Pledging Customer Securities – Series 7 Exam

🧾 Pledging Customer Securities – Series 7 Exam
📘 Understanding How Customer Securities Are Handled and Secured

One of the key regulatory concepts covered on the Series 7 exam is the pledging of customer securities. This involves the rules that broker-dealers must follow when using client-owned securities to secure loans or meet their own financial obligations. Let’s break it down clearly and concisely.

🎯 What Is Pledging Customer Securities?

• Pledging refers to the practice of a broker-dealer using securities held in a customer’s margin account as collateral to secure a loan from a bank or clearing firm.
• This is a normal practice in margin accounts because customers borrow money to buy securities, and those securities are used as collateral to secure the broker-dealer’s financing.

📚 Key Regulatory Framework

• Governed under Regulation U (Federal Reserve) and SEC customer protection rules.
• Customer securities may only be pledged if they are held in a margin account.
• Fully paid securities (in cash accounts or margin accounts without outstanding balances) cannot be pledged without customer consent.
• The broker-dealer must segregate fully paid securities to ensure they are protected and not improperly used.

🧠 Important Points to Remember for the Exam

🏦 Definitions You Need to Know

• Hypothecation: Customer pledges securities to the broker-dealer in exchange for a margin loan.
• Rehypothecation: Broker-dealer pledges those same securities to a third-party lender (like a bank) to obtain a loan for themselves.
• Debit Balance: Amount the customer owes in a margin account.

⚠️ Common Exam Traps

• Pledging Cash Account Securities: Not allowed unless the customer signs a separate agreement.
• Misusing Fully Paid Securities: Fully paid securities must be segregated and cannot be used unless the customer authorizes it.
• Rehypothecation Limit: Broker-dealer can pledge up to 140% of the customer’s debit balance, not the entire value of securities in the account.

🚀 Quick Example

• A customer has a margin debit balance of $10,000.
• The broker-dealer can rehypothecate securities worth up to $14,000 (140% of $10,000).

If the customer has fully paid securities worth $5,000, they must not be pledged unless explicitly authorized by the customer.

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