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

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

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

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

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

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

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

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

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

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

    \175\ See SIFMA 2 Letter; E*Trade 2 Letter.
    \176\ Id.
    \177\ See paragraph (j)(2)(i) of Rule 15c3-3, as adopted. The
technical changes delete the words ``convert'' and ``otherwise''
from the final rule because a broker-dealer would be prohibited from
``converting'' a customer's free credit balances and, therefore, it
is not necessary to include the word in the final rule. The word
``otherwise'' is redundant.
    \178\ Id.
---------------------------------------------------------------------------

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

    \179\ See SIFMA 4 Letter.
    \180\ Id. In its June 15, 2007 comment letter, SIFMA urged ``the
Commission to consider allowing a broker-dealer to remove funds from
a reserve account to cover a large same-day request for payment of a
free credit balance, as long as the free credit balance was included
in the latest Rule 15c3-3 reserve computation and the broker-dealer
begins a new reserve computation as of that date.'' See SIFMA 2
Letter.
    \181\ 17 CFR 240.15c3-3(g).
---------------------------------------------------------------------------

b. Treatment of Free Credit Balances in a Sweep Program
    The second and third set of conditions in the proposed rules
addressed using or transferring free credit balances in the context of
a sweep program.\182\ In particular, the Commission proposed four
conditions with respect to using or transferring free credit balances
in a sweep program. A broker-dealer would have been required to meet:
(1) all four conditions with respect to free credit balances in new
accounts; \183\ and (2) the second, third, and fourth conditions with
respect to

free credit balances in existing accounts.\184\ The four conditions
were:
---------------------------------------------------------------------------

    \182\ See Amendments to Financial Responsibility Rules, 72 FR at
12866.
    \183\ See paragraph (j)(2)(ii)(A)-(D) of Rule 15c3-3, as
adopted.
    \184\ See paragraph (j)(2)(iii)(A)-(C) of Rule 15c3-3, as
adopted.
---------------------------------------------------------------------------

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

    \185\ See SIFMA 2 Letter; First Clearing Letter; Pace Letter.
    \186\ See SIPC Letter.
    \187\ See Ellis Letter; Dworkin Letter. One commenter stated
that broker-dealers profit from ``excessive'' fees charged to
clients who opt out of the sweep programs. See Ellis Letter. The
second commenter suggested that the broker-dealer's ``customer has
been effectively denied the opportunity to opt out of bank account
sweeps by [the broker-dealer] preventing him or her from utilizing
any other vehicle to park his or her free credit balances. . . .''
See Dworkin Letter. The commenter noted that by opting out of the
sweep, the customer is ``confined to a situation where the free
credit balance cannot earn any kind of return at all[.]'' Id.
    \188\ See SIFMA 2 Letter.
    \189\ See Waddell Letter.
---------------------------------------------------------------------------

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

    \205\ Id.

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

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

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

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

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

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

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

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

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

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

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

``how the customer can notify the [broker-dealer] if the customer
chooses not to have the free credit balances transferred to the new
product or product type, or under new terms and conditions.'' \216\ The
commenter stated that these paragraphs appear to assume that the
customer will have the option of continuing to have free credit
balances treated as they were prior to the change to the sweep
arrangement.\217\ The commenter pointed out that, in fact, the broker-
dealer may elect not to continue offering the prior sweep options and
not to offer another sweep product.\218\ To account for this
possibility, the Commission has revised the text in paragraph
(j)(2)(ii)(B)(3)(ii) \219\ to require the broker-dealer to provide the
customer with a notice that contains a description of the options
available to the customer if the customer does not wish to accept the
new terms and conditions or product.\220\ This is intended to give
customers sufficient opportunity to make an informed decision in
connection with a Sweep Program.
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    \214\ See paragraph (j)(2)(ii)(B)(ii) of Rule 15c3-3, as
adopted. The final rule codifies this text in a separate paragraph
in order to emphasize the specific items the notice must contain.
    \215\ See SIFMA 2 Letter.
    \216\ Id.
    \217\ Id.
    \218\ Id.
    \219\ More specifically, paragraph (j)(2)(ii)(B)(3)(ii) provides
that ``the notice must describe the new terms and conditions of the
Sweep Program or product or the new product, and the options
available to the customer if the customer does not accept the new
terms and conditions or product.'' A customer that does not accept
the new terms and conditions or product would need to change how
free credit balances are treated by, for example, selecting
investments outside the Sweep Program or having the balances
transferred to an account at another financial institution.
    \220\ See Dworkin Letter.
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6. ``Proprietary Accounts'' Under the Commodity Exchange Act
    Some broker-dealers also are registered as futures commission
merchants under the Commodity Exchange Act (``CEA''). These firms carry
both securities and commodities accounts for customers. The definition
of free credit balances in paragraph (a)(8) of Rule 15c3-3 does not
include funds carried in commodities accounts that are segregated in
accordance with the requirements of the CEA.\221\ However, regulations
promulgated under the CEA exclude certain types of accounts
(``proprietary accounts'') from the CEA's segregation
requirements.\222\ This exclusion from the segregation requirements
under the CEA has raised a question as to whether a broker-dealer must
treat payables to customers in proprietary commodities accounts as
``free credit balances'' when performing a customer reserve
computation.\223\
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    \221\ 17 CFR 240.15c3-3(a)(8).
    \222\ Rule 1.20 requires a futures commission merchant to
segregate customer funds. See 17 CFR 1.20. Rule 1.3(k) defines the
term customer for this purpose. See 17 CFR 1.3(k). The definition of
customer excludes persons who own or hold a proprietary account as
that term is defined in Rule 1.3(y). See 17 CFR 1.3(y). Generally,
the definition of proprietary account refers to persons who have an
ownership interest in the futures commission merchant. Id.
    \223\ See Part 241-Interpretive Releases Relating to the
Securities Exchange Act of 1934 and General Rules and Regulations
Thereunder, Exchange Act Release No. 9922 (Jan. 2, 1973), 38 FR 1737
(Jan. 18, 1973) (interpreting the credit balance used in Item 1 of
the Rule 15c3-3a formula ``to include the net balance due to
customers in non-regulated commodities accounts reduced by any
deposits of cash or securities with any clearing organization or
clearing broker in connection with the open contracts in such
accounts'').
---------------------------------------------------------------------------

    In response to this question, the Commission notes that the
objective of the customer reserve requirement in Rule 15c3-3 is to
require broker-dealers to hold sufficient funds or qualified securities
to facilitate the prompt return of customer property to customers
either before or during a liquidation proceeding if the firm
fails.\224\ Under SIPA, customer property generally does not include
funds held in a commodities account.\225\ Therefore, funds held in a
proprietary commodities account generally would not constitute customer
property and persons having claims to those funds would not be
customers under SIPA.\226\ Moreover, the regulations under the CEA
similarly provide the persons having claims to funds in proprietary
commodities accounts are not customers for purposes of those
regulations.\227\ For these reasons, the Commission proposed a specific
amendment to the definition of the term free credit balances in
paragraph (a)(8) of Rule 15c3-3 that would have clarified that funds
held in a commodities account meeting the definition of a proprietary
account under CEA regulations are not to be included as free credit
balances in the customer reserve formula.\228\ As discussed below, the
Commission is adopting the amendment substantially as proposed.
---------------------------------------------------------------------------

    \224\ See Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for Broker-Dealers, Exchange
Act Release No. 68071 (Oct. 18, 2012), 77 FR 70214, 70274 (Nov. 23,
2012) (describing rationale and requirements of Rule 15c3-3
segregation requirements). See also Broker-Dealers; Maintenance of
Certain Basic Reserves, Exchange Act Release No. 9856 (Nov. 10,
1972), 37 FR 25224, 25225 (Nov. 29, 1972) (stating that the intent
of Rule 15c3-3 is, among other things, to ``facilitate the
liquidations of insolvent broker-dealers and to protect customer
assets in the event of a SIPC liquidation through a clear
delineation in Exchange Act Rule 15c3-3 of specifically identifiable
property of customers.''); Amendments to Financial Responsibility
Rules, 72 FR at 12862, 12868.
    \225\ As noted above, customer property under SIPA includes
``cash and securities (except customer name securities delivered to
the customer) at any time received, acquired, or held by or for the
account of the debtor from or for the securities accounts of a
customer, and the proceeds of any such property transferred by the
debtor, including property unlawfully converted.'' 15 U.S.C.
78lll(4). To receive protection under SIPA, a claimant must first
qualify as a customer as that term is defined in the statute.
Generally, a customer is any person who has: (1) ``a claim on
account of securities received, acquired, or held by the [broker-
dealer];'' (2) ``deposited cash with the debtor for the purposes of
purchasing securities;'' (3) ``a claim against the debtor for. .
.[positions]. . .received, acquired, or held in a portfolio margin
account carried as a securities account pursuant to a portfolio
margining program approved by the Commission;'' or (4) ``a claim
against the [broker-dealer] arising out of sales or conversions of
such securities.'' See 15 U.S.C. 78lll(2)(A)-(B). The definition of
security in SIPA specifically excludes commodities and non-
securities futures contracts and, thus, a person with a claim for
such assets (not held in a portfolio margin account carried as a
securities account) would not meet the definition of customer. See
15 U.S.C. 78lll(14).
    \226\ Id.
    \227\ See 17 CFR 1.3(k).
    \228\ See Amendments to Financial Responsibility Rules, 72 FR at
12868. The Commission proposed additional amendments to paragraph
(a)(8) of Rule 15c3-3 related to portfolio margining. See also
discussion below in section II.B. of this release.
---------------------------------------------------------------------------

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

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

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

(a)(9) of Rule 15c3-3.\230\ Therefore, in order to remove any ambiguity
as to the proper exclusion of proprietary accounts under the CEA from
Rule 15c3-3, the Commission also is amending the definition of the term
other credit balances in the final rule to delete the words ``as
aforesaid'' and insert the phrase ``in accordance with the Commodity
Exchange Act or in a similar manner, or funds carried in a proprietary
account as that term is defined in regulations under the Commodity
Exchange Act.'' \231\ Consequently, the amendments clarify that both
free credit balances and other credit balances as defined in Rule 15c3-
3 do not include funds carried in proprietary accounts under the CEA.
---------------------------------------------------------------------------

    \230\ Item 1 of Rule 15c3-3a requires a broker-dealer to include
in the customer reserve formula ``free credit balances and other
credit balances in customers' security accounts.'' Paragraph (a)(9)
of Rule 15c3-3 defines other credit balances as ``cash liabilities
of a broker or dealer to customers other than free credit balances
and funds in commodities accounts segregated as aforesaid.'' 17 CFR
240.15c3-3(a)(9).
    \231\ See paragraph (a)(9) to Rule 15c3-3. See also comments and
additional amendments to paragraph (a)(9) of Rule 15c3-3 discussed
in section II.B. of this release.
---------------------------------------------------------------------------

    One commenter also suggested that due to the changes to the swap
markets mandated by Title VII of the Dodd-Frank Act, swap accounts (in
addition to commodities accounts) are now subject to customer
protection rules under the CEA.\232\ This commenter suggested that the
Commission make it clear that funds in swap accounts also do not
constitute free credit balances, whether those funds are required to be
segregated by rules under the CEA (e.g., cleared swap accounts or
uncleared swap accounts that have opted for segregation) or excepted
from segregation under the CEA (e.g., cleared swaps proprietary
accounts or uncleared swap accounts that have not opted for
segregation). The commenter noted this treatment ``would be consistent
with the treatment of funds in commodities accounts and with the
regulation of swap accounts under the CEA.'' \233\ The Commission
agrees there may be additional accounts under the CEA, as amended by
the Dodd-Frank Act, that should explicitly be excluded from the
definition of free credit balances under Rule 15c3-3. However, the
amendments today are designed to clarify the specific question raised
with respect to the treatment of funds in proprietary commodities
accounts under the CEA and, consequently, the suggestions by the
commenter are beyond the scope of this rulemaking.
---------------------------------------------------------------------------

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

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

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

The operative procedures of the Special [Reserve] Account are
designed to protect the integrity of customer-generated funds by
insulating them against inroads from the broker-dealer's firm
activities, whether they be underwriting, market making, other
trading, investing, or mere speculation in securities, meeting
overhead or any other nature whatever. The Special [Reserve] Account
should achieve a virtual 100% protection to customers with respect
to the carrying and use of customers' deposits or credit balances
which is mandated by Section 7(d) of the SIPC Act.\235\
---------------------------------------------------------------------------

    \235\ Reserves and Related Measures Respecting the Financial
Responsibility of Brokers and Dealers, Exchange Act Release No. 9388
(Nov. 8, 1971), 36 FR 22312 (Nov. 24, 1971).
---------------------------------------------------------------------------

    In response to a petition for rulemaking,\236\ the Commission
proposed a limited expansion of the definition of qualified security to
include shares of an unaffiliated money market fund that: (1) Is
described in Rule 2a-7 under the Investment Company Act of 1940; (2)
invests solely in securities issued by the United States or guaranteed
by the United States as to interest and principal; (3) agrees to redeem
fund shares in cash no later than the business day following a
redemption request by a shareholder; and (4) has net assets equal to at
least 10 times the value of the shares deposited by the broker-dealer
in its customer reserve account.\237\ Twenty commenters addressed the
proposed amendment.\238\ A majority of commenters supported the
proposal and generally argued that the definition of qualified security
should be expanded further to include more types of instruments. One
commenter noted that permitting the use of certain money market funds
to make up the required reserve account deposit would introduce ``an
intermediary (namely, the holding company or money market fund) at
which problems might arise.'' \239\ The commenter also noted that a
number of SIPA liquidations have involved the mishandling of money
market or mutual fund shares or the confirmations of purchases of
nonexistent ``money market funds.'' \240\
---------------------------------------------------------------------------

    \236\ As discussed in the proposing release, Federated submitted
a petition for rulemaking on April 3, 2003, which it later amended
on April 4, 2005. See Amendments to Financial Responsibility Rules,
72 FR at 12865, 12874. More specifically, Federated's petition
requested that the Commission amend: (i) Rule 15c3-1 to lower the
haircut for certain money market funds to 0%; and (ii) Rule 15c3-3
to: (a) permit a broker-dealer to pledge such money market funds
when borrowing fully paid or excess margin securities from a
customer under paragraph (b)(3); and (b) treat such money market
funds as ``qualified securities'' that may be deposited into a
broker-dealer's customer reserve account. On February 9, 2009,
Federated submitted another request for rulemaking (Petition 4-577),
reiterating its first petition with respect to amending Rule 15c3-3
to allow a broker-dealer to treat certain money market funds as
``qualified securities'' that may be deposited into a reserve
account. However, this new petition changed the definition of the
types of funds that could be treated as qualified securities. More
specifically, the new petition proposed amending Rule 15c3-3(a)(6)
to define the term qualified securities to include, ``a redeemable
security of an investment company registered under the Investment
Company Act of 1940 and described in 17 CFR 270.2a-7, unaffiliated
with the broker-dealer and which limits its investments to
securities issued or guaranteed by the United States Government or
its agencies or instrumentalities (including repurchase
transactions).'' See Amendments to Financial Responsibility Rules,
72 FR at 12874 and n.112; see also Public Petitions for Rulemaking
No. 4-478 (Apr. 3, 2003) (available at http://www.sec.gov/rules/petitions/petn4-478.htm), as amended (Apr. 4, 2005) (amendment
available at http://www.sec.gov/rules/petitions/petn4-478a.pdf), and
No. 4-577 (Feb. 3, 2009) (available at http://www.sec.gov/rules/petitions/2009/petn4-577.pdf).
    \237\ See Amendments to Financial Responsibility Rules, 72 FR at
12865.
    \238\ See Federated Letter; Federated 2 Letter; Federated 3
Letter; Federated 4 Letter; Federated 5 Letter; Federated 6 Letter;
Federated 7 Letter; Federated 8 Letter; Meeks Letter; Meeks 2
Letter; Crane Data Letter; SIPC Letter; Curian Letter; FAF Letter;
Reserve Letter; Brown Brothers Letter; SIFMA Letter; First Clearing
Letter; ICI Letter; Barclays Letter; American Beacon Letter; Chamber
of Commerce Letter; ABASA Letter; UBS Letter; Fidelity/NFS Letter;
Barnard Letter; Federated 9 Letter; BOK Letter; Cornell Letter.
    \239\ See SIPC Letter.
    \240\ Id.
---------------------------------------------------------------------------

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

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

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

B. Holding Futures Positions in a Securities Portfolio Margin Account

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

D. Documentation of Risk Management Procedures

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

    \313\ See SIFMA 2 Letter. See also 17 CFR 240.15c3-4.
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E. Amendments to the Net Capital Rule

    Under Rule 15c3-1, broker-dealers are required to maintain, at all
times, a minimum amount of net capital.\314\ The capital standard in
Rule 15c3-1 is a net liquid assets test. This standard is designed to
allow a broker-dealer the flexibility to engage in activities that are
part of conducting a securities business (e.g., taking securities into
inventory) but in a manner that places the firm in the position of
holding at all times more than one dollar of highly liquid assets for
each dollar of unsubordinated liabilities (e.g., money owed to
customers, counterparties, and creditors).\315\ For example, Rule 15c3-
1 allows securities positions to count as allowable net capital,
subject to standardized or model-based deductions (``haircuts'').\316\
The rule, however, does not permit most unsecured receivables to count
as allowable net capital.\317\ This aspect of the rule severely limits
the ability of broker-dealers to engage in activities that generate
unsecured receivables (e.g., lending money without obtaining
collateral). The rule also does not permit fixed assets or other
illiquid assets to count as allowable net capital, which creates
disincentives for broker-dealers to own real estate and other fixed
assets that cannot be readily converted into cash.\318\ For these
reasons, Rule 15c3-1 incentivizes broker-dealers to confine their
business activities and devote capital to activities such as
underwriting, market making, and advising on and facilitating customer
securities transactions.\319\
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    \314\ See 17 CFR 240.15c3-1.
    \315\ See, e.g., Interpretation Guide to Net Capital Computation
for Brokers and Dealers, Exchange Act Release No. 8024 (Jan. 18,
1967), 32 FR 856 (Jan. 25, 1967) (``Rule 15c3-1 (17 CFR 240.15c3-1)
was adopted to provide safeguards for public investors by setting
standards of financial responsibility to be met by brokers and
dealers. The basic concept of the rule is liquidity; its object
being to require a broker-dealer to have at all times sufficient
liquid assets to cover his current indebtedness.'') (Footnotes
omitted); Net Capital Treatment of Securities Positions, Obligations
and Transactions in Suspended Securities, Exchange Act Release No.
10209 (June 8, 1973), 38 FR 16774 (June 26, 1973) (Commission
release of a letter from the Division of Market Regulation) (``The
purpose of the net capital rule is to require a broker or dealer to
have at all times sufficient liquid assets to cover its current
indebtedness. The need for liquidity has long been recognized as
vital to the public interest and for the protection of investors and
is predicated on the belief that accounts are not opened and
maintained with broker-dealers in anticipation of relying upon suit,
judgment and execution to collect claims but rather on a reasonable
demand one can liquidate his cash or securities positions.''); Net
Capital Requirements for Brokers and Dealers, Exchange Act Release
No. 15426 (Dec. 21, 1978), 44 FR 1754 (Jan. 8, 1979) (``The rule
requires brokers or dealers to have sufficient cash or liquid assets
to protect the cash or securities positions carried in their
customers' accounts. The thrust of the rule is to insure that a
broker or dealer has sufficient liquid assets to cover current
indebtedness.''); Net Capital Requirements for Brokers and Dealers,
Exchange Act Release No. 26402 (Dec. 28, 1989), 54 FR 315 (Jan. 5,
1989) (``The rule's design is that broker-dealers maintain liquid
assets in sufficient amounts to enable them to satisfy promptly
their liabilities. The rule accomplishes this by requiring broker-
dealers to maintain liquid assets in excess of their liabilities to
protect against potential market and credit risks.'') (Footnote
omitted).
    \316\ See 17 CFR 240.15c3-1(c)(2)(vi); 17 CFR 240.15c3-1e; 17
CFR 240.15c3-1f .
    \317\ See 17 CFR 240.15c3-1(c)(2)(iv).
    \318\ See, e.g., 17 CFR 240.15c3-1(c)(2)(iv)(A).
    \319\ See Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for Broker-Dealers, Exchange
Act Release No. 68071 (Oct. 18, 2012), 77 FR 70214, 70219 (Nov. 23,
2012).
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    Rule 15c3-1 requires broker-dealers to maintain a minimum level of
net capital (meaning highly liquid capital) at all times.\320\ The rule
requires that a broker-dealer perform two calculations: (1) A
computation of the minimum amount of net capital the broker-dealer must
maintain; \321\ and (2) a computation of the amount of net capital the
broker-dealer is maintaining.\322\ The minimum net capital requirement
is the greater of a fixed-dollar amount specified in the rule and an
amount determined by applying one of two financial ratios: The 15-to-1
aggregate indebtedness to net

capital ratio or the 2% of aggregate debit items ratio.\323\
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    \320\ See 17 CFR 240.15c3-1.
    \321\ See 17 CFR 240.15c3-1(a).
    \322\ See 17 CFR 240.15c3-1(c)(2). The computation of net
capital is based on the definition of net capital in paragraph
(c)(2) of Rule 15c3-1. Id.
    \323\ See 17 CFR 240.15c3-1(a).
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    In computing net capital, the broker-dealer must, among other
things, make certain adjustments to net worth such as deducting
illiquid assets, taking other capital charges, and adding qualifying
subordinated loans.\324\ The amount remaining after these adjustments
is defined as tentative net capital.\325\ The final step in computing
net capital is to take prescribed percentage deductions (``standardized
haircuts'') from the mark-to-market value of the proprietary positions
(e.g., securities, money market instruments, and commodities) that are
included in its tentative net capital.\326\ The standardized haircuts
are designed to account for the market risk inherent in these positions
and to create a buffer of liquidity to protect against other risks
associated with the securities business.\327\ Alternative Net Capital
or ``ANC'' broker-dealers and a type of limited purpose broker-dealer
that deals solely in OTC derivatives (``OTC derivative dealers'') are
permitted, with Commission approval, to, among other things, use
internal models as the basis for taking market risk charges as an
alternative approach in lieu of the standardized haircuts for classes
of positions for which they have been approved to use models.\328\ Rule
15c3-1 imposes substantially higher minimum capital requirements for
ANC broker-dealers and OTC derivatives dealers, as compared to other
types of broker-dealers, because, among other reasons, the use of
internal models to compute net capital can substantially reduce the
deductions for securities and money market positions as compared with
the standardized haircuts.\329\
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    \324\ See 17 CFR 240.15c3-1(c)(2)(i)-(xiii).
    \325\ See 17 CFR 240.15c3-1(c)(15).
    \326\ See 17 CFR 240.15c3-1(c)(2)(vi).
    \327\ See, e.g., Uniform Net Capital Rule, Exchange Act Release
No. 13635 (June 16, 1977), 42 FR 31778 (June 23, 1977) (``[Haircuts]
are intended to enable net capital computations to reflect the
market risk inherent in the positioning of the particular types of
securities enumerated in [the rule]''); Net Capital Rule, Exchange
Act Release No. 22532 (Oct. 15, 1985), 50 FR 42961 (Oct. 23, 1985)
(``These percentage deductions, or `haircuts', take into account
elements of market and credit risk that the broker-dealer is exposed
to when holding a particular position.''); Net Capital Rule,
Exchange Act Release No. 39455 (Dec. 17, 1997), 62 FR 67996 (Dec.
30, 1997) (``Reducing the value of securities owned by broker-
dealers for net capital purposes provides a capital cushion against
adverse market movements and other risks faced by the firms,
including liquidity and operational risks.'') (Footnote omitted).
    \328\ See 17 CFR 240.15c3-1(a)(5) and (a)(7); 17 CFR 240.15c3-
1e; 17 CFR 240.15c3-1f.
    \329\ See 17 CFR 240.15c3-1(a)(5) and (a)(7). See also Capital,
Margin, and Segregation Requirements for Security-Based Swap Dealers
and Major Security-Based Swap Participants and Capital Requirements
for Broker-Dealers, Exchange Act Release No. 68071, 77 FR at 70219
(``[T]he use of internal models to compute net capital can
substantially reduce the deductions for securities and money market
positions as compared with the standardized haircuts.'');
Alternative Net Capital Requirements for Broker-Dealers that are
Part of Consolidated Supervised Entities, Exchange Act Release No.
49830 (June 8, 2004), 69 FR 34428, 34431 (June 21, 2004) (``We
expect that use of the alternative net capital computation will
reduce deductions for market and credit risk substantially for
broker-dealers that use that method.'').
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1. Requirement To Deduct From Net Worth Certain Liabilities or Expenses
Assumed by Third Parties
    In the proposing release, the Commission expressed concern that
some broker-dealers may be excluding from their calculations of net
worth certain liabilities that relate directly to expenses or debts
incurred by the broker-dealer.\330\ The accounting justification for
the exclusion is that a third party (usually a parent or affiliate) has
assumed responsibility for these expenses and debts through an expense
sharing agreement.\331\ In some cases, however, the third party does
not have the resources --independent of the broker-dealer's revenues
and assets--to assume these liabilities. Thus, the third party is
dependent on the resources of the broker-dealer to pay the expenses and
debts. Excluding liabilities from the broker-dealer's net worth
calculation in these situations may misrepresent the firm's actual
financial condition, deceive the firm's customers, and hamper the
ability of regulators to monitor the firm's financial condition.\332\
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    \330\ See Amendments to Financial Responsibility Rules, 72 FR at
12871.
    \331\ See, e.g., Letter from Michael A. Macchiaroli, Associate
Director, Division of Market Regulation, Commission, to Elaine
Michitsch, Member Firm Operations, NYSE, and Susan DeMando,
Director, Financial Operations, NASD Regulation, Inc. (July 11,
2003) (``Third Party Expense Letter''); see also FINRA Notice to
Members 03-63, Expense-Sharing Agreements (Oct. 2003) (discussing
the issuance of the Third Party Expense Letter).
    \332\ See Amendments to Financial Responsibility Rules, 72 FR at
12871.
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    To address this issue, the Commission proposed--and is now adopting
substantially as proposed--an amendment to Rule 15c3-1 to add a new
paragraph (c)(2)(i)(F) that will require a broker-dealer, in
calculating net capital, to take into account any liabilities that are
assumed by a third party if the broker-dealer cannot demonstrate that
the third party has the resources--independent of the broker-dealer's
income and assets--to pay the liabilities.\333\
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    \333\ As adopted, the final rule does not include the ``-'' in
the phrase ``third-party.'' In addition, the final rule uses the
phrase ``broker or dealer'' in the place of the phrase ``broker-
dealer'' (which appeared in two places) to maintain consistency
throughout Rule 15c3-1, which uses the phrase ``broker or dealer.''
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    The Commission received five comments regarding this proposal.\334\
Two commenters stated that the amendment was overly burdensome and that
it would not result in a more accurate picture of a broker-dealer's
financial condition than obtained through current requirements.\335\
One of these commenters added that any implementation and enforcement
of the amendments ``should not be made retroactive.''\336\ This
commenter stated that it is unclear how, and unlikely that, this
amendment would achieve any of the desired results and argued that it
could conversely impair a firm's ability to continue as a going
concern.\337\ Finally, this commenter also argued that this amendment
would affect capital transactions that originate at the holding company
level.\338\ Two commenters agreed in principle with the amendments but
urged the Commission to carefully consider the potential consequences
of implementation and to provide clarification on the standard for
demonstrating that the third party has adequate financial resources,
including factors beyond those referred to in the proposing release
that they believed would be potentially relevant.\339\ One commenter
supported the Commission's goal of clarifying disclosures relating to
expense sharing or obligations.\340\
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    \334\ See Beer Letter; Levene Letter; Lowenstein Letter; SIFMA 2
Letter; NIBA 2 Letter.
    \335\ See Beer Letter; Levene Letter.
    \336\ See Levene Letter.
    \337\ Id.
    \338\ Id.
    \339\ See Lowenstein Letter; SIFMA 2 Letter.
    \340\ See NIBA 2 Letter.
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    As with the proposal, the amendment, as adopted, is designed to
prohibit a practice that could misrepresent a broker-dealer's actual
financial condition, deceive the firm's customers, and hamper the
ability of regulators to monitor the firm's financial condition.
Moreover, the amendment, as adopted, should not impose undue burdens or
present serious implementation difficulties because the requirement is
consistent with prior staff guidance regarding the treatment of broker-
dealer expenses assumed by a third party.\341\ Finally, as compared to
staff guidance, a federal regulation offers broker-dealers greater
certainty as to how to treat expense sharing agreements under Rule
15c3-1.
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    \341\ See, e.g., Third Party Expense Letter.
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    In response to the comments discussed above, and as the Commission
explained in the proposing release, a broker-dealer can demonstrate the
adequacy of the third party's financial

resources by maintaining records such as the third party's most recent
(i.e., as of a date within the previous twelve months) audited
financial statements, tax returns, or regulatory filings containing
financial reports.\342\ Given that the entity to which the broker-
dealer is seeking to shift one or more liabilities typically is an
affiliate, the staff's experience is that such records should be
available to the broker-dealer. Further, because the proposed rule
change is consistent with prior staff guidance regarding the need to be
able to demonstrate the third party's financial adequacy,\343\ a
broker-dealer seeking to shift a liability to a third party already
would be expected to provide such evidence of the third party's
financial resources. For these reasons, the change from staff guidance
to Commission rule should not result in implementation and burden
concerns of the magnitude raised by the two commenters.\344\
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    \342\ See Amendments to Financial Responsibility Rules, 72 FR at
12872. The Commission specifically requested comment regarding the
records by which a broker-dealer could demonstrate financial
resources. It received no comments in response to this request.
    \343\ See, e.g., Third Party Expense Letter.
    \344\ See Lowenstein Letter; SIFMA 2 Letter.
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    Finally, one commenter noted it would be helpful if the Commission
would clarify whether this amendment supersedes the Commission staff
guidance in the Third Party Expense Letter.\345\ Unlike the PAIB Letter
discussed above, the Commission is not directing the staff to withdraw
the Third Party Expense Letter on the effective date of these
amendments. The Third Party Expense Letter will still be relevant as
staff guidance, notwithstanding that it contains a condition that has
been codified into Rule 15c3-1 (i.e., that an expense of the broker-
dealer assumed by a third party will be considered a liability for net
capital purposes unless the broker-dealer can demonstrate that the
third party has adequate resources independent of the broker-dealer to
pay the liability or expense).\346\ In particular, the letter contains
additional staff guidance not incorporated into the rule that will be
relevant as staff guidance with respect to complying with the amendment
to Rule 15c3-1 being adopted today. For example, the letter contains
staff guidance with respect to the records a broker-dealer would be
expected to make, keep current, and preserve under Rules 17a-3 and 17a-
4 with respect to broker-dealer liabilities and expenses assumed by a
third party, as well as requirements regarding written expense sharing
agreements.\347\ Broker-dealers can continue to rely on the guidance in
the Third Party Expense Letter with respect to these matters in
complying with today's amendment.
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    \345\ See SIFMA 2 Letter.
    \346\ See Third Party Expense Letter, at 2-3.
    \347\ Id.
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2. Requirement To Subtract From Net Worth Certain Non-Permanent Capital
Contributions
    In the proposing release, the Commission noted its concern that
broker-dealers may be receiving capital contributions from investors
that are subsequently withdrawn after a short period of time (often
less than a year).\348\ In some cases, the capital may be contributed
under an agreement giving the investor the option to withdraw it at the
investor's discretion. In the past, the Commission has emphasized that
capital contributions to broker-dealers should not be temporary,\349\
and the Commission staff has explained that a capital contribution
should be treated as a liability if it is made with the understanding
that the contribution can be withdrawn at the option of the
investor.\350\
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    \348\ See Amendments to Financial Responsibility Rules, 72 FR at
12873.
    \349\ See Net Capital Rule, Exchange Act Release No. 28927 (Feb.
28, 1991), 56 FR 9124 (Mar. 5, 1991). See also Study of Unsafe and
Unsound Practices of Broker-Dealers, Report and Recommendations of
the Securities and Exchange Commission, H.R. Doc. No. 92-231 (1971),
at 17, 42 (recommending improvement of adequacy and permanency of
capital) (``During the 1967-1970 period under review, many broker-
dealers, some of them large retail houses, were found to have
inadequate and impermanent capital in relation to their
business.'').
    \350\ Letter from Michael A. Macchiaroli, Associate Director,
Division of Market Regulation, Commission, to Raymond J. Hennessy,
Vice President, NYSE, and Susan DeMando, Vice President, NASD
Regulation, Inc. (Feb. 23, 2000) (``Temporary Capital Letter'')
(``It is the view of the Division that, for net capital purposes, if
an individual investor contributes capital to a broker-dealer with
an understanding that the contribution can be withdrawn at the
option of the individual investor, the contribution may not be
included in the firm's net capital computation and must be re-
characterized as a liability. Any withdrawal of capital as to that
investor within a period of one year, other than a withdrawal
described in paragraph (e)(4)(iii) of Rule 15c3-1, shall be presumed
to have been contemplated at the time of the contribution.'')
(footnote omitted); see also Net Capital Rule, Exchange Act Release
No. 28927 (Feb. 28, 1991), 56 FR 9124 (Mar. 5, 1991).
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    Consistent with these Commission and staff positions that capital
is not temporary,\351\ and given the importance of this issue and the
Commission's concern that broker-dealers may not be properly treating
short-term capital contributions as liabilities, the Commission
proposed amending Rule 15c3-1 to add paragraph (c)(2)(i)(G) to further
incorporate these positions into the rule.\352\ The proposed change
would require a broker-dealer to treat as a liability any capital that
is contributed under an agreement giving the investor the option to
withdraw it or that is contributed with the intent to withdraw the
capital within one year. The Commission further proposed that capital
withdrawn within one year would be presumptively subject to treatment
as a liability (i.e., it would be presumed to have been contributed
with the intent to withdraw within one year).\353\
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    \351\ See Net Capital Rule, Exchange Act Release No. 28927 (Feb.
28, 1991), 56 FR 9124 (Mar. 5, 1991).
    \352\ See Amendments to Financial Responsibility Rules, 74 FR at
12871-12872.
    \353\ Id.
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    The Commission is adopting the final rule amendment with certain