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Margin Account
Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority.)

Customers buying stocks on MARGIN or engaging in short sales must have a general account (sometimes called a margin account), which also may be used for cash transactions.  The strictly cash account permits only cash transactions.

In opening the general account, the customer signs the customer's agreement or margin agreement, which provides for the following standardized clauses:

1.                  Hypothecation and rehypothecation clause:  "Any and all securities or commodities, or contracts relating thereto, nor or hereafter held or carried by you in any of my accounts (either individually or jointly with others), are to be held by you as security for the repayment of any liability to you in any of said accounts, from any one of my accounts to another when in your judgement such transfer may be necessary, and all such securities from any one of my accounts to another when in your judgement such transfer may be necessary, and all such securities and commodities may, from time to time, and without notice, be pledged and repledged by you, either separately or in common with other securities or commodities, for any amount due upon my account(s), or for any greater amount, without retaining in your possession or control for delivery a like amount of similar securities or commodities."

Hypothecation is the pledge of the securities to the broker as collateral for credit extended on margin purchases.  Rehypothecation, in turn, is the use by the broker of the securities thus pledged to obtain security loans from banks.  It is a rule of the New York Stock exchange that a member may not pledge a customer's securities for more than is "fair and reasonable in view of the indebtedness of the said customer to the said member firm or corporation."  It will be noticed also that the above clause permits commingling of the customer's securities by the broker for the purpose of obtaining security loans from banks.  Commingling consent must be expressly given by the customer.

2.                   "You shall have the right, whenever in your discretion you consider it necessary for your protection, or in the event that a petition in bankruptcy or for appointment of a receiver is filed by or against me or an attachment is levied against my account(s) with you (whether carried individually or jointly with others), to buy any or all securities and commodities which may be short in such demand for margin or additional margin, notice of sale or purchase, or other notice or advertisement, and any such sales or purchases may be made at your discretion on any exchange or other market where such business is then usually transacted, or at public auction or private sale; and in case of a sale at public auction or on an exchange, you may be the purchasers for your own account, it being understood that a prior demand, or call, or prior notice of the time and place of such sale or purchase shall not be considered herein provided, and it being further understood that I shall at all times be liable for the payment of any debit balance owing in any of my accounts with you upon demand, and that I shall be liable for any deficiency remaining in any such account(s) in the event of the liquidation thereof in whole or in part by you or by me."

Although this language permits the broker to sell out a margin customer without notice and thus is a one-sided agreement (most customers do not bother to read the fine print of these provisions), in practice brokers do give notice on calls for more margin and notice of sale.

3.                   "The monthly debit balance in my account(s) shall be charged, in accordance with your usual custom, with interest at a rate which shall include the average rate paid by you on your general loans during the period covered by such balances respectively and any extra rates caused by market stringency, together with a charge to cover your credit service and facilities."

In practice, interest on debit balances on small accounts of accounts with low activity tends to be somewhat higher than the current cost of credit to the broker, with the larger and more active accounts being given the benefit of variations in the cost of money to the broker.  Interest compounds unless paid.

4.                   "All communications, whether by mail, telegraph, telephone, messenger, or otherwise, sent to me at my address as given to you from time to time shall constitute personal delivery to me."  This provision covers the provision of law otherwise that call for margin and notice of sale must reach the attention of the customer.


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