There is one common requirement faced by every type of broker-dealer (“BD”), the concept of Regulatory Net Capital; however, depending upon the type of business the BD engages in, the thresholds could vary significantly. This article will provide an overview of some of the common types of BD and the minimum net capital requirements established by Securities and Exchange Act Rule 15c3-1 (15c3-1).
In general, BDs can be segregated into two broad categories: those that “carry customer accounts” and those that do not. The term “carry customer accounts” involves maintaining accounts for individuals or other brokers or dealers and also receiving and holding funds and/ or securities.
BDs that carry customer accounts are required to maintain net capital of at least $250,000, subject to the following exceptions:
- An introducing broker that introduces their accounts on a fully disclosed basis to a clearing firm will be subject to a minimum net capital requirement of $50,000. In order to qualify, the BD must have an agreement with a clearing firm that supports that the customers are customers of the clearing firm and not the BD, and statements and customer relationships are directly between the clearing firm and the customers
- A prime broker is required to maintain minimum regulatory net capital of $1.5 million.
- BDs that self-clear or clear prime broker transactions on behalf of an introducing executing broker is required to maintain net capital $1 million.
- A carrying BD claiming a (k)(2)(i) exemption, which provides that all transactions between the BD and its customers are conducted through a bank account designated as “Special Account for the Exclusive Benefit of Customers of XYZ BD,” has a minimum net capital requirement of $100,000.
BDs that do not carry customer accounts have minimum regulatory net capital requirements ranging from $5,000 to $100,000, as follows:
- Dealers are required to maintain net capital of $100,000, and include entities that endorse or write options (other than on a national exchange) or transact more than ten transactions for their own investment account(s) in any one calendar year. This requirement is often troublesome for other non-carrying BDs that would otherwise be subject to a lower minimum net capital requirement. Furthermore, it’s most commonly violated when a BD receives securities as compensation for services and sells those securities, or when a BD establishes a policy of investing excess cash on a periodic basis.
- As noted above, introducing brokers that meet the disclosure requirements are subject to a minimum net capital requirement of $50,000.
- BDs that only engage in the sale of redeemable shares of mutual funds or interests in an insurance company separate account are subject to a minimum net capital requirement of $25,000.
- All other BDs that do not carry customer accounts and do not receive funds or securities are subject to a $5,000 minimum net capital requirement. This includes BDs that act as investment bankers or receive commissions in conjunction securities offerings.
In addition to the regulatory net capital requirements set forth in 15c3-1, BDs will also be subject to other net capital thresholds based upon their aggregate indebtedness (liabilities). BDs also need to be aware of additional net capital requirements that may be mandated by their specific designated examining authority and other regulatory bodies that the BD is a member of, such as the Commodities Futures Trading Corporation (“CFTC”). The net capital rules are complex, but when understood and properly applied can become a useful tool for managing the financial strength of the BD.
If you have concerns that your firm’s activities might cause a violation of the net capital rules and a reclassification of the firm subjecting it to higher-unattainable thresholds, feel free to contact a member of the WS+B Broker-Dealer Team. Our experts can advise or make introductions to other industry professionals who can advise and help establish a system to ensure compliance.
– Brian Wallace