Cash accounts, margin accounts and discretion

Paying for it, and who decides what to buy

A cash account requires prompt full cash payment for a purchase and does not provide a broker margin loan. Settlement and the regulatory payment period are different deadlines; do not assume every purchase must be paid at the moment of the trade. A customer can still hold securities through a broker in cash without borrowing against them.

A margin account lets the customer borrow from the firm against securities. For a new purchase of ordinary marginable long stock with no existing account equity and no higher firm requirement, Regulation T requires 50 percent initial equity. For $20,000 of that stock, the customer supplies $10,000 and the firm may lend the rest. FINRA also has a $2,000 minimum equity requirement; for a purchase costing less than $2,000, cash need not exceed the purchase cost. A firm may require more. A margin agreement and risk disclosure explain the credit and risks.

A short sale needs a margin account because shares are borrowed; its risk is not limited to the original deposit. The 50 percent long-stock example is not the rule for every security or short position.

Initial and maintenance requirements answer different questions. For margin securities held long, FINRA Rule 4210 normally requires equity of at least 25 percent of current market value after purchase. Equity is market value less the loan. A firm may set a higher house requirement. A deficiency can produce a call, but the firm may instead sell assets without contacting the customer first. The firm decides what to sell; the customer has no right to an extension and still owes any shortfall after liquidation.

Choosing a security, buy-or-sell action or amount for someone else is discretionary authority under FINRA Rule 3260. It needs prior written customer authorization naming the individual and written firm acceptance. If the customer fixes a specified security, side and definite quantity, the person may choose only execution time or price without that discretionary authorization. In a retail account this limited authority ends that business day unless the customer provides a specific contrary instruction in writing, signed and dated.

Exam terms

Cash account

Every purchase is paid for in full; no credit is extended.

Margin account

The customer borrows from the firm against securities in the account.

Regulation T

The Federal Reserve rule setting the initial margin requirement.

Margin agreement

The paperwork that must be signed before a margin account can trade.

Minimum equity

FINRA generally requires $2,000 to open a margin position; for a purchase costing less than $2,000, cash need not exceed the purchase cost. The firm may require more.

Maintenance margin

For margin securities held long, at least 25 percent of current market value, or a higher house requirement.

Maintenance deficiency

Equity below the applicable level; the firm may issue a call or liquidate without prior contact.

Margin call

The firm’s demand that the customer bring account equity back up to the required level. The firm need not call first; it may sell assets without contacting the customer.

House requirement

A firm’s own margin level, set above the industry minimum.

Discretion

Choosing the asset, the action or the amount without asking the customer.

Time and price

Working an otherwise complete retail order only until that business day ends unless a specific signed, dated written extension exists.

Worked example

A new customer with no existing account equity buys $20,000 of ordinary marginable long stock. The firm sets no higher initial or maintenance requirement. Compare a cash account with a margin account, then classify a retail order.

1. In a cash account the purchase requires full cash payment of $20,000. Do not confuse the cash payment period with the settlement date.
2. In a margin account the Regulation T initial requirement is 50 percent, or $10,000. That exceeds FINRA’s $2,000 minimum equity; the firm can lend the other $10,000 under these assumptions.
3. Now suppose the stock falls by 25 percent, to $15,000. The cash customer has lost $5,000 of a $20,000 investment. The margin customer has lost the same $5,000, but against a $10,000 deposit, which is half of what they put in.
4. Margin equity is now $15,000 less the $10,000 loan, or $5,000. The long-stock FINRA maintenance floor is $3,750, so this example does not cause a deficiency. A greater fall or a higher firm rule could. The firm may liquidate without calling first.
5. The customer then says: buy 500 shares of a named company, and use your judgment about when today. The security, the side and the quantity are all specified, so the representative is choosing only the timing.
6. That retail time/price instruction is excepted today. It ends at this business day’s close unless the customer provides a specific signed, dated written extension. Choosing a different security would need the separate written discretionary authority and firm acceptance.

Check yourself

Try a question, then read the explanation to review the rule.

Same rule, new context

Related practice

• Cash vs margin and Regulation TPractice this