SEC Form 17-H

SEC Form 17-H — the Risk Assessment Report for Broker-Dealers — must be filed with the Securities and Exchange Commission (SEC) by all securities brokers. This six-page form cites a broker’s business activities related to its risk profile. SEC Form 17-H requests items such as the investment company’s current organizational chart, copies of all risk-management and related policies, information related to any legal proceedings, and the company's financial statements.

SEC Form 17-H requires broker-dealers (BD) to disclose information regarding the activities of certain affiliated entities, such as a parent company, holding company, or subsidiary that could materially affect the financial and operating conditions of a broker-dealer. SEC Form 17-H was appended to section 240 of the Securities and Exchange Act of 1934 (SEA) by the Penny Stock Reform Act of 1990 and officially adopted by the SEC in 1992 as a required filing by all BDs — along with its Final Temporary Risk Assessment Rules 17(h)-1T and 17(h)-2T, which remain unchanged today.

The SEC adopted Rule/Form 17-H on the heels of one of the most spectacular examples of insider trading in recent history — the collapse of legendary broker-dealer, Drexel Burnham Lambert, Inc. (DBL) and its holding company, Drexel Burnham and Lambert Group, Inc. (Drexel). In 1990, Drexel was already in trouble for its questionable high-yield bond trading practices proliferated Michael Milken and others in the 1980s, when DBL transferred $220 million of BD capital to its parent as a short-term loan. Neither the SEC nor the New York Stock Exchange was made aware of this significant capital transfer at the time. In a matter of weeks, Drexel and its associated entities could not meet their financial obligations, and as a result, DBL filed for bankruptcy. 

A core mission of the Securities and Exchange Commission is to protect investors and ensure that U.S. markets operate in a fair and orderly fashion. Thus, Rule 17-H is an important way that the SEC may screen securities organizations to mitigate or head off any potential risks and threats, like the Drexel demise cited above. One form of risk that SEC staff seek to identify is market manipulation (or misconduct). This type of risk is often unrelated to the merit of projects underlying the investment; rather, these situations are frequently motivated by conflicts of interest, and they often occur in the presence of asymmetric information between various market participants — for example, when hedge fund managers misvalue assets in order to inflate or smooth their returns; or when corporate issuers misstate earnings; or instances of brokers favoring some investors over others by cherry picking (or allocating) trades to them that may disregard material data or broad market metrics.

Another type of risk assessment deals with understanding and identifying market-wide, or systemic risks, which may flow from the correlated activities of many market participants. These risks can propagate through the entire market or a segment of it, adversely affecting many entities, including those that did not contribute to the activity that caused the market-wide risk. An example of this type of risk might occur by using derivative securities such as over-the-counter (OTC) swap agreements, for which inadequate margining could leave customers exposed to counterparty risk.

By disrupting market activities that investors rely on, such risks threaten access to, as well as the cost of, capital that is required to finance worthwhile investment opportunities in the economy. As part of its risk-assessment program, the SEC currently selects 50 firms a year — out of approximately 325 17-H filer firms — for in-person screening visits. The SEC is also developing an expanded liquidity review process, which may bring increased scrutiny of 17-H firms going forward. Focusing on liquidity was one of the big lessons learned during the 2008 financial crisis. 

Because the Financial Industry Regulatory Authority (FINRA) — formerly, the National Association of Securities Dealers (NASD) — is on the front line of licensing and regulating BDs and enforcing SEC regulations, it also plays an important role in helping to protect investors and financial markets from risk. One of FINRA's well-known risk-assessment services is BrokerCheck, a searchable database of brokers, investment advisors and financial advisors that includes certifications, education, and enforcement actions. At its 2018 annual meeting, FINRA reported that a top priority for the organization is continuing to identify high-risk firms and individual brokers in order to mitigate the potential risks that they may pose to investors. Specifically, FINRA will increase its scrutiny of brokerage firms’ hiring and supervisory practices including remote-supervision arrangements; point-of-sale (POS) activities, including individual broker accountability; and branch inspection programs.