On February 18, the U.S. Securities and Exchange Commission (SEC) and Federal Deposit Insurance Corporation (FDIC) (collectively, the Agencies) jointly proposed rules regarding the orderly liquidation of certain covered securities brokers and dealers.1 The proposal would implement provisions in Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) requiring the Agencies' joint promulgation of rules establishing an orderly liquidation process for certain large broker-dealers that would be distinct from the liquidation process under the Securities Investor Protection Act of 1970, as amended (SIPA). A resolution of a covered broker-dealer pursuant to the proposal (a Title II resolution) would not be a judicially supervised liquidation under SIPA. Rather, it represents an FDIC administrative proceeding under Title II of Dodd-Frank that incorporates the customer protection provisions of SIPA. The proposal seeks to clarify and integrate the requirements of Dodd-Frank and SIPA, to delineate the roles of the FDIC and Securities Investor Protection Corporation (SIPC), to establish a procedure for judicial recognition of a Title II resolution and to impose timing, notice and similar procedural requirements. Comments were due to the Agencies on Monday, May 2, at which time four comment letters were published in the public file.2 The comments generally support the Proposal but request that the Agencies make certain changes, including modifications to take account of the fact that the Proposal is likely to have a narrow scope of application and to clarify how the orderly liquidation of a covered broker-dealer would operate if the firm is also registered as a futures commission merchant with the U.S. Commodity Futures Trading Commission.
Broker-Dealer Liquidations in General
Broker-dealer liquidation generally is effected either pursuant to Subchapter III of Chapter 7 of the Bankruptcy Code3 or, for broker-dealers that are registered with the SEC and that are members of the SIPC, pursuant to SIPA.4 Because the vast majority of broker-dealer firms are SEC registered and SIPC members that are likely to
1 Securities Exchange Act (Exchange Act) Release No. 77157 (February 17, 2016), 81 FR 10798 (March 2, 2016) (the Proposal) available here. 2 Comments on the Proposal are available here. They include letters from (1) the Securities Industry and Financial Markets Association (SIFMA), the Clearing House Association (TCH) and the Financial Services Roundtable (FSR) (submitted jointly), (2) Occupy the SEC, (3) several student members of the Yale Law School Financial Markets and Corporate Law Clinic and (4) Keith Condemi. 3 11 U.S.C. 103(c). 4 15 U.S.C. 78aaa, et. seq.
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be liquidated pursuant to SIPA, stockbroker liquidations under the Bankruptcy Code generally apply only to intrastate stockbrokers that are not subject to SEC oversight.
Under SIPA, if the SEC or a self-regulatory organization determines that a SIPC member broker-dealer has failed to meet, or is in danger of failing to meet, its obligations to customers and that certain financial conditions are present (e.g., insolvency or noncompliance with the broker-dealer net capital rule), SIPC may file an application with a federal district court asserting that the customers are in need of the protections afforded under SIPA. If the court issues a protective decree in respect of the application, the broker-dealer becomes a "debtor" under SIPA, and the court will appoint a trustee if SIPC so requests in accordance with SIPA (a SIPA trustee) to administer liquidation of the broker-dealer.
The SIPA trustee is required, to the greatest extent possible, to distribute securities to customers to satisfy customer claims for securities. One of the first actions by the SIPA trustee in any SIPA case is to attempt to find another broker-dealer that is willing to purchase and carry the customer accounts of the failed broker-dealer. If the accounts are purchased and successfully transferred, customers are able to resume control of them at the new broker-dealer. Under SIPA, SIPC is also required to maintain a fund to be used, among other things, to advance funds to SIPA trustees for satisfying net equity claims of customers if the amount of the broker-dealer's pool of customer property is insufficient.
Proposed Rules for the Orderly Liquidation of Covered Broker-Dealers
Scope and Definitions
Title II of Dodd-Frank provides a statutory alternative insolvency regime for the orderly liquidation of certain large financial companies. As part of that regime, the Agencies are required, in consultation with SIPC, to issue rules regarding the orderly liquidation of certain large broker-dealers. Accordingly, the proposal specifically concerns only broker-dealers that meet the definition of a "covered broker or dealer." A covered broker-dealer is defined as (1) a covered financial company5 that is also (2) a qualified broker-dealer because it is registered with the SEC and is a SIPC member.6 A covered financial company means a financial company7 that the U.S. Treasury Secretary (Treasury Secretary) determines, in consultation with the President of the United States, meets seven criteria that relate to a financial company's financial condition, including whether it is in default or is in danger of default.8
Under Title II of Dodd-Frank, the SEC and the Federal Reserve Board are jointly authorized, in consultation with the FDIC, to issue a written orderly liquidation recommendation to the Treasury Secretary regarding whether a broker-dealer should be found to be a covered broker-dealer that is subject to a Title II resolution. Any such recommendation may be initiated either by a request from the Treasury Secretary or through the joint action of the SEC and the Federal Reserve Board. For any written recommendation to be made to the Treasury Secretary by the SEC and the Federal Reserve Board, it must be approved by a two-thirds majority of each agency's governing body then serving. The recommendation must also explicitly address eight criteria that
5 See 12 U.S.C. 5381(a)(8). 6 See 12 C.F.R. 380.60(d) and 17 C.F.R. 302.100(d) as proposed. See also 12 U.S.C. 5381(a)(7). 7 See 12 U.S.C. 5831(a)(11). 8 See 12 U.S.C. 5383(b)(1) (7). These criteria also include whether failure would have a serious adverse effect on financial stability, whether no viable private sector alternative is available to prevent default and whether the effects of initiating a Title II resolution would avoid or mitigate the adverse effects that might result if such action were not taken.
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generally concern the financial condition of the broker-dealer, the likelihood that private sector action might prevent a default and the likely effects of a default.9
While the proposed rules for Title II resolutions of covered broker-dealers are responsive in pertinent part to the Dodd-Frank statutory mandate, the application of the proposed rules in practice is likely to be limited. Not only must the circumstances in which such a Title II resolution is to be implemented include conditions of potential jeopardy to the financial stability of the U.S., but they are likely to exclude situations in which banking entities are being resolved. Resolution of a systemically important banking group under Title II of Dodd-Frank is intended to be encompassed by the FDIC's "single point of entry" strategy for resolving such banking groups in the United States.10 This same point regarding the limited application of the Proposal is also noted in the joint comment letter that was submitted by SIFMA, TCH and FSR.
Appointment of the FDIC as Receiver and SIPC as Trustee
If the Treasury Secretary determines pursuant to the written recommendation process described above that the entity is a covered broker-dealer, the Treasury Secretary will appoint the FDIC as receiver on a specific date (known as the Appointment Date), and the FDIC will in turn appoint SIPC as trustee (the SIPC trustee) for the covered broker-dealer.11 Court approval is not required for the FDIC's appointment of SIPC in the capacity of SIPC trustee after the FDIC has been appointed as receiver.12
Importantly, this appointment is not a discretionary act on the part of the FDIC, and no entity or authority other than SIPC may be so appointed. Unlike a SIPA liquidation proceeding, under which SIPC may or may not determine to act as SIPA trustee itself or appoint another trustee to act in such capacity, in a Title II resolution SIPC (and only SIPC) is required to be appointed to act in the analogous fiduciary capacity. These features of the proposed regulations serve to underscore the importance of involvement by the competent governmental regulatory authorities (i.e., both the FDIC and SIPC) in circumstances that have risen to such a significant level of importance to the financial system as to require a Title II resolution and to implicate both the FDIC and SIPC in implementing the Title II resolution in practice.
Notice and Application of Protective Decree
As trustee for the covered broker-dealer, SIPC is required to promptly file an application for a protective decree with a federal district court. Under the proposal, SIPC and the FDIC, in consultation with the SEC, jointly determine the terms of the protective decree. The purpose of filing the protective decree is to inform interested parties that the covered broker-dealer is in a Title II resolution and highlight the application of certain provisions.13 The terms of the protective decree may, among other things, provide notice of the following:
1. Block Pending and New Proceedings: Any existing case or proceeding with respect to the covered brokerdealer under the Bankruptcy Code or SIPA would be dismissed, and no such case or proceeding may commence while the FDIC is acting as receiver.
9 See 12 U.S.C. 5833(a)(2)(A) (H). These criteria are similar to those that the Treasury Secretary and the President must consider regarding whether the broker-dealer is a covered financial company. 10 See FDIC, Resolution of Systemically Important Financial Institutions: The Single Point of Entry Strategy, 78 FR 76614 (Dec. 18, 2013). 11 12 U.S.C. 5385(a). 12 12 U.S.C. 5385(a)(1). 13 Proposal, 81 FR at 10801 (e.g., applicable stays and other matters that might be addressed in a protective decree issued under SIPA).
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2. Revesting of Assets: Assets of the covered broker-dealer that have vested in other entities as a result of cases or proceedings under the Bankruptcy Code, SIPA or state insolvency laws shall revest, with certain exceptions, in the covered broker-dealer.
3. Stay of Litigation: The request of the FDIC for a stay in any judicial action or proceeding in which the covered broker-dealer is or becomes a party for up to 90 days from the Appointment Date.
4. Contracts: No person may exercise any contractual right or power to terminate, accelerate, declare default or obtain control of property of the covered broker-dealer without the consent of the FDIC during the 90 days following the Appointment Date, with the exception of certain qualified financial contracts (QFCs).14
5. QFCs: The exercise of rights and performance of obligations by parties to QFCs with the covered brokerdealer may be conditioned, stayed or delayed pursuant to Title II.15
The FDIC, as the receiver for a covered broker-dealer or in anticipation of being appointed as the receiver, may organize one or more special broker-dealers called "bridge broker-dealers" to help facilitate the orderly liquidation.16 In concept, the use of a bridge broker-dealer in a Title II resolution is similar to that of a bridge bank in the orderly liquidation of a bank. Use of a bridge broker-dealer is designed to give customers access to their account as quickly as practicable and to assist the FDIC in continuing the covered broker-dealer's operations, minimize systemic risk and maximize the value of assets of the receivership.
If the FDIC establishes one or more bridge broker-dealers, it would generally transfer all customer accounts, customer name securities and customer property to the bridge broker-dealer(s).17 The transfer of assets and liabilities of a covered broker-dealer to a bridge broker-dealer would be effective without any consent, authorization or approval of any person or entity, including governmental bodies and courts.18 Similarly, any succession to or assumption by a bridge broker-dealer of the covered broker-dealer's customer-related rights, powers, authorities or privileges would be effective without the consent, authorization or approval of any person or entity.19 The FDIC may also transfer any other assets and liabilities of the covered broker-dealer, including non-customer accounts and any associated property, as the FDIC may determine to be appropriate.20 However, under the Proposal, the transfer to a bridge broker-dealer of any account or property does not imply that the holder of such account or property qualifies as a "customer account," "customer name securities" or "customer
14 12 U.S.C. 5390(c)(8)(D) (defining QFCs as "any securities contract, commodity contract, forward contract, repurchase agreement, swap agreement, and any similar agreement that the [FDIC] determines by regulation, resolution, or order to be a qualified financial contract ..."). 15 See 12 C.F.R. 380.62(b) and 17 C.F.R. 302.102(b) as proposed. 16 12 U.S.C. 5390(h)(2)(H)(i). A bridge broker-dealer formed in this manner is deemed registered with the SEC and automatically becomes a member of SIPC. 17 The FDIC may elect to not make such a transfer if it determines in consultation with the SEC and SIPC that (1) the transfer of customer accounts, securities and property to one or more qualified broker-dealers will occur promptly or (2) the transfer would materially interfere with the ability of the FDIC to avoid or mitigate serious adverse effects on U.S. financial stability. See 12 C.F.R. 380.63(b) and 17 C.F.R. 302.103(b) as proposed. 18 See 12 C.F.R. 380.63(e) and 17 C.F.R. 302.103(e) as proposed. 19 See 12 C.F.R. 380.63(f) and 17 C.F.R. 302.103(f) as proposed. Under the Proposal, the bridge broker-dealer undertakes the obligations of the covered broker-dealer only with respect to the property and SIPC funds that are transferred and allocated to a customer's account. See 12 C.F.R. 380.63(d) and 17 C.F.R. 302.103(d) as proposed. 20 See 12 C.F.R. 380.63(c) and 17 C.F.R. 302.103(c) as proposed.
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property" within the meaning of SIPA. Rather, the status of the account holder and the assets would depend on whether the claimant is a customer within the meaning of SIPA.21
The orderly liquidation would proceed in a manner substantially similar to a SIPA proceeding. Each customer's claims with respect to the covered broker-dealer are determined on the basis of the customer's "net equity," which generally is the dollar value of a customer's account minus debts owed to the covered broker-dealer as of the Appointment Date.22 The FDIC, in consultation with SIPC, would allocate customer property, along with advances from SIPC,23 in a manner consistent with SIPA.24 A customer's net equity claim would be deemed satisfied and discharged to the extent that customer's property, along with advances from SIPC (if appropriate or where applicable), is transferred and allocated to the customer's account at the bridge broker-dealer.25 In the event that a customer's account and associated property are not so transferred, the customer's net equity claim would remain with the covered broker-dealer and would be subject to satisfaction by SIPC in the same manner as under a SIPA proceeding.26 In either case, each customer of a covered broker-dealer would receive cash and securities at least equal in amount and value to what the customer would have received in a SIPA proceeding. After the payment of all administrative expenses of the FDIC as receiver and of the bridge broker-dealer, any proceeds or other assets that remain would be distributed to the FDIC for the purpose of satisfying the claims of other creditors.27
Claims of Customers and Other Creditors
The FDIC would publish notice of its appointment as receiver and of SIPC as trustee and would determine, in consultation with SIPC, the procedures for filing claims against the covered broker-dealer.28 Under the proposal, the FDIC would establish a claims bar date that is six months after the notice to creditors is first published.29 Any claims received after the claims bar date would generally be disallowed. An exception would apply, however, in the case that a claimant did not receive notice in time to file a claim before the claims bar date and the claim is filed in time to permit payment of the claim.30
The FDIC would be required to notify a claimant whether it allows or disallows a claim within 180 days after the claim is filed or such longer period as the claimant and the FDIC may determine in writing.31 This would apply equally to claimants who are customers and claimants who are other creditors of the covered broker-dealer.
21 Under SIPA, customers have preferred status relative to general creditors with respect to customer property and customer name securities. See 15 U.S.C. 78fff(a). The proposed rules are designed to ensure that the customers of the covered broker-dealer under Title II are treated in a manner at least as beneficial as would have been the case had the broker-dealer been liquidated under SIPA. See 15 U.S.C. 5385(f)(1). 22 12 C.F.R. 380.63(h) and 17 C.F.R. 302.100(h) as proposed (defining "net equity"). 23 If sufficient funds and securities are not available at the covered broker-dealer to satisfy customer net equity claims, SIPC advances would be used to supplement the distribution, up to a ceiling of $500,000 per customer, including a maximum of $250,000 for cash claims. See 15 U.S.C. 78fff3(a). 24 Under SIPA, customer property is distributed to each customer on a pro rata basis based on each customer's net equity claim. See 15 U.S.C. 78fff-2(b). 25 The initial allocations of customer property at the bridge broker-dealer would be permitted to be derived from estimates based on the books and records of the covered broker-dealer or any other information deemed relevant by the FDIC in its capacity as receiver in consultation with SIPC. See 12 CFR 380.63(d) and 17 CFR 302.103(d) as proposed. 26 12 U.S.C. 5385(f)(2). 27 See 12 C.F.R. 380.63(h) and 17 C.F.R. 302.103(h) as proposed. 28 Notice would generally be published on the FDIC and SIPC websites. See 17 C.F.R. 380.64(b) and 17 C.F.R. 302.104(b) as proposed. 29 12 C.F.R. 380.64(b)(3) and 17 C.F.R. 302.104(b)(3) as proposed. 30 Id.; see also 12 U.S.C. 5390(a)(3)(C). 31 12 C.F.R. 380.64(c) and 17 C.F.R. 302.104(c) as proposed. See also 12 U.S.C. 5390(a)(3)(A). Although Title II of Dodd-Frank provides a process for expedited notice of allowance or disallowance of certain claims with 90 days, this provision would not operate under the proposal. 12 U.S.C. 5390(a)(5).
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However, other creditors would also be able to request expedited notice from the FDIC within 90 days from the time their claim is filed. Regarding any claim that is disallowed by the FDIC, the affected claimant would be also able to seek a judicial determination of the claim.32
Certain additional provisions are also proposed to provide clarity regarding special priority rules for administrative expenses and unsecured claims.33
In general, the FDIC's existing priority rule under the Federal Deposit Insurance Act, as amended,34 would determine the relative priority for claims that are allowed but have not been satisfied, including a customer's unsatisfied net equity claim. However, the proposed rules specify certain adjustments to this priority rule. First, the "administrative expenses of the receiver" generally have first priority in being paid. The proposed rules would provide that the administrative expenses of SIPC as trustee would be included among those administrative expenses and paid pro rata with the FDIC's administrative expenses. Second, "amounts owed to the United States" generally have second priority in being paid.35 The proposed rules provide that amounts paid by the FDIC to customers or SIPC would be included within the meaning of "amounts owed to the United States." Third, the proposed rules specify that amounts advanced by SIPC to satisfy customer claims for net equity would be paid after payment of any amounts owed to the United States (i.e., third priority) but before any payment to other specified classes.36
In addition, the proposed rules provide that expenses for services from third parties (e.g., private attorneys, accountants and consultants) used by SIPC as trustee would be included within the administrative expenses of SIPC.37 The costs of such third-party services are permitted as an allowable claim to the extent SIPC's use of such services is practicable, efficient and cost-effective.
Finally, the proposed rules specify that the rights and obligations of any party to a QFC to which the covered broker-dealer is a party shall be governed exclusively by Section 210 of Dodd-Frank.38 That section generally provides that any person who is party to a QFC with the covered broker-dealer may exercise its rights to terminate, liquidate or accelerate the QFC, which arises upon the Appointment Date or any time thereafter subject to certain restrictions.39
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32 12 C.F.R. 380.64(d) and 17 C.F.R. 302.104(d) as proposed; 12 U.S.C. 5390(a)(5). 33 12 U.S.C. 5390(b)(6). 34 12 C.F.R. 380.21. 35 See 12 C.F.R. 380.23 (defining "amounts owed to the United States"). 36 12 C.F.R. 380.65 and 17 C.F.R. 302.105 as proposed. 37 12 C.F.R. 380.66 and 17 C.F.R. 302.106 as proposed. 38 12 U.S.C. 5390. 39 12 U.S.C. 5390(c)(8)(A). Section 210(c)(10)(B) provides certain restrictions, including that the party to a QFC with the covered broker-dealer cannot exercise its rights to terminate, liquidate or accelerate the QFC solely by reason of or incidental to the Title II resolution until 5 p.m. Eastern time following the Appointment Date, or after the person has received notice that the QFC has been transferred to another financial institution. See 12 U.S.C. 5390(c)(10)(B) and (c)(9)(A).
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