The Audit Department often receives questions regarding the classification of deficit balances. The questions vary from the ability to offset accounts with related ownership to application of CFTC Interpretation No. 12. Regulatory pronouncements governing the treatment of deficits have not recently changed. However, the treatment of deficits remains a highly visible and sometimes confusing area in commodities accounting.

Attached please find our internal guide regarding the proper financial reporting of debit/deficits on the segregation, cross-margin segregation, and secured amounts statements as well as the balance sheet. The last page summarizes the regulatory treatment of "related" accounts for debit/deficit reporting.

If you have any questions, please contact the Audit Department at (312) 930-3230.

Debit/Deficit Guideline

Segregated/Secured Amounts Statement
Treatment of Debit/Deficit Accounts

 Notes:

(1)	Under CFTC Interpretation 12, a segregated debit/deficit may only be offset with segregated credit equity in the identical currency as that of the debit/deficit. For example, a segregated debit/deficit denominated in Deutsche Marks cannot be offset with segregated funds in U.S. dollars. Likewise, a segregated debit/deficit denominated in U.S. dollars may not be offset with segregated funds denominated in any foreign currency. For balance sheet presentation, a segregated debit/deficit may be secured with "free funds" in a related account denominated in a different currency. Note that for secured amount deficits, all currencies should be combined.
(2)	Debit/deficits for cross-margin accounts are computed using the combined commodity and security cross-margin equity balances. Debit/deficits are computed independently for cross-margin and noncross-margin accounts and reported on the respective segregation statement. For balance sheet presentation, "free funds" in either account may secure the other.
(3)	U.S. Treasury securities used to offset a debit/deficit must be held in the same origin as the deficit. Additionally, the firm must possess a written authorization from the customer to liquidate the securities at the firm's discretion. U.S. Treasury securities cannot be used to offset a segregated debit/deficit denominated in a foreign currency, however, can be used to offset secured amount deficits denominated in foreign currencies.
Note:	With respect to a commodity trading account, "free funds" are funds in excess of the initial margin requirements, provided a written authorization to transfer funds is on file. Each such transfer must be by the customer�s instructions.

Statement of Financial Condition
Treatment of Debit/Deficit Accounts

 Notes:

(1)	Refer to note (1) on page 2.
(2)	Refer to note (2) on page 2.
(3)	The account may be secured to the extent that the customer/noncustomer has "free funds" in one type of account. See "Note" on page 2.
(4)	Readily marketable securities used to secure a debit/deficit must be held in the same origin as the account in debit/deficit (if held in a different origin, the securities would be counted towards free funds in determining the amount available to secure the deficit). The account may be secured to the extent of the securities' collateral value (i.e. market value less applicable haircuts). The firm must possess a written authorization from the customer/noncustomer to liquidate the securities at the firm's discretion.
(5)	The account may be secured if the firm issues a margin/equity call for the debit/deficit balance and there was: (1) no debit/deficit balance in the account the previous business day, or (2) a debit/deficit balance in the account on the previous business day where the firm received sufficient new funds to liquidate the previous day's debit/deficit in its entirety.
(6)	A regulated commodity account cannot guarantee another account�s debit/deficit unless funds are actually transferred from the guarantor's account thereby reducing or eliminating the debit/deficit in the guarantee's account. Also, the firm must possess a written authorization for such transfers. Each such transfer must be by the customer�s instructions.
(7)	The account may be secured to the extent that there are "free funds" in the account of the guarantor. The firm must also possess a satisfactory written guarantee agreement (refer to CFTC 1-FR Instruction Manual) wherein the guarantor agrees to satisfy a debit/deficit in the customer/noncustomer account. The actual transfer of funds is not required. Note that a margin charge is still applicable as guarantees are not acceptable for margin purposes.
(8)	The account may be secured to the extent that a written agreement exists between the firm and the individual or entity to whom the commissions are due which specifically allows the firm to withhold commissions from the account executive to cover specific customer/noncustomer debit/deficits. The agreement must be specific as to the extent and manner in which the commissions will be withheld. Also, the commissions withheld must be due to the account executive at the report date, and the firm must continue to withhold these commissions until the customer/noncustomer repays his debit/deficit.

Broker/Dealer Notes:

For Broker/Dealers that reflect total equity debit/deficits on the balance sheet, an additional evaluation should be made in order to quantify the impact on capital due to option value in the account. Analyze each deficit to determine the existence of non-allowable Net Liquidating Value (NLV) deficits (i.e. after securing with available funds, commissions, one-day deficits, etc.). Assuming all non-allowable NLV deficits have been identified, the following chart indicates the required capital charge to be taken on the Computation of Net Capital Line 6.A.2.

Notes:

(1)

A capital charge applies for the difference between the non-allowable total equity deficit and the non-allowable NLV deficit. For example, an account has a TE deficit of $1 million, a NLV deficit of $1.2 million, and $500,000 of readily marketable securities. The balance sheet would reflect $500,000 as allowable and $500,000 as a non-allowable asset. The net capital computation would reflect a charge of $200,000 (non-allowable NLV ($1.2 million less $500,000 of securities or $700,000) less non-allowable TE of $500,000).

(2)

The total equity deficit should be reflected as an allowable receivable to the extent it is secured by net long option value in the account. For example, an account has a TE deficit of $1 million and a NLV deficit of $100,000. The balance sheet would reflect $900,000 as allowable and $100,000 as a non-allowable asset. A charge to the capital computation would not apply.

Offsetting Guide
Treatment of Debit/Deficit Accounts 

Notes:

(1)	See Note (1) on Page 2.
(2)	Accounts have to be of identical ownership and evidence must be maintained on file. An account of an individual and that individual�s sole corporation (i.e. John Doe and John Doe Corp.) cannot be combined for offsetting debit/deficits.
(3)	Funds available in a partnership account or joint account cannot be used to offset debit/deficits in an individual partner/joint owner�s trading account. However, funds in an individual partner/joint owner�s trading account can be used to offset debit/deficits in respective partnership/joint accounts (For partnership accounts, the individual cannot be a limited partner). This can be done to the extent that there is a written agreement between the partners (partnership agreement) or joint owners stating that the individual partners/joint account owners are jointly and severally liable for the debts of the partnership or joint tenancy. Additionally, the firm must possess a written agreement from the individual partner/joint account owner specifically authorizing the firm to transfer funds from the individual�s account to the partnership/joint account. Each transfer must be by the customer�s instructions.