The SEC Office of Investor Education and Advocacy ("OIEA") issued an updated Investor Bulletin on trading in cash accounts and how certain activities can lead to a 90-day account freeze.
In the bulletin, the OIEA explained that cash accounts require an investor to pay the full amount for purchased securities. In such accounts, an investor is not allowed to trade on margin, or borrow funds from a broker-dealer to fund a purchase. Regulation T allows a broker-dealer to purchase securities from an investor's cash account only if (i) the account contains sufficient funds to make the purchase or (ii) the broker-dealer "accepts in good faith the investor's agreement that the investor will promptly make "full cash payment" for the security before selling it and does not contemplate selling the security prior to making such payment."
The OIEA also warned investors about "freeriding," or the practice of buying and selling a security before paying for it. This practice is prohibited by Regulation T, and may occur if an investor uses the proceeds of a sale to fund a purchase without waiting for the proceeds to settle. A broker-dealer may be required to freeze the account of an investor for 90 days if the investor is found to have engaged in freeriding.
Commentary / Nihal Patel
Broker-dealers operating customer accounts should all be very familiar with these requirements. (Although the T+2 settlement periods in the SEC examples may still require a double-take for longtime practitioners.) What is worth a reminder here is that while a customer may be permitted to engage in a wide variety of transactions, in this space, labels matter. As the alert indicates, certain rules apply to "cash" accounts that would not apply if the customer is transacting in a "margin" account or a "good faith" account. Where a customer generally trades in a cash account, but wants to engage in credit transactions or other impermissible cash account transactions, broker-dealers should have procedures (and operational capacity) to recognize that the transaction needs to be booked to a different "account" for Regulation T purposes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
