Net Capital Calculations
Exchange Act Rule 15c3-1 (Net Capital Rule) requires firms to maintain net capital at specific levels to protect customers and creditors from monetary losses that can occur when firms fail.
Noteworthy Examination Findings
FINRA has continued to identify some of the same concerns noted in the Net Capital and Credit Risk Assessments section of the 2017 Report and Accuracy of Net Capital Calculations section of the 2018 Report, as well as the following additional issues.
- Incorrect Inventory Haircuts – Some firms did not apply correct haircut charges when computing net capital because they did not adequately assess and monitor the creditworthiness of fixed income securities, such as corporate debt and collateralized mortgage obligations (CMOs), to determine whether these products have a “minimal amount of creditworthiness” pursuant to Exchange Act Rule 15c3-1(c)(2)(vi)(I).23
- Incorrect Capital Charges for Underwriting Commitments – Some firms did not maintain an adequate process to assess moment-to-moment and open contractual commitment capital charges on underwriting commitments and did not understand their role as it pertained to the underwriting (i.e., best efforts or firm commitment).24
- Inaccurate Classification of Receivables, Liabilities and Revenue – In some instances, firms inaccurately classified receivables, liabilities and revenues, which resulted in inaccurate reporting of a firm’s financial position and, in some instances, a capital deficiency. In addition, upon settlement of a customer claim, some firms understated their liability by recognizing the monies due to the customer based on a payment schedule instead of recognizing the full amount owed at the time of settlement.
- Recognition of Insurance Claims – Some firms did not recognize on their books and records receivables due from insurance carriers and the corresponding liabilities owed to customers. Other firms did not obtain an opinion of counsel with respect to claims within seven business days, as required under Exchange Act Rule 15c3-1(c)(2)(iv)(D), thereby resulting in the receivables not being allowable for purposes of net capital, and the firm being required to take the full charge for the customer claim.
- Inadequate Documentation of Methodology for 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. Some firms were not accurately accruing expenses—such as technology fees, marketing charges, retirement account administrative fees and employees’ compensation—on their books and records. Further, some firms incorrectly netted intercompany accounts with different affiliated entities,25 resulting in books and records that did not accurately reflect the firms’ operating performance and financial condition.
- Interpretations of Financial and Operational Rules
- Notice to Members 03-63 (SEC Issues Guidance on the Recording of Expenses and Liabilities by Broker/Dealers)
23 These requirements were adopted as part of the SEC’s 2013 credit ratings amendments. See Exchange Act Release No. 71194 (Dec. 27, 2013), 79 Fed. Reg. 1522 (Jan. 8, 2014).
24 See Exchange Act Rule 15c3-1(c)(2)(viii); see also Moment to Moment Net Capital, Exchange Act Rule 15c3-1(a)(1)/001, in the Interpretations of Financial and Operational Rules.
25 See Netting of Intercompany Receivables and Payables with Affiliates, Exchange Act Rule 15c3-1(c)(2)(iv)(C)/073 in the Interpretations of Financial and Operational Rules.
Segregation of Client Assets