Series 24 - Financial Responsibility and Net Capital

What are the two requirements for a subordinated loan?

It must:

- Be in writing for a specified amount of cash or securities

- Have at least a one year duration; no prepayment for first year

What are the three requirements for a temporary subordinated loan?

- Allowed for a maximum duration of 45 days

- No more than three such loans in a 12-month period

- Firm's ratio of AI/NC does not exceed 10:1 or its net capital is not below 120% of the minimum

When must temporary and regular subordinated loan agreements be filed?

For SEC, 10 days prior to the effective date. For FINRA, temporary loan agreements 10 days prior to the effective date; and regular subordinated loan agreements 30 days prior to the effective date.

What is total capital, tentative net capital, and net capital?

Equity + Debt = Total Capital.

Total Capital - Non-Allowable Assets = Tentative Net Capital.

Tentative Net Capital - Haircuts on security positions = Net Capital.

What is the minimum net capital requirement for a prime broker?

$1,500,000

What is the minimum net capital requirement for a qualified block positioner?

$1,000,000

What is the minimum net capital requirement for a carrying broker?

$250,000

What is the minimum net capital requirement for underwriters and market makers?

$100,000

What is the minimum net capital requirement for non-carrying brokers?

$50,000. They receive, but do not hold, customer funds.

What is the minimum net capital requirement for other broker-dealers?

$5,000. They neither receive nor hold customer funds.

What are net capital requirements for a market maker?

$100,000 minimum and $1,000,000 maximum.

$1,000 per stock at $5 or less.

$2,500 per stock above $5.

Does aggregate indebtedness (AI) include subordinated loans?

No. AI does not include subordinated or collateralized loans (that are not collaterlized by customer funds).

What is the haircut on common stock with a ready market?

15%

What is the haircut on limited market stock (e.g. OTCBB) (i.e. fewer than 3 market makers)?

40%

What is the haircut on assets not readily convertible into cash, or on restricted stock (private placements)?

100%

What is the haircut on undue concentrations?

An extra 15% on any one non-exempt security position that exceeds 10% of Tentative Net Capital, calculated on the "concentrated" amount above the 10% limit.

A broker-dealer has computed Tentative Net Capital of $100,000. The firm holds a $30,000 position in ABC common stock in its inventory. What is the TOTAL haircut to be taken on the ABC position?

$7,500. The the regular 15% haircut ($4,500), plus an additional 15% ($3,000) on the amount that exceeds the 10% concentration limit ($20,000).

How often and when must carrying BDs file FOCUS Part I and Part II reports?

Part I monthly within 10 business days of month end, Part II quarterly within 17 business days of the end of the month and quarter, Part II audited annual within 60 days (90 days if extension granted by SEC).

How often and when must introducing (non-carrying) BDs file FOCUS Part I and Part IIA reports?

Part I not required, Part II quarterly within 17 business days of the end of the quarter, Part II audited annual within 60 days (90 days if extension granted by SEC).

What problems constitute a net capital violation?

-N.C. is below minimum dollar amount

-A.I. to N.C. ratio is greater than 15:1, New firm 8:1

-Outstanding subordinated debt exceeds 70% of debt-equity total for a period exceeding 90 days

What problems require an early warning report?

-N.C. is below 120% of minimum dollar amount

-A.I. to N.C. ratio is greater than 12:1

At what net capital amount or ratio will FINRA require a broker-dealer to reduce its level of business?

FINRA will force a firm to reduce its level of business if its ratio of AI/NC exceeds 12:1 or its Net Capital falls below 125% of the minimum requirement for 15 consecutive days.

When must net capital violation reports be submitted?

On the day the deficiency occurs

When must early warning reports be submitted?

Within 24 hours

What type of problem is involved with non-current books and records, and when must the problem be reported?

Problem: Fails to maintain books and records as required by SEC rules.

Report: On the day of discovery and follow with corrective action plan within 48 hours.

What type of problem is involved with material inadequacies and when must the problem be reported?

Problem: B/D discovers, or is notified by independent certified accountant, of inadequacies in its systems.

Report: Within 24 hours and follow with corrective action plan within 48 hours.

To whom are supplemental reports under 17a-11 sent?

All reports are sent to SEC's Washington office, SEC's regional office, and the firm's DEA

What are excess margin securities?

Security's value exceeding 140% of customer's debit balance

How often is the Special Reserve Bank Account calculation conducted?

Calculation is generally conducted weekly (Friday) with necessary deposit made on the second business day (Tuesday) following the calculation

How can the Special Reserve Bank Account calculation be conducted monthly?

B/D's AI-to-NC ratio does not exceed 8:1 and the firm holds less than $1,000,000 in customer free credit balances. The firm must deposit 105% of the computed amount 1 hour after banks open on the 2nd business day following the computation.

What is the customer free credit balance?

Represents customer proceeds resulting from sales, dividends, or interest payments that have not been withdrawn or invested

How often must a customer be notified about the free credit balance?

Whenever account statements are sent to a customer (at least quarterly), B/Ds must send the customer a notice regarding his free credit balance. Must disclose total amount due which is payable on demand, and that funds are not segregated and may be used in the conduct of the B/D's business

How often must the securities count be conducted?

Conducted on a quarterly basis. Not less than 2 months, or more than 4 months, from the previous count. Completed or supervised by someone not responsible for the care and handling of securities.

What is a short securities difference?

The firm has more securities recorded on its books than it actually has.

What happens when there is a short securities difference?

A short securities difference that is unresolved for seven business days is subject to a 15% net capital adjustment. Must be bought in 45 days after discovery.

What are the exceptions to the rule that B/Ds must make inquiry of SIC regarding every security that comes into its possession?

- Received from the issuer or its agent

- Received from another B/D or a Federal Reserve Bank

- Received from an existing customer and is registered in the customer's name (inquiry required for street name)

- Received from an existing customer and can be verified through B/D's records

- Part of a transaction for $10,000 or less

To whom and when must stolen or counterfeit securities be reported?

To FBI, SIC and transfer agent, One business day of

discovery

To whom and when must lost or missing securities be reported?

To SIC and transfer agent, One business day after a

two-day search

To whom and when must lost or missing securities from a box count be reported?

To SIC and transfer agent, No later than 10 business

days after the count

To whom and when must recovered securities be reported?

To SIC and transfer agent (possibly FBI), One business day of recovery

What records must be kept for the lifetime of the BD?

Corporate or partnership documents

What records must be retained for 6 years?

Blotters (records of original entry), ledgers, municipal complaints, new account form, POA

What records must be retained for 3 years?

Tickets, confirms, statements, Forms U4, U5 and employee records, all communications, trial balances, etc ...

How long must complaints be retained?

Four years

How long must records be kept readily accessible?

For the first two years

Prior to utilizing any form of electronic storage media, how much advance notice must be given to the BD's DEA?

90 days if the electronic storage media is other than CD-ROM

When must trades be blottered?

All trades must be recorded no later than the day after trade date

If an accountant is fired, who must be notified and when?

A BD must notify FINRA and the SEC electronically within 15 business days.

Is this a violation? Fully-disclosed broker-dealer with $300,000 of subordinated loans and $100,000 of equity for 60 days.

No. This firm has a Debt/Equity ratio of $300/$400 =75%. A grace period of 90 days is extended to firms whose ratio of Debt/Equity exceeds 70%.

Is this a violation? Established clearing broker-dealer with $1,750,000 in aggregate indebtedness and $175,000 of net capital.

Yes. Clearing firms have a minimum net capital requirement of $250,000.

Is this a violation? Established fully disclosed broker-dealer with $1,750,000 in aggregate indebtedness and $175,000 of net capital.

No. Fully disclosed broker-dealers are only required to have $50,000 of net capital if they receive, but do not hold, customer funds; or only $5,000 if they neither receive nor hold customer funds.

Is this a violation? Market maker in 35 stocks under $5 with $35,000 of net capital.

Yes. Market makers have a minimum capital requirement of $100,000.

What is an "aged" fail and what haircut must be taken?

A "fail to deliver" is aged on the 5th business day past settlement. At this point, the expected receipt of the security becomes uncertain and the position must be marked to market and a 15% haircut taken.