[Federal Register Volume 78, Number 162 (Wednesday, August 21, 2013)]
[Rules and Regulations]
[Pages 51823-51907]
[FR Doc No: 2013-18734]

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<PHONE_NUMBER>; Thomas K. McGowan, Deputy Associate
Director, at<PHONE_NUMBER>; Randall Roy, Assistant Director, at (202)
551-5522; Raymond Lombardo, Branch Chief, at<PHONE_NUMBER>; Sheila
Dombal Swartz, Special Counsel,<PHONE_NUMBER>; Carrie A. O'Brien,
Special Counsel,<PHONE_NUMBER>; or Kimberly N. Chehardy, Attorney
Advisor,<PHONE_NUMBER>; 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

    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

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

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

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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

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-

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

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

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

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

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\
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    \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

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

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\
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    \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

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