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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
Reserve account formula - how much is required to be on deposit
Weekly computation: Credits (liabilities) - Debits (Assets) Monthly computation: Credits - Debits + 5%
26
When can withdrawals of excess funds be made on the reserve account
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.
27
when is there no requirement to make a new computation when withdrawing funds from the special reserve account (4)
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
28
What is the definition of possession and control
The firm physically has the security or the firm knows the whereabouts of the security
29
What are items that the firm must maintain in its possession and control
Fully paid securities Excess margin securities (in excess of 140% of customer debits
30
What are excess margin securities
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
31
What is the rehypothecation limit on customer securities pledged to a bank
140% of customer debit balances
32
When is a security considered to be in possession or control (6)
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)
33
Computation requirement if firm has fully paid or excess margin securities in its possession or control
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.
34
If it's founds that securities that should be in a firms possession or control are not, what are the required actions
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
35
What is required if securities that are supposed to be in possession or control are not returned (5)
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" 4. Short securities differences >45 days old: Buy in (no borrowing allowed) 5. Customer fails to deliver >10 days old: Buy in (no borrowing allowed)
36
Minimum net capital in reserve required for alternative method
Must maintain a min NC = to the greater of 250,000 or 2% of debits in customer reserve
37
What type of broker can use the Alternative method for computing net capital
Clearing brokers that hold customer funds or securities
38
When does early warning start for BD's using the alternative method for NC
Early warning starts if NC falls below 5% of debits in reserve
39
What is hypothecation
When an asset is pledged as collateral to secure a loan
40
What does securities held in street name mean
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
What does Regulation U dictate
A bank can loan 70% on equity securities to a BD
42
What are the rules for BD's under 15c2-1 (3)
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
What must a firm do when hypothecating securities to a bank
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
What actions must a firm take if they find that collateral pledged to the bank exceeds 140% of customer debit balances
It must remove the excess collateral no later than 1/2 hour after the banks open on the next business day
45
What is the firm's obligation when receives dividends on rehypothecated shares from the issuer (in street name)
The firm is obligated to credit these dividends to the customers that actually own the shares
46
What are customer free credit balances (2)
Uninvested cash arising from dividends and interest received. Sales of securities
47
What are sweep programs
Customer free credit balances that are swept into interest earning vehicles such as money market funds or deposit accounts at FDIC insured banks
48
What is the BD obligation to the customer when enrolling it into a sweep program (3)
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
Notice required to customer for changes to sweep program
30 days advance notice adding or deleting or switching products
50
What is rule 15c2-1
Handles rules around hypothecation of customer securities
51
What is rule 15c2-4
Rules for transmission or maintenance of payments received in connection with underwritings
52
Details of 15c2-4 (4)
-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
What is rule 17a-13
Physical counts of securities
54
What is the rule under 17a-13
-clearing BD's must perform a quarterly count of securities in possession or control and reconcile with books (box count)
55
Cyclical count rules under 17a-13
- must be performed no earlier than 2 months from preceding count and -no later than 4 months from preceding count
56
To prevent fraud, who is to count the securities in possession under 17a-13
Performed or supervised by a person who does not have control over the physical custody of the securities or records
57
What are the requirements of a security count under 17a-13 (4)
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
What if there are unresolved differences found as a result of the securities count?
Differences must be recorded on the books and records of BD no later than 7 business days
59
What if there are short securities differences found as a result of the securities count? (counted as capital)
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
What if there are long securities differences found as a result of the securities count
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
What if long securities differences are sold (NC)
NC must be reduced by the sale amount. SEC disallows this increase to NC
62
What does the Securities investor protection act of 1970 do?
Protects customers from BD failure in the 1960's many BD's failed and took customer assets with them
63
what did the securities investor protection act create
SOPC - securities investor protection corp
64
What is SIPC coverage
500,00 per customer equity in an account. Inclusive of cash balances not exceeding 250k
65
What is SIPC
Securities investor protection corp Insurance fund derived from annual assessments made on BD's
66
If a BD fails, when are the securities valued
On the date of the trustee appointment
67
How does a trustee distribute assets of a failed BD
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
What happens to claims over 500k when a BD fails
The customer becomes a general creditor
69
Who is not covered under the SIPC insurance
partners of the firm and subordinate lenders of the firm
70
What happens to any uncompleted contracts when a trustee is appointed
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
Other SIPC requirement
each BD is required to use SIPC logo on advertising and in front of office location entrance
72
What does PAB stand for
Proprietary accounts of BD's
73
What is a PAB
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
What is the reserve computation requirement on a PAB
Weekly
75
Credit items in a PAB reserve formula
Introducing BD clearing deposits Monies owed by the carrying firm to the BD Investment account of the BD maintained at the carrying firm
76
Debit items in PAB reserve formula
Monies owed to the carrying firm by the BD Such as: commission charges, interest charges on margin losses, assets of BD's
77
How can the carrying firm use the PAB account securities
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
When is a PAB reserve computation done
Weekly, at the same time as the regular reserve computation
79
how can excess debits in the customer reserve be used against the PAB reserve
excess debits from the customer reserve calc can be used to meet the PAB reserve requirement
80
how can excess debits in the PAB reserve be used against the customer reserve
excess PAB debits cannot be used to meet the customer reserve requirement
81
What BD accounts must be included in the PAB reserve computation
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
Accounts excluded from the PAB reserve computation
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
How are PAB assets treated in the reserve computation
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
What does rule 10b-9 dictate
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
What happens under rule 10b-9 if the underwriting is not completed within the time limit
The investors are refunded their money, since the deal is all or none
86
Rule 10b-10 dictates (11) + (2)
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
What is regulation SP
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
How often does the privacy notice need to be delivered to the customer (regulation SP) and what does it include
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
Acceptable opt-out notices (4)
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
Unacceptable opt-out notices
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
Difference between customer and consumer
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
Difference of privacy notice requirements for a customer and consumer
Customer - initial and annually Consumer - only at the time of transaction because they do not hold an account
93
What is rule 1020
Notice to FINRA if change from exempt to non-exempt status under customer protection rule
94
What does rule 1020 require a BD to do
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
What is FINRA rule 4311
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

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