Advice to all Broker-Dealers Out There…

Last week’s blog mentioned issues discussed at the New York State Society Broker-Dealer Conference. In particular, one of the presenters mentioned that BDs should keep it simple. The BD should not guarantee anything nor should its assets secure anything.

Why is this important to the BD?  Well, in calculating a BD’s net capital requirements, the SEC Uniform Net Capital Rule (SEC Rule 15c3-1) requires the maintenance of minimum net capital and requires the ratio of aggregate indebtedness to net capital not to exceed certain ratios.

 A simple definition of aggregated indebtedness (AI) is the total money liabilities of a BD arising in connection with any transactions whatsoever.  At the conference it was mentioned that FINRA has been taking a look at AI.  They are of the belief that BDs that guarantee the debt of a related entity should include that full debt in the BDs calculation of AI.  As you can see, increasing the AI could cause the BD to fall below the required threshold of net capital to AI… A serious offense which could result in severe fines to the BD.

One of my partners who attended the conference, Brian Wallace, and I had a prospective client meeting this past week.  And wouldn’t you know it, when we read the financial statements of the BD we immediately noticed that there were guarantees made by the BD on behalf of the parent entity.  The financials did not include this guarantee in the AI calculation.  We brought this to the attention of the CFO, who explained that he had a long discussion with FINRA over this.  He was of the opinion that since the parent did not draw against the debt, the BD should not have to include this debt in its AI calculation. FINRA had a different interpretation, primarily because there was no ability of the BD to prevent the parent from drawing down on the line. The resulting adjustment to AI put the BD in a net capital deficiency position. Fortunately, the BD has a good relationship with FINRA and was able to take corrective measure and avoid penalties or disciplinary action.

Our advice to all BDs out there, do not guarantee the debt of any related or unrelated entity.


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