SEC no-action letter relating to prime brokerage: Difference between revisions

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SEC no-action letter relating to prime brokerage (view source)

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 ''But''.
-It does have a rather succinct description of what prime brokerage, for the most part, is. Made somewhat succincter, the JC reads the gist as follows:
+In a nutshell, the SEC no-action letter relating to prime brokerage of January 25, 1994 confirms that a cash trade executed by a customer with an executing broker for [[give-up]] to a [[prime broker]] does not violate the “free-rider” rule in [[Regulation T]].
-{{quote|Prime brokerage is the process by which a registered broker-dealer clears and settles of securities trades for its customers. It involves three distinct parties: the [[prime broker]], the [[executing broker]], and the [[customer]].
+Thus, once you have your BAU operational framework set up, [[Regulation T]] is not really something that should trouble the [[legal eagle]]s, at least from a documentation perspective, prescribing as it does how the business should operate, not how it is documented, though there are some documentation requirements, especially as regards the [[executing broker]].
+In saying this, the no-action letter does have a rather succinct description of what basic equity [[prime brokerage]] is. Made somewhat succincter, the [[JC]] reads the gist as follows — ''and by way of '''[[disclaimer]]''''', the [[JC]] knows a few New York attorneys but is not one, does not want to be one (and does not need any more brochures from the ''Hoboken Night School for the Perpetually Dense'', though thank-you to my many correspondents who have sent them in), is not steeped in the same tea as our American friends, so as long as you treat this as the feebleminded musings of a complete cretin, you won’t get yourself in too much of a pickle:
+{{quote|[[Prime brokerage]] is the process by which a registered broker-dealer clears and settles of securities trades for its customers. It involves three distinct parties: the [[prime broker]], the [[executing broker]], and the [[customer]].
 The '''prime broker''' is a [[registered broker-dealer]] that [[Clearing|clears]] and [[Margin lending|finances]] the trades the customer has executed with an “executing broker” — another [[registered broker-dealer]] at the customer’s request.
-Each [[executing broker]] receives a letter from the [[prime broker]] agreeing to clear and carry each trade placed with it by the [[customer]], where the customer directs delivery of money or securities under the trade to be made to or by the prime broker, to an account the customer maintains with the prime broker.
+Each [[executing broker]] receives a letter from the [[prime broker]] agreeing to clear and carry each trade placed with it by the [[customer]], where the customer directs delivery of money or securities under the trade to be made to or by the prime broker, to an account the customer maintains with the [[prime broker]].
 Orders placed with the executing broker are effected through an account with the executing broker in the name of the prime broker for the benefit of the customer.
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 The prime broker committee, chaired by Bear Stearns (remember them?) sought clarity from the SEC that a normal PB settlement would not be. It proposed to treat the “trade settlement” transaction between the [[prime broker]] and [[executing broker]] as an inter-dealer (principal) trade even though theoretically executed as [[agent]] for the customer. The SEC granted it, in the no-action letter.
+==Terms==
+The SEC Enfrocement Division will not recommend that the Commission take enforcement action if, under such a prime broker arrangement, the executing broker and prime broker treat the customer account as if it were a broker-dealer credit account under [[Regulation T]] and:
+====1-3 The PB and EB====
+[...][''Various matters relating to the regulatory status and set up of the prime broker itself]
+====4. The Customer====
+The customer must keep a [[minimum net equity]] with the prime broker of at least $500,000 in liquid assets )<ref>Being cash or securities with “a ready market”: see the definition  in 15-c3 of “[https://www.law.cornell.edu/cfr/text/17/240.15c3-1. ready market]”, which amounts to a liquid public market: “... a recognized established securities market in which there exists independent bona fide offers to buy and sell so that a price reasonably related to the last sales price or current bona fide competitive bid and offer quotations can be determined for a particular security almost instantaneously ...”.</ref> and the customer is obliged to cure any [[passive breach]]es of that USD500,000 limit within a rather leisurely 5 business days, on pain of the [[PB]] publicly disowning its customer and [[DK]]ing<ref>Until the year of our Lord 2021, the [[JC]] laboured under the gentle misapprehension that “[[DK]]” stood for “drop-kick”. To an American, not being wise in the ways of rugby union, it turns out [[DK]] means she “does not know” — that is, rejects — the trade allegation. Strange but true.</ref> all subsequent trades.
+A prime broker may settle prime broker trades for customers
+*whose accounts are managed by a [[Investment Advisers Act of 1940|registered]] investment adviser as long as the account has a minimum net equity of at least $100,000 in liquid assets.
+*who keep a [[minimum net equity]] with the prime broker of at least $100,000 in liquid assets, if the account cross-[[guarantee|guaranteed]] by another customer of the [[prime broker]] who itself has $500,000 in [[liquid assets]] in an account with the [[prime broker]].
+====5. Documentation====
+To qualify for no-action relief the following contracts must be executed and available for inspection:
+*The [[prime broker]] and [[executing broker]] must first have executed contract under which:
+:*each acknowledges and agrees to be bound by the terms of the [[SEC no-action letter|no-action letter]];
+:*the [[executing broker]] acknowledges its responsibility for [[Credit risk|credit sanction]]ing, [[KYC]] and locating shares to cover [[short sale]]s and [[DK]]’d trades; and
+:*the prime broker is obliged to notify the executing broker if its customer prime brokerage contract terminates
+*Both [[EB]] and [[PB]] must execute written contracts with their mutual customers consistent with the terms of the [[SEC no-action letter|no-action letter]].
+*The EB must inform any firm clearing its trades that is intends to act as an executing broker]]
+====6. Records====
+The PB must keep separate records for all of its customers available for inspection
+====7. EB notifications====
+The customer and the [[executing broker]] must inform the prime broker by open<ref>Technically, “morning”.</ref> on the next business day of each contract amount, the security, number of shares, and whether it was a long or short sale or purchase. The parties must use a registered clearing agent to issue trade confirmations by open<ref>Technically, “morning”.</ref> on the next business day.
+====8. Settlement by PB====
+The [[prime broker]] must confirm and settle the transactions the customer placed with the [[executing broker]] and within the timeframes above, unless it [[DK]]s a trade, which it must do by close of business on T+1. (This is why the executing broker must undertake its own KYC and credit review.)
+If, due to [[force majeure]] at the clearing agency, the [[prime broker]] receives a trade confirmation that was entered in a timely fashion after noon (eastern time) on T+1 the [[prime broker]] has until the close of business on T+1 of the day after receipt to [[DK]] the transaction.
+====9.  Record of DKs====
+The PB must keep a record of all DKs over the past three years, with reasons. Where a PB DKs a trade that remains the EB’s trade.
+====10. Short sale regulations====
+The EB must comply with all the applicable short sale provisions and, before executing any [[short sale]] must determine that the securities can be borrowed to deliver against the [[short sale]].
+====11. 10b-10 confirmations====
+The EB must send 10b-10-compliant trade confirmations to the customer for each trade placed under the PB arrangement. It may send these care of the [[prime broker]] where the customer has instructed this in writing (but the [[PB]] cannot make that instruction a condition to acting, nor give favourable fees to clients who give such an instruction. The [[PB]] must in any case make the confirmations available free of charge.
+The [[PB]]  must send the customer 10b-10-compliant notifications of each trade placed with the [[executing broker]] pursuant to the prime broker arrangement, based on information provided by
+the customer.
+====12. EB records====
+The EB must keep records of the PB trades per rule 17a-3.
+====13. DK procedure====
+When the PB DKs a trade:
+*The prime broker must give the customer a notice of cancellation.
+*The EB must send a new 10b-10-compliant replacement confirmation.
+{{sa}}
+*[https://www.sec.gov/divisions/marketreg/mr-noaction/pbroker012594-out.pdf The famous SEC no-action letter]
+{{ref}}