Securities and Exchange Commission

17 CFR Part 240

[Release No. 34-48694; File No. S7-22-03]

RIN 3235-AI97

Supervised Investment Bank Holding Companies

Agency: Securities and Exchange Commission (the "Commission").

Action: Proposed rule.

Summary: The Commission is proposing rules to implement Section 17(i) of the Securities Exchange Act of 1934, which created a new framework for supervising an investment bank holding company ("IBHC"). An IBHC that meets certain, specified criteria may voluntarily file a notice of intention with the Commission to become a supervised investment bank holding company ("SIBHC") and be subject to supervision on a group-wide basis. Pursuant to the statute and proposed rules, an IBHC would be eligible to be an SIBHC if it is not affiliated with certain types of banks and has a substantial presence in the securities markets. The proposed rules would provide an IBHC with a process to become supervised by the Commission as an SIBHC, and would establish regulatory requirements for an SIBHC, including requirements regarding its group-wide internal risk management control system, recordkeeping, and periodic reporting (including reporting of consolidated computations of allowable capital and risk allowances consistent with the Basel Standards). The Commission is also proposing to add an exemption to the Commission's risk assessment rules to exempt a broker-dealer that is affiliated with an SIBHC because the SIBHC will be maintaining records and reporting to the Commission regarding the financial and operational condition of members of the affiliate group. Finally, the Commission is proposing to adjust the audit requirements for OTC derivative dealers to allow accountants to use agreed-upon procedures when conducting audits of risk management control systems.

Dates: Comments must be received on or before February 4, 2004.

Addresses: To help us process and review your comments more efficiently, comments should be sent by hard copy or by email, but not by both methods. Comment letters sent by hard copy should be submitted in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Alternatively, comment letters sent electronically should be submitted to the following electronic-mail address: rule-comments@sec.gov. All comment letters should refer to File No. S7-22-03. This file number should be included in the subject line if you use electronic mail. We will make all comment letters available for public inspection and copying in our public reference room at the above address. We will post electronically submitted comment letters on the Commission's Internet website (http://www.sec.gov).¹

For Further Information Contact: With respect to general questions, contact Catherine McGuire, Chief Counsel, Lourdes Gonzalez, Assistant Chief Counsel, or Linda Stamp Sundberg, Attorney Fellow, at (202) 942-0073, Division of Market Regulation, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-1001.

With respect to calculations of allowable capital and risk allowances, internal risk management control systems, and books and records and reporting requirements, contact Michael A. Macchiaroli, Associate Director, at (202) 942-0132, Thomas K. McGowan, Assistant Director, at (202) 942-4886, Rose Russo Wells, Attorney, at (202) 942-0143, Bonnie L. Gauch, Attorney, at (202) 942-0765, or David Lynch, Financial Economist, at (202) 942-0059, Division of Market Regulation, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-1001.

Supplementary Information:

The Securities and Exchange Commission is publishing for comment proposed amendments to Rule 17a-12 [17 CFR 240.17a-12] and Rules 17h-1T and 17h-2T [17 CFR 240.17h-1T and 240.17h-2T], and proposed new Rules 17i-1 through 17i-8 [17 CFR 240.17i-1 through 240.17i-8] under the Exchange Act [15 U.S.C. 78a et seq.]

Table of Contents

1. INTRODUCTION.
2. DESCRIPTION OF THE PROPOSED RULES.
1. Proposed Rule 17i-1: Definitions.
2. Proposed Rule 17i-2: Notice of Intention to be Supervised by the Commission as an SIBHC.
1. Election criteria.
2. Notice of intention to become an SIBHC.
3. Process for review of notices of intention.
3. Proposed Rule 17i-3: Withdrawal from Supervision as an SIBHC.
4. Proposed Rule 17i-4: Internal Risk Management Control System Requirements for SIBHCs.
5. Proposed Rule 17i-5: Record Creation, Maintenance, and Access Requirements for SIBHCs.
1. Record creation.
2. Record maintenance.
3. Access to records.
6. Proposed Rule 17i-6: Reporting Requirements for SIBHCs.
1. Monthly reports.
2. Quarterly reports.
3. Additional reports.
4. Annual audit report.
5. Accountant's report on management controls — paragraph (i)(2) of proposed Rule 17i-6 and amendment to paragraph (l) of existing Rule 17a-12.
7. Exemption from Risk Assessment Rules for Broker-Dealer Affiliates of SIBHCs.
8. Proposed Rule 17i-7: Calculations of Allowable Capital and Risk Allowances or Alternative Capital Assessment.
1. Calculation of consolidated allowable capital.
2. Calculation of consolidated allowance for market risk.
3. Calculation of consolidated allowance for credit risk.
4. Calculation of consolidated allowance for operational risk.
5. Alternative capital assessment.
6. General questions regarding proposed Rule 17i-7.
7. Other questions regarding capital calculation.
9. Proposed Rule 17i-8: Notification Requirements for SIBHCs.

3. GENERAL REQUEST FOR COMMENT REGARDING PROPOSED RULES.
4. PAPERWORK REDUCTION ACT.
1. Collection of Information Under Amendments to Rules 17h-1T and 17h-2T and New Rules 17i-1 through 17i-8.
2. Proposed Use of Information.
3. Respondents.
4. Reporting and Recordkeeping Burdens.
1. Amendments to Rules 17h-1T and 17h-2T.
2. Proposed Rule 17i-2.
3. Proposed Rule 17i-3.
4. Proposed Rule 17i-4.
5. Proposed Rule 17i-5.
6. Proposed Rule 17i-6.
7. Proposed Rule 17i-8.
5. Collection of Information Is Mandatory.
6. Confidentiality.
7. Record Retention Period.
8. Request for Comments Regarding Paperwork Burden Estimates.
5. COSTS AND BENEFITS OF THE PROPOSED RULES AND RULE AMENDMENTS.
1. Benefits.
2. Costs.
1. Ongoing costs.
2. One-time costs.
3. Request for Comment Regarding Analysis of Costs and Benefits.
6. CONSIDERATION OF BURDEN ON COMPETITION, AND PROMOTION OF EFFICIENCY, COMPETITION AND CAPITAL FORMATION.
7. REGULATORY FLEXIBILITY ACT CERTIFICATION.
8. CONSIDERATION OF IMPACT ON THE ECONOMY.
9. STATUTORY AUTHORITY.

I. INTRODUCTION.

Section 231 of the Gramm-Leach-Bliley Act of 1999² (the "GLBA") amended Section 17 of the Securities Exchange Act of 1934 (the "Exchange Act" or the "Act") to create a regulatory framework under which a holding company of a broker-dealer may voluntarily be supervised by the Commission as an SIBHC. The rules we are proposing today would create a framework for the Commission to supervise SIBHCs. These rules also would enhance the Commission's supervision of the SIBHC's subsidiary broker-dealers through collection of additional information and examinations of affiliates of those broker-dealers. This framework would include qualification criteria for IBHCs that file notices of intention to be supervised by the Commission, as well as recordkeeping and reporting requirements for SIBHCs. An IBHC that meets the criteria set forth in the proposed rules would not be required to become an SIBHC; supervision as an SIBHC is voluntary. Taken as a whole, the proposed framework would permit the Commission to better monitor the financial condition, risk management, and activities of a broker-dealer's parent and affiliates on a group-wide basis. In particular, it would create a formal process through which the Commission could access important information regarding activities of a broker-dealer's affiliates that could impair the financial and operational stability of the broker-dealer or the SIBHC.

In addition, securities firms that do business in the European Union ("EU") have indicated that they may need to demonstrate that they have consolidated supervision at the holding company level that is "equivalent" to EU consolidated supervision.³ Generally, EU "consolidated supervision" would take the form of a series of rules, imposed at the holding company level, regarding firms' internal controls, capital adequacy, intra-group transactions, and risk concentration. Without a demonstration of "equivalent" supervision, securities firms located in the EU have stated that they may either be subject to additional capital charges or required to form a sub-holding company in the EU.

Congress addressed these concerns by enacting Section 17(i) of the Exchange Act,⁴ which authorizes an IBHC to voluntarily elect to be supervised by the Commission as an SIBHC.⁵ Pursuant to Section 17(i)(1)(A) of the Exchange Act, an IBHC that is not: (i) an affiliate of an insured bank (with certain exceptions) or a savings association;⁶ (ii) a foreign bank, foreign company, foreign bank branch agency, or a state-chartered commercial lending company;⁷ or (iii) a foreign bank that controls an Edge Act Corporation⁸ may elect to become an SIBHC.⁹

This regulatory framework for SIBHCs is intended to provide a basis for non-U.S. financial regulators to treat the Commission as the principal U.S. consolidated, home-country supervisor¹⁰ for SIBHCs and their affiliated broker-dealers. This would minimize duplicative regulatory burdens on broker-dealers that are active in the EU and in other jurisdictions that may have similar laws.

Under Section 17(i) of the Exchange Act, the Commission may adopt rules regarding, among other things: (i) the form of an IBHC's notice of intention to become an SIBHC and the information and documents to be included with that notice;¹¹ and (ii) creation and maintenance of records and reports, and submission of those reports to the Commission.¹² Further, Section 17(i)(3)(C) of the Exchange Act authorizes the Commission to examine an SIBHC (including any affiliate) in order to (i) inform the Commission regarding the nature of the operations and financial condition of the SIBHC and its affiliates, the financial and operational risks within the SIBHC that may affect any broker-dealer controlled by the SIBHC, and the systems of the SIBHC and its affiliates for monitoring and controlling those risks; and (ii) monitor compliance with the provisions of Section 17(i) of the Exchange Act.¹³ Section 17(i)(3)(C) also provides that the Commission may examine the SIBHC and any affiliate to monitor compliance with the provisions of Exchange Act Section 17(i), provisions governing transactions and relationships between any broker-dealer affiliated with the SIBHC and any of the company's other affiliates, as well as applicable provisions of the Bank Secrecy Act [31 U.S.C. 53, subchapter II].¹⁴ While Section 17(i) of the Exchange Act authorizes the Commission to inspect any affiliate of an SIBHC, it also limits the focus and scope of any examination to the SIBHC and any affiliate of the SIBHC that, because of its size, condition, or activities, the nature or size of the transactions between such affiliate and any affiliated broker-dealer, or the centralization of functions within the holding company system, could, in the discretion of the Commission, have a materially adverse effect on the operational or financial condition of the broker-dealer.¹⁵

The rules proposed under Section 17(i) are not intended to duplicate regulation of banks, insurance companies, or futures commission merchants by other regulatory agencies. Section 17(i) of the Exchange Act directs the Commission to: (i) accept, to the fullest extent possible, reports that an SIBHC or an affiliate thereof may have been required to provide to another appropriate regulatory agency or self-regulatory organization;¹⁶ (ii) use, to the fullest extent possible, reports of examination made by the appropriate regulatory agency or state insurance regulator;¹⁷ and (iii) defer to the appropriate regulatory agency or state insurance regulator with regard to interpretation and enforcement of banking or insurance regulations.¹⁸

II. DESCRIPTION OF THE PROPOSED RULES.

A. Proposed Rule 17i-1: Definitions.

Proposed Rule 17i-1 would incorporate the definitions set forth in Section 17(i)(5) of the Exchange Act¹⁹ into the rules promulgated under Section 17(i). Although these definitions apply regardless of whether they are incorporated into these rules, incorporating them lets individuals reading the proposed rules know that the terms are defined, and directs them to those definitions. In addition, the proposed rule includes definitions of the terms "affiliate group" and "material affiliate," which are used throughout proposed Rules 17i-1 through 17i-8.

Pursuant to the definitions in the Act, the term "investment bank holding company" means any person, other than a natural person, that owns or controls one or more broker-dealers and the associated persons of the investment bank holding company.²⁰ The term "associated person of an investment bank holding company" means any person directly or indirectly controlling, controlled by, or under common control with the IBHC.²¹ Thus, an IBHC includes the holding company and all other entities within the holding company structure that meet the "control" test. A "supervised investment bank holding company" is any IBHC that is supervised by the Commission pursuant to Section 17(i) of the Exchange Act.²²

Sections 17(i)(5)(C), (D), and (E) of the Exchange Act state that, for purposes of Section 17(i) of the Exchange Act, the terms "affiliate,"²³ "bank,"²⁴ "bank holding company,"²⁵ "company,"²⁶ "control,"²⁷ and "savings association"²⁸ have the same meaning as given in Section 2 of the Bank Holding Company Act of 1956²⁹ (the "Bank Holding Company Act"); the term "insured bank" has the same meaning as given in Section 3 of the Federal Deposit Insurance Act;³⁰ and the term "foreign bank" has the same meaning as given in Section 1(b)(7) of the International Banking Act.³¹

Proposed Rule 17i-1 also includes definitions of the terms "affiliate group" and "material affiliate." The term "affiliate group" is defined to include the SIBHC and every affiliate of the SIBHC because we believe that we would need to obtain information related to all affiliates to provide effective supervision of an SIBHC. We define the term "material affiliate" to include any member of the affiliate group that is material to the SIBHC because, based on the Commission's experience in reviewing holding company documentation, receiving information specific to affiliates material to a holding company provides us with a better understanding of the holding company, including how risk is managed on a consolidated level.

We request comment on whether the proposed definitions of affiliate group and material affiliate are appropriate, whether it would be helpful to reproduce the statutory definitions within the rules, and whether any additional terms need to be defined in these rules.

B. Proposed Rule 17i-2: Notice of Intention to be Supervised by the Commission as an SIBHC.

Section 17(i)(1)(B) of the Exchange Act states that in order to elect to become an SIBHC, an IBHC must file with the Commission a written notice of intention to become supervised by the Commission in such form and containing such information and documents concerning the IBHC as the Commission, by rule, may prescribe as necessary and appropriate in furtherance of the purposes of Section 17 of the Act (a "Notice of Intention").³² Proposed Rule 17i-2 would provide the method by which an IBHC could elect to become an SIBHC. In addition, consistent with Section 17(i)(1)(B) of the Exchange Act, proposed Rule 17i-2 indicates that the IBHC will automatically become an SIBHC 45 days after the Commission receives its completed Notice of Intention unless the Commission issues an order indicating either that it will begin its supervision sooner or that it does not believe it to be necessary or appropriate in furtherance of Section 17 of the Act for the IBHC to be so supervised. Finally, proposed Rule 17i-2 sets forth the criteria the Commission would use to make this determination.³³

If an IBHC becomes an SIBHC, supervision of its affiliated broker-dealer and related associated persons generally would not be affected, except that a broker-dealer affiliated with an SIBHC would be exempted from the requirements of Rules 17h-1T and 17h-2T.

1. Election criteria.

Section 17(i)(1)(A) of the Exchange Act sets forth certain limitations on whether an IBHC is eligible to become an SIBHC.³⁴ Specifically, an IBHC that is not (i) an affiliate of an insured bank (with certain exceptions) or a savings association;³⁵ (ii) a foreign bank, foreign company, or a company that is described in section 8(a) of the International Banking Act of 1978;³⁶ or (iii) a foreign bank that controls, directly or indirectly, a corporation chartered under section 25A of the Federal Reserve Act³⁷ would be eligible to file a Notice of Intention. Paragraph (a) of proposed Rule 17i-2 would incorporate these statutory exclusions.

2. Notice of intention to become an SIBHC.

Proposed Rule 17i-2(b) would require that an IBHC that elects to become an SIBHC file a written Notice of Intention with the Commission that includes (i) a request to become an SIBHC; (ii) a statement certifying that it is not affiliated with an entity listed in Section 17(i)(1)(A) of the Exchange Act;³⁸ (iii) documentation demonstrating that it owns or controls at least one broker-dealer that maintains a substantial presence in the securities business as evidenced either by its holding tentative net capital of $100 million or more or otherwise; and (iv) other supplemental documents described below.

To assist the Commission in evaluating the IBHC's activities, financial condition, risk management control systems, and the relationships among its associated persons in order to determine whether Commission supervision of the IBHC is necessary and appropriate in furtherance of the purposes of Section 17 of the Exchange Act, an IBHC also would be required to file the following supplemental documents with its Notice of Intention pursuant to proposed Rule 17i-2:

• A narrative describing the business and organization of the IBHC;
   
• An alphabetical list of the members of the affiliate group, a designation of those affiliates it considers to be "material affiliates" and the financial regulator(s), if any, with which the affiliate is registered;
   
• An organizational chart identifying the IBHC and its material affiliates;
   
• Consolidated and consolidating financial statements;
   
• Certain sample calculations of allowable capital and allowances for market, credit, and operational risk or alternative capital assessments made in accordance with proposed Rule 17i-7;
   
• A list of the positions held by the affiliate group in its proprietary accounts and the methods the IBHC intends to use for computing allowances for market risk and credit risk on those positions;
   
• A detailed description of the mathematical models the IBHC intends to use to calculate market and credit risk;
   
• A description of how the IBHC proposes to calculate current exposure;
   
• A description of how the IBHC proposes to determine credit risk weights;
   
• A description of the method the IBHC proposes to use to calculate its allowance for operational risk;
   
• A description of the internal risk management control system established by the IBHC to manage the risks of the affiliate group and how that system satisfies the requirements of proposed Rule 17i-4;
   
• Sample risk reports that the holding company provides to the persons responsible for managing the risks of the affiliate group; and
   
• An undertaking providing that the SIBHC will cooperate with the Commission as necessary if the disclosure of any information with regard to Rules 17i-1 through 17i-8 would be prohibited by law or otherwise and that the SIBHC will obtain, for any non-U.S. affiliate, consent to the jurisdiction of the Commission and an agreement to maintain a U.S. registered agent.

Because each firm manages its internal risks differently, the Commission, in its review of the Notice of Intention, would use the information and documents provided with the Notice of Intention to assess each firm's business, financial condition, and internal risk management control systems. We have successfully used similar information in the past to evaluate and monitor risks to broker-dealers. In addition to the information and documentation described in the proposed rules, the IBHC would be required to furnish such other information and documents, including documents relating to its financial position, internal controls, and mathematical models, as the Commission may request to complete its review of the Notice of Intention. A Notice of Intention would not be complete until the IBHC has provided to the Commission all the information and documentation specified in the Rule and requested by the Commission.

Further, depending on the relationship or the geographic location of the SIBHC and its affiliates, the Commission could require that an SIBHC obtain additional agreements that may be necessary for the Commission to adequately assess any risks that affiliate may pose to the SIBHC and its subsidiary broker-dealers. For example, the Commission may have a greater concern regarding access to information if a broker-dealer's affiliate operates in a jurisdiction that limits the exchange of information through bank secrecy laws or other impediments. Paragraph (b)(xiv) of proposed Rule 17i-2 would address this issue by requiring that an SIBHC provide the Commission with an undertaking indicating that it agrees to cooperate with the Commission as needed, including by describing any secrecy laws or other impediments that could restrict the ability of the SIBHC to provide information on the operations or activities of the SIBHC. If any material impediments exist, we would require the SIBHC to describe the manner in which it proposes to provide the Commission with adequate assurances of access to information.

Pursuant to paragraph (c) of proposed Rule 17i-2, IBHCs and SIBHCs would have a continuing requirement to amend their Notices of Intention. If any of the information or documentation filed with the Commission as part of the Notice of Intention is found to be or becomes inaccurate prior to a Commission determination, the IBHC would be required to notify the Commission and provide the Commission with a description of the circumstances in which the information or documentation was found to be or became inaccurate along with updated, accurate information and documents. Whereas after a Commission determination, if an SIBHC materially changes a mathematical model or other method used to compute allowable capital or allowance for market, credit, or operational risk, or its internal risk management control systems as described in its Notice of Intention, prior to making the changes the SIBHC would be required to file an amended Notice of Intention describing the changes.

We request comment as to whether the information and documents required to be included in the Notice of Intention pursuant to paragraph (b) of proposed Rule 17i-2 are appropriate, or whether the Commission should receive other financial, operational, or other types of information. If so, please indicate what additional information or documentation the Commission should require, and how the additional information and documents may assist the Commission in evaluating the financial and operational position of an IBHC.

3. Process for review of notice of intention.

Pursuant to paragraph (d)(2) of proposed Rule 17i-2, an IBHC would become an SIBHC subject to Commission supervision pursuant to Section 17(i) of the Exchange Act 45 calendar days after the Commission receives a completed Notice of Intention,³⁹ unless the Commission issues an order determining either that (i) the Commission will begin to supervise the IBHC as an SIBHC prior to 45 calendar days after the Commission received the completed Notice of Intention to become supervised; or (ii) the Commission will not supervise the IBHC because supervision of the entity as an SIBHC is not necessary or appropriate in furtherance of the purposes of Section 17 of the Exchange Act.⁴⁰

The Commission may begin supervising the IBHC as an SIBHC "[u]nless the Commission finds that such supervision is not necessary or appropriate in furtherance of the purposes" of Section 17.⁴¹ The purposes of Section 17 are quite broad. Section 17 generally permits the Commission to carry out its regulatory oversight responsibilities regarding broker-dealers by establishing rules related to recordkeeping, reporting, and examination. In addition, Section 17(h) provides the Commission authority to require that a broker-dealer obtain information and make and keep such records and reports regarding the broker-dealer's affiliates and the financial and securities activities, capital and funding of certain of those affiliates⁴² as the Commission prescribes to assess the financial and operational risks to a broker-dealer from those affiliates.

We believe that, consistent with the purposes of Section 17, the Commission's supervision of an IBHC as an SIBHC may be necessary and appropriate only when the IBHC is affiliated with a broker-dealer that has a "substantial presence" in the securities business.⁴³ Supervision of an SIBHC that owns or controls a broker-dealer with a substantial presence in the securities business would permit the Commission to be better informed regarding the financial and operational conditions of broker-dealers and their holding companies whose failure could have a materially adverse impact on other securities market participants, thus reducing systemic risk and furthering the purposes of Section 17. Evidence that an IBHC owns or controls a broker-dealer that maintains $100 million in tentative net capital would be sufficient to demonstrate a substantial presence in the securities business.

Paragraph (d)(1) of proposed Rule 17i-2 states that all Notices of Intention, amendments, and other documentation and information filed pursuant to proposed Rule 17i-2 will be accorded confidential treatment. We believe it is important to accord confidential treatment to the information and documents an SIBHC would be required provide to the Commission as part of its Notice of Intention because the information and documents would generally be highly sensitive, non-public business information.

The Commission seeks comment on the requirement that an SIBHC own or control a broker-dealer that has a substantial presence in the securities business. In addition, we request comment as to whether maintenance by a broker-dealer of a specified dollar amount of tentative net capital (e.g., $100 million) is an appropriate method to demonstrate whether a broker-dealer has a substantial presence in the securities business. If so, is $100 million in tentative net capital appropriate, or should the dollar amount be higher or lower?

C. Proposed Rule 17i-3: Withdrawal from Supervision as an SIBHC.

Proposed Rule 17i-3 would permit an SIBHC to withdraw from Commission supervision by filing a notice of withdrawal with the Commission. Pursuant to the proposed Rule, a notice of withdrawal from supervision would take effect one year after it is filed with the Commission (or a shorter or longer period that the Commission deems necessary or appropriate to ensure effective supervision of the material risks to the SIBHC and any affiliated broker-dealer or to prevent evasion of the purposes of Section 17 of the Exchange Act).⁴⁴ The proposed Rule would also require that an SIBHC include in its notice of withdrawal a statement that it is in compliance with proposed Rule 17i-2(c) regarding amendments to its Notice of Intention to help to assure that the Commission has updated information when considering the SIBHC's withdrawal request.

Paragraph (c) of proposed Rule 17i-3 states that the Commission may discontinue supervising an SIBHC if the Commission finds that the SIBHC no longer exists or is no longer an IBHC, or that continued supervision of the SIBHC is not necessary or appropriate in furtherance of the purposes of Section 17. Among other things, if an SIBHC makes a material amendment to a mathematical model, its internal risk management control systems, or its corporate structure as described in its Notice of Intention (and as modified from time to time), the Commission would review whether the change would cause continued supervision of the SIBHC to no longer be necessary or appropriate in furtherance of the purposes of Section 17 of the Act.

In order to determine whether continued supervision of an SIBHC is necessary or appropriate in furtherance of the purposes of Section 17 of the Act, the Commission would consider the same criteria it initially considered to determine whether an IBHC will be supervised by the Commission as an SIBHC.

We request comment on all aspects of the withdrawal provisions included in proposed Rule 17i-3. Specifically, we request comment on whether the information the Commission intends to use to determine whether continued supervision of an SIBHC is necessary or appropriate in furtherance of the purposes of Section 17 of the Act is appropriate, and whether the Commission should consider any additional factors. In addition, we request comment as to whether the time frames for withdrawal included in the proposed Rule are appropriate, or whether they should be longer or shorter. If the time periods should be longer or shorter, under what circumstances?

D. Proposed Rule 17i-4: Internal Risk Management Control System Requirements for SIBHCs.

Participants in the securities markets are exposed to various risks, including (i) market risk;⁴⁵ (ii) credit risk;⁴⁶ (iii) operational risk;⁴⁷ (iv) funding risk;⁴⁸ and (v) legal risk.⁴⁹ Large broker-dealers and IBHCs generally are more exposed to high levels of these types of risk due, in part, to their intricate corporate structures, the complexity of business activities in which they engage, and the diverse range of financial instruments they trade. Due to the level of risk exposures created by these types of business activities and products, it is important for firms to implement robust risk management control systems. A firm that has adopted and follows appropriate risk management controls reduces its risk of significant loss, which also reduces the risk that those losses will be spread to other market participants or throughout the financial markets as a whole.⁵⁰

The specific elements of a risk management control system will vary depending on the size, complexity, and organization of a firm. Accordingly, the design and implementation of a system of internal controls for a particular firm or affiliate group may differ from other firms. An individual firm must have the flexibility to implement specific policies and procedures unique to its circumstances. However, as we have found before, well-developed risk management systems generally share certain core principles such as establishing clear responsibilities at each level of management, separation of certain key responsibilities, and effective monitoring and reporting.

Proposed Rule 17i-4 would require an SIBHC to establish, document and maintain a system of internal risk management controls to assist it in managing the risks associated with its business activities, including market, credit, operational, funding, and legal risks.

Proposed Rule 17i-4 would require an SIBHC to comply with present Exchange Act Rule 15c3-4 as though it were a broker-dealer.⁵¹ Currently, Rule 15c3-4 applies to over-the-counter derivatives dealers⁵² ("OTC derivatives dealers"). Based on the Commission's experience with OTC derivatives dealers, we believe this rule would require an SIBHC to develop strong internal controls that would reduce risk at the SIBHC and would require an SIBHC to adequately document those controls so the controls can be examined.

Paragraph (b) of proposed Rule 17i-4 would require that an SIBHC establish, document, and maintain procedures for the detection and prevention of money laundering and terrorist financing as part of its internal risk management control system. These procedures should include appropriate safeguards at the holding company level to prevent money laundering through affiliates.⁵³ This proposed requirement would allow us to adequately inspect members of the affiliate group as required by the statute.⁵⁴

We request comment on all aspects of the internal risk management control system requirements included in proposed Rule 17i-4. We also request comment on whether Rule 17i-4 should incorporate Rule 15c3-4 or should be fashioned as a stand-alone rule. In addition, we request comment as to whether any aspect of Rule 15c3-4 could be better tailored to reflect unique aspects of group risk management practices (as opposed to internal firm risk management practices).

Finally, we request comment on whether Rule 15c3-4 should be amended to require that results of the periodic reviews of the internal risk management control system conducted by an internal auditor and annual reviews of the internal risk management control system conducted by an accountant should be reported in writing to the SIBHC's Board of Directors. In addition, we request comment on whether results of these periodic reviews should be reported in writing to the Commission.

E. Proposed Rule 17i-5: Record Creation, Maintenance, and Access Requirements for SIBHCs.

Pursuant to Section 17(i)(3)(A) of the Exchange Act, an SIBHC would be required to make and keep records, furnish copies thereof, and make such reports as the Commission may require by rule.⁵⁵ Proposed Rule 17i-5 would require that an SIBHC make and keep current certain records relating to its business. In addition, it would require that an SIBHC preserve those and other records for certain prescribed time periods. The purpose of this rule is to require an SIBHC to create and maintain records that would allow the Commission to remain informed as to the SIBHC's activities, financial condition, policies, systems for monitoring and controlling financial and operational risks, and transaction among members of the affiliate group, as well as determine whether the SIBHC is in compliance with the Exchange Act and rules to which it is subject.

1. Record creation.

Paragraph (a) of proposed Rule 17i-5 would require that the SIBHC make and keep current (i) a record reflecting the results of quarterly stress testing of the affiliate group's funding and liquidity with respect to certain specified events; (ii) a record of the SIBHC's contingency plans to respond to certain specified events affecting the affiliate group's funding and liquidity; and (iii) a record of the basis for credit risk weights for each counterparty.

The specified events concerning which an SIBHC would need to conduct stress tests and create a contingency plan would include, (i) a credit rating downgrade of the SIBHC; (ii) an inability of the SIBHC to access capital markets for short-term funding; (iii) an inability of the SIBHC to move liquid assets across international borders when (i) or (ii) occur; or (iv) an inability of the SIBHC to access credit or assets held at a particular institution when (i) or (ii) occur. These events are intended to identify possible liquidity and funding stress scenarios that would impose significant financial distress on the SIBHC. The Commission believes that records of the SIBHC's contingency plans to respond to those events would provide the Commission with important information during an examination that would be necessary to adequately assess the SIBHC's financial condition and financial and operational risks.

We request comment as to whether there are any other records that an SIBHC should be required to create. We also request comment as to whether it would be appropriate to expand the list of specified events described above.

2. Record maintenance.

Pursuant to paragraph (b) of proposed Rule 17i-5, the SIBHC would be required to preserve (i) the records required to be created pursuant to 17i-5(a); (ii) all Notices of Intention, amendments thereto, and other documentation and information filed with the Commission in accordance with proposed Rule 17i-2 and any responses thereto; (iii) reports and notices filed with the Commission in accordance with proposed Rules 17i-6 and 17i-8; and (iv) records documenting the internal risk management control system established in accordance with proposed Rule 17i-4 to manage the risks of the affiliate group.

Proposed Rule 17i-5 would require that an SIBHC maintain the specified records for a period of three years in an easily accessible place. Exchange Act Rule 17a-4 presently requires that broker-dealers maintain certain records for this time period, and we believe this time period is sufficient with relation to the records required pursuant to proposed Rule 17i-5 to allow effective examinations of SIBHCs. The proposed Rule would allow an SIBHC to maintain these records in any manner permitted pursuant to Rule 17a-4(f).⁵⁶

Paragraph (c) of proposed Rule 17i-5 would allow an SIBHC to maintain the records required under the rule either at the SIBHC, at an affiliate, or at a records storage facility, provided that the records are located within the boundaries of the United States. If these records are maintained by an entity other than the SIBHC, the SIBHC would be required to file a written undertaking from the entity with the Commission. This is intended to allow the SIBHC the flexibility to maintain records, while permitting the Commission to obtain those records.

Proposed Rule 17i-5 would not require an SIBHC to maintain its required records in a prescribed standard form. To reduce the recordkeeping burden on SIBHCs, proposed Rule 17i-5 would instead allow the SIBHC to meet its recordkeeping requirements through records created for its own use so long as those records include the information required in the proposed rules.

We request comment on the record maintenance provisions of paragraph (b) to proposed Rule 17a-5. Specifically, are there other records that an SIBHC should preserve in order to provide the Commission with adequate information in reviewing the SIBHC's financial or operational condition or compliance with applicable rules? In addition, we request comment as to what reports an SIBHC should maintain with respect to its affiliates that may be regulated by another financial regulator (for each such report, please delineate the information contained in that report, as well as any information an SIBHC would be required to maintain pursuant to proposed Rule 17i-6 that may not be included in that report).

3. Access to records.

The Commission has authority to examine an SIBHC and its affiliates pursuant to Section 17(i)(3)(C) of the Exchange Act.⁵⁷ However, the Act limits the focus and scope of such examinations. The statutory provisions also require that the Commission use, to the fullest extent possible, examination reports regarding an examination of the SIBHC or certain regulated affiliates made by an appropriate regulator.⁵⁸

Paragraph (d) of proposed Rule 17i-5 would specify that all information obtained by the Commission pursuant to this section from the SIBHC will be accorded confidential treatment pursuant to Section 24(b) of the Exchange Act. Section 17(j) of the Exchange Act⁵⁹ also provides for confidentiality of SIBHC documents. We believe it is important to accord confidential treatment to these documents because the information an SIBHC would be required create, maintain, and grant the Commission access to pursuant to the proposed Rules would generally be highly sensitive, non-public business information.

We believe the requirements set forth in proposed Rule 17i-5 are necessary to keep the Commission informed as to the SIBHC's activities, financial condition, policies, systems for monitoring and controlling financial and operational risks, transactions and relationships between any broker or dealer affiliate of the SIBHC, and the extent to which the SIBHC has complied with the provisions of the Act and the regulations prescribed and orders issued under the Act.

We request comment as to whether the Commission should accord confidential treatment to the documents an SIBHC is required to create, maintain, and grant the Commission access to pursuant to proposed Rule 17i-5.

F. Proposed Rule 17i-6: Reporting Requirements for SIBHCs.

Proposed Rule 17i-6 would require an SIBHC to file certain monthly and quarterly reports with the Commission, as well as an annual audit report. These reporting requirements are designed to inform the Commission about the activities of the SIBHC, as well as the financial condition, policies, systems for monitoring and controlling financial and operational risks, and transactions and relationships involving the affiliate group. In addition, these requirements are designed to keep the Commission informed of the extent to which the SIBHC or its affiliates have complied with the provisions of the Exchange Act, and regulations prescribed and orders issued under the Exchange Act.

1. Monthly reports.

Paragraph (a) of proposed Rule 17i-6 would require that the SIBHC file a monthly risk report with the Commission, within 17 business days after the end of each month that is not also the end of a quarter. This report would include consolidated financial statements for the affiliate group, computations of consolidated allowable capital and allowances for market, credit, and operational risk, a graph reflecting daily intra-month Value at Risk ("VaR") for each business line, consolidated credit risk information, a summary report of the SIBHC's exposures on a consolidated basis for each of the top ten countries to which it is exposed, and certain regular risk reports the SIBHC generally provides to the persons responsible for managing risk for the affiliate group. These reports would be due within the same time frames as the monthly FOCUS reports broker-dealers are required to file pursuant to Rule 17a-5(a). These reports would allow the Commission to review and monitor the risk profile for the affiliate group. Further, they would alert the Commission to any deterioration in the affiliate group's financial or operational position and risk profile. Broker-dealers currently are required to file detailed financial information, which is used by the Commission and the broker-dealer's designated examining authority⁶⁰ to evaluate the broker-dealer's financial and operational condition.

We request comment on the timing of the monthly reporting requirements. Further, we request comment on whether any additional information should be included in the monthly reports to be filed with the Commission. We also request comment on whether the monthly reporting requirement should be modified for an SIBHC (or a member of the affiliate group) required to file information, documents, and reports pursuant to §§ 13(a) or 15(d) of the Exchange Act and, if so, how and why they should be modified.

2. Quarterly reports.

Paragraph (a)(2) of proposed Rule 17i-6 would require that an SIBHC file a quarterly risk report with the Commission within 35 calendar days after the end of each quarter. This report would include, in addition to all the information required to be filed on a monthly basis, (i) consolidating financial statements (that break out data regarding each material affiliate into separate columns); (ii) the results of backtesting of each of the models used to compute allowable capital and allowances for market and credit risk; (iii) a description of all material pending legal or arbitration proceedings involving any member of the affiliate group that are required to be disclosed under generally accepted accounting principles; and (iv) the aggregate debt scheduled to mature within twelve months from the most recent quarter by each affiliate that is a broker-dealer and any other material affiliate, together with the allowance for losses for such transactions. The information an SIBHC would be required to file on a quarterly basis would provide the Commission with valuable insight as to the financial and operational condition of the SIBHC.

Requiring reports to be filed within 35 calendar days after the end of each quarter provides time frames similar to those for quarterly reports due from companies required to file information, documents, and reports pursuant to §§13(a) or 15(d) of the Exchange Act.⁶¹ We request comment as to whether this time period is appropriate for SIBHCs.

We request comment as to whether any additional information should be included in the quarterly reports to be filed with the Commission. We also request comment on whether the quarterly reporting requirement should be modified for an SIBHC (or member of the affiliate group) required to file information, documents, and reports pursuant to §§ 13(a) or 15(d) of the Exchange Act and, if so, how they should be modified.

3. Additional reports.

Paragraph (b) of proposed Rule 17i-6 would provide that, in addition to the monthly and quarterly reports specified in the proposed Rule, an SIBHC may be required, upon receiving written notice from the Commission, to provide the Commission with additional financial or operational information. As specified in the proposed Rule, the Commission may request additional reports in order to monitor the SIBHC's financial or operational condition, risk management system, any transactions and relationships among members of the affiliate group, and the extent to which the SIBHC has complied with the provisions of the Exchange Act and regulations and orders issued under the Exchange Act. This will allow the Commission the flexibility to obtain information, for instance, to more closely monitor the financial and operational condition of an SIBHC during periods of market stress.

In addition, if a broker-dealer affiliated with the SIBHC or the SIBHC were to file notice (pursuant to Rule 17a-11 or proposed Rule 17i-8, respectively), the Commission would be able to request additional reports from the SIBHC to fully assess the situation giving rise to the filing of the notice.

We request comment on our proposal to require that an SIBHC file such additional reports as the Commission may request.

4. Annual audit report.

Pursuant to paragraph (c)(1) of proposed paragraph 17i-6, the SIBHC would be required to file an annual audit report containing consolidated financial statements. Paragraphs (c)(2) and (c)(3) of proposed Rule 17i-6 would require that the annual audit report be "as of" the same date as, and filed with the Commission concurrently with, the annual audit report of the SIBHC's subsidiary broker-dealers.

Paragraphs (d), (e), (f), (g), (h), (i), (j), (k), (l), and (m) of proposed Rule 17i-6 are based on existing Rules 17a-5 and 17a-12 regarding (i) the nature and form or reports, (ii) accountants, (iii) audit objectives, (iv) the extent and timing of audit procedures, (v) the accountant's report, (vi) supplemental reports, (vii) notification of a change in fiscal year, (viii) extensions and exemptions, (ix) how the reports should be filed, and (x) confidentiality.

Paragraph (e) would require that the audit and supplemental reports be prepared by an accountant that is a "registered public accounting firm" as that term is defined in the Sarbanes-Oxley Act of 2002.⁶² We are proposing that the review be conducted by a registered public accounting firm because such firms would be subject to PCAOB rules, examination, and discipline.

We believe the requirements set forth in proposed Rule 17i-6 are necessary to keep the Commission informed as to the SIBHC's activities, financial condition, policies, systems for monitoring and controlling financial and operational risks, and transactions and relationships between any broker or dealer affiliate of the SIBHC and the extent to which the SIBHC has complied with the provisions of the Act and the regulations prescribed and orders issued under the Act. In addition, paragraph (k) of proposed Rule 17i-6 regarding extensions and exemptions would provide the Commission with flexibility to address firm-specific issues as they arise. Finally, we believe it is important to accord confidential treatment to the reports and statements filed pursuant to proposed Rule 17i-6, as specified in paragraph (m), because these reports would include information that generally would be non-public and highly sensitive.

We request comment on the proposed timing of the annual audit reports and whether any additional information should be included in that report. We also request comment on whether the annual audit requirements should be modified for an SIBHC (or member of the affiliate group) required to file information, documents, and reports pursuant to §§ 13(a) or 15(d) of the Exchange Act and, if so, how they should be modified. In addition, we request comment as to whether the Commission should accord confidential treatment to the reports filed with the Commission by the SIBHC pursuant to proposed Rule 17i-6.

We also request comment on our proposal to require that an SIBHC use a registered public accounting firm to perform its annual audit.

5. Accountant's report on management controls — paragraph (i)(2) of proposed Rule 17i-6 and amendment to paragraph (l) of existing Rule 17a-12.

Paragraph (i)(2) of proposed Rule 17i-6 would require that the SIBHC submit a supplemental report, prepared by the accountant, regarding the accountant's review of the internal risk management control system established and documented in accordance with proposed Rule 17i-4. This review would have to be accomplished using procedures agreed-upon by the accountant and the SIBHC. The Rule also specifies that the agreed-upon procedures would be required to be performed and the report to be prepared in accordance with the rules promulgated by the PCAOB. Pursuant to paragraph (i)(4) of proposed Rule 17i-6, the SIBHC would be required to submit the agreed-upon procedures to the Commission prior to the review.

Paragraph (i)(4) of proposed Rule 17i-6 differs from present Rule 17a-12(l), which requires that an accountant provide an opinion regarding an OTC derivatives dealer's compliance with its internal risk management control system. Auditors of OTC derivatives dealers have stated that the lack of standards for evaluating compliance with internal risk management control systems prevents them from issuing an opinion. For this reason, the Commission is proposing to amend present Rule 17a-12(l) so that, similar to the requirements of paragraph (i)(2) of proposed Rule 17i-6, an OTC derivatives dealer would be required to submit a supplemental report, prepared by the accountant using agreed-upon procedures, regarding the accountant's review of the internal risk management control system established and documented in accordance with Rule 15c3-4.

Paragraph (i)(2) of proposed Rule 17i-6 and this proposed amendment to Rule 17a-12(l) would allow an accountant to review an SIBHC's or OTC derivatives dealer's internal risk management control systems and provide a report regarding whether the risk management control systems comply with the requirements of proposed Rule 17i-4 or Rule 15c3-4, respectively, and that the SIBHC or OTC derivatives dealer is, in fact, following its risk management system.

We request comment as to whether the proposed amendment to Rule 17a-12(l) would adequately resolve the lack of standards for conducting an audit of a firm's internal risk management control systems and its compliance with those systems.

G. Exemption from Risk Assessment Rules for Broker-Dealer Affiliates of SIBHCs.

The Commission presently receives financial and risk information about holding companies and certain affiliates of broker-dealers, and certain off-balance sheet items of broker-dealers, their holding companies, and their affiliates pursuant to the risk assessment rules (Rules 17h-1T and 17h-2T) and through meetings with and reports from members of the Derivatives Policy Group.⁶³ These supervisory tools generally have performed well by assisting the Commission in identifying, at an early stage, firms that are experiencing financial problems.

As part of this rulemaking, the Commission is proposing to amend Rules 17h-1T and 17h-2T⁶⁴ to exempt broker-dealers that are affiliated with an SIBHC from those rules. Rule 17h-1T requires that a broker-dealer maintain and preserve records and other information concerning the broker-dealer's holding companies, affiliates, or subsidiaries that are likely to have a material impact on the financial or operational condition of the broker-dealer. Rule 17h-2T requires that broker-dealers file quarterly reports with the Commission concerning the information required to be maintained and preserved under Rule 17h-1T. We believe that exempting a broker-dealer that is affiliated with an SIBHC is appropriate because, pursuant to proposed Rule 17i-5, the SIBHC would be required to make and retain documents substantially similar to those the broker-dealer is required to make and retain pursuant to Rule 17h-1T. Further, pursuant to proposed Rule 17i-6, the SIBHC would be required to make reports that are substantially similar to those the broker-dealer is required to make pursuant to 17h-2T. We request comment on the proposed exemptions from Rules 17h-1T and 17h-2T for broker-dealers affiliated with an SIBHC.

H. Proposed Rule 17i-7: Calculations of Allowable Capital and Risk Allowances or Alternative Capital Assessment.

Proposed Rule 17i-7 would require an SIBHC to calculate the affiliate group's allowable capital and allowances for certain types of risk. Proposed Rule 17i-7 would not set minimum group-wide capital levels for SIBHCs; rather, it would require the SIBHC to perform certain calculations that the Commission could review to gain an understanding of the financial position of the affiliate group and identify any risks it poses to the broker-dealer.

The Basel Committee on Banking Supervision⁶⁵ ("Basel Committee") has developed international regulatory standards that aim to align economic capital calculations with regulatory capital requirements for large internationally active banking institutions ("Basel Standards").⁶⁶ The Basel Committee has proposed to modify the Basel Standards.⁶⁷ Our proposal incorporates a capital computation for the SIBHC that is consistent with the Basel Standards. The Basel Standards have been used by many other financial regulators for many years as a method to assess capital adequacy at the holding company level.

We are proposing what we believe are prudent parameters for measuring allowable capital and allowances for risk for the SIBHC that are consistent with the Basel Standards. In some cases these parameters may be more conservative than some firms believe are necessary to account for risk. For example, the proposal would place limits on the amount of subordinated debt that may be included in allowable capital, require that the VaR model used to calculate the allowance market risk be based on a ten business-day movement in rates and prices and that a 99% confidence level be used, and require that the VaR measure be multiplied by a factor of at least three. Requiring that an SIBHC calculate its allowable capital and allowances for market, credit and operational risk based on the Basel Standards would provide the Commission with a useful measure of the SIBHC's financial position and allow for greater comparability of an SIBHC's financial condition to that of other international securities firms and banking institutions.

1. Calculation of consolidated allowable capital.

Consistent with the Basel Standards,⁶⁸ proposed Rule 17i-7 would require that an SIBHC calculate "allowable capital" for the affiliate group that would include common shareholders' equity (less goodwill, deferred tax assets, other intangible assets, and certain other deductions), certain cumulative and non-cumulative preferred stock,⁶⁹ and certain properly subordinated debt. As set forth in further detail in the proposed rule, the cumulative and non-cumulative preferred stock and the subordinated debt would be subject to additional limitations based on comparisons of the individual components of allowable capital.

When first implemented, the Basel Standards allowed national bank supervisors discretion in counting goodwill as capital during a transition period. Thus, we solicit comment on whether goodwill should be included in allowable capital for a particular transition period and, if so, the length of the transition period.

An entity's debt is not ordinarily includible in its regulatory capital. However, because debt can provide a long-term source of working capital to the entity and may have many of the characteristics of capital, the Basel Standards permit unrestricted long-term subordinated debt⁷⁰ to count as regulatory capital. Under paragraph (a)(3)(ii) of proposed Rule 17i-7, consistent with the Basel Standards, subordinated debt could be included in allowable capital if it meets four criteria. First, the original weighted average maturity of the SIBHC's subordinated debt must be at least five years. Second, the subordinated debt instrument must state clearly on its face that repayment of the debt is not protected by the Securities Investor Protection Corporation ("SIPC") or any Federal agency. Third, the debt must be unsecured and subordinated in right of payment to all senior indebtedness of the SIBHC. Fourth, the terms of the subordinated debt agreement may permit acceleration only in the event of bankruptcy or reorganization of the SIBHC under Chapters 7 (liquidation) or 11 (reorganization) of the U.S. Bankruptcy Code.

The four criteria subordinated debt would have to satisfy to be included in allowable capital are necessary to help assure permanency of capital and to inform subordinated lenders of the risks associated with being a subordinated lender. Funds lent under a subordinated debt agreement necessarily are subject to the risks of the SIBHC's business and must be available to pay other creditors if the SIBHC defaults on other obligations. Although the customers of certain of the SIBHC's affiliates may be entitled to the protection of SIPC under specific circumstances, subordinated lenders of the SIBHC would not be entitled to that protection.

Under the proposal, to be included in allowable capital, subordinated debt would be required to be unsecured and subordinated in right of payment to all of the SIBHC's senior debt. Debt that, upon default, can be repaid by conversion of collateral or before other debt could not be considered subordinated in right of repayment to all senior indebtedness of the SIBHC because the debt effectively would have priority over at least some other debt.

Subordinated debt instruments that permit acceleration of payment upon events other than bankruptcy or reorganization of the SIBHC would not qualify for inclusion in allowable capital under the proposed rules.⁷¹ Acceleration clauses raise significant supervisory concerns because repayment of the debt could be accelerated at a time when an SIBHC is experiencing financial difficulties. Acceleration, therefore, could inhibit an SIBHC's ability to resolve its financial problems in the normal course of business and force the company into involuntary bankruptcy.

We request comment on the inclusion of subordinated debt in allowable capital generally and on the following questions in particular:

• Is five years the appropriate maturity for subordinated debt to be included in allowable capital? Would another term, whether longer or shorter, be more appropriate?
   
• To be included in allowable capital, should subordinated debt be subject to negative pledge provisions that, for example, would restrict an SIBHC's ability to pledge the equity securities of a subsidiary to secure the debt or to sell a subsidiary unless the buyer agreed to assume liability for some portion of the debt?
   
• Should subordinated debt that is subject to acceleration events other than bankruptcy or reorganization of the SIBHC under the Bankruptcy Code be included in allowable capital?
   
• What should be the maximum amount of subordinated debt that is includible in allowable capital?
   
• What are the additional costs of issuing subordinated debt versus long-term debt of the same maturity?

Some industry participants have suggested that certain long-term debt that cannot be accelerated should be included in allowable capital because at the SIBHC level there is no protected class of creditors, and therefore there is no significant difference between that type of long-term debt and subordinated debt. In addition, they assert that subordinated debt is more costly to an entity than long-term debt that cannot be accelerated because of the restrictive provisions associated with, and the lack of an active trading market for, subordinated debt.

We solicit comment on whether long-term debt, subject to appropriate limitations, should be included in allowable capital. Specifically, we request comment on the following issues:

• If long-term debt is included in allowable capital, what restrictions should apply?
   
• Would trading in its long-term debt provide a more reliable indication of the credit quality of the SIBHC than subordinated debt and, if so, why?
   
• Does a holder of its subordinated debt have a greater incentive to monitor the financial condition of the SIBHC than a holder of its long-term debt because its claim is more junior?
   
• Are there debt instruments other than subordinated debt that provide an equivalent market signal about the credit quality of the issuer?
   
• Is there a material difference between the depth of the market for the long-term debt of an SIBHC and the depth of the market for its subordinated debt and, if so, how would any such difference impact the cost of financing for the SIBHC?
   
• Would there be any other adverse effects if the SIBHC were permitted to include long-term debt in allowable capital?
   
• If long-term debt could be included in allowable capital, what, if any, requirements should apply to the maturity date of the long-term debt? What events of acceleration should be permissible?
   
• Should long-term debt be subject to a negative pledge, that, for example, would restrict an SIBHC's ability to pledge the equity securities of a subsidiary to secure the debt or to sell a subsidiary unless the pledgor or buyer agreed to assume liability for some portion of the debt?
   
• What other provisions concerning the inclusion of long-term debt in allowable capital should be considered?

2. Calculation of consolidated allowance for market risk.

Paragraph (b) of proposed Rule 17i-7 would require that an SIBHC calculate a consolidated allowance for market risk daily for all proprietary positions. The SIBHC would calculate an allowance for market risk for each position using either a VaR model or, if there is not adequate historical data to support a VaR model, an alternative method. Generally, the allowance for market risk would constitute three times⁷² the largest amount the SIBHC could lose over a ten-day period with a 99% confidence level (as determined using the VaR model or alternative method).⁷³ An SIBHC would need to provide the Commission with information regarding any alternative method for computing allowance for market risk for particular positions during the Commission's review of its Notice of Intention so that the Commission could evaluate the method to determine whether it adequately measured the risks of those positions.

Paragraph (b)(1) of proposed Rule 17i-7 would require that each VaR model used to calculate allowance for market risk must meet the qualitative and quantitative requirements set forth in rules the Commission is also proposing today in a separate release, proposed Rule 15c3-1e(e).⁷⁴ The qualitative and quantitative standards set forth in proposed Rule 15c3-1e(e) are similar to the requirements for models used by OTC derivatives dealers and are consistent with the Basel Standards. The qualitative requirements would address three aspects of an SIBHC's risk management system: (i) the model would have to be integrated into, and thus relied upon, in the SIBHC's daily risk management process; (ii) the model would be required to undergo periodic reviews by the SIBHC's internal audit staff and annual reviews by an accountant; and (iii) the SIBHC would need to conduct backtesting of the model (the results of the backtests would be used by the SIBHC to determine the multiplication factors to be used when calculating market and credit risk).⁷⁵ The quantitative requirements would set forth basic standards for each model including, (i) it must use a 99 percent, one-tailed confidence level and with price changes equivalent to a ten business-day movement in rates and prices for purposes of determining market risk, (ii) it must use an effective historical observation period that must be at least one year in length and include periods of market stress, and (iii) it must take into account and incorporate all significant identifiable market risk factors applicable to the affiliate group's positions.

Consistent with the Basel Standards, paragraph (b)(1) of proposed Rule 17i-7 would require that each VaR model used to calculate allowance for market risk also must be one that can be disaggregated by each line of business exposed to market risk and by each legal entity.

We request comment on all aspects of the proposed methods for calculating market risk, including whether any other quantitative or qualitative requirements should be applied to VaR models. In addition, we request that commenters address any perceived differences between the proposed methodology for calculating market risk and the Basel Standards. Further, we request comment on alternative methods for computing allowance for market risk, and the appropriateness of those methods.

3. Calculation of consolidated allowance for credit risk.

Paragraph (c) of proposed Rule 17i-7 would require that an SIBHC calculate a consolidated allowance for credit risk daily using either a calculation consistent with the Basel Standards or the methodology set forth in paragraph (c)(1) of proposed Rule 17i-7, which is similar to the proposed New Basel Capital Accord. This choice would provide SIBHCs with some flexibility while the Basel Standards are under review. The methodology set forth in paragraph (c)(1) of proposed Rule 17i-7 would require that an SIBHC multiply the credit equivalent amount of certain asset and off-balance sheet items by the appropriate credit risk weight of the asset or off-balance sheet item, and then multiply the result by 8%.⁷⁶ In general, the asset and off-balance sheet items subject to this allowance are loans and loan commitments receivable, receivables arising from derivatives contracts, repurchase and reverse repurchase agreements, structured financial products, credit substitutes, and other extensions of credit.

Consistent with the proposed New Basel Capital Accord, Paragraph (c)(1)(i) of proposed Rule 17i-7 would establish the manner in which the "credit equivalent amount" of a balance sheet item should be calculated. The credit equivalent amounts for receivables relating to (i) derivatives contracts, repurchase agreements, reverse repurchase agreements, stock loans, stock borrows, and other similar collateralized transactions; (ii) loans and loan commitments receivable; and (iii) other assets would be calculated differently, and are set forth in paragraphs (c)(1)(i)(A), (B), and (C) of proposed Rule 17i-7, respectively. Paragraph (c)(1)(i)(D) of proposed Rule 17i-7 would define the term "current exposure" to be the current replacement value of the counterparty's positions with the member of the affiliate group including the effect of netting agreements with that counterparty,⁷⁷ and taking into account the value of collateral from that counterparty⁷⁸ pledged to and held by any member of the affiliate group and the fair market value of any credit derivatives that specifically change the exposure to the counterparty (as long as the credit derivatives are not used to change the credit risk weight of the counterparty as provided in paragraph (c)(1)(ii)(E)).⁷⁹ Finally, paragraph (c)(1)(i)(E) of proposed Rule 17i-7 defines the term "maximum potential exposure" to be the increase in the net replacement value of the counterparty's positions with the member of the affiliate group, including the effect of netting agreements with that counterparty,⁸⁰ and taking into account the value of collateral from that counterparty⁸¹ pledged to and held by any member of the affiliate group and the fair market value of any credit derivatives that specifically change the exposure to the counterparty (as long as the credit derivatives are not used to change the credit risk weight of the counterparty as provided in paragraph (c)(1)(ii)(E)).⁸² Paragraph (c)(1)(i)(E) of proposed Rule 17i-7 also states that maximum potential exposure would be required to be calculated daily using a VaR model that meets the same qualitative and quantitative standards as required for models used to compute the allowance for market risk.⁸³

We request comment on whether the proposed method of calculating the credit equivalent amount is appropriate, or whether it should be changed. In addition we request comment on whether the definitions of "current exposure" and "maximum potential exposure" are appropriate, or if they should be changed. If the proposed method for calculating credit equivalent amount or the definitions of "current exposure" or "maximum potential exposure" should be changed, please elaborate as to how they should be changed.

Paragraph (c)(1)(ii) of proposed Rule 17i-7 provides that credit risk weights would generally be determined according to the standards published by the Basel Committee, as modified from time to time.⁸⁴ An SIBHC may also use internal credit ratings⁸⁵ or calculate credit risk weights using internal calculations⁸⁶ when calculating its allowance for credit risk.

In addition, paragraph (c)(1)(ii)(D) of proposed Rule 17i-7 would allow SIBHCs to adjust credit risk weights of receivables covered by certain types of guarantees,⁸⁷ and paragraph (c)(1)(ii)(E) of proposed Rule 17i-7 would allow SIBHCs to adjust credit risk weights of receivables covered by certain credit derivatives (such as credit default swaps, total return swaps, and similar instruments used to manage credit risk)⁸⁸ in recognition of the benefits these instruments provide.

The Commission requests comment on the determination of credit risk weights. In particular, the Commission requests comment on whether an additional method of calculating credit risk weights, based on internal estimates of annual probabilities of default, should be included in proposed Rule 17i-7. If such a method should be used, the Commission requests comment on whether the following table appropriately matches credit risk weights to annual probabilities of default:

These credit risk weights are based on the formulas provided in the Advanced Internal Ratings-based Approach to credit risk proposed by the Basel Committee.⁸⁹ We have derived the credit risk weights using a loss given default (the percentage of the amount owed by the counterparty the firm expects to lose if the counterparty defaults) of 75%. We believe 75% to be a conservative number for use in determining credit risk weights. We request comment as to whether 75% is appropriate, or whether it should be increased or decreased.

The Commission believes that calculating a credit risk capital charge on exposures arising from transactions in OTC derivatives instruments using a VaR model that meets that qualitative and quantitative requirements set forth in proposed § 240.15c3-1e(e)⁹⁰ to calculate maximum potential exposure is a more precise method than using a "notional add-on" to approximate maximum potential exposure. In addition, Commission reviews of risk management systems of large U.S. broker-dealers indicate that these broker-dealers generally use maximum potential exposure to measure and manage the credit risk of their portfolios. These broker-dealers would therefore incur little, if any, additional cost to calculate credit risk using maximum potential exposure as opposed to "notional add-ons."

We request comment on this approach to the calculation of credit risk on OTC derivatives, repurchase agreements, reverse repurchase agreements, stock lending and borrowing, and similar collateralized transactions. In addition, we request comment on the proposed requirements for guarantees used to reduce an SIBHC's allowance for credit risk. We also request comment on the appropriate treatment of credit derivatives in this context. Credit derivatives could enter into the calculation of credit risk in two ways. The first would be to substitute the credit risk weight of the writer of the credit derivative for the credit risk weight of the counterparty. The second would be to adjust the current exposure and the maximum potential exposure by the value of the credit derivative.

Certain accounting differences may cause differences in application of the Basel Committee's recommendations when applied to securities firms rather than banking firms. For instance, the broker-dealers must mark all positions to market, whereas banks may use cost as a basis to value securities held for investment purposes. These differences may require the Commission to apply adjustments to the Basel Committee's recommendations, or not to apply adjustments that are in the Basel Committee's recommendations. The Commission solicits comments on how the differences in accounting standards might affect the allowance for credit risk, and what modifications the Commission should make to the proposed rules to address those differences.

The Commission seeks comment on all aspects of the proposed method of calculating the allowance for credit risk. Because the Basel Standards have been implemented by many financial regulators, we request comment as to whether the proposed rule is consistent with the Basel Standards as they have been implemented. In addition, we request comment as to whether the proposed rule is consistent with the present version of the proposed New Basel Capital Accord and how various financial regulators have proposed to implement the proposed New Basel Capital Accord. Should an SIBHC have other alternative methods for calculating the allowance for credit risk?

4. Calculation of consolidated allowance for operational risk.

We solicit comment on all aspects of these three methods for calculating consolidated allowance for operational risk. In addition, we request that commenters address whether any of the three methods is preferable and, if so, explain why. Further, could any changes be made to these methods that would better accommodate the broker-dealer business? Finally, should we allow an SIBHC to choose one of the three methods, or should the proposed Rule require that SIBHCs use the advanced measurement approach?

5. Alternative capital assessment.

Under paragraph (e) of proposed Rule 17i-7, an SIBHC would be permitted to compute a capital assessment using the Basel Standards that the SIBHC already is required to submit to a financial regulator or supervisor in lieu of the computations described in paragraphs (a) through (d). This proposed Rule is intended to allow an entity that may already be subject to certain consolidated supervision requirements to continue to use its present systems and methodologies to compute a capital assessment for reporting purposes for the affiliate group so long as that computation is consistent with the Basel Standards.

6. General questions regarding proposed Rule 17i-7.

We believe the requirements set forth in proposed Rule 17i-7 are necessary to keep the Commission informed as to the SIBHC's financial condition.

We request comment on whether we should allow this alternative standard or whether some other approach may be warranted.

We are proposing what we believe are prudent parameters for computing an SIBHC's risk allowances, although in some cases these parameters may be more conservative than some firms may believe are necessary to account for risk. For example, the proposal requires that the VaR model used to calculate market risk be based on a ten business-day movement in rates and prices and that a 99% confidence level be used, and that the VaR measure be multiplied by a factor of at least three. These parameters are based on our experience and existing Commission rules (e.g., Appendix F of Rule 15c3-1) and rules of other regulatory agencies where there are similar risk factors in the regulated entities. We ask for comment on all these parameters.

7. Other questions regarding capital calculation.

Proposed Rules 17i-6 and 17i-7 would apply a capital reporting requirement consistent with the Basel Standards to the SIBHC. The Basel Committee is currently developing a new international agreement, the proposed New Basel Capital Accord. The proposed New Basel Capital Accord specifies three "pillars" for the group-wide supervision of internationally active banks and financial enterprises. The first pillar, "minimum regulatory capital" requirements, requires calculations for credit and operational risk and, for firms with significant trading activity, market risk. The second pillar, "supervisory review," requires that capital be assessed relative to overall risks and that supervisors review and take action in response to those assessments.

The third pillar requires certain disclosures which will allow market participants to assess key pieces of information concerning, for example, the capital, risk exposures, and risk assessment processes of the institution. The purpose of the third pillar is to complement the minimum capital requirements and the supervisory review process by encouraging market discipline.

The third pillar is discussed in the U.S. banking agencies' Advanced Notice of Proposed Rulemaking on the proposed New Basel Capital Accord.⁹² As the banking agencies noted, an integral part of the advanced approaches is enhanced public disclosure practices. Specific disclosure requirements would be applicable to all institutions using the advanced approaches and would encompass capital, credit risk, credit risk mitigation, securitization, market risk, operational risk, and interest rate risk.

We request comment on whether any additional disclosures by U.S. broker-dealer firms, their holding companies, and affiliates should be required to meet the requirements of the third pillar of the proposed New Basel Capital Accord. If additional, specific disclosure is warranted, commenters are asked to address where that disclosure should be made as well as whether disclosures should be made on a quarterly, annual, or other periodic basis. In addition, we request comment on whether additional required disclosures should depend on whether a firm is privately held or is a public reporting company.

We also request comment on whether the regulatory regime outlined in this proposal together with existing Commission regulation of broker-dealers would meet the requirements of the first and second pillars of the proposed New Basel Capital Accord or whether changes or enhancements should be made.

We request comment on whether, if the proposed New Basel Capital Accord is adopted, there should be a transition period before the Commission requires its use by SIBHCs.

I. Proposed Rule 17i-8: Notification Requirements for SIBHCs.

A broker-dealer that is part of a large holding company structure may be vulnerable to increased risks from the activities of its affiliates and may face difficulty in continuing its operations if a major affiliate ceased operations or encountered financial difficulties. Proposed Rule 17i-8 would require the SIBHC to notify the Commission upon the occurrence of certain events. The proposed early warning system is designed to provide the Commission with information so that it can identify these potential risks to the broker-dealer and its customers.

Paragraph (a) of proposed Rule 17i-8 would require the SIBHC to immediately notify the Commission upon the occurrence of certain events. These events include (i) the occurrence of certain backtesting exceptions; (ii) the SIBHC's computation reflects that consolidated allowable capital is less than 110% of the sum of consolidated allowances for market, credit and operational risk; (iii) an affiliate declares bankruptcy or otherwise becomes insolvent; (iv) the SIBHC becomes aware that a credit rating agency intends to decrease its evaluation of the creditworthiness of an affiliate or the credit rating assigned to one or more outstanding short or long-term obligations of an affiliate; (v) the SIBHC becomes aware that a financial regulatory agency or self-regulatory organization has taken certain regulatory actions against an affiliate; or (vi) the SIBHC becomes ineligible to be supervised by the Commission as a SIBHC (e.g., the SIBHC purchases an insured bank, or the SIBHC's affiliated broker-dealer's tentative net capital falls below $100 million).⁹³ We believe that these events would indicate a decline in the financial and operational well-being of the firm. Were an SIBHC to file a notification as required by proposed Rule 17i-8, the Commission may be prompted to request additional reports, as contemplated by proposed Rule 17i-6(b), and otherwise begin to monitor the firm's condition more closely.

In addition, proposed Rule 17i-8 would require that an SIBHC notify the Commission if there were a material change (along with a description of that change) in the ownership or organization of the affiliate group, the status of any affiliate that is material, or the major business functions of any material affiliate.⁹⁴

Paragraph (c) of proposed Rule 17i-8 would specify the manner in which these notices and reports should be provided to the Commission. In addition, paragraph (c) of proposed Rule 17i-8 would specify that the notices and reports filed with the Commission pursuant to Rule 17i-8 would be accorded confidential treatment. We believe it is important to accord confidential treatment to the notices and reports an SIBHC would be required provide pursuant to proposed Rule 17i-8 because the information contained in those notices and reports would generally be highly sensitive, non-public business information.

We believe the requirements set forth in proposed Rule 17i-8 are necessary to keep the Commission informed as to the SIBHC's activities, financial condition, policies, systems for monitoring and controlling financial and operational risks, and transactions and relationships between any broker or dealer affiliate of the SIBHC and the extent to which the SIBHC has complied with the provisions of the Act and the regulations prescribed and orders issued under the Act.

We request comment on all aspects of these notification requirements. In addition, we request comment as to whether the events that would trigger the notification requirement are appropriate, and whether other triggering events should be included.

III. GENERAL REQUEST FOR COMMENT REGARDING PROPOSED RULES.

The Commission solicits comment on its proposal to supervise IBHCs as SIBHCs. The Commission solicits comments on whether this proposal would provide adequate Commission oversight on a group-wide basis of IBHCs that file a Notice of Intent to become supervised by the Commission as an SIBHCs.

We note that on September 12, 2003, the Federal Reserve Board, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Deposit Insurance Commission requested public comment on an interim final rule and a notice of proposed rulemaking to amend their risk-based capital standards for the treatment of assets in asset-backed commercial paper programs consolidated under the recently issued Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities.⁹⁵ The rule would also modify the risk-based capital treatment of certain securitizations with early amortization provisions. In addition, the treatment of securitization exposures is discussed in the banking agencies Advanced Notice of Proposed Rulemaking on the proposed New Basel Capital Accord.⁹⁶

Should the Commission consider any modifications to the calculations of allowances for market and credit risk for asset-backed securitization programs as contemplated by proposed Rule 17i-7? If so, how and why should the Commission modify these calculations for asset-backed securitization programs? Should the Commission consider any other issues related to the capital treatment of securitization exposures?

Commenters may also wish to discuss whether the Commission should consider a different approach, and if so, what that approach should be.

Commenters should provide empirical data to support their views. Comments should be submitted by February 4, 2004.

IV. PAPERWORK REDUCTION ACT.

Certain provisions of proposed new Rules 17i-1 through 17i-8 and the amendments to Rules 17h1-T and 17h-2T contain "collection of information" requirements within the meaning of the Paperwork Reduction Act of 1995.⁹⁷ The Commission has submitted them to the Office of Management and Budget ("OMB") for review in accordance with 44 U.S.C. 3507(d) and 5 C.F.R. 1320.11. The titles for the collections of information are (i) Rules 17h-1T and 17h-2T Risk Assessment Rules; (ii) Rule 17i-2 Notice of Intention to be Supervised by the Commission as a Supervised Investment Bank Holding Company; (iii) Rule 17i-3 Withdrawal from Supervision as an Supervised Investment Bank Holding Company; (iv) Rule 17i-4 Internal Risk Management Control Systems Requirements for Supervised Investment Bank Holding Companies; (v) Rule 17i-5 Record Creation, Maintenance, and Access Requirements for Supervised Investment Bank Holding Companies; (vi) Rule 17i-6 Reporting Requirements for Supervised Investment Bank Holding Companies; and (vii) Rule 17i-8 Notification Requirements for Supervised Investment Bank Holding Companies. An agency may not conduct or sponsor, and a person is not required to comply with, a collection of information unless it displays a currently valid OMB control number.

A. Collection of Information Under the Amendments to Rules 17h-1T and 17h-2T and New Rules 17i-1 through 17i-8.

Proposed Rule 17i-1 through 17i-8 would create a framework for Commission supervision of SIBHCs. The collections of information included in these proposed rules are necessary to allow the Commission to effectively determine whether SIBHC supervision is necessary or appropriate in furtherance of the purposes of § 17 of the Act and allow the Commission to supervise the activities of these SIBHCs. These rules also would enhance the Commission's supervision of the SIBHCs' subsidiary broker-dealers through collection of additional information and inspections of affiliates of those broker-dealers. Regulatory oversight pursuant to this system is voluntary, and eligible IBHCs would not be required to be supervised in this manner. This framework would include procedures through which an IBHC could file a Notice of Intention to become supervised by the Commission as an SIBHC, as well as recordkeeping and reporting requirements for SIBHCs.

The amendments to Rules 17h-1T and 17h-2T⁹⁸ would exempt broker-dealers that are affiliated with an SIBHC from those rules and thus reduce their "collection of information" requirements. This exemption is designed to eliminate duplicative recordkeeping and reporting requirements.

B. Proposed Use of Information.

The Commission would use the information collected under the proposed new Rules to determine whether SIBHC supervision is necessary or appropriate in furtherance of the purposes of § 17 of the Act and to monitor the financial condition, risk management, and activities of SIBHCs on a group-wide basis. In particular, it would allow the Commission access to important information regarding activities of a broker-dealer's affiliates that could impair the financial and operational stability of the broker-dealer or the SIBHC.

C. Respondents.

An IBHC can file a Notice of Intention to be supervised by the Commission as an SIBHC only if it: (1) has a subsidiary broker or dealer that can evidence that it has a substantial presence in the securities business; and (2) is not (i) affiliated with an insured bank (with certain exceptions) or a savings association, (ii) a foreign bank, foreign company, or a company that is described in section 8(a) of the International Banking Act of 1978, or (iii) a foreign bank that controls a corporation chartered under section 25A of the Federal Reserve Act.⁹⁹ Paragraph (d)(2)(i)(B) of proposed Rule 17i-2 would indicate that the Commission would not consider it to be necessary or appropriate to supervise an IBHC unless it can demonstrate that it owns of controls a broker-dealer that has a substantial presence in the securities business (which may be demonstrated by a showing that the broker-dealer maintains tentative net capital of at least $100 million).

As of March 31, 2003, approximately 100 registered broker-dealers reported their tentative net capital as being between $100 million and $1 billion.¹⁰⁰ Many of these broker-dealers are affiliated with another broker-dealer that reported its tentative net capital as being more than $100 million. Approximately 35 could not be supervised by the Commission as an SIBHC due to the fact that each is either: (i) affiliated with an insured bank (with certain exceptions) or a savings association,¹⁰¹ (ii) a foreign bank, foreign company, or a company that is described in section 8(a) of the International Banking Act of 1978, or (iii) a foreign bank that controls a corporation chartered under section 25A of the Federal Reserve Act.¹⁰² In addition, some broker-dealers may not be active in jurisdictions that require securities firms to demonstrate that they have consolidated supervision at the holding company level that is equivalent to EU consolidated supervision, or may not find it to be cost-effective to register as an SIBHC for other reasons. Thus, the Commission estimates that six IBHCs will file notices of intent to be supervised by the Commission as SIBHCs.

D. Reporting and Recordkeeping Burdens.

1. Amendments to Rules 17h-1T and 17h-2T.

The amendments to Rules 17h-1T and 17h-2T¹⁰³ would exempt broker-dealers that are affiliated with an SIBHC from those rules and thus reduce their "collection of information" requirements. Rule 17h-1T requires that a broker-dealer maintain and preserve records and other information concerning the broker-dealer's holding companies, affiliates, or subsidiaries that are likely to have a material impact on the financial or operational condition of the broker-dealer. Rule 17h-2T requires broker-dealers to file with the Commission quarterly reports concerning the information required to be maintained and preserved under Rule 17h-1T. The present PRA burden for broker-dealers that are presently reporting pursuant to Rules 17h-1T and 17h-2T is 24 hours per year for each broker-dealer respondent. The estimated six firms therefore would have their annual burden reduced by an aggregate of 144 hours per year.

2. Proposed Rule 17i-2.

Proposed Rule 17i-2 would require that an IBHC file a Notice of Intention to become supervised by the Commission as an SIBHC. The Notice of Intention would have to set forth certain information and include a number of documents. The SIBHC would also have to submit amendments to its Notice of Intention if certain information became incorrect or if it made certain material changes. The Commission designed Rule 17i-2 so an IBHC could compile and submit existing documents with its Notice of Intention (as opposed to requiring that an IBHC create additional documents) in order to decrease any costs or burdens involved with this proposed rule.

As stated previously in section IV.C., we estimate that approximately six IBHCs will file Notices of Intention to become SIBHCs. We estimate that each IBHC that files a Notice of Intention to become supervised by the Commission would take approximately 900 hours to draft a Notice of Intention, compile the various documents to be included with the Notice of Intention, and work with the Commission staff. Further, we believe that an IBHC would have an attorney review its Notice of Intention, and we estimate that it would take the attorney approximately 100 hours to complete such a review. Consequently, we estimate the total burden for all six firms to be approximately 6,000 hours.¹⁰⁴ We believe this would be a one-time burden.

The estimates of the initial burden for proposed Rule 17i-2 are based on the estimates the Commission made in adopting Rule 17c3-1f, which contained similar requirements.¹⁰⁵ Our burden estimates for proposed Rule 17i-2 are lower than our burden estimates relating to the application provisions of Rule 15c3-1f because our estimates relating to the creation of mathematical models have been removed from the estimate. Proposed Rule 17i-2 does not require that mathematical models be created. In addition, the requirement to create a model is not a paperwork burden. Accordingly, the costs associated with creation of mathematical models are included in the Cost-Benefit discussion regarding proposed Rule 17i-7 (which would require that an SIBHC calculate allowances for market and credit risk using mathematical models). The estimates we used here were also adjusted based on the staff's experience in implementing the OTC derivatives dealer rules. We based our burden estimates for proposed Rule 17i-2 on our burden estimates for Rule 15c3-1f because the application provisions of Rule 15c3-1f and proposed Rule 17i-2 are substantially similar and because no comments were received regarding the burden estimates for Rule 15c3-1f.

Rule 17i-2 also requires that an IBHC/SIBHC¹⁰⁶ update its Notice of Intention on an ongoing basis. We estimate, based on the staff's experience, that an IBHC/SIBHC will take approximately 2 hours each month to update its Notice of Intention, as necessary. Thus, we estimate that it will take the six IBHC/SIBHCs, in the aggregate, about 144 hours each year¹⁰⁷ to update their Notices of Intention.

3. Proposed Rule 17i-3.

Proposed Rule 17i-3 would provide a method by which an SIBHC could withdraw from Commission supervision as an SIBHC. The proposed rule would require that an SIBHC file a notice of withdrawal with the Commission stating that the SIBHC wished to withdraw from Commission supervision.

Due to the benefits and costs associated with becoming supervised by the Commission as an SIBHC, we believe that an IBHC would carefully consider filing a Notice of Intention. For PRA purposes only, we estimate that one SIBHC may wish to withdraw from Commission supervision as an SIBHC over a ten-year period.

We estimate, based on the staff's experience, that an SIBHC that withdraws from Commission supervision as an SIBHC would take one attorney approximately 24 hours to draft a withdrawal notice and submit it to the Commission. Further, we believe the SIBHC would have a senior attorney or executive officer review the notice of withdrawal before submitting it to the Commission, and that it would take such person 8 hours to conduct such a review. Thus, we estimate that the annual, aggregate burden of withdrawing from Commission supervision as an SIBHC would be approximately 3.2 hours each year.¹⁰⁸

4. Proposed Rule 17i-4.

Proposed Rule 17i-4 would require an SIBHC to have in place a risk management control system appropriate for its business and organization. An SIBHC would need to consider, among other things, the sophistication and experience of its operations, risk management, and audit personnel, as well as the separation of duties among these personnel, when designing and implementing its internal control system's guidelines, policies, and procedures. These requirements are designed to result in control systems that would adequately address the risks posed by the firm's business and the environment in which it is being conducted. In addition, this would enable an SIBHC to implement specific policies and procedures unique to its circumstances.

Proposed Rule 17i-4 also would require that an SIBHC periodically review its internal risk management control system for integrity of the risk measurement, monitoring, and management process, and accountability, at the appropriate organizational level, for defining the permitted scope of activity and level of risk.

In implementing its policies and procedures, an SIBHC would be required to document and record its system of internal risk management controls. In particular, an SIBHC would be required to document its consideration of certain issues affecting its business when designing its internal controls. An SIBHC would also be required to prepare and maintain written guidelines that discuss its internal control system.

The information to be collected under proposed Rule 17i-4 would be essential to the supervision of SIBHCs and their compliance with the Commission's proposed rules. More specifically, the requirement that an SIBHC document the planning, implementation, and periodic review of its risk management controls is designed to assure that all pertinent issues are considered, that the risk management controls are implemented properly, and that they continue to adequately address the risks faced by SIBHCs.

As stated previously in section IV.C., we estimate that approximately six IBHCs will file Notices of Intention to be supervised by the Commission as SIBHCs. We further estimate that the average amount of time an SIBHC would spend assessing its present structure, businesses, and controls, and establishing and documenting its risk management control system would be about 3,600 hours, and that this would be a one-time burden. In addition, we estimate that an SIBHC would spend approximately 250 hours each year maintaining its risk management control system. Thus, we estimate that the total initial burden for all SIBHCs would be approximately 21,600 hours¹⁰⁹ and the continuing annual burden would be about 1,500 hours.¹¹⁰

The estimates of the initial and annual burdens for proposed Rule 17i-4 are based on the estimates the Commission made in adopting Rule 15c3-4. Proposed Rule 17i-4 makes Rule 15c3-4 applicable to SIBHCs. Our burden estimates for proposed Rule 17i-4 are higher than our burden estimates for Rule 15c3-4 because an SIBHC would be establishing, documenting, and maintaining a system of internal risk management controls for the affiliate group, and not just for one firm. We based our burden estimates for proposed Rule 17i-4 on our burden estimates for Rule 15c3-4 because Rule 15c3-4 and proposed Rule 17i-4 are substantially similar and because no comments were received regarding the burden estimates for Rule 15c3-4.

Internationally active firms generally already have in place risk management practices, and will generally review and improve their risk management practices in the near future despite these rules. However, we recognize that, to the extent an IBHC presently has a group-wide internal risk management control system, those systems may not take into account all of the elements and issues required by proposed Rule 17i-4. In addition, these firms may not have documented their consideration of these elements and issues, or other aspects of their internal risk management control systems.

5. Proposed Rule 17i-5.

Pursuant to proposed Rule 17i-5, an SIBHC would be required to make and keep current certain records relating to its business. In addition, it would be required to preserve those and other records for certain prescribed time periods. The purpose of this rule is to require that the SIBHC create and maintain records that would allow the Commission to evaluate SIBHC compliance with the rules to which it is subject. We expect that any additional burden under the proposed rule would be minimal because the information that would be called for under the proposed rule is information a prudent IBHC that manages risk on a group-wide basis would maintain in the ordinary course of its business.

Pursuant to proposed Rule 17i-5, an SIBHC would be required to make and keep records reflecting (i) the results of quarterly stress tests; (ii) that the firm had created a contingency plan to respond to certain possible funding and liquidity difficulties; and (iii) the basis for credit risk weights. We estimate that the average amount of time an SIBHC would spend to create a record regarding stress tests is about 64 hours each quarter, or approximately 256 hours each year. This estimate is based on the staff's experience working with models and dealing with firms that use models through implementation of the OTC derivatives dealers rules, as well as informal discussions with potential respondents. We further estimate that the average amount of time an SIBHC would spend to create and document a contingency plan regarding funding and liquidity of the affiliate group (which we believe an SIBHC would do only once, not on an ongoing basis) would be about 40 hours. This estimate is based on the staff's experience. In addition, we estimate that the average amount of time an SIBHC would spend to create a record regarding the basis for credit risk weights would be about 30 minutes for each counterparty, and that on average, an SIBHC will establish approximately 20 new counterparty arrangements each year.¹¹¹ This estimate is based on informal discussions the staff has had with potential respondents.

Pursuant to proposed Rule 17i-5, an SIBHC would be required to maintain these and other records for at least three years in an easily accessible place. We estimate that the average amount of time an SIBHC would spend to maintain these and other, specified records for three years would be about 24 hours per year per SIBHC. This estimate is based on our present estimates for Rule 17a-4, which previously have been subject to notice and comment and have been approved by OMB.

As stated previously in section IV.C., we estimate that approximately six IBHCs will file Notices of Intention to be supervised by the Commission as SIBHCs. Thus, the total initial burden relating to proposed new Rule 17i-5 for all SIBHCs would be approximately 240 hours¹¹² and the continuing annual burden would be approximately 1,740 hours.¹¹³

6. Proposed Rule 17i-6.

Proposed Rule 17i-6 would require an SIBHC to file certain monthly and quarterly reports with the Commission, as well as an annual audit report. These reporting requirements are necessary to keep the Commission informed as to the activities of the SIBHC, as well as the financial condition, transactions and relationships involving the affiliate group, and policies, systems for monitoring and controlling financial and operational risks. In addition, these requirements are essential to keeping the Commission informed of the extent to which the SIBHC or its affiliates have complied with Section 17(i) of the Exchange Act and the rules promulgated thereunder. Finally, these reports could also be used to evaluate the activities conducted by these SIBHCs and to anticipate, where possible, how they might be affected by significant economic events.

As stated previously in section IV.C., we anticipate that the proposed rule would affect approximately six SIBHCs. We estimate that, on average, it would take an SIBHC about 8 hours each month to prepare and file the monthly reports required by this rule (or approximately 96 hours per year).¹¹⁴ We estimate that, on average, it would take an SIBHC about 16 hours each quarter (or 64 hours each year)¹¹⁵ to prepare and file the quarterly reports required by this rule. We estimate that, on average, it would take an SIBHC about 200 hours to prepare and file the annual audit reports required by this rule. Thus, we estimate that the total annual burden of proposed Rule 17i-6 on all SIBHCs would be approximately 2,160 hours.¹¹⁶

These estimates are based on our present estimates for 17a-12, which were previously subject to notice and comment and have been approved by OMB. However the estimates for the monthly and quarterly reports were reduced somewhat due to the fact that an SIBHC would not be required to complete specified forms, but instead could provide the required information to the Commission in its existing format. We believe that our use of existing internal reports will decrease the burden on SIBHCs because an SIBHC may compile existing documents and submit them to the Commission. Further, the time burden relating to the annual audit was increased in recognition of the fact that the audit of a holding company is generally more time consuming than the audit of one entity (for both the accountants and the firm employees working with them). However, many of these holding companies are already audited at the holding company level, so, aside from the special supplemental reports, no additional burden should be imposed by proposed Rule 17i-6. We believe that most well-managed SIBHCs already report to their senior management much of the information required to be provided to the Commission pursuant to proposed Rule 17i-6.

7. Proposed Rule 17i-8.

Proposed Rule 17i-8 would require SIBHCs to report on the occurrence of certain events that may have a material adverse affect on the SIBHC. The proposed early warning system is modeled after the early warning system used with respect to broker-dealers in Exchange Act Rule 17a-11. Like Exchange Act Rule 17a-11, proposed Rule 17i-8 is designed to give the Commission advance warning of problems that may pose material risks to the financial and operational capability of an SIBHC and its affiliated broker-dealers. The proposed rule would be integral to the supervision of SIBHCs and their affiliated broker-dealers.

We estimate that it would take an SIBHC approximately one hour to create a notice required to be submitted to the Commission pursuant to proposed Rule 17i-8. This estimate is based on our present estimates for Rule 17a-11, which were previously subject to notice and comment and have been approved by OMB. The Commission received 692 Rule 17a-11 Notices from 627 broker-dealers during the year ending December 2001. At that time, there were approximately 7,217 active broker-dealers registered with the Commission.¹¹⁷ Thus, 9% of active, registered broker-dealers had a situation arise which caused them to file a notice pursuant to Rule 17a-11. Using this 9% figure, we estimate that of the approximately six IBHCs that we believe will register to be supervised as SIBHCs, one may be required to file notice pursuant to proposed Rule every other year.¹¹⁸ Thus, we estimate that the annual burden of proposed Rule 17i-8 for all SIBHCs would be about 30 minutes.

E. Collection of Information Is Mandatory.

The collections of information requirements in proposed new Rules 17i-1 through 17i-8 would be mandatory for every IBHC that files a Notice of Intention to be supervised by the Commission as an SIBHC and every SIBHC that is supervised by the Commission.

F. Confidentiality.

The information and documents collected, retained, and/or filed pursuant to proposed new Rules 17i-1 through 17i-8 would be accorded confidential treatment.

G. Record Retention Period.

Proposed Rule 17i-5(b) would require that an IBHC preserve for three years in an easily accessible place information relating to (i) its Notice of Intention; (ii) its group-wide system of internal risk management controls; (iii) the records it is required to make and keep current; (iv) the reports it is required to make; and (v) its calculations of allowable capital and allowances for market, credit, and operational risk.

H. Request for Comments Regarding Paperwork Burden Estimates.

Under 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to evaluate:

• Whether the proposed collection of information is necessary for the proper performance of the functions of the Commission, including whether the information would have practical utility;
   
• The accuracy of the Commission's estimate of the burden of the proposed collection of information;
   
• Ways in which we might enhance the quality, utility, and clarity of the information to be collected; and
   
• Ways in which we might minimize the burden of the collection of information on those required to respond, including through the use of automated collection techniques or other forms of information technology.

Persons wishing to submit comments on the collection of information requirements should address them to The Office of Management and Budget, Room 3208, Attention: Desk Officer for the Securities and Exchange Commission, Office of Information and Regulatory Affairs, New Executive Office Building, Washington, DC 20503; and should also send a copy of their comments to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. The submission should reference File No. S7-22-03. OMB is required to make a decision concerning the collection of information between 30 and 60 days after publication of this document in the Federal Register; therefore, comments to OMB are best assured of having full effect if OMB receives them within 30 days of this publication.

The Commission has submitted the proposed collections of information to OMB for approval. Requests for the materials submitted to OMB by the Commission with regard to these collections of information should be in writing, refer to File No. S7-22-03, and be submitted to the Securities and Exchange Commission, Records Management, Office of Filings and Information Services, 450 Fifth Street, NW, Washington, DC 20549-0609.

V. COSTS AND BENEFITS OF THE PROPOSED RULES AND RULE AMENDMENTS.

The Commission has identified certain costs and benefits that would be associated with the proposed framework for supervising SIBHCs. Supervision pursuant to this system is voluntary, and eligible IBHCs would not be required to be supervised in this manner. This framework would include requirements for IBHCs that file Notices of Intention to be supervised by the Commission as SIBHCs, as well as recordkeeping and reporting requirements for SIBHCs, including a requirement that an SIBHC calculate and report a calculation of allowable capital and allowances for market, credit and operational risk.

A. Benefits.

There are many quantifiable and non-quantifiable benefits that would be created by these rules. We have attempted to delineate those costs below.

U.S. securities firms that do business in the EU have indicated that they may need to demonstrate that they are subject to consolidated supervision at the holding company level that is "equivalent" to EU consolidated supervision. Generally, EU "consolidated supervision" would take the form of a series of rules, imposed at the holding company level, regarding firms' internal controls, capital adequacy, intra-group transactions, and risk concentration. Without a demonstration of "equivalent" supervision, securities firms located in the EU have stated that they may either be subject to additional capital charges or required to form a sub-holding company in the EU.¹¹⁹ The regulatory framework for SIBHCs set forth in the proposed rules is intended to provide a basis for non-U.S. financial regulators to treat the Commission as the principal U.S. consolidated, home-country supervisor¹²⁰ for SIBHCs and their affiliated broker-dealers. In response to a survey conducted during the rulemaking process to promulgate the OTC derivatives dealers rules, firms suggested that they would incur significant costs in creating a new, non-U.S. regulated affiliate. Based on that information, we estimate that it would cost an IBHC approximately $8 million to with create a new, non-U.S., regulated affiliate,¹²¹ or about $48 million in the aggregate for the six IBHCs we believe will file Notices of Intention to become supervised by the Commission as SIBHCs. We do not have sufficient information to estimate what additional capital charges may be imposed on securities firms that do business in the EU if they are not subject to equivalent supervision.

Certain broker dealers must create records and file quarterly reports with the Commission regarding the financial condition, organization, and risk management practices of the affiliated group pursuant to Exchange Act Rules 17h-1T and 17h-2T.