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This explains that the net capital rule is for the "ability of broker-dealers to meet their financial obligations to customers and other creditors."

My understanding, however, is that client funds/investments are segregated from the broker's funds/investments. So why are these requirements necessary? What does it actually protect?

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When a customer uses margin for trading, Reg T dictates the amount he can use and the extent to which the value his market position can decrease until he is required requires additional money. Otherwise, the broker liquidates the position. The Net Capital Rule is analogous in that it dictates how much 'margin' (as in assets) the broker must maintain in order to continue operating:

Net Capital Rule (Rule 15c3-1) – Requires a broker-dealer to maintain more than a dollar of highly liquid assets for each dollar of liabilities. If the broker-dealer fails, this rule helps to ensure that the broker-dealer has sufficient liquid assets to pay all liabilities to customers.

And yes, customer funds and securities must be segregated from the firm’s proprietary business activities. The assets cannot be commingled and used for company purposes. So if the company goes out of business, customer assets can be given back to them. This regulation is the Customer Protection Rule (Rule 15c3-3):

Broker-dealers sometime use their own funds to conduct trades and other transactions. Rule 15c3-3 essentially requires a broker-dealer that maintains custody of customer securities and cash to segregate such securities and cash from the broker-dealer’s proprietary activities. By segregating customer securities and cash from a firm’s proprietary business activities, the rule increases the likelihood that customer assets will be readily available to be returned to customers if a broker-dealer fails.

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  • Thanks for the answer. Your source says "if the broker-dealer fails, this rule helps to ensure that the broker-dealer has sufficient liquid assets to pay all liabilities to customers." I fail to see how its customers are exposed to risk given the customer protection rule. Do "customers" here refer to parties opposite the broker's personal trades? Jan 31 at 20:19
  • I'll leave it to you to figure out who, beyond the account holder at the broker, is and isn't protected (I hate legalese). See paragraph 2 Definitions here. Jan 31 at 20:32

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