Customer Protection and Custody of Assets

Broker-dealers hold customer cash and securities, and several rules and protections exist to keep those assets safe. This section covers the key regulatory requirements and the safety net that protects customers if a firm fails.

What You'll Learn

  • How SEC Rule 15c3-3 protects customer assets from misuse
  • What the Net Capital Rule (SEC Rule 15c3-1) requires of broker-dealers
  • How FINRA Rule 2150 prohibits improper use of customer property
  • What the Securities Investor Protection Corporation (SIPC) covers (and does not cover)

1. SEC Rule 15c3-3: The Customer Protection Rule

SEC Rule 15c3-3 is the primary rule governing custody of customer assets. Its purpose is to prevent broker-dealers from using customer funds and securities to finance their own operations.

Two primary requirements:

  1. Physical possession or control - the firm must maintain possession or control of all fully paid customer securities (securities the customer has paid for in full, not purchased on margin)
  2. Special Reserve Bank Account - the firm must maintain a dedicated bank account for the exclusive benefit of customers, holding the net cash owed to customers

Key principles:

  • Customer securities must be segregated from the firm's proprietary securities
  • Customer cash must be kept in a separate reserve account; the firm cannot use it for proprietary trading or other business purposes
  • If a broker-dealer fails, this segregation increases the likelihood that customer property will be returned

Exam Tip: Gotchas

  • "Fully paid" is the trigger. Only fully paid securities (not margin securities) must be in the firm's possession or control. Margin securities are pledged as collateral and follow different rules.
  • The Special Reserve Bank Account is untouchable. The firm cannot dip into it for any reason. If a question describes a firm borrowing from the reserve account, that is a violation.

2. SEC Rule 15c3-1: The Net Capital Rule

SEC Rule 15c3-1 requires broker-dealers to maintain a minimum level of net capital (liquid assets minus liabilities) at all times.

  • Net capital acts as a financial cushion, ensuring the firm can meet its obligations to customers even during market stress
  • If a firm's net capital falls below the required minimum, it must stop doing business until the shortfall is corrected
  • The rule is designed to protect customers by preventing firms from becoming insolvent while holding customer assets

Think of it this way: The Customer Protection Rule (15c3-3) keeps customer money separate. The Net Capital Rule (15c3-1) makes sure the firm itself stays financially healthy enough to operate. Together, they create a two-layer safeguard.

3. FINRA Rule 2150: Improper Use of Customer Assets

FINRA Rule 2150 reinforces the customer protection framework by explicitly prohibiting:

  • Using customer securities or funds for the firm's own benefit (unless the customer has given written authorization)
  • Commingling (mixing) customer assets with firm assets
  • Any other improper use of customer property

Exam Tip: Gotchas

  • Segregation is the key word. Customer assets and firm assets must be kept completely separate. A firm using customer funds to cover its own trading losses violates both Rule 15c3-3 and FINRA Rule 2150.
  • Commingling is always prohibited. There is no exception that allows a firm to mix customer and firm assets in the same account.

4. SIPC: Securities Investor Protection Corporation

The Securities Investor Protection Act of 1970 (SIPA) created the Securities Investor Protection Corporation (SIPC), a nonprofit membership corporation funded by member broker-dealers. SIPC provides a safety net when a broker-dealer fails financially.

Coverage limits:

  • $500,000 per customer for securities and cash combined
  • Within that $500,000 limit, $250,000 maximum for cash claims

What SIPC covers:

  • Stocks, bonds, Treasury securities, mutual funds, and other registered securities missing from a customer's account when a broker-dealer fails
  • Cash held in a brokerage account for the purpose of buying securities

What SIPC does NOT cover:

  • Losses from a decline in market value of securities (SIPC protects against firm failure, not bad investments)
  • Commodity futures contracts or forex trades
  • Fixed annuity contracts that are not registered as securities
  • Losses caused by a broker's bad investment advice

Separate capacity rule: Each "separate capacity" (individual account, joint account, IRA, etc.) is treated as a separate customer, each eligible for up to $500,000 in coverage.

Exam Tip: Gotchas

  • SIPC is NOT insurance against market losses. If your stock drops 50% in value, SIPC does not reimburse you. It only protects against missing assets when a broker-dealer fails.
  • $500,000 total, $250,000 cash sublimit. Two caps apply independently. A customer with $200,000 in securities and $400,000 in cash gets only $450,000 from SIPC ($200,000 securities + $250,000 cash), because the cash sublimit is the binding constraint, not the $500,000 overall cap.
  • SIPC is funded by its member broker-dealers, not by the federal government. It is not a government agency.

Think of it this way: SIPC coverage is like a suitcase with a compartment. The whole suitcase holds up to $500,000, but the cash pocket inside maxes out at $250,000 (exactly half). Securities fill the main compartment; cash goes in the smaller pocket. Both limits apply independently.