The Securities and Exchange Commission and the Federal Deposit Insurance Corporation recently jointly announced proposed rules for the liquidation of those broker-dealers deemed to present a systemic risk to the financial stability of the United States. The proposed rules are designed to give greater clarity and certainty to the procedures set out in Title II of the Dodd-Frank Act (“Act”) for the special non-judicial, administrative liquidation procedures for such entities. [1] Comments are due 60 days from publication of the proposed rules in the Federal Register, which period will run at least until April 17, 2016.

Congress intended the special systemic risk administrative liquidation procedures set out in the Act to avoid the complex and protracted litigation and resulting uncertainty surrounding the 2008 liquidation of Lehman Brothers, Inc. Any entity that was affected by that proceeding should be concerned about the liquidation process that will govern a future liquidation of a major broker-dealer like Lehman Brothers. These proposed rules therefore should be of interest to anyone interested in customer asset protection against insolvency/liquidation risk involving major broker-dealers.

In general, the Act supersedes SIPA and the Bankruptcy Code in liquidations of those entities that are  “covered broker-dealers” under the Act. The Act provides an alternative insolvency regime for the orderly liquidation of a covered broker-dealer outside of court supervision and under an administrative process, with SIPC acting as trustee for the covered broker-dealer and the FDIC as overall administrator. The FDIC also serves as receiver of such institutions or their parent or affiliates. The Act contemplates that the FDIC will transfer the assets and business of the covered broker-dealer to another institution, and if that is not practicable, the FDIC will establish a bridge broker-dealer to receive the assets and accounts of the broker pending an orderly transition. 

Unlike prior law, under the Act, the FDIC may operate the business of the covered broker-dealer through the bridge broker-dealer. The Act establishes a special account at the Treasury and grants the FDIC authority to draw on assets from this account  to finance the operations of the bridge broker-dealer to ensure an orderly transition. The Act grants the FDIC authority to restructure the business of the covered broker-dealer at the expense of the shareholders and general creditors. Where a customer’s account is transferred to the bridge broker-dealer under FDIC authority, that customer’s claims against the broker are likely to be offset to the extent of the value in their accounts at the time of transfer. The Act does require that customers of the covered broker-dealer be treated at least as beneficially as they would be under the present liquidation provisions of SIPA. The proposed rules clarify:

  • The roles of the FDIC as receiver;
  • The roles of SIPC as trustee for the covered broker-dealer; and
  • The administration of claims in the liquidation of a covered broker-dealer.

In general, the proposed rules provide greater uniformity for the administrative process by which SIPC as trustee determines the amount of customer claims and the customer property to be allocated to such claims. See proposed rule §380.64(a).

Any disputes about the determination of customer claims will be resolved by the FDIC as receiver. In general, the FDIC is given 180 days to resolve those disputes. See proposed rules §380.64(b) and (c). The rules clarify that any judicial review of the administrative claim is de novo. See proposed rule §380.64(d).

The proposed rules also set out the administrative priority for expenses of the receivership and the SIPC trustee. Seeproposed rules §380.65. As in bankruptcy generally, the Act contemplates that the administrative expenses of the receivership will be paid ahead of general creditors. The proposed rule clarifies that SIPC’s advances for satisfying customer claims are subordinate to the administrative expenses of the proceeding generally.

The rule is offered as a means of promoting predictability and efficiency during the liquidation process, and is anticipated to provide more structure to the framework for these special liquidations under Dodd-Frank, reducing the risk of inconsistent or varying procedures across large-scale liquidations. The Agencies are seeking written comment on the proposed rules, particularly comments concerning potential adverse impacts on market participants, potential negative impacts to customers or other claimants, and any matter that should be addressed within the rules that was omitted or is unclear.