Net Capital Requirements Flashcards
Elgin Brothers makes markets in 450 equity issues; 400 issues are priced greater than $5 and 50 issues at $5 or less. Its net capital requirement based on market making is:
a. $400,000
b. $250,000
c. $1,000,000
d. $1,050,000
C-The maximum net capital requirement based on the number of markets made is $1,000,000. Generally the price of the security is taken into account.
Shares greater than $5: 400 x $2,500 = $1,000,000
Shares less than or equal to $5: 50 x $1,000 = $50,000
But the net capital rule puts a $1,000,000 ceiling on this.
Consider the following information for Gemstar Trading, an introducing broker-dealer. Market-making activities: 12 stocks priced at $5 or less 20 stocks priced at greater than $5 Gemstar's minimum net-capital requirement based on the above is: a. $32,000 b. $62,000 c. $100,000 d. $250,000
c- Gemstar would be classified as a securities dealer under the Net Capital Rule with a minimum requirement of $100,000. Gemstar doesn’t make markets in enough issues for the formula dictated by the price of the stock to matter. If it made a market in one issue, its net-capital requirement would still be $100,000.
In which of the following situations could a broker-dealer be considered to be approaching financial difficulty?
I. A 30% decline in net capital experienced in the three-month period immediately preceding such a computation
II. Its books and records are not up-to-date
III. The broker-dealer is unable to clear and settle transactions in a timely manner
IV. The member currently has net capital of $1,400,000 with a requirement of $1,200,000
a. I and IV only
b. II and III only
c. I, III, and IV only
d. I, II, III, and IV
D- Any of these events could be indicative of an approaching net capital violation, requiring that the broker-dealer take precautionary steps. SEC and FINRA rules specifically indicate those conditions that broker-dealers must resolve in accordance with industry guidelines. The SEC’s Early Warning rule is triggered if a broker-dealer’s ratio of aggregate indebtedness to net capital exceeds 12:1 or its net capital is less than 120% of the required minimum. FINRA rules also describe conditions under which it considers a firm to be approaching “financial or operational difficulty,” including:
• Net capital of less than 150% of the minimum required (for more than 15 consecutive business days)
• Ratio of aggregate indebtedness to net capital exceeds 10:1 (for 15 consecutive business days)
• A reduction in excess net capital of 25% in the preceding two months or 30% or more in the three-month period immediately preceding such a computation
• A substantial change in the manner in which it processes its business which, in the view of FINRA, increases the potential risk of loss to customers
• Other broker-dealers’ books and records are not maintained in accordance with the provisions of SEC Rules 17a-3 and 17a-4
• Inability to clear and settle transactions promptly
FINRA members who are considered to be approaching financial or operational difficulty may be prohibited from expanding their business or may be required to reduce their level of business activity.
Which of the following statements are TRUE regarding the activities of introducing broker-dealers subject to a $50,000 net capital requirement?
I. They do not have fails to deliver on their books.
II. They may not act as a market maker.
III. They may charge commissions on an exchange-traded issue.
IV. They may participate in all types of underwritings.
a. I, II, and III only
b. I and III only
c. II, III, and IV only
d. III and IV only
A- Only clearing broker-dealers have fails to deliver and fails to receive on their books. An introducing broker-dealer would require $100,000 to act as a market maker. Firm commitment underwriting requires $100,000 of net capital. Introducing broker-dealers can always charge a commission on a trade.
A broker-dealer’s aggregate indebtedness fell but its net capital requirement rose. This could be attributable to:
a. Greater haircuts
b. Making more markets
c. Higher firm fails to receive
d. All of the above
B- A reduction in aggregate indebtedness could reduce a firm’s net capital requirement, but there are other factors at work. If a broker-dealer increased the number of markets it makes, its net capital requirement could rise. Remember that there is a ceiling of $1,000,000 as a capital requirement based on market-making activities.
A broker dealer has $30,000,000 in aggregate debit items from SEC Rule 15c3-3 Reserve Formula and determines its capital under the alternative minimum net capital method. Its minimum requirement is:
a. $250,000
b. $600,000
c. Based on the aggregate indebtedness of the broker-dealer
d. $1,000,000
B- A broker-dealer computing net capital under the alternative minimum method must maintain the greater of $250,000 or 2% of the aggregate debit items pursuant to the Reserve formula. 2% of $30,000,000 is $600,000.
Fails to receive for the account of the member firm for securities that have been sold:
a. Increase aggregate indebtedness
b. Have no affect on aggregate indebtedness
c. Decrease net capital
d. Are illegal
A- If the firm sells the stock, the fail would become aggregate indebtedness. The following example will clarify the rule.
A member firm buys $10,000 XYZ stock for its own account on Monday, November 1. The selling broker fails to deliver the stock on the settlement date of November 4. The $10,000 fail is not at this point aggregate indebtedness. On November 11, while still failing to receive the stock, the member firm decides to sell the stock. At this point, the $10,000 fail would be added to aggregate indebtedness.
A fail to receive for the account of customers is always aggregate indebtedness. If a customer were to buy $10,000 worth of stock and the selling broker did not deliver the stock to the buying broker by the settlement date, the fail to receive would be added to the buying firm’s aggregate indebtedness.
Which of the following is commonly associated with the activities of a carrying firm under SEC Rule 15c3-1?
a. Acting in a dealer capacity in an underwriting of corporate bonds
b. Conducting its own clearing activities
c. Making markets in Nasdaq National Market securities
d. All of the above
D- A broker-dealer is indentified as a carrying firm under SEC Rule 15c3-1 based on the activities that it conducts and the amount of net capital it is required to maintain. This firm may act in a principal capacity in underwriting contracts, may conduct clearing activities, and may engage in market-making activities.
A carrying broker-dealer has been in business for nine months and has aggregate indebtedness of $1,700,000. It computes its net capital under the standard method outlined in SEC Rule 15c3-1. What is the minimum net capital requirement for the broker-dealer?
a. $212,500
b. $113,333
c. $250,000
d. $100,000
C- During its first year of business, the maximum A.I. to N.C. ratio for a broker-dealer is 8:1. However, under no circumstance may its net capital be less than the regulatory minimum for a carrying firm, which is $250,000.
Liabilities that are subordinated to the claims of creditors under a satisfactory subordination agreement in accordance with the provisions of Rule 15c3-1 are:
a. Included in aggregate indebtedness
b. Excluded from aggregate indebtedness
c. Deducted from net capital
d. None of the above
B- In accordance with the provisions of Rule 15c3-1, liabilities that are subordinated to the claims of creditors under a satisfactory subordination agreement are excluded from aggregate indebtedness.
A new broker-dealer with $50,000 of net capital can support aggregate indebtedness of:
a. $3,333
b. $6,250
c. $400,000
d. $750,000
A- The net capital rules require that aggregate indebtedness not exceed net capital by more than 8 times for a broker-dealer in its first year of operation. Since the net capital is $50,000, a new broker-dealer could not have aggregate indebtedness exceeding $400,000.
Which of the following items would be included in the firm’s aggregate indebtedness?
a. Fails to deliver more than 5 days old
b. Fails to receive for customer accounts
c. Customer debit balances
d. Firm trading, sold short to customers
B- Fails to receive for customer accounts is part of the AI of the firm. Fails to deliver and customer debits are debit items on the trial balance and not part of AI. Firm trading, sold short to customers, is a credit item that is collateralized by the firm’s own assets, and therefore, is not part of aggregate indebtedness.
The trial balance of the firm indicates the following credit balance items. Use this information to answer this question. Mortgage on real estate $1,200,000 Customer credit balances $185,000 Fails to receive: Customer accounts $700,000 Firm trading, unsold $250,000 Firm trading, sold -- no offset $150,000 Loans outstanding: Customer accounts $375,000 Firm accounts $600,000 Securities loaned: Customer accounts $250,000 Firm accounts $900,000 Short securities differences -- 32 days old $135,000 What is the aggregate indebtedness of the firm? a. $4,645,000 b. $1,660,000 c. $2,985,000 d. $2,100,000
B- The following items would be included as AI.
Customer credit balances $ 185,000
Fails to receive customers $ 700,000
Fails to receive firm – sold $ 150,000
Loans outstanding – customers $ 375,000
Securities loaned – customers $ 250,000
$ 1,660,000
The summary table on page 5-3 of the text provides a list in of AI items as well as exclusions from the definitions of AI. The fail to receive of the firm unsold is also included in AI.
Under the provisions of SEC Rule 15c3-3, the Customer Protection Rule, monies due the customer must be segregated in a Reserve Bank Account. The amount of money that is on deposit in this account when calculating net capital will be:
a. Added to the aggregate indebtedness
b. Deducted from the aggregate indebtedness
c. A nonallowable asset
d. Subject to a haircut
B- The balance of the cash already on deposit in the Reserve Bank Account will be a deduction from the aggregate indebtedness of the firm.
A broker-dealer calculating net capital under the alternative method has aggregate debit items of $12,600,000. According to Rule 17a-11, a report must be filed if the firm's net capital falls below: a. $250,000 b. $300,000 c. $302,400 d. $630,000 Explanation:
D- Under the alternative computation, if the net capital falls below 5% of the aggregate debits, an early warning notice must be sent to the appropriate regulatory authorities. In this case, 5% of $12,600,000 is $630,000.
