In general, the new rules pertain to the following:

• Establishing record making requirements for security-based swap dealers (SBSDs) and major security-based swap participants (MSBSPs) and amending the existing record making requirements for broker-dealers
• Establishing record preservation requirements for SBSDs and MSBSPs and amending the existing record requirements for broker-dealers
• Establishing periodic reporting and annual audit requirements for SBSDs and MSBSPs and amending the existing reporting requirements for broker-dealers
• Establishing early warning notification requirements for SBSDs and MSBSPs
• Establishing security count requirements for SBSDs that are not registered as broker-dealers and do not have a prudence regulator (stand-alone SBSDs)
• Amending the SEC’s current cross-border rule to provide a means to request substituted compliance with respect to the recordkeeping and reporting requirements for SBSDs and MSBSPs.
• Amending a rule that permits certain SBSDs that are registered as swap dealers and predominantly engage in a swaps business to comply with Commodity Futures Trading Commission (CFTC) requirements instead of SEC requirements (this alternative CFTC compliance option also has the recordkeeping and reporting requirements being adopted as part of the rules package)

Recordkeeping and Reporting Requirements for SBSDs, MSBSPs, and Broker-Dealers

Scope

The following rules and their applications are being added or amended:

• Except where mentioned, SBSDs and MSBSPs that are also registered broker-dealers will be subject to the existing recordkeeping and reporting rules applicable to broker-dealers, which are as follows:
  • Rule 17a-3 (record making)
  • Rule 17a-4 (record preservation)
  • Rule 17a-5 (periodic reporting and annual audit)
  • Rule 17a-11 (early warning notification)
  • Rule 17a-13 (security count)
  These rules, except for Rule 17a-13, are also being amended to account for security-based swap activities of broker-dealer SBSDs/MSBSPs and broker-dealers that engage in security-based swap transactions but not at the required level for registration as a SBSD or MSBSP.
• SBSDs and MSBSPs that are not also registered as broker-dealers will now be subject to the following rules:
  • Rule 18a-5 (record making)
  • Rule 18a-6 (record preservation)
  • Rule 18a-7 (periodic reporting and annual audit)
  • Rule 18a-8 (early warning notification)
  • Rule 18a-9 (security count)
  Stand-alone SBSDs will also be subject to Rule 18a-9 (security count).
• SBSDs that are also registered as OTC derivatives dealers (a special purpose broker-dealer) will be subject to the following rules:
  • Rule 17a-3 (record making)
  • Rule 17a-4 (record preservation)
  • Rule 18a-7 (periodic reporting and annual audit)
  • Rule 18a-8 (early warning notification)
  OTC derivatives dealers are subject to the capital rule for stand-alone SBSDs (Rule 18a-1) rather than the capital rule for broker-dealers (Rule 15c3-1).

Record Making Requirements

Rule 17a-3 stipulates that a broker-dealer make and keep current certain financial and accounting records, which includes blotters itemizing a daily record of all purchases and sales of securities, ledgers accounting for all assets and liabilities, income and expense, and capital accounts, a securities record, and a memorandum of each brokerage order and proprietary securities transaction. Under the new amendments, this rule has been altered to require broker-dealers (including broker-dealer SBSDs and MSBPs) to create and maintain current records relating to their security-based swaps activities.

In addition, new Rule 18a-5 mandates that non-broker-dealer SBSDs and MSBSPs create and maintain current financial and accounting records and records relating to their security-based swaps activities. This rule is more finely tailored than Rule 17a-3, particularly with respect to requirements for bank SBSDs and MSBSPs.

Record Preservation Requirements

Rule 17a-4 describes the amount of time the required records (which must be made and kept current per Rule 17a-3) must be preserved and the manner in which this preservation is to take place. In addition, the rule identifies additional types of records that must be preserved if the record is made or received by the broker-dealer (for example, any written communications relating to the broker-dealer’s business). This rule has been amended to prescribe the time periods that the new security-based swap records required under Rule 17a-3 must be maintained by broker-dealers (including broker-dealer SBSDs and MSBSPs). These records are also now subject to the other preservation requirements in the rule.

Furthermore, new Rule 18a-6 indicates the period of preservation time applicable to records that are required to be created and kept current under new Rule 18a-5. This is relevant to non-broker-dealer SBSDs and MSBSPs. Rule 18a-6 also stipulates the manner in which these records must be preserved, as well as identifying any additional records that should be maintained.

Periodic Reporting and Annual Audit Requirements

There are two components to Rule 17a-5: 1) the requirement that broker-dealers periodically on a monthly or quarterly basis file an unaudited FOCUS Report containing information about their financial and operational condition, including a balance sheet, income statement, and capital and segregation computations, and 2) the requirement that broker-dealers annually file financial statements and certain reports that are audited by an accountant registered with the Public Company Accounting Oversight Board (PCAOB) using PCAOB standards. Part II of the FOCUS Report has been amended to include information about the capital and segregation computations of nonbank SBSDs and MSBSPs, security-based swap and swap transactions, and positions of broker-dealers and nonbank SBSDs and MSBSPs, among other things. Rule 17a-5 will also require broker-dealers (including broker-dealer SBSDs and MSBSPs) to file this amended FOCUS Report Part II, in addition to requiring broker-dealer SBSDs and MSBSPs to file the annual audited reports.

New Rule 18a-7 will also require non-broker-dealer SBSDs and MSBSPs to file the amended FOCUS Report Part II. In the case of bank SBSDs and MSBSPs, this requirement applies to the new FOCUS Report Part IIC, which is more limited than the amended FOCUS Report Part II and requires bank SBSDs and MSBSPs to report certain information about their security-based swap activities and financial condition (which will be largely drawn from the information they file with the prudential regulators). This new rule also mandates that stand-alone SBSDs and MSBSPs file annual audited reports. This requirement does not apply to bank SBSDs and MSBSPs.

Early Warning Notification

Rule 17a-11 identifies the situations under which a broker-dealer must notify the SEC and other regulators about adverse changes in the firm’s financial or operational condition. As an example, a broker-dealer would be required to provide notice when, among other things, its net capital falls below 120% of the minimum required amount or below the minimum required amount, when the firm fails to make and keep current the books and records required by the SEC, or when a broker-dealer discovers or is notified by its accountant of a “material weakness” as defined in Rule 17a-5. Rule 17a-11 has been amended to require notice if the broker-dealer (or broker-dealer SBSD or MSBSP) fails to make a required deposit into a security-based swap customer reserve account.

Rule 18a-8, which is new in the rules package, establishes notification requirements for non-broker-dealer SBSDs and MSBSPs. These requirements are similar to those stipulated in Rule 17a-11 and outlined above.

Security Counts

Rule 17a-13 requires a broker-dealer to examine and count the securities it physically holds, account for the securities that are subject to its control or direction but are not in its physical possession, verify the locations of securities under particular circumstances, and compare the results of the count and verification with its records. This must be done on a quarterly basis. Broker-dealer SBSDs and MSBSPs will be subject to this rule, and new Rule 18a-9 will require stand-alone SBSDs to perform a similar quarterly securities count.

Alternative Compliance Mechanism

Rule 18a-10 provides that an SBSD that is not a registered broker-dealer and is a registered as a swap dealer and predominantly engages in a swaps business may elect to comply with the capital, margin, and segregation requirements of the Commodity Exchange Act and the CFTC’s rules instead of complying with the SEC’s rules if certain conditions are met. This rule has been amended to allow these SBSDs to choose to comply with the CFTC’s recordkeeping and reporting requirements rather than the SEC’s requirements regarding these topics.

Cross-Border Application

The SEC’s cross-border rule has been amended to permit foreign SBSDs and MSBSPs to avail themselves of substituted compliance to satisfy the recordkeeping and reporting requirements.

These new rules will become effective 60 days after publication in the Federal Register. The compliance date for the rule amendments and new rules is 18 months after the effective date of any final rules addressing the cross-border application of certain security-based swap requirements.

Sources:

SEC Adopts New Rules and Amendments under Title VII of Dodd-Frank (www.sec.gov)
Recordkeeping and Reporting Requirements for Security-Based Swap Dealers, Major Security-Based Swap Participants, and Broker-Dealers (www.sec.gov)