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Trade clearing, is the process of matching trades and netting transactions so that only the net difference is “settled” in a cash settlement or securities settlement. As a result, the actual number of transactions requiring settlement is reduced.
After a transaction occurs, the broker dealer verifies the transaction, confirms the purchase or sale to the customer, and reports the transaction to a clearinghouse. The clearinghouse matches and guarantees trades so that if a member defaults, the counterparty is protected.
Trade settlement isn't complete until the securities are transferred onto the corporate book of record. Transfer occurs when a stock certificate is presented to the transfer agent for destruction and a new stock certificate is issued in the new shareholder’s name.
As a double check, every corporation also employs a registrar that verifies:
(1) That the number of shares being issued corresponds to the number on the stock certificate being canceled and
(2) That the total number of shares outstanding does not exceed the number authorized by the company’s Board. These procedures are a protection against theft and forgery; since a stock certificate is a negotiable instrument that can legally be transferred by signing and physical delivery.
To facilitate the transfer process, most shares are now held in “street name” rather than that of an individual shareholder. Street names are the nom de plumes of broker dealers, the owner of record, that hold shares for many customers, the beneficial owners. This permits a broker dealer to net transactions among their customers to avoid having each transaction separately transferred onto the company’s books.
To further facilitate the process, the securities industry is moving towards the elimination of stock certificates altogether in favor of a “book entry” system where shareholder records are simply maintained electronically.
A customer account can be designated either cash account or margin account. In a margin account part of the stocks bought are paid for with a loan from the broker. The advantage of margin accounts is that it permits increased leverage (leverage is the use of borrowed funds to increase one’s speculative capacity and thereby an increased rate of return) on stock trades. When you leverage you effectively increase your purchasing power. Initial margin specifies the percentage required to buy the stock; while maintenance margin specifies the percentage required to hold the stock over time. Margin rates vary over time, between brokers and between exchanges.
Assume that a broker offers an initial margin of 60 percent and a maintenance margin of 35 percent. If one share of ABM is trading at 50 1/8, what is the initial amount needed to deposit at the brokerage house to purchase two round lots? A round lot is 100 shares.
The answer is $6,015.00 because 50.125 x 200 lots x 60% = $6015.00
This would be instead of laying out $10,025.00 a saving of $4,010.00
If the stock fell then of course the market value falls and the owner of the shares would have a loan outstanding which was outside the ratio of 35% to initial market value. For example how far would ABM shares have to fall before the maintenance margin rate of 35% was reached.
$10,025 (initial market value) x 0.35 (35%) = $3,508.75/200 = $17.54 $50.125-$17.54 = $32.58
Investor Protection and Regulation
All stock markets are regulated by the government of the country they are in. This is done in order to insure that the country’s economy continues to function, and so that individual investors do not fall victim to criminal fraud. I will focus on the United States and take a look at the history of regulation.
Today’s regulatory framework was established after the 1929 stock market Crash. The Securities Act of 1933 governs the issuance of securities. The Securities Exchange Act of 1934 established the U.S. Securities and Exchange Commission to administer the securities acts, including the 1933 Act. The 1934 Act also regulates markets, the speculative use of credit, the unfair practices of brokers and dealers, and insider activities. An “insider” is an individual, typically a corporate executive, with material non-public information about a registrant.
Investors are also protected by self-regulatory organizations such as the National Association of Securities Dealers (“NASD”) and the compliance activities of the various exchanges.
Securities Exchange Act of 1934
The practices regulated by the Securities Exchange Act of 1934 include manipulative practices such as wash sales, corners, and pool operations.
“Wash sale” refers to trades between colluding parties at the same price to increase trading volume or create the appearance of activity, and interest, in a stock. A “corner” refers to a concentration of ownership, often intentional, in an issue that permits the shareholders to control the issue’s price. Typically, an investor or pool would purchase shares in an illiquid issue and, then, after driving the price up force short sellers to cover their positions at a loss.
A “pool” refers to any conspiracy using manipulative tactics to make a profit. Typically, a pool would accumulate a position, create the appearance of activity, manufacture favorable publicity, and, then, as the price rose, distribute its stock to the public.
In 1970, the Security Investor Protection Corporation (“SIPC”) was created to insure customers' brokerage accounts against a broker dealer's bankruptcy. The SEC was also charged by Congress with the creation of a national market, a step closer to the creation of the truly transparent market we have today.