Dispute over broker-dealer cash erupts

IRVINE, Calif. — An SEC proposal to change how broker-dealers can invest customer reserve funds has come under attack from a variety of industry interests.
The Securities and Exchange Commission is proposing to outlaw the use of affiliated banks for such funds and limit deposits at other banks.
At the same time, it wants to allow brokerage firms to use money market mutual funds for reserve fund assets — but with controversial restrictions.
Larger brokerage firms that keep customer assets under custody must calculate and fund reserves to ensure that client obligations can be met.
The SEC is concerned that reserve funds could be at risk if a broker-dealer — and its bank or money fund — goes under.
The SEC’s reserve fund proposal was part of a package of financial-responsibility rules floated by the SEC in March. The comment period, which closed in May, generated spirited feedback.
The proposal caught the banking and brokerage industries off guard.
It was a “nasty surprise with the ‘bankerages,’” Peter Crane, president and publisher at Crane Data LLC, a Westboro, Mass.-based publisher of money fund data, said of brokerage firms with bank affiliates.
The proposal also surprised members of the ABA Securities Association, a Washington-based affiliate of the American Bankers Association, said Sarah Miller, ABASA’s general counsel.
Reserve funds total some $150 billion in assets, said Eugene Maloney, executive vice president of Federated Investors Inc. in Pittsburgh.
He said 30% of reserve fund assets are invested in government paper, and 70% are in unsecured deposits at commercial banks.
No affiliated banks
Under the proposal, reserve accounts couldn’t be held at affiliated banks.
Accounts held at unaffiliated banks would be limited to the lesser of 50% of a brokerage firm’s excess net capital or 10% of the bank’s equity capital.
The banking industry says the SEC seems to be calling into question the soundness of banks.
“What kind of vote of confidence is it when you [cannot] let reserves go into [an affiliated] bank?” Ms. Miller said.
“The SEC has to give some confidence to [federal bank regulators],” she added.
Since relatively few banks are equipped to handle reserve funds, limiting deposits held at unaffiliated banks could force brokerage firms to use “less stable, less well-capitalized banks or banks with little or no experience administering reserve accounts,” The Clearing House Association LLC of New York, which represents major banks, said in a comment letter last month.
Industry observers like the idea of allowing money market funds for customer reserve funds.
“The frustration for us has been that when people want to give you money, you want to be there to take it,” Mr. Maloney said.
‘Far superior’
Diversified AAA-rated money funds are “far superior” riskwise to unsecured deposits at one bank, he said.
Even some banks support the use of money funds, Mr. Maloney said.
Broker reserve funds “tend to be very expensive deposits,” and many banks want an investment solution for their clients, he said.
But the SEC wants to restrict investment to funds that hold only U.S. Treasury securities.
That idea makes no sense, critics say.
Treasury-backed funds don’t offer enough yield to make it worthwhile for brokerage firms to use them, Mr. Crane said.
Additionally, the SEC wouldn’t allow the use of proprietary money funds for customer reserves.
Commenters have blasted that idea, as well.
The SEC’s own rules and laws covering money funds ensure that fund assets are completely segregated from the broker-dealer’s operations, Mr. Maloney and other observers said.
Congressional interest in the issue may have sparked the SEC to take a first step, Mr. Maloney said.
In February, a bill was introduced in the House of Representatives by Rep. Gregory Meeks, D-N.Y., that would require the SEC to approve the use of money funds. The bill is awaiting action in a House subcommittee.
The Investment Company Institute of Washington and the Securities Industry and Financial Markets Association of New York and Washington support the use of AAA-rated money funds and affiliated funds.
SIFMA also opposes the proposed rules covering the use of bank deposits.