All types of broker-dealers (“BD”) face a standard requirement, namely the concept of regulatory net capital; however, depending on the type of business involved in BD, the threshold may vary significantly. Generally, BD can be divided into two categories: those that “carry customer accounts” and those that “do not carry customer accounts.” The term “carry customer account” means maintaining accounts for individuals or other brokers or dealers, as well as receiving and holding funds or securities.
The Net Capital Rule focuses on liquidity and is designed to protect securities customers, counterparties, and creditors by requiring that broker-dealers have sufficient liquid resources on hand at all times to satisfy claims promptly.
All types of broker-dealers (“BD”) face a standard requirement: regulatory net capital. However, the threshold may vary significantly depending on the type of business involved in BD.
Generally, BD can be divided into two categories: those that “carry customer accounts” and those that “do not carry customer accounts.”
BDs that “carry customer accounts” are required to maintain a net capital of at least $250,000, subject to the following exceptions:
Introducing Broker: Brokers who introduce their accounts on a fully disclosed basis to a clearing firm will be subject to a minimum net capital requirement of $50,000. To qualify for this, the BD must have an agreement with the clearing firm that supports the fact that the customers are customers of the clearing firm and not the BD, and statements and customer relationships are directly between the clearing firm and the customers.
Carrying BD: This provides that all transactions between the BD and its customers are conducted through a bank account designated as a “Special Account for the Exclusive Benefit of Customers of XYZ BD,” which has a minimum net capital requirement of $100,000.
A Prime Broker is required to maintain a minimum regulatory net capital of $1.5 million. A prime brokerage is a bundled group of services that investment banks and other financial institutions offer to hedge funds and other large investment clients. They often need to be able to borrow securities or cash to engage in netting, which offsets the value of multiple positions or payments exchanged between two or more parties.
BDs that self-clear or clear prime broker transactions on behalf of an introducing executing broker are required to maintain a net capital of $1 million.
BDs that do “not carry customer accounts” have minimum regulatory net capital requirements ranging from $5,000 to $100,000, as follows:
Dealers are required to maintain a net capital of $100,000 and include entities that endorse or write options (other than on a national exchange) or transact more than ten transactions for their own investment account(s) in any one calendar year.
BDs that engage solely in the purchase, sale, and redemption of redeemable shares of registered Investment companies or an interest in an Insurance Company separate account are subject to a minimum net capital requirement of $25,000.
All other BDs that do not carry customer accounts and do not receive funds or securities are subject to a $5,000 minimum net capital requirement. This includes BDs that act as investment bankers or receive commissions in conjunction with securities offerings.
Exemptions
BD must comply with certain rules and regulations, as mentioned in Rule 15c3-3 of the Securities Exchange Act. However, they can claim exemption from such compliance under paragraph ‘k’ of Rule 15c3-3.
Exemptions given under paragraph ‘k’ include the following:
(k)(1) – SEC Rule 15c3-3(k)(1) provides an exemption from the requirements of SEC Rule 15c3-3 in respect of transactions of customers in (a) redeemable securities issued by a registered investment company under the U.S. Investment Company Act of 1940, (b) interests or participations in an insurance company separate account. The BD also promptly transmits all funds and delivers all securities received in connection with its activities as a broker-dealer and does not otherwise hold funds or securities for, or owe money or securities to, customers.
(k)(2)(i) – This exemption applies to BDs that do not carry margin accounts and promptly transmit all customer funds received. This type of BD firm does not carry or hold funds or securities for customers and uses a special bank account for financial transactions with customers.
(k)(2)(ii) – This exemption is for BDs who do all business through a clearing firm, and all business is fully disclosed.
(k)(3) – This provision is reserved for a BD who does not fall under the other exemption provisions but has submitted a written application to the SEC and been approved for exemption status.
Note – Many BD firms who are not required to maintain a special account and do not meet the exact exemptions of SEC Rule 15c3-3 have selected the 15c3-3(k)(2)(ii) option, as it was the least incorrect. To provide guidance in July 2020, the SEC and FINRA re-issued Footnote 74 to provide clear guidelines for these firms.
Additional Consideration
In inclusion to the regulatory net capital requirements outlined in 15c3-1, BDs will also be subject to other net capital thresholds based on their aggregate debt (AI) liabilities. In addition, BD should also be aware of additional net capital requirements that may be imposed by their particularly designated examining authority and other regulatory bodies to which BD is a member, such as the Commodities Futures Trading Corporation (“CFTC”). The net capital requirement rules are pretty complex, but they can be a sound/valuable tool for managing BD’s financial strength when we understand and apply these rules correctly.
Mercurius is registered with PCAOB, USA, and has assisted its clients with providing audit and assurance services for over a decade to various clients in the United States, including broker-dealers. We serve different broker-dealer firms registered in the United States w.r.t their broker-dealer audits under Rule 17a-5 under the Securities Exchange Act of 1934 (FINRA Audit). If you have any questions or wish to know more about BD’s minimum net capital requirement, kindly contact us.
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