Chapter 6: Customer Accounts Flashcards
Cash account information requirements - opening an account
- Customer’s name;
- Customer’s residential address;
- Customer’s date of birth;
- Customer’s Social Security number;
- Signature of the principal who approved the account; and
- Customer investment suitability information, including
Customer financial information;
Investment objective;
Risk tolerance; and
Time horizon.
NOTE: Customer signature NOT required
- In addition, the USA PATRIOT Act requires the broker/dealer to review the customer’s current, government-issued photo identification.
Cash account - Broker/Dealer responsibilities
- must have the customer verify new account information within 30 days of the account opening
- customer account information must be verified every 3 years (36 months).
- Firms must retain a record of the account’s last update for a period of 6 years after the update to any customer account information. If there are no updates, the record must be retained for 6 years after the account is closed.
Cash account - making purchases
Transactions must be fully paid for. Cannot conduct margin transactions.
For custodians of accounts owned by minors, securities are held in the name of the custodian, on behalf of the minor.
Cash accounts are also specifically required in the case of guardianship, because all securities purchased must be registered in the name of the guardian.
In a cash account, the investor must maintain a cash balance sufficient to purchase securities, or the investor must pay for the securities within 4 business days, which is the Reg T payment deadline. However, by establishing a margin account, it is possible to make purchases with credit extended by the broker/dealer.
Margin account balance requirements – long position
- Minimum initial balance of 50% of initial equity position.
- The minimum deposit is $2000.
- EXCEPT for if the entire purchase is less than $2000, then the entire purchase must be funded in the margin account
- must maintain at least 25% or face a margin call
Long equity formula (margin account)
Long market value (LMV) - debit balance (DB)= Long Equity (E)
Example: Buy 100 shares at $40/ea and meet Reg T 50% requirements, then LMV $4000 - DB $2000 = E $2000
Then stock falls to $35: LMV $3500 -DB $2000 = E $1500
Then stock rises to $43: LMV $4300 - DB $2000 = E $2300
Short equity formula (margin account)
Reminder: equity is always cash plus market value.
Short credit balance (CB) - short market value (SMV) = short equity (E)
Ex: Joe decides to sell short 100 shares of ABC at $60. He borrows 100 shares and immediately sells it at $60 (short sale proceeds) and meets Reg T by depositing $3,000 (50%).
CB $9,000 - SMV $6,000 = E $3,000
If the market value declines to $5,000, equity increases to $4,000 and the investor is ahead:
CB $9,000 - SMV $5,000 = E $4,000
On the other hand, if the market value rises to $7,500, the customer is behind because equity is now only $1,500.
CB $9,000 - SMV $7,500 = E $1,500
Equity formula with both short and long positions (margin account)
LMV - Debit Balance - SMV + Credit Balance = Account Equity
- Only two things affect equity: cash and market value changes.
“Going short against the box.”
A short sell against the box is the act of short selling securities that you already own, but without closing out the existing long position. This results in a neutral position where all gains in a stock are equal to the losses and net to zero. The purpose is to avoid realizing capital gains from a sale to close, and so it has been restricted by regulators in practice.
Ex: You own 100 shares of ABC and you tell your broker to sell short 100 shares of ABC without selling your long position, you conducted a short sale against the box - with the long position in one account and the short position in another.
Loan value (margin account)
Loan Value = Complement of Reg T% × Market Value
Maintenance rules - long margin account
Long maintenance is 25% of long market value. Thus, you buy 100 shares of Bulldurum at $40 and deposit $2,000 (Reg T). Maintenance is $1,000 or 25%.
If the account falls below minimum maintenance, there are three different ways to bring the account above maintenance:
1. the investor can deposit cash equal to the maintenance call;
2. deposit fully paid for marginable securities with a loan value equal to the margin call; or,
3. they can sell securities out of their account.
If the customer doesn’t meet the maintenance call, the broker/dealer has the ability to sell securities out of the customer’s account to meet the maintenance call.
Maintenance rules - short margin account
In a short account, maintenance is 30%; so if you sell short 1,000 shares at $60, you must deposit $30,000 (Reg T), and maintenance is $18,000 (30% of $60,000).
If the account falls below minimum maintenance, there are three different ways to bring the account above maintenance:
1. the investor can deposit cash equal to the maintenance call;
2. deposit fully paid for marginable securities with a loan value equal to the margin call; or,
3. they can sell securities out of their account.
If the customer doesn’t meet the maintenance call, the broker/dealer has the ability to sell securities out of the customer’s account to meet the maintenance call.
Three main suitability obligations
1.Reasonable basis suitability
2. Customer specific suitability
3. Quantitative suitability
The suitability obligation requires that firms and associated persons have ascertained a customer’s investment profile to determine the reasonable basis for a recommendation
Reasonable-basis suitability
Requires a broker to have a reasonable basis to believe, based upon reasonable diligence, that the recommendation is suitable for at least some investors
Customer-specific suitability
Requires that a broker have a reasonable basis to believe that the recommendation is suitable for a particular customer based upon that customer’s investment profile
Quantitative suitability
Requires a broker to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, are not excessive nor unsuitable for the customer, when taken together in light of the customers investment profile
Settlement: Prompt Payment for Securities Purchased
Except for government securities, payment for all securities transactions must be received by the broker/dealer within 4 business days, or no later than 2 business days beyond the regular way settlement date (Settlement + 2).
The NYSE and FINRA both accept 2 business days’ settlement for all securities transactions, EXCEPT governments and options (which are exempt from this rule) and cash trades made before 2:30 p.m. of the same day. Government securities are paid for and settle next day. Options contracts settle the next business day; the purchase and sale of the underlying securities are settled regular way, or T + 2.
Settlement: Good delivery
Occurs when a seller promptly delivers a properly endorsed certificate in good physical condition (not mutilated) with all of the legal items attached. It must be negotiable, or legible, and in proper denominations.
For equities, it must be breakable into 100 share round lots in one easy step. Thus, 5, 10, 20, 25, 50 are divisible into 100, but 15, 30, 40 or 80 are not.
In bonds, the legal opinion must accompany a municipal bond delivery unless marked ex-legal.
A letter of attestation from the transfer agent establishes good delivery.
Settlement: Collect on delivery
Payment is made upon delivery. The buyer and seller of the securities agree in advance upon the price with the proper documentation in place. If the funds are not available to pay for the securities at delivery, the receiving firm must promptly return the securities to the selling firm. No additional terms or payment extensions are available.
Settlement: When-, as-, and if-issued (or distributed) securities
In each of these cases, the transaction is conditional on a security that has been authorized, but not yet issued (or distributed). For example, in the case of a new issue of municipal securities, it includes the time period between the original date of the sale by the issuer and the delivery of the securities to and payment by the underwriter. Sales made during this period are subject to the issuance of the securities.
The when-issued confirmation will not include the settlement date, the accrued interest or the total amount paid for the bond. When the bonds are issued, the final confirmation will be sent. In the event a when-issued or when-distributed order is suspended, the client can place an order whenever he wishes, and the issuer is required to deliver securities based on regular way delivery and settlement. (NYSE Rule 63)
Settlement: Ex-rights, ex-dividends
On the day that a security is quoted ex-dividend, members are required to adjust the price and or quantity of shares prior to executing an order from another broker/dealer or customer. This also applies to securities that are quoted ex-rights, ex-distribution or ex-interest, unless the cash dividend or distribution is less than one cent. (FINRA Rule 5330)
Settlement: Extension of Time
An extension may be granted under certain circumstances.
Broker/dealers are allowed to waive Reg T calls in the amount of $1,000 or less. Under exceptional circumstances, the member firm may apply and FINRA may grant an extension to the payment date.
If no extension is received, the member firm must liquidate (sell) the securities and “freeze” the account.
Frozen Accounts
If payment is not received on time, the customer’s account is frozen for 90 days. During the 90-day period, no credit can be extended to the customer; however, the customer may continue to purchase securities on a cash basis.
If the customer fails to deliver the security by settlement, the broker/dealer could do a buy-in to close out the position. The broker/dealer is required to give 2 business days’ notice on the buy-in. In addition, the buy-in must be completed within 10 business days from settlement.
