Safeguarding Customer Assets

Beyond supervisory procedures and inspections, firms have a fundamental obligation to protect customer assets. The customer-protection rule and FINRA requirements create a framework for keeping customer funds and securities safe.

What Does the Customer Protection Rule Require?

This rule is a core investor protection measure in the securities industry:

• Broker-dealers must maintain physical possession or control of customers' fully paid securities and excess margin securities
• The firm must take timely steps in good faith to establish prompt physical possession or control
• The firm cannot use fully paid customer securities for its own trading or business purposes

Special Reserve Bank Account

• The firm must maintain a Special Reserve Bank Account for the exclusive benefit of customers
• The reserve must hold cash or qualified securities sufficient to cover the net cash owed to customers
• This protects customer assets in the event of the broker-dealer's insolvency
• The reserve computation determines how much the firm must set aside

Exam Tip: Gotchas

The customer-protection rule requires broker-dealers to segregate customer assets from firm assets. The firm cannot commingle customer funds with its own money or use fully paid customer securities for proprietary trading. Violations can lead to severe sanctions, including firm closure.

What Procedures Does a Firm Need for Handling Cash, Checks, and Securities?

Internal inspections under the FINRA supervision rule must specifically examine the safeguarding of customer funds and securities. Firms must have procedures addressing the physical receipt, delivery, and safekeeping of:

• Cash and cash equivalents: currency, cashier's checks, money orders
• Checks: proper endorsement, timely deposit, documentation
• Physical securities: stock/bond certificates received for deposit or transfer

What Must Happen Before and After a Transmittal?

When transmitting customer funds or securities, the firm must:

• Have procedures to verify the customer's instructions before transmitting
• Confirm the transmittal with the customer after it is completed
• Document the process

When Can a Firm Draw a Check From a Customer's Account?

• A member may not draw any negotiable instrument (check) from a customer's account unless the member has obtained prior written authorization from the customer
• The authorization must specifically authorize such drawings; a general trading authorization is not sufficient
• This prevents unauthorized withdrawals from customer accounts
• The customer's signature on the negotiable instrument itself can satisfy the authorization requirement; when the authorization is a separate document, the firm must preserve it for three years after it expires

Exam Tip: Gotchas

A general trading authorization is not enough to draw checks from a customer's account. The customer must provide specific written authorization for negotiable instrument drawings. Also note that the customer-protection rule is an SEC rule, not a FINRA rule, though FINRA enforces compliance through its inspection process.

What Should You Check on Exam Day?

• Can you state what the customer-protection rule requires: physical possession or control of fully paid and excess margin securities, plus a Special Reserve Bank Account covering net cash owed to customers?
• Do you know a firm cannot use fully paid customer securities for its own trading, and why that matters if the firm becomes insolvent?
• Can you explain the two-step transmittal safeguard: verify instructions before, confirm with the customer after?
• Do you know a check drawn on a customer's account needs specific written authorization, not just a general trading authorization?