the purchaser furnishes only a specified fraction of the total purchase
price of the securities bought and the broker furnishes the balance, charging
interest on that amount (the debit balance) until the customer either
sells the stock or pays off the loan and thus takes up the stock.
The broker in turn may obtain the funds for carrying margin accounts
from banks by rehypothecating the securities bought on MARGIN by customers
with the customer's permission, granted in advance in the customer's agreement
for opening a MARGIN ACCOUNT.
the passage of the SECURITIES EXCHANGE ACT OF 1934, on
the purpose of preventing the excessive use of credit for the purchase
or carrying of securities, the Federal Reserve Board shall, prior to the
effective date of this section and from time to time hereafter, prescribe
rules and regulations with respect to the amount of credit that may be
initially extended and subsequently maintained on any security (other
than an exempted security) registered on a national securities exchange."
The purpose is to prevent the excessive use of credit, not to influence
the level or trend of stock prices.
Also, the board is given power in the act to prescribe initial
as well as maintenance margins; it has prescribed only initial margins
from the beginning of such regulation.
T of the board of governors, pursuant to Sections 7 and 8(a) of the act,
G of the board of governors, "Collection of Noncash Items", was revoked
X of the board of governors was adopted by the board in 1971 to carry
out provisions of the Foreign Bank Secrecy Act of 1970.
Regulation X implements Section 7(f) of the act and generally applies
to borrowers obtaining credit from within the
margin requirements for bonds convertible into stocks were also adopted
by the board of governors effective
July 8, 1969, Regulations T, U, and G were amended principally to implement
the provisions of P.L. 90-347, adopted in regulations to cover credit
extended for the purchase of over-the-counter stocks having specified
market activity characteristics and company size and stock distribution
criteria, and bonds convertible into such stocks (the board of governors
issues the limit of such specific over-the-counter stocks).
T, U, G, and X limit the amount of credit to purchase and carry margin
stocks that may be extended on securities as collateral by prescribing
a maximum loan value which is the specified percentage of the market value
of the collateral at the time the credit is extended; thus margin requirements
are the difference between the market value (100%) and the maximum loan
8 of the act makes it unlawful for any member of a national securities
exchange, or any broker or dealer transacting business in securities through
the medium of any such member, to borrow in the ordinary course of business
on any security (other than an exempted security) registered on a national
securities exchange except (1) from or through a member bank of the Federal
Reserve System, (2) from any nonmember bank which shall have filed with
the Board of Governors of the Federal Reserve System an agreement undertaking
to comply with all provisions of the act, or (3) in accordance with any
rules and regulations of the board of governors permitting loans between
such members and such brokers or dealers.
members of national securities exchanges and brokers or dealers doing
business through them must borrow from member banks of the Federal Reserve
System or nonmember banks which have agreed to abide by the act, the Board
of Governors of the credit at the bank level by Regulation U, which reaches
borrowing by brokers and direct borrowing by customers on purpose loans
(loans to finance the purchasing or carrying of securities on margin).
U controls loans from banks by brokers both for the latter's own accounts
and for the purpose of financing customers' margin accounts; loans to
brokers for their own accounts are subject to the Regulation U margin
requirement (set by the board of governors), but loans to brokers representing
rehypothecation of customers' securities carried for the account of such
customers are not subject to Regulation U margin requirement (set
by the board of governors), instead being subject to the bank's own voluntary
margin requirements (varying with the quality, mix, and market characteristics
of the securities offered as collateral), which normally are less than
the board's margin requirement.
bank loans on securities collateral exempt from the Regulation U requirement
on margin include loans by banks to any bank, loans to dealers to aid
in the distribution of securities to customers (not through an exchange),
loans to brokers and dealers to meet emergencies, day loans, loans to
finance arbitrage transactions of emergencies, day loans, loans to finance
arbitrage transactions of customers of the broker, or loans to odd-lot
loans, i.e., loans not for the purpose of purchasing or carrying securities
on margin, are exempt from Regulation U margins,
the bank's own voluntary margins applying, even if the securities
are registered on a national securities exchange and non-exempt if used
for purpose loans. Such loans
are extended to firms and individuals for a variety of purposes.
An administrative problem arises in connection with proper policing
of such nonpurpose loans to ensure that this type of loan on securities
does not develop into a loophole for circumvention of
U applies specifically to the making by banks of any loans secured directly
or indirectly by any stock for the purpose of purchasing or carrying
any stock registered on a national securities exchange.
Thus, it does not apply if the purpose is to finance the exchange,
or any unlisted stocks or bonds.
The bank's own voluntary margins would apply in such cases.
For example, convertible bonds listed on a national securities
exchange could be purchased by an individual and financed by a bank loan
at the bank's own margin requirement, and Regulation U would not apply
even if the convertible bonds were converted into a stock listed on a
national securities exchange during the duration of the loan.
other than banks, brokers, or dealers who in the ordinary course of business
extend or arrange to extend credit totalling $50,000 or more in any calendar
quarter, or have outstanding at any time during the calendar quarter a
total of $100,000 or more in such credit, secured directly or indirectly,
in securities, are subject to the provisions of Regulation G, including
registration with the Board of Governors of the Federal Reserve System
through the district Federal Reserve bank.
Among the provisions of the regulation is that Regulation G lenders
obtain from the borrower a signed statement providing for, among other
things, an indication of the purpose of any stock-secured loan, that they
determine in good faith that the statement was correct, and that they
sign it as so accepted. This
requirement also applies to banks (Regulation U), but since loans by brokers
or dealers generally are for the purpose of purchasing or carrying securities,
no statement of purpose would ordinarily be required in connection with
III of the Foreign Bank Secrecy Act (P.L. 91-508) which was enacted October
26, 1970 to become effective November 1, 1971, made margin regulations
of the Board of Governors of the Federal Reserve System for the first
time directly applicable to U.S. borrowers and to foreign borrowers controlled
by them or acting for them. In
July 1971, the board of governors published for comment proposed amendments
to its Regulation T, U, and G, to implement the new statute.
The board of governors reports that the comments received prompted
it instead to combine the changes in a new regulation, designated Regulation
board of governors summarizes Regulation X as in essence providing that
subject borrowers obtaining credit in the U.S. or abroad must comply with
the margin regulation applicable to the lender, or if none applies, they
must treat the borrowing as if it were subject to Regulation G, the margin
regulation applicable to extensions of credit by persons other than banks,
brokers, or dealers. Exemptions
were provided for (1) individuals permanently resident abroad who obtain
$5,000 or less in purpose credit (for the purpose of purchasing or carrying
securities on margin) at any one time or in any one year, (2) foreign
subsidiaries of U.S. corporations making markets in Eurobonds, and (3)
extraordinary circumstances in which the board of governors may deem it
justifiable to grant individual exemptions by order, if the obtaining
of the credit is consonant with the purpose of the Foreign Bank Secrecy
Leverage in Margin Buying.
high margin requirements, the leverage possible on margin trading is low.
The purpose of buying on margin is to increase the possibility
of gain with available cash. The
advantage of buying on margin can be illustrated by the following example.
Assume a speculator with cash of $10,000 wishes to purchase as
much as possible of a certain stock selling at $100 per share.
If he bought the stock for cash and delivery, he would be able
to buy only 100 shares (ignoring commission costs).
On a 10% margin, however such as prevailed in the late 1920s, he
would be able to buy 1,000 shares, the broker putting up $9,000 and the
speculator $1,000 per 100 shares.
In this way, the speculator could purchase ten times as much stock
as he could by purchasing it outright.
If the stock rises one point, a profit of $1,000 is made, whereas
in an outright purchase the profit would be only $100.
This advantage of leveraged possibility of gain, however, is offset
by the disadvantage of equal possibility of loss, and therein lies the
danger of low margins. If
the stock declines one point, the speculator loses $1,000.
The broker will carry the stock provided there is adequate margin
to protect the account; a broker will rarely carry a stock until the minimum
maintenance (percentage) margin of the New York Stock Exchange is reached
(25%), particularly in an active and rapidly declining market.
a customer's percentage equity in a margin account falls below a level
considered adequate by the broker, a MARGIN CALL is sent to the customer;
if there is not a prompt response, the broker has the right to sell out
the customer either wholly or partially, the latter in order to restore
the account to a properly margined position.
The customer under New York Stock Exchange rule may not be permitted
by a member firm to make a practice of effecting transactions requiring
initial or additional margin and then furnishing such margin by liquidation
of the same securities or other securities.
The required margin must be obtained as promptly as possible, but
in any event before the end of the four full business days following the
date of the transaction. Cash
will of course cover the margin call; if securities are used, they must
be listed securities with the necessary loan value; e.g. with 50% margins,
the loan value is 50% of market value of such securities tendered in response
to a margin call.
unrestricted account is one whose percentage equity is at least the prevailing
board of governors' initial margin.
A restricted account is one whose equity percentage has dropped
below the board's initial margin; the board's regulation does not require
that a margin call be sent to the customer to restore the margin to the
initial margin level, but it does restrict the freedom of action of the
customer with respect to such an account.
Some of the restrictions are as follows.
general rule is that no withdrawal of cash or registered or exempted securities
will be permitted if the adjusted debit balance of the account would exceed
the maximum loan value of the securities in the account after such withdrawal.
following exceptions to the general rule are available only in the event
no cash or securities need to be deposited in the account in connection
with a transaction on a previous day, and none would need to be deposited
thereafter in connection with any withdrawal of cash or securities on
the current day:
Registered or exempted
securities may be withdrawn upon the deposit in the account of cash (or
registered or exempted securities counted at their maximum loan value)
at least equal to the retention requirement (50% of current market value
for registered securities other than exempted issues and maximum loan
value for exempted securities) of the securities withdrawn.
Cash may be withdrawn upon the deposit in the account of registered
or exempted securities having a maximum loan value at least equal to the
amount of cash withdrawn.
sale (other than short sale) of registered or exempted securities in the
account, there may be withdrawn in cash an amount equal to the difference
between current market value of the securities sold and the retention
requirement of those securities.
in a restricted account, i.e., changes in holdings by purchases and sales
on the same day, may be made provided the net result would not cause any
change in the status of the account in regard to existing margin requirements.
subscription accounts, in connection with the exercise of stockholders'
rights to subscribe to additional shares, call for satisfaction of initial
and maintenance margin requirements and thereafter for four quarterly
payments equal to 25% of the difference between initial equity in the
account and initial margin percentage of market value of the stock at
the time of the subscription.
miscellaneous accounts may be credited with the excess over margin requirements
in a margin account occurring by reason of a rise in market value (which
must be withdrawn on the same day it occurs) or dividends (which must
be withdrawn in 35 days).
NYSE Margin Trading.
The New York Stock Exchange (NYSE) points out that prior to