Hypothecation agreement

Hypothecation means pledging an asset as collateral for a loan while keeping ownership of it. In a brokerage margin account, the customer borrows part of a purchase price from the broker-dealer, and the securities bought serve as collateral for that loan. The hypothecation agreement is the document that formalizes this pledge, and no margin account can operate without a signed one.

The agreement gives the broker-dealer a lien on the customer's margin securities. If the account's equity falls too far and the customer fails to meet a maintenance call, the firm can sell the pledged securities to repay the loan — without asking permission first. This is why margin securities are held in street name rather than registered directly to the customer.

A closely related concept is rehypothecation: the broker-dealer repledges the customer's securities to a bank to finance the margin loan it made. Under Regulation T and SEC rules, a firm may rehypothecate customer securities worth up to 140% of the customer's debit balance; securities beyond that amount must be segregated. The customer typically consents to rehypothecation in the same paperwork.

Margin documentation is standard exam material. The SIE and Series 7 exams test the three margin account documents — the credit agreement, the hypothecation agreement, and the optional loan consent form — and the Series 9 covers the same ground from a supervisory angle. Remember that the hypothecation agreement is required, while the loan consent form is the only optional one.