Legal Definitions - Regulation T

Regulation T is a rule established by the Federal Reserve Board that governs how much creditsecurities brokers and dealers can extend to their customers for the purpose of buying or carrying securities. It sets important limits on the amount of money a broker can lend, specifies the initial margin requirements (the percentage of the purchase price a customer must pay upfront), and outlines the payment rules and deadlines for these transactions. Essentially, Regulation T ensures that customers using borrowed funds for securities purchases have a significant financial stake in their investments, thereby helping to manage risk within the financial markets.

Here are some examples to illustrate how Regulation T applies:

• Scenario: An Investor Buying Stock on Margin

  Maria wants to purchase $20,000 worth of shares in a promising new company. She plans to use her brokerage account to buy these shares on margin, meaning she will borrow a portion of the purchase price from her broker. Under Regulation T, her broker informs her that she must deposit at least 50% of the total cost from her own funds. Therefore, Maria needs to provide at least $10,000 (50% of $20,000) as an initial payment, and her broker can lend her the remaining $10,000.

  This example demonstrates Regulation T's core function of setting the initial margin requirement, which dictates the minimum percentage of the purchase price an investor must pay upfront when using credit to buy securities.

• Scenario: Broker Explaining Payment Deadlines

  A financial advisor is onboarding a new client, Mr. Henderson, who is interested in margin trading. The advisor explains that while the firm can lend him money to buy stocks, Regulation T requires that any funds Mr. Henderson is responsible for (his portion of the margin purchase) must be deposited into his account within two business days following the trade date. If he fails to meet this deadline, the brokerage firm is obligated to take specific actions, such as issuing a margin call or potentially selling some of his securities to cover the payment.

  This illustrates Regulation T's payment rules, which establish strict deadlines for customers to settle their portion of a securities transaction when credit is involved, ensuring timely completion of trades.

• Scenario: Consequences of Non-Payment

  Sarah buys $5,000 worth of stock on margin. According to Regulation T, she is required to deposit her 50% share, or $2,500, within two business days. However, due to an oversight, Sarah forgets to transfer the funds. Her brokerage firm, adhering to Regulation T, must then issue a "margin call" requiring her to deposit the funds immediately. If she still fails to do so, the firm may be forced to sell some of her other securities to cover the outstanding amount, or restrict her account from further margin trading for a period, to comply with the regulation.

  This scenario highlights the enforcement aspect of Regulation T, showing how the regulation mandates specific actions from brokers when customers fail to meet their payment obligations for margin trades, thereby protecting both the broker and the integrity of the market.