My friend and a legend in the securities regulatory field, Edwin Nordlinger, who served as Deputy Regional Director in the SEC’s New York office for years, was one of the nation’s premier experts on the SEC’s net capital and customer protection rules. He taught hundreds of SEC staff members and others about these rules over the years. However, when Ed would begin one of these lectures, he would always introduce himself by saying: “Hello, I am Ed Nordlinger from New York, where you do not go to jail for killing people, but you will go to jail if you violate the net capital or customer protection rules.” Well, Ed, you continue to be right on point about these rules and their impact.
The SEC’s net capital rule, SEC Exchange Act Rule 15c3-1, requires firms to maintain certain capital so that the firms will be able to meet their financial obligations to customers and other creditors. Similarly, SEC Exchange Act Rule 15c3-3, the customer protection rule, requires a firm that clears transactions to maintain certain reserve amounts to protect customers in the event of a firm failure.
Recently, the SEC found a firm to have violated the customer protection rule, and settled the matter with the firm whereby the firm agreed to pay a fine of $358 million and a total amount of $415 million. https://www.sec.gov/news/pressrelease/2016-128.html. Further, the SEC also charged the firm’s regulatory reporting officer and financial operations principal for aiding and abetting the violations by misleading regulators about the real reason behind certain transactions that caused the violations. In particular, the SEC claimed that the firm used synthetic securities transactions solely to reduce the reserve calculation and release capital. The firm also apparently used non-qualifying bank accounts that could be subject to bankruptcy if the firm were to fail.
The real kicker, however, is the SEC’s announcement that it plans to undertake a targeted sweep of firms to find potential violations by other firms of the customer protection rules. Of course, the SEC also encouraged firms to self-report any potential violations of the customer protection rule.
In short, Ed, after all these years, you are still right. Firms need to seriously undertake compliance with these rules, or there will be significant consequences. Accordingly, although the rules may seem technical with no fraud or customer losses, the SEC plans major activity to ensure compliance.