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The Investment FAQ (part 10 of 20)

( Part1 - Part2 - Part3 - Part4 - Part5 - Part6 - Part7 - Part8 - Part9 - Part10 - Part11 - Part12 - Part13 - Part14 - Part15 - Part16 - Part17 - Part18 - Part19 - Part20 )
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Archive-name: investment-faq/general/part10
Version: $Id: part10,v 1.62 2005/01/05 12:40:47 lott Exp lott $
Compiler: Christopher Lott

See reader questions & answers on this topic! - Help others by sharing your knowledge
The Investment FAQ is a collection of frequently asked questions and
answers about investments and personal finance.  This is a plain-text
version of The Investment FAQ, part 10 of 20.  The web site
always has the latest version, including in-line links. Please browse

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Neither the compiler of nor contributors to The Investment FAQ make
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compiler nor contributors will be liable to any user or anyone else
for any inaccuracy, error or omission, regardless of cause, in The
Investment FAQ or for any damages (whether direct or indirect,
consequential, punitive or exemplary) resulting therefrom.  

Rules, regulations, laws, conditions, rates, and such information
discussed in this FAQ all change quite rapidly.  Information given
here was current at the time of writing but is almost guaranteed to be
out of date by the time you read it.  Mention of a product does not
constitute an endorsement. Answers to questions sometimes rely on
information given in other answers.  Readers outside the USA can reach
US-800 telephone numbers, for a charge, using a service such as MCI's
Call USA.  All prices are listed in US dollars unless otherwise
Please send comments and new submissions to the compiler.

--------------------Check for updates------------------

Subject: Real Estate - Renting versus Buying a Home

Last-Revised: 21 Nov 1995
Contributed-By: Jeff Mincy (mincy at, Chris Lott ( contact me )

This note will explain one way to compare the monetary costs of renting
vs.  buying a home.  It is extremely prejudiced towards the US system. 
A few small C programs for computing future value, present value, and
loan amortization schedules (used to write this article) are available. 
See the article "Software - Investment-Related Programs" elsewhere in
this FAQ for information about obtaining them. 

1.  Abstract
   * If you are guaranteed an appreciation rate that is a few points
     above inflation, buy. 
   * If the monthly costs of buying are basically the same as renting,
   * The shorter the term, the more advantageous it is to rent. 
   * Tax consequences in the US are fairly minor in the long term. 

2.  Introduction
The three important factors that affect the analysis the most are the
  1. Relative cash flows; e.g., rent compared to monthly ownership
  2. Length of term
  3. Rate of appreciation

The approach used here is to determine the present value of the money
you will pay over the term for the home.  In the case of buying, the
appreciation rate and thereby the future value of the home is estimated. 
For home appreciate rates, find something like the tables published by
Case Schiller that show changes in house prices for your region.  The
real estate section in your local newspaper may print it periodically. 
This analysis neglects utility costs because they can easily be the same
whether you rent or buy.  However, adding them to the analysis is
simple; treat them the same as the costs for insurance in both cases. 

Opportunity costs of buying are effectively captured by the present
value.  For example, pretend that you are able to buy a house without
having to have a mortgage.  Now the question is, is it better to buy the
house with your hoard of cash or is it better to invest the cash and
continue to rent? To answer this question you have to have estimates for
rental costs and house costs (see below), and you have a projected
growth rate for the cash investment and projected growth rate for the
house.  If you project a 4% growth rate for the house and a 15% growth
rate for the cash then holding the cash would be a much better

First the analysis for renting a home is presented, then the analysis
for buying.  Examples of analyses over a long term and a short term are
given for both scenarios. 

3.  Renting a Home. 

Step 1: Gather data
     You will need:
        * monthly rent
        * renter's insurance (usually inexpensive)
        * term (period of time over which you will rent)
        * estimated inflation rate to compute present value
          (historically 4.5%)
        * estimated annual rate of increase in the rent (can use
          inflation rate)
Step 2: Compute present value of payments
     You will compute the present value of the cash stream that you will
     pay over the term, which is the cost of renting over that term. 
     This analysis assumes that there are no tax consequences (benefits)
     associated with paying rent. 

3.1 A long-term example of renting

     Rent = 990 / month
     Insurance = 10 / month
     Term = 30 years
     Rent increases = 4.5% annually
     Inflation = 4.5% annually
     For this cash stream, present value = 348,137.17. 

3.2 A short-term example of renting

     Same numbers, but just 2 years. 
     Present value = 23,502.38

4.  Buying a Home

Step 1: Gather data. 
     You need a lot to do a fairly thorough analysis:
        * purchase price
        * down payment and closing costs
        * other regular expenses, such as condominium fees
        * amount of mortgage
        * mortgage rate
        * mortgage term
        * mortgage payments (this is tricky for a variable-rate
        * property taxes
        * homeowner's insurance (Note: this analysis neglects
          extraordinary risks such as earthquakes or floods that may
          cause the homeowner to incur a large loss due to a high
          deductible in your policy.  All of you people in California
          know what I'm talking about.)
        * your marginal tax bracket (at what rate is the last dollar
        * the current standard deduction which the IRS allows
     Other values have to be estimated, and they affect the analysis
        * continuing maintenance costs (I estimate 1/2 of PP over 30
        * estimated inflation rate to compute present value
          (historically 4.5%)
        * rate of increase of property taxes, maintenance costs, etc. 
          (infl.  rate)
        * appreciation rate of the home (THE most important number of
Step 2: Compute the monthly expense
     This includes the mortgage payment, fees, property tax, insurance,
     and maintenance.  The mortgage payment is fixed, but you have to
     figure inflation into the rest.  Then compute the present value of
     the cash stream. 
Step 3: Compute your tax savings
     This is different in every case, but roughly you multiply your tax
     bracket times the amount by which your interest plus other
     deductible expenses (e.g., property tax, state income tax) exceeds
     your standard deduction.  No fair using the whole amount because
     everyone, even a renter, gets the standard deduction for free. 
     Must be summed over the term because the standard deduction will
     increase annually, as will your expenses.  Note that late in the
     mortgage your interest payments will be be well below the standard
     deduction.  I compute savings of about 5% for the 33% tax bracket. 
Step 4: Compute the present value
     First you compute the future value of the home based on the
     purchase price, the estimated appreciation rate, and the term. 
     Once you have the future value, compute the present value of that
     sum based on the inflation rate you estimated earlier and the term
     you used to compute the future value.  If appreciation is greater
     than inflation, you win.  Else you break even or even lose. 
     Actually, the math of this step can be simplified as follows:
                               /periods + appr_rate/100\ ^ (periods * 
      prs-value = cur-value * | ----------------------- |
                               \periods + infl_rate/100/
Step 5: Compute final cost
     All numbers must be in present value. 
     Final-cost = Down-payment + S2 (expenses) - S3 (tax sav) - S4 (prop

4.1 Long-term example Nr.  1 of buying: 6% apprecation

Step 1 - the data
        * Purchase price = 145,000
        * Down payment etc = 10,000
        * Mortgage amount = 140,000
        * Mortgage rate = 8.00%
        * Mortgage term = 30 years
        * Mortgage payment = 1027.27 / mo
        * Property taxes = about 1% of valuation; I'll use 1200/yr =
          100/mo (Which increases same as inflation, we'll say.  This
          number is ridiculously low for some areas, but hey, it's just
          an example!)
        * Homeowner's ins.  = 50 / mo
        * Condo.  fees etc.  = 0
        * Tax bracket = 33%
        * Standard ded.  = 5600 (Needs to be updated)
        * Maintenance = 1/2 PP is 72,500, or 201/mo; I'll use 200/mo
        * Inflation rate = 4.5% annually
        * Prop.  taxes incr = 4.5% annually
        * Home appreciates = 6% annually (the NUMBER ONE critical
Step 2 - the monthly expense
     The monthly expense, both fixed and changing components:
     Fixed component is the mortgage at 1027.27 monthly.  Present value
     = 203,503.48.  Changing component is the rest at 350.00 monthly. 
     Present value = 121,848.01.  Total from Step 2: 325,351.49
Step 3 - the tax savings
     I use my loan program to compute this.  Based on the data given
     above, I compute the savings: Present value = 14,686.22.  Not much
     when compared to the other numbers. 
Step 4 - the future and present value of the home
     See data above.  Future value = 873,273.41 and present value =
     226,959.96 (which is larger than 145k since appreciation is larger
     than inflation).  Before you compute present value, you should
     subtract reasonable closing costs for the sale; for example, a real
     estate broker's fee. 
Step 5 - the final analysis for 6% appreciation
     Final = 10,000 + 325,351.49 - 14,686.22 - 226,959.96
     = 93,705.31

So over the 30 years, assuming that you sell the house in the 30th year
for the estimated future value, the present value of your total cost is
93k.  (You're 93k in the hole after 30 years, which means you only paid

4.2 Long-term example Nr.  2 of buying: 7% apprecation
All numbers are the same as in the previous example, however the home
appreciates 7%/year. 
Step 4 now comes out FV=1,176,892.13 and PV=305,869.15
Final = 10,000 + 325,351.49 - 14,686.22 - 305,869.15
= 14796.12

So in this example, 7% was an approximate break-even point in the
absolute sense; i.e., you lived for 30 years at near zero cost in
today's dollars. 

4.3 Long-term example Nr.  3 of buying: 8% apprecation
All numbers are the same as in the previous example, however the home
appreciates 8%/year. 
Step 4 now comes out FV=1,585,680.80 and PV=412,111.55
Final = 10,000 + 325,351.49 - 14,686.22 - 412,111.55
= -91,446.28

The negative number means you lived in the home for 30 years and left it
in the 30th year with a profit; i.e., you were paid to live there. 

4.4 Long-term example Nr.  4 of buying: 2% appreciation
All numbers are the same as in the previous example, however the home
appreciates 2%/year. 
Step 4 now comes out FV=264,075.30 and PV=68,632.02
Final = 10,000 + 325,351.49 - 14,686.22 - 68,632.02
= 252,033.25

In this case of poor appreciation, home ownership cost 252k in today's
money, or about 700/month.  If you could have rented for that, you'd be

4.5 Short-term example Nr.  1 of buying: 6% apprecation
All numbers are the same as long-term example Nr.  1, but you sell the
home after 2 years.  Future home value in 2 years is 163,438.17
Cost = down+cc + all-pymts - tax-savgs - pv(fut-home-value - remaining
= 10,000 + 31,849.52 - 4,156.81 - pv(163,438.17 - 137,563.91)
= 10,000 + 31,849.52 - 4,156.81 - 23,651.27
= 14,041.44

4.6 Short-term example Nr.  2 of buying: 2% apprecation
All numbers are the same as long-term example Nr.  4, but you sell the
home after 2 years.  Future home value in 2 years is 150,912.54
Cost = down+cc + all-pymts - tax-savgs - pv(fut-home-value - remaining
= 10,000 + 31,849.52 - 4,156.81 - pv(150912.54 - 137,563.91)
= 10,000 + 31,849.52 - 4,156.81 - 12,201.78
= 25,490.93

5.  A Question

Q: Is it true that you can usually rent for less than buying?

Answer 1: It depends.  It isn't a binary state.  It is a fairly complex
set of relationships. 

In large metropolitan areas, where real estate is generally much more
expensive than elsewhere, then it is usually better to rent, unless you
get a good appreciation rate or if you are going to own for a long
period of time.  It depends on what you can rent and what you can buy. 
In other areas, where real estate is relatively cheap, I would say it is
probably better to own. 

On the other hand, if you are currently at a market peak and the country
is about to go into a recession it is better to rent and let property
values and rent fall.  If you are currently at the bottom of the market
and the economy is getting better then it is better to own. 

Answer 2: When you rent from somebody, you are paying that person to
assume the risk of homeownership.  Landlords are renting out property
with the long term goal of making money.  They aren't renting out
property because they want to do their renters any special favors.  This
suggests to me that it is generally better to own. 

6.  Conclusion

Once again, the three important factors that affect the analysis the
most are cash flows, term, and appreciation.  If the relative cash flows
are basically the same, then the other two factors affect the analysis
the most. 

The longer you hold the house, the less appreciation you need to beat
renting.  This relationship always holds, however, the scale changes. 
For shorter holding periods you also face a risk of market downturn.  If
there is a substantial risk of a market downturn you shouldn't buy a
house unless you are willing to hold the house for a long period. 

If you have a nice cheap rent controlled apartment, then you should
probably not buy. 

There are other variables that affect the analysis, for example, the
inflation rate.  If the inflation rate increases, the rental scenario
tends to get much worse, while the ownership scenario tends to look

--------------------Check for updates------------------

Subject: Regulation - Accredited Investor

Last-revised: 1 May 2000
Contributed-By: Chris Lott ( contact me )

The SEC has established criteria for preventing people who perhaps
should know better from investing in unregistered securities and other
things that are less well known than stocks and bonds.  For example, if
you've ever been interested in buying into a privately held company, you
have probably heard all about this.  In a nutshell, for an individual to
be considered a qualified investor (also termed an accredited investor),
that person must either have a net worth of about a million bucks, or
have an annual income in excess of 200k.  Companies who wish to raise
capital from individuals without issuing registered securities are
forced to limit their search to people who fall on the happy side of
these thresholds. 

To read the language straight from the securities lawyers, follow this

--------------------Check for updates------------------

Subject: Regulation - Full Disclosure

Last-revised: 30 Jan 2001
Contributed-By: Chris Lott ( contact me )

The full disclosure rules, also known as regulation FD, were enacted by
the SEC to ensure the flow of information to all investors, just just
well-connected insiders.  Basically the rule says that publically held
companies must disclose all material information that might affect
investment decisions to all investors at the same time.  The intent was
to level the playing field for all investors.  Regulation FD became
effective on 23 October 2000. 

What was life like before this rule? Basically there was selective
disclosure.  Before regulation FD, companies communicated well with
securities analysts who followed the company (the so-called back
channel), but not necessarily as well with individual investors. 
Analysts were said to interpret the information from companies for the
public's benefit.  So for example, if a company noticed that sales were
weak and that earnings might be poor, the company might call a group of
analysts and warn them of this fact.  The analysts in turn could tell
their big (big) clients this news, and then eventually publish the
information for the general public (i.e., small clients).  Put simply,
if you were big, you could get out before a huge price drop, or get in
before a big move up.  If you were small, you had no chance. 

Now, information is made available without any intermediaries like
analysts to interpret (or spin) it before it reaches the public.  There
have been some very noticeable consequences of forcing companies to
grant all investors equal access to a company's material disclosures at
the same time.  For example, company conference calls that were once
reserved for analysts only are now accessible to the general public. 
Another example is that surprises (e.g., earnings shortfalls) are true
surprises to everyone, which leads to more frequent occurrences of large
changes in a stock's price.  Finally, now that analysts no longer have
an easy source of information about the companies that they follow, they
are forced to do research on their companies - much harder work than
before.  Some have predicted wide-spread layoffs of analysts because of
the change. 

Timely information (i.e., disclosures) are filed with the SEC in 8-K
documents.  Note that disclosures can be voluntary (i.e., planned) or
involuntary (i.e., goofs).  In either case, the new rule says that the
company has to disclose the information to everyone as quickly as
possible.  So an 8-K might get filed unexpectedly because a company exec
accidentally disclosed material information during a private meeting. 

Here are some sites with more information. 
   * FDExpress, a service of Edgar.  Subscription required to access
     company filings.
   * CCBN, a company that provides investor relations services.

--------------------Check for updates------------------

Subject: Regulation - Money-Supply Measures M1, M2, and M3

Last-Revised: 4 Jan 2002
Contributed-By: Ralph Merritt

The US Federal Reserve Board measures the money supply using the
following measures. 

M1   Money that can be spent immediately.  Includes cash, checking
     accounts, and NOW accounts. 
M2   M1 + assets invested for the short term.  These assets include
     money- market accounts and money-market mutual funds. 
M3   M2 + big deposits.  Big deposits include institutional money-market
     funds and agreements among banks. 

The pamphlet "Modern Money Mechanics," which explains M1, M2, and M3 in
gory detail, was once available free from the Federal Reserve Bank of
Chicago.  That pamphlet is no longer in print, and the Chicago Fed
apparently has no plans to re-issue it.  However, electronic copies of
it are out there, and here's one:

--------------------Check for updates------------------

Subject: Regulation - Federal Reserve and Interest Rates

Last-Revised: 25 Apr 1997
Contributed-By: Jeffrey J.  Stitt, Himanshu Bhatt, Nikolaos Bernitsas,
Joe Lau

This article discusses the interest rates which are managed or
influenced by the US Federal Reserve Bank, a collective term for the
collection of Federal Reserve Banks across the country. 

The Discount Rate is the interest rate charged by the Federal Reserve
when banks borrow "overnight" from the Fed.  The discount rate is under
the direct control of the Fed.  The discount rate is always lower than
the Federal Funds Rate (see below).  Generally only large banks borrow
directly from the Fed, and thus get the benefit of being able to borrow
at the lower discount rate.  As of April 1997, the discount rate was

The Federal Funds Rate is the interest rate charged by banks when banks
borrow "overnight" from each other.  The funds rate fluctuates according
to supply and demand and is not under the direct control of the Fed, but
is strongly influenced by the Fed's actions.  As of April 1997, the
target funds rate is 5.38%; the actual rate varies above and below that

The Fed adjusts the funds rate via "open market operations".  What
actually happens is that the Fed sells US treasury securities to banks. 
As a result, the bank reserves at the Fed drop.  Given that banks have
to maintain at the Fed a certain level of required reserves based on
their demand deposits (checking accounts), they end up borrowing more
from each other to cover their short position at the Fed.  The resulting
pressure on intrabank lending funds drives the funds rate up. 

The Fed has no idea of how many billions of US treasuries it needs to
sell in order for the funds rate to reach the Fed's target.  It goes by
trial and error.  That's why it takes a few days for the funds rate to
adjust to the new target following an announcement. 

Adjustments in the discount rate usually lag behind changes in the funds
rate.  Once the spread between the two rates gets too large (meaning fat
profits for the big banks which routinely borrow from the Fed at the
discount rate and lend to smaller banks at the funds rate) the Fed moves
to adjust the discount rate accordingly.  It usually happens when the
spread reaches about 1%. 

Another interest rate of significant interest is the Prime Rate, the
interest that a bank charges its "best" customers.  There is no single
prime rate, but the commercial banks generally offer the same prime
rate.  The Fed does not adjust a bank's prime rate directly, but
indirectly.  The change in discount rates will affect the prime rate. 
As of April, 1997 the prime rate is 8.5%. 

For an in-depth look at the Federal Reserve, get the book by William
Greider titled Secrets of the temple: How the Federal Reserve runs the
country . 

--------------------Check for updates------------------

Subject: Regulation - Margin Requirements

Last-Revised: 26 May 2002
Contributed-By: Chris Lott ( contact me ), John Marucco

This article discusses the rules and regulations that apply to margin
accounts at brokerage houses.  The basic rules are set by the Federal
Reserve Board (FRB), the New York Stock Exchange (NYSE), and the
National Asssociation of Securities Dealers (NASD).  Every broker must
apply the minimum rules to customers, but a broker is free to apply more
stringent requirements.  Also see the article elsewhere in the FAQ for
an explanation of a margin account versus a cash account . 

Buying on margin means that your broker loans you money to make a
purchase.  But how much can you borrow? As it turns out, the amount of
debt that you can establish and maintain with your broker is closely
regulated.  Here is a summary of those regulations. 

The Federal Reserve Board's Regulation T states how much money you may
borrow to establish a new position .  Briefly, you may borrow 50% of the
cost of the new position.  For example, $100,000 of cash can be used to
buy $200,000 worth of stock. 

The NYSE's Rule 431 and the NASD's Rule 2520 both state how much money
you can continue to borrow to hold an open position .  In brief, you
must maintain 25% equity for long positions and 30% equity for short
positions.  Continuing the example in which $100,000 was used to buy
$200,000 of stock, the account holder would have to keep holdings of
$50,000 in the account to maintain the open long position.  The best
holding in this case is of course cash; a $200,000 margined position can
be kept open with $50,000 of cash.  If the account holder wants to use
fully paid securities to meet the maintenance requirement, then
securities (i.e., stock) with a loan value of $50,000 are required.  See
the rule above - you can only borrow up to 50% - so to achieve a loan
value of $50,000, the account holder must have at least $100,000 of
fully paid securities in the account. 

If the value of the customer's holdings drops to less than 25% of the
value of open positions (maybe some stocks fell in price dramatically),
than the brokerage house is required to impose a margin call on the
account holder.  This means that the person must either sell open
positions, or deposit cash and/or securities, until the account equity
returns to 25%.  If the account holder doesn't meet the margin call,
then four times the amount of the call will be liquidated within the

Here are a few examples, showing Long Market, Short Market, Debit
Balance, Credit Balance, and Equity numbers for various situations. 
Remember, Equity is the Long Market Value plus the Credit Balance, less
any Short Market Value and Debit Balance.  (The Current Market Value of
securities is the Long Market value less the Short Market value.) The
Credit Balance is cash - money that is left over after everything is
paid and all margin requirements are satisfied.  This is supposed to
give a feel for how a brokerage statement is marked to market each day. 

So in the first example, a customer buys 100,000 worth of some stock on
margin.  The 50% margin requirement (Regulation T) can be met with
either stock or cash. 

To satisfy the margin requirement with cash , the customer must deposit
50,000 in cash.  The account will then appears as follows; the "Equity"
reflects the cash deposit: Long
Market Short
Market Credit
Balance Debit
100,000 0 0 50,000 50,000

To satisfy the margin requirement with stock , the customer must deposit
marginable stock with a loan value of 50,000 (two times the amount of
the call).  The account will then appears as follows; the 200,000 of
long market consists of 100,000 stock deposited to meet reg.  T and
100,000 of the stock purchased on margin: Long
Market Short
Market Credit
Balance Debit
200,000 0 0 100,000 100,000

Here's a new example.  What if the account looks like this: Long
Market Short
Market Credit
Balance Debit
20,000 0 0 17,000 3,000
The maintenance requirement calls for an equity position that is 25% of
20,000 which is 5,000, but equity is only 3,000.  Because the equity is
less than 25% of the market value, a maintenance (aka margin) call is
triggered.  The call is for the difference between the requirement and
actual equity, which is 5,000 - 3,000 or 2000.  To meet the call, either
2,000 of cash or 4,000 of stock must be deposited.  Here is what would
happen if the account holder deposits 2,000 in cash; note that the cash
deposit pays down the loan.  Long
Market Short
Market Credit
Balance Debit
20,000 0 0 15,000 5,000

Here is what would happen if the account holder deposits 4,000 of stock:
Market Short
Market Credit
Balance Debit
24,000 0 0 17,000 7,000

Ok, now what happens if the account holder does not meet the call? As
mentioned above, four times the amount of the call will be sold.  So
stock in the amount of 8,000 will be sold and the account will look like
this: Long
Market Short
Market Credit
Balance Debit
12,000 0 0 9,000 3,000

In the case of short sales, Regulation T imposes an initial margin
requirement of 150%.  This sounds extreme, but the first 100% of the
requirement can be satisified by the proceeds of the short sale, leaving
just 50% for the customer to maintain in margin (so it looks much like
the situation for going long).  To maintain a short position, rule 2520
requires margin of $5 per share or 30 percent of the current market
value (whichever is greater). 

Let's say a person shorts $10,000 worth of stock.  They must have
securities with a loan value of at least $5,000 to comply with
regulation T.  In this example, to keep things simple, the customer
deposits cash.  So the Credit Balance consists of the 10,000 in proceeds
from the short sale plus the 5,000 Regulation T deposit.  Remember that
market value is long market value minus short market value, and because
we gave our customer no securities in this example, the "long market"
value is zero, making the market value negative.  Long
Market Short
Market Credit
Balance Debit
0 10,000 15,000 0 5,000

While we're discussing shorting, what about being short against the box?
(Also see the FAQ article about short-against-the-box positions .) When
an individual is long a stock position and then shorts the same stock, a
separate margin requirement is applicable.  When shorting a position
that is long in an account the requirement is 5% of the market value of
the underlying stock.  Let's say the original stock holding of $100,000
was purchased on margin (with a corresponding 50% requirement).  And the
same holding is sold short against the box, yielding $100,000 of
proceeds that is shown in the Credit Balance column, plus a cash deposit
of $5,000.  The account would look like this: Long
Market Short
Market Credit
Balance Debit
Initial position 100,000 50,000 50,000
Sell short 0 100,000 105,000 100,000 5,000
Net 100,000 100,000 105,000 150,000 55,000

Customer accounts are suppsed to be checked for compliance with
Regulation T and Rule 2520 at the end of each trading day.  A brokerage
house may impose a margin call on an account holder at any time during
the day, though. 

Finally, special conditions apply to day-traders.  Check with your

Here are some additional resources:
   * The NASD's Investor Education section has information about margin:
   * The full text of Regulation T

--------------------Check for updates------------------

Subject: Regulation - Securities and Exchange Commission (U.S.)

Last-revised: 22 Dec 1999
Contributed-By: Dennis Yelle

Just in case you want to ask questions, complain about your broker, or
whatever, here's the vital information:
     Securities and Exchange Commission
     450 5th Street, N.  W. 
     Washington, DC 20549
     Office of Public Affairs: +1 202 272-2650
     Office of Consumer Affairs: +1 202 272-7440
     SEC policy concerning online enforcement:
     A web-enabled complaint submission form:
     E-Mail address for complaints:

--------------------Check for updates------------------

Subject: Regulation - SEC Rule 144

Last-Revised: 6 June 2000
Contributed-By: Bill Rini (bill at, Julie O'Neill
(joneill at

The Federal Securities Act of 1933 generally requires that stock and
other securities must be registered with the Securities and Exchange
Commission (the "S.E.C.") prior to their offer or sale.  Registering
securities with the S.E.C.  can be expensive and time-consuming.  This
article offers a brief introduction to SEC Rule 144, which allows for
the sale of restricted securities in limited quantities without
requiring the securities to be registered. 

First it's probably appropriate to explain the basics of restricted
securities.  Restricted securities are generally those which are first
issued in a private placement exempt from registration and which bear a
restrictive legend.  The legend commonly states that the securities are
not registered and cannot be offered or sold unless they are registered
with the S.E.C.  or exempt from registration.  The restrictive legend
serves to ensure that the initial, unregistered sale is not part of a
scheme to avoid registration while achieving some broader distribution
than the initial sale.  Normally, if securities are registered when they
are first issued, then they do not bear any restrictive legend and are
not deemed restricted securities. 

Rule 144 generally applies to corporate insiders and buyers of private
placement securities that were not sold under SEC registration statement
requirements.  Corporate insiders are officers, directors, or anyone
else owning more than 10% of the outstanding company securities.  Stock
either acquired through compensation arrangements or open market
purchases is considered restricted for as long as the insider is
affiliated with the company.  For example, if a corporate officer
purchases shares in his or her employer on the open market, then the
officer must comply with Rule 144 when those shares are sold, even
though the shares when purchased were not considered restricted.  If,
however, the buyer of restricted securities has no management or major
ownership interests in the company, the restricted status of the
securities expires over a period of time. 

Under Rule 144, restricted securities may be sold to the public without
full registration (the restriction lapses upon transfer of ownership) if
the following conditions are met. 

  1. The securities have been owned and fully paid for at least one year
     (there are special exceptions that we'll skip here). 
  2. Current financial information must be made available to the buyer. 
     Companies that file 10K and 10Q reports with the SEC satisfy this
  3. The seller must file Form 144, "Notice of Proposed Sale of
     Securities," with the SEC no later than the first day of the sale. 
     The filing is effective for 90 days.  If the seller wishes to
     extend the selling period or sell additional securities, a new form
     144 is required. 
  4. The sale of the securities may not be advertised and no additional
     commissions can be paid. 
  5. If the securities were owned for between one and two years, the
     volume of securities sold is limited to the greater of 1% of all
     outstanding shares, or the average weekly trading volume for the
     proceeding four weeks.  If the shares have been owned for two years
     or more, no volume restrictions apply to non-insiders.  Insiders
     are always subject to volume restrictions. 

The most recent rule change of Feb 1997 reduced the holding periods by
one year.  For all the details, visit the SEC's page on this rule:

Julie O'Neill offers some insights about the SEC's Rule 144:

--------------------Check for updates------------------

Subject: Regulation - SEC Registered Advisory Service

Last-revised: 9 Jan 1996
Contributed-By: Paul Maffia (paulmaf at

Some advisers will advertise with the information that they are an
S.E.C.  Registered Advisory Service.  This does not mean a damn thing
except that they have obeyed the law and registered as the law requires. 
All it takes is filling out a long form, $150 and no convictions for
financial fraud. 

If they attempt to imply anything in their ads other than the fact they
are registered, they are violating the law.  Basically, this means that
they can inform you that they are registered in a none-too-prominent
way.  If the information is conveyed in any other way, such as being
very prominent, or using words that convey any meaning other than the
simple fact of registration; or implying any special expertise; or
implying special approval, etc., they are violating the law and can
easily be fined and as well as lose their registration. 

--------------------Check for updates------------------

Subject: Regulation - SEC/NASDAQ Settlement

Last-Revised: 26 Feb 1997
Contributed-By: John Schott (jschott at, Chris Lott (
contact me )

The SEC's settlement with NASDAQ in late 1996 will almost certainly
impact trading and price improvement in a favorable way for small
investors.  The settlement resulted in rule changes that are intended to
improve greater access to the market for individual investors, and to
improve the display and execution of orders.  The changes will be
implemented in several phases, with the first phase beginning on 10 Jan
1997.  Initially only 50 stocks will be in the program, but in
subsequent steps in 1997, the number of stocks will be expanded to cover
all NASDAQ stocks. 

This action began after many people complained about very high spreads
in some shares traded on the NASDAQ market.  In effect,the SEC
contention was that some market makers possible did not publically post
orders inside the spread because it impacted their profit margins. 

Here are some of the key changes that resulted from the settlement. 
   * All NASDAQ market makers must execute or publicly display customer
     limit orders that are (a) priced better than their public quote or
     (b) limit orders that add to the size of their quote. 
   * All investors will have access to prices previously available only
     to institutions or professional traders.  These rules are expected
to produce more trading inside the spread, so wide spreads may become
less common.  But remember, a market maker or broker making a market for
a stock has to be compensated for the risk they take.  They have to hold
inventory or risk selling you stock they don't have and finding some
quickly.  With a stock that moves about or trades seldom, they have to
make money on the spread to cover the "bad moves" that can leave them
holding inventory at a bad price.  Reduced spreads may in fact force
less well capitalized or managed market makers to leave the market for
certain stocks, as there may be less chance for profit. 

It will definitely be interesting to see how the spreads change over the
next few months as the NASDAQ settlement is phased in on more and more

--------------------Check for updates------------------

Subject: Regulation - Series of Examinations/Registrations

Last-revised: 30 Sep 1999
Contributed-By: Charlie H.  Luh, Chris Lott ( contact me )

The National Association of Securities Dealers (NASD) administers a
series of licensing examinations that are used to qualify people for
employment in many parts of the finance industry.  For example, the
Series 7 is commonly (although somewhat incorrectly) known as the
stockbroker exam.  The following examinations are offered:

   * Series 3 - Commodity Futures Examination
   * Series 4 - Registered Options Principal
   * Series 5 - Interest Rate Options Examination
   * Series 6 - Investment Company and Variable Contracts Products Rep. 
     Translation: qualifies sales representatives to sell mutual funds
     and variable annuities. 
   * Series 7 - Full Registration/General Securities Representative
     Translation: qualifies sales representatives to sell stocks and
     bonds.  Variations include:
        * Securities Traders (NYSE)
        * Trading Supervisor (NYSE)
   * Series 8 - General Securities Sales Supervisor
        * Branch Office Manager (NYSE)
   * Series 11 - Assistant Representative/Order Processing
   * Series 15 - Foreign Currency Options
   * Series 16 - Supervisory Analyst
   * Series 22 - Direct Participation Program Representative
   * Series 24 - General Securities Principal
   * Series 26 - Investment Company and Variable Contracts Principal
   * Series 27 - Financial and Operations Principal
   * Series 28 - Introducing B/D/Financial and Operations Principal
   * Series 39 - Direct Participation Program Principal
   * Series 42 - Options Representative
   * Series 52 - Municipal Securities Representative
   * Series 53 - Municipal Securities Principal
   * Series 62 - Corporate Securities Representative
   * Series 63 - Uniform Securities Agent State Law Examination
   * Series 65 - Uniform Investment Advisor Law Examination

The following NASD resources should help. 
   * The procedures for becoming a member of NASD, including details
     about registering personnel through the Central Registration
     Depository (CRD).
   * The NASD's CRD call center: +1 (301) 590-6500
   * The NASD home page.

--------------------Check for updates------------------

Subject: Regulation - SIPC, or How to Survive a Bankrupt Broker

Last-Revised: 26 May 1999
Contributed-By: Art Kamlet (artkamlet at, Dave Barrett

The U.S.  Securities Investor Protection Corporation (SIPC) is a
federally chartered private corporation whose job is to insure
shareholders against the situation of a U.S.  stock-broker going

The National Association of Security Dealers requires all of their
member brokers to have SIPC insurance.  Many brokers supplement the
limits that SIPC insures ($100,000 cash and $500,000 total, I think-- I
could be wrong here) with additional policies so you are covered up to
$1 million or more. 

If you deal with discount houses, all brokerages, their clearing agents,
and any holding companies they have which can be holding your assets in
street-name had better be insured with the S.I.P.C.  You're going to pay
a modest SEC tax (less than US$1) on any trade you make anywhere, so
make sure you're getting the benefit.  If a broker goes bankrupt it's
the only thing that prevents a total loss.  Investigate thoroughly!

The bottom line is that you should not do business with any broker who
is not insured by the SIPC. 

--------------------Check for updates------------------

Compilation Copyright (c) 2005 by Christopher Lott.

User Contributions:

Gerri Pisciotta
My employer accidentally advised the company handling the 401k investment that I had been terminated, when in fact I had not. As a result, withdrawals discontinued from my pay and I missed a couple years of contributions. Since I never withdrew from the plan, is my employer liable for making up these contributions? If I made a lump sum catchup contribution,could they do the same?
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