Notice Requirements for Broker-Dealers
With respect to the borrowing of securities from customers, Section 929X of the Dodd-Frank Act imposes the following two additional requirements on broker-dealers: (i) every registered broker or dealer must provide notice to its customers that they may elect not to allow their fully paid securities to be used in connection with short sales and (ii) if a broker or dealer uses a customer’s securities in connection with short sales, the broker or dealer must provide notice to its customer that the broker or dealer may receive compensation in connection with lending the customer’s securities.
SIFMA has outlined the following best practices for compliance with the notice requirements of Section 929X, which are based on discussions with various SIFMA members, as well as discussions with the staff in the SEC Division of Trading and Markets. Pursuant to Rule 15c3-3 under the Securities Exchange Act of 1934, broker-dealers are generally prohibited from borrowing a customer’s fully-paid securities unless the broker-dealer enters into a separate written agreement with the customer that contains the provisions set forth under Rule 15c3-3(b)(3). Accordingly, broker-dealers should review their disclosures to existing customers with brokerage accounts with whom the broker-dealer has entered into a fully-paid lending agreement pursuant to Rule 15c3-3(b)(3) for compliance with the notice requirements of the Dodd-Frank Act, and make any necessary adjustments to such disclosures before engaging in any new borrows with such customers. Specifically, broker-dealers should consider whether their disclosures provide notice to such customers that fully-paid securities they lend to the broker-dealer may be used in connection with short sales, and that the broker-dealer may receive compensation in connection with the use of the customer’s fully-paid securities.
Broker-dealers should also consider that the second requirement above does not specifically state that the disclosure only applies to fully-paid securities. Therefore, Broker-dealers should consider whether such disclosure should also be sent to margin customers whose securities may be rehypothecated. For existing margin customers, firms could include such notice in the course of standard information provided to existing margin customers in the next available cycle as part of information provided in a customer statement or otherwise. This notice should be incorporated into the customer agreements for future margin customers. The SEC may by rule, prescribe the form, content, time and manner of delivery of any such notice, but this provision of the Dodd-Frank Act otherwise appears to be self-operative.
Contact Steve Quinlivan for more information.