No Action, Interpretive and/or Exemptive Letter:
Additional Guidance for Broker-Dealers on FAS 150

September 7, 2004

Office of Broker-Dealers
Division of Corporation Finance

September 7, 2004

Ms. Elaine Michitsch
Vice President
Regulatory and Development Services
New York Stock Exchange, Inc.
20 Broad Street
New York, NY 10005

Ms. Susan DeMando
Director, Financial Operations
NASD, Inc.
1735 K Street, NW
Washington, DC 20006

Dear Ms. Michitsch and Ms. DeMando:

You have indicated that certain of your member firms seek additional clarification on treatment of mandatorily redeemable financial instruments for purposes of the net capital rule, Securities Exchange Act Rule 15c3-1,¹ in light of implementation of Financial Accounting Standards No. 150 (“FAS 150”), promulgated by the Financial Accounting Standards Board (“FASB”). On February 19, 2004, the staff of the Division of Market Regulation (“Division”) of the U.S. Securities and Exchange Commission (“Commission”) issued a response to a letter from the Securities Industry Association (“SIA”) related to the anticipated impact FAS 150 on calculation of broker-dealers’ net capital.²

FAS 150 generally requires an issuer to classify a financial instrument within its scope as a liability for purposes of Generally Accepted Accounting Principles (“GAAP”). A financial instrument issued in the form of shares³ is mandatorily redeemable and, therefore, within the scope of FAS 150 if it, “embodies an unconditional obligation requiring the issuer to redeem the instrument by transferring its assets at a specified or determinable date (or dates) or upon an event certain to occur.” For example, under FAS 150, broker-dealers that have issued shares that must be redeemed upon the holder’s death or termination of employment must record those shares as liabilities because the shares are mandatorily redeemable upon an event certain to occur.

In its letter, the SIA requested temporary relief from certain provisions of the Commission’s net capital rule. The SIA suggested that non-public broker-dealers might need time – at least one year – to amend partnership, limited liability company, shareholder, or other agreements to avoid potential adverse impacts of FAS 150 on their net capital.

In its February 19, 2004 letter, the Division stated that it would not object if non-public broker-dealers, in calculating net capital, added back to net worth the amounts of mandatorily redeemable financial instruments for a period of one year. This temporary relief was intended to provide non-public broker-dealers with sufficient time to comply with the net capital rule in light of enactment of FAS 150.

You have informed us that certain of your members seek additional guidance on when the temporary net capital relief expires. This letter clarifies that the relief granted in the February 19, 2004 letter became retroactively effective as of December 16, 2003 and remains effective through December 15, 2004. Consequently, non-public broker-dealers no longer may add back the value of mandatorily redeemable financial to net worth in calculating net capital after December 15, 2004.

We noted in our February 19, 2004 letter that this temporary relief applies only to the calculation of net capital and does not extend to the treatment of mandatorily redeemable financial instruments in broker-dealer financial statements prepared in accordance with GAAP. Broker-dealers, therefore, should ensure that financial statements that they prepare in accordance with GAAP, including FOCUS Reports, properly reflect GAAP treatment of mandatorily redeemable financial instruments.

This is a staff position with respect to enforcement only and does not purport to state any legal conclusion on this matter. Any material change in circumstances may warrant a different conclusion and should be brought immediately to the Division’s attention. Furthermore, this position may be withdrawn or modified if the staff determines that such action is necessary in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the securities laws.

Sincerely,

¹ 17 CFR 240.15c3-1.

² Letter from Michael A. Macchiaroli, Associate Director, U.S. Securities and Exchange Commission to Marshall J. Levinson, Chair, Capital Committee, The Securities Industry Association, dated February 19, 2004.

³ According to FAS 150, the term “[s]hares includes various forms of ownership that may not take the legal form of securities (for example, partnership interests), as well as other interests, including those that are liabilities in substance but not in form.”

http://www.sec.gov/divisions/marketreg/mr-noaction/fas150110704.htm