Agencies Propose Orderly Liquidation Rule for Covered Broker-Dealers

Pursuant to Dodd-Frank Act Section 205(h), the FDIC and the SEC proposed a rule to govern the orderly liquidation of “covered brokers-dealers,” or large broker-dealers that are subject to liquidation under Title II of the Dodd-Frank Act and not dissolution under the Securities Investor Protection Act (“SIPA”).

According to the proposal, the rule would clarify (i) how the customer protections of SIPA will be integrated with the orderly liquidation provisions of Dodd-Frank, (ii) the role of the FDIC as receiver and that of the Securities Investor Protection Corporation (“SIPC”) as trustee of a failed broker-dealer, and (iii) the administration of claims in an orderly liquidation process. In addition, the proposal would address (a) the priorities for unsecured claims against a covered broker-dealer, (b) the administrative expenses of SIPC and (c) the treatment of Qualified Financial Contracts (e.g., repurchase agreements and security-based swaps).

Much of the proposal consists of procedural details on how the liquidation of a covered broker-dealer would proceed, and how the process and distribution of assets through orderly liquidation would differ from those aspects of the ordinary SIPA process. The proposal specifies that although a “Title II orderly liquidation is under a different statutory authority, the process for determining and satisfying customer claims would follow a substantially similar process to a SIPA proceeding.” Additionally, the calculations of the amount due and the actual amount paid to customers are not intended to be affected by the existence of the proceeding.

The most important aspect of the new liquidation process is the ability it gives regulators to create a new legal entity, which the proposal defines as a “bridge broker-dealer,” to which contracts of the insolvent broker-dealer may be transferred. This bridge broker-dealer is deemed to be registered as a broker-dealer with the SEC and a member of any self-regulatory organization of which the insolvent firm was a member.

The right of a counterparty to declare a default under a Qualified Financial Contract would be (i) delayed until the close of business on the business day following the appointment of the FDIC as receiver for the insolvent broker-dealer or (ii) lost if the counterparty is notified that the relevant contract has been transferred to a bridge broker-dealer.

The proposal requests comments on a number of questions relating to the orderly liquidation process for a covered broker-dealer.

For large broker-dealers that may be “covered broker-dealers” and so would be subject to orderly liquidation, the key question is this: whether any aspect of the proposed process could make them appear unattractive as parties to Qualified Financial Contracts, or raise the cost for them of entering into such contracts.