Regulatory Notice 23-21

On December 22, 2023, the Financial Industry Regulatory Authority (FINRA) issued new Regulatory Notice 23-21 in relation to broker-dealers‘ obligations under
– SEA Rule 15c3-1 on net capital requirements of brokers or dealers;
– SEC Rule 17a-3 on recordkeeping requirements of certain exchange members, brokers, and dealers as regards account and book records, securities transactions, and various other activities; and
– SEC Rule 17a-5 on various reports to be made by certain brokers and dealers in relation to account transactions of customers (e.g. for clearing or margin transactions).
In this Regulatory Notice, FINRA addresses various issues that have arisen in this context particularly as regards compliance with Accounting Standard Code (ASC) 606 of the Financial Accounting Standards Board (FASB) on „Revenue from Contracts with Customers“. Specifically, the notice highlights potential compliance issues arising from the misapplication of ASC 606 in the revenue recognition process, leading to non-compliance with the beforementioned SEA Rules 15c3-1, 17a-3, and 17a-5 and overstated revenues, understated non-allowable assets and liabilities, and, in some cases, net capital deficiencies or a material reduction in excess net capital.
In detail, FINRA emphasizes that revenue recognition should occur when the related performance obligation has been satisfied, either at a point in time or over time, in accordance with the contract terms. Any fees that a broker-dealer has received from a customer should NOT be declared as „revenues“, if the corresponding performance obligation has not yet been satisfied by the firm. To ensure compliance with ASC 606 in recognizing revenue from contracts with customers, firms are advised to:
– Demonstrate, through a documented policy and consistent analysis, the basis for revenue recognition practices in accordance with ASC 606.
– Analyze each contract with customers for performance obligations and associated revenue.
– Document when and how each performance obligation has been satisfied.
– Prepare annual reports in accordance with SEA Rule 17a-5 and include necessary footnote disclosures, if necessary to demonstrate observance with the principle.
– Ensure revenue reported in financial statements is consistent with ASC 606 and annual report disclosures.
– Firms should review their revenue recognition practices to ensure alignment with the guidance provided in this notice, with the understanding that rule language takes precedence over the notice’s presentation.