Net Capital

Regulatory Obligations

SEA Rule 15c3-1 (Net Capital Rule) requires that firms must at all times have and maintain net capital at no less than the levels specified pursuant to the rule to protect customers and creditors from monetary losses that can occur when firms fail. SEA Rule 17a-11 requires firms to notify FINRA and the SEC in the event their net capital falls below the minimum amount required by the Net Capital Rule. 

If firms have an affiliate or parent paying any of their expenses, FINRA Notice to Members 03-63 (SEC Issues Guidance on the Recording of Expenses and Liabilities by Broker/Dealers) provides guidance for establishing an expense-sharing agreement. Additionally, firms must align their revenue recognition practices with the requirements of the Financial Accounting Standards Board’s (FASB) Topic 606 (Revenue from Contracts with Customers), which is a foundation for compliance with the Net Capital Rule, SEA Rule 17a-3 and 17a-5. As noted in Regulatory Notice 23-21 (FINRA Reminds Member Firms of Net Capital, Recordkeeping and Financial Reporting Requirements in Connection with Revenue Recognition Practices) firms are advised to ensure that they are able to demonstrate their proper application of Accounting Standards Codification (ASC) 606. 

Findings and Effective Practices

Findings

• Inadequate Supervision: Not having a reasonable process to determine when the firm has a net capital deficiency and should begin the process of suspending business operations, and ensure the firm files timely notices of its net capital deficiencies.
• Incorrect Capital Charges for Underwriting Commitments: Not maintaining an adequate process to assess moment-to-moment net capital and open contractual commitments (OCC) capital charges on underwriting commitments; not establishing and maintaining WSPs for calculating and applying OCC charges; not maintaining an accurate record or log of underwritings in which the firm is involved; and not understanding the firm’s role in the underwriting (i.e., best efforts or firm commitment).
• Inaccurate Net Capital Deductions: Not maintaining a process or WSPs to accurately compute capital charges of nonmarketable securities (e.g., failing to compute marketplace blockage properly); and for certain firms, applying “minimal amount of credit risk standard” despite not having an adequate process to conduct an internal credit analysis or an independent creditworthiness analysis of corporate and nonconvertible debt securities. 
• Inaccurate Recording of Revenue and Expenses: Not recording transactions in a timely manner, resulting in the firm’s noncompliance with SEA Rule 17a-3; or noncompliance generally with US Generally Accepted Accounting Principles (GAAP) by not maintaining financial records on an accrual basis. 
• Late or Inadequate Filings: Failing to timely file required notices of net capital deficiencies with FINRA and the SEC, and filing other notices that inaccurately reflected the firm’s aggregate indebtedness, minimum required net capital or excess net capital.
• Insufficient Capital for Underwriting Participation: Acting in the capacity as the lead underwriter without maintaining sufficient net capital to participate in the underwriting and cover the required OCC charges.
• Inaccurate OCC Charges: Failing to accurately capture OCC charges on firm commitment offerings (e.g., only capturing charges for the day of the pricing date or the settlement date, not capturing charges on unsold portion of underwriting from pricing date through settlement date, applying an incorrect haircut percentage on charges).

Effective Practices 

• Net Capital Assessment: Performing an ongoing assessment of the net capital treatment of assets to confirm that they were correctly classified for net capital purposes.
• Moment-to-Moment and Net Capital Compliance for Underwriting Commitments: Establishing control processes and maintaining current WSPs for: 
  • ensuring the firm’s role is clear within the agreement as it relates to its role in the underwriting (i.e., best efforts (either in a contingent or a firm commitment offering) or as having a firm commitment); 
  • establishing a process to track open contractual commitments in which the firm is involved at all times; and
  • calculating and applying OCC charges, as well as focusing on the product and proper haircut percentage. 

Additional Resources

• FINRA
  • Interpretations to the SEC’s Financial and Operational Rules
  • Regulatory Notices
    • Regulatory Notice 23-21 (FINRA Reminds Member Firms of Net Capital, Recordkeeping and Financial Reporting Requirements in Connection with Revenue Recognition Practices)
    • Notice to Members 03-63 (SEC Issues Guidance on the Recording of Expenses and Liabilities by Broker/Dealers)
• SEC
  • SEC Modernizes the Submission of Certain Forms, Filings, and Materials Under the Securities Exchange Act of 1934 (December 16, 2024)
  • Frequently Asked Questions Concerning the Amendments to Certain Broker-Dealer Financial Responsibility Rules
• FASB
  • ASU 2014-09 Revenue From Contracts With Customers (Topic 606)