Flashcards in Net Capital Requirements Deck (37)
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:
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.
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:
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:
c. Based on the aggregate indebtedness of the broker-dealer
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?
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- 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
Customer accounts $375,000
Firm accounts $600,000
Customer accounts $250,000
Firm accounts $900,000
Short securities differences -- 32 days old $135,000
What is the aggregate indebtedness of the firm?
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
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:
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.
Flint, Stone & Sparks Investments is a general securities broker-dealer. Its most recent inventory revealed a short securities difference of $75,000 and a long securities difference of $10,000. It is now 30 days after the securities count. The securities representing the short difference are now valued at $80,000. The value of the long securities difference is now $7,000. Which of the following statements is TRUE?
a. The firm's aggregate indebtedness has increased by $65,000.
b. The firm's aggregate indebtedness is unchanged.
c. The firm's net capital must be reduced by $73,000.
d. The record breaks must be reported to the broker-dealer's DEA within 24 hours.
B- Unresolved short securities differences do not become part of a broker-dealer's aggregate indebtedness after 30 days. The broker-dealer is required to establish a reserve to replace the missing securities. Replacement is required within 45 calendar days of the inventory.
Leveraged Capital LLC is a general securities broker-dealer. On March 10, its net capital was $560,000 of which $420,000 was debt capital. 50 days later, the broker-dealer has the same debt to equity ratio. A violation of the debt to equity ratio will occur in:
a. 40 days
b. 41 days
c. 90 days
d. 91 days
B- A broker-dealer's debt to equity ratio may not exceed 70% debt for a period greater than 90 days. Leveraged Capital's debt to equity ratio has been 75% debt ($420,000 / $560,000) and 25% equity for 50 days. If the debt ratio were not reduced, a violation would occur in 41 days.
Promptly forward under the net capital rule means:
a. As soon as possible
b. Within 30 seconds
c. By noon of the next business day
d. By the end of the day
C- The definition is important because a broker-dealer failing to promptly forward securities will be classified as a general securities broker-dealer (a clearing firm). This would change the minimum net capital requirement to $250,000
Which of the following statements most accurately describes the activities of a broker-dealer with a $5,000 net capital requirement?
a. The broker-dealer may act as a market maker in bonds.
b. The broker-dealer may act only in the capacity of an agent.
c. The broker-dealer may purchase as principal from another broker-dealer to fill a customer's order.
d. The broker-dealer may participate in a firm commitment underwriting.
C- A firm with a $5,000 net capital requirement may engage in simultaneous principal transactions without being subject to the dealer's minimum capital requirement of $100,000.
Caldwell Securities has established liability reserves subject to a contractual mutual fund plan. The accounting treatment under the net capital rule is:
a. The reserve is added to net worth
b. The reserve is subtracted from net capital
c. The reserve is excluded from aggregate indebtedness
d. Segregation of the assets in the reserve account according to Rule 15c3-3
C- Firms offering contractual mutual fund plans (also known as wrap around mutual fund plans) must establish reserves for sales charge refunds. Due to the high initial sales charges associated with these plans, customers who cancel the plan (within 45 days of the plan's inception) are entitled to a refund of the sales charge. The reserves established for sales charge refunds are not part of aggregate indebtedness and are separate from the reserves established according to Rule 15c3-3.
Z-Trade borrows $400,000 in stock from Quicktrade and lends the shares to Comstock Trading. What portion of the amount payable against securities loaned is a part of Z-Trade's aggregate indebtedness?
A- The net capital rule (15c3-1) specifies 85% of the amount payable (to Quicktrade) is excluded from aggregate indebtedness; the remaining 15% is treated as aggregate indebtedness.
Churchwell Brokerage had been computing its net capital under the aggregate indebtedness standard. The broker-dealer now elects to calculate net capital under the alternative standard. In order to do so, it must:
I. Perform the 15c3-3 computation weekly
II. Notify its DEA in writing
III. File a FOCUS Part II
IV. Maintain a Special Reserve Account for Customer Credit Balances
a. III only
b. I and II only
c. II and III only
d. III and IV only
B- When a change is made from the aggregate indebtedness standard to the alternative method, a broker-dealer is required to notify its designated examining authority and perform the reserve calculation on a weekly basis.
Client Morton sells short 500 shares of Oxford and creates a credit balance. How is this treated according to the net capital rule?
a. It is added to aggregate indebtedness.
b. It is excluded from aggregate indebtedness.
c. The credit balance is subject to a haircut.
d. Cash received by the broker-dealer offsets the credit balance.
A- Customer credit balances attributable to either long or short sales are treated as aggregate indebtedness.
Jupiter Trading has a fail to receive of 600 shares of Maywood Industries, which is offset by securities borrowed from Bluestone Brokerage (a broker-dealer). The treatment of the payable is:
a. Added to AI
b. Excluded from AI
c. Added to 15c3-3 computation on credit side
d. Recorded on a subsidiary ledger
B- A firm excludes from aggregate indebtedness a fail to receive offset by a fail to deliver. Another offset to the fail to receive are securities borrowed from a broker-dealer. If securities are borrowed from a customer to effect delivery, aggregate indebtedness increases.
Clayton brokerage, an introducing broker-dealer, is participating as a selling group member in a firm commitment underwriting. The minimum net capital requirement of the firm is:
B- The net capital rule permits introducing firms to function as selling group members (in firm commitment or best efforts underwritings) with $50,000 net capital. If the broker-dealer's role is that of a syndicate member (requiring a commitment of capital), the requirement increases to $100,000 net capital.
Which of the following items is included in aggregate indebtedness?
a. Credit balances in noncustomer accounts containing short securities positions
b. Equities in noncustomers accounts that are segregated according to the Commodity Exchange Act
c. Monies payable to the extent funds are required to be on deposit and are on deposit in a special reserve bank account
d. Liabilities on open contractual commitments
A- Credit balances in noncustomer accounts containing short positions are included in aggregate indebtedness.
A general securities broker-dealer makes markets in 50 stocks that trade between $15 and $60 per share. What is the firm's net capital requirement?
B- General securities broker-dealers must maintain at least $250,000 of net capital. It may be higher based on other factors such as market making. Market making has a minimum net capital requirement of $100,000 and a maximum of $1,000,000. The specific net capital requirement is based on the number of issues in which the broker-dealer makes a market. When shares are priced greater than $5, $2,500 must be maintained per issue. 50 x $2,500 = $125,000. Although this is greater than $100,000, $250,000 is required as a general securities broker-dealer.
An introducing broker-dealer with a $5,000 minimum net capital requirement may participate in which of the following activities?
a. Participate as a selling group member in a firm commitment underwriting
b. Accept cash and securities and immediately forward them to a clearing firm
c. Engage in market-making activities in fewer than 10 securities
d. Engage in occasional transactions for its proprietary account
D- A $5,000 broker-dealer introduces accounts on a fully-disclosed basis to another firm and does not receive customer funds or securities. An introducing broker-dealer that receives customer securities is subject to a $50,000 minimum net capital requirement. With regard to new issues, a $5,000 or $50,000 introducing broker-dealer may engage in a best-efforts or all-or-none underwriting only. The broker-dealer may accept checks made payable to the issuer only, and must forward such checks to the issuer promptly. In order to participate in a firm- commitment underwriting, an introducing broker-dealer needs at least $100,000 of net capital, which would permit it to act as a dealer. Introducing broker-dealers, like those just discussed, may only do occasional trades for their own accounts (no more than ten per calendar year). They may not act as dealers or market makers.
According to SEC Rule 15c3-1, which TWO of the following would trigger a $1,000,000 net capital requirement?
I. A self-clearing broker-dealer that acts as an executing broker in a prime brokerage relationship
II. An newly established broker-dealer that has $12,000,000 aggregate indebtedness
III. A member firm that makes a market in 500 issues priced at more than $5
IV. A prime broker
a. I and III
b. I and IV
c. II and III
d. II and IV
A- According to SEC Rule 15c3-1, a self-clearing broker-dealer that acts as an executing broker in a prime brokerage relationship must have minimum net capital of at least $1,000,000. The minimum net capital for a broker-dealer that engages in prime brokerage is $1,500,000. The maximum ratio of aggregate indebtedness (AI) to net capital for a newly established broker- dealer is 8:1 (800% AI) during its first year of operation. A newly established broker-dealer would need $1,500,000 of net capital to support $12,000,000 of AI. An established broker-dealer has a maximum ratio of 15:1. Market makers are required to maintain net capital of $1,000 for each security valued at $5 or less and $2,500 for each security priced above $5, with a maximum net capital requirement of $1,000,000. In choice III, the net capital would reach the maximum of $1,000,000, rather than $1,250,000 (500 x $2,500).