The SEC’s proposed amendments¹ to rule § 240.15c3-3² (“Rule 15c3-3” or “Customer Protection”) will require some broker-dealers to calculate a daily reserve requirement and a comprehensive update to the related internal controls over compliance (ICOC) per SEC rule § 240.17a-5(d)(3)(i)(A).³ A final rule is expected in late August or early September.⁴

It is imperative that broker-dealers implement effective ICOCs for Customer Protection, as this continues to be an area of focus for external auditors and regulators.⁵

This article outlines key steps and considerations to ensure compliance, achieve operational efficiency, and prepare for successful external audits and regulator examinations.

Overview of the Proposed Amendments

Rule 15c3-3, known as the Customer Protection Rule, requires broker-dealers that maintain custody of customer securities and cash (“carrying broker-dealers”) to have a special reserve bank account holding cash and/or qualified securities based on the computed net cash owed to their customers. Generally, carrying broker-dealers must perform weekly customer reserve computations and deposits into this account, and similarly compute and deposit weekly for the net cash owed to proprietary accounts of other broker-dealers (PAB accounts⁶).

The proposal requires certain broker-dealers to shift from weekly to daily computations of reserve requirements for customer and PAB accounts. Broker-dealers with average total credits of $250 million or more must perform daily calculations and maintain sufficient cash or qualified securities in Special Reserve Bank Accounts.

This change ensures dynamic matching of net cash owed with deposit amounts. Adapting to this requirement will likely involve significant system and process adjustments. Broker-dealers must have appropriate personnel and automated systems to manage the increased frequency of computations and meet compliance deadlines.

Below is an overview of the proposed amendments compared to current requirements:

How the Proposed Amendments Impact 17a-5 Controls 

In addition to requiring operational and financial reporting process changes, the proposed amendments significantly impact the 17a-5 controls framework, necessitating comprehensive changes to ensure compliance with the updated requirements. The transition from weekly to daily computations of reserve requirements demands a meticulous review and overhaul of existing controls. Here are the key areas impacted by the new rules:

What Broker-Dealers Need to Consider as Responses

1. Governance

Understanding the rule change is the first step in ensuring effective governance. It’s vital that senior management and the board of directors fully comprehend the implications of the new daily reserve rule and its impact on the organization. Strong governance is key to successfully implementing and maintaining the new controls. Regular updates and clear communication across all levels of the organization will help coordinate efforts and ensure that everyone is aligned with the new requirements. Establishing a governance framework that includes oversight responsibilities, reporting mechanisms, and escalation procedures will support effective implementation and ongoing compliance.

2. Procedure Manual Refresh

With governance support, the next step is revising procedure manuals to reflect the new daily reserve rule requirements. Detailed documentation should outline the new procedures for daily calculations, reconciliations, and adjustments. It’s essential to ensure that all relevant personnel are familiar with these changes and understand their roles in the updated process. Regularly updating and distributing these manuals will help maintain consistency and compliance.

3. 17a-5 Controls Gap Assessment

Next, review the existing 17a-5 controls to identify any gaps that the new rule may create. This involves a thorough gap assessment to determine which controls need to be updated from a weekly to a daily frequency. Instead of a blanket change, conduct an updated risk assessment to evaluate the necessity of each control’s frequency adjustment. This targeted approach ensures that only the most critical controls are updated to daily, optimizing resource allocation while maintaining compliance.

4. IT Controls

As most broker-dealers plan to use automation to handle the increased frequency and volume of data processing required for the daily calculation, the implementation of new IT controls is crucial. This includes enhancing application controls to ensure accurate and timely data processing. Controls over new Information Produced by the Entity (IPE) must be strengthened to validate data integrity.

Additionally, broker-dealers should consider obtaining System and Organization Controls (SOC) reports, specifically SOC 1 Type 2⁷ reports for any outsourced vendor applications to ensure that these third-party services meet the required control standards. Robust IT controls will be essential in mitigating the risks associated with daily reserve calculations and reporting.

5. Training

Finally, training is essential to equip staff with the knowledge and skills required to adapt to the new controls. This includes training on the updated procedure manuals, new IT systems, and the rationale behind the changes. Regular training sessions and refreshers will help maintain a high level of competency and ensure that staff can effectively manage their responsibilities under the new daily reserve rule. Tailoring training programs to different roles within the organization can further enhance their effectiveness.

Conclusion

Updating the 17a-5 controls process for the new 15c3-3 daily reserve rule is a multifaceted task that requires careful planning and execution. By starting with strong governance, updating procedure manuals, conducting a targeted gap assessment, enhancing IT controls, and providing comprehensive training, broker-dealers can achieve compliance and maintain operational efficiency. Proactive and strategic updates to the controls process will not only meet regulatory requirements but also strengthen the overall risk management framework of the organization.

1. “Daily Computation of Customer and Broker-Dealer Reserve Requirements under the Broker-Dealer Customer Protection Rule.” Securities and Exchange Commission. 17 CFR Part 240, Release No. 34-97877, File No. S7-11-23, RIN 3235-AN28, Proposed rule. Washington, DC: SEC.
2. 17 CFR 240.15c3-3
3. 17 CFR 240.17a-5
4. Public comments from Michael A. Macchiaroli, Associate Director, Division of Trading and Markets, U.S. Securities and Exchange Commission, at the SIFMA FMS Regional Conference in May 2024.
5. Areas of focus for SEC exams in 2024 include the Customer Protection Rule and related internal processes, procedures and controls (identified in the 2024 SEC Examination Priorities Report); the PCAOB has noted that auditor testing of controls over compliance with the Customer Reserve process is an area of continued focus (identified in “Spotlight: Staff Priorities for 2024 Inspections and Interactions With Audit Committees, December 2023, PCAOB” and “Annual Report on the Interim Inspection Program Related to Audits of Brokers and Dealers, PCAOB Release No. 2023-005 August 10, 2023”).
6. The term “PAB account” means a proprietary securities account of a broker-dealer (which includes a foreign broker-dealer, or a foreign bank acting as a broker-dealer) other than a delivery-versus-payment account or a receipt-versus-payment account. 17 CFR 240.15c3-3(a)(16). The term does not include an account that has been subordinated to the claims of creditors of the carrying broker-dealer.
7. SOC 1 Type 2 report is officially known as a “Report on Management’s Description of a Service Organization’s System and the Suitability of the Design and Operating Effectiveness of Controls.” The Type II report addresses the design and testing of the controls over a period of time. It also describes the testing performed and the results.