When opening a margin account, customers must sign a margin agreement. This agreement states that the customer will abide by the rules and regulations of the Federal Reserve Board, the SRO, and DriveWealth. The margin agreement will contain three separate agreements - the credit agreement, the hypothecation agreement, and the loan consent agreement.
By signing the credit agreement, customers recognize that they are borrowing funds from the firm and are responsible for payment of interest and repayment of the loan amount. The agreement discloses all the credit terms. The interest rate is variable and is typically tied to the broker call loan rate.
DriveWealth charges a variable rate of Fed Funds plus 400 basis points. Margin interest is charged on a daily basis and is posted to the customer’s account monthly.
In the United States, the interest paid in a margin account is generally tax-deductible against investment income.
The hypothecation agreement states that the customer hypothecates (pledges) their securities to the brokerage firm and gives the firm the right to rehypothecate (repledge) the securities to secure the loan at a bank.
Securities in a margin account are held in the name of DriveWealth in street name. The securities are held in street name so that the brokerage firm may sell them should the customer not meet a margin call. DriveWealth is the nominal owner (i.e., owner in name only). The stock belongs to the customer who is the beneficial owner.
Loan Consent Agreement
The loan consent agreement gives DriveWealth the right to lend customers’ securities. Broker-dealers typically lend these securities to clients wishing to borrow stock for short selling purposes. Based on current regulations, the customer is not required to sign this agreement.
When a margin account is opened for a customer, DriveWealth will make available to the customer a statement of the amount of interest that will be charged and the method by which interest will be computed. Disclosures:
- Conditions under which interest charges will be imposed
- The annual rate or rates that may be imposed
- The method of computing interest
- Whether the rates are subject to change without prior notice and the specific condition under which they may be changed
- The method of determining the debit balances on which interest will be charged and whether credit is given for credit balances
When a customer opens a margin account with DriveWealth, the customer is required to sign the margin agreement. The margin agreement contains a number of conditions that the customer agrees will apply to the account. If these terms and conditions are changed by DriveWealth, advanced written notice must be provided at least 30 days prior to the changes.
Margin Disclosure Document
The use of margin entails additional risks. For this reason, DriveWealth is required to furnish all margin customers with a disclosure document at the time of the account opening and annually thereafter. Disclosures:
- You can lose more funds than you deposit in the margin account.
- The firm can force the sale of securities or other assets in your account(s).
- The firm can sell your securities or other assets without contacting you.
- You are not entitled to choose which securities or other assets in your account(s) are liquidated or sold to meet a margin call.
- The firm can increase its house maintenance margin requirements at any time and is not required to provide you with advance notice.
- You are not entitled to an extension of time on a margin call.
Rule 15c2-1 is concerned with the hypothecation of customers’ securities. Hypothecation is the process in which a customer pledges securities in a margin account to DriveWealth. The rule considers certain practices to be fraudulent or manipulative acts. These prohibited practices are:
- Commingling (placing together) of securities carried for the account of a customer with those of another customer without obtaining the written consent of both customers
- Commingling the securities of a customer with those of any person who is not a customer of the broker-dealer, including securities owned by the broker dealer
- Hypothecating customer securities for a sum that exceeds the total indebtedness of all customers
With permission, DriveWealth is allowed to use their customers’ securities as collateral for bank loans under a process termed rehypothecation.
Amount That May Be Rehypothecated
SEC Rule 15c3-3, The Customer Protection Rule, permits DriveWealth to use stock with a value of 140% of the customers’ debit balance as collateral for a bank loan. DriveWealth may borrow only the amount that it lent the customer, but it may collateralize this borrowing with stock valued at 140% of the debit balance. The following example clarifies this point.:
The Regulation T margin requirement is 50%. A customer buys back stock with a total cost of $100,000 and deposits $50,000 with the firm. The firm lends the customer $50,000. The broker-dealer wishes to replace the $50,000 that it lent the customer by borrowing from a bank. The amount that it may borrow from the bank, using the customer’s stock as collateral for the loan, is $50,000. However, the bank will require more than $50,000 of collateral to safeguard its loan. The broker-dealer is allowed to use stock worth 140% of the customer’s debit balance or $70,000 and rehypothecate this stock as collateral for the loan. The rest of the customer’s shares, with a value of $30,000, are called excess margin securities. Excess margin securities must be segregated, which means that the broker-dealer will set these shares aside and not use them as collateral.
DriveWealth may not borrow more than it lends a customer. The 140% rule applies to the amount of stock that may be used as collateral, not the amount that may be borrowed. The example from above is used to illustrate this point.
The $50,000 the firm lends the customer is the customer’s debit balances. The broker-dealer is allowed to take stock with a value of 140% of the debit balance of $50,000 to a bank to rehypothecate as collateral for the loan. Therefore, the broker-dealer may use stock worth $70,000. Suppose the bank in this case willing to lend the broker-dealer 80% of the value of the collateral. 80% of $70,000 equals $56,000. However, the broker-dealer could not borrow this amount. It is allowed to borrow only the amount that it lent the customer and would, therefore, restrict its borrowing to $50,000.