An NSF Check, a Cash Account, and a 10:00 A.M. Funding Gap
On Monday morning Coastal Securities' bank returns a $310,000 check from customer Dalton, a long-standing client, marked NSF. Dalton's purchase of 10,000 shares at $31 settled Friday in a cash account, and the shares are already in his account. The controller had counted the deposit when funding Friday's $9.8 million clearing deposit. Today another customer's $600,000 purchase settles, and the firm's operating account holds $180,000 against a clearing-house requirement of $2.1 million due at 10:00 a.m. The margin clerk proposes to carry a $310,000 debit in Dalton's account, hope for a wire, and take no other action.
1. What are the firm's obligations on Dalton's unpaid cash purchase, and what should it do today?
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A cash-account purchase must be paid for; the firm may not extend credit in a cash account without a margin agreement and a Reg T extension. With the check returned, the firm holds an unpaid $310,000 item and 10,000 shares the customer has not paid for.
- If Dalton wires cleared funds today, the trade stands and there is no free-riding.
- If not, the firm must cancel or liquidate promptly rather than carry the debit indefinitely. At $28 the sale produces $280,000 against the $310,000 obligation: a $30,000 shortfall plus ticket costs, charged to the account and, if uncollected, to the firm's P&L.
- Impose the free-riding consequence: restrict the account so future purchases require cash in advance (commonly a 90-day freeze) and give the customer written notice.
Do not leave the position unhedged while hoping for the wire. The clerk's plan converts a payment problem into an open market risk plus an unsecured receivable.
2. How does the $310,000 debit affect net capital and the customer reserve computation - and may the firm use the debit to shrink its reserve deposit?
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The two computations pull in opposite directions, which is the trap.
Net capital. An unsecured customer debit is not an allowable asset. The $310,000, less any realizable collateral value, is deducted from net capital. If the firm holds the stock and can sell it, only liquidation value nets against the debit; a long equity position carried as collateral or proprietary carries a 15% haircut. A $30,000 realized loss therefore reduces net capital by roughly that amount plus the deduction for any unsecured remainder.
Reserve. Customer debit balances are debits in the Rule 15c3-3 formula and do reduce the required deposit - but only for a bona fide customer debit. Once the firm has written the receivable off, or elected to cancel or liquidate the trade, it cannot keep taking the debit in the reserve computation. Doing so manufactures a reduction of the customer reserve out of a loss.
The FINOP should make the two decisions consistently, in writing, on the day of discovery.
3. How should the controller close the funding gap, and what are the net capital and ratio consequences of each option?
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The roughly $1.92 million gap must be closed before the 10:00 a.m. clearing deadline. Options and consequences:
- Unsecured bank line or owner advance: resolves liquidity but adds to aggregate indebtedness, worsening the AI to net capital ratio. Check the result against the 1,000% and 1,200% lines before drawing.
- Subordinated loan meeting Rule 15c3-1(d) (written, fully subordinated, minimum lock-in term): counts as net capital, improves the ratio - but it must be executed and funded before it is counted.
- Secured borrowing against proprietary securities: possible, subject to haircuts and pledge limits. Customer securities can never be pledged for the firm's borrowings.
- Selling proprietary inventory: converts to cash but realizes losses and haircuts.
- Using customer free credit balances: permitted only to the extent the reserve is computed weekly and fully funded in the special reserve account. Drawing on free credit balances while underfunded is precisely the abuse Rule 15c3-3 exists to stop.
Document the source selected, then rerun both the reserve and net capital computations for the week: the Dalton loss and any new borrowing change both numbers.