Broker-Dealer Expense Sharing with Third Parties

Expense sharing agreements between broker-dealers and third parties are a hot topic for FINRA and the SEC. Firms and their FINOPs should fully understand the guidelines provided within Notice to Members 03-63.

What is an Expense Sharing Agreement?

As with any entity, a broker-dealer incurs costs related to running and operating its business. For example, these costs may include office space, utilities, personnel, and technology. It is common for a broker-dealer to share these expenses with another party, often a holding company or a third party with related owners.  However, in these cases, it is vital that the broker-dealer establishes what is known as an expense sharing agreement. The expense sharing agreement clearly defines which portion of each expense is allocated to the broker-dealer. 

In general, broker-dealers and their FINOPs should be aware of the basic principles and record keeping requirements with respect to expense sharing agreements. The firm must execute the expense sharing agreement, clearly document the rationale behind the allocation of expenses, review the agreement periodically, and update it as needed.

Examples of Shared Expenses

While the below examples are common occurrences, it is imperative for a broker-dealer to examine all aspects of its business, identify any possible shared expenses with third parties, and allocate appropriately.

Shared Office Space

If the broker-dealer uses an office within a larger office space leased by the holding company or a related third party, the broker-dealer would be responsible for the portion of rent that covers the square footage of the office in which it conducts business. Additionally, the broker-dealer must consider the utilities and ANY and ALL other items of which they consume a portion. These expenses should also be allocated appropriately.

Shared Personnel

It is also important to consider the personnel who contribute their time and talents to the broker-dealer.  Some personnel may be full time employees of the broker-dealer, in which case 100% of their salary would be paid by the broker-dealer. 

In other cases, personnel may split their time between the broker-dealer and a third party. In these scenarios, the broker-dealer must adequately account for the portion of the salary that is consumed.  This can be done in two ways.  Some broker-dealers may choose to allocate a percentage of the employee’s salary based on the amount of time they are expecting to spend working for the broker-dealer.  Alternatively, the more precise way is to have the personnel log their actual time worked for the broker-dealer and in turn the broker-dealer pays the employee for the hours worked. 

Guidance from FINRA

FINRA has provided guidance related to expense sharing agreements in a Notice to Members issued in October of 2003, NTM 03-63. This notice requires broker dealers to “make a record reflecting each expense incurred to its business and any corresponding liability, regardless of whether a third party has agreed to assume the expense or liability.” NTM 03-63 also emphasizes the requirement for the broker dealer to maintain records of these expenses or liabilities assumed by third parties regardless of the accounting treatment or impact on net capital. 

Exceptions

Furthermore, the notice explains that these expenses and liabilities assumed by the third party are to be considered as liabilities of the broker-dealer for net capital purposes unless:

  1. The third party has agreed in writing that the broker-dealer is not responsible for the expense;
  2. There is no evidence that would indicate the broker-dealer is responsible for the expense or liability;
  3. GAAP does not treat the expense or liability as that of the broker-dealers; and/or
  4. The broker-dealer can provide evidence of the third parties independent ability to pay the expenses.   

In conclusion, the firm’s FINOP should be fully versed with all related rules and regulations set forth by FINRA and the SEC. They are ultimately responsible for considering such liabilities and ensuring the firm stays within its net capital requirements at all times.

Further guidance can be found in Notice to Members 03-63 on the FINRA website.

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