Customer Treasuries in a Proprietary Account and a Supervisor Who Approves Himself
Halstead Securities is a government securities broker-dealer that clears fully disclosed through a bank custodian. On Monday the custodian reports that $12,000,000 face of a customer's fully paid Treasury note, which the customer sold on Thursday, was not received from the delivering counterparty - a fail to receive. For two years Halstead has instructed the custodian to keep customer Treasuries in the firm's own proprietary account to save roughly $18,000 a year in custody fees, tracking customer ownership on an internal spreadsheet. Separately, the desk's head trader is also its designated supervisory principal and personally approved his own allocation of a new-issue Treasury among three customer accounts.
1. Are the customer's Treasuries in the firm's possession or control? What must Halstead do about the fail?
Read the worked answer
No. Rule 15c3-3(b) requires physical possession or control of fully paid and excess margin customer securities, and 15c3-3(c) lists the permissible control locations - a clearing corporation, a bank account designated as belonging to customers, or the firm's own vault among them. The firm's proprietary account is not one of them; designating ownership on an internal spreadsheet segregates nothing and gives the firm's general creditors a claim that customer property rules exist to prevent.
The failed receipt compounds it: the customer's note is not on hand, so the firm must take prompt steps to obtain it, buying in the fail where necessary and charging the resulting cost to the responsible account. Until cured, the position supports a 15c3-3 deficiency on the next computation date, and for net capital purposes the receivable from the delivering counterparty cannot be carried as an allowable asset indefinitely. The $18,000 of fee savings is irrelevant to every part of this analysis.
2. Evaluate the head trader's approval of his own allocation. What is the supervisory failure and what fairness issues does it raise?
Read the worked answer
A supervisor approving his own allocation is self-review, which a supervisory system cannot tolerate. Someone with no economic stake in the outcome must review new-issue allocations against a documented policy, with the day's pricing checked to contemporaneous market levels.
The fairness overlay matters. If the favored account belongs to a customer with whom the trader has a relationship, or one where the firm holds a position, the allocation can be challenged under the antifraud provisions regardless of whether the price was fair. The firm's written supervisory procedures and its annual certifications will be tested on whether the desk had an independent principal at all; the fix is structural - separate the roles, or route allocations to a principal outside the desk - not a reminder memo.
3. What records should Halstead create and retain to show the issues were corrected?
Read the worked answer
A written instruction to the custodian to move all customer Treasuries into accounts designated as customer accounts, with written confirmation of the transfer and the date it took effect. A reconciliation of customer positions to the custodian's statement at least weekly, retained under 17a-3 and 17a-4, so a misdesignation would be caught rather than discovered a year later. A buy-in log for the failed Treasury showing when the fail was identified, the steps taken, when it settled, and how the cost was allocated. An amendment to the supervisory procedures naming an independent principal for allocations, with evidence that reviewer actually looked at prices and accounts.
Finally, a memorandum assessing the effect on the reserve formula for the computation dates in question, because a custodian holding customer securities in the wrong account changes the reserve calculation as well as the custody file. An examiner will ask for every one of these documents before believing the problem was fixed.