1
Q
Net Capital Rule
A
- uniform net capital rule under SEC Act of 1934
- sets forth financial requirements that borker-dealers must meet
2
Q
Essential provisions of the net capital rule
A
- dollar capital requirements
- net capital
- aggregate indebtedness
- max ratios of AI/NC
- subordinated loan rules
3
Q
Net Capital Dollar Requirements
A
- Minimum dollar requirements for “Net Capital” to be maintained by broker-dealers
- dependends on the type of business
- ensures the firm has sufficient liquid assets to meet foreseeable liability
- Net capital = liquid net worth
4
Q
Net Capital Requirement for a Clearing Broker
A
$250K
5
Q
Clearing Broker
A
- one that carries customer accounts and accepts funds and securities from borkers
- “general securities” broker-dealer
- Send out trade confirmations & statements
6
Q
Net Capital Requirements for
Fully Disclosed BD that Receives Securities
A
$50K
7
Q
Fully Disclosed BD
A
- does not carry customer accounts and does not hold customer funds or securities
- it has a clearing agreement with a clearing firm and has fully disclosed all of its accounts to this firm
- Also called “ introducing” BD
8
Q
A Fully Disclosed BD that receives but does not hold customer funds or securities are permitted to do what?
A
- Effect occasional trades for thier own investment accounts with or through another BD
- 10 or fewer transactions per year
- They can effect but not clear sec trades as a broker on national sec exchange for the account of another broker
9
Q
Net Capital Requirements for a Fully Disclosed BD thta DOES NOT Receive Sec
A
$5K
- firm can not recieve customer funds and securities
10
Q
$5K Fully disclosed BD cannot
A
- accept customer funds or securites
- must have procedures in place to notify the cusotmer that deliveries must be sent to the clearing firm
- cannot join in firm commitment underwritings as a syndicate or selling group member
- Can join in best efforts underwriting
- not permitted to effect an occaisional transaction for their own accounts
11
Q
Net Capital Requirements for Direct Participation Program BD
A
$5K
- a BD that sells only limited partnerships (DPPs) falls under the $5K fully disclosed BD
12
Q
Net Capital Requirements for an M&A BD
A
$5K
Advises large companies on how to structure their securities offerings
13
Q
Participation in Underwritings:
$250K Clearing B/D
A
- Firm Commitment Syndicate Member
- Firm Commitment Selling Group Member
- Best Efforts Syndicate Member
- Best Efforts Selling Group Member
14
Q
Participation in Underwritings:
$50K Introducing B/D
A
Yes:
* Firm Commitment Selling Group Member
* Best Efforts Syndicate Member
* Best Efforts Selling Group Member
No:
* Firm Commitment Syndicate Member
15
Q
Participation in Underwritings:
$5K Introducing BD
A
Yes:
* Best Efforts Synidcate Member
* Best Efforts Selling Group Member
No:
* Firm Committment Syndicate Member
* Firm Committment Selling Group Member
16
Q
Clearing Agreement
A
- between an introducing firm and its clearing agent
- must specify the responsibilties of each party
- It can require that all trades of the introducing grom go through the clearing broker or allow the introducing broker to eecute trades through other firms with those trades being reported to the clearing broker for settlement and clearence.
*
17
Q
Why do firms want flexilbity to direct trades?
A
- want flexiblity to direct a trade to a market maker that it feels is best qualified to handle the trade
- used by hedge fund broker dealers who want to direct their portfolio trades to differnt executing brokers in return for research, recommendations and other such services
18
Q
Give up the clearing arrangement
A
- when the clearing agreement allows the introducing firm to execute away from the clearing broker
19
Q
Prime Brokerage
A
In prime brokerage any number of executing brokers can handle parts of a trade, but the entire trade will be cleared and settled by the prime broker.
20
Q
G
Give Up
A
the executing broker dealer provies the clearing number of the prime broker when reporting the trade for comparison and clearance.
The executing broker gives up the name of the clearing prime broker when the trade is being reported.
21
Q
Step Out
A
the executing broker provides the clearing number of the prime broker after the trade is reported for comparison and clearence.
the executing broker “steps out” of the reported trade for comparison and clearlance purposes.
used to move a reported trade from the account of the executing memer to the clearing member
movement of position only.
22
Q
Net Capital Requirements for a Clearing Prime Broker
A
$1.5 MM
23
Q
Net Capital Requirements for an Executing Broker
A
$1MM
24
Q
What must the clearing BD provide to the introducing firm
A
- A written list of all the reports that the clearing BD can generate based on the activies of the introducing firm
- Intended to help the introducing firm supervise customer accounts and monitor transactions
- Must be provided annually by July st to the CEO and compliance officer of the introducing firm
25
Net capital requirements for a Market Maker
$1K for each sec bid at $5 or less
$2.5K for each sec bid over $5
$100K Min
$1MM Max
26
Net Capital Requirements for Mutual Fund and Variable Annuity Dealers
* Do not carry customer accounts
* if they take wire orders: $25K
* If they take subscriptions only: $5K
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Net Capital Computation
Liquid Assets - Total liabilities = Net Capital
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Simplified Net Capital Formula
Net worth - non alloable Assets = net capital
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Full Net Capital Formula
Net Worth + Subordinated Loans = Total Available Capital
- Non allowable Assets = Tenative Net Capital
- haircuts on allowable Assets = Net Capital
30
What assets are allowable for net capital calculation
* cash
* cash in reserve account
* customer debit balances
* fails to deliver w/ haircut if aged
* notes receivable fully secured
* Inventory w / haircut
* stock borrowed
*
31
Non allowable assest for net capital calculation
* unsecured notes receivable
* pre-paid expenses
* exchange membership
* real estate
32
assets subject to haircut
* fails to deliver
* securities inventory
33
Basic haircut percentage
* for equity securities is 15%
34
Fails to deliver haircut
Fails to deliver that are aged after the 4th business day past settlement
they are marked to market and take a 15% haircut
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36
Fails to deliver
a security that has not been delivered by a customer to the broker on the regular way settlement date
customer has 4 day grace period
on the 5th bueinss day its aged and the position is marked to market and 15% haircut is taken
on the 10th business day after the regular way settlement date the firm must buy the position and charge the loss ot the customer
37
Two items subject to haircut for net capital calculation
* fails to deliver
* securities inventory
* Undue concentration
38
When are fails to deliver considered aged
after the 4th business day
on the 5th business day they are marked to market and a 15$ haircut is taken
39
What haircut do securities inventories recieve
* Actively Traded (3 or more market makers): they are marked to market and receive a 15% haircut
* Limited traded (1 to 2 market makers): 40% haircut
* Non-marketable (no other market makers): 100%
40
Undue concentration haircut
A firm can have up to 10% of its tentative net capital amount invested in one security position
if a position exceeds 10% of its tentative net capital amount then an extra 15% haircut must be taken on the excess concentration amount
41
Tentative Net Capital Amount
Net Worth + subordinated Loans = total available capital - Non allowable assets
42
what are the non allowable assets
Real estate
exchange membership
prepaid expenses
43
Aggregate Indebtedness
*aggregate indebtedness cannot get to high relative to net capital
Maximum AI (aggregated indebtedness) / Net Capital:
first year = 8:1
after first year= 15:1
44
Max AI/NC
Max Aggregated Indebtedness / Net Capital
first year 8:1
next year 15:1
45
What is included in aggregated indebtedness
* all liabilties of a broker-dealer which are unsecured and all customer realted liablities
* essentially all monies that the broker dealer must pay if it liquidates
1. Accounts Payable
2. Customer Credit Balances
3. Fails to receive - customer account
4. fail to receive - firm account / no long position
5. Stock Loaned (firm loans out customer stock)
6. bank loans - customer collateral (loans from a bank to the broker using customer margin securities as collateral)
46
What reduces aggregated indebtedness
funds on deposit in special reserve bank account
47
What are the requirements for subordinated Loans
* Minimum term 1 year
* the agreement must state that they subordinate their claims to all other creditors
48
two forms of subordinated loans
* subordinated loan: lender gives cash to BD. BD plays interest and repays at maturity.
* Secured demand note: lender gives marginable securities to the BD, who places them in street name. the BD rehypothecates them to a bank for a loan. Set by REG U bank loans 70% of the value
49
Subordinated Loan
under this agreemetn the lender gives the BD cash.
The BD pays interest and repays principal at maturity.
50
Secured Demand Note
* The lender gives the BD marginable security
* The BD places the securities in street name
* The BD re-hypothecates these securities to a bank for a loan
*Under Reg U the bank can loan up to 70% of value
51
Excess colloteral for Secured demand notes
if the securities being used as collateral for a secured demand note goes up in value the lender can remove the excess collatoral
52
53
What happens if there is deficient collateral for a secured demand note
* if collateral value declines (securities used for collateral decline in value) the broker will demand additional collateral from the lender
54
What happens if the collateral value falls below the face amount of the secured demand note?
The lender and FINRA must be notified in writting (electronic notice) immediately.
the lender must produce the extra collateral by noon the following day
if they do not the bank can start selling out the seurities to pay down the loan balance.
55
Rights of a BD regarding collateral
* the collateral that is given by the lender to the BD under a subordinated agreement can be cash or securities
* Cash: BDs can deposit cash and use it as they see fit
*Securities: BDs can reyhpothecate securities to a bank for a loan or lend them to another BD
56
Rights of lender regarding collateral
* the lender can substitute the collateral with cash or marketable securities of equal loan value
* The lender retains the dividend rights and the BD remits any dividend payments to the lender of the shares
* Voting rights typically stay with BD. the BD is not obligated to send the proxy to the lender
57
Maximum Debt / Equity
* limit to the amount of subordinated loans a firm can carry
* Max debt/ equity = 70%
* Debt / Equity = subordinated debt/ total available capital
Grace period: 90 days
58
what is the grace period for debt / equity ratio?
Max is 70%
cannot be exceeded for more than 90 days
59
Total available capital
= Net worth + subordinated loans
60
Treatement of loans made by the owner with at least a 3 year life and still 1 year left
Treated as equity for the debt / equity ratio
61
Firm repayment of subordinated loan
If a firm pays down a subordinated loan capital falls.
The subordinated agreement must provide that if the paydown results in the AI / NC ratio going above 12:1 the repayment is suspended
62
Prepayment of Subordinated loan considerations
Prepayment of subordinated loan requires prior FINRA approval
Not required for principal repayment at maturity.
63
SEC Bar of Capital Withdrawal
SEC has the right to restrict any equity capital withdrawal by order for 20 business days
if it believes that it is detremental to the firms customers or business opertations.
64
Temporary Subordinated Loan
* for short term capital needs the firm may take out a temporary subordinated loan
* a "temp" loan could be used when a firm commitment underwriting is signed. becuase the firm has a open contractual committment considered to be the same as holding the secutities and will be haircut by 15% so a temp loan could be used to bolster capital for underwritings.
65
Temp loan restrictions
* maximum of 3 temporary loans per year
* Max duration of 45 days each
* can only be done if their AI / NC does not exceed 10:1 and its Net capital exceeds 120% of min requirement
66
Filing requirements for subordinated loan agreements
* subordinated loan agreements must be filed with FINRA and the SEC to count as "capital"
* FINRA has a standardized subordinated loan agreement that can be used
* if the standard contract is used it must be filed at least 10 business days in advane of their effective date with FINRA and SEC
* the agreement must be approved by FINRA before it can be counted as capital
67
Filing requirements for a non standard subordinated loan agreement
* non standard: firms own agreement or modified FINRA standard agreement
*must be filed with FINRA at least 30 days in advance of its effective date
* must be filed with SEC within 10 business days in advance of the effective date
* the agreement must be approved by FINRA before it can be counted as capital
68
Alternative Net Capital Requirement
The Net Capital Rule allows BDs to use an alternative method of computing net capital.
BD keeps min dollar capital of at least $250K or 2% of debit items included in the customer resesrve formula.
if this method is used there is no aggregate indebtedness tests for the firm.
Typically used by large retail firms with excess cpital to avoid technical violoations of the AI/NC ratio.
69
SEC Rule 3b-8
* defines different types of market makers for the purpose of the market maker borrowing from a bank using securities as collateral under Reg U
* Sets substantial net capital requirements for these market makers to borrow from banks
70
Qualified OTC Market Maker
A dealer in OTC margin securities that publishes regular bid-ask quotes and is ready willing and able to effect transacations in reasonable amounts.
Must maintain net cpital of the lesser of $250K or $25K plus $5K for each security in excess of 5 in which the firm makes a market
71
SEC net capital requirements for Qualified OTC market maker
Lesser of $250K or
$25K Plus $5K for each security in excess of 5 that the firm makes a market
72
Qualified thrid market maker
a dealer in any stock registered on a national that publishes regular bid -ask quotes and is ready, willing and able to effect transactions in reasonable amounts.
Must maintain the lesser of $500K or $100K plus $20K for each security in excess of 5 in which the firm makes a market
73
Net capital requirements for a qualified third market maker
lesser of $500K or $100K plus $20 K for each security in excess of 5 in which the firm makes a market
74
Qualified Block Positioner
A broker dealer who engages in the activity of purchasing or selling short a block of stock with a market value of $200K or more in a single transaction to facilitate a sale or purchase by a customer.
Minimum net capital of $1MM
75
Filing of clearing agreements
* Clearing agreements must always be filed by the clearing firm with FINRA's national office for review and approval before effective
* The newly formed BD must file a copy of the agreemnt with that firms FINRA district office
76
Early Warning Level
A firm hits the early warning leel if the capital falls below 5% of debits in the reserve formula
requires electronic notice to FINRA within 24 hours and the filing of any reports requested by FINRA
77
The Net Capital Rule limits subordinated loans of a BD to :
70% of the BDs total avialable capital (the total of equity plus subordinated loans)
for the ratio inlcude loans:
1. made by:
- owner
- partner/ principal (owner)
2. have at least 3 year duration
3. have at least 1 year left to maturity
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