Inability to meet Finra's net- capital requirements will force more small and independent broker- dealers to shut down this year.
Last week, Jesup & Lamont Securities Inc. became the latest in an increasing number of broker-dealers closed by regulators after their capital fell to levels deemed inadequate to fund continued operations. Such net-capital violations have recently plagued a number of small firms or independent broker-dealers, with some facing legal liabilities from private deals that have imploded.
“You're going to see more of this,” said Larry Papike, president of Cross-Search, a recruiting firm that specializes in independent-contractor representatives and broker-dealer executives.
The market downturn of 2008 and early 2009, coupled with pressure from securities regulators, is putting a squeeze on firms that don't carry an excess of net capital, he said.
“A lot of small firms are struggling,” said Joseph Steinman, partner and chief compliance officer with wealth management firm Fogel Neale Partners LLC.
“How many? You have no idea,” Mr. Steinman said.
His advice to broker-dealer executives is to have as much capital on hand as possible.
“The regulators are obviously not comfortable anymore. Raise capital, even though it's tough to do right now,” Mr. Steinman said.
Bob Matthews, a former
Citigroup Inc. brokerage executive and now an investor actively pursuing wealth management firms, offers a reason for the difficulty: “Most broker- dealers can't put forth a cogent, rational thought process as to why the capital can change the firm's business plan and improve profit.”
On June 18, the
Financial Industry Regulatory Authority Inc. ordered Jesup & Lamont Securities and its 300 reps to cease conducting business other than liquidating transactions. Although it is unclear what caused the net-capital violation, the firm, among its other legal woes, was reportedly facing pressure from the Securities and Exchange Commission over sales of $11 million in private shares of Jesup & Lamont's stock.
Alan Weichselbaum, chief executive of Jesup & Lamont Inc., the broker-dealer's parent company, didn't return calls last week requesting comment. The company's general counsel, Todd Zuckerbrod, said that the firm is taking “active steps” to be back in business, but declined to give a specific timeline for reopening.
On June 8, vFinance Investments Inc., with 154 reps, said it had reported to Finra and the Securities and Exchange Commission during the firm's fiscal year that it had been in the early warning stages of net-capital violations. But the condition has been alleviated, said Mark Goldwasser, chief executive of National Holdings Corp., which is the parent company of vFinance.
National Holdings said that it raised $1.7 million from new investors, along with certain members of management and the board.
In March, GunnAllen Financial Inc., facing tens of millions of dollars in legal liabilities, went out of business after it violated net-capital rules, scattering 400 reps and advisers.
The SEC's net-capital rule requires all broker-dealers to maintain a debt-to-liquid-asset ratio of no more than 15-to-1. Assets considered liquid are cash and securities such as Treasuries that can be converted to cash quickly.
A vexing issue for broker-dealers is that net-capital requirements vary based on the broker-dealer's size, riskiness of its business model and amount of litigation each faces. Because it hinges on transactions, a firm's net capital is also a fluid figure.
Firms facing net-capital issues have been on Finra's radar of late. Finra recently informed other small to midsize broker-dealers that the lack of adequate reserves is a serious issue.
Finra sees about a dozen net-capital violations per year, and there has been no increase through the first half this year, said spokesman Herb Perone. He declined to comment about the potential number of future broker-dealer violations.
In November, Finra said that Cullum & Burks Securities Inc. was in violation of its net-capital requirement. The firm then raised additional capital to continue normal operations, according to its Finra record.
That wasn't enough. Last month, Finra suspended the license of Cullum & Burks, which was heavily involved in the sale of private placements that went bust.
As of March 31, Jesup & Lamont Securities had net capital of $771,652, which was $521,652 in excess of the minimum requirement, according to a 10Q filing by the firm's parent company last month.
That SEC filing also revealed that parent Jesup & Lamont Inc. has been losing money. During the first quarter this year, the company lost $3.75 million, compared with a loss of $2.9 million a year earlier.
The parent company has been working to beef up its capital position for months, but so far to no avail.
In February, it said it had reached an agreement in principle to merge with Tri-Artisan Capital Partners LLC, a merchant bank. Part of the deal included raising capital “to fund the combined company's growth plan,” according to a statement released at the time.
The deal was supposed to close by the end of the second quarter, but it is unclear whether the transaction was completed. Gerald Cromack, Tri-Artisan's co-managing partner, didn't return calls last week seeking comment.
E-mail Bruce Kelly at [email protected].
