April 29, 2007
NASD has long allowed member firms to submit FOCUS reports indicating little or no liability, where those firms have elected to move the liabilities to the balance sheet of another business entity.
SEC's current proposal does not appear to disallow this practice but it does address it in a consequential way.
There are unknowns and uncertainties in this proposal, not the least of which is the metric by which a determination is to be made about the creditworthiness and 'acceptability' of the entity accepting the liabilities. And there is the as yet unanswerable question of how many NASD Member Firms will fail as a result of this proposal.
By its own analysis, SEC has determined that 702 member firms will be immediately impacted, when as and if this proposal becomes a Rule. That's in the neighborhood of 14% of the total number of Member Firms - that is a very big neighborhood.
What I and a number of my colleagues have noted is that the SEC provided no evidence, documentary or otherwise, which showed that the public has been endangered or has been left financially unprotected as a result of the practice of having another entity book some or all of a member's liabilities. If SEC has such evidence, there is no reason not to make it public in the interests of full disclosure and transparency, enabling a proper analysis of this proposal.
The SEC analysis indicates that as many as 702 firms may have to add, on average, roughly $280,000 in Gross Capital to their balance sheets to remain compliant with 15c3-1.
Member Firms may be shut down, sold or merged as an unintended consequence of this proposed new rule. This
set of potential outcomes went unmentioned in the SEC's analysis accompanying the proposal.
What are the expected and unexpected customer protection issues associated with mass closures of introducing member firms. Is NASD equipped and prepared to handle it.
Who will explain to public customers of $5,000 fully-disclosed broker/dealers that the SEC has shut down their broker in the interests of customer protection, a shut down brought about not by actual insolvency, but a pro-active shut down to protect them from a perceived risk?
Who will explain this and how will it be explainable?
These are substantial and as-yet unaddressed questions which may become the reality should this proposal move forward and achieve Rule status.
In conclusion, the proposal is sound in so far as it attempts to make sure that brokerage firms aren't abusing the practice of moving liabilities off the balance sheet to entities which lack sufficient financial wherewithal to handle them.
But as with any proposal of this type, the intended and unintended consequences must be analyzed extremely carefully before implementation.
At a minimum, we'd like to see the data and documentary evidence showing how many public customers have been financially hurt because an introducing firm or firms have moved liabilities to an entity which reneged or defaulted in the payment thereof.