The Securities and Exchange Commission issued an order (Order)1 on June 29, 2020, under Section 17(h)(4) of the Securities Exchange Act of 1934, raising the thresholds for compliance with the recordkeeping and reporting requirements under the SEC’s Risk Assessment Rules (Rules 17h-1T and 17h 2T). The Order raises these thresholds from $20 million to $50 million, provided the broker-dealer maintains less than $1 billion in total assets and meets the other conditions of the thresholds, as discussed below. Raising the thresholds for compliance with the Risk Assessment Rules is intended to reduce the regulatory burden on smaller broker-dealers, and to increase the efficiency of the filing intake and review processes without materially increasing risk to investors. The thresholds had not been updated since these rules were originally adopted in 1992.
Background
Congress added Section 17(h) to the Exchange Act following concerns that financial problems of a broker-dealer’s affiliate could trigger the broker-dealer to fail or experience significant financial difficulties, thus posing a significant risk to investors whose assets are held with the broker-dealer. Section 17(h) imposes on registered broker-dealers particular requirements related to obtaining, maintaining and reporting certain information. Section 17(h)(4) provides that the SEC may, by rule or order, exempt any person or class of persons from the provisions of Section 17(h).2
In 1992, pursuant to the authority granted under Section 17(h), the SEC adopted Rules 17h-1T and 17h-2T. Rule 17h-1T requires broker-dealers to maintain and preserve certain records, such as an organizational chart detailing the broker-dealer and its affiliates and consolidated financial statements.3 Rule 17h-2T requires broker-dealers to file Form 17-H with the SEC on a quarterly basis.4
Each rule provides thresholds for compliance by certain categories of broker-dealers, such as those that do not hold funds or securities for clients, provided that they maintain capital of less than $20 million. In adopting the $20 million threshold, the SEC stated its desire to focus its efforts on the largest broker-dealers.
Inspector General Report
In February of this year, the SEC’s Office of the Inspector General (IG) published a report (Report) detailing the results the IG’s evaluation of the Division of Trading and Markets’ Office of Broker-Dealer Finances (OBDF).5 To prepare the Report, the IG met with representatives from each OBDF sub-office and reviewed OBDF’s policies, procedures and other records. The Report contains three recommendations intended to improve OBDF operations, including a recommendation to raise the capital thresholds for reporting on Form 17-H.6 If the thresholds were raised, the Report states, “[t]he 17-H Risk Assessment Program would receive fewer quarterly and annual 17-H filings, increasing the overall efficiency of the filing intake and review processes.” The Report also found that increasing the capital thresholds would “reduce the reporting burden on smaller broker-dealer firms that currently file Form 17-H quarterly and annually.”
New Thresholds for Compliance under Rules 17h-1T and 17h-2T
Based on a recommendation in the Report, the Order raises the thresholds for the recordkeeping and reporting requirements of the rules applicable to broker-dealers, so that broker-dealers do not need to comply with those rules if they:
- Do not hold funds or securities for, or owe money or securities to, customers;
- Do not carry customer accounts;
- Maintain total assets of less than $1 billion; and
- Maintain capital, including debt subordinated, of less than $50 million.
Broker-dealers that are exempt from Rule 15c3-3 (Customer Protection Rule)7 need not comply with the recordkeeping and reporting rules, provided the broker-dealer maintains total assets of less than $1 billion and capital of less than $50 million.
By raising the thresholds for compliance from $20 million to $50 million, the Order states that it will provide relief to 59 broker-dealers (or approximately 21% of the approximately 275 broker-dealers currently subject to Rules 17h-1T and 17h-2T), based on data maintained by the SEC. Moreover, the SEC states in the Order that the increased thresholds will not materially increase risk for investors because “firms continuing to be subject to the rules account for over 98% of the total capital of firms subject to the rules prior to the issuance of [the] Order.”
The addition of the requirement that a broker maintain less than $1 billion in total assets is intended to ensure that highly leveraged firms with comparatively small levels of capital must comply with the Risk Assessment Rules. The SEC found that broker-dealers with high leverage and small levels of capital pose “heightened risks,” due to the broker-dealer having “less capital to absorb losses and, therefore, pos[ing] greater credit risk to its customers, counterparties, and other creditors.”
Conclusion
As the Order is effective immediately, broker-dealers should be aware of the change to compliance thresholds for Rules 17h-1T and 17h-2T. However, broker-dealers should note that the Order applies only to Rules 17h-1T and 17h-2T, and therefore they should continue to review their obligations under both FINRA and SEC recordkeeping requirements.
The authors would like to thank Devon Roberson for his contributions to this OnPoint.
Footnotes
1) SEC, Order Under Section 17(h)(4) of the Securities Exchange Act of 1934 Granting Exemption from Rule 17h-1T and Rule 17h-2T for Certain Broker-Dealers Maintaining Capital, Including Subordinated Debt of Greater than $20 Million but Less than $50 Million (Release No. 34-89184).
2) In granting such exemptions, Section 17(h)(4) requires the SEC to consider the following factors, among others:
(A) Whether information of the type required under this subsection is available from a supervisory agency (as defined in Section 1101(6) of the Right to Financial Privacy Act of 1978), a state insurance commission or similar state agency, the Commodity Futures Trading Commission, or a similar foreign regulator;
(B) The primary business of any associated person;
(C) The nature and extent of domestic or foreign regulation of the associated person’s activities;
(D) The nature and extent of the registered person’s securities activities; and
(E) With respect to the registered person and its associated persons, on a consolidated basis, the amount and proportion of assets devoted to, and re venues derived from, activities in the United States securities markets.
3) Rule 17h-1T requires broker-dealers to maintain: an organizational chart that includes all of the broker-dealer’s associated persons; written risk management policies and procedures; a description of material pending legal and arbitration proceedings involving the broker-dealer or its affiliates; consolidating and consolidated balance sheets, income statements, and cash flow statements; the broker-dealer’s securities and commodities position records; the value of instruments with off-balance sheet risk; the value of bridge loans, bank loans, commercial paper, and other borrowing; and data relating to real estate activities. See 17 CFR § 240.17h–1T.
4) The information required to be reported on Form 17-H consists of copies of the records and financial data required to be maintained under Rule 17h-1T.
5) SEC Office of the Inspector General, SEC’s Office of Broker-Dealer Finances Provides Effective Oversight but Opportunities to Improve Efficiency Exist (Feb. 26, 2020).
6) The Report also recommends that OBDF: complete a review of its policies and procedures for inspecting broker-dealers; consider defining supervisory review and record retention requirements in an updated version of those policies and procedures; require broker-dealers to electronically file their annual reports and risk assessment reports with the SEC; and finalize efforts to develop plans that coherently link OBDF’s programs and resources (including its future executive resources and other workforce needs) to organizational goals and objectives.
7) 17 CFR § 240.15c3–3.
