Broker-Dealer Net Capital Relief for Operating Leases

Christopher G. Johnson, CPA
On Nov. 8, 2016, the Securities and Exchange Commission (SEC) Division of Trading and Markets staff issued a no-action letter to the Securities Industry and Financial Markets Association (SIFMA) that provides net capital relief related to implementing the new accounting guidance for operating leases.

For broker-dealers,  Accounting Standards Update (ASU) No. 2016-02, “Leases” (Topic 842) will be effective for interim and annual periods beginning after Dec. 15, 2018. Under current guidance, most leases are considered operating leases, which are not accounted for on the lessees’ balance sheets. Under the new standard all leases, whether finance or operating, will be recorded on the balance sheet unless they are subject to the short-term lease accounting policy election (meaning the lease term is less than 12 months in duration). Under the new guidance, an asset will be recorded to represent the right to use the leased asset, and a liability will be recorded to represent the lease obligation.

The lease liability is measured initially at the present value of the lease payments, and the right-of-use asset is measured initially as the lease liability amount, adjusted for lease incentives received, initial direct costs incurred, and any lease payments made before or at commencement.

Under rule 15c3-1 of the Securities Exchange Act of 1934 (Exchange Act), when computing net capital, a broker-dealer makes adjustments to its equity, including making deductions for any asset that is not readily convertible into cash (deemed to be nonallowable assets).  Broker-dealers subject to the aggregate indebtedness standard are required to maintain net capital in an amount that is at least equal to the greater of a fixed-dollar amount specified in the rule and an amount determined by applying the 15-to-1 aggregate indebtedness to net capital ratio. Without further interpretation, it is assumed that the right-of-use asset would be considered a nonallowable asset and deducted in determining net capital. The lease liability would be considered aggregate indebtedness and potentially increase the required amount of net capital to be maintained.

The no-action letter provides that for operating leases only, the Division of Trading and Markets will not recommend enforcement action to the SEC under Exchange Act Rule 15c3-1 if a broker-dealer does either of the following:
  • Adds back the right-of-use asset to the extent of the associated lease liability when computing net capital. If the value of the lease liability exceeds the value of the associated lease asset, the amount by which the liability’s value exceeds the associated lease asset must be deducted for net capital purposes.
  • Does not include in its aggregate indebtedness a lease liability to the extent of the associated lease asset when determining its minimum net capital requirement using the aggregate indebtedness standard. If the value of the lease liability exceeds the associated lease asset, the amount by which the lease liability exceeds the lease asset must be included in the broker-dealer’s aggregate indebtedness.

In order to apply this relief, a broker-dealer must track and analyze right-of-use lease assets and lease liabilities on an individual lease-by-lease basis. The broker-dealer is allowed to offset the lease asset and liability related only to a specific lease. A broker-dealer cannot apply the relief to combined or aggregated lease assets to add back or offset combined or aggregated lease liabilities. Furthermore, this relief does not apply to finance leases.

Broker-dealers should start preparing for implementation by enhancing lease monitoring systems to verify appropriate lease-by-lease information is available and by adding internal controls to verify the information is complete and accurate.


1 SEC registered broker-dealers are considered to be public business entities because of the requirement to file audited financial statements with the SEC.
2 Securities Exchange Act of 1934, 17 CFR 240.15c3-1(c)(2)