1. Broker-dealer industry hot topics
Highlights from Grant Thornton LLP’s broker-dealer industry symposium
On June 19, 2012, Grant Thornton hosted a panel discussion The panelists addressed a number of current issues facing
on the major issues facing the broker-dealer industry. The the broker-dealer industry. The issues discussed included
discussion was hosted by Nichole Jordan, the firm’s National environmental pressures, changes in the regulatory atmosphere,
Banking and Securities Industry leader. It was moderated enhanced customer protection rules, and margin changes and
by Lee Pacchia, legal analyst and host of Bloomberg Law technology changes, including the use of social media.
multimedia programs. The panel comprised several broker-
dealer industry professionals, including these industry experts: Environmental pressures
The discussion stressed that the two major drivers that impact
• Steven Lofchie, partner, Cadwalader the industry relate to the inability of broker-dealers to address
• Kevin Piccoli, deputy director, Division of Swap Dealer and liquidity and collateral certainty. Effective implementation
Intermediary Oversight, U.S. Commodity Futures Trading of the rulemaking and regulatory initiatives discussed here is
Commission (CFTC) dependent on adequately addressing these issues.
• Lanny A. Schwartz, partner, Davis Polk & Wardwell LLP
• Grace Vogel, executive vice president of member regulation,
Financial Industry Regulatory Authority (FINRA)
The following are edited transcripts and summaries of panel
discussions from the conference. In all cases, the speakers’
comments represent their own views and are not necessarily
those of their respective organizations, Grant Thornton LLP or
its clients, or any other entity. The information provided may
not and should not be construed to imply endorsement or even
support by Grant Thornton LLP of the views expressed herein.

2. Broker-dealer industry hot topics
• Basel III – Recent financial crises have highlighted • Dodd-Frank implementation (Uniform Fiduciary
weaknesses in the global regulatory framework for financial Standard) – Under Dodd-Frank, the SEC is mandated to
firms. As a result, the Basel Committee on Banking study the need for establishing a uniform federal fiduciary
Supervision has adopted the global regulatory standard standard of care for broker-dealers and investment advisers
known as Basel III. It covers bank capital adequacy, stress who provide personalized investment advice. According to
testing and market liquidity risks. The Basel III initiative Vogel, FINRA believes a fiduciary standard is appropriate
will put increased pressure on broker-dealers’ profitability, for all customers, including brokerage customers. However,
particularly on returns on equity (ROE) given the increased FINRA does not believe every client is suitable for a fee-
capital and margin requirements. Balance sheets will also be based account, which may result in higher charges, and does
reduced because of increased leverage requirements. believe clients should have the option to have a self-directed
account for which they are charged on a commission basis.
One of the challenges broker-dealers are facing under Basel In a fee-based account, the customer is generally charged
III is how to replace or increase their revenues to maintain separately for each service provided, while a commission
the ROEs that shareholders have come to expect. From charge is incorporated into the transaction itself.
a sales practice perspective, regulators are concerned that
new products originally developed for institutional clients The proposed Investment Adviser Oversight Act suggests
are now being sold to retail customers, which may not be shifting the regulation of investment advisers from the SEC
appropriate for them. According to Panelist Grace Vogel, to FINRA. Panelist Lanny Schwartz indicated that the topic
while all the regulations governing the securities business of self-regulation for investment advisers has been around
took many years to develop, the regulations governing for many years. He agrees that there are important customer
the derivatives space evolved over a much shorter period benefits. This was highlighted in part by the Madoff crisis,
of time. And, she observed, as swaps move to execution when the principal regulator — the SEC — did not have
facilities and central clearing under the new guidelines, sufficient manpower to perform timely examinations of
margins to dealers will be dramatically reduced. the more than 12,000 advisers. (The SEC did perform an
audit of the Madoff broker-dealers, although the extent of
Regulators have been challenged to find the appropriate the clients who had invested in Madoff-managed accounts
model to determine the amount of capital that has to be through other advisers was the examination failure issue.)
maintained by broker-dealers. The value-at-risk model for According to Schwartz, as the broker-dealer and investment
trading assets is currently in use, but according to Vogel, advisory businesses converge, utilizing FINRA as the self-
that model presents challenges because it is accurate only regulatory organization (SRO) for investment advisers
99 percent of the time. This means that one out of every would promote a common set of standards and approaches
100 days will result in a loss that exceeds the model, Vogel for examinations. While the SEC has revised its custody
said. As a result, the SEC and the CFTC have set minimum examination requirements, installing an SRO would support
capital requirements. Under its Consolidated Supervised improvements to investment adviser examinations.
Entity program, the SEC required that broker-dealers have
at least $5 billion in tentative net capital (i.e., net liquid
assets). However, this proved to be insufficient in the case of
Lehman Brothers in 2008, when a lack of liquidity exposed
the firm’s inability to realize the measured fair value. Vogel
indicated that FINRA is now placing much more focus on
liquidity, asking firms to maintain sufficient liquidity at the The proposed Investment Adviser Oversight
broker-dealer level rather than at the holding company, and
to perform stress testing to ensure liquidity is available when
Act suggests shifting regulation of investment
needed. While currently there are no definitive SEC rules advisers from the SEC to FINRA.
governing liquidity, Vogel expects to see some liquidity rules
for securities-based swap dealers proposed this summer.

3. Broker-dealer industry hot topics
• JOBS Act regulation – The Jumpstart Our Business • Segregation and secure control locations for customer
Startups (JOBS) Act that was recently passed by Congress funds – Piccoli said that the CFTC will be recommending
brings two major reforms to securities law: changes to the changes to the method of computation for secured funds.
IPO process and facilitation of capital access to private FCMs should be using the net-liquidating equity method
companies. But what are the consequences for broker- to compute the secured amount versus the alternative
dealers on the research side? Panelist Steven Lofchie sees a method, which can leave any unused portion of customers’
contradiction in the regulation; for example, the CFTC has funds exposed to loss. Piccoli indicated that the CFTC will
been tightening its regulation of institutional research on be issuing a letter to FCMs in the near future, addressing
interest rates and FX, while the SEC is deregulating research computation methods. He expects some regulations
on emerging growth companies meant for retail investors. regarding secured funds to be forthcoming. He also
Schwartz pointed out that the legislation is an example of mentioned that the CFTC is contemplating whether FCMs
the trade-offs that come with securities regulation, because should be required to disclose the location of the secured
the JOBS Act may allow small businesses to more easily assets and to what extent that location should be made
raise capital and access the IPO market. available to the public.
• Uncertainty regarding the Volcker Rule – The Volcker • Proposed elimination of credit ratings in SEC rules –
Rule has created uncertainty for financial institutions and Under Dodd-Frank, the SEC has proposed removing
the financial markets in general. Lofchie sees difficulty references to credit ratings within the credit agency rules
in regulating non-U.S. financial institutions because that and, where appropriate, replacing them with an alternative
effort may negatively affect international relations with standard of creditworthiness. Vogel said that no-action
these institutions and could affect U.S. jobs. He also sees letters making reference to credit ratings will continue to
diminished liquidity and widening spreads in the market. exist, but the SEC is planning to change the language where
On the other hand, Vogel does not believe liquidity will be reference is made to a nationally recognized statistical rating
affected, indicating that there are many market makers that organization.
can provide liquidity not subject to the Volcker Rule.
• Importance of broker-dealers’ custody practices – Lofchie
• Risk review update – Panelist Kevin Piccoli indicated that emphasized the importance of the custody rule for broker-
liquidity is one of the main risk factors driving firms into dealers and advised firms to take a closer look at their foreign
troubled situations. He anticipates pressure on U.S. firms, control location agreements. He added that the treatment of
particularly the parent companies of futures commission affiliate accounts is a very important issue. Vogel commented
merchants (FCM), as a result of downgrades on some banks that there have been instances in which firms have lost
coupled with the European situation. It is important to significant amounts of money because they did not review
understand the risk elements in order to keep customers’ transactions closely enough; the transactions were masked
funds safe and secure. From an examination standpoint, because they were done on an intracompany basis.
Piccoli noted that the CFTC will be taking a closer look at
the risk profiles of firms and the effect on customers.

4. Broker-dealer industry hot topics
Additional areas of focus • Proposed additional documented procedures for clearing
• FINRA Rule 4524 (Rule 4524) – Rule 4524 allows FINRA firms – Proposed FINRA Rule 4516 will require clearing,
to collect information supplementary to the Financial and carrying and self-clearing firms to store certain records
Operational Combined Uniform Single (FOCUS) report. (e.g., lists of responsible parties, access letters to all control
According to Vogel, the FOCUS report is an SEC form, locations, detailed procedural write-ups) in a centralized
first approved in the mid-70s, that has become outdated. physical location at the principal office to enable regulators
The SEC has recently approved Rule 4524, which allows to take prompt action to protect investors in the event of a
FINRA to collect information supplementary to the liquidation. After receiving comments from member firms,
FOCUS report. Each form must go through the comment FINRA is making some modifications to the proposed rule,
period and rulemaking process; the first form that was including narrowing the universe of firms subject to the rule.
approved is a detailed income statement that must be filed
by every firm on a quarterly basis, with the first filing due • Use of social media and areas of concern – With the
for the period ending Sept. 30, 2012. This information will proliferation of social media use by broker-dealer personnel,
give FINRA a better understanding of how the firm is FINRA has developed detailed guidance for member firms.
making money and what its expenses are. FINRA will also Any communication made with the public falls under SEC
require additional information from firms that, during a rules and must be supervised and retained by the broker-
reporting period, derive more than 10 percent of their total dealer. A registered principal (principal) must approve the
revenues from participation in unregistered offerings. use of any social media site prior to its use by an associated
person. Any communication that recommends certain
The second form, which is applicable only to carrying and products may trigger the suitability rule, and additional
clearing firms, is a proposed supplemental off-balance sheet disclosures may be required. Certain social media meet
schedule, designed to give better insight to off-balance the definition of a public appearance, such as participation
sheet items. In the case of MF Global, several risks were in online forums, chat rooms and seminars. While these
not detected because they were off-balance sheet items actions do not need prior approval, a post-review would be
and were identified only after the annual audited financials required. Blogs that contain certain static content fall under
were released. There were some concerns regarding the the SEC’s advertising rules and require principal review
confidentiality of the schedule, but Vogel assured the prior to use. Use of Facebook, Twitter and LinkedIn also
audience that FINRA does not make the FOCUS report need to be supervised, and depending on how the associated
available to the public, and therefore would not make the person is using them, may require pre- or post-review.
supplemental schedule available either. Third-party posts are also an area of concern because
they could be attributed to the firm. Any links to a third-
party also raise concerns because these sites may contain
misleading or incorrect information.
The use of personal devices by broker-dealer personnel is
also an area of uneasiness. Vogel referred to it as “Bring
Your Own Device” because many firm personnel do not
want to carry several devices and prefer to be able to access
all of their work on their own personal device. The broker-
dealer needs to be able to retain and supervise all of the
activity on that device. Many firms are asking personnel to
sign an annual attestation of compliance with firm polices.

5. Broker-dealer industry hot topics
• Proposed efforts to increase customer protection – As • Creation of swap data repository and areas of concern
self-regulatory organizations for the futures commission, the – Under Dodd-Frank, market participants — particularly
National Futures Association and the Chicago Mercantile swap dealers — need to report certain data elements to a
Exchange merchants have proposed rule amendments to registered swap data repository or the CFTC. The industry
increase customer protection. In addition, Piccoli said the has many concerns about the structure, including the
CFTC is expecting each firm’s chief compliance officer ability of firms to gather all the information required in the
(CCO) to take an active role in ensuring the right areas are time frame put forth by the rule. There are also concerns
being reviewed. The CFTC is proposing that CCOs of swap about the swap data repositories themselves, including
dealers and FCMs perform an annual certification stating that how they operate, what their technical standards are and
policies, procedures and controls have been reviewed and the security of the data. Given the complexity of the swaps
are in position. This proposed rule is similar to FINRA Rule data, Schwartz voiced concern over how intelligible the
3130, which requires CEOs or their equivalent to annually information will be and how market participants will be
certify firm compliance policies and supervisory procedures. required to use it.
The CFTC will also be focusing on the amount of excess in
the funds required to be segregated or secured. This amount • Information learned from the May 6 flash crash – On
is traditionally viewed as the cushion, or as Piccoli called it, May 6, 2010, the Dow Jones fell almost 700 points in less
the target level. Firms will now be required to disclose how than 30 minutes in an event dubbed the “flash crash.”
the target level is determined, and they will be required to Pacchia asked what we have learned from it. Vogel indicated
notify the CFTC if there are changes in the level, and why. If that there is a more rational uptick rule that should prevent
more than 25 percent of the excess is withdrawn, this action the same thing from happening again, as well as SEC Rule
must be approved by the CEO or CFO. 15c3-5, which is the direct-market access rule requiring
firms to put controls in place.
• FINRA Rule 5310 (Best Execution Rule) – FINRA Rule
5310 (Rule 5310) is the new consolidated rule governing • High-frequency traders (HFT) and potential restrictions
members’ best execution requirements. Moderator Lee – According to Vogel, HFTs argue that they provide
Pacchia asked whether Rule 5310 will provide more comfort liquidity to the market. However, she said it is often difficult
to investors, and if regulators are focused on the right issues. to distinguish between an HFT and a market maker. Lofchie
Lofchie feels that the equity markets are incredibly efficient, feels that the SEC has taken away a lot of the incentive to
with very little fluctuation in price one way or another. be a market maker, and by default, the HFTs have become
Additionally, Lofchie feels there are other issues, such as market makers.
liquidity, that are more deserving of attention from firms and
regulators. From a regulatory perspective, he thinks that best
execution practices are a relatively low regulatory priority.
Given the complexity of the swaps data, Schwartz
voiced concern over how intelligible the
information will be and how market participants
will be required to use it.

6. Broker-dealer industry hot topics
• Status of SEC rules – The SEC is working on finalizing the The principal message from our panel of experts is to
new Form Custody report, which wil require information properly assess liquidity and provide adequate levels of capital
about how a broker-dealer maintains custody over customer to sustain a firm in troubled times. Firms should constantly
and noncustomer assets. Vogel said she expects the new verify their ability to timely recover assets maintained in
form to go into effect in the first quarter of 2013. The SEC separate control locations, regardless of the legal status.
is also planning to adopt a rule requiring a report from
auditors indicating compliance with SEC Rules 15c3-1, 15c-
3-3 — the customer protection rule — and 17a-13, which
requires a broker-dealer to count the securities it holds for
customers and for itself. Furthermore, the SEC is planning
to adopt a rule that would require auditors to speak directly
to the SEC to review their risk assessment processes.
• Inclusion of previously unregistered derivative entities as
major swap participants – Piccoli indicated that it will be
interesting to determine who actually qualifies as a major
swap participant. The CFTC currently anticipates 125 swap
dealers will be registered, some of which have never been
registered before. Piccoli said the CFTC will work with
these entities to determine best practices and to develop
testing methods the entities can understand.
Contact information
For more information about the topics covered at this event, contact one of our professionals:
Nichole Jordan
National Banking and Securities Leader
Grant Thornton LLP
T 212.624.5310
E nichole.jordan@us.gt.com
Jack Katz
National Managing Partner
Financial Services Content in this publication is not intended to answer specific questions or suggest suitability of action
Grant Thornton LLP in a particular case. For additional information on the issues discussed, consult a Grant Thornton
T 212.542.9660 client service partner.
E jack.katz@us.gt.com
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