SEC Limits the Use of Series LLCs for Broker-Dealers
The SEC recently took the wind out of the sails of broker-dealers hoping to use series LLCs for multiple broker-dealers within one LLC. In a letter dated September 1, 2009, the SEC staff advised the Financial Industry Regulatory Authority (FINRA) that the proposed series LLC structure would not pass muster under the SEC’s net capital rule, its customer protection rule, and its financial reporting rule.
FINRA proposed, for example, that an LLC would have two series, one to operate a retail broker-dealer and one to operate an institutional broker-dealer. The LLC, and not either series, would register with the LLC.
The LLC itself would have no business operations. Instead, each series would operate a separate brokerage and would have separate assets and liabilities. The liabilities of one series would not be enforceable against the assets of the other series or the overall LLC, but the assets and liabilities of the two series would be aggregated on the LLC’s consolidated financial statement, which is filed periodically with the SEC. (For a description of how series LLCs work, see my previous post, here.)
The SEC’s staff pointed out that partitioning each series’ assets and liabilities within the LLC would be inconsistent with applying the net capital rule at the LLC level. Reporting the LLC’s financials on a consolidated basis would greatly impair the SEC’s and FINRA’s ability to supervise the LLC’s financial position, since the SEC would not be able to determine the financial position of the LLC and each series without substantial effort.
The staff pointed out other problems regarding customer reserve accounts and equal treatment of customers in the event of a liquidation proceeding. The bottom line was that the idea of having the LLC be the regulated entity while yet having each series be treated as separate, independent entities for purposes of their assets and liabilities, is inconsistent with the SEC’s regulations.
Series LLCs have a place in the business world. But at least in this case, asking regulators to ignore the inherent inconsistency between regulating only the overall LLC, while disregarding the separate liability shield of each series within the LLC, was simply a bridge too far.
