hours.\134\ We do not believe firms would incur costs arising from
updating systems, purchasing software, or engaging outside counsel in
meeting this proposed requirement but seek comment on that estimate.
---------------------------------------------------------------------------

    \134\ 9 broker-dealers x 20 hours per firm = 180 hours.
---------------------------------------------------------------------------

2. PAB Customer Reserve Account Recordkeeping Requirements
    This proposed amendment to Rule 15c3-3 would require a broker-
dealer to perform a PAB reserve computation and obtain certain
agreements and notices related to PAB accounts and, therefore,

would impose recordkeeping burdens on a broker-dealer to the extent it:
(1) Has to perform a PAB computation; (2) chooses to use PAB securities
and, therefore, needs to obtain agreements from PAB accountholders; and
(3) opens a PAB reserve account at a new bank. The customer agreement
requirement would be a one-time burden. It is standard for a broker-
dealer to enter into a written agreement with an accountholder
concerning the terms and conditions under which the account would be
maintained. Therefore, requiring a written agreement would not result
in additional burden. Rather, additional burdens would arise from the
need to amend existing agreements and the standard agreement template
that would be used for future customers.
    Based on FOCUS Report filings, we estimate that there are
approximately 2,533 existing PAB customers and, therefore, broker-
dealers would have to amend approximately 2,533 existing PAB
agreements. We further estimate that, on average, a firm would spend
approximately 10 hours of employee resources amending each agreement.
We also estimate, based on FOCUS Reports, that approximately 75 broker-
dealers carry PAB accounts and, therefore, these 75 firms would have to
amend their standard PAB agreement template. We estimate a firm would
spend, on average, approximately 20 hours of employee resources on this
task. Therefore, we estimate the total one-time burden to the industry
from these requirements would be approximately 26,830 total hours.\135\
We do not believe firms would incur costs arising from updating
systems, purchasing software, or engaging outside counsel in meeting
these proposed requirements but seek comment on that estimate.
---------------------------------------------------------------------------

    \135\ (2,533 PAB customers x 10 hours per customer) + (75 firms
x 20 hours per firm) = 26,830 hours.
---------------------------------------------------------------------------

    The proposed requirements to perform a PAB computation and obtain
agreements and notices from banks holding PAB accounts would result in
annual burdens based on the number of broker-dealers that hold PAB
accounts and the number of times per year these broker-dealers open new
PAB bank accounts. Currently, to obtain the relief provided in the PAIB
Letter, broker-dealers are required to obtain the agreements and
notices from the banks. We understand that broker-dealers generally
already obtain these agreements and notices. Therefore, we estimate
there would be no additional burden imposed by this requirement but
seek comment on this estimate.
    The proposed amendment requiring a PAB computation would produce a
one-time burden. Based on FOCUS Report filings, we estimate that
approximately 75 broker-dealers would perform a PAB computation. These
firms already perform a reserve computation for domestic broker-dealer
customers under the PAIB letter. Nonetheless, we estimate these firms
would spend, on average, approximately 30 hours of employee resources
per firm updating their systems to implement changes that would be
necessitated by our proposed amendment. Therefore, we estimate that the
total one-time burden to the industry arising from this proposed
requirement would be approximately 2,250 hours.\136\
---------------------------------------------------------------------------

    \136\ 75 broker-dealers x 30 hours per firm = 2,250 hours.
---------------------------------------------------------------------------

    The proposed amendment requiring a PAB computation also would
produce an annual burden. Based on FOCUS Report filings, we estimate
that approximately 71 broker-dealers would perform the PAB computation
on a weekly basis and four broker-dealers would perform it on a monthly
basis. We further estimate that a broker-dealer would spend, on
average, approximately 2.5 additional hours to complete the Rule 15c3-3
reserve computation as a result of our proposed amendment. Therefore,
we estimate that the total annual burden to the industry from this
proposed requirement would be approximately 9,350 hours.\137\ We do not
believe firms would incur costs arising from purchasing software or
engaging outside counsel in meeting these proposed requirements but
seek comment on that estimate.
---------------------------------------------------------------------------

    \137\ ([71 weekly filers] x [52 weeks] x [2.5 hours per
computation]) + ([4 monthly filers] x [12 months] x [2.5 hours per
computation]) = 9,350 total hours.
---------------------------------------------------------------------------

3. Affirmative Consent
    This proposed amendment to Rule 15c3-3 would require a broker-
dealer to obtain the affirmative consent of a new customer before
changing the terms under which the customer's free credit balances are
treated and provide notice to existing customers prior to changing how
their free credit balances are treated. The broker-dealer also would be
required to make certain disclosures.
    This proposed requirement would result in one-time and annual
burdens to the broker-dealer industry. We note, however, that the
requirement only would apply to a firm that carries customer free
credit balances and opts to have the ability to change how its
customers' free credit balances are treated.
    Based on staff experience, we estimate that 50 broker-dealers would
choose to provide existing and new customers with the disclosures and
notices required under the proposed amendment in order to have the
ability to change how their customers' free credit balances are
treated. We further estimate these firms would spend, on average,
approximately 200 hours of employee resources per firm updating their
systems (including processes for generating customer account
statements) to incorporate changes that would be necessitated by our
proposed amendment. Therefore, we estimate that the total one-time
burden to the industry arising from this proposed requirement would be
approximately 10,000 hours.\138\
---------------------------------------------------------------------------

    \138\ 50 broker-dealers x 200 hours per firm = 2,250.
---------------------------------------------------------------------------

    We also estimate that these firms would consult with outside
counsel in making these systems changes, particularly with respect to
the language in the disclosures and notices. The Commission estimates
that, on average, an outside counsel would spend, on average,
approximately 50 hours assisting a broker-dealer in updating its
systems for a one-time aggregate burden to the industry of 2,500
hours.\139\ The Commission further estimates that this work would be
split between a partner and associate, with an associate performing a
majority of the work. Therefore, the Commission estimates that the
average hourly cost for an outside counsel would be approximately $400
per hour. For these reasons, the Commission estimates that the average
one-time cost to a broker-dealer would be approximately $20,000 \140\
and the one-time cost to the industry would be approximately
$1,000,000.\141\
---------------------------------------------------------------------------

    \139\ 50 broker-dealers x 50 hours per firm = 2,500 hours.
    \140\ $400 per hour x 50 hours = $20,000.
    \141\ 50 broker-dealers x $20,000 = $1,000,000.
---------------------------------------------------------------------------

    As for annual burden, we estimate these proposed requirements would
impact 5% of the total broker-dealer customer accounts per year. Based
on FOCUS Report filings, we estimate there are approximately
109,300,000 customer accounts and, consequently, 5% of the accounts
(5,465,000 accounts per year) would be impacted. We further estimate
that a broker-dealer would spend, on average, four minutes of employee
resources to process an affirmative consent for new customers and a
disclosure for existing customers. Therefore, we estimate that the
annual burden to the industry arising from the

requirement would be approximately 364,333 hours.\142\
---------------------------------------------------------------------------

    \142\ 5,465,000 accounts x 4 minutes/account = 364,333 hours.
---------------------------------------------------------------------------

4. Internal Control Recordkeeping Requirements
    These proposed amendments to Rules 17a-3 and 17a-4 would require
certain large broker-dealers to make and maintain records documenting
internal controls that assist in analyzing and managing risks. The
requirement would apply to broker-dealers that have more than
$1,000,000 in customer credits or $20,000,000 in capital. This
requirement would result in a one-time burden to the industry.
    Based on FOCUS Report filings, we estimate there are approximately
517 broker-dealers that meet the applicability threshold of this
amendment ($1,000,000 in credits or $20,000,000 in capital). Based on
staff experience, we estimate that these larger broker-dealers
generally already have documented the procedures and controls they have
established to manage the risks arising from their business activities.
Moreover, among these firms, the time per firm likely would vary
depending on the size and complexity of the firm. For some firms, the
burden may be close to 0 hours and for others it may be hundreds of
hours. Taking this into account, we estimate that a broker-dealer would
spend, on average, approximately 120 hours of employee resources
augmenting its documented procedures to come into compliance with this
proposed amendment. Therefore, we estimate the total one-time burden to
the industry would be approximately 62,040 hours.\143\
---------------------------------------------------------------------------

    \143\ 517 broker-dealers x 120 hours = 62,040 hours.
---------------------------------------------------------------------------

    We do not believe broker-dealers would incur costs arising from
updating systems, purchasing software, or engaging outside counsel in
meeting this proposed requirement but seek comment on that estimate.
5. Notice Requirements
    The proposed amendments to Rule 17a-11 would require a broker-
dealer to provide notice to the Commission and other regulatory
authorities if the broker-dealer becomes subject to certain insolvency
events, and notice to the Commission and other regulatory authorities
if the broker-dealer's securities borrowed and loan or securities
repurchase/reverse repurchase activity reaches a certain threshold or,
alternatively, provide regulatory authorities with a monthly report of
the broker-dealer's securities borrowed and loan or securities
repurchase/reverse repurchase activity.
    The notice requirements would result in irregular filings from a
small number of broker-dealers. As noted above, SIPC's 2005 annual
report indicates that in recent years an average of six broker-dealers
per year have become subject to a liquidation proceeding under the
Securities Investor Protection Act of 1970 (15 U.S.C. 78aaa et seq.)
(``SIPA''). Accordingly, we estimate that approximately six insolvency
notices would be sent per year and that a broker-dealer would spend, on
average, approximately ten minutes of employee resources to prepare and
send the notice. Therefore, we estimate that the total annual burden to
the industry arising from this proposal would be approximately one
hour.\144\ Based on FOCUS Report filings, we estimate that
approximately twelve stock loan/borrow notices would be sent per year.
We further estimate that a broker-dealer would spend, on average,
approximately ten minutes of employee resources to prepare and send the
notice. Therefore, we estimate that the total annual burden to the
industry arising from this proposal would be approximately two
hours.\145\
---------------------------------------------------------------------------

    \144\ 6 notices x 10 minutes per notice = 1 hour.
    \145\ 12 notices x 10 minutes per notice = 2 hours.
---------------------------------------------------------------------------

    Based on FOCUS Report filings, we estimate that 21 broker-dealers
per year would submit the monthly stock loan/borrow report. We estimate
each firm would spend, on average, approximately 100 hours of employee
resources updating its systems to generate the report. Therefore, we
estimate that the total one-time burden to the industry arising from
this proposed requirement would be approximately 2,100 hours.\146\ As
for annual burden, we estimate each firm would spend, on average,
approximately one hour per month (or twelve hours per year) of employee
resources to prepare and send the report. Therefore, we estimate the
total annual burden arising from this proposal would be approximately
255 hours.\147\
---------------------------------------------------------------------------

    \146\ 21 broker-dealers x 100 hours per firm = 2,100 hours.
    \147\ 21 broker-dealers x 12 hours per year or 252 hours.
---------------------------------------------------------------------------

    We do not believe firms would incur costs arising from purchasing
software or engaging outside counsel in meeting these proposed
requirements but seek comment on this estimate.

E. Collection of Information Is Mandatory

    These recordkeeping and notice requirements are mandatory with the
exception of the option for a broker-dealer to provide a monthly notice
of its securities lending activities to its designated examining
authority in lieu of filing the notice required under the proposed
amendment to Rule 17a-11.

F. Confidentiality

    The information collected under the amendments to Rules 15c3-1,
15c3-3, 17a-3 and 17a-4 would be stored by the broker-dealers and made
available to the various regulatory authorities as required in
connection with examinations, investigations, and enforcement
proceedings.
    The information collected under the amendments to Rule 17a-11 would
be generated from the internal records of the broker-dealers. It would
be provided to the Commission and other regulatory agencies but not on
a regular basis (except for the optional monthly reports). The
information provided to the Commission would be kept confidential to
the extent permitted by law.

G. Record Retention Period

    The proposed amendment to Rule 15c3-1 would require broker-dealers
to make disclosures to principals and obtain agreements from principals
with respect to securities lending transactions where the broker-dealer
acts as agent. These records would have to be maintained for at least
three years under paragraph (b)(7) of Rule 17a-4.\148\ The retention
period for the agreements also would depend on the length of time the
relationship between the broker-dealer and the principal lasts.
---------------------------------------------------------------------------

    \148\ 17 CFR 240.17a-4(b)(7).
---------------------------------------------------------------------------

    The proposed amendments to Rule 15c3-3 would require broker-dealers
to obtain written permission from a PAB customer if they want to use
the customer's fully paid and excess margin securities and to obtain
the affirmative consent of customers with respect to changing the terms
under which free credit balances are maintained. These agreements would
relate to the terms and conditions of the maintenance of the customer's
account and, accordingly, fall within the record retention requirements
of paragraph (c) of Rule 17a-4.\149\ Under this paragraph, the records
must be retained until six years after the closing of the customer's
account. The amendments to Rule 15c3-3 also would require broker-
dealers to obtain notices and contracts from the banks holding their
PAB customer reserve accounts. In order to comply with Rule 15c3-3,
broker-dealers would need to have these notices and contracts in place
and documented. Accordingly,

the retention period for these records is, at a minimum, equal to the
life of the PAB customer reserve account for which they are obtained.
---------------------------------------------------------------------------

    \149\ 17 CFR 240.17a-4(c).
---------------------------------------------------------------------------

    The proposed amendments to Rules 17a-3 and 17a-4 would require
broker-dealers to document various internal control systems, policies
and guidelines. The amendments to Rule 17a-4 include the establishment
of a retention period for these records, which would be until three
years after the termination of the use of such system, policy or
guideline.
    The proposed amendments to Rule 17a-11 would require broker-dealers
to provide notice or monthly reports to the Commission and other
regulatory authorities under certain circumstances. These notices and
reports would constitute communications relating to a broker-dealer's
``business as such'' and, therefore, would need to be retained for
three years.\150\
---------------------------------------------------------------------------

    \150\ 17 CFR 240.17a-4(b)(4).
---------------------------------------------------------------------------

H. Request for Comment

    We request comment on the proposed collections of information in
order to (1) evaluate whether the proposed collection of information is
necessary for the proper performance of the functions of the
Commission, including whether the information would have practical
utility, (2) evaluate the accuracy of the Commission's estimate of the
burden of the proposed collection of information, (3) determine whether
there are ways to enhance the quality, utility, and clarity of the
information to be collected, and (4) evaluate whether there are ways to
minimize the burden of the collection of information on those who
respond, including through the use of automated collection techniques
or other forms of information technology.
    Persons who desire to submit comments on the collection of
information requirements should direct their comments to the OMB,
Attention: Desk Officer for the Securities and Exchange Commission,
Office of Information and Regulatory Affairs, Washington, DC 20503, and
should also send a copy of their comments to Nancy M. Morris,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090, and refer to File No. S7-08-07. OMB is
required to make a decision concerning the collections of information
between 30 and 60 days after publication of this document in the
Federal Register; therefore, comments to OMB are best assured of having
full effect if OMB receives them within 30 days of this publication.
The Commission has submitted the proposed collections of information to
OMB for approval. Requests for the materials submitted to OMB by the
Commission with regard to these collections of information should be in
writing, refer to File No. S7-08-07, and be submitted to the Securities
and Exchange Commission, Records Management, Office of Filings and
Information Services, 100 F Street, NE., Washington, DC 20549.

V. Costs and Benefits of the Proposed Amendments

    We are sensitive to the costs and benefits that result from
Commission rules. We have identified certain costs and benefits of the
proposed amendments and request comment on all aspects of this cost-
benefit analysis, including identification and assessment of any costs
and benefits not discussed in the analysis.\151\ We seek comment and
data on the value of the benefits identified. We also welcome comments
on the accuracy of the cost estimates in each section of this cost-
benefit analysis, and request those commenters to provide data so we
can improve these cost estimates.
---------------------------------------------------------------------------

    \151\ For the purposes of this cost/benefit analysis, we are
using salaries for New York-based employees, which tend to be higher
than the salaries for comparable positions located outside of New
York. This conservative approach is intended to capture unforeseen
costs and to account for the fact that a substantial portion of the
work will be undertaken in New York. The salary information is
derived from the SIA Report on Management and Professional Earnings
in the Securities Industry 2005 (``SIA Management Report 2005'').
The hourly costs derived from the SIA Management Report 2005, and
referenced in this cost benefit section, are modified to account for
an 1800-hour work week and multiplied by 5.35 to account for
bonuses, firm size, employee benefits, and overhead.
---------------------------------------------------------------------------

    We also seek estimates and views regarding these costs and benefits
for particular types of market participants, as well as any other costs
or benefits that may result from the adoption of these proposed rules.

A. Amendments to the Customer Protection Rule

1. Proprietary Accounts of Broker-Dealers
    The proposed amendment to Rule 15c3-3 would require broker-dealers
to perform a reserve calculation for the proprietary accounts (``PAB'')
of domestic and foreign broker-dealers and foreign banks acting as
broker-dealers. It also would require them to obtain agreements from
these broker-dealer customers with respect to the use of their fully
paid and excess margin securities. Finally, it would require broker-
dealers to obtain agreements and notices from the banks holding the PAB
reserve deposits.
    As discussed above, there is a disparity between the customer
reserve requirements in Rule 15c3-3 and the treatment of customers in a
liquidation proceeding under the Securities Investor Protection Act of
1970 (``SIPA'').\152\ Rule 15c3-3 requires broker-dealers to reserve
the net amount of money they owe their customers. If the broker-dealer
fails, this net amount is available to be returned to customers ahead
of all other creditors. Moreover, if the failed broker-dealer is
subject to a SIPA proceeding, this net amount becomes part of the
estate of customer property, which is distributed pro rata to
customers.
---------------------------------------------------------------------------

    \152\ 15 U.S.C. 78aaa et seq.
---------------------------------------------------------------------------

    Foreign and domestic broker-dealers are not ``customers'' under
Rule 15c3-3. Therefore, broker-dealers are not required to reserve the
net amount of money owed to these entities. However, they are
``customers'' for the purposes of SIPA and, consequently, are entitled
to a pro rata share of the estate of customer property. Thus, even if a
failed broker-dealer properly reserved the net amount it owed its Rule
15c3-3 ``customers,'' the estate of customer property nonetheless may
be insufficient to return the money owed to these ``customers'' because
broader definition of ``customer'' in SIPA entitles foreign and
domestic broker-dealers to a pro rata share of the funds.
i. Benefits
    Our proposed amendment would address this discrepancy by requiring
broker-dealers to reserve for the net amount of money they owe other
broker-dealers. This would benefit the other customers as well as the
broker-dealer account holders by eliminating the inconsistency between
Rule 15c3-3 and SIPA, which could decrease the estate of customer
property in a SIPA liquidation. It also would minimize the risk that
advances from the fund administered by the Securities Investor
Protection Corporation (``SIPC'') would be necessary to protect
customer cash claims. We request comment on available metrics to
quantify these benefits and any other benefits the commenter may
identify. Commenters are requested to identify sources of empirical
data that could be used for the metrics they propose.
ii. Costs
    The proposed requirements to perform a PAB computation and obtain
agreements and notices from banks holding PAB accounts would result in
one-time and annual costs to broker-dealers that hold PAB accounts.
Under the no-action relief set forth in the PAIB Letter, these broker-
dealers already are performing a reserve computation for

domestic broker-dealer accounts and have obtained the necessary
agreements and notices from the banks holding their PAIB reserve
deposits. Therefore, the proposed amendments would result in
incremental costs.
    The proposed requirement to obtain written agreements from PAB
customers in order to use their fully paid and excess margin securities
would result in a one-time cost to the industry. As discussed above
with respect to the Paper Work Reduction Act of 1995 (``PRA''), it is
standard for broker-dealers to enter into written agreements with their
broker-dealer customers concerning the terms and conditions under which
the customers' accounts will be maintained. Therefore, requiring a
written agreement should not result in additional costs. Rather, the
one-time costs would arise from the need to amend existing agreements
and the standard agreement template that would be used for future
customers.
    As discussed with respect to the PRA, based on FOCUS Report
filings, we estimate that there are approximately 2,533 existing PAB
customers and, therefore, broker-dealers would have to amend
approximately 2,533 existing PAB agreements. We further estimate that,
on average, a firm would spend approximately 10 hours of employee
resources amending each agreement. We also estimate, based on FOCUS
Reports, that approximately 75 broker-dealers carry PAB accounts and,
therefore, these 75 firms would have to amend their standard PAB
agreement template. We estimate a firm would spend, on average,
approximately 20 hours of employee resources on this task. Therefore,
as noted with respect to the PRA, we estimate the total one-time hourly
burden to the industry from these requirements would be approximately
26,830 hours.\153\ For the purposes of this cost analysis, we estimate
this work would be undertaken by a broker-dealer's in-house attorneys.
The SIA Management Report 2005 indicates that the average hourly cost
of an attorney is $327. Therefore, we estimate that there would be a
one-time cost to the industry from these proposed requirements of
approximately $8,773,410.\154\
---------------------------------------------------------------------------

    \153\ (2,533 PAB customers x 10 hours per customer) + (75
broker-dealers x 20 hours per firm) = 26,830 hours.
    \154\ $327 per hour x 26,830 hours = $8,773,410.
---------------------------------------------------------------------------

    As discussed with respect to the PRA, the requirement to perform a
PAB computation also would produce a one-time burden to the extent the
system for performing the calculation would need to be updated. Based
on FOCUS Report filings, we estimate that approximately 75 broker-
dealers would perform a PAB computation. These firms already perform a
reserve computation for domestic broker-dealer customers under the PAIB
letter. Nonetheless, we estimate these firms would spend, on average,
approximately 30 hours of employee resources per firm updating their
systems to implement changes that would be necessitated by our proposed
amendment. With respect to the PRA, we estimate that the total one-time
hourly burden to the industry arising from this proposed requirement
would be approximately 2,250 hours.\155 \For the purposes of the cost
analysis, we estimate that this work would be undertaken by a Senior
Programmer. The SIA Management Report 2005 indicates the average hourly
cost of this position is approximately $268. Therefore, we estimate
that there would be a one-time cost to the industry from the proposed
requirement of approximately $603,000.\156\
---------------------------------------------------------------------------

    \155\ 75 broker-dealers x 30 hours per firm = 2,250 hours.
    \156\ $268 per hour x 2,250 hours = $603,000.
---------------------------------------------------------------------------

    As noted with respect to the PRA, the proposed requirement to
perform a PAB computation would result in an annual hourly burden to
the extent the new requirement would lengthen the time needed to
complete the computation. Based on FOCUS Report filings, we estimate
that approximately 71 broker-dealers would perform the PAB computation
on a weekly basis and four broker-dealers would perform it on a monthly
basis. We further estimate that a broker-dealer would spend, on
average, approximately 2.5 additional hours to complete the Rule 15c3-3
reserve computation as a result of our proposed amendment. Therefore,
as noted with respect to the PRA, we estimate that the total annual
hourly burden to the industry from this proposed requirement would be
approximately 9,350 hours.\157\ For purposes of this cost analysis, we
estimate that the responsibility for performing the PAB computation
would be undertaken by a financial reporting manager. As noted above,
the SIA Management Report 2005 indicates that the average hourly cost
for a financial reporting manager is $278. Therefore, we estimate that
the total annual cost to the industry resulting from these requirements
would be approximately $2,599,300.\158\
---------------------------------------------------------------------------

    \157\ ([71 weekly filers] x [52 weeks] x [2.5 hours per
computation]) + ([4 monthly filers] x [12 months] x [2.5 hours per
computation]) = 9,350 total hours.
    \158\ $278 per hour x 9,350 hours = $2,599,300.
---------------------------------------------------------------------------

    As noted above, we request comment on these proposed cost
estimates. In particular, we request comment on whether there would be
additional costs to broker-dealers as a consequence of these proposals.
For example, with respect to the PRA, we estimate that these
requirements would not result in costs arising from purchasing software
or engaging outside counsel. Therefore, we request comment on whether
these requirements would result in such costs and, if so, how to
quantify the costs. We also request comment on whether these proposals
would impose costs on other market participants, including broker-
dealer customers. Commenters should identify the metrics and sources of
any empirical data that support their costs estimates.
2. Banks Where Special Reserve Deposits May Be Held
    The proposed amendment to Rule 15c3-3 would limit the amount of
cash a broker-dealer could deposit at any one bank for the purposes of
maintaining a required customer or PAB reserve requirement and exclude
customer and PAB reserve cash deposits at affiliated banks from
counting towards the broker-dealer's reserve requirement.
i. Benefits
    The intent of this proposed amendment is to prevent broker-dealers
from concentrating customer related deposits that are large relative to
the broker-dealer or the bank in order to limit the risk arising from a
financial collapse and to prevent such deposits from being lost in a
group-wide financial collapse. Concentration poses a risk that some or
all of the deposit may be lost. Depending on the size of the deposit
and the broker-dealer, a lost deposit could cause the broker-dealer to
fail. If the broker-dealer fails and the deposit is not recovered, the
SIPC fund likely would not recover advances from the fund made for the
purpose of returning customer assets. Moreover, to the extent that
customer losses exceeded the SIPA advance limits, customers would
suffer permanent losses. The benefits that would be derived from this
proposed amendment are an increased safeguarding of SIPC funds and
customer assets.
    We request comment on available metrics to quantify these benefits
and any other benefits the commenter may identify. Commenters are
requested to identify sources of empirical data that could be used for
the metrics they propose.

ii. Costs
    We estimate that the costs resulting from this proposed amendment
would be incremental. Specifically, we estimate that approximately 216
broker-dealers would have reserve deposit requirements.\159\ A majority
of these firms meet a substantial portion of their deposit requirement
using qualified government securities as opposed to cash and,
therefore, would not be impacted by this proposal. Moreover, to the
extent that a broker-dealer's cash deposits exceed the limits, it could
open up one or more accounts at different banks or, alternatively, use
qualified securities to meet part of its deposit requirement.
---------------------------------------------------------------------------

    \159\ This estimate is based on FOCUS Report filings.
---------------------------------------------------------------------------

    In terms of quantifying costs, we estimate that, of the 216 firms
with reserve deposit requirements, only 5%, namely 11, would need to
open new bank accounts or substitute qualified securities for cash in
an existing reserve account. We estimate that the responsibility for
opening a new reserve bank account or substituting qualified securities
for cash in an existing account would be undertaken by a Senior
Treasury/Cash Management Manager. The SIA Management Report 2005
indicates that the average hourly cost of this position is $263. We
estimate that the senior treasury/cash management manager would spend
approximately 10 hours performing these changes. Therefore, we estimate
that the average cost per firm to make these changes would be
approximately $2,630.\160\ For these reasons, we estimate that the
total one-time cost to the industry would be approximately
$28,930.\161\
---------------------------------------------------------------------------

    \160\ $263 per hour x 10 hours = $2,630.
    \161\ 11 broker-dealers x $2,630 = $28,930.
---------------------------------------------------------------------------

    As noted above, we request comment on these proposed cost
estimates. In particular, we request comment on whether there would be
additional costs to broker-dealers as a consequence of these proposals,
such as costs arising from implementing systems changes, maintaining
additional bank or securities accounts, and managing pools of qualified
securities as opposed to a deposit of cash. We also request comment on
whether these proposals would impose costs on other market
participants, including broker-dealer customers. Commenters should
identify the metrics and sources of any empirical data that support
their cost estimates.
3. Expansion of the Definition of Qualified Securities To Include
Certain Money Market Funds
    The proposed amendment to Rule 15c3-3 would permit broker-dealers
to deposit certain money market funds in the customer reserve account.
This would benefit broker-dealers subject to the customer reserve
requirements in Rule 15c3-3 by creating a deposit alternative to cash
and United States Treasury securities. It would not result in any
additional costs to broker-dealers.
    We request comment on available metrics to quantify these benefits
and any other benefits the commenter may identify. Commenters are
requested to identify sources of empirical data that could be used for
the metrics they propose.
    In addition, while we do not believe the proposal would result in
costs to broker-dealers, we request comment on whether it would result
in costs to other market participants, including broker-dealer
customers, and banks. Commenters should identify the metrics and
sources of any empirical data that support their costs estimates.
4. Allocation of Customers' Fully Paid and Excess Margin Securities to
Short Positions
    The proposed amendment to Rule 15c3-3 would require broker-dealers
to obtain possession or control over fully paid or excess margin
securities that allocate to a proprietary or customer short position.
i. Benefits
    This proposed amendment would protect broker-dealer customers by
requiring broker-dealers to reduce long customer positions to
possession and control even if the positions may allocate to a customer
or proprietary short position. The possession or control requirement
seeks to ensure that customer securities are available to be returned
in the event the broker-dealer fails. Therefore, in addition to broker-
dealer customers, the proposal would benefit the SIPC fund to the
extent it mitigates outlays from the fund to make advances to customers
of a failed broker-dealer that cannot return all customer securities.
    We request comment on available metrics to quantify these benefits
and any other benefits the commenter may identify. Commenters are
requested to identify sources of empirical data that could be used for
the metrics they propose.
ii. Costs
    We estimate this proposed requirement would result in a one-time
cost to firms that carry customer securities to update systems for
complying with the possession and control requirements in Rule 15c3-3.
Based on FOCUS Report filings, we estimate that approximately 350
broker-dealers carry customer securities. We further estimate these
firms would spend, on average, approximately 40 hours of employee
resources per firm updating their systems to implement changes that
would be necessitated by our proposed amendment. For the purposes of
this cost analysis, we estimate that this work would be undertaken by a
Senior Programmer. The SIA Management Report 2005 indicates the average
hourly cost of this position is approximately $268. Therefore, we
estimate that the average cost per firm to make these changes would be
approximately $10,720.\162\ For these reasons, we estimate that the
total one-time cost to the industry would be approximately
$3,752,000.\163\
---------------------------------------------------------------------------

    \162\ $268 per hour x 40 hours = $10,720.
    \163\ 350 broker-dealers x $10,720 = $3,752,000.
---------------------------------------------------------------------------

    We believe the annual costs resulting from this amendment would be
de minimis. The proposal could result in some broker-dealers borrowing
securities to cover proprietary short positions rather than using
customer securities. However, currently when broker-dealers use
customer securities they are required to put a credit in the Rule 15c3-
3 reserve formula equal to the value of the securities. This credit
item can result in higher reserve deposit requirements, which must be
made using the broker-dealer's own capital. Thus, increased costs
associated with having to borrow securities to cover a short position
likely would be offset by decreased costs associated with devoting
capital to customer reserve requirements.
    As noted above, we request comment on these cost estimates. In
particular, we request comment on whether there would be additional
costs to broker-dealers as a consequence of these proposals. We also
request comment on whether these proposals would impose costs on other
market participants, including broker-dealer customers. Commenters
should identify the metrics and sources of any empirical data that
support their costs estimates.
5. Requirement To Obtain Customers' Affirmative Consent
    This proposed amendment to Rule 15c3-3 would require a broker-
dealer to obtain the affirmative consent of a new

customer in order to be able to change the terms under which the
customer's free credit balances are treated and provide notice to
existing customers prior to changing how their free credit balances are
treated. The broker-dealer also would be required to make certain
disclosures.
i. Benefits
    Free credit balances constitute money that a broker-dealer owes its
customers. Customers may maintain these balances at the broker-dealer
in anticipation of future stock purchases. Generally, customer account
agreements set forth how the broker-dealer will invest these balances.
For example, the broker-dealer may sweep them into a money market fund
or, alternatively, pay an amount of interest on the funds. This
proposed amendment is designed to ensure that customers are provided
meaningful notice if a broker-dealer seeks to change the terms under
which their free credit balances are invested. This would provide the
customers with an opportunity to opt out of the proposed change or re-
direct their free credit balances.
    We request comment on available metrics to quantify these benefits
and any other benefits the commenter may identify. Commenters are
requested to identify sources of empirical data that could be used for
the metrics they propose.
ii. Costs
    As discussed above with respect to the PRA, based on staff
experience, we estimate that 50 broker-dealers would choose to provide
existing and new customers with the disclosures and notices required
under the proposed amendment in order to have the flexibility to change
how their customers' free credit balances are treated. We further
estimate these firms would spend, on average, approximately 200 hours
of employee resources per firm updating their systems (including
processes for generating customer account statements) to incorporate
changes that would be necessitated by our proposed amendment. For the
purposes of this cost analysis, we estimate that this work would be
undertaken by a Senior Programmer. The SIA Management Report 2005
indicates the average hourly cost of this position is approximately
$268. Therefore, we estimate that the average cost per firm to make
these changes would be approximately $53,600.\164\ For these reasons,
we estimate that the total one-time cost to the industry would be
approximately $2,680,000.\165\
---------------------------------------------------------------------------

    \164\ $268 per hour x 200 hours = $53,600.
    \165\ 50 broker-dealers x $53,600 = $2,680,000.
---------------------------------------------------------------------------

    Also, as discussed above with respect to the PRA, we estimate that
these firms would consult with outside counsel in making these systems
changes, particularly with respect to the language in the disclosures
and notices. The Commission estimates that, on average, an outside
counsel would spend approximately 50 hours assisting a broker-dealer in
updating its systems for a one-time aggregate burden to the industry of
2,500 hours.\166\ The Commission further estimates that this work would
be split between a partner and associate, with an associate performing
a majority of the work. Therefore, the Commission estimates that the
average hourly cost for an outside counsel would be approximately $400
per hour. For these reasons, the Commission estimates that the average
one-time cost to a broker-dealer for engaging outside counsel would be
approximately $20,000 \167\ and the one-time cost to the industry would
be approximately $1,000,000.\168\
---------------------------------------------------------------------------

    \166\ 50 broker-dealers x 50 hours per firm = 2,500 hours.
    \167\ $400 per hour x 50 hours = $20,000.
    \168\ 50 broker-dealers x $20,000 = $1,000,000.
---------------------------------------------------------------------------

    As for annual burden, as discussed above with respect to the PRA,
we estimate that this requirement would impact approximately 5,465,000
customer accounts in a given year. We further estimate that a broker-
dealer would spend, on average, four minutes of employee resources to
process an affirmative consent for new customers and a disclosure for
existing customers. For the purposes of this cost analysis, we estimate
that the responsibility for processing the affirmative consents would
be undertaken by a compliance clerk. The SIA Report on Office Salaries
in the Securities Industry 2005 (``SIA Report on Office Salaries'')
indicates that the average hourly cost of this position is $68.
Additionally, we estimate the compliance clerk would spend
approximately four minutes per consent and notice. Therefore, we
estimate that the cost per account to process the affirmative consents
and notices would be approximately $4.50.\169\ Therefore, the total
annual cost to the industry would be approximately $24.5 million.\170\
---------------------------------------------------------------------------

    \169\ 4 minutes x $68 per hour = $4.50.
    \170\ 5,465,000 consents/notices x $4.50 per consent/notice =
$24,592,500.
---------------------------------------------------------------------------

    As noted above, we request comment on these proposed cost
estimates. In particular, we request comment on whether there would be
additional costs to broker-dealers as a consequence of these proposals.
We also request comment on whether these proposals would impose costs
on other market participants, including broker-dealer customers.
Commenters should identify the metrics and sources of any empirical
data that support their costs estimates.
6. Eliminating the 3% Reduction for Aggregate Debit Items
    The proposed amendment to paragraph (a)(1)(ii)(A) of Rule 15c3-1
would eliminate the requirement that broker-dealers using the
alternative standard reduce their Exhibit A--Item 10 debits by 3% in
lieu of the 1% reduction applicable to basic method firms. This would
benefit broker-dealers subject to the 3% reduction by potentially
reducing the amount of their reserve deposit requirements and, thereby,
freeing up capital. Based on FOCUS data, we estimate that broker-
dealers in the aggregate currently carry approximately $550 billion in
total credits and $380 billion in total debits. Moreover, we further
estimate that the amount of credits and debits held by firms that are
subject to the 1% reduction is insignificant and, consequently, for
purposes of this cost analysis, assume that the $550 billion in credits
and $380 billion in debits are held by firms subject to the 3%
reduction.
    Under the current requirement to reduce total debits by 3%, broker-
dealers, in the aggregate, reduce the approximately $380 billion in
total debits by $11.4 billion.\171\ This decreases the amount of debits
that can offset total credits from $380 billion to $368.6 billion.
Based on our estimates, this potentially increases the industry-wide
reserve requirement from approximately $170 billion \172\ to $181.4
billion.\173\ Under the proposed 1% reduction, broker-dealers, in the
aggregate, would reduce the approximately $380 billion in total debits
by $3.8 billion.\174\ This would decrease the amount of debits that can
offset credits from $380 billion to $376.2 billion. Based on our
estimates, this would potentially increase the industry-wide reserve
requirement from $170 billion \175\ to $173.8 billion (as opposed to
$181.4 billion).\176\ Accordingly, our proposed amendment would result
in a decrease in the industry-wide reserve requirement of approximately
$7.6

billion, which broker-dealers could re-direct to other business
activities.\177\
---------------------------------------------------------------------------

    \171\ $380 billion x 0.03% = $11.4 billion.
    \172\ $550 billion-$380 billion = $170 billion.
    \173\ $550 billion-$368.6 billion = $181.4 billion.
    \174\ $380 billion x 0.01% = $3.8 billion.
    \175\ $550 billion-$380 billion = $170 billion.
    \176\ $550 billion-$376.2 billion = $173.8 billion
    \177\ $11.4 billion-$3.8 billion = $7.6 billion.
---------------------------------------------------------------------------

    We do not anticipate any net costs to broker-dealers that would
result from the proposed amendment, given that the benefits from the
freed-up capital of potentially $7.6 billion would significantly offset
any costs arising from making necessary systems changes to implement
this proposed change to the customer reserve computation. However, it
could result in costs to other market participants. Therefore, we
request comment on whether it would result in such costs, including
costs to broker-dealer customers and banks. Commenters should identify
the metrics and sources of any empirical data that support their costs
estimates.
7. Clarification Regarding Funds in Certain Commodity Accounts
    The proposed amendment to paragraph (a)(8) of Rule 15c3-3 would
clarify that broker-dealers need not treat funds in certain commodities
accounts as ``free credit balances'' for purposes of the customer
reserve formula. This would benefit broker-dealers that are registered
as futures commission merchants by eliminating any ambiguity with
respect to such accounts and avoiding situations where they
unnecessarily increase reserve amounts. We do not anticipate the
proposed amendment would result in any costs to broker-dealers and, as
these funds are not protected under SIPA, would not expose the SIPC
fund to increased liabilities.
    We request comment on available metrics to quantify these benefits
and any other benefits the commenter may identify. Commenters are
requested to identify sources of empirical data that could be used for
the metrics they propose.
    In addition, while we do not believe the proposal would result in
costs to broker-dealers, we request comment on whether it would result
in costs to other market participants, including broker-dealer
customers, and banks. Commenters should identify the metrics and
sources of any empirical data that support their costs estimates.

B. Portfolio Margining

    There are two proposed amendments to accommodate SRO rules that
permit broker-dealers to determine customer margin requirements using a
portfolio-margining methodology. The first amendment would revise the
definition of ``free credit balances'' in paragraph (a)(8) of Rule
15c3-3. The revision would expand the definition to include funds in a
portfolio margin account relating to certain futures and futures
options positions and the market value of futures options as of the
filing date in a SIPA proceeding. The second amendment would add a
debit line item to the customer reserve formula in Rule 15c3-3a
consisting of margin posted by a broker-dealer to a futures clearing
agency.
1. Benefits
    The proposed amendments are designed to provide greater protection
to customers with portfolio margin accounts. They would require broker-
dealers to treat all cash balances in the accounts under the reserve
computation provisions of Rule 15c3-3, which are designed to ensure
that customer cash is available to be returned to customers in the
event the broker-dealer fails. The proposed amendments also are
designed to provide the protections of SIPA to these cash balances and
to futures options in the accounts.
    We request comment on available metrics to quantify these benefits
and any other benefits the commenter may identify, including the
identification of sources of empirical data that could be used for such
metrics.
2. Costs
    The requirements imposed by the proposed amendments would be
elective. They only would apply to broker-dealers choosing to offer
their customers portfolio margin accounts with a cross-margin feature
(i.e., the ability to hold futures and futures options in the account).
We estimate that approximately thirty-three broker-dealers would elect
to offer their customers portfolio margin accounts that would include
futures and futures options.\178\
---------------------------------------------------------------------------

    \178\ This estimate is based on data from FOCUS Report filings.
---------------------------------------------------------------------------

    The proposed amendment to the definition of ``free credit
balances'' in Rule 15c3-3 would require broker-dealers to include in
the customer reserve formula credit balances related to futures
positions in a portfolio margin account. The proposed amendment to add
a line item to the debits in the customer reserve formula of Rule 15c3-
3a would require broker-dealers to include the amount of customer
margin required and on deposit at a futures clearing organization as a
``debit'' in the reserve formula. Accordingly, these proposed
amendments would require changes to the systems broker-dealers use to
compute and account for their customer reserve requirements. We assume
that the responsibility for updating these systems will be undertaken
by a Senior Programmer. The SIA Management Report 2005 indicates the
average hourly cost of this position is approximately $268. We estimate
the senior programmer would spend approximately 130 hours to modify
software to conform it to the requirements of the proposed amendments.
Therefore, we estimate that the program and systems changes would
result, on average, in a one-time cost of approximately $34,840 on per
broker-dealer.\179\ For these reasons, we estimate the total one-time
cost to the industry would be approximately $1,149,720.\180\
---------------------------------------------------------------------------

    \179\ 130 hours x $268 = $34,840.
    \180\ 33 broker-dealers x $34,840 = $1,149,720.
---------------------------------------------------------------------------

    As noted above, we request comment on these proposed cost
estimates. In particular, we request comment on additional costs to
broker-dealers that would arise from these proposals, such as system
costs in addition to those discussed above (e.g., costs associated with
purchasing new software and updates to existing software). We also
request comment on whether these proposals would impose costs on other
market participants, including broker-dealer customers. Commenters
should identify the metrics and sources of any empirical data that
support their costs estimates.

C. Amendments With Respect to Securities Borrowed and Loaned and Repo
Activities

    We are proposing amendments to strengthen the financial
responsibility of broker-dealers engaging in a securities lending
business. The proposed amendments would require broker-dealers to (1)
disclose the principals and obtain certain agreements from the
principals in a transaction where they provide settlement services in
order to be considered an agent (as opposed to a principal) for the
purposes of the net capital rule, and (2) provide notice to the
Commission and other regulatory authorities if the broker-dealer's
securities borrowed and loan or securities repurchase/reverse
repurchase activity reaches a certain threshold or, alternatively,
provide regulatory authorities with a monthly report of the broker-
dealer's securities borrowed and loan or securities repurchase/reverse
repurchase activity.
1. Benefits
    The proposed amendments are intended to strengthen the financial
responsibility of broker-dealers engaged in a securities lending or
repo business and to assist securities regulators in

monitoring such activities. This would assist securities regulators in
responding to situations where a broker-dealer was in financial
difficulty due to a large securities lending or repo position. This
would help prevent significant losses to the firm's customers and other
broker-dealers, and reduce financial system risk.
    We request comment on available metrics to quantify these benefits
and any other benefits the commenter may identify. Commenters are
requested to identify sources of empirical data that could be used for
the metrics they propose.
2. Costs
i. Requirements To Avoid Principal Liability
    As discussed with respect to the PRA, we understand that most
existing standard securities lending master agreements in use today
already contain language requiring agent lenders to disclose principals
and for principals to agree not to hold the agents liable for a
counterparty default. Thus, the standard agreement used by the vast
majority of broker-dealers should contain the representations and
disclosures required by the proposed amendment. However, a small
percentage of broker-dealers may need to modify their standard
agreements. As discussed with respect to the PRA, we estimate that
approximately nine broker-dealers would need to amend their securities
lending agreements to include the required provision and that they
would each spend, on average, approximately 20 hours in making the
changes. We estimate that the responsibility for changing the language
in the securities lending master agreement template would be undertaken
collectively by an associate general counsel and attorney. The SIA
Management Report 2005 indicates that the average hourly cost of these
positions respectively is $431 for the associate general counsel and
$327 for the attorney. We estimate that, on average, the attorney would
spend 16 hours changing the template and the associate general counsel
would spend four hours overseeing the project. Therefore, we estimate
that the one-time cost to make these changes would be, on average,
$6,956 per firm.\181\ For these reasons, we estimate the total one-time
cost to the industry would be approximately $62,604.\182\
---------------------------------------------------------------------------

    \181\ ([16 hours] x [$327 per hour]) + ([4 hours] x [$431 per
hour]) = $6,956.
    \182\ 9 broker-dealers x $6,956 = $62,604.
---------------------------------------------------------------------------

    As noted above, we request comment on these proposed cost
estimates. In particular, we request comment on additional costs to
broker-dealers that would arise from these proposals, such as costs
arising from making systems changes. We also request comment on whether
these proposals would impose costs on other market participants,
including broker-dealer customers. Commenters should identify the
metrics and sources of any empirical data that support their costs
estimates.
ii. Notices or Monthly Reports
    The proposed amendment to Rule 17a-11 would require broker-dealers
engaged in securities lending or repurchase activities to either: (1)
File a notice with the Commission and their designated examining
authority whenever the total money payable against all securities
loaned, subject to a reverse repurchase agreement or the contract value
of all securities borrowed or subject to a repurchase agreement exceeds
2500% of tentative net capital; or, alternatively, (2) file a monthly
report on their securities lending and repurchase activities with their
designated examining authority.
    As discussed with respect to the PRA, based on FOCUS Report
filings, we estimate that approximately twelve notices per year would
be sent pursuant to this proposed amendment. We further estimate that a
broker-dealer would spend, on average, approximately ten minutes of
employee resources to prepare and send the notice. Therefore, we
estimate that the costs to the industry associated with this
requirement would be de minimis.
    As for the monthly reports, we estimated with respect to the PRA
that approximately 21 broker-dealers would choose the option under the
proposed rule of filing the reports. We also estimated with respect to
the PRA that each firm would spend, on average, approximately 100 hours
of employee resources updating its systems to generate the report. For
the purposes of this cost analysis, we assume that the responsibility
for updating these systems would be undertaken by a Senior Programmer.
The SIA Management Report 2005 indicates the average hourly cost of
this position is approximately $268. Therefore, we estimate that the
systems changes would result, on average, in a one-time cost of
approximately $26,800 per broker-dealer.\183\ For these reasons, we
estimate the total one-time cost to the industry would be approximately
$562,800.\184\
---------------------------------------------------------------------------

    \183\ 100 hours x $268 = $26,800.
    \184\ 21 broker-dealers x $26,800 = $562,800.
---------------------------------------------------------------------------

    As for the annual costs of generating and filing the monthly
report, we estimated with respect to the PRA that a broker-dealer would
spend, on average, approximately one hour per month (or twelve hours
per year) of employee resources to generate and send the report. We
assume the responsibility for generating and filing the monthly report
would be undertaken by a junior stock loan manager. The SIA Management
Report 2005 indicates the average hourly cost for this position is
$208. We further estimate that a junior stock loan manager would spend,
on average, approximately one hour per month compiling and filing this
report for an average monthly cost of $208. Therefore, we estimate the
cost to file the reports would be approximately $2,496 per firm.\185\
For these reasons, we estimate the total annual cost to the industry
would be approximately $52,416.\186\
---------------------------------------------------------------------------

    \185\ ([1 hour] x [$208 per hour]) x 12 months = $2,496.
    \186\ 21 broker-dealers x $2,496 = $52,416.
---------------------------------------------------------------------------

    As noted above, we request comment on these proposed cost
estimates. In particular, we request comment on additional costs to
broker-dealers that would arise from these proposals. We also request
comment on whether these proposals would impose costs on other market
participants, including persons active in the securities lending and
repo markets. Commenters should identify the metrics and sources of any
empirical data that support their costs estimates.

D. Documentation of Risk Management Procedures

    We are proposing amendments to the broker-dealer books and records
rules that would require certain large broker-dealers to document in
writing the procedures and guidelines they use for managing risk. The
proposed amendments do not require broker-dealers to implement
procedures. Rather, they require the documentation of procedures that
have been established by the broker-dealer.
1. Benefits
    These proposed amendments would require large broker-dealers to
document the controls they have implemented to address the risks they
face as a result of their business activities. This would benefit the
firms by mitigating the risk of financial loss or collapse and their
customers by mitigating the risk of losses associated with a firm's
failure or an employee's improper activities. Moreover, by
strengthening the internal processes of the broker-dealers, these
proposed amendments would benefit market participants and reduce
systemic financial risk. In addition, by making the documented controls
a required

record, securities regulators would have better access to them. This
would assist regulators in monitoring the risks faced by broker-dealers
and understanding the controls they implement to address the risks.
    We request comment on available metrics to quantify these benefits
and any other benefits the commenter may identify. Commenters are
requested to identify sources of empirical data that could be used for
the metrics they propose.
2. Costs
    These proposed amendments would apply to a limited number of
broker-dealers, namely, those firms with more than $1 million in
customer credits or $20 million in capital. This proposed requirement
would result in a one-time cost to some of these firms to the extent
they had established procedures that had not been documented. We
believe, generally, that most of these firms have documented their
established risk management controls and procedures. For these reasons,
we estimated with respect to the PRA that the one-time hourly burden to
meet the requirements of these proposed rules would range from 0 hours
for some firms and to hundreds of hours for other firms. Taking this
into account, we estimated with respect to the PRA that a broker-dealer
would spend, on average, approximately 120 hours of employee resources
augmenting its documented procedures to come into compliance with this
proposed amendment.
    For the purposes of this cost analysis, we estimate that the
responsibility for documenting the risk management procedures and
controls a broker-dealer has established would be coordinated by an
attorney working with operations specialists from the various risk
management departments in the firm. We further estimate that the
project would be overseen by an associate general counsel. The SIA
Management Report 2005 indicates the average hourly costs of these
positions respectively are approximately $431 for an associate general
counsel, $327 for an attorney and $144 for an operations specialist. We
estimate that the attorney would spend 40 hours compiling and
documenting the procedures, the operations specialists collectively
would spend 70 hours working with the attorney, and the associate
general counsel would spend ten hours overseeing the project.
Therefore, we estimate that the average one-time cost per firm to
comply with these proposed amendments would be $27,470.\187\ We
estimated with respect to the PRA that these amendments would apply to
approximately 517 broker-dealers. For these reasons, we estimate that
the total one-time cost to the industry would be approximately
$14,201,990.\188\
---------------------------------------------------------------------------

    \187\ ([40 hours] x [$327 per hour]) + ([70 hours] x [$144 per
hour]) + ([10 hours] x [$431 per hour]) = $27,470.
    \188\ 517 broker-dealers x $27,470 = $14,201,990.
---------------------------------------------------------------------------

    As noted above, we request comment on these proposed cost
estimates. In particular, we request comment on additional costs to
broker-dealers that would arise from these proposals, such as costs
arising from making changes to systems and costs associated with
maintaining these records. We also request comment on whether these
proposals would impose costs on other market participants, including
broker-dealer customers. Commenters should identify the metrics and
sources of any empirical data that support their costs estimates.

E. Amendments to the Net Capital Rule

1. Requirement to Add Back Certain Liabilities to Net Worth and Treat
Certain Capital Contributions as Liabilities
    These proposed amendments to Rule 15c3-1 would require a broker-
dealer to add back to net worth, when calculating net capital,
liabilities assumed by a third-party if the third-party did not have
the financial wherewithal to pay the liabilities. The proposed
amendments also would require a broker-dealer to treat as liabilities
capital contributions where the investor has the option to withdraw the
capital at any time.
i. Benefits
    These proposed amendments to Rule 15c3-1 would assist investors and
regulators by requiring broker-dealers to provide a more accurate
picture of their financial condition. This would permit regulators to
react more quickly if a firm experiences financial difficulty. This
would benefit customers of a troubled broker-dealer as well as its
counterparties and, accordingly, reduce systemic risk in the securities
markets. We request comment on available metrics to quantify these
benefits and any other benefits the commenter may identify. Commenters
are requested to identify sources of empirical data that could be used
for the metrics they propose.
ii. Costs
    These proposed amendments would apply to all broker-dealers.
However, the requirements only would impact a few broker-dealers,
namely those that have sought to shift their liabilities to a third-
party that lacks the resources--independent of the broker-dealer--to
assume the liabilities or those that provide investors with options to
withdraw capital. We believe the vast majority of broker-dealers either
do not seek to transfer responsibility for their liabilities to a
third-party or, if they do so, rely on a third-party that has the
financial resources--independent of the assets and revenue of the
broker-dealer--to pay the obligations as they become due. We also
believe that most broker-dealers do not accept capital contributions
under agreements permitting the investor to withdraw the capital at any
time.
    FOCUS Report filings indicate that approximately 702 broker-dealers
report having no liabilities. For the purposes of this analysis, we
conservatively estimate that the proposed amendment would impact all of
these firms. Requiring these broker-dealers to book liabilities would
decrease the amount of equity capital held by the firms and in some
cases may require them to obtain additional capital. The majority of
broker-dealers reporting no liabilities are introducing broker-dealers
that have a $5,000 minimum net capital requirement. The reported
average for total aggregate liabilities of introducing broker-dealers
is $280,354 per firm. Therefore, conservatively estimating that the 702
broker-dealers would have to each raise $280,354 in additional capital
as result of the proposed requirement, the total aggregate amount of
additional capital that would need to be raised would be
$196,808,508.\189\ We further estimate that the cost of capital is
approximately 5%.\190\ Therefore, we estimate that the total annual
cost to the industry would be approximately $10 million.\191\
---------------------------------------------------------------------------

    \189\ 702 broker-dealers x $280,354 = $196,808,508.
    \190\ We estimate this generally would be the cost to a broker-
dealer to obtain a subordinated loan that meets requirements of
Rules 15c3-1 and 15c3-1d (17 CFR 240.15c3-1d).
    \191\ $196,809,000 x 5% = $9,840,300.
---------------------------------------------------------------------------

    We estimate that amendments requiring broker-dealers to treat
certain capital contributions as liabilities should not result in
significant additional costs. Generally, broker-dealers do not enter
into agreements permitting an owner to withdraw capital at any time. To
the extent some firms may have engaged in this practice, they could
have to pay more for capital. Conservatively, we estimate that no more
than $100 million in capital at broker-dealers is subject to such
agreements. Assuming an incremental

cost of capital of 2.5%, we estimate that the proposed amendment would
result in an annual cost of approximately $2.5 million.\192\
---------------------------------------------------------------------------

    \192\ $100,000,000 x 2.5% = $2,500,000.
---------------------------------------------------------------------------

    As noted above, we request comment on these proposed cost
estimates. In particular, we request comment on additional costs to
broker-dealers that would arise from these proposals. We also request
comment on whether these proposals would impose costs on other market
participants, including broker-dealer customers. Commenters should
identify the metrics and sources of any empirical data that support
their costs estimates.
2. Account for Excess Fidelity Bond Deductibles
    This proposed amendment would require broker-dealers to deduct from
net capital, with regard to fidelity bonding requirements prescribed by
a broker-dealer's examining authority, the excess of any deductible
amount over the maximum amount permitted by self-regulatory
organization rules.
i. Benefits
    Self-regulatory organization rules relating to fidelity bonding
requirements provide safeguards with respect to the financial
responsibility and related practices of broker-dealers. This proposed
amendment would clarify that broker-dealers subject to capital charges
under self-regulatory organization rules for excess fidelity bond
deductibles also should include such deductions when determining net
capital for purposes of Rule 15c3-1.\193\ This would help in ensuring
that broker-dealers do not exceed regulatory limitations for fidelity
bond deductibles.
---------------------------------------------------------------------------

    \193\ 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

ii. Costs
    This proposed amendment would codify in a Commission rule capital
charges that broker-dealers are currently required to take pursuant to
the rules of various self-regulatory organizations. The proposed
amendment would not impose additional costs on broker-dealers with
respect to the purchasing or carrying of fidelity bond coverage. Nor
would the proposed amendment cause broker-dealers to incur additional
costs in determining or reporting excess deductible amounts over the
maximum amount permitted. Broker-dealers already make such
determinations under self-regulatory organization rules, and the manner
in which such excesses are typically reported (i.e., through periodic
FOCUS and other reports) would remain the same. For these reasons, we
believe any costs arising from this proposed amendment would be de
minimis.
    As noted above, we request comment on this cost estimate. In
particular, we request comment on whether there would be any costs to
broker-dealers as a consequence of this proposal. We also request
comment on whether this proposal would impose costs on other market
participants, including broker-dealer customers. Commenters should
identify the metrics and sources of any empirical data that support
their costs estimates.
3. Broker-Dealer Solvency Requirement
    This proposed amendment to Rule 15c3-1 would require broker-dealers
to cease doing a securities business if they become subject to certain
insolvency events. The companion amendment to Rule 17a-11 would require
such broker-dealers to provide notice of their insolvency to regulatory
authorities.
i. Benefits
    The proposed amendment to Rule 15c3-1 would benefit the securities
markets by removing risks associated with having a financially unstable
firm continue to operate. For example, the broker-dealer would not be
able to take on new customers and place their assets at risk of being
lost in its financial collapse or frozen in a liquidation proceeding.
Furthermore, the broker-dealer would not be able to enter into
proprietary transactions with other broker-dealers and place them or
clearing agencies at risk of counterparty default. The broker-dealer's
existing customers also would benefit in that ceasing a securities
business would assist in preserving any remaining capital of the firm,
which could be used to facilitate on orderly liquidation.
    The proposed amendment to Rule 17a-11 also would benefit the
securities markets in that it would provide regulators with the
opportunity to take steps to protect customers and counterparties at
the onset of the insolvency. These steps could include facilitating the
transfer of customer accounts to a solvent broker-dealer and monitoring
the liquidation of proprietary positions.
ii. Costs
    For the most part, the proposed amendments would have no impact on
existing broker-dealers. Should a broker-dealer become subject to an
insolvency proceeding, it would incur the cost of sending notice of
that fact to the Commission and its designated examining authority. We
believe this would be a rare occurrence and, accordingly, with respect
to the PRA estimated it would happen approximately six times a year.
For these reasons, we estimate that any costs arising from this
proposed amendment would be de minimis.
    As noted above, we request comment on this cost estimate. In
particular, we request comment on whether there would be costs to
broker-dealers as a consequence of this proposal. We also request
comment on whether this proposal would impose costs on other market
participants, including broker-dealer customers. Commenters should
identify the metrics and sources of any empirical data that support
their costs estimates.
4. Order Restricting Withdrawal of Capital From a Broker or Dealer
Amendment
    This proposed amendment to Rule 15c3-1(e) would eliminate the
qualification on Commission orders restricting withdrawals, advances
and unsecured loans made by broker-dealers that limits the order to
instances when recent withdrawals, advances or loans, in the aggregate,
exceed thirty percent of the broker-dealer's excess net capital.
i. Benefits
    The proposed amendment to Rule 15c3-1 would benefit the securities
markets by protecting customers and counterparties of a financially
stressed broker-dealer. For example, the broker-dealer would not be
able to make an unsecured loan to a stockholder or withdraw equity
capital while the order was outstanding, thereby preserving the assets
and liquidity of the broker-dealer and enabling the Commission and its
staff to examine the broker-dealer's financial condition, net capital
position and the risk exposure to the customers and creditors of the
broker-dealer to ensure the financial integrity of the firm.
ii. Costs
    The current rule permitting the Commission to restrict withdrawals
of capital from a financially distressed broker-dealer was adopted in
1991.\194\ Based on this experience with the rule, we estimate that the
proposed amendment would result in no or de minimis costs to broker-
dealers.
---------------------------------------------------------------------------

    \194\ See Exchange Act Release No. 28927 (February 28, 1991), 56
FR 9124 (March 5, 1991).
---------------------------------------------------------------------------

    As noted above, we request comment on this cost estimate. In
particular, we request comment on whether there would be costs to
broker-dealers as a consequence of this proposal. We also request
comment on whether this proposal would impose costs on other

market participants. Commenters should identify the metrics and sources
of any empirical data that support their costs estimates.
5. Adjusted Net Capital Requirements
    These proposed amendments would adjust required charges for broker-
dealers under Rule 15c3-1. The adjustments would better align the net
capital requirements of affected firms with the risks Rule 15c3-1 seeks
to mitigate. The amendments are relaxing existing requirements and,
therefore, would not result in costs to broker-dealers. Moreover,
because they seek to better match capital requirements with actual
risk, they should not have an adverse impact on the financial strength
of broker-dealers.
i. Calculating Theoretical Pricing Charges
    The proposed amendment to paragraph (b)(1)(vi) of Rule 15c3-1a
would make permanent the reduced net capital requirements that apply to
listed option positions in major market foreign currencies and high-
capitalization and non-high-capitalization diversified indexes in non-
clearing option specialist and market maker accounts. This would
benefit the broker-dealers that have been calculating charges under the
temporary relief granted by the Commission staff. Because broker-
dealers are already operating under the temporary relief, we believe
the amendment would not result in any costs.
    We request comment on available metrics to quantify the benefits
identified above and any other benefits the commenter may identify.
Commenters are requested to identify sources of empirical data that
could be used for the metrics they propose.
    In addition, we request comment on whether the proposal would
result in costs. Commenters should identify the metrics and sources of
any empirical data that support their costs estimates.
ii. Reduced Haircut on Money Market Funds
    Reducing the money market funds haircut from 2% to 1% would benefit
all broker-dealers in that it will make it less costly, in terms of
capital allocation, to hold these investments. We do not believe the
proposed amendment would result in any costs.
    We request comment on available metrics to quantify the benefits
identified above and any other benefits the commenter may identify.
Commenters are requested to identify sources of empirical data that
could be used for the metrics they propose.
    In addition, we request comment on whether the proposal would
result in costs. Commenters should identify the metrics and sources of
any empirical data that support their costs estimates.

F. Total Estimates Costs

    Given the estimates set forth above, the total one-time estimated
cost to the industry resulting from these rule proposals would be
approximately $32,814,454 \195\ and the total estimated annual cost to
the industry resulting from these rule proposals would be approximately
$39,651,716.\196\
---------------------------------------------------------------------------

    \195\ $8,773,410 + $603,000 + $28,930 + $3,752,000 + $2,680,000
+ $1,000,000 + $1,149,720 + $62,604 + $562,800 + $14,201,990 =
$32,814,454.
    \196\ $2,599,300 + $24,500,000 + $52,416 + $10,000,000 +
$2,500,000 = $39,651,716.
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VI. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition, And Capital Formation

    Section 3(f) of the Exchange Act requires the Commission, whenever
it engages in rulemaking and must consider or determine if an action is
necessary or appropriate in the public interest, to consider if the
action will promote efficiency, competition, and capital
formation.\197\ In addition, Section 23(a)(2) of the Exchange Act
requires the Commission, when adopting rules under the Exchange Act, to
consider the impact that any such rule would have on competition.\198\
Exchange Act Section 23(a)(2) prohibits the Commission from adopting
any rule that would impose a burden on competition not necessary or
appropriate in furtherance of the purposes of the Exchange Act. The
proposed amendments are intended to promote efficiency, competition,
and capital formation. They should not have any anti-competitive
effects.
---------------------------------------------------------------------------

    \197\ 15 U.S.C. 78c(f).
    \198\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The Commission requests comment on whether the proposed amendments
are likely to promote efficiency, competition, and capital formation.

A. Amendments to the Customer Protection Rule

    The proposed amendments to the customer protection rule respecting
PAB accounts,\199\ cash deposits at special reserve bank accounts,\200\
allocation of short positions,\201\ and the treatment of free credit
balances \202\ are designed to protect and preserve customer property
held at broker-dealers. These protections would reduce the risks to
individual investors and, thereby, promote participation in the
securities markets. Also, by strengthening requirements designed to
protect customer property, they would mitigate potential exposure of
the fund administered by the Securities Investor Protection Corporation
(``SIPC'') that is used to make advances to customers whose securities
or cash are unable to be returned by a failed broker-dealer. The
amendments reducing the debit reduction for alternative standard firms
from 3% to 1% and clarifying that funds in certain commodities accounts
need not be treated as ``free credit balances'' would free up capital
and, in the latter case, clarify an ambiguity in Rule 15c3-3.\203\
These results would promote capital formation and increase efficiency.
The amendment expanding the definition of qualified securities would
reduce operational burdens associated with holding securities in the
customer reserve account and, thereby, promote efficiency.\204\
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    \199\ See section II.A.1 of this release.
    \200\ See section II.A.2 of this release.
    \201\ See section II.A.4 of this release.
    \202\ See section II.A.5.i of this release.
    \203\ See sections II.A.6 and II.A.7 of this release.
    \204\ See section II.A.3 of this release.
---------------------------------------------------------------------------

B. Portfolio Margining Amendments

    The proposed amendments to accommodate portfolio margining \205\
would promote greater efficiency, competition and capital formation.
They are designed to provide portfolio margin customers with greater
protection through the reserve requirements of Rule 15c3-3 and SIPA.
This, in turn, would make portfolio margining more attractive to
investors. Portfolio margining can significantly reduce customer margin
requirements for offsetting positions involving securities and futures
products, which in turn reduces the costs of trading such products.
Moreover, portfolio margining promotes competition and better price
discovery across securities and futures products by allowing customers
to offset a position assumed in one market with a product traded on
another market.
---------------------------------------------------------------------------

    \205\ See section II.B of this release.
---------------------------------------------------------------------------

C. Securities Lending and Borrowing Amendments

    The proposed amendment requiring broker-dealers to disclaim
principal liability in securities lending transactions to avoid certain
capital charges under Rule 15c3-1 \206\ is consistent with the goal of
promoting efficiency and competition in the marketplace. This proposed
amendment would help eliminate the legal uncertainty among
counterparties as to the role played by market participants

in such transactions and clarify the nature of the services that
securities lending intermediaries provide their counterparties. The
proposed amendment to Rule 17a-11 \207\ to require a broker-dealer to
provide notice if its securities lending or repo transactions reach a
certain threshold, or alternatively provide its DEA with a monthly
report, is designed to enhance the monitoring of these activities by
securities regulators and, thereby, protect broker-dealer customers and
counterparties from the impact of a financial collapse. This would
strengthen the securities markets and make them more attractive to
investors.
---------------------------------------------------------------------------

    \206\ See section II.C of this release.
    \207\ Id.
---------------------------------------------------------------------------

D. Documentation of Risk Management Procedures

    The proposed amendments to Rules 17a-3 and 17a-4 \208\ requiring
firms to document their risk management controls and procedures are
designed to reduce the risks inherent to the business of operating as a
broker-dealer and, thereby, enhance a broker-dealer's financial
soundness. This would strengthen the securities markets making them
more attractive to investors.
---------------------------------------------------------------------------

    \208\ See section II.D of this release.
---------------------------------------------------------------------------

E. Amendments to the Net Capital Rule

    The proposed amendments to Rule 15c3-1 (1) requiring a broker-
dealer to account for certain liabilities or treat certain capital
contributions as liabilities,\209\ (2) requiring a broker-dealer to
account for certain excess fidelity bond deductibles,\210\ (3)
requiring an insolvent broker-dealer to cease conducting a securities
business and provide notice under the proposed amendment to Rule 17a-
11,\211\ (4) eliminating the qualification on Commission orders
restricting withdrawals, advances, and unsecured loans to instances
where recent withdrawals, advances or loans, in the aggregate, exceed
thirty percent of the broker-dealer's excess net capital,\212\ (5)
making permanent the reduced net capital requirements under Appendix A
for market makers,\213\ and (6) lowering the haircut for money market
funds,\214\ are consistent with promoting efficiency and competition in
the market place.
---------------------------------------------------------------------------

    \209\ See section II.E.1 of this release.
    \210\ See section II.E.2 of this release.
    \211\ See section II.E.3 of this release.
    \212\ See section II.E.4 of this release.
    \213\ See section II.E.5.i of this release.
    \214\ See section II.E.5.ii of this release.
---------------------------------------------------------------------------

    A broker-dealer that fails to account for liabilities that depend
on the broker-dealer's assets and revenues and accepts temporary
capital is obscuring its true financial condition. This interferes with
the process by which regulators monitor the financial condition of
broker-dealers and, thereby, impedes their ability to take proactive
steps to minimize the harm to customers, counterparties and clearing
agencies resulting from a broker-dealer failure.
    Requiring broker-dealers to take net capital charges for excess
fidelity bond deductibles imposed under self-regulatory organization
rules would promote efficiency by providing certainty as to the
applicability of such rules for purposes of Rule 15c3-1. Because
fidelity bond requirements provide a safeguard with regard to broker-
dealer financial responsibility, the proposed amendment would enhance
competition through the operation of more financially sound firms.
    The continued operation of an insolvent broker-dealer or the
withdrawal of capital from a broker-dealer that may jeopardize such
broker-dealer's financial integrity poses financial risk to its
customers, counterparties and the securities industry clearance
organizations. These risks increase costs.
    The elimination of the limitation on Commission orders restricting
capital withdrawals from a financially troubled broker-dealer would
provide greater protection to customers and counterparties of the firm
and securities industry clearance organizations. While such orders
would be infrequent, when issued they would lower costs to these
entities associated with having an outstanding obligation from the
troubled broker-dealer.
    The proposed amendments to the net capital rule that would reduce
the amount of net capital certain broker-dealers must maintain would
improve efficiency and competition and promote capital formation by
allowing firms to employ such capital in other areas of their business
activities. They also would lower the costs of capital for broker-
dealers.

VII. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996, or ``SBREFA,'' \215\ we must advise the OMB as to whether
the proposed regulation constitutes a ``major'' rule. Under SBREFA, a
rule is considered ``major'' where, if adopted, it results or is likely
to result in (1) an annual effect on the economy of $100 million or
more (either in the form of an increase or a decrease), (2) a major
increase in costs or prices for consumers or individual industries, or
(3) significant adverse effect on competition, investment or
innovation.
---------------------------------------------------------------------------

    \215\ Pub. L. No. 104-121, Title II, 110 Stat. 857 (1996)
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note
to 5 U.S.C. 601).
---------------------------------------------------------------------------

    If a rule is ``major,'' its effectiveness will generally be delayed
for 60 days pending Congressional review. We request comment on the
potential impact of each of the proposed amendments on the economy on
an annual basis. Commenters are requested to provide empirical data and
other factual support for their view to the extent possible.

VIII. Initial Regulatory Flexibility Analysis

    The Commission has prepared the following Initial Regulatory
Flexibility Analysis (IRFA), in accordance with the provisions of the
Regulatory Flexibility Act,\216\ regarding the proposed amendments to
Rules 15c3-1, 15c3-1a, 15c3-2, 15c3-3, 15c3-3a, 17a-3, 17a-4, and 17a-
11 under the Exchange Act.
---------------------------------------------------------------------------

    \216\ 5 U.S.C. 603.
---------------------------------------------------------------------------

    We encourage comments with respect to any aspect of this IRFA,
including comments with respect to the number of small entities that
may be affected by the proposed amendments. Comments should specify the
costs of compliance with the proposed amendments, and suggest
alternatives that would accomplish the goals of the amendments.
Comments will be considered in determining whether a Final Regulatory
Flexibility Analysis is required, and will be placed in the same public
file as comments on the proposed amendments. Comments should be
submitted to the Commission at the addresses previously indicated.

A. Amendments to the Customer Protection Rule

1. Reasons
    The proposed amendment that would require broker-dealers to perform
a reserve computation for domestic and foreign broker-dealer accounts
is responding to a disparity between Rule 15c3-3 and the SIPA. The
proposed amendment that would require broker-dealers to limit the
amount of cash deposited in a reserve account at any individual bank
and exclude cash deposited with a parent or subsidiary bank is
responding to the fact that some firms are concentrating such deposits
or placing them at risk of group-wide financial collapses. The proposed
amendment that would expand the definition of qualified securities is
intended to provide broker-dealers with

another option with respect to assets that can be deposited into the
customer reserve account. The proposed amendment that would require
broker-dealers to obtain possession and control of customers' fully
paid and excess margin securities allocated to a short position is
responding to the fact that some firms are permitting these positions
to accumulate, which puts customers at risk. The proposed amendment
that would require broker-dealers to provide certain notices and
disclosures before changing the terms and conditions under which the
broker-dealer treats customer free credit balances is intended to help
assure that the use of customer free credit balances accords with
customer preferences. The proposed amendment lowering the aggregate
debit item reduction from 3% to 1% is responding to the dramatic
increase in debit items accumulating at broker-dealers. The proposed
amendment clarifying that funds in certain commodities accounts are not
to be treated as ``free credit balances'' is intended to remove
uncertainty with respect to their treatment.
2. Objectives
    Most of the proposed amendments to Rule 15c3-3 are intended to
strengthen the protections afforded to customer assets held at a
broker-dealer. The intended result of the proposed amendments is to
minimize the risk that customer assets will be lost, tied-up in a
liquidation proceeding, or held in a manner that is inconsistent with a
customer's expectations. The proposed amendment expanding the
definition of qualified security is intended to lower operational
burdens of broker-dealers. The proposed amendment eliminating the 3%
reduction is intended to better align the requirement to reduce debits
with the credit risk being addressed by the requirement. The proposed
amendment clarifying the treatment of funds in certain commodities
accounts is intended to remove an ambiguity in the rule.
3. Legal Basis
    Pursuant to the Exchange Act and, particularly, Section 15, 15
U.S.C. 78o.
4. Small Entities Subject to the Rule
    Paragraph (c)(1) of Rule 0-10 \217\ states that the term ``small
business'' or ``small organization,'' when referring to a broker-
dealer, means a broker or dealer that had total capital (net worth plus
subordinated liabilities) of less than $500,000 on the date in the
prior fiscal year as of which its audited financial statements were
prepared pursuant to Rule 17a-5(d); \218\ and is not affiliated with
any person (other than a natural person) that is not a small business
or small organization.
---------------------------------------------------------------------------

    \217\ 17 CFR 240.0-10(c)(1).
    \218\ 17 CFR 240.17a-5(d).
---------------------------------------------------------------------------

    The Commission estimates there are approximately eight broker-
dealers that performed a customer reserve computation pursuant to Rule
15c3-3 and were ``small'' for the purposes of Rule 0-10.\219\
---------------------------------------------------------------------------

    \219\ This estimate is based on FOCUS Report filings.
---------------------------------------------------------------------------

5. Reporting, Recordkeeping, and Other Compliance Requirements
    The proposed amendments would (1) require broker-dealers to perform
a reserve computation for domestic and foreign broker-dealer accounts,
(2) limit the amount that a broker-dealer may deposit in a reserve
account at any individual bank in the form of cash, (3) require broker-
dealers to obtain possession and control of customers' fully paid and
excess margin securities allocated to a short position by borrowing
equivalent securities within a specified period of time, (4) require
broker-dealers to obtain an affirmative consent from a customer before
changing the terms and conditions under which the broker-dealer holds
credit balances related to the customer, and (5) lower the aggregate
debit reduction.
6. Duplicative, Overlapping or Conflicting Federal Rules
    We believe that there are no Federal rules that duplicate, overlap
or conflict with the proposed amendments.
7. Significant Alternatives
    Pursuant to section 3(a) of the RFA,\220\ the Commission must
consider certain types of alternatives, including (1) the establishment
of differing compliance or reporting requirements or timetables that
take into account the resources available to small entities, (2) the
clarification, consolidation, or simplification of compliance and
reporting requirements under the rule for small entities, (3) the use
of performance rather than design standards, and (4) an exemption from
coverage of the rule, or any part thereof, for small entities.
---------------------------------------------------------------------------

    \220\ 5 U.S.C. 603(c).
---------------------------------------------------------------------------

    Given the negligible impact these amendments would have on small
entities, we do not believe it is necessary or appropriate to establish
different compliance or reporting requirements or timetables; clarify,
consolidate, or simplify compliance and reporting requirements under
the rule for small entities; or exempt small entities from coverage of
the rule, or any part thereof. The Commission also does not believe
that it is necessary to consider whether small entities should be
permitted to use performance rather than design standards to comply
with the proposed amendments as the amendments already propose
performance standards and do not dictate for entities of any size any
particular design standards (e.g., technology) that must be employed to
achieve the objectives of the proposed amendments.
8. Request for Comments
    We encourage the submission of comments to any aspect of this
portion of the IRFA. Comments should specify costs of compliance with
the proposed amendment and suggest alternatives that would accomplish
the objective of the proposed amendments.

B. Portfolio Margining Amendments

1. Reasons
    The CBOE and the NYSE rules permit broker-dealers to determine
customer margin requirements using a portfolio margin methodology and
permit cross-margining; namely, the inclusion in the portfolio margin
account of futures and futures options on broad-based securities
indices. These proposed amendments are designed to provide portfolio
margin customers with protection for futures positions carried in their
securities accounts.
2. Objectives
    These proposed amendments are designed to provide customers with
futures and futures options in a portfolio margin account with SIPA
protections.
3. Legal Basis
    Pursuant to the Exchange Act and, particularly, section 15.\221\
---------------------------------------------------------------------------

    \221\ 15 U.S.C. 78o.
---------------------------------------------------------------------------

4. Small Entities Subject to the Rule
    Paragraph (c)(1) of Rule 0-10 \222\ states that the term ``small
business'' or ``small organization,'' when referring to a broker-
dealer, means a broker or dealer that had total capital (net worth plus
subordinated liabilities) of less than $500,000 on the date in the
prior fiscal year as of which its audited financial statements were
prepared pursuant to Rule 17a-5(d); \223\ and is not affiliated with
any person (other than a natural

person) that is not a small business or small organization.
---------------------------------------------------------------------------

    \222\ 17 CFR 240.0-10(c)(1).
    \223\ 17 CFR 240.17a-5(d).
---------------------------------------------------------------------------

    The Commission estimates there are approximately eight broker-
dealers that performed a customer reserve computation pursuant to Rule
15c3-3 and were ``small'' for the purposes of Rule 0-10.\224\
---------------------------------------------------------------------------

    \224\ This estimate is based on FOCUS Report filings.
---------------------------------------------------------------------------

5. Reporting, Recordkeeping, and Other Compliance Requirements
    These proposed amendments would (1) revise the definition of ``free
credit balances'' in Rule 15c3-3 to include funds in a portfolio margin
account relating to certain futures and futures options positions and
the market value of futures options as of the filing date in a SIPA
proceeding, and (2) add a debit line item to the customer reserve
formula in Rule 15c3-3a consisting of margin posted by a broker-dealer
to a futures clearing agency.
6. Duplicative, Overlapping or Conflicting Federal Rules
    We believe that there are no Federal rules that duplicate, overlap
or conflict with the proposed amendments.
7. Significant Alternatives
    Pursuant to Section 3(a) of the RFA,\225\ the Commission must
consider certain types of alternatives, including (1) the establishment
of differing compliance or reporting requirements or timetables that
take into account the resources available to small entities, (2) the
clarification, consolidation, or simplification of compliance and
reporting requirements under the rule for small entities, (3) the use
of performance rather than design standards, and (4) an exemption from
coverage of the rule, or any part thereof, for small entities.
---------------------------------------------------------------------------

    \225\ 5 U.S.C. 603(c).
---------------------------------------------------------------------------

    Given the negligible impact this amendment would have on small
entities, we do not believe it is necessary or appropriate to establish
different compliance or reporting requirements or timetables; clarify,
consolidate, or simplify compliance and reporting requirements under
the rule for small entities; or exempt small entities from coverage of
the rule, or any part thereof.
    The Commission also does not believe that it is necessary to
consider whether small entities should be permitted to use performance
rather than design standards to comply with the proposed amendments as
the amendments already propose performance standards and do not dictate
for entities of any size any particular design standards (e.g.,
technology) that must be employed to achieve the objectives of the
proposed amendments.
8. Request for Comments
    We encourage the submission of comments to any aspect of this
portion of the IRFA. Comments should specify costs of compliance with
the proposed amendment and suggest alternatives that would accomplish
the objective of the proposed amendments.

C. Securities Lending, Borrowing, and Repurchase/Reverse Repurchase
Amendments

1. Reasons
    In 2001, MJK Clearing, a broker-dealer with a substantial number of
customer accounts, failed when it could not meet its securities lending
obligations. This failure has highlighted the risks associated with
securities lending and the economically similar repurchase and reverse
repurchase agreements and the need to manage those risks.
2. Objectives
    These proposed amendments are intended to strengthen the
documentation controls broker-dealers employ to manage their securities
lending and borrowing and securities repurchase and reverse repurchase
activities and to enhance regulatory monitoring. The intended result of
the amendments is to minimize the risk that a firm would fail as a
result of inadequate controls over its securities lending and borrowing
securities repurchase and reverse repurchase activities.
3. Legal Basis
    Pursuant to the Exchange Act and, particularly, Sections 15 and 17
thereof, 15 U.S.C. 78o and 78q.
4. Small Entities Subject to the Rule
    Paragraph (c)(1) of Rule 0-10 \226\ states that the term ``small
business'' or ``small organization,'' when referring to a broker-
dealer, means a broker or dealer that had total capital (net worth plus
subordinated liabilities) of less than $500,000 on the date in the
prior fiscal year as of which its audited financial statements were
prepared pursuant to Rule 17a-5(d);\227\ and is not affiliated with any
person (other than a natural person) that is not a small business or
small organization.
---------------------------------------------------------------------------

    \226\ 17 CFR 240.0-10(c)(1).
    \227\ 17 CFR 240.17a-5(d).
---------------------------------------------------------------------------

    The Commission estimates that none of the broker-dealers that
engage in securities lending and borrowing or securities repurchase and
reverse repurchase activity are ``small'' for the purposes Rule 0-
10.\228\ Therefore, the proposed amendments should not impact on
``small'' broker-dealers.
---------------------------------------------------------------------------

    \228\ This estimate is based on FOCUS Report filings.
---------------------------------------------------------------------------

5. Reporting, Recordkeeping, and Other Compliance Requirements
    These proposed amendments would require broker-dealers to (1)
disclose the principals and obtain certain agreements from the
principals in a transaction where they provide settlement services in
order to be considered an agent (as opposed to a principal) for the
purposes of the net capital rule, and (2) provide notice to the
Commission and other regulatory authorities if the broker-dealer's
securities lending or repo activity reaches a certain threshold or,
alternatively, provide regulatory authorities with a monthly report of
the broker-dealer's securities lending and repo activity.
6. Duplicative, Overlapping or Conflicting Federal Rules
    We believe that there are no Federal rules that duplicate, overlap
or conflict with the proposed amendments.
7. Significant Alternatives
    Pursuant to Section 3(a) of the RFA,\229\ the Commission must
consider certain types of alternatives, including (1) the establishment
of differing compliance or reporting requirements or timetables that
take into account the resources available to small entities, (2) the
clarification, consolidation, or simplification of compliance and
reporting requirements under the rule for small entities, (3) the use
of performance rather than design standards, and (4) an exemption from
coverage of the rule, or any part thereof, for small entities.
---------------------------------------------------------------------------

    \229\ 5 U.S.C. 603(c).
---------------------------------------------------------------------------

    As noted above, we estimate that this proposed amendment would have
no impact on small entities. Thus, we do not believe it is necessary or
appropriate to establish different compliance or reporting requirements
or timetables; clarify, consolidate, or simplify compliance and
reporting requirements under the rule for small entities; use
performance rather than design standards, or any part thereof.
    The Commission also does not believe that it is necessary to
consider whether small entities should be permitted to use performance
rather than design standards to comply with the proposed amendments as
the amendments already

propose performance standards and do not dictate for entities of any
size any particular design standards (e.g., technology) that must be
employed to achieve the objectives of the proposed amendments.
8. Request for Comments
    We encourage the submission of comments to any aspect of this
portion of the IRFA. Comments should specify costs of compliance with
the proposed amendment and suggest alternatives that would accomplish
the objective of the proposed amendments.

D. Documentation of Risk Management Procedures

1. Reasons
    Requiring certain large broker-dealers to document their risk
management procedures would assist firms in ensuring adherence to their
established risk controls and regulators in reviewing the controls.
2. Objectives
    These proposed amendments are intended to strengthen the controls
certain large broker-dealers employ to manage risk. The intended result
of these proposed amendments is to lower systemic risk in the
securities industry by enhancing risk management.
3. Legal Basis
    Pursuant to the Exchange Act and, particularly, Sections 15 and 17
thereof, 15 U.S.C. 78o and 78q.
4. Small Entities Subject to the Rule
    Paragraph (c)(1) of Rule 0-10 \230\ states that the term ``small
business'' or ``small organization,'' when referring to a broker-
dealer, means a broker or dealer that had total capital (net worth plus
subordinated liabilities) of less than $500,000 on the date in the
prior fiscal year as of which its audited financial statements were
prepared pursuant to Rule 17a-5(d); \231\ and is not affiliated with
any person (other than a natural person) that is not a small business
or small organization.
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    \230\ 17 CFR 240.0-10(c)(1).
    \231\ 17 CFR 240.17a-5(d).
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    The Commission estimates that none of the broker-dealers that would
be subject to this proposed amendment would be ``small'' for the
purposes Rule 0-10.\232\ Therefore, these amendments should not have
any impact on ``small'' broker-dealers.
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    \232\ This estimate is based on FOCUS Report filings.
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5. Reporting, Recordkeeping, and Other Compliance Requirements
    These proposed amendments would require broker-dealers to document
any controls, procedures and guidelines they use for managing risk. The
proposed amendments do not require broker-dealers to implement
procedures. Rather, they require the documentation of any procedures
that are being used.
6. Duplicative, Overlapping or Conflicting Federal Rules
    We believe that there are no federal rules that duplicate, overlap
or conflict with the proposed amendments.
7. Significant Alternatives
    Pursuant to section 3(a) of the RFA,\233\ the Commission must
consider certain types of alternatives, including (1) the establishment
of differing compliance or reporting requirements or timetables that
take into account the resources available to small entities, (2) the
clarification, consolidation, or simplification of compliance and
reporting requirements under the rule for small entities, (3) the use
of performance rather than design standards, and (4) an exemption from
coverage of the rule, or any part thereof, for small entities.
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    \233\ 5 U.S.C. 603(c).
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    As noted above, these proposed amendments would have no impact on
``small'' broker-dealers. Thus, we do not believe it is necessary or
appropriate to establish different compliance or reporting requirements
or timetables; clarify, consolidate, or simplify compliance and
reporting requirements under the rule for small entities; or exempt
small entities from coverage of the rule, or any part thereof.
    The Commission also does not believe that it is necessary to
consider whether small entities should be permitted to use performance
rather than design standards to comply with the proposed amendments as
the amendments already propose performance standards and do not dictate
for entities of any size any particular design standards (e.g.,
technology) that must be employed to achieve the objectives of the
proposed amendments.
8. Request for Comments
    We encourage the submission of comments to any aspect of this
portion of the IRFA. Comments should specify costs of compliance with
the proposed amendment and suggest alternatives that would accomplish
the objective of the proposed amendments.

E. Amendments to the Net Capital Rule

1. Limitations on Withdrawal of Capital, Solvency, Expense Sharing,
Temporary Capital and Fidelity Bond Deductions
i. Reasons
    Some broker-dealers have excluded from their regulatory financial
reports certain liabilities that have been shifted to third-parties
that lack the resources--independent of the assets and revenue of the
broker-dealer--to pay the liabilities or have utilized infusions of
temporary capital. These practices obscure the true financial condition
of the broker-dealer and, thereby, impede the ability of regulators to
take proactive steps to reduce the harm to customers, counterparties
and clearing agencies that may result from the broker-dealer's failure.
    Currently, broker-dealers are required to take net capital charges
pursuant to self-regulatory organization rules relating to fidelity
bond deductions, but Rule 15c3-1 does not explicitly incorporate such
charges for purposes of computing net capital.
    In the past several years, a number of broker-dealers have sought
to obtain protection under the bankruptcy laws while still engaging in
a securities business. Permitting an insolvent broker-dealer to
continue to transact a securities business endangers its customers and
counterparties and places clearance organizations at risk.
    An important goal of the Commission is to protect the financial
integrity of the broker-dealer so that if the firm must liquidate it
may do so in an orderly fashion. Allowing a withdrawal of capital that
may jeopardize the financial integrity of a broker-dealer exposes
customers and creditors of the broker-dealer to unnecessary risk.
ii. Objectives
    The objective of these proposed amendments is to reduce systemic
risk to the securities industry associated with the failure of the
broker-dealer.
iii. Legal Basis
    Pursuant to the Exchange Act and, particularly, Sections 15 and 17
thereof, 15 U.S.C. 78o and 78q.
iv. Small Entities Subject to the Rule
    Paragraph (c)(1) of Rule 0-10 \234\ states that the term ``small
business'' or ``small organization,'' when referring to a broker-
dealer, means a broker or dealer that had total capital (net worth plus
subordinated liabilities) of less than $500,000 on the date in the
prior fiscal year as of which its audited financial

statements were prepared pursuant to Rule 17a-5(d);\235\ and is not
affiliated with any person (other than a natural person) that is not a
small business or small organization.
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    \234\ 17 CFR 240.0-10(c)(1).
    \235\ 17 CFR 240.17a-5(d).
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    The Commission estimates that there are approximately 915 broker-
dealers that are ``small'' for the purposes Rule 0-10.\236\ These
proposed amendments would apply to all ``small'' broker-dealers in that
they would be subject to the requirements in the proposed amendments.
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    \236\ This estimate is based on FOCUS Report filings.
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v. Reporting, Recordkeeping, and Other Compliance Requirements
    The proposed amendments would require an insolvent broker-dealer to
cease conducting a securities business and provide the securities
regulators with notice of its insolvency. They also would require
broker-dealers to add back certain liabilities and treat certain
capital as a liability, as well as require broker-dealers to deduct
from net capital, with regard to fidelity bonding requirements, the
excess of any deductible amount over the maximum amount permitted by
self-regulatory organization rules. Finally, under the proposed
amendment to the rule on Commission orders restricting withdrawals of
capital, a broker-dealer subject to an order would not be permitted to
withdraw any capital.
vi. Duplicative, Overlapping or Conflicting Federal Rules
    We believe that there are no Federal rules that duplicate, overlap
or conflict with the proposed amendments.
vii. Significant Alternatives
    Pursuant to section 3(a) of the RFA,\237\ the Commission must
consider certain types of alternatives, including (1) the establishment
of differing compliance or reporting requirements or timetables that
take into account the resources available to small entities, (2) the
clarification, consolidation, or simplification of compliance and
reporting requirements under the rule for small entities, (3) the use
of performance rather than design standards, and (4) an exemption from
coverage of the rule, or any part thereof, for small entities.
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    \237\ 5 U.S.C. 603(c).
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    Given the minimal impact these amendments will have on small
entities, we do not believe it is necessary or appropriate to establish
different compliance or reporting requirements or timetables; clarify,
consolidate, or simplify compliance and reporting requirements under
the rule for small entities; or exempt small entities from coverage of
the rule, or any part thereof.
    The Commission also does not believe that it is necessary to
consider whether small entities should be permitted to use performance
rather than design standards to comply with the proposed amendments as
the amendments already propose performance standards and do not dictate
for entities of any size any particular design standards (e.g.,
technology) that must be employed to achieve the objectives of the
proposed amendments.
viii. Request for Comments
    We encourage the submission of comments to any aspect of this
portion of the IRFA. Comments should specify costs of compliance with
the proposed amendment and suggest alternatives that would accomplish
the objective of the proposed amendments.
2. Adjusted Net Capital Requirements
i. Reasons
    The Commission's experience over the past several years in
overseeing the capital requirements of broker-dealers indicates that
certain capital charges may be adjusted downward without impairing the
goal of the net capital rule. These proposed amendments are a result of
this experience.
ii. Objective
    The proposed amendments are intended to better align the capital
requirements with the risks these requirements are designed to address.
iii. Legal Basis
    Pursuant to the Exchange Act and, particularly, Sections 15 and 17
thereof, 15 U.S.C. 78o and 78q.
iv. Small Entities Subject to the Rule
    Paragraph (c)(1) of Rule 0-10 \238\ states that the term ``small
business'' or ``small organization,'' when referring to a broker-
dealer, means a broker or dealer that had total capital (net worth plus
subordinated liabilities) of less than $500,000 on the date in the
prior fiscal year as of which its audited financial statements were
prepared pursuant to Rule 17a-5(d); \239\ and is not affiliated with
any person (other than a natural person) that is not a small business
or small organization.
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    \238\ 17 CFR 240.0-10(c)(1).
    \239\ 17 CFR 240.17a-5(d).
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    The Commission estimates that there are approximately 915 broker-
dealers that were ``small'' for the purposes Rule 0-10.\240\ The
amendment to Appendix A of Rule 15c3-1 likely should have no, or
little, impact on ``small'' broker-dealers, since most, if not all, of
these firms do not carry non-clearing option specialist or market maker
accounts. The reduction of the haircut for money market funds from 2%
to 1% could impact all ``small'' firms, since they may hold these
securities as part of their net capital.
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    \240\ This estimate is based on FOCUS Report filings.
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v. Reporting, Recordkeeping, and Other Compliance Requirements
    The proposed amendments would (1) make permanent a temporary rule
that reduced the haircut for non-clearing options specialist and market
maker accounts under Appendix A, and (2) lower the haircut for money
market funds from 2% to 1%. As noted, we estimate that generally only
the second proposed amendment would affect ``small'' broker-dealers.
vi. Duplicative, Overlapping or Conflicting Federal Rules
    We believe that there are no federal rules that duplicate, overlap
or conflict with the proposed amendments.
vii. Significant Alternatives
    Pursuant to section 3(a) of the RFA,\241\ the Commission must
consider certain types of alternatives, including (1) the establishment
of differing compliance or reporting requirements or timetables that
take into account the resources available to small entities, (2) the
clarification, consolidation, or simplification of compliance and
reporting requirements under the rule for small entities, (3) the use
of performance rather than design standards, and (4) an exemption from
coverage of the rule, or any part thereof, for small entities.
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    \241\ 5 U.S.C. 603(c).
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    Given the deregulatory impact of these amendments, we do not
believe it is necessary or appropriate to establish different
compliance or reporting requirements or timetables; clarify,
consolidate, or simplify compliance and reporting requirements under
the rule for small entities; or exempt small entities from coverage of
the rule, or any part thereof.
    The Commission also does not believe that it is necessary to
consider whether small entities should be permitted to use performance
rather than design standards to comply with the proposed amendments as
the amendments already propose performance standards and do not dictate
for entities of any size any

particular design standards (e.g., technology) that must be employed to
achieve the objectives of the proposed amendments.
viii. Request for Comments
    We encourage the submission of comments to any aspect of this
portion of the IRFA. Comments should specify costs of compliance with
the proposed amendment and suggest alternatives that would accomplish
the objective of the proposed amendments.

IX. Statutory Authority

    The Commission is proposing amendments to Rules 15c3-1, 15c3-3,
17a-3, 17a-4 and 17a-11 under the Exchange Act pursuant to the
authority conferred by the Exchange Act, including Sections 15, 17,
23(a) and 36.\242\
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    \242\ 15 U.S.C. 78o, 78q. 78w and 78mm.
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Text of Proposed Rule

List of Subjects in 17 CFR Part 240

    Brokers, Reporting and recordkeeping requirements, Securities.

    In accordance with the foregoing, the Commission hereby proposes
that Title 17, Chapter II of the Code of Federal Regulation be amended
as follows.

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

    1. The general authority for part 240 is revised to read as
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i,
78j, 78j-l, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5,
78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4
and 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless otherwise
noted.
* * * * *
    2. Section 240.15c3-1 is amended by:
    a. Revising the first sentence of the introductory text of
paragraph (a);
    b. Revising paragraph (a)(1)(ii)(A);
    c. Removing from paragraph (a)(6)(iii)(A) the text ``paragraph
(c)(2)(x)(A)(1) through (9) of this section'' and in its place adding
the text ``Appendix A (Sec.  240.15c3-1a)'';
    d. Revising the introductory text of paragraph (c)(2)(i);
    e. Adding paragraphs (c)(2)(i)(F) and (G);
    f. Revising paragraphs (c)(2)(iv)(B), (c)(2)(iv)(E), and
(c)(2)(vi)(D)(1);
    g. Adding paragraph (c)(2)(xiv) before the undesignated heading;
    h. Adding paragraph (c)(16) and an undesignated heading;
    i. Revising paragraph (e)(3)(i); and
    j. Removing from the second sentence in paragraph (e)(3)(ii) the
text ``The hearing'' and in its place adding the text ``A hearing on an
order temporarily prohibiting the withdrawal of capital''.
    The revisions and additions read as follows:

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

    (a) Every broker or dealer shall at all times have and maintain net
capital no less than the greater of the highest minimum requirement
applicable to its ratio requirement under paragraph (a)(1) of this
section, or to any of its activities under paragraph (a)(2) of this