NASD Notice to Members 04-33 - April 2004

Limited Net Capital Relief from the Reclassification of Certain Equity as Liabilities in Accordance with Statement of Financial Accounting Standards No. 150

Executive Summary

In May 2003, the Financial Accounting Standards Board (FASB) released Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (the “Statement” or “Statement 150”) as part of a broad effort to ensure that entities recognize as liabilities contractual obligations to transfer cash, other assets, or equity interests to other parties. One of the primary requirements of the Statement is the need to reclassify mandatorily redeemable financial instruments, generally defined as ownership interests in the issuing entity with mandatory redemption features, as liabilities.

 

This reclassification requirement is applicable to non-public entities beginning with the commencement of the first fiscal year starting after December 15, 2003. Because of the effect of these requirements on non-public entities, particularly since many non-public companies are capitalized solely with stock that may be redeemed upon the death or retirement of a shareholder, many non-public companies requested an extension of the Statement’s effective date. In a November 7, 2003, Staff Position Release (Release 150-3), the FASB decided that it would not revise the effective date of the Statement for non-public entities that are required to file financial statements with the Securities and Exchange Commission (SEC). As a result, the Statement provisions remain applicable to non-public broker-dealers at the start of the fiscal year that begins after December 15, 2003.

 

In response to a request from the Securities Industry Association (SIA), the SEC Division of Market Regulation (DMR) concluded in a February 19, 2004, No-Action Letter (No-Action Letter) that it “will not recommend enforcement action to the Commission if a broker-dealer that is a non-public entity, in calculating net capital under [Securities Exchange Act] Rule 15c3-1, adds to its regulatory net worth the carrying value of mandatorily redeemable financial instruments that FAS [Statement] 150 excludes from the firm’s GAAP equity.” The No-Action Letter only provides relief from the net capital ramifications of the Statement’s treatment of mandatorily redeemable financial instruments and does not extend to the accounting treatment of financial instruments (whether or not mandatorily redeemable) as set forth in the Statement. (See Exhibit A for a copy of the No-Action Letter.) The No-Action Letter further requires that “a broker-dealer that wishes to take advantage of this relief must advise its designated examining authority of its intent.” Consequently, to take advantage of the relief granted by the No-Action Letter, a member must advise NASD of its intent to rely on the No-Action Letter by May 10, 2004, and prior to applying the relief.

 

Questions regarding this Notice may be directed to Andrew Labadie, Financial Analyst, Member Regulation, Regulatory Policy and Oversight (RPO), at (202) 728-8397; or Susan DeMando, Director, Financial Operations, Member Regulation, RPO, at (202) 728-8411.