More small B-Ds try to maintain capital reserves

Low trading volume, credit crunch put firms in regulator's sights

Aug 15, 2010 @ 12:01 am

By Bruce Kelly

The tight credit market, coupled with lower trading volume, is forcing more small broker-dealers to close or merge as their capital approaches regulatory minimums, according to industry observers.

Aware that several firms are near violating net-capital rules, examiners at the Financial Industry Regulatory Authority Inc. are stepping up their scrutiny of how -broker-dealers book liabilities, observers said.

Finra spokeswoman Nancy Condon disputed the notion that the regulator is scrutinizing firms' net-capital reserves more aggressively, saying: “Our approach to net capital has not changed.”

Although the rules governing net-capital requirements haven't changed, observers said, Finra examiners are being more aggressive in how they enforce those rules.

Richard Nummi, executive consultant at Accounting and Compliance International, said that examiners are looking closely at how broker-dealers adjust their net capital to account for possible arbitration claims.

“People have low-balled liability in the past,” said Moshe Silver, managing director and chief compliance officer for Hedgeye Risk Management LLC, a registered investment adviser in New Haven, Conn.

Changes in assumptions about liability can potentially be punishing, Mr. Nummi said. “It's almost like [Finra] has a new bowie knife in their belt,” he said.

“The net-capital pressure on small firms is enormous, and Finra is picking up on accruals,” said David Sobel, executive vice president, counsel and chief compliance officer with Abel/Noser Corp., a New York institutional broker-dealer.

The attention to accruals, a firm's reserves for future payments, comes as broker-dealers are ponying up more cash to the Securities Investor Protection Corp. for coverage, he said.

“Finra is asking for more-stringent controls of net capital, and it's being attacked at the same time,” Mr. Sobel said.

The overwhelming number of Finra registered broker-dealers are small firms with 10 representatives or fewer, and those firms are feeling the pressure intensely, he said. Three thousand of the nation's 4,700 broker-dealers fall into that category, Mr. Sobel said.

The Securities and Exchange Commission is also paying close attention to broker-dealers' net capital. In April, SEC Chairman Mary Schapiro said in testimony before Congress that the commission's staff was reviewing whether to raise minimum-net-capital requirements for broker-dealers. She made her comments before the House Financial Services Committee in a hearing about the 2008 failure of Lehman Brothers Holdings Inc.

Although they pose little systemic risk to the nation's financial system, more small broker-dealers are falling by the wayside because of inadequate capital.

This month, Lighthouse Financial Group LLC, a small prime-brokerage firm serving more than 20 hedge fund clients, closed.

“Effective Aug. 3, 2010, Lighthouse has suspended trading activities until further notice,” the firm said on its website and reported in Securities Technology Monitor, a trade publication.

Jeffrey Morfit, chief executive of Lighthouse Financial, didn't return a call seeking comment about the firm's closing down.

A handful of firms have been shut down this year for failing to meet industry net-capital rules, while others facing capital problems have been pushed to merge, executives said. The closed firms include GunnAllen Financial Inc., Jesup & Lamont Securities Corp. and Chicago Investment Group LLC.

E-mail Bruce Kelly at


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