FINRA Rules 2264 & 4210: Margin Requirements & Disclosures

Instructor: Byron Yee

Byron has over 5 years of experience in banking and investments and is currently a Candidate for the Chartered Financial Analyst (CFA) Institute. He also is registered with FINRA Series 7 and 66 and has his Life & Disability Insurance producers license for WA state. Previous to his career in banking, he spent 2 years in West Africa as a Peace Corps Volunteer and 4 years in China as an English teacher and financial analyst. Byron double majored in Theatre Arts and Business Administration at Western Washington University. In his free time he enjoys hiking, cycling, running, and being in the great outdoors with his family.

This lesson provides an overview of how margin accounts operate and then covers details of the required margins for these accounts. Examples are provided in order to put these rules into context and increase understanding.

Margin Account Overview

Before we jump into these two rules, it is crucial that we have a solid understanding of how margin accounts work and some key related concepts. First, a margin account is when an investor can buy or sell securities using funds borrowed from the brokerage firm. It is common to hear that Stock ABC was purchased 'on the margin', which means that a portion of funds for the purchase were borrowed.

Why would an investor use a margin account? The main goal is that one can make profitable trades without having to use their own money. For example, if you borrow $1,000 and are charged 2% interest, but you buy and then sell stock at make a 5% return, you still have made a profit, but also have $1,000 in your pocket to use for other investing activities. Margin accounts typically have one of two positions being made by the investor:

  • Long position: An investor is 'long' a security if they have purchased and are holding a stock. An investor in a long position may also be referred to as the 'buyer' or 'holder' of the security.
  • Short position: An investor is 'short' if they are selling the stock. They may also be referred to as a 'seller' or 'writer' of a security.

The easiest way to remember this is:

Buyer = Holder = Long Position

Seller = Writer = Short Position

Finally, if an investor buys a stock with borrowed money and the stock price crashes to zero, the brokerage firm might never get their loan repaid. To avoid this, the Securities Exchange Commission (SEC) and the Financial Industry Regulator Authority (FINRA) placed limits on how much an investor can borrow. We'll cover the detailed limits in the next two sections, but there are two more terms to remember:

  • Initial margin: This is the minimum amount of funds (cash or fully paid equities) the investor needs to have in their account before opening any new positions, meaning trading a stock not currently in their account.
  • Maintenance margin: This is the ongoing amount of funds the investor needs to keep in the account after a new position has been established. This maintenance percentage is usually lower than the initial margin amount because the price of the stocks are expected to fluctuate.

Margin Requirements

In this section, we'll cover the details of the margin requirements mentioned for both the initial margin and the ongoing maintenance margin. FINRA 4210 covers the required margin amounts for all types of securities traded. For the sake of this lesson, we focus specifically on equity securities (stocks) as this is the most prominent.

  • Initial margin: The initial margin requirements actually follow SEC's Regulation T, which has higher requirements than FINRA. This rule requires an investor to have 50% of the stock's market value or a minimum of $2,000 in cash or fully paid securities to cover any new positions. This applies to either long or short positions.
  • Maintenance margin: Once a new position has been established, the required levels are relaxed a bit, however the amount depends on the type of position.
    • For long positions, the investor is required to maintain 25% of the stock's market value in cash or fully paid securities.
    • For short positions:
      • If the stock price is less than $5 per share, then the margin requirement is 100% of the (short) sale price or $2.50 per share, whichever is greater.
      • If the stock price is greater than $5 per share, then the margin requirement is 30% of the (short) sale price or $5 per share, whichever is greater.

A table is provided below for your reference. Note that market value is determined by the end-of-day stock prices.

Initial Margin (Reg. T) Maintenance Margin (FINRA)
Long Short Long Short
Equities 50% or min. $2,000 50% or min. $2,000 25% Price<$5: greater of 100% or $2.50/share; Price>$5 per share: Greater of 30% or $5 per share

What if an investor's cash balance falls below the maintenance margin? The broker will make a margin call, which is a request to add more cash (or fully paid securities) to put these margin portions back in the minimum limits.

Let's put this into context with an example. James wants to buy 100 shares of Stock ABC, which is currently valued at $10 per share (total purchase is 100 x $10 = $1,000). The initial margin is $500 ($1,000 x 50% = $500). However since there is a $2,000 minimum, $2,000 is the opening requirement. The ongoing maintenance margin is 25%, so at $10 per share this would be $250 ($1,000 x 25% = $250), but since James already has $2,000 cash in the account, he's well over that limit.

Later Stock ABC's price rises to $90 per share. Now the total market value of the portfolio is 100 shares x $90 = $9,000. The maintenance margin amount is: 25% x $9,000 = $2,250. However, James only initially deposited $2,000, so his broker is going to issue a margin call and request that he deposit an additional $250 ($2,250 - $2,000 = $250) into his account to maintain the required margins.

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