Good Faith Account

THE REGULATION

The good faith account regulation is found under Federal Reserve, Code of federal regulation, Title 12 › Chapter II › Subchapter A › Part 220 › Section 220.6. You can find the following wording there:

§ 220.6 Good faith account.

In a good faith account, a creditor may effect or finance customer transactions in accordance with the following provisions:

(b) Arbitrage. A creditor may effect and finance for any customer bona fide arbitrage transactions. For the purpose of this section, the term “bona fide arbitrage” means:

(1) A purchase or sale of a security in one market together with an offsetting sale or purchase of the same security in a different market at as nearly the same time as practicable for the purpose of taking advantage of a difference in prices in the two markets; or

(2) A purchase of a security which is, without restriction other than the payment of money, exchangeable or convertible within 90 calendar days of the purchase into a second security together with an offsetting sale of the second security at or about the same time, for the purpose of taking advantage of a concurrent disparity in the prices of the two securities.

You can also read the history about when the regulation came into force on April 1st, 1998. You can read the full information on this link to FINRAS document on page 31 here that contains the important text showed here:

Another important change is the creation of the good-faith account. Prior to April 1, 1998, Reg T had provided a margin account and eight special purpose accounts in which to record all financial relations between a customer and a creditor. As of April 1, 1998, Reg T now provides a margin account and four special purpose accounts: the cash account, the special memorandum account, the broker/dealer credit account, and a new account called the “good-faith account”. The good-faith account incorporates the old “nonpurpose,” “arbitrage,” and “government securities” accounts, and can be used to extend good-faith credit against all non-equity securities. Specifically, the good-faith account may be used for:

The purchase and sale of non-equity securities on a credit or cash basis.

Repurchase and reverse repurchase agreements on non-equity securities.

The purchase and sale of options on non-equity securities.

The good-faith account has no specific payment/margin requirements and does not require sell-out. In theory, transactions in the good-faith account may liquidate to a deficit. However, broker/dealers must comply with NASD Rule 2520 and/or New York Stock Exchange Rule 431 on margin requirements. Also, it is important to note that the loan value in the good faith account cannot be used to effect transactions in equity securities in the cash or margin accounts. These three accounts must be treated separately.

Amendments to NASD Rule 2520 Regarding Margin Requirements

Background And Discussion

Regulation T of the Federal Reserve Board establishes initial margin requirements for securities transactions effected in margin accounts. Regulation T also establishes margin requirements for transactions in non-equity securities held in “good faith” accounts. Such transactions are subject to the margin required by the creditor in “good faith” or the percentage set by the regulatory authority where the trade occurs, whichever is greater.3 Consequently, the margin requirements of NASD Rule 2520 apply to non-equity positions maintained in customers’ accounts.

The amendments to Rule 2520 provide for margin requirements for non-equity securities that are commensurate with the risk associated with positions in such securities held by customers. In particular, for positions not maintained in “exempt accounts,” Rule 2520, as amended, reduces the customer maintenance margin requirement for certain non-equity securities and establishes a customer maintenance margin requirement of 20% of current market value for other marginable non-equity securities. The amended Rule 2520 also permits the extension of good faith margin to certain non-equity securities held in “exempt accounts” and limits the amount of capital charges a broker/dealer may take in lieu of collecting marked to the market losses.

3 Regulation T defines “good faith” margin as the amount of margin that a broker/dealer would require in exercising sound credit judgment.

THE HISTROY

The history from Friday, January 16, 1998 of FEDERAL RESERVE SYSTEM regulation of Securities Credit Transactions; Credit by Brokers and Dealers (Regulation T), that led to the creation of the regulation of the Good Faith Account’s Appropriateness and Prohibition on transactions causing a deficit:


2. Good Faith Account
a. Appropriateness: In addition to proposing good faith loan value
for all non-equity securities, the Board proposed creating an account
separate from the margin account described in Sec. 220.4 of Regulation
T to effect transactions involving these securities. The new account
would allow purchases and sales of non-equity securities on a credit or
cash basis, repurchase and reverse repurchase agreements on non-equity
securities and the purchase or sale of options on non-equity
securities. All commenters supporting good faith loan value for all
debt securities supported creation of a new account. The Board is
adopting its proposal for a non-equity account and, as discussed below,
is merging it with the government securities account and other accounts
and naming it the “good faith account.” The good faith account
replaces the government securities account formerly found in Sec. 220.6
of Regulation T.

b. Prohibition on transactions causing a deficit: The Board has
generally viewed section 7 of the ’34 Act as prohibiting broker-dealers
from extending purpose credit 27 that is either unsecured or secured
by collateral other than securities. In proposing to create a new non-
equity account, the Board included a prohibition on transactions that
would cause the account to liquidate to a deficit (i.e., cause the
market value of the collateral to fall below the customer’s debit
balance). This proposed provision was included to prevent broker-
dealers from extending unsecured purpose credit, which might be an
evasion of the good faith margin requirement. Commenters generally
opposed the proposal to prohibit transactions that would cause the
account to liquidate to a deficit, stating that the restriction would
seriously undermine the usefulness of the proposed account for
transactions in fixed-income securities because it would present
substantial uncertainty with respect to bilateral extensions of credit
such as reverse repurchase agreements, which may liquidate to a
deficit, and would continue to place broker-dealers at a disadvantage
vis-a-vis banks and other lenders.
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27 “Purpose credit” is defined as credit for the purpose of
buying, carrying, or trading in securities.
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Several commenters argued that section 7(c)(1)(B)(ii) of the ’34
Act does not prohibit unsecured credit if the credit is either “not
for the purpose of purchasing or carrying securities” or not extended
for the purpose of “evading or circumventing” the Board’s rules
regarding credit secured by securities. This reading of the statute
allows broker-dealers to extend unsecured purpose credit if the Board
concludes that such credit is not for the purpose of evading or
circumventing its rules regarding secured credit. The Board believes
that this interpretation is consistent with the statute and therefore
is eliminating the proposed “liquidate to a deficit” prohibition for
the good faith account. The Board believes that permitting transactions
in a non-equity securities account to liquidate to a deficit is not
necessarily an evasion or circumvention of the rules permitting
good faith loan credit for these securities as a lender extending good
faith credit may consider factors other than the immediate liquidation
value of the collateral.