September 25, 2022

Volume XII, Number 268


September 23, 2022

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September 22, 2022

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SEC Staff Issues No-Action Relief Addressing Customer Protection Rule Violations Despite the Objection of Two Commissioners

On October 22, the staff of the Division of Trading and Markets of the Securities and Exchange Commission (DTM) issued a no-action letter (the No-Action Letter) to the Financial Industry Regulatory Authority (FINRA) providing time-limited relief for broker-dealers operating fully paid lending programs (FPL Programs) in which they borrow fully paid and excess margin securities from their customers without complying with the requirement that the broker-dealer physically deliver collateral supporting the loan to the customer making the loan. Paragraph (b)(3) of SEC Rule 15c3-3 (the customer protection rule) requires that a broker-dealer that borrows fully paid or excess margin securities from a customer enter an agreement with such customer that requires the broker-dealer to:

  1. provide the lender with appropriate forms of collateral that fully secures the loan (cash, US Treasury bills or notes, an irrevocable letter of credit issued by a bank, or such other collateral as the Commission designates as permissible);

  2. mark the loan to market not less than daily and provide additional collateral as necessary; and

  3. notify the lender that the provisions of the Securities Investor Protection Act of 1970 may not protect the lender (meaning collateral delivered to the lender may be the only means of satisfaction of the broker-dealer’s obligation to return the securities).

Rather than transferring actual physical possession of collateral to customers, some broker-dealers are depositing the required collateral into accounts at the broker-dealer or in omnibus accounts at a bank in the name of the broker-dealer. The DTM Staff views this arrangement as impermissible because it permits the broker-dealer to retain control over the collateral that is used to secure their borrowings of fully paid and excess margin securities.

The DTM staff is now granting time-limited relief for the requirement in paragraph (b)(3) of Rule 15c3-3 that a broker-dealer physically deliver to the customer, collateral that fully secures the loan (i.e., by delivering the collateral away from the broker-dealer). To rely on the No-Action Letter, the broker-dealer must have an FPL Program that was in existence before October 22; adhere to all other aspects of Rule 15c3-3(b)(3); and comply with Rule 15c3-3(b)(3) as soon as practicable (but in no event later than April 22, 2021).

Promptly following the issuance of the No-Action Letter, on October 23, SEC Commissioners Allison Herren Lee and Carolina A. Crenshaw issued a joint response letter criticizing the DTM staff’s reliance on no-action relief as a mechanism to remediate violations of the customer protection rule. While the Commissioners agree that the practices described in the No-Action Letter are inconsistent with the customer protection rule, Commissioners Lee and Crenshaw indicate that no-action relief should be granted to clarify gray areas of regulation and should not be used to “provide a grace period for compliance with clear violations of law.” The commissioners suggest that violations that put investor funds directly at risk “should be remediated without delay.”

The No-Action Letter is available here. The Commissioners’ joint statement is available here.

©2022 Katten Muchin Rosenman LLPNational Law Review, Volume X, Number 304

About this Author

Michael T. Foley, Katten, Lawyer, Finance, FINRA, Chicago
Special Counsel

Michael Foley represents broker-dealers, investment advisers and other financial services industry participants with respect to a broad spectrum of legal and regulatory matters arising under the federal securities laws.

Michael has nearly 20 years of experience in private practice and in-house at both a large, full-service broker-dealer and at an online discount broker-dealer, advising broker-dealers and other financial institutions regarding compliance with the federal securities and commodities laws, and with the regulations of the US Securities and Exchange...

Laura Krcmaric, Financial Services Attorney, Katten Law Firm

Laura Krcmaric represents clients in the financial services industry, focusing on regulatory and compliance work. Prior to joining Katten, Laura served as counsel for Credit Suisse, where she provided advice to the private banking and wealth management division. She also was an honors intern with the Securities and Exchange Commission.

While in law school, Laura served as a staff member and symposium editor for the North Carolina Law Review. She also was a member of the Community Development Law Clinic, representing nonprofit organizations.