Regulation of Credit

One of the main reasons the stock market crashed in 1929 was the aggressive lending of money to investors who wanted to purchase securities on margin. In an effort to ward off future excessive lending practices, authority was given to The Federal Reserve Board to regulate the extension of credit for securities purchases. Regulation “T’ of The Securities Exchange Act of 1934 allowed the FRB to regulate the extension of credit by broker dealers.

Regulation T

Once a customer has established a margin account, Regulation T sets the minimum initial requirement that must be met by the customer to purchase securities on margin. Regulation T currently requires that the customer deposit 50% of the securities purchase price. However the NYSE and FINRA require that a customer meet a minimum initial equity requirement of $2,000 before a firm may lend money to an investor. In order to establish a position in a new margin account, the investor must deposit the greater of $2,000 or 50% of the securities’ purchase price. The broker dealer may pledge or re-hypothecate the customer’s securities to obtain a loan at a bank for the customer. The broker dealer may pledge the customer’s securities with a value of 140% of the customer’s debit balance to obtain the loan for the customer. All excess margin securities must be segregated.

Example:

       Purchased                     Min Equity               Reg. T at 50%      Required Deposit

1000 ABC at 10

$2,000

$5,000

$5,000

1000 XYZ at 5

$2,000

$2,500

$2,500

1000 RTY at 3

$2,000

$1,500

$2,000

100 KLM at 15

$2,000

$750

$1,500

 

Note:  A customer may never be required to deposit more than the purchase price of the securities.

Investors who purchase securities on margin are charged interest monthly on the amount of the loan. An investor in theory may hold the securities on margin indefinitely and will be required to repay the principal amount of the loan upon the sale of the securities.  Investors purchasing securities on margin must hypothecate or pledge the securities they purchased as collateral for the loan. All securities purchased on margin will be held in the name of the broker dealer or “street name”. Holding the securities in the name of the broker dealer will allow the firm to liquidate the securities to protect their loan if the securities fall too far in value. Regulation T also establishes which securities may be purchased on margin. Marginable securities include:

  • All exchange listed stocks and bonds
  • All NASDAQ GLOBAL MARKET stocks
  • All securities on the FRB’s approved list

Investors who purchase securities on margin must deposit the required amount within five business days. If the investor is unable to make the deposit by the fifth business day the broker dealer can apply for an extension on behalf of the customer. The broker dealer must request the extension by writing a letter to either the NYSE or FINRA by the expiration of the fifth business day. An investor may meet their margin requirement by:

  • Depositing cash equal to the requirement; Or
  • Depositing marginable securities with a loan value equal to the amount of the requirement

Note: Broker dealers may waive a call for $1,000 or less.

A marginable security’s loan value is equal to the compliment of Reg. T. When Reg. T is 50% the security’s loan value is 50%

Example:

An investor purchasing $20,000 worth of securities in a margin account may meet the Reg. T requirement by:

  • Depositing $10,000
  • Depositing $20,000 worth of fully paid-for marginable securities.

Non-Marginable securities include:

  • Non NASDAQ OTC securities
  • Options
  • IPO’s and new issues for 30 days
  • When Issued, non exempt securities

Certain securities are exempt from the margin requirements of regulation T. While an investor may still borrow money from the broker dealer to purchase these securities, the investor is not required to deposit 50% of the purchase price. Securities exempt from Regulation T include:

  • US Government securities
  • US Government agencies
  • Municipal securities
  • Non convertible corporate debt

The initial margin requirement for exempt securities is set by the NYSE or FINRA. The initial margin requirement for US Government securities is 1-7% of the par value. For municipal securities, it is the greater of 7% of par or 15% of the market value.

House Rules

A broker dealer may elect to increase the minimum amount of margin that must be deposited by the investor or they may elect not to extend credit to customers at all. A broker dealer may never lower the amount of the required deposit below regulation T. or below the requirements of the NYSE or FINRA.

Need Help Passing Your Series 99 Exam?

 

D. Compliance and the Patriot Act

Related Articles
  1. Investing

    What Is a Broker-Dealer and Why Should You Care?

    Before deciding who to use for help with your investing, learn what brokers, dealers, and broker-dealers are and what services they provide.
  2. Insights

    FINRA: How It Protects Investors

    Find out the history of FINRA, and how it's organized to monitor the markets and protect investors.
  3. Financial Advisor

    Why Banks Don't Need Your Money to Make Loans

    Contrary to the story told in most economics textbooks, banks don't need your money to make loans, but they do want it to make those loans more profitable.
  4. Investing

    A Look At Primary And Secondary Markets

    Knowing how the primary and secondary markets work is key to understanding how stocks, bonds and other securities are traded.
  5. Investing

    Brokerage Functions: Underwriting and Agency Roles

    Learning about underwriting and agency roles at a brokerage can give insight into how securities are issued and traded.
  6. Personal Finance

    What is Fractional Reserve Banking?

    Fractional reserve banking is the banking system most countries use today.
  7. Investing

    How to Trade Futures Contracts

    Futures is short for Futures Contracts, which are contracts between a buyer and seller of an asset who agree to exchange goods and money at a future date, but at a price and quantity determined ...
Trading Center