NASD Regulation reminds NASD members of their trade reporting obligations in riskless principal transactions involving prime brokerage arrangements where the customer in the arrangement is a broker/dealer. In such transactions, two trades must be reported: (1) the trade between the executing broker and the contra-side; and (2) the trade between the executing broker and the broker/dealer customer under the prime brokerage arrangement. As detailed below, however, if the customer is not a broker/dealer, only one trade report would be required.
Prime brokerage arrangements are established to facilitate the clearance and settlement of securities trades for highly capitalized investors who actively participate in the market. They are designed to provide a centralized clearing facility and custodian for all of the customers trades and resultant securities positions, regardless of the number of brokers used by the customer to execute its transactions.
These arrangements involve at least three parties the prime broker, the customer, and the executing broker(s). The prime broker clears and settles the trades executed by one or more executing brokers at the direction of the customer. The obligations of the respective parties are specified in contracts between the prime broker and executing broker(s), and in individual contracts between each party and the customer.
Accordingly, the customer may place orders directly with the various executing brokers who are party to the prime brokerage arrangement. Each executing broker holds an account in the name of the prime broker for the benefit of the customer, and will record the customers trade in such account.
On trade date, the customer notifies the prime broker of the trade performed by the executing broker. The prime broker issues a confirmation to the customer and computes all applicable credit and Regulation T amounts. The executing broker confirms the trade with the prime broker, who then generally has until the close of business of trade date plus one to affirm or disaffirm the trade. The prime broker will affirm the trade if its information matches with that of the executing broker, and if the trade is within the credit limits and other parameters established for the customers account.
The prime broker issues at least a monthly statement to the customer, which notes all of the customers securities transactions during the subject period as well as resultant securities positions and monetary balances. Additionally, on the day following each trade placed with the executing broker(s), the prime broker sends notification of such trade(s) to the customer, based upon the information provided by the customer. If the customer has properly designated that the executing broker(s) send the trade confirmation(s) to the customer in care of the prime broker, the prime broker must inform the customer in writing that the confirmation is available to the customer without charge promptly upon request.
Where the customer in a prime brokerage arrangement is a registered broker/dealer, reporting requirements for principal transactions by the executing broker differ from those where the customer is a non-broker/dealer. Both situations are subject to NASD Rule 4632(d)(3)(A), which generally provides that for principal transactions the reporting member (the executing broker in the prime brokerage arrangement) must report separately each purchase and sale transaction. However, the application of the riskless principal exception to trade reporting is different depending on whether or not the customer is a non-broker/dealer. In sum, as detailed below, if the customer is a non-broker/dealer, the riskless principal exception applies and there should be only one trade report; conversely, if the customer is a broker/dealer, the riskless principal exception does not apply and there should be two trade reports.
A riskless principal transaction is a transaction in which a member that is not a market maker in the security, after having received from a customer an order to buy (sell), purchases (sells) the security as principal to then satisfy the order. Subsection (d)(3)(B) provides that such occurrence shall be reported as one transaction in the same manner as an agency transaction.
The riskless principal transaction exception does not apply to prime brokerage trades where the customer in the prime brokerage arrangement is a registered broker/dealer, however. Subsection (d)(3)(B) limits the exception to those instances where the subject order is for the account of a customer. In this regard, NASD Rule 0120 provides that the term customer shall not include a broker or dealer. Accordingly, the exception described in subsection (d)(3)(B) may not be relied upon in any situation where the order being facilitated by the reporting member was entered for the proprietary account of a registered broker/dealer.
Principal transactions by the prime brokerage executing broker on behalf of another broker/dealer must be reported as separate purchase and sale transactions; and, the subject broker/dealer must be identified as a party to the second transaction. As noted above, where a member who is not a market maker in a given security executes a proprietary order entered by another broker/dealer on a riskless principal basis, however, the initial and the facilitation transactions must be reported as separate trades.
Alternatively, the executing broker may give up the prime brokerage customer in the initial trade report pursuant to a give up arrangement between the two parties. In a give up arrangement, a member who reports or accepts a trade in the Automated Confirmation Transaction ServiceSM(ACTSM) on behalf of another member would identify in the ACT screen give up box the member on whose behalf the trade was being reported or accepted. Where the executing broker accepts a trade that has been reported by another member, the reporting member would have to report the trade with the executing broker as the contra-side and identify the prime brokerage customer as the contra-side give up. The executing broker may then accept the trade as presented. This would avoid a second trade report and ensure that the prime brokerage customer is identified to the NASD. Give up arrangements should be set out in writing and submitted to the Nasdaq Market Operations Department.
Any questions concerning this matter may be directed to Richard McDonald, Senior Attorney, Market Regulation, NASD Regulation, Inc., at (301) 590-6444.
Prime Broker AccountsOn December 30, 1997, the SEC granted a permanent extension of its January 25, 1994, no-action letter that permits broker/dealers to treat a prime-broker account as if it were a broker/dealer credit account pursuant to Section 220.11 of Regulation T. The SEC had twice previously extended the relief granted in the letter and has now granted permanent status to that relief.
The term prime-broker account refers to an account maintained by a broker/dealer (usually a full-service firm) to facilitate the clearing and settling of securities transactions for highly capitalized investors who are active market participants. A unique feature of these accounts allows the customers to place orders directly with one or more other registered broker/dealers (the executing broker).
The no-action letter establishes certain conditions that broker/dealers must meet to treat these accounts as broker/dealer credit accounts. In particular, the letter clarifies the responsibilities and obligations of the prime broker, the executing broker, and the customer.
In addition, the SEC has granted an extension, until December 31, 1998, of relief contained in a July 9, 1997, no-action letter for broker/dealers that engage in prime brokerage activities with certain investment advisers that are no longer required to be registered under Section 203 of the Investment Advisers Act of 1940.
Good Foreign Control Locations for SEC Rule 15c3-3On December 31, 1997, the SEC extended its interim approval of foreign control locations in states that were previously part of the former USSR as satisfactory locations for customer fully paid and excess margin securities under the possession and control requirements of SEC Rule 15c3-3. SEC approval is extended now until December 31, 1998.
Under SEC Rule 15c3-3, broker/dealers must obtain prompt possession and control of all fully paid and excess margin securities that belong to customers. Subparagraphs (c)(4) and (c)(7) of the Rule allow the SEC, upon application, to designate foreign depositories, foreign clearing agencies, foreign custodian banks, or other locations as satisfactory control locations for customer fully paid and excess margin securities. The original approval to use foreign control locations in the former USSR states was granted through December 31, 1997. Following inquiries from firms seeking to continue to use these locations after that date, the SEC extended its approval until December 31, 1998.
Questions concerning these matters may be directed to your localNASD Regulation District Office, or to Samuel Luque, Jr., Associate Director,Compliance, NASD Regulation, Inc., at (202) 728-8472.