Customer Agreements - Margin

Now that you understand the basic new account requirements, this section covers margin accounts: where customers borrow money from the broker-dealer to purchase securities. Margin involves multiple regulators, each setting different requirements.

Margin Account Overview

• A margin account allows a customer to borrow money from the broker-dealer to purchase securities or borrow securities for short sales
• Opening a margin account requires executing a margin agreement in addition to the standard new account form
• The margin agreement has three components, two of which are mandatory

Components of the Margin Agreement

• The hypothecation agreement and credit agreement must be signed promptly after the first margin transaction; they do not need to be signed before the account opens
• The loan consent form is the only optional component

Exam Tip: Gotchas

• The loan consent form is the ONLY optional component of the margin agreement. Without it, the customer still has a fully functional margin account; the firm just cannot lend the customer's securities to others.

Rehypothecation

• When the broker-dealer pledges the customer's margined securities as collateral for its own borrowings (typically from a bank), this is called rehypothecation
• The broker-dealer may rehypothecate customer securities up to 140% of the customer's debit balance
• The broker-dealer may not pledge more than 140% of what the customer owes

Exam Tip: Gotchas

• Rehypothecation is limited to 140% of the customer's debit balance, not 140% of the market value of securities. This is a common exam trap.

Who Sets Margin Requirements

This is one of the most-tested distinctions on the exam:

• Regulation T (Reg T) is promulgated by the Federal Reserve Board under the Securities Exchange Act of 1934
• The 50% initial margin requirement has been in effect since 1974
• Broker-dealers may impose higher requirements (called "house requirements") but may never set requirements lower than Reg T or FINRA minimums

Exam Tip: Gotchas

• The Federal Reserve (Reg T) sets the INITIAL margin at 50%. FINRA Rule 4210 sets the MAINTENANCE margin at 25% (long) and 30% (short). Broker-dealers may set HIGHER house requirements but may NEVER go LOWER than Reg T or FINRA minimums.

Long Margin Accounts

• Initial margin (Reg T): 50% of the purchase price
  • Example: To purchase $10,000 of stock on margin, the customer must deposit at least $5,000
• Maintenance margin (FINRA): 25% of the current long market value (LMV)
• If equity drops below 25% of the LMV, the broker-dealer issues a margin call (maintenance call)
• The customer must deposit additional cash or securities to bring the account above maintenance
• If the customer fails to meet the margin call, the broker-dealer may liquidate securities without the customer's consent

Short Margin Accounts

• In a short sale, the customer borrows securities from the broker-dealer and sells them, hoping to buy back later at a lower price
• Initial margin (Reg T): 50% of the short sale proceeds
• Maintenance margin (FINRA): 30% of the current short market value (SMV)
• Short accounts have a higher maintenance requirement (30%) than long accounts (25%) because short positions have theoretically unlimited risk

Margin Calls

• A margin call is issued when an account's equity falls below the minimum maintenance requirement
• The customer must satisfy the call by depositing additional funds or marginable securities
• If the customer does not respond, the broker-dealer may liquidate positions without prior notice or consent
• The broker-dealer is not required to give the customer a specific number of days to meet a margin call

Special Memorandum Account (SMA)

• The SMA is a bookkeeping entry (not a separate account) that tracks excess equity in a margin account
• Excess equity is created when the market value of securities rises above the Reg T requirement or when the customer deposits more than required
• The customer may use the SMA to purchase additional securities or withdraw cash, as long as the account remains above the maintenance margin requirement
• The SMA can never have a negative balance

Non-Marginable Securities

Certain securities cannot be purchased on margin and require 100% cash payment:

• Options contracts with less than 9 months to expiration
• New issues for the first 30 days after the IPO
• Mutual fund shares for the first 30 days after purchase
• Penny stocks (OTC securities priced below $5 per share)

Exempt Securities - Reduced Margin

U.S. Government obligations and certain sovereign debt have reduced margin requirements based on maturity:

• All other exempt securities: 7% of market value
• Investment-grade corporate debt: 10% of current market value