Updated Guidance for Broker Dealers on Exemption Provisions

Updated Guidance for Broker Dealers on Exemption Provisions

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By Courtney Corallo, CPA, Business Assurance & Advisory Services Senior Manager and Mary-Margaret Sword, CPA, Business Assurance & Advisory Services Manager | Financial Services Industry Team

Changes for Broker Dealers in Maintaining Exemptive Status Under Rule 15c3-3

The Securities Exchange Commission (SEC) recently published updated guidance concerning the exemptive provisions of the broker-dealer reporting rule. This updated guidance changes the way that many broker-dealers will maintain their exemptive status under Rule 15c3-3.

Traditionally, broker dealers that have claimed exemption under Rule 15c3-3 have done so under paragraph (k) of the Rule, even if the nature of their business did not fall directly under one of the exemptions listed in the paragraph. These paragraph (k) exemptions include the following:

  • (k)(1) – This is a very limited and restrictive business model reserved for a broker dealer that is involved solely in direct mutual fund or variable annuity business.
  • (k)(2)(i) – This exemption applies to a broker dealer that carries no margin accounts, promptly transmits all customer funds received and does not otherwise hold funds or securities for customers and effectuates all financial transactions with customers through one or more bank accounts designated as a special account for the exclusive benefit of customers. This exemption has been commonly used as a default for broker dealers that do not fit under one of the other exemption provisions.
  • (k)(2)(ii) – This exemption applies to a broker dealer that does all business through a clearing firm on a fully disclosed basis.
  • (k)(3) – This paragraph is reserved for a broker dealer that does not fall under one of the other exemption provisions but has submitted a written application to the SEC and has been approved to otherwise receive an exemptive status.

Refer to the full details of the exemptive provisions under paragraph (k) of Rule 15c3-3.

Overview of Footnote 74

To address the situation, the SEC issued Footnote 74 in July 2020, providing a much-needed alternative, specifically for firms engaging in capital raising activities (often Capital Acquisition Brokers). The updated SEC guidance states that certain broker dealers may maintain their exemptive status under Footnote 74 of SEC Release No. 34-70073 if they do not meet the specific exemptions of Rule 15c3-3 but meet the following conditions:

  1. Do not directly, or indirectly receive, hold, or owe funds or securities for or to customers, other than funds received and promptly transmitted in compliance with paragraphs (a) or b(2) of Rule 15c2-4. Refer to the SEC Staff Interpretation of Rule 15c2-4;
  2. Do not carry accounts of customers; and
  3. Do not carry proprietary accounts as defined in Rule 15c3-3.

Refer to the full SEC Release No. 34-70073.

What Type of business is Considered a Non-Covered Firm?

These Footnote 74 broker dealers are referred to as Non-Covered Firms. The major difference between firms claiming an exemption under (k)(2)(i) and Non-Covered Firms is that (k)(2)(i) firms can receive customer funds and securities provided they are deposited and held in a special bank account in the broker dealer’s name. Non-Covered Firms do not receive customer funds and securities and, if received, promptly transmit customer funds and securities back to the customer or to an unaffiliated bank.

Non-Covered Firms should no longer claim an exemption on the quarterly FOCUS reports by leaving items 4550, 4560, 4570, and 4580 on the FOCUS Reports blank.

Non-Covered Firms should remove any mention of paragraph (k) from their exemption report, submitted in conjunction with their annual audited financial statements and reviewed by an independent accountant.  Instead, they should include a description of all the broker dealer’s business activities and a statement that, during the reporting period, the firm met the three conditions above.

In addition, once determining that they meet the exempt status under Footnote 74, these Non-Covered Firms should amend their membership agreement with FINRA accordingly.

As a summary, based on guidance included in the SEC FAQ’s (updated July 1, 2020) the following types of firms will likely be considered Non-Covered Firms:

  • Private placement agents that effect securities transactions on a best efforts or subscription basis (not on a firm commitment basis) and don’t receive or hold customer funds or securities;
  • Merger and acquisition advisory firms that refer securities transactions to other broker dealers; and
  • Broker dealers that provide technology or platform services and do not receive or hold customer funds or securities.

Refer to SEC FAQ’s for the full information related to this new guidance.

Questions on how this guidance may impact your firm? Contact your Keiter Opportunity Advisor, Email or Call: 804.747.0000

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About the Authors

Mary Margaret performs numerous audits of broker-dealers, real-estate investment funds, alternative investment funds, and other financial institutions. She possesses an understanding of PCAOB, FINRA, and other regulations as they relate to the financial services industry, and in particular, broker-dealers. She also has performed custody examinations for clients in compliance with Rule 206(4)-2 and Rule 204-2(b) of the Investment Advisors Act of 1940.

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Courtney is a Senior Manager in Keiter’s Business Assurance and Advisory Services practice. She delivers high quality client service by assisting firms with accounting and regulatory compliance.

Courtney provides audit and review services for not-for-profit organizations as well as financial services companies. She is a member of the Not-for-Profit team and Financial Services Industry team.

Read Courtney’s accounting insights on our blog.

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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.

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