Time’s Up! Broker-Dealers Must Comply with the Customer Protection Rule When Borrowing Customer Securities

On April 16, 2021, the staff of the SEC Division of Trading and Markets reminded broker-dealers borrowing fully paid and excess margin securities from their customers (FPL programs) that they are obligated to comply with Exchange Act Rule 15c3-3 (Customer Protection Rule), and in particular, paragraph (b)(3).  This reminder was a follow up to a no-action letter (NAL) the staff issued to FINRA in mid-October 2020.  The NAL was unusual for several reasons.  First, it was a “temporary position” of the staff that was backwards-looking rather than relating to some new business proposed by a firm or an interpretation of whether certain existing activity was consistent with applicable laws or regulations.  Second, the NAL acknowledged that some firms are not complying with the Customer Protection Rule in relation to their FPL programs (including by failing to physically turn over the collateral to the customer/lender and therefore retaining control over the collateral).[1]  Finally, the NAL essentially provided a six-month grace period within which firms could bring their FPL programs into compliance.

Firms operating FPL programs should be mindful of the requirements in the Customer Protection Rule, that the NAL grace period ends on April 22, 2021, and that SEC Examinations staff will likely have this issue on their radar during future exams.

[1] At issue is Rule 15c3-3(b)(3), which requires, in part, that a broker-dealer borrowing fully paid or excess margin securities from a customer enter into a written agreement with the customer/lender that, at a minimum, specifies that the broker-dealer must: (1) provide the customer/lender collateral to fully secure the loan, such collateral consisting of cash, U.S. Treasury bills or notes, an irrevocable letter of credit issued by a bank, or other collateral the SEC deems permissible; (2) mark the loan to market at least daily and provide additional collateral as necessary to fully collateralize the loan; and (3) notify the customer/lender that the provisions of the Securities Investor Protection Act may not protect the customer/lender and, therefore, that the collateral delivered to the customer/lender may constitute the only source of satisfaction of the broker-dealer’s obligation to return the securities in the event the broker-dealer fails to return them.