NASD Examiners request further information from Member Firms regarding Expense Sharing Agreements

As a result of recent regulatory scrutiny regarding accounting practices that have been utilized by various public companies over the past year, the NASD has begun an investigation into the handling of expenses paid by parent companies on behalf of their broker/dealer affiliates which are subject to Expense Sharing Arrangements. As a result of the concerns expressed by the NASD, the NASD contacted all member firms in October who reported zero liabilities on their September 30th Focus IIA Report. As an extension of that inquiry, the NASD is currently contacting the same member firms to determine how many firms would be adversely affected, and or be placed in a net capital violation, as a result of a proposed interpretation which is being considered by the SEC on this topic.

The SEC's proposed interpretation appears to focus on the use of Expense Sharing Arrangements as it affects whether or not a broker/dealer must accrue all expenses paid on its behalf or assumed on its behalf, in its financial statements. Additionally, any liability recorded on the books would be required to remain on the financials of the firm until such time as the broker/dealer is able to confirm that such liabilities/expenses have been paid by its parent organization.

The SEC has stated that it has consulted with the office of the Chief Accountant re GAAP in this area and it fully expects to share a draft of the proposed interpretation with the SIA's capital committee as well as the AICPA task force before it is finalized.

Currently, there are no clear guidelines available to member firms on how to allocate expenses in response to the NASD's inquiry. Member firms should be aware that it has been represented that the SEC has advised the NASD that NASD membership can apply Staff Accounting Bulletin ("SAB") 55, dated November 30, 1983, Topic 1-B (Allocation of Expenses and Related Disclosure in Financial Statements of Subsidiaries, Divisions, or Lesser Business Components of Another Entity). While SAB 55 does not appear to apply to Broker/Dealers, the SEC is purported to be currently preparing interpretations that will apply to broker/dealer financials, and it is represented that they will conform generally to SAB 55 and SAB 79. Further, MGL has been advised by senior staff at the NASD that no action would be taken against the member firm for an apparent violation of SEC Rule 15c3-1 ("the Net Capital Rule") based upon the expense information received as a result of this inquiry, which if posted to the firm's financial statement pursuant to the proposed interpretation, would result in the firm's net capital position dropping below its required minimum statutory amount. Additionally, once the interpretation is released, we have been advised that the NASD will not retroactively enforce or otherwise take action against a member firm for not including such expenses on its financial statements prior to the effective date of the interpretation. It is anticipated that the SEC will issue its interpretation during the first part of 2003.

While the information requested may be difficult for member firms to ascertain, it has been represented to MGL that the utilization of a reasonable method of allocation, and a best "guess" number that is reasonably supportable will be acceptable to the NASD at this time. With that in mind, MGL has developed a list of questions its clients can use to assist the firm with allocating expenses to its operations in order to provide the NASD staff with both the number they are attempting to quantify, and an explanation of the allocation method utilized, along with the logic behind the method utilized to insure that a reasonable determination has been made.