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Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority.)

An intermediary who brings together buyers and sellers of the same security or commodity and executes their orders, receiving a commission or brokerage therefore.  A broker is a specialist, and accordingly is well versed in the technique of his or her particular market, knowing the sources of supply and demand and being an expert on prices and price trends.  There are brokers in many fields - stock, grain, cotton, produce, note, ship, real estate, mortgage, arbitrage, insurance, discount, money, etc.

The relationship between customer and broker is that of principal and AGENT, and in most cases, such as stock exchange broker, the broker is a special agent.  The law of agency, therefore, underlies the customer-broker relationship.

A stock exchange broker is a member of the stock exchange and as such is bound not only by the law of agency but also by the rules of the exchange.  The customer-broker relationship starts with the opening of the account by the customer.  Under New York Stock Exchange rules, the broker must obtain essential facts about the customer, usually on an information or signature card signed by the customer, giving residence, occupation, employment, age, and one or more references.  He or she also must obtain information for proper handling of the account, such as type of account (cash, margin, or commodity account); instructions on notices and statements; account number, etc.

Customers' Accounts.  

Cash account transactions are all in cash.  No margin purchases or short sales occur in this type of account.  General accounts (margin accounts) comprehend cash transactions, margin purchases, and short sales.  For the latter type of accounts, the customer signs the margin agreement (also known as the customer's agreement or standard customer's agreement), which contains a series of clauses pertaining to margin transactions:  (1) authority to the broker to pledge the customer's securities in collateral loans, either alone or with other customers' securities (security loan consent or hypothecation agreement); (2) authority to the broker at his or her discretion to sell the securities carried on margin and securing the customer's liability for debit balance (amount of credit plus interest), on notice, when in the broker's opinion the customer's margin is inadequate; (3) communication consent authorizing the broker to make all notices and demands upon the customer by mail, telegraph, telephone, or orally; and 4) specification that all transactions shall be subject to rules and customs of the exchange where such transactions are consummated, including reference to arbitration of any differences or controversies.  In addition to initial margins prescribed by the Board of Governors of the Federal Reserve System, both initial and maintenance margins are prescribed by New York Stock Exchange rules.

Thereafter, the customer's instructions to the broker will be observed by the latter as agent, including the different types of orders:  market, limit, stop, stop and limit orders with respect to price; and day, week, month, and open or good 'til cancelled (GTC) orders with respect to time limits.  Completely discretionary orders are regulated by Rule 408 of the New York Stock Exchange, which provides that in addition to carrying the customer's written consent, such an order shall be approved and initialled on the day entered by a member, allied member, or a manager designated with written authority by a member or allied member to do so.

Cash or margin accounts will not be accepted for persons under 21 years of age.  Parents, however, may buy securities for their own account and transfer them to the minor children upon their reaching 21 or serve as custodians for the minor children on gifts of securities and manage the investment for the children until they reach 21 (other adults may also be designated as custodians), under gifts to minors acts of various states.

Cash or margin accounts of employees of the New York Stock Exchange and employees of member firms must have the prior written consent of the employer.  Such prior written consent of the employer is also required for margin accounts of employees of banks, trust companies, insurance companies, or any other broker or dealer in securities in any form, bills of exchange, acceptances, or other forms of commercial paper.  Such disabilities (Rule 407 of the New York Stock Exchange) are not considered to apply to independent insurance agents or officers of banks, trust companies, insurance companies, etc.

Besides the basic cash accounts and margin accounts, special types of accounts, for particular kinds of transactions or to allow for particular application of margin rules and regulations, include the following:

1.    When issued margin accounts, to cover transactions on a when issued basis.

2.    Special subscription accounts.

3.    Arbitrage accounts.

4.    Specialists' accounts.

5.    Omnibus accounts for a number of customers of a securities firm placing the orders through a correspondent firm.

6.    Special bond accounts for exempt securities.

7.    Memorandum accounts for such miscellaneous activity as collection or exchange of securities, foreign exchange transactions, etc., for customers and miscellaneous transactions for other securities firms.  Commodity accounts would encompass activity in commodities for customers.

Customer Relations.  

Many stock brokerage houses may act as dealers for their own account in transactions with customers in unlisted securities and as broker for customers in transactions in listed and unlisted securities.  Strict rules in many cases prevent a broker from acting as both broker and dealer in the same transaction.

The customer receives from his or her stockbroker the confirmation of execution of the transaction, whether purchase or sale, by mail.  The confirmation is usually mailed on the day of the transaction.  In addition, member firms of the New York Stock Exchange send monthly statements to all customers with active accounts, showing the transactions affecting the account during the month and indicating by the bring-down on the lower part of the statement the net securities position (inventory) of the customer in the account at the end of the month.  The customer has a reasonable time after receipt of this statement, which in legal effect is an account stated, in which to challenge any item thereon.

A member firm of the New York Stock Exchange must immediately notify the exchange in writing as soon as it commences to carry accounts or hold securities for customers.  In addition, each member and member firm shall answer financial questionnaires whenever called for by the exchange, and be subject to an audit, by independent public accountants, as of the date of an answer to a financial questionnaire.  Moreover, each member firm doing business with the public is required to have an annual surprise audit by independent public accountants.  Each member firm shall make available to any customer at his or her request a statement of its financial condition as of the date of its most recent answer to the financial questionnaire of the exchange or as of a date subsequent thereto, which financial statement in the opinion of the firm shall fairly present its financial condition.  Each monthly statement sent to a customer by a New York Stock Exchange firm carries a legend reading:  "A financial statement of the firm (or corporation) is available for your personal inspection at its offices, or a copy of it will be mailed upon your written request."  Moreover, within 35 days of the date after each annual exchange, each customer shall be sent either the statement based upon such audit, or a notice with return postcard inviting personal inspection of the statement at the firm's offices or a request for mailing of the statement.

Reports to Exchange.  

The New York Stock Exchange also requires other financial reports from members, allied members, and member organizations, including the following:

1.    Reports on loans obtained where any part of the proceeds is used to supply working capital to the firm.  (Note:  Net capital of the firm, figured pursuant to rules of the exchange, is required to equal at all times at least 6⅔% of total liabilities, including free credit balances of customers.)

2.    Periodic reports with respect to the following:

a.    Short positions in listed securities.

b.    Obligations in respect of security underwritings and net positions resulting therefrom.

c.    Total of collateral loans from banks, trust companies, and other lenders in the U.S. , excluding borrowings from other members of national securities exchanges.

d.    Customers' debit and credit balances.

e.    Total fail to deliver and fail to receive contracts.


Problem of Fails.  

Fail contracts originate when the selling broker or dealer in a transaction fails to deliver the securities on the normal settlement date of the trade to the buying broker or dealer.  On the books of the selling broker or dealer, the fail to deliver creates a long security position.  On the books of the buying broker or dealer, the fail to receive creates a short security position.

Data on fails to deliver securities accord the best single measure of the extent of the brokerage industry's paperwork backlog.  Among the consequences of fails are the following:  (1) imposition by the exchange of restraints, where firms had not voluntarily done so, on business emanating from such problem areas as over-the-counter transactions, where numerically most of the fails originated; (2) promulgation of the mandatory buy-in rule (NYSE Rule 282) to provide for mandatory buy-ins of securities not delivered 50 calendar days after the due date; (3) inauguration of the fail clearance system, whereby old fails submitted by firms are paired off and intermediate deliveries are eliminated, with money differences settled directly; and (4) addition of a special operations questionnaire required by the exchange on the status of each major area of record-keeping, including general ledger and customer account postings, dividends and stock record, and information on such related topics as overtime, customer complaints, etc.  The log-jam also led to the extraordinary action of a voluntary closing of the markets, per recommendation of the Ad Hoc Committee on Back-Office Procedures, on the New York Stock Exchange, American Stock Exchange, and over-the-counter markets on four separate business days in June and early July, 1968, and extension of closings to include the last four Wednesdays in July, 1968.  With computer confusion finally cleared away (but not until various firm casualties had occurred), the Wall Street community resumed a normal situation with regard to fails.

Disagreements between a broker and a client are sometimes submitted to arbitration.  A 1987 decision of the U.S. Supreme Court confirmed the binding nature of the arbitration clause, which precluded filing suit in federal court before the arbitration process was complete and limiting the nature of appeals from the arbitration decision.  

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