Unit 11- Account Features (Margin)

Cash accounts

customer pays in full for securities purchased and is expected to pay by EOD on the settlement date (T+1)

Regular way settlement

industry standard enforced by the self-regulatory organizations, primarily FINRA (T+1)

Regulation T

gives Federal Reserve Board authorization to set minimum deposit in margin accounts (federal gov. expectation for timely payment), payment must occur not later than two business days after the standard settlement period (S+2)

Margin accounts

allows customers to trade larger positions than they could afford by borrowing either cash or securities through their BDs, leverage investment by borrowing a portion of the purchase price or leverage increases in the rate of return if the security price moves in the direction the customer wants

Long margin account

customers purchase securities with borrowed money and pay interest on the money borrowed until the loan is repaid, bullish investors use to purchase securities they believe will increase in value (minimum maintenance requirement 25%)

Short margin account

customers borrow stock and then sell that stock short, enabling the customer to profit if its value declines, bearish investors use to purchase securities they believe will decrease in value (minimum maintenance requirement 30%)

Leverage

using borrowed money or stocks (i.e. using debt fund an investment/purchase securities)

Disadvantage of margin accounts

investor pays interest on the amount borrowed and leverage will increase the rate of loss if the security price moves against the investor

Required forms to add margin

credit agreement, hypothecation agreement, and consent to loan agreement (optional), BD is also required to provide customer with risk disclosure document

Credit agreement

discloses the terms of the credit extended to the customer by BD, including the method of interest computation and a description of situations under which interest rates may change

Hypothecation agreement

allows BD to hold the securities in the account as collateral for the loan, all customer securities must be held in street name when in a margin account

Consent to loan agreement

gives firm permission to loan the customer's margin securities to other customers or BDs, usually to provide shares for short sales where securities need to be borrowed

Eligible accounts for margin

individual and joint, corporate and partnership (depending on bylaws/corporate charter if silent it is allowed), and trust and other fiduciary accounts (trust doc must specify margin allowed if silent then it is not)

Ineligible accounts for margin

those that have contribution limits (IRAs and other retirement plans) and custodial accounts may not be margin accounts

May be purchased on margin & used as collateral for a margin loan

• Exchange-listed stocks and bonds

• Nasdaq stocks

• Over-the-counter (OTC) issues approved by the Federal Reserve Board (FRB)

• Warrants

Cannot be purchased on margin or used as collateral for a margin loan

• Options (calls and puts)

• Rights

• Non-national Market System (non-NMS) securities

• OTC issues not approved by FRDB

• Insurance contracts

Cannot be purchased on margin but can be used as collateral after being held for 30 days

• Mutual funds

• New issues, if securities can be used as collateral for a margin loan

Exempt securities from the FRB's Regulation T margin requirement

U.S treasury bills, notes, and bonds, government agency issues, and municipal securities (if bought or sold on margin the firm determines the initial deposit requirement)

Margin

amount of cash or securities that must be deposited to provide sufficient equity to meet the minimum requirement (50%) for a margin purchase or load

Marginable

securities that can be used as collateral for a margin loan

Regulation T minimum deposit

50% of purchase price in margin account, anything greater than $4k (more common), can be changed by the Federal Reserve Board anytime it deems appropriate

FINRA minimum deposit

$2k or 100% of purchase price is less than $2k in margin account, less than $2k to $4k (used for smaller investments)

Magin maintenance call

occurs when the equity in a margin account falls below the minimum maintenance requirement, BD will require client to deposit additional cash or securities to bring the account back up to the required level (25% of account’s market value – if not met the BD may liquidate assets to bring the equity up to 25%

Fee-based accounts

account where customer is charged a regular and ongoing fee for all the trading in the account, fees may be a set amount charged monthly or quarterly but is often based on the size of the account (% of account’s value) charged annually – best for investors that trade frequently not those that use a buy-and-hold approach

Commission-based accounts

customer is charged a fee for every trade based on the size of the trade where the schedule is disclosed at account opening, larger trades have a smaller commission as a percentage of the trade – better for strategic investors that don’t trade frequently

Wrap fee accounts

firms provide a group of services (i.e. asset allocation, portfolio management, executions, and admin) for a single fee that may be monthly or quarterly but often a % of AUM – IA accounts

Investment advisory accounts

account where RIAs/IAs provide investment advice to clients and charge wrap fees, BD must meet fiduciary requirements and register under state or federal law, must include statement that client can get the same services on a separate basis for a lower cost

Solicited trade

BD recommends the purchase of a security to a customer, something the BD did that led to the customer placing a trade – must be marked as such on the trade ticket

Unsolicited trade

if client places a trade that has not been suggested by the BD or a representative – must be marked on trade ticket or order form

Discretionary trade

customer may give trading authority to a registered representative (RR) to place trades in the customer's account without their permission, requires discretionary authority – must be marked on trades

Requirements for discretionary trade

1) client agrees in writing 2) principal of firm approves authority in writing

Discretionary authority

type of POA that is granted by the customer to the RR, not the BD, if representative leaves or die the authority ends

Three A’s of discretion

action (buy or sell), amount (shares or dollars), and asset (specific asset bought or sold)

Non-discretionary trade

customer must provide (or agree to) all three of the A elements before the trade is entered, each element is clearly identifiable

Time and price authority

allowing the representative to choose the time or the price at which a trade is executed (not considered discretion)