ACI FinOps for broker dealers

SEC Footnote 74 Provides Alternative for Broker-Dealers Who Don’t Hold Customer Funds

The SEC recently provided non-carrying broker dealers with an alternative option as to how they can maintain their exemptive status under SEC Rule 15c-3-3. 

ACI Managing Partner, Jay Gettenberg, has worked closely with the Public Company Accounting Oversight Board  (PCAOB)  and FINRA in recent years to address the practical reality that there are FINRA member firms who do not hold customer funds, yet do not technically qualify under any of the four exemptions listed on the X-17A-5 Focus Report. These firms historically have been electing the k(2)(i) exemption, which effectively was the least incorrect option. 

To address the situation, the SEC issued Footnote 74 in July, providing a much needed alternative, specifically for firms engaging in capital raising activities (often Capital Acquisition Brokers). The guidance refers to such broker-dealers as “Non-Covered Firms.”  Non-Covered Firms that solely engage in Non-Covered Firm activities are no longer characterized as exempt under Rule 15c3-3(k), and thus no longer subject to any Rule 15c3-3 requirements, according to the footnote. Any broker-dealer that determines itself to be a Non-Covered Firm engaging in Non-Covered Firm activities may ask FINRA to amend its FINRA membership agreement to reflect this change.

Proposed Amendment

Mr. Gettenberg, while calling the new guidance “a great step by the SEC,” stills hopes additional clarity can be provided.  He said one step could be to amend the Focus Report to include SEC Footnote 74 as one of the exemption boxes that can be checked by member firms in the preparation and submission of their regulatory filings.  As currently proposed, the expectation is that these firms will claim no exemption, but still be exempt.  It would make sense to provide a formal box for the Footnote 74 exemption, so firms can formally state their exemption on these mandatory submissions.

Advocating a Simpler Solution

Mr. Gettenberg continues to advocate for a simpler solution for the implementation and use of this rule. He has proposed to the FINRA Small Firm Advisory Committee and various other regulatory committees that firms should be allowed to simply select “exempt” or “non-exempt,” without needing to specify the reason for which an exemption is applicable. This would particularly make sense if the SEC is going to offer firms an exemption option that is not listed in the current exemption section of the filings. He believes that restating a common-sense approach to regulation will be the basis for effective change in the future.

ACI and Mr. Gettenberg appreciate the work the SEC and FINRA have done to help firms handle this situation and hope progress on the issue will continue.

Footnote 74 Details

On July 1, 2020, the SEC and FINRA issued guidance on the characterization of U.S. registered broker-dealers under Securities Exchange Act Rule 15c3-3. In the past, FINRA required all broker-dealers to claim an exemption under Rule 15c3-3, as provided in paragraph (k), in their membership agreements even when their business activities did not require the exemption.

This might include broker-dealers who:

  • Don’t carry accounts of or for customers
  • Don’t receive customer funds or securities, or self-clear customer transactions through a separate account
  • Don’t receive or hold funds or securities for customers, either directly or indirectly, or otherwise owe such funds and securities to customers
  • Don’t carry proprietary accounts of other broker-dealers

The July guidance refers to such broker-dealers as “Non-Covered Firms.” The guidance states that Non-Covered Firms that solely engage in Non-Covered Firm activities are no longer characterized as exempt under Rule 15c3-3(k), and thus no longer subject to any Rule 15c3-3 requirements. Such broker-dealers no longer can claim the exemption from the rule in their FINRA membership agreements, FOCUS report filings, and annual exemption reports as required under the provisions of Exchange Act Rule 17a-5.

Any broker-dealer who determines it is a Non-Covered Firm engaging in Non-Covered Firm activities may ask FINRA to amend its FINRA membership agreement to reflect this change. The broker-dealer should state in this request that it is not required to comply with Rule 15c3-3 by reason of the SEC’s guidance set forth in circumstances described in footnote 74 to Exchange Act Release No. 34-70073 (July 30, 2013). Such broker-dealers generally include:

  • Private placement agents that effect securities transactions on a best efforts or subscription basis (not on a firm commitment basis) and don’t receive or hold customer funds or securities
  • Merger and acquisition advisory firms that refer securities transactions to other broker-dealers
  • Broker-dealers that provide technology or platform services and do not receive or hold customer funds or securities

The guidance also states that broker-dealers who engage in business activities that fit within the paragraph (k) exemption will continue to be exempt. These broker-dealers are not required to change their FINRA membership agreement unless they at some point restrict their business activities to those of a Non-Covered Firm.

Going forward, Non-Covered Firms will have to file annual exemption reports and periodic FOCUS reports differently. Firms that no longer need to claim a Rule 15c3-3 exemption with respect to Non-Covered Firm activities should describe their business activities in their exemption reports and also state that, during the reporting period, they:

  • Didn’t directly or indirectly receive, hold, or otherwise owe funds or securities for or to customers other than money or other considerations received and promptly transmitted in compliance with paragraph (a) or (b)(2) of Exchange Act Rule 15c2-4
  • Didn’t carry accounts of or for customers
  • Didn’t carry broker-dealer proprietary accounts as defined in Exchange Act Rule 15c3-3

Also, a Non-Covered Firm should no longer indicate in its FOCUS report that it is claiming an exemption from Rule 15c3-3 with respect to Non-Covered Firm activities. Specifically, Items 4550, 4560, 4570 and 4580, Part II or Part IIA, under “Exemptive Provision under Rule 15c3-3” should be left blank.

ACI will provide updates on our Resources page as we continue to work with the SEC and FINRA to simplify FOCUS report filings