SEC Division of Trading and Markets no-action letter: Securities Industry Association

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON. D.C. 20549 DIVISION OF MARKET REGULATION September 20, 1993 Douglas Gw Preston, Es~. 120 Broadway New York, NwY. 10271 Re: Rules 17h-1T and 17h-2T under the Securities and Exchanse Act of 1934 Dear Mr. resto on:
This is in response to your November 3, 1992 letter on behalf of the Securities Industry Association ("SIA1'), in which you asked questions regarding certain requirements under Rules 17h-1T and 17h-2T and Form 17-H under the Securities Exchange Act of 1934 ("Exchange Actt1) .' INTRODUCTION On July 16, 1992, thel securities and Exchange Commission (llCommissionu) adopted ~ules 17h-1T .and 17h-2T, which, together with Form 17-HI establish a risk assessment recordkeeping and reporting system for broker-dealers. * Rule 17h-IT, a recordkeeping rule, requires a broker-dealer to maintain information and other records concerning certain affiliated entities of the broker-dealer. Rule 17h-2T, a reporting rule, requires a broker-dealer to file information on Form 17-H with t!~ Cammissiofi. The SIA has compi1ed.a number of requests for various interpretations of the Rules. It has asked the ~ivision of Market Regulation (tlDivisiontl) to issue an interpretative letter 'see Securities Exchange Act Rules 17h-1T and 17h-2T; 17 C.F=R= § 5 240.17h-1T and 240.17h-2T. %. t 'see - Securities Exchange Act Release NO. 30929 (July 16, 1992), 57 FR 32159 (July 21, 1992). The Rules were adopted pursuant to the authority conferred on the Commission by the Market Reform Act of 1990, which added Section 17(h) to the Exchange Act. Market Reform Act of 1990, pub. L. NO. 101-432, § 4, 104 Stat. 963, 966-973 (1990); 15 U.S.C. 5 78q(h)

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Douglas Go Preston, Es~.

regarding these questions. In response to this request, the

Division sets forth its interpretation of certain provisions of

the Rules.

11. DETERMINATION OF MATERIAL ASSOCIATED PERSONS

Section 17(h) of the Exchange Act requires every registered

broker-dealer to Itobtain such information and make and keep such

recordstt describing "those of its associated persons, other than

a natural person . . . whose business activities are reasonably likely to have a material impact on the financial and operational

conditiont1 of the broker-dealer .=The Rules amplify the statutory standard by setting forth several factors to be

considered by a broker-dealer in determining which yf its

associated persons are Material Associated Persons. The SIA has

requested guidance with respect to the circumstances set forth

below.

A broker-dealer that has no holding company will be treated

by the Division as an exempt broker-dealer; accordingly, this

firm has no reporting or recordkeeping obligations under Rules

17h-1T and 17h-2~.'

'see -Section 17 (h) (1) of the Exchange Act. The term "associated person" is defined in section 3 (a) (18) of the Exchange Act.

Paragraph (a)(2) of Rule 17h-1T directs a broker-dealer to

consider the following factors ili its designation of Material

Associated Persons: (i) the legal relationship between the broker

or dealer and the associated person; (ii) the overall financing

requirements of the broker or dealer and the associated person,

and the degree, if any, to which the broker or dealer and the

associated person are financially dependent on each other;

(iii) the degree, if any, to which the broker or dealer or its

customers rely on the associated person for operational support

or services in connection with the broker's or dealer's business;

(iv) the level of risk present in the broker's or dealer's

associated persons; and (v) the extent to which the associated

person has the authority or the ability to cause a withdrawal of

capital from the broker or dealer.

'certain broker-dealers within a holding company are affiliated

with other broker-dealers that are subject to the Rules. + Paragraph (b) (4) of Rule 17h-2T permits the broker-dealer with

the greatest amount of capital (as of the reporting date) within

a holding company to request designation as a "Reporting Broker

or Dealer.'' The Commission recently has issued orders

designating 58 broker-dealers as Reporting Brokers or Dealers

under the Rules.

Further, the SIA has asked whether partnerships-_and , Subchapter S corporations may be treated TsZiatural persons who

€h%reby-would be outside the scope of the ~uies. The ~ivision

believes that a Subchapter S corporation may be treated as a

natural person for purposes of the Rules if the Subchapter S

corporation is owned by one natural person. Partnerships,

however, may not be treated as natural persons and, depending on

the facts and circumstances, may be Material Associated Persons

ofsthe broker-dealer.

RULE 17h-1T -- RECORDKEEPING REQUIREMENTS Rule 17h-1T requires each broker-dealer subject to the Rules

to maintain and preserve three general categories of information

concerning its associated persons. The first, set forth in

paragraphs (a) (1) (i) through (a)(1.) (iii) of Rule 17h-IT, includes the holding company's organizational structure and risk

management policies, and a description of all pending legal

proceedings involving Material Associated Persons that are

required to be disclosed under generally accepted accounting

principles ("GAAPt1) .6 The second consists of the financial

statements described in paragraphs (a) (1) (iv) and (a) (1) (v) of

Rule 17h-1T. The third contains the financial and securities

activity-related data described in paragraphs (a)(l) (vi) through

(a)(l)(x) of Rule 17h-1T and the corresponding sections of Part

I1 of Form 17-H.

B. Information Remired by Parasra~hs (a) (1)(i) throush

(a)(1) liii) of Rule 17h-1T

Organizational Chart

Paragraph (a) (1) (i) of Rule 17h-1T requires a broker-dealer

to maintain and preserve an organizational chart that sets forth

the broker-dealer and all its associated persons, and that

designates which associated persons are Material Associated

Persons. his information should preferably be maintained in a

chart format; however, the broker-dealer may provide a written

description of the broker-dealer's organizational structure that

clearly sets forth the relationships among the broker-dealer and

its associated persons. c
%he legal proceedings required to be reported are to be

disclosed by the highest level Material ~ssociated Person holding-----

company, not necessarily the ultimate parent holding company.

2. Risk Management Policies or Procedures
   Paragraph (a) (1) (ii) of Rule 17h-1T requires a broker￾dealer to maintain written policies, procedures or systems concerning, among other things, the broker-dealer's methods monitoring the financial and operational risks to it result for -ng from the activities of any of its associated persons. As noted in the release accompanying the final Rules, a broker-dealer is not coppelled to create such policies or procedures when none exist. The Rules, however, would require a broker-dealer that operates under informal or oral policies or procedures to summarize these policies in written form, and to file them with the Commission. -~dditionall~, a broker-dealer that operates without the policies referred to in the Rules is repired to document, in writing, the absence of such policies. Financial Statements Remired by Paraqraphs (a) (1) (iv) and (a) (1) (v) of Rule 17h-1T Paragraphs (a) (1) (iv) and (a) (1) (v) of Rule 17h-1T require a broker-dealer to maintain and preserve quarterly consolidated and consolidating balance sheets and income statements, and consolidated-cash flow statements that are prepared in accordpance with GAAP, including the notes to these financial statements. The SIA has asked whether a broker-dealer may refer back to previous footnotes so that footnotes would not have to be repeated in subsequent Form 17-H filings. Broker-dealers may refer to notes in previously filed financial statements, but only if the notes referenced are components of a prior Form 17-H filing.'' In general, a complete set of the notes to the 'see Securities Exchange Act Release No. 30929 (July 16, 19921, 57 FR 32159 (July 21, 1992). *. '~n general, a broker-dealer may maintain the consolidatirig income statements required by paragraph (a)(l)(v) of Rule 17h-1T and Item 4 of Form 17-H on a cumulative yearrto-date basis rather than on a quarterly basis.

• • --YFO~ example, it is not acceptable for a broker-dealer to refer
    to notes that are components of a Form 10-Q or 10-K.

financial statements should be filed with the Commission once

every year.

2. Presentation of Associated Persons in the

~inancial Statements

In preparing the financial statements required by paragraphs

(a)(1) (iv) and (a) (1) (v) of Rule 17h-IT, broker-dealers should

provide separate entries for each Material Associated Person and

for each other significant associated person. Broker-dealers may'

combine insignificant non-Material Associated Persons in a single

entry in the financial statements.

3. Financial Statements for Broker-Dealers within

Multi-Tiered Holding Company Structures

The SIA has inquired about the requirement to provide the

financial statements required by Rule 17h-1T in the case of

multi-tiered holding company structuxes. Specifically, the SIA

has requested clarification as to whether the financial

statements are required to include only those holding companies

which are Material Associated Persons, and whether the ultimate

holding company which is not a Material Associated Person may be

excluded.

In preparing the financial statements required by the Rules,

broker-dealers must provide dinancia1 statements for the ultimate

holding company onlypwhere the holding company is a Material

Associated Person. The Division believes that financial

statements should be maintained in this manner for most broker-

dealer holding company structures.

Cases in which the ultimate parent holding company is a non-

Material Associated Person are unusual. For example, an ultimate % holding conpany that, engages primarily in non-financial or non￾securities activities such as manufacturing or retailing, and has

an intermediate holding company that does engage in financial and

securities activities (including funding the broker-dealer)

probably is not a ater rial Associated Person. In such a case, it

would be sufficient for the financial statements required by the

Rules to include on1.y the intermediate holding company, which is

a Material Associated Person.
%

• 4. Auditing of Financial Statements
  A broker-dealer is not required to have-the financial

statements described in paragraphs (a) (1)(iv) and (a) (1)(v) of

Rule 17h-1T audited by an independent public accountant. If

these statements, however, are audited for purposes other than

Douglas Go Preston, Es~.

compliance with the Rules, then the broker-dealerllshould file the

audited financial statements with the Commission.

Do Financial and Securities Information Recruired bv

Paraaraphs (a) (1)(vi) throuah (a1 (1)(XIof Rule 17h-1T

1. Consolidated Reporting for Material Associated

Persons

The financial and securities-related data described in

paragraphs (a) (1) (vi) through (a) (1)(x) of Rule 17h-1T must be maintained by a broker-dealer, and filed with the Commission on

Part I1 of Form 17-H. Part I1 of Form 17-H requires a separate

column, or a separate form, to be completed for each Material

Associated Person. In the cases where a broker-dealer has an

associated person which is not a Material Associated Person,

which associated person in turn has subsidiaries that are

Material Associated Persons, the broker-dealer may maintain and

report the financial information set forth in paragraphs

(a)(1)(vi) through (a) (1)(x) of Rule 17h-1T for the subsidiaries that are Material dssociated Persons on a consolidated basis

through the non-Material Associated Person.

2. Aggregate Securities and Commodities Positions

Paragraph (a) (1)(vi) of Rule 17h-1T requires a broker-

dealer to maintain and preserve data reflecting the aggregate

securities and commodities positions at quarter-end (and month-

end if greater than quarter-end) for the broker-dealer and each

Material Associated Person, including a separate listing for each

''single unhedged securities or commodities position that exceeds

the Materiality Threshold. "12 he following guidelines should be used in complying with this paragraph:

(1) Generally, the determination of whether a

securities or commodities position is unhedged for

purposes of paragraph (a) (1)(vi) of Rule 17h-1T

should be made by each broker-dealer. In

determining whether a position is unhedged for the

purposes of this paragraph, broker-dealers should

"see -Securities Exchange Act Release No. 30929 (July 16, J992), 57 FR 32159 (July 21, 1992).

I2~heterm "Materiality Thresholdn is defined- in paragraph (a) (4) of Rule 17h-1T to mean the greater of: (i) $100 million; or

(2) 10% of the broker or dealer's tentative net capital based on

the most recently filed FOCUS Report or 10% of the ater rial

Associated Person's tangible net worth, whichever is greater-

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Douglas Go Preston, Es~.

consider only existing positions; if a broker￾dealer needs to put on further positions in the event of a market move, such additional position(s) should be considered unhedged for purposes of this paragraph. (2) A Reporting Broker or Dealer should compare the relevant position or exposure to its own capital level in determining whether an item has exceeded the Materiality Threshold.
3. Certain Financial Instruments
Paragraph (a) (1) (vii) of Rule 17h-IT, in part, requires a

broker-dealer to maintain data concerning the value, as of

quarter-and, of financial instruments wkih off -balance sheet risk

and with concentrations of credit risk. A broker-dealer should

maintain and report this data in the manner set forth below:

Commodities positions should be reported on Part

11, Section (11) (E) of Form 17-H.

Interest rate swaps that are neither U.S.

denominated nor cross currency (e-s., D-Mark/D-

Mark, D-Mark/Yen, etc.) should be reported on Part

11, Section (11) (B) (2) of Form 17-H.

Two foreign forward transactions should be treated

as a foreign exchange swap, and should be reported

on Part 11, Section (11) (C) (1) of Form 17-H.

For purposes of reporting the lkontractual value

of naked written option contractsftl the term

Ikontractual value1' means mark-to-market value.

For the purposes of this section, the term ''nakedr:

refers to option positions that are not offset by

underlying securities positions, or commodities,

forwards or other instruments.

Foreign currency swaps should be reported on Part

11, Section (11) (C) (I) of Form 17-H.

Broker-dealers are required to report the ' "aggregate current cost of replacing contrhcts by

counterparty in which the c ate rial Associated - The financial instruments described in paragraph (a) (1) (vii) of

Rule 17h-1T include commodities positions as set forth in Part

11, Section (11) (E) of om n-~.

Person has a gainw on Part I1 of Form 17-H with

respect to financial instruments with off-balance

sheet risk and concentration of credit risk. This

information may be reported net of any collateral

or other securities received and may be offset by

contracts in a loss position where a master

netting arrangement exists as defined in Financial

Accounting Standards Board Interpretation No. 39.

If information is reported on a net or offset

basis, the broker-dealer should indicate such

reporting in its filing.

4. Extensions of Credit

Paragraph (a) (1) (viii) of Rule 17h-1T requires a broker-

dealer to maintain and preserve data on bridge loans and other

material unsecured extensions of credit (not including intra-

group receivables) for each of its Material Associated Persons at

quarter-e.xr. The tern "intra-qroupw ri-fers to exposures within

the ultimate holding company structure; accordingly, Rule 17h-1T

requires a broker-dealer to maintain data only on extensions of

credit outside the holding company (i.e., to knrelated third

parties).

5. Data Relating to Real Estate Activities

Paragraph (a) (1) (x) of kule 17h-1T requires a broker-dealer

to maintain and preserve data relating to real estate activities

conducted by each Material ~ssociated Person. This paragraph of

Rule 17h-1T and the corresponding section of Form 17-H pertain

only to real estate development for investment purposes, not to

"real estate development for use wholly or substantially by the

broker-dealer, its holding company, or its - other affiliates.
IV. RULE 17h-2T -- REPORTING REQUIREMENTS
A. Method of Filinq '
Paragraph (a) of Rule 17h-2T requires broker-dealers subject

to the Rules to file with the Commission the information

caintained pursuant to Rule i7h-1T on Form 17-H. Broker-dealers

should not file Form 17-H on the EDGAR system; rather, Form 17-H

will be considered filed when the report, together with the

facing page of Form 17-H, is received at the Commissionls'

principal office in Washington, D.C.
-
14see H- Rep. No. 524, lOlst Cong., 26 Sess. 27, 30 (1990).

B. Form 17-H Filina Reauirements

1. ~escription of the Information Reported on Parts I

and I1 of Form 17-H

Form 17-H is comprised of two parts. Part I consists of the

organizational, policy and legal information required by

paragraphs (a) (1)(i) through (a) (1)(iii) of Rule 17h-IT, in

addition to the financial statements required by paragraphs

(a)(1)(iv) and (a) (1)(v) of Rule 17h-1T.

Part I1 of Form 17-H contains line items for reporting the

data required by paragraphs (a) (1) (vi) through (a) (1) (x) of Rule

17h-1T. The information reported on Part I1 of Form 17-H should

not include broker-dealer pbsitions that are reported in the

broker-dealer's FOCUS Report. In addition, it should be noted

that a broker-dealer should.report each Material Associated

Person's gross positions, including intercompany positions, which

positions will be netted out in the cumulative consolidating

financial statements filed by the broker-dealer at the end of

each fiscal quarter.

2. Time Periods for Filing Form 17-H

Paragraph (a)(l) of Rule 17h-2T requires a broker-dealer to

file a Part I and Part I1 of Form 17-H with the Commission within

60 calendar days of the end of its fiscal quarter for the first

three fiscal quarters. The fourth fiscal quarter Part I1 filing

should be filed within 60 days of the end of the broker-dealer's

fiscal year. The cumulative year-end financial statements

described in paragraphs (a) (1) (iv) through (a) (1) (v) of Rule 17h-

1T may be filed separately within 105 calendar days of the end of

the fiscal year. If the information reported in the cumulative

year-end financial statements is materially different from the

information in the fourth fiscal quarter filing, the diff. i-?t:bces

should be reflected in an amended fourth quarter filing. In the

event a broker-dealer finds4t necessary to amend a Form 17-H

that has been filed with the Commission, the broker-dealer should

refile the pertinent part of the Form, as soon as practicable,

together with a newly executed facing page.

C. Material Associated Persons under the Supervision of a
Federal Bankins Asencv b.
€

1. Recordkeeping and Reporting

paragraph (b) (1) of Rule 17h-1T and paragraph (c) of Rule

17h-2T contain special provisions pertaining to a broker-dealer

with a Material Associated Person that is a domestic or foreign ---- banking association which is under the supervision of a Federal

banking agency. Under these paragraphs, a broker-dealer with a

Material Associated Person that is a US. bank may file with the

Commission copies of the reports filed on ~orni FR-Y-9C and FR Y￾6 for use by ~ederal banking regulators. Similarly, a broker-

dealer with a Material Associated Person that is a foreign bank

subject to U.S. banking regulation may file with the ~omdssion

copies of Form FR Y-7 that are prepared for Federal banking

regulators.

It should be noted that these paragraphs do not apply with

respect to the information described in paragraphs (a)(l)(i)

through (a) (1) (iii) of Rule 17h-IT, (i. e., the organizational

chart, policy data and disclosure of legal proceedings).

Accordingly, broker-dealers are required to maintain the

information set forth in paragraphs (a) (1) (i) through

(a)(1) (iii) , complete Items 1, 2 and 3 under Part I of Form 17- H, and file Form 17-H with the Commission.

2. The Periods for Filing Federal Eanking Reports
   with the Commission

Federal banking reports should be filed with a separately

executed facing page of Form 17-H when they are due to the

Federal banking agency, even if this differs from the time period

required for the broker-dealer's filing by Rule 17h-2T.

D. Material ~ssociated Persons under the Supervision of a

Foreisn Financial Resulatorv Authoritv

1. Recordkeeping and Reporting

Paragraph (c) of Rule 17h-1T and paragraph (d) of Rule 17h-

2T set forth special provisions that apply to a broker-dealer

with a Material Associated Permn that is under the supervision

of a Foreign Financial Regulatory A~thority.'~ Under these

paragraphs, a broker-dealer may file with the Commission those

he term "foreign financial regulatory authorityt1 is defined in

Section 3 (a) (51) of the Exchange Act to include any: (A) foreign

securities authorit;:: ;a! 9th ::r ccvernmenkal body or foreigr, equivalent of a sel;.-regulatory organization empowered by a

foreign government to administer or enforce its laws relaf ing to

the regulation of fiduciaries, trusts, commercial lending;

insurance, trading in contracts of sale of a commodity for future

delivery, or other instruments traded on or subject to the rules

of a contract market, board of trade, or foreign equivalent or

• other financial activities; or (C) membership orqanization a --- function-of which is to regulate participation 05 its members in
  the activities listed above.

16

reports that are filed with the primary banking, financial or

securities entity that exercises regulatory authority over its

Material Associated Person.

It shouldbe noted that these paragraphs do not apply with

respect to. the information described in paragraphs (a) (1) (i)

through (a) (1) (iii) of Rule 17h-IT, (e., the organizat .ona chart, policy data and disclosure of legal proceedings).

Accordingly, broker-dealers are requ ired to maintain the

information set forth in paragraphs (a) (1) (i) through

(a)(l)(iii), complete Items 1, 2 and 3 under Part I of Form 17-

H, and file Form 17-H with the Commission.

Rule 17h-1T does not require a broker-dealer to maintain

copies of ancillary materials such as working papers, that were

used by its Material Associated Person to prepare the reports.

Paragraph (c) of Rule 17h-1T does require the broker-dealer to

maintain copies of these reports within the United States.

Broker-dealers should file along with the report a short

narrative setting forth the material differences between U.S. and

foreign conventions (for example, a statement explaining the

differences between foreign accounting conventions and U.S. GAAP,

etc. ) . A quantitative reconciliation is not required.16
2. Time Periods for Filing with the Commission

Reports that are Filed with a Foreign Financial

Regulatory Authority

Broker-dealers should file with the Commission the most

recent report filed with a Foreign Financial Regulatory

Authority, even if the time period for reporting to the ~oreign

Financial Regulatory ~uthority differs from that required by Rule

17h-2T. For example, a broker-dealer with a calendar end fiscal

year may file the report filed xith a foreign financial

regulatory authority on September 30 along with the broker-

dealer's Form 17-H due on or before March 1.

The Rule requires a reporting broker-dealer to file with the

Commission one copy of the original report, and a copy translated

into the English language.

Douglas Gw Preston, Esqw
V. CONCLUSION
You should understand that the positions stated in this letter are staff positions and do not necessarily reflect the views of the Commissionw If you have any further questions, please do not hesitate to contact me at (202) 272-2904, or Roger G. Coffin at (202) 272-7375. Sincerely, Michael A. Macchiaroli Associate Director