Customer Protection: The Reserve Formula and Possession or Control
The principle
Rule 15c3-3 requires a firm that holds customer funds or securities to protect them. Customer securities must be in the firm's possession or control, meaning fully paid and excess-margin securities are kept safe, and customer cash must be backed by a deposit in a special reserve bank account for the exclusive benefit of customers, the PAB.
Reserve formula
The weekly computation compares credit items, money the firm owes customers such as free credit balances, with debit items, money customers owe the firm such as margin debit balances. Required reserve equals credits minus debits. The firm compares that to the PAB balance and deposits any shortfall, or may withdraw a surplus. The computation is made as of the close of the last business day of the week, and the deposit is due by 10:00 a.m. of the next business day. Deficiencies trigger immediate telephone notice to the SEC and FINRA and written notice within 48 hours.
Introducing brokers
An introducing broker that never holds customer funds or securities does not maintain a PAB, but it must route customer funds promptly to the carrying firm and must not commingle them with firm funds.
Traps
Questions often confuse the reserve formula with net capital: a reserve deficiency is not cured by excess net capital. Another trap is forgetting that customer securities cannot be used to finance the firm's business.
Worked example
Credits $2,000,000, debits $1,700,000, so the required reserve is $300,000. The PAB holds $250,000, so the firm deposits $50,000 by the deadline.