The Owner's Distribution: Three Ratio Tests and a Bad Receivable
Ridgeway Securities LLC is a carrying broker-dealer with a $250,000 minimum net capital requirement. As of the latest month-end computation its net capital is $318,000 and its aggregate indebtedness is $3,180,000. The sole owner has instructed the controller to wire him a $48,000 distribution on Friday. While reviewing the computation, the controller also finds a $22,000 receivable due from an affiliated company that was treated as allowable; there is no written agreement, no collateral and no repayment schedule, and the affiliate has negative net worth. The controller must decide what to do before the wire leaves, and the firm's annual audit is six weeks away.
1. May Ridgeway pay the $48,000 distribution? Test the request against each applicable restriction and show the numbers.
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No - it fails both prohibitions, and the request should be stopped before the wire.
Rule 15c3-1(e) bars an equity withdrawal (dividend, distribution, or unsecured loan) if, after giving effect to it, either:
- net capital would fall below 120% of the minimum dollar requirement: 120% x $250,000 = $300,000; or
- aggregate indebtedness would exceed 1,000% of net capital.
Post-distribution arithmetic:
- Net capital: $318,000 - $48,000 = $270,000
- Ratio: $3,180,000 / $270,000 = 11.78, i.e. 1,178%
$270,000 < $300,000 and 1,178% > 1,000%. Either test alone bars the payment.
The 1,500% absolute ceiling and the 1,200% early-warning line are different thresholds; being under them does not authorize the distribution.
2. After the affiliate receivable is deducted, what is the firm's position and what must the controller do?
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An unsecured receivable from a negative-net-worth affiliate, with no agreement, no collateral and no schedule, is not an allowable asset. It must be deducted from net capital, not merely monitored.
- Net capital: $318,000 - $22,000 = $296,000
- Aggregate indebtedness: $3,180,000 (unchanged)
- Ratio: $3,180,000 / $296,000 = 10.74, i.e. 1,074%
- 120% of minimum: $300,000, breached by $4,000
The firm has entered the early-warning zone. Rule 17a-11 requires written notice to the SEC and to FINRA (the designated examining authority) promptly - in practice within 24 hours - describing the deficiency and the cure plan. The distribution stays prohibited: even if the 120% test were met, the 1,074% ratio exceeds the 1,000% test.
3. What legitimate options exist to restore net capital, and which superficially attractive fixes would not work?
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Workable:
- Cash or marketable-securities capital contribution - immediate, with no ratio side-effect.
- A subordinated loan meeting Rule 15c3-1(d): in writing, fully subordinated to all creditor and customer claims, minimum lock-in term (at least one year), no acceleration and no repayment on demand. Executed and funded before the computation date.
- Collecting the affiliate receivable or converting it to collateralized, scheduled debt.
- Disposing of or writing off non-allowable assets.
Not workable:
- Reclassifying the affiliate receivable as allowable without collateral or an agreement.
- Counting an oral advance or an unsecured demand note as net capital.
- Deferring recognition of an expense or liability to keep the ratio down - that is a reporting violation layered on a capital problem.
- Paying the distribution and curing afterwards; the withdrawal itself is prohibited and the firm would be reporting a compliant computation it did not have.