Study guide
Introducing firms do not compute the customer reserve formula; instead, they must operate scrupulously within an exemption from SEA Rule 15c3-3 and manage the handoffs to their clearing firm. This chapter covers the exemptions, carrying agreements, margin and Regulation T basics, short-sale delivery, and how introducing firms fund themselves.
Operating Within the 15c3-3(k) Exemptions
SEA Rule 15c3-3, the customer protection rule, requires carrying firms to maintain possession or control of customer securities and lock up net customer money in a special reserve bank account computed by formula. That full regime is Series 27 territory. The Series 28 tests the exemptions in paragraph (k) and, more importantly, what a firm must do to stay inside them. The workhorse is (k)(2)(ii): a firm introducing accounts on a fully disclosed basis to a clearing firm is exempt if it promptly transmits all customer funds and securities it receives to the clearing firm, which carries the accounts and performs the reserve computation. The (k)(2)(i) exemption suits firms such as mutual fund or direct-participation distributors: the firm holds no customer funds or securities except that customer checks may flow through a Special Account for the Exclusive Benefit of Customers, and all transactions are effected through that account with prompt transmission. Prompt transmission has a hard definition: forwarding by noon of the business day following receipt. Many 5,000 dollar minimum firms avoid even that by accepting only checks made payable to third parties, the clearing firm or the product sponsor, and forwarding them by noon of the next business day after receipt. Discipline matters because the exemption report the firm files with its annual audit asserts compliance throughout the year, and every check that sat on a desk for three days is an exception. If Bluewater Advisors Ltd. decides to start holding customer positions directly, it is changing its exempt status: that requires an application to and approval from FINRA under the membership continuance process before the business change, along with the capital and infrastructure of a carrying firm.
Carrying Agreements: FINRA Rule 4311 and the Division of Labor
The relationship between an introducing firm and its clearing firm lives in a written carrying agreement governed by FINRA Rule 4311. The rule requires the agreement to allocate, function by function, the responsibilities of each party: opening and approving accounts, extending credit, receiving and delivering funds and securities, safeguarding assets, sending confirmations and statements, and accepting orders. The carrying firm must submit the agreement, or a standard form of it, to FINRA for approval, and each customer must be notified in writing of the arrangement and the allocation of responsibilities when the account is opened. Allocation does not equal abdication: the introducing firm remains responsible under FINRA rules for its own conduct, and functions not specifically allocated stay with the party performing them. Two allocations matter most for exam purposes. First, anti-money-laundering duties are split: the clearing firm typically monitors movements it can see, but the introducing firm knows its customers, so it retains customer identification, due diligence and suspicious activity responsibilities; a carrying agreement cannot outsource the introducing firm's own AML program required by Rule 3310. Second, the carrying firm must supply the introducing firm with exception reports it produces, and the introducing firm's principals must actually review them; FINRA has disciplined firms whose FINOPs ignored margin, suitability and activity exception reports. The carrying agreement also addresses proprietary accounts of the introducing broker, called PAIB accounts: for an introducing firm's proprietary assets held at the clearing firm to be allowable for net capital, the clearing firm must perform a separate PAIB reserve computation. When Sable Ridge Clearing terminates an agreement, Rule 4311 requires notice provisions so introduced customers are not stranded.
Regulation T and Cash Account Discipline
Regulation T, issued by the Federal Reserve Board, governs the extension of credit by broker-dealers. In a margin account, the initial requirement for most equity securities is 50 percent of the purchase price, meaning a customer buying 20,000 dollars of stock must deposit at least 10,000 dollars. Payment for purchases must be received within the payment period, defined as the standard settlement cycle plus two business days; with T+1 settlement that means three business days after the trade date. If payment is not received, the firm must cancel or liquidate the position and, when required, obtain an extension of time; FINRA Rule 4230 designates FINRA as the authority that grants Regulation T extension requests for its members, and firms track extensions because habitual use invites scrutiny. Cash accounts have their own discipline. A customer must have sufficient funds or make full cash payment, and freeriding, buying a security and selling it before paying for the purchase, triggers the 90-day freeze: for 90 calendar days the account may buy only to the extent settled funds are already in the account. The exam also expects the FINOP to know what happens operationally at an introducing firm: Regulation T compliance is usually allocated to the clearing firm in the 4311 agreement, but the introducing firm's representatives take the orders, so the introducing firm typically initiates extension requests through its clearing firm, which submits them to FINRA, and the introducing firm answers for patterns of violations in accounts it introduced. Imagine a customer of Copperline Investments buys shares on Monday and sells them Wednesday without ever depositing funds: the clearing firm flags it, but Copperline's principal handles the freeze notice and the customer conversation.
Margin Maintenance, Day Trading and Short-Sale Delivery
After Regulation T sets initial requirements, FINRA Rule 4210 sets maintenance requirements: equity must not fall below 25 percent of the market value of long positions, and short positions require 30 percent of market value, with higher dollar-based minimums for low-priced stocks. A minimum equity deposit of 2,000 dollars, or full payment if less, is required to open a margin account. When equity falls below maintenance, the firm issues a margin call; if the customer does not meet it promptly, the firm may liquidate positions, and in volatile conditions may do so without prior notice as the account agreement permits. Pattern day traders, customers executing four or more day trades in five business days where those trades are more than six percent of total trades, must maintain minimum equity of 25,000 dollars and receive day-trading buying power of four times maintenance margin excess. Regulation SHO addresses short-sale delivery. Rule 203 requires a locate: before accepting a short sale, the firm must have borrowed the security, arranged to borrow it, or have reasonable grounds to believe it can be borrowed for delivery. Rule 204 requires close-outs: fails to deliver from short sales must be closed out by purchasing or borrowing securities by the beginning of regular trading on the settlement day after settlement date, with a longer three-day window for long-sale fails and 35 days for certain deemed-to-own positions; a firm that fails to close out is penalized with a pre-borrow requirement on future shorts in that security. At an introducing firm these functions run through the clearing firm, but 4210 obligations follow the customer relationship, and the FINOP must understand the credit exposure the introduced book creates.
Underwriting Proceeds, Privacy and Funding the Firm
Three remaining topics complete the customer protection picture. First, SEA Rule 15c2-4 governs money received in underwritings and best-efforts offerings. In an all-or-none or other contingency offering, customer funds must be promptly transmitted to a bank escrow account or held by a qualified agent until the contingency is met; if it fails, funds are returned in full. A broker-dealer that touches offering proceeds without proper escrow both violates 15c2-4 and can blow its 15c3-3(k) exemption and its 5,000 dollar net capital status in one stroke. Second, Regulation S-P requires financial institutions to deliver initial and annual privacy notices describing information-sharing practices, give customers the right to opt out of certain sharing with nonaffiliated third parties, and safeguard customer records under a written program. Amendments adopted in 2024 require an incident response program and notification to individuals whose sensitive customer information was likely accessed or used without authorization, generally within 30 days of discovery; compliance dates ran through 2025 and 2026, so smaller firms are now subject as well. Disposal rules require secure destruction of consumer report information. Third, funding: an introducing firm that needs capital for growth, a haircut spike, or a rough quarter has a menu. Equity contributions are simplest but face the withdrawal restrictions of 15c3-1(e). Appendix D subordinated loans and secured demand notes add regulatory capital while excluding the liability from aggregate indebtedness, but require minimum one-year terms and FINRA approval in advance. The disciplined FINOP at Kestrel Peak Securities models capital needs before signing a new clearing agreement or expense commitment, because raising capital after an early warning notice is far harder than raising it before.
Key terms
- SEA Rule 15c3-3
- — The customer protection rule requiring carrying firms to maintain possession or control of customer securities and a special reserve bank account; introducing firms operate under its paragraph (k) exemptions.
- (k)(2)(ii) exemption
- — The exemption for firms that introduce accounts on a fully disclosed basis and promptly transmit all customer funds and securities to a carrying clearing firm.
- (k)(2)(i) exemption
- — The exemption for firms whose customer transactions flow through a Special Account for the Exclusive Benefit of Customers at a bank, with no other holding of customer funds or securities.
- Prompt transmission
- — Forwarding customer funds and securities by noon of the business day following receipt; the operational standard for keeping a 15c3-3(k) exemption.
- Carrying agreement (FINRA 4311)
- — The written, FINRA-approved contract allocating responsibilities between introducing and carrying firms, with required customer notification of the arrangement.
- PAIB account
- — Proprietary account of an introducing broker held at the clearing firm; a separate clearing-firm reserve computation is required for those assets to be allowable in the introducing firm's net capital.
- Regulation T
- — The Federal Reserve rule setting a 50 percent initial margin requirement and cash account payment rules, with payment due within the settlement cycle plus two business days.
- 90-day freeze
- — The Regulation T penalty for freeriding in a cash account: for 90 days the customer may purchase only with funds already settled in the account.
- FINRA Rule 4210
- — The maintenance margin rule: 25 percent equity on long positions, 30 percent on shorts, 2,000 dollar minimum equity, and 25,000 dollar minimum equity for pattern day traders.
- Regulation SHO Rules 203 and 204
- — The short-sale locate requirement and the close-out requirement for fails to deliver, generally by the open on the day after settlement for short-sale fails.
- SEA Rule 15c2-4
- — The rule requiring prompt transmission of funds in underwritings and escrow of customer money in contingency offerings until the contingency is satisfied.
- Regulation S-P
- — The privacy rule requiring notices, opt-out rights, safeguarding programs and, under the 2024 amendments, incident response and breach notification generally within 30 days.
Exam tips
- The Series 28 tests operating within the exemption, not computing the reserve formula. If a question offers the reserve computation as the introducing firm's obligation, it is describing the clearing firm's job.
- Prompt transmission means by noon of the next business day after receipt. Checks payable to third parties follow the same forwarding clock, and lapses create exceptions that must appear in the exemption report.
- Under a 4311 carrying agreement, allocation is not abdication: the introducing firm keeps its own AML program, its supervision duties, and responsibility for reviewing exception reports the clearing firm provides.
- Memorize the margin ladder: 50 percent Regulation T initial, 25 percent long and 30 percent short maintenance, 2,000 dollars to open a margin account, 25,000 dollars for pattern day traders, and the 90-day freeze for freeriding.
- In a contingency offering, customer funds go promptly to a bank escrow until the contingency is met; a firm that holds proceeds itself violates 15c2-4 and likely destroys its 15c3-3(k) exemption.