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Series 27 > Net Capital Rule > Flashcards

Net Capital Rule Flashcards

1
Q

Net Capital Rule number

A

Rule 15c3-1

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2
Q

Net capital essential provisions

A

Dollar capital requirements
Net capital definition
Aggregate Indebtedness Definition
Ratios of AI/NC
Subordinated loan rules

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3
Q

What is Net Capital?

A

Liquid net worth - The firm should always have sufficient liquid assets to meet any foreseeable liability.

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4
Q

Clearing (General Securities) Broker-Dealer Net Capital Requirement

A

250,000

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5
Q

What is a clearing broker dealer? (also called general securities)

A

One that carries customer accounts and who accepts funds and securities from customers

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6
Q

A firm is deemed clearing if it

A

if it receives funds, checks, drafts or any other items of indebtedness

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7
Q

Definition of customer under SEC rules

A

Any person who has an active account at a broker-dealer. Includes omnibus accounts

Officers and partners of broker-dealers are excluded

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8
Q

Fully disclosed broker-dealer net capital requirements

A

50,000

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9
Q

Fully disclosed broker-dealer definition

A

One that enters into a clearing agreement with a clearing firm and has fully disclosed all of its customer accounts to this firm.

Does not carry customer accounts and does not hold customer funds or securities.

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10
Q

Who sends confirmations to the customer

A

Clearing firms

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11
Q

How long can a fully disclosed broker-dealer hold customer cash

A

It must be forwarded promptly (same day) to the clearing firm

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12
Q

Can a fully disclosed broker-dealer participate in firm commitment underwritings as a syndicate member?

A

No, this requires 250,000 of net capital since the broker-dealer takes full financial responsibility in such a commitment

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13
Q

Can a fully disclosed broker-dealer participate in firm commitment underwritings as a selling group member?

A

Yes, because there is no liability to the broker-dealer to do so.

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14
Q

Do best efforts underwritings create a liability?

A

No they do not. Customer funds in such underwritings are held in a escrow account, therefore there is no risk.

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15
Q

Fully disclosed broker-dealer which does not receive securities can join in what underwritings

A

Applies to firms that NEVER receive customer funds and securities. They cannot join in firm commitment underwritings as either a syndicate or selling group member.

They can join best efforts syndicates

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16
Q

Fully disclosed broker-dealer net capital requirement

A

50,000

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17
Q

Broker-dealer categories

A

Firm commitment syndicate member
Firm commitment selling group member
Best efforts syndicate member
Best efforts selling group member

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18
Q

Other firms that would fall under the 5K requirement

A

Limited Partnership broker-dealer - one that solely sells limited partnerships. All monies go directly to the sponsor.

Mergers and Acquisitions broker-Dealer - One that only works on mergers and acquisitions. No customers are involved

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19
Q

Can fully disclosed broker dealers accept mutual fund orders

A

Yes, fully disclosed broker-dealers can accept orders to purchase or redeem investment company shares (mutual funds and variable annuities) as long as checks are made out to and all funds or securities are promptly forwarded to the investment company

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20
Q

occasional transactions are defined as

A

10 or fewer transactions from the BD account per year

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21
Q

Can 50k fully disclosed broker-dealers effect occasional trades for own account

A

Yes, they are permitted to effect occasional transactions in securities for their own investment accounts through another broker-dealer.

They are also allowed to effect (not clear) securities trades as a broker on a national securities exchange for the account of another broker.

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22
Q

Can 5k fully disclosed broker-dealers effect occasional trades for own account

A

No, they cannot.

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23
Q

Under what conditions is a 50k fully disclosed broker-dealer firm required to have net capital of 100k?

A

Effects more than 10 transactions per year for the firms investment account (excluding transactions in money market instruments); OR

Writes or endorses over the counter option contracts (note that the sale of exchange-listed options, such as those traded on the CBOE, does not fall under this definition)

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24
Q

If a fully disclosed firm receives and promptly transmits customer securities what is their net capital requirement

A

50,000

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25
Q

If a fully disclosed firm receives and promptly transmits checks from customers made payable to the appropriate third party what is their net capital requirement

A

5,000

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26
Q

When a clearing agreement is signed what is the reporting requirements to be submitted by the clearing firm under FINRA rules

A

Clearing broker-dealer must provide a written list of all the reports it can generate based upon the activities of the introducing firm.

Additionally, the clearing firm must provide an updated list of available reports annually (by July 1st) to the COO and CCO of the introducing firm.

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27
Q

Give up clearing arrangement definition

A

When the clearing agreement allows the introducing firm to execute away from the clearing broker.

This means that the introducing firm gives up the name of the clearing broker to the firms that it enters order with.

This alerts the firms that payment for purchases and delivery of securities sold will be handled by the clearing broker (Prime brokerage account).

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28
Q

Clearing prime broker minimum capital requirements

A

1,500,000 AND it must notify FINRA that it will be acting as a prime broker.

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29
Q

Executing prime broker minimum capital requirements

A

1,000,000

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30
Q

Clearing broker-dealer obligations in a standard clearing agreement (4)

A

execute all trades
settle all trades
maintain custody
provide financing

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31
Q

Market Maker minimum net capital requirement

A

100,000. the actual dollar varies with the number of issues in which the firm makes a market:

$1,000 for each security bid @ $5 or less
$2,500 for each security bid over $5

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32
Q

Market Maker maximum capital

A

1,000,000

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33
Q

What is the consequence of early warnings

A

Accelerated reporting of FINRA of financial results

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34
Q

When do early warnings trigger

A

When net capital falls below 120% of the minimum requirement

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35
Q

What is a qualified block positioner

A

a broker-dealer who engages in the activity of purchasing or selling a short block of stock fora customer with a market value of $200,000 or more in a single transaction

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36
Q

Qualified block positioner minimum net capital requirement

A

1,000,000

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37
Q

Specialist - Designated Market Maker Net Capital Requirements (4)

A
  1. Only deals with other BD’s
  2. Does not carry customer accounts
  3. Does not effect transactions in OTC options (over the counter)
  4. Only effects its trades through a market maker account cleared and carried by another BD
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38
Q

Specialist - “Designated Market Maker” Net Capital Rule (once requirements are met)

A

If requirements are met then:
Only required to maintain 100k net capital.
Must maintain liquidating equity in respect to security positions at least = to:
25% of the market value of long positions
30% of the market value of short positions

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39
Q

What is a Specialist “Designated Market Maker?

A

Smaller market makers that are often 1-2 people firms.

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40
Q

What are Mutual Fund/Variable Annuity Dealers

A

Firms dealing solely in Investment Company shares that do not hold customer funds. They place all orders through the sponsor and make cheques out to the sponsor

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41
Q

Net capital for Mutual Fund BD’s if take wire orders

A

If a mutual fund BD accepts wires from customers their net capital requirement is 25k.

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42
Q

Net capital for Mutual Fund BD’s if take subscriptions

A

If a mutual fund BD accepts subscription orders from customers their net capital requirement is 5k

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43
Q

If Mutual fund BD’s take wire payments how fast does the payments need to be transferred

A

7 calendar days

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44
Q

What is a Reverse Repo

A

A secured overnight loan
It uses excess cash to buy government securities from another dealer then sells the securities back to the dealer the next day.
Difference between the purchase and sale price is interest earned.

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45
Q

How were BD’s misusing reverse repos and what was the event the SEC caught

A

“Matched Reverse Repos’
Were receiving securities valued substantially in excess of the amount advanced. Then sold the excess securities under another repo for additional cash.

Misappropriating customer collateral

ESM Government securities - 1985

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46
Q

What was the result of BD’s misuse of reverse repos

A

BD’s must now increase net capital by 10% of excess market value of securities pledged as collateral. So 10% any excess value of:
1. Treasury Securities over 105% of contract price
2. Agency or mortgage-backed securities over 110% of contract price
3. Any other securities over 120% of the contract price

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47
Q

Difference between net capital and net worth

A

Net worth = Total assets - Total Liabilities

Net Capital = Liquid assets - Total liabilities

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48
Q

Another word for net worth

A

Equity capital

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49
Q

What is a subordinated loan

A

Formal agreements where the lender subordinates their claim to all other creditors and agrees that the funds are at risk with the BD

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50
Q

Almost net capital formula

A

Net worth
+ subordinate loans
= Total available capital
- Non-allowable assets
= Tentative net capital

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51
Q

What is a haircut

A

A percentage taken off allowable assets to reflect any potential losses on liquidation.

Above the line haircuts - securities and inventory, deficiencies in collateral, 2nd reg. T. Extension

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52
Q

Final net capital formula
Standard method

A

Adjusted net worth
+ subordinate loans
= Total available capital
- Non-allowable assets
= Tentative net capital
- haircuts on allowable assets
= Net capital

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53
Q

Allowable assets (13)

A

01 Cash
02 Cash in reserve account (restricted funds)
03 Customer debit balances (secured by securities purchased)
05 & 06 Fails to deliver
07 Secured Note Receivable (With collateral)
08 Inventory (with Haircut)
09 Stock borrowed
11 Municipal Syndicate Receivable or good faith deposits - Allowable for 60 or fewer days old
12 Corporate good faith deposits - allowable for 11 business days old
13 commission receivable - under 30 days old
13 Commissions receivable from clearing B/D > 30 days allowed if include a PAIB credit (Proprietary Assets of an introducing BD)
PAB (Proprietary Accounts of BD’s) - clearing deposits of introducing BD’s
14 Prepaids (rent and insurance) (where recovery is certain)

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54
Q

Non-allowable assets (13)

A

Where recovery is uncertain
10 Firm Investment Account - Unregistered Warrants
12 Corporate syndicate profits receivable
Unsecured Note Receivable
14 Prepaid expenses (where recovery uncertain)
Exchange membership
19 Real Estate - Only equity portion is allowable if used for BD business
18 Furniture and fixtures
Automobiles
Goodwill, intangible assets
Collateral deficiencies
Petty cash
Uncovered or unacknowledged insurance claims
Free security shipments > 7 business days - in excess of 5k
DPP Investments (Direct Participation Program) - Limited partnership tax shelter. They are illiquid

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55
Q

What are customer debt balances

A

When a customer borrows funds then firm holds the securities as collateral until the customer pays

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56
Q

What is fails to deliver

A

When a customer fails to deliver securities on settlement date. When the security arrives the firm will deliver and eliminate the fail.

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57
Q

General Haircut percentage

A

15%

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58
Q

Calculate adjusted net worth

A

Prior years RE + common equity + net income (loss) = Adjusted net worth

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59
Q

What is a Reg. T. Extension and what is the haircut applied

A

Regulation T extension
When a customer buys margin securities and the firm issues a margin call the customer has 2 days to pay. If they do not, the firm can apply for an extension in the amount of 2 days.
If the customer still doesn’t pay then a haircut on the collateral deficiency is taken and the position is marked to market.

60
Q

What does marked to market mean

A

This means that we have to value the security at its market rate. If collections is unlikely then a haircut is needed to reflect closer to fair value.

61
Q

Calculation rule of net capital if collateral is in BD possession/control on a reverse repo

A

Amount is allowable without haircut BUT the BD is required to deduct a reverse repurchase deficit from net capital.
The amount by which the contract resale price exceeds the collateral value

62
Q

Aged fail to deliver haircut and NC rules

A

Take 15% haircut on 5th business day
After the 10th business day from the original settlement the firm must buy in the position, charging any losses to the customer.
Any gains on mark to market cannot be used to increase net capital

63
Q

Why fail to deliver isn’t common in practice (but still examable)

A

FINRA states that any BD that clears trades through continuous net settlement (CNS) are not required to age fails to deliver.
Most BD’s clear through National Securities clearing corp that uses a CNS system that locks in trades for clearance.

64
Q

Municipal securities fail to deliver aging rule

A

21 business days (not 5)

65
Q

How much of a secured note receivable is allowed in net capital

A

allowable to the extent of the haircutted value of the collateral underlying the note.

66
Q

What are introducing BD’s

A

Introducing broker-deals are considered to be customers of clearing firms. They are required to maintain a clearing deposit (usually around 50k-100k).

67
Q

Short securities differences - what is the deduction from net capital (4)

A

If a BD finds that it is missing securities and cannot resolve the difference it must deduct from its capital:
> 7 days from discovery = -25% of MV
>14 days from discovery = -50% of MV
>21 days from discovery = -75% of MV
>28 days from discovery = -100% of MV

68
Q

What is the haircut for equity securities (greater risk)

A

15% to the greater side - 15% of the value of longs if greater than shorts +

If short exceeds 25% of longs an additional 15% haircut on the excess portion of the short is needed. (anything over 25% of longs)

69
Q

Haircuts: If the equity security is held and not actively traded the haircut percentages are based on the liquidity of the securities (3):

A

If there are:

  1. three or more market makers in a security aside from the firm, this is considered active and the haircut is 15%
  2. one to two market makers aside from the firm, this is considered limited and the haircut is 40%
  3. No market makers aside from your firm, this is considered non-marketable and the haircut is 100%
70
Q

What is an undue concentration haircut

A

Can’t have too many eggs in one basket

Concentration risk exposure

A firm can only have 15% of it’s tentative net capital invested in one security. Any amounts over that must have an extra 15% haircut

71
Q

How do concentration haircuts apply to governments

A

They do not apply to exempt securities such as US government and agencies or mutual funds.

Concentration haircuts only apply to risky positions (Securities of non-exempt issuers such as corps)

72
Q

How do concentration haircuts apply to municipals

A

They do apply to concentrated positions in municipal securities, options, money market instruments, preferred stock and corp debt.

Basic haircut on equity securities is the same = 15%
Concentration haircut for securities mention above is 50% of the basic haircut

73
Q

When is a haircut applied on concentration equity securities inventory added through underwriting

A

If a firm adds equity securities through an underwriting, the concentration haircut only applies if it is in inventory for over 11 business days.

Otherwise, the concentration haircut is taken immediately.

74
Q

Threshold amount for equity securities concentration haircut

A

The undue concentration haircut is only required to be taken on equity position on the greater of amounts above 10k or the value of 500 shares.

Therefore this results in a reduction of undue concentration haircut. (10% of tentative net capital less the greater of 10k or value of 500 shares

75
Q

US government and agencies haircut considerations (3)

A
  1. The haircut is taken on the net long or short position. Not on the greater side as is the case for equity securities.
  2. The size of the haircut depends on the security. The longer the life of the instrument, the bigger the haircut.
  3. Haircut on a 12-month treasury obligation is 1%. The max is 6% for bonds over 25 years
76
Q

What is MBS’s

A

Mortgage backed securities

77
Q

Municipal securities considerations (3)

A
  1. The haircut is taken on the greater of the long or short position.
  2. The size of the haircut depends on the maturity. The longer the life of the instrument, the greater the haircut.
  3. Haircut on a 12 month municipal bond is 1%. The max is 7% for bonds over 20 years.
78
Q

What is the haircut for non-investment grade municipal bonds with a ready market?

A

They fall into “all other securities” and get a 15% haircut

79
Q

What is the haircut for non-marketable or defaulted bonds

A

They are subject to a 100% haircut

80
Q

What are safe money market instruments? (3)

A
  1. commercial paper
  2. Bankers acceptances
  3. Negotiable certificates of deposit
81
Q

What is the haircut for safe money market instruments (that are not mutual funds)?

A

If the security is rated A or better, or issued by a bank, and is over 271days but less than a year to maturity the greatest haircut is .5%

Otherwise it is treated as “All other securities” and is subject to 15%.

The haircut applies to the greater of the long or short position.

82
Q

What is the haircut for money market mutual funds?

A

2%

83
Q

What is the haircut on investment grade non-convertible debt (4)

A
  1. The securities cannot be in default, must be rated BBB or better.
  2. The greater of the long or short position
  3. Size of the haircut depends on the maturity. The longer the life of the instrument, the greater the haircut
  4. On a 1 year corp bond the haircut is 3%. Max is 9% for corp bonds over 25 years to maturity
84
Q

What is the haircut on non-traded or default bonds

A

100% haircut

85
Q

Eligible investment grade convertible debt trading below par gets how much haircut?

A

It gets a “debt” haircut which is 3%-9% (1-25 years)

86
Q

What rating requirements for investment grade debt make them eligible for lower haircuts?

A

Security must be rated BBB or better
Security is not in default

87
Q

What is the haircut for an non-eligible investment grade convertible debt trading above par? (2)

A
  1. If the security is rated BB or lower, or is trading at or above par it is considered “All other securities” and has a 15% haircut
  2. If the security is not rated, not traded, or is in default the haircut is 100%
88
Q

What are the haircuts for redeemable mutual funds? (4 types)

A
  1. Money Market funds: 2% of the market value of the greater of the long or short position
  2. Government or Municipal bond funds: 7% of the market value of the greater of the long or short position
  3. Investment grade corp bond funds: 9% of the market value of the greater of the long or short position
  4. All other mutual funds get a regular 15% “equity” haircut
89
Q

What is an ETF

A

Exchange traded funds

A bundle of assets bought and sold on an exchange

90
Q

What is the haircut for ETFs?

A

If broad based ETFs such as SPDR 500 index or the QQQ 100 index then 10%.

All others at the 15% “equity” security haircut

SPDR = Standard & Poor
QQQ = NASDAQ

91
Q

What is the hair cut for preferred stock?

A
  1. cumulative preferred stock rated BBB or better = 10% on the greater of the long or short position as long as it is not in arrears as to dividends
  2. All others treated as equity securities and get 15%
92
Q

Open Contractual Commitment haircuts

A

IPO: 30% of market value, (not contract value), of the net commitment common stock offerings.

Secondary Distribution: reduced to 15%

Both need to be trading on an exchange or NASDAQ

93
Q

What are open contractual commitments (3)

A

Underwriting commitments signed by the BD,
contracts for ‘when issued’ securities,
and foreign currency commitments

94
Q

Haircut exception for firms with > 250k of net capital

A

They can add back 150k of haircut

95
Q

Summary of haircuts
Money Market Instrument - Invest. Grade
Money Market Mutual fund
US Govt/Agency Security
Municipal Bond - Invest grade
Corporate Bond - Invest grade
Preferred Stock/ Broad based ETF Invest. grade
All other securities
What is the haircut taken from?
What is the rule of bd has > 250k NC?
Convertible Bonds - invest grade (below par or above par)
Stocks with limited trading market
Open contractual commitments (underwritings)
Undue Concentration

A

Money Market Instrument - Invest. Grade =.5%
Money Market Mutual fund = 2%
US Govt/Agency Security = 0%-6%
Municipal Bond - Invest grade = 1%-7%
Corporate Bond - Invest grade = 2% - 9%
Preferred Stock/ Broad based ETF Invest. grade = 10%
All other securities = 15%

Plus these dets:
Haircut the greater of long or short position
Then take 25% of the greater side and if small side exceeds that amount, take an extra 15% haircut on the excess amount

Convertible Bonds - invest grade
If trading below par, gets a debt H/C - max 9%
If trading at or above par, gets equity H/C -15%

Stocks with limited trading market
If there are only 1-2 market makers - 40%
If there are no market makers or if shares are restricted/non-marketable = 100%
Open contractual commitments (underwritings) IPO - 30%, Add-on offerings - 15%
but if firm has 250k net capital, 1st 150k H/C is excluded

Undue Concentration
If any single, non-exempt security position > 10% of tentative net capital, take extra 15% h/c on concentration amount (in addition to regular haircut)

96
Q

Haircut on listed options (on an exchange)
Long Stock
Long listed Option
Long Unlisted Option
Short Stock
Short naked option
Long stock/put or short stock long call
Long stock/put (covered call writer) or short stock long call (covered put writer)
Long call/ Short call or Long put/Short put

A
  1. Long Stock: 15% of market value of stock
  2. Long listed options (calls and puts): 50% of the market value (premium) of the option
  3. Long unlisted options: 15% of market value, but never more than premium (max loss)
  4. Short stock: 15% of market value
  5. Short uncovered (naked) options (calls and puts): 15% of the market value of the security, reduced by any ‘out of the money’ amounts, but not less than $250 per contract
  6. Long stock/put or short stock long call: 15% of market value plus 50% of option premium but never more than max position loss
  7. Long stock/put (covered call writer) or short stock long call (covered put writer): 15% market value of stock minus in the money amount
  8. Long call/ Short call or Long put/Short put: Debt spread = 0
    Credit spread = difference in strike prices
97
Q

Alternative net capital requirement

A

If a firm keeps a min capital of $250k of 2% of debit items then there are no aggregate indebtedness limits.

98
Q

Commodities / Futures net capital rules (3)

A
  1. If a partner/owner has a commodities account at the firm, any equity in the account cannot be used to increase net worth. (100% excluded)
  2. Mgmt fees receivable from commodities pools are allowable for 30 days
  3. Receivables from clearing corps are allowable without limit
99
Q

What are the requirements for commodities inventory to be 100% allowable? (2)

A
  1. must be registered as deliverable with the contract market (met markets standards)
  2. Must be covered by an open futures contract or options contract
100
Q

What are the haircuts on commodities inventory that are not 100% allowable? (3)

A
  1. If not registered as deliverable but is covered by open futures contract then 5% H/C
  2. If is registered as deliverable but is not covered by an open futures contract then 20% H/C
  3. If not registered as deliverable and not covered by an open contract then 100% H/C
101
Q

What is the haircut on non-offset currency positions

A

If has an offsetting balance, security position futures contract, or contractual commitment then not subject to H/C

If not offset then:
6% H/C for Euro, Pound, Swiss Franc, CAD, Yen
20% H/C for Any other currency

102
Q

Gold and Silver are excluded from H/C if 3 conditions are met

A
  1. Must be in BD control (serial number, immediate disposition)
  2. Must be in good deliverable form (refined, assayed)
  3. Must be insured, regardless of in custody, in transit, stored.
103
Q

What is aggregate indebtedness

A

The firm’s debt level. Sum of all BD’s liabilities, as presented on the balance sheet, that are either unsecured or secured by assets not belonging to the BD, and all customer related liabilities.

It does not include liabilities that are secured by the BD or liabilities that are subject to a haircut deduction.

104
Q

Maximum ratios of AI/NC are

A

First year of operations: 8:1
After first year of operations: 15:1

105
Q

What items are part of AI?

A

Accounts payable
Taxes payable
Wages payable
Payables to affiliates (parent companies)
Customer credit balances
Fails to receive - customer account
Fail to receive - firm account - sold
Stock loaned - customer
Stock loaned and offset by stock borrowed - 15% inclusion
Bank loans - customer collateral
Unapproved subordinate loan from a customer
Short securities differences over 30 days old
Auto loan payable

106
Q

What items are not included in AI

A

Deferred taxes payable
Fails to receive - firm account - unsold
Stock loaned and offset by stock borrowed - 85% inclusion
Subordinated loans - unsecured (customer approved)
Unapproved subordinate loan from non-customer (related party)
Mortgage payable - business use

107
Q

What affect does funds in a special reserve bank account have on AI

A

Since the amount is restricted to pay customer claims only, the amount may be used to offset the aggregate indebtedness balance when computing AI/NC ratio

108
Q

What is a subordinated loan

A

A loan, usually done by an affiliate, where the lender subordinates their claims to all other creditors. The funds are at risk in the operations of the BD

109
Q

What is a secure demand note

(subordinated loan)

A

The lender gives marginable securities to the BD that are then rehypothecated to a bank for a loan (used as collateral)

110
Q

What does it mean when a BD sells marginable securities in street name

A

It means that they were lent the securities (therefore do not own them) but they are selling them in the BD name

111
Q

How does the bank treat a secured demand note and then what is the SEC haircut to the asset loan value

A

As a general rule, the bank will loan 70% of the value of equity securities to a BD.

The haircut applied to the secured demand note collateral is 30%

112
Q

What happens when the loaned securities collateral increases in value

A

The lender can remove the excess collateral from the bank.

113
Q

What happens when the loaned securities collateral decreases in value?

A

The bank will demand the collateral that is deficient.
The extra collateral must be produced by 12pm the next day after the demand or the bank can start selling the securities to pay down the loan

114
Q

What must BD do if the collateral value falls below the unpaid principal amount of the note?

A

The BD must immediately submit notice to the lender and FINRA

115
Q

What is the max allowable reduction in principal amount on a loan agreement with a collateral deficiency ?

A

15%

116
Q

What are the requirements to be able to reduce the principal amount on a loan agreement with a collateral deficiency?

A
  • This firms AI/NC ratio does not exceed 10:1
  • The form has at least 120% of the minimum net capital requirement
  • prior approval of the firms DEA (FINRA) is obtained
117
Q

Rights of a lender regarding collateral in a subordinate loan

A

-Right to substitute collateral with cash or marketable securities at any time
Retains the right to any dividends on the securities even though the securities have switched ownership
-any share voting rights typically stay with the BD

118
Q

How does FINRA limit the amount of subordinated loans that a firm has

A

The max debt/equity ratio is 70%

The ratio looks at subordinated loans against total available capital.

70% cannot be exceeded for over 90 days (grace period)

119
Q

Loans made by owner with >= 3 yr life and >= 1 yr remaining rule

A

As long as the firm’s debt/equity ratio is below 70%

It is treated as equity for the debt/equity ratio.

120
Q

What if the owner/partner borrows money to give a subordinate loan to a BD?

A
  1. The firm must submit a copy of the loan agreement to FINRA for approval
  2. The loan must have a min of 12 month duration
  3. The lender cannot have recourse to the assets of the BD if the borrower defaults
121
Q

If a BD wants to have funds from a subordinate loan from a parent that is a bank, to be an allowable asset what is the requirement?

A

That the funds are deposited into a third party bank

122
Q

A firm cannot repay subordinated loan at maturity if:

A

If repayment of the subordinated loan causes the firm to enter into early warning (meaning the net capital is falling too low) then it is disallowed

Early warning is triggered when net capital falls below 120% of min requirement OR when AI/NC ratio exceeds 12:1

When a BD pays down its liabilities it’s net capital naturally goes down. The firms AI/NC ratio then increases

Alternative net capital formula: net capital cannot fall below 5% of debits in the reserve formula

123
Q

A firm cannot prepay a subordinated loan if:

A

The AI/NC ratio goes to 10:1 OR
Net capital falls below 120% of the minimum requirement

Prepayment requires FINRA prior approval

Alternative net capital formula: net capital cannot fall below 5% of debits in the reserve formula

124
Q

Equity can only be withdrawn on a subordinate loan if:

A

AI/NC ratio equals or is below 10:1
Net capital is below 120% of min requirement

Alternative net capital formula: net capital cannot fall below 5% of debits in the reserve formula

125
Q

SEC’s right to bar capital withdrawals

A

for 20 business days if it believes that it is detrimental to the firms customers or business operations

126
Q

Rules for a temporary subordinate loan

A

Max of 3 per year
max life of 45 days
AI/NC ratio < 10:1
Net capital > 120% of the min requirement

127
Q

What is the difference between:
Clearing firm
50k min cap fully disclosed BD (introducing firm)
5k min cap fully disclosed BD

A

250k Clearing firm:
- Can receive and hold customer funds
- Can join a firm commitment as either syndicate or selling group
- Can join a best efforts as either a syndicate or selling group

50k fully disclosed BD:
-Cannot join in a firm commitment as a syndicate
-Can join in a firm commitment as a selling group (no liability)
-Can join in a best efforts as either syndicate or selling group (no liability)
-Can receive but does not hold customer funds

5k fully disclosed BD:
-Does not receive customer funds or securities
-Cannot join in firm commitment underwritings as either a syndicate or selling group
-They can join as best efforts as either syndicate or selling group (no liability - escrow)

128
Q

What is a revolving Subordinated loan

A

Where a firm member can enter into an agreement that allows for prepayment in less than the 1 year min life.
These prepayments are made at the optin of the BD but require prior approval from FINRA

129
Q

Revolving loan prepayment exception

A

A prepayment is not allowed if it causes NC to go < 200% of min required net cap or if the firms AI/NC ratio exceeds 9:1

Also cannot be counted as equity for purposes of debt/equity test

130
Q

When does FINRA and SEC need to be notified if capital falls to low for firms with revolving prepayment subordinated loans

A

FINRA and SEC must be notified immediately when a firm realizes the AI/Nc ratio will exceed 12:1 or NC will fall below 120%, while taking in consideration all payment obligations over 6 months

Alternative net capital formula: net capital cannot fall below 5% of debits in the reserve formula

131
Q

When does a standard subordinated loan agreement need to be filed with FINRA and SEC for it to count as capital?

A

at least 10 business days in advance of effective date.

FINRA provides standard agreement templates

132
Q

When does a non-standard subordinated loan agreement need to be filed with FINRA and SEC for it to count as capital?

A

FINRA at least 30 days in advance of effective date

SEC still 10 days in advance

If using own agreement or modifies the standard agreement

133
Q

How many copies of the subordinated loan agreement must be filed with FINRA and at which offices

A

2 copies to FINRA depart of surveillance in Washington DC

1 copy to FINRA district office where BD maintains principal place of business

134
Q

How many copies of the subordinated loan agreement must be filed with SEC and at which offices

A

2 copies to SEC commissions regional office where BD maintains principal place of business

135
Q

How is a unapproved subordinated loan from a customer treated in relation to AI/NC

A

It does not count as capital

It has to be added to aggregate indebtedness until approved

136
Q

How is a unapproved subordinated loan from a non-customer treated in relation to AI/NC

A

It is not considered aggregated indebtedness

137
Q

What are the SEC rules around restricting a withdrawal of equity capital

A

If a firm’s equity capital is getting too low the SEC can issue an order prohibiting withdrawal for 20 business days. This gives them time to examine the firm to determine if they should allow the withdrawal. Cannot be below 10:1 or 120% of NC requirement

138
Q

What are the temporary capital contribution rules (2)

A

Must be treated as a liability:

  1. capital that is contributed under an agreement giving the investor (customer) the option to withdraw on demand
  2. Any capital contribution that is intended to be withdrawn within 1 year
139
Q

What needs to happen if a BD wants to withdraw capital within 1 year of its contribution to the firm

A

The BD must obtain permission from FINRA before doing so

The firm will need to reclassify historical financial statements previously submitted to FINRA and SEC (part of net capital to AI (liability)

This could cause the firm to be in violation of the net cap rule

140
Q

Expense sharing requirements (5)
In order for expense liabilities to not be included in the NC or AI computations there must be:

A
  1. A written agreement that the BD is not responsible for the expense
  2. Agreement in writing that the BD is not directly or indirectly liable for the expense
  3. It cannot be a liability of the BD under GAAP
  4. The BD can demonstrate that the third party has adequate resources independent of the BD to pay for the liability.
141
Q

What is a BD required to do if it fails to record expenses that are included in an expense sharing agreement with a third party

A

It is required to file notice with FINRA that includes the date of the agreement and the name of the parties in the agreement

142
Q

FINRA restricts business expansion if (3):

A

If any condition exists for more than 15 business days

  1. The firm’s net capital is less than 150% of the minimum
  2. The firm’s AI/NC ratio exceeds 10:1
  3. Firms under the alternative NC requirement NC falls below 5% of debits in the reserve formula
143
Q

FINRA requires business reduction if (3):

A

If any condition exists for more than 15 business days

  1. Firm’s net capital is less than 125% of the minimum
  2. Firm’s AI/NC ratio exceeds 12:1
  3. Firms under the alternative NC requirement, NC falls below 4% of debits in the reserve formula
144
Q

Other reasons FINRA can restrict a firm from expanding or require it to reduce its level of business (3)

A

For any financial or operational reason. Examples are:

the firm experiences falling capital levels
The firms books and records are not current
The firm is unable to clear transactions promptly

145
Q

What must a BD do if they are deemed insolvent

A

Must cease conducting a securities business
Immediately notify FINRA and SEC

146
Q
A

Series 27 (7 decks)

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