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Series 27 > Customer Funds > Flashcards

Customer Funds Flashcards

1
Q

What is the purpose of the customer protection rule 15c3-3 (2)

A
  1. To ensure that BD’s always have sufficient funds on hand to meet customer claims in a liquidation.
  2. For BD to promptly obtain possession or control of securities on settlement
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2
Q

Special reserve weekly requirement for clearing BD’s

A

To perform a weekly computation comparing the amount that customers owe the firm (customer debits) to what the firm owes customers (customer credits)

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3
Q

Major items included in the reserve computation are:

A

Customer debits
1. *Debit balances in customer accounts
2. *Fails to deliver for customer accounts, not over 30 days
3. *Stock borrowed for customer accounts
4. Margin required and on deposit with options clearing corp for customer positions

Customer credits
1. *Credit balances in customer accounts
2. *Fails to receive for customer accounts
3. *Stock loaned from customer accounts
4. *Bank loans using customer collateral
5. *Credit bal’s in firm accounts arising from short sales to customers
6. *MV of short securities count differences over 30 days

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4
Q

What is a PAB reserve account

A

Proprietary account of broker dealer reserve

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5
Q

What is needed from the bank when opening a special reserve or PAB account?

A

Written notice that the bank:

1, was informed that all cash and qualified securities (treasuries) deposited will be held for the benefit of the customers and account holders of the BD
2. will, at no time, use the cash or qualified securities separate from any other accounts maintained by the BD
3. will not permit the cash or qualified securities to be subject to any right, charge, security interest, lien, claim of any kind in favor of the bank or any person claiming through the bank

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6
Q

What can be deposited into a special reserves account (2)

A

Cash
U.S government guaranteed securities (treasuries and ginnie maes)

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7
Q

What is the haircut rules for government guaranteed securities

A

They are not subject to haircuts therefore are 100% included for reserve deposit purposes

However they will be haircutted for NC requirements

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8
Q

What is the rules when depositing to an affiliated bank

A

Cash has no value for reserve deposit purposes

Qualified securities do count toward the reserve deposit (harder to misappropriate)

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9
Q

What is the unaffiliated bank equity capital rule when depositing cash

A

Cash deposits cannot exceed 15% of the banks equity capital, as reported by the bank in its most recent quarterly call report

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10
Q

What is the rule on cash deposits for a US branch of a foreign bank

A

They are not eligible to hold customer reserve cash deposits unless a special exemptive order is obtained

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11
Q

Bank deposit weekly requirement

A

If a deposit is required, it must be made by 1 hour after bank opening, 2 business days following the computation

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12
Q

Rule when computing AI for ratio purposes for customer funds on deposit in reserve

A

AI/NC ratio purposes: Deduct the lessor of required deposit or amount on deposit.

Funds on deposit in special reserve bank account are deducted from aggregate indebtedness when computing AI/NC.

If there are funds on deposit in excess of the required amount, only the required can be deducted.

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13
Q

If a firm is in solid financial shape what is the alternative computation cadence they are allowed to take (and what defines solid shape)

A

Solid financial shape:
1. cannot have credits in customer accounts in excess of 1mil
2. AI/NC ratio cannot exceed 8:1

Firm can elect to compute monthly instead of weekly. Firm must deposit 105% of any calculated amount.

If AI/NC ratio exceeds 8:1 at any time, it must resume weekly computations. 4 consecutive weeks at 8:1 must pass before they can resume monthly

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14
Q

What is required if a firm fails to make a deposit to the special reserve bank

A

It must give immediate electronic notice to FINRA and SEC. Then promptly confirm the electronic notice in writing.

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15
Q

Exemptions from the requirement to maintain a special reserve bank account

A
  1. K1 exemption: mutual fund BD’s
    -solely handle investment company shares
    -accepting subscriptions = 5k NC required
    -accepting wires = 25k NC required
  2. K2 exemption: No margin accounts; all customer trades through reserve a/c
    - Firm does not lend funds for trade
    - Customer monies are always segregated in a ‘special bank account for benefit of customers’
    - Firm promptly transmits all customer funds and securities to clearing firm
    -NC requirement = 100k
  3. Omnibus arrangements
    -when introducing BD does not fully disclose names of customers then = omnibus
    -Introducing BD sends confirmations to customers
    Customer funds are transmitted to introducing firm who transmits to clearing firm
    -NC requirement = 100k
  4. K2-ii Exemption: Fully Disclosed BD’s
    -non-clearing, fully disclosed BD’s that neither receive nor hold customer funds, NC = 5k
    - Fully disclosed BD’s that receive but do not hold customer funds, NC = 50k
    -BD that trade for their own account, NC = 100k
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16
Q

Generally speaking, which BD’s are the only ones that are required to maintain a reserve account

A

250k BD’s carrying customer accounts

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17
Q

What is included and excluded in customer debits (customer control)

A

-both cash and margin debit balances
-Any doubtful of collection amounts must be excluded
-Partially secured doubtful amounts on 2nd Reg T extension must by marked to market and a 15% haircut is taken
-Debit balances of non-customers excluded (partners, officers, family members, other BD, subordinate lenders)

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18
Q

What is the reduction that needs to be taken when calculating the reserve and why

A

1% reduction of “good” customer debits

This is taken to reflect any potential loss to the BD from “bad” customer debits

Firms using alterative method of computing NC: 3% reduction of ALL debits in the reserve

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19
Q

What happens when securities used as collateral for customer debits are concentrated in any one non-exempt security

A

The debit balance used for reserve computation must be haircutted

Concentration = 15% of ALL securities collateral on customer debits

Haircut = non-exempt security over the concentration amount/140%

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20
Q

Difference between NC undue concentration and Special reserve undue concentration

A

NC: an undue concentration exists if any single position (except for treasuries and agencies) exceeds 10% of tentative NC

Customer reserve: an undue concentration exists if collateral backing customer debits (except treasuries, agencies, municipals) exceeds 15% of MV of ALL customer collateral pledged

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21
Q

Margin account customer debit concentration rule

A

If a single customer debit is > 25% of tentative NC, the excess is deducted from customer debits in reserve computation

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22
Q

How are credit balances in the firms proprietary accounts treated in the reserve calc

A

Any credit balances in the firm accounts that are related to customer short sales are included as a credit in the reserve calc

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23
Q

How are customer fails to receive treated in the reserve calc

A

These security positions are owed to the customer.

They are included as a normal credit. At 30 days old the contract value must be increased to the current market price, if the values have risen.

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24
Q

How are short securities differences treated in the reserve calc

A

If the short security differences are 30 calendar days old or more they must be included as a credit in the formula.

At 45 days the differences immediately bought.

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25
Q

Reserve account formula - how much is required to be on deposit

A

Weekly computation: Credits (liabilities) - Debits (Assets)

Monthly computation: Credits - Debits + 5%

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26
Q

When can withdrawals of excess funds be made on the reserve account

A

No later than 1 hour after the banks open on the 2nd business day after computation.

Computations can be made more that once weekly. Records of that computation must be kept.

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27
Q

when is there no requirement to make a new computation when withdrawing funds from the special reserve account (4)

A
  1. Qualified securities withdrawn are being replaced with other qualified securities at or prior to the withdrawal
  2. Used exclusively for deposit of funds remitted to a mutual fund sponsor to buy mutual funds. Must be withdrawn and remitted by 12 noon on the next business day
  3. Used exclusively for deposit of funds for customer IRA and retirement contributions. Must be withdrawn only to buy mutual funds or other qualified investments for retirement purposes.
  4. If a substantial (25% of all credit items) deposit is made for specific purpose that will deplete the deposit.
    - Funds must be segregated from other funds
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28
Q

What is the definition of possession and control

A

The firm physically has the security or the firm knows the whereabouts of the security

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29
Q

What are items that the firm must maintain in its possession and control

A

Fully paid securities
Excess margin securities (in excess of 140% of customer debits

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30
Q

What are excess margin securities

A

are those in excess of the maximum amount (140%) allowed to be rehypothecated to a bank

customer share purchase value - (customer debit on the account * 140%) = excess margin security

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31
Q

What is the rehypothecation limit on customer securities pledged to a bank

A

140% of customer debit balances

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32
Q

When is a security considered to be in possession or control (6)

A

If the certificates are in:

  1. the custody of the firm or clearing corp
  2. an omnibus account at a clearing BD in compliance with regulation T
  3. the custody of a bank which has provided written acknowledgment that the securities are not subject to liens or claims
  4. the custody of a foreign depository or bank that has been designated a satisfactory control location
  5. transfer for not more than 40 days (if more than 40 days, issuer can provide a written statement verifying they are still in transfer)
  6. transit between offices of BD (no more than 5 business days)
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33
Q

Computation requirement if firm has fully paid or excess margin securities in its possession or control

A

Daily computation, as of the preceding days close

Must know the quantity of fully paid and excess margin securities that should be in its possession or control.

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34
Q

If it’s founds that securities that should be in a firms possession or control are not, what are the required actions

A

on the next business day the firm must:

  1. Issue instructions to the BD’s holding the securities subject to a lien to return them within 2 business days
  2. Securities that were loaned to another BD must be returned within 5 business days of instructions
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35
Q

What is required if securities that are supposed to be in possession or control are not returned (5)

A
  1. Securities >30 days old: promptly buy in any securities failed to receive. Alternatively, securities can be borrowed
  2. Stock splits or dividends >45 days old: take prompt steps to obtain or borrow securities to be received from stock splits or dividends
  3. Naked short sales >30 days old: Mandatory buy-in or borrowing of securities where BD failed to deliver on settlement

FINRA wording: “close out of short positions that allocate to customer long positions”

  1. Short securities differences >45 days old: Buy in (no borrowing allowed)
  2. Customer fails to deliver >10 days old: Buy in (no borrowing allowed)
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36
Q

Minimum net capital in reserve required for alternative method

A

Must maintain a min NC = to the greater of 250,000 or 2% of debits in customer reserve

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37
Q

What type of broker can use the Alternative method for computing net capital

A

Clearing brokers that hold customer funds or securities

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38
Q

When does early warning start for BD’s using the alternative method for NC

A

Early warning starts if NC falls below 5% of debits in reserve

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39
Q

What is hypothecation

A

When an asset is pledged as collateral to secure a loan

40
Q

What does securities held in street name mean

A

A security is held in street name when a BD holds it on behalf of the customer. The name that appears on the certificate is the BD but the customer retains ownership rights

facilitates speedy trading and reduces trading costs

41
Q

What does Regulation U dictate

A

A bank can loan 70% on equity securities to a BD

42
Q

What are the rules for BD’s under 15c2-1 (3)

A
  1. Cannot obtain loans in excess of funds lent to customers
  2. Cannot commingle firm and customer securities
  3. No cross liens on customer securities
    (Only a one-way lien is permitted)
43
Q

What must a firm do when hypothecating securities to a bank

A

must give written statement to the bank that the security pledged is carried for the account of a customer and that the provisions of rule 15c2-1 is not being violated

44
Q

What actions must a firm take if they find that collateral pledged to the bank exceeds 140% of customer debit balances

A

It must remove the excess collateral no later than 1/2 hour after the banks open on the next business day

45
Q

What is the firm’s obligation when receives dividends on rehypothecated shares from the issuer (in street name)

A

The firm is obligated to credit these dividends to the customers that actually own the shares

46
Q

What are customer free credit balances (2)

A

Uninvested cash arising from dividends and interest received.

Sales of securities

47
Q

What are sweep programs

A

Customer free credit balances that are swept into interest earning vehicles such as money market funds or deposit accounts at FDIC insured banks

48
Q

What is the BD obligation to the customer when enrolling it into a sweep program (3)

A

Must notify the customer of:
1. general terms of investment products under the program
2. the BD may change the products available
3. Customer must give written consent to have their free credits swept through the sweep program

49
Q

Notice required to customer for changes to sweep program

A

30 days advance notice

adding or deleting or switching products

50
Q

What is rule 15c2-1

A

Handles rules around hypothecation of customer securities

51
Q

What is rule 15c2-4

A

Rules for transmission or maintenance of payments received in connection with underwritings

52
Q

Details of 15c2-4 (4)

A

-applied solely to best efforts
-BD only acts as an agent for the issuer
-prohibits BD’s participating in best efforts underwritings from accepting funds from customers unless:
the funds are promptly transmitted
-all or none underwriting checks are payable to an escrow agent that is a bank. Monies are forwarded to issuer

Rule does not apply to commitment underwritings

53
Q

What is rule 17a-13

A

Physical counts of securities

54
Q

What is the rule under 17a-13

A

-clearing BD’s must perform a quarterly count of securities in possession or control and reconcile with books (box count)

55
Q

Cyclical count rules under 17a-13

A
  • must be performed no earlier than 2 months from preceding count
    and
    -no later than 4 months from preceding count
56
Q

To prevent fraud, who is to count the securities in possession under 17a-13

A

Performed or supervised by a person who does not have control over the physical custody of the securities or records

57
Q

What are the requirements of a security count under 17a-13 (4)

A

All securities:

  1. held must be physically examined and counted
  2. in transfer, transit, pledged, loaned, borrowed, failed to receive, failed to deliver which are subject to control but not possession must be accounted for by examination of ledger and control accounts
  3. taken as collateral for repurchase or reverse repurchase agreements must be accounted for by examination or ledger and control accounts
  4. positions not in possession stated above, but in a control location, must be verified if more than 30 days

Exam note: securities in reclamation are not included in the list of items to be counted

58
Q

What if there are unresolved differences found as a result of the securities count?

A

Differences must be recorded on the books and records of BD no later than 7 business days

59
Q

What if there are short securities differences found as a result of the securities count? (counted as capital)

A

The value of the missing securities must be haircutted out of NC on an increasing scale. (25, 50, 75, 100)

After 45 days have passed, securities must be bought in.

60
Q

What if there are long securities differences found as a result of the securities count

A

meaning - there are more securities present than the amount recorded on books

Firm not allowed to add the positions to NC.

Firm must straighten out its books and find the true owner of the securities

61
Q

What if long securities differences are sold (NC)

A

NC must be reduced by the sale amount. SEC disallows this increase to NC

62
Q

What does the Securities investor protection act of 1970 do?

A

Protects customers from BD failure

in the 1960’s many BD’s failed and took customer assets with them

63
Q

what did the securities investor protection act create

A

SOPC - securities investor protection corp

64
Q

What is SIPC coverage

A

500,00 per customer equity in an account. Inclusive of cash balances not exceeding 250k

65
Q

What is SIPC

A

Securities investor protection corp

Insurance fund derived from annual assessments made on BD’s

66
Q

If a BD fails, when are the securities valued

A

On the date of the trustee appointment

67
Q

How does a trustee distribute assets of a failed BD

A

securities registered in customer name are returned w/o dollar limit (fully paid securities which must be segregated by law

Street name (margin) securities are distributed among beneficial owners on a pro-rata basis up to 500k of equity in each customer account

If the distribution does not meet the customers’ claim, SIPC will fund the balance. Total coverage not exceeding 500k of equity, inclusive of 250k max cash coverage

68
Q

What happens to claims over 500k when a BD fails

A

The customer becomes a general creditor

69
Q

Who is not covered under the SIPC insurance

A

partners of the firm and subordinate lenders of the firm

70
Q

What happens to any uncompleted contracts when a trustee is appointed

A

Uncompleted contracts to be closed-out by the other BD on the trade.

Failed BD cannot settle any open trades

If there is a net profit on the close-out, it must be paid to the trustee

If there is a net-loss on the close-out, the other BD may file a claim with the trustee

71
Q

Other SIPC requirement

A

each BD is required to use SIPC logo on advertising and in front of office location entrance

72
Q

What does PAB stand for

A

Proprietary accounts of BD’s

73
Q

What is a PAB

A

Special reserve bank account for BD’s

Proprietary securities account held by a carrying firm

Carrying BD’s who clear transactions of BD’s must establish a special reserve bank account for BD’s (PAB)

These accounts have a separate reserve calc on a weekly basis

74
Q

What is the reserve computation requirement on a PAB

A

Weekly

75
Q

Credit items in a PAB reserve formula

A

Introducing BD clearing deposits

Monies owed by the carrying firm to the BD

Investment account of the BD maintained at the carrying firm

76
Q

Debit items in PAB reserve formula

A

Monies owed to the carrying firm by the BD

Such as: commission charges, interest charges on margin losses, assets of BD’s

77
Q

How can the carrying firm use the PAB account securities

A

They may use the securities for their own purpose, such as a stock loan

Carrying firm must inform PAB account holders in writing. If account holder objects, the carrying firm cannot use the securities

The MV of the securities is added as a credit in the PAB reserve calc

78
Q

When is a PAB reserve computation done

A

Weekly, at the same time as the regular reserve computation

79
Q

how can excess debits in the customer reserve be used against the PAB reserve

A

excess debits from the customer reserve calc can be used to meet the PAB reserve requirement

80
Q

how can excess debits in the PAB reserve be used against the customer reserve

A

excess PAB debits cannot be used to meet the customer reserve requirement

81
Q

What BD accounts must be included in the PAB reserve computation

A

Proprietary accounts of BD’s held at the clearing firm

Omnibus accounts of BD’s held at the clearing firm

Foreign BD accounts held at the clearing firm

82
Q

Accounts excluded from the PAB reserve computation

A

Delivery versus payment accounts (DVP)

Receipt versus payment accounts (RVP)

(both only hold cash for short periods)

Any account that has been subordinated to the claims of creditors of the carrying firm

83
Q

How are PAB assets treated in the reserve computation

A

Assets of BD’s are included as a credit since they are monies owed by the carrying firm to the BD unless the introducing BD subordinates its claims to other creditors

84
Q

What does rule 10b-9 dictate

A

prohibits misrepresentation in all or none underwritings

It cannot be represented to a customer that an offering is all or none and that money paid by a customer in the underwiring will be promptly refunded unless:

All of the securities are sold at the public offering price within a specified time limit AND

The total amount due to the issuer is received within a specified time limit

85
Q

What happens under rule 10b-9 if the underwriting is not completed within the time limit

A

The investors are refunded their money, since the deal is all or none

86
Q

Rule 10b-10 dictates (11) + (2)

A

Confirmation closure: Requires disclosure on confirmations to customers to include:

  1. Customer name and address
  2. Firm name and telephone
  3. Name of security purchased
  4. Size of trade, price of trade
  5. Trade date, settlement date
  6. Bond trade: Accrued interest
  7. agency trade: commission must be disclosed
  8. Principal transactions: mark-up is not disclosed unless in NASDAQ stocks (dif between reported transaction price and price to the customer)
  9. Payment for order flow - any fees paid by a market maker to a introducing BD
  10. CUSIP number - committee on uniform security identification procedures
  11. Type of the account in which the trade occurred

Upon written request:

  1. time of trade
  2. name of other party
87
Q

What is regulation SP

A

SEC regulation SP - Statement of privacy

Requires BD’s and other financial institutions to provide retail (not institutional) customers with a notice of the firm’s privacy policies and practices.

Firms cannot divulge non-public information about customer to 3rd parties unless the firm has given notice to the customer that this may happen and the customer has chosen to not opt out

88
Q

How often does the privacy notice need to be delivered to the customer (regulation SP) and what does it include

A

At account opening and annually thereafter

Must include type of info collected about the customer

Must give the customer the right to opt-out of such data collection and disclosure

89
Q

Acceptable opt-out notices (4)

A

Including a reply form together with the opt-out notice

Providing an electronic means to opt out, if the customer agrees to the electronic delivery

providing a toll free number that consumers may call

including designated check-off boxes in a prominent position on the forms with the opt out notice

90
Q

Unacceptable opt-out notices

A

Having a customer write a letter exercising their write to opt out

Having the consumer use a check-off box on a form only included in the initial notice, but not subsequent notices

91
Q

Difference between customer and consumer

A

Customer is individuals that have funds or securities in custody of the firm

Consumer is Individuals that do not have an account and simply wants the firm to sell securities they hold and they remit a check

92
Q

Difference of privacy notice requirements for a customer and consumer

A

Customer - initial and annually

Consumer - only at the time of transaction because they do not hold an account

93
Q

What is rule 1020

A

Notice to FINRA if change from exempt to non-exempt status under customer protection rule

94
Q

What does rule 1020 require a BD to do

A

requires BD’s that have obtained a K1, K2-i or K2-ii exemption from the provisions of the customer protection rule, to not change their method of doing business that would cause them to lose the exemption, unless prior written approval is obtained from FINRA

95
Q

What is FINRA rule 4311

A

Clearing firms cannot ignore customer complaints about the introducing firm.

Clearing firms are required to forward promptly, any written customer complaint to the introducing firm and FINRA.

Clearing firms are required to send the customer an acknowledgment of receipt of the complaint in writing and let them know its been forwarded to the introducing firm and FINRA

96
Q
A

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