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Recordkeeping and Reporting Requirements for Security-Based Swap Dealers, Major Security-Based Swap Participants, and Broker-Dealers

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Start Preamble Start Printed Page 68550

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

In accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), the Securities and Exchange Commission (“Commission”), pursuant to the Securities Exchange Act of 1934 (“Exchange Act”), is adopting recordkeeping, reporting, and notification requirements applicable to security-based swap dealers (“SBSDs”) and major security-based swap participants (“MSBSPs”), securities count requirements applicable to certain SBSDs, and additional recordkeeping requirements applicable to broker-dealers to account for their security-based swap and swap activities. The Commission also is making substituted compliance available with respect to recordkeeping, reporting, and notification requirements under Section 15F of the Exchange Act and the rules thereunder.

DATES:

Effective date: February 14, 2020.

Compliance date: The compliance dates are discussed in section III.B. of this release.

Start Further Info

FOR FURTHER INFORMATION CONTACT:

Michael A. Macchiaroli, Associate Director, at (202) 551-5525; Thomas K. McGowan, Associate Director, at (202) 551-5521; Randall W. Roy, Deputy Associate Director, at (202) 551-5522; Joseph I. Levinson, Senior Special Counsel, at (202) 551-5598; Raymond A. Lombardo, Assistant Director, at (202) 551-5755; Timothy C. Fox, Branch Chief, at (202) 551-5687; Valentina Minak Deng, Special Counsel, at (202) 551-5778; Rose Russo Wells, Special Counsel, at (202) 551-5527; or Abraham Jacob, Special Counsel, at (202) 551-5583; Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-7010.

End Further Info End Preamble Start Supplemental Information

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

II. Final Rules and Rule Amendments

A. Recordkeeping

1. Introduction

2. Records To Be Made and Kept Current

3. Record Maintenance and Preservation Requirements

B. Reporting

1. Introduction

2. Periodic Filing of FOCUS Report

3. Filing of Annual Audited Financial Reports and Other Reports

C. Notification

1. Introduction

2. Amendments to Rule 17a-11 and New Rule 18a-8

3. Additional Amendments to Rule 17a-11 and Modifications to Rule 18a-8

D. Quarterly Securities Count and Capital Charge for Unresolved Securities Differences

1. Introduction

2. Rule 18a-9

E. Alternative Compliance Mechanisms

1. Limited Alternative Compliance Mechanism—Rules 17a-3 and 18a-5

2. Full Alternative Compliance Mechanism—Rule 18a-10

F. Cross-Border Application and Availability of Substituted Compliance

1. Cross-Border Application of Recordkeeping and Reporting Requirements

2. Availability of Substituted Compliance in Connection With Recordkeeping and Reporting Requirements

G. Amendments to Rule 18a-1

H. Delegation of Authority

III. Explanation of Dates

A. Effective Date

B. Compliance Date

C. Effect on Existing Commission Exemptive Relief

D. Application to Substituted Compliance

IV. Paperwork Reduction Act

A. Summary of Collections of Information Under the Rule Amendments and New Rules

1. Amendments to Rule 17a-3 and New Rule 18a-5

2. Amendments to Rule 17a-4 and New Rule 18a-6

3. Amendments to Rule 17a-5 and New Rule 18a-7

4. Amendments to Rule 17a-11 and New Rule 18a-8

5. Amendments to Rule 17a-12

6. New Rule 18a-9

7. Amendments to Rule 18a-10

8. Amendments to Rule 3a71-6

B. Use of Information

C. Respondents

D. Total Initial and Annual Recordkeeping and Reporting Burden

1. Amendments to Rule 17a-3 and New Rule 18a-5

2. Amendments to Rule 17a-4 and New Rule 18a-6

3. Amendments to Rule 17a-5 and New Rule 18a-7

4. Amendments to Rule 17a-11 and New Rule 18a-8

5. Amendments to Rule 17a-12

6. New Rule 18a-9

7. Amendments to Rule 18a-10

8. Amendments to Rule 3a71-6

E. Collection of Information Is Mandatory

F. Confidentiality

G. Retention Period for Recordkeeping Requirements

V. Economic Analysis

A. Introduction

B. Baseline of Economic Analysis

1. Available Data From the Security-Based Swap Market

2. Security-Based Swap Market: Market Participants and Activity

3. Existing Regulation of OTC Derivatives Market Participants and Broker-Dealers

C. Analysis of the Adopted Program and Alternatives

1. Benefits of Recordkeeping, Reporting, Notification, and Securities Count Requirements

2. Costs of the Recordkeeping, Reporting, Notification, and Securities Count Requirements

3. Economic Effects of the Approach to Recordkeeping, Reporting, Notification, and Securities Count Requirements

4. Cross-Border Application and Substituted Compliance

D. Impact on Efficiency, Competition, and Capital Formation

E. Alternatives to the Adopted Recordkeeping, Reporting, Notification, and Securities Count Rules

VI. Other Matters

VII. Regulatory Flexibility Act Certification

VIII. Statutory Basis

I. Background

Title VII of the Dodd-Frank Act (“Title VII”) established a new regulatory framework for the U.S. over-the-counter (“OTC”) derivatives markets.[1] Section 764 of the Dodd-Frank Act added Section 15F to the Exchange Act.[2] Section 15F(f)(2) provides that the Commission shall adopt rules governing reporting and recordkeeping for SBSDs and MSBSPs. Section 15F(f)(1)(A) Start Printed Page 68551provides that SBSDs and MSBSPs shall make such reports as are required by the Commission, by rule or regulation, regarding the transactions and positions and financial condition of the SBSD or MSBSP. Section 15F(f)(1)(B)(ii) provides that SBSDs and MSBSPs without a prudential regulator [3] (respectively, “nonbank SBSDs” and “nonbank MSBSPs”) shall keep books and records in such form and manner and for such period as may be prescribed by the Commission by rule or regulation.[4] Section 15F(f)(1)(B)(i) provides that SBSDs and MSBSPs for which there is a prudential regulator (respectively, “bank SBSDs” and “bank MSBSPs”) shall keep books and records of all activities related to their business as an SBSD or MSBSP in such form and manner and for such period as may be prescribed by the Commission by rule or regulation. Section 15F(g) of the Exchange Act requires SBSDs and MSBSPs to maintain daily trading records with respect to security-based swaps and provides that the Commission shall adopt rules governing daily trading records for SBSDs and MSBSPs. Finally, Section 15F(i)(2) of the Exchange Act provides that the Commission shall adopt rules governing documentation standards for SBSDs and MSBSPs.

Section 17(a)(1) of the Exchange Act provides the Commission with authority to adopt rules requiring broker-dealers—which would include broker-dealer SBSDs and MSBSPs—to make and keep for prescribed periods such records, furnish such copies thereof, and make and disseminate such reports as the Commission, by rule, prescribes as necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Exchange Act.[5] The Commission anticipates that a number of broker-dealers will register as SBSDs.[6] The Commission expects that some broker-dealers that are not registered as SBSDs or MSBSPs (“stand-alone broker-dealers”) nonetheless will engage in security-based swap and swap activities.[7]

In April 2014, the Commission proposed recordkeeping, reporting, and notification requirements applicable to SBSDs and MSBSPs, securities count requirements applicable to certain SBSDs, and additional recordkeeping requirements applicable to broker-dealers to account for their security-based swap and swap activities.[8] The proposed requirements were modeled on existing broker-dealer requirements.[9] The Commission received a number of comments in response to these proposals.[10] Separately, the Commission proposed rules governing the cross-border treatment of recordkeeping and reporting requirements with respect to SBSDs and MSBSPs.[11] The Commission received comments in response to these cross-border proposals as well.[12] The Commission carefully considered the comments received on the proposals described above and, as discussed below, made modifications in light of the comments in crafting final rules and amendments.

In this document, the Commission is amending certain existing rules and adopting new rules. In particular, the Commission is amending existing rules 17 CFR 240.17a-3 (“Rule 17a-3”), 17 CFR 240.17a-4 (“Rule 17a-4”), 17 CFR 240.17a-5 (“Rule 17a-5”), and 17 CFR 240.17a-11 (“Rule 17a-11”), and adopting new rules 17 CFR 240.18a-5 (“Rule 18a-5”), 17 CFR 240.18a-6 (“Rule 18a-6”), 17 CFR 240.18a-7 (“Rule 18a-7”), 17 CFR 240.18a-8 (“Rule 18a-8”), and 17 CFR 240.18a-9 (“Rule 18a-9”). The amendments and new rules establish recordkeeping, reporting, and notification requirements for SBSDs and MSBSPs and securities count requirements for stand-alone SBSDs (collectively “recordkeeping and reporting requirements”). The amendments to Rules 17a-3 and 17a-4 also establish additional recordkeeping requirements applicable to stand-alone broker-dealers to the extent they engage in security-based swap or swap activities. The Commission also is adopting largely technical amendments to Rules 17a-3, 17a-4, 17a-5, and 17a-11 as well as a conforming amendment to existing rule 17 CFR 240.17a-12 (“Rule 17a-12”).[13] Further, the Commission is adopting amendments to Parts II and III of the Financial and Operational Combined Uniform Single Report (“FOCUS Report”),[14] and adopting Part IIC of the FOCUS Report. Part II of the FOCUS Report, as amended, and Part IIC of the FOCUS Report, as adopted, will be used by registrants to report financial and operational information. Part III of the FOCUS Report will accompany the annual reports that certain of the registrants will file. The Commission also is amending existing rule 17 CFR 240.3a71-6 (“Rule 3a71-6”) with respect to the cross-border application of the recordkeeping and reporting rules and the availability of substituted compliance.

On June 21, 2019, the Commission adopted, among other requirements, capital and margin requirements for nonbank SBSDs and MSBSPs and segregation requirements for SBSDs.[15] Start Printed Page 68552As discussed below, these capital, margin, and segregation requirements are integrated into the recordkeeping and reporting requirements being adopted in this document. Moreover, at the same time that the Commission adopted the capital, margin, and segregation requirements, the Commission adopted an alternative compliance mechanism (17 CFR 240.18a-10 “Rule 18a-10”).[16] The Commission is amending Rule 18a-10 in this document to incorporate recordkeeping and reporting requirements into its provisions. The Commission also is amending an SBSD capital rule (17 CFR 240.18a-1 “Rule 18a-1”).

The Commission staff consulted with staff from the prudential regulators and the CFTC in drafting these final rules and amendments.[17] In addition, relevant CFTC rules were considered as part of this rulemaking effort.[18]

II. Final Rules and Rule Amendments

A. Recordkeeping

1. Introduction

The Commission is adopting a recordkeeping program for SBSDs and MSBSPs under Sections 15F and 17(a) of the Exchange Act that is modeled on the recordkeeping requirements for broker-dealers as set forth in Rules 17a-3 and 17a-4. Under this recordkeeping program, broker-dealer SBSDs and MSBSPs—as broker-dealers—will be subject to Rules 17a-3 and 17a-4.[19] The Commission is adopting amendments to these rules to implement the recordkeeping requirements mandated under the Dodd-Frank Act with respect to broker-dealer SBSDs and MSBSPs and to account for the security-based swap and swap activities of stand-alone broker-dealers.

Stand-alone and bank SBSDs and MSBSPs will be subject to Rules 18a-5 and 18a-6, which are modeled on Rules 17a-3 and 17a-4, respectively, as amended. Rules 18a-5 and 18a-6 do not include a parallel requirement for every requirement in Rules 17a-3 and 17a-4 because some of the requirements in Rules 17a-3 and 17a-4 relate to activities that are either not expected or not permitted to be conducted by stand-alone and bank SBSDs and MSBSPs. Further, the recordkeeping requirements applicable to bank SBSDs and MSBSPs are more limited in scope because: (1) The Commission's authority under Section 15F(f)(1)(B)(i) of the Exchange Act is tied to activities related to the conduct of the firm's business as an SBSD or MSBSP; (2) bank SBSDs and MSBSPs are subject to recordkeeping requirements applicable to banks with respect to their banking activities; and (3) the prudential regulators—rather than the Commission—are responsible for capital, margin, and other prudential requirements applicable to bank SBSDs and MSBSPs. For these reasons, the recordkeeping requirements for bank SBSDs and MSBSPs are tailored more specifically to their security-based swap activities as an SBSD or MSBSP.

2. Records To Be Made and Kept Current

The Commission is adopting amendments to Rule 17a-3 to account for the security-based swap and swap activities of broker-dealers, including broker-dealer SBSDs and MSBSPs.[20] The Commission is adopting Rule 18a-5—which is modeled on Rule 17a-3, as amended—to require stand-alone and bank SBSDs and MSBSPs to make and keep current certain records.[21] As stated above, Rule 18a-5 does not include a parallel requirement for every requirement in Rule 17a-3.[22] Paragraph (a) of Rule 18a-5 contains one set of recordkeeping requirements applicable to stand-alone SBSDs and MSBSPs, and paragraph (b) of Rule 18a-5 contains a separate set of recordkeeping requirements applicable to bank SBSDs and MSBSPs that are more limited in scope.

A commenter urged the Commission to harmonize its recordkeeping requirements for SBSDs and MSBSPs with the CFTC's final recordkeeping requirements for swap dealers and major swap participants to the maximum extent possible, with the goal of permitting firms to utilize a single recordkeeping system for swap and security-based swap transactions and positions.[23] As discussed in more detail below in section II.E.1. of this release, in response to the comment and to promote harmonization with CFTC requirements, the Commission is adopting a limited alternative compliance mechanism in Rules 17a-3 and 18a-5.[24] In particular, an SBSD or MSBSP that also is registered with the CFTC as a swap dealer or major swap participant may comply with the recordkeeping requirements of the CEA and the rules thereunder in lieu of the requirements (discussed below) to make and keep current trade blotters, customer account ledgers, and stock records solely with respect to information required to be included in those records regarding security-based swap transactions and positions if the SBSD or MSBSP meets certain conditions. The conditions include, Start Printed Page 68553among other things, that the SBSD or MSBSP preserves all of the data elements necessary to create a trade blotter, customer account ledger, or stock record reflecting security-based swap and swap transactions and positions and upon request promptly furnishes to representatives of the Commission such a trade blotter, customer account ledger, or stock record that includes security-based swap and swap transactions and positions in the format required by Rule 17a-3 or 18a-5, as applicable. This provision will permit an SBSD or MSBSP that also is registered with the CFTC as a swap dealer or major swap participant to maintain a single recordkeeping system for security-based swap and swap transactions and positions in accordance with the CFTC's rules with respect to these required records.

Rules 17a-3 and 18a-5 require broker-dealers, SBSDs, and MSBSPs to make and keep current daily trading records, ledger accounts, a securities record, memoranda of brokerage orders, and/or memoranda of proprietary trades that include certain data elements with respect to security-based swap transactions.[25] The data elements are: (1) The type of security-based swap; (2) the reference security, index, or obligor; (3) the date and time of execution; (4) the effective date; (5) the scheduled termination date; (6) the notional amount(s) and the currenc(ies) in which the notional amount(s) is expressed; (7) the unique transaction identifier; and (8) the counterparty's unique identification code (collectively, the “transaction data elements”).[26]

As proposed, the counterparty's unique identification code data element was the unique counterparty identifier.[27] Commenters suggested that the Commission replace the requirement to record the unique counterparty identifier with a requirement to record the counterparty's legal entity identifier (“LEI”).[28] One commenter further stated that the Commission should allow firms to use different counterparty identifiers for internal purposes provided that they are able to translate their internal counterparty identifiers into the standard LEI convention.[29]

For the sake of consistency with previously adopted Commission rules, the Commission is replacing the requirement to record the unique counterparty identifier throughout Rule 17a-3, as amended, and Rule 18a-5, as adopted, with a requirement to use the counterparty's unique identification code (“UIC”), as defined in Regulation SBSR.[30] In particular, Regulation SBSR requires market participants—including broker-dealers, SBSDs, and MSBSPs—to report certain data elements to security-based swap data repositories (“SDRs”). One of the required data elements is a UIC, which Rule 900 of Regulation SBSR defines as “a unique identification code assigned to a person, unit of a person, product, or transaction.” [31] SDRs must use UICs assigned by an internationally recognized standards-setting system (“IRSS”) if an IRSS has been recognized by the Commission and issues that type of UIC.[32] In the release adopting Regulation SBSR, the Commission recognized the Global Legal Entity Identifier System (“GLEIS”)—which is responsible for issuing LEIs—as an IRSS that satisfies the requirements of Rule 903 of Regulation SBSR.[33] Under Rule 903, if an IRSS recognized by the Commission has assigned a UIC to a person, unit of a person, or product, each SDR must employ that UIC for reporting purposes under Regulation SBSR, and SDR participants must obtain such UICs for use under Regulation SBSR. Although a firm may use different counterparty identifiers for internal purposes, the firm's records compiled pursuant to the recordkeeping rules being adopted in this document must record the counterparty's UIC. To date, LEIs are the only specific type of UIC that must be used under Regulation SBSR.[34]

In addition to that modification, the final requirements modify the transaction data elements by replacing the data elements “the termination or maturity date” and “the notional amount” with the data elements “the scheduled termination date” and “the notional amount(s) and the currenc(ies) in which the notional amount(s) is expressed”, respectively. This aligns the terminology identifying the data elements with the terminology used in Regulation SBSR.[35]

The Commission stated when proposing the recordkeeping requirements that “[w]here a data element that would need to be documented in the daily trading records of security-based swap transactions under the proposed amendments to Rule 17a-3 or proposed Rule 18a-5 is substantively the same as a data element that would need to be reported under proposed Rule 901, the Commission preliminarily believes that the type of information that would need to be documented in the daily trading records could be the same data element reported under proposed Rule 901.” [36] The following data element requirements being adopted in this document use the same terminology as Rule 901 of Regulation SBSR: (1) The date and time of execution; (2) the effective date; (3) the scheduled termination date; and (4) the notional amount(s) and the currenc(ies) in which the notional amount(s) is expressed. The Commission clarifies that for these data elements registrants may record the same information provided pursuant to the requirements of Rule 901 to satisfy the related requirements of Rules 17a-3, as amended, and 18a-5, as adopted.

Finally, a commenter urged the Commission to provide firms with the flexibility to keep the proposed required trade blotters, general ledgers, ledgers for customer accounts, and stock record (discussed below) in various formats without mandating a particular format as long as all required information is kept and accessible to the Commission.[37] For example, with respect to the stock record, the commenter urged the Commission to provide SBSDs and MSBSPs flexibility in the manner in which they create records for security-based swap transactions and not mandate a detailed specified format (particularly with respect to tracking collateral received and pledged), provided that all required information is recorded and retained and can be pulled together upon request to create something that recognizably Start Printed Page 68554would be a record of the firm's security-based swap transactions.

These types of records are fundamental business records that a prudent company should make and retain in the ordinary course to document and track, among other things, its operations, financial account balances and transactions, asset and liability accounts, and custodial positions. The daily creation of these records builds an historical audit trail that can be used to reconstruct the sequence of transactions and changes in balances and positions, and to reconcile with third-party accounts. Having the records in place also can assist a firm account for transactions, balances, and positions if data feeds or other information systems that feed into the records are disrupted. Moreover, broker-dealers have been required to make and retain these types of records for their securities business and transactions for many years, and the Commission does not believe that doing so imposes a great burden. Further, based on staff experience, the Commission believes that creating a daily record of this information will facilitate the prompt production of the materials necessary for examinations and the oversight of broker-dealers, SBSDs, and MSBSPs. For these reasons, as discussed below, the Commission is adopting the requirements substantially as proposed. However, except for the general ledger, the firm can utilize the limited alternative compliance mechanism with respect to these records as they pertain to security-based swap and swap transactions and positions if the conditions of the limited alternative compliance mechanism are met.[38]

a. Amendments to Rule 17a-3 and New Rule 18a-5

Undesignated Introductory Paragraph

The Commission proposed adding an undesignated introductory paragraph to Rule 17a-3 explaining that the rule applies to a broker-dealer, including a broker-dealer dually registered with the Commission as an SBSD or MSBSP.[39] The paragraph further explained that an SBSD or MSBSP that is not dually registered as a broker-dealer (i.e., a stand-alone SBSD or MSBSP, or bank SBSD or MSBSP) is subject to the books and records requirements in proposed Rule 18a-5. Similarly, proposed Rule 18a-5 included an undesignated introductory paragraph explaining that the rule applies to an SBSD or MSBSP that is not dually registered as a broker-dealer and that a broker-dealer that is dually registered as an SBSD or MSBSP is subject to the books and records requirements in Rule 17a-3. The Commission received no comments on the proposed undesignated introductory paragraphs and is adopting them with non-substantive modifications to clarify which rule (17a-3 or 18a-5) applies to a given type of entity.[40]

Trade Blotters

Paragraph (a)(1) of Rule 17a-3 requires broker-dealers to make and keep current trade blotters (or other records of original entry) containing an itemized daily record of all transactions in securities, all receipts and deliveries of securities, all receipts and disbursements of cash, and all other debits and credits. The Commission proposed to amend this paragraph to require that the trade blotters of broker-dealers, including broker-dealer SBSDs and MSBSPs, contain specific information about security-based swaps, including by recording specific transaction data elements.[41] The Commission proposed to include parallel trade blotter requirements in Rule 18a-5 to apply to stand-alone and bank SBSDs and MSBSPs.

As discussed above, a commenter urged the Commission to provide firms with the flexibility to keep the proposed trade blotters in various formats without mandating a particular format as long as all required information is kept and accessible to the Commission.[42] For the reasons discussed above, the Commission does not believe this would be appropriate. However, the Commission clarifies that a firm can create two separate trade blotters (one for security-based swaps and one for other types of positions). Moreover, as discussed in more detail below in section II.E.1. of this release, to promote harmonization with CFTC requirements and increase flexibility, an SBSD or MSBSP that is also registered as a swap dealer or major swap participant may opt to use the limited alternative compliance mechanism with respect to these records as they pertain to security-based swap and swap transactions and positions.[43] For these reasons, the Commission is adopting the trade blotter requirements substantially as proposed.[44]

General Ledger

Paragraph (a)(2) of Rule 17a-3 requires broker-dealers, including broker-dealer SBSDs and MSBSPs, to make and keep current ledgers (or other records) reflecting all assets and liabilities, income and expense and capital accounts. These records reflect the overall financial condition of the broker-dealer and in the Commission's view can incorporate security-based swap activities without the need for a clarifying amendment. The Commission proposed a parallel provision in Rule 18a-5 requiring stand-alone SBSDs and MSBSPs to make and keep current the same types of general ledgers.[45]

As discussed above, a commenter urged the Commission to provide firms with the flexibility to keep the proposed general ledger in various formats as long as all required information is kept and accessible to the Commission.[46] For the reasons discussed above, the Commission does not believe this would be appropriate. Moreover, as discussed above, the Commission does not believe it would be appropriate to apply the limited alternative compliance mechanism for this record because the information that must be recorded in a general ledger is broader than security-based swap information.[47] For this reason, the Commission is adopting the general ledger requirement as proposed.[48]

Ledgers for Customer and Non-Customer Accounts

Paragraph (a)(3) of Rule 17a-3 requires broker-dealers to make and keep current certain ledger accounts (or other records) relating to securities and Start Printed Page 68555commodities transactions in customer and non-customer cash and margin accounts. The Commission proposed to amend this paragraph to require that broker-dealers, including broker-dealer SBSDs and MSBSPs, make and keep current ledger accounts (or other records) that record specific security-based swap transaction data elements.[49] The Commission proposed in Rule 18a-5 that stand-alone SBSDs and MSBSPs be required to make and keep current the same types of ledgers (or other records). However, the proposed rule text did not refer to “cash and margin accounts” because these types of accounts involve activities that may not be undertaken by stand-alone SBSDs and MSBSPs because they are not registered as broker-dealers. The Commission proposed in Rule 18a-5 that bank SBSDs and MSBSPs make and keep current ledger accounts (or other records) relating to securities and commodity transactions, but only with respect to their security-based swap customers and non-customers.

As discussed above, a commenter urged the Commission to provide firms with the flexibility to keep the proposed ledgers for customer accounts in various formats as long as all required information is kept and accessible to the Commission.[50] For the reasons discussed above, the Commission does not believe this would be appropriate. However, as discussed in more detail below in section II.E.1. of this release, to promote harmonization with CFTC requirements and provide additional flexibility, an SBSD or MSBSP that is also registered as a swap dealer or major swap participant may opt to use the limited alternative compliance mechanism with respect to these ledgers as they pertain to security-based swap and swap transactions and positions.[51] For these reasons, the Commission is adopting the ledger account requirements substantially as proposed.[52]

Stock Record

Paragraph (a)(5) of Rule 17a-3 requires broker-dealers to make and keep current a securities record (also referred to as a “stock record”). This is a record of the broker-dealer's custody and movement of securities. The “long” side of the record accounts for the broker-dealer's responsibility as a custodian of securities and shows, for example, the securities the firm has received from customers and securities owned by the broker-dealer. The “short” side of the record shows where the securities are located, such as at a securities depository. The Commission proposed to amend this paragraph to require that the securities record of broker-dealers, including broker-dealer SBSDs and MSBSPs, specifically account for security-based swap activity by reflecting separately for each security-based swap certain of the transaction data elements and other information.[53] In addition, the Commission proposed parallel securities record requirements in Rule 18a-5 for stand-alone and bank SBSDs and MSBSPs. However, the requirements for bank SBSDs and MSBSPs were limited to positions related to their business as an SBSD or MSBSP.

As discussed above, a commenter urged the Commission to provide firms with the flexibility to keep the proposed stock record in various formats as long as all required information is kept and accessible to the Commission.[54] For the reasons discussed above, the Commission does not believe this would be appropriate. However, as discussed in more detail below in section II.E.1. of this release, to promote harmonization with CFTC requirements and increase flexibility, an SBSD or MSBSP that is also registered as a swap dealer or major swap participant may opt to use the limited alternative compliance mechanism with respect to the stock record as it pertains to security-based swap and swap transactions and positions.[55] The Commission also clarifies that the requirement as adopted does not necessarily require the use of two separate stock records (i.e., one for securities and one for security-based swaps); instead, a broker-dealer SBSD may elect to use a single stock record that incorporates all of its securities customers, including security-based swap customers.

A commenter stated that the Commission should replace the terms “long” and “short” in the proposed requirements with “bought” and “sold,” respectively.[56] The commenter explained that the former two terms were “not really applicable” to security-based swaps. The Commission agrees and the final amendment and rule use the terms “bought” and “sold.” For the reasons discussed above, the Commission is adopting the stock record requirements with this modification but otherwise substantially as proposed.[57]

Memoranda of Brokerage Orders

Paragraph (a)(6) of Rule 17a-3 requires broker-dealers to make and keep current a memorandum of each brokerage order, and of any other instruction, given or received for the purchase or sale of a security. The memorandum must show the terms and conditions of each brokerage order. The Commission proposed to amend this paragraph to require broker-dealers, including broker-dealer SBSDs and MSBSPs, to make and keep current a memorandum of each brokerage order given or received for the purchase or sale of a security-based swap.[58] Further, the rule required that certain of the security-based swap transaction data elements be documented in the memorandum. The Commission proposed a parallel provision in Rule 18a-5 for bank SBSDs and MSBSPs. The Commission did not propose a parallel provision for stand-alone SBSDs and MSBSPs because these registrants are not permitted to engage in the business of effecting brokerage orders in security-based swaps without registering as a broker-dealer or a bank.[59]

Start Printed Page 68556

A commenter expressed general support for the proposed requirements but asked the Commission to confirm that the order ticket requirement only applies when there are in fact orders received for execution (i.e., where the orders are potentially executed on a security-based swap execution facility), and not where there is a negotiation that results in a transaction without any executable order or other instruction given.[60] Furthermore, the commenter also asked the Commission to confirm that no order ticket needs to be created by the broker-dealer or its affiliated SBSD when a registered broker-dealer acts as an agent in connection with negotiated transactions between an affiliated SBSD and its customers without any executable order being received. In response, the Commission clarifies that the firm must receive an executable order or other instruction to trigger the memorandum requirement (i.e., an order or instruction that the broker-dealer, SBSD, or MSBSP has agreed to execute on behalf of the counterparty). Consequently, preliminary negotiations or responding to questions about a potential transaction alone do not trigger the recordkeeping requirement. For these reasons, the Commission is adopting these requirements substantially as proposed.[61]

Memoranda of Proprietary Orders

Paragraph (a)(7) of Rule 17a-3 requires broker-dealers to make and keep current a memorandum of each purchase and sale for the account of the broker-dealer. Generally, this paragraph requires broker-dealers to document the terms of securities transactions where they are acting as a dealer or otherwise trading for their own account. The Commission proposed to amend this paragraph to require the terms of security-based swap transactions to be documented as well.[62] In addition, the Commission proposed parallel memorandum requirements in Rule 18a-5 for stand-alone and bank SBSDs and MSBSPs, but only with respect to security-based swap transactions. The Commission received no comment that specifically addressed these proposed requirements and is adopting them substantially as proposed.[63]

Confirmations

Paragraph (a)(8) of Rule 17a-3 requires broker-dealers to keep copies of all trade confirmations. In addition, the Commission has adopted rules that require SBSDs and MSBSPs to provide trade acknowledgments containing the details of a security-based swap transaction within prescribed timeframes and to establish, maintain, and enforce written policies and procedures that are reasonably designed to obtain prompt verification of the terms of the trade acknowledgments.[64] In particular, Rule 15Fi-2 requires SBSDs and MSBSPs to promptly verify the accuracy of, or otherwise dispute with their counterparties, the terms of trade acknowledgments they receive.

The Commission proposed to amend paragraph (a)(8) of Rule 17a-3 to require that broker-dealers, including broker-dealer SBSDs and MSBSPs, make and keep current copies of the security-based swap trade acknowledgments and verifications made pursuant to Rule 15Fi-2.[65] The Commission also proposed in Rule 18a-5 that stand-alone SBSDs and MSBSPs make and keep current copies of: (1) Confirmations of all purchases or sales of securities that are not security-based swaps; and (2) security-based swap trade acknowledgments and verifications made pursuant to Rule 15Fi-2. The Commission further proposed parallel confirmation requirements in Rule 18a-5 for bank SBSDs and MSBSPs. However, the requirement to make and keep current copies of confirmations of all purchases and sales of securities that are not security-based swaps would be limited to transactions that related to their business as an SBSD or MSBSP.

A commenter stated that the Commission should not require a bank SBSD or MSBSP to make and keep current copies of all confirmations of all purchases and sales of securities (other than security-based swaps) or, in the alternative, the Commission should narrowly interpret when securities transactions are “related to the business” of a bank as an SBSD or MSBSP.[66] The Commission disagrees that confirmations should not be made for transactions when the security is not a security-based swap. A confirmation of any securities transaction that occurs within a security-based swap account will assist examiners in reviewing all the activities in the account and whether the firm is acting in accordance with applicable securities laws. The Commission notes, however, that a bank SBSD or MSBSP must make and keep current copies of confirmations relating to transactions in securities, other than security-based swaps, only if the transaction relates to its business as an SBSD or MSBSP. Consequently, the final requirements do not apply to a security transaction that relates solely to the bank acting as a bank and not as an SBSD or MSBSP. For these reasons, the Commission is adopting the requirements as proposed.[67]

Accountholder Information

Paragraph (a)(9) of Rule 17a-3 requires broker-dealers to make a record for each securities accountholder that contains certain information about the person. The Commission proposed to amend this paragraph to require broker-dealers, including broker-dealer SBSDs and MSBSPs, to record certain information with respect to security-Start Printed Page 68557based swap accountholders.[68] The Commission proposed parallel requirements in Rule 18a-5 for stand-alone and bank SBSDs and MSBSPs with respect to recording the information about security-based swap accountholders.

A commenter stated that it is not common practice in the swaps market to obtain signatures of persons authorized to transact business on behalf of a counterparty in a swap account and recommended instead that broker-dealers, SBSDs, and MSBSPs be permitted to satisfy this requirement by establishing policies and procedures relating to counterparty trade authorization.[69] It is a prudent business practice for financial institutions to formalize relationships with their counterparties and to take orders from individuals only if they are authorized to enter into transactions on behalf of the counterparty. This provides greater legal certainty in terms of enforcing the rights of the financial institution and its counterparty. Obtaining the signatures of persons authorized to transact on behalf of the counterparty is one way to promote these objectives, but the Commission agrees with the commenter that it is not the only way. Maintaining a record of persons authorized to transact on behalf of the counterparty such as a copy of a corporate resolution granting the person such authority is another way. Consequently, the Commission is modifying the text of the final rules so that the means of establishing a record of the authorization of each person to whom the counterparty has granted authority to transact business in the security-based swap account are not limited to obtaining signatures of such persons. In particular, the final rules provide that, for each security-based swap account, the broker-dealer, SBSD, or MSBSP must make and retain a record of the authorization of each person the counterparty has granted authority to transact business in the security-based swap account. This record could be, for example, a signature of the person, a copy of the corporate resolution of the counterparty granting the person authority to trade on its behalf, or a communication from the counterparty identifying the person as having been granted authority to act on its behalf. In addition to promoting the objectives described above, this record will assist Commission staff in examining whether a given transaction has been appropriately authorized.

Another commenter raised concerns about disclosures to the Commission regarding clients, associated persons, or other such persons arising from confidentiality requirements under the local laws of certain non-U.S. jurisdictions.[70] The Commission understands that some foreign laws and regulations may limit or prevent disclosure of customer information to the Commission. These types of restrictions may include privacy laws, which generally restrict disclosure of certain identifying information about a natural person or entity, and so-called “blocking statutes” (including secrecy laws) that prevent the disclosure of information relating to third parties and/or foreign governments. In response, the Commission notes that it has proposed in a separate release additional provisions that are designed to address concerns about the cross-border application of certain requirements that will be or have been proposed to be applicable to SBSDs and MSBSPs.[71] For the foregoing reasons, the Commission is adopting the accountholder requirements with the modifications discussed above.[72]

Options Positions

Paragraph (a)(10) of Rule 17a-3 requires broker-dealers to make and keep current a record of all options positions. The Commission did not propose to amend this paragraph to account for security-based swaps. In addition, because the records required under this paragraph are not specific to security-based swaps, the Commission did not propose to include an analogous provision applicable to bank SBSDs and MSBSPs. However, in order to facilitate the monitoring of the financial condition of stand-alone SBSDs and MSBSPs, the Commission proposed a parallel provision in Rule 18a-5 applicable to these entities.[73] One commenter expressed support for this proposed requirement.[74] The Commission is adopting the options position recordkeeping requirement as proposed.[75]

Trial Balances and Computation of Net Capital

Paragraph (a)(11) of Rule 17a-3 requires broker-dealers, including broker-dealer SBSDs and MSBSPs, to make and keep current a record of the proof of money balances of all ledger accounts in the form of trial balances and certain records relating to the computation of aggregate indebtedness and net capital under the broker-dealer net capital rule.[76] The Commission did not propose that bank SBSDs and MSBSPs make similar records as the prudential regulators administer the capital requirements applicable to these entities.[77] The Commission did propose a parallel requirement in Rule 18a-5 for stand-alone SBSDs and MSBSPs to facilitate the review and monitoring of their financial condition and their compliance with the regulatory capital requirements in proposed Rules 18a-1 and 18a-2, respectively.[78] One commenter noted the importance of including recordkeeping and reporting requirements with respect to trial balances and the computation of net capital.[79] The Commission has adopted capital requirements for stand-alone SBSDs and MSBSPs in Rules 18a-1 and 18a-2, respectively.[80] Consequently, the Commission is adopting the trial balances and computation of net capital recordkeeping requirement for stand-alone SBSDs and MSBSPs as proposed.[81]

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Associated Persons

Paragraph (a)(12) of Rule 17a-3 requires broker-dealers, including broker-dealer SBSDs and MSBSPs, to make and keep current a questionnaire or application for employment for each associated person that contains information about the associated person (the “questionnaire requirement”) as well other information about associated persons. The Commission proposed parallel requirements in Rule 18a-5 for stand-alone and bank SBSDs and MSBSPs.[82] Further, the Commission proposed to amend the definition of “associated person” in Rule 17a-3 to include in the definition a person associated with an SBSD or MSBSP as defined in Section 3(a)(70) of the Exchange Act. The Commission proposed a parallel definition in Rule 18a-5. However, the proposed Rule 18a-5 definition was more limited as applied to bank SBSDs and MSBSPs in that it covered persons whose activities relate to the conduct of the bank's business as an SBSD or MSBSP.

Commenters requested that the Commission limit the proposed questionnaire requirement for stand-alone and bank SBSDs and MSBSPs to associated persons who effect or are involved in effecting security-based swaps on the firm's behalf.[83] The Commission agrees with the comments. The questionnaire requirement, as proposed, was designed to provide a basis for assessing compliance with Section 15F(b)(6) of the Exchange Act and a related rule thereunder.[84] Both the statute and the rule (Rule 15Fb6-2) apply to associated persons who effect or are involved in effecting security-based swaps on behalf of the SBSD or MSBSP.[85] Accordingly, the Commission is narrowing the scope of the questionnaire requirement in Rule 18a-5 for stand-alone and bank SBSDs and MSBSPs so that it applies only with respect to associated persons who effect or are involved in effecting security-based swaps on the firm's behalf.[86]

A commenter also requested that the Commission modify the proposal for foreign SBSDs and MSBSPs so that the questionnaire requirement does not apply to associated persons who effect or are involved in effecting security-based swap transactions with non-U.S. persons or foreign branches.[87] As noted above, the questionnaire requirement is intended to support the substantive prohibition in Section 15F(b)(6) of the Exchange Act and the related certification and background check requirements in Rule 15Fb6-2. The Commission recognizes, however, as noted by the commenters, that there may be situations in which an SBSD or MSBSP is prohibited by applicable non-U.S. law from receiving, creating, or maintaining records with respect to certain of the information that needs to be recorded pursuant to the questionnaire requirement. Consequently, the Commission has proposed in a separate release additional provisions in Rule 18a-5 that would address situations where the law of a non-U.S. jurisdiction in which an associated person is employed or located may prohibit a stand-alone or bank SBSD or MSBSP from receiving, or creating or maintaining a record of, any of the information mandated by the questionnaire requirement.[88]

Finally, for the sake of clarity, the Commission emphasizes that these associated person recordkeeping requirements apply to natural persons and not to legal entities that may be associated persons. For the reasons stated above, the Commission is adopting the associated person recordkeeping requirements with the modifications discussed above.[89]

Liquidity Stress Test

In 2012, the Commission proposed liquidity stress test requirements for entities that are or would be authorized to use internal models to compute net capital; namely, certain stand-alone broker-dealers (“ANC broker-dealers”) as well as certain broker-dealer and stand-alone SBSDs.[90] Consequently, the Commission proposed that these entities be required to make and keep current certain records relating to the liquidity stress test requirements, if applicable.[91] The Commission has deferred consideration of the proposed liquidity stress test requirements.[92] Accordingly, the Commission is deferring consideration of the related recordkeeping requirements.[93]

Account Equity and Margin Calculations

The Commission proposed to amend Rule 17a-3 to require broker-dealer SBSDs and MSBSPs to make and keep current a record of the daily calculations that would be required under the proposed margin rule for non-cleared security-based swaps—Rule 18a-3.[94] The Commission proposed a parallel requirement in Rule 18a-5 for stand-alone SBSDs and MSBSPs. A commenter expressed support for the proposal [95] and the Commission has adopted Rule 18a-3 requiring the daily calculations.[96] For the reasons discussed in the proposing release, the Start Printed Page 68559Commission is adopting daily calculation recordkeeping requirements substantially as proposed.[97]

Possession or Control Requirements

The Commission proposed to amend Rule 17a-3 to require broker-dealer SBSDs to make and keep current a record of compliance with the possession or control requirements in the proposed segregation rule for SBSDs—Rule 18a-4.[98] The Commission proposed a parallel requirement in Rule 18a-5 for stand-alone SBSDs. A commenter supported the proposal [99] and the Commission has adopted Rule 18a-4 prescribing possession or control requirements.[100] For the reasons discussed in the proposing release, the Commission is adopting the security-based swap possession or control recordkeeping requirements substantially as proposed.[101]

Customer Reserve Account Requirements

The Commission proposed to amend Rule 17a-3 to require broker-dealer SBSDs to make and keep current a record of security-based swap reserve account computations pursuant to proposed Rule 18a-4.[102] The Commission proposed a parallel requirement in Rule 18a-5 for stand-alone SBSDs. A commenter expressed support for the proposal [103] and the Commission has amended Rule 15c3-3 and adopted Rule 18a-4 to prescribe security-based swap reserve account requirements.[104] For the reasons discussed in the proposing release, the Commission is adopting the security-based swap customer reserve account recordkeeping requirements substantially as proposed.[105]

Unverified Transactions

It is prudent practice for counterparties to promptly confirm the terms of executed OTC derivatives transactions.[106] The Commission adopted Rule 15Fi-2 to promote this practice. As discussed above, Rule 15Fi-2 requires, among other things, that SBSDs and MSBSPs provide trade acknowledgments containing the details of security-based swap transactions and promptly verify the accuracy of, or otherwise dispute with their counterparties, the terms of trade acknowledgments they receive. To promote compliance with then proposed Rule 15Fi-2 and the risk management practices of SBSDs and MSBSPs, the Commission proposed to amend Rule 17a-3 and include parallel provisions in Rule 18a-5 that would require these entities to make and keep current a record of each security-based swap trade acknowledgment that is not verified within five business days of execution.[107] While the Commission did not prescribe a timeframe for security-based swap trade acknowledgments to be verified, paragraph (e) of Rule 15Fi-2 requires procedures reasonably designed to obtain “prompt verification.”

A commenter urged the Commission not to establish a rigid threshold of five business days and suggested that the Commission “enter into a constructive dialogue with interested constituencies to establish best practices for trade verification.”[108] The requirement to make a record of security-based swap trade acknowledgments not verified within five business days is not intended to establish a maximum timeframe within which verification should be obtained pursuant to Rule 15Fi-2. Instead, it is designed to require SBSDs and MSBSPs to make a record of the transactions that have gone unverified for a significant length of time, as the delay in obtaining verification may indicate, for example, the existence of a disagreement with the counterparty as to the terms of the transaction. The Commission believes that five business days represents an appropriate amount of time to wait before requiring a record to be made. This timeframe is designed to strike an appropriate balance in terms of a time period that is not too short and would capture information that is not relevant to Rule15Fi-2 or that is too long and would not promote compliance with Rule 15Fi-2. For these reasons, the Commission is adopting the unverified transaction recordkeeping requirements substantially as proposed.[109]

Finally, the Commission has previously noted that in complying with the trade acknowledgement and verification requirements, policies and procedures reasonably designed to ensure prompt verification of a transaction may include policies and procedures under which an SBSD or MSBSP relies on its counterparty's negative affirmation to the terms of a trade acknowledgment. The Commission has stated that those policies and procedures generally should require the SBSD or MSBSP to document its counterparty's agreement to rely on negative affirmation.[110] As such, transactions verified by negative affirmation do not need to be recorded as unverified under Rules 17a-3 and 18a-5.

Records Relating to Business Conduct Standards

The Commission has adopted rules to establish business conduct and chief compliance officer requirements for SBSDs and MSBSPs.[111] The Start Printed Page 68560requirements in these rules address (among other things):

  • Verification of the status of the counterparty;
  • Certain disclosures related to the daily mark and its calculation;
  • Disclosures regarding material incentives, conflicts of interest, material risks, and characteristics of the security-based swap, and certain clearing rights;
  • Certain “know your counterparty” and suitability obligations for SBSDs;
  • Supervisory requirements, including written policies and procedures;
  • Certain requirements regarding interactions with special entities;
  • Provisions intended to prevent SBSDs from engaging in certain “pay to play” activities; and
  • Certain minimum requirements relating to chief compliance officers.

To promote compliance with these then-proposed requirements, the Commission proposed to amend Rule 17a-3 and include parallel provisions in Rule 18a-5 that would require all SBSDs to make and keep current a record that demonstrates their compliance with Rule 15Fh-6 (regarding political contributions by certain SBSDs).[112] In addition, the Commission proposed to amend Rule 17a-3 and include parallel provisions in Rule 18a-5 to require that all SBSDs and MSBSPs make and keep current a record that demonstrates their compliance with Rules 15Fh-1 through 15Fh-5 and Rule 15Fk-1, as applicable.[113] These recordkeeping requirements would require covered firms to keep supporting documents evidencing their compliance with the business conduct and chief compliance officer requirements; a mere attestation of compliance would not be sufficient. To the extent that the rules require providing or receiving written disclosures or written representations, the SBSD or MSBSP would be required to retain a copy of the disclosures or representations.

A commenter asked the Commission to confirm that the proposed requirements would not create additional recordkeeping obligations with respect to the business conduct standards,[114] particularly with respect to the requirements relating to compliance with such requirements.[115] The commenter also generally stated that the Commission should not adopt additional recordkeeping rules relating to the pay-to-play provisions set forth in the Commission's business conduct release.[116]

In response to the commenter's concern, the Commission notes that the proposed recordkeeping requirements were not intended to add additional substantive business conduct or pay-to-play requirements. The relevant substantive requirements are prescribed in the business conduct and pay-to-play rules; the recordkeeping requirements are designed to require records of compliance with those already existing substantive requirements. The Commission acknowledges, however, that they would impose new requirements to document a registrant's compliance with several of the substantive business conduct and pay-to-play requirements as well as new requirements to provide written documentation where the business conduct and pay-to-play rules allowed for oral disclosure. These proposed documentation requirements were designed to assist Commission examiners in reviewing compliance with the business conduct and pay-to-play requirements, and the anticipated additional burdens they will impose on registrants are discussed below in Sections IV and V. For these reasons, the Commission is adopting the business conduct standards recordkeeping requirements substantially as proposed.[117]

b. Additional Amendments to Rule 17a-3 and Modifications to Rule 18a-5

The Commission proposed several amendments to Rule 17a-3 to eliminate obsolete text, improve readability, and modernize terminology. The Commission received no comments addressing these proposed amendments and, as discussed below, is adopting them substantially as proposed.

Reference is made throughout Rule 17a-3 to “members” of a national securities exchange as a distinct class of registrant in addition to “brokers” and “dealers.” The Commission proposed to remove these references to “members” given that the rule applies to brokers-dealers, which would include members of a national securities exchange that are brokers-dealers.[118] The rule being adopted does not remove these references to “members” to avoid confusion as to whether their removal resulted in a substantive change to the rule.

The Commission is adopting a global change to replace the word “shall” in the rule with the word “must” or “will” where appropriate.[119] Similarly, when defining terms, the Commission is replacing the phrase “shall mean” with the word “means.” [120] The Commission is also adopting certain stylistic, corrective, and punctuation amendments to improve the rule's readability.[121] The Commission is Start Printed Page 68561simplifying the text in paragraph (a) of Rule 17a-3 to state that Rule 17a-3 applies to “every broker or dealer,” since the newly adopted undesignated introductory paragraph already provides sufficient detail as to the types of registrants to which the rule applies.[122] In recognition of the fact that broker-dealers may execute orders for non-customers, the Commission is amending paragraph (a)(6) of Rule 17a-3 to specify that a broker-dealer must maintain a copy of the customer's or non-customer's subscription agreement.[123]

The Commission is restructuring paragraph (a)(11) of Rule 17a-3 to eliminate paragraphs (a)(11)(i) and (ii).[124] Under these amendments, the text formerly located in paragraph (a)(11)(i) of Rule 17a-3 is set forth in the second sentence of paragraph (a)(11) of Rule 17a-3, as amended, and the text of paragraph (a)(11)(ii) has been deleted from the rule. The Commission proposed to amend the “Provided, however” paragraph in paragraph (a)(12) of Rule 17a-3 that follows paragraph (a)(12)(i)(H) by replacing the list of entities enumerated in the paragraph with the term “a self-regulatory organization.” [125] The Commission is amending the paragraph substantially as proposed but adding the phrase “a registered national securities association or a registered national securities exchange” rather than the term “a self-regulatory organization” in order to more accurately reflect the nature of the entities listed in the paragraph prior to these amendments. The Commission is also redesignating this paragraph as paragraph (a)(12)(i)(I) of Rule 17a-3.

As discussed in more detail in section II.E.1. of this release, the Commission is adopting a limited alternative compliance mechanism in Rules 17a-3 and 18a-5.[126] The provisions of the limited alternative compliance mechanism are in paragraph (b) of Rule 17a-3 and in paragraph (c) of Rule 18a-5. As a result, the Commission is redesignating paragraphs (b) through (g) of Rule 17a-5 as paragraphs (c) through (g) and is redesignating proposed paragraph (c) of Rule 18a-5 as paragraph (d).

The Commission also is amending paragraph (b) of Rule 17a-3 (and, as mentioned above, is redesignating it as paragraph (c)). Paragraph (b)(1) was designed to avoid duplication so that an introducing broker-dealer will not be required to make and keep current the same records that would customarily be made by the firm's clearing broker-dealer. However, the language in paragraph (b)(1) beginning with the phrase “Provided, That” is outdated insofar is it references a capital standard that has been superseded, and the Commission is deleting it accordingly. In revising paragraph (b)(1), the intent of the provision—to avoid the duplicative creation of records related to transactions introduced by one broker or dealer and cleared by a different broker or dealer—remains the same. However, the Commission is eliminating the outdated capital standard reference.[127] The Commission is also deleting paragraph (b)(2), as it would be redundant of paragraph (b) of Rule 17a-3, as amended.

The Commission is deleting paragraphs (c) and (d) of Rule 17a-3. Paragraph (c) references instruments such as U.S. Defense Savings Stamps and U.S. Defense Savings Bonds that are no longer widely circulated and thus a specific carve-out for these instruments from the general rule set forth in paragraph (a) of Rule 17a-3 is no longer appropriate.[128] Paragraph (d) provides a de minimis exception from paragraph (a) of Rule 17a-3 for any cash transaction of $100 or less involving only subscription rights or warrants which by their terms expire within 90 days after their issuance. This exception was adopted in 1953 to reduce the burden and expense of making accounting entries for these transactions. The burden associated with these accounting entries is no longer significant in light of the technological advances in recordkeeping systems since 1953.[129] In addition, the removal of this exception will affect only a small number of transactions. As a consequence of the removal of paragraphs (c) and (d) from Rule 17a-3, paragraphs (e), (f), (g), and (h) are being redesignated as paragraphs (d), (e), (f), and (g), respectively.

Paragraph (e) of Rule 17a-3 references Municipal Securities Rulemaking Board (“MSRB”) Rule G-8 and states that compliance with that rule will be deemed to be compliance with this section. The Commission is adding the phrase “or any successor rule” to the reference to Rule G-8 so that the reference does not become superseded over time.

The Commission also made a number of non-substantive modifications to the text of Rule 18a-5 in addition to the modifications discussed above in section II.A.2.a. of this release.[130]

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3. Record Maintenance and Preservation Requirements

Rule 17a-4 requires a broker-dealer to preserve certain types of records if it makes or receives them. The rule also prescribes the time period that these records and the records required to be made and kept current under Rule 17a-3 must be preserved and the manner in which they must be preserved. The Commission is adopting amendments to Rule 17a-4 that are designed to account for the security-based swap activities of broker-dealers, including broker-dealer SBSDs and MSBSPs.[131] The Commission also is adopting a number of largely technical amendments to Rule 17a-4. The Commission is adopting Rule 18a-6—which is modeled on Rule 17a-4, as amended—to establish record maintenance and preservation requirements for stand-alone and bank SBSDs and MSBSPs. Rule 18a-6 does not include a parallel requirement for every requirement in Rule 17a-4.[132] In addition, the recordkeeping requirements in Rule 18a-6 applicable to bank SBSDs and MSBSPs are more limited in scope than the requirements in the rule applicable to stand-alone SBSDs and MSBSPs.

a. Rule 17a-4 and Rule 18a-6

Undesignated Introductory Paragraph

The Commission proposed adding an undesignated introductory paragraph to Rule 17a-4 explaining that the rule applies to a broker-dealer, including a broker-dealer SBSD or MSBSP, while a stand-alone or bank SBSD or MSBSP is subject to Rule 18a-6.[133] Similarly, the Commission proposed an undesignated introductory paragraph to Rule 18a-6 explaining that the rule would apply to a stand-alone or bank SBSD or MSBSP, while a broker-dealer SBSD or MSBSP is subject to Rule 17a-4. The Commission received no comments on the proposed undesignated introductory paragraphs to Rules 17a-4 and 18a-6 and is adopting them with non-substantive modifications to clarify which rule (17a-4 or 18a-6) applies to a given type of entity.[134]

Six Year Preservation Requirement for Certain Rule 17a-3 and Rule 18a-5 Records

Paragraph (a) of Rule 17a-4 provides that brokers-dealers subject to Rule 17a-3 must preserve for a period of not less than six years, the first two years in an easily accessible place, certain categories of records required to be made and kept current under Rule 17a-3 (the “six year preservation requirement”).[135] Consequently, under this existing requirement, broker-dealer SBSDs and MSBSPs are required to preserve for six years the same categories of records as stand-alone broker-dealers. As discussed above, paragraphs (a) and (b) of Rule 18a-5 contain certain recordkeeping requirements that parallel existing requirements in Rule 17a-3, as amended. Under these parallel requirements, stand-alone and bank SBSDs and MSBSPs must make and keep current certain categories of records that broker-dealers must maintain pursuant to the six year preservation requirement in Rule 17a-4. Consequently, as proposed, paragraphs (a)(1) and (2) of Rule 18a-6 would require that these categories of records must be preserved for a period of not less than six years, the first two years in an easily accessible place.[136] The Commission received no comments on Start Printed Page 68563paragraphs (a)(1) and (2) of proposed Rule 18a-6 and is adopting them as proposed.[137]

Three Year Preservation Requirement for Certain Rule 17a-3 and Rule 18a-5 Records

Paragraph (b)(1) of Rule 17a-4 provides that broker-dealers subject to Rule 17a-3 must preserve for at least three years, the first two years in an easily accessible place, certain records required to be made and kept current under Rule 17a-3 (the “three year preservation requirement”).[138] The Commission did not propose to amend or change any of the existing cross-references to Rule 17a-3 in paragraph (b)(1) of Rule 17a-4. The Commission did, however, propose adding cross-references to certain new paragraphs that are being added to Rule 17a-3 to address security-based swap activities of broker-dealers, including broker-dealer SBSDs and MSBSPs.[139] As discussed above, paragraphs (a) and (b) of Rule 18a-5 require stand-alone and bank SBSDs and MSBSPs make and keep current certain categories of records that broker-dealers must maintain pursuant to the three year preservation requirement, as amended to incorporate the new records relating to security-based swap activities. Consequently, as proposed, paragraphs (b)(1) and (2) of Rule 18a-6 would similarly require that these categories of records be preserved for a period of not less than three years, the first two years in an easily accessible place. The Commission received no comments on these proposed preservation requirements and is adopting them substantially as proposed.[140]

Three Year Preservation Requirement for Certain Other Records

Paragraphs (b)(2) through (13) of Rule 17a-4 also provide that a broker-dealer subject to Rule 17a-3 must preserve for a period of not less than three years, the first two years in an easily accessible place, other categories of records if the broker-dealer makes or receives the record. These are not categories of records a broker-dealer is required to make and keep current under Rule 17a-3 but rather types of records that a broker-dealer may make or receive in the ordinary course of business. As discussed in more detail below, the Commission proposed to amend certain of the provisions in paragraphs (b)(2) through (13) of Rule 17a-4 to account for security-based swaps and to require that broker-dealers, including broker-dealer SBSDs and MSBSPs, preserve certain additional records related to security-based swap activities.[141] Further, as discussed below, the Commission proposed requirements in paragraph (b) of Rule 18a-6 that would require stand-alone and bank SBSDs and MSBSPs to preserve similar records.

In addition, the categories of records identified in paragraphs (b)(3) through (5) and (7) of Rule 17a-4 must be retained only if they relate to the broker-dealer's business as such (i.e., business as a broker-dealer). Security-based swap activities of a broker-dealer that is not registered as an SBSD or MSBSP are part of the broker-dealer's business as such for the purposes of Rule 17a-4 just like activities relating to other types of securities. In the case of a broker-dealer SBSD or MSBSP, the Commission proposed to amend Rule 17a-4 to clarify that the business as such of these entities would include the firm's business as an SBSD or MSBSP.[142] The Commission received no comment on the proposed definition and is adopting it substantially as proposed.[143]

Bank Records

Paragraph (b)(2) of Rule 17a-4 requires a broker-dealer, including a broker-dealer SBSD or MSBSP, to preserve all check books, bank statements, cancelled checks, and cash reconciliations. The Commission did not propose to amend this paragraph to specifically account for security-based swaps. However, the Commission did propose a parallel requirement in Rule 18a-6 applicable to stand-alone SBSDs and MSBSPs.[144] The Commission received no comments on this proposed bank record preservation requirement and is adopting it as proposed.[145]

Bills

Paragraph (b)(3) of Rule 17a-4 requires a broker-dealer, including a broker-dealer SBSD or MSBSP, to preserve all bills receivable or payable, paid or unpaid, relating to the business of the broker-dealer. The Commission proposed a parallel requirement in Rule 18a-6 that would require stand-alone SBSDs and MSBSPs to preserve these types of bills.[146] The Commission received no comments on this proposed bill preservation requirement and is adopting it as proposed.[147]

Communications

Paragraph (b)(4) of Rule 17a-4 requires a broker-dealer, including a broker-dealer SBSD or MSBSP, to preserve originals of all communications received and copies of all communications sent (and any approvals thereof) by the broker-dealer (including inter-office memoranda and communications) relating to its business as such, including all communications which are subject to the rules of a self-regulatory organization (“SRO”) of which the broker-dealer is a member regarding communications with the Start Printed Page 68564public.[148] The term “communications,” as used in paragraph (b)(4) of Rule 17a-4, includes all electronic communications (e.g., emails and instant messages).[149] Communications related to security-based swap activities would be communications relating to the business as such of a broker-dealer, including a broker-dealer SBSD and MSBSP.

The Commission had not previously interpreted the term “communications” to include telephonic communications. However, Section 15F(g)(1) of the Exchange Act provides that each registered SBSD and MSBSP shall maintain daily trading records of the security-based swaps of the registered SBSD or MSBSP and all related records (including related cash or forward transactions) and recorded communications, including electronic mail, instant messages, and recordings of telephone calls, for such period as may be required by the Commission by rule or regulation. Therefore, to implement Section 15F(g)(1) of the Exchange Act, the Commission proposed amendments to the preservation requirement in paragraph (b)(4) of Rule 17a-4 to require recordings of telephone calls required to be maintained pursuant to Section 15F(g)(1) of the Exchange Act.[150] Under this requirement, a broker-dealer SBSD or MSBSP would be required to preserve for three years telephone calls that it records to the extent the recordings are required to be maintained pursuant to Section 15F(g)(1). The Commission proposed communication preservation requirements for stand-alone and bank SBSDs and MSBSPs that would parallel those in Rule 17a-4, as proposed to be amended, to further implement Section 15F(g)(1). The provision applicable to bank SBSDs and MSBSPs would limit the requirement to communications that relate to the business of an SBSD or MSBSP.

The Commission emphasizes that the Section 15(g)(1) of the Exchange Act and the new rules requiring the retention of telephone calls do not establish requirements to record telephone calls. Instead, the rules require firms to retain recordings of telephone calls that are within the scope of Section 15(g)(1) of the Exchange Act. Thus, if the firm records a telephone call voluntarily or for some other reason, it will need to retain the recording if the call falls within the scope of Section 15(g)(1) of the Exchange Act. However, a firm's decision not to record a telephone call that falls within the scope of Section 15(g)(1) of the Exchange Act will not implicate these new retention requirements.

A commenter urged the Commission to apply a one-year retention requirement as was adopted by the CFTC with respect to retaining recordings of telephone calls.[151] In response, the Commission notes that applying the three-year retention requirement to these recordings is designed to allow staff examiners access to records they may need to review the past activities of SBSDs and MSBSPs, given that examinations are conducted using a risk-based program. In addition, the Commission believes that a three-year retention period will benefit counterparties in that it will preserve information that may help support them if, for example, a dispute arises about a transaction with an SBSD or MSBSP. A three-year retention period also is consistent with the retention period applicable to the vast majority of broker-dealer records, as compared to a one year period. Further, although the CFTC requires registrants to make and keep records of all oral communications pertaining to pre-execution trade information, including telephone calls, the Commission's record retention rule applies only to recordings of telephone calls, i.e., those voluntarily made by the registrant.[152] The Commission is adopting the communications preservation requirements as proposed.[153]

Trial Balances

Paragraph (b)(5) of Rule 17a-4 requires a broker-dealer, including a broker-dealer SBSD or MSBSP, to preserve all trial balances, computations of aggregate indebtedness and net capital (and working papers in connection therewith), financial statements, branch office reconciliations, and internal audit working papers relating to the firm's business as a broker-dealer. The Commission proposed including a parallel requirement in Rule 18a-6 applicable to stand-alone SBSDs and MSBSPs.[154] In contrast to Rule 17a-4, the provision in Rule 18a-6, as proposed, did not refer to computations of “aggregate indebtedness” because the proposed capital rules for stand-alone SBSDs and MSBSPs—Rules 18a-1 and 18a-2, respectively—did not include such a calculation.[155] Further, to account for the capital standard for stand-alone MSBSPs, the proposed requirement referred to tangible net worth.[156] The Commission received no comments on the proposal and adopted Rules 18a-1 and 18a-2.[157] Consequently, the Commission is adopting the trial balance preservation requirements as proposed.[158]

Account Documents

Paragraph (b)(6) of Rule 17a-4 requires a broker-dealer, including a broker-dealer SBSD or MSBSP, to preserve all guarantees of accounts and all powers of attorney and other evidence of the granting of any discretionary authority given in respect of any account as well as copies of resolutions empowering an agent to act on behalf of a corporation. The Commission proposed parallel requirements in Rule 18a-6 for stand-alone and bank SBSDs and MSBSPs to preserve similar types of records, but only with respect to security-based swap accounts.[159] For example, bank SBSDs and MSBSPs would not be required to maintain these records with respect to accounts involving exclusively banking related services. The Commission received no comments on the proposed account documentation Start Printed Page 68565preservation requirements and is adopting them as proposed.[160]

Written Agreements

Paragraph (b)(7) of Rule 17a-4 requires a broker-dealer, including a broker-dealer SBSD or MSBSP, to preserve all written agreements (or copies thereof) entered into by the firm relating to its business as such, including agreements with respect to any account. The Commission proposed to amend this paragraph to require the preservation of written agreements with respect to a security-based swap customer or non-customer—including governing documents or any document establishing the terms and conditions of security-based swaps of the customer or non-customer—with the account records of the customer or non-customer.[161] The Commission proposed parallel requirements in Rule 18a-6 for stand-alone and bank SBSDs and MSBSPs. The provision applicable to bank SBSDs and MSBSPs would limit the preservation requirement to written agreements relating to the registrant's business as an SBSD or MSBSP. The Commission received no comments on the proposed written agreement preservation requirements and is adopting them substantially as proposed.[162]

Information Supporting Financial Reports

Paragraphs (b)(8)(i) through (xv) of Rule 17a-4 require a broker-dealer, including a broker-dealer SBSD or MSBSP, to preserve records containing various types of information that support amounts included in the broker-dealer's FOCUS Report prepared as of the broker-dealer's audit date and amounts in the annual audited financial statements the broker-dealer is required to file under Rule 17a-5 or 17a-12, as applicable. The paragraphs specifically identify the types of supporting information that must be preserved, including money balances, securities positions (which will include security-based swap positions), futures positions, commodity positions, and options positions, among other things.

The Commission proposed to: (1) Amend certain of these paragraphs to require the preservation of the same type of supporting information required of commodity positions, but for swap positions; (2) add a paragraph to require a broker-dealer SBSDs to preserve records that contain detail relating to the calculation of the risk margin amount under the proposed SBSD capital rules; and (3) add a new paragraph to require broker-dealer SBSDs to preserve records containing detail relating to the possession or control requirements in the proposed SBSD segregation rule.[163] The Commission proposed requirements in Rule 18a-6 for stand-alone SBSDs and MSBSPs that paralleled the requirements in paragraphs (b)(8)(i) through (xv) of Rule 17a-4, as proposed to be amended. Finally, the Commission proposed that bank SBSDs preserve records containing detail relating to the possession or control requirements in the proposed SBSD segregation rule (but not any of the other preservation requirements). The Commission received no comments on these proposals and has adopted the SBSD capital rules requiring a risk margin amount calculation and the SBSD segregation rules prescribing a possession or control requirement.[164] Consequently, the Commission is adopting the information supporting financial statement preservation requirements substantially as proposed.[165]

Rule 15c3-4 Risk Management Records

OTC derivatives dealers and ANC broker-dealers are subject to risk management requirements.[166] In particular, Rule 15c3-4 requires these broker-dealers to establish, document, and maintain a system of internal risk management controls to assist in managing the risks associated with the firm's business activities, including market, credit, leverage, liquidity, legal, and operational risks. The rule also requires periodic reviews (which may be performed by internal audit staff) and annual reviews (which must be conducted by independent public accountants) of the firm's risk management systems. Paragraph (b)(10) of Rule 17a-4 requires broker-dealers subject to Rule 15c3-4 to preserve the records required to be made under the rule and the results of the periodic reviews required to be conducted under the rule.

The Commission proposed that nonbank SBSDs and MSBSPs be required to comply with Rule 15c3-4.[167] Broker-dealer SBSDs will be subject to paragraph (b)(10) of Rule 17a-4. The Commission proposed a parallel provision in Rule 18a-6 to require nonbank SBSDs and MSBSPs to preserve the same types of records relating to Rule 15c3-4.[168] The Commission did not propose that bank SBSDs and MSBSPs comply with Rule 15c3-4 [169] and thus did not propose a Start Printed Page 68566parallel record preservation requirement for these entities. The Commission received no comments on these proposals and has adopted the requirement that nonbank SBSDs and MSBSPs comply with Rule 15c3-4.[170] Consequently, the Commission is adopting the risk management records preservation requirements as proposed.[171]

Credit Risk Determinations

Paragraph (c)(4)(vi)(A) of § 240.15c3-1e (appendix E to Rule 15c3-1) requires an ANC broker-dealer to make and keep current a record of the basis of its internal credit assessments of counterparties for purposes of the credit risk charges it must take as part of its net capital computation. Paragraph (b)(12) of Rule 17a-4 requires an ANC broker-dealer to preserve these records. A broker-dealer SBSD approved to use models to compute net capital will be subject to the recordkeeping provision in paragraph (c)(4)(vi)(A) of appendix E to Rule 15c3-1 and the corresponding record preservation requirement in paragraph (b)(12) of Rule 17a-4. The proposed capital rule for SBSDs included a parallel provision requiring a stand-alone SBSD approved to use models to make and keep current the same type of record of the basis of its internal credit assessments of counterparties.[172] Therefore, the Commission proposed a parallel corresponding record preservation requirement in Rule 18a-6 for such a stand-alone SBSD.[173] The Commission received no comments on the proposal and adopted the requirement in the capital rule for stand-alone SBSDs to make and keep current these records.[174] Consequently, the Commission is adopting the credit risk determination preservation record requirement as proposed.[175]

Regulation SBSR

As discussed above, the Commission has adopted Regulation SBSR, which assigns the duty to report a security-based swap transaction to a registered SDR.[176] The Commission proposed to amend paragraph (b)(14) of Rule 17a-4 to require that broker-dealers, including broker-dealer SBSDs and MSBSPs, preserve the information they are required to submit to a registered SDR under Regulation SBSR.[177] In addition, the Commission proposed to include parallel preservation requirements in Rule 18a-6 for stand-alone and bank SBSDs. The Commission received no comments on the proposed Regulation SBSR record preservation requirements and is adopting them as proposed.[178]

Records Relating to Business Conduct Standards

As discussed above, the Commission has adopted Rules 15Fh-1 through 15Fh-6 and Rule 15Fk-1. These rules require, among other things, that SBSDs and MSBSPs make certain disclosures, provide certain notices, and make other records. The Commission proposed to amend paragraph (b) of Rule 17a-4 to add a requirement that broker-dealer SBSDs and MSBSPs preserve copies of documents, communications, and notices related to the business conduct and chief compliance officer requirements in Rules 15Fh-1 through 15Fh-6 and Rule 15Fk-1.[179] In addition, the Commission proposed to adopt parallel record preservation requirements in Rule 18a-6 for stand-alone and bank SBSDs and MSBSPs. The Commission received no comments on the proposed business conduct record preservation requirements and is adopting them as proposed.[180]

Section 15F(h)(4)(C) of the Exchange Act imposes duties on SBSDs that act as advisors to special entities. Paragraph (a) of Rule 15Fh-2 defines what it means to act as an advisor to a special entity. If an SBSD is acting in this capacity, Section 15F(h)(4)(C) and paragraph (b) of Rule 15Fh-4 require the SBSD to make reasonable efforts to obtain such information as it considers necessary to make a reasonable determination that a security-based swap or trading strategy involving a security-based swap is in the best interests of the special entity. Section 15F(h)(5)(A) and paragraph (a) of Rule 15Fh-5 require an SBSD or MSBSP that is acting as a counterparty to a special entity to have a reasonable basis to believe that the special entity has a “qualified independent representative,” as that term is defined in the rule. The Commission proposed to amend paragraph (b) of Rule 17a-4 to add a requirement that broker-dealer SBSDs and MSBSPs preserve records relating to the determinations made pursuant to Section 15F(h)(4)(C) and Section 15F(h)(5)(A) of the Exchange Act.[181] In addition, the Commission proposed parallel record preservation requirements in Rule 18a-6 for stand-alone and bank SBSDs. The Commission received no comments on the proposed special entity advisor record preservation requirements and is adopting them as proposed.[182]

Corporate Documents

Paragraph (d) of Rule 17a-4 requires broker-dealers to preserve during the life of the enterprise corporate documents such as articles of incorporation, minute books, and stock certificate books. It also requires broker-dealers to preserve during the life of the enterprise registration and licensing information such as all Forms BD, Forms BDW, and licenses or other documentation showing registration with a securities regulatory authority. The Commission proposed to amend paragraph (d) of Rule 17a-4 to add references to proposed Form SBSE-BD and proposed Form SBSE-W.[183] These were the registration and withdrawal of registration forms, respectively, the Commission proposed for broker-dealer SBSDs and MSBSPs.[184] The Start Printed Page 68567Commission proposed a parallel requirement in Rule 18a-6 for stand-alone and bank SBSDs and MSBSPs, except that rule text referred to the registration forms these entities would use (i.e., Forms SBSE and SBSE-A, respectively) rather than Form SBSE-BD.[185]

The Commission received no comments on these proposals and has adopted the forms.[186] However, to correct an inadvertent omission, they now also require preservation of Form SBSE-C (17 CFR 249.1600c).[187] The registration rule for SBSDs and MSBSPs requires firms applying to register as an SBSD or MSBSP to file Form SBSE-C (which contains two separate certifications) in addition to Forms SBSE, SBSE-A, and/or SBSE-BD.[188] For these reasons, the Commission is adopting the corporate document preservation requirements with the modifications discussed above.[189]

Associated Persons

As discussed above, paragraph (a)(12) of Rule 17a-3 requires a broker-dealer, including a broker-dealer SBSD or MSBSP, to make and keep current records of information about associated persons, and the Commission is adopting parallel requirements in Rule 18a-5 to require a stand-alone or bank SBSD or MSBSP to make and keep current the same types of records.[190] Paragraph (e)(1) of Rule 17a-4 requires broker-dealers to maintain and preserve the associated person's records in an easily accessible place until at least three years after the associated person's employment and any other connection with the broker-dealer has terminated. The Commission proposed to include a parallel requirement in Rule 18a-6 for stand-alone and bank SBSDs and MSBSPs to maintain and preserve their records about associated persons.[191] The Commission received no comments on these proposed associated persons record preservation requirements and is adopting them as proposed.[192]

Regulatory Authority Reports

Paragraph (e)(6) of Rule 17a-4 requires a broker-dealer, including a broker-dealer SBSD or MSBSP, to maintain and preserve in an easily accessible place each report that a securities regulatory authority has requested or required the firm to make and furnish to it pursuant to an order of settlement, and each regulatory exam report until three years after the date of the report.[193] The Commission proposed parallel record preservation requirements in Rule 18a-6 for stand-alone SBSDs and MSBSPs to maintain and preserve the same types of reports until three years after the date of the report.[194] The Commission proposed a parallel requirement in Rule 18a-6 for bank SBSDs and MSBSPs but only if the reports relate to security-based swap activities. The Commission received no comments on these proposed regulatory authority reports preservation requirements and is adopting them as proposed.[195]

Compliance, Supervisory, and Procedures Manuals

Paragraph (e)(7) of Rule 17a-4 requires a broker-dealer, including a broker-dealer SBSD or MSBSP, to maintain and preserve in an easily accessible place each compliance, supervisory, and procedures manual, including any updates, modifications, and revisions, describing the policies and practices of the broker-dealer with respect to compliance with applicable laws and rules and supervision of the activities of each natural person associated with the broker-dealer until three years after the termination of the use of the manual. The Commission proposed a parallel requirement in Rule 18a-6 for stand-alone SBSDs and MSBSPs to maintain and preserve the same types of compliance, supervisory, and procedures manuals for the same period of time.[196] The Commission proposed a parallel requirement in Rule 18a-6 for bank SBSDs and MSBSPs but only if the manuals involve compliance with applicable laws and rules relating to security-based swap activities. The Commission received no comments on these proposed compliance, supervisory, and procedures manual preservation requirements and is adopting them as proposed.[197]

Electronic Storage

Paragraph (f) of Rule 17a-4 provides that the records a broker-dealer, including a broker-dealer SBSD or MSBSP, is required to maintain and preserve under Rules 17a-3 and 17a-4 may be immediately produced or reproduced on micrographic media or by means of electronic storage media and be maintained and preserved for the required time in that form. The use of Start Printed Page 68568electronic storage media is subject to certain conditions, including that the media must preserve the records exclusively in a manner that is non-rewriteable and non-erasable (also known as a write once, read many or “WORM”).[198] The Commission proposed including a parallel record maintenance and preservation requirement in Rule 18a-6, but only with respect to electronic storage media.[199] The Commission believes that SBSDs and MSBSPs that are not dually registered as broker-dealers would not use micrographic media to maintain and preserve records because electronic storage media is more technologically advanced and offers greater flexibility in managing records.[200]

The Commission received comments that its electronic storage requirements for SBSDs and MSBSPs, including for broker-dealers dually registered as SBSDs, should not mandate that the records be preserved exclusively in a WORM format.[201] One commenter further urged the Commission, in any event, “not to expand the WORM requirement to SBSDs at this time.” [202] The Commission also received comment requesting that it act on a rule petition filed by several organizations in November 2017 and harmonize its final rule with the CFTC's corresponding requirements, which were recently modified to eliminate a similar WORM requirement.[203]

The Commission's electronic record storage requirements in Rule 17a-4 are based on the “importance for recordkeeping of ready access, reliability, and permanence of records.” [204] The Commission has described the recordkeeping requirements in Rules 17a-3 and 17a-4 as “integral to the Commission's investor protection function because the preserved records are the primary means of monitoring compliance with applicable securities laws, including antifraud provisions and financial responsibility standards.” [205] Any modification to the electronic storage requirements in Rule 17a-4 may raise issues that are distinct from those raised by stand-alone and bank SBSDs and MSBSPs. Accordingly, the Commission believes that any change to these requirements should be addressed in a separate regulatory initiative in which the Commission intends to consider electronic storage media issues.

However, the Commission is clarifying that the WORM requirement does not mandate the use of a specific type of media. In particular, the Commission issued guidance in 2003 to clarify that the WORM requirement can be met using an “electronic storage system that prevents the overwriting, erasing or otherwise altering of a record during its required retention period through the use of integrated hardware and software control codes.” [206] This statement in the release—because it refers to “hardware” control codes—has raised questions as to whether an electronic storage system that relies exclusively on software coding to meet the WORM requirement is permitted under the rule. The Commission is clarifying that a software solution that prevents the overwriting, erasing, or otherwise altering of a record during its required retention period would meet the requirements of the rule. For example, the rule does not require the use of a specific medium such as optical disk, CD-ROM, or magnetic tape to meet the WORM requirement.

The Commission recognizes that the entities that may register as stand-alone or bank SBSDs or MSBSPs may have existing electronic storage systems that do not meet the WORM requirement and therefore could incur substantial costs in building a recordkeeping system that meets this requirement. For these reasons, the Commission is modifying Rule 18a-6 to eliminate the requirement that the electronic storage system preserve the records exclusively in a non-rewriteable and non-erasable format (i.e., a WORM format).[207] In connection with this modification, the Commission is eliminating the proposed requirement that the stand-alone or bank SBSD or MSBSP notify the Commission at least 90 days before using electronic storage media other than optical disk technology because this provision is no longer relevant given the absence of the WORM requirement in the rule as adopted.[208] The Commission also is modifying the proposed rule text by replacing the phrase “electronic storage media” throughout paragraph (e) of Rule 18a-6, as adopted, with the phrase “electronic storage system” to further clarify that the final rule does not require the use of a particular storage media such as optical disk or CD-ROM (as is the case with Rule 17a-4, as noted above).[209]

The Commission is modifying the provision of the rule that required the original and duplicate units of the storage media to be serialized and time-dated to clarify that this must be done if applicable (i.e., if the firm uses a storage media such as optical disk or CD-ROM).[210] The Commission also is modifying the provision of the rule that required the firm to have available facilities for immediate, easily readable projection or productions of electronic storage media images and for producing easily readable images; the final rule instead provides that the facilities can be for the projection or production of images or records that are maintained on the electronic storage system.[211] This modification is designed to accommodate electronic storage systems that do not use optical disk or CD-ROM media. Further, the Commission is modifying the provision of the rule that required the firm to be ready at all times to immediately provide an facsimile enlargement which the staff of the Commission may request; the final rule requires instead that the firm must be ready at all times to immediately provide in a readable format any record or index stored on the electronic storage system which the staff of the Commission may request.[212]

The elimination of the WORM requirement as the exclusive means of storing records electronically will provide flexibility to stand-alone and bank SBSDs and MSBSPs in terms of establishing and maintaining electronic storage systems and will eliminate a potential conflict with the requirements of the CFTC. However, eliminating the WORM requirement does not change the Start Printed Page 68569underlying requirements in Rules 18a-5 and 18a-6 that stand-alone and bank SBSDs and MSBSPs make and keep certain records, preserve those and other records for required time periods, and furnish promptly legible, true, complete, and current copies of records to a representative of the Commission. A firm's obligation to comply with these requirements is the same irrespective of whether it stores records in paper form or electronically and, therefore, a firm that elects to store records electronically should keep these obligations in mind in designing, implementing, and maintaining an electronic storage system.

The Commission also is modifying the final rule to eliminate the proposed provision that required at least one third party to have access to and the ability to download information from the electronic storage media and for that third party to execute an undertaking that the third party would provide the Commission with the information necessary download information from the electronic storage media.[213] This provision was designed to facilitate the Commission's access to electronically stored records. A commenter stated that this requirement (along with the WORM requirement) was “outdated in light of the changed technological environment.” [214] The commenter further stated that it requires broker-dealers to provide third-party access to firm systems and client information, which “needlessly exposes firms to data leakage and cybersecurity threats.” As noted above, the Commission believes that any change to the broker-dealer electronic storage provisions should be addressed in a separate regulatory initiative where the Commission intends to consider electronic storage media issues in a broader context, including with respect to other market participants. Accordingly, for the purposes of Rule 18a-6, the Commission believes it is appropriate not to adopt the proposed requirement.

Finally, paragraph (e)(3)(v) of Rule 18a-6, as proposed, would require firms that use an electronic storage system to have an audit system providing for accountability regarding the inputting of records to the electronic storage system and inputting of any changes made to every original and duplicate record.[215] This provision was modeled on the audit system requirement prescribed in paragraph (f)(3)(v) of Rule 17a-4. A commenter stated that firms report substantial difficulty assessing whether they have complied with the audit system requirement of Rule 17a-4.[216]

The Commission explained the audit system requirement when it adopted the electronic storage provisions of Rule 17a-4.[217] In particular, the Commission stated that the rule requires an audit system to be utilized only when records required to be maintained under Rule 17a-4 are being entered or when any additions to existing records are made.[218] Consequently, an audit record is not required when a record is accessed but cannot be altered by the reader.[219] The Commission further stated that, although it was not specifying the contents of each audit system, data automatically or otherwise stored (in the computer or in hard copy) regarding inputting of records and changes to existing records will be part of that system.[220] The Commission envisioned that the identities of individuals actually inputting records and making particular changes, and the identity of documents changed and the identity of new documents created, are the kind of information that automatically would be collected pursuant to the audit system requirements.[221]

In addition, as part of the 2003 guidance with respect to the WORM requirement, the Commission stated that the audit system would need to provide accountability regarding the length of time records are stored in a non-rewriteable and nonerasable manner.[222] The Commission further stated that this should include senior management level approval of how the system is configured to store records for their required retention periods in a non-rewriteable and nonerasable manner.[223]

The audit system requirements of Rule 18a-6 are modeled on the existing requirements of Rule 17a-4. Consequently, firms can rely on the Commission's description of the Rule 17a-4 requirements—as set forth above—for the purposes of Rule 18a-6.

For the foregoing reasons, the Commission is adopting the electronic storage requirements with the modifications discussed above.[224]

Prompt Production of Records

Paragraph (i) of Rule 17a-4 applies when a broker-dealer, including a broker-dealer SBSD or MSBSP, uses a third party to prepare or maintain the records required to be maintained and preserved pursuant to Rules 17a-3 and 17a-4. It requires the third party to file an undertaking with the Commission stating, among other things, that the records are the property of the broker-dealer and will be promptly furnished to the Commission or its designee. Paragraph (j) of Rule 17a-4 requires a broker-dealer, including a broker-dealer SBSD or MSBSP, to furnish promptly to a representative of the Commission legible, true, complete, and current copies of those records of the broker-dealer that are required to be preserved under Rule 17a-4, or any other records of the broker-dealer subject to examination under Section 17(b) of the Exchange Act that are requested by the Start Printed Page 68570representative of the Commission.[225] The Commission proposed including parallel requirements in Rule 18a-6 for stand-alone and bank SBSDs and MSBSPs.[226] The proposed requirement for these entities to promptly produce records referenced Section 15F of the Exchange Act (rather than Section 17(b)).[227] The Commission received no comments on these proposed prompt production requirements and is adopting them as proposed.[228]

b. Additional Amendments to Rule 17a-4 and Modifications to Rule 18a-6

The Commission proposed several amendments to Rule 17a-4 to eliminate obsolete text, improve readability, and modernize terminology.[229] Reference is made throughout Rule 17a-4 to “members” of a national securities exchange as a distinct class of registrant in addition to broker-dealers. The Commission proposed to remove these references to “members” given that the rule applies to brokers-dealers, which would include members of a national securities exchange that are brokers-dealers. The rule being adopted in this document does not remove these references to “members” to avoid confusion as to whether their removal resulted in a substantive change to the rule.

The Commission proposed a second global change that would replace the phrase “Every broker and dealer” with “Every broker or dealer.” [230] The Commission also proposed a global change to replace the use of the word “shall” in the rule with the word “must” or “will” where appropriate.[231] In paragraph (m) of Rule 17a-4, the Commission proposed to replace the words “shall have” with the word “has.” [232] The Commission also proposed certain stylistic, corrective, and punctuation amendments to improve the readability of Rule 17a-4.[233]

Further, as discussed above, the Commission is eliminating the requirements in current paragraphs (c) and (d) of Rule 17a-3 and, as a consequence, current paragraphs (e) through (h) have been redesignated as paragraphs (d) through (g), respectively. The Commission proposed to amend Rule 17a-4 to make corresponding changes to cross-references to these paragraphs of Rule 17a-3.

The Commission proposed amendments to paragraph (b)(8) of Rule 17a-4 that would replace the phrase “annual audited financial statements” with the phrase “the annual financial statements” to reflect the broader range of documents required by Rule 17a-5. Due to the addition of paragraphs (b)(8)(xiv) and (xvi) to Rule 17a-4, as discussed above, the Commission proposed to redesignate paragraphs (b)(8)(xiv) and (xv) as paragraphs (b)(8)(xv) and (xvii), respectively.

The Commission proposed amendments to paragraph (h) of Rule 17a-4 that would add, after the phrase “Rule G-9 of the Municipal Securities Rulemaking Board,” the phrase “or any successor rule” to address the possibility of a future change in how the MSRB's rules are designated.

The Commission received no comments on these proposed amendments and is adopting them substantially as proposed, with the modification discussed above about retaining references to “members.” [234] The Commission is also making certain non-substantive modifications to Rule 18a-6 as proposed in addition to those discussed above.[235]

Start Printed Page 68571

B. Reporting

1. Introduction

The Commission in this document is establishing a reporting program for SBSDs and MSBSPs under Sections 15F and 17(a) of the Exchange Act that is modeled on the reporting program for broker-dealers in Rule 17a-5. Rule 17a-5 has two main elements: (1) A requirement that broker-dealers file periodic unaudited reports about their financial and operational condition using the FOCUS Report form; and (2) a requirement that broker-dealers annually file financial statements and certain reports, as well as reports covering those statements and reports prepared by an independent public accountant registered with the Public Company Accounting Oversight Board (“PCAOB”) in accordance with PCAOB standards. The Commission proposed to amend Rule 17a-5 to account for the security-based swap activities of stand-alone broker-dealers and to establish a reporting regime for broker-dealer SBSDs and MSBSPs.[236] The Commission further proposed new Rule 18a-7 (which was modeled on Rule 17a-5) to establish a reporting regime for stand-alone and bank SBSDs and MSBSPs. The Commission is adopting the proposed amendments to Rule 17a-5 and new Rule 18a-7 with modifications, as discussed below.

A commenter requested clarification as to whether an OTC derivatives dealer dually registered as an SBSD or MSBSP would be subject to Rule 17a-5 or instead to new Rule 18a-7.[237] The applicability of Rule 17a-5 or 18a-7 will depend on whether the firm is subject to the capital requirements of Rule 15c3-1 (in which case Rule 17a-5 will apply), is subject to the capital requirements of Rules 18a-1 or 18a-2 (in which case Rule 18a-7 will apply), or has a prudential regulator (in which case Rule 18a-7 will apply).[238] Therefore, a stand-alone broker-dealer, including a stand-alone OTC derivatives dealer, (which is subject to Rule 15c3-1) will continue to be subject to Rule 17a-5.[239] Similarly, a broker-dealer, other than an OTC derivatives dealer, that is also an SBSD (which is subject to Rule 15c3-1) will be subject to Rule 17a-5. A broker-dealer, including an OTC derivatives dealer, that is also an MSBSP (which is subject to Rule 15c3-1) will be subject to Rule 17a-5. A stand-alone SBSD (which is subject to Rule 18a-1) will be subject to Rule 18a-7. Similarly, an SBSD that is also an OTC derivatives dealer (“OTCDD/SBSD”) (which is subject to Rule 18a-1) will be subject to Rule 18a-7.[240] A stand-alone MSBSP (which is subject to Rule 18a-2) will be subject to Rule 18a-7. Finally, a bank SBSD or MSBSP (which has a prudential regulator) will be subject to Rule 18a-7.

The Commission is also adopting amendments to the FOCUS Report. The Commission proposed to create a new part of the FOCUS Report—Form SBS—to be filed by all types of SBSDs and MSBSPs, while stand-alone broker-dealers would continue filing FOCUS Report Parts II, IIA, IIB, or II CSE, as applicable.[241] After further consideration of the issue, the Commission believes the best approach is to consolidate Form SBS and FOCUS Report Parts II, IIB, and II CSE into a single form: The FOCUS Report Part II. In addition, the Commission believes it is appropriate to adopt a new form—the FOCUS Report Part IIC—to be filed by bank SBSDs and MSBSPs rather than Form SBS as was proposed. The decision to require bank SBSDs and MSBSPs to file a separate form is based on the more limited information that they will need to provide on the form (as compared to FOCUS Report Part II filers). Consequently, broker-dealers that file the FOCUS Report Part II will continue to do so. ANC broker-dealers and OTC derivatives dealers also will file the FOCUS Report Part II, as will broker-dealer and stand-alone SBSDs and MSBSPs. Bank SBSDs and MSBSPs will file the FOCUS Report Part IIC.

A commenter urged the Commission not to impose “position reporting requirements,” arguing that they are unnecessary in light of the “transaction reporting requirements” of Regulation SBSR.[242] The Commission disagrees. The reporting requirements are designed to promote transparency of the financial and operational condition of a broker-dealer, SBSD, or MSBSP to the Commission and, in the case of a portion of the annual reports, to the public.[243] This information will assist the Commission staff in monitoring these firms and examining them for compliance with the securities laws. Position records are of a different nature, and serve a different purpose, than the transaction data that will be reported pursuant to Regulation SBSR. Specifically, position records provide an overview of a firm's holdings at a specific point in time. The commenter states that position reporting requirements are unnecessary “for purposes of market surveillance.” [244] However, as discussed above, the recordkeeping requirements being adopted in this document are designed to elicit information about the financial and operation condition of the filer. Market surveillance is not the objective of the requirements. Finally, the commenter stated that if the Commission does adopt position reporting requirements, it “should limit the scope of such requirements for non-U.S. SBSDs to transactions that are either (i) cleared on a U.S.-registered clearing agency or derivatives clearing organization or (ii) opposite a U.S. person counterparty.” [245] As discussed above, the purpose of the reporting requirements is to obtain information about the financial and operational condition of the filer. Limiting the requirements to a subset of the filer's positions would not provide a complete picture of the filer's financial and operational condition. Moreover, the Commission has proposed in a separate release additional provisions that are designed to address concerns about the cross-border application of certain requirements applicable to SBSDs and MSBSPs.[246]

Start Printed Page 68572

2. Periodic Filing of FOCUS Report

a. Rule 17a-5 and Rule 18a-7

Undesignated Introductory Paragraph

The Commission proposed amending Rule 17a-5 to add an undesignated introductory paragraph stating that: (1) The rule applies to a broker-dealer, including a broker-dealer SBSD or MSBSP; and (2) a stand-alone or bank SBSD or MSBSP is subject to the reporting requirements under proposed Rule 18a-7.[247] The Commission also proposed amending Rule 17a-5 to remove paragraph (a)(1), which provides that paragraph (a) shall apply to every broker-dealer registered pursuant to Section 15 of the Exchange Act, because this text was redundant of the undesignated introductory paragraph of Rule 17a-5, as proposed to be added. Similarly, the Commission proposed that Rule 18a-7 have an undesignated introductory paragraph explaining that the rule applies to an SBSD or MSBSP that is not dually registered as a broker-dealer (i.e., a stand-alone or bank SBSD or MSBSP). The Commission received no comments on the introductory paragraphs but, as discussed above, is modifying them to clarify which rule (17a-5 or 18a-7) applies to a given type of entity.[248] The Commission received no comments on the proposed amendment to remove paragraph (a)(1) from Rule 17a-5 and is adopting it as proposed.[249]

Requirement To File the FOCUS Report

Rule 17a-5 requires a broker-dealer, other than an OTC derivatives dealer, to file FOCUS Report Part II or IIA.[250] The Commission proposed amending the rule to require a broker-dealer SBSD or MSBSP to file proposed Form SBS rather than the FOCUS Report Part II or IIA.[251] The Commission also proposed including parallel requirements in Rule 18a-7 that: (1) Stand-alone SBSDs and MSBSPs be required to file proposed Form SBS with the Commission or its designee within seventeen business days after the end of each month; and (2) bank SBSDs and MSBSPs be required to file Form SBS with the Commission or its designee within seventeen business days after the end of each calendar quarter (instead of each month).[252] The Commission proposed quarterly financial reporting for bank SBSDs and MSBSPs, instead of monthly reporting, because the prudential regulators currently require banks to file reports of financial and operational condition known as “call reports” on a quarterly basis.[253] Under the proposal, the information reported by bank SBSDs and MSBSPs on the FOCUS Report Part IIC largely would be information that banks are required to provide in the call reports.

In response to the Commission's proposal to require bank SBSDs and MSBSPs to file Form SBS seventeen business days after the end of the quarter, a commenter requested that it change the deadline to match the prudential regulators' requirement to file call reports thirty calendar days after the end of the quarter.[254] To respond to the commenter's concerns, as well as to promote harmonization with prudential regulators' requirements, the Commission is adopting a thirty calendar-day requirement as requested by the commenter. Since the proposed seventeen business-day requirement would have corresponded with twenty-four calendar days (with a conservative assumption of no public holidays), this will provide administrative relief to bank SBSDs and MSBSPs by allowing them six additional calendar days to file the FOCUS Report Part IIC with the Commission.

The Commission also proposed amendments to Rule 17a-5 to make explicit the requirement that the FOCUS Report filed by a stand-alone broker-dealer or the Form SBS filed by a broker-dealer SBSD or MSBSP must be “executed.” [255] The Commission proposed parallel requirements in Rule 18a-7 to require that a Form SBS filed by a stand-alone or bank SBSD or MSBSP must be executed. The Commission received no comment on these proposals for executed forms. For the reasons discussed above, the Commission is adopting the FOCUS Report filing requirements substantially as proposed.[256]

Additional Reporting Requirements for Registrants That Use Models

Rule 17a-5 requires ANC broker-dealers to file additional reports on a monthly or quarterly basis with the FOCUS Report.[257] The Commission proposed similar reporting requirements in Rule 18a-7 for stand-alone SBSDs approved to use internal models to compute net capital.[258] These entities would be required to file most of the required documents within 17 business days after the end of each month. However, to correspond with the timing requirement in the proposed capital rule for these entities (Rule 18a-1),[259] they would be required to file the following reports within seventeen business days after the end of each calendar quarter (instead of each month): A report identifying the number of business days for which the actual daily net trading loss exceeded the corresponding daily value at risk (“VaR”); and the results of backtesting of all internal models used to compute allowable capital, indicating the number of backtesting exceptions. Start Printed Page 68573The Commission received no comment on these additional reporting proposals for stand-alone SBSDs and has adopted Rule 18a-1.[260] Consequently, the Commission is adopting the additional reporting requirements, but with the modification that an OTCDD/SBSD must file them pursuant to Rule 18a-7 (rather than Rule 17a-5).[261]

b. FOCUS Report

As discussed above, the Commission proposed Form SBS as the reporting form for all categories of SBSDs and MSBSPs. Proposed Form SBS was modeled on the FOCUS Report, particularly FOCUS Report Part II CSE. FOCUS Report Part II CSE served as the template for proposed Form SBS because it was designed to account for the use of internal models to compute net capital by ANC broker-dealers and elicits more detailed information about derivatives positions and exposures than FOCUS Report Parts II and IIA.[262] Based on staff experience, including experience monitoring ANC broker-dealers, the Commission anticipates that most SBSDs will use internal models to compute their net capital.[263]

However, as discussed above, the Commission is not adopting Form SBS as proposed, but is instead requiring the FOCUS Report Part II to be filed by nonbank SBSDs and MSBSPs. Further, the Commission is requiring that bank SBSDs and MSBSPs file FOCUS Report Part IIC (rather than proposed Form SBS or the FOCUS Report Part II, as amended). The information that must be provided by SBSDs and MSBSPs is substantively the same information elicited by proposed Form SBS, except that the information is now being elicited in FOCUS Report Parts II and IIC. Accordingly, the Commission is adopting changes to FOCUS Report Part II and the corresponding instructions to update the form, reflect the required filers, and account for these firms' derivatives activity.

Thus, ANC broker-dealers that filed Part II CSE prior to these amendments and OTC derivatives dealers that filed Part IIB prior to these amendments instead will be required to file FOCUS Report Part II, as amended—FOCUS Report Parts II CSE and IIB will be discontinued. From the perspective of these entities, the information they will be required to enter into the revised FOCUS Report Part II as compared to FOCUS Report Parts II CSE and IIB is substantively the same. Similarly, from the perspective of broker-dealers that were required to file FOCUS Report Part II prior to these amendments, the information they will be required to enter into the revised form is substantively the same.[264] Importantly, there is already significant overlap among the four forms filed on the eFOCUS system of the Financial Industry Regulatory Authority (“FINRA”): The FOCUS Report Parts II, IIA, IIB, and II CSE.[265] Much of this duplication and overlap between forms is eliminated by combining the forms into a single revised FOCUS Report Part II and modifying the form to include the line items that were in proposed Form SBS.

The Commission believes that broker-dealers registering as an SBSD or MSBSP will find the consolidation preferable, since rather than familiarizing themselves with a new form (Form SBS), such dual registrants can continue to file FOCUS Report Part II, as amended. The consolidation is also expected to enhance the Commission's supervisory capacities, since it will be easier to compare different types of registrants' FOCUS Report responses when they are filing the same form.

Bank SBSDs and MSBSPs will file FOCUS Report Part IIC, which elicits more limited information than FOCUS Report Part II. Moreover, much of the information elicited is already reported by these entities on their call reports. The Commission believes that bank SBSDs and MSBSPs will find it simpler to utilize the shorter FOCUS Report Part IIC, which is tailored to these entities and focuses on their business as an SBSD or MSBSP. Indeed, bank SBSDs and MSBSPs would have shared only one section in common with other Form SBS filers (the cover page), so the vast majority of Form SBS would not have been applicable to these bank entities.[266] In addition, the capital and margin requirements applicable to nonbank SBSDs and MSBSPs—which are the source of the information input into the revised FOCUS Report Part II—do not apply to bank SBSDs and MSBSPs. Bank SBSDs and MSBSPs are instructed to follow FFIEC Form 031's instructions regarding a majority of the line items on FOCUS Report Part IIC, as adopted, since most of the sections require these entities to report general financial information that banks are already required to report on FFIEC Form 031.

FOCUS Report Part II, as amended, continues to elicit financial and Start Printed Page 68574operational information about a filer through sections consisting of uniquely numbered line items.[267] To the extent a line item number has already been assigned in FOCUS Report Parts II, IIA, IIB, and/or II CSE, revised FOCUS Report Part II uses the same line item number. However, the amended form also includes new lines and corresponding line items that were proposed in Form SBS and are relevant to security-based swap and swap activities. These line items are identified by numbers on revised FOCUS Report Part II with a 5-digit number beginning with 12000 and generally increasing upward.

Proposed Form SBS would have been divided into five parts.[268] FOCUS Report Part II, as amended, and FOCUS Report Part IIC, as adopted, are not divided into parts. Dividing the form into parts was a more useful approach when bank entities would have been required to file the same form as nonbank entities. However, now that bank SBSDs and MSBSPs will separately file FOCUS Report Part IIC, there is no longer a need to subdivide the form into parts based on the type of registrant (e.g., bank SBSD versus broker-dealer SBSD). In addition, separate parts are not necessary because the header at the top of each page of FOCUS Report Parts II and IIC identifies the type of registrants required to complete that page (as proposed in Form SBS). Nonetheless, the sections of revised FOCUS Report Part II appear in the same order as they appeared in proposed Form SBS, so they still follow the logic used to order the sections in the proposed form.

The Commission is amending the instructions for FOCUS Report Part II and adopting instructions for FOCUS Report Part IIC to provide further guidance on the information to be entered into certain line items.[269]

i. Revised FOCUS Report Part II

Cover Page

The FOCUS Report Parts II, IIA, IIB, and II CSE prior to these amendments (collectively and individually, the “Pre-Amendment FOCUS Reports”) include a cover page that elicits basic information about the reporting firm. Proposed Form SBS included a cover page largely in the same format as the cover page in Pre-Amendment FOCUS Report Part II, but with modifications to account for the additional registrants required to file the form.[270] The Commission is adopting the cover page in proposed Form SBS by retaining the existing cover page in FOCUS Report Part II, as amended, with non-substantive changes largely to account for the additional registrants required to use this form (stand-alone broker-dealers, ANC broker-dealers, OTC derivatives dealers, and broker-dealer and stand-alone SBSDs and MSBSPs) and in response to comment.[271]

Statement of Financial Condition

The Pre-Amendment FOCUS Reports have a Statement of Financial Condition section that elicits detail about filers' assets, liabilities, and ownership equity. Proposed Form SBS similarly had a Statement of Financial Condition section largely modeled on the parallel section in Pre-Amendment FOCUS Report Part II CSE.[272] The Commission received a number of comments on this proposed section and has modified it in response to these comments.

First, a commenter suggested that Lines 8 through 10 on the assets side of the Statement of Financial Condition section (which elicited details about securities, including security-based swaps, commodities, and swaps positions) should be simplified and consolidated into a single line item.[273] As discussed below, the revised FOCUS Report Part II elicits details about these positions in other sections of the form. Accordingly, the Commission is consolidating these lines into Line 9 (Total net securities, commodities, and swaps positions) and making a corresponding modification in Line 24 of the liability side of the section (Total net securities, commodities, and swaps positions).[274]

Second, the Statement of Financial Condition section of proposed Form SBS required filers to report the amount of certain assets and liabilities that were includable in the broker-dealer customer reserve formula, the proposed SBSD reserve formula, and a catch-all “other” section in which information about assets and liabilities related to segregation requirements under the CEA would be entered if the filer is also registered with the CFTC.[275] Given that Commission and CEA segregation requirements are the most widely applicable segregation requirements for FOCUS Report filers, the Commission is consolidating the reporting of these amounts into single lines to the extent applicable.[276]

Third, the Statement of Financial Condition section of proposed Form SBS required filers to report information about payables due to securities customers and non-customers, security-based swap customers and non-customers, and swap customers and non-customers.[277] A commenter suggested simplifying the form by deleting payables to security-based swap and swap customers and non-customers from the Statement of Financial Condition and capturing this information in the schedule that elicits detail on derivatives positions.[278] The Commission agrees and has deleted these line items from this section and, instead, requires the information to be reported in Schedule 1 to FOCUS Report Part II, as amended.[279] Similarly, Start Printed Page 68575the commenter noted the imbalance of requiring the reporting of other derivatives payables on the liabilities side of the balance sheet, but not requiring the reporting of other derivatives receivable on the assets side of the balance sheet.[280] The Commission agrees and filers no longer must report other derivatives payable on the Statement of Financial Condition section and instead will report this information on Schedule 1 to FOCUS Report Part II, as amended.[281]

Fourth, the Statement of Financial Condition section of proposed Form SBS directed filers to report ownership equity from sole proprietorships, partnerships, corporations, and limited partners. The Commission is adding a reference to “members” in Line 29 of the Statement of Financial Condition in FOCUS Report Part II, as amended, instead of solely referencing “limited partners.” This change recognizes the legal structure of limited liability companies as well.

Fifth, lines are being added to the assets and liabilities sides of the Statement of Financial Condition for filers to report excess cash collateral pledged on derivative transactions (Lines 6 and 21 on FOCUS Report Part II, as amended). On the assets side, a broker-dealer or SBSD will report cash collateral posted to a counterparty that exceeds the amount of variation margin the firm has posted to cover current exposure. On the liability side, the broker-dealer or SBSD will report cash collateral posted from a counterparty that is in excess of the amount of variation margin the counterparty is required to post to cover current exposure. The addition of these lines requires firms to report the specific amounts on the asset side that are allowable and non-allowable assets. Establishing unique lines to report this information will avoid firms reporting the amounts in other lines that are not specifically tailored to present the information, which—based on staff experience—has resulted in firms reporting the information on several different lines. For the foregoing reasons, the Statement of Financial Condition section in proposed Form SBS is being adopted by retaining the parallel section in FOCUS Report Part II, as amended, with the modifications discussed above and certain other modifications.[282] This section is required to be completed by stand-alone broker-dealers and broker-dealer and stand-alone SBSDs and MSBSPs.

Computation of Net Capital

The Pre-Amendment FOCUS Reports have a Computation of Net Capital section. Proposed Form SBS included two sections: One to be completed by SBSDs authorized to use internal models to compute net capital under the proposed capital requirements and the other to be completed by filers not authorized to use internal models for this purpose.[283] The Commission has adopted capital requirements for nonbank SBSDs under which certain firms may be authorized to use internal models to compute net capital.[284]

The Computation of Net Capital section for filers authorized to use models was largely modeled on the parallel section in Pre-Amendment FOCUS Report Part II CSE. The section in proposed Form SBS had a line for filers to report their contractual securities commitments because this line appeared on the Computation of Net Capital section in Pre-Amendment FOCUS Report Part II.[285] However, this line item does not apply to filers authorized to use models and is removing it from the section.[286]

In addition, a commenter requested that the Computation of Net Capital section for filers authorized to use internal models account for firms approved to use the Basel 2.5 framework to compute market risk deductions.[287] The Commission agrees and has added new Line 10 that elicits detail about market risk deductions computed under the Basel 2.5 framework.[288] This will provide the Commission and other relevant securities regulators with greater detail about the components of the firms' calculations.

For the foregoing reasons, the Computation of Net Capital section for filers authorized to use models in Form SBS is being adopted by adding that section to FOCUS Report Part II, as amended, with the modifications discussed above and certain other modifications.[289] This section is required to be completed by stand-alone broker-dealers and broker-dealer and stand-alone SBSDs and MSBSPs authorized to use internal models to compute net capital.

The Computation of Net Capital section in proposed Form SBS for filers not authorized to use models was largely the same as the parallel section in Pre-Amendment FOCUS Report Part II. The Commission received no comment on this section. However, the Commission is adding new Line 9.C.8., titled “Risk-based haircuts computed under 17 CFR 240.15c3-1a or 17 CFR 240.18a-1a” and updating the instructions to FOCUS Report Part II accordingly. This change is intended to provide a specific line to report this information. The staff has observed that because the form currently does not have a unique line to enter the information, firms enter the information on several different lines. The Commission is also adopting non-substantive modifications to promote clarity.[290] This section is required to be completed by stand-alone broker-dealers and broker-dealer and stand-alone SBSDs and MSBSPs not authorized to use internal models to compute net capital.

Computation of Minimum Regulatory Capital Requirements

The Pre-Amendment FOCUS Reports have a Computation of Minimum Start Printed Page 68576Regulatory Capital Requirements section in which a broker-dealer inputs the calculation of its minimum net capital requirement. Proposed Form SBS included two such sections: One to be completed by broker-dealer SBSDs and MSBSPs and the other to be completed by stand-alone SBSDs.[291] Proposed Form SBS included these separate sections because the proposed minimum net capital computation applicable to a broker-dealer SBSD differs from the computation applicable to a stand-alone SBSD. The section for broker-dealer SBSDs was largely modeled on the parallel section in Pre-Amendment FOCUS Report Part II used by broker-dealers. The section for stand-alone SBSDs was a substantially scaled down version of that section reflecting the simpler calculation these entities would perform under the proposed nonbank SBSD capital rule (Rule 18a-1). The Commission received no comment on either of the proposed sections and has adopted capital requirements for nonbank SBSDs under which these firms will need to calculate a minimum net capital requirement.[292] However, because an OTCDD/SBSD will be subject to Rule 18a-1, the Computation of Minimum Regulatory Capital Requirements sections have been modified to indicate that an OTCDD/SBSD must complete the simpler section that will also be used by stand-alone SBSDs. Consequently, these sections in proposed Form SBS are being adopted with this modification and additional non-substantive modifications by retaining the parallel section in FOCUS Report Part II, as amended, to be used by stand-alone broker-dealers, broker-dealer SBSDs (other than OTCDD/SBSDs), and broker-dealer MSBSPs, and adding the section for stand-alone SBSDs and OTCDD/SBSDs.[293]

Computation of Tangible Net Worth

The Commission's proposed capital requirement for stand-alone MSBSPs and broker-dealer MSBSPs in Rule 18a-2 was a tangible net worth test.[294] Accordingly, proposed Form SBS included a Computation of Tangible Net Worth section to be completed by stand-alone MSBSPs and broker-dealer MSBSPs.[295] The Commission received no comment on this section. However, the Commission ultimately adopted Rule 18a-2 to apply solely to stand-alone MSBSPs (i.e., not to broker-dealer MSBSPs, which are subject to Rule 15c3-1).[296] Accordingly, the Computation of Tangible Net Worth section in proposed Form SBS is being adopted as an addition to the FOCUS Report Part II with the modification that it applies only to stand-alone MSBSPs.[297]

Statement of Income (Loss) or Statement of Comprehensive Income

The Pre-Amendment FOCUS Reports have a Statement of Income (Loss) section in which filers enter information about revenues and expenses. In 2012, the Commission approved a FINRA rule change to adopt Form SSOI (Supplemental Statement of Income), which elicits more detailed information about revenues and expenses.[298] Proposed Form SBS included a Statement of Income (Loss) section modeled on the more detailed Form SSOI to simplify the filings broker-dealers would need to make with the Commission and their designated examining authority (“DEA”).[299]

The Commission proposed to incorporate Form SSOI into the Statement of Income (Loss) section of proposed Form SBS. The Commission understands, however, that firms sometimes are required to disclose their FOCUS Reports to third parties for commercial reasons, potentially raising privacy concerns. The Commission further understands that the income information disclosed in Form SSOI is highly proprietary, given the level of detail required to be disclosed in the form. Moreover, the Commission already has access to the information in Form SSOI. Consequently, the Commission believes that it is not necessary to incorporate all the Form SSOI elements into the Statement of Income (Loss).[300]

The Commission recently amended the Statement of Income (Loss) sections in FOCUS Report Parts II, IIA, and IIB to elicit information about comprehensive income and rename the sections “Statement of Income (Loss) or Statement of Comprehensive Income.” [301] Accordingly, the Statement of Income (Loss) in proposed Form SBS is being adopted by retaining the Statement of Income (Loss) or Statement of Comprehensive Income section in FOCUS Report Part II, as amended. However, the Commission is adding a new line—Line 3—to the Statement of Income (Loss) or Statement of Comprehensive Income, as amended. This line elicits information about gains or losses from derivatives trading that was elicited on Line Item 3926 on Form SSOI and FOCUS Report Part II CSE. The Commission is also adopting several other non-substantive modifications to this section of FOCUS Report Part II.[302] The Statement of Start Printed Page 68577Income (Loss) or Statement of Comprehensive Income must be completed by stand-alone broker-dealers and broker-dealer and stand-alone SBSDs and MSBSPs.

Capital Withdrawals and Capital Withdrawals—Recap

The Pre-Amendment FOCUS Report Parts II, IIB, and II CSE have a Capital Withdrawal section and a Capital Withdrawals—Recap section that elicit details about filers' ownership equity and subordinated liabilities maturing or proposed to be withdrawn within the next six months, and accruals which have not been deducted in the computation of net capital. Proposed Form SBS had these two sections, which were largely modeled on the parallel sections in Pre-Amendment FOCUS Report Parts II and II CSE.[303] The Commission received no comment on these sections and has adopted capital requirements for nonbank SBSDs under which these firms will be subject to a net capital requirement.[304] Consequently, the Commission is adopting these sections in proposed Form SBS by retaining the parallel sections in FOCUS Report Part II, as amended, with certain non-substantive modifications.[305] These sections are required to be completed by stand-alone broker-dealers, stand-alone SBSDs, and broker-dealer SBSDs and MSBSPs.

Financial and Operational Data

The Pre-Amendment FOCUS Report Part II CSE included a Financial and Operational Data section that elicited detail about filers' operations, including operational deductions from capital and potential operational charges not deducted from capital. Proposed Form SBS had a Financial and Operational Data section modeled largely on the parallel section in Pre-Amendment FOCUS Report Part II CSE.[306] The Commission received no comment on this proposed section and has adopted capital requirements for nonbank SBSDs under which these firms will need to calculate a minimum net capital requirement.[307] Consequently, the Commission is adopting this section in proposed Form SBS by retaining the parallel section in FOCUS Report Part II, as amended, with non-substantive changes for clarity.[308] The section must be completed by stand-alone broker-dealers, stand-alone SBSDs, and broker-dealer SBSDs and MSBSPs.

Computation for Determination of Customer Reserve Requirements

Pre-Amendment FOCUS Report Parts II and II CSE have a Computation for Determination of Reserve Requirements section that elicited detail about filers' customer reserve computation under the broker-dealer customer protection rule (Rule 15c3-3). Proposed Form SBS had a Computation for Determination of Customer Reserve Requirements section modeled largely on the parallel section in Pre-Amendment FOCUS Report Part II CSE.[309] The Commission received no comment on this section in proposed Form SBS and is adopting it by retaining the parallel section in FOCUS Report Part II, as amended, with non-substantive changes for clarity.[310] This section must be completed by stand-alone broker-dealers and broker-dealer SBSDs and MSBSPs.

Possession or Control for Customers

Pre-Amendment FOCUS Report Parts II and II CSE have an Information for Possession or Control Requirements section that elicits detail about securities kept in possession or control for customers under Rule 15c3-3. Proposed Form SBS had a Possession or Control for Customers section modeled on the parallel section in Pre-Amendment FOCUS Report Part II CSE.[311] The Commission received no comment on this section of proposed Form SBS and is adopting it by retaining the parallel section in FOCUS Report Part II, as amended, with non-substantive changes for clarity.[312] This section must be completed by stand-alone broker-dealers and broker-dealer SBSDs and MSBSPs.

Computation for Determination of PAB Requirements

In 2013, the Commission amended Rule 15c3-3 to establish PAB reserve bank account requirements under which a broker-dealer must perform a reserve account calculation with respect to broker-dealer clients that is similar to the calculation for customers discussed above.[313] Proposed Form SBS included a Computation for Determination of PAB Requirements section for filers to Start Printed Page 68578input this calculation.[314] The Commission received no comment on this proposed section of Form SBS and is adding it to FOCUS Report Part II, as amended, with non-substantive changes for clarity.[315] The section must be completed by stand-alone broker-dealers and broker-dealer SBSDs and MSBSPs.

Claiming an Exemption From Rule 15c3-3

Pre-Amendment FOCUS Report Part II has a section for broker-dealers claiming an exemption from Rule 15c3-3 to identify the paragraph of the rule upon which the firm's exemption is based. Proposed Form SBS had a similar section modeled on the parallel section in Pre-Amendment FOCUS Report Part II.[316] The Commission received no comment on this section of proposed Form SBS and is adopting it by retaining the parallel section in FOCUS Report Part II, as amended, with non-substantive changes for clarity and accuracy.[317] This section must be completed by stand-alone broker-dealers and broker-dealer SBSDs and MSBSPs claiming an exemption from Rule 15c3-3.

Computation for Determination of Security-Based Swap Customer Reserve Requirements

The Commission's proposed segregation requirements for SBSDs in Rule 18a-4 required them to maintain a security-based swap customer reserve account and to determine the amount kept in the account using the formula in 17 CFR 240.18a-4a (Exhibit A to Rule 18a-4).[318] Accordingly, proposed Form SBS had a section titled “Computation for Determination of the Amount to be Maintained in the Special Reserve Account for the Exclusive Benefit of Security-Based Swap Customers” in which an SBSD would enter its security-based swap reserve account calculation.[319] The Commission received no comment on this section. However, the final segregation rules codified the security-based swap reserve account requirements in: (1) Rule 15c3-3 to apply to stand-alone broker-dealers and broker-dealer SBSDs and MSBSPs; and (2) Rule 18a-4 to apply to stand-alone SBSDs.[320] Consequently, the Commission is adopting the section in proposed Form SBS by adding it to FOCUS Report Part II, as amended, with non-substantive changes for consistency internally and with Rules 15c3-3 and 18a-4.[321] The modifications also include an instruction that the section must be completed by stand-alone broker-dealers in addition to broker-dealer SBSDs and MSBSPs.

Possession or Control for Security-Based Swap Customers

The Commission's proposed segregation requirements for SBSDs in Rule 18a-4 required them to maintain possession or control over excess security collateral.[322] Accordingly, proposed Form SBS had a section titled “Information for Possession or Control Requirements Under Rule 18a-4” that elicits detail about excess securities collateral kept in possession or control for customers under proposed Rule 18a-4.[323] The Commission received no comment on this section of proposed Form SBS. However, the final segregation rules codified the security-based swap reserve account requirements in: (1) Rule 15c3-3 to apply to stand-alone broker-dealers and broker-dealer SBSDs and MSBSPs; and (2) Rule 18a-4 to apply to stand-alone SBSDs.[324] Consequently, the Commission is adopting the section in proposed Form SBS by adding it to FOCUS Report Part II, as amended, with non-substantive changes for consistency internally and with Rules 15c3-3 and 18a-4.[325] The modifications also include an instruction that the section must be completed by stand-alone broker-dealers in addition to broker-dealer SBSDs and MSBSPs.

Claiming an Exemption From Rule 18a-4

As adopted, Rule 18a-4 applies to stand-alone and bank SBSDs and to OTCDD/SBSDs.[326] In addition, the final rule exempts these SBSDs from its requirements of if the SBSD meets certain conditions, including that the SBSD does not clear security-based swap transactions for other persons, provides notice to the counterparty regarding the right to segregate initial margin at an independent third-party custodian, and discloses in writing that any collateral received by the SBSD for non-cleared security-based swaps will not be subject to a segregation requirement and regarding how a claim of the counterparty for the collateral would be treated in a bankruptcy or other formal liquidation proceeding of the SBSD. In light of these modifications to the rule from the proposal (which did not provide an exemption), the Commission is adding a line item to the FOCUS Report Part II for a stand-alone SBSD or OTCDD/SBSD to indicate whether the firm is claiming an exemption from Rule 18a-4.[327]

Sections Completed by FCMs

FCMs are required to periodically file Form 1-FR-FCM with the CFTC and their designated SRO.[328] The form elicits financial and operational information about an FCM. To account Start Printed Page 68579for broker-dealers that are dually registered as FCMs, Pre-Amendment FOCUS Report Parts II and II CSE incorporate, in substantially the same format, most of the sections in Form 1-FR-FCM. A broker-dealer dually registered as an FCM was permitted to file Pre-Amendment FOCUS Report Part II or II CSE (as applicable) with the CFTC and its designated SRO rather than Form 1-FR-FCM.[329]

Proposed Form SBS contained the following sections from Form 1-FR-FCM in order to permit dual registrants to file Form SBS (rather than Form 1-FR-FCM) with the CFTC and its designated SRO: (1) A Computation of CFTC Minimum Net Capital Requirement; (2) a Statement of Segregation Requirements and Funds in Segregation for Customers Trading on U.S. Commodity Exchanges; (3) a Statement of Cleared Swaps Customer Segregation Requirements and Funds in Cleared Swaps Customer Accounts under Section 4d(f) of the CEA; (4) a Statement of Segregation Requirements and Funds in Segregation for Customers' Dealer Options Accounts; (5) a Statement of Secured Amounts and Funds Held in Separate Accounts for Foreign Futures and Foreign Options Customers Pursuant to CFTC Regulation 30.7 (and Foreign Futures and Foreign Options Secured Amounts Summary); and (6) a Statement of Secured Amounts and Funds Held in Separate Accounts for Foreign Futures and Foreign Options Customers Pursuant to CFTC Regulation 30.7 (and Funds Deposited in Separate CFTC Regulation 30.7 Accounts) (17 CFR 30.7).[330] The Commission received no comment on these sections of proposed Form SBS and is adopting them by retaining or adding them to FOCUS Report Part II, as amended, with non-substantive changes.[331] These sections will be filed by broker-dealers that are dually registered with the CFTC as FCMs. The Commission believes that this will promote harmonization with CFTC requirements.

Defined Terms in the Schedules to FOCUS Reports Parts II and IIC

Pre-Amendment FOCUS Report Part II CSE has schedules that elicit information about derivatives positions, counterparties, and exposures. Proposed Form SBS included four schedules that were modeled largely on the schedules to Pre-Amendment FOCUS Report Part II CSE. As discussed in detail below, the Commission is adopting the schedules to proposed Form SBS by adding all four of them to FOCUS Report Part II, as amended, and including one of them in FOCUS Report Part IIC, as adopted. As proposed, the schedules contained the following common terms that were defined in the proposed instructions to Form SBS: (1) “gross replacement value”, also referred to as “gross replacement value—receivable”; (2) “gross replacement value—payables”; (3) “net replacement value”; (4) “current net exposure”; (5) “total exposure”; and (6) “margin collected.” [332] For the sake of clarity, the term “total exposure” is revised to the term “current net and potential exposure in FOCUS Report Part II, as amended, and FOCUS Report Part IIC, as adopted, and in the instructions to the forms.[333] The definition of the term is not revised. The Commission received no comment on the remaining terms and their definitions and is adopting them as proposed.[334]

Schedule 1 to FOCUS Report Part II

Pre-Amendment FOCUS Report Part II CSE has a schedule titled “Aggregate Securities and OTC Derivatives Positions” that required ANC broker-dealers to report the month-end gross replacement value of aggregate long and short positions in various categories of financial instruments held by the firm.[335] Schedule 1 to proposed Form SBS was modeled largely on this schedule but instead of including a single line for derivatives, it required filers to enter the aggregate long and short positions for cleared and non-cleared: (1) Debt security-based swaps (other than credit default swaps); (2) equity security-based swaps; (3) credit default security-based swaps; and (4) other security-based swaps.[336] It required the same information with respect to mixed swaps and the following categories of swaps: (1) interest rate swaps; (2) foreign exchange swaps; (3) commodity swaps; (4) debt index swaps (other than credit default swaps); (5) equity index swaps; (6) credit default swaps; and (7) other swaps.

A commenter raised concerns about the practicality of reporting exposures to these subcategories of financial instruments, including the potential that firms will interpret them differently.[337] The Commission believes it is important to record separately amounts attributable to security-based swaps, mixed swaps, and swaps given the Commission's supervisory responsibilities regarding these products. The Commission further believes, however, that requiring reporting of the exposures to the subcategories of instruments could lead to inconsistent reporting across filers, which, in turn, could diminish the utility of receiving this information in terms of comparing firms. Accordingly, Schedule 1 to the FOCUS Report Part II, as amended, elicits the amounts attributable to cleared and non-cleared security-based swaps, mixed swaps, and swaps, and includes definitions for these products in the instructions, but no longer elicits information regarding the sub-categories. The Commission also received comment that “bought” and “sold” could help clarify the Start Printed Page 68580schedule,[338] and in response the columns in Schedule 1 to FOCUS Report Part II, as amended, are relabeled “long/bought” and “short/sold” and the instructions are updated accordingly.

The details in Schedule 1 may be of increased value to examiners if the totals in the schedule (Line Items 8370 and 8371) match the amounts reported for total securities, commodities, and swap positions in the Statement of Financial Condition (Line Items 12024 and 12044). Accordingly, the “Other securities and commodities” and “Securities with no ready market” lines are moved up to Lines 12 and 13 (instead of Lines 16 and 17) in Schedule 1 so that they can be included in the subtotal for “Total net securities and spot commodities.” In addition, Schedule 1 now elicits “Counterparty netting” and “Cash collateral netting” and includes these amounts in the subtotal for “Total derivative receivables and payables.” Consequently, the totals on Schedule 1, titled “Total net securities, commodities, and swaps positions,” are now equal to the sum of “Total net securities and spot commodities” and “Total derivative receivables and payables.” [339]

For the foregoing reasons, the Commission is adopting Schedule 1 to proposed Form SBS by adding it to FOCUS Report Part II, as amended, with the modifications discussed above.[340] Schedule 1 must be completed by stand-alone broker-dealers and stand-alone and broker-dealer SBSDs and MSBSPs.

Schedule 2 to FOCUS Report Part II

Pre-Amendment FOCUS Report Part II CSE has a schedule titled “Credit-Concentration Report for Fifteen Largest Net Exposures in Derivatives” that requires ANC broker-dealers to provide details about the fifteen counterparties to which they have the largest credit exposures in derivatives.[341] Schedule 2 to proposed Form SBS had two tables that were modeled largely on this schedule.[342] The first table would require the filer to identify in the first column the fifteen counterparties to which the firm had the largest current net exposure, in order from the largest to the smallest current net exposure. The second table would require the filer to identify in the first column the fifteen counterparties to which the firm had the largest total exposure, in order from the largest to the smallest total exposure.

A commenter raised concerns about the potential ramifications if counterparties obtained this information and disagreed with the internal credit rating assigned to them.[343] The Commission acknowledges that firms may be required to disclose the FOCUS Report Part II to counterparties and other third parties for commercial reasons, and that this could cause internal credit ratings to be disclosed to the rated entity. The disclosure of this information or the potential disclosure of the information to the rated entity could negatively affect the integrity of the filer's credit risk function. For example, it could give firms an incentive to assign a higher internal credit rating than warranted to avoid negatively affecting its relationship with a counterparty and potentially losing that entity's business. Accordingly, the Commission is modifying the table so that it continues to require counterparty identifiers but no longer elicits the internal credit rating assigned to a particular counterparty. This information is available to Commission staff through its monitoring and examination programs.

For the foregoing reasons, Commission is adopting Schedule 2 to proposed Form SBS by adding it to FOCUS Report Part II, as amended, with the modification discussed above.[344] Schedule 2 must be completed by stand-alone broker-dealers that are authorized to calculate net capital using internal models and all stand-alone and broker-dealer SBSDs and MSBSPs.

Schedule 3 to FOCUS Report Part II

Pre-Amendment FOCUS Report Part II CSE has a schedule titled “Portfolio Summary of OTC Derivatives Exposures by Internal Credit Rating” that required ANC broker-dealers to provide details about their aggregate credit exposures to counterparties grouped by the internal credit rating assigned to the counterparty.[345] Schedule 3 to proposed Form SBS had a table modeled on this schedule.[346] The table would require the filer to set forth its internal credit rating scale in the left hand column. For each notch in the rating scale, the filer would need to provide detail about aggregate amounts of exposures and collateral collected from the counterparties rated at that notch. The Commission received no comment on Schedule 3 to proposed Form SBS and is adopting it by adding the schedule to FOCUS Report Part II, as amended.[347] Schedule 3 must be completed by stand-alone broker-dealers that are authorized to calculate net capital using internal models and all stand-alone and broker-dealer SBSDs and MSBSPs.

Schedule 4 to FOCUS Report Part II

Pre-Amendment FOCUS Report Part II CSE has a schedule titled “Geographic Distribution of Derivatives Exposures for Ten Largest Countries” that required ANC broker-dealers to provide details about their OTC derivatives exposures grouped by country.[348] Schedule 4 to proposed Form SBS included two tables modeled on this schedule.[349] The first table would require the filer to identify in the left column the ten largest countries in terms of the filer's aggregate current net exposure to counterparties located in the country, in order from the largest to the smallest current net exposure amounts. The second table would require the filer to identify in the left column the ten largest countries in terms of the filer's total exposure to counterparties located in the country, in order from the largest to the smallest total exposure amounts. The Commission received no comment on Schedule 4 and is adopting it by adding the schedule to the FOCUS Report Part II, as amended.[350] Schedule 4 must be completed by stand-alone broker-dealers Start Printed Page 68581that are authorized to calculate net capital using internal models and all stand-alone and broker-dealer SBSDs and MSBSPs.

ii. FOCUS Report Part IIC

As discussed above, the Commission is requiring bank SBSDs and MSBSPs to report certain general financial information on new FOCUS Report Part IIC to facilitate monitoring these registrants' financial condition. The Commission's reporting requirements for bank SBSDs and MSBSPs generally are designed to be tailored specifically to their activities as an SBSD or an MSBSP. Accordingly, FOCUS Report Part IIC, as adopted, is based on FFIEC Form 031, which most banks are required to file on a quarterly basis.[351] FFIEC Form 031 elicits financial and operational information about a bank that is entered into uniquely numbered line items.

FOCUS Report Part IIC, as adopted, requires bank SBSDs and MSBSPs to report certain information they already report on FFIEC Form 031. Specifically, it includes: (1) A Balance Sheet section that largely mirrors Schedule RC to FFIEC Form 031; (2) a Regulatory Capital section that is a scaled-down version of Schedule RC-R to FFIEC Form 031; and (3) an Income Statement section that is a scaled-down version of Schedule RI to FFIEC Form 031. If the same line appears in both FFIEC Form 031 and FOCUS Report Part IIC, as adopted, the same line item number is used in both forms, except that the FOCUS Report Part IIC line item ends with an additional “b” character.[352]

One commenter pointed out that not all banks file FFIEC Form 031, noting that U.S. branches and agencies of foreign banks file FFIEC Form 002.[353] The Commission acknowledges that there are multiple types of FFIEC reporting forms, but modeled the FOCUS Report Part IIC on the form it believes most bank SBSDs and MSBSPs will use. FFIEC Form 031 is filed by banks with both domestic and foreign offices, while FFIEC Form 041 is filed by banks with domestic offices only. All of the line items that appear on FOCUS Report Part IIC, as adopted, appear on both FFIEC Form 031 and FFIEC Form 041, except for three line items which do not apply to FFIEC Form 041 filers.[354]

In addition to the sections drawn from FFIEC Form 031, FOCUS Report Part IIC, as adopted, includes sections for: (1) A Computation for Determination of Security-Based Swap Customer Reserve Requirements; (2) Possession or Control for Security-Based Swap Customers; and (3) Schedule 1—Aggregate Security-Based Swap and Swap Positions. Finally, the Commission is adopting instructions for FOCUS Report Part IIC, which closely track the instructions for proposed Form SBS and FOCUS Report Part II, as amended.[355]

Cover Page

As discussed above, proposed Form SBS included a cover page modeled largely on the cover page to Pre-Amendment FOCUS Report Part II.[356] The Commission received no comment on the proposed cover page and is adopting it in FOCUS Report Part IIC with non-substantive changes largely to account for the fact that FOCUS Report Part IIC will only be filed by bank SBSDs and MSBSPs.[357]

Balance Sheet

A bank must report details about its assets, liabilities, and equity capital on Schedule RC to FFIEC Form 031. Schedule RC also includes a Memoranda section that elicits information about the bank's external auditors and fiscal year end. Proposed Form SBS had a Balance Sheet section to be completed by bank SBSDs and MSBSPs.[358] The lines and line items in this section were the same as in Schedule RC to FFIEC Form 031, except that it did not include line items from the Memoranda section. The Commission received no comment on this proposed section and is adopting it in FOCUS Report Part IIC with non-substantive changes for consistency with Schedule RC to FFIEC Form 031.[359] This section must be completed by bank SBSDs and MSBSPs.

Regulatory Capital

The prudential regulators are responsible for administering capital requirements for bank SBSDs and MSBSPs. A bank must report details about its regulatory capital on Schedule RC-R to FFIEC Form 031. Schedule RC-R also includes a Memoranda section that elicits detail about derivatives. Proposed Form SBS similarly included a regulatory capital section to be completed by bank SBSDs and MSBSPs.[360] The lines and line items in this section were largely the same as in Schedule RC-R to FFIEC Form 031. More specifically, the proposed section required banks to enter the total amounts of the components of bank regulatory capital (i.e., total Tier 1, Tier 2, or Tier 3 capital) and other summary measures, rather than requiring the level Start Printed Page 68582of detail required by the prudential regulators on Schedule RC-R. The Commission received no comment on this proposed section and is adopting it in FOCUS Report Part II, with non-substantive changes for consistency with Schedule RC-R to FFIEC Form 031.[361] This section must be completed by bank SBSDs and MSBSPs.

Income Statement

A bank must report details about its income or loss and expenses on Schedule RI to FFIEC Form 031. Schedule RI also includes a Memoranda section that elicits further details about the bank's income or loss. Proposed Form SBS included an income statement section to be completed by bank SBSDs and MSBSPs.[362] The proposed income statement section included some—but not all—of the line items on Schedule RI. More specifically, to focus the reporting on summary information and information relevant to securities and derivatives activities, the proposed income statement section included only line items from Schedule RI that require the entry of: (1) Total amounts for categories of income, expense, and loss; (2) details about gains and losses on securities positions; (3) details about trading revenues; and (4) details about gains and losses on derivatives. The Commission received no comment on the proposed income statement section and is adopting it in FOCUS Report Part IIC with minor non-substantive changes.[363] This section must be completed by bank SBSDs and MSBSPs.

Computation for Determination of Security-Based Swap Customer Reserve Requirements

As discussed above, FOCUS Report Part II, as amended, includes a section for broker-dealers and stand-alone SBSDs to provide a computation of their security-based swap customer reserve requirements. Proposed Form SBS would have required bank SBSDs to complete an identical section.[364] The Commission received no comment on applying this section to bank SBSDs and is adopting it in FOCUS Report Part IIC with non-substantive changes for consistency internally and with Rules 15c3-3 and 18a-4.[365]

Possession or Control for Security-Based Swap Customers

As discussed above, FOCUS Report Part II, as amended, includes a section in which broker-dealers and stand-alone SBSDs enter information related to possession or control for security-based swap customers. Proposed Form SBS required bank SBSDs to complete an identical section.[366] The Commission received no comment on applying this section to bank SBSDs and is adopting it in FOCUS Report Part IIC with non-substantive changes for consistency internally and with Rules 15c3-3 and 18a-4.[367]

Claiming an Exemption From Rule 18a-4

As discussed above, Rule 18a-4, as adopted, exempts bank SBSDs from the requirements of the rule if the SBSD meets certain conditions.[368] In light of this modification to the rule from the proposal (which did not provide an exemption), the Commission is adding a line item to the FOCUS Report Part IIC for a bank SBSD to indicate whether the firm is claiming an exemption from Rule 18a-4.[369]

Schedule 1 to FOCUS Report Part IIC

As discussed above, FOCUS Report Part II, as amended, includes a Schedule 1 that elicits details about filers' aggregate long and short positions in various categories of financial instruments, including sub-categories of security-based swaps and swaps. Proposed Form SBS would have required bank SBSDs and MSBSPs to complete a similar but more truncated version of this section.[370] The Commission received no comment on applying this truncated version of the schedule to bank SBSDs and MSBSPs. However, as discussed above, the Commission did receive comment on the practicality of reporting exposures to subcategories of security-based swaps and swaps, including the potential that firms will interpret them differently.[371] Accordingly, the Commission is modifying the proposed schedule for bank SBSDs and MSBSPs so that it no longer elicits details regarding the sub-categories of security-based swaps and swaps. As discussed above, the Commission also received comment suggesting that references to “long” and “short” positions in security-based Start Printed Page 68583swaps, mixed swaps, and swaps [372] should be changed to references to “long/bought” and “short/sold” positions. The Commission agrees and is making this modification.

For the foregoing reasons, the Commission is adopting the requirement that bank SBSDs and MSBSPs must complete a truncated version of Schedule 1 by including it in FOCUS Report Part IIC, as adopted, with the modifications discussed above.

3. Filing of Annual Audited Financial Reports and Other Reports

Rule 17a-5 generally requires a broker-dealer to, among other things, annually file reports audited by a PCAOB-registered independent public accountant, disclose certain financial information to customers, and notify the Commission of a change of accountant. The rule also requires the independent public accountant to notify the broker-dealer if the accountant determines that the broker-dealer is not in compliance with certain broker-dealer financial responsibility rules or that a “material weakness,” as defined in paragraph (d)(3)(iii) of the rule, exists. As discussed above, the Commission is amending Rule 17a-5 so that it is applicable to broker-dealer SBSDs, other than OTCDD/SBSDs, and broker-dealer MSBSPs. With respect to stand-alone SBSDs and MSBSPs and OTCDD/SBSDs, the Commission is adopting in new Rule 18a-7 many requirements that parallel requirements in Rule 17a-5, as amended. However, Rule 18a-7 does not include a parallel requirement for every requirement in Rule 17a-5.[373] Further, the requirements in Rule 18a-7 relating to the filing of annual audited reports and other reports do not apply to bank SBSDs and MSBSPs (as discussed above, bank SBSDs and MSBSPs are subject to requirements to file FOCUS Report Part IIC on a quarterly basis).

a. Amendments to Rule 17a-5 and Adoption of Rule 18a-7

Liquidity Stress Test Reports

The Commission proposed that broker-dealers (including broker-dealer SBSDs) and stand-alone SBSDs authorized to use internal models to compute net capital be subject to liquidity stress test requirements.[374] Consequently, the Commission proposed to amend Rule 17a-5 and include in proposed Rule 18a-7 a parallel provision to require these entities to file a monthly report with the Commission containing the results of the liquidity stress test.[375] As consideration of the proposed liquidity stress test requirements is being deferred,[376] the Commission is deferring consideration of these related reporting requirements.[377]

Customer Statements

Paragraph (c) of Rule 17a-5 requires, among other things, that certain broker-dealers annually send their customers audited statements that must include (along with other information) a statement of financial condition (with appropriate notes), a footnote with information about the firm's net capital, and, if applicable, information about any material weaknesses in the firm's internal control over compliance with certain broker-dealer financial responsibility rules identified in the most recent reports of the firm's auditor. In addition, this paragraph requires these broker-dealers to send their customers unaudited statements dated six months after the date of the audited statements that must include (along with other information) a statement of financial condition and a footnote containing information about the firm's net capital. Under paragraph (c)(5) of Rule 17a-5, a broker-dealer is exempt from sending the statements to customers if the broker-dealer, among other things, semi-annually sends its customers a financial disclosure statement that includes, among other things, information regarding the firm's net capital and a statement that the audited and unaudited statements are available at no charge on the broker-dealer's website and by calling a toll-free number to request a paper copy of the statements. Broker-dealer SBSDs, other than OTCDD/SBSDs, and broker-dealer MSBSPs will be subject to these requirements and therefore will need to send the audited and unaudited statements to their customers, including security-based swap customers. However, these firms will be permitted to take advantage of the exemption described above.[378]

The Commission proposed in Rule 18a-7 that stand-alone SBSDs and MSBSPs be required to disclose on their websites (rather than send paper copies) information that is similar to the information broker-dealers are required to send to customers.[379] The proposal required stand-alone SBSDs and MSBSPs to disclose on their websites an audited statement of financial condition with appropriate notes within ten business days after the date the firm is required to file its audited annual reports with the Commission. In addition, it required a stand-alone SBSD (but not an MSBSP) to disclose on its website at the same time: (1) A statement of the amount of the firm's net capital and required net capital and other information, if applicable, related to the firm's net capital; and (2) if, in connection with the firm's most recent annual reports, the report of the independent public accountant identified one or more material weaknesses, a copy of the report. Further, the proposal required stand-alone SBSDs and MSBSPs to disclose on their websites unaudited statements containing the same information as the audited statement discussed above within 30 calendar days of the date of the unaudited statements. Finally, it required stand-alone SBSDs and MSBSPs to make a paper copy of the information required to be disclosed on their websites available at no charge upon request of the customer and to maintain a toll-free number to receive such requests. The Commission received no comments on these customer disclosure proposals and is adopting them with the modification that an OTCDD/SBSD will be subject to these requirements pursuant to Rule 18a-7 (rather than Rule 17a-5).[380]

Annual Reports

Paragraph (d) of Rule 17a-5 requires broker-dealers, among other things, to file with the Commission annual reports consisting of a financial report and either a compliance report or an Start Printed Page 68584exemption report, as well as reports that are prepared by an independent public accountant registered with the PCAOB covering the financial report and the compliance report or the exemption report in accordance with standards of the PCAOB. The financial report must contain financial statements, including, among others, a statement of financial condition, a statement of income, and a statement of cash flows and also must contain, as applicable, supporting schedules consisting of a computation of net capital under Rule 15c3-1, a computation of the reserve requirements under Rule 15c3-3, and information relating to the possession or control requirements under Rule 15c3-3. Generally, broker-dealers that maintain custody of customer securities and/or cash (and, therefore, do not claim an exemption from Rule 15c3-3) must file the compliance report. The report must contain statements about the broker-dealer's internal control over compliance with Rules 15c3-1, 15c3-3, 17a-13, and SRO customer account statement rules as well as statements as to whether the firm was in compliance with Rule 15c3-1 and paragraph (e) of Rule 15c3-3 (the customer reserve account requirement) as of the end of the firm's fiscal year. The exemption report must contain statements about the broker-dealer's claimed exemption from Rule 15c3-3.

The Commission proposed amending paragraph (d) of Rule 17a-5 to require a broker-dealer that was subject to proposed Rule 18a-4 (i.e., a broker-dealer SBSD)[381] to: (1) File the compliance report and related report of the independent public accountant covering the compliance report (i.e., the firm could not file the exemption report even if it claimed an exemption from Rule 15c3-3); and (2) incorporate the possession or control and customer reserve requirements of the proposed SBSD segregation rule into the financial report supporting schedules and the compliance report.[382]

The Commission also proposed parallel annual reporting requirements in proposed new Rule 18a-7 for stand-alone SBSDs and MSBSPs. The proposals required stand-alone SBSDs and MSBSPs to annually file with the Commission a financial report. In addition, they required stand-alone SBSDs to file a compliance report that contained statements about the firm's compliance with the proposed SBSD capital and segregation rules and statements about the firm's internal control over compliance with those rules and the proposed SBSD securities count rule. Further, the proposals required stand-alone SBSDs and MSBSPs to file reports of an independent public accountant covering the financial report and the compliance report.

The final segregation rule for stand-alone SBSDs, bank SBSDs, and OTCDD/SBSDs (Rule 18a-4) establishes an exemption from its requirements if the firm meets certain conditions.[383] Consequently, the Commission is modifying the proposed annual reports provisions in Rule 18a-7 to require a stand-alone SBSD or OTCDD/SBSD that is operating under the exemption from Rule 18a-4 to file an exemption report instead of the compliance report.[384] The exemption report for stand-alone SBSDs and OTCDD/SBSDs is modeled on the existing exemption report for broker-dealers. In the report, the SBSD must state that it met the exemptive provisions in Rule 18a-4 throughout the most recent fiscal year without exception or with one or more exceptions. If applicable, the firm will need to briefly describe the nature of each exception and the approximate dates the exception existed. In addition, the stand-alone SBSD or OTCDD/SBSD will need to file a report of its independent public accountant covering the exemption report. Permitting these firms to file the exemption report in lieu of the compliance report should reduce the costs of the audit and will result in a report that aligns more closely with their activities (i.e., operating under the exemption).

Finally, a commenter requested that the Commission permit the independent public accountant to adhere to generally accepted auditing standards (“GAAS”) rather than PCAOB standards. The commenter stated that: (1) This would promote consistency with other U.S. regulators; (2) the PCAOB standards are “almost identical” to GAAS; and (3) using GAAS would be the lowest cost alternative.[385] The commenter also stated that the Commission should eliminate the PCAOB standards' applicability to audited compliance and exemption reports, because the requirement provides a “non-existent benefit” in light of existing Commission regulations and Commission and FINRA staff examinations.

In response, the Commission first notes that the requirement that broker-dealer annual financial statements be certified by a PCAOB-registered independent public accountant is consistent with the requirements imposed by the Exchange Act.[386] Moreover, as noted above, this requirement applies to all broker-dealers that must file certified annual reports. Further, the PCAOB has issued attestation standards specific to the examination of compliance reports and the review of exemption reports.[387] Consequently, the Commission does not believe it would be appropriate to amend Rule 17a-5 to permit broker-dealers subject to that rule to file annual reports that are not certified by a PCAOB-registered accountant because the firm is dually registered as an SBSD. Additionally, the Commission does not believe it would be appropriate to have the financial reports audited under PCAOB standards and the compliance or exemption report (as applicable) examined or reviewed, respectively, under GAAS.

However, the Commission believes it would be appropriate to permit SBSDs and MSBSPs subject to Rule 18a-7 to file annual reports that are certified by independent public accountants that are not registered with the PCAOB. Stand-alone SBSDs and MSBSPs are not subject to a statutory requirement that their financial statements filed with the Commission be certified by a PCAOB-registered accountant, and the audits of these entities will not be subject to the PCAOB's examination and enforcement authority. While an OTC derivatives dealer (as a broker-dealer) is subject to the statutory requirement, an OTCDD/SBSD will be subject to the same net capital rule (Rule 18a-1) and the same reporting rule (Rule 18a-7) as a stand-alone SBSD. The Commission believes an OTCDD/SBSD should be treated Start Printed Page 68585similarly to a stand-alone SBSD because they are both subject to the same capital rule. Further, Rule 17a-12, the OTC derivatives dealer reporting rule, does not require that the auditor of an OTC derivatives dealer's annual audited financial statements be registered with the PCAOB or that the audit be conducted in accordance with standards of the PCAOB.[388] Accordingly, the Commission believes that stand-alone SBSDs and MSBSPs and OTCDD/SBSDs should have the option to engage an independent public accountant that is not registered with the PCAOB, and that the independent public accountant engaged by the firm should have the option to use either GAAS in the United States or PCAOB standards.[389]

For these reasons, the Commission is adopting the proposed annual reports requirements with the modifications that stand-alone SBSDs and OTCDD/SBSDs operating under the exemption from Rule 18a-4 will be required to file the exemption report instead of the compliance report, that stand-alone SBSDs and MSBSPs and OTCDD/SBSDs may engage an independent public accountant that is not registered with the PCAOB, and that the accountant must undertake, as part of the engagement, to prepare its reports based on an examination or review, as applicable, of the reports prepared by the broker-dealer in accordance with GAAS in the United States or PCAOB standards.[390] In addition, the Commission made a number of non-substantive modifications to paragraph (d) of Rule 17a-5,[391] as proposed to be amended, and paragraph (c) of Rule 18a-7, as proposed to be adopted.[392]

Timing and Location of Filing

Paragraph (d)(5) of Rule 17a-5 provides that a broker-dealer, broker-dealer SBSD, other than an OTCDD/SBSD, and broker-dealer MSBSP must file the annual reports with the Commission not more than sixty calendar days after the end of the firm's fiscal year. Paragraph (d)(6) of Rule 17a-5 requires that the broker-dealer file the annual reports: (1) At the office of the Commission for the region where the broker-dealer has its principal place of business; (2) at the Commission's principal office in Washington, DC; (3) at the principal office of the broker-dealer's DEA; and (4) with SIPC. The Commission proposed parallel filing requirements in Rule 18a-7 for stand-alone SBSDs and MSBSPs, except that these entities would need to file the annual reports solely with the Commission.[393] Broker-dealers, including OTC derivatives dealers, currently may file their annual reports electronically.[394] The Commission is amending paragraph (d)(6) of Rule 17a-5 to provide broker-dealers, including broker-dealer SBSDs and MSBSPs the option to file the annual reports with the Commission electronically. In addition, the Commission is modifying paragraph (c)(6) of Rule 18a-7 to provide this option to stand-alone SBSDs, OTCDD/SBSDs, and stand-alone MSBSPs. For these reasons, the Commission is adopting the proposed requirements regarding the timing and location of the filings with these modifications.[395]

Nature and Form of the Reports

Paragraph (e) of Rule 17a-5, among other things: (1) Requires the broker-dealer to attach a notarized oath or affirmation to the financial reports; (2) provides that the annual reports are not confidential, except that the broker-dealer can request confidentiality for all parts of the annual reports other than the statement of financial condition and related accountant's report; and (3) requires a broker-dealer to file certain additional reports with SIPC. FOCUS Report Part III serves as the cover sheet for the annual reports and provides a template for the broker-dealer to execute the oath or affirmation. Broker-dealer SBSDs, other than OTCDD/SBSDs, and broker-dealer MSBSPs will be subject to these requirements, as amended. The Commission proposed amendments to paragraph (e) of Rule 17a-5 and parallel nature and form of the reports requirements in Rule 18a-7 for stand-alone SBSDs and MSBSPs.[396]

More specifically, the Commission proposed amending paragraph (e) of Rule 17a-5 to remove the text of the oath or affirmation because the text is set forth in FOCUS Report Part III as well. The Commission received no comment on this aspect of the proposal. However, to avoid confusion as to whether this change would result in a new substantive requirement, the Commission has determined to retain the text of the oath or affirmation in paragraph (e)(2) of Rule 17a-5 and to include it in paragraph (d)(1) of Rule 18a-7.

Paragraph (e)(4)(i) of Rule 17a-5 requires a broker-dealer to file with SIPC “a report on the SIPC annual general assessment reconciliation or exclusion from membership forms that contains such information and is in such format as determined by SIPC by rule and approved by the Commission.” SIPC's rule (SIPC Rule 600, “Rules Relating to Supplemental Report of SIPC Membership”) was approved by the Commission on March 14, 2016.[397]

Under paragraph (e)(4)(ii) of Rule 17a-5, broker-dealers are required to file the report with the Commission pursuant to the requirements in that paragraph (which prescribes the information that must be included in, and the format of, the report). However, under paragraph (e)(4)(ii) of Rule 17a-5, broker-dealers were no longer required to do so after SIPC adopted its rule under paragraph (e)(4)(i) of Rule 17a-5 and the rule was approved by the Commission. Therefore, for fiscal years that ended on or after April 30, 2016, Start Printed Page 68586when SIPC's rule became effective, paragraph (e)(4)(ii) of Rule 17a-5 became moot. As a consequence, the Commission is making the technical amendment to paragraph (e)(4) of Rule 17a-5 to eliminate paragraph (e)(4)(ii). As amended, paragraph (e)(4) of Rule 17a-5 provides that: “The broker or dealer must file with SIPC a report on the SIPC annual general assessment reconciliation or exclusion from membership forms that contains such information and is in such format as determined by SIPC by rule and approved by the Commission.” A broker-dealer is not required to also file the report with the Commission. There is no parallel provision in Rule 17a-12, the reporting rule for OTC derivatives dealers,[398] or in Rule 18a-7, because these entities are not (or will not) be members of SIPC.

In addition, the Commission proposed a number of changes to FOCUS Report Part III, which before these amendments was the cover page to be attached to a broker-dealer's annual reports, to accommodate its use by OTC derivatives dealers and stand-alone SBSDs and MSBSPs.[399] The Commission also proposed amending FOCUS Report Part III to address amendments made to Rule 17a-5 in 2013.[400] Further, the Commission proposed a number of non-substantive changes to FOCUS Report Part III.[401] The Commission received no comments on these proposed requirements and is adopting them.[402] However, the Commission is making several non-substantive changes to the original proposal to improve the clarity of FOCUS Report Part III.[403] The Commission is also making several non-substantive changes to the checklist on the second page of FOCUS Report Part III.[404]

Qualification of the Independent Public Accountant

As noted above, a broker-dealer is required to file with the Commission a report of a PCAOB-registered independent public accountant covering the annual reports. Paragraph (f) of Rule 17a-5: (1) Prescribes certain minimum qualifications for the independent public accountant; (2) requires the broker-dealer to file with the Commission a statement concerning the accountant; and (3) requires the broker-dealer to file a notice when replacing the accountant. Broker-dealer SBSDs, other than OTCDD/SBSDs, and broker-dealer MSBSPs will be subject to these requirements. The Commission proposed to include in Rule 18a-7 parallel independent public accountant qualifications, statement, and notice requirements for stand-alone SBSDs and MSBSPs.[405] The Commission is modifying these requirements to conform them to the modifications discussed above pursuant to which a Start Printed Page 68587stand-alone SBSD or MSBSP as well as an OTCDD/SBSD may engage an independent public accountant that is not registered with the PCAOB. The Commission received no other comments related to these proposed accountant qualification requirements and is adopting them with the modification discussed above.[406]

Engagement of the Independent Public Accountant

Paragraph (g) of Rule 17a-5 provides that the independent public accountant engaged by the broker-dealer to provide the reports covering the annual reports must, as part of the engagement, undertake to prepare the following reports, as applicable, in accordance with PCAOB standards: (1) A report based on an examination of the financial report; and (2) either a report based on an examination of certain statements in the compliance report or a report based on a review of the statements in the exemption report. Broker-dealer SBSDs, other than OTCDD/SBSDs, and broker-dealer MSBSPs will be subject to these requirements. The Commission proposed parallel engagement of accountant requirements in Rule 18a-7 for stand-alone SBSDs and MSBSPs.[407] The Commission is modifying these requirements to conform them to the modifications discussed above pursuant to which a stand-alone SBSD or MSBSP as well as an OTCDD/SBSD may engage an independent public accountant that is not registered with the PCAOB and the accountant may use GAAS in the United States or PCAOB standards. The Commission received no other comments related to these proposed requirements and is adopting them with the modification discussed above and with one additional modification.[408] As discussed above, the final segregation rule for stand-alone SBSDs, OTCDD/SBSDs, and bank SBSDs includes an exemption from the rule's requirements if firm meets certain conditions.[409] Consequently, the Commission is requiring a stand-alone SBSD or OTCDD/SBSD that is exempt from the segregation rule to file the exemption report instead of the compliance report. Accordingly, a stand-alone SBSD or OTCDD/SBSD that is exempt from the segregation rule must engage the independent public accountant to perform a review of the firm's exemption report instead of an examination of the compliance report.[410]

Notification of Non-Compliance or Material Weakness

Paragraph (h) of Rule 17a-5 requires the independent public accountant engaged to prepare reports covering a broker-dealer's annual reports to provide the broker-dealer with a notification if, during the course of preparing its reports, the accountant discovers the firm is not in compliance with Rule 15c3-1, 15c3-3, 17a-13, or SRO customer account statement rules, or if the accountant determines that any material weaknesses exist. If the notification from the accountant concerns an occurrence that requires the broker-dealer to provide notification to the Commission (e.g., under Rule 17a-11), the broker-dealer must provide the accountant with a copy of the notification sent to the Commission. If the accountant does not receive the copy of the notification within one business day, or if the accountant disagrees with the statements in the notification, the accountant must notify the Commission and the broker-dealer's DEA within one business day.[411] Broker-dealer SBSDs, OTCDD/SBSDs, and broker-dealer MSBSPs will be subject to these requirements.

The Commission proposed parallel notification requirements in Rule 18a-7 for stand-alone SBSDs and MSBSPs and their independent public accountants.[412] The proposed notification requirements for stand-alone SBSDs would be triggered if the independent public accountant discovers the firm is not in compliance with the proposed SBSD capital, segregation, or security-count rules or that a material weakness exists. The proposed notification requirements for stand-alone MSBSPs would be triggered if the independent public accountant discovers the firm is not in compliance with the proposed MSBSP capital rule. The Commission received no comment on these proposed notification requirements and is adopting them with the modification that an OTCDD/SBSD will be subject to these requirements pursuant to Rule 18a-7 (rather than Rule 17a-5).[413]

Reports of the Independent Public Accountant

Paragraph (i) of Rule 17a-5 prescribes requirements for the reports of the independent public accountant covering the broker-dealer's annual reports, including: (1) Technical requirements; (2) required representations; (3) the opinions or conclusions to be expressed in the accountant's reports; and (4) requirements related to matters to which the accountant takes exception. Broker-dealer SBSDs, other than OTCDD/SBSDs, and broker-dealer MSBSPs will be subject to these requirements. The Commission proposed parallel requirements in Rule 18a-7 for stand-alone SBSDs and MSBSPs.[414] The Commission is modifying these requirements to conform them to the modifications discussed above pursuant to which a stand-alone SBSD or MSBSP as well as an OTCDD/SBSD also registered as an OTC derivatives dealer may engage an independent public accountant that is not registered with the PCAOB and the accountant may use GAAS in the United States or PCAOB standards. The Commission received no other comments related to these proposed requirements regarding reports of the independent accountant and is adopting them as proposed.[415]

Notification of Change of Fiscal Year

Paragraph (n)(1) of Rule 17a-5 requires a broker-dealer to notify the Commission and its DEA of a change of its fiscal year. Paragraph (n)(2) requires that the notice contain a detailed explanation for the reasons for the change and requires that changes in the filing period for the annual reports must be approved in writing by the broker-dealer's DEA. Broker-dealer SBSDs, other than OTCDD/SBSDs, and broker-dealer MSBSPs will be subject to these requirements. The Commission proposed a parallel notification of a change of fiscal year requirement in Rule 18a-7 for stand-alone SBSDs and MSBSPs, except that under the proposal, the Commission (rather than the DEA) must approve a change in the Start Printed Page 68588filing period for the annual reports.[416] The Commission received no comments on these proposed requirements regarding notification of a change of fiscal year and is adopting them with the modification that an OTCDD/SBSD will be subject to these requirements pursuant to Rule 18a-7 (rather than Rule 17a-5).[417]

Filing Requirements

Paragraph (o) of Rule 17a-5 provides that a filing pursuant to the rule is deemed to be accomplished when it is received by the Commission's principal office with duplicates filed simultaneously at the locations prescribed in particular paragraphs of Rule 17a-5. Broker-dealer SBSDs, other than OTCDD/SBSDs, and broker-dealer MSBSPs will be subject to this requirement. The Commission proposed a parallel filing requirement in proposed Rule 18a-7 for stand-alone and bank SBSDs and MSBSPs.[418] The Commission received no comment on these proposed filing requirements and is adopting them with the modification that an OTCDD/SBSD will be subject to these requirements pursuant to Rule 18a-7 (rather than Rule 17a-5).[419]

b. Additional Amendments to Rule 17a-5 and Modifications to Rule 18a-7

The Commission proposed several amendments to Rule 17a-5 to eliminate obsolete text, improve readability, and to modernize terminology.[420] The Commission also proposed to redesignate certain paragraphs in Rule 17a-5 as a consequence of the proposal to delete other paragraphs in Rule 17a-5. The Commission received no comment on these amendments or redesignations and is adopting them as substantially as proposed.[421]

The Commission proposed amending paragraph (a)(4) of Rule 17a-5 to specify that a DEA “must promptly transmit that information” obtained through the filing of Form Custody, instead of merely requiring that the DEA “transmit the information” obtained through the Form Custody filing.[422] The Commission received no comment on this amendment and is adopting it as proposed. The Commission also proposed changes to the structuring of paragraph (a)(5) of Rule 17a-5, which requires certain ANC reports to be filed.[423] The Commission received no comment on this reorganization and is adopting it as proposed.

The Commission also made additional modifications to the text of Rule 18a-7 as proposed.[424]

C. Notification

1. Introduction

After considering the anticipated business activities of SBSDs and MSBSPs, the Commission proposed a notification program for these registrants under Sections 15F and 17(a) of the Exchange Act modeled on the Start Printed Page 68589notification program for broker-dealers codified in Rule 17a-11. Rule 17a-11 specifies the circumstances under which a broker-dealer must notify the Commission and other regulators about its financial or operational condition, as well as the form of the notice. Rule 17a-11 is being amended to account for the security-based swap activities of entities subject to its requirements and new Rule 18a-8—which is modeled on Rule 17a-11—is being adopted to establish reporting requirements for SBSDs and MSBSPs that will not be subject to Rule 17a-11. Rule 18a-8 does not include a parallel requirement for every requirement in Rule 17a-11.[425]

As is the case with Rules 17a-5 and 18a-7, the applicability of Rule 17a-11 or 18a-8 will depend on whether the firm is subject to the capital requirements of Rule 15c3-1 (in which case Rule 17a-5 will apply), is subject to the capital requirements of Rules 18a-1 or 18a-2 (in which case Rule 18a-7 will apply), or has a prudential regulator (in which case Rule 18a-7 will apply).[426] Therefore, a stand-alone broker-dealer, including a stand-alone OTC derivatives dealer, (which is subject to Rule 15c3-1) will continue to be subject to Rule 17a-11. Similarly, a broker-dealer SBSD, other than an OTCDD/SBSD, (which is subject to Rule 15c3-1) will be subject to Rule 17a-11. A broker-dealer, including an OTC derivatives dealer, that is also an MSBSP (which is subject to Rule 15c3-1), will be subject to Rule 17a-11. A stand-alone SBSD (which is subject to Rule 18a-1) will be subject to Rule 18a-8. Similarly, an OTCDD/SBSD (which is subject to Rule 18a-1) will be subject to Rule 18a-8.[427] A stand-alone MSBSP (which is subject to Rule 18a-2) will be subject to Rule 18a-8. Finally, a bank SBSD or MSBSP (which has a prudential regulator) will be subject to Rule 18a-8.[428]

2. Amendments to Rule 17a-11 and New Rule 18a-8

Undesignated Introductory Paragraph

The Commission proposed that an undesignated introductory paragraph be added to Rule 17a-11, explaining that the rule applies to a broker-dealer, including a broker-dealer SBSD or MSBSP.[429] Further, the Commission proposed to delete paragraph (a) of Rule 17a-11, which provides that the rule shall apply to every broker-dealer registered pursuant to Section 15 of the Exchange Act. This text would be redundant given the proposed undesignated introductory paragraph. Similarly, the Commission proposed that Rule 18a-8 have an undesignated introductory paragraph explaining that the rule applies to an SBSD or MSBSP that is not registered as a broker-dealer.[430] The note further explained that a broker-dealer that is dually registered as an SBSD or MSBSP is subject to the notification requirements under Rule 17a-11. The Commission received no comments on the introductory paragraphs but, as discussed above, is modifying them to clarify which rule (17a-11 or 18a-8) applies to a given type of entity.

Failure To Meet Minimum Capital Requirements

Rule 17a-11 requires a broker-dealer to notify the Commission if the firm discovers or is informed by the Commission or its DEA that its net capital has declined below the minimum amount required under Rule 15c3-1.[431] Further, a broker-dealer registered as an OTC derivatives dealer also must provide notice if its tentative net capital falls below the minimum amount required under Rule 15c3-1. Broker-dealer SBSDs, other than OTCDD/SBSDs, and broker-dealer MSBSPs will be subject to these existing notification requirements, as applicable. The Commission proposed parallel capital notification requirements in Rule 18a-8 for stand-alone SBSDs and MSBSPs.[432] The Commission received no comment on these notification provisions and has adopted the capital rules for nonbank SBSDs and MSBSPs.[433] The Commission is adopting the failure to meet minimum capital requirements notification provisions as proposed with the modification that an OTCDD/SBSD will be subject to these requirements pursuant to Rule 18a-7 (rather than Rule 17a-5).[434]

Early Warning of Potential Capital or Model Problem

Rule 17a-11 specifies five events that trigger a requirement that a broker-dealer send notice promptly (within twenty-four hours) to the Commission.[435] These notices are designed to provide the Commission with “early warning” that the broker-dealer may experience financial difficulty.[436] Broker-dealer SBSDs, other than OTCDD/SBSDs, and broker-dealer MSBSPs will be required to comply with these existing notification requirements. The Commission proposed parallel early warning notification requirements in Rule 18a-8 for stand-alone SBSDs and MSBSPs.[437] The Commission received no comment on these early warning provisions and is adopting them with the modification that an OTCDD/SBSD will be subject to these requirements pursuant to Rule 18a-7 (rather than Rule 17a-5).[438]

Notice of Adjustment of Reported Capital Category

Prudential regulators have established five capital categories that are used to describe a bank's capital strength: Well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized.[439] The definition of each capital category is based on capital measures under the bank capital standard and other factors.[440] A bank is required to notify its appropriate prudential regulator of adjustments to the bank's capital category that would put the bank into a lower capital category from the category previously assigned to it. Following the notice, the Start Printed Page 68590prudential regulator determines whether the bank needs to adjust its capital category.[441] The Commission proposed to include a notification requirement in Rule 18a-8 that requires a bank SBSD to give notice to the Commission when it files an adjustment of reported capital category with its prudential regulator by transmitting a copy of the notice to the Commission.[442] The Commission received no comment on this provision and for the reasons discussed in the proposing release is adopting it as proposed.[443]

Failure To Make and Keep Current Books and Records

Rule 17a-11 requires a broker-dealer that fails to make and keep current the books and records required under Rule 17a-3 to notify the Commission of this fact on the same day that the failure arises.[444] In addition, a broker-dealer is required to report to the Commission within forty-eight hours of the original notice a report stating what the broker or dealer has done or is doing to correct the situation. Broker-dealer SBSDs, other than OTCDD/SBSDs, and broker-dealer MSBSPs will be required to comply with these existing notification requirements. The Commission proposed a parallel books and records notification requirement in Rule 18a-8 for stand-alone and bank SBSDs and MSBSPs.[445] The Commission received no comment on this provision and is adopting it with the modification that an OTCDD/SBSD will be subject to these requirements pursuant to Rule 18a-7 (rather than Rule 17a-5).[446]

Material Weakness

Rule 17a-11 requires a broker-dealer to provide notification about a material weakness as that term is defined in Rule 17a-5.[447] Specifically, the rule provides that, whenever a broker-dealer discovers or is notified by an independent public accountant of a material weakness as defined in Rule 17a-5, the broker-dealer must: (1) Give notice to the Commission within twenty-four hours of the discovery or notification of the material weakness; and (2) transmit a report within forty-eight hours of the notice stating what the broker-dealer has done or is doing to correct the situation. Broker-dealer SBSDs, other than OTCDD/MSPSPs, and broker-dealer MSBSPs will be required to comply with these existing notification requirements. The Commission proposed a parallel material weakness notification requirement in Rule 18a-8 applicable to stand-alone SBSDs.[448] The Commission received no comment on this provision and is adopting it with the modification that an OTCDD/SBSD will be subject to these requirements pursuant to Rule 18a-7 (rather than Rule 17a-5).[449]

Insufficient Liquidity Reserve

The Commission proposed that broker-dealers (including broker-dealer SBSDs) and stand-alone SBSDs authorized to use internal models to compute net capital be subject to liquidity stress test requirements.[450] Consequently, the Commission proposed that these types of broker-dealers and stand-alone SBSDs give immediate notice in writing if the liquidity stress test indicates that the amount of the firm's liquidity reserve is insufficient.[451] As consideration of the proposed liquidity stress test requirements is being deferred,[452] the Commission is deferring consideration of these related notification requirements.[453]

Failure To Make a Required Reserve Deposit

Paragraph (i) of Rule 15c3-3 requires a broker-dealer to notify the Commission and its DEA if it fails to make a required deposit into its customer reserve account under Rule 15c3-3. Since a broker-dealer SBSD was required to maintain a separate reserve account for its security-based swap customers under Rule 18a-4, as proposed, the Commission proposed a new notification requirement in Rule 17a-11 that would be triggered if a broker-dealer SBSD fails to make a required deposit into its special account for the exclusive benefit of security-based swap customers.[454] The Commission also proposed a parallel reserve account notification requirement in Rule 18a-8 applicable to stand-alone SBSDs and bank SBSDs. The Commission received no comment on these notification provisions and has adopted security-based swap customer segregation requirements.[455] The Commission is adopting the proposed notification requirements for the reasons discussed in the proposing release with certain modifications.[456] In particular, the security-based swap reserve requirement applicable to broker-dealers, including broker-dealer SBSDs (other than OTCDD/SBSDs), is codified in Rule 15c3-3 and is expanded to apply to stand-alone broker-dealers engaged in security-based swap activities. Accordingly, the Commission is adopting requirements that stand-alone broker-dealers and SBSDs must provide notice if they fail to make a required security-based swap customer reserve deposit.[457]

Manner of Notification

Rule 17a-11 specifies how and to whom the notices and reports required by the rule must be transmitted. Broker-dealers, broker-dealer SBSDs, other than OTCDD/SBSDs, and broker-dealer MSBSPs will be required to give notice or transmit the notices and reports, including the proposed new notices, pursuant to these existing requirements.[458] The Commission proposed to amend this paragraph to no longer permit notice by telegraphic transmission, and instead to only allow notice by facsimile transmission.[459] The change was proposed in light of the fact that telegrams are no longer widely used in the United States,[460] and that Commission staff no longer receive Rule 17a-11 notices by telegram.[461] The Start Printed Page 68591Commission received no comment on this revision but believes it would be appropriate to further modernize the rule by amending it to permit the notices to be sent by email. Accordingly, the rule, as amended, provides in pertinent part that the notice section must be given or transmitted to the principal office of the Commission in Washington, DC and the regional office of the Commission for the region in which the broker or dealer has its principal place of business, or to an email address provided on the Commission's website.[462] This modification to provide for notification by email is based on the notification provision in recently adopted Rule 18a-10 and is designed to provide a simpler and more efficient process for sending the notifications (i.e., via email).[463] Consequently, a broker-dealer will be able to transmit a notification required pursuant to Rule 17a-11 using an email address provided on the Commission's website and designated for the purpose of receiving such notifications.

The Commission proposed a parallel manner of notification requirement in Rule 18a-8.[464] The Commission received no comment on this provision but is modifying Rule 18a-8 to provide that the notice must be given or transmitted to the principal office of the Commission in Washington, DC and the regional office of the Commission for the region in which the SBSD or MSBSP has its principal place of business, or to an email address provided on the Commission's website.[465] Consequently, SBSDs and MSBSPs also will be permitted to transmit a notification required pursuant to Rule 18a-8 using an email address provided on the Commission's website and designated for the purpose of receiving such notifications.

For these reasons, the Commission is adopting the manner of notification requirements with the modification discussed above and with the modification that an OTCDD/SBSD will be subject to these requirements pursuant to Rule 18a-7 (rather than Rule 17a-5).

3. Additional Amendments to Rule 17a-11 and Modifications to Rule 18a-8.

The Commission proposed several amendments to Rule 17a-11 to eliminate obsolete text, improve readability, and modernize terminology. The Commission proposed a global change to Rule 17a-11 that replaced the use of the word “shall” in the rule with the word “must” or “will” where appropriate.[466] The Commission also proposed certain stylistic, corrective, and punctuation amendments to improve the readability of Rule 17a-11.[467] The Commission received no comment on these amendments and is adopting them as proposed.

As a consequence of the deletion of paragraph (a), paragraphs (b) through (e) of Rule 17a-11 were redesignated paragraphs (a) through (d), respectively. Further, the Commission is adding two new notification provisions to Rule 17a-11 that are codified in paragraphs (e) and (f) of the rule, as amended. As a consequence of the deletion of paragraph (a) and the addition of the two new provisions, paragraphs (f) through (i) were redesignated paragraphs (g) through (j), respectively. Similarly, due to the addition and deletion of various paragraphs, the Commission made a global change that replaced the cross-references to “paragraph (g)” of Rule 17a-11 with “paragraph (h)” of Rule 17a-11.[468] The Commission received no comment on these revisions and is adopting them as proposed.

Prior to these amendments, paragraph (f) of Rule 17a-11 made reference to a “member” of a national securities exchange as a distinct class of registrant in addition to a “broker” and “dealer.” The Commission proposed to remove this reference to a “member” given that the rule applies to broker-dealers, which would include a member of a national securities exchange that is a broker-dealer (and as discussed above, proposed to redesignate paragraph (f) as paragraph (g)).[469] The Commission received no comment on this revision and is adopting it as proposed.

Prior to these amendments, paragraph (f) of Rule 17a-11 contained a reference to the notices required under “paragraphs (b), (c), (d), or (e)” of Rule 17a-11. The Commission proposed to replace the quoted language with a reference to “this section” (and as discussed above, proposed to redesignate paragraph (f) as paragraph (g)).[470] The proposed change incorporated all the notices required under Rule 17a-11, including notices that are required under the new security-based swap customer reserve account notification requirement. The Commission received no comment on this revision and is adopting it as proposed.[471]

Finally, prior to these amendments, paragraph (h) contained references to “§ 240.15c3 1(a)(6)(iv)(B), § 240.15c3 1(a)(6)(v), § 240.15c3 1(a)(7)(ii), § 240.15c3 1(c)(2)(x)(B)(1), § 240.15c3 1(e), § 240.15c3 1d(c)(2), § 240.15c3 3(i), § 240.17a 5(h)(2), and § 240.17a 12(f)(2).” The Commission proposed amending the references to state, “§ 240.15c3-1, § 240.15c3-1d, § 240.15c3-3, § 240.17a-5, and § 240.17a-12.” [472] This amendment corrected certain cross-references that are outdated due to the recently adopted amendments to some of these rules.[473] It also eliminated cross-references to specific paragraphs in the event of future amendments to these cross-referenced rules. The Commission received no comment on this amendment and is adopting it as proposed.[474]

The Commission also made certain non-substantive modifications to Rule 18a-8.[475]

Start Printed Page 68592

D. Quarterly Securities Count and Capital Charge for Unresolved Securities Differences

1. Introduction

The Commission proposed a securities count program for stand-alone SBSDs under Section 15F of the Exchange Act that is modeled on the securities count program for broker-dealers codified in Rule 17a-13.[476] Rule 17a-13 requires certain broker-dealers (generally, broker-dealers that hold customer funds and securities) to examine and count the securities they physically hold, account for the securities that are subject to their control or direction but are not in their physical possession, verify the locations of securities under certain circumstances, and compare the results of the count and verification with their records. Broker-dealer SBSDs, including OTCDD/SBSDs, and broker-dealer MSBSPs will be subject to Rule 17a-13.[477] Consequently, they must comply with the existing securities count requirements in the rule with respect to security-based swaps.

Stand-alone SBSDs will be subject to Rule 18a-9, which is modeled on Rule 17a-13. Rule 18a-9 does not include a parallel requirement for every requirement in Rule 17a-13.[478] In addition, Rule 18a-9 does not apply to stand-alone MSBSPs because the customer protection rationale for Rule 17a-13 and Rule 18a-9 is not as pertinent to stand-alone MSBSPs. For example, the Commission does not anticipate that stand-alone MSBSPs will engage in securities operations involving the movement of funds and securities from buyer to seller that are as complex as the operations of dealers in securities such as broker-dealers and SBSDs.

2. Rule 18a-9

Undesignated Introductory Paragraph

The Commission proposed that Rule 18a-9 have an undesignated introductory paragraph explaining that the rule applies only to a stand-alone SBSD.[479] The note further explained that a broker-dealer, including a broker-dealer SBSD, is subject to the securities count requirements under Rule 17a-13.[480] The Commission received no comments on this proposed introductory paragraph and is adopting it with modifications to clarify which rule (17a-13 or 18a-9) applies to a given type of entity.[481]

Requirement To Perform a Securities Count

Paragraph (b) of Rule 17a-13 requires a quarterly securities count and specifies the steps a broker-dealer must take in performing the count. In general terms, the rule requires a broker-dealer to physically examine, count, and verify all securities positions (e.g., equities, corporate bonds, and government securities, and, after the Commission's exemptive relief expires,[482] security-based swaps), and to compare the results of the count and verification with the firm's records at least once each calendar quarter. A securities count difference results when the count reflects positions different than those reflected in the firm's books and records.

The Commission proposed parallel securities count requirements in Rule 18a-9 that mirrored the requirements in paragraph (b) of Rule 17a-13.[483] Consequently, a stand-alone SBSD would be required to perform a securities count each quarter following steps that are identical to the steps specified in paragraph (b) of Rule 17a-13.[484] Moreover, a securities count needed to be performed no sooner than two months after the last count and no later than four months after the last count.[485]

Stand-alone SBSDs may have limited activities. The Commission believes, however, that stand-alone SBSDs will likely hold securities in a proprietary capacity and as hedges or collateral related to their swaps activity, and therefore are susceptible to the same risks as broker-dealers if securities are not counted and verified. This is the same reason that OTC derivatives dealers are not exempt from performing quarterly securities counts even though they also conduct a more limited business than traditional broker-dealers.

The Commission acknowledges that security-based swaps are not held in depositories or at other types of custodians. Instead, they are documented in contractual agreements. In order to meet the requirements of Rules 17a-13 and 18a-9, as applicable, a broker-dealer and SBSD generally will need to account for or verify its open security-based swap transactions. The method of doing so could involve steps to confirm open transactions reflected in the firm's books and records with securities clearing agencies or counterparties. The Commission is adopting this requirement as proposed.[486]

Date of the Count

Paragraph (c) of Rule 17a-13 provides that: (1) The examination, count, verification, and comparison may be made either as of a date certain or on a cyclical basis covering the entire list of securities; (2) in either case the recordation of unresolved differences shall be effected within seven business days subsequent to the examination, count, verification, and comparison of a particular security; (3) in the event that an examination, count, verification, and comparison is made on a cyclical basis, it shall not extend over more than one calendar quarter-year; and (4) no security shall be examined, counted, verified, or compared for the purpose of the rule less than two months or more than four months after a prior examination, count, verification, and comparison. This permits a broker-dealer to perform the securities count on a rolling basis throughout the quarter as opposed to performing it all at once.[487] The Commission proposed a parallel securities count requirement in Rule 18a-8.[488] Consequently, a stand-alone SBSD could perform the securities count as of a date certain or on a cyclical basis subject to conditions that Start Printed Page 68593are identical to the conditions in paragraph (c) of Rule 17a-13. The Commission received no comment on this provision and is adopting it as proposed.[489]

Separation of Duties

Paragraph (d) of Rule 17a-13 provides that the examination, count, verification, and comparison shall be made or supervised by persons whose regular duties do not require them to have direct responsibility for the proper care and protection of the securities or the making or preservation of the subject records. Thus, the rule requires a separation of duties as a control to promote the integrity of the securities count process. The Commission proposed a parallel separation of duties requirement in Rule 18a-9 that mirrored the requirement in paragraph (d) of Rule 17a-13.[490] Consequently, a stand-alone SBSD was required to assign responsibility for making or supervising the count to individuals whose regular duties do not require them to have direct responsibility for the proper care and protection of the securities or the making or preservation of the subject records.[491] The Commission received no comment on this provision and is adopting it as proposed.[492]

E. Alternative Compliance Mechanisms

A commenter urged the Commission to harmonize its recordkeeping requirements for SBSDs and MSBSPs with the CFTC's final recordkeeping requirements for swap dealers and major swap participants to the maximum extent possible with the goal of permitting firms to utilize a single recordkeeping system for security-based swaps and swaps.[493] In response to the comment and to promote harmonization with CFTC requirements, the Commission—as discussed below—is adopting a limited alternative compliance mechanism in Rules 17a-3 and 18a-5 and amending Rule 18a-10 to add recordkeeping and reporting requirements to the full alternative compliance mechanism provided by that rule.[494]

1. Limited Alternative Compliance Mechanism—Rules 17a-3 and 18a-5

Under the limited alternative compliance mechanism, an SBSD or MSBSP may comply with the recordkeeping requirements of the CEA and the rules thereunder applicable to swap dealers and major swap participants in lieu of complying with the requirements in Rules 17a-3 and 18a-5 to make and keep current trade blotters, customer account ledgers, and stock records solely with respect to information required to be included in these records regarding security-based swap transactions and positions if the SBSD or MSBSP:

  • is registered as an SBSD or MSBSP pursuant to Section 15F of the Exchange Act;
  • is registered as a swap dealer or major swap participant pursuant to section 4s of the Commodity Exchange Act and the rules thereunder;
  • is subject to 17 CFR 23.201-202, 17 CFR 23.402, and 17 CFR 23.501 (the “CFTC's Books and Records Rules”) with respect to its swap-related books and records;
  • preserves all of the data elements necessary to create the records required by paragraphs (a)(1), (3), and (5) of Rule 17a-3; paragraphs (a)(1), (3), and (4) of Rule 18a-5; or paragraphs (b)(1) through (3) of Rule 18a-5, as applicable, as they pertain to security-based swap and swap transactions and positions;
  • upon request furnishes promptly to representatives of the Commission the records required by paragraphs (a)(1), (3), and (5) of Rule 17a-3; paragraphs (a)(1), (3), and (4) of Rule 18a-5; or paragraphs (b)(1) through (3) of Rule 18a-5, as applicable, as they pertain to security-based swap and swap transactions and positions, as well as the records required by the CFTC's Books and Records Rules, as they pertain to security-based swap and swap transactions and positions, in the format applicable to that category of record as set forth in Rule 17a-3 or Rule 18a-5, as applicable; and
  • provides notice of its intent to utilize the limited alternative compliance mechanism by notifying the Commission in writing, both at the principal office of the Commission in Washington, DC and at the regional office of the Commission for the region in which the registrant has its principal place of business, and, if the registrant is a broker-dealer, by notifying in writing the registrant's DEA.[495]

These records must be maintained for the retention period and in the manner specified for that category of record in Rule 17a-4 or 18a-6, as applicable.

The first three prongs of the limited alternative compliance mechanism identify the entities that may use it; that is, entities that are registered with the Commission as an SBSD or MSBSP and with the CFTC as a swap dealer or major swap participant and are subject to the recordkeeping requirements of the CFTC with respect to its swap-related books and records. The fourth and fifth prongs set forth the substantive requirements of the limited alternative compliance mechanism: (1) That the registrant preserve the data elements necessary to create the relevant required records as they pertain to security-based swap and swap transactions and positions, regardless of format; and (2) that the registrant provide those data elements as they pertain to security-based swap and swap transactions and positions in the format required by Commission rules upon request by a representative of the Commission. In effect, these two requirements taken together mean that a firm will not be required to create a trade blotter, customer account ledger, or stock record reflecting security-based swap transactions and positions formatted pursuant to the Commission's rules each day, but instead only when requested to do so by Commission staff. This should promote harmonization with CFTC requirements because firms will be able to create the daily records for both security-based swap and swap transactions and positions in the format required by the CFTC. For example, firms will not have to create on a daily basis two sets of trade blotters for security-based swap and swap transactions and positions: one in the Commission's required format and the other in the CFTC's required format.

The limited alternative compliance mechanism applies only to the provisions of Rules 17a-3 and 18a-5 that were specifically referenced by the commenter as appropriate for “harmonization,” [496] with the exception of the general ledger requirements in paragraph (a)(2) of Rules 17a-3 and 18a-5. Consequently, the limited alternative compliance mechanism may be applied to: (1) The trade blotter requirements in paragraph (a)(1) of Rule 17a-3, as amended, and paragraphs Start Printed Page 68594(a)(1) and (b)(1) of Rule 18a-5, as adopted; (2) the customer account ledger requirements of paragraph (a)(3) of Rule 17a-3, as amended, and paragraphs (a)(3) and (b)(2) of Rule 18a-5, as adopted; and (3) the stock record requirements of paragraph (a)(5)(ii) of Rule 17a-3, as amended, and paragraphs (a)(4) and (b)(3) of Rule 18a-5, as adopted. The Commission does not believe it would be appropriate to apply the limited alternative compliance mechanism to the general ledger requirements in paragraph (a)(2) of Rules 17a-3 and 18a-5 because the information that must be recorded in a general ledger is not limited to security-based swap and swap information. In particular, the general ledger must include information reflecting all assets and liabilities, income and expense, and capital accounts in order to facilitate examinations of the firm's overall financial condition and solvency. The Commission believes that the substantive requirements of the remaining provisions identified by the commenter as applied to security-based swap and swap transactions and positions are sufficiently similar to their counterparts in the CFTC's Books and Records Rules to make use of the limited alternative compliance mechanism appropriate. The Commission emphasizes that the limited alternative compliance mechanism applies solely to the books and records requirements with respect to security-based swap and swap transactions and positions, and does not extend to any books and records requirements for other types of transactions and positions. For other types of transactions and positions, the SBSD or MSBSP must make and keep current a trade blotter, customer account ledger, and stock record in the format required by Rule 17a-3 or 18a-5 as applicable.

The commenter seeking harmonization with the CFTC's requirements also stated that the Commission should permit bank SBSDs and MSBSPs to satisfy the Commission's recordkeeping requirements by complying with recordkeeping rules established by their prudential regulator, stating that “[s]uch rules should be supplemented with additional requirements only to the extent that such additional obligations are necessary for the Commission to fulfill its regulatory oversight of bank SBSDs and MSBSPs.” [497] Based largely on its consultations with the prudential regulators regarding their recordkeeping and reporting requirements, the Commission believes that the final amendments and rules being adopted in this document achieve this objective by specifically addressing a bank's activities as an SBSD or an MSBSP and only those activities. In particular, the rules being adopted in this document for bank SBSDs and MSBSPs are focused solely on documenting or requiring the reporting of information relating to engaging in security-based swap activities as opposed to the more traditional banking activities addressed by prudential regulators' existing recordkeeping and reporting requirements. In addition, as discussed above in section II.B.2. of this release, the Commission is adopting a reporting form for bank SBSDs and MSBSPs (the FOCUS Report Part IIC) that elicits information that largely is drawn from the call reports banks must file with the prudential regulators. In this way, the Commission has harmonized its reporting requirements for bank SBSDs and MSBSPs with the reporting requirements of the prudential regulators.

2. Full Alternative Compliance Mechanism—Rule 18a-10

The Commission adopted the full alternative compliance mechanism in Rule 18a-10.[498] Rule 18a-10 permits certain SBSDs that are registered as swap dealers and that predominantly engage in a swaps business to elect to comply with the capital, margin, and segregation requirements of the CEA and the CFTC's rules in lieu of complying with the capital, margin, and segregation requirements of Rules 18a-1, 18a-3, and 18a-4.[499] The Commission is amending Rule 18a-10 in this document to permit firms that will operate under Rule 18a-10 to elect to comply with the recordkeeping and reporting requirements of the CEA and the CFTC's rules in lieu of complying with Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9.

Paragraph (a) of Rule 18a-10 sets forth the conditions that an SBSD must meet to operate under the full alternative compliance mechanism. The Commission is amending the preface of paragraph (a) to reference recordkeeping and reporting requirements of the CEA and the CFTC's rules as well as Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9 in order to add these requirements to the full alternative compliance mechanism.[500] The conditions for operating under the full alternative compliance mechanism are set forth in paragraphs (a)(1) through (5) of Rule 18a-10. Paragraphs (a)(1) through (3) of Rule 18a-10 provide that the firm must be registered with the Commission as an SBSD, must not be registered with the Commission as a broker-dealer (including an OTC derivatives dealer), and must be registered with the CFTC as a swap dealer. Paragraph (a)(4) of Rule 18a-10 provides that the SBSD must be exempt from the segregation requirements of Rule 18a-4. Paragraph (a)(5) of Rule 18a-10 provides that the aggregate gross notional amount of the firm's outstanding security-based swap positions must not exceed the lesser of two thresholds as of the most recently ended quarter of the firm's fiscal year.[501] The thresholds are: (1) The maximum fixed-dollar gross notional amount of open security-based swaps specified in paragraph (f) of the rule (“maximum fixed-dollar threshold”); and (2) 10% of the combined aggregate gross notional amount of the firm's open security-based swap and swap positions. The amount of the maximum fixed-dollar threshold is $250 billion for a transitional period of three years and will then drop to $50 billion unless the Commission, by order: (1) Maintains the maximum fixed-dollar amount at $250 billion for an additional period of time or indefinitely after the 3-year transition period ends; or (2) lowers it to an amount that is less than $250 billion but greater than $50 billion.[502] Other than the amendment to the preface of paragraph (a) discussed above, the Commission is not amending the conditions set forth in paragraphs (a)(1) through (5) of Rule 18a-10. In addition, the Commission is not amending paragraph (f) of Rule 18a-10 (specifying the maximum fixed-dollar threshold).

Paragraph (b) of Rule 18a-10 sets forth requirements for a firm that is Start Printed Page 68595operating pursuant to the rule. Paragraph (b)(1) provides, in pertinent part, that the firm must comply with the capital, margin, and segregation requirements of the CEA and the CFTC's rules applicable to swap dealers. The Commission is amending paragraph (b)(1) to reference recordkeeping and reporting requirements of the CEA and the CFTC's rules to add these requirements to this provision.[503] Consequently, a firm that is subject to Rule 18a-10 must comply with applicable capital, margin, segregation, recordkeeping, and reporting requirements of the CEA and the CFTC's rules and a failure to comply with one or more of those rules will constitute a failure to comply with Rule 18a-10.

Paragraph (b)(1) also provides, in pertinent part, that the firm must treat security-based swaps and related collateral pursuant of the CEA and the CFTC's rules to the extent the requirements do not specifically address security-based swaps and related collateral. This provision is designed to ensure that security-based swaps and related collateral do not fall into a “regulatory gap” with respect to an SBSD operating under the full alternative compliance mechanism. Under a CFTC no-action letter, if a capital, margin, segregation, recordkeeping, or reporting requirement applicable to a swap or collateral related to a swap is silent as to a security-based swap or collateral related to a security-based swap, the nonbank SBSD must treat the security-based swap or collateral related to the security-based swap pursuant to the requirement applicable to the swap or collateral related to the swap.[504]

The Commission is making clarifying amendments to paragraph (b)(1) of Rule 18a-10 to provide that the firm must treat a security-based swap or collateral related to a security-based swap as a swap or collateral related to a swap, as applicable, if the CEA or the CFTC's rules do not specifically address a security-based swap or collateral related to a security-based swap.[505]

The amendments to Rule 18a-10 being adopted in this document will require a firm operating under the rule to treat security-based swaps and related collateral pursuant to the recordkeeping and reporting requirements of the CEA and the CFTC's rules as if they were swaps or related collateral to the extent those requirements do not specifically address security-based swaps and related collateral. For example, if the recordkeeping and reporting requirements of the CEA and CFTC's rules do not address a security-based swap transaction, the firm will need to treat it as a swap transaction for the purposes of the recordkeeping and reporting requirements that apply to swap transactions.

Paragraph (b)(2) of Rule 18a-10 requires the firm to provide a written disclosure to its counterparties after it begins operating pursuant to the rule. The disclosure must be provided before the first transaction with the counterparty after the firm begins operating pursuant to the rule. The disclosure must notify the counterparty that the firm is complying with the applicable capital, margin, and segregation requirements of the CEA and the CFTC's rules in lieu of complying with Rules 18a-1, 18a-3, and 18a-4. The Commission is amending paragraph (b)(2) to reference the recordkeeping and reporting requirements of the CEA and the CFTC's rules as well as Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9 in order to add these requirements to the disclosure requirement.[506]

Paragraph (b)(3) of Rule 18a-10 requires the SBSD to immediately notify the Commission and the CFTC in writing if it fails to meet a condition in paragraph (a) of the rule. The Commission is making a non-substantive amendment to paragraph (b)(3) because—as discussed next—new paragraph (b)(4) is being added to the rule.[507] As discussed above in section II.C. of this release, Rule 17a-11 specifies the circumstances under which a broker-dealer must notify the Commission and other regulators about its financial or operational condition, as well as the form of the notice. Stand-alone and bank SBSDs and MSBSPs are subject to Rule 18a-8, which is modeled on Rule 17a-11. Rule 18a-8 is designed to provide the Commission with the ability to take effective proactive steps to respond when a stand-alone or bank SBSD is experiencing or likely to experience financial difficulty.[508] However, an SBSD operating under Rule 18a-10 may comply with the notification requirements of the CFTC's rules in lieu of complying with Rule 18a-8. Therefore, in order to retain a requirement that the SBSD provide notice to the Commission if it is experiencing or likely to experience financial difficulty, the Commission is adding paragraph (b)(4) to Rule 18a-10. This paragraph provides that an SBSD operating pursuant to Rule 18a-10 must simultaneously notify the Commission if the firm is required to send a notice concerning its capital, books and records, liquidity, margin operations, or segregation operations to the CFTC by transmitting to the Commission a copy of the notice being sent to the CFTC.[509]

In addition, as discussed in section II.A.3.a. of this release, paragraph (j) of Rule 17a-4 requires a broker-dealer to furnish promptly to a representative of the Commission legible, true, complete, and current copies of those records of the broker-dealer that are required to be preserved under Rule 17a-4, or any other records of the broker-dealer subject to examination under Section 17(b) of the Exchange Act that are Start Printed Page 68596requested by the representative of the Commission. Paragraph (g) of Rule 18a-6 prescribes a parallel prompt production requirement for stand-alone and bank SBSDs and MSBSPs. However, an SBSD operating under Rule 18a-10 may comply with the record preservation requirements of the CFTC's rules in lieu of complying with Rule 18a-6. Therefore, in order to retain a requirement that the SBSD furnish records promptly to the Commission, paragraph (b)(5) is being added to Rule 18a-10. This paragraph provides that the SBSD must furnish promptly to a representative of the Commission legible, true, complete, and current copies of those records of the SBSD that are required to be preserved under the CEA and CFTC's rules applicable to swap dealers, or any other records of the SBSD subject to examination pursuant to Section 15F of the Exchange Act that are requested by a representative of the Commission.

Paragraph (c) of Rule 18a-10 addresses the situation in which a firm fails to comply with a condition in paragraph (a) of the rule and, therefore, no longer qualifies to operate pursuant to the rule. The paragraph provides that a firm in that circumstance must begin complying with Rules 18a-1, 18a-3, and 18a-4 no later than either: (1) Two months after the end of the month in which the firm failed to meet the condition in paragraph (a); or (2) after a longer period of time as granted by the Commission by order subject to any conditions imposed by the Commission. The Commission is amending the preface to paragraph (c) to reference Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9 in order to add these rules to the compliance requirement.[510]

Paragraph (d) of Rule 18a-10 addresses how a firm would elect to operate pursuant to the rule. Under paragraph (d)(1), a firm can make the election as part of the process of applying to register as an SBSD. In this case, the firm must provide written notice to the Commission and the CFTC during the registration process of its intent to operate pursuant to the rule. Upon being registered as an SBSD, the firm can begin complying with Rule 18a-10, provided it meets the conditions in paragraph (a) of the rule. Under paragraph (d)(2) of Rule 18a-10, an SBSD can make the election after the firm has been registered as an SBSD. In this case, paragraph (d)(2)(i) provides that the firm must provide written notice to the Commission and the CFTC of its intent to operate pursuant to the rule. In addition, paragraph (d)(2)(ii) provides that the firm must continue to comply with Rules 18a-1, 18a-3, and 18a-4 for two months after the end of the month in which the firm provides the notice or for a shorter period of time as granted by the Commission by order subject to any conditions imposed by the Commission. The Commission is amending the preface to paragraph (d)(2)(ii) to reference Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9 in order to add these rules to the compliance requirement.[511]

As discussed above, paragraph (b)(3) requires a firm operating pursuant to the rule to immediately notify the Commission and the CFTC in writing if the SBSD fails to meet a condition in paragraph (a). Further, paragraphs (d)(1) and (2) require a firm to provide written notice to the Commission and the CFTC of its intent to operate pursuant to the rule. Paragraph (e) of Rule 18a-10 provides that the notices required by the rule must be sent by facsimile transmission to the principal office of the Commission and the regional office of the Commission for the region in which the security-based swap dealer has its principal place of business or to an email address to be specified separately, and to the principal office of the CFTC in a manner consistent with the notification requirements of the CFTC. The paragraph also requires that notices include a brief summary of the reason for the notice and contact information for an individual who can provide further information about the matter that is the subject of the notice (emphasis added). The Commission is amending paragraph (e) of Rule 18a-10 to provide that the notice must be sent by facsimile transmission to the principal office of the Commission and the regional office of the Commission for the region in which the security-based swap dealer has its principal place of business or to an email address provided on the Commission's website, and to the principal office of the CFTC in a manner consistent with the notification requirements of the CFTC. This amendment is intended to clarify the location of the email address for firms that choose to send the notice via email.

F. Cross-Border Application and Availability of Substituted Compliance

1. Cross-Border Application of Recordkeeping and Reporting Requirements

In the 2013 cross-border proposing release, the Commission preliminarily interpreted the Title VII requirements associated with registration to apply generally to the activities of registered entities.[512] In reaching that preliminary conclusion, the Commission did not concur with the views of certain commenters that the Title VII requirements should not apply to the foreign security-based swap activities of registered entities, stating that such a view could be difficult to reconcile with, among other things, the statutory language describing the requirements applicable to SBSDs.[513] The Commission further preliminarily identified the recordkeeping and reporting requirements as entity-level requirements, rather than requirements specifically applicable to particular transactions. Entity-level requirements primarily address concerns relating to the entity as a whole, with a particular focus on safety and soundness of the entity to reduce systemic risk in the U.S. financial system. The Commission accordingly proposed to apply the entity-level requirements on a firm-wide basis to address risks to the SBSD as a whole. The Commission did not propose any exception from the application of the entity-level requirements to SBSDs.[514]

A commenter expressed the view that requirements with respect to daily trading records and confirmations should be deemed transaction-level, on the grounds that the application and enforcement of these requirements will be addressed at the transaction level, and for consistency with the CFTC's approach.[515] After considering the commenter's concerns, the Commission continues to believe that the entirety of the recordkeeping and reporting requirements—including requirements addressing daily trading records and confirmations—appropriately are considered entity-level requirements.516 Start Printed Page 68597If the Commission treated its recordkeeping requirements as transaction-based requirements, and then excluded certain transactions from its recordkeeping requirements, it would not be able to effectively regulate and examine registrants. Not only would the Commission have an incomplete picture of registrants' transactions if other jurisdictions did not require records regarding the excluded transactions, but this approach would create logistical complexities when comparing records kept in different formats. These concerns about an incomplete picture of a registrant's business are exacerbated by the possibility that a registrant would not keep records of excluded transactions because its jurisdiction does not regulate either the transaction (e.g., exclusions for certain security-based swap products or for certain transactions) or the entity. For these reasons, the Commission is treating recordkeeping and reporting requirements as entity-level requirements.

2. Availability of Substituted Compliance in Connection With Recordkeeping and Reporting Requirements

a. Existing Substituted Compliance Rule

In 2013, the Commission proposed to make substituted compliance potentially available in connection with the requirements applicable to foreign SBSDs pursuant to Section 15F of the Exchange Act, other than the registration requirements applicable to dealers. Because the recordkeeping and reporting requirements being adopted are grounded in Section 15F, substituted compliance generally would have been available for those requirements under the proposal.[517] Upon a Commission substituted compliance determination, a person would be able to satisfy relevant recordkeeping or reporting requirements by substituting compliance with corresponding requirements under a foreign regulatory system.

The Commission subsequently adopted Rule 3a71-6, which provides that substituted compliance is available with respect to the Commission's business conduct requirements, and (rather than addressing all requirements under Section 15F of the Exchange Act) reserved the issue as to whether substituted compliance also would be available in connection with other requirements under that statute.[518] Rule 3a71-6 was amended to make substituted compliance available with respect to the Commission's trade acknowledgment and verification requirements,[519] and to make it available with respect to capital and margin requirements.[520]

b. Amendments to Final Rule

A commenter requested that the Commission permit a foreign SBSD or MSBSP to satisfy its recordkeeping requirements by complying with recordkeeping rules established by its foreign regulator, provided the Commission determines such rules impose requirements comparable to Commission rules.[521] Another commenter stated that “[t]he Commission should allow non-U.S. SBSDs to satisfy any public disclosure requirements through substituted compliance.” [522] The Commission agrees with the commenters and is amending Rule 3a71-6 to provide foreign SBSDs and MSBSPs with the potential to utilize substituted compliance with comparable foreign requirements to satisfy Section 15F of the Exchange Act and Exchange Act Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9 thereunder.[523]

A commenter requested that foreign branches of U.S. banks (i.e., registered bank SBSDs that engage in dealing activity through foreign branches) be eligible for substituted compliance with respect to recordkeeping and reporting requirements classified as transaction-level requirements.[524] As discussed above, the Commission does not believe it would be appropriate to the treat the recordkeeping and reporting requirements as transaction-level requirements. In addition, the Commission has previously stated its belief that substituted compliance should not be available to registered entities that are U.S. persons.[525]

In amending Rule 3a71-6, the Commission concludes that the principles associated with substituted compliance for the business conduct, trade acknowledgment and verification, and capital and margin requirements in large part similarly apply to these recordkeeping and reporting requirements. Accordingly, except as discussed below, the revised substituted compliance rule applies to Section 15F of the Exchange Act and Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9 thereunder in the same manner as it applies to the business conduct, trade acknowledgment and verification, and capital and margin requirements.

i. Basis for Substituted Compliance in Connection With the Recordkeeping and Reporting Requirements

In light of the global nature of the security-based swap market and the prevalence of cross-border transactions within that market, there is the potential that the application of the Title VII recordkeeping and reporting requirements may lead to requirements that are duplicative of or in conflict with applicable foreign requirements, even when the two sets of requirements implement similar goals and lead to similar results. Those results have the potential to disrupt existing business relationships, and, more generally, to reduce competition and market efficiency.[526]

To address those effects, the Commission concludes that under certain circumstances it may be appropriate to allow for the possibility of substituted compliance whereby foreign SBSDs and MSBSPs may satisfy Section 15F of the Exchange Act and Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9 thereunder by complying with Start Printed Page 68598comparable foreign requirements. Allowing for the possibility of substituted compliance in this manner may help achieve the benefits of these recordkeeping and reporting requirements in a way that helps avoid regulatory duplication or conflict and hence promotes market efficiency, enhances competition, and facilitates a well-functioning global security-based swap market. Accordingly, Rule 3a71-6 is amended to identify the recordkeeping and reporting requirements of Section 15F of the Exchange Act and Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9 thereunder as being eligible for substituted compliance.[527]

ii. Comparability Criteria, and Consideration of Related Requirements

The Commission will endeavor to take a holistic approach in determining the comparability of foreign requirements for substituted compliance purposes, focusing on regulatory outcomes as a whole rather than on requirement-by-requirement similarity.[528] The Commission's comparability assessments associated with Section 15F of the Exchange Act and Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9 thereunder accordingly will consider whether, in the Commission's view, the foreign regulatory system achieves regulatory outcomes that are comparable to the regulatory outcomes associated with these recordkeeping and reporting requirements. However, paragraph (a)(2)(i) of Rule 3a71-6 provides that the Commission's substituted compliance determination will take into account factors that the Commission determines appropriate, such as, for example the scope and objectives of the relevant foreign regulatory requirements, as well as the effectiveness of the supervisory compliance program administered, and the enforcement authority exercised, by a foreign financial regulatory authority or authorities in such system to support its oversight of such foreign security-based swap entity (or class thereof) or of the activities of such security-based swap entity (or class thereof).

In reviewing applications, the Commission may determine to conduct its comparability analyses regarding the recordkeeping and reporting requirements in conjunction with comparability analyses regarding other Exchange Act requirements in connection with SBSDs and MSBSPs. Accordingly, depending on the applicable facts and circumstances, the comparability assessment associated with the recordkeeping and reporting requirements may constitute part of a broader assessment of the foreign regulatory system's risk mitigation requirements, and the applicable comparability assessments may be conducted at the level of those risk mitigation requirements as a whole.

Commenters generally requested additional guidance regarding the criteria the Commission would consider when making a substituted compliance determination.[529] Such criteria have been set forth in the final rule as discussed below. The Commission's recordkeeping, reporting, notification, and security count requirements reflect and support prudent business practices and accountability of registrants and have facilitated the ability of securities regulators to review and monitor compliance with securities laws. The Commission's recordkeeping and reporting requirements are integral to the ability of the Commission and other securities regulators to effectively examine and inspect regulated firms' compliance with the applicable securities laws.[530] More specifically, the records that firms are required to preserve can be reviewed by Commission staff and other securities regulators to monitor compliance with applicable securities laws.[531] Similarly, FOCUS Reports are used to determine which firms are engaged in various securities-related activities, and how economic events and government policies might affect segments of the securities industry.[532]

The Commission's recordkeeping and reporting requirements are also important for protecting customers against the risks involved in having their securities held by a third party.[533] A failure to maintain accurate, accessible, and true records may lead to situations where a firm cannot account for customer property or its own assets.[534] Similarly, the Commission's reporting requirements promote transparency of the financial and operational condition of broker-dealers to the Commission, the firm's DEA, and, in the case of a portion of the annual reports, to the public.[535]

In light of these considerations, paragraph (d)(6) of Rule 3a71-6 states that prior to making a substituted compliance determination regarding SBSD and MSBSP recordkeeping and reporting requirements, the Commission intends to consider (in addition to any conditions imposed), whether the foreign financial regulatory system's required records and reports, the timeframes for recording or reporting information, the accounting standards governing the records and reports, and the required format of the records and reports are comparable to applicable provisions arising under the Act and its rules and regulations and would permit the Commission to examine and inspect regulated firms' compliance with the applicable securities laws.

A commenter stated that a Commission substituted compliance determination should not be a Start Printed Page 68599prerequisite for a foreign bank SBSD to comply with “home-country” financial recordkeeping and reporting requirements in lieu of the Commission's requirements.[536] The commenter referred to this approach as “Automatic Substituted Compliance” for foreign bank SBSDs. Rule 3a71-6 does not provide “automatic” substituted compliance for any type of registrant. Moreover, as discussed above, the Commission preliminarily interpreted the Title VII requirements associated with registration to apply generally to the activities of registered entities.[537] Further, in reaching that preliminary conclusion, the Commission did not concur with the views of certain commenters that the Title VII requirements should not apply to the foreign security-based swap activities of registered entities, stating that such a view could be difficult to reconcile with, among other things, the statutory language describing the requirements applicable to SBSDs.[538] The Commission believes that it is appropriate to evaluate the substance of a foreign regulatory system to which substituted compliance would apply before granting substituted compliance to an entity. An “automatic” substituted compliance regime would be contrary to this view, as it would permit a foreign bank SBSD to comply with local requirements without any analyses by the Commission as to whether those requirements were comparable to the Commission's requirements. Therefore, the Commission does not believe the approach suggested by the commenter would be appropriate.

The same commenter stated that the Commission should allow a foreign stand-alone SBSD to satisfy financial recordkeeping and reporting requirements through substituted compliance if the SBSD qualifies for substituted compliance with respect to the Commission's capital and margin requirements for SBSDs.[539] The commenter referred to this approach as “One-Step Substituted Compliance.” The Commission does not believe that a positive substituted compliance determination with respect to nonbank SBSD capital and margin requirements should automatically result in a positive substituted compliance determination with respect to SBSD recordkeeping and reporting requirements. Once again, the Commission believes that it is appropriate to evaluate the substance of each foreign regulatory system to which substituted compliance would apply before granting substituted compliance to an entity. As discussed above, the recordkeeping and reporting requirements are integral to the ability of the Commission and other securities regulators to effectively examine and inspect regulated firms' compliance with the applicable securities laws, including capital and margin requirements. Therefore, the Commission will need to analyze a jurisdiction's recordkeeping and reporting requirements to determine whether they would permit the Commission to examine and inspect regulated firms' compliance with the applicable securities laws in a manner comparable to its examinations and inspections for firms subject to the recordkeeping and reporting requirements specified in Section 15F of the Exchange Act and Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9.

However, as discussed above, in reviewing substituted compliance applications, the Commission may conduct its comparability analyses regarding the recordkeeping and reporting requirements in conjunction with comparability analyses regarding other Exchange Act requirements that promote risk management in connection with SBSDs and MSBSPs. Thus, the Commission's comparability analyses regarding the recordkeeping and reporting requirements could be made in conjunction with comparability analyses regarding capital and margin requirements.

Finally, this commenter also stated that, if substituted compliance is not available with respect to a disclosure requirement, “the Commission should limit the application of such public disclosure requirements to SBSDs that are not otherwise subject to a public disclosure regime.” [540] For example, the commenter argues that paragraph (b)(7) of Rule 18a-7, as proposed, “could require a standalone SBSD that is a public reporting company to publish material, non-public information every six months, rather than on an annual basis on Form 20-F.” [541] Form 20-F, however, requires the public disclosure of substantially more information than will be required by Rule 18a-7, which requires relatively little information to be publicly disclosed. Moreover, Rule 18a-7 will require the disclosure of information such as a firm's net capital computation that may not be required under other disclosure regimes. For these reasons, the Commission is not adopting the commenter's proposed approach.

G. Amendments to Rule 18a-1

Paragraph (e) of appendix E to Rule 15c3-1 establishes a non-exclusive list of circumstances under which the Commission may restrict the business of an ANC broker-dealer, including when the firm fails to meet the reporting requirements set forth in Rule 17a-5 or an event specified in Rule 17a-11 occurs. The Commission proposed a parallel provision in Rule 18a-1 to apply to a stand-alone SBSD authorized to use models.[542] The circumstances in proposed Rule 18a-1 under which the Commission could have restricted the stand-alone SBSD's business included that the firm failed to meet a proposed reporting requirement or an event in the proposed notification rule for SBSDs occurs. The Commission adopted the provision in Rule 18a-1 under which the Commission may restrict the business of a stand-alone SBSD or OTCDD/SBSD authorized to use models.[543] However, in the final rule, the circumstances under which the Commission can restrict a firm's business did not include that the firm fails to meet a reporting requirement or an event in the notification rule for SBSDs occurs. As the SBSD reporting and notification rules are being adopted in this document, the Commission is amending Rule 18a-1 to add the these circumstances to those listed in the rule under which the Commission may restrict the business of a stand-alone SBSD or OTCDD/SBSD authorized to use models: (1) The SBSD fails to meet the reporting requirements set forth in Rule 18a-7; or (2) any event specified in Rule 18a-8 occurs.[544]

H. Delegation of Authority

In recognition of the adoption in this document of recordkeeping, reporting, and notification requirements for SBSDs and MSBSPs, securities count requirements applicable to certain SBSDs, and additional recordkeeping requirements applicable to broker-dealers to account for their security-based swap and swap activities in accordance with the Dodd-Frank Act, the Commission is amending its rule governing delegations of authority to the Director of the Division of Trading and Markets (“Division”).Start Printed Page 68600

Because OTC derivatives dealers will be required to file FOCUS Report Part II instead of FOCUS Report Part IIB, the reference to FOCUS Report Part IIB is being changed to FOCUS Report Part II. Specifically, paragraph (a)(65) of 17 CFR 200.30-3 (“Rule 30-3”) is being amended to delegate authority to the Division to authorize the issuance of orders requiring OTC derivatives dealers to file FOCUS Report Part II instead of FOCUS Report Part IIB. In addition, due to re-numbering of paragraphs as a result of these amendments, paragraph (a)(30) of Rule 30-3 is amended to cross-reference paragraph (a)(3) instead of paragraph (a)(4) of Rule 17a-5. Finally, paragraph (a)(65)'s cross-reference to Rule 17a-12 is corrected to read “§ 240.17a-12(a)(1)(ii)” instead of “§ 240.17a-12(a)(ii),” [545] and paragraph (a)(5)'s cross-reference to Rule 17a-5 is corrected to read “§ 240.17a-5(m)(3) of this chapter (Rule 17a-5(m)(3))” instead of “Rule 17a-5(1)(3) (§ 240.17a-5(1)(3) of this chapter).” These delegations of authority are intended to preserve Commission resources and increase the effectiveness and efficiency of the Commission's oversight of compliance with the financial responsibility rules. Nevertheless, the Division may submit matters to the Commission for its consideration, as it deems appropriate.

Administrative Law Matters

The Commission finds, in accordance with the Administrative Procedure Act (“APA”),[546] that these amendments relate solely to agency organization, procedure, or practice, and do not relate to a substantive rule. Accordingly, the provisions of the APA regarding notice of rulemaking, opportunity for public comment, and publication of the amendment prior to its effective date are not applicable. For the same reason, and because this amendment does not substantively affect the rights or obligations of non-agency parties, the provisions of the Small Business Regulatory Enforcement Fairness Act,[547] are not applicable. Additionally, the provisions of the Regulatory Flexibility Act, which apply only when notice and comment are required by the APA or other law,[548] are not applicable. Further, because this amendment imposes no new burdens on private persons, the Commission does not believe that the amendment will have any anti-competitive effects for purposes of Section 23(a)(2) of the Exchange Act.[549] Finally, this amendment does not contain any collection of information requirements as defined by the Paperwork Reduction Act of 1980, as amended.

III. Explanation of Dates

A. Effective Date

These final rules will be effective 60 days following publication of this release in the Federal Register.

B. Compliance Date

The compliance date for the rules being adopted in this document, other than the amendments to Rule 3a71-6 discussed below, will be 18 months after the effective date of any final rules originally proposed in May 2019 addressing the cross-border application of certain security-based swap requirements.[550] As set forth recently in the release adopting capital, margin, and segregation requirements, this compliance date will also be the compliance date for SBSD and MSBSP registration requirements (the “Registration Compliance Date”).[551] The Commission believes the compliance date provided in this release, which will be in excess of 18 months, will allow sufficient time to prepare for and come into compliance with the new recordkeeping and reporting requirements.

A commenter asked to delay cross-border application of the Commission's recordkeeping and reporting rules with respect to home jurisdiction regulations that have not yet been finalized, as a preferable solution to requiring foreign firms to build the technological, operational, and compliance systems required to comply with U.S. law for a short, interim period if the home jurisdiction is ultimately deemed comparable for substituted compliance purposes.[552] The commenter's concerns should be mitigated by the extended compliance date applicable to the rules being adopted in this document. The Commission believes that such a delay would not be appropriate because a comprehensive set of records will be integral to the Commission's ability to exercise its regulatory responsibilities once these firms are registered.[553] In addition, as discussed below in section III.D. of this release, to address concerns that the compliance date could be before substituted compliance determinations are made, the Commission would consider substituted compliance requests that are submitted prior to the compliance date.

Finally, one commenter stated that SBSDs and MSBSPs will require adequate time following registration to begin complying with substantive Title VII requirements, since considerable resources will be needed to amend recordkeeping systems and documentation processes between finalization of recordkeeping and documentation rules and the initial compliance dates for those rules.[554] Regarding the Commission's policy statement on the sequencing of final rules governing security-based swaps,[555] another commenter suggested grouping rulemakings into two categories in terms of the applicable compliance date.[556] In response, the Commission notes that it has coordinated the compliance dates Start Printed Page 68601for the Commission's: (1) SBSD and MSBSP registration requirements; (2) nonbank SBSD and MSBSP capital and margin requirements; (3) SBSD and MSBSP segregation requirements; (4) SBSD and MSBSP recordkeeping and reporting requirements; (5) SBSD and MSBSP business conduct and chief compliance officer requirements; (6) SBSD and MSBSP trade acknowledgement and verification requirements; and (7) statutory disqualification process. The Commission also does not believe it would be appropriate to delay the compliance date for the Commission's recordkeeping rules beyond the compliance date for the rules establishing the registration process for SBSDs and MSBSPs, because this would undermine the Commission's ability to effectively regulate and supervise registrants.

C. Effect on Existing Commission Exemptive Relief

On July 1, 2011, the Commission issued an order granting, among other things, temporary exemptive relief from compliance with certain recordkeeping and reporting provisions of the Exchange Act that would have applied to the security-based swap activities of registered broker-dealers due to the expansion of the Exchange Act definition of “security” to include security-based swaps.[557] The compliance dates of this release implicate the expiration of this temporary exemptive relief related to registered broker-dealer recordkeeping and reporting requirements.

With regard to the recordkeeping and reporting obligations of registered broker-dealers, the Exchange Act Exemptive Order provided limited exemptions for registered broker-dealers, subject to certain conditions and limitations, from compliance with Sections 17(a) and 17(b) of the Exchange Act and Rules 17a-3, 17a-4, 17a-5, 17a-11, and 17a-13 (collectively, “the Recordkeeping Provision Exemptions”) in connection with security-based swaps solely to the extent the provisions or rules did not apply to the broker-dealer's security-based swap positions or activities as of July 15, 2011.[558] The Exchange Act Exemptive Order also provided that, until such time as the underlying exemptive relief expires, no contract entered into on or after July 16, 2011 shall be void or considered voidable by reason of Section 29(b) of the Exchange Act because any person that is a party to the contract violated a provision of the Exchange Act for which the Commission provided exemptive relief in the Exchange Act Exemptive Order (“Section 29(b) Exemption).[559] The Recordkeeping Provision Exemptions are scheduled to expire on the compliance date for any final rules regarding recordkeeping and reporting requirements for SBSDs and MSBSPs.[560] Accordingly, all the Recordkeeping Provision Exemptions, together with the portion of the Section 29(b) Exemption that relates to the Exchange Act provisions for which the Commission provided exemptive relief in the Recordkeeping Provision Exemptions, will expire upon the compliance date set forth in section III.B. of this release.

In addition, the Commission also has provided an exemption from the “dealer” registration requirements of Section 15(a)(1) of the Exchange Act, and the other requirements of the Exchange Act and the rules and regulations thereunder that apply to a dealer that is not registered with the Commission, solely in connection with dealing activities involving security-based swaps with counterparties that meet the definition of eligible contract participant as set forth in Section 1a(12) of the CEA as in effect on July 20, 2010 (“Dealer Exemptions”).[561] The Dealer Exemptions are scheduled to expire on the later of the compliance dates set forth in any final rules regarding capital, margin, and segregation requirements for SBSDs and MSBSPs and any final rules regarding recordkeeping and reporting requirements for SBSDs and MSBSPs [562] As noted in section III.B. of this release, both relevant compliance dates will be 18 months after the effective date of any final rules addressing the cross-border application of certain security-based swap requirements or the Registration Compliance Date. Accordingly, all of the Dealer Exemptions, together with the portion of the Section 29(b) Exemption that relates to the Exchange Act provisions for which the Commission provided exemptive relief in the Dealer Exemptions, will expire upon the Registration Compliance Date.

Finally, the Commission has provided an exemption from the “broker” registration requirements of Section 15(a)(1) of the Exchange Act, and the other requirements of the Exchange Act and the rules and regulations thereunder that apply to a broker that is not registered with the Commission, solely in connection with broker activities involving security-based swaps (“Broker Exemptions”).[563] The Broker Exemptions are scheduled to expire on the later of the compliance dates set forth in any final rules regarding capital, margin, and segregation requirements for SBSDs and MSBSPs and any final rules regarding recordkeeping and reporting requirements for SBSDs and MSBSPs.[564] Start Printed Page 68602However, the Commission has stated that an entity that meets the definition of “security-based swap execution facility” in Section 3(a)(77) of the Exchange Act also would meet the definition of “broker” in Section 3(a)(4) of the Act.[565] The Commission also has granted temporary exemptions from the registration requirements for security-based swap execution facilities in Section 3D(a)(1) of the Exchange Act and from certain disclosure requirements in Section 3D(c) of the Exchange Act (“SB SEF Exemptions”).[566] The SB SEF Exemptions will expire on the earliest compliance date set forth in any of the final rules regarding registration of security-based swap execution facilities.[567] The Commission recognizes that market participants who currently rely on the SB SEF Exemptions pending the Commission's finalization of registration rules for security-based swap execution facilities may also currently rely on the Broker Exemptions. The Commission therefore finds that it is necessary and appropriate in the public interest and consistent with the protection of investors to extend the Broker Exemptions, insofar as they apply to persons and activities subject to the SB SEF Exemptions, until the expiration date for the SB SEF Exemptions.[568]

Accordingly, solely for purposes of the Exchange Act Exemption Extension Order as it relates to exemption from the “broker” registration requirements of Section 15(a)(1) of the Exchange Act and the other requirements of the Exchange Act and the rules and regulations thereunder that apply to a broker that is not registered with the Commission, and solely in connection with the operation of a facility for the trading or processing of security-based swaps that is not currently registered as a national securities exchange or as a security-based swap execution facility (“SB SEF Broker Exemptions”), the compliance date is the expiration date of the SB SEF Exemptions. Similarly, solely for purposes of the Exchange Act Exemption Extension Order as it relates to the portion of the Section 29(b) Exemption that relates to the Exchange Act provisions for which the Commission provided exemptive relief in the SB SEF Broker Exemptions, the compliance date set forth in this release is the expiration date of the SB SEF Exemptions. All other portions of the Broker Exemptions, together with the portion of the Section 29(b) Exemption that relates to the Exchange Act provisions for which the Commission provided exemptive relief in these other portions of the Broker Exemptions, will expire upon the Registration Compliance Date.

D. Application to Substituted Compliance

For the amendments to Rule 3a71-6 being adopted in this release to provide foreign SBSDs and MSBSPs with the potential to utilize substituted compliance with comparable foreign requirements to satisfy Section 15F of the Exchange Act and new Exchange Act Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9, consistent with the other rules adopted in this document, the Commission is adopting an effective date of 60 days following publication in the Federal Register. There will be no separate compliance date in connection with that rule amendment, as the rule does not impose obligations upon entities. As discussed above, SBSDs and MSBSPs will not be required to comply with the recordkeeping and reporting requirements until they are registered, and the registration requirement for those entities will not be triggered until a number of regulatory benchmarks have been met.

In practice, the Commission recognizes that if the requirements of a foreign regime are comparable to Title VII requirements, and the other prerequisites to substituted compliance also have been satisfied, then it may be appropriate to permit an SBSD or MSBSP to rely on substituted compliance commencing at the time that entity is registered with the Commission. Accordingly, to address commenters' concerns that the compliance date could be before substituted compliance determinations are made, the Commission would consider substituted compliance requests that are submitted prior to the compliance date for its recordkeeping and reporting requirements.

IV. Paperwork Reduction Act

Certain provisions of the rule amendments and new rules being adopted in this release contain a new “collection of information” within the meaning of the Paperwork Reduction Act of 1995 (“PRA”).[569] The Commission submitted the rule amendments and new rules to the Office of Management and Budget (“OMB”) for review and approval in accordance with the PRA.[570] The Commission's earlier PRA assessments have been revised to reflect the modifications to the rules and amendments from those that were proposed, as well as additional information and data now available to the Commission.[571] An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid OMB control number. The titles and OMB control numbers for the collections of information are:

RuleRule titleOMB control No.
Rule 17a-3Records to be made by certain exchange members, brokers and dealers3235-0033
Rule 17a-4Records to be preserved by certain exchange members, brokers and dealers3235-0279
Rule 17a-5Reports to be made by certain brokers and dealers3235-0123
Start Printed Page 68603
Rule 17a-11Notification provisions for brokers and dealers3235-0085
Rule 17a-12Reports to be made by certain OTC derivatives dealers3235-0498
Rule 18a-5Records to be made by certain security-based swap dealers and major security-based swap participants3235-0745
Rule 18a-6Records to be preserved by certain security-based swap dealers and major security-based swap participants3235-0751
Rule 18a-7Reports to be made by certain security-based swap dealers and major security-based swap participants3235-0749
Rule 18a-8Notification provisions for security-based swap dealers and major security-based swap participants3235-0750
Rule 18a-9Quarterly security counts to be made by certain security-based swap dealers3235-0752
Rule 18a-10Alternative compliance mechanism for security-based swap dealers that are registered as swap dealers and have limited security-based swap activities3235-0702
Rule 3a71-6Substituted compliance for security-based swap dealers and major security-based swap participants3235-0715

A. Summary of Collections of Information Under the Rule Amendments and New Rules

1. Amendments to Rule 17a-3 and New Rule 18a-5

Rule 17a-3 requires a broker-dealer to make and keep current certain records. The Commission is amending this rule to account for the security-based swap and swap activities of broker-dealers, including broker-dealer SBSDs and MSBSPs. With respect to stand-alone SBSDs and MSBSPs, and bank SBSDs and MSBSPs, the Commission is adopting new Rule 18a-5—which is modeled on Rule 17a-3, as amended—to require these registrants to make and keep current certain records.[572] Rule 18a-5 does not include a parallel requirement for every requirement in Rule 17a-3. Paragraph (a) of Rule 18a-5 contains recordkeeping requirements for stand-alone SBSDs and MSBSPs, and paragraph (b) contains recordkeeping requirements for bank SBSDs and MSBSPs that are more limited in scope. The amendments to Rule 17a-3 and new Rule 18a-5 establish a number of new collections of information, as summarized in the table below.

Stand-alone broker-dealersNon-model broker-dealer SBSDsANC broker-dealer SBSDsBroker-dealer MSBSPsNon-model stand-alone SBSDsModel stand-alone SBSDsBank SBSDsStand-alone MSBSPs
Trade blotters* 17a-3(a)(1)* 17a-3(a)(1)* 17a-3(a)(1)* 17a-3(a)(1)18a-5(a)(1)18a-5(a)(1)18a-5(b)(1)18a-5(a)(1)
General ledger18a-5(a)(2)18a-5(a)(2)18a-5(a)(2)
Ledgers for customer and non-customer accounts* 17a-3(a)(3)* 17a-3(a)(3)* 17a-3(a)(3)* 17a-3(a)(3)18a-5(a)(3)18a-5(a)(3)18a-5(b)(2)18a-5(a)(3)
Stock record* 17a-3(a)(5)* 17a-3(a)(5)* 17a-3(a)(5)* 17a-3(a)(5)18a-5(a)(4)18a-5(a)(4)18a-5(b)(3)18a-5(a)(4)
Memoranda of brokerage orders* 17a-3(a)(6)* 17a-3(a)(6)* 17a-3(a)(6)* 17a-3(a)(6)18a-5(b)(4)
Memoranda of proprietary orders* 17a-3(a)(7)* 17a-3(a)(7)* 17a-3(a)(7)* 17a-3(a)(7)18a-5(a)(5)18a-5(a)(5)18a-5(b)(5)18a-5(a)(5)
Confirmations* 17a-3(a)(8)* 17a-3(a)(8)* 17a-3(a)(8)* 17a-3(a)(8)18a-5(a)(6)18a-5(a)(6)18a-5(b)(6)18a-5(a)(6)
Accountholder information* 17a-3(a)(9)* 17a-3(a)(9)* 17a-3(a)(9)* 17a-3(a)(9)18a-5(a)(7)18a-5(a)(7)18a-5(b)(7)18a-5(a)(7)
Options positions18a-5(a)(8)18a-5(a)(8)18a-5(a)(8)
Trial balances and computation of net capital18a-5(a)(9)18a-5(a)(9)18a-5(a)(9)
Associated person's employment application18a-5(a)(10)18a-5(a)(10)18a-5(b)(8)18a-5(a)(10)
Account equity and margin calculations under Rule 18a-317a-3(a)(25)17a-3(a)(25)17a-3(a)(25)18a-5(a)(12)18a-5(a)(12)18a-5(a)(12)
Possession or control requirements for security-based swap customers17a-3(a)(26)17a-3(a)(26)17a-3(a)(26)17a-3(a)(26)18a-5(a)(13)18a-5(a)(13)18a-5(b)(9)
Security-based swap customer reserve requirements17a-3(a)(27)17a-3(a)(27)17a-3(a)(27)17a-3(a)(27)18a-5(a)(14)18a-5(a)(14)18a-5(b)(10)
Unverified transactions17a-3(a)(28)17a-3(a)(28)17a-3(a)(28)18a-5(a)(15)18a-5(a)(15)18a-5(b)(11)18a-5(a)(15)
Political contributions17a-3(a)(29)17a-3(a)(29)18a-5(a)(16)18a-5(a)(16)18a-5(b)(12)
Compliance with business conduct requirements17a-3(a)(30)17a-3(a)(30)17a-3(a)(30)18a-5(a)(17)18a-5(a)(17)18a-5(b)(13)18a-5(a)(17)
* The Commission is amending these pre-existing paragraphs of Rule 17a-3 to account for the security-based swap and swap activities of broker-dealers, including broker-dealer SBSDs and MSBSPs.

A commenter urged the Commission to harmonize its recordkeeping requirements for SBSDs and MSBSPs with the CFTC's final recordkeeping requirements for swap dealers and major swap participants to the maximum extent possible, with the goal of permitting firms to utilize a single recordkeeping system for swaps and security-based swaps.[573] As discussed in more detail above, in response to the comment and to promote harmonization with CFTC requirements, the Commission is adopting a limited alternative compliance mechanism in Rules 17a-3 and 18a-5.[574] In particular, an SBSD or MSBSP that also is registered with the CFTC as a swap dealer or major swap participant may comply with the recordkeeping requirements of the CEA and the rules thereunder applicable to swap dealers and major swap participants in lieu of complying with the requirements in Rules 17a-3 and 18a-5 to make and keep current trade blotters, customer account ledgers, and stock records Start Printed Page 68604solely with respect to information required to be included in these records regarding security-based swap transactions and positions if the SBSD or MSBSP meets certain conditions. The conditions include, among other things, that the SBSD or MSBSP preserves all of the data elements necessary to create these records as they pertain to security-based swap and swap transactions and upon request promptly furnishes to representatives of the Commission such records that includes security-based swap and swap transactions and positions in the format required by Rule 17a-3 or 18a-5, as applicable. This provision will permit an SBSD or MSBSP that also is registered with the CFTC as a swap dealer or major swap participant to maintain a single recordkeeping system for security-based swap and swap transactions and positions in accordance with the CFTC's rules with respect to these required records.

2. Amendments to Rule 17a-4 and New Rule 18a-6

Rule 17a-4 requires a broker-dealer to preserve certain records if it makes or receives them and prescribes the time period and the manner in which records must be preserved. The Commission is amending this rule to account for the security-based swap and swap activities of broker-dealers, including broker-dealer SBSDs and MSBSPs. With respect to stand-alone SBSDs, stand-alone MSBSPs, bank SBSDs, and bank MSBSPs, the Commission is adopting new Rule 18a-6—which is modeled on Rule 17a-4, as amended. Rule 18a-6 does not include a parallel requirement for every requirement in Rule 17a-4, and the recordkeeping requirements in Rule 18a-6 applicable to bank SBSDs and MSBSPs are more limited in scope than the requirements in the rule applicable to stand-alone SBSDs and MSBSPs. As discussed above, the records a broker-dealer, including a broker-dealer SBSD or MSBSP, is required to maintain and preserve under Rules 17a-3 and 17a-4 may be maintained and preserved by means of electronic storage media. The use of electronic storage media is subject to certain conditions, including that the media must preserve the records exclusively in a non-rewriteable and non-erasable format. In response to comment, the Commission is modifying Rule 18a-6 to eliminate the requirement that the electronic storage system preserve the records exclusively in a non-rewriteable and non-erasable format.[575] The amendments to Rule 17a-4 and new Rule 18a-6 establish a number of new collections of information, as summarized in the table below.

Stand-alone broker-dealersNon-model broker-dealer SBSDsANC broker-dealer SBSDsBroker-dealer MSBSPsNon-model stand-alone SBSDsModel stand-alone SBSDsBank SBSDsStand-alone MSBSPs
Records to be preserved for a period of not less than 6 years
Trade blotters18a-6(a)(1) citing 18a-5(a)(1)18a-6(a)(1) citing 18a-5(a)(1)18a-6(a)(2) citing 18a-5(b)(1)18a-6(a)(1) citing 18a-5(a)(1)
General ledger18a-6(a)(1) citing 18a-5(a)(2)18a-6(a)(1) citing 18a-5(a)(2)18a-6(a)(1) citing 18a-5(a)(2)
Ledgers for customer and non-customer accounts18a-6(a)(1) citing 18a-5(a)(3)18a-6(a)(1) citing 18a-5(a)(3)18a-6(a)(2) citing 18a-5(b)(2)18a-6(a)(1) citing 18a-5(a)(3)
Stock record18a-6(a)(1) citing 18a-5(a)(4)18a-6(a)(1) citing 18a-5(a)(4)18a-6(a)(2) citing 18a-5(b)(3)18a-6(a)(1) citing 18a-5(a)(4)
Records to be preserved for a period of not less than 3 years
Memoranda of brokerage orders18a-6 (b)(2)(i) citing 18a-5(b)(4)
Memoranda of proprietary orders18a-6 (b)(1)(i) citing 18a-5(a)(5)18a-6 (b)(1)(i) citing 18a-5(a)(5)18a-6 (b)(2)(i) citing 18a-5(b)(5)18a-6 (b)(1)(i) citing 18a-5(a)(5)
Confirmations18a-6 (b)(1)(i) citing 18a-5(a)(6)18a-6 (b)(1)(i) citing 18a-5(a)(6)18a-6 (b)(2)(i) citing 18a-5(b)(6)18a-6 (b)(1)(i) citing 18a-5(a)(6)
Accountholder information18a-6 (b)(1)(i) citing 18a-5(a)(7)18a-6 (b)(1)(i) citing 18a-5(a)(7)18a-6 (b)(2)(i) citing 18a-5(b)(7)18a-6 (b)(1)(i) citing 18a-5(a)(7)
Options positions18a-6 (b)(1)(i) citing 18a-5(a)(8)18a-6 (b)(1)(i) citing 18a-5(a)(8)18a-6 (b)(1)(i) citing 18a-5(a)(8)
Trial balances and computation of net capital17a-4(b)(1) citing 17a-3(a)(11)17a-4(b)(1) citing 17a-3(a)(11)17a-4(b)(1) citing 17a-3(a)(11)17a-4(b)(1) citing 17a-3(a)(11)18a-6 (b)(1)(i) citing 18a-5(a)(9)18a-6 (b)(1)(i) citing 18a-5(a)(9)18a-6 (b)(1)(i) citing 18a-5(a)(9)
Account equity and margin calculations under new Rule 18a-317a-4(b)(1) citing 17a-3(a)(25)17a-4(b)(1) citing 17a-3(a)(25)17a-4(b)(1) citing 17a-3(a)(25)18a-6 (b)(1)(i) citing 18a-5(a)(12)18a-6 (b)(1)(i) citing 18a-5(a)(12)18a-6 (b)(1)(i) citing 18a-5(a)(12)
Start Printed Page 68605
Possession or control requirements for security-based swap customers17a-4(b)(1) citing 17a-3(a)(26)17a-4(b)(1) citing 17a-3(a)(26)17a-4(b)(1) citing 17a-3(a)(26)17a-4(b)(1) citing 17a-3(a)(26)18a-6 (b)(1)(i) citing 18a-5(a)(13)18a-6 (b)(1)(i) citing 18a-5(a)(13)18a-6 (b)(2)(i) citing 18a-5(b)(9)
Security-based swap customer reserve requirements17a-4(b)(1) citing 17a-3(a)(27)17a-4(b)(1) citing 17a-3(a)(27)17a-4(b)(1) citing 17a-3(a)(27)17a-4(b)(1) citing 17a-3(a)(27)18a-6 (b)(1)(i) citing 18a-5(a)(14)18a-6 (b)(1)(i) citing 18a-5(a)(14)18a-6 (b)(2)(i) citing 18a-5(b)(10)
Unverified transactions17a-4(b)(1) citing 17a-3(a)(28)17a-4(b)(1) citing 17a-3(a)(28)17a-4(b)(1) citing 17a-3(a)(28)18a-6 (b)(1)(i) citing 18a-5(a)(15)18a-6 (b)(1)(i) citing 18a-5(a)(15)18a-6 (b)(2)(i) citing 18a-5(b)(11)18a-6 (b)(1)(i) citing 18a-5(a)(15)
Political contributions17a-4(b)(1) citing 17a-3(a)(29)17a-4(b)(1) citing 17a-3(a)(29)18a-6 (b)(1)(i) citing 18a-5(a)(16)18a-6 (b)(1)(i) citing 18a-5(a)(16)18a-6 (b)(2)(i) citing 18a-5(b)(12)
Compliance with business conduct requirements17a-4(b)(1) citing 17a-3(a)(30)17a-4(b)(1) citing 17a-3(a)(30)17a-4(b)(1) citing 17a-3(a)(30)18a-6 (b)(1)(i) citing 18a-5(a)(17)18a-6 (b)(1)(i) citing 18a-5(a)(17)18a-6 (b)(2)(i) citing 18a-5(b)(13)18a-6 (b)(1)(i) citing 18a-5(a)(17)
Bank records18a-6 (b)(1)(ii)18a-6 (b)(1)(ii)18a-6 (b)(1)(ii)
Bills18a-6 (b)(1)(iii)18a-6 (b)(1)(iii)18a-6 (b)(1)(iii)
Communications17a-4(b)(4)*17a-4(b)(4)*17a-4(b)(4)*17a-4(b)(4)*18a-6 (b)(1)(iv)18a-6 (b)(1)(iv)18a-6 (b)(2)(ii)18a-6 (b)(1)(iv)
Trial balances18a-6 (b)(1)(v)18a-6 (b)(1)(v)18a-6 (b)(1)(v)
Account documents18a-6 (b)(1)(vi)18a-6 (b)(1)(vi)18a-6 (b)(2)(iii)18a-6 (b)(1)(vi)
Written agreements17a-4(b)(7)*17a-4(b)(7)*17a-4(b)(7)*17a-4(b)(7)*18a-6 (b)(1)(vii)18a-6 (b)(1)(vii)18a-6 (b)(2)(iv)18a-6 (b)(1)(vii)
Information supporting financial reports17a-4(b)(8)*17a-4(b)(8)*17a-4(b)(8)*17a-4(b)(8)*18a-6 (b)(1)(viii)18a-6 (b)(1)(viii)18a-6 (b)(2)(v)18a-6 (b)(1)(viii)
Rule 15c3-4 risk management records (OTC derivatives dealers only)18a-6 (b)(1)(ix)18a-6 (b)(1)(ix)18a-6 (b)(1)(ix)
Credit risk determinations18a-6 (b)(1)(x)
Regulation SBSR information17a-4(b)(14)17a-4(b)(14)17a-4(b)(14)17a-4(b)(14)18a-6 (b)(1)(xi)18a-6 (b)(1)(xi)18a-6 (b)(2)(vi)18a-6 (b)(1)(xi)
Records relating to business conduct standards17a-4(b)(15)17a-4(b)(15)17a-4(b)(15)18a-6 (b)(1)(xii)18a-6 (b)(1)(xii)18a-6 (b)(2)(vii)18a-6 (b)(1)(xii)
Special entity documents17a-4(b)(16)17a-4(b)(16)17a-4(b)(16)18a-6 (b)(1)(xiii)18a-6 (b)(1)(xiii)18a-6 (b)(2)(viii)18a-6 (b)(1)(xiii)
Associated person's employment application18a-6(d)(1)18a-6(d)(1)18a-6(d)(1)18a-6(d)(1)
Regulatory authority reports18a-6 (d)(2)(i)18a-6 (d)(2)(i)18a-6 (d)(2)(ii)18a-6 (d)(2)(i)
Compliance, supervisory, and procedures manuals18a-6 (d)(3)(i)18a-6 (d)(3)(i)18a-6 (d)(3)(ii)18a-6 (d)(3)(i)
Life of the enterprise and of any successor enterprise
Corporate documents17a-4(d)*17a-4(d)*17a-4(d)*17a-4(d)*18a-6(c)18a-6(c)18a-6(c)
* The Commission is amending these pre-existing paragraphs of Rule 17a-4 to account for the security-based swap and swap activities of broker-dealers, including broker-dealer SBSDs and MSBSPs.

3. Amendments to Rule 17a-5 and New Rule 18a-7

Rule 17a-5, the broker-dealer reporting rule, requires, among other things, that broker-dealers file periodic unaudited reports about their financial and operational condition using the FOCUS Report form; and that broker-dealers annually file financial statements and certain reports, as well as reports covering those statements and reports prepared by an independent public accountant registered with the PCAOB, in accordance with PCAOB standards.

Rule 17a-5 is being amended to account for the security-based swap activities of entities subject to its requirements and new Rule 18a-7—which is modeled on Rule 17a-5; is being adopted to establish reporting requirements for SBSDs and MSBSPs that will not be subject to Rule 17a-5.[576] A stand-alone broker-dealer, including a stand-alone OTC derivatives dealer, will continue to be subject to Rule 17a-5.[577] Similarly, a broker-dealer, other than an Start Printed Page 68606OTC derivatives dealer, that is also an SBSD will be subject to Rule 17a-5. A broker-dealer, including an OTC derivatives dealer, that is also an MSBSP will be subject to Rule 17a-5. A stand-alone SBSD will be subject to Rule 18a-7. Similarly, an SBSD that is also an OTC derivatives dealer will be subject to Rule 18a-7. A stand-alone MSBSP will be subject to Rule 18a-7. Finally, a bank SBSD or MSBSP will be subject to Rule 18a-7.

4. Amendments to Rule 17a-11 and New Rule 18a-8

Rule 17a-11 specifies the circumstances under which a broker-dealer must notify the Commission and other securities regulators about its financial or operational condition, as well as the form that the notice must take. The Commission is amending Rule 17a-11 to account for the security-based swap activities of broker-dealers.[578] The Commission is adopting new Rule 18a-8—which is modeled on Rule 17a-11, as amended—to establish notification requirements for stand-alone SBSDs and MSBSPs, and bank SBSDs and MSBSPs.[579] The amendments to Rule 17a-11 and new Rule 18a-8 establish a number of new collections of information, as summarized in the table below.

Non-SBSD/ MSBSP broker-dealersNon-model broker-dealer SBSDsANC broker-dealer SBSDsBroker-dealer MSBSPsModel stand-alone SBSDsNon-model stand-alone SBSDsBank SBSDsStand-alone MSBSPs
Net capital below minimum18a-8 (a)(1)(i)18a-8 (a)(1)(i)
Tentative net capital below minimum18a-8 (a)(1)(ii)
Tangible net worth below minimum18a-8 (a)(2)
Early warning of net capital18a-8(b)(1)18a-8(b)(1)
Early warning of tentative net capital18a-8 (b)(2)
Early warning of tangible net worth18a-8(b)(3)
Backtesting exception18a-8(b)(4)
Notice of adjustment of reported capital category18a-8(c)
Failure to make and keep current books and records18a-8(d)18a-8(d)18a-8(d)18a-8(d)
Material weakness18a-8(e)18a-8(e)
Failure to make a required special reserve deposit17a-11(f)17a-11(f)17a-11(f)18a-8(g)18a-8(g)18a-8(g)

5. Amendments to Rule 17a-12

The amendments to Rule 17a-12, the OTC derivatives dealer reporting rule,[580] require OTC derivatives dealers to file FOCUS Report Part II, as amended, instead of FOCUS Report Part IIB by replacing the phrase “Part II” with the phrase “Part IIB” each time it appears in the rule.[581]

6. New Rule 18a-9

The Commission is adopting new Rule 18a-9, which is modeled on Rule 17a-13, to require stand-alone SBSDs to examine and count the securities they physically hold, account for the securities that are subject to their control or direction but are not in their physical possession, verify the locations of securities under certain circumstances, and compare the results of the count and verification with their records. Rule 18a-9 does not include a parallel requirement for every requirement in Rule 17a-13.[582] In addition, Rule 18a-9 does not apply to stand-alone MSBSPs because the customer protection rationale for Rules 17a-13 and 18a-9 is not as pertinent to stand-alone MSBSPs.

7. Amendments to Rule 18a-10

Rule 18a-10 permits certain SBSDs that are registered as swap dealers and that predominantly engage in a swaps business to elect to comply with the capital, margin, and segregation requirements of the CEA and the CFTC's rules in lieu of complying with the capital, margin, and segregation requirements of Rules 18a-1, 18a-3, and 18a-4.[583] The Commission is amending Rule 18a-10 to permit firms that will operate under the rule to elect to comply with the recordkeeping and reporting requirements of the CEA and the CFTC's rules in lieu of complying with Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9.[584]

As discussed above, Rule 17a-11 specifies the circumstances under which a broker-dealer must notify the Commission and other regulators about its financial or operational condition, as well as the form of the notice. Stand-alone and bank SBSDs and MSBSPs are subject to Rule 18a-8, which is modeled on Rule 17a-11 and is designed to provide the Commission with the ability to take effective proactive steps to respond when a firm is experiencing or likely to experience financial difficulty.[585] A stand-alone SBSD operating under Rule 18a-10, however, may comply with the notification requirements of the CFTC's rules in lieu of complying with Rule 18a-8. In order to retain a requirement that the SBSD provide notice to the Commission if it is experiencing or likely to experience financial difficulty, the Commission is Start Printed Page 68607adding paragraph (b)(4) to Rule 18a-10. This paragraph provides that the SBSD must simultaneously notify the Commission if the firm is required to send a notice concerning its capital, books and records, liquidity, margin operations, or segregation operations to the CFTC by transmitting to the Commission a copy of the notice being sent to the CFTC.[586]

8. Amendments to Rule 3a71-6

In May 2016, the Commission adopted Rule 3a71-6 to provide that foreign SBSDs and MSBSPs could satisfy applicable business conduct requirements under Section 15F by complying with comparable regulatory requirements of a foreign jurisdiction, subject to certain conditions. The Commission is amending Rule 3a71-6 to provide foreign SBSDs and MSBSPs with the option to apply for substituted compliance to satisfy the recordkeeping and reporting requirements of Section 15F of the Exchange Act and Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9 thereunder.[587]

B. Use of Information

Rules 17a-3 and 17a-4, as amended, and new Rules 18a-5 and 18a-6 are designed, among other things, to promote the prudent operation of broker-dealers, SBSDs, and MSBSPs, and to assist the Commission, SROs, and state securities regulators in conducting effective examinations.[588] Thus, the collections of information under the amendments to Rules 17a-3 and 17a-4, and new Rules 18a-5 and 18a-6, are expected to facilitate the examinations of broker-dealers, SBSDs, and MSBSPs.

Rules 17a-5, 17a-11, 17a-12, and 18a-10, as amended, and new Rules 18a-7 and 18a-8 are designed to promote compliance with the financial responsibility requirements for broker-dealers, SBSDs, and MSBSPs, facilitate regulators' oversight and examinations of such firms, and promote transparency of their financial condition and operation.

Rule 18a-9 is designed to promote an SBSD's custody of securities and accurate accounting for securities.

The Commission plans to use the information collected pursuant to Rule 3a71-6, as amended, to evaluate requests for substituted compliance determinations with respect to the recordkeeping and reporting requirements applicable to foreign SBSDs and MSBSPs.

C. Respondents

The Commission estimated the number of respondents in the proposing release. The Commission received no comment on these estimates and continues to believe they are appropriate. However, the Commission is updating its estimated number of broker-dealers to reflect the number of broker-dealers registered with the Commission as of December 31, 2018 (instead of April 1, 2013 as reflected in the proposing release), and is revising the number of respondents with respect to certain rules, as discussed below, to reflect the amendments to Rule 18a-10. The following chart summarizes the Commission's estimated number of respondents:

Consistent with prior releases, based on available data regarding the single-name CDS market—which the Commission believes will comprise the majority of security-based swaps—the Commission estimates that the number of MSBSPs likely will be five or fewer and, in actuality, may be zero.[589] Therefore, to capture the likely number of MSBSPs that may be subject to the collections of information for purposes of this PRA, the Commission estimates for purposes of this PRA that five entities will register with the Commission as MSBSPs.

The Commission estimates there will be one broker-dealer FCM MSBSP for the purposes of calculating PRA Start Printed Page 68608burdens, in recognition that broker-dealer MSBSPs and stand-alone MSBSPs are subject to different burdens under the new and amended rules in certain instances.[590] However, by definition, an MSBSP's primary business is not engaging in security-based swap activity, so it would be rare for an MSBSP to qualify as a broker-dealer and/or FCM but not an SBSD. Such an MSBSP would be engaged in the business of effecting securities transactions,[591] but not in the business of effecting security-based swap transactions [592] or commodities, securities futures products, or swaps [593] and yet involved in enough security-based swap transactions to be required to register as an MSBSP.[594]

Consistent with prior releases, the Commission estimates that 50 or fewer entities ultimately may be required to register with the Commission as SBSDs, and 16 broker-dealers will likely seek to register as SBSDs.[595] The Commission believes that all 16 broker-dealer SBSDs also will be registered as FCMs, since SBSDs may find it beneficial to hedge security-based swap positions with futures contracts, options on futures, or swaps.[596]

Because many of the dealers that currently engage in OTC derivatives activities are banks, the Commission estimates that approximately 75% of the 34 non-broker-dealer SBSDs will register as bank SBSDs (i.e., 25 firms), and the remaining 25% will register as stand-alone SBSDs (i.e., 9 firms).[597] The Commission believes that none of the bank SBSDS will register as FCMs, because of the burden associated with complying with three different supervisors' regulatory requirements.[598] However, the Commission cannot precisely estimate how many of the nine stand-alone SBSDs will register as FCMs. The Commission anticipates that entities that want to clear security-based swaps for others may also want to clear swaps for others and, therefore, may need to register as FCMs.[599] The Commission also anticipates that some stand-alone SBSDs that deal in non-cleared security-based swaps will generally seek exemption from the omnibus segregation requirements in Rule 18a-4. In order to qualify for the exemption, these firms cannot clear security-based swap transactions for others. The Commission believes that stand-alone SBSDs that seek this exemption and thus will not clear security-based swaps for others likely also would not clear swaps for others, which obviates the need for these SBSDs to register as an FCM.[600] For purposes of developing paperwork burden estimates in connection with the recently adopted capital, margin, and segregation requirements, the Commission estimated six of nine stand-alone SBSDs would avail themselves of the exemption under paragraph (f) of Rule 18a-4.[601] Consistent with that estimate, the Commission estimates that the remaining three of the nine stand-alone SBSDs will also be registered as FCMs.

Of the nine stand-alone SBSDs, the Commission estimates that, based on its experience with ANC broker-dealers and OTC derivatives dealers, four of the nine stand-alone SBSDs will apply to operate as stand-alone SBSDs which will use internal models to compute net capital under Rule 18a-1.[602] This estimate has been reduced from six in the proposing release [603] to account for the adoption of Rule 18a-10, which will enable stand-alone SBSDs to elect the full alternative compliance mechanism and comply with certain CFTC rules in lieu of Commission rules, including recordkeeping and reporting rules. Finally, in the proposing release, the Commission estimated that three stand-alone SBSDs would not apply to use models.[604] This estimate has been modified from three to two in the final release to account for the nonbank SBSDs that will elect the full alternative compliance mechanism under Rule 18a-10.

Of the 16 broker-dealer FCM SBSDs, the Commission estimates that ten firms will operate as ANC broker-dealer SBSDs, which use internal models to compute net capital under Rule 15c3-1.[605]

As of December 31, 2018, there were 3,764 broker-dealers registered with the Commission. The Commission estimates that 25 registered broker-dealers will be engaged in security-based swap activities but will not be required to register as an SBSD or MSBSP. Other than OTC derivatives dealers, which are subject to significant limitations on their activities, broker-dealers historically have not participated in a significant way in security-based swap trading for at least two reasons.[606] First, because the Exchange Act has not previously defined security-based swaps as securities, security-based swaps have not been required to be traded through registered broker-dealers.[607] Second, a broker-dealer engaging in security-based swap activities is currently subject to existing regulatory requirements with respect to those activities, including capital, margin, segregation, and recordkeeping requirements. The existing financial responsibility requirements make it more costly to conduct these activities in a broker-dealer than in an unregulated entity. As a result, security-based swap activities are mostly concentrated in affiliates of broker-dealers, not broker-dealers themselves.[608]

Finally, for purposes of estimating the number of respondents with respect to the amendments to Rule 3a71-6, applications for substituted compliance may be filed by foreign financial authorities, or by non-U.S. SBSDs or Start Printed Page 68609MSBSPs. Consistent with prior estimates, the Commission staff expects that there may be approximately 22 non-U.S. entities that may potentially register as SBSDs.[609] Potentially, all such non-U.S. SBSDs, or some subset thereof, may seek to rely on substituted compliance in connection with the requirements adopted in this document.[610] For purposes of this PRA, however, consistent with prior estimates, the Commission estimates that three of these security-based swap entities will submit such applications in connection with the Commission's recordkeeping, reporting, and notification requirements.[611]

D. Total Initial and Annual Recordkeeping and Reporting Burden

1. Amendments to Rule 17a-3 and New Rule 18a-5

The amendments to Rule 17a-3 and new Rule 18a-5 will impose collection of information requirements that result in initial and annual burdens for broker-dealers, SBSDs, and MSBSPs. The Commission estimates that these amendments to Rule 17a-3 will impose the following initial and annual burdens: [612]

BurdenInitial burdenAnnual burden
New security-based swap recordsPer firm: 70 hours Industry: 2,940 hours.Per firm: 42 hours. Industry: 1,764 hours.
New burdens applicable to broker-dealer SBSDs and MSBSPs.Per firm: 60 hours Industry: 1,020 hours.Per firm: 75 hours. Industry: 1,275 hours.
New burdens applicable to broker-dealer SBSDsPer firm: 20 hours Industry: 320 hours.Per firm: 25 hours. Industry: 400 hours.
Total—Amendments to Rule 17a-3Industry: 4,280 hours.Industry: 3,439 hours.

The Commission estimates that new Rule 18a-5 will impose the following initial and annual burdens: [613]

BurdenInitial burdenAnnual burden
Burdens applicable to stand-alone SBSDs and MSBSPsPer firm: 260 hours and $1,000 Industry: 2,600 hours and $10,000Per firm: 325 hours and $4,650. Industry: 3,250 hours and $46,500.
Burdens applicable to stand-alone SBSDsPer firm: 60 hours Industry: 360 hoursPer firm: 75 hours. Industry: 450 hours.
Burdens applicable to bank SBSDs and MSBSPsPer firm: 200 hours Industry: 5,000 hoursPer firm: 250 hours. Industry: 6,250 hours.
Burdens applicable to bank SBSDsPer firm: 60 hours Industry: 1,500 hoursPer firm: 75 hours. Industry: 1,875 hours.
Total—New Rule 18a-5Industry: 9,460 hours and $10,000Industry: 11,825 hours and $46,500.

Estimated Hours and Costs of Amendments to Rule 17a-3

In the proposing release, the Commission estimated that many of the amendments to Rule 17a-3 are not expected to impose an initial burden.[614] The Commission received no comment on these estimates and continues to believe they are appropriate.

The Commission is amending Rule 17a-3 to require broker-dealers to make and keep current various records for security-based swaps.[615] The Commission estimates that these amendments will impose on each broker-dealer that engages in security-based swap activities an initial burden of 70 hours and an ongoing burden of approximately ten minutes per business day, or 42 hours per year.[616] The Commission estimates that there are 42 respondents.[617] Thus, the Commission estimates that the amendments will add to the industry an estimated initial burden of 2,940 hours [618] and an ongoing burden of 1,764 hours per year.[619]

The amendments to Rule 17a-3 require three additional types of records to be made and kept current by broker-dealer SBSDs and MSBSPs.[620] Because the burden to run the applicable calculation or comply with the Start Printed Page 68610applicable standard is accounted for in the PRA estimates for Rules 18a-3, 15Fi-2, 15Fh-1 through 15Fh-5, and 15Fk-1,[621] the burden imposed by these new requirements is the requirement to make and keep current a written record of these tasks. The Commission estimates that paragraphs (a)(25), (a)(28), and (a)(30) of Rule 17a-3, as amended, will impose an initial burden of 60 hours per firm and an ongoing annual burden of 75 hours per firm. The Commission estimates that there are 17 respondents (16 broker-dealer SBSDs and 1 broker-dealer MSBSP), adding to the industry an initial burden of 1,020 hours [622] and an ongoing burden of 1,275 hours per year.[623]

The amendments to Rule 17a-3 require one additional type of record to be made and kept current by broker-dealer SBSDs.[624] Because the burden to run the applicable calculation or comply with the applicable standard is accounted for in the PRA estimate for Rule 15Fh-6,[625] the burden imposed by this requirement is the requirement to make and keep current a written record of these tasks. The Commission estimates that new paragraph (a)(29) of Rule 17a-3 will impose an initial burden of 20 hours per firm and an ongoing annual burden of 25 hours per firm. The Commission estimates that there are 16 broker-dealer SBSDs, adding to the industry an initial burden of 320 hours [626] and an ongoing burden of 400 hours per year.[627]

The Commission received no comments regarding its hour and cost burden estimates for the amendments to Rule 17a-3. However, the estimated initial burden for Rule 17a-3 is increased to reflect that the requirements to make and keep possession or control and special reserve account computation records now apply to all broker-dealers engaged in security-based swap activities (instead of just broker-dealer SBSDs).[628] Other than this change, the Commission continues to believe its hour and cost burden estimates for the amendments to Rule 17a-3 are appropriate.

Estimated Hours and Costs of New Rule 18a-5

The Commission estimates that new Rule 18a-5 will cause a stand-alone SBSD or MSBSP to incur an initial dollar cost of approximately $1,000 to purchase recordkeeping system software and an ongoing dollar cost of $4,650 per year for associated equipment and systems development. The Commission estimates that there are 10 respondents (6 stand-alone SBSDs and 4 stand-alone MSBSPs), resulting in an estimated industry-wide initial burden of $10,000 [629] and an industry-wide ongoing burden of $46,500 per year.[630]

New Rule 18a-5 is not expected to increase the initial and ongoing dollar costs that bank SBSDs and MSBSPs incur to purchase recordkeeping system software and for equipment and systems development. Banks are already subject to recordkeeping requirements by their prudential regulators,[631] so they should already own or have established the requisite recordkeeping system software. Although bank SBSDs and MSBSPs may need to program the software to begin collecting additional records, the Commission expects these services to be performed in-house, and these hour burdens are estimated below.

New Rule 18a-5 requires 13 types of records to be made and kept current by stand-alone SBSDs and MSBSPs.[632] New Rule 18a-5 imposes the burden to make and keep current these records, but does not require the firm to perform the underlying task.[633] Therefore, after consideration of the estimated burdens under Rule 17a-3, as amended, the Commission estimates that these 13 paragraphs will impose on each firm an initial burden of 260 hours and an ongoing annual burden of 325 hours. The Commission estimates that there are 10 respondents (6 stand-alone SBSDs and 4 stand-alone MSBSPs), resulting in an estimated industry-wide initial burden of 2,600 hours [634] and an industry-wide ongoing annual burden of 3,250 hours.[635]

New Rule 18a-5 requires three types of records to be made and kept current by stand-alone SBSDs.[636] Because the burden to run the applicable calculation or comply with the applicable standard is accounted for in the PRA estimates for Rules 18a-4 and 15Fh-6,[637] the burden imposed by these new requirements is the requirement to make and keep current a written record of these tasks. The Commission estimates that these three paragraphs will impose an initial burden of 60 hours per firm and an ongoing annual burden of 75 hours per firm. The Commission estimates that there are 6 stand-alone SBSDs, resulting in an industry-wide initial burden of 360 hours [638] and an industry-wide ongoing burden of 450 hours per year.[639]

New Rule 18a-5 requires ten types of records to be made and kept current by bank SBSDs and MSBSPs, all of which are limited to the firm's business as an SBSD or MSBSP.[640] New Rule 18a-5 Start Printed Page 68611imposes the burden to make and keep current these records, but does not require the firm to perform the underlying task. Therefore, after consideration of the estimated burdens under Rule 17a-3, as amended, the Commission estimates that these ten paragraphs will impose on each firm an initial burden of 200 hours per firm and an ongoing burden of 250 hours per firm. The Commission estimates that there are 25 respondents (25 bank SBSDs and no bank MSBSPs), resulting in an estimated industry-wide initial burden of 5,000 hours [641] and an industry-wide ongoing burden of 6,250 hours per year.[642]

New Rule 18a-5 requires three types of records to be made and kept current by bank SBSDs, all of which are limited to the firm's business as an SBSD.[643] Because the burden to run the applicable calculation or comply with the applicable standard is accounted for in the PRA estimates for Rules 18a-4 and 15Fh-6,[644] the burden imposed by these new requirements is the requirement to make and keep current a written record of these tasks. The Commission estimates that these three paragraphs will impose an initial burden of 60 hours per firm and an ongoing annual burden of 75 hours per firm. The Commission estimates that there are 25 bank SBSDs, resulting in an industry-wide initial burden of 1,500 hours [645] and an industry-wide ongoing burden of 1,875 hours per year.[646]

The Commission received no comments regarding its hour and cost burden estimates for new Rule 18a-5 and continues to believe they are appropriate.

Estimated Hours and Costs of the Limited Alternative Compliance Mechanism

As discussed above, the Commission is adopting the limited alternative compliance mechanism. The registrant's obligation to preserve these records will continue for the retention period specified for that category of record as set forth in Rule 17a-4 or Rule 18a-6, as applicable.

The Commission believes that registrants who choose to use the limited alternative compliance mechanism will incur lower costs and hour burdens, especially with respect to initial compliance burdens, than they would pursuant to the standard compliance requirements. Indeed, were that not the case, registrants would be unlikely to use the limited alternative compliance mechanism. However, for purposes of this Paperwork Reduction Act analysis, the Commission is making the conservative estimate that no firms will utilize the limited alternative compliance mechanism.

2. Amendments to Rule 17a-4 and New Rule 18a-6

The amendments to Rule 17a-4 and new Rule 18a-6 impose collection of information requirements that will result in initial and ongoing burdens for broker-dealers, SBSDs, MSBSPs, and certain third-party custodians. The Commission estimates that the amendments to Rule 17a-4 will impose the following initial and annual burdens: [647]

BurdenInitial burdenAnnual burden
Recorded telephone callsPer firm: 13 hours Industry: 221 hoursPer firm: 6 hours and $2,000. Industry: 102 hours and $34,000.
New burdens applicable to all broker-dealersPer firm: 65 hours Industry: 2,730 hoursPer firm: 30 hours and $600. Industry: 1,260 hours and $25,200.
New burdens applicable to broker-dealer SBSDs and MSBSPsPer firm: 65 hours Industry: 1,105 hoursPer firm: 30 hours and $600. Industry: 510 hours and $10,200.
New burdens applicable to broker-dealer SBSDsPer firm: 13 hours Industry: 208 hoursPer firm: 6 hours and $120. Industry: 96 hours and $1,920.
Total—Amendments to Rule 17a-4Industry: 4,264 hoursIndustry: 1,968 hours and $40,720.

The Commission estimates that new Rule 18a-6 will impose the following initial and annual burdens: [648]

BurdenInitial burdenAnnual ′Burden
Burdens applicable to stand-alone SBSDs and MSBSPsPer firm: 364 hours Industry: 3,640 hoursPer firm: 280 hours and $5,720. Industry: 2,800 hours and $57,200.
Burdens applicable to stand-alone SBSDsPer firm: 44 hours Industry: 264 hoursPer firm: 30 hours and $360. Industry: 180 hours and $2,160.
Burdens applicable to model stand-alone SBSDsPer firm: 18 hours Industry: 72 hoursPer firm: 10 hours and $120. Industry: 40 hours and $480.
Start Printed Page 68612
Burdens applicable to bank SBSDs and MSBSPsPer firm: 247 hours Industry: 6,175 hoursPer firm: 190 hours and $4,520. Industry: 4,750 hours and $113,000.
Burdens applicable to bank SBSDsPer firm: 57 hours Industry: 1,425 hoursPer firm: 40 hours and $480. Industry: 1,000 hours and $12,000.
Burdens applicable to third-party custodiansPer firm: 0 hours Industry: 0 hoursPer firm: 2 hours. Industry: 35 hours.
Total—New Rule 18a-6Industry: 11,576 hoursIndustry: 8,805 hours and $184,840.

Estimated Hours and Costs of Amendments to Rule 17a-4

In the proposing release, the Commission estimated that many of the amendments to Rule 17a-4 are not expected to impose an initial burden.[649] The Commission received no comment on these estimates and continues to believe they are appropriate.

The Commission is amending Rule 17a-4 to require broker-dealer SBSDs and MSBSPs to retain telephone calls that are already recorded and are related to the broker-dealer SBSD's and broker-dealer MSBSP's business as such.[650] Because the retention of telephonic recordings is only required if the broker-dealer SBSD or broker-dealer MSBSP voluntarily chooses to record, the Commission's burden estimate does not include the cost of recording phone calls. Therefore, the burdens imposed by the amendment will be to provide adequate physical space and computer hardware and software for storage. The Commission estimates that the amendment will impose an initial burden of 13 hours per firm. The Commission estimates that there are 17 respondents (16 broker-dealer SBSDs and 1 broker-dealer MSBSP), resulting in an estimated industry-wide initial burden of 221 hours.[651]

The Commission estimates that each firm will incur an annual burden of approximately 6 hours to confirm that telephonic communications are being retained in accordance with Rule 17a-4, and approximately $2,000 for server, equipment, and systems development costs. The Commission estimates that there are 17 respondents (16 broker-dealer SBSDs and 1 broker-dealer MSBSP), resulting in an estimated industry-wide ongoing annual cost of 102 hours [652] and $34,000.[653]

The amendments to Rule 17a-4 add five types of records to be preserved by broker-dealers.[654] Because the burden to create these records is already accounted for in the PRA estimates for Rule 17a-3, Rule 15c3-1, or Regulation SBSR,[655] the Commission estimates that these amendments will impose an initial burden of 65 hours per firm and an ongoing annual burden of 30 hours and $600 per firm.[656] The Commission estimates that there are 42 respondents—16 broker-dealer SBSDs, 1 broker-dealer MSBSP, and 25 stand-alone broker-dealers engaged in security-based swap activities.[657] Thus, these amendments will add to the industry an estimated initial burden of 2,730 hours [658] and an ongoing annual burden of 1,260 hours [659] and $25,200.[660]

The amendments to Rule 17a-4 add five types of records to be preserved by broker-dealer SBSDs and MSBSPs.[661] Because the burden to create these records is accounted for in the PRA estimates for Rule 17a-3 or for Rules 15Fh-1 through 15Fh-5 and 15Fk-1,[662] the Commission estimates that these amendments will impose an initial burden of 65 hours per firm and an ongoing annual burden of 30 hours and $600 per firm. The Commission estimates that there are 17 respondents (16 broker-dealer SBSDs and 1 broker-dealer MSBSP), adding to the industry an initial burden of 1,105 hours [663] and an ongoing annual burden of 510 hours [664] and $10,200.[665]

The amendments to Rule 17a-4 add one type of record to be preserved by broker-dealer SBSDs.[666] Because the burden to create this record is accounted for in the PRA estimate for Start Printed Page 68613Rule 17a-3, as amended,[667] the Commission estimates that the amendment will impose an initial burden of 13 hours per firm and an ongoing annual burden of 6 hours and $120 per firm. The Commission estimates that there are 16 broker-dealer SBSDs, adding to the industry an initial burden of 208 hours,[668] and an ongoing annual burden of 96 hours [669] and $1,920.[670]

The Commission received no comments regarding its hour and cost burden estimates for the amendments to Rule 17a-4. However, the estimated burden for Rule 17a-4 is increased to reflect that the requirements to make and keep possession or control and special reserve account computation records now apply to all broker-dealers engaged in security-based swap activities (instead of just broker-dealer SBSDs).[671] Other than this change, the Commission continues to believe its hour and cost burden estimates for the amendments to Rule 17a-3 are appropriate.

Estimated Hours and Costs of New Rule 18a-6

New Rule 18a-6 requires 27 types of records to be preserved by stand-alone SBSDs and MSBSPs.[672] The Commission estimates that the record preservation requirements applicable to stand-alone SBSDs and MSBSPs will impose an initial burden of 364 hours [673] and an ongoing annual burden of 280 hours and $5,720 per firm. The Commission estimates that there are 10 respondents (6 stand-alone SBSDs and 4 stand-alone MSBSPs), resulting in an estimated industry-wide initial burden of 3,640 hours,[674] and an industry-wide ongoing annual burden of 2,800 hours [675] and $57,200.[676]

New Rule 18a-6 requires three types of records to be preserved by stand-alone SBSDs.[677] The Commission estimates that the relevant portions of paragraph (b)(1)(i) of new Rule 18a-6 will impose an initial burden of 44 hours per firm,[678] and an ongoing annual burden of 30 hours and $360 per firm. The Commission estimates that there are 6 stand-alone SBSDs, resulting in an industry-wide initial burden of 264 hours [679] and an industry-wide ongoing annual burden of 180 hours [680] and $2,160.[681]

New Rule 18a-6 requires one type of record to be preserved by stand-alone SBSDs authorized to use models to compute capital.[682] The Commission estimates that paragraph (b)(1)(x) will impose an initial burden of 18 hours [683] and an ongoing annual burden of ten hours and $120 per stand-alone SBSD authorized to use models. The Commission estimates that there are 4 stand-alone SBSDs authorized to use models to compute capital, resulting in an industry-wide initial burden of 72 hours [684] and an industry-wide ongoing annual burden of 40 hours [685] and $480.[686]

New Rule 18a-6 requires 18 types of records to be preserved by bank SBSDs and MSBSPs, all of which are limited to the firm's business as an SBSD or MSBSP.[687] After consideration of the Start Printed Page 68614similar burdens imposed by Rule 17a-4, as amended, the Commission estimates that new Rule 18a-6 will impose on bank SBSDs and MSBSPs an initial burden of 247 hours per firm [688] and an ongoing burden of 190 hours and $4,520 per firm. The Commission estimates that there are 25 respondents (25 bank SBSDs and no bank MSBSPs), resulting in an estimated industry-wide initial burden of 6,175 hours [689] and an industry-wide ongoing annual burden of 4,750 hours [690] and $113,000.[691]

New Rule 18a-6 requires four types of records to be preserved by bank SBSDs, all of which are limited to the firm's business as an SBSD.[692] The Commission estimates that paragraphs (b)(2)(i) and (v) of new Rule 18a-6 will impose an initial burden of 57 hours per firm [693] and an ongoing annual burden of 40 hours and $480 per firm. The Commission estimates that there are 25 bank SBSDs, resulting in an industry-wide initial burden of 1,425 hours [694] and an industry-wide ongoing annual burden of 1,000 hours [695] and $12,000.[696]

Paragraph (f) of new Rule 18a-6 requires third-party custodians for non-broker-dealer SBSDs and non-broker-dealer MSBSPs to file with the Commission a written undertaking and surrender the SBSD or MSBSP's records upon the Commission's request.[697] The obligation to provide documents upon the Commission's request does not impose a new burden, since this requirement merely changes the respondent's identity rather than adding to the quantity of burdens. Thus, the burden is the requirement to prepare and file a written undertaking. The Commission estimates that 50% of the 35 non-broker-dealer SBSDs and non-broker-dealer MSBSPs will retain a third-party custodian, resulting in approximately 17.5 written undertakings. The Commission estimates that paragraph (f) of new Rule 18a-6 will impose an ongoing annual burden of 2 hours per written undertaking, resulting in an industry-wide ongoing burden of 35 hours per year.[698]

The Commission received no comments regarding its hour and cost burden estimates for new Rule 18a-6 and continues to believe they are appropriate.

3. Amendments to Rule 17a-5 and New Rule 18a-7

The amendments to Rule 17a-5 and new Rule 18a-7 will impose collection of information requirements that result in annual burdens for broker-dealers, SBSDs, and MSBSPs. The Commission estimates that the amendments to Rule 17a-5 will impose the following initial and annual burdens: [699]

BurdenInitial burdenAnnual burden
FOCUS Report Part II (ANC broker-dealer SBSDs)Per firm: 25 hours Industry: 250 hoursPer firm: 228 hours. Industry: 2,280 hours.
FOCUS Report Part II (non-model broker-dealer SBSDs)Per firm: 50 hours Industry: 300 hoursPer firm: 240 hours. Industry: 1,440 hours.
FOCUS Report Part II (broker-dealer MSBSPs)Per firm: 35 hours Industry: 35 hoursPer firm: 204 hours. Industry: 204 hours.
FOCUS Report Part II (stand-alone broker-dealers engaged in security-based swap activities)Per firm: 20 hours Industry: 500 hoursPer firm: 120 hours. Industry: 3,000 hours.
Total—Amendments to Rule 17a-5Industry: 1,085 hoursIndustry: 6,924 hours.

The Commission estimates that Rule 18a-7 will impose the following initial and annual burdens: [700]

BurdenInitial burdenAnnual burden
Additional ANC reportsPer firm: 0 hours Industry: 0 hoursPer firm: 120 hours. Industry: 480 hours.
Customer statementsPer firm: 10 hours Industry: 100 hoursPer firm: 1 hours. Industry: 10 hours.
Annual report (stand-alone SBSDs not exempt from Rule 18a-4)Per firm: 0 hours Industry: 0 hoursPer firm: 70 hours and $6.70. Industry: 0 hours and $0.
Annual report (stand-alone SBSDs exempt from Rule 18a-4)Per firm: 0 hours Industry: 0 hoursPer firm: 17 hours and $6.70. Industry: 102 hours and $40.2.
Start Printed Page 68615
Annual report (stand-alone MSBSPs)Per firm: 0 hours Industry: 0 hoursPer firm: 10 hours and $6.70. Industry: 40 hours and $26.80.
Statement regarding accountantPer firm: 10 hours Industry: 100 hoursPer firm: 2 hours and 50¢. Industry: 20 hours and $5.00.
Engagement of accountant (stand-alone SBSDs not exempt from Rule 18a-4)Per firm: 0 hours Industry: 0 hoursPer firm: $450,000. Industry: $0.
Engagement of accountant (stand-alone SBSDs exempt from Rule 18a-4)Per firm: 0 hours Industry: 0 hoursPer firm: $303,000. Industry: $1,818,000.
Engagement of accountant (stand-alone MSBSPs)Per firm: 0 hours Industry: 0 hoursPer firm: $300,000. Industry: $1,200,000.
Notice of change of fiscal yearPer firm: 0 hours Industry: 0 hoursPer firm: 1 hour and 50¢. Industry: 1 hour and 50¢.
FOCUS Report Part II (stand-alone SBSDs)Per firm: 160 hours Industry: 960 hoursPer firm: 192 hours. Industry: 1,152 hours.
FOCUS Report Part II (stand-alone MSBSPs)Per firm: 40 hours Industry: 160 hoursPer firm: 48 hours. Industry: 192 hours.
FOCUS Report Part IIC (bank SBSDs)Per firm: 36 hours Industry: 900 hoursPer firm: 16 hours. Industry: 400 hours.
Total—New Rule 18a-7Industry: 2,220 hoursIndustry: 2,397 hours and $3,018,072.5.

Estimated Hours and Costs of Amendments to Rule 17a-5

In the proposing release, the Commission estimated that many of the amendments to Rule 17a-5 are not expected to impose an initial burden.[701] The Commission received no comment on these estimates and continues to believe they are appropriate.

Paragraph (a)(1)(ii) of Rule 17a-5, as amended, will require broker-dealer SBSDs and MSBSPs to file FOCUS Report Part II, as amended, monthly instead of filing the applicable part of the FOCUS Report quarterly.[702] Part II, Part IIA, and Part II CSE of the FOCUS Report each impose a different burden on respondents due to their varying lengths and calculations, so the burden of filing FOCUS Report Part II, as amended, depends on which part of the FOCUS Report the firm is currently required to file.

ANC broker-dealer SBSDs will be required to file FOCUS Report Part II, as amended, instead of FOCUS Report Part II CSE. Although FOCUS Report Part II, as amended, is modeled on Part II CSE, the burden on ANC broker-dealer SBSDs will increase, because ANC broker-dealer SBSDs will be required to complete additional sections and line items eliciting more detail about their security-based swap and swap activities.[703] In consideration of these additional requirements, the Commission estimates that the requirement for ANC broker-dealer SBSDs to file FOCUS Report Part II, as amended, every month will add an initial burden of 25 hours per firm and an ongoing annual burden of 228 hours per firm. The Commission estimates that there are ten ANC broker-dealer SBSDs, adding to the industry an initial burden of 250 hours [704] and an ongoing burden of 2,280 hours per year.[705]

Non-model broker-dealer SBSDs will be required to file FOCUS Report Part II, as amended, instead of Part II or Part IIA of the FOCUS Report. Given that SBSDs are expected to be larger and relatively sophisticated firms, the Commission assumes that all non-model broker-dealer SBSDs are carrying firms that file Part II. Although sections of Part II are also found in FOCUS Report Part II, as amended, the burden on non-model broker-dealer SBSDs will increase (but not as much as for ANC broker-dealer SBSDs), because non-model broker-dealer SBSDs will be required to file monthly instead of quarterly and will complete additional sections and line items eliciting more detail about their security-based swap and swap activities.[706] In consideration of these additional requirements, the Commission estimates that the Start Printed Page 68616requirement for non-model broker-dealer SBSDs to file FOCUS Report Part II, as amended, every month will add an initial burden of 50 hours per firm and an ongoing annual burden of 240 hours per firm. The Commission estimates that there are 6 non-model broker-dealer SBSDs, adding to the industry an initial burden of 300 hours [707] and an ongoing burden of 1,440 hours per year.[708]

Broker-dealer MSBSPs will be required to file FOCUS Report Part II, as amended, instead of Part II or Part IIA of the FOCUS Report. Given that MSBSPs are expected to be larger and relatively sophisticated firms, the Commission assumes that broker-dealer MSBSPs are carrying firms that file Part II. Although sections of Part II are also found in FOCUS Report Part II, as amended, the burden on broker-dealer MSBSPs will increase (but not as much as for broker-dealer SBSDs), because broker-dealer MSBSPs will be required to file monthly instead of quarterly and will complete additional sections and line items eliciting more detail about their security-based swap and swap activities.[709] In consideration of these additional requirements, the Commission estimates that the requirement for broker-dealer MSBSPs to file FOCUS Report Part II, as amended, every month will add an initial burden of 35 hours per firm and an ongoing annual burden of 204 hours per firm. The Commission estimates that there will be one broker-dealer MSBSP, meaning that the estimated burden on the industry will be the same as for a single broker-dealer MSBSP.

Stand-alone non-model broker-dealers that engage in security-based swap activities will be required to file FOCUS Report Part II, as amended, instead of the currently existing FOCUS Report Part II. Although sections of Part II are also found in FOCUS Report Part II, as amended, the burden on stand-alone non-model broker-dealers engaged in security-based swap activities will increase, because stand-alone non-model broker-dealers will be required to complete additional line items eliciting more detail about their security-based swap and swap activities.[710] In consideration of these additional requirements, the Commission estimates that the requirement for stand-alone non-model broker-dealers engaged in security-based swap activities to file FOCUS Report Part II, as amended, will add an initial burden of 20 hours per firm and an ongoing annual burden of 120 hours per firm. The Commission estimates that there are 25 stand-alone non-model broker-dealers engaged in security-based swap activities, adding to the industry an initial burden of 500 hours [711] and an ongoing burden of 3,000 hours per year.[712]

The Commission received no comments regarding its hour and cost burden estimates for new Rule 17a-5 and continues to believe they are appropriate. However, the estimated burden for Rule 17a-5 is decreased to reflect that stand-alone non-model broker-dealers are no longer required to complete Schedules 2 through 4 of the FOCUS Report. Other than this change, the Commission continues to believe its hour and cost burden estimates for the amendments to Rule 17a-5 are appropriate.

Estimated Hours and Costs of New Rule 18a-7

New Rule 18a-7, which is modeled on Rule 17a-5, as amended, will require non-broker-dealer SBSDs and non-broker-dealer MSBSPs to satisfy certain reporting requirements.[713]

New Rule 18a-7 will require stand-alone SBSDs authorized to use models to compute capital to periodically file certain additional reports relating to their use of internal models to calculate net capital.[714] After consideration of the Supporting Statement accompanying the most recent extension of Rule 17a-5, which estimates that the requirement to file additional ANC reports imposes a burden of 120 hours per respondent,[715] the Commission estimates that paragraph (a)(3) of new Rule 18a-7 will impose an annual burden of 120 hours per model stand-alone SBSD. The Commission estimates that there are 4 model stand-alone SBSDs, resulting in an industry-wide ongoing burden of 480 hours per year.[716]

New Rule 18a-7 will require stand-alone SBSDs and MSBSPs to disclose certain financial statements on their Start Printed Page 68617internet websites.[717] After consideration of the Supporting Statement accompanying the most recent extension of Rule 17a-5, which requires similar disclosures by mail instead of on the firm's website,[718] the Commission staff's experience with burden estimates for similar collections of information, and the estimated initial web development costs, the Commission estimates that paragraph (b) of new Rule 18a-7 will impose an initial burden of ten hours per firm and an annual burden of one hour per firm. The Commission estimates that there are 10 respondents (6 stand-alone SBSDs and 4 stand-alone MSBSPs), resulting in an industry-wide initial burden of 100 hours [719] and an industry-wide ongoing burden of 10 hours per year.[720]

New Rule 18a-7 will require stand-alone SBSDs and MSBSPs to file with the Commission an annual report consisting of certain financial reports, and attach to the financial report an oath or affirmation.[721] Based on the Commission staff's experience with the burden imposed by current Rule 17a-5's annual reports requirement and related postage costs,[722] the Commission estimates that paragraphs (c) and (d) of new Rule 18a-7 will impose on stand-alone MSBSPs an annual burden of 10 hours and $6.70 per firm. The Commission estimates that there are 4 stand-alone MSBSPs, resulting in an industry-wide ongoing burden of 40 hours [723] and $26.80 per year.[724] In the proposing release, the Commission estimated that many of the amendments to Rule 17a-5 are not expected to impose an initial burden.[725] The Commission received no comment on these estimates and continues to believe they are appropriate.

Stand-alone SBSDs not exempt from Rule 18a-4 will be required to include a compliance report with their annual reports.[726] Thus, after consideration of the Supporting Statement accompanying the most recent extension of Rule 17a-5, which estimates that each compliance report takes approximately 60 hours to prepare,[727] the Commission estimates that paragraphs (c) and (d) of new Rule 18a-7 will impose an annual burden of 70 hours and $6.70 per stand-alone SBSD that files a compliance report. The Commission estimates that there are no stand-alone SBSDs that will file a compliance report, resulting in an industry-wide ongoing burden of 0 hours [728] and $0 per year.[729]

Stand-alone SBSDs exempt from Rule 18a-4 will be required to include an exemption report with their annual reports.[730] Thus, after consideration of the Supporting Statement accompanying the most recent extension of Rule 17a-5, which estimates that each exemption report takes approximately 7 hours to prepare,[731] the Commission estimates that paragraphs (c) and (d) of new Rule 18a-7 will impose an annual burden of 17 hours and $6.70 per stand-alone SBSD that files an exemption report. The Commission estimates that there are 6 stand-alone SBSDs that will file an exemption report, resulting in an industry-wide ongoing burden of 102 hours [732] and $40.20 per year.[733]

New Rule 18a-7 will require stand-alone SBSDs and MSBSPs to file a statement regarding the independent public accountant engaged to audit the firm's annual reports.[734] In addition to postage costs, the Supporting Statement accompanying the most recent extension of Rule 17a-5 estimates that the parallel requirement in Rule 17a-5 will impose a two-hour burden on each introducing broker-dealer to file an updated statement, and a more significant ten-hour burden on each carrying broker-dealer, since the changes may require renegotiating the carrying broker-dealer's agreement with its independent public accountant.[735] Consistent with that Supporting Statement, the Commission estimates that paragraph (e) of new Rule 18a-7 will impose an initial burden of ten hours per firm and an annual burden of 2 hours and 50 cents per firm.[736] The Commission estimates that there are 10 respondents (6 stand-alone SBSDs and 4 stand-alone MSBSPs), resulting in an industry-wide initial burden of 100 hours [737] and an industry-wide ongoing burden of 20 hours [738] and $5.00 per year.[739]

New Rule 18a-7 will require stand-alone SBSDs and MSBSPs to engage an independent public accountant to provide reports covering the firm's annual reports.[740] As discussed above, the Commission is modifying the provisions of Rule 18a-7 to allow stand-alone SBSDs and MSBSPs, as well as an SBSD also registered as an OTC derivatives dealer, to engage an independent public accountant that is not registered with the PCAOB, and to permit the accountant to use GAAS in the United States or PCAOB Start Printed Page 68618standards.[741] The Supporting Statement accompanying the most recent extension of Rule 17a-5 estimates that it will cost each carrying firm $300,000 to retain an independent public accountant to audit its financial statements and $150,000 to examine its compliance report.[742] Stand-alone MSBSPs are not required to file a compliance or exemption report, while stand-alone SBSDs will be required to retain an independent public accountant to review their compliance report (if they are not exempt from Rule 18a-4) or exemption report (if they are exempt from Rule 18a-4).

Therefore, the Commission estimates that paragraph (f) of new Rule 18a-7 will impose an annual cost of $300,000 on each stand-alone MSBSP. The Commission estimates that there are 4 stand-alone MSBSPs, resulting in an industry-wide ongoing burden of $1,200,000 per year.[743] The Commission estimates that paragraph (f) of new Rule 18a-7 will impose on stand-alone SBSDs exempt from Rule 18a-4 an annual cost of $303,000 per firm,[744] since both their financial statements and exemption report will need to be audited. The Commission estimates that there are 6 stand-alone SBSDs exempt from Rule 18a-4, resulting in an industry-wide ongoing burden of $1,818,000 per year.[745] The Commission estimates that paragraph (f) of new Rule 18a-7 will impose on stand-alone SBSDs not exempt from Rule 18a-4 an annual cost of $450,000 per firm,[746] since both their financial statements and compliance report will need to be audited. The Commission estimates that there are no stand-alone SBSDs not exempt from Rule 18a-4, resulting in an industry-wide ongoing burden of $0 per year.[747]

New Rule 18a-7 will require stand-alone SBSDs and MSBSPs to notify the Commission of a change in fiscal year.[748] Based on the Commission staff's experience with the parallel requirement under Rule 17a-5, and the Supporting Statement accompanying the most recent extension of Rule 17a-11, which estimates that each financial notice takes approximately 1 hour to prepare and file with the Commission,[749] the Commission estimates that paragraph (i) of new Rule 18a-7 will impose a burden of 1 hour and 50 cents on a firm planning to change its fiscal year. The Commission estimates that each year, 1 firm will change its fiscal year, such that the estimated burden on the industry will be 1 hour and 50 cents per year.

New Rule 18a-7 will require stand-alone SBSDs and MSBSPs to file FOCUS Report Part II, as amended, monthly,[750] and will require bank SBSDs and MSBSPs to file new FOCUS Report Part IIC quarterly.[751]

Stand-alone SBSDs will be required to file FOCUS Report Part II, as amended, on a monthly basis.[752] FOCUS Report Part II, as amended, includes eleven sections and four schedules applicable to stand-alone SBSDs.[753] Stand-alone SBSDs dually registered as FCMs will be required to complete five additional sections, all of which the CFTC already requires FCMs to file as part of Form 1-FR-FCM.[754] In consideration of these additional requirements, the Commission estimates that the requirement for stand-alone SBSDs to file FOCUS Report Part II, as amended, every month will impose an initial burden of 160 hours per firm and an ongoing annual burden of 192 hours per firm. The Commission estimates that there are 6 stand-alone SBSDs, resulting in an industry-wide initial burden of 960 hours [755] and an industry-wide ongoing burden of 1,152 hours per year.[756]

Stand-alone MSBSPs will be required to file FOCUS Report Part II, as amended, on a monthly basis.[757] FOCUS Report Part II, as amended, includes three sections and four schedules applicable to stand-alone MSBSPs.[758] Stand-alone MSBSPs dually registered as FCMs will be required to complete five additional sections, all of which the CFTC already requires FCMs to file as part of Form 1-FR-FCM.[759] In Start Printed Page 68619consideration of these additional requirements, the Commission estimates that the requirement for stand-alone MSBSPs to file FOCUS Report Part II, as amended, every month will impose an initial burden of 40 hours per firm and an ongoing annual burden of 48 hours per firm. The Commission estimates that there are 4 stand-alone MSBSPs, resulting in an industry-wide initial burden of 160 hours [760] and an industry-wide ongoing burden of 192 hours per year.[761]

Bank SBSDs will be required to file new FOCUS Report Part IIC on a quarterly basis.[762] New FOCUS Report Part IIC includes five sections and one schedule applicable to bank SBSDs.[763] The Commission does not expect new FOCUS Report Part IIC to impose a significant burden on bank SBSDs, because two of the five sections require the firm to file calculations already computed in accordance with Rule 18a-3, and the other three sections either mirror or are scaled down versions of schedules to FFIEC Form 031, which banks are already required to file with their prudential regulator (although they will need to transpose this information from FFIEC Form 031 to FOCUS Report Part IIC). Although bank SBSDs dually registered as FCMs will be required to complete five additional sections, the CFTC already requires FCMs to file these schedules on Form 1-FR-FCM.[764] In consideration of these additional requirements, the Commission estimates that the requirement for bank SBSDs to file FOCUS Report Part IIC quarterly will impose an initial burden of 36 hours per firm and an ongoing annual burden of 16 hours per firm. The Commission estimates that there are 25 bank SBSDs, resulting in an industry-wide initial burden of 900 hours [765] and an industry-wide ongoing burden of 400 hours per year.[766]

Bank MSBSPs will be required to file new FOCUS Report Part IIC on a quarterly basis.[767] New FOCUS Report Part IIC includes three sections and one schedule applicable to bank MSBSPs.[768] Bank MSBSPs dually registered as FCMs will be required to complete five additional sections, all of which the CFTC already requires FCMs to file as part of Form 1-FR-FCM.[769] However, the Commission does not expect any banks to register with the Commission as MSBSPs and therefore does not anticipate these requirements to impose an additional burden.[770]

The Commission received no comments regarding its hour and cost burden estimates for new Rule 18a-7 and continues to believe they are appropriate.

4. Amendments to Rule 17a-11 and New Rule 18a-8

The amendments to Rule 17a-11 and new Rule 18a-8 will impose collection of information requirements that result in annual burdens for broker-dealers, SBSDs, MSBSPs, and national securities exchanges and national securities associations. The Commission estimates that Rule 17a-11, as amended, will impose the following initial and annual burdens: [771]

BurdenAnnual burden
New notice of failure to deposit in Rule 15c3-3(p) accountPer notice: 1 hour. Industry: 100 hours.
New notices filed by exchanges and national securities associationsPer notice: 1 hour. Industry: 5 hours.
Total—Amendments to Rule 17a-11Industry: 105 hours.
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The Commission estimates that new Rule 18a-8 will impose an annual burden of 4.6 hours per year.

Estimated Hours and Costs of Amendments to Rule 17a-11

The Commission is adopting paragraph (f) to Rule 17a-11, which will require broker-dealers engaged in security-based swap activities to notify the Commission if they fail to make a deposit required under paragraph (p) of Rule 15c3-3.[772] Because the burden to calculate the reserve amount is already accounted for in the PRA estimate for Rule 15c3-3,[773] the burden imposed by paragraph (f) of Rule 17a-11, as amended, is the requirement to notify the Commission when the firm fails to act in accordance with paragraph (p) of Rule 15c3-3. Given the similarity of this new requirement to the current requirements of Rule 17a-11, the Commission estimates that each required notice will take one hour to prepare and file.[774] Based on Commission experience with the number of notices filed under current Rule 17a-11,[775] the Commission estimates that 100 notices will be filed each year under paragraph (f) of Rule 17a-11, as amended, resulting in an industry-wide ongoing burden of 100 hours per year.[776]

The Commission is redesignating current paragraph (f) of Rule 17a-11 as paragraph (g) and requiring a broker-dealer's national securities exchange or national securities association to notify the Commission if it learns that the broker-dealer failed to provide a notice required under any paragraph of Rule 17a-11 (instead of just paragraphs (b) through (e) of Rule 17a-11 as it currently requires).[777] Thus, these entities will be subject to new burdens to file a delinquent broker-dealer's notices under new paragraph (f) (failure to deposit in Rule 15c3-3(p) account). After considering the similar preexisting Rule 17a-11 requirement, the Commission estimates that each required notice will take one hour to prepare and file.[778] Based on Commission experience with the number of notices currently filed by these entities, the Commission estimates that five notices will be filed pursuant to the amendment to paragraph (g) of Rule 17a-11, as amended, resulting in an estimated industry-wide ongoing burden of five hours per year.[779]

The Commission received no comments regarding its hour and cost burden estimates for the amendments to Rule 17a-11 and continues to believe they are appropriate.

Estimated Hours and Costs of New Rule 18a-8

New Rule 18a-8 will require non-broker-dealer SBSDs and non-broker-dealer MSBSPs to notify the Commission of certain indicia of their financial condition.[780] The Commission estimates that each Rule 18a-8 notice will take approximately 55 minutes to prepare and file, in contrast to its estimate that a Rule 17a-11 notice will take one hour to prepare and file,[781] because stand-alone SBSDs and MSBSPs do not have a DEA with which to file a copy of the Rule 17a-11 notice and bank SBSDs and MSBSPs are not required to file the Rule 17a-11 notice with their prudential regulator.[782]

The Commission estimates that it will receive approximately five Rule 18a-8 notices per year, based on the substantially smaller pool of possible respondents, as compared with current Rule 17a-11. Under current Rule 17a-11, there are approximately 3,582 possible respondents—3,764 registered broker-dealers, minus approximately 182 broker-dealers registered pursuant to Section 15(b)(11)(A) of the Exchange Act.[783] In contrast, the Commission estimates that there will be 35 non-broker-dealer SBSDs and non-broker-dealer MSBSPs (25 bank SBSDs, 6 stand-alone SBSDs, and 4 stand-alone MSBSPs). Assuming that each of the 5 Rule 18a-8 notices takes 55 minutes to prepare and file, the Commission estimates new Rule 18a-8 will result in an industry-wide ongoing burden of 4.6 hours per year.[784]

The Commission received no comments regarding its hour and cost burden estimates for new Rule 18a-8 and continues to believe they are appropriate.

5. Amendments to Rule 17a-12

Rule 17a-12, as amended, will require OTC derivatives dealers to file FOCUS Report Part II, as amended, instead of FOCUS Report Part IIB. This is not so much a new burden as a different burden, since in the absence of this amendment these firms would be required to file FOCUS Report Part IIB instead. The new lines on FOCUS Report Part II, as amended, will generally not be applicable to OTC derivatives dealers. Some new lines on FOCUS Report Part II, as amended, require similar types of information as FOCUS Report Part IIB, but may be phrased in a different way.[785] Other new lines on FOCUS Report Part II, as amended, may require additional detail regarding information that was already required to be reported on FOCUS Report Part IIB.[786] Still other new lines on FOCUS Report Part II, as amended, require information that the OTC derivative dealers are already required to calculate pursuant to another Exchange Act rule.[787] Finally, some new line items on FOCUS Report Part II, as amended, are not applicable to OTC derivatives dealers and therefore will not be completed by these firms.[788]

Although FOCUS Report Part II, as amended, is partially modeled on Part Start Printed Page 68621IIB, the initial burden on OTC derivatives dealers is expected to increase, so that firms can analyze revised FOCUS Report Part II. However, once firms have analyzed FOCUS Report Part II, as amended, the amendments to Rule 17a-12 are not expected to change the estimated ongoing burden imposed by Rule 17a-12. The Commission estimates that Rule 17a-12, as amended, will impose on each OTC derivative dealers an initial burden of 20 hours. The Commission estimates that there are 4 respondents, resulting in an estimated industry-wide initial burden of 80 hours.[789] The Commission estimates that Rule 17a-12, as amended, will not change the estimated ongoing burden imposed by Rule 17a-12.

6. New Rule 18a-9

New Rule 18a-9, which is modeled on Rule 17a-13, will require stand-alone SBSDs to establish a securities count program.[790] As explained below, the Commission estimates that new Rule 18a-9 will impose an industry-wide initial burden of 225 hours and an industry-wide ongoing burden of 900 hours per year.

The current approved PRA estimate for Rule 17a-13 estimates a securities count program imposes an average ongoing cost of 100 hours per year.[791] The Commission is using this estimate, and therefore estimates that new Rule 18a-9 will impose an ongoing annual burden of 100 hours per stand-alone SBSD. The Commission estimates that there are 6 stand-alone SBSDs, resulting in an estimated industry-wide ongoing burden of 600 hours per year.[792]

The Commission also estimates that new Rule 18a-9 will impose an initial burden of 25 hours per firm. The records required by new Rule 18a-9 should already be recorded by the systems implemented under new Rules 18a-5 and 18a-6, and accordingly, the resulting initial burden is largely already accounted for under these rules.[793] However, the Commission estimates that the initial cost to establish procedures for conducting the securities count program, including identifying the persons involved in the program, will create an initial burden of approximately 25 hours per stand-alone SBSD, or 150 hours for the estimated 6 stand-alone SBSDs.[794]

The Commission received no comments regarding its hour and cost burden estimates for new Rule 18a-9 and continues to believe they are appropriate.

7. Amendments to Rule 18a-10

Rule 18a-10, as amended, contains an alternative compliance mechanism pursuant to which a stand-alone SBSD that is registered as a swap dealer and predominantly engages in a swaps business may elect to comply with the recordkeeping and reporting requirements of the CEA and the CFTC's rules in lieu of complying with Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9.[795] The Commission estimates that 3 stand-alone SBSDs will elect to operate under Rule 18a-10. These respondents were included in the proposing release in other collections of information (Rule 18a-5, Rule 18a-6, Rule 18a-7, Rule 18a-8, and Rule 18a-9, as proposed), and have been moved to the information collection for new Rule 18a-10.[796]

The Commission estimates the paperwork burden associated with transmitting to the Commission a copy of the notice required by paragraph (b)(4) of Rule 18a-10, as amended, to be 5 minutes for a stand-alone SBSD operating under Rule 18a-10. The Commission further estimates that it will receive one notice from a single submitting SBSD per year. The Commission is basing this estimate on the smaller pool of possible respondents, as compared with new Rule 18a-8.[797]

Assuming that the single Rule 18a-10 notice takes 5 minutes to transmit to the Commission, the Commission estimates Rule 18a-10, as amended, will result in an industry-wide ongoing burden of 0.083 hours per year.[798]

8. Amendments to Rule 3a71-6

Rule 3a71-6, as amended, will require submission of certain information to the Commission to the extent foreign SBSDs or MSBSPs elect to request a substituted compliance determination with respect to the Title VII recordkeeping and reporting requirements. The Commission expects that foreign SBSDs and MSBSPs will seek to rely on substituted compliance upon registration, and that it is likely that the majority of such requests will be made during the first year following the effective date of this amendment. Requests will not be necessary with regard to applicable rules and regulations of a foreign jurisdiction that have previously been the subject of a substituted compliance determination in connection with the applicable rules.

The Commission expects that the majority of substituted compliance applications will be submitted by foreign authorities, and that very few substituted compliance requests will come from SBSDs or MSBSPs. For purposes of this assessment, the Commission estimates that three SBSDs or MSBSPs will submit such applications in connection with the Commission's recordkeeping and reporting requirements.[799] After consideration of the release adopting Rule 3a71-6, the Commission estimates that the total paperwork burden incurred by such entities associated with preparing and submitting a request for a substituted compliance determination in connection with the recordkeeping and reporting requirements will be approximately 240 hours, plus $240,000 for the services of outside professionals for all 3 requests.[800]

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The Commission received no comments regarding its hour and cost burden estimates for Rule 3a71-6, as amended, and continues to believe they are appropriate.

E. Collection of Information Is Mandatory

The collections of information pursuant to the rule amendments and new rules, being adopted, are mandatory, as applicable, for broker-dealers, SBSDs, MSBSPs, certain third-party custodians, and NSEs and NSAs. Compliance with the collection of information requirements associated with Rule 3a71-6, regarding the availability of substituted compliance, is mandatory for all foreign financial authorities, foreign SBSDs, or foreign MSBSPs that seek a substituted compliance determination.

F. Confidentiality

The broker-dealer and stand-alone SBSD and MSBSP annual reports filed with the Commission are not confidential, except that if the statement of financial condition is bound separately from the balance of the annual reports and each page of the balance of the annual reports is stamped “confidential,” then the balance of the annual reports shall be deemed confidential to the extent permitted by law.[801] Subject to certain exceptions,[802] if there are material weaknesses, the accountant's report on the compliance report must be made available for customers' inspection and, consequently, it will not be deemed confidential.[803] Subject to certain exceptions,[804] a broker-dealer must furnish to its customers its unaudited financial statements,[805] and must provide annually a balance sheet with appropriate notes prepared in accordance with generally accepted accounting principles and which must be audited if the broker-dealer is required to file audited financial statements with the Commission.[806]

Stand-alone SBSDs and MSBSPs must also make publicly available on their websites audited and unaudited financial statements, and also make these documents available in writing, upon request, to any person that has a security-based swap account.[807] A stand-alone SBSD will also be required to disclose on its website at the same time: (1) A statement of the amount of the firm's net capital and required net capital and other information, if applicable, related to the firm's net capital; [808] and (2) if, in connection with the firm's most recent annual reports, the report of the independent public accountant identifies one or more material weaknesses, a copy of the report.[809]

The forms that the Commission has adopted for use by applicants for registration as SBSDs or MSBSPs provides for applicants to notify the Commission regarding intended reliance on substituted compliance.[810] The Commission generally will make requests for substituted compliance determinations public, subject to requests for confidential treatment being submitted pursuant to any applicable provisions governing confidentiality under the Exchange Act.[811]

With respect to the other information collected under the rule amendments and new rules being adopted, the firm can request the confidential treatment of the information.[812] If such a confidential treatment request is made, the Commission anticipates that it will keep the information confidential subject to the provisions of applicable law.[813]

@G. Retention Period for Recordkeeping Requirements

Rule 17a-4, as amended, specifies the required retention periods for a broker-dealer.[814] New Rule 18a-6 specifies the required retention periods for non-broker-dealer SBSDs and non-broker-dealer MSBSPs.[815] Many of the required records must be retained for three years; certain other records must be retained for longer periods.[816]

V. Economic Analysis

A. Introduction

The Commission is sensitive to the costs and benefits of its rules. The following economic analysis presents the costs and benefits—including the effects on efficiency, competition, and capital formation—that will result from the new recordkeeping, reporting, notification, and securities count rules for stand-alone SBSDs, stand-alone MSBSPs, bank SBSDs, and bank MSBSPs and from the amendments to Rules 17a-3, 17a-4, 17a-5, 17a-11 and 17a-12 with respect to firms that are registered as broker-dealers. The costs and benefits of adopting these new rules and rule amendments are discussed below and have informed the policy choices described throughout this release.

As discussed more fully in section II. above, pursuant to Sections 15F and 17(a) of the Exchange Act, the Commission is amending Rules 17a-3, 17a-4, 17a-5, 17a-11, and 17a-12 to establish recordkeeping, reporting, and notification requirements for broker-dealers, including broker-dealer SBSDs and MSBSPs to account for their security-based swap activities. Pursuant to Section 15F of the Exchange Act, the Commission is adopting new Rules 18a-5 through 18a-9 to establish recordkeeping, reporting, and notification requirements for stand-alone SBSDs, stand-alone MSBSPs, bank SBSDs, and bank MSBSPs, and securities count requirements for stand-alone SBSDs. Further, pursuant to Sections 15F and 17(a) of the Exchange Act, the Commission is amending FOCUS Report Part II that consolidates proposed Form SBS and existing FOCUS Report Parts II, IIB, and II CSE that will be filed by nonbank SBSDs, nonbank MSBSPs, stand-alone broker-dealers, and stand-alone OTC derivatives dealers to report financial information. The Commission is adopting FOCUS Report Part IIC for bank SBSDs and MSBSPs to report their financial information because these entities will be required to provide more limited information relative to other SBSDs and MSBSPs. The Commission believes these rules and rule amendments will help regulators Start Printed Page 68623determine whether relevant market participants comply with the recently adopted capital, margin, and segregation requirements.[817]

As discussed above, the Commission is establishing limited and full alternative compliance mechanisms. The limited alternative compliance mechanism in Rules 17a-3 and 18a-5 will allow an SBSD or MSBSP that also is registered with the CFTC as a swap dealer or major swap participant to comply with the requirements to make and keep certain current trade blotters, customer account ledgers, and stock records solely with respect to required information regarding security-based swaps by complying with the requirements of the CEA and the rules thereunder applicable to swap dealers and major swap participants if the SBSD or MSBSP meets certain conditions.[818]

The Commission is amending the full alternative compliance mechanism in existing Rule 18a-10 that permits certain SBSDs that are registered as swap dealers and that predominantly engage in a swaps business to elect to comply with the capital, margin, and segregation requirements of the CEA and the CFTC's rules in lieu of complying with the capital, margin, and segregation requirements in Rules 18a-1, 18a-3, and 18a-4. The amendments to Rule 18a-10 will permit firms that will operate under Rule 18a-10 to elect to comply with the recordkeeping and reporting requirements of the CEA and the CFTC's rules in lieu of complying with Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9.[819] The Commission believes the availability of the alternative compliance mechanisms will promote harmonization with CFTC requirements and reduce compliance costs for eligible SBSDs and MSBSPs.

Additionally, as discussed above, the Commission is amending Rule 3a71-6 to provide non-U.S. stand-alone SBSDs and non-U.S. stand-alone MSBSPs with the potential to utilize substituted compliance with comparable foreign requirements to satisfy the recordkeeping and reporting requirements of Section 15F of the Exchange Act and Rules 18a-5, 18a-6, 18a-7, 18a-8 and 18a-9 thereunder.[820] The Commission believes that allowing for the possibility of substituted compliance will help achieve the benefits of the recordkeeping and reporting requirements being adopted in this document in a manner that avoids the costs that non-U.S. stand-alone SBSDs and non-U.S. stand-alone MSBSPs would have to bear due to regulatory duplication or conflict.

The sections below present an overview of the security-based swap market, a discussion of the general costs and benefits of the adopted recordkeeping and reporting requirements, and a discussion of the costs and benefits of each amendment and new rule. The Economic Analysis also includes a discussion of the potential effects of the rule amendments and new rules on competition, efficiency, and capital formation. Where possible, the Commission has attempted to quantify the costs, benefits, and effects on efficiency, competition, and capital formation expected to result from adopting these rules. At times, however, the Commission is unable to quantify the economic effects because, as explained in detail below, it lacks the information necessary to provide a reasonable estimate, and in those instances, the discussion of the economic effects of the rule or amendment is qualitative in nature.

B. Baseline of Economic Analysis

To assess the economic impact of the final rules described in this release, the Commission employs as a baseline the security-based swap market as it exists at the time of this release, including applicable rules that the Commission already has adopted but excluding rules that the Commission has proposed but not yet finalized. The baseline for analysis includes the statutory provisions that currently govern the security-based swap market pursuant to the Dodd-Frank Act and rules adopted in the Commission's intermediary definitions release,[821] cross-border release,[822] SDR registration release,[823] security-based swap entity registration release,[824] Regulation SBSR release and amendments,[825] U.S. activity release,[826] business conduct release,[827] and trade acknowledgment release [828] as these statutes and final rules—even if compliance is not yet required—are part of the existing regulatory landscape that market participants expect to govern their security-based swap activity.

Additionally, the baseline includes any recordkeeping and reporting rules currently applicable to participants in the security-based swap market including applicable rules previously adopted by the Commission,[829] but excludes the rules and rule amendments addressed in this release. With respect to the minor amendments to Rules 17a-3, 17a-4, 17a-5, 17a-11, and 17a-12, the baseline for purposes of this economic analysis is the current recordkeeping and reporting regime for broker-dealers under such rules.

The following sections provide an overview of aspects of the security-based swap market that are likely to be most affected by the amendments being adopted in this document, as well as elements of the current market structure, such as central clearing and platform trading, that are likely to determine the scope of transactions that will be covered by them.

1. Available Data From the Security-Based Swap Market

The Commission's understanding of the market is informed, in part, by available data on security-based swap transactions, though the Commission acknowledges that limitations in the data limit the extent to which it is possible to quantitatively characterize the market.[830] Since these data do not Start Printed Page 68624cover the entire market, the Commission has analyzed market activity using a sample of transactions data that includes only certain segments of the market. The Commission believes, however, that the data underlying this analysis provides reasonably comprehensive information regarding single-name credit default swap (“CDS”) transactions and the composition of the participants in the single-name CDS market.

Specifically, the analysis of the current state of the security-based swap market is based on data obtained from the DTCC Derivatives Repository Limited Trade Information Warehouse (“TIW”), especially data regarding the activity of market participants in the single-name CDS market during the period from 2008 to 2017. Although the definition of security-based swaps is not limited to single-name CDS,[831] single-name CDS contracts make up a majority of security-based swaps, and the Commission believes that the single-name CDS data are sufficiently representative of the market to inform our analysis of the current security-based swap market. According to data published by the Bank for International Settlements (“BIS”), the global notional amount outstanding in single-name CDS was approximately $4.6 trillion,[832] in multi-name index CDS was approximately $4.4 trillion, and in multi-name, non-index CDS was approximately $343 billion.[833] The total gross market value outstanding in single-name CDS was approximately $130 billion, and in multi-name CDS instruments was approximately $174 billion.[834] The global notional amount outstanding in equity forwards and swaps as of December 2017 was $3.21 trillion, with total gross market value of $197 billion.[835]

The Commission further notes that the data available from TIW does not encompass those CDS transactions that both: (i) Do not involve U.S. counterparties; [836] and (ii) are based on non-U.S. reference entities. Notwithstanding this limitation, the TIW single-name CDS data should provide sufficient information to permit the Commission to identify the types of market participants active in the security-based swap market and the general pattern of dealing within that market.[837]

2. Security-Based Swap Market: Market Participants and Activity

The final rules and rule amendments will apply regulatory requirements to security-based swap market participants. The following sections provide information about the security-based swap market, focusing on the subset of participants likely to incur recordkeeping and reporting requirements as a result of these rules and rule amendments and the activities that would be subject to these requirements.

a. Security-Based Swap Dealers

Security-based swap activity is concentrated in a relatively small number of dealers, which already represent a small percentage of all market participants active in the security-based swap market. Based on an analysis of the 2017 single-name CDS data, the Commission's earlier estimates of the number of entities likely to register as security-based swap dealers remain largely unchanged. Of the approximately 50 entities that the Commission estimates might register as security-based swap dealers, the Commission believes that it is reasonable to expect 22 to be non-U.S. persons.

Many of these dealers are already subject to other regulatory frameworks under U.S. law based on their role as intermediaries or on the volume of their positions in other products, such as swaps. Persons who will register as SBSDs and MSBSPs are likely also to be engaged in swap activity, which is subject to regulation by the CFTC.[838] This overlap reflects the relationship between single-name CDS contracts, which are security-based swaps, and index CDS contracts, which may be swaps or security-based swaps. A single-name CDS contract covers default events for a single reference entity or reference security. Index CDS contracts and related products make payouts that are contingent on the default of index components and allow participants in these instruments to gain exposure to the credit risk of the basket of reference entities that comprise the index, which is a function of the credit risk of the index components. A default event for a reference entity that is an index component will result in payoffs on both single-name CDS written on the reference entity and index CDS written on indices that contain the reference entity. Because of this relationship between the payoffs of single-name CDS and index CDS products, prices of these Start Printed Page 68625products depend upon one another,[839] creating hedging opportunities across these markets.

These hedging opportunities mean that participants that are active in one market are likely to be active in the other. Commission staff's analysis of approximately 4,358 TIW accounts that participated in the market for single-name CDS in 2017 revealed that approximately 2,936 of those accounts, or 67%, also participated in the market for index CDS. Of the accounts that participated in both markets, data regarding transactions in 2017 suggests that, contingent upon an account transacting in notional volume of index CDS in the top third of accounts, the probability of the same account landing in the top third of accounts in terms of single-name CDS notional volume is approximately 38%; by contrast, the probability of the same account landing in the bottom third of accounts in terms of single-name CDS notional volume is only 5.4%.

The CFTC has adopted recordkeeping and reporting requirements that apply to registered swap dealers. The Commission estimates that approximately 46 of the 50 expected security-based swap dealers will be dually registered with the CFTC and therefore be subject to CFTC requirements.[840] Accordingly, the recordkeeping baseline for entities that are currently registered with the CFTC as swap dealers or major swap participants includes the activities related to compliance with the CFTC's recordkeeping and reporting requirements for swaps.

Additionally, based on an analysis of TIW data and filings with the Commission, the Commission estimates that 16 market participants that will register as security-based swap dealers have already registered with the Commission as broker-dealers and are thus subject to Exchange Act and FINRA requirements applicable to such entities. As the Commission discusses below, some registered dealers may also be subject to similar requirements in one or more foreign jurisdictions.

Finally, the Commission also notes that it has adopted rules for the registration of security-based swap dealers and major security-based swap participants, although market participants are not yet required to comply with those rules. Thus, there are not yet any security-based swap dealers or major security-based swap participants registered with the Commission.

b. Security-Based Swap Market Activity

As already noted, firms that act as dealers play a central role in the security-based swap market. Based on an analysis of 2017 single-name CDS data in TIW, accounts of those firms that are likely to exceed the security-based swap dealer de minimis thresholds and trigger registration requirements intermediated transactions with a gross notional amount of approximately $2.9 trillion, approximately 55% of which was intermediated by the top five dealer accounts.[841]

These dealers transact with hundreds or thousands of counterparties. Approximately 21% of accounts of firms expected to register as security-based dealers and observable in TIW have entered into security-based swaps with over 1,000 unique counterparty accounts as of year-end 2017.[842] Another 25% of these accounts transacted with 500 to 1,000 unique counterparty accounts; 29% transacted with 100 to 500 unique accounts; and 25% of these accounts intermediated security-based swaps with fewer than 100 unique counterparties in 2017. The median dealer account transacted with 495 unique accounts (with an average of approximately 570 unique accounts). Non-dealer counterparties transacted almost exclusively with these dealers. The median non-dealer counterparty transacted with two dealer accounts (with an average of approximately three dealer accounts) in 2017.

Figure 2 below describes the percentage of global, notional transaction volume in North American corporate single-name CDS reported to TIW between January 2008 and December 2017, separated by whether transactions are between two ISDA-recognized dealers (interdealer transactions) or whether a transaction has at least one non-dealer counterparty. Figure 2 also shows that the portion of the notional volume of North American corporate single-name CDS represented by interdealer transactions has remained fairly constant through 2015 before falling from approximately 72% in 2015 to approximately 40% in 2017. This fall corresponds to the availability of clearing to non-dealers. Interdealer transactions continue to represent a significant fraction of trading activity, even as notional volume has declined over the past ten years,[843] from more than $6 trillion in 2008 to less than $700 billion in 2017.[844]

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The high level of interdealer trading activity reflects the central position of a small number of dealers, each of which intermediates trades with many hundreds of counterparties. While the Commission is unable to quantify the current level of trading costs for single-name CDS, these dealers appear to enjoy market power as a result of their small number and the large proportion of order flow that they privately observe.

Against this backdrop of declining North American corporate single-name CDS activity, about half of the trading activity in North American corporate single-name CDS reflected in the set of data that the Commission analyzed was between counterparties domiciled in the United States and counterparties domiciled abroad, as shown in Figure 3 below. Using the self-reported registered office location of the TIW accounts as a proxy for domicile, the Commission estimates that only 12% of the global transaction volume by notional volume between 2008 and 2017 was between two U.S.-domiciled counterparties, compared to 49% entered into between one U.S.-domiciled counterparty and a foreign-domiciled counterparty and 39% entered into between two foreign-domiciled counterparties.[845]

If the Commission instead considers the number of cross-border transactions from the perspective of the domicile of the corporate group (e.g., by classifying a foreign bank branch or foreign subsidiary of a U.S. entity as domiciled in the United States), the percentages shift significantly. Under this approach, the fraction of transactions entered into between two U.S.-domiciled counterparties increases to 34%, and to 51% for transactions entered into between a U.S.-domiciled counterparty and a foreign-domiciled counterparty. By contrast, the proportion of activity between two foreign-domiciled counterparties drops from 39% to 15%. This change in respective shares based on different classifications suggests that the activity of foreign subsidiaries of U.S. firms and foreign branches of U.S. banks accounts for a higher percentage of security-based swap activity than U.S. subsidiaries of foreign firms and U.S. branches of foreign banks. It also demonstrates that financial groups based in the United States are involved in an overwhelming majority (approximately 85%) of all reported transactions in North American corporate single-name CDS.

Financial groups based in the United States are also involved in a majority of interdealer transactions in North American corporate single-name CDS. Of the 2017 transactions on North American corporate single-name CDS between two ISDA-recognized dealers and their branches or affiliates, 94% of transaction notional volume involved at least one account of an entity with a U.S. parent. The Commission notes, in addition, that a majority of North American corporate single-name CDS transactions occur in the interdealer Start Printed Page 68627market or between dealers and foreign non-dealers, with the remaining portion of the market consisting of transactions between dealers and U.S.-person non-dealers. Specifically, 60% of North American corporate single-name CDS transactions involved either two ISDA-recognized dealers or an ISDA-recognized dealer and a foreign non-dealer. Approximately 39% of such transactions involved an ISDA-recognized dealer and a U.S.-person non-dealer.

c. Participation of Banks and Broker-Dealers

A high degree of concentration is equally prevalent in derivatives activity within the U.S. banking system: According to the OCC, at the end of the fourth quarter of 2017, derivatives activity in the U.S. banking system continues to be dominated by a small group of large financial institutions. Four large commercial banks represent 89.4% of the total banking industry notional amounts and 85.9% of industry net current credit exposure.[846] This concentration largely appears to reflect the fact that larger entities are well-capitalized and therefore possess competitive advantages in engaging in dealing activities by providing potential counterparties with adequate assurances of financial performance.[847]

Other than OTC derivatives dealers, which are subject to significant limitations on their activities, broker-dealers historically have not participated in a significant way in security-based swap trading.

Table 1—The Number and Percentage of Account Holders—by Type—Who Participate in the Security-Based Swap Market Through a Registered Investment Adviser, an Unregistered Investment Adviser, or Directly as a Transacting Agent, From November 2006 Through December 2017

Account holders by typeNumberRepresented by a registered  investment adviser  Represented by an unregistered investment adviserParticipant is transacting agent 848
Private Funds3,8571,97351%1,85948%251%
DFA Special Entities1,3191,26296%373%202%
Registered Investment Companies1,1591,08293%736%40%
Banks (non-ISDA-recognized dealers)349206%82%32192%
Start Printed Page 68628
Insurance Companies30119665%3411%7124%
ISDA-Recognized Dealers9100%00%91100%
Foreign Sovereigns836376%34%1720%
Non-Financial Corporations755269%45%1925%
Finance Companies201155%00%945%
Other/Unclassified5,8833,74564%1,88732%2514%
All13,1378,40464%3,90530%8286%

3. Existing Regulation of OTC Derivatives Market Participants and Broker-Dealers

As discussed above, the adopted rules and amendments will apply to various different entities that the Commission anticipates will register as SBSDs or MSBSPs, including stand-alone firms, banks, and registered broker-dealers. In addition, the adopted amendments will also apply to certain stand-alone broker-dealers that do not register as an SBSD or MSBSP but nonetheless still engage in security-based swap transactions. For all of these entities, the economic baseline includes the reports and records these firms currently generate in the ordinary course of their business and in anticipation of regulatory reporting requirements, such as Regulation SBSR's requirement for SBSDs and MSBSPs to report each security-based swap transaction to a registered SDR [849] and to establish, maintain, and enforce written policies and procedures that are designed to ensure compliance with security-based swap transaction reporting obligations.[850] Because compliance with registration rules for SBSDs and MSBSPs is not yet required,[851] however, there are no entities of any type currently registered as SBSDs or MSBSPs and the Commission can only arrive at an estimate of the number and type of these registrants based on an analysis of the 2017 single-name CDS data.[852]

Below, the Commission summarizes, based on available information, the current recordkeeping, reporting, notification, and securities count practices of these various entities, including those practices that are required by regulation and those that have been independently adopted by the entities.

a. Stand-Alone SBSDs and MSBSPs

Certain firms that are neither banks nor broker-dealers that participate in the market for security-based swaps will register with the Commission as stand-alone SBSDs and MSBSPs. The Commission believes that firms engaged in the security-based swap market currently produce, as part of their ordinary business practices, financial reports such as a balance sheet and a quarterly and year-end income statement that are included in the financial reporting requirements the Commission is adopting in this document. Such firms may not, however, produce annual audited financial statements, as required under the adopted rules. The Commission also believes that firms engaged in the security-based swap business currently maintain records documenting the firms' derivatives positions to facilitate, among other things, effective risk management. The Commission expects that these firms maintain these records for the duration for which they hold a given position and for some period of time thereafter. Moreover, the Commission believes that firms that eventually register with the Commission as SBSDs or as MSBSPs will likely create transaction records to submit to registered SDRs as a result of their anticipated reporting obligations under Regulation SBSR and will likely have order management systems in place to record information that is required to be submitted under Regulation SBSR.

Given that the Commission has not previously regulated these firms, the Commission does not have information regarding the recordkeeping and reporting costs these nonbank and non-broker-dealer firms presently incur in the ordinary course of business. As noted above, the Commission believes that these firms, however, maintain some records documenting their business activities as a matter of routine business practice and maintain some transaction records in anticipation of their reporting obligations under Regulation SBSR. Any new costs imposed by the new rules should be incremental to the costs currently being incurred by these entities.

b. Bank SBSDs and MSBSPs

In addition to stand-alone SBSDs and MSBSPs, the Commission expects certain banks to register as SBSDs and MSBSPs. The economic baseline for banks that participate in the security-based swap market includes the existing recordkeeping, record retention, reporting, and notification requirements that are imposed on banks by their relevant prudential regulator as well as the reports and records these firms currently generate in the ordinary course of their business.

Prudential regulators already subject banks to recordkeeping and retention requirements.[853] In addition, banks must file financial statements and supporting schedules known as “call reports” with their prudential regulator.[854] The Commission believes that the most common form of call report for a bank that will register as an SBSD or MSBSP is FFIEC Form 031.[855] Like the FOCUS Report, FFIEC Form 031 elicits financial and operational information about a bank, which is entered into uniquely numbered line Start Printed Page 68629items. A bank must report details about its assets, liabilities, and equity capital on Schedule RC to FFIEC Form 031.[856] A bank must also report details about its regulatory capital on Schedule RC-R to FFIEC Form 031.[857] The information elicited on Schedule RC-R is designed to facilitate an analysis of the bank's regulatory capital. A bank must report details about its income (loss) and expenses on Schedule RI to FFIEC Form 031.[858]

The Commission has estimated the cost of the existing recordkeeping, record retention, reporting, and notification requirements that are applicable to nationally chartered banks under existing regulations issued by the OCC. The Commission arrived at the estimate by examining PRA collections to which national banks are subject and selecting those that are analogous to the recordkeeping, record retention, reporting, and notification rules the Commission is adopting herein.[859] The Commission then estimated that reporting burdens generate approximately $79/hour of cost for national banks and that recordkeeping burdens generate approximately $30/hour of cost for national banks.[860] The Commission estimates that national banks currently incur annual costs of $55,982,398 to comply with the OCC's financial reporting, notification and recordkeeping rules.[861] The OCC's rules generally relate to banking activities, not securities and security-based swap activities. The Commission thus recognizes that some of the costs reflected in the OCC's rules may not be analogous to costs that may be imposed by the Commission's new rules. Nonetheless, these cost estimates may help provide context and cost ranges with respect to the nationally chartered banks impacted by the Commission's new rules.

c. Broker-Dealers, SBSD Broker-Dealers, and MSBSP Broker-Dealers

As noted above, the Commission expects some broker-dealers to register as broker-dealer SBSDs or broker-dealer MSBSPs, while other broker-dealers engaging in security-based swap transactions may be subject to regulation as stand-alone broker dealers. A broker-dealer that engages in security-based swap activities is currently subject to existing regulatory requirements, including capital, margin, segregation, recordkeeping, reporting, notification, and securities count requirements.[862] Specifically, the existing broker-dealer capital requirements make it relatively costly for broker-dealers to conduct security-based swap activities in broker-dealers.[863] Instead of occurring at broker-dealers, security-based swap dealing activity is currently mostly concentrated in entities that are affiliated with broker-dealers, but not in broker-dealers themselves.[864]

Reporting/recordkeepingAnnual hourly industry burdenCompensation rate (per hour)Estimated annual cost
Interagency Call Report (FFIEC 031 and 041)406,141$79$32,085,139
Foreign Branch Call Report (FFIEC 041)4,65179367,429
Country Exposure Report (FFIEC 009)8,38479662,336
Exchange Act Disclosures Reported to the OCC5237941,317
Recordkeeping Requirements for Securities Transactions6,94430208,320
Disclosure of Financial and Other Information6697952,851
Interagency Guidance on Asset Securitization Activities7783023,340
Advanced Capital Adequacy Framework Reporting137,5007910,862,500
Liquidity Risk Report43,992793,475,368
General Reporting and Recordkeeping by Savings Associations61,362301,840,860
Notice or Application for Capital Distributions5467943,134
Annual Stress Test Rule and Stress Test Reporting Templates73,876795,836,204
Recordkeeping and Disclosure Provisions Associated with Stress Testing Guidance16,12030483,600
Total Costs55,982,398

As of December 31, 2018, there were 3,764 broker-dealers registered with the Commission. The broker-dealers registered with the Commission vary significantly in terms of their size, business activities, and the complexity of their operations.[865] The Commission estimates that as of December 31, 2018, ten broker-dealers dominated the Start Printed Page 68630broker-dealer industry, holding over half of all the capital held by broker-dealers.[866]

Broker-dealers registered with the Commission are currently subject to recordkeeping, reporting, notification, and securities count requirements. The baseline for the economic analysis for registered broker-dealers includes Rules 17a-3, 17a-4, 17a-5, 17a-11, and 17a-12 as they existed prior to these amendments as well as any reports and records these firms currently generate in the ordinary course of their business. Below, the Commission discusses the obligations these existing rules currently place on registered broker-dealers.

i. Existing Rules 17a-3 and 17a-4

The Commission is adopting amendments to Rules 17a-3 and 17a-4 to establish additional recordkeeping requirements for broker-dealer SBSDs, broker-dealer MSBSPs,[867] and broker-dealers that conduct security-based swap activities but are not registered as SBSDs.[868] Under existing Rule 17a-3, broker-dealers must make and keep certain books and records. The Commission estimates that Rule 17a-3 currently imposes $218,361,917 of annual costs on broker-dealers.[869] Rule 17a-4 currently requires that firms preserve the records made and kept under Rule 17a-3, as well as additional records, including written agreements, communications relating to its business as such, and records reflecting inputs into the FOCUS Report. The rule also establishes retention periods for all records required under Rule 17a-3 and required to be preserved under Rule 17a-4, along with storage media requirements for those firms that preserve records electronically. The Commission estimates that current Rule 17a-4 imposes $86,220,558 of annual costs on broker-dealers.[870]

ii. Existing Rule 17a-5

The existing broker-dealer financial reporting requirements appear in Rule 17a-5. The baseline for this economic analysis with respect to the amendments to Rule 17a-5 is the broker-dealer financial reporting requirements as they exist prior to the amendments being adopted in this document. The Commission estimates that current Rule 17a-5 imposes $140,225,396 of annual costs on broker-dealers.[871]

Rule 17a-5 has two main elements: (1) Broker-dealers must file periodic unaudited reports containing information about their financial and operational condition on a FOCUS Report; and (2) broker-dealers must annually file financial statements and certain reports and a report covering the financial statements and reports prepared by an independent public accountant registered with the PCAOB in accordance with PCAOB standards.[872] In addition to these two main elements, a few other aspects of Rule 17a-5 are described below.

a. Periodic Reports

Broker-dealers periodically report information about their financial and operational condition on FOCUS Report Part II, Part IIA, Part IIB, or Part II CSE. Each version of the report is designed for a particular type of broker-dealer and the information to be reported is tailored to the type of broker-dealer.[873]

b. Annual Audited Reports and Related Notifications

Under paragraphs (d) and (g) of Rule 17a-5, a broker-dealer is required to, among other things, annually file reports with the Commission that are audited by a PCAOB-registered independent public accountant, disclose certain financial information to customers, notify the Commission of a change of accountant, and notify the Commission of a change in its fiscal year.[874] Paragraph (h) of Rule 17a-5 also requires the independent public accountant to notify the broker-dealer if the accountant discovers an instance of non-compliance with certain broker-dealer rules or determines that any material weakness exists.

c. Customer Statements

Paragraph (c) of Rule 17a-5 requires, among other things, that certain broker-dealers annually send their customers audited and unaudited statements regarding their financial condition. Under paragraph (c)(5), a broker-dealer is exempt from sending the statement of financial condition to customers if the broker-dealer, among other things: (1) Sends its customers semi-annual statements relating to the firm's net capital and, if applicable, the identification of any material weaknesses; and (2) makes the statement of financial condition described above available on the broker-dealer's website home page and maintains a toll-free number that customers can call to request a copy of the statement.

d. Additional ANC Broker-Dealer Reports

Paragraph (a)(6) of Rule 17a-5 requires ANC broker-dealers to periodically file certain reports with the Commission. The reports contain information related to the ANC broker-dealers' use of internal models to calculate market and credit risk charges when computing net capital.

iii. Existing Rule 17a-11

The existing broker-dealer notice requirements are contained in Rule 17a-11. The baseline for this economic analysis with respect to the amendments to Rule 17a-11 is the broker-dealer notification requirements as they exist today. Rule 17a-11 specifies the circumstances under which a broker-dealer must notify the Commission and other securities regulators about its financial or operational condition, as well as the form that the notice must take. The Commission estimates that current Rule 17a-11 imposes $90,115 of annual costs on broker-dealers in the aggregate.[875]

Start Printed Page 68631

a. Failure To Meet Minimum Capital Requirements

Paragraph (b) of Rule 17a-11 requires a broker-dealer to notify the Commission if the firm's net capital or, if applicable, tentative net capital declines below the minimum amount required under Rule 15c3-1.

b. Early Warning of Potential Capital or Model Problem

Paragraph (b)(2) of Rule 17a-11 requires an OTC derivatives dealer or an ANC broker-dealer to notify the Commission when its tentative net capital falls below the minimum required for these types of broker-dealers. Paragraph (c) of Rule 17a-11 specifies four events that, if they occur, trigger a requirement that a broker-dealer send notice promptly (but within twenty-four hours) to the Commission. These notices are designed to provide the Commission with an “early warning” that the broker-dealer may experience financial difficulty.[876] The events triggering the early warning notification requirements are:

  • The computation of a broker-dealer subject to the aggregate indebtedness standard of Rule 15c3-1 shows that the firm's aggregate indebtedness is in excess of 1,200% of its net capital;[877]
  • The computation of a broker-dealer which has elected to use the alternative standard of calculating net capital under Rule 15c3-1 shows that the firm's net capital is less than 5% of aggregate debit items computed in accordance with Exhibit A of Rule 15c3-3;[878]
  • A broker-dealer's net capital computation shows that its total net capital is less than 120% of its required minimum level of net capital or of its required minimum level of tentative net capital, in the case of an OTC derivatives dealer;[879]
  • With respect to an OTC derivatives dealer, the occurrence of the fourth and each subsequent backtesting exception under 17 CFR 240.15c3-1f (appendix F of Rule 15c3-1) during any 250 business days measurement period.[880]

c. Failure To Make and Keep Current Books and Records

Paragraph (d) of Rule 17a-11 requires a broker-dealer that fails to make and keep current the books and records required under Rule 17a-3 to notify the Commission of this fact on the same day that the failure arises. The notice must specify the books and records which have not been made or which are not current. A broker-dealer is required to report to the Commission within 48 hours of the original notice what the broker or dealer has done or is doing to correct the situation.

d. Material Weakness

Paragraph (e) of Rule 17a-11 requires a broker-dealer to provide notification about a material weakness as that term is defined in Rule 17a-5. Specifically, paragraph (e) provides that, whenever a broker-dealer discovers or is notified by an independent public accountant of a material weakness as defined in Rule 17a-5, the broker-dealer must: (1) Give notice to the Commission within twenty-four hours of the discovery or notification of the material weakness; and (2) transmit a report within forty-eight hours of the notice indicating what the broker-dealer has done or is doing to correct the situation.[881]

e. Failure To Make a Required Reserve Deposit

An additional broker-dealer notification is required under Exchange Act Rule 15c3-3, rather than Rule 17a-11. Specifically, under paragraph (i) of Rule 15c3-3, a broker-dealer is required to notify the Commission and its DEA if it fails to make a required deposit into its customer reserve account under Rule 15c3-3.

iv. Existing Rule 17a-12

The Commission is adopting amendments to Rule 17a-12 to require OTC derivatives dealers to file revised FOCUS Report Part II instead of FOCUS Report Part IIB as required by current Rule 17a-12.[882] The baseline for this economic analysis with respect to amendments to Rule 17a-12 is current Rule 17a-12. The Commission estimates that current Rule 17a-12 imposes an annual burden of $568,320 in the aggregate.[883]

4. Regulation SBSR

Regulation SBSR implements requirements for regulatory reporting and public dissemination of security-based swap transactions set forth in Title VII of the Dodd-Frank Act. Regulation SBSR assigns the reporting side [884] the obligation of reporting primary and secondary trade information about the transaction to a registered SDR or to the Commission, in the event that there is no registered SDR to accept the report.[885]

Based on historical data the Commission estimated that 300 entities would be required to report transaction information under Regulation SBSR,[886] including all 50 potential registered SBSDs and all 5 potential registered MSBSPs. As a result of the Regulation SBSR reporting hierarchy, the Commission expected all these SBSDs and MSBSPs to incur reporting obligations because at least one of these 55 potential registrants appeared on either side of the majority of security-based swap transactions.[887]

The Commission believes that SBSDs and MSBSPs will have incurred three categories of costs to comply with Regulation SBSR. First, they would likely have had to establish and maintain an internal order management system (“OMS”) capable of capturing relevant security-based swap transaction information in order for it to be reported. Second, they would have had to implement reporting mechanisms. Start Printed Page 68632Third, given that manual processes would likely have been incapable of capturing and reporting the numerous data elements relating to security-based swaps required by Regulation SBSR, SBSDs and MSBSPs would have had to establish an appropriate compliance program and support for operating any OMS and reporting mechanism capable of reporting data within the timeframe set forth by Regulation SBSR.[888]

To the extent that the same or similar information is needed to comply with the recordkeeping and reporting rules being adopted in this document, market participants can use the infrastructure already in place in anticipation of Regulation SBSR to comply with their recordkeeping and reporting obligations under the current rulemaking. Consistent with prior releases, the Commission believes that once a respondent's reporting infrastructure and compliance systems are in place the marginal burden of reporting transactions would be de minimis when compared to the costs of putting those systems in place and maintaining them over time.[889] Thus the changes implemented in anticipation of compliance with Regulation SBSR are likely to substantially reduce certain compliance related burdens emanating from the recordkeeping, reporting, notification, and securities count rules and rule amendments being adopted in this document. As a result, the Commission's estimates of these burdens [890] should be viewed as an upper bound of the potential costs of these rules and rule amendments.

5. Global Regulatory Efforts

The global security-based swap market is highly interconnected and highly concentrated.[891] This interconnectedness allows U.S. market participants to use security-based swaps as a tool for sharing financial and commercial risks and to access liquidity across jurisdictional boundaries.[892] However, these opportunities for risk sharing also represent channels for risk transmission to the U.S. financial system: Because dealers facilitate the majority of security-based swap transactions, with bilateral relationships that extend to potentially thousands of counterparties, deficiencies in SBSD records and reports may have outcomes that affect a large number of counterparties and have potentially significant cross-border implications.[893]

In 2009, the G20 Leaders—whose membership includes the United States, 18 other countries, and the European Union (“EU”)—addressed global improvements in the OTC derivatives markets. They expressed their view on a variety of issues relating to OTC derivatives contracts. In subsequent summits, the G20 Leaders have returned to OTC derivatives regulatory reform and encouraged international consultation in developing standards for these markets.[894]

Many SBSDs will likely already be subject to foreign regulation of their security-based swap activities that are similar to regulations that may apply to them pursuant to Title VII, even if the relevant foreign jurisdictions do not classify certain market participants as “dealers” for regulatory purposes. Some of these regulations may duplicate, and in some cases conflict with, certain elements of the Title VII regulatory framework including the recordkeeping and reporting rules being adopted in this document.

C. Analysis of the Adopted Program and Alternatives

In determining appropriate recordkeeping, reporting, notification, and securities count requirements, the Commission assessed and considered a number of different costs and benefits, and the determinations it has made may have a variety of economic consequences for the relevant firms, markets, and the financial system as a whole. As an initial matter, the recordkeeping, reporting, notification, and securities count rules and rule amendments being adopted in this document represent the manner in which SBSDs and MSBSPs will document, report, and retain evidence of their compliance with, among other things, the Commission's capital, margin, and segregation rules. The Commission believes that these rules, by their nature, will have a more limited economic impact as compared to the Commission's capital, margin, and segregation rules.

With respect to the likely benefits of the adopted rules and amendments, the recordkeeping, reporting, notification, and securities count requirements are broadly intended to facilitate effective oversight of SBSD and MSBSPs. Requiring registered firms to comply with recordkeeping and reporting rules should help ensure more effective regulatory oversight. The new rules and rule amendments should further help the Commission determine whether an SBSD or MSBSP is operating in compliance with the Exchange Act and the rules thereunder.

The Commission further believes that the required annual audit of nonbank SBSDs' and nonbank MSBSPs' financial statements and the public availability of firms' Statement of Financial Condition will provide customers and counterparties access to financial information that will permit them to better assess the financial condition of firms. While it is difficult to quantify the extent to which lack of information about the financial conditions of other market participants reduces willingness to participate in the security-based swap market, the Commission staff's experience is that market participants' willingness to engage in activities increases when such participants are better able to understand the financial condition of other market participants and counterparties.

The Commission also recognizes that there will be costs associated with the new rules and rule amendments. These costs include the costs of complying with the new rules and rule amendments, for example one-time and ongoing financial reporting costs, and costs associated with ongoing record maintenance. To the extent that costs associated with the new rules and amendments arise from complying with the new requirements, these costs are discussed below in section V.C.2. of this release.

The Commission believes that the new rules and rule amendments will require improvements in technology to meet minimum standards for recordkeeping and reporting. SBSDs and MSBSPs that do not have the technology to store and maintain the information required by the new rules and rule amendments will likely need to invest in technology. While investments in new technology will entail costs for SBSDs and MSBSPs, these technological investments may generate benefits for financial markets at large by helping Start Printed Page 68633regulators to more effectively track trading and risk exposure in security-based swaps. Moreover, to the extent that improvements in technology required by the rule and rule amendments also enable SBSDs and MSBSPs to more effectively track their trading and risk exposure in security-based swaps, the cost of these improvements for these entities may be partially offset.

In addition, the rules being adopted in this document, in conjunction with other requirements established under the Dodd-Frank Act, could have a substantial impact on international commerce and the relative competitive position of intermediaries operating in multiple jurisdictions. For example, intermediaries operating in other jurisdictions could be advantaged relative to U.S. competitors if corresponding requirements are not established in other jurisdictions or if the Commission's rules are substantially more stringent and costly than corresponding requirements in other jurisdictions. This could affect the ability of intermediaries and other market participants based in the U.S. to participate in non-U.S. markets and the propensity of non-U.S.-based intermediaries and other market participants to participate in U.S. markets or perform market-facing activities using personnel located in the United States. Accordingly, the reporting, recordkeeping, notification, and security count requirements for security-based swaps being adopted in this document could entail substantial differences in the costs of compliance between the U.S. and foreign jurisdictions and could therefore have international implications in terms of the extent of market participation in U.S. versus non-U.S. jurisdictions.[895]

In certain instances it is difficult to quantify the potential benefits and costs of the new rules and rule amendments. For example, firms that choose to register in some capacity as an SBSD or MSBSP may not currently be subject to Commission, CFTC, or prudential regulation. The Commission does not have comprehensive information about such firms' current recordkeeping, reporting, notification, and securities count practices with respect to their security-based swap activities and thus it is difficult to reliably gauge the economic effect of the new rules and rules amendments on these firms. With regard to entities that are currently regulated by the Commission and that are likely to be affected by the rules and rule amendments being adopted in this document, the Commission staff's experience with broker-dealers under the existing recordkeeping, reporting, notification, and securities count rules gives it a better understanding of the compliance-related costs (such as those related to retaining attorneys, accountants, and other professionals), and in such cases the Commission has prepared below a summary of its estimate of these costs.[896]

The benefits and costs of each adopted rule and amendment, as well as the reasonable alternatives, are discussed in further detail below.

1. Benefits of Recordkeeping, Reporting, Notification, and Securities Count Requirements

a. Requirements To Make and Keep Records

i. Broker-Dealer SBSDs, Broker-Dealer MSBSPs, and Stand-Alone Broker-Dealers (Amendments to Rule 17a-3)

The Commission is amending existing Rule 17a-3 to account for security-based swap activities of broker-dealers, including broker-dealer SBSDs and MSBSPs.[897] The Commission believes that the amendments to Rule 17a-3 will generate valuable information that will assist the Commission to improve the regulatory oversight and documentation of the security-based swap activities of stand-alone broker-dealers, broker-dealer SBSDs and MSBSPs. For example, requiring these firms to record the UIC of the counterparties in their security-based swap transactions will assist the Commission in accurately determining which parties are involved in the specific security-based swap transactions and will thereby improve the Commission's analysis of the firms' credit and counterparty risk exposures as well as assist in the accurate determination of the firms' aggregate financial exposure to the related parties.

As noted above in section II.A.2. of this release, in practice, the Commission's adoption of a requirement to use UICs for the purposes of Rules 17a-3 and 18a-5 means that until such time as the Commission recognizes any other IRSS, registrants will be required to use LEIs as requested by commenters.[898] As the Commission noted in the Regulation SBSR adopting release, requiring the use of UICs will provide a streamlined way of reporting, disseminating, and interpreting security-based swap information.[899] The Commission believes Rules 17a-3 and 18a-5 will require few entities that are not already required to obtain UICs under Regulation SBSR to obtain UICs.[900]

The records generated as a result of amendments to Rule 17a-3 will also constitute an important means of determining compliance of market participants with securities laws such as the capital, margin, and segregation rules applicable to SBSDs and MSBSPs. The amendments to Rule 17a-3 will therefore facilitate more effective oversight and surveillance of the participants in and the market for security-based swaps.

ii. Stand-Alone SBSDs, Stand-Alone MSBSPs, Bank SBSDs, and Bank MSBSPs (New Rule 18a-5)

The Commission is adopting new Rule 18a-5—which is modeled on Rule 17a-3, as amended—to require stand-alone SBSDs, stand-alone MSBSPs, bank SBSDs, and bank MSBSPs to make and keep current certain records.[901] As with Rule 17a-3, under Rule 18a-5, firms are required to document specific attributes of their security-based swap transactions (e.g., the contract price of the security-based swap; the type of security-based swap; the reference security, index or obligor etc.). However, not all of the provisions of Rule 17a-3 are being included as part of Rule 18a-5 because some of Rule 17a-3's provisions relate to activities that are not expected or permitted of stand-alone SBSDs and MSBSPs not dually registered as a broker-dealer. Similarly, and as described above, the new requirements that apply to bank SBSDs and MSBSPs under new Rule 18a-5 are more limited than the new requirements that apply to stand-alone SBSDs and MSBSPs under the same rule because the Commission's authority under Section 15F(f)(1)(B)(i) of the Exchange Act is limited to activities related to their business as an SBSD or MSBSP and because banks are already subject to the existing recordkeeping requirements from prudential regulators who are responsible for capital, margin, and Start Printed Page 68634other prudential requirements applicable to bank SBSDs and MSBSPs.

The Commission believes that new Rule 18a-5 will provide for improved regulatory oversight of the security-based swap activities of stand-alone SBSDs, stand-alone MSBSPs, bank SBSDs, and bank MSBSPs. As with the records generated by broker-dealer SBSDs and MSBSPs under the amendments to Rule 17a-3, records generated as a result of new Rule 18a-5 will also constitute an important means of determining compliance of non-broker-dealer SBSDs and MSBSPs with securities laws such as the capital, margin, and segregation rules applicable to SBSDs and MSBSPs and will facilitate the Commission's regulation of the security-based swap market.[902]

b. Requirements To Preserve Records

i. Broker-Dealer SBSDs, Broker-Dealer MSBSPs, and Stand-Alone Broker-Dealers (Amendments to Rule 17a-4)

The Commission is adopting amendments to existing Rule 17a-4—which contains requirements for broker-dealers subject to Rule 17a-3 to preserve certain types of records required to be made and kept current under Rule 17a-3 and prescribes the duration for which and the manner in which these records must be preserved—to account for the security-based swap activities of broker-dealers, including broker-dealer SBSDs and MSBSPs, as well as certain non-substantive amendments.

For example, and as discussed above,[903] the Commission is adopting amendments to certain provisions in paragraph (b) of existing Rule 17a-4 to account for security-based swap transactions, and is adopting amendments that require broker-dealers, including broker-dealer SBSDs and MSBSPs, to preserve certain additional records related to security-based swap activities. Further, the Commission is amending the preservation requirement in paragraph (b)(4) of existing Rule 17a-4 to include “recordings of telephone calls required to be maintained pursuant to section 15F(g)(1) of the [Exchange] Act.” The amendment establishes a requirement to preserve for three years telephone calls that a covered firm chooses to record to the extent that the calls are required to be maintained pursuant to Section 15F(g)(1) of the Exchange Act.

The Commission believes that by keeping current, preserving and ensuring ready access to the records required under Rule 17a-3, as amended, the amendments to Rule 17a-4 will support the benefits emanating from the amendments to Rule 17a-3. These benefits primarily include improving the Commission's regulatory oversight by ensuring its ability to monitor and review documentation of the security-based swap activities of stand-alone broker-dealers, broker-dealer SBSDs and MSBSPs.

ii. Stand-Alone SBSDs, Stand-Alone MSBSPs, Bank SBSDs, and Bank MSBSPs (New Rule 18a-6)

With respect to stand-alone SBSDs, stand-alone MSBSPs, bank SBSDs, and bank MSBSPs, the Commission is adopting new Rule 18a-6 to establish record preservation requirements for these categories of potential registrants. New Rule 18a-6 is modeled on the record preservation requirements of Rule 17a-4, as amended, but contains modifications to account for the differences applicable to stand-alone SBSDs, stand-alone MSBSPs, bank SBSDs and MSBSPs consistent with their anticipated business activities related to security-based swaps.[904] Many, but not all, of the same record preservation requirements that are applicable to broker-dealer SBSDs and MSBSPs under the amendments to Rule 17a-4 will also apply to stand-alone SBSDs, stand-alone MSBSPs, bank SBSDs, and bank MSBSPs under new Rule 18a-6. For example, analogous to paragraph (a) of Rule 17a-4, as amended [905] paragraph (a) of new Rule 18a-6 requires that certain records required to be created and maintained under Rule 18a-5 be preserved for a period of not less than six years, the first two in an easily accessible place.[906]

In response to comments received to the proposing release, the Commission is modifying Rule 18a-6 to eliminate the requirement that the electronic storage system preserve records exclusively in a non-rewriteable and non-erasable format.[907] The Commission believes that the removal of these requirements will reduce the likelihood that stand-alone or banks SBSDs and MSBSPs will need to maintain an extra set of records, and avoid the associated costs of maintaining those extra records, in order to comply with the rule.[908] For SBSDs and MSBSPs that are also registered with the CFTC as swap dealers and major swap participants, these modifications to the rule will also eliminate a potential conflict with the requirements of the CFTC.

The Commission believes that by keeping current, preserving, and ensuring ready access to the records required under new Rule 18a-5, new Rule 18a-6 will support the benefits stemming from new Rule 18a-5 without increasing the costs associated with keeping records. These benefits primarily include improving the Commission's regulatory oversight by ensuring its ability to monitor and review documentation of the security-based swap activities of non-broker-dealer SBSDs and MSBSPs.

c. Reporting

The Commission is adopting amendments to existing Rule 17a-5—which contains requirements for broker-dealers to file periodic unaudited reports containing information about their financial and operational condition and for broker-dealers to file annual financial statements, certain reports and a report covering these financial statements and reports prepared by an independent public accountant registered with the PCAOB in accordance with PCOAB standards [909] —to account for the security-based swap activities of broker-dealers, including broker-dealer SBSDs and MSBSPs, as well as certain non-substantive amendments. Further, the Commission is adopting new Rule 18a-7—which is modeled on Rule 17a-5, as amended—to establish reporting requirements for stand-alone SBSDs, SBSDs also registered as OTC derivatives dealers, stand-alone MSBSPs, bank SBSDs, and bank MSBSPs. The Commission believes that the economic effects associated with the new reporting requirements will depend upon the nature of the filings that potential registrants make today based upon their current registration status (e.g., broker-dealer vs. non-broker-dealer).

Start Printed Page 68635

i. Stand-Alone Broker-Dealers (Amendments to Rule 17a-5)

As described above, under these rules and rule amendments, stand-alone broker-dealers (including stand-alone OTC derivatives dealers and stand-alone ANC broker-dealers) that engage in security-based swap activities but that do not register with the Commission as an SBSD or MSBSP will be required to complete revised FOCUS Report Part II.[910] FOCUS Report Part II, as amended, largely retains the structure and line items of the FOCUS Report Part II that existed prior to these amendments, but also includes new line items and schedules tailored specifically to security-based swap activities.[911] It also largely elicits the same information as FOCUS Report Parts IIB and II CSE.[912] Consequently, broker-dealers that filed the FOCUS Report Part II prior to these amendments, ANC broker-dealers that filed the FOCUS Report Part II CSE, and OTC derivatives dealers that filed the FOCUS Report Part IIB will need to enter into the FOCUS Report Part II, as amended, substantively the same information as was required of them prior to these amendments.

The Commission believes that the information elicited from stand-alone broker-dealers on their security-based swap activities will assist the Commission and the DEAs of these entities to examine them more effectively. The reporting requirements for stand-alone broker-dealers on account of their security-based swap related activities are also expected to promote transparency of the financial and operational condition of these entities to the Commission.

ii. Broker-Dealer SBSDs and MSBSPs (Amendments to Rule 17a-5)

The Commission has designed FOCUS Report Part II, as amended, to elicit the information that it believes it needs to effectively oversee the financial condition of broker-dealer SBSDs and MSBSPs. The Commission has carefully considered FOCUS Report Part II, as amended, in light of its experience with broker-dealer regulation and in relation to its new statutory responsibilities under Section 15F of the Exchange Act. The Commission believes that the information elicited in FOCUS Report Part II, as amended, will promote compliance of the relevant regulated entities with Rules 15c3-1 and 15c3-3 and will assist the Commission, SROs, state securities regulators and the regulated entities' DEAs in conducting effective examinations of these entities. Additionally, the broker-dealer SBSD and broker-dealer MSBSP reporting requirements related to their security-based swap activities should promote transparency of the financial and operational condition of the broker-dealer to the Commission and the firms' DEA. This may, in turn, improve the Commission's ability to value the relevant registrants' security-based swap exposures and assist the Commission in assessing these entities' compliance with rules related to capital requirements.

iii. Stand-Alone SBSDs and MSBSPs (New Rule 18a-7)

As described in more detail above,[913] stand-alone SBSDs and MSBSPs will be required to file FOCUS Report Part II, as amended, with the Commission or its designee on a monthly basis.[914] With respect to their security-based swap activities, stand-alone SBSDs and MSBSPs are required to report information similar to that required of broker-dealer SBSDs. However, these entities are not required to complete the sections applicable only to broker-dealers.

In addition, stand-alone MSBSPs will be required to complete a simpler Computation of Tangible Net Worth, compared to the much longer and more complex Computation of Net Capital and Computation of Minimum Regulatory Capital Requirements sections that stand-alone SBSDs are required to complete.[915] Moreover, stand-alone MSBSPs will not be required to complete the sections in FOCUS Report Part II, as amended, that require firms to compute the amount that must be maintained in the security-based swap customer reserve account or the section relating to information for the possession or control requirements for security-based swap customers because stand-alone MSBSPs generally will not be subject to those requirements under Rule 18a-4.[916] Furthermore, stand-alone MSBSPs will not be required to complete and file a number of sections of FOCUS Report Part II, as amended, that relate to the operational data related to the firm; specifically, they will not be required to complete and file the Capital Withdrawals, Capital Withdrawals Recap, and the Financial and Operational Data sections of FOCUS Report Part II, as amended.[917] The Commission therefore believes that the economic effects associated with the reporting requirements on stand-alone MSBSPs will be significantly less than the economic effects of the reporting requirements on stand-alone SBSDs.

In addition, stand-alone SBSDs and MSBSPs will be required to generate and file their financial report and, in the case of stand-alone SBSDs, compliance report or exemption report, with the Commission on an annual basis.[918] While the Commission expects that stand-alone SBSDs and MSBSPs currently prepare financial statements that encompass their security-based swap activity, under the new rules, these entities will be required to prepare a financial report in a format consistent with FOCUS Report Part II, as amended, which includes numerous entries, computations, and schedules that a stand-alone SBSD may not currently prepare as a part of its business practices.

For stand-alone SBSDs approved to use models, there will be a number of additional monthly and quarterly reporting requirements, independent of those on FOCUS Report Part II, as amended.[919] The additional reports required of stand-alone SBSDs approved to use models are modeled on parallel reporting requirements for ANC broker-dealers.[920] Consequently, stand-alone SBSDs approved to use models will be required to file the same types of additional reports relating to their use of internal models as ANC broker-dealers, including ANC broker-dealer SBSDs.

The Commission believes that using the new reporting requirements will help the Commission to evaluate whether stand-alone SBSDs and MSBSPs are operating in compliance with the Exchange Act and the rules thereunder. The Commission also believes that the availability of FOCUS Report Part II, as amended, will greatly enhance the Commission's ability to oversee the financial condition of the relevant registrants, and that the public Start Printed Page 68636availability of a firm's audited Statement of Financial Condition and net capital computations will facilitate the public's evaluation of the firm's financial health.

In response to comments received to the proposing release, the Commission is modifying Rule 18a-7 so that stand-alone SBSDs and MSBSPs, as well as SBSDs also registered as an OTC derivatives dealers, may engage an independent public accountant that is not registered with the PCAOB, and that the accountant may prepare its reports in accordance with GAAS in the United States or PCAOB standards.[921] The Commission estimates that of the 9 stand-alone SBSDs, 3 will make use of the full alternative compliance mechanism.[922] The Commission estimates that of the 5 MSBSPs, one will also be registered as an FCM. As with Commission registered broker-dealers, CFTC-registered FCMs are required to use independent accountants that are registered with the PCAOB.[923]

The Commission estimates that there will be 6 stand-alone SBSDs and 4 MSBSPs that may engage an independent public accountant as a result of Rule 18a-7.[924] The Commission estimates the total cost to these 10 entities to engage an accountant as required by Rule 18a-7 to be $3,018,000.[925] Providing these options to these types of SBSDs and MSBSPs will not change the requirement to engage an independent public accountant but will increase the number of accountants that could potentially be hired. The Commission believes this could result in lower costs to this group of firms.

iv. Bank SBSDs and MSBSPs (New Rule 18a-7)

As described above,[926] bank SBSDs and MSBSPs will be required to periodically complete and file FOCUS Report Part IIC with the Commission. Relative to what broker-dealer SBSDs, broker-dealer MSBSPs, stand-alone SBSDs, and stand-alone MSBSPs will report in FOCUS Report Part II, as amended, bank SBSDs and MSBSPs will report less information on FOCUS Report Part IIC because FOCUS Report Part IIC is tailored specifically to a bank's activities as an SBSD or an MSBSP. Further, FOCUS Report Part IIC elicits financial information that largely derives from the information that banks already report on the call reports that they file with their prudential regulators.[927] Finally, unlike broker-dealer SBSDs, broker-dealer MSBSPs, stand-alone SBSDs and MSBSPs, bank SBSDs and MSBSPs will not be required to complete and file an annual audited financial report because this set of potential registrants are currently subject to the reporting requirements administered by their prudential regulators. These reporting requirements include filing of annual audited financial reports.

Consistent with the directive in Section 15F(f) of the Exchange Act, bank SBSDs and MSBSPs will also be required to report, in FOCUS Report Part IIC, details relating to their security-based swap activities. To this end bank SBSDs and MSBSPs will be required to create and maintain additional relevant details about their security-based swap positions. In relation to reporting details about bank SBSDs' or bank MSBSPs' security-based swap positions, the Commission has limited the number of schedules required to be completed and filed by these entities in FOCUS Report Part IIC to one schedule that elicits details about their security-based swap positions. This schedule is also largely derived from the banks' call report.

The Commission believes that the reporting requirements for bank SBSDs and MSBSPs will help the Commission and other regulators ensure that registrants follow applicable capital, margin, and segregation rules. The Commission believes that such capital, margin, and segregation rules are an integral part of ensuring that security-based swap activity is conducted in a financially responsible manner.

d. Notification Requirements

i. Broker-Dealer SBSDs and MSBSPs (Amendments to Rule 17a-11)

The Commission is adopting amendments to existing Rule 17a-11—which specifies the circumstances under which a broker-dealer must notify the Commission and other securities regulators about its financial or operational condition, as well as the form that the notice must take—to account for the security-based swap activities of broker-dealer SBSDs and MSBSPs.[928] Specifically, a broker-dealer SBSD will be required to notify the Commission when it fails to make a deposit in its security-based swap customer account.[929]

The Commission believes that the amendments to Rule 17a-11 will result in improving Commission and DEA oversight of broker-dealer SBSDs' and broker-dealer MSBSPs' security-based swap activities, including activities and financial conditions that suggest a material level of risk to the firm.

ii. Stand-Alone SBSDs, Stand-Alone MSBSPs, Bank SBSDs, and Bank MSBSPs (New Rule 18a-8)

The Commission is adopting new Rule 18a-8—which is modeled on Rule 17a-11, as amended—to establish notification requirements for stand-alone SBSDs, stand-alone MSBSPs, bank SBSDs, and bank MSBSPs.[930] New Rule 18a-8 is modeled closely upon the requirements applicable to broker-dealer SBSDs and MSBSPs. For example, the Commission has included a net capital deficiency and tentative net capital deficiency notification requirement in paragraph (a)(1) of Rule 18a-8 applicable to stand-alone SBSDs that is modeled on the notification requirements applicable to broker-dealers, over-the-counter derivatives dealers, and ANC broker-dealers that appear in paragraph (a) of Rule 17a-11, as amended.[931] The Commission has also included “early warning” notification requirements in paragraph (b) of Rule 18a-8 that will be applicable to stand-alone SBSDs and MSBSPs and that are modeled after the relevant early warning provisions applicable to broker-dealers in paragraph (b) of Rule 17a-11, as amended.[932] Likewise, the requirement for a bank SBSD, bank MSBSP, stand-alone SBSD, or stand-alone MSBSP to notify the Commission in the event that it fails to make and keep current its required books and records is modeled on a similar requirement for broker-dealers.[933]

These notification requirements serve an important role in the context of the reporting and recordkeeping rules for broker-dealer SBSDs, broker-dealer Start Printed Page 68637MSBSPs, stand-alone SBSDs, stand-alone MSBSPs, bank SBSDs, and bank MSBSPs because they serve to alert the Commission to the fact that certain events are occurring at a registrant that are highly relevant to the registrant's overall ability to continue to meet its obligations to customers and counterparties. For example, a report of a capital deficiency will alert the Commission to the fact that a registrant may lack sufficient capital to continue to operate its business and to meet its obligations to customers and counterparties. The notification requirements are thus critical to helping the Commission fulfill its statutory responsibility to monitor whether SBSDs and MSBSPs are operating in compliance with the Exchange Act and the rules thereunder.[934]

e. Quarterly Securities Count Requirement for Stand-Alone SBSDs (New Rule 18a-9)

As discussed in greater detail above,[935] the Commission is establishing a securities count program for SBSDs under Sections 15F and 17(a) of the Exchange Act that is modeled on Rule 17a-13's securities count program for broker-dealers. More specifically, stand-alone SBSDs will be subject to new Rule 18a-9. For reasons explained above, new Rule 18a-9 will not apply to stand-alone MSBSPs, bank SBSDs, or bank MSBSPs.[936] Rule 18a-9 applies substantially all the same affirmative obligations to stand-alone SBSDs that apply to broker-dealers under Rule 17a-13.[937]

As discussed in the Recordkeeping and Reporting Proposing Release, Rule 17a-13, the model for Rule 18a-9, arose in the aftermath of the 1967-1970 securities industry crisis where deficiencies in broker-dealers' internal controls and procedures for, among other things, adequately checking and counting securities created a serious “paperwork crisis” in the securities markets.[938] The Commission believes that instituting a parallel provision will help to avoid a similar problem for stand-alone SBSDs. Moreover, the Commission believes that to the extent a stand-alone SBSD has not invested in the technology necessary to help ensure that it can accurately track and safeguard securities, the rule will require such investments to be made,[939] which could improve the quality of such tracking and safeguarding.

2. Costs of the Recordkeeping, Reporting, Notification, and Securities Count Requirements

Compliance with the new rules and rule amendments will impose certain implementation-related costs on SBSDs and MSBSPs, as well as on stand-alone broker-dealers engaged in security-based swap activities. These costs may include start-up costs, including other costs such as those related to personnel and technology. The Commission understands that entities that engage in security-based swap transactions currently already incur costs during their normal business activities and that the new rules and rule amendments will impose incremental costs on such entities. While these incremental costs are not negligible, the Commission believes that they are unlikely to be material.

Based on section IV.D. of this release, the Commission has estimated the implementation-related costs of the new rules and rule amendments for SBSDs, MSBSPs, and stand-alone broker-dealers that engage in security-based swap activities.[940] The Commission estimates that across all potential SBSDs and MSBSP registrants including stand-alone broker dealers that engage in security-based swap transactions, the initial implementation costs are approximately $10 million and the ongoing annual costs of implementation are approximately $9 million.

The following is a breakdown of the estimates of the costs imposed by the different rules and rule amendments being adopted in this document on each of the affected parties.[941]

a. Requirements To Make and Keep Records

i. Broker-Dealer SBSDs, Broker-Dealer MSBSPs, and Stand-Alone Broker-Dealers (Amendments to Rule 17a-3)

Amendments to Rule 17a-3 are estimated to impose a one-time initial cost of approximately $1,151,320 [942] and an annual ongoing cost of approximately $216,657 [943] across the entire industry that includes broker-dealer SBSDs, broker-dealer MSBSPs and stand-alone broker-dealers engaged in security-based swap activities.

ii. Stand-Alone SBSDs, Stand-Alone MSBSPs, Bank SBSDs, and Bank MSBSPs (New Rule 18a-5)

The Commission estimates that new Rule 18a-5 will result in a total initial industry cost of $2,554,740 for non-broker-dealer SBSDs and MSBSPs.[944] On an ongoing annual basis, the Commission estimates that new Rule 18a-5 will result in $791,475 of total industry costs for non-broker-dealer SBSDs and MSBSPs.[945]

The Commission believes that requiring non-broker-dealer SBSDs and MSBSPs to comply with more limited recordkeeping requirements relative to broker-dealer SBSDs and MSBSPs, in keeping with the former entities' more restricted SBS-related business activities, will reduce compliance costs for these entities without compromising the effectiveness of the regulatory oversight achieved by the adopted rules.

Additionally, the Commission has attempted to reduce compliance burdens and to allow firms subject to Rule 18a-5 to take advantage of potential efficiencies by basing new Rule 18a-5 upon existing Rule 17a-3 rather than starting with a wholly new rule. The Commission believes that many non-broker-dealer SBSDs and non-broker-dealer MSBSPs will be affiliates of broker-dealers that already have familiarity with Rule 17a-3 upon Start Printed Page 68638which new Rule 18a-5 is modeled. Greater familiarity with the rule should reduce compliance burdens and costs for these entities. However, the Commission does acknowledge that with respect to entities not so affiliated, this approach is much less likely to ease compliance burdens.

b. Requirements To Preserve Records

i. Broker-Dealer SBSDs, Broker-Dealer MSBSPs, and Stand-Alone Broker-Dealers (Amendments to Rule 17a-4)

The Commission estimates that the amendments to Rule 17a-4 will result in a total initial industry cost of $1,338,896 to broker-dealers.[946] On an ongoing annual basis, the Commission estimates that the amendments to Rule 17a-4 will result in $164,704 in industry costs to broker-dealers.[947]

ii. Stand-Alone SBSDs, Stand-Alone MSBSPs, Bank SBSDs, and Bank MSBSPs (New Rule 18a-6)

The Commission estimates that new Rule 18a-6 will result in $3,634,864 in terms of initial costs to the industry [948] and $750,615 in terms of annual ongoing costs to the industry.[949]

c. Reporting Requirements

i. Broker-Dealer SBSDs, Broker-Dealer MSBSPs, and Stand-Alone Broker-Dealers (Amendments to Rule 17a-5)

The Commission anticipates that there may be additional costs associated with stand-alone broker dealers, broker-dealer SBSDs or broker-dealer MSBSPs completing and filing the annual reports required under paragraph (d) of Rule 17a-5, as amended. For example, the amendments will increase the cost of completing the annual compliance report filed by a broker-dealer SBSD because the compliance report for such firms will include statements about the firms' compliance with Rule 18a-4, the customer segregation rule that will apply to broker-dealer SBSDs.[950] Similarly, an ANC broker-dealer that currently files FOCUS Report Part II CSE and that registers with the Commission as an SBSD or MSBSP will experience a marginal impact on its reporting obligations due to new line items and schedules tailored to specifically elicit details about security-based swap activities.[951]

The Commission also anticipates that the cost of auditing the annual reports filed by stand-alone broker-dealers, broker-dealer SBSDs and MSBSPs will rise.[952] Currently, and as described in more detail above, broker-dealers are required to engage a PCAOB-registered independent public accountant to conduct an annual audit of their annual reports.[953] The Commission believes the additional required components of the financial report and the compliance report will increase the costs of ongoing compliance as well as those of the annual audit for these entities.

However, the Commission believes that overall the additional costs imposed by the amendments will be insubstantial because the FOCUS Report Part II, as amended, largely retains the same structure as it existed prior to the amendments. This will reduce uncertainty and avoid additional compliance costs that could stem from devising an entirely new reporting form and rules. Furthermore, the scope of the additional information—generally related to the firms' security-based swap activities—requested in FOCUS Report Part II, as amended, is circumscribed by what broker-dealer SBSDs and MSBSPs report currently in FOCUS Report Part II, Part II CSE, or Part IIB. The Commission believes that the economic effects associated with the requirement to file FOCUS Report Part II, as amended, will accordingly be circumscribed by the relevant registrants' current reporting obligations.

The Commission estimates that the amendments to Rule 17a-5 will result in an initial total cost of $291,865 to broker-dealers.[954] On an ongoing annual basis, the Commission estimates that the amendments to Rule 17a-5 will result in total costs of $1,862,556 per year to broker-dealers.[955]

ii. Stand-Alone SBSDs, Stand-Alone MSBSPs, Bank SBSDs, and Bank MSBSPs (New Rule 18a-7)

New Rule 18a-7 as adopted will require stand-alone SBSDs and MSBSPs to file FOCUS Report Part II, as amended, with the Commission or its designee on a monthly basis. Given that stand-alone SBSDs and MSBSPs are not broker-dealers, these firms do not have experience filing the FOCUS Report, and thus reporting on FOCUS Report Part II, as amended, could represent a significant undertaking for them.

Relative to the information these firms generate now, FOCUS Report Part II, as amended, likely elicits greater detail about the registrants' security-based swap positions. In order to be able to provide the security-based swap information elicited by FOCUS Report Part II, as amended, registrants will need to have the requisite additional details regarding their security-based swap positions. While the Commission expects that stand-alone SBSDs and MSBSPs currently prepare financial statements that encompass their security-based swap activity, reporting on FOCUS Report Part II, as amended, may require these firms to establish new systems that facilitate their reporting of the required information. While these upgrades are likely to entail costs for firms, firms may also use these upgrades towards more efficiently tracking their trading and security-based swap exposures.

Moreover, since many of the entities that the Commission expects will register as stand-alone SBSDs and MSBSPs are currently not regulated, they are likely to be unaccustomed to completing and filing detailed reports with financial regulators. Therefore the Commission anticipates that stand-alone SBSDs and MSBSPs will bear substantial costs in connection with completing and filing FOCUS Report Part II, as amended.

Rule 18a-7 as adopted further requires stand-alone SBSDs to generate and file their financial report and their Start Printed Page 68639compliance report or exemption report with the Commission on an annual basis. The compliance report contains several statements and descriptions related to the firms' compliance with the financial responsibility rules. The exemption report contains several statements regarding the firms' exemption from Rule 18a-4. These details will be entirely new for most stand-alone SBSD registrants. Finally, Rule 18a-7 requires stand-alone SBSDs and MSBSPs to file an annual audited report with the Commission. Stand-alone SBSDs and MSBSPs will be required to hire an independent public accountant to perform the audit and to prepare the annual audit report. The Commission is modifying Rule 18a-7 to permit stand-alone SBSDs and MSBSPs the option to engage an independent public accountant that is not registered with the PCAOB, and to permit the accountant to use GAAS in the United States or PCAOB Standards.[956]

The Commission believes that this will entail compliance-related costs for these entities. Specifically, the Commission believes that stand-alone SBSDs approved to use models may incur compliance costs related to, among other things, preparing and filing the additional reports that will be required under the new rules. The Commission estimates that all stand-alone MSBSPs will incur costs stemming from the requirement to engage an auditor. The Commission anticipates that stand-alone MSBSPs will incur fewer costs in complying with these requirements as compared to stand-alone SBSDs because stand-alone MSBSPs will not be required to file the compliance report or the exemption report. The Commission believes the additional reports that stand-alone SBSDs approved to use models will be required to file with the Commission will give rise to less substantial compliance costs relative to the other costs generated by the reporting requirements. This is the case because the additional reporting obligations for stand-alone SBSDs approved to use models are relatively few and are generally closely related to their use of internal models approved by the Commission to calculate market and credit risk. Stand-alone SBSDs approved to use models will incur the majority of the costs associated with these internal models in designing and operating the models themselves rather than in filing the reports arising from these models.

While the Commission understands that stand-alone SBSDs and MSBSPs may not currently be registered as broker-dealers and thus may not currently be filing the FOCUS Report (and thus have no familiarity with it), many stand-alone SBSDs and MSBSPs may be affiliated with, or be part of, a larger financial firm that contains a broker-dealer, thus providing a source of experience with the FOCUS Report that is internal to the firm and reducing compliance-related costs. Moreover, the accounting and legal communities are familiar with the FOCUS Report so the Commission believes that this familiarity should mitigate the compliance costs for stand-alone SBSDs and MSBSPs insofar as they have access to external assistance that has experience with the FOCUS Report. At the same time, the Commission acknowledges that there may be stand-alone SBSDs and MSBSPs affiliated with, for example, FCMs, and such firms would conceivably benefit from rules based upon or similar to CFTC rules.

Furthermore, the information required to be reported by bank SBSDs and MSBSPs on the FOCUS Report Part IIC largely would be information that banks are already required to provide in call reports. Thus, the Commission does not believe that FOCUS Report Part IIC will require substantial additional effort to complete.[957]

The Commission estimates that Rule 18a-7 will result in an initial industry cost of $597,180.[958] The Commission further estimates that Rule 18a-7 will result in an ongoing annual industry cost of $3,169,083.50.[959]

d. Notification Requirements

The Commission believes that costs of the notification requirement will be incidental to the related underlying substantive obligation.

i. Broker-Dealer MSBSPs and Stand-Alone Broker-Dealers (Amendments to Rule 17a-11)

The Commission believes that most of the costs stemming from the notification requirements contained in amendments to Rule 17a-11 will arise from preparing and filing the notices. In the aggregate, the Commission estimates the amendments to Rule 17a-11 to result in an ongoing annual industry cost of $28,245 to broker-dealer SBSDs and MSBSPs.[960]

ii. Stand-Alone SBSDs, Stand-Alone MSBSPs, Bank SBSDs, and Bank MSBSPs (New Rule 18a-8)

The Commission estimates that the notification requirements contained in new Rule 18a-8 for non-broker-dealer SBSDs and MSBSPs will result in an ongoing annual industry-wide costs of $1,237.[961]

e. Quarterly Securities Count Requirement (New Rule 18a-9)

The Commission believes that the costs and any larger economic effects associated with new Rule 18a-9 should be similar to the costs associated with existing Rule 17a-13 on which new Rule 18a-9 is modeled. These costs will primarily be related to the development and maintenance of internal procedures and controls and the investment in technology. The Commission estimates that Rule 18a-9 will impose an initial industry-wide cost of $51,150 [962] and an industry-wide ongoing annual cost of $75,600.[963]

Start Printed Page 68640

3. Economic Effects of the Approach to Recordkeeping, Reporting, Notification, and Securities Count Requirements

In addition to the costs and benefits of the specific rules and amendments discussed above, certain economic effects arise from the Commission's overall approach in adopting recordkeeping, reporting, notification, and securities count requirements. Generally, the new requirements being adopted in this document are based upon the existing comprehensive system of recordkeeping, reporting, notification, and securities count rules applicable to broker-dealers, as modified to capture and document the security-based swap activities of broker-dealers, SBSDs, and MSBSPs. As discussed in Section II. above, the current broker-dealer recordkeeping, reporting, notification, and securities count requirements served as the template for the new rules and rule amendments for several reasons. The financial markets in which entities expected to register as SBSDs and MSBSPs operate are similar to the financial markets in which broker-dealers currently operate in that the markets are driven in significant part by dealers that buy and sell on a regular basis and take principal risk.

The Commission believes that adopting a similar regulatory approach for similar markets is likely to mitigate the cost borne by market participants. Broker-dealers and third-party service providers that assist broker-dealers in meeting their recordkeeping, reporting, and notification requirements are familiar with Commission recordkeeping, reporting, and notification rules for broker-dealers. To the extent that these entities become subject to these final rules or provide services to entities that become subject to these final rules, consistency with the existing recordkeeping, reporting, and notification requirements for broker-dealers will likely reduce the costs associated with compliance with these rules. The Commission believes that these efficiencies could be realized even by firms that are not currently registered as broker-dealers given that some of the new registrants will likely be part of larger financial firms that have a broker-dealer affiliate, thus providing a source of in-house experience with the Commission's broker-dealer rules. However, the Commission acknowledges that these reductions in compliance costs may be much more limited for firms that are not currently broker-dealers and are not affiliated with broker-dealers.

In addition, Commission staff consulted with staff from fellow regulators regarding the new rules and rule amendments, as those regulators may have analogous regulations. The Commission believes the final rules may benefit security-based swap markets by applying recordkeeping and reporting requirements that are consistent with similar requirements in other jurisdictions. In considering whether there were other practicable regulatory alternatives, the Commission also examined existing rules of the prudential regulators. For example, the OCC has promulgated rules governing recordkeeping and confirmation requirements for securities transactions effected by national banks.[964] Paragraph (a)(1) of the OCC rule governing the record that a national bank effecting securities transactions for customers must maintain (Rule 12.3) appears broadly consistent with paragraph (a)(6) of Rule 17a-3, as amended, as well as with paragraph (b)(7) of Rule 18a-5.[965] Consistency with prudential regulators' requirements may mitigate compliance burdens for bank SBSDs and MSBSPs that become subject to the adopted rules.

The Commission also believes the new rules and rule amendments herein are broadly consistent with the approach taken by the CFTC. The CFTC's final rules were modeled on existing rules promulgated by both the CFTC and the Commission.[966] As noted above,[967] entities that are active participants in the security-based swap market also tend to be active participants in the CFTC-regulated swap market, and the Commission estimated that approximately 35 of the 50 expected SBSDs will be dually registered with the CFTC and therefore be subject to CFTC recordkeeping, reporting, and notification requirements.

The recordkeeping rules the Commission is adopting are similar to those of the CFTC in terms of their level of prescriptiveness. For example, paragraph (a)(1) of existing Rule 17a-3 sets forth the requirement that a broker-dealer make and keep current a trade blotter, while paragraphs (a)(1) and (b)(1) of Rule 18a-5 include parallel blotter requirements for stand-alone SBSDs and MSBSPs and bank-SBSDs and bank-MSBSPs respectively.[968] In comparison, the CFTC's rule 202 (“Daily Trading Records”), which corresponds to the Commission's Rules 17a-3 and 18a-5, prescribes that swap dealers and major swap participants must make and keep trade execution records that are very similar to the records required to be made and kept by Rules 17a-3 and 18a-5.[969] Because the Commission is adopting requirements that are similar to CFTC requirements, entities that are already registered with the CFTC may experience relatively lower costs to become compliant with the adopted rules.

Further, as the Commission has noted in other releases, regulatory consistency can also reduce the likelihood of regulatory arbitrage. The new requirements applicable to stand-alone SBSDs and MSBSPs seek to regulate these firms' security-based swap activity in a manner consistent with the regulation of security-based swap activities conducted at broker-dealers and at banks, while reflecting the business model of such entities.[970] As a result, the final rules mitigate the risk that bank SBSDs and MSBSPs restructure their activities in order to take advantage of differences in prudential regulators' recordkeeping and reporting requirements and those adopted by the Commission.

The Commission believes that applying consistent requirements across all entities that engage in security-based swap activity will facilitate competition between these entities on similar terms insofar as firms operating in different jurisdictions will incur similar compliance costs. The Commission is seeking to provide all security-based swap activity, irrespective of the entity within which such activity is conducted, a level regulatory playing field while being cognizant of the fact that firms with a more limited security-based swap business should also be subject to an appropriately circumscribed set of regulations.Start Printed Page 68641

In response to a commenter's concerns regarding harmonization with the CFTC's recordkeeping requirements as well as to promote harmonization with CFTC requirements,[971] the Commission is also adopting a limited alternative compliance mechanism that—subject to certain requirements [972] —allows registrants to employ a single recordkeeping system for swap and security-based swap transactions and positions and to follow a single set of recordkeeping requirements while helping to ensure that the requisite records are promptly available to the Commission staff in a format that readily permits examination. The limited alternative compliance mechanism could thereby ease compliance burdens—particularly initial burdens—for registrants that have already devoted substantial resources towards complying with the CFTC's recordkeeping requirements for swap transactions and positions and will not be required to incur afresh the costs of the recordkeeping system software needed to comply with the Commission's new recordkeeping requirements for security-based swap transactions and positions. The limited alternative compliance mechanism should also afford the relevant registrants greater flexibility in the manner in which they record security-based swap transactions and positions.[973]

Finally, the Commission is amending the full alternative compliance mechanism in existing Rule 18a-10 that permits certain SBSDs that are registered as swap dealers and that predominantly engage in a swaps business to elect to comply with the capital, margin, and segregation requirements of the CEA and the CFTC's rules in lieu of complying with the capital, margin, and segregation requirements in Rules 18a-1, 18a-3, and 18a-4. The amendments to Rule 18a-10 will permit firms that will operate under Rule 18a-10 to elect to comply with the recordkeeping and reporting requirements of the CEA and the CFTC's rules in lieu of complying with Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9. The Commission believes the availability of the full alternative compliance mechanism will promote harmonization with CFTC requirements and reduce compliance costs for eligible SBSDs and MSBSPs. The Commission estimates that in the absence of the full alternative compliance mechanism, the initial industry compliance costs could be as much as $827,715 higher and the ongoing annual industry compliance could be as much as $1,292,637 higher.[974]

4. Cross-Border Application and Substituted Compliance

As discussed above,[975] the Commission treats the adopted recordkeeping and reporting requirements as entity-level requirements. Entity-level requirements apply to all the security-based swap transactions of the registered entity regardless of the U.S. person status of the entity or the U.S. person status of the entity's counterparty to any particular transactions. The Commission believes that the concentration of global security-based swap activity within a small group of large entities makes entity level regulation—thereby not exempting certain transactions from the recordkeeping, reporting, notification, and securities count requirements being adopted in this document—critical to advancing the policy objectives of Title VII.

Classifying security-based swap recordkeeping and reporting requirements as entity-level requirements may facilitate and strengthen Commission oversight of registered SBSDs and enhance compliance with the full range of obligations under Federal securities laws and Commission rules regardless of the location of counterparties or personnel. Title VII security-based swap recordkeeping and reporting requirements may enhance the Commission's ability to evaluate foreign SBSDs and MSBSPs' records for evidence of market manipulation or other abusive practices within the United States. Moreover, since the marginal cost of keeping daily trading records and confirmations is likely to be low for SBSDs and MSBSPs, the Commission does not believe that the savings associated with limited application of these requirements to a subset of an SBSD's or MSBSP's transactions is likely to be high.

In considering the scope of the entities that will be included within the ambit of the new recordkeeping, reporting, notification, and securities count requirements being adopted in this document, the Commission is aware that market participants may respond to entity-level requirements by restructuring their business or exiting markets to reduce the likelihood of incurring an obligation to register with the Commission. Compliance with the recordkeeping and reporting requirements will increase costs for SBSDs and MSBSPs, including those that are non-U.S. persons. To the extent that foreign SBSDs and MSBSPs have market power, they may pass the costs of these requirements through to U.S. persons in the form of higher transaction costs. Furthermore, to the extent that non-U.S. persons avoid transacting with U.S. persons to avoid registration requirements, U.S. persons may implicitly bear the costs of compliance through reduced access to liquidity provided by non-U.S. persons.[976]

Given that security-based swap markets are global and the Commission expects registered SBSDs and MSBSPs to transact across multiple jurisdictions, some registered SBSDs may be subject to duplicative or mutually conflicting recordkeeping and reporting requirements in multiple foreign jurisdictions. This may impede the entry of foreign SBSDs and MSBSPs into the U.S. security-based swap market, disrupt existing business relationships, and, more generally, reduce competition and market efficiency. As discussed above, the Commission is amending Rule 3a71-6 to provide non-U.S. SBSDs and non-U.S. MSBSPs with the potential to utilize substituted compliance with comparable foreign requirements to satisfy the recordkeeping and reporting requirements of Section 15F of the Exchange Act and Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9 thereunder.[977]

Allowing for the possibility of substituted compliance is expected to help achieve the benefits of the recordkeeping and reporting requirements being adopted in this document in a manner that avoids the costs that foreign registrants would have Start Printed Page 68642to bear due to regulatory duplication or conflict. A substituted compliance determination could thus preserve the access of foreign registrants into U.S. security-based swap markets and hence promote market efficiency and enhance competition therein while also generally facilitating a well-functioning global security-based swap market. Further, as the availability of substituted compliance lowers the potential costs to non-U.S. SBSDs and non-U.S. MSBSPs of complying with the rules being adopted in this document, the costs of completing security-based swap transactions may be lower, relative to the case where substituted compliance is not available and counterparties, including non-dealer counterparties, may bear lower transactions costs as a result. At the same time, the process of making substituted compliance requests may cause foreign registrants to incur additional costs of applying for a substituted compliance determination. These substituted compliance requests will be made on a voluntary basis, and foreign registrants will only make such requests when the anticipated costs of relying on substituted compliance are lower than the costs of complying directly with the final rules being adopted in this document. Further, after a substituted compliance determination is made, foreign registrants will choose substituted compliance only if their expected private benefits from participating in U.S. security-based swap markets exceed expected private costs, including any conditions the Commission may attach to the substituted compliance determination.

The Commission also recognizes that these costs and the overall economic effects of allowing substituted compliance for the final recordkeeping and reporting rules will depend on, among other things: Whether and to what extent substituted compliance requests will be granted for jurisdictions in which some of the most active foreign registrants are currently regulated and supervised; the costs of potential relocation, business restructuring, or direct compliance by foreign registrants that may be denied substituted compliance requests; the relevant information required to demonstrate consistency between the foreign regulatory requirements and the Commission's recordkeeping and reporting rules; the relevant information required to demonstrate the adequacy of the foreign regime's compliance and enforcement mechanisms; the fraction of foreign registrants in a given jurisdiction that may choose to make substituted compliance requests; and whether substituted compliance determinations for subsequent applications are more likely to be granted after an initial affirmative substituted compliance determination for the first applicant from a given jurisdiction. Nevertheless, the potential for the duplication of recordkeeping and reporting compliance costs on foreign registrants may be more significant in cases where the foreign jurisdictions' regulatory regimes impose less stringent recordkeeping and reporting requirements than the requirements being adopted in this document or when other prerequisites for substituted compliance have not been satisfied. The Commission thus recognizes that there will be limits to the availability of substituted compliance, including the possibility that substituted compliance may be permitted with regard to some requirements and not with regard to others, or that, in certain circumstances, substituted compliance may not be permitted with respect to any requirements of a particular jurisdiction.

D. Impact on Efficiency, Competition, and Capital Formation

Section 3(f) of the Exchange Act provides that whenever the Commission engages in rulemaking under the Exchange Act and is required to consider or determine whether an action is necessary or appropriate in the public interest, the Commission shall also consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation. In addition, Section 23(a)(2) of the Exchange Act requires the Commission, when making rules under the Exchange Act, to consider the impact such rules would have on competition.[978] Section 23(a)(2) of the Exchange Act also prohibits the Commission from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act.

In the aggregate, the recordkeeping, reporting, and notification rules are an integral part of the financial responsibility rules governing security-based swaps which, in turn, are part of the regulatory regime for OTC derivatives markets established by Title VII of the Dodd Frank Act. As stated above, the Commission believes that the recordkeeping, reporting, notification, and securities count rules and rule amendments being adopted in this document address, among other things, the documentation, reporting, and evidence of compliance with the capital, margin, and segregation rules. Thus, the Commission believes that these rules, by their nature, will have a more limited economic impact as compared to the Commission's capital, margin, and segregation rules.[979]

Similarly, while the Commission expects that the adoption of these rules and rule amendments, and their attendant benefits and costs, will affect competition, efficiency, and capital formation, the Commission believes that such impact will be more limited than the impact from the capital, margin, and segregation rules. In most instances, the Commission believes the costs of the new rules and rule amendments will be implementation-related and the benefits will stem from enabling the Commission to evaluate whether SBSDs and MSBSPs are in compliance with the financial responsibility rules governing security-based swap activities. The Commission's belief that the costs of the rule and rule amendments will be implementation-related is supported by the results of a broker-dealer survey conducted prior to the finalization of the OTC derivatives rules.[980] According to this survey even though the majority, i.e., 57.5% of surveyed broker-dealers, stated that they expected to be “highly impacted” by the regulation of OTC derivatives markets under Title VII of the Dodd Frank Act,[981] the specific areas that were anticipated as representing top operational challenges were all implementation-related. Thus, the majority, i.e., 61.9% of surveyed broker-dealers, indicated that their top anticipated challenge from Title VII regulations for OTC derivatives markets was “documenting compliance with suitability requirements when making recommendations to counterparties” followed by 59.5%, who cited the “need for subject matter expertise to derivatives and the disclosure obligations set forth in the CFTC's recently proposed rules.” In terms of the areas that the survey respondents anticipated would represent the most significant operational challenges emerging from the Dodd-Frank Act, 45.3% indicated “regulatory inquiries and exams” followed by 35.7% for Start Printed Page 68643“trade reporting” and 19% for “disclosures and reporting requirements.”

The rules are designed to provide greater regulatory transparency into the business activities of firms that engage in security-based swap activities and to assist the Commission and other regulators in reviewing and determining compliance with the capital, margin, and segregation requirements. As the Commission has discussed in its associated release,[982] the capital, margin, and segregation requirements have the potential to enhance efficiency and capital formation in financial markets through their impact on competition. In general, the Commission believes that the new rules and rule amendments will thus help ensure that firms that engage in security-based swap activities do so in a financially responsible manner. The Commission further believes that the new rules and rule amendments, by improving its ability to monitor the financial condition of the relevant registrants, could increase the willingness of market participants that value regulatory oversight of the security-based swap market to engage in security-based swap activities. Additional participation in the security-based swap market could lead to increased competition between suppliers of security-based swap liquidity and increased efficiency, through both lower transactions costs and reduced search costs. These, in turn, may have a positive effect on capital formation, to the extent that they improve opportunities for risk sharing using security-based swaps.

The Commission is cognizant, however, that it must be sensitive to the costs and burdens imposed by its rules on both individual firms and financial markets as a whole. For example, overly restrictive or costly recordkeeping requirements could reduce the willingness of firms to engage in security-based swap trading. This could, in turn, increase transaction costs for market participants and dampen liquidity in the market. Even if the costs of overly restrictive recordkeeping, reporting, notification, and securities count requirements were shouldered only by those market participants that are subject to them, the regulations will impose additional costs on capital markets at large since the resources used to comply with the regulations will not be available for potentially more efficient uses, thereby distorting capital allocation and, in turn, adversely affecting capital formation. Similarly, the additional costs of the new recordkeeping, reporting, securities count, and notification requirements could represent barriers to entry for potential market participants; however, the Commission believes that these rules and rule amendments are unlikely to increase the barriers to entry in this market in a material way. Notwithstanding this belief, the Commission has taken steps, where appropriate, to reduce compliance costs for some SBSDs and MSBSPs by establishing the limited and full alternative compliance mechanisms.

As described in more detail above, broker-dealers historically have not participated in a significant way in security-based swap trading, in part, because the existing broker-dealer capital requirements make it relatively costly to conduct these activities in broker-dealers.[983] Thus, from among the 3,893 stand-alone broker-dealers registered with the Commission as of December 31, 2017, the Commission estimates that approximately twenty-five (or only 0.62%) will be engaged in security-based swap activities while not being required to register as SBSDs or MSBSPs.[984]

To the extent that the new rules or rule amendments are burdensome or costly, they may induce market participants to scale back their activities or exposures to avoid incurring the obligation to register as SBSDs or MSBSPs. This reduction in scale could adversely impact competition between liquidity suppliers leading to lower liquidity, impeded price discovery, and higher transaction costs, all of which are characteristics of reduced levels of efficiency in the market. Moreover, it is possible that increased costs could lead certain market participants to cease engaging altogether in security-based swap trading or to restructure their activities in ways that allow them to avoid registration with the Commission and entity-level requirements under Title VII.

The Commission is particularly cognizant of the impacts of restructuring in financial markets that are global in scope. Competitive disparities in regulations across different jurisdictions coupled with SBSDs' flexibility to restructure their businesses and operations may result in market fragmentation.[985] The outcome of such restructuring could be a large pool of security-based swap liquidity consisting of transactions that are carried out by unregistered non-U.S.-person dealers with non-U.S.-person counterparties using personnel outside of the United States and a smaller pool consisting of transactions involving U.S. persons or using personnel located in a U.S. branch or office. Such fragmentation could make it more difficult for U.S. persons to find liquidity in the United States, and those U.S. persons that might otherwise use security-based swaps to hedge financial and commercial risks may reduce their hedging activity and assume an inefficient amount of risk, or engage in precautionary savings by accumulating capital to mitigate the effects of market risks, which would inhibit capital formation. The Commission notes, however, that the type of restructuring necessary to avoid counting security-based swap dealing activity towards de minimis thresholds which will trigger requirements to register as an SBSD will likely be costly for non-U.S. persons,[986] and these costs may reduce the likelihood that non-U.S. persons restructure in response to the requirements being adopted in this release. In particular, to the extent that the costs of restructuring are larger than the costs of complying with Commission recordkeeping, reporting, and notification rules, they may reduce the likelihood of market fragmentation and the associated impacts on competition, efficiency, and capital formation that might otherwise result from counterparties seeking to avoid complying with these rules.

In addition to the competitive effects of compliance burdens discussed above, the approach to substituted compliance may impact competition between U.S. and non-U.S. entities. Substituted compliance for recordkeeping and reporting requirements may reduce burdens for foreign SBSDs and MSBSPs and may promote competition if it reduces the likelihood that foreign SBSDs and MSBSPs exit the U.S. security-based swap market. Moreover, substituted compliance could improve efficiency by reducing the potential that a fragmented market develops, in which Start Printed Page 68644U.S. persons cannot easily access liquidity provided by foreign SBSDs and MSBSPs.

E. Alternatives to the Adopted Recordkeeping, Reporting, Notification, and Securities Count Rules

The Commission recognizes that there may be other appropriate approaches to establishing recordkeeping, reporting, and notification requirements. In the course of preparing and considering the new rules and rule amendments it is adopting in this document, Commission staff reviewed and analyzed analogous rule sets utilized by the Commission's fellow Federal regulators, with a view towards determining whether there may be other practicable alternatives.

One alternative would be for all SBSDs and MSBSPs to keep and report the same records and other financial reports. While technically possible and arguably simpler to implement and administer, the Commission does not believe such a requirement would be justified given the different capital, margin, and segregation requirements that apply to each participant. For example, since a stand-alone MSBSP is not subject to a minimum net capital requirement under the capital rules applicable to SBSDs and MSBSPs (it is subject to a positive tangible net worth standard instead),[987] it may be unduly burdensome to require stand-alone MSBSPs to calculate and report in FOCUS Report Part II, as amended, the amount of net capital they hold. Hence, while the Commission considered this approach, the Commission believes that such an approach would be confusing and unduly burdensome for firms required to complete and file FOCUS Report Part II, as amended, and would introduce significant compliance challenges beyond those imposed by the new rules and rule amendments.

Another alternative to the new rules and rule amendments the Commission is adopting would be rules that are less prescriptive. Under such rules, detailed record production and retention requirements could be replaced by more general references to the types of information the firm needs to document and retain for examination purposes. This approach could promote a consistent view and management of recordkeeping and reporting obligations within a large financial firm that has numerous subsidiaries. This approach would also likely have the advantage of being less costly, as the firm would be more able to bring recordkeeping practices at its subsidiaries into conformity with existing recordkeeping practices at the parent. While this approach has its benefits, the financial markets and transactions in which SBSDs and MSBSPs are expected to operate and engage in, respectively, are similar to the financial markets and transactions in which broker-dealers operate, and the Commission believes these similarities argue for a consistent regulatory approach.[988] In addition, as discussed above, the objectives of these broker-dealer requirements are similar to the objectives underlying the new rules and rule amendments regarding security-based swaps.[989]

The Commission considered modifying the electronic storage requirements in Rule 17a-4 to remove the requirement that the electronic storage system preserve records exclusively in a non-rewriteable and non-erasable format similar to the modification made to Rule 18a-6 in response to comments that it received. The Commission concluded that any such modification to Rule 17a-4 would affect a large number of broker-dealers that are not likely to register either as SBSDs or MSBSPs and may raise issues that are distinct from those raised by stand-alone or bank SBSDs and MSBSPs. Accordingly, the Commission believes that any change to these requirements should be addressed in a separate rulemaking.[990]

The Commission has also considered alternatives to the financial reporting rules being adopted. For example, with respect to bank SBSDs and MSBSPs, one alternative would be to permit these firms to use the existing financial reports made with their respective prudential regulators. This approach would allow the firms to avoid creating and filing an additional financial report with the Commission, and would likely result in fewer compliance-related costs. The Commission is aware of the burdens and costs associated with preparing an additional regulatory submission such as FOCUS Report Part IIC, but Rule 18a-7(a) is designed to lower burdens that bank SBSDs and MSBSPs may face to meet reporting requirements by aligning certain Commission reporting requirements with requirements these entities already face because they are subject to prudential regulators' reporting requirements. While FOCUS Report Part IIC seeks certain specific transaction and position data regarding bank SBSDs' and bank MSBSPs' security-based swap activities, the other required financial data in FOCUS Report Part IIC for bank SBSDs and MSBSPs are likely readily available because these come directly from the filings these firms are already required to make with their respective prudential regulators.[991]

The Commission has also considered alternative financial reporting arrangements for stand-alone SBSDs or stand-alone MSBSPs. For example, the Commission is aware that the CFTC proposed that stand-alone swap dealers and stand-alone major swap participants be required to submit monthly unaudited financial statements within 17 business days of the end of the month, as well as GAAP financial statements within 60 days of the end of the fiscal year.[992] The Commission believes that the information elicited by FOCUS Report Part II, as amended, should assist the Commission and the firms' DEAs to conduct effective examinations of broker-dealer SBSDs and MSBSPs. The broker-dealer SBSD and broker-dealer MSBSP reporting requirements should promote transparency of the financial and operational condition of these entities to both the Commission and the public.

The Commission has also considered alternatives to the notification and securities count rules.[993] An alternative to the notification rule would be to not have such a rule, or to have fewer events give rise to the requirement for a notification. Similarly, with respect to the quarterly securities count rule, the Commission believes the alternative would be to specify a less frequent count or to omit altogether the requirement for securities count.

The Commission adopted the notification and securities count rules because it believes that the rules are an appropriate component of its oversight of the financial responsibility of firms engaged in the security-based swap business. The broker-dealer recordkeeping, reporting, notification, and securities count requirements are part of the broker-dealer financial responsibility rules.[994] The financial responsibility rules are designed to work together to establish a comprehensive regulatory program designed to promote the prudent Start Printed Page 68645operation of broker-dealers and the safeguarding of customer securities and funds held by broker-dealers. In this regard, the notification and securities count rules (in conjunction with the recordkeeping and reporting rules) are designed to promote compliance with the capital, margin, and segregation requirements for broker-dealers. The recordkeeping, reporting, notification, and securities count requirements applicable to SBSDs and MSBSPs, along with the capital, margin, and segregation requirements for these registrants, are designed to establish a comprehensive financial responsibility program for SBSDs and MSBSPs. Like the broker-dealer rules, the recordkeeping, reporting, notification, and securities count requirements applicable to SBSDs and MSBSPs are designed to promote compliance with the capital, margin, and segregation requirements applicable to SBSDs and MSBSPs. Omitting such rules would create regulatory disparities between broker-dealers, banks, stand-alone SBSDs, and stand-alone MSBSPs. For these reasons, the Commission believes that alternative approaches would not be as effective in helping to ensure compliance with the capital, margin, and segregation requirements applicable to SBSDs and MSBSPs.

VI. Other Matters

If any of the provisions of these rules, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application.

Pursuant to the Congressional Review Act,[995] the Office of Information and Regulatory Affairs has designated these rules as “[not a major rule],” as defined by 5 U.S.C. 804(2).

VII. Regulatory Flexibility Act Certification

The Regulatory Flexibility Act (“RFA”) [996] requires Federal agencies, in promulgating rules, to consider the impact of those rules on small entities. Pursuant to Section 605(b) of the RFA,[997] the Commission certified in the Proposing Release and the Cross-Border Proposing Release that the proposed amendments to Rules 17a-3, 17a-4, 17a-5, and 17a-11 and new Rules 3a71-6 and 18a-5 through 18a-9 would not have a significant economic impact on any “small entity” [998] for purposes of the RFA.[999]

For purposes of Commission rulemaking in connection with the RFA, a small entity includes: (1) When used with reference to an “issuer” or a “person,” other than an investment company, an “issuer” or “person” that, on the last day of its most recent fiscal year, had total assets of $5 million or less,[1000] or (2) a broker-dealer with total capital (net worth plus subordinated liabilities) of less than $500,000 on the date in the prior fiscal year as of which its audited financial statements were prepared pursuant to paragraph (d) of Rule 17a-5, or, if not required to file such statements, a broker-dealer with total capital (net worth plus subordinated liabilities) of less than $500,000 on the last day of the preceding fiscal year (or in the time that it has been in business, if shorter); and is not affiliated with any person (other than a natural person) that is not a small business or small organization.[1001]

Based on available information about the security-based swap market, the market, while broad in scope, is largely dominated by entities such as those that will be covered by the SBSD and MSBSP definitions. Based on feedback from industry participants about the security-based swap markets, the Commission continues to believe that (1) the types of entities that would engage in more than a de minimis amount of dealing activity involving security-based swaps—which generally would be large financial institutions—would not be “small entities” for purposes of the RFA; [1002] and (2) the types of entities that may have security-based swap positions above the level required to register as “major security-based swap participants” would not be “small entities” for purposes of the RFA. Thus, the Commission believes that it is unlikely that the requirements applicable to SBSDs and MSBSPs that are being established under the amendments to Rules 3a71-6, 17a-3, 17a-4, 17a-5, 17a-11, and 17a-12 and new Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9, will have a significant economic impact on any small entity.

The Commission estimates that as of December 31, 2018 there are approximately 996 broker-dealers that are “small” for the purposes Rule 0-10. While the amendments to Rules 17a-3, 17a-4, and 17a-5 relating to making and keeping records that include details about security-based swaps and swaps and reporting information about security-based swaps and swaps will apply to all broker-dealers with such positions, it is unlikely that these amendments will have any impact on small broker-dealers, since most, if not all, of these firms generally do not hold these types of positions. In addition, the technical amendments to Rules 17a-3, 17a-4, 17a-5, 17a-11, and 17a-12 will apply to all broker-dealers, including broker-dealers that are small. However, these amendments will have no impact on broker-dealers, including small broker-dealers, because they will not establish new substantive requirements.

For the foregoing reasons, the Commission certifies that the amendments to Rules 3a71-6, 17a-3, 17a-4, 17a-5, 17a-11, and 17a-12 and new Rules 18a-5 through 18a-9, will not have a significant economic impact on a substantial number of small entities for purposes of the RFA.

VIII. Statutory Basis

The Commission is revising Rules 30-3, 17a-3, 17a-4, 17a-5, 17a-11, 17a-12, and 3a71-6 under the Exchange Act (17 CFR 200.30-3, 17 CFR 240.17a-3, 17 CFR 240.17a-4, 17 CFR 240.17a-5, 17 CFR 240.17a-11, 17 CFR 240.17a-12, and 17 CFR 240.3a71-6), Part II of Form X-17A-5 and the instructions thereto (17 CFR 249.617), and Part III of Form X-17A-5 (17 CFR 249.617), and adding new Rules 18a-5, 18a-6, 18a-7, 18a-8, and 18a-9 under the Exchange Act (17 CFR 240.18a-5, 17 CFR 240.18a-6, 17 CFR 240.18a-7, 17 CFR 240.18a-8, and 17 CFR 240.18a-9), and Part IIC of Form X-17A-5 and the instructions thereto (17 CFR 249.617) pursuant to the authority conferred by the Exchange Act, including Sections 15F, 17, and 23(a).

Start List of Subjects

List of Subjects

17 CFR Part 200

  • Administrative practice and procedure
  • Authority delegations (Government agencies)
  • Civil rights
  • Classified information
  • Conflicts of interest
  • Environmental impact

17 CFR Part 240

  • Brokers
  • Confidential business information
  • Fraud
  • Reporting and recordkeeping requirements
  • Securities

17 CFR Part 249

  • Brokers
  • Recordkeeping and reporting requirements
  • Securities
End List of Subjects

Text of Rules and Rule Amendments

For the reasons set out in the preamble, the Commission is amending title 17, chapter II, of the Code of Federal Regulations as follows:

Start Part

PART 200—ORGANIZATION; CONDUCT AND ETHICS; AND INFORMATION AND REQUESTS

Subpart A—Organization and Program Management

End Part Start Amendment Part

1. The authority citation for part 200, subpart A, continues to read in part as follows:

End Amendment Part Start Authority

Authority: 15 U.S.C. 77c, 77o, 77s, 77z-3, 77sss, 78d, 78d-1, 78d-2, 78 o-4, 78w, 78ll(d), 78mm, 80a-37, 80b-11, 7202, and 7211 et seq., unless otherwise noted.

End Authority
* * * * *

Section 200.30-3 is also issued under 15 U.S.C. 78b, 78d, 78f, 78k-1, 78q, 78s, and 78eee.

* * * * *
Start Amendment Part

2. Section 200.30-3 is amended by revising paragraphs (a)(5) and (30) and (a)(65)(i) to read as follows:

End Amendment Part
Delegation of authority to Director of Division of Trading and Markets.
* * * * *

(a) * * *

(5) Pursuant to § 240.17a-5(m)(3) of this chapter (Rule 17a-5(m)(3)), to consider applications by brokers and dealers for exemptions from, and extension of time within which to file, reports required by § 240.17a-5 of this chapter (Rule 17a-5) and to grant, and to authorize the issuance of orders denying, such applications, provided such applicant is advised of his right to have such denial reviewed by the Commission.

* * * * *

(30) Pursuant to section 17(a) of the Act, 15 U.S.C. 78q, to approve amendments to the plans which are consistent with the reporting structure of §§ 240.17a-5(a)(2) and 240.17a-10(b) of this chapter (Rules 17a-5(a)(2) and 17a-10(b)) filed by self-regulatory organizations pursuant to §§ 240.17a-5(a)(3) and 240.17a-10(b) of this chapter (Rules 17a-5(a)(3) and 17a-10(b)).

* * * * *

(65) * * *

(i) To authorize the issuance of orders requiring over-the-counter (OTC) derivatives dealers to file, pursuant to § 240.17a-12(a)(1)(ii) of this chapter, monthly, or at least at such times as shall be specified, Part II of Form X-17A-5 (§ 249.617 of this chapter) and such other financial and operational information as shall be specified.

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PART 240—GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934

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3. The general authority citation for part 240 continues to read, in part, as follows:

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Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f, 78g, 78i, 78j, 78j-1, 78k, 78k-1, 78 l, 78m, 78n, 78n-1, 78 o, 78 o-4, 78 o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78dd, 78 ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 7201 et seq., and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; Pub. L. 111-203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112-106, sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted.

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4. Amend § 240.3a71-6 by adding paragraph (d)(6) to read as follows:

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Substituted compliance for security-based swap dealers and major security-based swap participants.
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(d) * * *

(6) Recordkeeping and reporting. The recordkeeping and reporting requirements of Section 15F of the Act (15 U.S.C. 78 o-10) and §§ 240.18a-5 through 240.18a-9; provided, however, that prior to making such a substituted compliance determination the Commission intends to consider (in addition to any conditions imposed), whether the foreign financial regulatory system's required records and reports, the timeframes for recording or reporting information, the accounting standards governing the records and reports, and the required format of the records and reports are comparable to applicable provisions arising under the Act and its rules and regulations and would permit the Commission to examine and inspect regulated firms' compliance with the applicable securities laws.

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5. Amend § 240.17a-3 by:

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a. Adding introductory text;

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b. Revising paragraphs (a) introductory text, (a)(1) and (3), (a)(4)(vi) and (vii), (a)(5) through (11), (a)(12)(i) introductory text, and (a)(12)(i)(A) and (E) through (H);

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c. Removing the undesignated paragraph following paragraph (a)(12)(i);

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d. Adding paragraph (a)(12)(i)(I);

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e. Revising paragraph (a)(12)(ii);

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f. In paragraphs (a)(16)(ii)(A) and (B), removing the phrase “shall mean” and adding in its place “means”;

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g. In paragraphs (a)(17)(i)(A) and (a)(17)(i)(B)( 1), removing the word “shall” and adding in its place “must” wherever it appears;

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h. In paragraphs (a)(17)(i)(C) and (D), removing the word “shall” and adding in its place “will” wherever it appears;

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i. In paragraphs (a)(18)(i) and (a)(19)(i), removing the word “shall” and adding in its place “must” wherever it appears;

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j. Adding paragraphs (a)(25) through (30);

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k. Revising paragraphs (b) through (g); and

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l. Removing paragraph (h).

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The additions and revisions read as follows:

Records to be made by certain exchange members, brokers and dealers.

This section applies to the following types of entities: A member of a national securities exchange who transacts a business in securities directly with others than members of a national securities exchange; a broker or dealer who transacts a business in securities through the medium of a member of a national securities exchange; a broker or dealer, including an OTC derivatives dealer as that term is defined in § 240.3b-12, registered pursuant to section 15 of the Act (15 U.S.C. 78 o); a security-based swap dealer registered pursuant to section 15F of the Act (15 U.S.C. 78 o-10) that is also a broker or dealer, including an OTC derivatives dealer, registered pursuant to section 15 of the Act; and a major security-based swap participant registered pursuant to section 15F of the Act that is also a broker or dealer, including an OTC derivatives dealer, registered pursuant to section 15 of the Act. Section 240.18a-5 (rather than this section) applies to the following types of entities: A security-based swap dealer registered pursuant to section 15F of the Act that is not also a broker or dealer, including an OTC derivatives dealer, registered pursuant to section 15 of the Act; and a major security-based swap participant registered pursuant to section 15F of the Act that is not also a broker or dealer, including an OTC Start Printed Page 68647derivatives dealer, registered pursuant to section 15 of the Act.

(a) Every member of a national securities exchange who transacts a business in securities directly with others than members of a national securities exchange, every broker or dealer who transacts a business in securities through the medium of any such member, and every broker or dealer registered pursuant to section 15 of the Act (15 U.S.C. 78 o) must make and keep current the following books and records relating to its business:

(1) Blotters (or other records of original entry) containing an itemized daily record of all purchases and sales of securities (including security-based swaps), all receipts and deliveries of securities (including certificate numbers), all receipts and disbursements of cash and all other debits and credits. Such records must show the account for which each such purchase or sale was effected, the name and amount of securities, the unit and aggregate purchase or sale price, if any (including the financial terms for security-based swaps), the trade date, and the name or other designation of the person from whom such securities were purchased or received or to whom sold or delivered. For security-based swaps, such records must also show, for each transaction, the type of security-based swap, the reference security, index, or obligor, the date and time of execution, the effective date, the scheduled termination date, the notional amount(s) and the currenc(ies) in which the notional amount(s) is expressed, the unique transaction identifier, and the counterparty's unique identification code.

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(3) Ledger accounts (or other records) itemizing separately as to each cash, margin, or security-based swap account of every customer and of such member, broker or dealer and partners thereof, all purchases, sales, receipts and deliveries of securities (including security-based swaps) and commodities for such account, and all other debits and credits to such account; and, in addition, for a security-based swap, the type of security-based swap, the reference security, index, or obligor, the date and time of execution, the effective date, the scheduled termination date, the notional amount(s) and the currenc(ies) in which the notional amount(s) is expressed, the unique transaction identifier, and the counterparty's unique identification code.

(4) * * *

(vi) All long and all short securities record differences arising from the examination, count, verification, and comparison pursuant to §§ 240.17a-5, 240.17a-12, 240.17a-13, and 240.18a-7, as applicable (by date of examination, count, verification, and comparison showing for each security the number of long or short count differences); and

(vii) Repurchase and reverse repurchase agreements.

(5) A securities record or ledger reflecting separately for each:

(i) Security, other than a security-based swap, as of the clearance dates all “long” or “short” positions (including securities in safekeeping and securities that are the subjects of repurchase or reverse repurchase agreements) carried by such member, broker or dealer for its account or for the account of its customers or partners, or others, and showing the location of all securities long and the offsetting position to all securities short, including long security count differences and short security count differences classified by the date of the physical count and verification in which they were discovered, and in all cases the name or designation of the account in which each position is carried.

(ii) Security-based swap, the reference security, index, or obligor, the unique transaction identifier, the counterparty's unique identification code, whether it is a “bought” or “sold” position in the security-based swap, whether the security-based swap is cleared or not cleared, and if cleared, identification of the clearing agency where the security-based swap is cleared.

(6)(i) A memorandum of each brokerage order, and of any other instruction, given or received for the purchase or sale of a security, except for the purchase or sale of a security-based swap, whether executed or unexecuted.

(A) The memorandum must show the terms and conditions of the order or instructions and of any modification or cancellation thereof, the account for which entered, the time the order was received, the time of entry, the price at which executed, the identity of each associated person, if any, responsible for the account, the identity of any other person who entered or accepted the order on behalf of the customer, or, if a customer entered the order on an electronic system, a notation of that entry; and, to the extent feasible, the time of execution or cancellation. The memorandum need not show the identity of any person, other than the associated person responsible for the account, who may have entered or accepted the order if the order is entered into an electronic system that generates the memorandum and if that system is not capable of receiving an entry of the identity of any person other than the responsible associated person; in that circumstance, the member, broker or dealer must produce upon request by a representative of a securities regulatory authority a separate record which identifies each other person. An order entered pursuant to the exercise of discretionary authority by the member, broker or dealer, or associated person thereof, must be so designated. The term instruction must include instructions between partners and employees of a member, broker or dealer. The term time of entry means the time when the member, broker or dealer transmits the order or instruction for execution.

(B) The memorandum need not be made as to a purchase, sale or redemption of a security on a subscription way basis directly from or to the issuer, if the member, broker or dealer maintains a copy of the customer's or non-customer's subscription agreement regarding a purchase, or a copy of any other document required by the issuer regarding a sale or redemption.

(ii) A memorandum of each brokerage order, and of any other instruction, given or received for the purchase or sale of a security-based swap, whether executed or unexecuted. The memorandum must show the terms and conditions of the order or instructions and of any modification or cancellation thereof; the account for which entered; the time the order was received; the time of entry; the price at which executed; the identity of each associated person, if any, responsible for the account; the identity of any other person who entered or accepted the order on behalf of the customer, or, if a customer entered the order on an electronic system, a notation of that entry; and, to the extent feasible, the time of cancellation, if applicable. The memorandum also must include the type of the security-based swap, the reference security, index, or obligor, the date and time of execution, the effective date, the scheduled termination, the notional amount(s) and the currenc(ies) in which the notional amount(s) is expressed, the unique transaction identifier, and the counterparty's unique identification code. An order entered pursuant to the exercise of discretionary authority must be so designated.

(7)(i) A memorandum of each purchase or sale of a security, other than for the purchase or sale of a security-based swap, for the account of the member, broker or dealer showing the price and, to the extent feasible, the time of execution; and, in addition, where the purchase or sale is with a customer other than a broker or dealer, Start Printed Page 68648a memorandum of each order received, showing the time of receipt; the terms and conditions of the order and of any modification thereof; the account for which it was entered; the identity of each associated person, if any, responsible for the account; the identity of any other person who entered or accepted the order on behalf of the customer, or, if a customer entered the order on an electronic system, a notation of that entry. The memorandum need not show the identity of any person other than the associated person responsible for the account who may have entered the order if the order is entered into an electronic system that generates the memorandum and if that system is not capable of receiving an entry of the identity of any person other than the responsible associated person. In the circumstance in the preceding sentence, the member, broker or dealer must produce upon request by a representative of a securities regulatory authority a separate record that identifies each other person. An order with a customer other than a member, broker or dealer entered pursuant to the exercise of discretionary authority by the member, broker or dealer, or associated person thereof, must be so designated.

(ii) A memorandum of each purchase or sale of a security-based swap for the account of the member, broker or dealer showing the price; and, in addition, where the purchase or sale is with a customer other than a broker or dealer, a memorandum of each order received, showing the time of receipt; the terms and conditions of the order and of any modification thereof; the account for which it was entered; the identity of any other person who entered or accepted the order on behalf of the customer, or, if a customer entered the order on an electronic system, a notation of that entry. The memorandum must also include the type of security-based swap, the reference security, index, or obligor, the date and time of execution, the effective date, the scheduled termination date, the notional amount(s) and the currenc(ies) in which the notional amount(s) is expressed, the unique transaction identifier, and the counterparty's unique identification code. An order entered pursuant to the exercise of discretionary authority must be so designated.

(8)(i) With respect to a security other than a security-based swap, copies of confirmations of all purchases and sales of securities, including all repurchase and reverse repurchase agreements, and copies of notices of all other debits and credits for securities, cash and other items for the account of customers and partners of such member, broker or dealer.

(ii) With respect to a security-based swap, copies of the security-based swap trade acknowledgment and verification made in compliance with § 240.15Fi-2.

(9) A record with respect to each cash, margin, and security-based swap account with such member, broker or dealer indicating, as applicable:

(i) The name and address of the beneficial owner of such account;

(ii) Except with respect to exempt employee benefit plan securities as defined in § 240.14a-1(d), but only to the extent such securities are held by employee benefit plans established by the issuer of the securities, whether or not the beneficial owner of securities registered in the name of such members, brokers or dealers, or a registered clearing agency or its nominee objects to disclosure of his or her identity, address, and securities positions to issuers;

(iii) In the case of a margin account, the signature of such owner; provided that, in the case of a joint account or an account of a corporation, such records are required only in respect of the person or persons authorized to transact business for such account; and

(iv) For each security-based swap account, a record of the unique identification code of such counterparty, the name and address of such counterparty, and a record of the authorization of each person the counterparty has granted authority to transact business in the security-based swap account.

(10) A record of all puts, calls, spreads, straddles, and other options in which such member, broker or dealer has any direct or indirect interest or which such member, broker or dealer, has granted or guaranteed, containing, at least, an identification of the security, and the number of units involved. An OTC derivatives dealer must also keep a record of all eligible OTC derivative instruments as defined in § 240.3b-13 in which the OTC derivatives dealer has any direct or indirect interest or which it has written or guaranteed, containing, at a minimum, an identification of the security or other instrument, the number of units involved, and the identity of the counterparty.

(11) A record of the proof of money balances of all ledger accounts in the form of trial balances and a record of the computation of aggregate indebtedness and net capital, as of the trial balance date, pursuant to § 240.15c3-1 or § 240.18a-1, as applicable. The computation need not be made by any member, broker or dealer unconditionally exempt from § 240.15c3-1 pursuant to § 240.15c3-1(b)(1) or (3). Such trial balances and computations must be prepared currently at least once a month.

(12)(i) A questionnaire or application for employment executed by each associated person as that term is defined in paragraph (g)(4) of this section of the member, broker or dealer, which questionnaire or application must be approved in writing by an authorized representative of the member, broker or dealer and must contain at least the following information with respect to the associated person:

(A) The associated person's name, address, social security number, and the starting date of the associated person's employment or other association with the member, broker or dealer;

* * * * *

(E) A record of any denial, suspension, expulsion, or revocation of membership or registration of any member, broker or dealer with which the associated person was associated in any capacity when such action was taken;

(F) A record of any permanent or temporary injunction entered against the associated person, or any member, broker, dealer, security-based swap dealer or major security-based swap participant with which the associated person was associated in any capacity at the time such injunction was entered;

(G) A record of any arrest or indictment for any felony, or any misdemeanor pertaining to securities, commodities, banking, insurance or real estate (including, but not limited to, acting or being associated with a broker or dealer, investment company, investment adviser, futures sponsor, bank, or savings and loan association), fraud, false statements or omissions, wrongful taking of property or bribery, forgery, counterfeiting, or extortion, and the disposition of the foregoing; and

(H) A record of any other name or names by which the associated person has been known or which the associated person has used.

(I) Provided, however, that if such associated person has been registered as a registered representative of such member, broker or dealer with, or the associated person's employment has been approved by a registered national securities association or a registered national securities exchange, then retention of a full, correct, and complete copy of any and all applications for such registration or approval will be deemed to satisfy the requirements of this paragraph (a)(12)(i).

(ii) A record listing every associated person of the member, broker or dealer Start Printed Page 68649which shows, for each associated person, every office of the member, broker or dealer, where the associated person regularly conducts the business of handling funds or securities or effecting any transactions in, or inducing or attempting to induce the purchase or sale of any security for the member, broker or dealer and the Central Registration Depository number, if any, and every internal identification number or code assigned to that person by the member, broker or dealer.

* * * * *

(25) A record of the daily calculation of the current exposure and, if applicable, the initial margin amount for each account of a counterparty required under § 240.18a-3(c).

(26) A record of compliance with possession or control requirements under § 240.15c3-3(p)(2).

(27) A record of the reserve computation required under § 240.15c3-3(p)(3).

(28) A record of each security-based swap transaction that is not verified under § 240.15Fi-2 within five business days of execution that includes, at a minimum, the unique transaction identifier and the counterparty's unique identification code.

(29) A record documenting that the broker or dealer has complied with the business conduct standards as required under § 240.15Fh-6.

(30) A record documenting that the broker or dealer has complied with the business conduct standards as required under §§ 240.15Fh-1 through 240.15Fh-5 and 240.15Fk-1.

* * * * *

(b) A broker or dealer may comply with the recordkeeping requirements of the Commodity Exchange Act and chapter I of this title applicable to swap dealers and major swap participants in lieu of complying with paragraphs (a)(1), (3), and (5) of this section solely with respect to required information regarding security-based swap transactions and positions if:

(1) The broker or dealer is registered as a security-based swap dealer or major security-based swap participant pursuant to section 15F of the Act (15 U.S.C. 78 o-10);

(2) The broker or dealer is registered as a swap dealer or major swap participant pursuant to section 4s of the Commodity Exchange Act and chapter I of this title;

(3) The broker or dealer is subject to 17 CFR 23.201, 23.202, 23.402, and 23.501 with respect to its swap-related books and records;

(4) The broker or dealer preserves all of the data elements necessary to create the records required by paragraphs (a)(1), (3), and (5) of this section as they pertain to security-based swap and swap transactions and positions;

(5) The broker or dealer upon request furnishes promptly to representatives of the Commission the records required by paragraphs (a)(1), (3), and (5) of this section as well as the records required by 17 CFR 23.201, 23.202, 23.402, and 23.501 as they pertain to security-based swap and swap transactions and positions in the format applicable to that category of record as set forth in this section; and

(6) The broker or dealer provides notice of its intent to utilize this paragraph (b) by notifying in writing the Commission, both at the principal office of the Commission in Washington, DC, and at the regional office of the Commission for the region in which the registrant has its principal place of business, as well as by notifying in writing the registrant's designated examining authority.

(c) A member of a national securities exchange, or a broker or dealer registered pursuant to section 15 of the Act (15 U.S.C. 78 o), that introduces accounts on a fully-disclosed basis, is not required to make or keep such records of transactions cleared for such member, broker or dealer as are made and kept by a clearing broker or dealer pursuant to the requirements of this section and § 240.17a-4. Nothing in this paragraph (c) will be deemed to relieve such member, broker or dealer from the responsibility that such books and records be accurately maintained and preserved as specified in this section and § 240.17a-4.

(d) For purposes of transactions in municipal securities by municipal securities brokers and municipal securities dealers, compliance with Rule G-8 of the Municipal Securities Rulemaking Board or any successor rule will be deemed to be in compliance with this section.

(e) The provisions of this section will not apply to security futures product transactions and positions in a futures account (as that term is defined in § 240.15c3-3(a)(15)); provided, that the Commodity Futures Trading Commission's recordkeeping rules apply to those transactions and positions.

(f) Every member, broker or dealer must make and keep current, as to each office, the books and records described in paragraphs (a)(1), (6), (7), (12), and (17), (a)(18)(i), and (a)(19) through (22) of this section.

(g) When used in this section:

(1) The term office means any location where one or more associated persons regularly conduct the business of handling funds or securities or effecting any transactions in, or inducing or attempting to induce the purchase or sale of, any security.

(2) The term principal means any individual registered with a registered national securities association as a principal or branch manager of a member, broker or dealer or any other person who has been delegated supervisory responsibility over associated persons by the member, broker or dealer.

(3) The term securities regulatory authority means the Commission, any self-regulatory organization, or any securities commission (or any agency or office performing like functions) of the States.

(4) The term associated person means a “person associated with a broker or dealer” or “person associated with a security-based swap dealer or major security-based swap participant” as defined in sections 3(a)(18) and (70) of the Act (15 U.S.C. 78c(a)(18) and (70)) respectively, but does not include persons whose functions are solely clerical or ministerial.

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6. Amend § 240.17a-4 by:

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a. Adding introductory text;

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b. Revising paragraphs (a), (b) introductory text, (b)(1), (3) through (5), and (7), (b)(8) introductory text, (b)(8)(i), (v) through (viii), and (xii) through (xv);

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c. Adding paragraphs (b)(8)(xvi) and (xvii);

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d. Revising paragraph (b)(9);

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e. In paragraph (b)(11), removing the word “shall” and adding in its place the word “must”;

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f. Revising paragraphs (b)(12) and (13);

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g. Adding paragraphs (b)(14) through (16);

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h. Revising paragraphs (c), (d), (e) introductory text, and (e)(1) through (4) and (6);

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i. In the last sentence of paragraph (e)(8), removing the word “shall” and adding in its place the word “must”;

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j. In paragraph (f) introductory text, removing the word “paragraph,” and adding in its place the word “section”;

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k. In paragraphs (f)(2) introductory text and (f)(3) introductory text, removing the word “shall” and adding in its place the word “must”;

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l. In paragraph (f)(3)(iv)(B), removing the phrase “each index.” and adding in its place the phrase “the index.”;

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m. In paragraph (f)(3)(vi), removing the phrase “the self-regulatory organizations” and adding in its place the phrase “any self-regulatory organization”; Start Printed Page 68650

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n. Revising paragraphs (f)(3)(vii) and (g);

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o. In paragraph (h), adding the phrase “or any successor rule” after the word “Board”;

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p. Revising paragraph (i) and removing the undesignated paragraph following paragraph (i);

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q. In paragraph (j), removing the word “shall” and adding in its place the word “must”;

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r. In paragraph (k)(1), removing the word “shall” and adding in its place the word “must” wherever it appears;

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s. In paragraph (l), removing “§ 240.17a-3(g)” and adding in its place “§ 240.17a-3(e)”;

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t. Revising paragraphs (m)(1) through (4); and

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u. Adding paragraph (m)(5).

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The additions and revisions read as follows:

Records to be preserved by certain exchange members, brokers and dealers.

This section applies to the following types of entities: A member of a national securities exchange who transacts a business in securities directly with others than members of a national securities exchange; a broker or dealer who transacts a business in securities through the medium of a member of a national securities exchange; a broker or dealer, including an OTC derivatives dealer as that term is defined in § 240.3b-12, registered pursuant to section 15 of the Act (15 U.S.C. 78 o); a security-based swap dealer registered pursuant to section 15F of the Act (15 U.S.C. 78 o-10) that is also a broker or dealer, including an OTC derivatives dealer, registered pursuant to section 15 of the Act; and a major security-based swap participant registered pursuant to section 15F of the Act that is also a broker or dealer, including an OTC derivatives dealer, registered pursuant to section 15 of the Act. Section 240.18a-6 (rather than this section) applies to the following types of entities: A security-based swap dealer registered pursuant to section 15F of the Act that is not also a broker or dealer, including an OTC derivatives dealer, registered pursuant to section 15 of the Act; and a major security-based swap participant registered pursuant to section 15F of the Act that is not also a broker or dealer, including an OTC derivatives dealer, registered pursuant to section 15 of the Act.

(a) Every member, broker or dealer subject to § 240.17a-3 must preserve for a period of not less than 6 years, the first two years in an easily accessible place, all records required to be made pursuant to § 240.17a-3(a)(1) through (3), (5), and (21) and (22), and analogous records created pursuant to § 240.17a-3(d).

(b) Every member, broker or dealer subject to § 240.17a-3 must preserve for a period of not less than three years, the first two years in an easily accessible place:

(1) All records required to be made pursuant to § 240.17a-3(a)(4), (6) through (11), (16), (18) through (20), and (25) through (30), and analogous records created pursuant to § 240.17a-3(e).

* * * * *

(3) All bills receivable or payable (or copies thereof), paid or unpaid, relating to the member, broker or dealer's business as such.

(4) Originals of all communications received and copies of all communications sent (and any approvals thereof) by the member, broker or dealer (including inter-office memoranda and communications) relating to its business as such, including all communications which are subject to rules of a self-regulatory organization of which the member, broker or dealer is a member regarding communications with the public. As used in this paragraph (b)(4), the term communications includes sales scripts and recordings of telephone calls required to be maintained pursuant to section 15F(g)(1) of the Act (15 U.S.C. 78 o-10(g)(1)).

(5) All trial balances, computations of aggregate indebtedness and net capital (and working papers in connection therewith), financial statements, branch office reconciliations, and internal audit working papers, relating to the member, broker or dealer's business as such.

* * * * *

(7) All written agreements (or copies thereof) entered into by such member, broker or dealer relating to its business as such, including agreements with respect to any account. Written agreements with respect to a security-based swap customer or non-customer, including governing documents or any document establishing the terms and conditions of the customer's or non-customer's security-based swaps must be maintained with the customer's or non-customer's account records.

(8) Records which contain the following information in support of amounts included in the report prepared as of the fiscal year end on Part II or IIA of Form X-17A-5 (§ 249.617 of this chapter), as applicable, and in the annual financial statements filed with the Commission required by § 240.17a-5(d), § 240.17a-12(b), or § 240.18a-7(c), as applicable:

(i) Money balance and position, long or short, including description, quantity, price, and valuation of each security including contractual commitments in customers' accounts, in cash and fully secured accounts, partly secured accounts, unsecured accounts, and in securities accounts payable to customers;

* * * * *

(v) Description of futures commodity contracts or swaps, contract value on trade date, market value, gain or loss, and liquidating equity or deficit in customers' and non-customers' accounts;

(vi) Description of futures commodity contracts or swaps, contract value on trade date, market value, gain or loss, and liquidating equity or deficit in trading and investment accounts;

(vii) Description, money balance, quantity, price, and valuation of each spot commodity, and swap position or commitments in customers' and non-customers' accounts;

(viii) Description, money balance, quantity, price, and valuation of each spot commodity, and swap position or commitments in trading and investment accounts;

* * * * *

(xii) Description, settlement date, contract amount, quantity, market price, and valuation for each aged failed to deliver requiring a charge in the Computation of Net Capital pursuant to § 240.15c3-1 or § 240.18a-1, as applicable;

(xiii) Detail relating to information for possession or control requirements under § 240.15c3-3 or § 240.18a-4, as applicable and reported in Part II or IIA of Form X-17A-5 (§ 249.617 of this chapter), as applicable;

(xiv) Detail relating to information for security-based swap possession or control requirements under § 240.15c3-3 or § 240.18a-4, as applicable, and reported in Part II or IIA of Form X-17A-5 (§ 249.617 of this chapter);

(xv) Detail of all items, not otherwise substantiated, which are charged or credited in the Computation of Net Capital pursuant to § 240.15c3-1 or § 240.18a-1, as applicable, such as cash margin deficiencies, deductions related to securities values and undue concentration, aged securities differences, and insurance claims receivable;

(xvi) Detail relating to the calculation of the risk margin amount pursuant to § 240.15c3-1(c)(17) or § 240.18a-1(c)(6), as applicable; and

(xvii) Other schedules which are specifically prescribed by the Commission as necessary to support information reported as required by §§ 240.17a-5, 240.17a-12, and 240.18a-7, as applicable.Start Printed Page 68651

(9) The records required to be made pursuant to § 240.15c3-3(d)(5) and (o) or § 240.18a-4, as applicable.

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(12) The records required to be made pursuant to § 240.15c3-1e(c)(4)(vi) or § 240.18a-1(e)(2)(iii)(F)(2), as applicable.

(13) The written policies and procedures the broker-dealer establishes, documents, maintains, and enforces to assess creditworthiness for the purpose of § 240.15c3-1(c)(2)(vi)(E), (c)(2)(vi)(F)(1) and (2), and (c)(2)(vi)(H) or § 240.18a-1(c)(1)(vi)(2), as applicable.

(14) A copy of information required to be reported under §§ 242.901 through 242.909 of this chapter (Regulation SBSR).

(15) Copies of documents, communications, disclosures, and notices related to business conduct standards as required under §§ 240.15Fh-1 through 240.15Fh-6 and 240.15Fk-1.

(16) Copies of documents used to make a reasonable determination with respect to special entities, including information relating to the financial status, the tax status, the investment or financing objectives of the special entity as required under section 15F(h)(4)(C) and (5)(A) of the Act (15 U.S.C. 78 o-10(h)(4)(C) and (5)(A)).

(c) Every member, broker or dealer subject to § 240.17a-3 must preserve for a period of not less than six years after the closing of any customer's account any account cards or records which relate to the terms and conditions with respect to the opening and maintenance of the account.

(d) Every member, broker or dealer subject to § 240.17a-3 must preserve during the life of the enterprise and of any successor enterprise all partnership articles or, in the case of a corporation, all articles of incorporation or charter, minute books, and stock certificate books (or, in the case of any other form of legal entity, all records such as articles of organization or formation, and minute books used for a purpose similar to those records required for corporations or partnerships), all Forms BD (§ 249.501 of this chapter), all Forms BDW (§ 249.501a of this chapter), all Forms SBSE-BD (§ 249.1600b of this chapter), all Forms SBSE-C (§ 249.1600c of this chapter), all Forms SBSE-W (§ 249.1601 of this chapter), all amendments to these forms, and all licenses or other documentation showing the registration of the member, broker or dealer with any securities regulatory authority or the Commodity Futures Trading Commission.

(e) Every member, broker or dealer subject to § 240.17a-3 must maintain and preserve in an easily accessible place:

(1) All records required under § 240.17a-3(a)(12) until at least three years after the associated person's employment and any other connection with the member, broker or dealer has terminated.

(2) All records required under § 240.17a-3(a)(13) until at least three years after the termination of employment or association of those persons required by § 240.17f-2 to be fingerprinted.

(3) All records required pursuant to § 240.17a-3(a)(15) during the life of the enterprise.

(4) All records required pursuant to § 240.17a-3(a)(14) for three years.

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(6) Each report which a securities regulatory authority or the Commodity Futures Trading Commission has requested or required the member, broker or dealer to make and furnish to it pursuant to an order or settlement, and each securities regulatory authority, Commodity Futures Trading Commission, or prudential regulator examination report until three years after the date of the report.

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(f) * * *

(3) * * *

(vii) For every member, broker or dealer exclusively using electronic storage media for some or all of its record preservation under this section, at least one third party (the undersigned), who has access to and the ability to download information from the member's, broker's or dealer's electronic storage media to any acceptable medium under this section, must file with the designated examining authority for the member, broker or dealer the following undertakings with respect to such records:

The undersigned hereby undertakes to furnish promptly to the U.S. Securities and Exchange Commission (“Commission”), its designees or representatives, any self-regulatory organization of which it is a member, or any State securities regulator having jurisdiction over the member, broker or dealer, upon reasonable request, such information as deemed necessary by the staffs of the Commission, any self-regulatory organization of which it is a member, or any State securities regulator having jurisdiction over the member, broker or dealer to download information kept on the member's, broker's or dealer's electronic storage media to any medium acceptable under § 240.17a-4. Furthermore, the undersigned hereby undertakes to take reasonable steps to provide access to information contained on the member's, broker's or dealer's electronic storage media, including, as appropriate, arrangements for the downloading of any record required to be maintained and preserved by the member, broker or dealer pursuant to §§ 240.17a-3 and 240.17a-4 in a format acceptable to the staffs of the Commission, any self-regulatory organization of which it is a member, or any State securities regulator having jurisdiction over the member, broker or dealer. Such arrangements will provide specifically that in the event of a failure on the part of a member, broker or dealer to download the record into a readable format and after reasonable notice to the broker or dealer, upon being provided with the appropriate electronic storage medium, the undersigned will undertake to do so, as the staffs of the Commission, any self-regulatory organization of which it is a member, or any State securities regulator having jurisdiction over the member, broker or dealer may request.

(g) If a person who has been subject to § 240.17a-3 ceases to transact a business in securities directly with others than members of a national securities exchange, or ceases to transact a business in securities through the medium of a member of a national securities exchange, or ceases to be registered pursuant to section 15 of the Act (15 U.S.C. 78 o) such person must, for the remainder of the periods of time specified in this section, continue to preserve the records which it theretofore preserved pursuant to this section.

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(i)(1) If the records required to be maintained and preserved pursuant to the provisions of §§ 240.17a-3 and 240.17a-4 are prepared or maintained by an outside service bureau, depository, bank which does not operate pursuant to § 240.17a-3(b)(2), or other recordkeeping service on behalf of the member, broker or dealer required to maintain and preserve such records, such outside entity must file with the Commission a written undertaking in form acceptable to the Commission, signed by a duly authorized person, to the effect that such records are the property of the member, broker or dealer required to maintain and preserve such records and will be surrendered promptly on request of the member, broker or dealer and including the following provision:

With respect to any books and records maintained or preserved on behalf of [BD], the undersigned hereby undertakes to permit examination of such books and records at any time or from time to time during business hours by representatives or designees of the Securities and Exchange Commission, and to promptly furnish to said Commission or its designee true, correct, complete and current hard copy of any or all or any part of such books and records.

(2) Agreement with an outside entity will not relieve such member, broker or dealer from the responsibility to prepare Start Printed Page 68652and maintain records as specified in this section or in § 240.17a-3.

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(m) * * *

(1) The term office has the meaning set forth in § 240.17a-3(g)(1).

(2) The term principal has the meaning set forth in § 240.17a-3(g)(2).

(3) The term securities regulatory authority has the meaning set forth in § 240.17a-3(g)(3).

(4) The term associated person has the meaning set forth in § 240.17a-3(g)(4).

(5) The term business as such includes security-based swap activity.

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