Segregation of Assets and Customer Protection
Regulatory Obligations and Related Considerations
Exchange Act Rule 15c3-3 (Customer Protection Rule) imposes certain requirements on firms that are designed to protect customer funds and securities. Firms are obligated to maintain custody of customer securities and safeguard customer cash by segregating these assets from the firm’s proprietary business activities, and promptly deliver to their owner upon request. Firms can satisfy this requirement by either keeping customer funds and securities in their physical possession, or in a good control location that allows the firm to direct their movement (e.g., a clearing corporation).
- What is your firm’s process to prevent, identify, research and escalate new or increased deficits which are in violation of the Customer Protection Rule?
- What controls does your firm have in place to identify and monitor its possession or control deficits, including the creation, cause and resolution?
- If your firm claims an exemption from the Customer Protection Rule and it is required to forward customer checks promptly to your firm’s clearing firm, how does your firm implement consistent processes for check forwarding and maintain accurate blotters to demonstrate that checks were forwarded in a timely manner?
- How does your firm train staff on Customer Protection Rule requirements?
- What are your firm’s processes to confirm that your firm correctly completes its reserve formula calculation and maintains the amounts that must be deposited into the special reserve bank account(s)?
- If your firm is engaging in digital asset transactions, what controls and procedures has it established to support facilitation of such transactions, including initial issuance or secondary market trading of digital assets? Has the firm analyzed these controls and procedures to address potential concerns that they may be viewed as a custodian (i.e., holding or controlling customer property)?
Exam Findings and Effective Practices
- Inconsistent Check-Forwarding Processes – Not implementing consistent processes for check forwarding to comply with an exemption from the Customer Protection Rule.
- Inaccurate Reserve Formula Calculations – Failing to correctly complete reserve formula calculations due to errors in coding because of limited training and staff turnover, challenges with spreadsheet controls, limited coordination between various internal departments and gaps in reconciliation calculations.
- Omitted or Inaccurate Blotter Information – Maintaining blotters with insufficient information to demonstrate that checks were forwarded in a timely manner and inaccurate information about the status of checks.
- Legal and Compliance Engagement – Collaborating with legal and compliance departments to confirm that all agreements supporting control locations are finalized and executed before the accounts are established and coded as good control accounts on firms’ books and records.
- Addressing Conflicts of Interest – Confirming which staff have system access to establish a new good control location and that they are independent from the business areas to avoid potential conflicts of interest; and conducting ongoing review to address emerging conflicts of interest.
- Reviews and Exception Reports for Good Control Locations – Conducting periodic review of and implementing exception reports for existing control locations for potential miscoding, out-of-date paperwork or inactivity.
- Check-Forwarding Procedures – Creating and implementing policies to address receipt of customer checks, checks written to the firm, and checks written to a third party.
- Check Forwarding Blotter Review – Creating and reviewing firms’ check received and forwarded blotters to confirm that they are up to date, and including the information required to demonstrate compliance with the Customer Protection Rule exemption.
- Customer Protection – Reserves and Custody of Securities (SEA Rule 15c3-3)
- U.S. Securities and Exchange Commission, Custody of Digital Assets Securities by Special Purpose Broker-Dealers, Exchange Act Release No. 90,788 (Dec. 23, 2020)
- U.S. Securities and Exchange Commission, No-Action Letter to FINRA re: ATS Role in the Settlement of Digital Asset Security Trades (Sept. 25, 2020)
Credit Risk Management
Credit Risk Management