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NASD is concerned that clearing firms and introducing firms are frequently failing to introducing broker vs carrying broker consider deficits in introduced accounts in accordance with an August interpretation published in NASD Guide to Rule Interpretations May This Notice is intended to remind members of their responsibilities in this regard.

In addition, please note that reviews introducing broker vs carrying broker the proper handling of deficits in introduced accounts will be an integral part of NASD's examination program for both clearing and introducing firms.

Questions concerning this Notice introducing broker vs carrying broker be directed to Susan M. The SEC's Net Capital Rule specifies the circumstances in which a clearing firm must take a charge to its net capital for unsecured or partly secured debits.

Deficits in unsecured and partly secured introduced accounts shall be deducted by the carrying broker-dealer and the introducing broker-dealer when the clearing agreement states that such deficits are the liability of the introducing broker-dealer.

The amount is deductible by the carrying broker-dealer upon occurrence after application of timely calls for margin, marks to market, or other required deposits which are not outstanding for more than five business days unless there is reason to believe payment will not be made. The introducing broker-dealer must deduct the charge on the day after it becomes a charge to the carrying broker and the carrying broker-dealer must advise the introducing broker-dealer in writing on a daily basis of all such deficits to be charged.

NASD believes that some clearing firms may fail to notify their introducing firms of the deficits to be charged, as required by the Interpretation. Even when notified, introducing firms may fail to take the capital charge. Some clearing firms appear to believe that the use of the term "when" introducing broker vs carrying broker the Interpretation which specifically refers to the existence of language in the clearing agreement indicating that deficits are the responsibility of the introducing firm can be read to permit the clearing firm to determine "when" a deficit has occurred.

Some clearing and introducing firms appear to have concluded that as long as they are "in discussions" as to how to collect or otherwise resolve a deficit, the clearing firm can delay providing the required notification, and the introducing firm can postpone taking the capital charge.

The Interpretation does not permit a clearing firm to delay "passing on the deficit," nor does it permit an introducing firm to postpone taking a capital charge for deficits in introduced accounts. If the clearing agreement states that the introducing broker-dealer is responsible for customer deficits, the clearing firm and the introducing broker-dealer must comply with the conditions of the Interpretation. These conditions require that the amount of the deficit is deducted by: NASD believes that the delays in "passing on the deficit" may be more prevalent when the size of the deficit would cause the introducing firm to be under capital.

This conduct gives the introducing firm a competitive advantage compared to other introducing firms that voluntarily cease conducting a securities business when under capital.

The economics of such situations have caused some clearing firms to regard delays in "passing on the deficit" as simple "business decisions," rather than conduct entirely inconsistent with the Interpretation. Clearing firms must review their operations introducing broker vs carrying broker ensure that they have policies and procedures in place to comply with the Interpretation.

Firms must immediately correct any deficiencies noted as a result of this review. Where necessary, NASD may impose limitations on introducing broker vs carrying broker clearing firm's operations relative to introduced accounts until the clearing firm can demonstrate compliance with this Notice. Clearing firms issuing deficit reports, and introducing firms receiving such introducing broker vs carrying broker, must maintain these records for a period of not less than three years, the first two years in an easily accessible place.

NASD anticipates that deficits will be satisfied in several ways. We believe the most common will be: If the parent or affiliate of the broker-dealer or other third party agrees to pay the deficit in full or through payments, the introducing firm must comply with the SEC July 11,letter titled Recording Certain Broker-Dealer Expenses and Liabilities see NASD Notice to Memberswhether or not the introducing firm and the paying party have an expense sharing agreement for other purposes.

For each correspondent, the clearing firm must report the total deficitin writing, on a daily basis. The introducing broker-dealer introducing broker vs carrying broker exclude the subordinated liability from Aggregate Indebtedness; however, it shall be considered as a liability in the determination of net worth if it is not subject to a satisfactory subordination agreement as defined in Appendix D of SEC Rule 15c This language is relevant to the discussion, however, in that it states that where no subordination agreement exists relative to a deficit in an unsecured or partly secured introduced account, it must be considered as a liability in the determination of the net worth of the introducing firm.

The introducing broker-dealer must still take the customers'deficits as a deduction in computing introducing broker vs carrying broker capital when the clearing agreement states that such deficits are the introducing firm's responsibility. The amount of the introducing broker-dealer's deposits must also be included in the carrying broker-dealer's PAIB computation.

Discussion The SEC's Net Capital Rule specifies the circumstances in which a clearing firm must take a charge to its net capital for unsecured or partly secured debits. Deficits In Introduced Accounts Deficits in unsecured and partly secured introduced accounts shall be deducted by the carrying broker-dealer and the introducing broker-dealer when the clearing agreement states that such deficits are the liability of the introducing broker-dealer. Action Required Clearing firms must review their operations to ensure that they have policies and procedures in place to comply with the Interpretation.

Record Retention Clearing firms issuing deficit reports, and introducing firms receiving such reports, must maintain these records for a period of not less than three years, the first two years in an easily accessible place. Reporting the "Deficit" to Introducing Firms For each correspondent, the clearing firm must report the total deficitin writing, on a daily basis.

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Plaintiffs, seeking to maximize their recoveries, are generally inclined to cast a liability net over as many potential wrongdoers as possible. This observation is particularly valid in securities litigation and arbitration where broker-dealers, registered representatives, supervisory personnel, issuers and other parties are routinely joined as a matter of course.

In the context of financially distressed or defunct introducing brokers, the plaintiff's search for the deep pocket frequently brings it to the clearing firm's front door.

But is a clearing firm an appropriate liability target? Are clearing firms responsible for the alleged wrongdoings of introducing firms and their representatives? Do some clearing firms create liability for themselves where others do not? Do arbitrators adhere to court-ordained liability standards? Will potential industry rule revisions expand or contract clearing firm liability? This article generally explores these questions and surveys the current landscape and climate.

In a typical securities clearing arrangement, an "introducing broker" formally contracts with a "clearing" or "carrying" broker to complete and settle the securities trades of the introducing broker's customers. The arrangement benefits the introducing broker, which while providing investment advice through direct contact with its investor customers, may not have the financial resources, net capital, personnel or expertise to clear its own trades.

As such, the clearing broker performs numerous back room and administrative functions for the introducing broker, including: The clearing broker typically performs these functions through a "fully disclosed agreement" in which the introducing broker's customer is disclosed to the clearing broker to enable the mailing of trade confirms and account statements.

Clearing arrangements abound within the securities industry. Indeed, they provide a vital resource to many securities dealers who could not otherwise participate in the retail industry.

Recent industry statistics reflect that approximately one hundred twenty NYSE clearing firms serve the needs of more than four thousand introducing brokers. Any views expressed herein do not apply to future cases, which by necessity will turn upon their particular facts and circumstances.

Publications Liability Of Clearing Firms: Traditional and Developing Perspectives By: The Role of Clearing Firms. The Prevailing Legal Standard. Recovery Theories and Illustrative Cases. Liability Under Section 10 b and Rule 10b Former Aiding and Abetting Liability. Controlling Person Liability under Section 20 a. Contact Us Disclaimer Sitemap built by oneRhino. This website contains attorney advertising. Prior results do not guarantee a similar outcome.