With respect to the latest issue, the SEC amended its rules on net capital and financial liability of brokers and dealers in 2013 to address third-party liability for brokerage drug dealers` debts and expenses. In particular, the Commission`s amendments to Rule 15c3-1 of the stock exchange law involved the requirement for “a broker to adjust its net assets in the calculation of net capital by incorporating all liabilities borne by a third party if the broker is unable to prove that the third party has the resources to pay the debts regardless of the broker`s income and assets.” 1 The Commission`s main concern was that the third party, independent of the broker-trader, did not have sufficient resources to assume such debts or charges in order to distort the broker`s actual financial situation2. These supporting documents may include the last financial statements, tax returns or administrative documents of the third party. Cost-sharing agreements between brokers and third parties are a hot topic for FINRA and the SEC. Businesses and their FINOP should fully understand the guidelines provided in the communication to members 03-63. At the end of the year, the broker-dealer must prove that the third party has sufficient resources, regardless of the broker-dealer, to bear the costs incurred by the broker. This can be achieved by receiving a copy of the audited annual accounts of the third party. However, due to the current focus on securities rationing systems implemented by dealers and their related companies, the SEC has again focused on auditing and analyzing fee allocation relationships. In recent times, member companies that use cost-sharing agreements have been subject to enhanced scrutiny during the FINRA cycle reviews, resulting in most cost-sharing agreements and the allocation process being found to be deficient by FINRA, regardless of the adequacy results in previous round evaluations. FINRA provided guidance on cost-sharing agreements in a communication to members published in October 2003. This communication requires brokers to “establish a data set that reflects all expenses incurred for their business and any corresponding liability, whether a third party has agreed to bear the costs or liability.” 03-63 also emphasizes the broker`s obligation to keep records of these expenses or liabilities assumed by third parties, regardless of accounting treatment or the impact on net capital. Like many investment firms, brokers incur various costs, such as real estate, technology and back-office costs, while conducting their operations.
These expenses are often borne by third parties, usually by the broker`s parent company or another related company. The Securities and Exchange Commission (“SEC” or “Commission”) and the Financial Industry Regulatory Authority (FINRA) expect brokers to execute and implement cost-sharing agreements with these third parties and meet related net capital requirements.