The SEC just adopted amendments to Rule 15c3-3 (the Customer Protection Rule) to require certain broker-dealers (known as PAB account holders) to increase the frequency with which they perform computations of the net cash they owe to customers and other broker-dealers from weekly to daily.

The amended rule will require that broker-dealers with average total credits over the past 12 months of $500m or more perform these calculations daily.

The securities watchdog also adopted amendments to Rule 15c3-1 (the Broker-Dealer Net Capital Rule) to permit certain broker-dealers that perform a daily customer reserve computation to decrease the required 3% “buffer” in the customer reserve bank account by reducing the customer-related receivables charge from 3% to 2% in the computation.

The stated reason for the rule’s proposal and adoption: A slim majority of the commissioners believes it helps better protect customers in the event a large broker-dealer fails.

Background

Rule 15c3-3 was adopted in 1972 adoption. Without anything resembling today’s electronic trading systems, it took a full week to settle securities transactions. More than 95% of trades cleared through the Depository Trust Clearing Corporation are affirmed, confirmed, and allocated by 9pm on the same day they’re traded, SEC Chair Gary Gensler pointed out in a statement accompanying the rule change.

Under the Broker-Dealer Customer Protection Rule, carrying broker-dealer, or those broker-dealers that maintain custody of customer securities and cash, must have a special reserve bank account that holds “qualified securities” and/or cash in an amount determined by a weekly computation. The idea is that if the broker-dealer fails, the securities and cash it holds for customers can be promptly returned.

[W]ith regard to the large broker-dealers covered by the rule, the difference of 1% would have freed up a monthly average of $7.4 billion of liquidity in 2023 to use elsewhere in their businesses.

A firm must hold an amount of cash or US Treasury securities in the reserve account equal in value to the net amount of cash owed to customers, which is the amount by which total cash owed to customers (for example, cash balances in securities accounts) exceeds total amount of cash customers owed to the broker-dealer (such as through margin loans to customers).

In July of 2023, the SEC proposed to amend the rule to require certain broker-dealers to compute their customer and reserve deposit requirements, and make any required deposits into their reserve accounts on a daily basis rather than a weekly basis.

Stats from the adopting release

As the rule’s adopting release notes, nine of the largest broker-dealers already make these calculations on a daily basis.

The new rule would standardize this practice for an estimated 49 broker-dealers whose total credit balances averaged at least $500m in 2023. As mentioned in the release, these 49 carrying broker-dealers held more than 99% of aggregate total credits of all carrying broker-dealers in 2023.

The adopting release also adjusts the amount of the required buffer that broker-dealers must maintain with regard to their customer reserve deposits.

Under the rule last amended in 1975, certain broker-dealers needed to maintain an additional three percent in segregated funds. Under the new, final rule, those firms calculating their customer reserve formula daily will be able to reduce this buffer from 3% to 2%.

As discussed in the adopting release, with regard to the large broker-dealers covered by the rule, the difference of 1% would have freed up a monthly average of $7.4 billion of liquidity in 2023 to use elsewhere in their businesses.

Thoughts from Peirce (approving) and Uyeda (dissenting)

Commissioner Mark Uyeda dissented from the final vote on these rule amendments, while Commissioner Hester Peirce supported them, thanks to late revisions to them.

Commissioner Uyeda felt the final amendments did not adequately address a number of thoughtful public comments on the proposal or consider the trade-offs between costs and benefits.  ,

“In my view, the Commission has not yet fully explored potentially more cost-effective means of achieving the sought-after risk amelioration. Indeed, many sensible suggestions in the public comment file appear to have been brushed aside in an attempt to rush it across the finish line,” Uyeda said. “Our markets are characterized by different types of broker-dealer business models, some of which present greater risk than others in terms of customer protection concerns. The amended rule could have been more narrowly targeted to those riskier business models.”

Commissioner Peirce said the final rule is not perfect, as It will increase costs and operational challenges for 40 of the estimated 49 carrying broker-dealers that will be subject to this daily computation requirement, and the rule could have done more to address the treatment of funds that will be placed in sweep accounts the next business day.

“On the other hand, the final amendments do incorporate an increased threshold for triggering the requirement that mitigates some of the costs. In addition, it allows carrying broker-dealers that use the alternative method for net capital and perform a daily customer reserve computation to reduce their aggregate debit items by 2% (instead of the 3% that is currently required). On balance, I believe the amendments are net beneficial to investors,” Peirce stated.