Navigating Through the New Broker-Dealer Reporting & Financial Responsibility Rules
Table of Contents
- Form Custody
- Compliance and Exemption Reports
- Changes to the Net Capital Rule
- Changes to the Customer Protection Rules
New Rules Affecting All Broker-Dealers
On July 30, 2013, the Securities and Exchange Commission (the "SEC") amended various rules relating to the annual reporting requirements, including the audit responsibilities, net capital requirements, and segregation rules. These changes, which are substantial, also have various effective dates, further complicating the implementation.
EisnerAmper has produced various articles discussing the various changes. In addition, we held an event, in November 2013, titled Navigating Through the New Broker-Dealer Reporting & Financial Responsibility Rules, to summarize these changes for broker-dealers.
Based on a poll taken at the event, fewer than 10% of broker-dealers present are ready for all the new rules and fewer than 30% have an action plan in place. After considering these results, we decided to provide information regarding the new rules in one convenient location in order to help broker-dealers prepare for the new reporting requirements and financial responsibility rules.
|How far along is your broker-dealer in the implementation process related to the new reporting requirements and financial responsibility rules?|
|We understand the new requirements and have an action plan in place, but still have some open items before complete implementation.|
|We have had preliminary discussions about the new rules, but have a long way to go before being fully compliant.|
|We have not begun discussion regarding the new rules.|
|What is Form Custody?||Form Custody is intended to be a single source of readily available information to assist examiners in preparing for and performing focused custody exams. It is designed to provide information concerning whether a broker-dealer maintained custody of customer and non-customer assets, and, if so, how such assets were maintained. This will make it easier for examiners to identify risks and possible violations of laws and regulations concerning the broker-dealer's custody of assets.|
|When does Form Custody become effective?||Commencing December 31, 2013, a broker-dealer must file Form Custody within 17 business days after the end of each calendar quarter. If the broker-dealer has a fiscal year-end date that is not the end of a calendar year, the broker-dealer must also file Form Custody within 17 business days after the broker-dealer's fiscal year-end.|
|How often does Form Custody have to be filed and with whom?||Form Custody must be filed with a broker-dealer's designated examining authority ("DEA") within 17 business days after the end of each calendar quarter, regardless of the broker-dealer's year-end. Broker-dealers that select a fiscal year-end date that is not the end of a calendar quarter must also file Form Custody with their DEA within 17 business days after their fiscal year-end.|
|Are any broker-dealers exempt from filing Form Custody?||The rule requires that all broker-dealers registered with the SEC file Form Custody with their DEA.
The SEC is concerned about circumstances where broker-dealers falsely represent to regulators and others that they do not handle funds or securities or issue trade confirmations or account statements. The requirements to file Form Custody will promote greater focus and attention to custody practices by requiring that broker-dealers make specific representations in this regard.
|If the broker-dealer is dually registered as an investment advisor subject to Form ADV, is it also required to file Form Custody?||Broker-dealers are required to file Form Custody even if they are also registered as an investment advisor and subject to Form ADV. The SEC acknowledges that although some overlap exists between the information collected on both forms, there is also a significant amount of information and data collected that is not overlapping and therefore both forms will be required to be completed. As such, these broker-dealers will file both Form Custody and Form ADV.|
|Does Form Custody require an audit by a PCAOB-registered independent public accountant?||Broker-dealers are not required to engage an independent public accountant for purposes of reviewing Form Custody.|
|Summary||Form Custody provides a comprehensive profile of a broker-dealer's custody practices and arrangements by consolidating information about the broker-dealer's custodial responsibility and relationships with other custodians into one report. We expect that the workload related to preparing this new form will be manageable for most broker-dealers.|
Compliance and Exemption Reports
Effective June 1, 2014, the independent report on internal control will be replaced by one of two new reports: a compliance report or an exemption report, one of which will be required to be filed by all registered broker-dealers.
|Compliance Report||Exemption Report|
|Who files which report?||
Registered broker-dealers who:
Registered broker-dealers who:
|What are the objectives of the report?||
This report is intended to increase the focus of independent public accountants on the custody practices of broker-dealers and to help identify broker-dealers that have weak controls for safeguarding investor assets. It replaces the term "material inadequacy" and separates it into two components:
|This report is intended to provide a standardized statement across all broker-dealers claiming an exemption from Rule 15c3-3 for the independent public accountant to review. The exemption report will provide the SEC and the broker-dealer's DEA with more information than currently is reported by non-carrying broker-dealers in the FOCUS report. The SEC seeks to identify exceptions to the exemptive provisions in paragraph (k) of Rule 15c3-3 in order to assess the nature, extent, and significance of the exceptions.|
|What are the requirements of the report?||
As of the end of the most recent fiscal year, the compliance report is required to contain statements as to whether:
The compliance report must also contain a description of:
The exemption report is required to contain statements which:
Changes to Net Capital Rule
As part of the SEC's final rule relating to broker-dealers, numerous changes were made relating to the Net Capital Rule (15c3-1). These changes had an effective date of October 21, 2013, except for broker-dealer accounts maintained at another brokerdealer which have an effective date of March 3, 2014.
|Broker-dealer accounts maintained at another broker-dealer||To avoid a charge, a non-clearing broker must have a PAIB (Primary Account of Introducing Brokers and Dealers) agreement with the clearing broker under which the clearing broker-dealer agrees to segregate the credit balances of the non-clearing broker.||A PAIB agreement is no longer required. The non-clearing broker is no longer required to take a charge for cash or securities held in the account at the clearing broker provided the account is not subordinated to the general creditor claims of the carrying firm.|
|Securities lending/ borrowing, repurchase/ reverse repurchase transactions||A charge is taken against net capital under certain conditions where the broker-dealer acted as principal to the transaction.||
Broker-dealers are assumed to be acting as principal and subject to the charges appropriate for these activities, unless:
|Deduct certain liabilities or expenses assumed by third parties from net worth||
Under the "Third Party Expense Letter" (from the SEC to the NYSE and NASD, dated July 11, 2003), a charge must be taken for each expense incurred related to its business and any corresponding liability, regardless of whether a third party has agreed to assume the expense or liability, unless:
|The portion of the "Third Party Expense Letter" is now codified into 15c3-1. The additional staff guidance not incorporated into the rule will remain relevant as staff guidance with respect to complying with the amendment to 15c3-1.|
|Solvency Requirement||A solvency requirement was not explicitly stated prior to the amendments.||
A broker-dealer must cease conducting securities business if deemed to be insolvent, as defined. Insolvency includes:
|Restrictions on capital withdrawals (part 1)||A provision permitted the SEC to restrict withdrawals of capital from broker-dealers to the extent that the total of such withdrawals, loans, and advances over a 30 calendar-day period exceeded 30% of the firm's excess net capital.||The 30% provision is eliminated. The SEC can restrict withdrawals of capital from a broker-dealer "under such terms and conditions as the SEC deems necessary or appropriate in the public interest or consistent with the protection of investors."|
|Restrictions on capital withdrawals (part 2)||A contribution should record as a liability if the contribution is made with the understanding that the contribution can be withdrawn at the option of the investor.||The new rule goes further than the initial rule: Capital contributed under an agreement allowing the capital to be withdrawn at any time or any capital contributed and intended to be withdrawn within 1 year of the contribution should be recorded as a liability. Capital withdrawn within 1 year is deemed intended to be withdrawn within 1 year unless the DEA consents to the withdrawal.|
|Fidelity bonding deductible limits||There is no specific reference to self-regulatory organizations ("SRO") deductible requirements as a charge to net worth, thus not requiring a broker-dealer to account for the deduction required by the SRO rule in computing net capital.||The broker-dealer shall deduct the amount specified by rule of the SRO for the broker-dealer with respect to a requirement to maintain fidelity bond coverage.|
Changes to Customer Protection Rule
As part of the SEC's final rule relating to carrying broker-dealers, changes were made relating to the Custody Protection Rule (15c3-3). These changes are effective as of March 3, 2014 (unless otherwise noted), as summarized below:
|Broker-dealer accounts maintained at another broker-dealer (Proprietary Accounts of Broker-dealers or "PAB Accounts")||A carrying broker-dealer who carried a PAB Account was not required to consider the PAB Account in a reserve account computation unless it had contractually agreed to do so.||
|PAB Account Reserve, like customer reserve||Broker-dealers that carried accounts of other broker-dealers under PAIB agreements performed a calculation and reserved net credits in the proprietary accounts of non-carrying broker-dealer clients.||
|Sweep program – (adopted October 21, 2013)||
No comparable rule prior to the issuance of the new rules.
|Documenting Risk Management (adopted October 21, 2013)||No comparable rule prior to the issuance of the new rules.||
With all the new rules, broker-dealers have much to be concerned with. Based on a poll taken at the Navigating Through the New Broker-Dealer Reporting & Financial Responsibility Rules event led by EisnerAmper LLP, almost half of the broker-dealers present were most concerned about the preparation of a compliance or exemption report; approximately one third are most concerned with the new financial responsibility rules. Only 7% of broker-dealers stated that they were ready for the new rules. More action appears to be necessary.
|Which aspect of the broker-dealer rules will be most challenging to contend with?|
|Preparation of Form Custody.|
|Compliance with new financial responsibility rules.|
|Preparation of a Compliance or Exemption Report.|