Trading broker and clearing broker dealership
In the context of financially distressed or defunct introducing brokers, the plaintiff's search for the deep pocket frequently brings it to the clearing firm's front door. But is a clearing firm an appropriate liability target? Are clearing firms responsible for the alleged wrongdoings of introducing firms and their representatives? Do some clearing firms create liability for themselves where others do not? Do arbitrators adhere to court-ordained liability standards?
Will potential industry rule revisions expand or contract clearing firm liability? This article generally explores these questions and surveys the current landscape and climate. In a typical securities clearing arrangement, an "introducing broker" formally contracts with a "clearing" or "carrying" broker to complete and settle the securities trades of the introducing broker's customers.
The arrangement benefits the introducing broker, which while providing investment advice through direct contact with its investor customers, may not have the financial resources, net capital, personnel or expertise to clear its own trades.
As such, the clearing broker performs numerous back room and administrative functions for the introducing broker, including: The clearing broker typically performs these functions through a "fully disclosed agreement" in which the introducing broker's customer is disclosed to the clearing broker to enable the mailing of trade confirms and account statements.
Clearing arrangements abound within the securities industry. Indeed, they provide a vital resource to many securities dealers who could not otherwise participate in the retail industry. Recent industry statistics reflect that approximately one hundred twenty NYSE clearing firms serve the needs of more than four thousand introducing brokers. 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.
Both situations are subject to NASD Rule 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.
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.
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 provides that the term "customer" shall not include a broker or dealer.
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 Service SM ACT SM 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.
This would avoid a second trade report and ensure that the prime brokerage customer is identified to the NASD. The SEC had twice previously extended the relief granted in the letter and has now granted permanent status to that relief. In particular, the letter clarifies the responsibilities and obligations of the prime broker, the executing broker, and the customer.
SEC approval is extended now until December 31, 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, Following inquiries from firms seeking to continue to use these locations after that date, the SEC extended its approval until December 31,