Possession Or Control

A firm is owed a delivery of securities from a counterparty that has failed to deliver them. The firm's own customer, meanwhile, holds a fully paid position in that same security. Does the fact that the firm is contractually owed the missing securities count toward satisfying its possession-or-control obligation to its customer?

1. A.Yes -- a fail-to-receive is treated identically to actual possession, since the firm has a valid contractual right to receive the securities regardless of whether they have actually arrived.Wrong. A contractual right to receive securities is not treated identically to actual possession or control.
2. B.Yes, but only if the counterparty that failed to deliver is itself a registered broker-dealer rather than some other type of financial institution.Wrong. The type of counterparty does not change the fact that a fail-to-receive does not itself satisfy possession or control.
3. C.No -- a fail-to-receive does not count toward possession or control, since the firm does not actually have the securities in hand or under its control yet; the firm may need to take further action, such as a buy-in, to actually obtain securities that satisfy the customer's possession-or-control requirement.Correct. A fail-to-receive does not satisfy possession or control; the firm must actually obtain the securities.
4. D.No, and the firm has no obligation to take any further action at all, since the fail-to-receive is entirely the failing counterparty's problem to resolve.Wrong. The firm does have its own obligation to take further action, such as a buy-in, to satisfy its customer's possession-or-control requirement.

Why: Possession or control is about what the firm actually has, not what it is merely owed. A fail-to-receive means the firm has a contractual right to a delivery that has not yet actually happened -- the securities themselves are not yet in the firm's hands or under its control. Because that contractual right does not itself satisfy the customer's possession-or-control requirement, the firm may need to take further action, such as buying in the position, to actually obtain securities that do satisfy it.

Wexford Trading executes trades for an institutional customer that settles receive versus payment through its own custodian bank and never leaves securities or free credit balances with Wexford. What does the customer protection rule require Wexford to reduce to possession or control for this account?

1. A.A quantity of each security equal to the position of the customer, because Wexford executed the trades on its behalf.Wrong. Executing a trade does not put the resulting position onto the books of the executing firm.
2. B.The positions from trade date until the custodian bank makes payment, because delivery is made against payment.Wrong. No such interim window exists; the obligation turns on custody, not on the timing of the exchange.
3. C.Nothing, because the securities and cash are held at the custodian bank of the customer rather than at Wexford.Correct. With no customer assets on the books of the firm there is nothing to segregate or control.
4. D.Nothing at Wexford, because the obligation passes to the custodian bank acting as its agent.Wrong. The bank is the custodian of the customer and is not a broker-dealer made subject to this rule through Wexford.

Why: The possession-and-control obligation attaches to fully paid and excess margin securities that a broker-dealer carries for a customer. In a delivery-versus-payment or receive-versus-payment relationship the assets of the customer sit at its own custodian bank, so the broker-dealer is never carrying them and there is nothing for the obligation to attach to. That follows from where the assets are, not from the customer being institutional. Were the same customer to open a cash account and leave securities at Wexford, the obligation would attach to those positions immediately.

A customer walks into a branch of Halvorsen Securities and hands the representative certificates for securities she wants deposited into her account. Under the SEC customer protection rule's possession or control requirement, the firm's primary obligation with respect to those fully paid securities is to:

1. A.Deposit them into the firm's general inventory so they can be used to satisfy the firm's delivery obligations.Fully paid customer securities may not be used for the firm's own purposes, including its deliveries.
2. B.Hold them at the branch until the customer requests a sale, so that the certificates remain available to her.Certificates must be forwarded promptly to cashiering and recorded, not left sitting at a branch.
3. C.Pledge them as collateral for a firm bank loan, provided the customer receives written notice.Fully paid customer securities may not be pledged for the firm's account, with or without notice.
4. D.Forward them promptly to cashiering and hold them free of lien, segregated from the firm's own securities.Correct. The rule requires possession or control of fully paid customer securities, segregated and free of any lien.

Why: The customer protection rule requires a carrying broker-dealer to obtain and maintain physical possession or control of customers' fully paid and excess margin securities, segregated from the firm's own assets and free of any lien. Certificates received at a branch must be forwarded promptly to the cashiering department and reflected in the firm's records so the segregation obligation is satisfied.

A firm properly places customer fully paid securities at a bank that qualifies as a good control location. The bank then, without proper authorization from the firm consistent with the customer protection rule, re-pledges those same securities to a third party as collateral for its own separate obligation. What is the effect on the firm's possession-or-control status for these securities?

1. A.The securities fall out of possession or control once they become subject to this unauthorized third-party claim, since a security encumbered by a claim beyond what the rule permits is no longer free of interference with the customer's ownership, regardless of the fact that it was initially placed at a properly qualifying location.Correct. An unauthorized subsequent claim against the securities causes the firm to lose possession-or-control status for them.
2. B.Nothing changes -- once securities are placed at a qualifying good control location, they remain in the firm's possession or control indefinitely regardless of anything the location subsequently does with them.Wrong. Placement at a qualifying location does not guarantee possession-or-control status indefinitely regardless of subsequent unauthorized claims.
3. C.The firm automatically loses its status as a broker-dealer the moment any custodian misuses securities placed with it, regardless of the firm's own conduct.Wrong. The firm does not automatically lose its broker-dealer status due to a custodian's misconduct; the consequence is a loss of possession-or-control status for the affected securities.
4. D.The customer, rather than the firm, bears sole responsibility for monitoring what the custodian bank does with her securities after they are placed there.Wrong. The customer does not bear sole responsibility for monitoring the custodian; the firm's own possession-or-control status is affected.

Why: Placing securities at a qualifying location satisfies possession or control only as long as they remain free of any claim beyond what the rule permits. Once the custodian itself creates an unauthorized third-party claim against those securities, they are no longer free of interference with the customer's ownership, and the firm's possession-or-control status for them is lost, regardless of the fact that the initial placement was proper. Possession or control is not a one-time determination that locks in permanently once satisfied.