Part-13
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Tarheel Consultancy Services Corporate Training and Consulting
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Part-13 Brokerage Operations A Macro View
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Structure of a Brokerage Firm
The activities of a brokerage firm can be broken into three broad categories: Front-Office Operations Back-Office Operations Proprietary Operations
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Structure (Cont…)
All activities that involve client contact take place in the front office. These tasks include the soliciting and taking of orders; execution of trades; and provision of investment advice. Back-office operations include supporting activities.
4
Structure (Cont…)
The back-office clears and settles all trades; maintains accounts, produces research reports; and creates and operates information systems. Proprietary operations include cash and risk management; and speculative deals on account of the firm itself.
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The Front Office
Brokers solicit order flow by advertising and by calling prospective clients. They also provide potential clients with extensive investment information and research inputs, to induce them to trade. Sales Brokers are front office staff whose primary function is to interact with clients.
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Front Office (Cont…)
They work in the Sales & Trading department of the firm. Floor Brokers are employees who arrange trades on the exchange and on the trading floor of the firm, if the firm itself were to operate a trading platform. This division of a brokerage firm is called Floor Operations. 7
Front Office (Cont…)
Large brokerage firms have a Corporate Finance department whose staff are engaged in distributing large stock and bond offerings made by companies. These personnel work closely with Sales Brokers. 8
Research
Many firms employ Financial Analysts to generate information reports. Each analyst will in general specialize in an industry or commodity. The responsibilities of such analysts include forecasting future prices and earnings. These analysts work in the Research Department.
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Research (Cont…)
Research analysts also have the task of enabling customers to understand the intricacies of financial instruments and trading techniques. Their reports are the tools with which Sales Brokers solicit business. These analysts also work closely with Corporate Finance Departments by giving inputs on M&A activities. 10
Customer Service
Customer service agents help the clients to manage their accounts. Their activities include facilitating the establishment of new accounts; and the transfer and closure of existing accounts. They advise clients with respect to deposits into and withdrawals from their accounts. 11
Customer Service (Cont…)
Customers can get help from these agents if required, to interpret the periodical accounts statements provided by the brokerage firm. All these activities come within the ambit of the Customer Service Department. 12
The Back Office
Brokerage firms use computerized accounting systems to keep track of their accounts, and to clear and settle trades. Most small firms and some large firms buy such systems off the shelf. Some of the larger brokerage houses however use proprietary systems.
13
Back Office (Cont…)
In some cases it is because these firms have special needs which ready made systems cannot satisfy. In other cases it is simply because an in house system had been developed, before the advent of sophisticated off the shelf systems. 14
Street Name Securities
Traders often choose to allow brokers or depositories to hold securities on their behalf. Such securities are said to be held in Street Name. In these cases, where a broker holds the security on behalf of the client, the broker is the legal owner. 15
Street Name (Cont…)
The client only has a corresponding relationship in his account. When a security is held in Street Name, the broker has certain responsibilities thrust on him. Firstly he must collect interest or dividends payments from the issuing firms, and credit them to the proper client accounts. 16
Street Name (Cont…)
He must keep track off and handle corporate re-organizations such as name changes, splits/reverse splits, bonus issues, mergers, acquisitions, and liquidations. He must also ensure that the issuers of securities can at all times communicate with the beneficial owners of the securities, namely the clients.
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Street Name (Cont…)
Such activities are overseen by the Corporate Reorganizations Department of the brokerage firm.
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Market Data & Order Routing
Brokerage houses invest heavily in voice and data systems that enable their employees to communicate with clients, dealers, markets, and with each other. These systems are mainly provided by third party vendors. 19
Market Data … (Cont…)
When data systems written by different vendors are used to exchange information, there can be serious co-ordination problems. And co-ordination is absolutely vital. This is because the clearing and settlement system needs to report trades to the accounting system, which needs to relay position reports to the former.
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Market Data … (Cont…)
The software industry has developed certain communications protocols that enable systems developed by different vendors to interact with each other. The most important of these are: Financial Information eXchange (FIX) protocol and 21
Market Data … (Cont…)
Open Financial Exchange (OFE) protocol FIX primarily serves institutional traders while OFE is essentially for internet based retail traders. The protocols allow traders to route orders and transmit related information in standard formats that can be interpreted by any FIX or OFE based system. 22
Credit Management
Brokers often extend credit to clients, to other brokers, and to dealers. Credit extension may arise on various scores. A client may have insufficient funds to buy securities and may consequently seek to borrow a part of the required amount. This is called Margin Trading. 23
Credit Management (Cont…)
Or he may seek to sell a security that he does not own, in which case he will need to borrow a security. This is called Short Selling. The broker must carefully evaluate all credit relationships to avoid potential losses. This task is undertaken by the Credit Manager of the firm. 24
Proprietary Operations
These activities are undertaken by the brokerage firm for its own account, or what is known as the house account. We will consider various activities under this category.
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Cash Management & Stock Lending and Borrowing
Brokerage firms which hold cash and securities on behalf of their clients will not permit these assets to remain idle. That is they will seek to keep these assets productively invested. The cash management activities will be undertaken by the Cashier’s Department. 26
Cash Management (Cont…)
Stock lending and borrowing comes into the picture where short sales are involved. A broker may lend a share or arrange for a share to be lent to a client or another broker for undertaking a short sale. Or else he may borrow a share from a client or another broker to enable his client to short sell. 27
Cash Management (Cont…)
Employees who handle such activities are a part of the Margin Department or the Stock Loan Department.
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Risk Management
The Risk Manager is required to monitor all activities of the firm to ensure that risks do not become unmanageable. The specific roles are: To ensure that management is aware of all financial and legal risks 29
Risk Management (Cont…)
To ensure that adequate controls are in place to prevent rogue traders from creating unauthorized positions To ensure that the concerned employees understand the financial ramifications of all proprietary trades. To ensure that proper credit appraisal of potential clients is undertaken.
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Opening an Account
Opening an account with a broker requires that the client provide relevant and sufficient information to enable the broker to `know its customer’. The rules pertaining to establishing a broker-client relationship are governed by NYSE Rule 405 and NASD Conduct Rule 2310. 31
Account Opening (Cont…)
These rules state that a customer should only receive advice and recommendations which are consistent with his stated investment objectives. Brokers are required as per these rules to obtain `essential facts’ relative to each customer account and each order that is placed in such an account.
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Account Opening (Cont…)
The minimum information necessary to open an account with an NYSE member firm includes: Full Name Address – Residential and Business (if any) Telephone Number Social Security or TIN (taxpayer identification number) 33
Account Opening (Cont…)
Employment Details Marital Status An acknowledgement that the client is of legal age
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Account Opening (Cont…)
An investor need not be employed to open an account. However, if the client is an employee of a bank or another securities firm, then special considerations will apply. A bank employee who seeks to open a margin account must present the written permission of his employer.
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Account Opening (Cont…)
An employee of another broker/dealer must present his employee’s written permission to open any kind of account. Such a client must also give his consent to the broker to forward duplicate confirmations of all transactions and statements of account to his employer.
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Investment Objectives
Every client must provide a statement of purpose listing the goal of the account. What could be the possible goals? These include: Preservation of capital Earning of income Earning of tax-free income 37
Investment Objectives (Cont…)
Capital gains Speculation Hedging The broker and the client should reach an agreement on how the goals ought to be indicated, to avoid potential legal disputes. 38
Other Information
Such information varies from firm to firm, but is generally consistent across brokers. It includes: bank references brokerage account references income details net worth details number of dependents 39
Types of Accounts
Almost all customer related securities transactions take place in either a cash account or in a margin account. In addition brokers/dealers transact significant business with each other through house accounts. Investment advisors, mutual funds, and other institutions use omnibus accounts.
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Types of Accounts (Cont…)
What is an Omnibus Account? It allows institutions to make large single transactions which can then be allocated to various subaccounts. Futures contracts are executed through special accounts that are set up for this purpose. 41
Cash Accounts
A trader can buy or sell any security on a cash and carry basis. That is, if the purchase is paid for in full, or if adequate funds exist in the account, then a cash account transaction can be put through. The securities traded may be stocks, bonds, mutual funds, warrants, or options. 42
Cash Accounts (Cont…)
Customers will receive a written confirmation from their broker that payments are due within 3 business days, in the case of T+3 settlement. If the client fails to pay, the broker will liquidate the position, and impose a 90 day block or freeze on the account.
43
Margin Accounts
Margin accounts are used to gain leverage through the use of borrowed funds, and for executing short sales. Margin customers have to sign a margin agreement also called a customer’s agreement or a hypothecation agreement. 44
Margin Accounts (Cont…)
The margin agreement pledges the customer’s securities as collateral for the margin loans extended by the broker.
The agreement may also contain a stockloan consent form which allows the broker to lend the margined securities of his clients to other clients for short sales, and arbitrage transactions. 45
Margin Accounts (Cont…)
Margin customers have to be provided with a copy of the Federal Truth-in-lending agreement, which describes how interest will be computed by the broker.
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Truth-in-lending Act
This Act more correctly known as the Consumer Credit Protection Act was passed by the U.S. Congress in 1968. It is firstly about truthful disclosure of the terms of a loan. But beyond that, it defines and prohibits extortionate credit practices.
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TIL Act (Cont…)
The Act requires lenders to disclose the annual percentage rate of interest (APR) that is being charged on the loan. Lenders must disclose the total dollar cost associated with granting a loan – known as the Finance Charge – which is the sum of all the charges that are required to be paid by the consumer in order to secure the loan.
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TIL Act (Cont…)
These additional charges may include credit investigation fees, insurance premia etc. Since every lender has to quote his APR based on the same method of computation, it makes it easier for the consumer to shop around. Why do we need this Act? Consider an illustration. 49
Illustration
Consider a loan where $ 1,200 is lent for a year at a stated rate of 10%. The borrower is required to repay the principal plus $ 120 after one year as interest. The effective rate of interest is 120 ------ = .10 = 10% which is the stated rate 1200 of interest.
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Illustration (Cont…)
Now consider what is called a Discounted Loan. The lender lends a principal amount of $ 1200. However he calculates the interest for one year at a rate of 10%, which is $ 120, and deducts it upfront. Thus the borrower receives $ 1,080 at the outset, and must pay back $1,200.
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Illustration (Cont…)
In this case although the stated rate of interest is 10% the effective rate of interest is: 120 ------ = 11.11% 1080 The borrower is clearly paying a higher rate. 52
Illustration (Cont…)
Prior to the enactment of the TIL Act, lenders in both the cases could state that they were charging a rate of interest of 10% per annum. And many gullible borrowers would get deceived by the second lender. The TIL Act prevents this kind of misleading information. 53
Illustration (Cont…)
Now in both of these cases, the lenders must quote the APR which is 10% for the first loan and 11.11% in the case of the second loan. Thus unless an investor is forced to accept a loan with inferior terms, like for instance due to a bad credit record, he will not go for the second option.
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Street Name Stocks
Securities in a margin account are held in street name. This is done so as to facilitate the transfer and pledging of such securities. This is because the broker has a lien on such securities as long as there is a debit balance in the account.
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Street Name (Cont…)
Consequently, if a client fails to respond to a payment request, the broker can liquidate or transfer the shares without obtaining his signature. Thus when securities are held in street name, the customer’s name will not be on the share certificate and nor will it be known to the issuer.
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Street Name (Cont…)
In such cases, therefore the brokerage firm is the registered owner or owner of record. The customer is considered to be the beneficial owner. This is because all dividend and interest payments, and other reports issued by the issuer will be received and forwarded to the client by the broker. 57
Street Name (Cont…)
Holding of securities in street name offers certain advantages to clients. Firstly it simplifies the transfer process. Secondly it reduces the risk of the securities being lost or stolen, for the broker performs the safekeeping functions.
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Street Name (Cont…)
When the client wants to sell all it requires a mere phone call. Neither signatures, or signature verifications, are required.
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Advisory Accounts
Some customers lack the knowledge, time, or inclination to manage their investments. They therefore seek the services of a professional money manager, investment advisor, or counselor. Such facilities can be availed of from a number of sources. 60
Advisory Accounts (Cont…)
These include: Bank Trust Departments Large National Advisory Firms Smaller Specialized Advisory Firms Investment Counseling Subsidiaries of Major Securities Firms 61
Advisory Accounts (Cont…)
Having chosen an advisor, the client will sign a limited power of attorney or trading authorization in his favour. The advisor can then trade without consulting the client. The customer is liable for all transactions costs and advisor fees.
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Advisory Accounts (Cont…)
Large advisors give a lot of business to brokers and consequently can command lower commissions.
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Discretionary Accounts
This is an alternative approach to fund management. The customer in such cases will sign a trading authorization in favour of a registered representative of a brokerage firm. Some firms have separate registration account agreements for this purpose. 64
Discretionary Accounts (Cont…)
However there is a potential conflict of interest between the client and the registered representative. This is because the broker’s representative gets no management fee. On the contrary his compensation is based on the volume of trading activity in the account.
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Discretionary Accounts (Cont…)
Since the representative does not need permission to trade, it is always possible for a client to level allegations of excessive trading subsequently. Such charges may or may not be justified. Another criticism is that brokers use such accounts as dumping grounds for unsuccessful IPOs. 66
Discretionary Accounts (Cont….)
Thus there is a lot of potential for regulatory and legal problems. Many brokers either prohibit such accounts or else restrict them to carefully screened customers. They also ensure that such accounts are handled by their senior personnel. 67
Revenues
The primary source of revenue for most brokerage firms is commissions. Other sources include: Payment for orders Interest on cash balances Margin interest on loans Underwriting fees M&A consulting fees Security lending fees 68
Commissions
In most countries commissions are negotiable. There are however countries where government or exchange regulations specify fixed commission rates that a broker must charge. Until 2003, the minimum commission in Hong Kong was 0.25% of the trade value. 69
Deregulation
Commissions were deregulated in 1975 in the U.S, in 1987 in the U.K., and in 1999 in Japan. In a deregulated industry, commissions can vary substantially from broker to broker. The quantum of commission will depend on the extent and quality of services provided. 70
Commissions (Cont…)
Deep discount brokers charge the least. However they provide only the bare minimum by way of service. Full service brokers charge the maximum, but offer value-added services and advice. Discount and deep discount brokers specify standard commission schedules.
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Commissions (Cont…)
They may even offer additional discounts to their best clients. The commission schedule provided by a full service broker is usually just list prices, analogous to the rack rate quoted by a hotel. Very few clients will pay the list price. The regular clients can negotiate substantially lower rates. 72
Commissions (Cont…)
Full service brokers are increasingly charging a flat fee for the accounts that they advise. This fee covers: All trading commissions Investment research fees Portfolio management fees Account maintenance fees 73
Commissions (Cont…)
In the absence of a flat fee, the client would have to pay separately for each service. Clients are happy because this system, because it takes away the incentive for the broker to churn the account. Churning refers to inducing trades primarily to benefit from commissions.
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Commissions (Cont…)
The typical flat fee is 1 to 3 percent of the total value of the account, and is negotiable. Fixed fee accounts are also known as wrap accounts because all commissions and expenses are wrapped in a single fee. 75
Commissions (Cont…)
The average price is 5-6 cents per share, but it can range from 1-12 cents per share. In most countries, however, institutional brokers base their commissions on the size of the transaction. In almost all countries the rates are negotiable. 76
Commissions (Cont…)
The rate may vary depending on: The size of the trade The difficulty of arranging it The soft dollars that it generates Institutional clients sometimes get volume discounts based on the total volume traded during a month, quarter, or year. 77
Commissions (Cont…)
Most NYSE/NASD member firms establish a rate schedule and revise it periodically. The smaller brokerage firms generally wait for changes from industry leaders like Merrill Lynch or Salomon Smith Barney before adjusting their own rates. The rates inevitably favour larger transactions over smaller ones. 78
Commissions (Cont…)
The brokerage house will share the commission with the registered representative who is handling the client. The principle is the same. For a large transaction, the representative may receive 25-50% of the gross commissions earned by the firm. 79
Commissions (Cont…)
But for smaller trades the payout will be less and may even be nil. Thus representatives lack an incentive to handle small investors who are perceived as unprofitable. Institutional investors on the other hand witness fierce competition for their business. 80
Commissions (Cont…)
There are cases where large institutions are charged no commission. The loss in such cases can be justified by the perceived gains from liquidity and order flow. Brokerage houses welcome greater liquidity because most of them are dual traders. 81
Commissions (Cont…)
However, it is not as if institutions have been the sole beneficiaries of deregulation. Retail customers too have benefited. Prior to deregulation, the fixed commission structure was subsidizing retail customers at the expense of institutional clients. Thus when rates were deregulated, retail clients witnessed a sharp increase in rates. This lead to the evolution of Discount Broking.
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Discount Brokers
These firms started out as small no-frills players. But some of them like Charles Schwab and Fidelity Investment have grown large enough to be comparable with the big full service brokerage houses. Such brokers offer the same services or attractions to all their clients.
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Discount Brokers (Cont…)
In most cases they do not offer their own research. Many simply offer Standard and Poor’s reports on major companies. Fidelity is an exception. In 1997 it established an agreement with Salomon to offer its institutional research.
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Discount Brokers (Cont…)
In return Fidelity agreed to provide Salomon with access to its customers for marketing new equity issues. In a discount brokerage house, the registered representative is merely an order taker. He is forbidden by firm policy to make any kind of investment recommendation. 85
Discount Brokers (Cont…)
The representative’s pay is not linked to the solicitation of new business or to active trading. And it is much lower than that of a representative working with a full service firm.
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Deep Discount Brokers
These firms charge even less as compared to discount brokers. But they usually require a minimum number of trades annually and/or a large account balance.
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Soft Commissions
In an unregulated market how will a broker obtain greater order flow. He will lower his commissions And he will try and offer better services In a price regulated market the only choices are: Offer better service Or offer other things of value 88
Soft Commissions (Cont…)
Before deregulation brokers gave institutional clients many free services. The services took many forms. They provided investment research They gave away accounting systems; communications systems; computing systems; and provided staff training.
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Soft Commissions (Cont…)
Clients were given marketing incentives such as: Tickets to major sporting events All expense paid trips to investment conferences in exotic locations In return clients paid high commissions. 90
Soft Commissions (Cont…)
To promote fairness in the systems, that is, to ensure that the services provided were commensurate with the value of business, they created a system of soft dollar accounting. Under this scheme, a client earned one soft or notional dollar for a certain amount of hard dollars spent by way of commissions.
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Soft Commissions (Cont…)
These soft dollars could then be used to procure services from the broker. They could even be used to procure services from third parties via brokers. The soft dollar system allowed brokers to compete for business despite the fixed commissions.
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Soft Commissions (Cont…)
A more aggressive broker would simply gift away soft dollars more easily. Clients benefited from the competition and by way of lower net trading costs. The soft dollar system basically undermined the concept of fixed brokerage commissions and hastened deregulation.
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Soft Commissions (Cont…)
But the abolition of the fixed commission regime has not lead to the end of the soft dollar system. In fact, the use of soft dollars has increased after deregulation. According to the SEC the total value of research paid for with soft dollars exceeded US dollars 1 billion in 1998. 94
Soft Commissions (Cont…)
In fact to obtain such soft dollars, many institutional traders, are willing pay much higher commissions than they would otherwise have had to pay for trade execution. In 1998 soft dollar brokers offered 1 dollar of soft dollar services on an average, for every 1.7 dollars received by way of hard dollar commissions. 95
Soft Commissions (Cont…)
What is it that makes the soft dollar system popular, despite deregulation? The reason is that mutual funds find this system to be attractive. When an investment fund pays hard dollars for expenses other than trading commissions, the cost appears as an expense in the books of accounts.
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Soft Commissions (Cont…)
Trading commissions, however, even though they are paid for with hard dollars do not show up as direct expenses in the books of account. Instead they have a financial impact on the net price at which the fund buys or sells shares. Commissions will raise purchase prices, and lower sales proceeds.
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Soft Commissions (Cont…)
Many investors prefer to invest in funds with a low expense ratio. Thus many funds prefer to pay for services with soft dollars in order to create an illusion that costs are being managed more effectively.
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Directed Brokerage & Commission Recapture
Many institutional investment sponsors direct their investment advisors to use the services of specific brokers. The sponsors thus create direct brokerage relationships to support specific brokers. For instance, political considerations force many state and municipal pension funds to use in-state brokers.
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Directed Brokerage (Cont…)
Pension plans at times negotiate commission recapture agreements with brokers to whom they direct orders. These agreements require the broker to return to the sponsor some of the commissions that are paid. These recaptured commissions may reflect volume discounts or may simply be rebates.
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Directed Brokerage (Cont…)
State and municipal plan sponsors use this money to pay for investment consulting services for which they would otherwise have no budget. According to the Employment Retirement Income Security Act (ERISA), trustees of private pension plans in the U.S have to treat commissions as assets of the fund.
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Directed Brokerage (Cont…)
Thus if they were to recapture any commissions they would have to return them to the fund. Thus private pension plans generally do not negotiate such recapture agreements.
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Payments for Order Flow
These payments are made by dealers to brokers for directing orders to them from their clients. For many retail-based security brokers, such payments can be a significant source of revenue.
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Interest Income
Some times brokers lend a part of the money that is required by an investor to buy securities. This is called Margin Trading. In such cases the broker will charge interest on the margin loan. The rate of interest is based on the broker call money rate. 104
Interest Income (Cont…)
This is the rate at which a broker can borrow from another broker or a bank. Brokers also earn interest on the cash that is deposited with them by their clients. But this is largely offset by the interest that they are required to pay to their clients on such balances. But in the net the broker will still make money.
105
Interest Income (Cont…)
Some brokers will not pay interest on the client’s cash balance. And there are others who will pay only if the balance were to exceed a certain minimum figure.
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Short Interest Rebate
When a trader wants to short sell a security his broker must have the security ready for delivery to the buyer. Thus before a broker accepts an order to short sell, he will first determine if the security is available. In practice the broker will usually have securities that he is holding in street name.
107
Short Interest (Cont…)
If so, he can deliver these securities. If not he must borrow the securities from someone else. When the broker delivers a security that he holds in street name, he will not pass on the proceeds to the short seller. He will keep the cash as collateral in order to ensure that the short seller is able to repurchase the security. 108
Short Interest (Cont…)
Thus the broker can invest the proceeds from the short sale, and will earn interest income on the same.
109
Short Interest (Cont…)
The interest that a broker earns directly or indirectly on the proceeds from a short sale can be a very significant source of revenue. Large clients and professional traders demand that their brokers rebate some of the interest earned on the proceeds of the short sale. 110
Short Interest (Cont…)
This kind of an interest payment is called a short interest rebate. Retail brokers however, generally refuse to pay short interest rebates to their clients as a matter of firm policy.
111
Security Lending Fees
A broker who holds securities in street name will often lend them for short sales. In return he will get a securities lending fee. The fee would depend on the demand for short positions and the availability of the shares. 112
Placing Orders
Once an investor has opened an account he may place an order by:
Telephone Mail Telex Fax Personal contact Over the Internet 113
Placing Orders (Cont…)
When the order is received, a registered representative will fill out an order form. He must take the utmost care while filling out the form. A wrong entry may cause the computer to reject the order, which could lead to the investor missing the market. 114
An Order Form
Typical information sought on an order form includes:
Buy order or Sell order If sell, sell long or sell short Place of execution – NYSE, AMEX etc. Type of account – cash or margin Normal settlement or cash settlement Solicited or unsolicited order 115
An Order Form (Cont…)
Disposition of securities purchased:
Transfer and ship to customer Retain in street name Deliver against payment to a bank or another broker
Application of sale proceeds
Retain or Payout 116
An Order Form (Cont…)
The security symbol or description Number of shares Price indication
Market Limit Stop Stop-limit
Customer’s name and account number Representative’s name and number 117
Following Execution
Once the order is executed, the representative should phone the customer as promptly as possible, and relay the following:
Execution price Approximate amount – including fees and commissions Settlement date 118
Following Execution (Cont…)
A customer should not wait for the receipt of the confirmation by mail before remitting the funds
The market makes no allowance for postal delays Funds must therefore arrive on time – confirmation or no confirmation
119
Confirmations
It is a report sent by the broker to the customer on how the order was executed. It is called `confirm’ by Wall Street traders. It will have to disclose the following information. 120
Confirmations (Cont…)
Trade date Settlement date Security Number of shares Or principal amount in the case of bonds Execution price Place of execution 121
Confirmations (Cont…)
Principal or agency transaction Commissions or markup Accrued Interest in the case of bonds Net amount due inclusive of all fees
To the broker in the case of purchases To the customer in the case of sales
122
Statements
NYSE rules require that a statement of account should be sent to a customer in a month if there is an activity in the account. The activity could be:
A trade A dividend credit A deposit 123
Statements (Cont…)
If there is no activity, the client must get at least a quarterly statement. The statement summarizes all account activity during the past period and gives the date for each entry 124
Cash Balances
Brokers do not require a minimum amount of cash to be held as a credit balance in the account. Some retail brokers will not pay interest on such balances
There is no legal requirement that such interest be paid.
125
Cash Balances (Cont…)
Large brokers and some small ones offer a combined money market and brokerage account
That is, idle credit balances are automatically swept into MMMF shares. This concept was pioneered by Merrill Lynch Cash Management Account. Holders can write checks against such balances. 126
Cash Balances (Cont…)
Such accounts require a minimum balance to open – ranging from $5,000 to $25,000. These accounts usually permit margin trading.
127
1
Part-13 Brokerage Operations A Macro View
2
Structure of a Brokerage Firm
The activities of a brokerage firm can be broken into three broad categories: Front-Office Operations Back-Office Operations Proprietary Operations
3
Structure (Cont…)
All activities that involve client contact take place in the front office. These tasks include the soliciting and taking of orders; execution of trades; and provision of investment advice. Back-office operations include supporting activities.
4
Structure (Cont…)
The back-office clears and settles all trades; maintains accounts, produces research reports; and creates and operates information systems. Proprietary operations include cash and risk management; and speculative deals on account of the firm itself.
5
The Front Office
Brokers solicit order flow by advertising and by calling prospective clients. They also provide potential clients with extensive investment information and research inputs, to induce them to trade. Sales Brokers are front office staff whose primary function is to interact with clients.
6
Front Office (Cont…)
They work in the Sales & Trading department of the firm. Floor Brokers are employees who arrange trades on the exchange and on the trading floor of the firm, if the firm itself were to operate a trading platform. This division of a brokerage firm is called Floor Operations. 7
Front Office (Cont…)
Large brokerage firms have a Corporate Finance department whose staff are engaged in distributing large stock and bond offerings made by companies. These personnel work closely with Sales Brokers. 8
Research
Many firms employ Financial Analysts to generate information reports. Each analyst will in general specialize in an industry or commodity. The responsibilities of such analysts include forecasting future prices and earnings. These analysts work in the Research Department.
9
Research (Cont…)
Research analysts also have the task of enabling customers to understand the intricacies of financial instruments and trading techniques. Their reports are the tools with which Sales Brokers solicit business. These analysts also work closely with Corporate Finance Departments by giving inputs on M&A activities. 10
Customer Service
Customer service agents help the clients to manage their accounts. Their activities include facilitating the establishment of new accounts; and the transfer and closure of existing accounts. They advise clients with respect to deposits into and withdrawals from their accounts. 11
Customer Service (Cont…)
Customers can get help from these agents if required, to interpret the periodical accounts statements provided by the brokerage firm. All these activities come within the ambit of the Customer Service Department. 12
The Back Office
Brokerage firms use computerized accounting systems to keep track of their accounts, and to clear and settle trades. Most small firms and some large firms buy such systems off the shelf. Some of the larger brokerage houses however use proprietary systems.
13
Back Office (Cont…)
In some cases it is because these firms have special needs which ready made systems cannot satisfy. In other cases it is simply because an in house system had been developed, before the advent of sophisticated off the shelf systems. 14
Street Name Securities
Traders often choose to allow brokers or depositories to hold securities on their behalf. Such securities are said to be held in Street Name. In these cases, where a broker holds the security on behalf of the client, the broker is the legal owner. 15
Street Name (Cont…)
The client only has a corresponding relationship in his account. When a security is held in Street Name, the broker has certain responsibilities thrust on him. Firstly he must collect interest or dividends payments from the issuing firms, and credit them to the proper client accounts. 16
Street Name (Cont…)
He must keep track off and handle corporate re-organizations such as name changes, splits/reverse splits, bonus issues, mergers, acquisitions, and liquidations. He must also ensure that the issuers of securities can at all times communicate with the beneficial owners of the securities, namely the clients.
17
Street Name (Cont…)
Such activities are overseen by the Corporate Reorganizations Department of the brokerage firm.
18
Market Data & Order Routing
Brokerage houses invest heavily in voice and data systems that enable their employees to communicate with clients, dealers, markets, and with each other. These systems are mainly provided by third party vendors. 19
Market Data … (Cont…)
When data systems written by different vendors are used to exchange information, there can be serious co-ordination problems. And co-ordination is absolutely vital. This is because the clearing and settlement system needs to report trades to the accounting system, which needs to relay position reports to the former.
20
Market Data … (Cont…)
The software industry has developed certain communications protocols that enable systems developed by different vendors to interact with each other. The most important of these are: Financial Information eXchange (FIX) protocol and 21
Market Data … (Cont…)
Open Financial Exchange (OFE) protocol FIX primarily serves institutional traders while OFE is essentially for internet based retail traders. The protocols allow traders to route orders and transmit related information in standard formats that can be interpreted by any FIX or OFE based system. 22
Credit Management
Brokers often extend credit to clients, to other brokers, and to dealers. Credit extension may arise on various scores. A client may have insufficient funds to buy securities and may consequently seek to borrow a part of the required amount. This is called Margin Trading. 23
Credit Management (Cont…)
Or he may seek to sell a security that he does not own, in which case he will need to borrow a security. This is called Short Selling. The broker must carefully evaluate all credit relationships to avoid potential losses. This task is undertaken by the Credit Manager of the firm. 24
Proprietary Operations
These activities are undertaken by the brokerage firm for its own account, or what is known as the house account. We will consider various activities under this category.
25
Cash Management & Stock Lending and Borrowing
Brokerage firms which hold cash and securities on behalf of their clients will not permit these assets to remain idle. That is they will seek to keep these assets productively invested. The cash management activities will be undertaken by the Cashier’s Department. 26
Cash Management (Cont…)
Stock lending and borrowing comes into the picture where short sales are involved. A broker may lend a share or arrange for a share to be lent to a client or another broker for undertaking a short sale. Or else he may borrow a share from a client or another broker to enable his client to short sell. 27
Cash Management (Cont…)
Employees who handle such activities are a part of the Margin Department or the Stock Loan Department.
28
Risk Management
The Risk Manager is required to monitor all activities of the firm to ensure that risks do not become unmanageable. The specific roles are: To ensure that management is aware of all financial and legal risks 29
Risk Management (Cont…)
To ensure that adequate controls are in place to prevent rogue traders from creating unauthorized positions To ensure that the concerned employees understand the financial ramifications of all proprietary trades. To ensure that proper credit appraisal of potential clients is undertaken.
30
Opening an Account
Opening an account with a broker requires that the client provide relevant and sufficient information to enable the broker to `know its customer’. The rules pertaining to establishing a broker-client relationship are governed by NYSE Rule 405 and NASD Conduct Rule 2310. 31
Account Opening (Cont…)
These rules state that a customer should only receive advice and recommendations which are consistent with his stated investment objectives. Brokers are required as per these rules to obtain `essential facts’ relative to each customer account and each order that is placed in such an account.
32
Account Opening (Cont…)
The minimum information necessary to open an account with an NYSE member firm includes: Full Name Address – Residential and Business (if any) Telephone Number Social Security or TIN (taxpayer identification number) 33
Account Opening (Cont…)
Employment Details Marital Status An acknowledgement that the client is of legal age
34
Account Opening (Cont…)
An investor need not be employed to open an account. However, if the client is an employee of a bank or another securities firm, then special considerations will apply. A bank employee who seeks to open a margin account must present the written permission of his employer.
35
Account Opening (Cont…)
An employee of another broker/dealer must present his employee’s written permission to open any kind of account. Such a client must also give his consent to the broker to forward duplicate confirmations of all transactions and statements of account to his employer.
36
Investment Objectives
Every client must provide a statement of purpose listing the goal of the account. What could be the possible goals? These include: Preservation of capital Earning of income Earning of tax-free income 37
Investment Objectives (Cont…)
Capital gains Speculation Hedging The broker and the client should reach an agreement on how the goals ought to be indicated, to avoid potential legal disputes. 38
Other Information
Such information varies from firm to firm, but is generally consistent across brokers. It includes: bank references brokerage account references income details net worth details number of dependents 39
Types of Accounts
Almost all customer related securities transactions take place in either a cash account or in a margin account. In addition brokers/dealers transact significant business with each other through house accounts. Investment advisors, mutual funds, and other institutions use omnibus accounts.
40
Types of Accounts (Cont…)
What is an Omnibus Account? It allows institutions to make large single transactions which can then be allocated to various subaccounts. Futures contracts are executed through special accounts that are set up for this purpose. 41
Cash Accounts
A trader can buy or sell any security on a cash and carry basis. That is, if the purchase is paid for in full, or if adequate funds exist in the account, then a cash account transaction can be put through. The securities traded may be stocks, bonds, mutual funds, warrants, or options. 42
Cash Accounts (Cont…)
Customers will receive a written confirmation from their broker that payments are due within 3 business days, in the case of T+3 settlement. If the client fails to pay, the broker will liquidate the position, and impose a 90 day block or freeze on the account.
43
Margin Accounts
Margin accounts are used to gain leverage through the use of borrowed funds, and for executing short sales. Margin customers have to sign a margin agreement also called a customer’s agreement or a hypothecation agreement. 44
Margin Accounts (Cont…)
The margin agreement pledges the customer’s securities as collateral for the margin loans extended by the broker.
The agreement may also contain a stockloan consent form which allows the broker to lend the margined securities of his clients to other clients for short sales, and arbitrage transactions. 45
Margin Accounts (Cont…)
Margin customers have to be provided with a copy of the Federal Truth-in-lending agreement, which describes how interest will be computed by the broker.
46
Truth-in-lending Act
This Act more correctly known as the Consumer Credit Protection Act was passed by the U.S. Congress in 1968. It is firstly about truthful disclosure of the terms of a loan. But beyond that, it defines and prohibits extortionate credit practices.
47
TIL Act (Cont…)
The Act requires lenders to disclose the annual percentage rate of interest (APR) that is being charged on the loan. Lenders must disclose the total dollar cost associated with granting a loan – known as the Finance Charge – which is the sum of all the charges that are required to be paid by the consumer in order to secure the loan.
48
TIL Act (Cont…)
These additional charges may include credit investigation fees, insurance premia etc. Since every lender has to quote his APR based on the same method of computation, it makes it easier for the consumer to shop around. Why do we need this Act? Consider an illustration. 49
Illustration
Consider a loan where $ 1,200 is lent for a year at a stated rate of 10%. The borrower is required to repay the principal plus $ 120 after one year as interest. The effective rate of interest is 120 ------ = .10 = 10% which is the stated rate 1200 of interest.
50
Illustration (Cont…)
Now consider what is called a Discounted Loan. The lender lends a principal amount of $ 1200. However he calculates the interest for one year at a rate of 10%, which is $ 120, and deducts it upfront. Thus the borrower receives $ 1,080 at the outset, and must pay back $1,200.
51
Illustration (Cont…)
In this case although the stated rate of interest is 10% the effective rate of interest is: 120 ------ = 11.11% 1080 The borrower is clearly paying a higher rate. 52
Illustration (Cont…)
Prior to the enactment of the TIL Act, lenders in both the cases could state that they were charging a rate of interest of 10% per annum. And many gullible borrowers would get deceived by the second lender. The TIL Act prevents this kind of misleading information. 53
Illustration (Cont…)
Now in both of these cases, the lenders must quote the APR which is 10% for the first loan and 11.11% in the case of the second loan. Thus unless an investor is forced to accept a loan with inferior terms, like for instance due to a bad credit record, he will not go for the second option.
54
Street Name Stocks
Securities in a margin account are held in street name. This is done so as to facilitate the transfer and pledging of such securities. This is because the broker has a lien on such securities as long as there is a debit balance in the account.
55
Street Name (Cont…)
Consequently, if a client fails to respond to a payment request, the broker can liquidate or transfer the shares without obtaining his signature. Thus when securities are held in street name, the customer’s name will not be on the share certificate and nor will it be known to the issuer.
56
Street Name (Cont…)
In such cases, therefore the brokerage firm is the registered owner or owner of record. The customer is considered to be the beneficial owner. This is because all dividend and interest payments, and other reports issued by the issuer will be received and forwarded to the client by the broker. 57
Street Name (Cont…)
Holding of securities in street name offers certain advantages to clients. Firstly it simplifies the transfer process. Secondly it reduces the risk of the securities being lost or stolen, for the broker performs the safekeeping functions.
58
Street Name (Cont…)
When the client wants to sell all it requires a mere phone call. Neither signatures, or signature verifications, are required.
59
Advisory Accounts
Some customers lack the knowledge, time, or inclination to manage their investments. They therefore seek the services of a professional money manager, investment advisor, or counselor. Such facilities can be availed of from a number of sources. 60
Advisory Accounts (Cont…)
These include: Bank Trust Departments Large National Advisory Firms Smaller Specialized Advisory Firms Investment Counseling Subsidiaries of Major Securities Firms 61
Advisory Accounts (Cont…)
Having chosen an advisor, the client will sign a limited power of attorney or trading authorization in his favour. The advisor can then trade without consulting the client. The customer is liable for all transactions costs and advisor fees.
62
Advisory Accounts (Cont…)
Large advisors give a lot of business to brokers and consequently can command lower commissions.
63
Discretionary Accounts
This is an alternative approach to fund management. The customer in such cases will sign a trading authorization in favour of a registered representative of a brokerage firm. Some firms have separate registration account agreements for this purpose. 64
Discretionary Accounts (Cont…)
However there is a potential conflict of interest between the client and the registered representative. This is because the broker’s representative gets no management fee. On the contrary his compensation is based on the volume of trading activity in the account.
65
Discretionary Accounts (Cont…)
Since the representative does not need permission to trade, it is always possible for a client to level allegations of excessive trading subsequently. Such charges may or may not be justified. Another criticism is that brokers use such accounts as dumping grounds for unsuccessful IPOs. 66
Discretionary Accounts (Cont….)
Thus there is a lot of potential for regulatory and legal problems. Many brokers either prohibit such accounts or else restrict them to carefully screened customers. They also ensure that such accounts are handled by their senior personnel. 67
Revenues
The primary source of revenue for most brokerage firms is commissions. Other sources include: Payment for orders Interest on cash balances Margin interest on loans Underwriting fees M&A consulting fees Security lending fees 68
Commissions
In most countries commissions are negotiable. There are however countries where government or exchange regulations specify fixed commission rates that a broker must charge. Until 2003, the minimum commission in Hong Kong was 0.25% of the trade value. 69
Deregulation
Commissions were deregulated in 1975 in the U.S, in 1987 in the U.K., and in 1999 in Japan. In a deregulated industry, commissions can vary substantially from broker to broker. The quantum of commission will depend on the extent and quality of services provided. 70
Commissions (Cont…)
Deep discount brokers charge the least. However they provide only the bare minimum by way of service. Full service brokers charge the maximum, but offer value-added services and advice. Discount and deep discount brokers specify standard commission schedules.
71
Commissions (Cont…)
They may even offer additional discounts to their best clients. The commission schedule provided by a full service broker is usually just list prices, analogous to the rack rate quoted by a hotel. Very few clients will pay the list price. The regular clients can negotiate substantially lower rates. 72
Commissions (Cont…)
Full service brokers are increasingly charging a flat fee for the accounts that they advise. This fee covers: All trading commissions Investment research fees Portfolio management fees Account maintenance fees 73
Commissions (Cont…)
In the absence of a flat fee, the client would have to pay separately for each service. Clients are happy because this system, because it takes away the incentive for the broker to churn the account. Churning refers to inducing trades primarily to benefit from commissions.
74
Commissions (Cont…)
The typical flat fee is 1 to 3 percent of the total value of the account, and is negotiable. Fixed fee accounts are also known as wrap accounts because all commissions and expenses are wrapped in a single fee. 75
Commissions (Cont…)
The average price is 5-6 cents per share, but it can range from 1-12 cents per share. In most countries, however, institutional brokers base their commissions on the size of the transaction. In almost all countries the rates are negotiable. 76
Commissions (Cont…)
The rate may vary depending on: The size of the trade The difficulty of arranging it The soft dollars that it generates Institutional clients sometimes get volume discounts based on the total volume traded during a month, quarter, or year. 77
Commissions (Cont…)
Most NYSE/NASD member firms establish a rate schedule and revise it periodically. The smaller brokerage firms generally wait for changes from industry leaders like Merrill Lynch or Salomon Smith Barney before adjusting their own rates. The rates inevitably favour larger transactions over smaller ones. 78
Commissions (Cont…)
The brokerage house will share the commission with the registered representative who is handling the client. The principle is the same. For a large transaction, the representative may receive 25-50% of the gross commissions earned by the firm. 79
Commissions (Cont…)
But for smaller trades the payout will be less and may even be nil. Thus representatives lack an incentive to handle small investors who are perceived as unprofitable. Institutional investors on the other hand witness fierce competition for their business. 80
Commissions (Cont…)
There are cases where large institutions are charged no commission. The loss in such cases can be justified by the perceived gains from liquidity and order flow. Brokerage houses welcome greater liquidity because most of them are dual traders. 81
Commissions (Cont…)
However, it is not as if institutions have been the sole beneficiaries of deregulation. Retail customers too have benefited. Prior to deregulation, the fixed commission structure was subsidizing retail customers at the expense of institutional clients. Thus when rates were deregulated, retail clients witnessed a sharp increase in rates. This lead to the evolution of Discount Broking.
82
Discount Brokers
These firms started out as small no-frills players. But some of them like Charles Schwab and Fidelity Investment have grown large enough to be comparable with the big full service brokerage houses. Such brokers offer the same services or attractions to all their clients.
83
Discount Brokers (Cont…)
In most cases they do not offer their own research. Many simply offer Standard and Poor’s reports on major companies. Fidelity is an exception. In 1997 it established an agreement with Salomon to offer its institutional research.
84
Discount Brokers (Cont…)
In return Fidelity agreed to provide Salomon with access to its customers for marketing new equity issues. In a discount brokerage house, the registered representative is merely an order taker. He is forbidden by firm policy to make any kind of investment recommendation. 85
Discount Brokers (Cont…)
The representative’s pay is not linked to the solicitation of new business or to active trading. And it is much lower than that of a representative working with a full service firm.
86
Deep Discount Brokers
These firms charge even less as compared to discount brokers. But they usually require a minimum number of trades annually and/or a large account balance.
87
Soft Commissions
In an unregulated market how will a broker obtain greater order flow. He will lower his commissions And he will try and offer better services In a price regulated market the only choices are: Offer better service Or offer other things of value 88
Soft Commissions (Cont…)
Before deregulation brokers gave institutional clients many free services. The services took many forms. They provided investment research They gave away accounting systems; communications systems; computing systems; and provided staff training.
89
Soft Commissions (Cont…)
Clients were given marketing incentives such as: Tickets to major sporting events All expense paid trips to investment conferences in exotic locations In return clients paid high commissions. 90
Soft Commissions (Cont…)
To promote fairness in the systems, that is, to ensure that the services provided were commensurate with the value of business, they created a system of soft dollar accounting. Under this scheme, a client earned one soft or notional dollar for a certain amount of hard dollars spent by way of commissions.
91
Soft Commissions (Cont…)
These soft dollars could then be used to procure services from the broker. They could even be used to procure services from third parties via brokers. The soft dollar system allowed brokers to compete for business despite the fixed commissions.
92
Soft Commissions (Cont…)
A more aggressive broker would simply gift away soft dollars more easily. Clients benefited from the competition and by way of lower net trading costs. The soft dollar system basically undermined the concept of fixed brokerage commissions and hastened deregulation.
93
Soft Commissions (Cont…)
But the abolition of the fixed commission regime has not lead to the end of the soft dollar system. In fact, the use of soft dollars has increased after deregulation. According to the SEC the total value of research paid for with soft dollars exceeded US dollars 1 billion in 1998. 94
Soft Commissions (Cont…)
In fact to obtain such soft dollars, many institutional traders, are willing pay much higher commissions than they would otherwise have had to pay for trade execution. In 1998 soft dollar brokers offered 1 dollar of soft dollar services on an average, for every 1.7 dollars received by way of hard dollar commissions. 95
Soft Commissions (Cont…)
What is it that makes the soft dollar system popular, despite deregulation? The reason is that mutual funds find this system to be attractive. When an investment fund pays hard dollars for expenses other than trading commissions, the cost appears as an expense in the books of accounts.
96
Soft Commissions (Cont…)
Trading commissions, however, even though they are paid for with hard dollars do not show up as direct expenses in the books of account. Instead they have a financial impact on the net price at which the fund buys or sells shares. Commissions will raise purchase prices, and lower sales proceeds.
97
Soft Commissions (Cont…)
Many investors prefer to invest in funds with a low expense ratio. Thus many funds prefer to pay for services with soft dollars in order to create an illusion that costs are being managed more effectively.
98
Directed Brokerage & Commission Recapture
Many institutional investment sponsors direct their investment advisors to use the services of specific brokers. The sponsors thus create direct brokerage relationships to support specific brokers. For instance, political considerations force many state and municipal pension funds to use in-state brokers.
99
Directed Brokerage (Cont…)
Pension plans at times negotiate commission recapture agreements with brokers to whom they direct orders. These agreements require the broker to return to the sponsor some of the commissions that are paid. These recaptured commissions may reflect volume discounts or may simply be rebates.
100
Directed Brokerage (Cont…)
State and municipal plan sponsors use this money to pay for investment consulting services for which they would otherwise have no budget. According to the Employment Retirement Income Security Act (ERISA), trustees of private pension plans in the U.S have to treat commissions as assets of the fund.
101
Directed Brokerage (Cont…)
Thus if they were to recapture any commissions they would have to return them to the fund. Thus private pension plans generally do not negotiate such recapture agreements.
102
Payments for Order Flow
These payments are made by dealers to brokers for directing orders to them from their clients. For many retail-based security brokers, such payments can be a significant source of revenue.
103
Interest Income
Some times brokers lend a part of the money that is required by an investor to buy securities. This is called Margin Trading. In such cases the broker will charge interest on the margin loan. The rate of interest is based on the broker call money rate. 104
Interest Income (Cont…)
This is the rate at which a broker can borrow from another broker or a bank. Brokers also earn interest on the cash that is deposited with them by their clients. But this is largely offset by the interest that they are required to pay to their clients on such balances. But in the net the broker will still make money.
105
Interest Income (Cont…)
Some brokers will not pay interest on the client’s cash balance. And there are others who will pay only if the balance were to exceed a certain minimum figure.
106
Short Interest Rebate
When a trader wants to short sell a security his broker must have the security ready for delivery to the buyer. Thus before a broker accepts an order to short sell, he will first determine if the security is available. In practice the broker will usually have securities that he is holding in street name.
107
Short Interest (Cont…)
If so, he can deliver these securities. If not he must borrow the securities from someone else. When the broker delivers a security that he holds in street name, he will not pass on the proceeds to the short seller. He will keep the cash as collateral in order to ensure that the short seller is able to repurchase the security. 108
Short Interest (Cont…)
Thus the broker can invest the proceeds from the short sale, and will earn interest income on the same.
109
Short Interest (Cont…)
The interest that a broker earns directly or indirectly on the proceeds from a short sale can be a very significant source of revenue. Large clients and professional traders demand that their brokers rebate some of the interest earned on the proceeds of the short sale. 110
Short Interest (Cont…)
This kind of an interest payment is called a short interest rebate. Retail brokers however, generally refuse to pay short interest rebates to their clients as a matter of firm policy.
111
Security Lending Fees
A broker who holds securities in street name will often lend them for short sales. In return he will get a securities lending fee. The fee would depend on the demand for short positions and the availability of the shares. 112
Placing Orders
Once an investor has opened an account he may place an order by:
Telephone Mail Telex Fax Personal contact Over the Internet 113
Placing Orders (Cont…)
When the order is received, a registered representative will fill out an order form. He must take the utmost care while filling out the form. A wrong entry may cause the computer to reject the order, which could lead to the investor missing the market. 114
An Order Form
Typical information sought on an order form includes:
Buy order or Sell order If sell, sell long or sell short Place of execution – NYSE, AMEX etc. Type of account – cash or margin Normal settlement or cash settlement Solicited or unsolicited order 115
An Order Form (Cont…)
Disposition of securities purchased:
Transfer and ship to customer Retain in street name Deliver against payment to a bank or another broker
Application of sale proceeds
Retain or Payout 116
An Order Form (Cont…)
The security symbol or description Number of shares Price indication
Market Limit Stop Stop-limit
Customer’s name and account number Representative’s name and number 117
Following Execution
Once the order is executed, the representative should phone the customer as promptly as possible, and relay the following:
Execution price Approximate amount – including fees and commissions Settlement date 118
Following Execution (Cont…)
A customer should not wait for the receipt of the confirmation by mail before remitting the funds
The market makes no allowance for postal delays Funds must therefore arrive on time – confirmation or no confirmation
119
Confirmations
It is a report sent by the broker to the customer on how the order was executed. It is called `confirm’ by Wall Street traders. It will have to disclose the following information. 120
Confirmations (Cont…)
Trade date Settlement date Security Number of shares Or principal amount in the case of bonds Execution price Place of execution 121
Confirmations (Cont…)
Principal or agency transaction Commissions or markup Accrued Interest in the case of bonds Net amount due inclusive of all fees
To the broker in the case of purchases To the customer in the case of sales
122
Statements
NYSE rules require that a statement of account should be sent to a customer in a month if there is an activity in the account. The activity could be:
A trade A dividend credit A deposit 123
Statements (Cont…)
If there is no activity, the client must get at least a quarterly statement. The statement summarizes all account activity during the past period and gives the date for each entry 124
Cash Balances
Brokers do not require a minimum amount of cash to be held as a credit balance in the account. Some retail brokers will not pay interest on such balances
There is no legal requirement that such interest be paid.
125
Cash Balances (Cont…)
Large brokers and some small ones offer a combined money market and brokerage account
That is, idle credit balances are automatically swept into MMMF shares. This concept was pioneered by Merrill Lynch Cash Management Account. Holders can write checks against such balances. 126
Cash Balances (Cont…)
Such accounts require a minimum balance to open – ranging from $5,000 to $25,000. These accounts usually permit margin trading.
127
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