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This booklet is designed for the beginning investor. It
briefly describes how a security transaction occurs,
what to be aware of after the transaction is effected,
and what to do if a discrepancy occurs in your
account.
Ordering the security
When you place an order, your agent fills out
a form called an “order ticket” which records
essential information about the order, such as the
security symbol, your account number and the
number of shares. The order ticket is taken to a
wire operator who transmits the order to the firm’s
trader. A“fill” will usually occur within a few minutes.
After the order is filled, a wire notice is sent
back to your agent, notifying him or her that the
transaction has been effected. Atrade confirmation
will be generated at the end of the day and mailed
to you to notify you of your obligation to make
payment or deliver marketable securities on or
before the “settlement” date. The settlement date is
three business days after the “trade date.” This
means that when you buy securities, your payment
must be received by your brokerage firm no later
than three business days after the trade is executed.
And if you sell securities, your brokerage firm
must receive your securities certificate no later
than three business days after you authorize the
sale.
Types of orders
In a normal securities transaction, you will place
an order with your stockbroker to be filled at the
present market price. However, there may be instances
when buying or selling now at the market
will not be appropriate, and you will want to enter
a different kind of order. An open order is a standing
order you leave with your broker to fill when
the price of the security reaches a certain point. A limit order is used when you will not pay more
than a certain amount or sell for less. A stop order is an order that becomes a market order when the
market reaches a certain price. For example, if you
wanted to limit your loss to $2.00 per share on the
shares you bought for $10.00, you would put in a
stop order at $8.00. As soon as the market reached
$8.00, your broker would put in an order to sell at
the market. If the market were moving very
quickly, then your loss might be greater than
$2.00. If the market bounced back from an $8.00
low, your loss might be less.
Broker- dealers and others
There are different kinds of broker-dealers, each
performing different levels of service. An exchange member firm takes your order to the exchange
to have it effected and will generally handle
virtually every aspect of the transaction. An introducing broker-dealer (some times called a fully disclosed broker-dealer) acts only in a sales
capacity and turns your order over to a clearing broker-dealer to be effected. The clearing broker
places the order, generates the confirmation and
handles the payment. Securities and funds are not
held by the introducing broker but by the clearing
broker.
Transfer agents are not broker-dealers under
Missouri law, but do play an important part in the
transaction. A transfer agent keeps track of the
owners of the securities of a given company and is
responsible for issuing your share certificate in
your name, if you choose to hold the shares yourself.
If you hold your securities in “street name” at
your broker-dealer, the transfer agent’s records
will show the broker-dealer as the owner, and the
broker-dealer’s records will reflect that a certain
number of the shares it holds belong to you. (Street
name is especially good for someone who trades
with any frequency, as it makes delivery by settlement
date much easier).
Broker-dealers compensation
Broker-dealers are paid for their participation in
the securities transaction in one of two ways. A
broker-dealer is paid a commission when it arranges
a trade between you and a third party (an agency transaction). There is usually a fixed minimum
commission and then a percentage of the
trade that decreases as the size of the trade increases.
This amount will be deducted from your proceeds
in a sale or added to your bill in a purchase.
Sometimes the broker-dealer does not arrange
the trade with a third party, but actually is the other
party (a principal transaction). In this case, the
broker-dealer does not charge a commission, but
makes its money on the “spread”. The spread is the
difference between the “bid” and the “ask”, or the
price at which you could sell and at which you
could buy, respectively. In most securities transactions,
the spread is so small that there is little difference
to you whether the transaction is agency or
principal, but in some transactions, especially
penny stock transactions, the spread can be huge
and can result in significant losses to the investor.
If your trade was a principal trade, your confirmation
will say so.
Trade confirmations and
monthly statements
Trade confirmations are a source of significant
information about your trade and should be reviewed carefully immediately upon receipt. Always check to make certain that the transaction
was what you ordered. Your stockbroker is only
human and could either make a mistake or misunderstand
what you wanted, or you could have miscommunicated your order. The confirmation will
indicate whether your broker-dealer “makes a
market” in the security you purchased, a fact really relevant only in penny stock transactions.
(Another booklet in this series, Penny Stocks,
explains market making in more detail.)
The confirmation will state the amount of commission
charged on the transaction and whether
the transaction was agency or principal. No commission
will show on principal transactions and on
certain other transactions, particularly bonds and
mutual funds. It is important to keep in mind that,
no matter how it shows on the confirmation, your
broker-dealer is compensated in some fashion and
you have the right to know about it.
Always check your monthly statement to be
sure that all of the securities you have at your broker-
dealer are shown on your monthly statement.
As with trade confirmations, discrepancies should
be immediately brought to your broker’s attention.
If you have difficulty reading or understanding
your statements, arrange an appointment with your
broker to go over them with you. Keep in mind
that only securities held at your broker-dealer will
show on your monthly statement.
Margin
Margin is the extension of credit to the investor by
the broker-dealer to be used for securities transactions.
To open a margin account, you deposit cash
or negotiable securities as a partial payment or
pledge for the securities purchased or to be purchased
by the broker on your behalf. You sign a
margin agreement that sets forth your obligations
to pay in general and meet “margin calls”, and
gives the broker-dealer the right to pledge the
securities held in your margin account as collateral
for bank loans and to liquidate your securities
positions if you fail to meet the margin calls on
time. The margin agreement also contains a clause
whereby you and broker-dealer agree that all disputes
concerning the account will be taken to arbitration
and not to court.
If the equity (the percentage of the market price
of your securities that you have paid for) in your
account falls below the minimum amount required
by the firm or by an exchange (this happens because
the market price falls) then you will receive
a “margin call” that requires you to deposit money
or additional securities into your account to bring
it back up to the minimum.
Stock splits
Stock splits are where a share is split up into a
larger number of shares. Reverse splits are where
a number of shares are combined to form a smaller
amount of shares. If, in a reverse split, the split
will result in a fractional share, the value of that
fractional interest will normally be paid in cash to
the investor. In general, the price of the shares is
adjusted so that the total value of the shares you
owned before the split will be the same as the total
value after the split. The usual reason for splits is
to increase or decrease the par value of the stock.
As splits do not have much effect on the actual
value of your investment, the only real importance
is to be aware of the actual number of shares you
hold in case you want to sell, or in case dividends
per share are distributed.
Dividends
Dividends are payments designated by the board
of directors of a corporation to be distributed to the
shareholders on a per-share basis. The dividend
amount for preferred shares is usually a fixed
amount but for common stock varies with the performance of the company. The decision to pay a
dividend depends on the cash on hand, expansion
plans, savings plans and how well the business is
doing.
If the dividend on the preferred stock is cumulative,
and the fixed amount has not been paid as it
should have been, it will have to be paid before
any common stock dividend can be paid. Noncumulative
dividends are more common. If a dividend
is not paid in a particular year or period, there
is no obligation to make up that payment before
common stock divdends can be paid.
Record date
Dividends and splits occur as of a specific date
called the record date, a date declared by the company,
sometimes without notice to you but often
on a set annual or semianual date. If you own the
stock on the record date, then you are entitled to
the dividend or the additional shares from the split.
The record date concept is important if you buy or
sell shares near the record date, because it makes
settlement confusing. For example, if you sold
your 100 shares the day before a 2-for-1 split, the
trade would not settle until after the record date.
You would tender your 100 shares and then,
because you still held but did not actually own 100
shares on the record date, you would get another
100 shares issued to you. These are not yours to
keep, of course, since you were paid the full presplit
price for your 100 shares. When dividends are
issued near the trade date, there is usually a discount
or premium on the trade to compensate the
party that will not receive the dividend.
Bond calls
Most bonds have a feature that gives the issuer the
option to call the bond at any time. This means that
if you buy a bond that pays 15% interest and interest
rates fall, the company that issued the bonds can
state that it is buying back your bonds and will not
pay any interest after the call date, so that it can
reissue the bonds at a lower interest rate. The company
only pays the principal amount plus any interest
that accrued by the call date. The company is
not liable for payment of additional interest after
the call date. This rule prevents bondholders from
delaying cashing in the bonds so as to stay at the
higher rate of interest as long as possible. However,
the company is not required to notify bondholders
of the call individually, but only to advertise
with public notices in certain financial publications.
The bonds are generally called the day after an interest
payment, and investors are usually not aware
that the bonds were called until the next interest
payment is due.
Options
An option is the right, but not the obligation, to purchase
a security at a particular price, called the strike price. When you buy or sell an option, you
are essentially betting that the market will move a
certain way, and you are locking in a price at which
you can buy or sell a certain quantity of securities,
at a fixed price, within a certain period of time. A call option gives the buyer the right to purchase the
underlying securities at the strike price on or before
the expiration date. A put option gives the buyer
the right to sell. Both put and call options can be
either naked or covered. The covered option seller
owns the actual securities underlying the option. A naked option is written without the securities as
protection in the seller’s account.
You buy a put when you believe that the price
will decrease and a call when you believe that the
price will increase. You sell the same option if you
believe the opposite (that is, you sell a put if you
think the price will increase, etc.). If you buy the
option, your risk is limited to the premium you pay
for the option. If the price does not reach the strike
price by the expiration date, then the option will
expire worthless and you will not exercise it. Your
loss will be the loss of the premium you paid for
the option, and the seller’s gain will be the money
you paid.
If however, the price went beyond the strike
price, then you would exercise your option. If you
bought a call and the price rose above the strike
price, you would buy the securities at the option
price (which is now lower than the market price)
from the party that sold you the option. If the seller
was covered, then they would sell you the securities
out of their account. If the seller was naked,
then they would have to go into the market and
purchase the securities at the higher market price
to sell to you at the lower option price.
As you can see from this example, the risk associated
with option transactions varies greatly with
each type. Option buyers’ risk is limited to the
amount they pay for the option. In a covered call,
the seller’s risk is limited to the price appreciation
they might have gotten on the securities they
already own. In a naked sale, the risk is theoretically
unlimited.
Covered call writing (selling) can allow you to
generate a greater return on the securities you hold
by receiving the premiums people will pay for the
option to buy your securities at a certain price. There is always risk, and there is a risk that the
purchaser may exercise the option and “call” away your shares. You must decide whether the money
that will be generated is worth the risk of having to
sell your shares at a certain price. Naked option
writing is not appropriate for the beginning investor.
Arbitration
Arbitration is a way of resolving a dispute by impartial
persons who know about the areas of controversy.
Arbitration of securities cases has proven
to be a quicker and less expensive way to resolve
disputes than lawsuits. Arbitration decisions are
final. That is, the decision can be reviewed by a
court only on a very limited basis. The arbitration
proceeding must be initiated within 6 years or
within the time required by state or federal statutes
of limitation, whichever is shorter.
In an arbitration proceeding, you are not
required to have an attorney, but may have one if
you wish. There are usually three arbitrators, the
majority of which are not affiliated with the securities
industry. The arbitrators do not give a written
opinion explaining their decision the way courts
do, so you will not be given a reason for the decision.
Although this can be unnerving to the losing
party, the lack of written opinions is one of the big
factors contributing to the efficiency of the arbitration
system. The biggest practical difference
between arbitration and the courts is that arbitrators
sit in equity. That means that they resolve the
dispute on what seems to them to be fair, based on
the standards of practice of the investment community,
the expectations of the parties when the
securities transactions were made, and on common sense.
Services Missouri Division of Securities
of The Missouri Securities Division is a division of
the Office of the Secretary of State. The Securities
Division registers securities and licenses the individuals who sell them. The staff of the Division is
available to answer questions, receive complaints
or check licenses and disciplinary history between
the hours of 8:00 a.m. and 5:00 p.m. The office is
located in Room 229 of the James C. Kirkpatrick
State Information Center in Jefferson City.
Inquiries about securities registration:
(573) 751-4136
Inquiries about salesperson licenses:
(573) 751-2061
Complaints and questions:
(573) 751-4704
Toll-free hotline:
(800) 721-7996