July 12, 2001
Kevin Keogh, Esq.
This is in response to your letter of May 10, 2001, concerning your client, a member firm of the New York Stock Exchange. Your letter indicates that the NYSE has asked your client to request a letter from Board staff confirming that the proposed admission of a new class of members to the firm will not result in a violation of Regulation T.
We understand the facts to be as follows. Your client is a registered broker-dealer that is currently a limited liability company beneficially owned by one person. The firm would like to invite approximately 70 employees to become a new class of members of the LLC by contributing capital to the firm. The new class will contribute less than five percent of the firm's increased capital.
Members of the new class will share in a portion of the profits and costs of all firm short-term trading accounts. These accounts represent at least 95 percent of the total firm business. There is no relationship between the amount of capital contributed by a member and the size of the trading account that a member may manage. Members are not liable for losses except that their capital is at risk in the firm as a whole.
Members' draws will be based on gross revenues per month reconciled quarterly so that a member may receive a draw even if the member's trading produces a loss. Continued losses by a member may reduce further draws to zero, but members will not be required to contribute additional money to the firm or incur additional liabilities based on losses incurred by the member on the firm's behalf.
Quarterly reconciliation will be based on distributions to the new members, as determined by several formulas, including alternative calculations. Among the main factors to be used for these determinations are the net gain attributable to the trading activities of the individual member and the net profits of the short-term trading business of the firm as a whole. If the firm as a whole is profitable a member may receive a distribution even if no net gains are attributable to the trading activities of that member. If the firm as whole is not profitable, the trader still may receive a distribution if the member has net gains attributable to his or her trading activities.
In the past, Board staff has addressed the issue of whether trading accounts, whether in the name of a registered broker-dealer or not, are, in fact, disguised customer accounts or joint ventures (see Staff Opinions of October 19, 1984, and November 10, 1994, digested in the Federal Reserve Regulatory Service at 5-621.51 and 5-638.9, respectively). Such a determination must be made on the basis of the facts and circumstances of the relationship between the firm and the trader. If the account is, in fact, a customer margin account, the broker-dealer must follow the requirements of section 220.4 of Regulation T. If an account is a joint venture between a broker-dealer and a customer, section 220.4(b)(6) of Regulation T requires margin for any disproportionate interest between the capital contributed by the trader/customer and his or her share of the profits.
Board staff does not believe that the proposed admission of new members as described above would be a violation of Regulation T. Among the factors that support this conclusion is the fact that there is no relationship between the amount of capital contributed by a member and the size of the trading account managed by that member. In addition, a member may receive a distribution even if that member only has losses in the trading account managed by the member. After considering all of the facts and circumstances described above, Board staff believes that for the purposes of Regulation T the proposed members would not be customers of the broker-dealer and the trading accounts managed by individual members would not be joint ventures.
This is a staff opinion only, as the matter has not been presented to the Board. Different facts could compel a different conclusion.
(Signed) Scott Holz