Deposit requirements

Regulation T & FINRA margin rules

Deposit requirements represent the money required to execute an investment strategy in a margin account. Investors are subject to Regulation T and FINRA requirements when borrowing money from their broker-dealer.

Regulation T is a rule established in the Securities Exchange Act of 1934 and controlled by the Federal Reserve, which requires investors to make a specified deposit when borrowing money for investment purposes. Investors must generally deposit 50% to establish stock positions in margin accounts. For example, an investor purchasing $10,000 of stock must deposit a minimum of $5,000 (borrowing the other $5,000).

FINRA requires a margin equity (ownership) level of $2,000 to make use of margin loans. Applicable margin regulations require a deposit of the greater of their Regulation T and FINRA requirements. Let’s go through an example to understand this concept better.

An investor opens a new margin account and subsequently executes a purchase of 100 shares of ABC stock at $30. What is their deposit requirement?

Can you figure it out?

What if an investor purchases less than $2,000? For example, an investor buys stock for a total value of $1,200. Does it make sense to require a deposit of $2,000 if their maximum loss was $1,200 (assuming the stock became worthless)? No - it wouldn’t. Therefore, investors deposit 100% of the transaction if purchasing less than $2,000. Essentially, their account is treated like a cash account.

The rules discussed above apply to long margin accounts, which are accounts involving purchases of securities (no short sales). Here’s a summary of the margin initial deposit rules:

Investors owning fully-paid securities (those owned without borrowed funds) can avoid typical deposit requirements. These securities can act as collateral in margin accounts, allowing the investor to borrow funds from the broker-dealer without posting cash. In particular, investors can post twice the cash deposit requirement in fully-paid marginable* securities. For example, let’s assume an investor wants to purchase $10,000 of stock in their new margin account. The standard Regulation T cash deposit requirement is 50%, or $5,000. Instead of posting cash, the investor can transfer $10,000 of fully-paid securities (2 x $5,000) from another account into the new margin account to meet the Regulation T requirement.

*A marginable security can be purchased on margin or utilized as collateral in a margin account. A list of marginable securities is provided later in this chapter.

Short account margin rules

Deposit rules are different for short positions. When an investor sells short, they can lose more than the initial value of the investment. For example, assume an investor goes short 100 shares of stock at $15. Although the initial short position is only $1,500, the investor could lose an unlimited amount if the stock price increased considerably. If the stock price went to $50, they would be obligated to spend $5,000 repurchasing it ($50 x 100 shares), resulting in a $3,500 loss ($1,500 short sale - $5,000 repurchase).

Due to the heightened risk of short positions, margin rules always require a minimum deposit equaling the greater of 50% or $2,000. Most importantly - even a small initial short position well below $2,000 requires at least a $2,000 deposit. For example:

An investor opens a new margin account and executes a short sale of 10 shares of ABC stock at $40. What is their deposit requirement?

Although the position is only worth $400 (10 shares x $40), the investor must deposit $2,000. Unlike long positions, short sales always require a deposit of at least $2,000. If the same example above was changed to a long purchase of 10 shares at $40, the investor would only be required to deposit $400.

Marginable securities & accounts

Many securities are marginable, meaning they can be purchased with borrowed funds or act as collateral. Marginable securities include:

• Exchange-listed stocks (including NASDAQ)
• Federal Reserve approved OTC stocks*
• Debt securities (US government, municipal, corporate)
• Primary offerings after 30 days of ownership**
• LEAPS options with more than 9 months to expiration
• Warrants

*The Federal Reserve provides a list of OTC (unlisted) stocks they deem marginable. As a reminder, unlisted stocks are typically volatile and risky. The Fed generally only approves the “best of the worst,” typically the least volatile securities in this group. Here’s an old example of their marginable OTC stock list.

**Primary market offerings include both initial public offerings (IPOs) and mutual funds. These securities cannot be purchased on margin with borrowed funds, but can act as collateral towards a purchase of another security. For example, assume an investor opens an account and buys mutual fund shares with their own money. After 30 days of holding the position, it is worth $10,000. They could purchase $10,000 of a marginable stock (a completely different security) and not deposit any extra funds.

These securities are not marginable:

• OTC stocks not approved by the Federal Reserve
• Primary offerings held less than 30 days
• Any option with 9 months or less to maturity
• Insurance products (e.g., annuities)
• Rights

In addition, only non-retirement margin accounts* can utilize margin. The following account types cannot utilize margin:

• Custodial accounts (UGMA & UTMA)
• Guardianship accounts
• Trust accounts unless specifically authorized in the trust agreement
• Education plans (529 and Coverdell)
• Retirement accounts (qualified, non-qualified, IRAs)

*In recent years, some broker-dealers have introduced “limited margin retirement accounts”. While most non-margin accounts require investors to wait before using unsettled proceeds (e.g., selling stock and using the proceeds immediately), limited margin accounts permit investors to bypass settlement requirements. Other forms of margin, like borrowing funds to purchase new securities, cannot be used. This concept is generally untested, and you should assume retirement accounts cannot use margin.

Regulation T settlement

Regulation T also relates to settlement for both margin and cash accounts. Although securities maintain various settlement times, Regulation T settlement is always two business days after regular-way settlement. This is the last day the cash for a purchase or the securities for a sale can be delivered (investors pay cash when they buy securities and deliver securities when they sell).

If an investor does not fulfill their Regulation T call (failing to deliver the required cash or securities by Regulation T settlement), the broker-dealer maintaining custody of their account must take action. The firm can reach out to the appropriate self-regulatory organization (usually FINRA) and request an extension for the customer or can close out the position for the client and “freeze” their account.

If the firm obtains an extension from an SRO, it gives the customer extra time to fulfill their obligation. For example, if a customer is subject to a $10,000 Regulation T call for a recent security purchase, they’ll get a few extra days to make the $10,000 deposit. Extension requests occur infrequently and are sometimes denied.

The more common process is liquidating a customer’s position(s) and freezing the account. Again, let’s assume a customer is subject to a $10,000 Regulation T call on a recent security purchase. If the required deposit isn’t made by Regulation T settlement (two days after regular-way settlement), the firm can liquidate $10,000 of securities in the customer’s account. They’ll keep the $10,000 to pay for the transaction, then freeze the customer’s account.

The term ‘frozen’ is not exactly what it seems. Frozen accounts can continue to perform transactions, but only if the funds are immediately available. Before the investor executes a new securities purchase, they must have the required cash or collateral available in their account to pay for it. Accounts remain frozen for 90 days, then the restriction is removed.