United States: Broker-Dealer Pays Penalty To Settle Customer Protection Rule Violation

A broker-dealer agreed to pay a $7.5 million penalty to settle SEC charges of violating Securities Exchange Act Rule 15c3-3 (the "Customer Protection Rule"). The SEC found that the broker dealer was conducting trades involving customer cash in order to lower borrowing costs.

Generally, broker-dealers must exclude "debits" generated by affiliate activity from their calculation of the amounts required to be held in Special Reserve Accounts unless those debits are directly related to "credits" in the formula. The reason for prohibiting the inclusion of debits in such calculations is that if credits stemming from affiliates' short-sale proceeds are treated as "directly related" to debits stemming from affiliates' margin loans, then broker-dealers can use customer securities to finance affiliates' positions. In this case, the broker-dealer treated credits that arose in connection with its affiliates' short-sale proceeds as "directly related" to the debits generated by margin loans to those affiliates. As expressed in FINRA's guidance on the Customer Protection Rule, such treatment of credits is impermissible.

In addition to the $7.5 million penalty, the broker-dealer also agreed to implement strengthened controls and increase the cushion that it maintains in the Special Reserve Account. SEC Enforcement Division, Complex Financial Instruments Unit Chief Michael J. Osnato stated that in seeking to reduce borrowing costs, broker-dealers must not neglect their obligations to customers and the law:

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