The arbitrage account is available for use by customers under the conditions specified in section 220.7 of Regulation T whether or not the security involved is a margin security. STAFF OP. of Sept. 24, 1986.

The staff was asked whether the provision in Regulation T permitting exempt credit for bona fide arbitrage transactions cover conversions and reverse conversions in the listed options market. A conversion consists of buying the underlying stock and also buying a put option and selling a call option. In a reversal, the trader sells stock short, sells a put, and buys a call.

Company A was recently bought by Company B. Shares of Company A can be converted into shares of Company B in 90 days. Employees of Company A hold employee stock options that are exercisable into Company A stock. The stock of Company A is no longer traded and is not marginable.

The staff was asked about the permissibility of conducting a pair of transactions in the arbitrage account. The transactions involve securities of a company that is undergoing a reorganization pursuant to the Bankruptcy Code and that has at least three types of securities: old common stock, warrants, and new common stock. Holders of the old common stock are entitled to receive warrants convertible into the new common stock, at a later date, based on a market price to be determined at a later date as well. The exchange ratio between the old common stock and the warrants was fixed after the reorganization became effective.

A customer bought 100 shares of common stock in a company on February 6 and, on February 14, sold short 15 notes issued by the company. The notes are convertible into approximately 100 shares of common stock of the company.

See 5-535.

See Special Arbitrage Account for opinions issued before the 1983 revision of Regulation T.

The Board determined that Regulation T would prohibit an officer of a brokerage firm from purchasing margin stock in installments from three officers of the issuing corporation, a client of his firm, under the following circumstances. An officer of a brokerage firm bought 10,000 shares of margin stock at $35 per share from three private individuals, all three of whom are officers of a corporation for which the brokerage firm acted as underwriter. The stock became registered on a national exchange shortly before the agreement was executed. The agreement between the sellers and the buyer provided that the buyer was to pay one-half of the purchase price about one month after the date of the agreement, and the remainder six months later. The maximum loan value of the stock was 20 percent; therefore, the sellers extended credit to the buyer in excess of the maximum loan value of the purchased stock. Although the buyer maintained a securities account with his employer (the brokerage firm), the purchase was not effected in that account, nor did the buyer inform his employer of this purchase; however, the brokerage firm subsequently consented to the acts of its officer. A second purchase for another 10,000 shares at $30, also on credit terms, was agreed to between the same parties four months later. Throughout the period in which these transactions took place, the buyer’s brokerage firm was the principal investment banker, underwriter, and financial adviser to the corporation of which the sellers were officers. The buyer was also instrumental in maintaining the investment banking and financial adviser relationship between the brokerage firm and the corporation of the sellers.

A U.S. corporation proposes to transfer a sum of money to a partnership, which would invest that money in margin securities. Simultaneously, the general partner of the partnership, a British investment trust, would transfer to the British second-tier subsidiary of the U.S. corporation an equivalent amount in sterling, to be used for business purposes. Both sides of the transaction are to be arranged by a broker-dealer. Since the transfer of funds is equal, neither broker-dealer would be arranging for credit to purchase or carry securities, and Regulation T would not be applicable. STAFF OP. of Dec. 1, 1972.

The private placement of a debt security by a broker or dealer for an issuer has been viewed by the Board as the arranging by the creditor for the extension of credit to the issuer. The private placement of an equity security for an issuer is not regarded as such an arranging. Regulation T does not prohibit an issuer of an equity security from using the proceeds of a stock sale (whether the sale is a public offering or a private placement) for the purchase of margin securities. STAFF OP. of March 29, 1979.

The inquirer asked whether the participation of NASD dealers in a public offering of oil and gas limited partnership interests would constitute arranging. According to the registration statement, the total amount of each limited partner’s subscription is due and payable at the time the subscription agreement is submitted, and no limited partner may be called upon for an additional assessment. Therefore, the terms of the offering do not contemplate extensions of any credit. It then follows that a broker-dealer engaged in selling the limited partnership interests would not be arranging for credit within the meaning of section 220.7(a) of Regulation T. STAFF OP. of May 8, 1980.

A dealer proposes to arrange an offering of unsecured corporate notes in the United States. The offerings would be exempt from registration under the Securities Act of 1933 because the securities would be guaranteed by a bank, would have maturities not exceeding nine months, or would be offered in a private placement. The proceeds of the offering or placement would be used by the issuer of the notes to purchase and carry securities, including margin securities.

A broker-dealer proposes to purchase certain mortgage pass-through certificates in a private placement. The issuer, who is also the servicer of the mortgage pass-through certificates, guarantees the timely payment of principal and interest whether or not the payment has been collected on the mortgage loans. The issuer’s obligation in this area, of course, is totally contingent in nature.

A Canadian company proposes to make an international offering of exchangeable debt securities. Counsel for the underwriters inquired about the applicability of Board interpretation 12 CFR 220.131 (at 5-470.1) to the U.S. portion of the proposed offering. In that interpretation, the Board takes the position that the purchase of a privately placed debt security is an extension of credit.

Recent Regulation T amendments affecting a broker-dealer’s ability to arrange for the extension of credit have changed the analysis concerning the use of credit cards by customers of broker-dealers. Regulation T prohibits a broker-dealer from extending unsecured credit to purchase securities. In addition, before July 1, 1996, section 220.13 of Regulation T generally prohibited a broker-dealer from arranging for a lender not subject to Regulation T to extend credit that the broker-dealer could not itself extend under Regulation T. Since the use of a credit card usually results in an unsecured loan to the cardholder, broker-dealers were prohibited from accepting credit cards for securities transactions based on the view that this would involve a broker-dealer’s arranging of credit that did not comply with Regulation T.

See 5-882.14.

See 5-616.11.

See 5-650.355.

An SEC interpretive letter states that a mutual fund may lend its securities portfolio. However, a broker or dealer is prohibited from borrowing securities unless they are needed to make an actual delivery in connection with a specific transaction that has already occurred or is about to occur. It does not authorize the broker or dealer to borrow securities merely to have the securities on hand or to anticipate some need that may or may not arise in the future. A fund that lends securities should be aware of these restrictions on brokers and dealers and should avoid running the risk of aiding and abetting a violation by the broker or dealer by lending securities that will not be used for one of the purposes specified in section 6(h) of Regulation T. STAFF OP. of June 26, 1972.

A company whose stock is listed on the New York Stock Exchange is concerned that large amounts of its common stock are being borrowed by broker-dealers and banks shortly before the company’s dividend record date with the apparent purpose of using the borrowed shares to qualify for a discount under the company’s dividend reinvestment plan. The borrower under this strategy becomes the record owner of the borrowed shares and is thus permitted, under the dividend reinvestment plan, to reinvest the cash dividend from the company by purchasing additional shares of the company’s common stock at 95 percent of current market value. This has been a serious and recurring problem for the company because it views the strategy as contrary to the purposes for which the plan was adopted. On or shortly before a recent dividend record date, a national bank borrowed shares of the company’s common stock, and on another dividend record date, a broker-dealer did the same. In both cases, the borrowed shares were returned on the day after the dividend record date.

To take advantage of a reduced price under a dividend reinvestment plan, Broker A borrowed stock from Broker B, against a deposit of cash, just before the dividend record date, using facilities of a depository trust company (DTC). As owner, on the records of DTC, Broker A, instead of receiving a cash dividend, elected to purchase additional stock at a discount of 5 percent less than the current market price of the stock. The borrowed stock was then returned for the cash deposit. Within a week, Broker A sold the stock obtained instead of a cash dividend and split the profit with Broker B. These procedures violated section 220.16 of Regulation T, because the stock was not borrowed for a permitted purpose. Also, the transaction did not qualify as a bona fide arbitrage and was therefore not permitted under section 220.7. STAFF OP. of March 2, 1984.

The staff was asked if securities can be loaned to, as well as borrowed from, an institution that does not meet the definition of a broker or dealer as defined in section 3(a)(4) and (5) of the Securities Exchange Act of 1934 for the purposes specified in section 220.16 of Regulation T.

A broker-dealer proposes to engage in an arbitrage transaction involving the purchase of qualifying convertible securities concurrent with an offsetting sale of the underlying securities, for the purpose of making a profit. Brokers often borrow the underlying security to make delivery on the sale. The convertible security purchased is then converted and given to the stock lender to close out the stock loan. Instead of borrowing the underlying security to make delivery on the sale, the broker-dealer proposes to borrow the convertible security. This security would then be immediately converted in order to make delivery on the sale. The convertible security purchased, when received, would be used to close out the stock loan.

Enforcement staff of the SEC asked Board staff for its views on the propriety under Regulation T of certain purported “short sale” securities transactions involving a broker-dealer and a single customer. Over a three-year period, the broker-dealer arranged to borrow millions of shares of common stock every month solely to qualify for discounts offered under a variety of issuers’ dividend reinvestment plans. The gross profits were allocated, on a prearranged basis, between the broker-dealer and the customer. Evidence indicated that the securities transactions between the broker-dealer and the customer involving stock borrowings were artificial contrivances designed to create the impression that the borrowing of the dividend reinvestment plan stock was for a permitted purpose.

A reserved-borrowing option was added to the Euroclear Securities Lending and Borrowing Program in April 1992. Prior to April 1992, the borrowing or lending of securities in the program was effected when securities were needed to meet a delivery instruction, i.e., on settlement date. The reserved-borrowing option permits borrowing or lending on a designated “start date” regardless of whether or not the securities are needed to meet a delivery instruction.

A registered broker-dealer and its customers sell securities short from time to time. These are bona fide short sales for which the required margin is posted. The broker-dealer or its clients anticipate that they will be able to close out the short sales later with stock they expect to receive pursuant to a dividend reinvestment plan (DRP) in which they are already qualified to participate. Many DRPs permit participants to purchase additional shares of the company (the supplemental-purchase option) at a discount from the market price computed over a period of time (the pricing period). Most of the plans require participants to put up money to purchase additional shares before the pricing period begins. At least one plan allows payment at the conclusion of the pricing period.

A new provision of Regulation T covering the lending of foreign securities to a foreign person, section 220.16(b), takes effect July 1, 1996. The Federal Register notice describing the addition of the section stated that “coverage of the term ‘foreign lender’ is determined by the status of the beneficial owner of an account and includes a non-U.S. person with a U.S. investment adviser or other fiduciary.” Board staff was asked whether a foreign borrower who has engaged a U.S. investment adviser or other fiduciary would be deemed to be a foreign person for purposes of section 220.16(b) of Regulation T.

Section 220.10 of Regulation T allows a creditor to borrow or lend securities to make delivery in the case of short sales, failure to receive securities required to be delivered, or other similar situations. The regulation allows “pre-borrowing” of a security up to one standard settlement cycle in advance of trade date. The standard settlement cycle is currently three business days.

A Cayman Islands corporation wholly owns an intermediary subsidiary, a Bermuda corporation that in turn wholly owns a Delaware corporation that is a registered broker-dealer. The second-tier broker-dealer carries an account for the parent in which the parent engages in proprietary trading in commodities, securities, and options on these instruments. Although the parent is not itself registered with the SEC as a broker-dealer, it is a corporate general partner in a registered broker-dealer and is treated as a broker-dealer under the Securities Exchange Act of 1934.

A Delaware corporation (subsidiary) is wholly owned by an investment banking firm that is a registered broker-dealer (parent). The subsidiary proposes to incorporate a wholly owned subsidiary (affiliated corporation) to act as general partner for an oil and gas limited partnership (partnership). The subsidiary has been actively engaged in exploring for and producing oil and gas, both for its own account and with others, since 1976.

Under section 220.11(a)(3) of Regulation T, a broker-dealer clearing firm may extend credit to one or more of its partners or shareholders who may in turn make a capital contribution to, or purchase stock in, a market maker specialist broker-dealer. However, that section is specific in stating that the extension of credit must be made to a partner or shareholder who will use the funds to purchase stock or make a capital contribution to his or her firm, an affiliated firm, or another creditor. The rule does not provide for a direct transfer from the creditor to another unrelated creditor.

A broker-dealer will offer to make loans to prospective investors to finance up to 80 percent of the subscription price of their limited partnership units. Regulation T prohibits the extension of credit to purchase limited partnership interests unless those interests come within the definition of “margin security,” which most limited partnership interests do not.

A partner in a specialist firm elects to withdraw his capital. A New York Stock Exchange clearing firm that clears and carries positions for specialists is willing to make a subordinated loan to replace the missing capital. The New York Stock Exchange will give its approval.

The broker-dealer credit account may properly be used for trades with other broker-dealers involving mortgage-backed securities and OTC options on mortgage-backed securities that are cleared through the Midwest Clearing Corporation. The Midwest Clearing Corporation collects margin from all of its participants, and their positions are marked to market daily.

A broker-dealer who is a U.S. government securities dealer may buy over-the-counter options on U.S. government securities from other broker-dealers in the broker-dealer credit account if the trades are settled promptly against full payment. STAFF OP. of Nov. 17, 1987.

The staff was asked whether a transaction between two creditors, both of whom are selfclearing members of an exchange, is permitted under section 220.11(a)(1) when the transaction is a short sale, recorded on the floor of the exchange as such. The broker-dealer credit account is available to self-clearing creditors effecting proprietary positions rather than transactions on behalf of customers. The sale can be long or short but must be based on a good faith agreement for prompt payment against delivery of the security. STAFF OP. of Jan. 28, 1988.

After the October 1987 market break, the Chicago Board Options Exchange approved a limited number of subordinated loans from a clearing firm to the firm’s market maker customers whose accounts were in deficit. The amount of each loan equalled the deficit in each market maker’s account and resulted in a capital charge to the clearing firm. In order to resume trading, the market maker obtained additional capital from a source other than the clearing firm and was subjected to new restrictive risk guidelines. The arrangement provided a way for the market maker to repay the debt to the clearing firm. Only market makers who had been highly successful in the past and who could reasonably be expected to be able to repay the debt through future earnings were permitted to use this arrangement.

This staff opinion was withdrawn. See 5-615.813.

Although brokers who clear their own transactions are not subject to Regulation T restrictions on those transactions, several self-clearing broker-dealers had formed jointly owned and financing broker-dealers to process transactions for their parent firms in the interest of efficiency and economy. However, because the clearing firm was itself a broker-dealer, the transactions it processed for its parents were considered to be transactions processed for “customers” under an earlier version of Regulation T and therefore subject to the restrictions in the regulation on credit to customers. Section 220.11(a)(2) was added in 1983 to allow the joint venture to be treated as if all owners were self-clearing firms.

A broker-dealer has a subsidiary that is also a broker-dealer. The subsidiary’s business is described as providing clearing services to approximately 100 unaffiliated broker-dealers; however, it actually clears both proprietary and correspondent transactions through the parent broker-dealer.

Joint-back-office (JBO) arrangements between broker-dealers are permitted pursuant to section 220.7(c) of Regulation T. Such an arrangement allows special margin treatment for broker-dealers without clearing operations, known as JBO participants, who invest in a clearing and servicing broker-dealer, known as a JBO broker. Under Regulation T, the JBO participants are not treated as customers of the JBO broker.

Joint back office (JBO) arrangements allow creditors (generally referred to in this context as “JBO participants”) to clear their proprietary transactions through another broker-dealer without being considered customers of the clearing broker under Regulation T if the JBO participants purchase an equity interest in the clearing broker-dealer. JBO arrangements are permitted under section 220.7(c) of Regulation T, which provides that a creditor “may effect or finance transactions of any of its owners if the creditor is a clearing and servicing broker or dealer owned jointly or individually by other creditors.”

See Clearing Firm.

The SEC requested staff’s views on the rule change proposal of the Chicago Board Options Exchange relating to the use of an escrow agreement in the cash account as cover for either a put or a call. Section 220.8 of Regulation T allows a broker-dealer to permit a customer (1) to write a call option if the customer holds the underlying security (or one convertible into it) in the account or (2) to write a put option if the customer holds in the account cash (or certain specified financial instruments with features that enable the instrument to be used instead of cash) in an amount equal to the exercise price of the put. In addition, a broker-dealer may permit a customer to write an option in the cash account and use an escrow agreement in lieu of the cash or underlying security position if “in the case of a call or a put, the creditor is advised by the customer that the required securities or cash are held by a bank and the creditor independently verifies that an appropriate escrow agreement will be delivered by the bank promptly. . . .”

Staff was asked to explain the interaction of requirements under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and requirements under Regulation T. The inquirer’s concern was with those accounts, both cash and margin, in which backup withholding is required by TEFRA, a situation called “lacking receipt of W9 form.” It was staff’s view that a sale of securities in a cash account with a purchase of securities identical in value will trigger a call for cash if the account is subject to the 20 percent backup-withholding requirement. Assuming that 80 percent of the sale proceeds are designated by the customer as part payment for the new purchase, a Regulation T call should be made for the 20 percent balance. If the 20 percent deposit is not received by the due date under section 220.8(b) of Regulation T, the creditor is required to liquidate sufficient securities to cover the Regulation T margin call.

British Telecommunications (BT), the principal supplier of domestic and international telecommunications services in the United Kingdom, was organized pursuant to the British Telecommunications Act of 1981 as a separate statutory corporation managed by a board appointed by the United Kingdom government. The United Kingdom government (HMG) has announced its decision to transfer control of BT to the private sector. To this end, BT has been reorganized as a public limited company under English law, wholly owned, licensed, and regulated by HMG. HMG now proposes to offer for sale to the public more than half of the outstanding ordinary shares of BT. The aggregate offering price of the shares will be between three billion and four billion pounds sterling.

Sections 220.4(d) and 220.8(b)(4) of Regulation T permit a broker-dealer to disregard for regulatory purposes any amount under $500 due from a customer. The purpose of these rules is to permit a broker-dealer to avoid selling out an account when a de minimis amount remains unpaid. A customer’s purchasing 1,000 shares of a $23 stock with commission of $236 and sending a check for only $23,000 because he or she misread the confirmation would be the type of situation the rule contemplated. The staff assumed that the New York Stock Exchange’s interpretation of the Regulation T requirement would not require a liquidation in the above example. It also assumed that the firm would want to collect its commission as soon as possible.

The staff received two questions regarding the Regulation T cash account.

A customer who had cash accounts with 17 broker-dealers engaged in the practice of buying a new issue at one broker-dealer (Broker-Dealer 1) and selling the same issue at a different broker-dealer (Broker-Dealer 2) on the same day. Broker-Dealer 1 was instructed to deliver the securities against payment to a third broker-dealer (the clearing broker). Broker-Dealer 2 was instructed to receive payment for securities sold from the clearing broker. When the securities arrived, the clearing broker paid for them and debited the customer’s margin account. On 12 occasions there were insufficient funds in the margin account to pay for the new issues; so the purchases were paid for with the proceeds of their sale.

A broker-dealer has an in-house money market fund. A customer who orders liquidation of a balance from his or her money market fund is entitled to receive the cash on the next day (or on the same day if the liquidation is ordered before noon). A customer has $5,000 in the in-house money market fund held in a cash account. The customer buys $5,000 worth of stock in the cash account on Day 1 and sells the same stock on Day 2. If the customer does not pay for the stock (by ordering liquidation of the money market balance or otherwise) at the same time as ordering its sale, the broker-dealer freezes the account for 90 days.

The staff was asked for its views on the propriety of net settlement of offsetting purchases and sales of “mortgage-related securities.” The Secondary Mortgage Market Enhancement Act of 1984 (SMMEA) defined that term and amended the securities acts and certain acts governing depository institutions to provide preferential treatment for securities meeting the definition. Among the amendments to the various acts made by the SMMEA was a change in section 7 of the Securities Exchange Act of 1934, the section covering margin requirements. The amendment recognizes a fundamental difference between marketing mortgage-related securities and marketing other securities in that the market for mortgage-related securities is essentially a forward trading and delivery market that requires a settlement period of as much as four to six months. The amendment states that credit will not be deemed to have been extended or arranged within the meaning of section 7 “by reason of a bona fide agreement for delayed delivery of a mortgage-related security against full payment of the purchase price” within 180 days of the purchase. The Board was given authority to adopt rules modifying this provision if needed for investor protection. Thus far, no such rules have been adopted.

Dividend-roll or dividend-recapture programs are not permitted in the cash account unless sufficient funds for full cash payment are in the account on trade date. This anti-free-riding rule, emanates from the requirement for an agreement that the customer does not contemplate selling the security purchased in the account before paying for it. In these programs, of course, the customer contemplates selling the security as soon as possible after purchase.

On Day 1 a customer purchases stock of Company A. On Day 2 the customer enters an additional purchase order for stock of Company B. Later on Day 2 the customer sells the stock of Company A.

Many asset-backed securities qualify as OTC margin bonds. In general, they represent an undivided interest in a trust formed under a pooling and servicing agreement between the originator and a bank. Recent issues have been backed by auto loans, leases, credit card receivables, and other unsecured consumer loans. Some issues have credit enhancements through letters of credit used to ensure liquidity on distribution dates.

The staff was asked if, in the case of an initial public offering (IPO), the seven-day time period for payment of purchases in a cash account should be calculated from the trade date on the confirmation sent to customers or from the day the underwriter settles with the issuer.

A question arose concerning Regulation T and the relationship between a firm (broker-dealer) and a nonbank bank (the bank) in connection with the 90-day-freeze provision. The broker-dealer has contracted to provide the bank with back-office operational services, including proxy and reorganization services and securities clearing and processing.

Section 220.8(a)(2) allows a creditor to sell a customer’s security held in a cash account. Questions have arisen about the meaning of the requirement that the customer state that the security is “owned by the customer” if it is not held in the account. Board staff has always interpreted the word “owned” to mean that the security has been paid for in full. If a creditor were permitted to sell a security that had not been paid for, the customer would be able to pay for the purchase of a security with the proceeds of its sale. This practice is known as free-riding and is prohibited in the cash account. STAFF OP. of Nov. 9, 1989.

Day trading and free-riding in a cash account are not permitted under Regulation T. The letter-of-free-funds requirement in section 220.8(c)(2) is a method of protecting a broker-dealer from unwittingly aiding a customer in doing what the regulation attempts to prohibit. The money to pay for the security should already be at the second broker before the security is transferred to the second broker, and the letter should so state. Receipt of the letter at any time after the security has been delivered to the second broker would raise questions about the good faith intentions of the customer, a prerequisite for booking the transaction in the cash account. A customer requesting the withdrawal of a security from a cash account to be sent to another broker (who the customer asserts holds the money to pay for it on settlement date) would be in violation of Regulation X if that customer has sold the security at the other broker and plans to use the proceeds of the sale to pay for the purchase. The 90-day freeze provision in the regulation effectively prohibits a person from making new transactions in a cash account for 90 days without putting the required cash up front once a security has been sold before payment. STAFF OP. of Jan. 8, 1990.

In transactions between a principal disclosed firm and an introducing broker, the clearing firm is responsible for Regulation T compliance because it is the creditor that extends the credit.

A customer makes a purchase in a cash account when a 90-day freeze is in effect. The customer has sufficient funds in an in-house money market account on trade date and has instructed the broker-dealer to redeem those funds to pay for the purchase in the restricted account.

The opinion at 5-615.98 should not be interpreted to mean that the customer is entitled to benefit from the funds remaining in the money market account from trade date to settlement date. The customer, by issuing liquidation instructions on trade date, has in effect relinquished all rights to the funds, including interest accrued between trade date and settlement date. STAFF OP. of Jan. 23, 1992.

The question was raised whether a customer can sell one security to pay for the purchase of another security in the cash account without incurring a 90-day freeze under section 220.8(c) of Regulation T. The example given was of a customer, long a security known as a money market preferred, who sells that security for next-day settlement. On the same day, the customer enters a purchase order for another security for next-day settlement. The securities purchased will be paid for with the proceeds of the sale of the first security.

A customer has purchased securities in a cash account in which no 90-day freeze is in effect. Under regular settlement procedures, payment is due on the fifth business day. The customer’s account contains fully paid-for U.S. government securities. The proceeds of the sale of the government securities are to be used to pay for the purchase of the other securities.

The SEC asked Board staff for its views on the following. Certain customers of an introducing broker had both cash and margin accounts at the clearing broker. The customers used their cash accounts to sell new issues on the same day they had bought the securities at other brokers. These securities were delivered to the clearing broker on the customers’ behalf against payment, although the relevant cash accounts did not contain sufficient funds to pay for the securities. One of two co-chief operating officers of the clearing broker (the COO) claims that funds to pay for the securities were held in the customers’ special memorandum accounts (SMAs). The brokers from whom the customers purchased the securities did not always request letters of free funds from the clearing broker. When requested, the clearing broker issued a letter of free funds based on the customer’s balance in its special memorandum account and not the balance in its cash account.

SEC staff analyzed cash account statements of a broker-dealer’s five most active customers for a four-month period. Approximately 32 percent of the transactions in these five accounts were not paid for within seven business days of the trade date. Most were long transactions in over-the-counter options written by the broker-dealer and costing between $125 and $1,000. The broker-dealer did not apply for extensions in any of these cases.

A customer purchases and sells the same security on the same day in the cash account portion of his asset management account. The customer has sufficient money market fund value in the account on trade date to cover the purchase. Board staff assumed this value is sufficient to cover all similar transactions on trade date.

A customer sells a fully paid security in a cash account and purchases another security of equal value on the same day. The cash account holds securities but no cash.

A customer has a cash account with fully paid-for securities and no cash. On trade date, the customer instructs the creditor to sell the securities. Later on the same trade date the customer instructs the creditor to repurchase the same issue of securities for the same cost.

A customer engages in four transactions on a single day using a cash account. At the beginning of the day, the customer’s cash balance in the account is $10,000. First, the customer purchases $10,000 worth of stock in Company A. The customer subsequently sells the Company A stock and buys $10,000 worth of stock in Company B. Before the end of the day, the customer sells all of the Company B stock. The customer does not withdraw any cash from the account prior to settlement date.

In 1992, the Board issued an advance notice of proposed rulemaking and request for comment regarding Regulation T (57 Fed. Reg. 37,109, Aug. 18, 1992), containing the following statement:

The government securities account was adopted by the Board later that year. In 1998, the Board merged the government securities account into the newly created “good faith account” currently found in section 220.6 of Regulation T.

Board staff was asked about the following trading pattern in a cash account. A customer sells Stock A on Day 1, buys Stock B on Day 2, sells stock B on Day 3, and then buys and sells Stock C on Day 5. All of the individual purchases cost less than the “account balance” and it was assumed that Stock A had been paid for it before it was sold on Day 1.

Section 220.8(a)(1) of Regulation T describes two methods of purchasing a security in a cash account. Under the first method, described in section 220.8(a)(1)(i), the customer has sufficient funds in the account on trade date. The second method, described in section 220.8(a)(1)(ii), allows a broker-dealer to effect a purchase for its customer even though the customer’s cash account does not have sufficient funds to cover the purchase on trade date. To use the second method, the broker-dealer must accept in good faith the customer’s agreement that the customer will promptly make full cash payment for the security before selling it and does not contemplate selling it before making such payment.

See 5-638.5.

See 5-628.11 and 5-628.17.

See Extension of Time.

See Special Cash Account for related opinions issued before the 1983 revision of Regulation T.

The Board has held that while a wholly owned subsidiary has a separate existence for some purposes, it is ordinarily more appropriate to treat the subsidiary as part of the broker-dealer for purposes of the margin regulations. Therefore, the staff has concluded that the relationship between a broker-dealer and a wholly owned subsidiary that carries trading accounts does not result in the broker-dealer’s being considered a customer of its subsidiary.

A clearing corporation, being a member of a national securities exchange, is subject to Regulation T because it is a creditor under section 220.2(b). A member of a national securities exchange is permitted to effect and finance transactions for another member of a national securities exchange or for a broker or dealer registered with the SEC in a special omnibus account on an exempt basis if the exchange member receives written notice from the other broker or dealer indicating that all security positions carried in the account will be for the account of the customers of the other broker or dealer. The rule does not limit the securities that may be carried in an omnibus account to “margin securities.”

In a transaction between a “principal disclosed clearing firm” and an “introducing broker-dealer” the clearing firm was responsible for compliance with Regulation T because it extended the credit.

A broker-dealer requested that its wholly owned subsidiary not be considered a customer of the parent for purposes of Regulation T. The parent and the subsidiary, both registered broker-dealers, file a consolidated income tax return. The subsidiary provides research, investment advisory, and portfolio management services but does not carry public customer accounts, nor does it intend to. Customers who want to buy or sell securities are introduced to the parent on a fully disclosed basis. Unlike the traditional arrangement, the parent serves as the clearing firm for the subsidiary. The subsidiary’s proprietary trading includes block positioning activities and arbitrage. For purposes of the net capital rules of the SEC, the subsidiary’s trading subjects the parent to “haircut” charges.

STAFF OP. of March 1, 1983.

A British corporation (international) is a wholly owned subsidiary of another corporation wholly owned by a New York Stock Exchange member (broker-dealer). The broker- dealer will clear and carry all of the international’s own trading Eurobond transactions. In addition, all the international’s public Eurobond customers will be carried on the broker-dealer’s books and will receive confirmations and statements from the broker-dealer. In all respects, the international will act merely as part of the broker-dealer’s current Eurobond trading operation and will be under the direct supervision of the broker-dealer general partner in New York in charge of Eurobond trading activity. For internal tax and accounting purposes and on the consolidated balance sheet, the international’s trading positions will be taken as a charge against the broker-dealer’s net capital under SEC Rule 15c3-3. Staff was asked whether the international would be considered a customer of the broker-dealer.

Regulations T and U were structured so that a broker or dealer may hypothecate customer securities on a good faith basis at a bank only if the financing of those security positions has already met the margin requirements set forth in Regulation T. All accounts must be treated consistently under both Regulations T and U. Therefore, a firm would be prohibited from treating an account as a customer account under Regulation U and as the broker-dealer’s own account under Regulation T. STAFF OP. of Oct. 22, 1984.

Section 220.11 of Regulation T permits a creditor to “effect or finance transactions of any of its owners if the creditor is a clearing and servicing broker or dealer owned jointly or individually by other creditors” (§ 220.11(a)(2)). Without this provision, a clearing broker-dealer that clears for its owner would have to treat the owner as a customer (§ 220.2(c)).

The question was raised whether telephonic notice of receipt of funds or securities from a customer, coupled with same-day mailing of a document reflecting receipt, constitutes “written notification” as prescribed in section 220.3(e)(2) of Regulation T. The staff assumed that the inquirer’s “small correspondent brokers” are brokers who do not generally carry customers’ accounts (as described in 17 CFR 240.15c3-1(a)(2)(vi)) and that the firm was carrying the customers’ accounts and was therefore responsible for complying with Regulation T. If the correspondents without direct access systems mail the specified security and receipt bearing that date as the date of receipt, or the deposit ticket dated that date to the firm’s bank account for a check or draft, receipt of these instruments is effective when they are mailed. The staff therefore has no difficulty with the proposed system.

A broker-dealer (clearing broker) proposes to clear, on a fully disclosed basis, the stock exchange market maker/specialist transactions and proprietary transactions of another broker-dealer (Broker A), which is a member of a major securities exchange. The clearing broker is 100 percent owned by a sole proprietor broker-dealer (Broker B). Officers of the clearing broker hold options that would dilute the ownership of Broker B to approximately 90 percent. Broker B also owns a 94.9 percent limited partnership interest in Broker A. It was proposed that one or more or the officers of the clearing broker may be the general partner(s) in Broker A.

A parent holding company owns three independent broker-dealer subsidiaries. One of the broker-dealers clears all transactions for the other two broker-dealers and is currently margining their trading accounts as retail customer accounts. It was suggested that credit could be extended on a good faith basis because the broker-dealers are all wholly owned by the same parent. Section 220.11(a)(2) of Regulation T allows a broker-dealer to “[e]ffect or finance transactions of any of its owners if the creditor is a clearing and servicing broker or dealer owned jointly or individually by other creditors.” Good faith credit would be appropriate if the two broker-dealers owned some part of the clearing broker, but in the absence of such a relationship, the current practice of margining the trading accounts the same as those of any retail customer is correct. STAFF OP. of Dec. 16, 1988.

Authority: 12 CFR 220.11(a)(2) (revised 1998; now 12 CFR 220.7(c)).

See also 5-618.

The broker-dealer subsidiary of the National Corporation for Housing Partnerships (NHP) will offer limited partnership interests in housing projects. NHP was created by Congress in 1968. In 1971, the SEC issued a no-action letter stating that no enforcement action would be recommended to the commission if NHP did not register as a broker-dealer. It would not be necessary or appropriate to view the NHP broker-dealer subsidiary as subject to Regulation T. STAFF OP. of June 6, 1980.

The definition of “creditor” in Regulation T covers registered representatives as well as the firms for which they work because it includes some associated persons. If the registered representative is involved in an account with another person and the other person shares profits disproportionate to his or her investment, Regulation T covers the relationship because a creditor is extending credit to a customer. STAFF OP. of Dec. 17, 1987.

The definition of creditor in Regulation T includes “any member of a national securities exchange.” Under Rules 1.1(ff), 3.1(b)(3), 3.3(a) of the Chicago Board Options Exchange, lessors of seats on the CBOE are considered members of the exchange, even though they need not be registered as a broker or dealer pursuant to section 15 of the Securities Exchange Act of 1934. Therefore, a subsidiary of a broker-dealer that is not registered as a broker-dealer but leases out a seat on the CBOE is a creditor under Regulation T. STAFF OP. of March 18, 1991.

See 5-942.7.

The Board was asked about a registered broker-dealer’s arranging certain interim and permanent financing for a wholly owned subsidiary. The subsidiary would be formed for the purpose of acquiring the assets of a corporation engaged in owning and operating a transportation facility (company) by means of a cash tender offer for all the shares of the company and a subsequent statutory merger of the company into the subsidiary.

Subsidiary A, a wholly owned subsidiary, is a member organization of the NYSE and is engaged in the business of providing securities clearing services to approximately 100 unaffiliated broker-dealers, on a basis that is fully disclosed to the unaffiliated broker-dealer’s customers. Subsidiary B is also a wholly owned subsidiary of the same parent and is a registered broker-dealer under the Securities Exchange Act of 1934. Subsidiary B clears transactions for market makers on the Chicago Board Options Exchange. Subsidiary B provides financing to its clearing clients on a good faith margin basis in a market functions account pursuant to section 220.12(b)(3)(i) and (ii) of Regulation T for specialists’ transactions and on the margin prescribed by section 220.18 of Regulation T with respect to any other transactions. Subsidiary B presently obtains funds for such financing by borrowing from a bank which loans it 80 percent of the value of the collateral Subsidiary B obtains from its clearing members for their borrowings.

A broker has set up a number of trading accounts that are carried in its own name. The broker contributes the capital for these accounts and certain individual traders who are employees of the broker share in the profits and losses. These trading accounts are margin accounts, and the traders/employees are charged interest at the current broker-dealer rate. Trading profits and losses are calculated monthly. At year-end the accounts are settled and it is determined whether profits or losses have been realized. These profits or losses are then shared by the trader/employee and the firm.

Two wholly owned guaranteed broker-dealer subsidiaries of a registered broker-dealer and New York Stock Exchange member (Subsidiaries A and B) engage in funding transactions similar to the one described in the staff opinion at 5-621.5. Securities involved in Subsidiary A’s borrowings from a bank are not physically held by the bank as collateral but are segregated on the books of Subsidiary B. The financing is provided on an agreement-to-pledge basis.

A limited partnership organized to engage in investment activities is contemplating having a broker-dealer act as the general partner. The general partner would have a 30 percent interest in the net profits of the limited partnership with no capital contribution. The partnership would be authorized to borrow funds, sell short, and purchase securities on margin so long as the aggregate of the indebtedness created by the borrowings and the margin transactions did not exceed the aggregate capital accounts of the partners. It is assumed that the general partner would execute all security transactions for the partnership. The limited partnership would therefore be a customer of the general partner and would have to meet margin calls for short sales and purchases in the same manner as any other customer. The general partner would have to enforce all requirements of Regulation T against the limited partnership.

A registered broker-dealer is currently a limited liability company (LLC) beneficially owned by one person. The firm would like to invite approximately 70 employees to become a new class of members of the LLC by contributing capital to the firm. The new class will contribute less than 5 percent of the firm’s increased capital.

See Clearing Firm, beginning at 5-618.

Board staff was asked about the possible status of a broker-dealer as an “exempted borrower,” based on its trading activity. The borrowing broker-dealer is registered with the Securities and Exchange Commission and is a member of the New York Stock Exchange. The firm engages in both index arbitrage and spread trading. Its index arbitrage trading involves taking a long position in an equity index and a short position in the related equity index future. Its spread trading involves taking a long position in an equity index future and a short position in the same equity index future, but with a different expiration than the long futures position. It was explained that the counterparties for transactions in futures for both of these trading strategies are typically floor members of the Chicago Mercantile Exchange that are not brokers or dealers or persons associated with brokers or dealers.

Although the Board does not have authority to set margin requirements on exempted securities (FNMA stock is an exempted security), brokers and national securities exchanges can establish margin requirements more restrictive than those of the Board. BD. RULING of June 28, 1972.

The issuer of certain dormitory bonds was not a political subdivision of a state, but it could possibly be an instrumentality or agency of a state. However, this issuer could guarantee payment of principal and interest only to the extent that it received rental payments from the dormitories. The guarantee did not pledge the full faith and credit of the issuer. This being the case, the dormitory bonds could not be considered “exempted securities” as that term is defined in section 3(a)(12) of the Securities Exchange Act. STAFF OP. of Aug. 16, 1972.

Section 802(ff) of the Housing and Urban Development Act of 1968, amending section 311 of the Federal National Mortgage Association Charter Act, provides that stock of FNMA is deemed to be an exempt security within the meaning of the laws administered by the SEC. Therefore, the broker through whom the purchase of FNMA common stock was made was able to extend good faith loan value, which is the amount the broker would customarily lend on a security. STAFF OP. of Oct. 22, 1974.

Authority: FNMA Charter Act § 311, 12 USC 1723c; 12 CFR 220.8(b) (revised 1998; now 12 CFR 220.12(b)).

United States Individual Retirement Bonds are an exempted security within the definition set forth in section 3(a)(12) of the Securities Exchange Act of 1934 because they are direct obligations of the United States. Accordingly, the bonds are exempt from regulation under section 7 of the 1934 act, which authorizes the Federal Reserve Board to establish margin requirements regarding securities other than exempted securities. STAFF OP. of March 18, 1975.

GNMA securities are exempted securities and as such are generally not subject to the Board’s margin regulations. The provisions of Regulation T that do apply to exempted securities are administrative details aimed at preventing the circumvention of the substantive rules applicable to other securities. Regulation T is therefore not violated if a broker or dealer (1) fails to obtain margin from a customer in a transaction involving GNMA securities sold on either an immediate- or delayed-delivery basis or (2) fails to cancel or otherwise liquidate a transaction involving GNMA securities in a special account when full payment is not made within seven days after the date of purchase. STAFF OP. of April 12, 1978.

Authority: 12 CFR 220.4(c) (revised 1998; now 12 CFR 220.8).

The purchase and sale of exempted securities is permitted in the cash account; however, only bona fide cash transactions may occur in a cash account. A bona fide cash transaction is one in which the customer does not sell or contemplate selling a purchased security before paying for that security. Therefore, sufficient funds must be held in the cash account to pay for the purchase, or the creditor can in good faith rely upon the customer’s promise to make full cash payment for the security promptly. The rules governing the cash account work to prevent free-riding, which is regulated by exchange rules. If the customer sells a security before having paid for it, section 4(c)(8) requires the creditor to impose a 90-day freeze upon the account; however, the 90-day freeze is not imposed if a customer sells an exempted security purchased in the cash account before having paid for it. Nevertheless, the practice of selling exempted securities before having paid the purchase price could be considered a circumvention of Regulation T. Whether a particular activity is proscribed is a question of fact.

The question was raised whether, for purposes of Regulation T, certain bonds issued by the Government Development Bank for Puerto Rico (GDB) are exempted securities. The GDB is a public corporation and instrumentality of Puerto Rico created by the Legislature of Puerto Rico in 1948. It is exempt from taxation in Puerto Rico and from the provisions of the Puerto Rico Banking Law. It is required to have an annual examination and audit by certified public accountants of national reputation selected by the board of directors. As are all Puerto Rico banks, the GDB is also subject to examination and supervision by the secretary of the Treasury of Puerto Rico. The controller of Puerto Rico, who is responsible to the legislature, reviews the GDB’s operations.

A broker-dealer indicated it believed that “all governmental securities do not come under Regulation T.” “Government security” is not defined in the Securities Exchange Act of 1934, under which Regulation T was promulgated. Section 3(a)(12) of the act defines “exempted securities” to include “securities which are direct obligations of, or obligations guaranteed as to principal or interest by, the United States.” Section 220.18 of Regulation T lists margin requirements; exempted securities are eligible for good faith loan value. Thus, while exempted securities do not require a 50 percent margin, it is not correct to say that they “do not come under Regulation T.”

Many securities issued by the Student Loan Marketing Association (Sallie Mae) would qualify as margin securities under Federal Reserve regulations because some are listed on a national securities exchange and others trade in the NASD’s national market system. Nevertheless, the legislation that created Sallie Mae (20 USC 1087-2(l)) states that “[a]ll stock and obligations issued by the Association pursuant to this section shall be deemed to be exempt securities within the meaning of laws administered by the Securities and Exchange Commission. . . . ” Therefore, Sallie Mae securities are exempted securities under the Securities Exchange Act of 1934 and the Board’s securities credit regulations. The required margin for exempted securities, as listed in the supplement to Regulation T, is “the margin required by the creditor in good faith.” STAFF OP. of May 27, 1988.

Authority: 20 USC 1087-2(l); SEA § 3(a)(12), 15 USC 78c(a)(12); 12 CFR 220.18(b) (revised 1998; now 12 CFR 220.12(b)).

A sale of government trust certificates represents a financing arrangement undertaken pursuant to the Foreign Operations Export Financing and Related Programs Appropriations Act of 1988 (the Appropriations Act), which permits borrowers to prepay certain eligible high-interest loans made by the Federal Financing Bank under the foreign military sales credit programs. The borrower in this transaction is the government of Israel. The Appropriations Act permits prepayment of the high-interest loans with the proceeds of new loans and authorizes the issuance of a full faith and credit U.S. government guaranty covering 90 percent of principal and interest. The remaining 10 percent is secured by a security interest in collateral consisting of non-callable securities issued or guaranteed by the United States government or derivatives thereof.

The New York Stock Exchange asked for the Board staff’s views on the permissibility of net settlement of the same exempt security in a cash account, citing the New York Federal Reserve Bank policy of encouraging a reduction in the size and number of large-dollar wire transfers through net settlement of transactions in U.S. Treasury securities.

Since the publication of the staff opinion at 5-628.16, the staff has been asked to look at similar offerings by other countries as well as additional offerings by the government of Israel and has written letters covering offerings by the Republic of Turkey (November 23, 1988), the Hashemite Kingdom of Jordan (December 13, 1988), and the Islamic Republic of Pakistan (February 2, 1989).

To finance the construction of a new archives facility, certificates of participation in installment payments are to be made by the United States of America, acting by and through the National Archives and Records Administration pursuant to an installment sale and trust agreement.

Certificates of participation evidencing proportionate interests in fixed rent are being issued in connection with the Judiciary Office Building Development Act (Public Law 100-480). The act authorizes the architect of the Capitol to enter into an agreement for the development of a new judiciary office building and an agreement for the lease of the building to the architect.

Pursuant to Public Law 101-302, the Agency for International Development (AID) is authorized to guarantee up to $400 million in loans to Israel for the purpose of providing housing in Israel for Soviet refugees. The guaranteed loans will be held by trusts that will issue certificates of beneficial interest to investors. Board staff told SEC staff that it has no objection to the inclusion of section 7(c) of the Securities Exchange Act of 1934 in an SEC staff no-action letter concerning this program. The SEC staff letter, dated March 27, 1991 states that the Division of Market Regulation will not recommend enforcement action if the program is conducted as described. Thus, the certificates may be treated as exempted securities for Regulation T purposes. STAFF OP. of March 29, 1991.

The legislation that created the Federal Home Loan Mortgage Corporation (“Freddie Mac”) states that “[a]ll securities issued or guaranteed by the Corporation (other than securities guaranteed by the Corporation that are backed by mortgages not purchased by the Corporation) shall. . .be deemed to be exempt securities within the meaning of the laws administered by the Securities and Exchange Commission” (12 USC 1455(g)).

The College Construction Loan Insurance Association (“the Corporation”), also known as Connie Lee, intends to insure bonds issued by academic institutions for new equipment and buildings. Congressional legislation concerning the Corporation was enacted in 1986. Section 1132f(b) of title 20 of the United States Code indicates that “[t]he Corporation shall not be an agency, instrumentality, or establishment of the United States Government.” Another section (20 USC 1132f-6) states that “[n]o obligation which is insured, guaranteed, or otherwise backed by the Corporation, shall be deemed to be an obligation which is guaranteed by the full faith and credit of the United States.”

The question was raised whether broker-dealers, for Regulation T purposes, may treat certain custodial receipts representing interests in obligations guaranteed by the U.S. government as exempted securities. The custodial receipts at issue represent a 100 percent interest in a number of confirmations of originator’s fees (COOFs). Each COOF represents the right to receive excess future interest payments due on obligations guaranteed by the full faith and credit of the United States through the U.S. Small Business Administration (SBA). The COOFs are created, in accordance with SBA regulations, by the SBA’s Fiscal and Transfer Agent in connection with the pooling of the SBA-guaranteed portions of loans. They represent excess interest payments arising from the SBA requirement that all loans in a pool have the same interest rate.

The requirement in section 7(a) of the Securities Exchange Act of 1934 (SEA) that the Board limit the amount of credit that may be extended on a security does not apply to exempted securities. Consequently, the Board does not set a specific margin on the purchase of exempted securities. Loans on exempted securities are subject to a good faith margin requirement, the only limitation being that the loan value of the exempted security cannot exceed 100 percent of its market value. This limitation stems from section 7(c)(2) of the SEA, which generally prohibits a broker-dealer from extending unsecured credit. The Board’s reasoning is that a loan in excess of the collateral’s market value is partially unsecured and therefore prohibited.

See 5-666.2 and 5-666.21.

A trust maintains 4,500 individually established, self-directed retirement plans whose beneficial owners are the ultimate customers in special cash accounts established at member firms. For all of these accounts, the member firms use the same tax ID number assigned to the trust by the IRS. Because of this fact, the trust argues that the NYSE rules for extensions of time could restrict trading by trust participants and request a blanket extension of time. In 1973, Board staff indicated it would have no objections to the NYSE’s granting a blanket extension of time in a similar situation.

While section 220.8(b)(4) normally requires prompt cancellation or liquidation of a transaction for which a customer has not made full cash payment within the required time, a creditor may “disregard any sum due from the customer not exceeding $500.” Although not specifically stated in the regulation, the staff is of the view that no extension of time need be filed for any transaction covered by the last sentence of section 220.8(b)(4). STAFF OP. of April 25, 1989.

Form T-4 is a statement of the purpose of the credit, to be completed by the broker or dealer and the customer only if the credit is for a purpose other than to purchase, carry, or trade in securities—regardless of the nature of the collateral. STAFF OP. of June 14, 1972.

A broker-dealer proposes to offer nonbrokerage services to various customers, who will pay for these services by using either a bank credit card or a line of credit. The nonbrokerage services would include magazine and news letter subscriptions, and quotation information, research, and nonpersonalized advice available through home computer systems. The broker-dealer would not actually be extending the credit itself but would be acting as a conduit between the customer and the actual source of the credit. In the case of the computer services, the customers would be billed monthly even though the actual liability could be incurred piecemeal throughout the month and the charges debited to a customer’s account.

See 5-650.82.

If a deficiency in a margin account is not the result of a purchase of securities, but of a decline in the market price of securities already held as collateral by a broker, Regulation T would not compel the broker to liquidate the collateral to eliminate the deficiency, although the broker’s own rules may require a margin call. There is no legal obstacle to borrowing money from a bank on a good faith loan basis to meet the broker’s margin call if the bank loan is not secured by stock. Of course, the customer would not be permitted to withdraw securities from the margin account and furnish them as collateral for the bank loan. STAFF OP. of March 2, 1971.

A single customer wants to carry two margin accounts with one brokerage firm. One account would be an options account and the other would be a general account. Both accounts would be carried in the books in the name of the client, with separate account numbers and separate transaction confirmations and monthly statements.

Broker-dealers are always permitted to lend in any margin account up to the maximum loan value of the collateral in the account and to allow the customer to withdraw from the account the cash realized from the borrowing. The cash can be used in any way the customer desires. Using the money to purchase a nonmargin security such as a tax shelter program in a cash account, for example, would be permissible. Once the borrowing of cash was made as permitted under Regulation T, the margin account or accounts involved would probably be charged a certain rate of interest for margin loans. STAFF OP. of May 28, 1982.

See 5-712.1.

See “Margin Account” for opinions issued after 1982.

Because foreign settlement mechanisms differ from the arrangements used in the United States for settling and clearing transactions, questions have arisen about the settlement and clearance of transactions in foreign securities by U.S. broker-dealers. The seven-day period for obtaining payment in both the cash and margin accounts provides a few extra days beyond the typical five-day settlement time used extensively in the securities industry. Section 220.8(b)(2) of Regulation T provides up to 35 calendar days for delivery-against-payment transactions in the cash account if delivery of the security is delayed because of the mechanics of the transaction and is not related to the customer’s willingness or ability to pay.

Using the cash account, a broker-dealer proposes to effect for customers in the United States transactions in securities traded on the Brussels Stock Exchange in Belgium. No credit will be extended or arranged, nor will the Belgian securities be used for loan value under Regulation T. Counsel for the broker-dealer told the staff that the Belgian settlement procedures are substantially identical to the French procedures discussed in the staff opinion at 5-638.5. A Brussels Stock Exchange publication shows the settlement dates for 1988.

A broker-dealer plans to begin arranging for securities transactions to be effected for its customers on the Stock Exchange of Singapore Ltd. (SES). All trades in SES-listed securities will be booked in cash accounts, usually on a delivery-against-payment basis.

The New York Stock Exchange asked about the applicability of the staff opinions at 5-638.5 and 5-638.53 to transactions effected on the Milan Stock Exchange. The inquiry stated that the settlement procedures in Italy are similar to those in Belgium and France. There is no reason to restrict the previous staff opinions to the exchanges or countries covered by those letters. As long as the NYSE (or any self-regulatory organization) is satisfied that a foreign country’s required settlement date for a given transaction may exceed 35 days from trade date, Board staff believes an SRO extension may be granted for a delivery-against-payment transaction. STAFF OP. of April 27, 1990.

The International Securities Market Association (ISMA) establishes rules and guidelines related to the purchase and sale of “international securities,” commonly known as Eurobonds. ISMA Rules 222 and 223 provide that settlement is normally the third business day following trade date but may be any other day “mutually agreed between the buyer and the seller at the time of dealing.” Under section 220.8(b)(1)(ii) of Regulation T, a customer purchasing a foreign security in a cash account must make payment within five business days or on “the date on which settlement is required to occur by the rules of the foreign securities market,” up to a maximum of 35 calendar days.

Since 1938, Regulation T has contained a provision regarding joint accounts in which a broker-dealer participates. In essence, if a broker-dealer participates in a margin account that is a joint venture and the other party shares in the profits to a greater extent than its contribution to the account, the difference is treated as an extension of credit from the broker-dealer to the other party. The substance of this provision and the Board’s position have not changed since 1938. The restriction is currently found in section 220.5(e) of Regulation T. In addition, this issue was addressed by the Board in a 1966 interpretation (12 CFR 220.121 at 5-485) and by Board staff in a 1984 opinion (at 5-621.51), both of which confirm the application of Regulation T to joint ventures as laid out in the regulation.

An investor asked how Regulation T would apply to a situation in which a broker has purchased stock for a customer who has not paid for the stock. Regulation T forbids a lender who is a broker-dealer (creditor) to extend more credit, under described circumstances, than the amounts specified in the current supplement to the regulation. Section 220.3(e) requires that the creditor effect liquidating transactions in a margin account when the deposit required by section 220.3(b) is not obtained within the requisite period, and section 220.4(c)(2) contains a corresponding provision applicable to cash accounts. STAFF OP. of July 28, 1970.

Staff objected to language in a proposed prospectus that would give a defaulting investor in a limited partnership the option to cure the default within 30 days after notice. Staff felt that this would depart from the “prompt liquidation” requirement contained in section 220.4(c). To give the buyer 30 days in which to cure the default would be tantamount to extending credit beyond seven days, a practice that would violate Regulation T. STAFF OP. of June 2, 1971.

Trading in a security has been suspended because of market manipulation in which a customer was involved. Several brokers are required by Regulation T to liquidate positions in this stock. If all the stock is immediately sold in the market when trading is resumed, there could be a market disruption over and above that created by the disclosure of the market manipulation.

An investor asked whether a broker-dealer is required by Regulation T to provide a customer with written notice prior to liquidating securities in a margin account to satisfy a federal margin call. Section 220.4(d) requires the broker to liquidate the securities if any margin call is not met within the required time. A “margin call” is defined as “a demand by a creditor to a customer for a deposit of additional cash or securities to eliminate or reduce a margin deficiency as required under this part” (§ 220.2(l)).

A customer ordered securities, failed to pay for them by the extended settlement date, and suffered a loss because of a forced liquidation. A broker-dealer must receive payment within seven business days of the trade, liquidate the position, or secure an extension. Regulation T permits seven business days for payment to allow for mailing, payment-posting operations, and other transaction-related activities. Extensions can be granted only under very specific conditions outlined in Regulation T and are therefore the exception rather than the norm.

Although staff believes that Regulation T permits liquidation or cancellation on the eighth business day after trade date, it is recognized that some firms and New York Stock Exchange officials are of the view that liquidation or cancellation is required at the end of the seventh day. Obviously, staff would like to encourage uniformity.

Section 5 of the Securities Act of 1933 and the rules thereunder require that purchasers of securities in a public offering receive a prospectus before a sale can be consummated. Customers, who may have decided to purchase securities in a public offering on the basis of a preliminary prospectus or otherwise, do have the right to cancel the order after receiving the final prospectus. Although Regulation T does not provide an exemption from section 220.8(c)(1) (90-day freeze) if the customer decides to cancel the order after receiving the prospectus, it is obvious that a customer should not be penalized for exercising this legal right. However, it cannot be assumed that every customer ordering a new issue and failing to pay for it within seven business days was exercising that legal right. If a customer wishes to cancel an order, that information should be communicated to the broker before settlement date. We assume that the broker would want that information as soon as possible so that efforts to complete the distribution can be made.

A determination of a “good faith loan value” should reflect the creditor’s business judgment based on arm’s length dealing with the borrower, the creditor’s general lending practice, and the nature of the collateral. The good faith loan value of a security would be limited, for example, to the amount the creditor would customarily lend on the particular security in question, without regard to other assets of the borrower or other collateral the creditor might hold in connection with separate transactions. Of course, credit extended on exempt securities should not be used to circumvent the margin requirements that relate to regulated loans under the Board’s regulations. STAFF OP. of Aug. 30, 1974.

To calculate the buying power in an account, the maximum loan value of the securities must first be determined. The Regulation T excess is determined by subtracting the general [now margin] account debit balance from the maximum loan value. A margin requirement of 50 percent results in buying power that is double the excess figure. STAFF OP. of Nov. 2, 1976.

A registered broker-dealer proposes to grant 50 percent margin loan value in a general account on the collateral of fully paid-for units of unit investment trusts originally offered and sold pursuant to an effective registration statement under the Securities Act of 1933.

Trading in S&P Index depository receipts (SPDRs) commenced on the American Stock Exchange on January 29, 1993. SPDRs are a trading vehicle that enable investors to use the exchange to trade a unit investment trust operating on an open-end basis; each unit represents a fractional interest in the S&P 500 index.

Section 220.2 of Regulation T defines “margin security” to include “any security registered or having unlisted trading privileges on a national securities exchange.” The Boston Stock Exchange is a national securities exchange registered with the Securities and Exchange Commission under section 6 of the Security Exchange Act of 1934. Therefore, any security listed on the Boston Stock Exchange is a margin security for purposes of the Board’s Regulation T. STAFF OP. of Dec. 4, 1997.

Authority: 12 CFR 220.2 (as revised 1998).

A new issue of securities known as DIAMONDS^SM are expected to begin trading on the American Stock Exchange in January 1998. They will be issued by a unit investment trust composed of a portfolio of Dow Jones Industrial Average (DJIA) stocks. The American Stock Exchange asked Board staff to address the margin requirements for DIAMONDS, the use of DIAMONDS to offset margin requirements for short sales of DJIA stocks and for DJIA options, and permitted offsets for specialists in DIAMONDS.

The American Stock Exchange is listing new depository receipts—Nasdaq-100 Shares^SM and nine Select Sector SPDR® Funds—which are similar to Standard & Poor’s Index depository receipts (SPDRs) and DIAMONDS^SM (see 5-646.14 and 5-646.16). Nasdaq-100 Shares are units of beneficial interest in a unit investment trust based on the Nasdaq-100 Index. Nine Select Sector SPDR Funds are units of beneficial interest in an open-end investment company based on the Standard & Poor’s 500 Composite Stock Index. The nine funds represent nine mutually exclusive subsets (known as “sectors”) of the stocks that constitute the S&P 500.

Board staff was asked about the status of auction-rate preferred securities under Regulation T.

See 5-666.16

See Options.

An individual investor purchased in a margin account certain shares of stock that are listed on the AMEX. He was informed at the time of purchase that he would not be required to deposit additional margin in the account unless the price of the stocks dropped by 80 percent. Nonetheless, when the price dropped by only 60 percent, he was informed that he would have to make an additional deposit to bring the account to a 100 percent margin status, and the firm sold stock from his account to accomplish this.

Regulation T imposes an initial margin requirement in connection with transactions in a margin account. It appears, however, that the liquidation in an investor’s account was effected pursuant to the maintenance requirement imposed by the stock exchanges of which his broker-dealer is a member. Regulation T does not contain such a requirement. Maintenance requirements are set out in the rules filed with the Securities and Exchange Commission and in the margin agreement that one signs when becoming a customer of the firm. STAFF OP. of May 18, 1970.

Authority: 12 CFR 220.7(e) (revised 1983; now 12 CFR 220.1(b)(2)).

A customer ordered his registered representative to cover a short position and to make an offsetting purchase of another security, to preserve the leverage in the account. Because the customer’s account was below the firm’s maintenance requirement, his representative was unable to purchase securities equal in value to the covered short position. Subsequently, securities in the customer’s account were sold to meet the firm’s maintenance requirement. The customer was not contacted before the sale. The Board’s regulations do not prevent brokerage firms from imposing additional requirements, especially maintenance requirements. STAFF OP. of Aug. 21, 1972.

The matter of imposing maintenance requirements has been left to the discretion of the individual broker-dealer firms and the various stock exchanges. Rule 431 of the NYSE provides a maintenance margin rule that must be applied by a broker. Section 220.7(e) of Regulation T provides that nothing in the regulation shall prevent brokerage firms from imposing maintenance requirements.

The Board does not set minimum maintenance requirements, although it has the authority to do so. Regulation T establishes the initial amount of margin that a brokerage firm must obtain from its customers; however, it does not prevent a brokerage firm from imposing additional requirements, particularly maintenance requirements. STAFF OP. of Feb. 26, 1981.

Credit extended by broker-dealers is governed by Regulation T. This regulation requires a customer to deposit a specific amount of margin when engaging in certain securities transactions in a margin account. The broker must effect liquidating transactions in a margin account if the initial deposit is not obtained within seven business days after the transaction. Although the Board, under section 7 of the Securities Exchange Act of 1934, has the authority to set maintenance margin rules, this function has traditionally been left up to the various exchanges. The stock exchange maintenance margin rules restrict the amount of margin indebtedness customers may maintain in relation to the value of all the securities serving as collateral in their accounts. These stock exchange rules require brokers to make “margin calls” on their customers to put up additional cash or securities when a declining market causes an account to become undermargined and to effect liquidating transactions if the the margin calls are not met.

Regulation T was issued in 1934 pursuant to sections 7 and 8 of the Securities Exchange Act of 1934 (15 USC 78g and 78h). The legislative history of this act indicates that Congress was concerned that continued excessive speculative credit in securities transactions could cause a reoccurrence of the stock market crash of 1929. Consequently, Congress authorized the Federal Reserve Board to limit the extent of credit available to securities investors. Originally, the Board had only regulations restricting the amount of credit that could be extended by brokers and dealers (Regulation T) and banks (Regulation U). In 1968, the Board promulgated a regulation pertaining to other lenders who could extend credit for the purpose of purchasing or carrying securities (Regulation G).

Although Regulation T sets forth the initial margin required when a security is purchased in a margin account, the Federal Reserve Board has not set maintenance requirements since the rules of self-regulatory organizations (SROs) include margin-maintenance requirements. In addition, most broker-dealers also have in-house maintenance requirements that are usually five to ten percentage points higher than those of the SROs.

A question was raised regarding the maintenance of two separate margin accounts with one broker, at two different branches of that broker. The general rule is that an individual may maintain separate margin accounts with one broker only if the accounts are for separate legal entities and therefore can be treated as the accounts of separate customers under Regulation T. The “John Doe Trust” is a revocable living trust with John Doe’s Social Security number. A valid revocable living trust normally requires the filing of informational returns with the Internal Revenue Service under a unique taxpayer identification number. If the John Doe Trust has its own taxpayer identification number, this number would be used for the margin account; this account could be treated as a separate account from the John Doe account registered with the individual’s Social Security number. As long as the trust is registered with the individual Social Security number, it is not the account of a different customer, and the existence of the two separate accounts with the broker would violate Regulation T, unless the accounts are excepted. This would be the case regardless of the broker’s account numbering or the branch offices where the accounts were opened. While the broker may agree to maintain the two account numbers for convenience, for the purposes of Regulation T there can be only one account.

The stock of a bank holding company is listed in NASD’s “pink sheets.” This stock may not be used for collateral in a margin account at a broker-dealer. The stock may, however, be used as collateral for a bank loan and given a good faith valuation regardless of the use of the loan proceeds.

A broker-dealer and credit union propose to offer a package consisting of three integrated financial services: (1) a conventional discount brokerage account at the broker-dealer, (2) an insured share draft (checking) and share savings account at the credit union, and (3) a premium credit card with a $5,000 line of credit offered through the credit union. A minimum equity level of $5,000 in the brokerage account and $5 in the savings account is necessary to qualify for the package. The customer fills out forms authorizing automatic transfers of cash and margin loan proceeds in certain specific situations.

A brokerage customer asked why the rate for “call money” rose dramatically in the beginning of the year. It was his understanding that the rate of interest charged by his broker for his margin account was based on the rate for call money.

For the purposes of Regulation T, all securities of the same class are marginable, even though some shares may be owned by control persons or are subject to some other restriction on their sale. This treatment follows the logic of SEC Rule 12d1-1, which indicates that every share of a class of securities is considered registered on an exchange (and therefore a margin security under the Board’s margin rules) if an application to the SEC for registration of a specified number of the same class of shares by a national securities exchange has already become effective.

On Day 1 a customer purchases $100,000 in margin equity securities and deposits $50,000 in cash. The value of the securities at end of day falls to $90,000. On Day 2 there are no transactions, but the value of the securities at end of day rises to $93,000. On Day 3 the customer purchases $2,000 in margin equity securities and makes no deposit.

A U.S. broker-dealer wants to clear and finance transactions for its foreign affiliates. None of the affiliates are U.S.-registered broker-dealers. The omnibus account described in section 220.10 is unavailable for non-U.S. broker-dealers.

A broker-dealer would like to assign more than one account number to a single corporate customer’s margin account. The example provided is of a customer that trades foreign-currency options on the Philadelphia Stock Exchange in more than one currency. The customer would like to receive separate information on options for each currency.

A brokerage firm charges variable interest rates to customers with margin accounts, depending on the average debit balance in the account. A customer who believes this interest rate structure is discriminatory wrote to his state securities commissioner. The state indicated that state law does not regulate the interest rates on margin accounts. The letter was then forwarded to the Federal Reserve to address the effect of Regulation T.

Regulation T does not regulate the interest rates on margin accounts. Regulation T is generally concerned with which securities are good collateral for margin accounts and how the collateral may be valued. Board staff’s understanding of other regulations and laws in this area is that before trading in a margin account, a customer must enter into a written agreement with the broker and the broker must disclose its method of computing interest charges on margin balances. However, Board staff is unaware of any regulation or law that would prohibit the interest rate structure described in the letter. STAFF OP. of Jan. 12, 1993.

Regulation T does not regulate the payment of interest by either a broker-dealer or its customer. The only references to interest can be found in section 220.4(f) and 220.6(b) of the regulation. These sections simply acknowledge that the interest charges imposed by the broker-dealer may be debited to the margin account and interest payments due to the customer may be credited to the special memorandum account. STAFF OP. of Dec. 2, 1994.

Board staff was asked about the application of the margin regulations to transactions involving a broker-dealer registered with the United States Securities and Exchange Commission (the U.S. broker-dealer) and the U.S. broker-dealer’s parent company, a foreign broker-dealer not registered with the SEC (the foreign broker-dealer). Many of the transactions also involve U.S. customers of the U.S. broker-dealer. All of the transactions involve foreign stock.

See 5-615.971.

See 5-650.86.

See General Account for related opinions issued before the 1983 revision of Regulation T.

See Loan Value starting at 5-644.

The Board’s authority under section 7 of the Securities Exchange Act of 1934 to set margin requirements does not extend to any “exempted security,” and a Treasury bill is generally conceded to come within the statutory definition of an “exempted security.” Regulation T allows a broker-dealer to extend credit on an exempted security up to 100 percent of the current market value of that security. In the case of a fully paid Treasury bill with a current market value of $100,000, a broker-dealer could make a loan up to $100,000.

In August of 1980, the Board amended section 220.2(f) of Regulation T to permit brokers and dealers to lend on mutual fund shares. Although Regulation T does not prohibit the purchase of a money market fund in a margin account, the Securities and Exchange Commission does view mutual fund shares to be in continuous distribution. The distribution, therefore, is continually subject to the prohibition of section 11(d) of the Securities Exchange Act of 1934. STAFF OP. of Aug. 13, 1982.

The question was raised whether a broker-dealer may extend credit on mutual fund shares by any method other than having the customer physically deposit certificates for the shares with the lending broker-dealer. Effective January 28, 1985, a new SEC rule exempts from the provisions of section 11(d)(1) of the Securities Exchange Act of 1934 mutual fund and unit investment trust shares sold by a broker-dealer to a customer more than 30 days prior to an extension of credit by the broker-dealer on those shares. Section 11(d)(1) of the act prohibits a broker-dealer from extending or arranging credit for a customer on any security that was part of a new issue if the broker-dealer participated in the distribution of that security within 30 days prior to the transaction. Because the SEC always viewed mutual fund shares as securities in continuous distribution, any broker-dealer distributing the shares as a principal underwriter or as a retailer previously could not accept such shares as collateral from any customer. Broker-dealers are still prohibited from selling mutual fund shares on margin if the shares are to be used as collateral, but they may extend credit on shares that they have sold and that have been held by the customer for more than 30 days. The new rule should greatly increase the number of shares available for use as collateral in margin accounts.

The purchase of futures contracts that are secured by corporate bonds should take place in the nonsecurities credit account because any credit extended is not for the purpose of purchasing securities. The Board does not set margin levels for the purchase of commodities. Rather, the rules of the futures exchange upon which the transaction is executed would apply. STAFF OP. of June 24, 1985.

A broker-dealer may make mortgage loans if the proceeds will not be used to purchase, carry, or trade in securities. A broker’s customer cannot borrow on an unsecured basis or on any collateral other than securities if the purpose of the credit is to purchase, carry, or trade in securities. Federal Reserve Form T-4 has been developed to ensure compliance with Regulation T requirements. STAFF OP. of Sept. 6, 1985.

A broker-dealer’s customers often need credit for a particular, single nonpurpose use but either do not require the funds immediately or do not require all the funds immediately. For example, a customer who wants a loan to purchase a home must be assured on signing the purchase contract that funds will be available on the closing date, which is often several months or more thereafter. Another example is that of a customer who requires a loan to cover the full cost of constructing a home but will pay the contractor in installments, at various stages of construction stretching out over a number of months, and who therefore does not need immediate access to the full contract price.

A company that makes real estate-secured loans, described as “purchase-money mortgages and no-cash-out refinances,” is owned by a holding company that is owned by a broker-dealer. For a company that is not a broker-dealer to be subject to Regulation T, it must be owned or controlled by a broker-dealer. If the mortgage company were owned directly by a broker-dealer, it would clearly be subject to Regulation T. A holding company between the broker-dealer and the mortgage company does not change this result.

A proposed arrangement involving a broker-dealer and its affiliate, a futures commission merchant (FCM), involves the deposit of nonmargin securities at the broker-dealer and a bank letter of credit to be used as initial margin at the FCM. The broker-dealer is subject to Regulation T, which prohibits broker-dealers from arranging for any credit they cannot extend themselves.

The nonsecurities credit account is the only account in Regulation T in which a broker-dealer may extend credit that is not collateralized by securities. A customer with a line of credit from a broker-dealer that is secured by real estate may not use this line of credit to purchase securities. Futures contracts, physical coins or metals, and foreign currency are not considered securities under Regulation T. Transactions in futures contracts and transactions in foreign currency are specifically listed as permissible (§§ 220.9(a)(1) and (2)). Buying and selling physical coins or metals, while not specifically listed, would be permissible under section 220.9(a)(3). STAFF OP. of Oct. 29, 1990.

A broker-dealer in the process of registration with the SEC plans to extend credit to customers against the collateral of marginable debt securities, including government securities. Loans would be in either the margin account or the nonpurpose credit account. In either case, the loan-repayment schedule would coincide with the interest payments on the debt security and be for amounts less than the interest payments. Thus, the customer will receive money each time interest is paid on the debt securities, but the amount received will be reduced by the scheduled loan payment.

A broker-dealer extended nonpurpose credit to a customer pursuant to section 220.9 of Regulation T. The customer would like to transfer to his wife the nonsecurities credit account that was used to record the nonpurpose loan. The loan was made over a year ago and is still in compliance with NYSE maintenance margin rules. It was not the intention of the customer when the loan was made to transfer the account or evade the requirements of Regulation T. The wife will provide the broker-dealer with a letter acknowledging that the account is only for nonpurpose credit. Neither the customer nor his wife have any other accounts with the broker-dealer.

See 5-632.1.

An individual investor attempting to sell a six-month put was required by his broker to deposit $2,800 cash or $14,000 in value of listed securities in connection with his guarantee of the put. NYSE Rule 431(d)(2) requires a maintenance margin in connection with the guarantee of a put or call option. The rule provides that “the issuance or guarantee for a customer of a put or a call shall be considered as a security transaction subject to paragraph (a) of this Rule. For the purpose of paragraph (b) of this Rule such puts and calls shall be considered as if they were exercised.” In short, the minimum margin required by the NYSE is 25 percent of the market value of a put covering $3,500 worth of stock, or $875. However, Regulation T permits brokers to require higher margins if they wish.

Under section 220.3(h)(1) of Regulation T, unissued securities require the same margin as if the securities were issued. At the time this letter was written, the initial margin requirement for purchases of listed securities, OTC margin stock, and listed unissued securities was 65 percent of the current market value of the security that must be deposited before the expiration of five full business days^* following the date of the transaction. This requirement applies both to purchases and to short sales.

Since a broker must guarantee an option for itto be salable, the broker extends credit to the writer of the option, and the transaction is therefore appropriately included in the margin account. In the case of puts, even though the writer agrees to keep the full amount of the purchase price of the stock on deposit with a broker, this amount must similarly be marked to the market, because of fluctuations in the price of the optioned stock. STAFF OP. of May 24, 1971.

An expiration-price option is an option containing a provision that it shall expire before the contract terminates if, during the life of the contract, the market price of the optioned security, in the case of a call, declines to a specified point (called the expiration price) below the striking price. The particular expiration-price option involved in the present case is structured so that the difference between the expiration price and the striking price decreases as the life of the contract decreases. This increases the possibility that the option will expire during the lifetime of the contract and reduces the probability that the option will have to be bought back.

Board staff responded to several requests for guidance in connection with the implementing of an amendment to Regulation T that established a uniform margin for the writing of options.

Section 220.3(b) of Regulation T requires a margin call whenever a transaction causes the adjusted debit balance of an account to exceed the maximum loan value of the securities in the account. The margin call for such an excess may be met with cash, with securities valued at their maximum loan value, or with a combination of cash and securities. The writing of an option against a long stock position may change the value of the long stock position in this computation, as exchanges have always recognized. The Board’s uniform minimum margin rule (§ 220.3(i)(2)), contains the following statement: “When a security held in the account serves in lieu of the margin required for a call, such security shall be valued at no greater than the exercise price of the call.” In accordance with the customary practice in this regard, no Regulation T margin call must be issued on the day a call is written against an existing stock position, even though its current market value is higher than the striking price. On any subsequent day, however, the stock’s value must be calculated on the lower of the current market price or the option exercise price.

Certain questions about the application of section 220.3(i)(6) have been raised. The calculations of the margin deposit arising from an option transaction may produce different requirements, depending upon which option or stock position held in the account is matched against a short option position as cover. If the regulation were to specify the method the creditor must use in matching positions, it would be excessively complex. Section 220.3(i)(6) was adopted to provide flexibility so that an acceptable procedure for making the daily matching calculation could be utilized with positions being shifted each day based upon any method the creditor and the customer agree to use.

“Escrow receipt” is a generic term that includes the approved option guarantee letter of the NYSE; the escrow receipt of the Options Clearing Corporation (OCC); or any other agreement under which a bank represents that it holds either securities that are the subject of a call or the cash to purchase securities subject to a put, and that it will deliver, or accept delivery, of the securities against payment upon exercise of the option. When the use of escrow receipts for option transactions was authorized by the Board, it was staff’s understanding that escrow receipts would not be issued on securities held as collateral by a bank for an already outstanding loan. STAFF OP. of Jan. 30, 1978.

A bank may accept in escrow the cash to be delivered upon the exercise of a “put” and, while waiting for an exercise notice, invest that cash in a security, such as a Treasury bill, that can be converted into cash within a very short period of time with no practical risk of loss. STAFF OP. of May 2, 1978.

The Board’s rules allow a complete release of the premiums earned from writing options. Regardless of the equity status of an account, money earned as premiums from option writing may be deposited into the special miscellaneous [now special memorandum] account, may be used to provide part or all of the margin required if the option written is not covered, may be taken out of the firm (if the firm’s rule permits), or may be used in any of the various ways that cash is used at a brokerage firm.

Option positions transferred from a firm’s trading account to its specialist account would not qualify for preferential treatment under section 220.4(g) of Regulation T. This preferential treatment is available only for those securities transactions entered into by people performing their specialist function on the floor of an exchange. The Board permitted creditors to extend preferential credit to specialists in recognition of the unique obligations they have under section 11(b) of the Securities Exchange Act and SEC Rule 11b-1. These obligations are not imposed on individuals who trade securities for their own account; therefore, such transactions are not eligible for preferential treatment. Since the provisions of section 220.4(g) are limited solely to bona fide specialist transactions, the commingling of specialist and nonspecialist positions in the account would not be permitted. STAFF OP. of Aug. 28, 1979.

Margin normally included in the adjusted debit balance for a written call option need not be deposited when a security immediately convertible into the underlying security without restriction is held against exercise of the call. Section 220.3(i)(2) requires that a security against which options have been written may be valued at no more than the exercise price of the call. When a customer elects to write a covered call against an existing convertible bond position, the customer is using the stock aspect of the security and its value is therefore the amount that will be received if the option is exercised and the customer converts the bond and delivers the stock against payment of the exercise price.

It is staff’s view that an escrow receipt for a narrow-based index option that is also settled in cash for the in-the-money amount could be used under section 220.8(a)(4)(i) of Regulation T to provide a covered transaction. This view would also be applicable to a transaction in a cash account involving a narrow-based index option settled in a similar manner. STAFF OP. of Nov. 15, 1984.

It was an inquirer’s belief that Regulation T and the relevant options exchange rules would permit the writing of a Treasury bond call option covered by a Treasury bond other than the one specifically underlying the option written. The inquirer noted that rules of the Options Clearing Corporation (OCC) permit the substitution of other Treasury bonds to meet settlement of exercise assignments when market conditions result in a scarcity of the underlying bonds. In addition, the OCC does not prohibit the holder in a long call option from accepting a substitute when exercising Treasury bond options. Under existing rules, therefore, a Treasury bond other than the specific issue upon which the option is written may be delivered in settlement of the contract. Board staff would have no objection to the above-described method of cover for Treasury bond options. STAFF OP. of Nov. 16, 1984.

A broker-dealer proposes to market a service by which employees of companies with formal stock option plans and publicly traded margin securities may exercise their options by designating the securities to be received on exercise to be collateral and by borrowing the entire amount of the option exercise price from the broker-dealer. If the exercise price were greater than the amount permitted to be borrowed on the securities to be received, the employee would pay the balance required to bring the loan into conformity with Regulation T when designating the securities to be received on exercise.

The staff was asked to consider eliminating the margin requirements on any stock purchases of retail customers using hedging strategies involving stocks and options, because the transactions are essentially riskless. As a former member of a national securities exchange, the inquirer was able to take advantage of the Board’s separate rules for specialists and market makers to effect the described hedging transactions with considerably lower margin requirements.

Securities and Exchange Commission Rule 3a12-7 designates over-the-counter options on government securities representing obligations of $250,000 or more as exempted securities. Section 220.18(b) of Regulation T states that the margin on exempted securities is “the margin required by the creditor in good faith”; therefore, an escrow receipt for an OTC government option whose underlying value is $250,000 or greater could be collateralized by cash.

The maintenance margin rules of the NASD do not prescribe any margin requirements for options on exempt securities unless those options are traded on an exchange or displayed in the NASDAQ system. SEC Rule 3a12-7 (17 CFR 240.3a12-7) made any over-the-counter option on exempt securities itself an exempt security if the securities underlying the option represented an obligation equal to or exceeding $250,000 in principal amount. In May 1983, when the Board adopted a completely revised and simplified Regulation T, the Board took explicit note of the then-pending SEC rule change: “The language of the section describing margin required for OTC options on exempted debt securities [220.18(g)] has been modified to exclude any options on exempt securities that the SEC determines are themselves exempt securities.” After a 1985 amendment, the substance of section 220.18(g) was contained in section 220.18(f). Therefore, the initial margin requirement for the writing of OTC options on government securities of at least $250,000 in principal amount is covered by section 220.18(b) and is a good faith margin. STAFF OP. of Nov. 23, 1987.

The Options Clearing Corporation will normally process options on the day an exercise notice is tendered to it. A broker-dealer explained that the large number of investors tendering on the Friday before the option expires often results in the OCC’s processing these options on the following day (Saturday). The broker-dealer asked if it could accept an order to sell the underlying stock on the Friday before expiration if the customer has exercised the option that Friday. Staff believes the processing date is not relevant as long as the customer instructs the broker to exercise the option and sell the underlying stock on the same day. This will not result in a violation of Regulation T.

The Chicago Board Options Exchange (CBOE) ceases trading in the options of specific companies when the underlying stock no longer trades due to a merger or acquisition. While no new options are traded, options outstanding as of the merger date continue to exist and may not expire for many months. Holders of these long options who choose to exercise them will receive a set amount regardless of when they exercise their option because the difference between the strike price and the value of underlying stock is fixed as of the date of the merger. Similarly, writers of these options find that their exposure is fixed because the price of the underlying stock does not fluctuate after the merger date.

Escrow receipts are often specific to a particular transaction. The Chicago Board Options Exchange described an escrow agreement that permits the customer to cover various different put series written on different days as long as the aggregate exercise value of all outstanding puts does not exceed the cash available to cover the escrow receipt. The bank will know what series are covered by the receipt at all times, but will not reissue the receipt when the covered series expire, are sold, or are replaced by other series.

The question was raised whether margin must be collected in connection with the sale, through a U.S. broker-dealer, of an option on foreign securities written by a U.S. institutional investor in favor of a foreign broker-dealer.

See 5-677.5 et seq.

See Valuation.

See Cash Account as well as this heading.

See 5-541.

See Arranging—Public Offering of Debt Securities.

Board interpretation 12 CFR 220.119 (at 5-490), to the effect that loans to retire stock are not purpose loans, is still in effect. The interpretation is limited in that it applies to issuers of securities and is available only if the stock is to be retired immediately.

A company proposes to place notes (refinancing) privately with two insurance companies. The refinancing will be used to retire two loans held by a consortium of banks, a revolving-credit agreement, and a term-loan agreement. The company used the proceeds of the borrowing under the revolving-credit agreement to purchase stock that is neither a margin security under Regulation G nor a publicly held security under Regulation T. Part of the proceeds of the loan were used to repay another bank loan, which had financed the acquisition of shares of a subsidiary, whose stock was listed on the NYSE. Because of a merger, the stock of the subsidiary is no longer a margin stock.

A bank loan would finance a reverse triangular merger. The stock involved is on the Board’s OTC list. It is staff’s opinion that a loan to “cash out” stockholders is a loan for the purchase of securities. STAFF OP. of June 21, 1978.

Authority: 12 CFR 220.7(a) (revised 1983; now 12 CFR 220.13).

Although an extension of credit to purchase a seat on an exchange has not been viewed as a purpose loan, a loan made by a clearing member to a market maker factoring the proceeds of a sale of an exchange seat is prohibited under Regulation T when the loan is used to eliminate a deficit outstanding and resume trading activity.

Under a proposed lending arrangement, a broker-dealer would lend a customer approximately $1 million to be secured by an irrevocable surety bond issued by an insurance company. The credit would be purpose credit. The obligation under the surety bond would be secured by United States Treasury securities owned by the insurance company and held in a custodial account at a bank. The broker-dealer would have the unconditional right to liquidate the insurance company’s Treasury securities upon default of the customer’s obligation to the broker-dealer and a corresponding default on the surety bond. This arrangement would violate Regulation T. STAFF OP. of June 15, 1984.

A broker-dealer proposes to enter into agreements with one or more issuers, agreeing to use its best efforts to purchase in the open market up to a specified number of shares of the issuer’s common stock at prices below a specified level. All purchases will comply with SEC Rule 10b-18. Any shares acquired by the issuer pursuant to the agreement will be retired.

Section 220.3(e)(4) of Regulation T, effective January 25, 1988, permits various arrangements between broker-dealers and issuers and between broker-dealers and customers. An issuer would not violate Regulation G by accepting a stock option exercise notice and instructions on Day 1 against payment on Day 5 from the proceeds from the sale of the shares of stock issued upon exercise of the relevant stock option. STAFF OP. of Jan. 7, 1988.

In determining customers’ eligibility to submit their stock options and delivery instructions pursuant to section 220.3(e)(4) of Regulation T, the key requirements are that the option was awarded in connection with the customer’s employment and that the customer may still exercise the option by its terms. This reasoning extends to employees who have been fired and the estates of deceased employees (or former employees), as long as exercise is currently permitted by the terms of the option. It should not matter whether the customer is a U.S. citizen or whether the employer is a U.S. corporation. Strictly speaking, the amendment applies to “creditors” as defined in Regulation T, and the nationalities of the other parties is irrelevant. Nevertheless, Regulation T should not be viewed as overriding any foreign laws that may be applicable.

Under a company’s employee stock option plan, an employee who wishes to exercise an option may tender cash or shares of the company’s stock that he or she already owns. An employee who already has some of the employer’s stock in a margin account exercises an option. A broker-dealer who follows the procedures listed in section 220.3(e)(4) may treat the exercise notice and instructions as if they were the stock to be received upon exercise. The broker-dealer may then withdraw either cash or securities to send to the employer. STAFF OP. of Nov. 28, 1990.

Section 220.3(e)(4) of Regulation T allows brokers to help finance the exercise of their customers’ employee stock options by allowing the creditor to treat the exercise notice and delivery instructions as if they were the stock to be realized from the exercise. Because the customer is treated as being long the underlying stock for Regulation T purposes, the broker has collateral against which it can lend the exercise price or which can be sold to realize the money needed for exercise.

Section 220.3(e)(4) of Regulation T allows a broker-dealer to help a customer with an employee stock option effect what is commonly called a “cashless exercise” of the option. In most cases, the customer exercises his or her option and instructs the broker to immediately sell some or all of the resulting stock.

Section 220.3(e)(4) of Regulation T allows a broker-dealer to temporarily advance funds on the customer’s behalf to the customer’s employer to exercise employee stock options. Repayment of the short-term loan is made either by selling some (or all) of the resulting stock or by the deposit of margin securities with sufficient loan value in a margin account.

Some individuals with employee stock options (“donors”) may wish to donate the stock to be realized from the exercise of the options to various charitable organizations (“donees”). A broker-dealer that wishes to assist such a customer will accept a copy of the donor’s exercise notice and irrevocable instructions to the issuer to send the stock to the broker. After verifying with the issuer that the stock will be delivered promptly to the broker, the broker will advance funds to the issuer to cover exercise of the option and any related withholding taxes. The donor will instruct the broker to transfer the resulting stock to the donee and the donee will instruct the broker to sell the stock. The donee will be entitled to the portion of the sales proceeds that were not sent to the issuer. These procedures are consistent with section 220.3(e)(4) of Regulation T. STAFF OP. of Nov. 6, 1991.

A broker-dealer wishes to use section 220.3(e)(4) of Regulation T in connection with a company’s stock purchase plan. Under the plan, eligible employees would be able to acquire stock at a discount. Employees would pay for the shares in cash or through payroll deduction. The stock is registered with the SEC on an S-8 registration statement, the form used for securities offered pursuant to employee benefit plans.

See 5-541.

The Board has no statutory authority to state whether or not an offering of securities is subject to the registration requirements of the Securities Act of 1933 (except those securities issued by a bank, organized under state law, that is a member of the Federal Reserve System), regardless of the presence of credit arrangements that may be part of the security or extraneous thereto. Congress has given only the Securities and Exchange Commission authority to define the registration requirements for offerings of securities, except for certain exempted securities. STAFF OP. of May 18, 1973.

The exemption from registration under section 4(2) of the Securities Act of 1933 resulted from Congress’s recognition that the public benefits of SEC registration of certain transactions would not justify the expense and trouble of such registration. The SEC adopted Rule 146 to provide objective 4(2) exemption standards. However, compliance with Rule 146 is not meant to be the exclusive method of justifying a 4(2) exemption; the exemption can also be supported by other criteria based on court and SEC determinations.

The Pennsylvania Securities Act requires registration of securities with the state unless the transaction or security is exempted. One exemption includes “[a]ny security listed, or approved for listing upon notice of issuance, on the New York, American, or Philadelphia stock exchange.  . .and any security. . .which satisfies the margin requirements of the Board of Governors of the Federal Reserve System under Regulation T.” Pa. Stat. Ann. tit. 70, § 1-202(f) (Purdon 1989).

Regulation T was promulgated by the Board pursuant to the mandate of Congress contained in section 7 of the Securities Exchange Act of 1934. However, the duty of enforcing the regulation was entrusted to the Securities and Exchange Commission. STAFF OP. of April 15, 1970.

Brokers may not extend credit on unlisted bonds and preferred stocks. Sections 220.4(i) and 220.8(b) of Regulation T allow brokers to extend credit only on exchange-registered bonds, while section 220.8(f) allows brokers to extend credit only on exchange-registered and OTC margin preferred stocks.

Regulation T is not applicable to a proposedoffering of dairy cow management contracts and the applicability of the Board’s margin regulations thereto, because the registrant will offer the management contracts to the public without the assistance of a broker-dealer. Neither the registrant, its principals, nor the “finders” have been deemed brokers or dealers by the SEC or by an appropriate state regulatory agency.

In a public exchange offer, shares of common stock will be exchanged for new debentures. The common stock is currently listed on the AMEX. The debentures will be listed on an exchange as soon as possible, but at the time of exchange they will not be a margin security. The question raised is whether customers who hold the common stock in margin accounts will be able to make the exchange without meeting Regulation T’s rules regarding the withdrawal of securities, which in most instances would require the deposit of additional cash or securities?

The exchange of old debentures (listed on the NYSE) for new debentures (not listed, but application for listing on the Pacific Stock Exchange was made at the time of the offering) constituted a recapitalization and was therefore eligible for the special treatment provided by section 220.6(e). When an issuer is revising its capital structure, the voluntariness of an exchange is not a factor to be considered for Regulation T purposes. Although section 220.6(e) permits a creditor to effect the exchange for a customer without regard to the withdrawal provisions of Regulation T, it does not require that it do so. STAFF OP. of Jan. 20, 1978.

The common stock of a publicly traded company, which proposes to reorganize, is now traded over the counter and appears on the Board’s list of OTC margin stocks. Shares of company stock would be exchanged for depository receipts evidencing ownership of limited partnership interests (new securities). The new securities would be freely transferable and are expected to be traded in the over-the-counter market.

Staff responded to a request that the use of certain categories of bank-issued certificates of deposit (CDs) be permitted as collateral in margin accounts subject to Regulation T. A recent federal case, Gary Plastic Packaging Corp. v. Merrill Lynch, appears to preclude the Board’s taking such action. The CDs described in the Gary case were issued by a domestic bank and were freely transferable, as is the case with most securities. However, without some change in the law that would make these CDs “securities,” section 7(c) of the Securities Exchange Act of 1934 prohibits their use in a margin account. STAFF OP. of July 19, 1984.

Regulation T operates separately and is independent of the NYSE regulations. Therefore, the Regulation T requirement of an initial deposit of 80 percent in connection with short sales cannot be met from the value of securities held in a margin account unless the value is above the 80 percent initial requirement.

An investor wants information about the treatment of convertible securities and the securities into which they are convertible when the latter securities are sold short.

A customer who holds a call on the warrants of certain stock would have to deposit margin for the stock sold short, because a call option is not a security having any value for margin purposes.

It is asked whether the proceeds of a short sale against the box would reduce his debit balance and interest charges on that balance. The applicable margin regulations governing this question are sections 220.3(d)(3) and 220.3(g) of Regulation T.

Regulation T section 220.3(d)(3) requires the customer’s adjusted debit balance to include a sum representing the current market value of any stock sold short in the account even when the account holds a bond convertible into that stock. The Board adopted a margin requirement on short sales to prevent persons with a given amount of money from exerting greater influence on the short side of the market than they could exert on the long side. On August 14, 1972, an amendment to section 220.4(j) became effective, allowing a customer to effect a short sale of the amount of margin stock into which listed convertible bonds held in the account are convertible in the special convertible debt security account. STAFF OP. of Feb. 9, 1973.

Authority: 12 CFR 220.3(d) and 220.4(j).

Section 220.3(d)(3) of Regulation T requires that a customer deposit the same margin when making a short sale as when taking a long position but permits the requirement to be satisfied by the deposit of a security that is “exchangeable or convertible within 90 calendar days, without restriction other than the payment of money, into such securities sold short”. Warrants have been considered securities “exchangeable or convertible” for the underlying stock and may be used to supply the place of margin for a short sale.

As a general rule, no funds may be released to the customer in the event of a short cover. The Board has established a retention requirement of 100 percent of net cost on a repurchase of a short position. After the short cover, the account in question may be recomputed, and any Regulation T excess that exists may be paid to the customer. If no Regulation T excess exists, no funds may be released. STAFF OP. of Nov. 21, 1979.

Unless a short sale is covered by the same securities or securities convertible within 90 calendar days into securities sold short, the adjusted debit balance of a customer’s account is increased (at current margin rates) by 150 percent of the current market value of the security sold short. As the credit balance created through a short sale would represent only 100 percent of the current market value of the security, the credit is insufficient to offset the required debit balance.

Cash proceeds from a short sale of the underlying margin equity securities cannot be released when the short sale is executed in the special convertible debt security account [now the margin account], a practice described as “convertible hedging.” Section 220.4(j)(5) of Regulation T permits the short sale of margin equity securities in an amount equal to the number of shares into which a margin debt security held in the account is convertible without the additional margin required in the supplement to Regulation T.

Although the Board’s authority to prescribe margins for short sales is specifically granted in section 7(a) of the Securities Exchange Act of 1934, the question of whether the broker is actually extending credit sometimes arises. In 1960 the Board ruled that although no money may have been paid out by the broker in connection with the short sale, the short sale is considered a credit extension because of the broker’s assumption of the credit risk on behalf of the customer. That view is consistent with the Board interpretation at 5-802 (12 CFR 221.118) in which a guarantee was viewed as an extension of credit.

The staff was asked whether the use of a Euro-warrant convertible into foreign securities within 90 days and without restriction other than the payment of money, the cash to convert the warrant into the foreign securities, and an irrevocable order to convert (the warrant box) combined with a short sale of the foreign securities could be viewed as a short sale against the box.

The staff was asked whether the netting principle inherent in the Regulation T provision covering a short sale against the box (§  220.5(b)(2)) applies when the short position is taken first, followed by a long purchase of the same security, thereby “boxing the short.”

See 5-615.78.

See 5-541.2.

See 5-928.2.

A corporation has an outstanding bond issue subject to a sinking fund. The sinking-fund provisions require that the corporation redeem a designated portion of the outstanding issue annually. It can do this either by purchasing its bonds in the open market and then delivering them to the trustee to satisfy the sinking-fund requirements or by paying into the sinking fund cash with which to redeem the designated portion of bonds.

BD. RULING of June 5, 1972.

Regulation T contains no rule about whether the cash account must be shown on a customer’s monthly statement and labeled as a separate account from the general [now margin] account. Regulation T does not specify the form of the account. It deals only with the content of the account. Traditionally, customer accounts are clearly identified as either cash or general accounts.

An investor proposes to buy preferred shares that are convertible into approximately two shares of common stock. Both issues are traded on the NYSE. Common is selling at $32 per share, and the preferred at $79.50 per share. Simultaneously with the purchase of preferred, the investor would sell the common short. This would result in a loss of about 18 cents per share of preferred.

Over the years, the Board has felt that exempt credit for arbitrage transactions should be available only when the transaction performed a market function in equalizing prices at an instant in time in different markets or between relatively equivalent securities. In no case has the Board allowed exempt arbitrage credit unless consummation of the arbitrage position is ensured. This, of course, would prevent the use of exempt credit in most risk arbitrage transactions. STAFF OP. of Feb. 15, 1973.

Accrued interest payable on convertible bonds must be taken into consideration as a cost of purchase in a bona fide arbitrage transaction. Even though such interest will be reimbursed at the end of the interest period or upon sale of the bond, Regulation T looks at the transaction at the time of purchase, not at subsequent events. STAFF OP. of May 14, 1979.

A customer who purchases securities through a broker-dealer using a COD arrangement pursuant to section 220.4(c)(5) must, within seven days after the date of purchase, deposit the full purchase price of the securities with the bank or other custodian to which delivery is to be made against payment and must leave the funds on deposit until used by the custodian for payment against delivery of the margin security, regardless of any delay in delivery due to a fail. STAFF OP. of May 25, 1971.

Authority: 12 CFR 220.4(c) (revised 1998; now 12 CFR 220.8(b)(2)).

As of November 12, 1994, the seven-day period was reduced to five days.

The question was raised whether a mutual fund dealer who is not transacting any business as a broker be deemed to be extending credit for the purchase or carrying of a security if the dealer sells the security in the special cash account. Staff held that credit would be extended in the special cash account if a customer purchased a security in the account and did not pay the full cash purchase price either before or simultaneously with the purchase. Allowing the customer to pay after the purchase (section 220.4(c)(2) limits the maximum period to seven full business days) is an extension of credit to that customer, although for a relatively short period of time. STAFF OP. of Aug. 27, 1971.

A fiduciary, which is custodian of a pension fund’s (fund) portfolio, arranges for the purchase of securities on behalf of the fund from broker-dealer firms that are subject to Regulation T. Since the purchases are made in a special cash account, the regulation requires the fund to furnish the bank with the funds needed to make payment for such purchases within seven full business days after their execution.

A bank opens a special cash account with a broker in its own name, and all payments are to be made COD. The bank allows private individuals to buy and sell margin and nonmargin stock through its account but gives the outward appearance that the transactions are for the bank rather than the individuals. The bank knows that the customer’s account does not contain funds with which to pay for the stock and that the customer intends to pay for the stock out of the proceeds of the sale. There is an understanding between the bank and the individuals that the bank is entitled to rely on the stock purchased, or its proceeds, as security for the individuals’ indebtedness.

The NYSE’s five-day rule governs members of that exchange in the “regular way” purchase and sale of bonds, rights, and stocks (other than U.S. government securities). This rule is different from Regulation T’s special cash account rule, which requires a customer of a broker or dealer, when purchasing a security for cash, to make full cash payment within seven business days after the date the purchase order is given to the broker. If the customer places a sell order with a broker or dealer, Regulation T requires the customer to deposit the security promptly in his or her account with the broker or dealer.

A broker who after seven business days has not received full cash payment for securities purchased in a special cash account is generally required to cancel or otherwise liquidate the transaction promptly. A broker is, however, allowed to disregard any sum not exceeding $100 due from the customer.

The essential points in section 220.4(c)(1)(ii) of Regulation T are (1) that the creditor must reasonably believe that the customer owns the security being sold on the customer’s behalf and (2) the security must be promptly deposited with the creditor. “Promptly” must be defined in light of the particular circumstances.

The question involves the applicability of Regulation T section 220.4(c)(8) to the following situations: (1) A customer with a credit balance of $31 purchases securities of a total value of $125 and sells the securities without paying the balance due of $94. Following this liquidation, he effects another purchase. (2) A customer with a credit balance of $287 purchases securities of a total value of $300 and sells the securities without paying the balance due of $13. Following this liquidation, he effects another purchase.

Four thousand limited partnership interests will be offered through a registered broker-dealer at $2,500 per interest. This amount is payable in full when the investor subscribes, but payment shall not be due until the effective date of the registration statement. Staff concluded that a broker-dealer would not be prohibited from participating in the sale of these partnership interests since an investor must pay in full upon entering a subscription, a practice specifically required by section 220.4(c)(1)(i) of Regulation T. STAFF OP. of May 17, 1973.

If a purchase is a cash transaction, section 220.4(a) of Regulation T requires that the customer make full cash payment within seven business days after the date on which the security is so purchased. The purchasing broker may, however, as a matter of policy, require payment within five business days. If the purchase is effected in the general [now margin] account, the customer must make the deposit of the required margin as promptly as possible and, in any event, before the expiration of five full business days following the date of the transaction—whether or not the broker has delivered the stock certificate to the customer.

A state educational institution’s endowment funds are held in a custodian account with a fiduciary. It is assumed that the educational institution itself, the fiduciary, or the investment advisors place the institution’s purchase orders with broker-dealers subject to Regulation T. It is further assumed that such purchases are made in a special cash account, pursuant to section 220.4(c), which requires the educational institution to furnish the fiduciary with funds for payment of such purchases within seven full business days after their execution. Since the fiduciary need not make payment until securities are actually delivered, it wants to invest the money on behalf of the educational institution in the interim. Staff concluded that, in the circumstances described, commitments must be limited to those investments securities readily convertible to cash on short notice and with minimal risk of loss, because of the necessity of paying for purchased securities when received. STAFF OP. of March 27, 1975.

An investor intends to purchase securities in the “third market,” using a bank as his agent. The transactions are to be bona fide cash transactions. Regulation U is inapplicable in this instance since no credit will be extended to the investor by the bank. However, since the bank will purchase shares from a broker-dealer, Regulation T will apply. Section 220.4(c)(2) requires a broker to liquidate any transactions in a cash account for which full cash payment is not made within seven business days, unless an exception is available. Section 220.4(c)(5) provides an exception for COD transactions by allowing up to 35 days for consummation of a transaction when a customer and broker agree that prompt cash payment is to be made against a prompt delivery. STAFF OP. of April 1, 1975.

X acts as a custodian for clients who purchase and sell securities. These clients include pension funds, educational institutions, and a group of insurance companies. Securities are purchased from brokers and dealers subject to Regulation T. Because of delays resulting from bona fide industry practices, securities purchased by or for the accounts are often not delivered to X within seven business days after execution of the purchase.

One of the provisions in an offering of limited partnerships stated that the first installment would be due 30 days after the organization of the partnership. Staff stated that, to be consistent with section 220.4(c) of Regulation T, payment on the first installment would have to be made within seven business days after the date on which the security is made available by the issuer for delivery to the purchaser (presumably, seven days after the partnership is organized). Section 220.4(c) does not allow the use of the special cash account unless the customer agrees to make full cash payment on the installment promptly.

A registered broker-dealer proposes to issue letters of credit to limited partners (investors) in a partnership formed for a specific investment. The firm will obtain from the individual investors fully paid-for collateral having a loan value under Regulation T equal to the initial requirements in effect at the time of the transaction. The securities would be held in a cash account labeled “John Doe—Escrow Account.” These accounts would be maintained at no less than 130 percent of the value of the letters of credit. Individuals electing to use this financing method would retain dividend, interest, and proxy rights in the securities, which would be segregated as required under Rule 15c3-3.

Under a proposed offering of limited partnership interests in offshore oil rigs, customers would be required to pay cash for the interests on the closing date in January 1982, when the interests would be available for transfer to the customers. Subscriptions for these interests would be taken in the second or third quarters of 1981, and each person subscribing for a limited partnership interest would be required to deliver an irrevocable bank letter of credit covering the full price of the limited partnership interest to be purchased. If the customer does not pay cash for the interest on the closing date, the bank issuing the letter of credit would be called to supply the funds. All letters of credit would be held by a bank escrow agent until the closing date.

A sale of bonds was proposed to finance the renovation and expansion of a hospital. The hospital and a broker (Broker S) will enter into an agreement whereby the bonds will be issued by the hospital to Broker S. Broker S will transfer title to the bonds to trusts pursuant to a supplemental agreement. Because of the mechanics by which the trusts acquire their portfolios, it is necessary for Broker S to serve as a conduit by purchasing the bonds in the first instance, as described below.

See Cash Account for related opinions issued after the 1983 revision of Regulation T.

Money or securities may be received into the special memorandum account (SMA) or paid out or delivered from the SMA for the customer without regard to any other account the customer may hold at a broker-dealer. When a customer issues instructions for a transaction that will result in a deficiency in the margin account, this deficiency can be eliminated by either a transfer from the SMA or the customer’s deposit of additional cash or qualified securities into the account. If the firm intends to make a transfer from the SMA to the margin account in lieu of issuing a margin call, the creditor should have an agreement with the customer, preferably in writing. This will ensure that the customer is fully aware of the procedure to be followed and aware that the SMA excess used in this way is no longer available for withdrawal.

A customer withdrew $10,000 from his special memorandum account in the morning and in the afternoon made a $10,000 purchase of securities. The question arose whether the broker-dealer would be in violation of section 220.4(e)(1)(ii) of Regulation T, which states that cash or securities may be withdrawn from a margin account except when the withdrawal together with other transactions would create or increase a margin deficiency.

The question was raised whether a customer’s SMA balance could be taken away without the customer’s permission and whether the SMA balance can be used to meet a margin call for a new obligation when the equity in the margin account is less than 50 percent.

A customer objected to his broker’s characterization of the special memorandum account (SMA) balance as a “line of credit.” While such a characterization is not the regulatory language of Regulation T, it is not an illegal misrepresentation, nor is another term often used in the industry, “borrowing power.” Both are used to indicate to a customer that for the calculation of interest charges on margin debt, credits in the SMA are used to offset debits in the margin account. When SMA amounts are withdrawn as cash from the firm or used as margin for a new security transaction, they no longer serve as an offset to the net debit balance on which interest is charged. The withdrawal of cash from the SMA or the use of it as the required margin for a new transaction (long or short) is permissible under Regulation T. However, the maintenance margin requirements of the firm (usually 30 percent) or the New York Stock Exchange (25 percent) do not permit the withdrawal of cash or the use of SMA balances as margin on new security positions when the net equity in the two accounts fall below the required maintenance margin.

A broker-dealer sought confirmation that an SMA need not be used with every margin account. Section 220.5(a) states that “[a] special memorandum account (SMA) may be maintained in conjunction with a margin account.” The word “may” in this section indicates that the use of an SMA is not mandatory. If a margin account is maintained without an SMA, entries normally made to the SMA such as dividends, interest payments, and cash not required by Regulation T would be made directly to the margin account.

See 5-616.11.

When Regulation T was first adopted in 1934, section 220.3(b) provided for the extension of credit to other brokers and dealers in a separately recorded special account. Although this special account was not called a special omnibus account in the regulations until the general revision that became effective on January 1, 1938, the description of this account indicates that it is in the same genre as the special omnibus account. It appears that these “omnibus accounts” were in general use in the brokerage industry before the enactment of Regulation T and were referred to by the industry and the Board as such. The Annual Report of the Board of Governors of the Federal Reserve System for 1937, for example, reports on page 3: “In the case of loans to other members, brokers and dealers for the purpose of financing customers’ commitments (commonly called omnibus accounts or omnibus loans) the margin requirement was reduced from 40 percent to 25 percent.”

A broker-dealer has excess capital funds that it wants to use more profitably by offering to establish and maintain a special omnibus account for each of one or more broker-dealers for the purpose of financing that broker-dealer’s customer debit balances.

Section 220.4(b) of Regulation T limits the use of the omnibus account to brokers and dealers registered with the SEC under section 15 of the Securities Exchange Act of 1934 or members of national securities exchanges. The regulation unquestionably permits the use of the special omnibus account by exchange members who are not registered with the SEC as brokers or dealers. Prior to the effective date of the relevant 1975 amendments to the 1934 act, particularly section 15(a), brokers and dealers were not required to register with the SEC if they effected transactions exclusively on the floor of a national exchange.

See also Clearing Firm.

A customer transferred his margin account from Broker A to Broker B and then to Broker C. Subsequently, Broker A issued a special miscellaneous [ now special memorandum] account (SMA) letter for the customer. The investor asks if Regulation T requires Broker A to forward the SMA letter to Broker B or C.

A broker-dealer asked about the possibility of transferring a short position in a customer’s margin account from one broker-dealer to another. Section 220.5(f) of Regulation T allows the transfer of a margin account from one creditor to another as if it had been maintained from the date of origin if the receiving creditor accepts a written statement that any margin call issued has been satisfied. No provision of the regulation would permit the transfer of a short position that is only part of an account from a margin account held at one creditor to an account at another at the price used in the original transaction. Such a transaction would have to be effected at the current market price for the security on the day of the transaction.

An employee holding an unqualified stock option agreement to purchase shares of a margin security wants to open a margin account with a broker-dealer for the purpose of financing the purchase of the securities subject to the option. The employee would permit the broker-dealer to exercise the options on his behalf and to deposit into the account all shares issued pursuant to the terms of the option. The issuer has agreed to deliver those shares to the broker-dealer against cash payment, upon exercise of the option. Shares so delivered will not be encumbered or restricted in any manner, and their current market value is in excess of twice the exercise price of the option.

The staff was asked for its views on the proper valuation of stock used to cover an option under the following circumstances. The account holds a short position in a call that is covered by the appropriate number of shares of stock (“the covering stock”). The exercise price of the call is less than the current market value of the covering stock. The customer enters a closing purchase transaction eliminating the existing option position and a new opening writing transaction for an option on the covering stock. The exercise price of the new option is the same as the current market value of the covering stock.

A customer holds a long in-the-money call option in a margin account. If he exercises this option, he will be able to buy a certain number of shares of stock at a stated price (the strike price) substantially below the current market price. If the customer chooses to exercise the call, he must have available in his account, or be able to deposit by settlement date, cash or qualified securities to meet the initial margin required on the purchase. In the case of an equity security, the initial margin would be 50 percent of the strike price, not 50 percent of the current market price of the security. The amount of the margin call is determined on trade date; however, Regulation T allows a customer seven business days after the margin deficiency is created to make this deposit.

A proposed variable-annuity plan calls for the purchaser to “owe” the price of an annuity (itself a security) secured by a deposit of equity securities. Staff concluded that such a plan was in essence a cash sale not subject to the margin requirements of Regulation T. STAFF OP. of July 1, 1970.

Authority: 12 CFR 220.4(c).

An issuer proposes a sale of shares in accordance with a published plan on a when-distributed basis. The proposed offering will use the typical offering and sales procedures of the United Kingdom securities market exclusively. No U.S. underwriting or dealer group will be involved. Any U.S. person who wants to purchase the shares must submit an application on the prescribed form with a deposit in the form of a check drawn in sterling on a bank in the United Kingdom. If the application is accepted, a letter of acceptance will be issued with instructions for payment in sterling on a date three months later. On that date, the share certificates will be available for distribution to those who have made full payment. Regulation T states that if a security purchased in special cash account is a when-distributed security to be distributed in accordance with a published plan, full payment must be made within seven days after the security is distributed. Full payment for the shares here involved must be made on or before the date when the shares are available for distribution.

When-issued securities cannot be used to offset options positions in a market-maker account, because when-issued securities cannot be delivered in the event of exercise or assignment of an existing options position. STAFF OP. of May 14, 1979.

A broker-dealer has agreed to solicit subscriptions on a best efforts basis from a limited group of persons eligible to purchase corporate debentures. A Regulation T question arises because the offering provides two methods of payment. One is a typical special cash account transaction, with the entire subscription payment due within five business days after a request for payment is sent to the subscriber. This method raises no regulatory issues. The other provides for 24 monthly installments. In general, a broker-dealer under Regulation T cannot sell securities or arrange for their sale on an installment plan. The proposed method of payment, however, differs from the usual installment sale in that the purchaser (1) is not charged interest and (2) does not receive the entire principal amount of debentures at the outset, but receives units pro rata over the 24 months. A private placement exemption under section 220.7(a) is not available, since an S-1 has been filed with the SEC.

Under the unissued-security provision of Regulation T (§  220.8(b)(1)(ii)), the seven business days^* during which the broker-dealer must obtain full cash payment for a security does not start to run until the security is issued and made available by the issuer for delivery to purchasers. The regulation, therefore, treats a transaction as if no credit is extended until the security is actually issued, or if the security is not issued. The provision for unissued securities in section 220.5(a) of Regulation T (covering margin-account exceptions and special provisions) does require margin for net long or net short commitments in unissued securities.