\ SRO rules typically 
permit a broker-dealer to have a deductible provision included in the 
bond; however, such rules provide that the deductible must not exceed 
certain amounts. With regard to firms that maintain deductible amounts 
over certain specified amounts, a number of SRO rules provide that the 
broker-dealer must deduct this specified amount from net worth when 
calculating net capital under Rule 15c3-1.\845\
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    \844\ See, e.g., FINRA Rule 4360, CBOE Rule 9.22, and NASDAQ OMX 
PHLX Rule 705. SRO fidelity bonding requirements typically contain 
agreements covering the following areas: A ``Fidelity'' insuring 
clause to indemnify against loss of property through dishonest or 
fraudulent acts of employees; an ``On Premises'' agreement insuring 
against losses resulting from crimes such as burglary and theft and 
from misplacement of property of the insured; an ``In Transit'' 
clause indemnifying against losses occurring while property is in 
transit; a ``Forgery and Alteration'' agreement insuring against 
loss due to forgery or alteration of various kinds of negotiable 
instruments; and a ``Securities Loss'' clause protecting against 
losses incurred through forgery and alteration of securities. Id.
    \845\ See, e.g., FINRA Rule 4360 and CBOE Rule 9.22.
---------------------------------------------------------------------------

    Rule 15c3-1, however, does not specifically reference the SRO 
deductible requirements as a charge to net worth, meaning that a 
broker-dealer would not be required for the purposes of Commission 
rules to show the impact of the deduction in the net capital 
computation required by an SRO on the FOCUS Report.\846\ To address the 
reporting inconsistency, the Commission is amending Rule 15c3-1 to add 
paragraph (c)(2)(xiv), which will require broker-dealers to deduct the 
amount specified by rule of the Examining Authority of the broker-
dealer with respect to a requirement to maintain fidelity bond 
coverage. This rule amendment will provide consistency in broker-dealer 
reporting requirements.\847\
---------------------------------------------------------------------------

    \846\ See 17 CFR 240.17a-5.
    \847\ Conversely, not adopting this rule amendment would have 
resulted in continued inconsistency among existing SRO rules and 
Rule 15c3-1.
---------------------------------------------------------------------------

    This amendment will also codify in a Commission rule capital 
charges that broker-dealers are currently required to take pursuant to 
the rules of various SROs. Consequently, any economic effects, 
including costs and benefits, should be compared to a baseline of 
current practices. The amendment should not impose additional costs on 
broker-dealers with respect to the purchasing or carrying of fidelity 
bond coverage. Nor will the amendment cause broker-dealers to incur 
additional costs in determining or reporting excess deductible amounts 
over the deductible permitted. Broker-dealers already make such 
determinations under SROs rules, and the manner in which such excesses 
are typically reported (i.e., through periodic FOCUS Reports and other 
reports) would remain the same.
    The Commission received one comment opposing the fidelity bond 
amendment, stating that FINRA Rule 4360 and the Commission's amendment 
would result in a de facto increase in minimum net capital requirements 
for some broker-dealers.\848\ Any increase in net capital cited by the 
commenter

[[Page 51891]]

would result from existing SRO rules.\849\ Stated differently, broker-
dealers that are members of an SRO with such a fidelity bonding rule 
must already account for the deduction in complying with the net 
capital requirements of SROs and nothing in the Commission's amendment 
to paragraph (c)(2)(xiv) of Rule 15c3-1 would alter this status quo. 
Consequently, while there is currently no deduction required under the 
baseline of current Rule 15c3-1 relating to fidelity bond deductibles, 
because SRO rules currently require this deduction, the adoption of 
this amendment under Rule 15c3-1 should not impose any additional costs 
on broker-dealers that they are not already incurring under existing 
SRO rules.
---------------------------------------------------------------------------

    \848\ See NIBA 2 Letter.
    \849\ For example, the Commission approved FINRA Rule 4360 
through the SRO rule filing process. See Order Approving Proposed 
Rule Change to Adopt FINRA Rule 4360 (Fidelity Bonds) in the 
Consolidated FINRA Rulebook, Exchange Act Release No. 63961 (Feb. 
24, 2011), 76 FR 11542 (Mar. 2, 2011). Pursuant to Section 19(b)(1) 
of the Exchange Act, each SRO must file with the Commission any 
proposed change in, addition to, or deletion from the rules of the 
exchange electronically on a Form 19b-4 through the Electronic Form 
19b-4 Filing System, which is a secure Web site operated by the 
Commission. 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-4.
---------------------------------------------------------------------------

d. Broker-Dealer Solvency Requirement
    As discussed in section II.E.4., the amendment to paragraph (a) of 
Rule 15c3-1 states that no broker-dealer shall be ``insolvent'' as that 
term is defined under paragraph (c)(16) of the rule. The companion 
amendment to paragraph (b)(1) of Rule 17a-11 requires insolvent broker-
dealers to provide notice to regulatory authorities.
    Allowing an insolvent broker-dealer to continue conducting a 
securities business during the period of its insolvency, 
notwithstanding its net capital position, could jeopardize customers 
and other market participants because a broker-dealer that has made an 
admission of insolvency, or is otherwise deemed insolvent or entitled 
to protection from creditors, does not possess the financial resources 
necessary to operate a securities business. Continuing to operate in 
such circumstances poses a significant credit risk to counterparties 
and to the clearance and settlement system, and, in the event the firm 
ends up in a liquidation proceeding under SIPA, may impair the ability 
of the SIPA trustee to make the customers of the broker-dealer whole 
and satisfy the claims of other creditors out of the assets of the 
general estate.\850\
---------------------------------------------------------------------------

    \850\ See Amendments to Financial Responsibility Rules, 72 FR at 
12872.
---------------------------------------------------------------------------

    Consequently, the amendment to Rule 15c3-1 benefits the securities 
markets, and indirectly, all other market participants, by removing 
risks associated with the continued operation of a financially unstable 
firm. For example, the amendment will limit the potential that an 
insolvent firm would take on new customers and place their assets at 
risk. Furthermore, the broker-dealer will not be able to enter into 
proprietary transactions with other broker-dealers and place them or 
clearing agencies at further risk of counterparty default. The broker-
dealer's existing customers also will benefit from preservation of any 
remaining capital of the firm, which could be used to facilitate an 
orderly liquidation.
    The amendment to Rule 17a-11 also benefits the securities markets 
in that it will provide regulators with the opportunity to more quickly 
take steps to protect customers and counterparties at the onset of the 
insolvency, including, if appropriate, notifying SIPC of the need to 
commence a SIPA liquidation.
    The baseline for this proposed amendment is current Rules 15c3-1 
and 17a-11, which currently do not contain requirements to cease 
conducting a securities business (or to notify the Commission) if 
certain insolvency events were to occur. The amendments generally will 
have no impact on broker-dealers when compared to the current baseline. 
Should a broker-dealer become subject to an insolvency proceeding, it 
will incur the cost of sending notice of that fact to the Commission 
and its DEA. The Commission estimated in the PRA that it will occur 
approximately two \851\ times a year for all broker-dealers.\852\ For 
these reasons, the Commission estimates that any costs arising from 
this amendment will be de minimis.
---------------------------------------------------------------------------

    \851\ This estimate is based on the 2012 SIPC Annual Report, 
which indicates that over the last ten year-period, the annual 
average of new customer protection proceedings was three. A copy of 
the 2012 Annual Report is available at http://www.sipc.org/.
    \852\ The internal hours would likely be performed by a 
compliance clerk. Therefore, the estimated internal costs for this 
hour burden would be calculated as follows: Compliance Clerk at $63 
per hour x 20 minutes = $21.00. See section IV.D.8. of this release.
---------------------------------------------------------------------------

    One commenter stated that involuntary bankruptcy proceedings do not 
necessarily indicate that the broker-dealer is insolvent, as such 
proceedings can be frivolous, malicious, or otherwise lacking in merit, 
and noted standard industry forms generally provide a grace period for 
a party to such a proceeding to obtain a stay or dismissal before an 
event of default is deemed to have occurred. The Commission considered 
this alternative approach and notes that if a firm believes that it is 
the subject of an unwarranted involuntary bankruptcy proceeding and 
that its case will not be dismissed within the 30 day timeframe, as is 
the case with existing net capital requirements, pursuant to Rule 15c3-
1(b)(3), the Commission may, upon written application, exempt the 
broker-dealer from the requirement.
    In addition, one commenter objected to the amendments as 
unnecessary, citing the Rule 15c3-1 prohibition on broker-dealers 
effecting securities transactions if their net capital is below certain 
minimums.\853\ The commenter stated that the net capital of an 
insolvent broker-dealer would, by definition, be below those 
minimums.\854\ The Commission considered the commenter's view and the 
alternative of not adopting the amendments. The purpose of the 
amendment is to address cases where the broker-dealer is subject to an 
insolvency event but maintains that it is in compliance with the net 
capital rule. Therefore, the Commission is adopting this amendment, 
because, while such instances may be rare, an insolvent broker-dealer 
could seek the protection of the bankruptcy laws but continue to effect 
transactions with the public, potentially jeopardizing customers and 
other creditors of the broker-dealer, including counterparties.
---------------------------------------------------------------------------

    \853\ See St. Bernard Financial Services Letter.
    \854\ Id.
---------------------------------------------------------------------------

    As noted above, the Commission requested comment on this cost 
estimate. In particular, the Commission requested comment on whether 
there would be costs to broker-dealers as a consequence of the 
proposal. The Commission also requested comment on whether this 
proposal would impose costs on other market participants, including 
broker-dealer customers. Commenters were asked to identify the metrics 
and sources of any empirical data that supported their costs estimates. 
The Commission did not receive any comments in response to these 
requests.
e. Amendment To Rule Governing Restrictions of Withdrawals of Capital
    As discussed in section II.E.5. of this release, paragraph (e) of 
Rule 15c3-1, which places certain conditions on a broker-dealer when 
withdrawing capital,\855\ also allows the Commission to issue an order 
temporarily restricting a broker-dealer from withdrawing capital or 
making loans or advances to stockholders, insiders, and affiliates

[[Page 51892]]

under certain circumstances.\856\ The rule, however, limits such orders 
to withdrawals, advances, or loans that, when aggregated with all other 
withdrawals, advances, or loans on a net basis during a 30 calendar day 
period, exceed 30% of the firm's excess net capital.\857\
---------------------------------------------------------------------------

    \855\ See 17 CFR 240.15c3-1(e).
    \856\ See 17 CFR 240.15c3-1(e)(3).
    \857\ Id.
---------------------------------------------------------------------------

    The Commission has determined that the requirement is difficult to 
enforce, as it generally would not be clear when the 30% threshold had 
been reached, due to the inherent unreliability of a troubled broker-
dealer's books and records. The Commission considered retaining the 30% 
threshold, but determined that a more appropriate approach would be to 
eliminate the 30% threshold requirement from the rule, rather than 
retain a provision that is difficult to enforce. Consequently, the 
Commission proposed, and is adopting, a change to delete this provision 
and instead to allow the Commission to restrict all withdrawals, 
advances, and loans so long as the other conditions under the rule (all 
of which remain unchanged) were met.
    The amendment to paragraph (e) of Rule 15c3-1 benefits the 
securities markets by protecting customers and counterparties of a 
financially stressed broker-dealer. For example, by prohibiting 
unsecured loans to a stockholder or withdrawal of equity capital while 
the order is outstanding, the amendment will help to preserve the 
assets and liquidity of the broker-dealer and enable the Commission and 
its staff, as well as other regulators, to examine the broker-dealer's 
financial condition, net capital position, and the risk exposure to the 
customers and creditors of the broker-dealer.
    The current rule permitting the Commission to restrict withdrawals 
of capital from a financially distressed broker-dealer was adopted in 
1991.\858\ This rule is the baseline for purposes of this economic 
analysis. When the Commission adopted this paragraph of Rule 15c3-1 
more than twenty years ago, the Commission stated that it was intended 
to be an emergency provision, applicable only to the most exigent of 
circumstances where the continued viability of the broker-dealer 
appears to be at stake.\859\ In the ensuing years, the Commission has 
only utilized this provision one time.\860\ Based on this experience 
with the rule, and the fact that the rule is intended as an emergency 
provision only, as compared to the current baseline, the Commission 
estimates that the amendment will result in no or de minimis costs to 
broker-dealers.
---------------------------------------------------------------------------

    \858\ See Net Capital Rule, Exchange Act Release No. 28927 (Feb. 
28, 1991), 56 FR 9124 (Mar. 5, 1991).
    \859\ Net Capital Rule, Exchange Act Release No. 28927, 56 FR 
9124, 9128.
    \860\ Order Regarding Withdrawals, Unsecured Loans or Advances 
from Refco Securities, LLC and Refco Clearing, LLC, Exchange Act 
Release No. 52606 (Oct. 13, 2005).
---------------------------------------------------------------------------

    As noted above, the Commission requested comment on this cost 
estimate. The Commission also requested comment on whether the proposal 
would impose costs on other market participants. Commenters were asked 
to identify the metrics and sources of any empirical data that support 
their cost estimates. One commenter supported the amendment but 
believed that the rule is intended to protect the capitalization of 
large firms while ignoring small firms, and proposed that the 
Commission state all the conditions that need to exist for a firm to 
withdraw, repay or redeem any amount that does not endanger the firm or 
its customers.\861\ The commenter also stated that it opposes 
regulation that arbitrarily reduces the value of small broker-dealers 
and their competitive position relative to larger broker-dealers. A 
second commenter noted that the proposed amendment would impose 
additional compliance burdens on broker-dealers and would significantly 
limit broker-dealers' flexibility in the event of a liquidity 
crisis.\862\
---------------------------------------------------------------------------

    \861\ See NIBA 2 Letter.
    \862\ See Raymond James 2 Letter.
---------------------------------------------------------------------------

    In adopting the final rule, the Commission considered the 
alternatives and modifications suggested by commenters. In response to 
these comments, the Commission notes that the amendment would eliminate 
the 30% threshold from paragraph (e)(3)(i) of Rule 15c3-1, which 
relates to the Commission's authority to temporarily restrict 
withdrawals of net capital. It cannot impose these restrictions without 
concluding that ``such withdrawal, advance or loan may be detrimental 
to the financial integrity of the broker or dealer, or may unduly 
jeopardize the broker or dealer's ability to repay its customer claims 
or other liabilities which may cause a significant impact on the 
markets or expose the customers or creditors of the broker or dealer to 
loss without taking into account the application of the Securities 
Investor Protection Act of 1970.'' \863\ While paragraph (e)(3)(i) of 
Rule 15c3-1 would apply to all broker-dealers, the stringent conditions 
under which the Commission may exert its authority under the rule to 
temporarily restrict a broker-dealer's withdrawals of net capital would 
apply to only the circumstances where the continued viability of the 
broker-dealer appears to be at stake.\864\ The Commission, however, 
agrees with the importance of maintaining flexibility in the context of 
ordering restrictions on withdrawals, advances, and loans. Therefore, 
the Commission modified the amendment, as adopted, to add language to 
paragraph (e)(3)(i) to state (following the phrase ``employee or 
affiliate'') that such orders will be issued, ``under such terms and 
conditions as the Commission deems necessary or appropriate in the 
public interest or consistent with the protection of investors . . . 
.'' \865\
---------------------------------------------------------------------------

    \863\ See 17 CFR 240.15c3-1(e)(3)(i).
    \864\ Net Capital Rule, Exchange Act Release No. 28927, 56 FR 
9124, 9128.
    \865\ See paragraph (e) of Rule 17a-3, as adopted. See 
generally, 15 U.S.C. 78mm(a)(1).
---------------------------------------------------------------------------

    In summary, the Commission does not believe that the deletion of 
the 30% threshold will affect the competitiveness or unduly restrict 
the ongoing business operations of small broker-dealers as compared to 
larger firms. All broker-dealers remain subject to the other notice and 
withdrawal limitations on equity capital set forth in paragraphs (e)(1) 
and (e)(2) of Rule 15c3-1, which are not the subject of this rule 
amendment.
f. Amendment to Rule 15c3-1 Appendix A
    As discussed in section II.E.6.i. of this release, the amendment to 
paragraph (b)(1)(vi) of Rule 15c3-1a will make permanent the reduced 
net capital requirements that apply to listed option positions in major 
market foreign currencies and high-capitalization and non-high-
capitalization diversified indexes in non-clearing option specialist 
and market maker accounts. This change will benefit the broker-dealers 
that have been calculating charges under a temporary amendment the 
Commission originally adopted in 1997.\866\ The temporary amendment 
expired on September 1, 1997, subject to extension.\867\ The Commission 
staff subsequently issued a no-action letter on January 13, 2000, which 
stated that the staff would not recommend enforcement action if broker-
dealers continued to rely on the temporary amendment.\868\ The 
Commission

[[Page 51893]]

considered whether to keep the amendment temporary but determined that 
making the temporary amendment permanent, as proposed, was the more 
appropriate alternative because it creates certainty for broker-dealers 
relying on the rule.
---------------------------------------------------------------------------

    \866\ See Net Capital Rule, Exchange Act Release No. 38248 (Feb. 
6, 1997), 62 FR 6474 (Feb. 12, 1997).
    \867\ See 17 CFR 15c3-1a(b)(1)(iv)(B).
    \868\ Letter from Michael Macchiaroli, Associate Director, 
Division of Market Regulation, Commission, to Richard Lewandowski, 
Vice President, Regulatory Division, The Chicago Board Options 
Exchange, Inc. (Jan. 13, 2000) (stating that the Division of Trading 
and Markets ``will not recommend . . . enforcement action if non-
clearing option specialists and market-makers continue to rely on 
subparagraph (b)(1)(iv) of Appendix A to Rule 15c3-1 under the 
Exchange Act until such time as the Commission has determined 
whether it should be extended'').
---------------------------------------------------------------------------

    Because this amendment seeks to match capital requirements with 
actual risks, it should not have an adverse impact on the financial 
strength of broker-dealers. Moreover, because broker-dealers are 
already operating under the temporary relief, which is the current 
baseline, the amendment should not result in any costs for broker-
dealers as compared to the current baseline.
    The Commission requested comment on available metrics to quantify 
the benefits identified above and any other benefits the commenter may 
identify. In addition, the Commission requested comment on whether the 
proposal would result in any costs. Commenters were asked to identify 
the metrics and sources of any empirical data that support their cost 
estimates. The Commission did not receive any comments in response to 
these requests.
ii. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation
    Rule 15c3-1 is designed to help ensure that a broker-dealer holds 
at all times liquid assets sufficient to pay its non-subordinated 
liabilities and retain a ``cushion'' of liquid assets used to pay 
customers without delay in the event that the broker-dealer fails. For 
example, a broker-dealer that inappropriately excludes certain 
liabilities when presenting its financial position \869\ or includes 
non-permanent capital contributions in its financial statements \870\ 
distorts the view of the firm's financial condition and undermines the 
rule. In either event, such practices jeopardize the broker-dealer's 
ability to self-liquidate and promptly pay customers.
---------------------------------------------------------------------------

    \869\ See section II.E.1. of this release.
    \870\ See section II.E.2. of this release.
---------------------------------------------------------------------------

    The Commission's experience with the broker-dealer financial 
responsibility rules, underscored by the 2008 financial crisis, 
highlights the effects that the failure of a broker-dealer, 
particularly a large carrying broker-dealer, could have on customers 
and other market participants. Losses resulting from the disorderly 
winding down of a broker-dealer may often undermine the participation 
of investors in the U.S. capital markets, with possible negative 
effects on capital formation and market efficiency. Thus, it is 
imperative that broker-dealers operate in compliance with Rule 15c3-1 
and that the Commission takes the necessary steps to help ensure that 
broker-dealers are prohibited from engaging in practices that obscure 
noncompliance.
    The amendments to Rule 15c3-1 are designed to reduce the risk of a 
disorderly failure of a broker-dealer and lessen the potential that 
market participants may seek to rapidly withdraw assets and financing 
from broker-dealers during a time of market stress. These Rule 15c3-1 
amendments may affect efficiency and capital formation through their 
positive impact on competition among broker-dealers. Specifically, 
markets that are competitive can, all other things equal, be expected 
to promote an efficient allocation of capital.\871\
---------------------------------------------------------------------------

    \871\ See Capital, Margin, and Segregation Requirements for 
Security-Based Swap Dealers and Major Security-Based Swap 
Participants and Capital Requirements for Broker-Dealers, Exchange 
Act Release No. 68071 (Oct. 18, 2012), 77 FR 70213, 70315 (Nov. 23, 
2012).
---------------------------------------------------------------------------

    The amendments to Rule 15c3-1--(1) Requiring a broker-dealer to 
account for certain liabilities or treat certain capital contributions 
as liabilities,\872\ (2) requiring a broker-dealer to deduct certain 
fidelity bond deductibles,\873\ (3) requiring an insolvent broker-
dealer to cease conducting a securities business and provide notice 
under the amendment to Rule 17a-11,\874\ (4) eliminating the 
qualification on Commission orders restricting withdrawals, advances, 
and unsecured loans to instances where recent withdrawals, advances or 
loans, in the aggregate, exceed 30% of the broker-dealer's excess net 
capital,\875\ and (5) making permanent the reduced net capital 
requirements under Appendix A for market makers \876\--are consistent 
with promoting efficiency, competition, and capital formation in the 
market place.
---------------------------------------------------------------------------

    \872\ See sections II.E.1. and 2. of this release.
    \873\ See section II.E.3. of this release.
    \874\ See section II.E.4. of this release.
    \875\ See section II.E.5. of this release.
    \876\ See section II.E.6.i. of this release.
---------------------------------------------------------------------------

    First, a broker-dealer that fails to include liabilities that 
depend on the broker-dealer's assets and revenues and accepts temporary 
capital contributions is obscuring its true financial condition. This 
also interferes with the process by which regulators monitor the 
financial condition of broker-dealers and, thereby, impedes their 
ability to take proactive steps to minimize the harm resulting from a 
broker-dealer failure to customers, counterparties, and clearing 
agencies.
    Second, requiring broker-dealers to take net capital charges for 
excess fidelity bond deductibles imposed under SRO rules will promote 
efficiency by providing consistency among Rule 15c3-1 and SRO rules. 
Because fidelity bond requirements provide a safeguard with regard to 
broker-dealer financial responsibility, the amendment will enhance 
competition through the operation of more financially sound firms.
    Third, the continued operation of an insolvent broker-dealer or the 
withdrawal of capital from a broker-dealer that may jeopardize such 
broker-dealer's financial integrity poses financial risk to its 
customers, counterparties, and the registered clearing agencies. These 
risks increase costs and decrease efficiency of the marketplace.
    Fourth, the elimination of the limitation on Commission orders 
restricting capital withdrawals under paragraph (e)(3) of Rule 15c3-1 
from a financially troubled broker-dealer will provide greater 
protection to customers and counterparties of the firm and registered 
clearing agencies. While such orders are expected to be infrequent, 
when issued they should lower costs to these entities associated with 
having an outstanding obligation from the troubled broker-dealer, 
thereby promoting efficiency and facilitating capital formation.
    One commenter expressed concern that the proposed amendments to 
Rule 15c3-1 would be particularly burdensome on small broker-dealers, 
negatively impacting capital formation for small issuers and increasing 
the cost of capital for small broker-dealers.\877\ For example, the 
commenter stated that it believed that the proposed changes requiring a 
broker-dealer to subtract from net worth certain non-permanent capital 
contributions and to deduct from net worth certain liabilities or 
expenses assumed by third parties would negatively impact capital 
formation for small issuers and increase the cost of capital for small 
broker-dealers.\878\
---------------------------------------------------------------------------

    \877\ See NIBA 2 Letter.
    \878\ Id.
---------------------------------------------------------------------------

    While the Commission is cognizant that the Rule 15c3-1 amendments 
may impose burdens on broker-dealers, including non-carrying broker-
dealers, the commenter is treating the amendments as entirely new 
additions to the net capital rule. Yet, as discussed

[[Page 51894]]

in section II.E. of this release, the Commission has emphasized that 
capital contributions to broker-dealers should not be temporary. 
Further, the Commission staff has explained that a capital contribution 
should be treated as a liability if it is made with the understanding 
that such contribution can be withdrawn at the option of the 
investor.\879\ Based on the Commission's experience with the 
application of Rule 15c3-1, the majority of broker-dealers operate 
consistent with past Commission and staff rules and guidance regarding 
the nature of capital and, thus, the Rule 15c3-1 amendments should not 
represent a substantial change for most broker-dealers. Therefore, the 
final rule should not negatively impact capital formation for small 
issuers, nor increase the cost of capital for small broker-dealers, to 
the extent that these firms already comply with current guidance and 
interpretations.\880\ For those firms that will need to raise capital 
to comply with the amendments to Rule 15c3-1, the rule amendments 
potentially may negatively impact capital formation. However, the 
potential costs to some broker-dealers could be offset by the aggregate 
increase in capital formation related to heightened confidence in 
broker-dealer financial requirements.
---------------------------------------------------------------------------

    \879\ See section II.E.2. of this release.
    \880\ See NIBA 2 Letter.
---------------------------------------------------------------------------

    Finally, the Commission recognizes that, as discussed above, the 
amendments to Rule 15c3-3 adopted today impose certain costs on broker-
dealers that could affect competition among broker-dealers. However, 
the Commission is of the opinion that these costs are justified by the 
significant benefits described in this economic analysis. In sum, the 
costs of compliance resulting from the requirements in the amendments 
to Rule 15c3-3 should not impose a burden on competition not necessary 
or appropriate in furtherance of the purposes of the Exchange Act in 
light of the benefits discussed above.

VI. Final Regulatory Flexibility Analysis

    The Commission proposed amendments to Rules 15c3-1, 15c3-1a, 15c3-
2, 15c3-3, 15c3-3a, 17a-3, 17a-4, and 17a-11 under the Exchange Act. An 
Initial Regulatory Flexibility Analysis (``IRFA'') was included in the 
proposing release.\881\ This Final Regulatory Flexibility Analysis 
(``FRFA'') has been prepared in accordance with the provisions of the 
RFA.\882\
---------------------------------------------------------------------------

    \881\ See Amendments to Financial Responsibility Rules, 72 FR 
12862.
    \882\ 5 U.S.C. 604(a).
---------------------------------------------------------------------------

    The Commission requested comment with regard to matters discussed 
in the IRFA, including comments with respect to the number of small 
entities that may be affected by the proposed rule amendments.\883\ The 
Commission also requested that commenters specify the costs of 
compliance with the proposed amendments, and suggest alternatives that 
would accomplish the goals of the amendments.\884\ The Commission 
received one general comment on the IRFA.\885\ In addition, the 
Commission received a number of comments regarding the impact on small 
entities with respect to specific aspects of the proposed rule 
amendments, including comments relating to amendments under Rule 15c3-3 
with respect to where special reserve deposits may be held, and 
amendments under Rule 15c3-1 relating to the requirement to subtract 
from net worth certain liabilities or expenses assumed by third 
parties.\886\ The general comment on the IRFA is discussed directly 
below. The specific comments are discussed in the applicable sections 
below.
---------------------------------------------------------------------------

    \883\ See Amendments to Financial Responsibility Rules, 72 FR at 
12888.
    \884\ Id.
    \885\ See Angel Letter.
    \886\ These comments are discussed in the applicable section 
below.
---------------------------------------------------------------------------

 A. General Issues Raised by Public Comments

    The commenter stated that the Commission should pay ``explicit 
attention to regulatory trends in the rest of the world'' because doing 
so ``benefits not only small entities (by reducing their regulatory 
burden) but all entities, as larger entities can experience more 
consistent regulatory procedures around the world.'' \887\ The 
commenter suggested that the Commission consider a ``Basel II type 
approach to net capital requirements.'' \888\ In response to the 
commenter, the Commission notes that the amendments relate to discrete 
areas of the broker-dealer financial responsibility rules (i.e., they 
do not establish new financial responsibility standards such as would 
be the case if the Commission were to adopt a ``Basel II type approach 
to net capital requirements.''). As noted above, the commenter's 
suggestion is beyond the scope of this rulemaking.\889\
---------------------------------------------------------------------------

    \887\ See Angel Letter.
    \888\ Id.
    \889\ The commenter cited the JP Morgan Letter in support of the 
suggestion to ``consider regulatory trends in the rest of the 
world.'' Id. The JP Morgan Letter recommends that the Commission 
adopt a due diligence standard--citing a U.K. regulation--with 
respect to the amendments regarding customer reserve account cash 
deposits. See JP Morgan Letter. The Commission addresses this 
comment above in section V.D.1.i.b.(III) of this release.
---------------------------------------------------------------------------

B. Amendments to the Customer Protection Rule

1. Need for and Objectives of the Rule Amendments
    The final rule amends certain provisions of Rule 15c3-3.\890\ The 
amendment that requires broker-dealers to perform a PAB reserve 
computation is designed to address a disparity between Rule 15c3-3 and 
the SIPA, and to incorporate provisions of the PAIB Letter into 
Commission rules.\891\ The amendment that will require broker-dealers 
to exclude cash deposited at an affiliated bank and cash deposited with 
an unaffiliated bank to the extent that the amount exceeds 15% of the 
bank's equity capital from being used to meet a broker-dealer's reserve 
requirements is designed to avoid the situation where a carrying 
broker-dealer's cash deposits constitute a substantial portion of the 
bank's deposits.\892\ The amendment that will require broker-dealers to 
obtain possession and control of customers' fully paid and excess 
margin securities allocated to a short position is designed to address 
the fact that Rule 15c3-3 currently permits a broker-dealer to monetize 
customer securities, which is contrary to the customer protection goals 
of Rule 15c3-3, which seeks to ensure that broker-dealer's do not use 
customer assets for proprietary purposes.\893\ The amendment that will 
require broker-dealers to provide certain notices and disclosures 
before changing the terms and conditions under which the broker-dealer 
treats customer free credit balances is intended to help ensure that 
the use of customer free credit balances accords with customer 
preferences.\894\ The importation of certain provisions of Rule 15c3-2 
into Rule 15c3-3 streamlines the customer protection rules and 
eliminates irrelevant provisions in Rule 15c3-2 due to Rule 15c3-
3.\895\ The amendments clarifying that funds in certain commodities 
accounts are not to be treated as free credit balances or other credit 
balances are intended to remove uncertainty with respect to their 
treatment under Rule 15c3-3.\896\
---------------------------------------------------------------------------

    \890\ 17 CFR 240.15c3-3.
    \891\ See section II.A.2. of this release.
    \892\ See section II.A.3. of this release.
    \893\ See section II.A.4. of this release.
    \894\ See section II.A.5. of this release.
    \895\ Id.
    \896\ See section II.A.6. of this release.
---------------------------------------------------------------------------

    The amendments to Rule 15c3-3 are intended to strengthen the 
protections afforded to customer assets held at a

[[Page 51895]]

broker-dealer. The amendments are designed to minimize the risk that 
customer assets will be lost, tied-up in a liquidation proceeding, or 
held in a manner that is inconsistent with a customer's expectations.
2. Significant Issues Raised by Public Comment
    The Commission received numerous comments with respect to the 
amendment under paragraph (e)(5) of Rule 15c3-3 that will require 
broker-dealers to exclude cash deposited at an affiliated bank and cash 
deposited with an unaffiliated bank to the extent that the amount 
exceeds 15% of the bank's equity capital from being used to meet a 
broker-dealer's reserve requirements.\897\ As proposed, new paragraph 
(e)(5) of 15c3-3 would have provided that, in determining whether a 
broker-dealer maintains the minimum reserve deposits required (customer 
and PAB), the broker-dealer must exclude any cash deposited at an 
affiliated bank. In addition, the proposed amendment would have 
required a broker-dealer to also exclude cash deposited at an 
unaffiliated bank to the extent the cash deposited exceeds (1) 50% of 
the broker-dealer's excess net capital (based on the broker-dealer's 
most recently filed FOCUS Report),\898\ or (2) 10% of the bank's equity 
capital (based on the bank's most recently filed Call Report or Thrift 
Financial Report).\899\
---------------------------------------------------------------------------

    \897\ See section II.A.3. of this release.
    \898\ Under Rule 17a-5 broker-dealers must file FOCUS Reports. 
17 CFR 240.17a-5.
    \899\ See Amendments to Financial Responsibility Rules, 72 FR at 
12864.
---------------------------------------------------------------------------

    With respect to the proposed limits on the amounts that could be 
deposited in unaffiliated banks, some commenters argued that the 
percentages were too restrictive while other commenters suggested 
alternative approaches to the proposed percentage limitations.\900\ One 
commenter stated that the percentage thresholds would negatively impact 
smaller broker-dealers because these firms would still be required 
under the proposed rule to maintain at least two reserve bank accounts 
at different banks.\901\ This commenter noted that limiting Rule 15c3-3 
deposits at a single bank to 50% of a broker-dealer's excess net 
capital could impact 10 to 15% of its broker-dealer customers in that 
many of these customers would be required to open accounts at multiple 
institutions.\902\ This commenter suggested the Commission consider 
higher percentages for cash deposits at large money-centered banks, 
since the proposed percentage thresholds would negatively impact small 
broker-dealers because they would exceed the 50% of excess net capital 
threshold at lower deposit levels.\903\ This commenter also noted that 
conducting due diligence and opening new accounts and the ongoing 
monitoring and periodic re-evaluation of such additional accounts would 
require much more time than the 10 hours originally estimated by the 
Commission.\904\ A second commenter concurred with this cost 
assessment, stating that the Commission significantly underestimated 
the cost of the proposal to smaller firms.\905\
---------------------------------------------------------------------------

    \900\ See Deutsche Bank Securities Letter; SIFMA 2 Letter; First 
Clearing Letter; ICI Letter; BlackRock Letter.
    \901\ See SIFMA 2 Letter (``[T]he [percentage] tests could 
prevent a smaller firm from maintaining reserve account deposits at 
any single bank, even though those deposits are relatively small 
compared to the size of the bank--e.g., a broker-dealer with excess 
net capital of $500,000 could not maintain more than $250,000 in 
reserve account cash deposits at any one bank, regardless of the 
ratio between such bash deposits and the overall size or equity 
capital of the bank.'').
    \902\ Id.
    \903\ Id.; see also SIFMA 4 Letter.
    \904\ See SIFMA 2 Letter.
    \905\ See NIBA 2 Letter.
---------------------------------------------------------------------------

    With respect to the use of qualified securities to meet reserve 
requirements, one commenter noted that broker-dealers will ``likely 
have a significant amount of additional operational and transactional 
costs.'' \906\ The commenter believes that ``[w]hile larger broker-
dealers may be able to reallocate existing trading desk, operational, 
regulatory reporting and treasury functions to assist in ongoing 
maintenance activities, midsized and smaller broker-dealers may be 
required to hire additional staff to manage and maintain a securities 
portfolio.'' \907\
---------------------------------------------------------------------------

    \906\ See JP Morgan Letter.
    \907\ Id. The commenter noted that managing pools of qualified 
securities involves various tasks, such as ``monitoring income 
collection, redemption processing, marking the securities to market, 
collateral substitutions and collateral segregation amongst other 
tasks.'' Id.
---------------------------------------------------------------------------

    In response to commenters concerns, the Commission has eliminated 
the provision that would have excluded the amount of a deposit that 
exceeds 50% of the broker-dealer's excess net capital. After review of 
the comment letters, the Commission believes that this provision likely 
would have disproportionately impacted small and mid-size broker-
dealers when they deposited cash into large commercial banks since they 
would exceed the excess net capital threshold well before exceeding the 
bank equity capital threshold.\908\ The bank equity capital threshold 
is the more important metric since it relates directly to the financial 
strength of the bank, which is the entity holding the account. In 
particular, if the carrying broker-dealer's deposit constitutes a 
substantial portion of the bank's total deposits, the bank may not have 
the liquidity to quickly return the deposit to the broker-dealer. The 
elimination of the excess net capital threshold should mitigate 
concerns expressed by small broker-dealers that they would need to open 
multiple bank accounts to make cash deposits or hire additional staff, 
if they sought to deposit qualified securities in a reserve account in 
order to avoid opening multiple accounts. This is because the excess 
net capital threshold likely would have impacted smaller broker-
dealers, which--consistent with their size--maintain less net capital 
than larger firms.
---------------------------------------------------------------------------

    \908\ See SIFMA 2 Letter; JP Morgan 2 Letter.
---------------------------------------------------------------------------

    Second, with respect to the bank equity capital threshold, in 
response to comments, the Commission has increased the trigger level 
from 10% to 15% of the bank's equity capital. The increase of the 
threshold to 15% is designed to address concerns raised by commenters 
that the proposed percentage tests were unduly restrictive in certain 
respects and should be modified, particularly with respect to large 
broker-dealers with large deposit requirements. Consequently, the 
increase from 10% to 15% is designed to mitigate commenters concerns 
that the 10% threshold would require broker-dealers to spread out 
deposits over an excessive number of banks, while still providing 
adequate protection against undue concentrations of deposits, 
particularly where smaller banks are concerned.
    The elimination of the 50% of excess net capital threshold and 
increase of the bank capital threshold from 10% to 15% is designed to 
appropriately address concerns raised by commenters that they would 
have to substantially alter their current cash deposit practices in 
light of the goal of the rule to promote the broker-dealer's ability to 
have quick access to the deposit.
    With the elimination of the broker-dealer excess net capital 
threshold, and the increase in the bank equity capital threshold, it is 
likely that very few broker-dealers (including small broker-dealers) 
would be required to maintain reserve accounts at multiple banks, 
unless they chose to do so for operational, business or other reasons. 
Therefore for the reasons discussed above, as adopted, paragraph (e)(5) 
of Rule 15c3-3, should not significantly impact a substantial number of 
small entities.

[[Page 51896]]

3. Small Entities Subject to the Rule
    Paragraph (c)(1) of Rule 0-10 \909\ states that the term small 
business or small organization, when referring to a broker-dealer, 
means a broker or dealer that had total capital (net worth plus 
subordinated liabilities) of less than $500,000 on the date in the 
prior fiscal year as of which its audited financial statements were 
prepared pursuant to Rule 17a-5(d); \910\ and is not affiliated with 
any person (other than a natural person) that is not a small business 
or small organization.
---------------------------------------------------------------------------

    \909\ 17 CFR 240.0-10(c)(1).
    \910\ 17 CFR 240.17a-5(d).
---------------------------------------------------------------------------

    Based on FOCUS Report data, as of December 31, 2011, the Commission 
estimates there are approximately 5 broker-dealers that performed a 
customer reserve computation pursuant to Rule 15c3-3 and were ``small'' 
for the purposes Rule 0-10.
4. Reporting, Recordkeeping, and Other Compliance Requirements
    The amendments (1) Require broker-dealers to perform a PAB reserve 
computation, (2) limit the amount that a broker-dealer may deposit in a 
reserve account at any individual bank in the form of cash, (3) require 
broker-dealers to obtain possession and control of customers' fully 
paid and excess margin securities allocated to a short position by 
borrowing equivalent securities or through other means within a 
specified period of time, and (4) require broker-dealers to obtain the 
written affirmative consent of a new customer before including a 
customer's free credit balances in a Sweep Program, as well as provide 
certain disclosures and notices to all customers with regard to the 
broker-dealer's Sweep Program.
5. Agency Action To Minimize Effect on Small Entities
    The RFA directs the Commission to consider significant alternatives 
that would accomplish the stated objectives, while minimizing any 
significant adverse impact on small entities. In connection with 
adopting the final rules, the Commission considered, as alternatives, 
establishing different compliance or reporting requirements that take 
into account the resources available to smaller entities, exempting 
smaller entities from coverage of the disclosure requirements, and 
clarifying, consolidating, or simplifying disclosure for small 
entities.\911\
---------------------------------------------------------------------------

    \911\ 5 U.S.C. 604(a)(5).
---------------------------------------------------------------------------

    As discussed above, the impact on individual small broker-dealers, 
as well as all small broker-dealers, should be minimal, and thus the 
Commission is not establishing different compliance or reporting 
requirements or timetables; clarifying, consolidating, or simplifying 
compliance and reporting requirements under the rule for small 
entities; or exempting small entities from coverage of the rule, or any 
part thereof. The amendments impose performance standards and do not 
dictate for entities of any size any particular design standards (e.g., 
technology) that must be employed to achieve the objectives of the 
amendments.

C. Holding Futures Positions in a Securities Portfolio Margining 
Account

1. Need for and Objectives of the Amendments
    The amendments to Rule 15c3-3 and 15c3-3a are designed to 
accommodate futures positions in a securities account that is margined 
on a portfolio basis.\912\ Under SRO portfolio margin rules, a broker-
dealer can combine securities and futures positions in a portfolio 
margin securities account to compute margin requirements based on the 
net market risk of all positions in the account. The amendments to Rule 
15c3-3 and 15c3-3a complement the amendments to SIPA in the Dodd-Frank 
Act, as well as provide additional protections to customers through the 
strengthened reserve requirements of Rule 15c3-3. In particular, the 
changes will apply the protections in Rules 15c3-3 and Rule 15c3-3a to 
all positions in a portfolio margin account.
---------------------------------------------------------------------------

    \912\ See Amendments to Financial Responsibility Rules, 72 FR at 
12868-12870.
---------------------------------------------------------------------------

    These additional protections should make portfolio margining more 
attractive to investors. Portfolio margining can significantly reduce 
customer margin requirements for offsetting positions involving 
securities and futures products, which in turn reduces the costs of 
trading such products.
2. Significant Issues Raised by Public Comments
    The Commission did not receive any specific comments with respect 
to this portion of the IRFA.
3. Small Entities Subject to the Rules
    As discussed above in section V.D.2. of this release, based on 
FOCUS Report data, as of December 31, 2011, the Commission estimates 
that approximately 35 broker-dealers will elect to offer their 
customers portfolio margin accounts that will include futures and 
futures options. None of these broker-dealers are ``small'' for 
purposes of Rule 0-10.
4. Reporting, Recordkeeping, and Other Compliance Requirements
    These amendments (1) revise the definition of free credit balances 
and other credit balances in Rule 15c3-3 to include funds in a 
portfolio margin account relating to certain futures and futures 
options positions, and (2) add a debit line item to the customer 
reserve formula in Rule 15c3-3a consisting of margin posted by a 
broker-dealer to a derivatives clearing organization.
 5. Agency Action To Minimize Effect on Small Entities
    As stated above, the Commission does not believe that any of the 
broker-dealers that will elect to offer portfolio margining are 
``small'' for purposes of Rule 0-10. Further, the requirements imposed 
by the portfolio margin amendments will be elective. Therefore, the 
Commission does not believe it is necessary or appropriate to establish 
different compliance or reporting requirements or timetables; clarify, 
consolidate, or simplify compliance and reporting requirements under 
the rule for small entities; or exempting small entities from coverage 
of the rule, or any part thereof. The amendments also contain 
performance standards and do not dictate for entities of any size any 
particular design standards (e.g., technology) that must be employed to 
achieve the objectives of the proposed amendments.

D. Securities Lending and Borrowing and Repurchase/Reverse Repurchase 
Transactions

1. Need for and Objectives of the Amendments
    These rules amend subparagraph (c)(2)(iv)(B) of Rule 15c3-3 to 
clarify that broker-dealers providing securities lending and borrowing 
settlement services are deemed, for purposes of the rule, to be acting 
as principals and are subject to applicable capital deductions, unless 
the broker-dealer takes certain steps to disclaim principal 
liability.\913\ In addition, the Commission is adopting paragraph 
(c)(5) to Rule 17a-11 to require that a broker-dealer notify the 
Commission whenever the total amount of money payable against all 
securities loaned or subject to a repurchase agreement exceeds 2,500 
percent of tentative net capital.\914\ The final rule also exempts a 
broker-dealer from this 17a-11 notice requirement if it reports monthly 
its securities lending and borrowing and repurchase and reverse

[[Page 51897]]

repurchase activity to its DEA in a form acceptable to its DEA.
    In 2001, MJK Clearing, a broker-dealer with a substantial number of 
customer accounts, failed when it could not meet its securities lending 
obligations. This failure has highlighted the risks associated with 
securities lending and repurchase and reverse repurchase agreements and 
the need to manage those risks. More specifically, two concerns arose 
from the failure of MJK, namely, (1) that broker-dealers with principal 
liability in a stock loan transaction may erroneously be considering 
themselves as acting in an agency capacity and, consequently, not 
taking appropriate capital charges; and (2) that broker-dealers that 
have historically not been very active in stock loan transactions may 
be rapidly expanding their balance sheets with such transactions, and 
thereby, increase leverage to a level that poses significant financial 
risk to the firm and its counterparties.
---------------------------------------------------------------------------

    \913\ See section II.C. of this release.
    \914\ Id.
---------------------------------------------------------------------------

    These amendments are intended to strengthen the documentation 
controls broker-dealers employ to manage their securities lending and 
borrowing and securities repurchase and reverse repurchase activities 
and to enhance regulatory monitoring. The intended result of the 
amendments is to avoid ambiguity regarding the applicability of the 
stock loan charges in the net capital rule to a particular broker-
dealer. As the failure of MJK illustrated, disputes can arise over 
whether a broker-dealer is acting as a principal or agent in a stock 
loan transaction.\915\
---------------------------------------------------------------------------

    \915\ See, e.g., Nomura v. E*Trade, 280 F.Supp.2d 184 (S.D.N.Y. 
2003).
---------------------------------------------------------------------------

    The amendments to paragraph (c)(5) to Rule 17a-11 will help 
identify broker-dealers with highly leveraged non-government securities 
lending and borrowing and repo operations and make it easier for 
regulators to respond more quickly and protect customers in the event a 
firm is approaching insolvency.\916\ This notice provision is designed 
to alert regulators to a sudden increase in a broker-dealer's stock 
loan and repo positions, which could indicate that the broker-dealer is 
taking on new risk that it may have limited experience in managing, as 
well as to help identify those broker-dealers highly active in 
securities lending and repos. Finally, the objective of the exemption 
from the notice provision of paragraph (c)(5) of Rule 17a-11 through 
monthly reporting is designed to accommodate large broker-dealers that 
are active in this business and regularly maintain stock loan and repo 
balances that exceed the threshold.
---------------------------------------------------------------------------

    \916\ 17 CFR 240.17a-11(c)(5).
---------------------------------------------------------------------------

2. Significant Issues Raised by Public Comments
    The Commission did not receive any specific comments with respect 
to this portion of the IRFA.
3. Small Entities Subject to the Rule
    Based on FOCUS Report data, as of December 31, 2011, the Commission 
estimates that none of the broker-dealers that engage in securities 
lending and borrowing or securities repurchase and reverse repurchase 
activity are ``small'' for the purposes Rule 0-10. Therefore, the 
amendments should not affect ``small'' broker-dealers.
4. Reporting, Recordkeeping, and Other Compliance Requirements
    These amendments require broker-dealers to (1) disclose the 
principals and obtain certain agreements from the principals in a 
transaction where they provide settlement services in order to be 
considered an agent (as opposed to a principal) for the purposes of the 
net capital rule, and (2) provide notice to the Commission and other 
regulatory authorities if the broker-dealer's securities lending or 
repo activity reaches a certain threshold or, alternatively, report 
monthly the broker-dealer's securities lending and repo activity to the 
broker-dealer's DEA, in a form acceptable to the DEA.
5. Agency Action To Minimize Effect on Small Entities
    As noted above, the Commission estimates that this amendment will 
have no impact on small entities. Thus, the Commission does not believe 
it is necessary or appropriate to establish different compliance or 
reporting requirements or timetables, nor is it clarifying, 
consolidating, or simplifying compliance and reporting requirements 
under the rule for small entities; or exempt small entities from 
coverage of the rule, or any part thereof. The amendments also use 
performance standards and do not dictate for entities of any size any 
particular design standards (e.g., technology) that must be employed to 
achieve the objectives of the proposed amendments.

E. Documentation of Risk Management Procedures

1. Need for and Objectives of the Amendments
    Requiring certain large broker-dealers to document and preserve 
their internal credit, market, and liquidity risk management controls 
under paragraph (a)(23) to Rule 17a-3 and (e)(9) to Rule 17a-4 will 
assist firms in evaluating and adhering to their established internal 
risk management controls and regulators in reviewing such 
controls.\917\
---------------------------------------------------------------------------

    \917\ See section II.D. of this release.
---------------------------------------------------------------------------

    These amendments are intended to strengthen the controls certain 
large broker-dealers employ to manage risk. These amendments are 
designed to lower systemic risk primarily in the securities markets by 
enhancing risk management through reinforcement of documentation 
practices and making it easier for regulators to access a broker-
dealer's procedures and controls, to ensure a broker-dealer is adhering 
to such documented controls.
    Additionally, by making the documented controls a required record 
under Rule 17a-3, a broker-dealer's regulator likely will have better 
access to them, as this benefit will only be realized to the extent a 
broker-dealer has existing market, credit and liquidity risk management 
controls in place because the rule does not specify the type of 
controls a broker-dealer must establish to manage these risks. It 
simply requires the documentation of the procedures the broker-dealer 
has established. The final rule amendment will require any such records 
of the market, credit, and liquidity risk management controls be 
available to the broker-dealer's regulators so they can review whether 
the broker-dealer is adhering to these controls.
2. Significant Issues Raised by Public Comments
    The Commission did not receive any specific comments with respect 
to this portion of the IRFA.
3. Small Entities Subject to the Rule
    These amendments apply to a limited number of broker-dealers, 
namely, those firms with more than $1 million in customer credits or 
$20 million in capital. Based on FOCUS Report data, as of December 31, 
2011, the Commission estimates that none of the broker-dealers that 
will be subject to this amendment will be ``small'' for the purposes 
Rule 0-10.
4. Reporting, Recordkeeping, and Other Compliance Requirements
    These amendments will require broker-dealers to document any 
credit, market, and liquidity risk management controls established and 
maintained by the broker-dealer to assist it in analyzing and managing 
the risks associated with its business activities. The Commission is 
not mandating any specific controls, procedures, or policies that must 
be established by a broker-dealer to manage

[[Page 51898]]

market, credit, or liquidity risk. Rather, the Commission is requiring 
that a control, procedure, or policy be documented if it is in place.
5. Agency Action To Minimize Effect on Small Entities
    As noted above, these amendments will have no impact on ``small'' 
broker-dealers. Thus, the Commission is not establishing different 
compliance or reporting requirements or timetables; clarifying, 
consolidating, or simplifying compliance and reporting requirements 
under the rule for small entities; nor exempting small entities from 
coverage of the rule, or any part thereof.
    The amendments also use performance standards and do not dictate 
for entities of any size any particular design standards (e.g., 
technology) that must be employed to achieve the objectives of the 
amendments.

F. Amendments to the Net Capital Rule

1. Need for and Objectives of the Amendments
    The amendments to Rule 15c3-1 are designed to address several areas 
of concern regarding the financial responsibility requirements for 
broker-dealers. Some broker-dealers have excluded from their regulatory 
financial reports certain liabilities that have been shifted to third 
parties that lack the resources--independent of the assets and revenue 
of the broker-dealer--to pay the liabilities, or have utilized 
infusions of temporary capital. These practices may misrepresent the 
true financial condition of the broker-dealer and, thereby, impede the 
ability of regulators to take proactive steps to reduce the harm to 
customers, counterparties and clearing agencies that may result from 
the broker-dealer's failure. To address these issues, the Commission is 
adopting an amendment to Rule 15c3-1 to add a new paragraph 
(c)(2)(i)(F) requiring a broker-dealer to adjust its net worth when 
calculating net capital by including any liability or expense for which 
a third party has assumed the responsibility, unless the broker-dealer 
can demonstrate that the third party has adequate resources, 
independent of the broker-dealer to pay the liability or expense.\918\ 
In addition, the Commission is adopting amendments to paragraph 
(c)(2)(i)(G)(2) of Rule 15c3-1, to require a broker-dealer to subtract 
from net worth any contribution of capital to the broker-dealer: (1) 
Under an agreement that provides the investor with the option to 
withdraw the capital; or (2) that is intended to be withdrawn within a 
period of one year of its contribution. Under the final rule, any 
withdrawal of capital made within one year of its contribution is 
deemed to have been intended to be withdrawn within a period of one 
year, unless the withdrawal has been approved in writing by the broker-
dealer's DEA.\919\
---------------------------------------------------------------------------

    \918\ See section II.E.1. of this release.
    \919\ See section II.E.2. of this release.
---------------------------------------------------------------------------

    Further, currently, broker-dealers are required to take net capital 
charges pursuant to SRO rules relating to fidelity bond deductibles, 
but Rule 15c3-1 does not explicitly incorporate such charges for 
purposes of computing net capital. To address this inconsistency, the 
Commission is adopting paragraph (c)(2)(xiv) to Rule 15c3-1.\920\
---------------------------------------------------------------------------

    \920\ See section II.E.4. of this release.
---------------------------------------------------------------------------

    In addition, a number of broker-dealers have sought to obtain 
protection under the bankruptcy laws while still engaging in a 
securities business. Permitting an insolvent broker-dealer to continue 
to transact a securities business endangers its customers and 
counterparties and places securities clearing agencies at risk. To 
address this concern, the Commission is adopting an amendment to 
paragraph (a) of Rule 15c3-1 to require a broker-dealer to cease its 
securities business activities if certain insolvency events were to 
occur, as defined in new paragraph (c)(16) to Rule 15c3-1.\921\
---------------------------------------------------------------------------

    \921\ See section II.E.5. of this release.
---------------------------------------------------------------------------

    Finally, an important goal of the Commission is to protect the 
financial integrity of the broker-dealer so that if the firm must 
liquidate it may do so in an orderly fashion. Allowing a capital 
withdrawal that may jeopardize the financial integrity of a broker-
dealer exposes customers and creditors of the broker-dealer to 
unnecessary risk. Paragraph (e) of Rule 15c3-1, which places certain 
conditions on a broker-dealer when withdrawing capital,\922\ allows the 
Commission to issue an order temporarily restricting a broker-dealer 
from withdrawing capital or making loans or advances to stockholders, 
insiders, and affiliates under certain circumstances.\923\ The rule, 
however, limits such orders to withdrawals, advances, or loans that, 
when aggregated with all other withdrawals, advances, or loans on a net 
basis during a thirty calendar day period, exceed 30% of the firm's 
excess net capital. The Commission is amending paragraph (e) to remove 
the 30% of excess net capital limitation because the Commission has 
determined that the requirement is difficult to enforce, as it 
generally would not be clear when the 30% threshold had been reached, 
due to the inherent unreliability of a troubled broker-dealer's books 
and records.\924\
---------------------------------------------------------------------------

    \922\ See 17 CFR 240.15c3-1(e).
    \923\ See 17 CFR 240.15c3-1(e)(3).
    \924\ See section II.E.6. of this release.
---------------------------------------------------------------------------

    Finally, the Commission is making permanent a temporary amendment 
to Appendix A of Rule 15c3-1, which permits broker-dealers to employ 
theoretical option pricing models to calculate haircuts for listed 
options and related positions that hedge those options.\925\ The 
temporary amendment decreased the range of pricing inputs to the 
approved option pricing models, which effectively reduced the haircuts 
applied by the carrying firm with respect to non-clearing option 
specialist and market maker accounts.\926\ The amendment is intended to 
better align the capital requirements with the risks these requirements 
are designed to address.
---------------------------------------------------------------------------

    \925\ 17 CFR 240.15c3-1a; See Net Capital Rule, Exchange Act 
Release No. 38248 (Feb. 6, 1997), 62 FR 6474 (Feb. 12, 1997). See 
also Letter from Michael Macchiaroli, Associate Director, Division 
of Market Regulation, Commission, to Richard Lewandowski, Vice 
President, Regulatory Division, The Chicago Board Options Exchange, 
Inc. (Jan. 13, 2000) (stating that the Division of Market Regulation 
``will not recommend . . . enforcement action if non-clearing option 
specialists and market-makers continue to rely on subparagraph 
(b)(1)(iv) of Appendix A to Rule 15c3-1 under the Exchange Act until 
such time as the Commission has determined whether it should be 
extended''). The letter did not grant any other relief.
    \926\ See Net Capital Rule, Exchange Act Release No. 38248 (Feb. 
6, 1997), 62 FR 6474 (Feb. 12, 1997).
---------------------------------------------------------------------------

2. Significant Issues Raised by Public Comments
    The Commission received three comments in response to requests for 
comment related to the amendments to the net capital rule requiring 
broker-dealers to add back to its net worth certain liabilities assumed 
by third parties and treat certain temporary capital contributions as 
liabilities.\927\
---------------------------------------------------------------------------

    \927\ See Beer Letter; Levene Letter; NIBA 2 Letter.
---------------------------------------------------------------------------

    One commenter noted that there should be no circumstance in which a 
broker-dealer accepted a capital contribution for net capital purposes 
that could be withdrawn at the option of the investor.\928\ This 
commenter also noted that if small firms were required to raise over 
$300,000 in capital each, there will be the largest dissolution of 
small broker-dealers in the history of the regulated securities 
industry.\929\ The commenter requested that the Commission state a 
reasonable time period for broker-dealers to raise capital

[[Page 51899]]

to meet these new standards.\930\ This commenter also stated that the 
Commission's estimate of a gross cost of capital of 7.5% (5% + 2.5%) is 
a totally unrealistic cost of capital for small broker-dealers and that 
these broker-dealers will categorically have costs significantly higher 
than 7.5%.\931\
---------------------------------------------------------------------------

    \928\ See NIBA 2 Letter.
    \929\ Id.
    \930\ Id.
    \931\ Id.
---------------------------------------------------------------------------

    Further, the commenter stated that, until the Commission convenes a 
small broker-dealer representative panel to assist it with establishing 
such costs, the Commission is ``speculating'' on such costs, and is 
therefore without adequate information to consider the effects of such 
costs and changes on small firms.\932\ This commenter specifically 
requested the Commission consider the needs of small firms that will 
likely require additional net capital over the next decade.\933\
---------------------------------------------------------------------------

    \932\ Id.
    \933\ Id. The commenter stated that any rule that would 
``restrict small broker-dealers from raising capital as a result of 
uncertainty of investors or owner-operators related to the return of 
their capital in a reasonable time frame will create a 
disproportionate and impossible hurdle for small broker-dealers to 
overcome.'' See NIBA 2 Letter.
---------------------------------------------------------------------------

    Additionally, this commenter believed that the rule is intended to 
protect the capitalization of large firms while ignoring small firms. 
The commenter also noted that it opposes regulation that arbitrarily 
reduces the value of small broker-dealers and their competitive 
position relative to larger broker-dealers.\934\ Finally, the commenter 
expressed concern that the proposed amendments to Rule 15c3-1 would be 
particularly burdensome on small broker-dealers, negatively impacting 
capital formation for small issuers and increasing the cost of capital 
for small broker-dealers.\935\
---------------------------------------------------------------------------

    \934\ See NIBA 2 Letter.
    \935\ Id. The commenter noted that broker-dealers ``are dealing 
with a relatively static commission and fees matrix versus what they 
may charge customers.'' Consequently, the commenter believes 
``broker-dealers will be unable to pass any of these costs increases 
directly to customers, irrespective of the type of customer or type 
of business that they are conducting with small broker-dealers, 
which further threatens the financial profit potential and return on 
equity of small broker-dealers.'' Id. The commenter further believes 
that the cost increases over a short period of time will threaten 
the viability of all small broker-dealers. Id.
---------------------------------------------------------------------------

    Another commenter stated that this proposal will require the 702 
mentioned debt-free introducing broker-dealers to needlessly take on 
debt of approximately $280,354.\936\ Further, the commenter stated 
that, if the proposed is approved, it would force the majority of small 
firms out of business and ultimately deny investors the right and 
opportunity to deal with smaller, more personalized and debt-free 
member firms.\937\ One commenter stated that it also must be considered 
that any implementation and enforcement of these proposed changes 
should not be made retroactive, because to subject firms to a new set 
of rules and guidelines will effectively penalize small firms that have 
been in full compliance with the rules and regulations.\938\
---------------------------------------------------------------------------

    \936\ See Beer Letter.
    \937\ Id.
    \938\ See Levene Letter.
---------------------------------------------------------------------------

    The Commission considered all comments discussed above and the 
potential impact on small broker-dealers.\939\ The Commission continues 
to believe that the estimated cost of capital is not unrealistic for 
small broker-dealers. However, as discussed above in section V. of this 
release, in response to comments, the Commission increased the 
estimated cost of capital for these amendments is 12%.
---------------------------------------------------------------------------

    \939\ See Beer Letter; Levene Letter; NIBA 2 Letter.
---------------------------------------------------------------------------

    Moreover, as discussed in section II.E.1 and 2. of this release, 
the baseline of these rules is current Rule 15c3-1 and existing 
guidance and interpretations. The Commission staff has provided 
guidance with respect to the treatment and recording of certain broker-
dealer expenses and liabilities that is consistent with the rule 
amendment.\940\ In addition, existing broker-dealer recordkeeping rules 
require that a broker-dealer record its income and expenses.\941\ For 
example, paragraph (a)(2) of Rule 17a-3, requires a broker-dealer to 
make and keep current ledgers (or other records) reflecting all assets 
and liabilities, income and expense and capital accounts.\942\ 
Therefore, the Commission does not expect small broker-dealers to incur 
significant costs or burdens to comply with the amendment regarding 
broker-dealers and payment of expenses by third parties.\943\
---------------------------------------------------------------------------

    \940\ See, e.g., Third Party Expense Letter; see also FINRA 
Notice to Members 03-6, Expense Sharing Agreements.
    \941\ 17 CFR 240.17a-3; 17 CFR 240.17a-4.
    \942\ 17 CFR 240.17a-3(a)(2).
    \943\ See NIBA 2 Letter.
---------------------------------------------------------------------------

    At the same time, the purpose of the requirement in new paragraph 
(c)(2)(i)(F) of Rule 15c3-1 is to address the practices of a broker-
dealer that raise concerns when a broker-dealer shifts liabilities to 
an entity with no revenue or assets independent of the broker-dealer to 
inappropriately increase its reported net capital, by excluding the 
liability from the calculation of net worth. Therefore, the final rule, 
as discussed above in section II.E.1. of this release, is designed to 
prohibit a practice that could misrepresent a broker-dealer's actual 
financial condition, deceive the firm's customers, and hamper the 
ability of regulators to monitor the firm's financial condition.
    Moreover, in response to comments,\944\ the rule amendment, as 
adopted, should not impose burdens or present serious implementation 
difficulties to small broker-dealers \945\ that are appropriately 
recording their assets and liabilities under current Commission rules 
and interpretive guidance.\946\ These broker-dealers also should not be 
required to obtain loans to increase their capital as a result of the 
Rule 15c3-1 amendments. Therefore, the Commission does not believe a 
longer time period for compliance or the formation of a small broker-
dealer advisory cost committee is necessary.\947\
---------------------------------------------------------------------------

    \944\ Id.
    \945\ See Beer Letter; Levene Letter; NIBA 2 Letter.
    \946\ See, e.g., Third Party Expense Letter.
    \947\ See NIBA 2 Letter.
---------------------------------------------------------------------------

    In response to the commenters' concerns about the negative impact 
of the rule amendments on the capital of small broker-dealers,\948\ as 
discussed above, the final rule amendment is a codification of existing 
Commission staff guidance,\949\ and thus should not represent a change 
for small broker-dealers with respect to capital withdrawals. Moreover, 
with respect to commenters' concerns about obtaining capital,\950\ the 
rule does not prohibit an investor from withdrawing capital at any 
time. Rather, it prohibits a broker-dealer from treating temporary cash 
infusions as capital for purposes of the net capital rule. Finally, the 
final rule amendments provide a mechanism for a broker-dealer to apply 
to its DEA to make a withdrawal within one year of the capital 
contribution without triggering the deduction under certain 
circumstances (e.g., de minimis withdrawals).
---------------------------------------------------------------------------

    \948\ See Beer Letter; Levene Letter; NIBA 2 Letter.
    \949\ See Temporary Capital Letter. See also section II.E.2. of 
this release.
    \950\ See Beer Letter; NIBA 2 Letter.
---------------------------------------------------------------------------

3. Small Entities Subject to the Rule

    Based on FOCUS Report data, as of December 31, 2011, the Commission 
estimates that there are approximately 2,506 introducing and carrying 
broker-dealers that are ``small'' for the purposes Rule 0-10. The 
amendments relating to certain subtractions from net worth and the 
restrictions on the withdrawal of capital will apply to all ``small'' 
broker-dealers in that they will be subject to the requirements in the 
amendments. The amendment to Appendix A of Rule 15c3-1 likely should 
have no, or little, impact on ``small'' broker-dealers, because based 
on staff experience, most,

[[Page 51900]]

if not all, of these firms do not carry non-clearing option specialist 
or market maker accounts.
4. Reporting, Recordkeeping, and Other Compliance Requirements
    The amendments will require an ``insolvent'' broker-dealer to cease 
conducting a securities business and provide the securities regulators 
with notice of its insolvency. The amendments also will require broker-
dealers to deduct from net worth certain liabilities and certain 
temporary capital contributions, as well as require broker-dealers to 
deduct from net capital, certain specified amounts as required by SRO 
fidelity bond rules. Finally, under the amendment to the rule on 
Commission orders restricting withdrawals of capital, a broker-dealer 
subject to an order will not be permitted to withdraw capital. Finally, 
the amendments will make permanent a temporary rule that reduced the 
haircut for non-clearing options specialist and market maker accounts 
under Appendix A to Rule 15c3-1.
5. Agency Action To Minimize Effect on Small Entities
    As discussed in detail above, the Commission considered all 
comments received and adopted the amendment substantially as 
proposed.\951\ The Commission understands the concerns relating to 
small broker-dealers raised by commenters \952\ and reiterates that the 
rule is designed to address situations where there is no legitimate 
reason to book liabilities to a separate legal entity that otherwise 
would accrue to the broker-dealer. Moreover, the final rule is 
consistent with current staff interpretations regarding third-party 
expense sharing and thus should not represent a change for broker-
dealers. The Commission also notes that the final rule is designed to 
prohibit a practice that could misrepresent a broker-dealer's actual 
financial condition, deceive the firm's customers, and hamper the 
ability of regulators to monitor the firm's financial condition. 
Moreover, the rule change, as adopted, should not impose undue burdens 
or present serious implementation difficulties for large or small 
broker-dealers. As the Commission explained in the proposing release, a 
broker-dealer can demonstrate the adequacy of the third party's 
financial resources by maintaining records such as the third party's 
most recent (i.e., as of a date within the previous twelve months) 
audited financial statements, tax returns, or regulatory filings 
containing financial reports.\953\ Given that the entity to which the 
broker-dealer is seeking to shift one or more liabilities typically is 
an affiliate, the staff's experience is that such records should be 
available to the broker-dealer. Further, because the proposed rule 
change is consistent with prior staff guidance regarding the need to be 
able to demonstrate the third party's financial adequacy, the broker-
dealer seeking to shift a liability to a third party already would, 
under existing staff interpretations, expect to be ready to provide 
such evidence of the third party's financial resources. Taken together, 
these realities should mitigate the implementation and burden concerns 
raised by commenters as they relate to small broker-dealers.
---------------------------------------------------------------------------

    \951\ See section II.E.1. of this release.
    \952\ See Beer Letter; Beer 2 Letter; Levene Letter; Lowenstein 
Letter; NIBA 2 Letter. See also discussion in section II.E.1. of 
this release.
    \953\ Amendments to Financial Responsibility Rules, 72 FR at 
12872. The Commission specifically requested comment regarding the 
records by which a broker-dealer could demonstrate financial 
resources. It received no comments in response to this request.
---------------------------------------------------------------------------

    One or more of these record types are generally readily available. 
The general availability of a satisfactory measure of financial 
resources should mitigate the implementation and burden concerns raised 
by the commenters.
    As discussed above, given the minimal impact these amendments will 
have on small entities, the Commission is not establishing different 
compliance or reporting requirements or timetables; clarifying, 
consolidating, or simplifying compliance and reporting requirements 
under the rule for small entities; nor exempting small entities from 
coverage of the rule, or any part thereof.
    The amendments use performance standards and do not dictate for 
entities of any size any particular design standards (e.g., technology) 
that must be employed to achieve the objectives of the amendments.

VII. Statutory Authority

    The Commission is adopting amendments to Rules 15c3-1, 15c3-3, 17a-
3, 17a-4 and 17a-11 under the Exchange Act pursuant to the authority 
conferred by the Exchange Act, including Sections 15, 17, 23(a) and 
36.\954\
---------------------------------------------------------------------------

    \954\ 15 U.S.C. 78o, 78q, 78w and 78mm.
---------------------------------------------------------------------------

Text of Final Rules

List of Subjects in 17 CFR Part 240

    Brokers, Reporting and recordkeeping requirements, Securities.
    In accordance with the foregoing, the Commission hereby amends 
Title 17, Chapter II of the Code of Federal Regulation as follows.

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
1. The general authority for Part 240 continues to read as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f, 
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4, 
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et. seq., and 
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and 
Pub. L. 111-203, 939A, 124 Stat. 1376, (2010), unless otherwise 
noted.
* * * * *

0
2. Section 240.15c3-1 is amended by:
0
a. Revising the first sentence of paragraph (a) introductory text;
0
b. Removing from paragraph (a)(6)(iii)(A) the phrase ``paragraph 
(c)(2)(x)(A)(1) through (9) of this section'' and in its place adding 
the phrase ``Appendix A (Sec.  240.15c3-1a)'';
0
c. Revising the paragraph (c)(2)(i) heading;
0
d. Adding paragraphs (c)(2)(i)(F) and (G);
0
e. Revising paragraphs (c)(2)(iv)(B), (c)(2)(iv)(E), and 
(c)(2)(vi)(D)(1);
0
f. Adding paragraph (c)(2)(xiv);
0
g. Adding paragraph (c)(16) and an undesignated center heading;
0
h. Revising paragraph (e)(3)(i); and
0
i. Removing from the second sentence in paragraph (e)(3)(ii) the text 
``The hearing'' and in its place adding the phrase ``A hearing on an 
order temporarily prohibiting the withdrawal of capital''.
    The revisions and additions read as follows:


Sec.  240.15c3-1  Net capital requirements for brokers or dealers.

    (a) Every broker or dealer must at all times have and maintain net 
capital no less than the greater of the highest minimum requirement 
applicable to its ratio requirement under paragraph (a)(1) of this 
section, or to any of its activities under paragraph (a)(2) of this 
section, and must otherwise not be ``insolvent'' as that term is 
defined in paragraph (c)(16) of this section. * * *
* * * * *
    (c) * * *
    (2) * * *
    (i) Adjustments to net worth related to unrealized profit or loss, 
deferred tax provisions, and certain liabilities.* * *
* * * * *
    (F) Subtracting from net worth any liability or expense relating to 
the

[[Page 51901]]

business of the broker or dealer for which a third party has assumed 
the responsibility, unless the broker or dealer can demonstrate that 
the third party has adequate resources independent of the broker or 
dealer to pay the liability or expense.
    (G) Subtracting from net worth any contribution of capital to the 
broker or dealer:
    (1) Under an agreement that provides the investor with the option 
to withdraw the capital; or
    (2) That is intended to be withdrawn within a period of one year of 
contribution. Any withdrawal of capital made within one year of its 
contribution is deemed to have been intended to be withdrawn within a 
period of one year, unless the withdrawal has been approved in writing 
by the Examining Authority for the broker or dealer.
* * * * *
    (iv) * * *
    (B) All unsecured advances and loans; deficits in customers' and 
non-customers' unsecured and partly secured notes; deficits in omnibus 
credit accounts maintained in compliance with the requirements of 12 
CFR 220.7(f) of Regulation T under the Act, or similar accounts carried 
on behalf of another broker or dealer, after application of calls for 
margin, marks to the market or other required deposits that are 
outstanding 5 business days or less; deficits in customers' and non-
customers' unsecured and partly secured accounts after application of 
calls for margin, marks to market or other required deposits that are 
outstanding 5 business days or less, except deficits in cash accounts 
as defined in 12 CFR 220.8 of Regulation T under the Act for which not 
more than one extension respecting a specified securities transaction 
has been requested and granted, and deducting for securities carried in 
any of such accounts the percentages specified in paragraph (c)(2)(vi) 
of this section or Appendix A, Sec.  240.15c3-1a; the market value of 
stock loaned in excess of the value of any collateral received 
therefor; receivables arising out of free shipments of securities 
(other than mutual fund redemptions) in excess of $5,000 per shipment 
and all free shipments (other than mutual fund redemptions) outstanding 
more than 7 business days, and mutual fund redemptions outstanding more 
than 16 business days; and any collateral deficiencies in secured 
demand notes as defined in Appendix D, Sec.  240.15c3-1d; a broker or 
dealer that participates in a loan of securities by one party to 
another party will be deemed a principal for the purpose of the 
deductions required under this section, unless the broker or dealer has 
fully disclosed the identity of each party to the other and each party 
has expressly agreed in writing that the obligations of the broker or 
dealer do not include a guarantee of performance by the other party and 
that such party's remedies in the event of a default by the other party 
do not include a right of setoff against obligations, if any, of the 
broker or dealer.
* * * * *
    (E) Other Deductions. All other unsecured receivables; all assets 
doubtful of collection less any reserves established therefor; the 
amount by which the market value of securities failed to receive 
outstanding longer than thirty (30) calendar days exceeds the contract 
value of such fails to receive; and the funds on deposit in a 
``segregated trust account'' in accordance with 17 CFR 270.27d-1 under 
the Investment Company Act of 1940, but only to the extent that the 
amount on deposit in such segregated trust account exceeds the amount 
of liability reserves established and maintained for refunds of charges 
required by sections 27(d) and 27(f) of the Investment Company Act of 
1940; Provided, That the following need not be deducted:
    (1) Any amounts deposited in a Customer Reserve Bank Account or PAB 
Reserve Bank Account pursuant to Sec.  240.15c3-3(e),
    (2) Cash and securities held in a securities account at a carrying 
broker or dealer (except where the account has been subordinated to the 
claims of creditors of the carrying broker or dealer), and
    (3) Clearing deposits.
* * * * *
    (vi) * * *
    (D)(1) In the case of redeemable securities of an investment 
company registered under the Investment Company Act of 1940, which 
assets consist of cash or money market instruments and which is 
described in Sec.  270.2a-7 of this chapter, the deduction will be 2% 
of the market value of the greater of the long or short position.
* * * * *
    (xiv) Deduction from net worth for excess deductible amounts 
related to fidelity bond coverage. Deducting the amount specified by 
rule of the Examining Authority for the broker or dealer with respect 
to a requirement to maintain fidelity bond coverage.
* * * * *

Insolvent

    (16) For the purposes of this section, a broker or dealer is 
insolvent if the broker or dealer:
    (i) Is the subject of any bankruptcy, equity receivership 
proceeding or any other proceeding to reorganize, conserve, or 
liquidate such broker or dealer or its property or is applying for the 
appointment or election of a receiver, trustee, or liquidator or 
similar official for such broker or dealer or its property;
    (ii) Has made a general assignment for the benefit of creditors;
    (iii) Is insolvent within the meaning of section 101 of title 11 of 
the United States Code, or is unable to meet its obligations as they 
mature, and has made an admission to such effect in writing or in any 
court or before any agency of the United States or any State; or
    (iv) Is unable to make such computations as may be necessary to 
establish compliance with this section or with Sec.  240.15c3-3.
* * * * *
    (e) * * *
    (3)(i) Temporary restrictions on withdrawal of net capital. The 
Commission may by order restrict, for a period of up to twenty business 
days, any withdrawal by the broker or dealer of equity capital or 
unsecured loan or advance to a stockholder, partner, sole proprietor, 
member, employee or affiliate under such terms and conditions as the 
Commission deems necessary or appropriate in the public interest or 
consistent with the protection of investors if the Commission, based on 
the information available, concludes that such withdrawal, advance or 
loan may be detrimental to the financial integrity of the broker or 
dealer, or may unduly jeopardize the broker or dealer's ability to 
repay its customer claims or other liabilities which may cause a 
significant impact on the markets or expose the customers or creditors 
of the broker or dealer to loss without taking into account the 
application of the Securities Investor Protection Act of 1970.
* * * * *


Sec.  240.15c3-1a  [Amended]

0
3. Section 240.15c3-1a is amended by:
0
a. Removing paragraph (b)(1)(iv)(B); and
0
b. Redesignating paragraphs (b)(1)(iv)(A) introductory text, 
(b)(1)(iv)(A)(1), (b)(1)(iv)(A)(2), and (b)(1)(iv)(A)(3) as paragraphs 
(b)(1)(iv) introductory text, (b)(1)(iv)(A),

[[Page 51902]]

(b)(1)(iv)(B), and (b)(1)(iv)(C) respectively.


Sec.  240.15c3-2  [Removed and Reserved]

0
4. Section 240.15c3-2 is removed and reserved.

0
5. Section 240.15c3-3 is amended by:
0
a. Removing from paragraph (a)(1) introductory text, third sentence, 
the citation ``220.19'' and in its place adding the citation 
``220.12'';
0
b. In paragraph (a)(1)(iii), after the phrase ``(15 U.S.C. 78aaa et 
seq.)'' adding ``(SIPA)'';
0
c. Removing the ``;'' at the end of paragraph (a)(1)(iv) and adding a 
period in its place;
0
d. Revising paragraphs (a)(3), (4), (7), (8), and (9);
0
e. Adding paragraphs (a)(16) and (17);
0
f. In paragraph (b)(2):
0
i. In the first sentence, removing the phrase ``his physical possession 
or under his control'' and in its place adding ``the broker's or 
dealer's physical possession or under its control'';
0
ii. In the second sentence, removing the word ``he'' and in its place 
adding ``it''; and
0
iii. In the second sentence, removing the word ``his'' and in its place 
adding ``its'';
0
g. Removing from paragraphs (b)(3)(iv) and (b)(4)(i)(C) the phrase 
``the Securities Investor Protection Act of 1970'' and in its place 
adding ``SIPA'';
0
h. At the end of paragraph (b)(4)(i)(C) adding the word ``and,'';
0
i. In paragraph (b)(4)(v), removing the word ``his'' and adding in its 
place ``the person's'';
0
j. Adding paragraph (b)(5);
0
k. In paragraph (c)(2):
0
i. Removing ``a special omnibus'' and in its place adding ``an omnibus 
credit'';
0
ii. Removing the text ``section 4(b) of Regulation T under the Act (12 
CFR 220.4(b))'' and in its place adding ``section 7(f) of Regulation T 
(12 CFR 220.7(f))''; and
0
iii. Removing the word ``he'' and in its place adding ``it'';
0
l. In paragraph (c)(3), removing the words ``him'' and ``he'' wherever 
they appear and in their place adding ``the broker or dealer'';
0
m. In the first sentence of paragraph (d) introductory text, removing 
the word ``his'' wherever it appears and in its place adding ``its'';
0
n. In paragraph (d)(2), removing the word ``his'' and in its place 
adding ``the broker's or dealer's'';
0
o. Removing the period at the end of paragraph (d)(3) and in its place 
adding ``; or'';
0
p. Redesignating paragraph (d)(4) as paragraph (d)(5);
0
q. Adding a new paragraph (d)(4);
0
r. Revising paragraphs (e) and (f);
0
s. Revising the first sentence of paragraph (g);
0
t. Removing from paragraph (i) the text ``his reserve bank account'' 
and in its place adding ``its Customer Reserve Bank Account, PAB 
Reserve Bank Account'';
0
u. Adding paragraph (j);
0
v. In paragraph (k)(1)(i), removing the phrase ``His dealer 
transactions'' and in its place adding ``The broker's or dealer's 
transactions as dealer'', and removing the word ``his'' the second and 
third time the word ``his'' appears and in its place adding ``its'';
0
w. In paragraph (k)(1)(ii), removing the word ``His'' and in its place 
adding ``The broker's or dealer's'';
0
x. In paragraph (k)(1)(iii), removing the word ``He'' and in its place 
adding ``The broker or dealer'' and removing the word ``his'' and in 
its place adding ``its'';
0
y. In paragraph (k)(2)(i), removing the word ``his'' and in its place 
adding ``its'' wherever it appears;
0
z. Revising paragraph (l)(2);
0
aa. Removing from the last sentence in paragraph (m) before the Note, 
the text ``a special omnibus'' and in its place adding ``an omnibus 
credit'' and removing the text ``section 4(b) of Regulation T [12 CFR 
220.4(b)]'' and in its place adding ``section 7(f) of Regulation T (12 
CFR 220.7(f))'';
0
bb. Redesignate the Note following paragraph (m) as ``Note to paragraph 
(m).'';
0
cc. Removing from the first sentence in paragraph (n) the phrase 
``paragraphs (d)(2) and (3)'' and in its place adding ``paragraphs 
(d)(2) through (4)''; and
0
dd. Removing from paragraph (o)(2)(i)(A) the phrase ``the Securities 
Investor Protection Act of 1970 (15 U.S.C. 78aaa et seq.)'' and in its 
place adding ``SIPA'';
    The revisions and additions read as follows:


Sec.  240.15c3-3  Customer protection--reserves and custody of 
securities.

    (a) * * *
    (3) The term fully paid securities means all securities carried for 
the account of a customer in a cash account as defined in Regulation T 
(12 CFR 220.1 et seq.), as well as securities carried for the account 
of a customer in a margin account or any special account under 
Regulation T that have no loan value for margin purposes, and all 
margin equity securities in such accounts if they are fully paid: 
Provided, however, that the term fully paid securities does not apply 
to any securities purchased in transactions for which the customer has 
not made full payment.
    (4) The term margin securities means those securities carried for 
the account of a customer in a margin account as defined in section 4 
of Regulation T (12 CFR 220.4), as well as securities carried in any 
other account (such accounts hereinafter referred to as ``margin 
accounts'') other than the securities referred to in paragraph (a)(3) 
of this section.
* * * * *
    (7) The term bank means a bank as defined in section 3(a)(6) of the 
Act and will also mean any building and loan, savings and loan or 
similar banking institution subject to supervision by a Federal banking 
authority. With respect to a broker or dealer that maintains its 
principal place of business in Canada, the term ``bank'' also means a 
Canadian bank subject to supervision by a Canadian authority.
    (8) The term free credit balances means liabilities of a broker or 
dealer to customers which are subject to immediate cash payment to 
customers on demand, whether resulting from sales of securities, 
dividends, interest, deposits or otherwise, excluding, however, funds 
in commodity accounts which are segregated in accordance with the 
Commodity Exchange Act or in a similar manner, or which are funds 
carried in a proprietary account as that term is defined in regulations 
under the Commodity Exchange Act. The term ``free credit balances'' 
also includes, if subject to immediate cash payment to customers on 
demand, funds carried in a securities account pursuant to a self-
regulatory organization portfolio margining rule approved by the 
Commission under section 19(b) of the Act (15 U.S.C. 78s(b)) (``SRO 
portfolio margining rule''), including variation margin or initial 
margin, marks to market, and proceeds resulting from margin paid or 
released in connection with closing out, settling or exercising futures 
contracts and options thereon.
    (9) The term other credit balances means cash liabilities of a 
broker or dealer to customers other than free credit balances and funds 
in commodity accounts which are segregated in accordance with the 
Commodity Exchange Act or in a similar manner, or funds carried in a 
proprietary account as that term is defined in regulations under the 
Commodity Exchange Act. The term ``other credit balances'' also 
includes funds that are cash liabilities of a broker or dealer to 
customers other than free credit balances and are carried in a 
securities account pursuant to an SRO portfolio margining rule, 
including

[[Page 51903]]

variation margin or initial margin, marks to market, and proceeds 
resulting from margin paid or released in connection with closing out, 
settling or exercising futures contracts and options thereon.
* * * * *
    (16) The term PAB account means a proprietary securities account of 
a broker or dealer (which includes a foreign broker or dealer, or a 
foreign bank acting as a broker or dealer) other than a delivery-
versus-payment account or a receipt-versus-payment account. The term 
does not include an account that has been subordinated to the claims of 
creditors of the carrying broker or dealer.
    (17) The term Sweep Program means a service provided by a broker or 
dealer where it offers to its customer the option to automatically 
transfer free credit balances in the securities account of the customer 
to either a money market mutual fund product as described in Sec.  
270.2a-7 of this chapter or an account at a bank whose deposits are 
insured by the Federal Deposit Insurance Corporation.
    (b) * * *
    (5) A broker or dealer is required to obtain and thereafter 
maintain the physical possession or control of securities carried for a 
PAB account, unless the broker or dealer has provided written notice to 
the account holder that the securities may be used in the ordinary 
course of its securities business, and has provided an opportunity for 
the account holder to object.
* * * * *
    (d) * * *
    (4) Securities included on the broker's or dealer's books or 
records that allocate to a short position of the broker or dealer or a 
short position for another person, excluding positions covered by 
paragraph (m) of this section, for more than 30 calendar days, then the 
broker or dealer must, not later than the business day following the 
day on which the determination is made, take prompt steps to obtain 
physical possession or control of such securities. For the purposes of 
this paragraph (d)(4), the 30 day time period will not begin to run 
with respect to a syndicate short position established in connection 
with an offering of securities until the completion of the 
underwriter's participation in the distribution as determined pursuant 
to Sec.  242.100(b) of Regulation M of this chapter (17 CFR 242.100 
through 242.105); or
* * * * *
    (e) Special reserve bank accounts for the exclusive benefit of 
customers and PAB accounts. (1) Every broker or dealer must maintain 
with a bank or banks at all times when deposits are required or 
hereinafter specified a ``Special Reserve Bank Account for the 
Exclusive Benefit of Customers'' (hereinafter referred to as the 
Customer Reserve Bank Account) and a ``Special Reserve Bank Account for 
Brokers and Dealers'' (hereinafter referred to as the PAB Reserve Bank 
Account), each of which will be separate from the other and from any 
other bank account of the broker or dealer. Such broker or dealer must 
at all times maintain in the Customer Reserve Bank Account and the PAB 
Reserve Bank Account, through deposits made therein, cash and/or 
qualified securities in amounts computed in accordance with the formula 
attached as Exhibit A (17 CFR 240.15c3-3a), as applied to customer and 
PAB accounts respectively.
    (2) With respect to each computation required pursuant to paragraph 
(e)(1) of this section, a broker or dealer must not accept or use any 
of the amounts under items comprising Total Credits under the formula 
referred to in paragraph (e)(1) of this section except for the 
specified purposes indicated under items comprising Total Debits under 
the formula, and, to the extent Total Credits exceed Total Debits, at 
least the net amount thereof must be maintained in the Customer Reserve 
Bank Account and PAB Reserve Bank Account pursuant to paragraph (e)(1) 
of this section.
    (3) Reserve Bank Account computations. (i) Computations necessary 
to determine the amount required to be deposited in the Customer 
Reserve Bank Account and PAB Reserve Bank Account as specified in 
paragraph (e)(1) of this section must be made weekly, as of the close 
of the last business day of the week, and the deposit so computed must 
be made no later than one hour after the opening of banking business on 
the second following business day; provided, however, a broker or 
dealer which has aggregate indebtedness not exceeding 800 percent of 
net capital (as defined in Sec.  240.15c3-1) and which carries 
aggregate customer funds (as defined in paragraph (a)(10) of this 
section), as computed at the last required computation pursuant to this 
section, not exceeding $1,000,000, may in the alternative make the 
Customer Reserve Bank Account computation monthly, as of the close of 
the last business day of the month, and, in such event, must deposit 
not less than 105 percent of the amount so computed no later than one 
hour after the opening of banking business on the second following 
business day.
    (ii) If a broker or dealer, computing on a monthly basis, has, at 
the time of any required computation, aggregate indebtedness in excess 
of 800 percent of net capital, such broker or dealer must thereafter 
compute weekly as aforesaid until four successive weekly Customer 
Reserve Bank Account computations are made, none of which were made at 
a time when its aggregate indebtedness exceeded 800 percent of its net 
capital.
    (iii) A broker or dealer that does not carry the accounts of a 
``customer'' as defined by this section or conduct a proprietary 
trading business may make the computation to be performed with respect 
to PAB accounts under paragraph (e)(1) of this section monthly rather 
than weekly. If a broker or dealer performing the computation with 
respect to PAB accounts under paragraph (e)(1) of this section on a 
monthly basis is, at the time of any required computation, required to 
deposit additional cash or qualified securities in the PAB Reserve Bank 
Account, the broker or dealer must thereafter perform the computation 
required with respect to PAB accounts under paragraph (e)(1) of this 
section weekly until four successive weekly computations are made, none 
of which is made at a time when the broker or dealer was required to 
deposit additional cash or qualified securities in the PAB Reserve Bank 
Account.
    (iv) Computations in addition to the computations required in this 
paragraph (e)(3), may be made as of the close of any business day, and 
the deposits so computed must be made no later than one hour after the 
opening of banking business on the second following business day.
    (v) The broker or dealer must make and maintain a record of each 
such computation made pursuant to this paragraph (e)(3) or otherwise 
and preserve each such record in accordance with Sec.  240.17a-4.
    (4) If the computation performed under paragraph (e)(3) of this 
section with respect to PAB accounts results in a deposit requirement, 
the requirement may be satisfied to the extent of any excess debit in 
the computation performed under paragraph (e)(3) of this section with 
respect to customer accounts of the same date. However, a deposit 
requirement resulting from the computation performed under paragraph 
(e)(3) of this section with respect to customer accounts cannot be 
satisfied with excess debits from the computation performed under 
paragraph (e)(3) of this section with respect to PAB accounts.

[[Page 51904]]

    (5) In determining whether a broker or dealer maintains the minimum 
deposits required under this section, the broker or dealer must exclude 
the total amount of any cash deposited with an affiliated bank. The 
broker or dealer also must exclude cash deposited with a non-affiliated 
bank to the extent that the amount of the deposit exceeds 15% of the 
bank's equity capital as reported by the bank in its most recent Call 
Report or any successor form the bank is required to file by its 
appropriate Federal banking agency (as defined by section 3 of the 
Federal Deposit Insurance Act (12 U.S.C. 1813)).
    (f) Notification of banks. A broker or dealer required to maintain 
a Customer Reserve Bank Account and PAB Reserve Bank Account prescribed 
by paragraph (e)(1) of this section or who maintains a Special Account 
referred to in paragraph (k) of this section must obtain and preserve 
in accordance with Sec.  240.17a-4 a written notification from each 
bank with which it maintains a Customer Reserve Bank Account, a PAB 
Reserve Bank Account, or a Special Account that the bank was informed 
that all cash and/or qualified securities deposited therein are being 
held by the bank for the exclusive benefit of the customers and account 
holders of the broker or dealer in accordance with the regulations of 
the Commission, and are being kept separate from any other accounts 
maintained by the broker or dealer with the bank, and the broker or 
dealer must have a written contract with the bank which provides that 
the cash and/or qualified securities will at no time be used directly 
or indirectly as security for a loan to the broker or dealer by the 
bank and will not be subject to any right, charge, security interest, 
lien, or claim of any kind in favor of the bank or any person claiming 
through the bank.
    (g) Withdrawals from the reserve bank accounts. A broker or dealer 
may make withdrawals from a Customer Reserve Bank Account and a PAB 
Reserve Bank Account if and to the extent that at the time of the 
withdrawal the amount remaining in the Customer Reserve Bank Account 
and PAB Reserve Bank Account is not less than the amount then required 
by paragraph (e) of this section. * * *
* * * * *
    (j) Treatment of free credit balances. (1) A broker or dealer must 
not accept or use any free credit balance carried for the account of 
any customer of the broker or dealer unless such broker or dealer has 
established adequate procedures pursuant to which each customer for 
whom a free credit balance is carried will be given or sent, together 
with or as part of the customer's statement of account, whenever sent 
but not less frequently than once every three months, a written 
statement informing the customer of the amount due to the customer by 
the broker or dealer on the date of the statement, and that the funds 
are payable on demand of the customer.
    (2) A broker or dealer must not convert, invest, or transfer to 
another account or institution, credit balances held in a customer's 
account except as provided in paragraphs (j)(2)(i) and (ii) of this 
section.
    (i) A broker or dealer is permitted to invest or transfer to 
another account or institution, free credit balances in a customer's 
account only upon a specific order, authorization, or draft from the 
customer, and only in the manner, and under the terms and conditions, 
specified in the order, authorization, or draft.
    (ii) A broker or dealer is permitted to transfer free credit 
balances held in a customer's securities account to a product in its 
Sweep Program or to transfer a customer's interest in one product in a 
Sweep Program to another product in a Sweep Program, provided:
    (A) For an account opened on or after the effective date of this 
paragraph (j)(2)(ii), the customer gives prior written affirmative 
consent to having free credit balances in the customer's securities 
account included in the Sweep Program after being notified:
    (1) Of the general terms and conditions of the products available 
through the Sweep Program; and
    (2) That the broker or dealer may change the products available 
under the Sweep Program.
    (B) For any account:
    (1) The broker or dealer provides the customer with the disclosures 
and notices regarding the Sweep Program required by each self-
regulatory organization of which the broker or dealer is a member;
    (2) The broker or dealer provides notice to the customer, as part 
of the customer's quarterly statement of account, that the balance in 
the bank deposit account or shares of the money market mutual fund in 
which the customer has a beneficial interest can be liquidated on the 
customer's order and the proceeds returned to the securities account or 
remitted to the customer; and
    (3)(i) The broker or dealer provides the customer with written 
notice at least 30 calendar days before:
    (A) Making changes to the terms and conditions of the Sweep 
Program;
    (B) Making changes to the terms and conditions of a product 
currently available through the Sweep Program;
    (C) Changing, adding or deleting products available through the 
Sweep Program; or
    (D) Changing the customer's investment through the Sweep Program 
from one product to another.
    (ii) The notice must describe the new terms and conditions of the 
Sweep Program or product or the new product, and the options available 
to the customer if the customer does not accept the new terms and 
conditions or product.
* * * * *
    (l) Delivery of securities. * * *
    (2) Margin securities upon full payment by such customer to the 
broker or dealer of the customer's indebtedness to the broker or 
dealer; and, subject to the right of the broker or dealer under 
Regulation T (12 CFR 220) to retain collateral for its own protection 
beyond the requirements of Regulation T, excess margin securities not 
reasonably required to collateralize such customer's indebtedness to 
the broker or dealer.
* * * * *

0
6. Section 240.15c3-3a is revised to read as follows:


Sec.  240.15c3-3a  Exhibit A--Formula for determination of customer and 
PAB account reserve requirements of brokers and dealers under Sec.  
240.15c3-3.

----------------------------------------------------------------------------------------------------------------
                                                                                    Credits           Debits
----------------------------------------------------------------------------------------------------------------
1. Free credit balances and other credit balances in customers' security                   XXX   ...............
 accounts. (See Note A).......................................................
2. Monies borrowed collateralized by securities carried for the accounts of                XXX   ...............
 customers (See Note B).......................................................
3. Monies payable against customers' securities loaned (See Note C)...........             XXX   ...............
4. Customers' securities failed to receive (See Note D).......................             XXX   ...............
5. Credit balances in firm accounts which are attributable to principal sales              XXX   ...............
 to customers.................................................................
6. Market value of stock dividends, stock splits and similar distributions                 XXX   ...............
 receivable outstanding over 30 calendar days.................................
7. Market value of short security count differences over 30 calendar days old.             XXX   ...............

[[Page 51905]]

 
8. Market value of short securities and credits (not to be offset by longs or              XXX   ...............
 by debits) in all suspense accounts over 30 calendar days....................
9. Market value of securities which are in transfer in excess of 40 calendar               XXX   ...............
 days and have not been confirmed to be in transfer by the transfer agent or
 the issuer during the 40 days................................................
10. Debit balances in customers' cash and margin accounts excluding unsecured   ...............             XXX
 accounts and accounts doubtful of collection. (See Note E)...................
11. Securities borrowed to effectuate short sales by customers and securities   ...............             XXX
 borrowed to make delivery on customers' securities failed to deliver.........
12. Failed to deliver of customers' securities not older than 30 calendar days  ...............             XXX
13. Margin required and on deposit with the Options Clearing Corporation for    ...............             XXX
 all option contracts written or purchased in customer accounts. (See Note F).
14. Margin required and on deposit with a clearing agency registered with the   ...............             XXX
 Commission under section 17A of the Act (15 U.S.C. 78q-1) or a derivatives
 clearing organization registered with the Commodity Futures Trading
 Commission under section 5b of the Commodity Exchange Act (7 U.S.C. 7a-1)
 related to the following types of positions written, purchased or sold in
 customer accounts: (1) security futures products and (2) futures contracts
 (and options thereon) carried in a securities account pursuant to an SRO
 portfolio margining rule (See Note G)........................................
    Total credits.............................................................  ...............  ...............
    Total debits..............................................................  ...............  ...............
15. Excess of total credits (sum of items 1-9) over total debits (sum of items  ...............             XXX
 10-14) required to be on deposit in the ``Reserve Bank Account'' (Sec.
 240.15c3-3(e)). If the computation is made monthly as permitted by this
 section, the deposit must be not less than 105% of the excess of total
 credits over total debits....................................................
----------------------------------------------------------------------------------------------------------------

Notes Regarding the Customer Reserve Bank Account Computation

    Note A. Item 1 must include all outstanding drafts payable to 
customers which have been applied against free credit balances or other 
credit balances and must also include checks drawn in excess of bank 
balances per the records of the broker or dealer.
    Note B. Item 2 must include the amount of options-related or 
security futures product-related Letters of Credit obtained by a member 
of a registered clearing agency or a derivatives clearing organization 
which are collateralized by customers' securities, to the extent of the 
member's margin requirement at the registered clearing agency or 
derivatives clearing organization. Item 2 must also include the amount 
of Letters of Credit which are collateralized by customers' securities 
and related to other futures contracts (and options thereon) carried in 
a securities account pursuant to an SRO portfolio margining rule.
    Note C. Item 3 must include in addition to monies payable against 
customers' securities loaned the amount by which the market value of 
securities loaned exceeds the collateral value received from the 
lending of such securities.
    Note D. Item 4 must include in addition to customers' securities 
failed to receive the amount by which the market value of securities 
failed to receive and outstanding more than thirty (30) calendar days 
exceeds their contract value.
    Note E. (1) Debit balances in margin accounts must be reduced by 
the amount by which a specific security (other than an exempted 
security) which is collateral for margin accounts exceeds in aggregate 
value 15 percent of the aggregate value of all securities which 
collateralize all margin accounts receivable; provided, however, the 
required reduction must not be in excess of the amounts of the debit 
balance required to be excluded because of this concentration rule. A 
specified security is deemed to be collateral for a margin account only 
to the extent it represents in value not more than 140 percent of the 
customer debit balance in a margin account.
    (2) Debit balances in special omnibus accounts, maintained in 
compliance with the requirements of Section 7(f) of Regulation T (12 
CFR 220.7(f)) or similar accounts carried on behalf of another broker 
or dealer, must be reduced by any deficits in such accounts (or if a 
credit, such credit must be increased) less any calls for margin, mark 
to the market, or other required deposits which are outstanding 5 
business days or less.
    (3) Debit balances in customers' cash and margin accounts included 
in the formula under Item 10 must be reduced by an amount equal to 1 
percent of their aggregate value.
    (4) Debit balances in cash and margin accounts of household members 
and other persons related to principals of a broker or dealer and debit 
balances in cash and margin accounts of affiliated persons of a broker 
or dealer must be excluded from the Reserve Formula, unless the broker 
or dealer can demonstrate that such debit balances are directly related 
to credit items in the formula.
    (5) Debit balances in margin accounts (other than omnibus accounts) 
must be reduced by the amount by which any single customer's debit 
balance exceeds 25% (to the extent such amount is greater than $50,000) 
of the broker-dealer's tentative net capital (i.e., net capital prior 
to securities haircuts) unless the broker or dealer can demonstrate 
that the debit balance is directly related to credit items in the 
Reserve Formula. Related accounts (e.g., the separate accounts of an 
individual, accounts under common control or subject to cross 
guarantees) will be deemed to be a single customer's accounts for 
purposes of this provision.
    If the registered national securities exchange or the registered 
national securities association having responsibility for examining the 
broker or dealer (``designated examining authority'') is satisfied, 
after taking into account the circumstances of the concentrated account 
including the quality, diversity, and marketability of the collateral 
securing the debit balances or margin accounts subject to this 
provision, that the concentration of debit balances is appropriate, 
then such designated examining authority may grant a partial or plenary 
exception from this provision. The debit balance may be included in the 
reserve formula computation for five business days from the day the 
request is made.
    (6) Debit balances in joint accounts, custodian accounts, 
participation in hedge funds or limited partnerships or similar type 
accounts or arrangements that include both assets of a person or 
persons who would be excluded from the definition of customer 
(``noncustomer'') and assets of a person or persons who would be 
included in the definition of customer must be included in the Reserve 
Formula in the

[[Page 51906]]

following manner: If the percentage ownership of the non-customer is 
less than 5 percent then the entire debit balance shall be included in 
the formula; if such percentage ownership is between 5 percent and 50 
percent then the portion of the debit balance attributable to the non-
customer must be excluded from the formula unless the broker or dealer 
can demonstrate that the debit balance is directly related to credit 
items in the formula; or if such percentage ownership is greater than 
50 percent, then the entire debit balance must be excluded from the 
formula unless the broker or dealer can demonstrate that the debit 
balance is directly related to credit items in the formula.
    Note F. Item 13 must include the amount of margin required and on 
deposit with the Options Clearing Corporation to the extent such margin 
is represented by cash, proprietary qualified securities and letters of 
credit collateralized by customers' securities.
    Note G. (a) Item 14 must include the amount of margin required and 
on deposit with a clearing agency registered with the Commission under 
section 17A of the Act (15 U.S.C. 78q-1) or a derivatives clearing 
organization registered with the Commodity Futures Trading Commission 
under section 5b of the Commodity Exchange Act (7 U.S.C. 7a-1) for 
customer accounts to the extent that the margin is represented by cash, 
proprietary qualified securities, and letters of credit collateralized 
by customers' securities.
    (b) Item 14 will apply only if the broker or dealer has the margin 
related to security futures products, or futures (and options thereon) 
carried in a securities account pursuant to an approved SRO portfolio 
margining program on deposit with:
    (1) A registered clearing agency or derivatives clearing 
organization that:
    (i) Maintains the highest investment-grade rating from a nationally 
recognized statistical rating organization; or
    (ii) Maintains security deposits from clearing members in 
connection with regulated options or futures transactions and 
assessment power over member firms that equal a combined total of at 
least $2 billion, at least $500 million of which must be in the form of 
security deposits. For the purposes of this Note G, the term ``security 
deposits'' refers to a general fund, other than margin deposits or 
their equivalent, that consists of cash or securities held by a 
registered clearing agency or derivative clearing organization; or
    (iii) Maintains at least $3 billion in margin deposits; or
    (iv) Does not meet the requirements of paragraphs (b)(1)(i) through 
(b)(1)(iii) of this Note G, if the Commission has determined, upon a 
written request for exemption by or for the benefit of the broker or 
dealer, that the broker or dealer may utilize such a registered 
clearing agency or derivatives clearing organization. The Commission 
may, in its sole discretion, grant such an exemption subject to such 
conditions as are appropriate under the circumstances, if the 
Commission determines that such conditional or unconditional exemption 
is necessary or appropriate in the public interest, and is consistent 
with the protection of investors; and
    (2) A registered clearing agency or derivatives clearing 
organization that, if it holds funds or securities deposited as margin 
for security futures products or futures in a portfolio margin account 
in a bank, as defined in section 3(a)(6) of the Act (15 U.S.C. 
78c(a)(6)), obtains and preserves written notification from the bank at 
which it holds such funds and securities or at which such funds and 
securities are held on its behalf. The written notification will state 
that all funds and/or securities deposited with the bank as margin 
(including customer security futures products and futures in a 
portfolio margin account), or held by the bank and pledged to such 
registered clearing agency or derivatives clearing agency as margin, 
are being held by the bank for the exclusive benefit of clearing 
members of the registered clearing agency or derivatives clearing 
organization (subject to the interest of such registered clearing 
agency or derivatives clearing organization therein), and are being 
kept separate from any other accounts maintained by the registered 
clearing agency or derivatives clearing organization with the bank. The 
written notification also will provide that such funds and/or 
securities will at no time be used directly or indirectly as security 
for a loan to the registered clearing agency or derivatives clearing 
organization by the bank, and will be subject to no right, charge, 
security interest, lien, or claim of any kind in favor of the bank or 
any person claiming through the bank. This provision, however, will not 
prohibit a registered clearing agency or derivatives clearing 
organization from pledging customer funds or securities as collateral 
to a bank for any purpose that the rules of the Commission or the 
registered clearing agency or derivatives clearing organization 
otherwise permit; and
    (3) A registered clearing agency or derivatives clearing 
organization establishes, documents, and maintains:
    (i) Safeguards in the handling, transfer, and delivery of cash and 
securities;
    (ii) Fidelity bond coverage for its employees and agents who handle 
customer funds or securities. In the case of agents of a registered 
clearing agency or derivatives clearing organization, the agent may 
provide the fidelity bond coverage; and
    (iii) Provisions for periodic examination by independent public 
accountants; and
    (iv) A derivatives clearing organization that, if it is not 
otherwise registered with the Commission, has provided the Commission 
with a written undertaking, in a form acceptable to the Commission, 
executed by a duly authorized person at the derivatives clearing 
organization, to the effect that, with respect to the clearance and 
settlement of the customer security futures products and futures in a 
portfolio margin account of the broker or dealer, the derivatives 
clearing organization will permit the Commission to examine the books 
and records of the derivatives clearing organization for compliance 
with the requirements set forth in Sec.  240.15c3-3a, Note G (b)(1) 
through (3).
    (c) Item 14 will apply only if a broker or dealer determines, at 
least annually, that the registered clearing agency or derivatives 
clearing organization with which the broker or dealer has on deposit 
margin related to securities future products or futures in a portfolio 
margin account meets the conditions of this Note G.

Notes Regarding the PAB Reserve Bank Account Computation

    Note 1. Broker-dealers should use the formula in Exhibit A for the 
purposes of computing the PAB reserve requirement, except that 
references to ``accounts,'' ``customer accounts, or ``customers'' will 
be treated as references to PAB accounts.
    Note 2. Any credit (including a credit applied to reduce a debit) 
that is included in the computation required by Sec.  240.15c3-3 with 
respect to customer accounts (the ``customer reserve computation'') may 
not be included as a credit in the computation required by Sec.  
240.15c3-3 with respect to PAB accounts (the ``PAB reserve 
computation'').
    Note 3. Note E(1) to Sec.  240.15c3-3a does not apply to the PAB 
reserve computation.
    Note 4. Note E(3) to Sec.  240.15c3-3a which reduces debit balances 
by 1% does not apply to the PAB reserve computation.

[[Page 51907]]

    Note 5. Interest receivable, floor brokerage, and commissions 
receivable of another broker or dealer from the broker or dealer 
(excluding clearing deposits) that are otherwise allowable assets under 
Sec.  240.15c3-1 need not be included in the PAB reserve computation, 
provided the amounts have been clearly identified as payables on the 
books of the broker or dealer. Commissions receivable and other 
receivables of another broker or dealer from the broker or dealer that 
are otherwise non-allowable assets under Sec.  240.15c3-1 and clearing 
deposits of another broker or dealer may be included as ``credit 
balances'' for purposes of the PAB reserve computation, provided the 
commissions receivable and other receivables are subject to immediate 
cash payment to the other broker or dealer and the clearing deposit is 
subject to payment within 30 days.
    Note 6. Credits included in the PAB reserve computation that result 
from the use of securities held for a PAB account (``PAB securities'') 
that are pledged to meet intra-day margin calls in a cross-margin 
account established between the Options Clearing Corporation and any 
regulated derivatives clearing organization may be reduced to the 
extent that the excess margin held by the other clearing corporation in 
the cross-margin relationship is used the following business day to 
replace the PAB securities that were previously pledged. In addition, 
balances resulting from a portfolio margin account that are segregated 
pursuant to Commodity Futures Trading Commission regulations need not 
be included in the PAB Reserve Bank Account computation.
    Note 7. Deposits received prior to a transaction pending settlement 
which are $5 million or greater for any single transaction or $10 
million in aggregate may be excluded as credits from the PAB reserve 
computation if such balances are placed and maintained in a separate 
PAB Reserve Bank Account by 12 p.m. Eastern Time on the following 
business day. Thereafter, the money representing any such deposits may 
be withdrawn to complete the related transactions without performing a 
new PAB reserve computation.
    Note 8. A credit balance resulting from a PAB reserve computation 
may be reduced by the amount that items representing such credits are 
swept into money market funds or mutual funds of an investment company 
registered under the Investment Company Act of 1940 on or prior to 10 
a.m. Eastern Time on the deposit date provided that the credits swept 
into any such fund are not subject to any right, charge, security 
interest, lien, or claim of any kind in favor of the investment company 
or the broker or dealer. Any credits that have been swept into money 
market funds or mutual funds must be maintained in the name of a 
particular broker or for the benefit of another broker.
    Note 9. Clearing deposits required to be maintained at registered 
clearing agencies may be included as debits in the PAB reserve 
computation to the extent the percentage of the deposit, which is based 
upon the clearing agency's aggregate deposit requirements (e.g., dollar 
trading volume), that relates to the proprietary business of other 
brokers and dealers can be identified.
    Note 10. A broker or dealer that clears PAB accounts through an 
affiliate or third party clearing broker must include these PAB account 
balances and the omnibus PAB account balance in its PAB reserve 
computation.

0
7. Section 240.17a-3 is amended by adding paragraph (a)(23) to read as 
follows:


Sec.  240.17a-3  Records to be made by certain exchange members, 
brokers and dealers.

    (a) * * *
    (23) A record documenting the credit, market, and liquidity risk 
management controls established and maintained by the broker or dealer 
to assist it in analyzing and managing the risks associated with its 
business activities, Provided, that the records required by this 
paragraph (a)(23) need only be made if the broker or dealer has more 
than:
    (i) $1,000,000 in aggregate credit items as computed under Sec.  
240.15c3-3a; or
    (ii) $20,000,000 in capital, which includes debt subordinated in 
accordance with Sec.  240.15c3-1d.
* * * * *

0
8. Section 240.17a-4 is amended by:
0
a. Removing from paragraph (b)(1) the citation ``Sec.  240.17a-3(f)'' 
and its place adding the citation ``Sec.  240.17a-3(g)'';
0
b. Removing from paragraph (b)(9) the citation ``Sec.  240.15c3-
3(d)(4)'' and in its place adding the citation ``Sec.  240.15c3-
3(d)(5)''; and
0
c. Adding paragraph (e)(9).
    The addition reads as follows:


Sec.  240.17a-4  Records to be preserved by certain exchange members, 
brokers and dealers.

* * * * *
    (e) * * *
    (9) All records required pursuant to Sec.  240.17a-3(a)(23) until 
three years after the termination of the use of the risk management 
controls documented therein.
* * * * *

0
9. Section 240.17a-11 is amended by:
0
a. Revising the first sentence of paragraph (b)(1);
0
b. Removing from paragraph (c) introductory text ``or (c)(4)'' and in 
its place adding ``, (c)(4) or (c)(5)''; and
0
c. Adding paragraph (c)(5).
    The revision and addition read as follows:


Sec.  240.17a-11  Notification provisions for brokers and dealers

* * * * *
    (b)(1) Every broker or dealer whose net capital declines below the 
minimum amount required pursuant to Sec.  240.15c3-1, or is insolvent 
as that term is defined in Sec.  240.15c3-1(c)(16), must give notice of 
such deficiency that same day in accordance with paragraph (g) of this 
section. * * *
* * * * *
    (c) * * *
    (5) If a computation made by a broker or dealer pursuant to Sec.  
240.15c3-1 shows that the total amount of money payable against all 
securities loaned or subject to a repurchase agreement or the total 
contract value of all securities borrowed or subject to a reverse 
repurchase agreement is in excess of 2500 percent of its tentative net 
capital; provided, however, that for purposes of this leverage test 
transactions involving government securities, as defined in section 
3(a)(42) of the Act (15 U.S.C. 78c(a)(42)), must be excluded from the 
calculation; provided further, however, that a broker or dealer will 
not be required to send the notice required by this paragraph (c)(5) if 
it reports monthly its securities lending and borrowing and repurchase 
and reverse repurchase activity (including the total amount of money 
payable against securities loaned or subject to a repurchase agreement 
and the total contract value of securities borrowed or subject to a 
reverse repurchase agreement) to its designated examining authority in 
a form acceptable to its designated examining authority.
* * * * *

    By the Commission.

     Dated: July 30, 2013.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2013-18734 Filed 8-20-13; 8:45 am]
BILLING CODE 8011-01-P