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New No-Action Letter Giving Broker-Dealers Relief on Lease Liabilities

In October 2018, the SEC issued another no-action letter and withdrew the original letter they released in November 2016. The new letter reiterates the previous one; however, it removes the requirement that a broker-dealer deduct from net capital the excess of a lease liability over a lease asset.

Lease Liabilities Background

In February 2016, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2016-02: Leases. Under the new standard broker-dealers will be required to recognize operating leases with terms of greater than twelve months on the statement of financial condition by recording a lease liability and corresponding right-of-use asset at the present value of future lease payments. The asset may also include initial direct costs, prepaid lease payments and any lease incentives. The effective date of ASU 2016-02 is for fiscal years beginning after December 15, 2018.

The changes to accounting for leases could’ve had a material impact on the net capital of a broker-dealer by requiring the right-of-use asset to be deducted as nonallowable while also including the lease liability in the aggregate indebtedness computation.  This would have required owners of broker-dealers to make additional capital infusions into the entity prior to this accounting rule taking effect or risk a potential net capital deficiency.

In November 2016, the Securities and Exchange Commission (SEC) Division of Trading and Markets issued a no-action letter stating it would “not recommend enforcement action if a broker-dealer computing net capital adds back an operating lease asset to the extent of the associated operating lease liability.  If the value of the operating lease liability exceeds the value of the associated operating lease asset, the amount by which the liability’s value exceeds the associated lease asset must be deducted for net capital purposes.  A broker-dealer cannot add back an operating lease asset to offset an operating lease liability unless the asset and the liability arise from the same operating lease; nor can a broker-dealer add back combined or aggregated operating lease assets to offset combined or aggregated operating lease liabilities.”

More on the Impact of New Accounting Lease Standards

With respect to how the no-action letter gives relief to the aggregated indebtedness calculation and ratio the SEC Division of Trading and Markets would “not recommend enforcement action if a broker-dealer determining its minimum net capital requirement using the AI standard does not include in its aggregate indebtedness an operating lease liability to the extent of the associated operating lease asset.  If the value of the operating lease liability exceeds the associated operating lease asset, the amount by which the lease liability exceeds the lease asset must be included in the broker-dealer’s aggregate indebtedness.  A broker-dealer cannot add back an operating lease asset to offset and operating lease liability unless the asset and the liability arise from the same operating lease; nor can a broker-dealer add back combined or aggregated operating lease assets to offset combined or aggregated operating lease liabilities.”

October 2018 No-Action Letter

In October 2018, the SEC issued another no-action letter and withdrew the November 2016 letter.  The new letter reiterates the above; however, it removes the requirement that a broker-dealer deduct from net capital the excess of a lease liability over a lease asset.  This change corrects the “hole” that was left from the previous letter.  Under the withdrawn letter net capital would have been reduced twice for the portion of the liability that exceeded the asset, first by recording the expense and second by deducting the difference between the asset and liability.  This would have been the case because any difference where the liability exceeded the asset would mean that more expense was being taken than actually being paid. The requirement that broker-dealers analyze each lease liability and related asset individually remains in effect.

Click here to acess the new no-action letter.

Author: Jessica Cicero, CPA  | jcicero@withum.com


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