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SIFMA Provides Best Practices on Dodd-Frank Provision Requiring Broker Notification of Short-Sales

By Jim Hamilton

The Dodd-Frank Act, Sec, 929X, requires brokers to provide notice to their customers that they may elect not to allow their fully paid securities to be used in connection with short sales. And a broker using a customer?s securities in connection with short sales must provide notice to its customer that the broker may receive compensation in connection with lending the customer?s securities. Section 929X appears to be self-operating, noted SIFMA, since it provides that the SEC may prescribe the form, content, time and manner of delivery of any such notice.

SIFMA has outlined some best practices for compliance with the notice requirements of Section 929X, which are based on discussions with various SIFMA members, as well as discussions with the staff in the SEC Division of Trading and Markets. Pursuant to Rule 15c3-3 under the Securities Exchange Act , brokers are generally prohibited from borrowing a customer?s fully-paid securities unless they enter into a separate written agreement with the customer that contains the provisions set forth under Rule 15c3-3(b)(3).

Therefore, according to SIFMA, to comply with the notice requirements of Section 929X, brokers should consider reviewing their disclosures to existing customers with brokerage accounts with whom they have entered into a fully-paid lending agreement pursuant to Rule 15c3-3(b)(3), and make any necessary adjustments to such disclosures before engaging in any new borrows with such customers. More specifically, brokers should consider the extent to which their disclosures provide notice to such customers that fully-paid securities they lend to the broker-dealer may be used in connection with short sales, and that the broker-dealer may receive compensation in connection with the use of the customer?s fully-paid securities.

In addition to ensuring that this disclosure is included in disclosures to existing customers with brokerage accounts with whom the broker-dealer has entered into a fully-paid lending agreement pursuant to Rule 15c3-3(b)(3), continued SIFMA, broker-dealers should also consider the fact that the language of Section 929X does not specifically reference that this disclosure only applies to fully-paid securities. Brokers should therefore consider the extent to which such disclosure should also be sent to margin customers whose securities may be rehypothecated. While firms may choose different mechanisms to disseminate this information to such margin customers, SIFMA suggested that one approach could be to include such notice in the course of standard information provided to existing margin customers in the next available cycle, for example as part of information provided in a customer statement or otherwise, as well as through amendments to agreements for future margin customers.

Full post as published by Jim Hamilton's World of Securities Regulation on August 22, 2010 (boomark / email).