Orderly liquidation of covered broker-dealers

Authored by Patrick Warch

On July 24, 2020, the U.S. Securities and Exchange Commission (SEC) and the Federal Deposit Insurance Corporation (FDIC), along with consultation from the Securities Investor Protection Corporation (SIPC), implemented a final rule required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) relating to the orderly liquidation of covered broker-dealers if the FDIC is the appointed receiver under Title II. The original proposed rule by the SEC and FDIC was made in March 2016 and has been under review since then. The rule approved is almost identical to the original proposed rule and will become effective 60 days after the publication in the Federal Register.

Title II of the Dodd-Frank Act relates to an “alternative insolvency regime for the orderly liquidation of large financial companies that meet specified criteria.” Section 205 of this act creates specific provisions for the orderly liquidation of certain large broker-dealers.

The goal is to have an orderly liquidation of a covered broker-dealer to ensure that the customers receive payments or property that are “at least as beneficial to them as would have been the case had the covered broker-dealer been liquidated under the Securities Investor Protection Act of 1970 (SIPA).” The rule incorporates clarity for the relevant provisions of SIPA that must be factored into the Title II rules. The FDIC would be the appointed receiver, and then the FDIC would appoint SIPC to act as the trustee for the broker-dealer. SIPC would then have the responsibility to determine and satisfy customer claims in a comparable manner as if the proceedings were done under SIPA. Any qualified financial contract would be governed in accordance with Title II.

The rule aims to protect market participants by creating expectations that are clear and fair for both the customers and creditors of failed broker-dealers as well as other market participants. An economic analysis was conducted to see the potential impact to ensure that the benefits did outweigh the costs. This assessment also factored into the impact that these rules may have on efficiency, competition and capital formation.

The final rule gives additional insight as to the claims process that customers and other creditors of the covered broker-dealer would need to follow. It also gives additional insight into the FDIC’s role as the receiver with “respect to the transfer of assets of a covered broker-dealer to a bridge broker-dealer.” This rule only adds clarity to the process to be used in the liquidation of covered broker-dealers, and does not change any prior requirements or create any new requirements.

The key benefit expected based on this rule will be to create a more structured framework to implement section 205 of the Dodd-Frank Act which should result in a more orderly liquidation of the covered broker-dealer. This would be beneficial to the liquidating entity as well as any other affected parties. These specific guidelines are targeted to ensure an orderly liquidation process in which it is streamlined and defined as to what the next step would be. Prior to this rule there was more uncertainty as to how different parties may interpret the statutory requirement, which could lead to confusion and delays. Having more defined guidelines will assist the applicable customers, creditors and counterparties as to how things will progress and set clear expectations.

The rule has three distinct parts relating to the liquidation that add additional insight to guide the process:

1. The process of initiating the orderly liquidation – this rule adds additional clarity relating to where notices and applications need to be filed, the impact of certain dates and how to inform relevant parties of the initiation of orderly liquidation
2. The process of account transfers to the bridge broker-dealer – the rule establishes clear guidelines for the process; under section 205 there had not been specific rules provided
3. The processing of the claims process for customers and other creditors – the rule echoes section 205’s requirement that the trustee’s allocation shall be in “an amount and manner, including form and timing, at least as beneficial as such customer would have received under a SIPA proceeding”; it also establishes additional clarity to the process

Overall, the expectation is that this rule will add additional guidance around what can be a complicated process of liquidation. By having more defined steps it adds additional assurance to those affected by the liquidation that a proper process is being followed and that this rule will help guide the process to be as orderly a liquidation as possible for the covered broker-dealer. Information included above was sourced from the SEC website, in particular press release 2020-163 and referenced content within. See the SEC website for additional details on the final rule on orderly liquidation of covered broker-dealers. 

For more information or to learn how Baker Tilly’s Value Architects™ can assist your organization, contact our team.