Accuracy of Net Capital Computations
Securities Exchange Act of 1934 (Exchange Act) Rule 15c3-1 (Net Capital Rule) requires that firms must at all times have and maintain net capital at levels as specified under the rule. The Net Capital Rule is designed to help protect customers and creditors of broker-dealers from monetary losses that can occur when a broker-dealer fails. Some firms have faced challenges in complying with this rule and related guidance from the SEC staff.
- Insufficient Documentation Regarding Expense-Sharing Agreements – Staff of the SEC Division of Trading and Markets issued guidance in 2003 regarding the application of the Net Capital Rule to, among other situations, when a third party agrees to assume responsibility for payment of a firm’s expenses via expense-sharing agreements. Some firms did not maintain sufficient documentation to substantiate their methodology for allocating specific broker-dealer costs to the firm or an affiliate. Other firms’ expense-sharing agreements have not clearly set forth a method of allocation for payment of certain expenses by the firm as opposed to a third party. As a result, the books and records of such firms may not accurately reflect their operating performance and financial condition.
- Incorrect Inventory Haircuts – Some smaller firms did not adequately design or document policies and procedures for assessing and monitoring the creditworthiness of certain securities or money market instruments to determine whether these products have a “minimal amount of credit risk” pursuant to Exchange Act Rule 15c3-1(c)(2)(vi)(i).20 As a result, some firms may not have applied the correct haircuts to these products for purposes of computing their net capital.
- Inaccurate Operational Charges – Some firms miscalculated their operational charges due to misinterpretations of the Net Capital Rule, e.g., by failing to take appropriate haircuts in non-purpose equity securities borrowed transactions or in certain underwritings.21 Further, in some instances, firms encountered challenges with calculating operational changes—e.g., suspense or aged fail charges—as a result of human error and limited spreadsheet controls.
20 These requirements are set forth in the SEC’s 2013 credit ratings amendments. See Exchange Act Release No. 71194 (Dec. 27, 2013), 5 Fed. Reg. 1522 (Jan. 8, 2014).
21 For additional information about non-purpose equity securities borrowed transactions, see Net Capital Requirements for Brokers or Dealers, Non-Purpose Equity Securities Borrowed Transactions, SEA Rule 15c3-1(c)(2)(iv)(B)/093, available here. For additional information about underwritings, see Net Capital Requirements for Brokers or Dealers, Moment to Moment Net Capital, SEA Rule 15c3-1(a)/001 and Haircuts on Contractual Commitments, SEA Rule 15c3-1(c)(2)(viii)(C)/03, available here.