6 August 2010

Dodd-Frank Rules Changes Affecting Broker-Dealers

Brokers, placement agents, and underwriters should be aware of Dodd-Frank financial legislation provisions that might affect their business practices:
United States Finance and Banking
To print this article, all you need is to be registered or login on

Brokers, placement agents, and underwriters should be aware of Dodd-Frank financial legislation provisions that might affect their business practices:

Private Placement Rules

Accredited investor net worth test. Effective immediately, the value of a natural person's primary residence is excluded from the accredited investor net worth test.

The natural person accredited investor minimum net worth is fixed at $1 million for the next four years, but the legislation also authorizes the SEC to adjust the income test, before then. (Of course, the SEC has always had such authority.) In four years, and every four years thereafter, the SEC is required to review all natural person accredited investor criteria and adjust them, if appropriate.

Investment adviser qualified client test. With respect to qualified clients, registered investment advisers (RIA) are exempt from restrictions on performance-based fees. Within one year, and every five years thereafter, the SEC is required to adjust the investment adviser qualified client dollar-amount test for inflation. Under the current dollar test, a qualified client is a natural person with net worth exceeding $1.5 million, having at least $750,000 under management with the RIA.

Bad actor disqualification. Within one year, the SEC is required to adopt rules disqualifying persons that have violated securities laws from participating in Rule 506 private offerings. The rules are to be substantially similar to prohibitions now applicable to Regulation A offerings.

Debt Ratings

The legislation rescinds the SEC rule that exempted debt ratings from the "expertization" provisions of the Securities Act. Such ratings can no longer be included in a prospectus without the consent of the issuing ratings agency, which the agencies have announced they will not give, at least until their potential liabilities under the Securities Act for the ratings are clarified. In response, the SEC has issued temporary relief from its ratings disclosure rules relating to asset-based debt. 

Retail Customers

The SEC is required, within six months, to prepare a report concerning "the effectiveness of existing legal or regulatory standards of care for brokers, dealers, [and investment advisers]," in giving investment advice to retail customers. The legislation authorizes the SEC in its discretion to impose on brokers, when selling to retail customers, the same standard of conduct as required of investment advisers under the Investment Advisers Act and "clarifies" the SEC's authority to prescribe disclosure, regarding investment objectives, risks, and broker-dealer compensation, to be made by brokers and dealers when selling to retail customers. (No time limit has been placed on the SEC in the creation of these fiduciary duty rules.)

Securities Lending

Within two years, the SEC must adopt rules "designed to increase the transparency of information available to brokers, dealers, and investors with respect to the loan or borrowing of securities."

Short Sales

The SEC is required to adopt rules regarding public disclosure of short sale information and is provided discretionary authority to adopt rules regarding broker-dealer disclosure to customers regarding short sales and securities lending activity. The bill requires broker-dealers to notify customers that they may elect to not allow their fully paid securities to be loaned to cover others' short sales and that the broker-dealer may receive compensation for lending the customer's securities.

Broker-Dealers' Auditors

The legislation amends the Sarbanes-Oxley Act to require broker-dealers' auditors to be registered with the PCAOB, as the Act requires of auditors of public companies.

SIPC Coverage

The limit on cash protection is permanently increased from $100,000 to $250,000, subject to adjustment for inflation every five years, beginning January 1, 2011.

The legislation also prohibits a member of SIPC with customer accounts from entering an insolvency, receivership or bankruptcy proceeding without SIPC's consent.

In addition, the bill encourages portfolio margining by providing SIPC protection to futures and options on futures in portfolio margining accounts.

Authority Over Formerly-Associated Persons of a Broker-Dealer

The legislation authorizes sanctions against an individual for violations committed while associated with a broker-dealer after the association terminates.

Deadline for Completing Examinations, Inspections and Enforcement Actions

The legislation requires that the SEC, subject to exceptions for complex cases, to decide whether to file an enforcement action within 180 days after issuing a Wells notification. In addition, the SEC must inform the subject of an examination, within 180 days from the date the SEC completes its on-site exam, whether the exam has concluded without findings or whether corrective action is required.


The legislation authorizes the SEC to adopt rules limiting use of mandatory arbitration provisions in customer agreements. The SEC is required to study broker, dealer, and investment adviser sales practices, conflicts of interest, and compensation arrangements to determine whether any are contrary to the public interest and also to facilitate provision to investors of simple, clear disclosures of the terms of broker-customer relationships; the SEC is also required to study short sales and, within two years, make recommendations for improving the market. The U.S. Comptroller General is required, within 18 months, to issue a report on potential conflicts of interest between investment banking and analyst functions within the same firm.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

See More Popular Content From

Mondaq uses cookies on this website. By using our website you agree to our use of cookies as set out in our Privacy Policy.

Learn More