Certified Electrical Safety Worker (CESW)

Correct: Under SEC Rule 15c3-3, for a bank to be considered a satisfactory control location, it must provide a written representation that the securities are not subject to any right, charge, security interest, lien, or claim of any kind in favor of the bank or any person claiming through the bank. This ensures that the broker-dealer maintains absolute control over customer assets and that those assets are protected from the custodian’s creditors.

Incorrect: Fidelity bond coverage requirements apply to the broker-dealer itself rather than being a qualifying condition for a third-party custodial control location. While many custodians are broker-dealers, banks also serve as control locations and are not required to be SIPC members or meet specific broker-dealer net capital minimums to hold customer assets. Daily mark-to-market and cash reserve requirements are features of the Reserve Formula or margin accounts, not the fundamental criteria for establishing a ‘good control location’ for custody.

Takeaway: To qualify as a satisfactory control location under SEC Rule 15c3-3, a custodian must provide a written waiver of all liens and claims against the customer securities it holds.

Correct: Under SEC Rule 15c3-1, specifically the provisions related to Appendix A (Options), a broker-dealer must obtain written approval from its Designated Examining Authority (DEA), such as FINRA, to use a theoretical option pricing model for net capital purposes. This model allows the firm to calculate haircuts based on the net risk of a portfolio of related positions, such as stocks and their corresponding options, rather than applying fixed percentages to each position separately. This methodology recognizes the risk-reducing nature of hedged positions.

Incorrect: The purpose of using a model is to achieve a more accurate risk-based capital charge, which often results in a lower haircut than standard percentages, so requiring it to be higher is incorrect. Margin models are typically used for marketable securities like equities and options where risk offsets can be modeled, not non-marketable securities. There is no regulatory requirement to notify the SEC within 24 hours for every 10% variance between model-based and standard haircuts; the regulatory focus is on the initial approval and the ongoing integrity of the model’s risk parameters.

Takeaway: Broker-dealers must obtain formal DEA approval before utilizing theoretical option pricing models to determine net capital haircuts for proprietary portfolios.

Correct: According to SEC Rule 15c3-1, assets that cannot be readily converted into cash are considered non-allowable. Securities that are subject to legal or contractual restrictions, such as a 180-day lock-up period, do not meet the definition of having a ‘ready market.’ Consequently, the entire carrying value of these restricted securities must be deducted from the firm’s net worth when calculating net capital, rather than simply applying a percentage haircut.

Incorrect: Treating the securities as marketable with a 15% haircut is incorrect because the contractual lock-up prevents the firm from selling the securities in the open market, thus failing the ‘ready market’ test. While a 100% haircut might seem functionally similar to a deduction, the regulatory framework specifically categorizes restricted assets as non-allowable deductions from net worth. The intent behind the lock-up (protecting client holdings) is irrelevant to the liquidity-based requirements of the Net Capital Rule.

Takeaway: Securities subject to contractual or legal restrictions that prevent immediate sale are non-allowable assets under the Net Capital Rule due to the absence of a ready market.

Correct: The methodology of utilizing a Special Reserve Bank Account for the Exclusive Benefit of Customers (EBOC) is the cornerstone of SEC Rule 15c3-3. This approach ensures that customer funds and the cash realized from the use of customer securities are kept separate from the firm’s own money. By restricting the use of customer credits solely to the financing of customer debits (such as margin loans), the firm prevents the use of customer assets to fund its own proprietary trading or operational expenses, which is the primary goal of the Customer Protection Rule.

Incorrect: The approach of commingling customer and proprietary assets is a direct violation of the physical segregation requirements of Rule 15c3-3, as sub-ledger tracking does not satisfy the legal requirement for separate accounts. Using customer fully paid securities as collateral for firm loans is a prohibited practice known as improper hypothecation and represents a severe regulatory failure. Applying uniform haircuts to all securities ignores the fundamental distinction between proprietary positions (which are subject to haircuts under Rule 15c3-1) and customer securities (which must be fully segregated or held in a good control location under Rule 15c3-3).

Takeaway: The fundamental principle of the Customer Protection Rule is the strict segregation of customer assets from firm assets to ensure that customer property is not at risk from the broker-dealer’s proprietary business activities.

Correct: Under SEC Rule 15c3-3, broker-dealers are strictly required to obtain and maintain physical possession or control of all fully paid and excess margin securities. These assets must be held in a ‘good control location’ and must be free of any liens or encumbrances that would allow a third party to claim an interest in them, ensuring that customer assets are protected from the firm’s creditors.

Incorrect: The use of customer securities as collateral for firm loans is a direct violation of the Customer Protection Rule, regardless of the firm’s aggregate indebtedness ratio. Written waivers do not allow a firm to bypass the fundamental segregation requirements for fully paid securities. While the Special Reserve Bank Account is a requirement of Rule 15c3-3, it pertains to customer cash and credits, and its funding level does not grant permission to use customer securities for firm financing.

Takeaway: Broker-dealers must ensure that fully paid customer securities are completely segregated from firm assets and held free of any third-party liens to comply with the Customer Protection Rule.

Correct: Under SEC Rule 15c3-1, when a broker-dealer participates in a joint trading account, it must reflect its proportionate interest in the account’s assets and liabilities. The firm is required to include its share of the securities positions and apply the standard regulatory haircuts to those positions as if they were held directly in the firm’s proprietary account.

Incorrect: Treating the entire account as a non-allowable asset is incorrect because the firm’s proportionate interest in marketable securities is generally considered an allowable asset. Subordination agreements relate to liabilities and do not exempt a firm from reporting its share of joint securities positions. A flat 100% haircut is not the standard treatment for marketable securities in a joint account; rather, the specific haircut associated with the type of security (e.g., equity, corporate bond) is applied to the firm’s share.

Takeaway: For net capital purposes, a broker-dealer must account for its proportionate share of securities in a joint account and apply the appropriate haircuts to that share.

Correct: According to SEC Rule 15c3-1, when a broker-dealer participates in a joint account, it must reflect its proportionate interest in the account’s assets and liabilities. For the purpose of computing net capital, the firm is required to take the appropriate haircut on its share of the securities held in the joint account. This ensures the firm’s net capital accurately reflects the market risk associated with its specific economic exposure to those securities.

Incorrect: Treating the capital contribution as a non-allowable asset is incorrect because the underlying securities are marketable and the firm has a direct interest in them. Excluding positions based on which firm acts as the clearing agent is not permitted, as the firm still bears the market risk of its share. Applying the haircut to the entire account value is also incorrect, as the firm is only responsible for the risk associated with its own 40% interest, not the interest held by the other participant.

Takeaway: A broker-dealer must apply the applicable haircut to its proportionate share of securities held in a joint trading account to accurately reflect market risk in its net capital calculation.

Correct: Under SEC Rule 15c3-3 (the Customer Protection Rule), a broker-dealer is required to maintain possession or control of all fully paid and excess margin securities. When a deficiency is identified, the first operational step is to identify the location of the securities. The firm must determine if the securities are held at a location that is not ‘satisfactory’ (such as a bank where the securities are pledged as collateral for a firm loan) or if they are in transit. Identifying the location is a prerequisite to taking corrective action, such as moving the securities to a clearing corporation or a designated depository.

Incorrect: Executing a buy-in is a corrective action that is required only after a specific period of time has elapsed (for example, 10 business days for certain fails to receive), rather than being the immediate first step upon discovery. Applying a 100% haircut is a net capital treatment for non-allowable assets, but it does not satisfy the possession and control requirements of the Customer Protection Rule. Amending a FOCUS report is a regulatory reporting obligation that would occur after the financial impact is assessed, but it does not address the underlying operational deficiency of missing customer securities.

Takeaway: The primary responsibility under SEC Rule 15c3-3 is to verify that customer securities are held in satisfactory control locations free of any liens or third-party claims.

Correct: Under SEC Rule 15c3-1, the Net Capital rule, any asset that cannot be readily converted into cash because it lacks a ready market is generally considered a non-allowable asset. For proprietary securities positions, if there is no ready market (as defined by the absence of a viable independent market or the inability to settle the position quickly at a price near the last sale), the entire carrying value must be deducted from net worth. Applying a percentage haircut is only appropriate for securities that possess a ready market.

Incorrect: Applying a standard 15% haircut or an increased haircut like 40% is incorrect because those treatments assume the asset is ‘allowable’ but subject to market risk; however, assets without a ready market are fundamentally non-allowable. Undue concentration charges apply to allowable securities that have a ready market but represent a disproportionate share of capital. Historical volatility models or custom haircuts cannot be used to bypass the requirement that an asset must have a ready market to be considered allowable for net capital purposes.

Takeaway: Securities that lack a ready market must be treated as non-allowable assets and deducted in full from net worth during the Net Capital computation, regardless of the investment strategy used to hold them.

Correct: Under FINRA and SEC regulatory standards, gifts and entertainment expenses must be recognized as expenses and cannot be capitalized into the cost basis of securities. For the purposes of the Net Capital Rule (SEA Rule 15c3-1), these expenses reduce net worth immediately. Capitalizing them would artificially inflate the firm’s assets and net capital. Additionally, FINRA Rule 3220 limits gifts to $100 per person per year, and while entertainment is generally not subject to the $100 limit if a representative is present, the accounting treatment must still reflect an expense rather than an asset.

Incorrect: Amortizing entertainment costs is not permitted under GAAP or regulatory accounting for broker-dealers as these are period costs, not capital improvements. Recording expenditures as a deferred asset is incorrect because entertainment does not provide a future economic benefit that meets the criteria for an asset on a broker-dealer’s balance sheet. Adjusting a haircut is a method for addressing market risk, not for accounting for operational or promotional expenses, and would result in an inaccurate net capital computation.

Takeaway: Gifts and entertainment expenses must be treated as immediate charges against net worth and cannot be capitalized into the cost basis of securities positions for net capital reporting.