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The unofficial grace period for US broker-dealers thought to be operating fully-paid lending programmes that do not comply with Exchange Act Rule 15c3-3's requirement to physically transfer collateral is set to expire this week.
In October 2020, staff at the US Securities and Exchange Commission (SEC) raised concerns that several broker-dealers were believed to be contravening customer protection requirements under Rule 15c3-3 by retaining control over the collateral used to secure their borrowings of fully paid and excess margin securities.
Securities lending market participants were subsequently advised in a no-action letter by commission staff they had six months to make their programmes compliant or wind them down in an orderly fashion.
A staff no-action letter does not carry any legal weight in terms of altering a regulation and is not endorsed by the SEC as a regulator, but is considered a way for market overseers to fire a warning shot to highlight areas of concern ahead of formal action.
In this instance, the customer protection rule — Rule 15c3-3(b)(3) — outlines obligations for a broker-dealer to provide the underlying lender with collateral that fully secures the loan. It can be made up of cash, US treasury bills or other collateral approved by the SEC.
The broker-dealers must also mark the loan to market daily and provide additional collateral as needed.
Crucially, all collateral posted must be physically transferred to the underlying lender.
In a written response to the no-action letter, also published in October, the SEC’s deputy director at the division of trading and markets, Lizzie Baird, stated that evidence exists which suggests some broker-dealers operating fully-paid programmes are failing to turn over the collateral physically to the lender and therefore are retaining control over it.
“For example, the collateral may be deposited into the lender’s securities account at the broker-dealer or an omnibus account at a bank in the name of the broker-dealer,” she explained.
“In either case, during the term of the loan, the collateral must be accessed through the broker-dealer and the broker-dealer has the operational ability to transfer or liquidate the collateral.
“The written agreement underlying such a programme gives the broker-dealer control over the collateral. As the commission has stated, paragraph (b)(3) of Rule 15c3-3 ‘compel[s] the firm to turn over the collateral physically to the lender’.”
In an update to the no-action letter published on 16 April, commission staff reaffirmed that broker-dealers operating these programmes “should be mindful of the importance of complying with the requirements of Rule 15c3-3 and ensuring that retail investor funds receive the full protections afforded under the Securities Investor Protection Act.
“To the extent that broker-dealers have questions about their programmes, they are encouraged to reach out to and/or continue to engage with commission staff regarding any questions.”
