Regulatory update for broker-dealers

Aug 23, 2020
Aug 23, 2020
0 min. read
Audit Financial reporting SEC matters Capital markets

Several regulations affecting broker-dealers (BDs) recently have been issued or updated. The following are highlights of and reminders about these important regulations:

Regulation Best Interest: The Broker-Dealer Standard of Conduct

Regulation Best Interest: The Broker-Dealer Standard of Conduct established a new standard of conduct for BDs and natural persons who are associated persons of a BD (associated persons) when making a recommendation of any securities transaction or investment strategy involving securities (including account recommendations) to a retail customer. When making such a recommendation to a retail customer, the BD and associated persons must act in the best interest of the retail customer at the time the recommendation is made, without placing their financial or other interest ahead of the retail customer’s interests. The compliance date for this general obligation was June 30, 2020, upon which the BD and associated persons must have created or updated the necessary disclosures, policies, procedures and systems, as appropriate, to achieve compliance with Regulation Best Interest.

This general obligation is satisfied only if the BD and associated persons comply with four specified component obligations:

  • Disclosure obligation: Provide certain required disclosure, before or at the time of the recommendation, about the recommendation and the relationship between the BD/associated person and the retail customer;
  • Care obligation: Exercise reasonable diligence, care and skill in making the recommendation;
  • Conflict-of-interest obligation: Establish, maintain and enforce written policies and procedures reasonably designed to address conflicts of interest; and
  • Compliance obligation: Establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.

The standard also introduces new record-making and recordkeeping requirements.

Regulation Best Interest does not apply to investment advice provided to a retail customer by a dual-registrant when acting in the capacity of an investment adviser, even if the retail customer has a brokerage relationship with the dual-registrant or the dual-registrant executes the transaction in a brokerage capacity. A “retail customer” is a natural person, or the legal representative of such person, who (a) receives a recommendation of any securities transaction or investment strategy involving securities from a broker, dealer or a natural person who is an associated person of a broker or dealer; and (b) uses the recommendation primarily for personal, family or household purposes. The determination of whether a broker-dealer has made a recommendation that triggers application of Regulation Best Interest is based on the facts and circumstances of the particular situation and therefore is not determined by a bright line rule or test.

The following provide additional guidance regarding Regulation Best interest:

SEC FAQ: Multiple exemptions and Non-Covered Firms

Non-carrying BDs may have multiple business activities with customers and therefore may be able to claim exemption from Rule 15c3-3 under more than one of the paragraphs of Rule 15c3-3 (for example, paragraphs (k)(2)(i) and (k)(2)(ii)). In July 2020, the SEC clarified (in Question 12 of the related SEC FAQ) that the BD should identify all paragraphs of Rule 15c3-3 under which the BD claims exemption from Rule 15c3-3 in its exemption report. The BD should reflect all such exemption provisions supporting its claim in the exemption report, and should also identify any applicable exceptions under each. In such a situation, the BD should indicate on its FOCUS Report each exemption provision in Rule 15c3-3(k)(2) it is relying on to claim an exemption from the rule, as applicable.

The SEC also clarified (in Question 8 of the FAQ) that a BD is considered a “Non-Covered Firm” if it meets the following:

  • Directly or indirectly receives, holds, or otherwise owes funds or securities for or to customers (other than money or other consideration received and promptly transmitted in compliance with paragraph (a) or (b)(2) of Rule 15c2-4);
  • Carries accounts of or for customers; or
  • Carries PAB accounts (as defined in Rule 15c3-3).

A Non-Covered Firm that limits its business activities to one of more of the following activities may file an exemption report:

  • Proprietary trading
  • Effecting securities transactions via subscriptions
  • Receiving transaction-based compensation for identifying potential merger and acquisition opportunities for clients, referring securities transactions to other broker-dealers, or providing technology or platform services
  • Participating in distributions of securities (other than firm commitment underwritings) in accordance with the requirements of paragraphs (a) or (b)(2) of Rule 15c2-4
  • Engaging solely in activities permitted for capital acquisition brokers

A Non-Covered Firm should include in its exemption report a description of its business activities and a statement that it (1) did not directly or indirectly receive, hold, or otherwise owe funds or securities for or to customers; (2) did not carry accounts of or for customers; and (3) did not carry PAB accounts. In addition, a Non-Covered Firm should not indicate in the FOCUS Report that it is claiming an exemption, and Items 4550, 4560, 4570 and 4580 of the FOCUS Report should be left blank.

Rules 17h-1T and 17h-2T

Exchange Act Rules 17h-1T and Rule 17h-2T require a BD to maintain and preserve certain records related to its organizational structure and affiliates and to file Form 17-H with the SEC on a quarterly basis. Effective June 29, 2020, the SEC issued an order to update the filing threshold for Form 17-H filings if the BD:

  • Does not hold funds or securities for, or owe money or securities to, customers;
  • Does not carry the accounts of or for customers (or that is exempt from Rule 15c3-3 pursuant to paragraph (k)(2) of that rule);
  • Maintains total assets of less than $1 billion; and
  • Maintains capital, including debt subordinated, of less than $50 million (increased from $20 million)

Quarterly securities count of physical certificates under Rule 17a-13

Due to the COVID-19 pandemic, the SEC Division of Trading and Markets has provided that it will not recommend an enforcement action if a BD is unable to conduct a physical securities count from April through December of 2020 if such BD:

  • Notifies the SEC’s Office of Compliance Inspections and Examinations by email at and notifies the BD’s FINRA Risk Monitoring Analyst of (a) the nature of the problem it will have conducting a physical count and (b) an estimate of the number and value of physical certificates that cannot be counted; and
  • Makes and retains a bookkeeping summary of the movements of physical certificates that are received or delivered and were not counted during the impacted period to assist the firm in performing an accurate count once the impacted period passes.

FINRA relief: Net capital treatment of covered loans under the CARES Act

Section 1106(b) of the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) provides that a recipient of a covered loan (as defined in Section 1106(a)(1)) is eligible for forgiveness of indebtedness on the covered loan in an amount (the Forgivable Expense Amount) equal to the sum of the following costs incurred and payments made during the eight-week period beginning on the date of the origination of the covered loan:

  • Payroll costs (as defined in Section 1106(a)(8));
  • Any payment of interest on any covered mortgage obligation (as defined in Section 1106(a)(2)), which shall not include any prepayment of or payment of principal on a covered mortgage obligation;
  • Any payment on any covered rent obligation (as defined in Section 1106(a)(4)); and
  • Any covered utility payment (as defined in Section 1106(a)(5)).

FINRA relief has provided that a member firm that has included a covered loan as a liability on its balance sheet may add the Forgivable Expense Amount back to net capital to the extent the firm has recorded expenses for the costs and payments making up the Forgivable Expense Amount, provided that the add-back to net capital may not exceed the amount of the balance sheet liability for the covered loan that the firm reasonably expects to be forgiven pursuant to Section 1106 (taking into account, among other matters, the limits under Section 1106(d) on the amount of forgiveness). Since the add-back cannot be greater than the balance sheet liability for the covered loan, the add-back cannot increase net capital by more than the balance sheet liability for the covered loan.

A member firm that makes such an add-back must create and retain documentation of the basis of the add-back, including a record of its computation of the Forgivable Expense Amount, a record of the costs and payments making up that amount, and a record of its estimate of any limits under Section 1106(d) with the basis for such estimate. In the firm’s FOCUS Reports, the add-back must be reported in Item 3525, “Other (deductions) or allowable credits.”

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Audit Financial reporting SEC matters Capital markets

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