SIE PREP | FINANCIAL REGULATION COURSES
Regulation T — formally titled Credit by Brokers and Dealers and codified at 12 CFR Part 220 — is the Federal Reserve Board regulation that governs the extension of credit by broker-dealers to their customers for the purchase of securities, establishing the initial margin requirement that determines how much of any securities purchase the investor must fund from their own resources and how much the broker-dealer may lend.
Issued by the Board of Governors of the Federal Reserve System pursuant to the authority granted by Section 7 of the Securities Exchange Act of 1934 — which authorises the Federal Reserve to prescribe rules and regulations with respect to the amount of credit that may be initially extended and subsequently maintained on any security — Regulation T has maintained its fifty percent initial margin requirement for marginable equity securities since 1974, making it one of the most stable and consistently applied provisions in the federal securities regulatory framework.
The Statutory Authority
Section 7(a) of the Securities Exchange Act of 1934 grants the Federal Reserve Board authority to prescribe rules and regulations with respect to the amount of credit that may be initially extended and subsequently maintained on any security registered on a national securities exchange. Section 7(c) prohibits any broker or dealer from extending credit to or for any customer on any security — other than an exempted security — except in accordance with the Federal Reserve's regulations. Section 7(d) extends these restrictions to members of national securities exchanges.
This statutory framework places the authority to set margin requirements squarely with the Federal Reserve rather than with the SEC or FINRA — a structural design choice reflecting Congress's view that margin credit levels are primarily a macroprudential and monetary policy concern affecting systemic financial stability, rather than a retail investor protection matter appropriate for securities regulators. The initial margin percentage has been set at fifty percent since 1974 — unchanged for over five decades — though the Federal Reserve retains authority to adjust it at any time.
The Initial Margin Requirement — The Fifty Percent Rule
The core operational requirement of Regulation T is the initial margin requirement applicable to margin accounts — the minimum percentage of the purchase price of a marginable security that the investor must deposit from their own resources at the time of purchase, with the broker-dealer permitted to lend the remainder.
Under Regulation T Section 220.4 — the margin account provision — the initial margin requirement for the purchase of marginable equity securities is fifty percent of the current market value of the security. An investor who wants to purchase ten thousand dollars of marginable stock must deposit at least five thousand dollars of their own cash or marginable securities — the broker may lend no more than the remaining five thousand dollars.
The amount lent by the broker-dealer creates a debit balance in the account — the outstanding loan secured by the securities held in the margin account.
The fifty percent initial margin requirement has two simultaneous effects. It limits the leverage available to margin investors to two-to-one — investors can control two dollars of securities for every dollar of their own capital. And it provides the broker-dealer with a fifty percent equity cushion in the account above the loan amount at the time of the initial purchase — protecting the broker against the risk of loss if the securities value declines before a margin call can be satisfied.
The fifty percent initial margin requirement applies specifically to the purchase of new positions. It does not govern the ongoing equity requirement in existing margin accounts — that is the maintenance margin requirement set by FINRA Rule 4210 at a minimum of twenty-five percent, which may be higher under individual broker-dealer house rules.
Marginable and Non-Marginable Securities
Regulation T distinguishes between securities that are eligible for margin lending — marginable securities — and those that are not. Only marginable securities may serve as collateral for broker-dealer credit extensions under Regulation T.
Marginable securities include equity securities listed on national securities exchanges — NYSE, NASDAQ, NYSE American — and certain over-the-counter equity securities meeting Federal Reserve criteria for inclusion on the Board's list of marginable OTC stocks under Regulation T Section 220.11.
Government securities — Treasury bills, notes, bonds, and agency securities — are exempt securities under Section 3(a)(12) of the Exchange Act and are subject to special margin treatment under Regulation T rather than the standard fifty percent initial margin rule.
Investment grade corporate bonds and municipal bonds qualify as margin securities with loan values set by the broker-dealer in good faith subject to Regulation T guidelines.
Non-marginable securities must be purchased in cash accounts or paid for in full in margin accounts — the broker-dealer may not lend any portion of the purchase price. The most examination-critical non-marginable categories are initial public offerings — IPO shares may not be purchased on margin during the offering period — and mutual fund shares, which newly purchased shares may not serve as margin collateral until the investor has held them for thirty days. Certain OTC equity securities that do not meet the Federal Reserve's criteria for inclusion on the marginable OTC list are non-marginable. Broker-dealers may also designate individual securities as non-marginable based on their own risk assessment — particularly penny stocks and other highly volatile issues — even if the securities would otherwise qualify under Federal Reserve criteria.
The Cash Account — The Alternative to Margin
Regulation T Section 220.8 governs the cash account — the account type in which all transactions must be fully paid for from the investor's own funds without any credit extension from the broker-dealer. In a cash account, the investor must make full payment for every securities purchase by the payment date — currently two business days after the trade date under SEC Rule 15c6-1, which moved the standard equity settlement cycle to T plus one effective May 28, 2024.
The cash account is the default account type for investors who do not specifically request and qualify for margin account privileges. Most retail investors conducting basic buy-and-hold investing use cash accounts exclusively and have no need for margin credit.
Free Riding — The Critical Cash Account Prohibition
Free riding is a prohibited practice in cash accounts that is directly tested on securities licensing examinations and that Regulation T specifically addresses. Free riding occurs when an investor purchases securities in a cash account without having the funds available to pay for them at the time of purchase, and then sells the securities before payment is due and uses the sales proceeds to pay for the original purchase.
The prohibited scenario unfolds as follows. An investor buys one thousand dollars of stock in a cash account on Monday with no cash available. The stock rises to twelve hundred dollars by Wednesday. The investor sells on Wednesday, generating twelve hundred dollars in proceeds. On Thursday — settlement date for the Monday purchase — the investor uses the Wednesday sale proceeds to pay the one thousand dollar Monday purchase price, pocketing two hundred dollars without ever having put up their own capital.
Free riding is prohibited under Regulation T Section 220.8 because it allows investors to speculate without risk using the broker's implicit credit — effectively circumventing the cash account's purpose of requiring full payment from the investor's own resources. When free riding is detected, Regulation T requires the broker-dealer to freeze the account for ninety days — during the freeze period, the investor must have sufficient funds on deposit before any purchase can be made, eliminating the ability to buy and immediately sell without paying.
The Regulation T Call — Payment Period
When a new purchase in a margin account exceeds the available margin — the investor has insufficient equity to cover the initial margin requirement — a Regulation T call is generated. This differs from the FINRA Rule 4210 maintenance margin call, which is triggered when existing positions decline below the maintenance threshold.
The payment period for meeting a Regulation T call is three business days from the trade date — the investor must deposit the required additional cash or marginable securities within this period to bring the account back into compliance with the initial margin requirement.
Failure to meet the Regulation T call within three business days requires the broker-dealer to take action — typically liquidating sufficient securities in the account to eliminate the margin deficiency. Under Regulation T, the broker-dealer may grant a one-time three-business-day extension of the payment period in certain circumstances, but subsequent extensions require FINRA approval.
The Relationship Between Regulation T, Regulation U, and Regulation X
Regulation T governs credit extensions by broker-dealers. Regulation U — codified at 12 CFR Part 221 — applies the same margin standards to banks extending credit for the purpose of purchasing or carrying securities — purpose credit. Regulation X — codified at 12 CFR Part 224 — extends the margin requirements to United States persons who obtain credit outside the United States to purchase or carry securities registered on a domestic exchange, preventing circumvention of Regulation T through offshore borrowing arrangements.
Together, these three Federal Reserve regulations form a comprehensive framework ensuring that margin requirements apply uniformly to securities credit regardless of whether the lender is a broker-dealer, a bank, or a foreign entity.
FINRA's Complementary Margin Rules
Regulation T establishes the initial margin requirement — the minimum at the time of purchase. FINRA Rule 4210 establishes the maintenance margin requirement — the minimum equity percentage that must be maintained in a margin account on an ongoing basis as securities values fluctuate. The twenty-five percent maintenance minimum under FINRA Rule 4210 is a separate and independent requirement from the fifty percent initial requirement under Regulation T — both must be satisfied, at different points in time and for different purposes.
Broker-dealers may impose house rules that are stricter than both Regulation T and FINRA Rule 4210 — requiring higher initial or maintenance margins for specific securities, sectors, or account types. House rules may never be more permissive than Regulation T or FINRA Rule 4210. The regulatory minimums set a floor below which no broker-dealer may go, while competitive and risk management considerations drive individual firms to set higher requirements for concentrated positions, volatile securities, or other elevated-risk situations.
Examination Relevance and Key Takeaways
Regulation T is tested on the SIE and Series 7 examinations in the context of margin accounts, the initial margin requirement, the cash account, free riding, and the Regulation T payment period.
The key points to retain are these.
Regulation T — 12 CFR Part 220 — is issued by the Federal Reserve Board pursuant to Section 7 of the Securities Exchange Act of 1934 and governs credit extensions by broker-dealers to customers for the purchase of securities.
The initial margin requirement under Regulation T is fifty percent of the purchase price of marginable equity securities — unchanged since 1974. The investor must deposit at least fifty percent from their own resources and the broker may lend no more than fifty percent.
Non-marginable securities require one hundred percent cash payment and include IPO shares during the offering period, newly purchased mutual fund shares within thirty days of purchase, and securities designated non-marginable by the broker or the Federal Reserve.
The cash account under Regulation T Section 220.8 requires full payment from the investor's own funds by the settlement date — currently T plus one under SEC Rule 15c6-1. Free riding — purchasing securities in a cash account without available funds and then selling before settlement to generate proceeds to pay for the purchase — is prohibited under Regulation T and results in a ninety-day account freeze requiring full payment before any new purchase.
The Regulation T payment period for margin calls is three business days from the trade date — failure to meet the call within this period requires the broker to liquidate positions.
Regulation U at 12 CFR Part 221 applies equivalent margin standards to bank purpose credit. Regulation X at 12 CFR Part 224 extends margin requirements to United States persons obtaining credit offshore. Regulation T sets the initial margin floor — FINRA Rule 4210 separately sets the ongoing maintenance margin minimum of twenty-five percent — broker-dealer house rules may be stricter than either but may never be more permissive.
