Prop Trading Firms - Note On Threatening Regulatory Developments

[CutsThrough]

Quote from jasmine1:

There will always be a place for proprietary traders who can consistently make money. I for one am glad this capital deposit (skin, token money...) could be eliminated because it will raise the standards in the boutique trading business and force firms to hire real talent and not just fill those arcade seats, collect their commissions, fees and profit splits and dump ALL the risk on the trader.

How would this happen?

All that it's going to do is raise the barriers to entry for prop firms. In the future, they'll just add traders to thier account and pay them based on the P/L of thier trades, not hold them accountable for losses. This is currently the case at MANY firms in NYC that recruit recent college grads and asian video gamers.

The barrier to entry for the prop firm will be thier own capital account.

The only people that any reg T enforcement would push out are older traders who don't have the required capital to pony up the 25k.

 

[Maverick74]

Quote from riskarb:

Huh... IB is offering it in Nov of this year, or so they say. I do see the $5mm minimum mentioned in the doc. I'll have to drop IB an email.

Yes, every broker will offer it, or most I should say when the program goes live. It's still being tested in the pilot program. Fimat was the only firm in the pilot program and the pilot program involved only index options, not equities.

Everything I have heard from the exchanges said there would be a very steep minimum. Probably not 5 million like now, but at least 500k to a million.

No retail broker wants to deal with the headache of managing risk based haircuts Beck. Hell, we are in the haircut business and we hate dealing with them. It's a nightmare. Last thing we need is grandma selling gamma after she gets home from an Optionetics seminar and then blows up the brokerage firm because she thought she was only risking 20k on a trade, not 500k. LOL.

 

[HunterGatherer]

I found the following at traderstatus.com. Most people reading this thread do not have series 24 or 27, work compliance at a prop/arcade or run a jumbo hedge fund.

6.19) JBO?
Joint Back-Office. Section 220.7(c) of Regulation T authorizes the creation of JBO arrangements. These JBO arrangements permit "a creditor [to] effect or finance transactions of any of its owners if the creditor is a clearing and servicing broker or dealer owned jointly or individually by other creditors." 12 CFR 220.7(c).

Arthur Levitt , Chairman of the U.S. Securities and Exchange Commission September 16, 1999 said:
When day-trading firms are organized as LLCs and individual day traders contribute to the firm's capital, the day traders are permitted to trade using the firm's capital. These LLC firms typically participate in joint back office ("JBO") arrangements, which allow them to enhance their borrowing power. JBO arrangements have become popular because they allow day-trading firms to receive preferential margin treatment from their clearing firms. Specifically, a day-trading firm that participates in a JBO arrangement can receive credit from its JBO clearing firm on "good faith" terms. As a result, the customer margin requirements found in Regulation T and SRO rules do not limit the extension of credit to a JBO participant. Rather, credit can be extended for up to 100 percent of the purchase price of the securities. As discussed below, the SROs have proposed revisions to their rules that would make these JBO arrangements more difficult to use.

Because of the borrowing power permitted by JBO arrangements, the leverage of day-trading firms organized as LLCs is limited only by the net capital rule. This essentially allows firms to leverage their position 6 to 1, rather than the 2 to 1 leverage allowed day traders under SROs' rules.

General rules:

1. Each JBO participant must be registered as a broker-dealer pursuant to Section 15 of the Securities Exchange Act of 1934 and subject to the capital requirements prescribed by Rule 15c3-1 therein; and shall not be eligible to operate under the provisions of SEC Rule 15c3-1(b)(i).

2. Each JBO participant must meet and maintain a minimum account equity requirement of $1,000,000 with each clearing broker-dealer where a JBO account is carried. If equity is below $1,000,000 the carrying organization must issue a call for additional funds or securities which shall be obtained within five business days. If funds or securities sufficient to eliminate the deficiency are not received within 5 business days, the carrying organization must margin the account in accordance with the requirements prescribed for a customer in Regulation T and Exchange Rule 12.3.

3. Each JBO participant must meet and maintain the ownership standards established by the clearing broker-dealer; and

4. Each JBO participant must employ (or have access to) a qualified Series 27 principal.

3.7) What is a Prop Trader (the real deal)?
Proprietary Trader. One who is involved with transactions with a securities firm that affect the firm's accounts (or his own linked account within the firm) but not affecting the accounts of the firm's clients.

Strictly speaking a prop trading firm is one where you would trade the firm's capital (and only their money). But today the most common so-called "prop firms" are ones where you put up $5,000, $10,000 or more and then you trade using 10:1 intraday leverage. These are also called "trading arcades" by (the) Hoi Poli.

3.8) What is a Prop Trader ("arcade trading")?
Called "trading arcades," because these so-called "prop firms" push you to churn your account, so that they can make their money off the commissions. If you are profitable they also take a percentage of your profits, but that's just an added bonus to them. Commissions are their main income.

So how does being a JBO negate a requirement to share in profits in profits and losses and not take personal deposits? If Greentrader is correct then the following will no longer be true (?):

Arthur Levitt , Chairman of the U.S. Securities and Exchange Commission September 16, 1999 said:
When day-trading firms are organized as LLCs and individual day traders contribute to the firm's capital, the day traders are permitted to trade using the firm's capital.

 

[mushinseeker]

This is what I got out of the conf call sponsored by Greentrader ( I was 10 min late so please correct me if I an way off.

The SEC is looking to crackdown on prop firms. The principals in the conf call then tried to distinguish between JBO firms whose members are licensed , members of an exchange, registered as a BD. VS. prop firms that are more like "wholesalers". The latter would typically open a retail account (ex. XYZ Trading Group) with a broker (Genesis, Assent,etc), deposit class A money lets say 400K, creates an LLC agreement where traders can put up 5K , get 20:1 margin intraday with zero overnight positions, and get paid accdg to pnl. Their lsoses are covered by the 5k deposit. They are allowed that leverage because they are in effect using the 400K 4:1 intraday BP of the class A members afforded to them under Reg T.

The difference lies in the fact that this company has a retail account with the broker and has very low barrier to entry vs. the former setup. The conf call principals implied that the SEC seeks to protect the "widows and orphans" which presumably would be found more in the XYZ trading group setup.

My personal opinion? I'd be wary of joining prop firms that have the latter setup. How about the future of the 1st? Mr. Bright , Jeff from Echo what ya think...
edit: Now don't get me wrong , there is very little diff bet the 2 setups in terms of real $ chaning hands. I think the issue is the barrier to entry. It is always politically correct expecially this year to protect "widows and orphans"

 

[ang_99]

Reardon metal is an echo trader I believe who is close with management, maybe he could shed some light on this from echo's perspective.

 

[riskarb]

Quote from Maverick74:

Yes, every broker will offer it, or most I should say when the program goes live. It's still being tested in the pilot program. Fimat was the only firm in the pilot program and the pilot program involved only index options, not equities.

Everything I have heard from the exchanges said there would be a very steep minimum. Probably not 5 million like now, but at least 500k to a million.

No retail broker wants to deal with the headache of managing risk based haircuts Beck. Hell, we are in the haircut business and we hate dealing with them. It's a nightmare. Last thing we need is grandma selling gamma after she gets home from an Optionetics seminar and then blows up the brokerage firm because she thought she was only risking 20k on a trade, not 500k. LOL.

I don't disagree with any of your opinions on the matter -- I was told by an IB manager in Philly that it will be open to all IB margin accounts. Just off the phone. Pointless to only offer it on index options. Index futures options are very liquid. Slight commish advantage to equity contracts, however.

Red sell, green buy... 400 combos!

 

[bbing]

Just a thought here after consuming too much wine...
If the SEC overzealously invalidates the common prop model,
why not form sub llc's in Canada of BD in the US and allow USA
citizens to join? It is very ironic, but it does seem that socialist
Canada has a much more stable( and less intrusive) regulatory enviorment for this
type of business model. After all, we are in the age of globilization. American citizens, just like corporations, should have the right to opt for the most accomodating enviorment to
ensure the success of their endeavors. I am not an expert in
American citizens having ownership in overseas enterprizes, but
if Exxon-Mobile or Microsoft can do it, so can any American.

 

[HunterGatherer]

perhaps SSFs gain traction. 5x1 v. 4x1 or 2x1. SwiftTrade to rule the world.

 

[MilleniumMan]

If Swifttrade ever rules anything I will have to hang myself. If the SEC should look into anything they should ask how a firm like Swift gets the ability to offer all there traders 100's of millions in BP to disease up the market and trade for credits and put in all those fake orders to supply there Millenium pumps is beyond me. But like it says on the webite "we rule the market"

Also quoted on ther website is "I traded a million shares of Microsft today" Well isn't that great you idiot you traded 1 million shares lost $50 dollars but managed to make $500 for providing all that liquidity, thanks for coming out. Then there is the little guy that trades his 4 to 1, 10 to 1 and makes a decent living and has a little risk but understands it. That guy gets punished. A guy that knows more about trading than most and has worked real hard to get where he is today. That guy gets shut down and while 12 year olds, car salesman, and monkeys bang keys, for credits and try to gang up on thin stocks.

there is something eriously wrong with this and the SEC NASD whoever needs to give there head a shake. Nothing prevents grandma from opening up a brokerage account buying 20,000,000 of SSTY on the OTCBB @.0000001 a share and watching criminals take all her money and destroy a company. When i saw this post I was furious as I am one of the guys that gets the 10 to 1 leverage and I am not gonna hide it. I llike the company I work with I like the software and the risk to them is small and the risk to me is small.

there are crafty people in this business that will offer you the world, take your cash and run. Maybe get rid of those people, make some rules but don't what is really the problem here and is this really the cause, I think not.

Sorry about the rant but this is garbage.

MM

 

[Don Bright]

Quote from Traveler:

Wonder if the 5 MM requirement can be satisfied by a pooled broker dealer account at a prop firm like Bright etc?

Whoa, whoa, no "pooled" $$ here. Tradrers use our money, we don't need the traders money for RegT or anything else.

(Just keeping the rumor mill at a distance).

Don