What Is Reg T and How Does It Affect Margin Accounts?

Regulation T, or Reg T, is a set of rules issued by the Federal Reserve Board. Its primary purpose is to govern the extension of credit by broker-dealers to their customers for the purchase of securities. This regulation plays a significant role in maintaining financial stability within the securities markets and helps prevent excessive speculation. By setting boundaries on how much money investors can borrow, Reg T aims to mitigate potential systemic risks in the financial system.

Understanding Margin Accounts and Credit

A margin account is a brokerage account that allows investors to borrow money from their broker to purchase securities. This practice, known as buying on margin, increases an investor’s purchasing power. Securities bought with borrowed funds serve as collateral for the loan, which accrues interest.

In contrast, a cash account requires investors to pay the full amount for securities purchased. Margin accounts offer the opportunity to amplify potential returns if investments perform well, but they also significantly magnify potential losses. Risks include losing more than the initial investment and incurring interest charges, making them generally more suitable for experienced investors.

Key Requirements of Regulation T

Regulation T establishes specific requirements for margin trading, focusing on initial margin. For most equity securities, Reg T mandates an initial margin requirement of 50% of the purchase price. This means an investor must deposit at least half of the security’s cost in cash, with the remaining portion borrowed from the broker. For example, to buy $10,000 worth of a marginable stock, an investor needs to provide $5,000 of their own funds.

Regulation T also sets the payment period for securities purchased on margin. Investors are required to pay for these securities within two business days after the trade date, often referred to as T+2. Reg T applies to exchange-listed stocks, corporate bonds, and certain convertible bonds. It excludes government securities, municipal bonds, and commodities, which are regulated separately.

Practical Application and Consequences

If an investor fails to meet payment requirements within the T+2 period, a Regulation T call, also known as a Fed Call, is issued by the broker. This call demands additional funds or marginable securities to bring the account into compliance. If the call is not met, the broker can liquidate positions in the account without prior notice to cover the outstanding balance.

Failure to resolve a Regulation T call can lead to consequences for the investor. The account may be placed on a “restricted account” status, limiting future margin trading activities for a period, such as 90 days, if violations like “freeriding” occur. Brokers may offer an extension to meet the call, but such extensions are not guaranteed and are solely at the broker’s discretion. These enforcement mechanisms ensure compliance and prevent excessive risk-taking in the market.