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Blocked Funds, Administrative Hold and the Tooth Fairy

The Tooth Fairy is a wonderful myth of childhood. Children would place their tooth under their pillow and wake up excitedly the following morning to find a shiny coin under their pillow; this is a childhood joy many of us experienced. Alas, the sad reality is there is no Tooth Fairy; the money came from mom and pop’s pockets.
There is no free money in life.

Blocked funds and administrative hold reside in the same mythical village as the Tooth Fairy, Santa and the Easter Bunny. Let’s imagine you wish to buy a rare automobile. You are lucky enough find a 1967 Ferrari P4, you are indeed very fortunate, and the seller tells you there are two other wealthy potential buyers. He
wants a deposit of 10 percent to hold the car for you. You tell him that’s not a problem; I have been searching worldwide for years for such a car here is my check.The dealer deposits your check in his account only to be told by his bank it is not good funds. What! It was written on funds in a blocked account. But not a problem
for the dealer, he simply sells the car to one of the other buyers with real money.Your blocked funds could not facilitate a transaction and your P4 belongs to a buyer operating in the real world.

The trading of real financial instruments in Private Placement Memorandums, such as CMO’s, Treasury Bonds, Securities, MTN’s, CD’s, Commodities and Currencies, is no different than the example of the rare car purchase. Sellers of securities want to be paid in cash. Platform trading relies on the ebb and flow of billions of dollars every day.

Trading platforms also rely on heavy utilization of leverage to generate high returns. Leverage in turn is dependent on margin utilization. To see how margin works let’s take an example most people are familiar with, buying real estate. If you buy a house for $100, 000 and you pay a down payment, let’s say 10 %, you
pay $10,000 cash and a bank lends you the balance. You are controlling a $100,000 investment with $10, 000. This is leverage. You have significantly leveraged your $10,000. In fact your leverage is 10 to 1 or 10x. If the house was to double in price, you have made a $100,000 on your investment. Of course you have to deduct expenses,although still a nice return. The $10,000 you put down on the house was a cash payment.

Think about it. When have you made a down payment, paid a utility bill, paid taxes or paid for anything with blocked funds? When a trade platform places a trade, they use a deposit called margin. Let’s say a trader wants to buy 1,000,000 shares of stock and that stock, XYZ stock, is trading at $50 a share. He is going to utilize leverage by buying on margin. Margin in the U.S. is set by the Federal Reserve at 50% under
Regulation T.The trader draws $25,000,000 from the customer’s segregated funds account at the broker dealer through which he is executing and the broker/dealer pays the seller through an exchange such as the New York Stock Exchange, the Chicago mercantile Exchange the London Stock Exchange or an Over the Counter Exchange. The broker/dealer lends him the other $25,000,000 and charges him an interest rate called the broker loan rate.

Now let’s say the investors in this particular trade platform have all invested with blocked funds or funds on administrative hold. The institution that sold your trader $50,000,000 of XYZ stock wants to be paid. If they don’t get paid in cash your trader gets no stock !!!




One thought on “Blocked Funds, Administrative Hold and the Tooth Fairy

  1. Hi,

    Perhaps, the largest problem is not all investment community understand the definition of “segregated accounts”. The term of segregated accounts is not unique for traders and investors.

    However, promoting the segregated accounts to new investors, particularly the investors that have no investment in such trading, then you could be frustrated. Thus, “block funds” to be promoted by brokers (not traders). Traders will always say “segregated accounts” under SMA – seperate managed accounts or PAMM – percent allocation money management.

    Thus, it is to whom you are talking to.

    Posted by Johanes L. Sitanggang | March 23, 2014, 6:53 pm

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