The Securities Exchange Act 1934 (“Exchange Act” or “Act”) governs the way in which the securities markets in United States and its brokers & dealers operate. Broker-dealers in US are required to meet certain financial responsibilities including maintaining minimum net capital or liquid assets; safeguarding the customer funds and securities; and making and preservation of accurate books and records.
The Act generally defines a “broker” broadly as any person engaged in the business of effecting transactions in securities for the account of others such as investment advisers, financial consultants, placement agents, independent contractors etc. Unlike a broker, who acts as agent, a dealer acts as principal. The Act defines a “dealer” as any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise.
Below mentioned are the essential 5 financial responsibilities which are to be followed by broker- dealers:
- Minimum Net Capital as per Net Capital Rule (Rule 15c3 – 1)
Under this rule, broker-dealers must maintain minimum net capital levels based upon the type of securities activities they conduct and based on certain financial ratios. Broker-dealers must maintain adequate net capital at all times before, during and after purchasing or selling proprietary securities which can be explained as below:
- Moment to moment net capital
Broker-dealer should have at all times enough net capital to meet the haircut requirements of the Capital Rule before taking on any new proprietary positions.
- Consolidations, minimum net capital requirement
The minimum net capital of the consolidated entity is determined by adding the amount of net capital required for compliance by each consolidated subsidiary subject to the Rule to the minimum net capital requirement of the parent broker-dealer.
- Inactive Exchange Members
An inactive Exchange member is not subject to a net capital requirement so long as he is not conducting or engaged in the securities business.
- Registered Traders
A registered Trader (other than a registered trader in options) is subject to a net capital requirement if he trades for his own account. This is so even if he is associated with another broker-dealer. If he trades solely for the account of the broker-dealer he is associated with, he is not individually subject to a requirement.
- Use of Customer Balance (Rule 15c3-2)
Broker-dealers who use free credit balances of customers in their business must establish procedures in order to provide information to a customer which inculcates:
- the amount due to those customers;
- the fact that such funds are not separated and may be used by the broker-dealer in its business; and
- the fact that those funds are payable on demand of the customer.
- Customer Protection Rule (Rule 15c3-3)
This rule helps protecting customers fund and securities held by broker-dealers. Under this rule, a broker-dealer have to determine daily that it is in compliance with the control or possession of all fully-paid or excess margin securities held for the account of customers. Also, broker-dealers have to make periodic computations to determine how much money it is holding that is either customer money or obtained from the use of customer securities. If this amount is greater than the amount that it is owed by customers or by other broker-dealers relating to customer transactions, the broker-dealer has to deposit the excess in a special reserve bank account for the exclusive benefit of customers. Thus, this rule prevents a broker-dealer from using customer funds to finance its business.
- Required Books, Records, and Reports (Rules 17a-3, 17a-4, 17a-5, 17a-11)
Broker-dealers are required to maintain current books and record detailing, securities transactions, money balances and securities positions. They have to keep records for required periods and furnish copies of the records to Securities Exchange Commission (SEC) on request including e-mails. Broker-dealer also files the SEC periodic reports, which includes quarterly and annual financial statements. The annual statements must be certified by an independent public accountant. Broker- dealers also have to notify SEC and the appropriate Self-Regulatory Organizations (SROs) regarding net capital, recordkeeping, other operational problems, and in some cases file reports regarding those problems, within certain time span. This results in early warning of these problems to SROs.
- Risk Assessment Requirements (Rules 17h-1T and 17h-2T)
Broker-dealers are required to maintain and preserve information regarding those affiliates, subsidiaries and holding companies whose business activities are likely to have a material impact on their own financial and operating condition including the broker-dealer’s net capital, liquidity, or ability to conduct or finance operations. Broker-dealers must file a quarterly summary of this information which is designed to permit SEC to assess the impact these entities may have on the broker-dealer.
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