Ch 2: Broker-Dealer Operations Flashcards
How may broker-dealers act?
As agent (broker) or principal (dealer)
Agent
Firm attempts to locate another investor to take the other side of a trade
Principal
When a firm trades for (or from) its proprietary account.
Increased risk requires higher net capital.
Market Maker
A firm that stands ready to buy or sell a specific security on a principal basis.
Municipal Broker’s Broker
Specialized entity that brokers trades for other municipalities.
- Acts exclusively as an undisclosed agent in the purchase of munis for a registered b/d or municipal securities dealer that has no “customers” and that doesn’t have or maintain any munis in its proprietary or other accounts.
- To operate as a broker’s broker, firm must have and maintain net capital of $150,000 or more.
Riskless Principal Transaction
When b/d accepts an order from a customer, buys the shares for its own account, then fills its customer’s order from the shares in its own account.
Stock passed through inventory briefly.
Generally treated as broker transactions.
Regulation SHO
SEC rule that governs short sell trading strategies. Aiming to prevent unethical practices, Regulation SHO applies standards to the behavior and practices of both brokers and traders/investors.
Rule 200 - Marking Requirements
Requires that a broker-dealer must mark all sell orders of any equity security as “long,” “short” or “short exempt.”
A sell order may only be marked “long” if the seller is “deemed to own” the security being sold and either: (i) the security to be delivered is in the physical possession or control of the broker or dealer; or (ii) it is reasonably expected that the security will be in the physical possession or control of the broker or dealer no later than the settlement of the transaction. The “short exempt” marking requirement applies only with respect to the short sale price test restriction.
Owner of a Security - Rule 200
If he/she has purchased the security or entered into an unconditional and binding contract to make the purchase, but has yet to receive the security.
Or if he/she holds a security futures contract to purchase the security and received notification the position will be physically settled and he/she will receive the security.
Aggregation - Rule 200
B/d must aggregate all its positions in a security to determine its net long (short) position.
Unless qualifies for independent trading unit aggregation.
Long position
Seller owns the security being sold and it’s either in the possession or control of the b/d or it’s reasonably expected that the security will be delivered not later than settlement day (T+2).
Short position
Seller owns the security being sold, but doesn’t reasonably believe it will be in the possession or control of the b/d prior to settlement day (T+2), or, the seller doesn’t own the security, or, any sale that’s effected by the delivery of a borrowed security.
Rule 203 - Locate Requirements
Rule 203(b)(1) generally prohibits a broker-dealer from accepting a short sale order in any equity security from another person, or effecting a short sale order in an equity security for the broker-dealer’s own account, unless the broker-dealer has:
- borrowed the security, or; - entered into a bona-fide arrangement to borrow the security, or; - reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due.
Rule 203(b)(2) provides an exception to the locate requirement for short sales effected by a market maker in connection with bona-fide market making activities.
May a b/d use borrowed securities to make deliver?
Generally, no.
Exceptions:
- B/d lending security to another b/d.
- B/d knows, or has been led to believe the seller owns the security being sold and will deliver it by the scheduled settlement date, but the seller fails to deliver.
- Before a loan arrangement for a security to make delivery or before a fail to deliver, an exchange or a securities association discovers that the sale originated from a good faith mistake, although the b/d use due diligence regarding the sale, and the requirement of a buy-in would cause undue hardship or sale had been effected an unacceptable price.
Exceptions to Acceptance of Short Sales Requirements
- Unless b/d accepting short sale has contractual responsibility to comply.
- When b/d informed the owner of a security will deliver security when all possible restrictions removed. (If not delivered w/in 35 days after trade date, b/d effecting the transaction must borrow or buy a security in like kind.
- Transactions by a market maker in a connection with bona fide market making activities in the security.
Threshold securities
Threshold securities are US equity securities where, for 5 consecutive settlement days:
- Have an aggregate fail to deliver position at a NSCC totaling 10,000 shares or more; and
- The level of fails equal to at least 0.5% of the issuer’s total shares outstanding, and
- Are included on a list published by a self-regulatory organization (SRO).
Fail to deliver in threshold security
Fail-to-deliver status for 13 continuous settlement days:
- B/d must immediately close out the fail-to-deliver by purchasing like kind securities
- The closeout must occur no later than the start of the trading day after the 13th settlement day.
Order Ticket (memorandum)
Form used to place an order.
Account name & number Account type (cash/margin) Security name or symbol Terms and Conditions of sale Discretionary Order/Discretion Not Exercised Solicited/Unsolicited
