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Purchase and Sales – P&S

The Purchase and Sales Department is the brokerage firm’s first line of defense against trading and settlement errors. The primary functions of the P&S Department are:

Trade Figuration

Trade Figuration is the determination of the Net Amount of a securities transaction. The Net Amount is the dollar amount ultimately owed by or to the brokerage client for the purchase or sale of marketable securities. Calculation of the Net Amount requires the consideration and calculation of the following concepts and amounts:

Net Amount

The Net Amount of a securities transaction is the amount a client must ultimately pay for the purchase of securities, or the amount to be paid by the client upon the sale of securities.

Several factors affect the calculation of Net Amount:

  • Security Type – Equity, Fixed Income or Option
  • Buy or Sell
  • Exchange or Market of execution

These factors are discussed in greater detail in the following sections.

Principal Amount

The Principal Amount is the starting point for the calculation of the Net Amount. The Principal Amount is calculated by multiplying the Quantity (number of shares traded) by the price of execution.

For example, Slick Sam, a brokerage client, purchases 100 shares of XYZ Co. at a price of $72 per share. The Principal Amount of the transaction is $7,200:

Quantity

100

Purchase Price

x 72

Principal Amount

$ 7,200

Certain types of securities require the use of a multiplier or factor in order to calculate the Principal Amount:

  • Fixed Income Securities
  • Options

Fixed Income Securities

Fixed Income Securities generally require the use of a ‘multiplier’ when calculating the Principal Amount of the transaction. It is important to note that although the vast majority of fixed income transactions require the use of a multiplier, that multiplier might not be the same as the one provided in the example that follows. The concepts, however, are applied in the same manner.

Most fixed income securities, but certainly not all, are sold in units of value of $1,000 each. That is, the value of 1 bond at maturity is $1,000.

However, trading prices are quoted from a Par Value of $100, + or – basis point (percentages) depending on the current economic environment. Therefore, a client purchasing 1 bond of $1,000 value at Par would be quoted a price of $100.

The calculation of Principal Amount becomes distorted in this case. For example, assume our client, Sam, instead purchased 1 Bond of $1,000 value at Par – a quoted price of $100 per bond. Without the use of a multiplier the Principal Amount would appear to be $100:

Quantity

1

Price

x 100

Principal Amount

$ 100

To remedy this situation, a multiplier or factor of 10 is required to calculate the correct Principal Amount.

Quantity

1

Price

x 100

Multiplier

x 10

Principal Amount

$ 1,000

Options

One Option contract gives it’s owner the right, but not the obligation, to buy or sell 100 shares of a designated underlying security. Option prices, however, are expressed in terms of buying or selling 1 share of the underlying security.

Because each option entitles it’s holder to buy or sell 100 shares, but the quoted price for that option is expressed in terms of only 1 share, a multiplier of 100 must be applied to the calculation of Principal Amount. As with Fixed Income Securities, the Option multiplier of 100 is the general rule, but certain Option securities require multipliers of different values. Fortunately, the application of the multiplier in these instances is the same. Accordingly, our example will focus only on Options with a multiplier of 100.

Assume Slick instead purchased 1 Call Option for the underlying security XYZ Co. at a price of 2 ¾. This Option gives Slick the right to buy 100 shares of XYZ Co. at an agreed upon Strike Price if – and only if – market conditions are favorable.

The execution price, 2 ¾, is the premium paid for the right to purchase 1 share of XYZ Co. stock. Because the single option contract entitles our client to purchase 100 shares of XYZ the total premium – or Principal Amount – is $275.

Quantity

1

Price

x 2 3/4

Multiplier

x 100

Principal Amount

$ 275

Commission

A Brokerage Firm charges its clients a commission when the firm serves that client in the capacity of a broker or agent. A Brokerage Firm "Acts as Agent" in a securities transaction when the firm is the middle man – bringing both buyer and seller together for the purposes of executing that transaction.

When the Brokerage Firm Acts as Agent or Broker for its client, the client buys and/or sells securities to or from another investor working through the broker dealer. Clients in this case are not entering into transactions directly with the firm itself.

Commissions are generally expressed in terms of cents per share, and are either added to or subtracted from the Principal Amount in order to calculate the Net Amount of the trade. Commissions are added to the Principal Amount to determine the Net Amount of a Buy Trade. Conversely, commissions are subtracted from the Principal Amount to determine the Net Amount of a sell trade.

Buy Trades

When a client buys securities through a Brokerage Firm, the Net Amount of the trade represents the amount the client must pay the firm for the transaction.

The Net Amount of a buy trade includes the cost of the stock (Principal Amount) plus any additional fees (Commission) charged by the broker dealer.

Assume that Sam buys through his broker 100 shares of XYZ Co. stock @ 15 ¾ per share. Sam also agrees to pay his broker a commission of 5 cents per share.

The Principal Amount of this transaction is $1,575:

Quantity

100

Price

x 15 3/4

Principal Amount

$ 1,575

The total Commission to be paid is $5:

Quantity

100

Commission Rate

x .05

Commission Amount

$ 5

The 5$ commission is added to the Principal Amount to arrive at the Net Amount of the buy trade:

Principal Amount

$ 1,575

Commission

+ 5

Net Amount

$ 1,580

Sell Trades

When a client sells securities through a Brokerage Firm, the Net Amount of the trade represents the amount the client will receive from the firm for the transaction.

The Net Amount on a sell trade (sell proceeds) represents the amount owed to the client by the Brokerage Firm. The sell proceeds are equal to the amount received for the sale of the securities (Principal Amount) less any fees (Commission) charged by the broker. Therefore, Commissions are deducted from the Principal Amount to determine the Net Amount of a sell trade.

Had Slick instead sold the 100 shares of XYZ Co. through his broker the Net Amount would have been $,1570:

Principal Amount

$ 1,575

Commission

- 5

Net Amount

$ 1,570

Gross Credit

When the Brokerage Firm enters into a Principal or Dealer Transaction with its client, the firm buys and sells securities directly with that client from a firm trading account. This is also known as buying or selling from inventory.

When the broker dealer buys/sells shares to/from a client through a firm dealer/inventory account, the firm no longer Acts as Agent and cannot charge the client a commission. Instead, the firm acts as a dealer, or Acts as Principal.

When Acting as Principal the firm makes its profit by increasing or decreasing the price at which buys or sells securities from or to its clients.

This process is very similar to that employed by the local grocery store. The grocer buys inventory and applies a mark-up to his cost, to determine the price at which he is willing to sell that inventory to you, the consumer.

When a firm sells securities to its clients from a dealer account, the firm’s trader increases or "marks-up" the price of the securities above what was originally paid for those securities so that the firm can earn its profit. The amount of the mark-up – the difference between what the firm originally paid and the price the firm charges its client is also referred to the spread, gross credit or concession.

The amount of the mark-up is generally expressed as an amount per share, and must be clearly disclosed to the client at the time of the trade.

When a firm buys securities from its clients into a dealer account, the firm’s trader decreases or "marks-down" the price of the securities below what the firm can sell those securities for so that the firm can earn its profit.

The amount of the mark-down is also referred to as the spread, gross credit or concession. It is generally expressed as an amount per share and must be clearly disclosed to the client at the time of the trade.

Because the mark-up or mark-down is built into the transaction price, the Gross Credit is neither added to nor subtracted from the Principal Amount when calculating the Net Amount of the trade. However, because the Gross Credit plays such an important role in the overall determination of the transaction cost it is mentioned in this section.

Accrued Interest

Accrued Interest is used in the calculation of the Net Amount of a securities transaction for interest paying Fixed Income Securities only.

Essentially, Fixed Income Securities (Bonds, Notes etc.) represent loans by investors to corporations or government entities (the issuer). In payment of these loans, the issuing entity pays its fixed income investors interest on the loan for each day that the loan is outstanding.

Although interest accrues (grows) to the investor daily, the actual interest payment from the issuer is generally made at set periodic intervals – monthly, quarterly, semi-annually or annually. At the time of the payment, an interest amount representing the total daily interest accruals for the entire payment period is paid to the owner of the bonds. The payment period is simply the number of days between the set periodic payments.

This presents a problem when the bonds are traded from one investor to another during the interest accrual period, because only the new (or current in the event of multiple sales) owner of the bonds will receive the interest payment from the issuer (or more likely the issuer’s paying agent).

For example, assume that an investor owns 10 interest paying XYZ Co. bonds with a principal value of $10,000. The XYZ bonds pay investors a total of 5% interest each year – which is divided into two semi-annual payments. The payments are made each year on June 15th and December 15th.

Let’s also assume that our investor owns the 10 bonds on June 15th and is entitled to the entire interest payment he receives from XYZ Co.

On September 16th the investor sells all 10 bonds to another investor. We will assume for this example that the new investor does not sell the bonds before the next interest payment date – December 15th.

On December 15th, XYZ Co. will only pay interest to the current holder of the bonds – our investor, Sam, will not receive any interest payment from the issuer.

Another problem when bonds are traded during the interest accrual period is that the payment received by the current owner is for the entire accrual period – even though the current owner is only entitled to interest for that portion of the accrual period during which the investor owned those securities. Additionally, prior owners during that same accrual period are also entitled to their respective portions of the interest accrual.

Continuing the previous example, on December 15th, XYZ Co. will pay a full 6 months interest to the current investor. This 6 month payment covers the entire accrual period from June 16th through December 15th.

The current owner is only entitled to interest accruals for those days on which he/she actually owned the bonds – September 16th through December 15th. Additionally, the original investor, Sam, is also entitled to interest for that portion of the period in which he owned the bonds – June 15th through September 15th.

Because most Fixed Income Securities are bought and sold frequently, it is not feasible for the issuer to track each sale and pay each owner – both past and present – their pro-rata share of the accrued interest.

To account for this interest accrual problem, at the time of the trade the buyer of interest bearing fixed income pays the seller "Accrued Interest." Accrued Interest serves two purposes:

  1. It compensates the seller for the entitled interest payment which will not be received directly from the issuer
  2. It reduces the amount of interest received by the new owner by offsetting the interest payment received from the issuer

Accrued Interest is calculated by dividing the annual interest payment into a daily accrual amount, and pro-rating for the number of days in the accrual period that the bonds were owned by the investor.

To calculate Accrued Interest use the following steps:

  1. Count the number of Accrual Days
  2. Calculate the total amount of annual interest to be paid to the investor
  3. Calculate the daily accrual amount
  4. Multiply the number of accrual days by the daily accrual amount

1. Calculate the Number of Accrual Days

To calculate Accrued Interest you must determine the number of accrual days between the last interest payment and the date of the trade. The number of days includes all days through – but not including – the settlement date of the trade.

2. Calculate the Total Amount of Annual Interest to Paid to the Investor

To calculate the total annual amount of interest to be paid to the investor multiply the coupon or interest rate by the principal value of the traded bonds. That is, if 10 bonds with a 5% coupon and a principal value of $10,000 are sold, the annual interest is:

Coupon Rate

5%

Principal Amount

x $10,000

Annual Interest

$ 500

3. Calculate the Daily Accrual Amount

The annual interest calculated in Step 2 is then divided by 360 (or 365 depending on the particular bond issue) to arrive at the daily accrual amount.

The number of days used (360 vs. 365) to calculate the amount of the daily accrual is set by he issuer at the time the bonds are issued to the public. Some bonds accrue interest based on the assumption that there are 360 days each year. This assumption is made to simplify the process of counting the number of interest accrual days for the holding period and thus to simplify the calculation of Accrued Interest.

For 360 day bonds, 30 days of interest accrues each month. Bonds that accrue interest on a 365 day basis follow the actual calendar. The number of accrual days each month depends on the actual number of calendar days for that month.

4. Multiply the Number of Accrual Days by the Daily Accrual Amount

To calculate the amount of Accrued Interest the number of accrual days calculated in Step 1 is multiplied by the daily accrual amount from Step 3.

Unlike commission, the amount of Accrued Interest is always added to the Principal Amount when calculating the Net Amount of the trade. That is, Accrued Interest is added for both buy and sell transactions. This is because the Accrued Interest represents a flow of money from the buyer to the seller. Therefore the total amount to paid by the buyer is the Principal Amount plus any Accrued Interest. Similarly, the total amount to be received by the seller is the Principal Amount plus any Accrued Interest.

Assume from the previous example that the 10 5% XYZ Co. bonds held by our client accrue interest based on a 360 day calendar, and that the bonds were sold on settlement date September 16th at a price of 98 ½ per bond.

The Principal Amount of the trade is $9,850:

Quantity

10

Price

x 98 1/2

Multiplier

x 10

Principal Amount

$ 9,850

1. Calculate the Number of Accrual Days

June 16th through 30th

15 Days

July 1st through 30th

30 Days

August 1st through 30th

30 Days

September 1st through 15th

15 Days

2. Calculate the Total Amount of Annual Interest to Paid to the Investor

Principal Value of Bonds

$ 10,000

Coupon Rate

x 5%

Annual Interest Payment

$ 500

3. Calculate the Daily Accrual Amount

Annual Interest Payment

$ 500

Number of Annual Days

) 360

Daily Accrual Amount

$ 1.39

4. Multiply the Number of Accrual Days by the Daily Accrual Amount

Daily Accrual Amount

$ 1.39

Number of Accrual Days

x 90

Total Accrued Interest

$ 125.10

Therefore, assuming a $50 commission the Net Amount for the buyer would be:

Principal Amount

$ 9,850.00

Accrued Interest

+ 125.10

Commission

+ 50

Net Amount

$ 10,025.10

The Net Amount for the seller, Slick Sam, would be:

Principal Amount

$ 9,850.00

Accrued Interest

+ 125.10

Commission

- 50

Net Amount

$ 9,925.10

SEC Fee

Section 31 of the 1934 Exchange Act empowers the SEC – the Securities and Exchange Commission – to collect transaction fees on securities transactions. The fees are "designed to recover the costs to the government of the supervision and regulation of securities markets and securities professionals, and costs related to such supervision and regulation, including enforcement activities, policy and rulemaking activities, administration, legal services and international regulatory activities."

This fee, commonly referred to as the SEC Fee, is assessed only on sales of US equities executed on a US exchange or market. The fee, which is $0.15 for every $10,000 of Principal Amount, is subtracted from the sale proceeds, thereby reducing the sell Net Amount, and is paid to the SEC by the brokerage firm on a monthly basis.

A simple method of calculating the SEC Fee is to multiply the Principal Amount of the trade by $.000015. Always round up to the nearest penny. For example, assume a sale of 1,000 shares of XYZ Co. stock @ $47 per share. The SEC Fee is calculated as follows:

    1. Calculate the Principal Amount
    2. Multiply the Principal Amount by $.000015.

1. Calculate the Principal Amount

Quantity

1,000

Price

x 47

Principal Amount

$ 47,000

2. Multiply the Principal Amount by $.000015

Principal Amount

$ 47,000

SEC Multiplier

x $.000015

SEC Fee

$ .71

The Net amount, assuming a $0.05 per share commission would be:

Principal Amount

$ 47,000

SEC Fee

-$ .71

Commission

- 50

Net Amount

$ 46,949.29

Had the example been a buy trade, no SEC Fee would have been imposed.

NASD Trade Activity Fee (TAF)

On October 1, 2002, the NASD - National Association of Securities Dealers - assessed a new Trade Activity Fee on all sell transactions in Covered Securities. Covered securities include:

  1. Exchange-registered securities wherever executed (non-debt securities)
  2. Equity securities traded other than on an exchange.
  3. Security futures, wherever executed.

Essentially, the TAF is to be charged whenever an SEC Fee is to be charged. If no SEC Fee is required, the NASD TAF is not to be charged. Member firms are required to report to the NASD monthly the total aggregate shares, contracts and/or futures transactions subject to the Activity Fee. The fee assessed is on the aggregate total and is calculated at the following rates:

Security Type

NASD Activity Fee

Sales of a covered securities

$0.0001 per share

Sales of option securities

$0.002 per contract

Futures Transactions

$0.08

Miscellaneous Fees – Postage and Handling Fee

Brokerage firms often collect additional fees from trading activity to help recover certain administrative expenses. One such fee, Postage and Handling, is generally collected on buy transactions and has the same effect on Net Amount – that is, it is added to the Principal Amount to determine the total amount due from the client.

Postage and Handling fees are collected only once for each order executed. Therefore, if one order is executed in multiple lots, only the first execution from that order is subject to the handling fee. Additionally, the combination of the commission and the handling fee cannot exceed 5% of the Principal Amount.

Because the calculation of Net Amount is the same for that of commissions, no additional example will be provided here. If necessary, please refer to the section on commissions to review this example.

State Tax

In the past, the State of New York also imposed a securities transaction tax - which was reduced from the proceeds of all sell transactions.

In recent years the tax was repealed. However, brokerage firms are still required to calculate how much this tax should be, and are under obligation to report the daily state tax total – the amount that would have been collected – to the New York State Department of Taxation.

Although State Tax is calculated as part of the trade figuration process, the amount has no impact on the calculation of Net Amount. Accordingly, no examples of State Tax calculations are provided here.

Trade Balancing and Reconciliation

Trade Balancing and Reconciliation is the core function performed by the Purchase and Sales Department. Balancing and Reconciliation provides assurance that all trades processed on the firm’s books and records are in fact legitimate trades and not data input or trading errors. Balancing and Reconciliation helps limit the firm’s exposure to potential monetary loss resulting from an erroneous transaction on the firm’s trading records.

Balancing and Reconciliation commences on Trade Date + 1 (T+1) and concludes on Settlement Date + 1 (S+1). Trade Date (T) is the business day on which the trade is executed on a securities exchange or market, or between the client a the firm’s inventory account. T+1 is the first business day immediately following Trade Date. Settlement Date (S) is the 3rd business day after Trade Date or T+3, and Settlement Date + 1 is the business day after S. If this is unclear, please take a moment to review the concepts in the section titled The Trade Cycle.

The logic behind Trade Balancing and Reconciliation is rooted in basic accounting principles. Every entry must be a balanced entry. This means that for every debit entry there must be a credit entry of equal value. In the stock brokerage world, this applies to entries for both securities (the quantity of shares, bonds, options etc.) and entries for currency (the Net Amount of money, a.k.a. dinero).

For each buy trade processed (Debit Entry) there must be an offsetting credit entry. Conversely, for each sell trade processed (Credit Entry) there must be an offsetting debit entry. Therefore, to keep the firm’s accounting records balanced, for every buy trade processed there must be an offsetting sell trade and visa versa.

Simply stated, Trade Balancing and Reconciliation is knowing where to find the offsetting entry for each and every trade processed – and then verifying that that offsetting entry was processed correctly. If the offsetting entry is not processed correctly, an out-of-balance will result on S+1. Therefore, the P&S staff has 3 business days – T+1, T+2 and T+3 - to resolve any trade differences that are identified.

The use of electronic trading, comparison and settlement systems ensures that, on average, 98% - 99% of all securities transactions are processed correctly on Trade Date and do not require additional attention nor human intervention throughout the comparison and settlement process.

Due to the sheer volume of securities transaction processed each day, Brokerage Firms employ a process called "Exception Processing". Exception processing utilized powerful computer systems and applications to systematically match each record on the firm’s buy and sell trading activity with its appropriate bookkeeping offset. Trades that do not have a corresponding offset are output to an "Exception Report" for review and resolution. Thus, in the exception processing environment, the Purchase and Sales staff is only concerned with true exceptions – real trade differences.

The Process

The specific process employed during Balancing and Reconciliation is driven by the type of trade (Street vs. Dealer), the security type traded (Equity, Bond, Option etc.), and the comparison and settlement method for the particular security traded.

Trade Blotters

Each trade processed on the Brokerage Firm’s bookkeeping system is assigned to a specific Trade Blotter. A trade blotter is an accounting sub-ledger. Sub-ledgers provide supporting details to accounting entries in the main or general ledger. Trades are assigned to a specific trade blotter based on the following criteria:

  • Security Type - Equity, Fixed Income, Option etc.
  • Trade Type – As Agent vs. Dealer
  • Buy or Sell
  • NSCC Comparison Eligibility
  • Settlement Method – CNS, Non-CNS, Trade-for-Trade, Ex-Clearing

Dealer (Pair-Off) Trades

Dealer Trades are purchases and sales of securities executed directly between a Brokerage Firm and its client. Dealer trades are processed on designated "Pair-Off" Trade Blotters. Buy trades are booked on a Buy Pair-Off Trade Blotter and sell trades are booked on a Sell Pair-Off Trade Blotter. Dealer trades are often referred to as "Pair-Off" transactions, because the total of buy and sell trades – the total debits and credits processed - on the Pair-Off Blotters should be equal – thus pairing-off or netting to a zero balance.

Balancing and Reconciliation of Dealer Trades involves matching all the buy trades booked on the firm’s dealer trade blotters with all of the corresponding sell trades booked on the firm’s dealer trade blotters.

When a client buys securities from the brokerage firm in a dealer transaction, a buy trade (debit) is booked in the client’s account. The offsetting sell trade (credit) is processed in the firm’s Dealer Inventory Account. When a client sells securities to the brokerage firm, a sell trade (credit) is booked in the client’s account and the offsetting buy trade (debit) is processed in the firm’s inventory account.

A Dealer (Pair-Off) Trade is in balance when both the buy and sell trades are processed correctly – that is, both buy and sell match on the following key trade elements:

  • Security
  • Quantity
  • Price
  • Principal Amount
  • Gross Credit Amount

For example, let’s assume that our client, Slick Sam, purchases 200 shares of XYZ Co. from his broker @ 37 ¾ per share. The broker sells Sam these shares from his dealer account. The price – 37 ¾ - includes a mark-up or gross credit of ¼.

The following trades must be booked on the broker dealer’s records in order for this trade to be balanced. If the trades are not processed as detailed below, an exception will result.

Sam’s Account:

  • Buy
  • Trade Blotter - Dealer
  • Quantity - 200 Shares
  • Security - XYZ Co.
  • Price – 37 ¾
  • Principal Amount - $7,550
  • Gross Credit - $50

Dealer Account:

  • Sell
  • Trade Blotter - Dealer
  • Quantity - 200 Shares
  • Security - XYZ Co.
  • Price – 37 ¾
  • Principal Amount - $7,550
  • Gross Credit - $50

The matching process for dealer trades is performed primarily by the firm’s technology applications. All the buy trades on the Pair-Off Blotter are compared against all the sell trades on the same Pair-Off Blotter. All differences are output to an exception report.

If either the buy or sell is not processed, or the two trades do not successfully match on one or more of the key trade elements, an exception report is generated. The P&S Department must work closely with the firm’s traders to resolve the discrepancy.

Differences that are not resolved on or before settlement date will create an out-of-balance in the firm’s accounting records. This results because the transaction is not a balanced accounting entry – that is, the debit entry does not equal the credit entry.

Generally, two types of differences will result on S+1 from an incorrectly processed Dealer (Pair-Off) Trade:

  1. Stock Record Break
  2. Bookkeeping Break.

Although it is possible to have a Stock Record Break without a Bookkeeping Break – and visa versa – a dual break combining both types is most common.

When the debit and credit quantities of the trades do not equal, a Stock Record Break results. A Stock Record Break indicates that the firm’s total long position does not equal its total short position in a particular security.

A money break is the result when the dollar amount of the buy and sell trades does not equal. Money breaks are commonly referred to as "Bookkeeping" breaks.

All post settlement date exceptions resulting from incorrectly processed Dealer Trades – both Stock Record and Bookkeeping Breaks – must be resolved on S+1.

Street Trades

Street Trades are those executed between two brokerage firms. A street trade is executed with another brokerage firm - on a securities exchange or market - on behalf of one of the firm’s clients (As Agent), or for one of the firm’s inventory or proprietary trading accounts.

Balancing and Reconciliation of Street Trades involves matching all the street trades booked on the firm’s trade blotters with all of the trade comparisons received from both automated and manual comparison systems. The trade and comparison must match on the following key elements:

  • Side – Buy or Sell
  • Market of Execution
  • Quantity
  • Security
  • Price
  • Principal Amount
  • Contra Broker

For example, let’s assume that Sam purchases 200 shares of XYZ Co. through his broker @ 37 ¾ per share. The broker executed this trade on the NYSE with FIRM 2. Therefore, the broker bought 200 shares of XYZ Co. from FIRM 2 on the New York Stock Exchange for its client, Sam.

First, the following trade is booked on the firm’s records.

Sam’s Account

  • Side - Buy
  • Trade Blotter – Street
  • Market of Execution - NYSE
  • Quantity - 200 Shares
  • Security - XYZ Co.
  • Price – 37 ¾
  • Principal Amount - $7,550
  • Contra Broker – FIRM 2

Further, a trade comparison must be received from the NSCC for the trade. The comparison must contain the following details:

Trade Comparison

  • Buy
  • Market of Execution - NYSE
  • Quantity - 200 Shares
  • Security - XYZ Co.
  • Price – 37 ¾
  • Principal Amount - $7,550
  • Contra Broker – FIRM 2

The process used to balance and reconcile street side transactions depends on the type of comparison generated, and the settlement method for the particular trade.

Trades Comparison is accomplished in one of two ways:

  1. Electronically through the use of an automated clearing house such as the NSCC
  2. Manually via Ex-Clearing

Trade Settlement is accomplished by one of four methods:

  1. CNS
  2. Non-CNS
  3. Trade-for-Trade
  4. Ex-Clearing

The following comparison and settlement combinations are possible:

  1. NSCC Eligible – CNS Settlement
  2. NSCC Eligible – Non-CNS Settlement
  3. NSCC Eligible – Trade-for-Trade Settlement
  4. Ex-Clearing – Comparison and Settlement

Generally, Street Trades are booked on the firms records on Trade Date, on an appropriate Trade Blotter designated for Street Trades. To facilitate the process of matching trades with comparisons, each Exchange or Market utilizes a separate trade blotter. Additionally, the Street Side Trade Blotters for each market or exchange are often further segregated as to the comparison eligibility of the security traded and the settlement method of the trade.

For example, an NSCC Eligible – CNS Settlement transaction executed on the New York Stock Exchange would be booked on a trade blotter specifically designated for that Exchange and settlement type. A Non-CNS Settlement trade executed on the same exchange would be assigned to a different trade blotter. An Ex-Clearing trade executed on the OTC Market would be processed on a unique blotter as well. Again, the use of unique trade blotters assists the Purchase and Sales staff with the matching aspects of the Trade Balancing and Reconciliation process.

Additionally, on T, the firm submits the trade details for all eligible street transactions to the NSCC for comparison with other brokerage firms. Trades that are successfully matched by NSCC result in trade comparisons or compared trades. Compared trades files and reports received by the broker from NSCC are segregated by Market or Exchange of execution and include specific information regarding the method of settlement.

Trades in securities that are not eligible for the NSCC comparison process are booked on an Ex-Clearing Trade Blotter, and are compared manually by the Purchase and Sales Department.

For the purposes of explaining Trade Balancing and Reconciliation, CNS Settlement and Non-CNS Settlement - Non-CNS, Trade-for-Trade and Ex-Clearing – will be discussed separately.

CNS Settlement

In order to settle via CNS, a securities transaction must be both successfully matched during the NSCC Comparison Process and properly designated as a CNS settling trade. Therefore, trades that settle via CNS by definition are necessarily eligible for the NSCC Comparison System.

The vast majority of all domestic securities transactions settle through the CNS Settlement System. It is the role of the Purchase and Sales Department to ensure that all trades booked on a CNS Settlement Trade Blotter – for each domestic exchange and market - are properly matched by NSCC as CNS Compared Trades.

This is accomplished by matching each compared trade on the NSCC CNS trade comparison file with its corresponding trade on the firm’s CNS Trade Blotter. Trades are matched to comparisons based on the following key elements:

  • Side – Buy or Sell
  • Market of Execution
  • Quantity
  • Security
  • Price
  • Principal Amount
  • Contra Broker

For CNS settling trades, an offsetting entry is booked in the firm’s CNS clearance account prior to settlement date. For each buy trade (Debit) processed on a CNS trade blotter, an offsetting sell trade (Credit) is booked in the CNS account. For each sell trade (Credit) processed on a CNS trade blotter, an offsetting buy trade (Debit) is booked in the CNS account.

Comparisons and/or trades on the firm’s records that are not successfully matched during the balancing and reconciliation process will be output to an exception report. The P&S staff must work with the firm’s traders to resolve all exceptions before settlement date.

In the event that a CNS comparison is received from NSCC that cannot be matched against a trade on the CNS trade blotter – a client trade or "House Ticket" must be processed. If a trade on the CNS trade blotter cannot be matched to a CNS comparison – a comparison must be generated.

If a comparison and/or trade is not successfully matched by settlement date, a difference will result in the firm’s CNS Account on S+1.

Non-CNS, Trade-for-Trade and Ex-Clearing Settlement

Transactions that do not settle through CNS may or may not be eligible for the NSCC Trade Comparison System. Non-CNS and Trade-for-Trade Settlement are both products of the NSCC trade comparison process. Ex-Clearing transactions, on the other hand, do not utilize the NSCC matching cycle.

Non-CNS and Trade-for-Trade (T-f-T)

The comparison process for Non-CNS and Trade-for-Trade Settlement is very similar to that for CNS Settlement. Both utilize the NSCC automated comparison system. However, Non-CNS trades are processed on Non-CNS trade blotters and Trade-for-Trade transactions are booked on T-f-T trade blotters.

Further, Non-CNS and Trade-for-Trade transactions are not forwarded to CNS for settlement. Instead, the NSCC generates a balance order – which instructs the firm to deliver (sells) or receive (buys) securities to another brokerage firm. The balance order also identifies the net amount or settlement amount to be received (sells) or paid (buys) by each firm.

The brokerage firm uses the NSCC balance order as an instruction to manually settle Non-CNS and Trade-for-Trade transactions. This is either done by delivering or receiving securities through an electronic depository (such as DTC), or by delivering or receiving actual physical (paper) certificates.

Because the trade balancing and reconciliation process is the same for both Non-CNS and Trade-for-Trade settlements, both will be covered in one section. Because neither settles through CNS – Non-CNS and Trade-for-Trade will be used interchangeably in this section.

Trade balancing and reconciliation for Non-CNS and T-f-T trades is accomplished by matching each compared trade on the Non-CNS and T-f-T NSCC trade comparison file with its corresponding trade on the firm’s Non-CNS and T-f-T Trade Blotters. Trades are matched to comparisons based on the following key elements:

  • Side – Buy or Sell
  • Market of Execution
  • Quantity
  • Security
  • Price
  • Principal Amount
  • Contra Broker

Comparisons and/or trades on the firm’s records that are not successfully matched during the balancing and reconciliation process will be output to an exception report. The P&S staff must work with the firm’s traders to resolve all exceptions before settlement date.

In the event that a Non-CNS or T-f-T comparison is received from NSCC that cannot be matched against a trade on a CNS ineligible trade blotter – a client trade or "House Ticket" must be processed. If a trade on the Non-CNS or T-f-T trade blotter cannot be matched to a similar NSCC comparison – a comparison must be generated.

Prior to settlement date, the NSCC generates balance orders for all Non CNS eligible compared trades. The brokerage firm generates a "Fail Record" for each balance order received. A Fail Record is an entry to the firm’s Receive and Deliver (R&D) File. The R&D File is an accounting sub-ledger which contains settlement details such as the security traded, the quantity bought or sold, the net amount to be settled, and the contra broker with which to settle the trade. In basic accounting terminology, the "Fail" is either an open deliverable (securities are sold) or an open receivable (securities are purchased).

When the firm sells securities to another brokerage firm a Deliver Balance Order is generated by the NSCC. A Fail-to-Deliver is set-up prior to settlement date for each Deliver Balance Order. For accounting purposes, the actual sell trade is a credit entry. The Fail-to-Deliver is a debit entry. Because debit and credit entries offset, the trade results in a balanced accounting entry.

When the firm buys securities from another brokerage firm a Receive Balance Order is generated by the NSCC. A Fail-to-Receive is set-up prior to settlement date for each Receive Balance Order. For accounting purposes, the actual buy trade is a debit entry. The Fail-to-Receive is a credit entry. Because debit and credit entries offset, the trade results in a balanced accounting entry.

If a comparison and/or trade is not successfully matched by settlement date, a difference will result on S+1.

An uncompared trade on the Non-CNS or Trade-for-Trade blotter will not generate a balance order and will result in a one sided trade. If no balance order is received, no fail is generated. If no fail is generated the transaction is no longer a balanced entry.

Similarly, a Non-CNS or T-f-T comparison that does not match a trade on the CNS ineligible trade blotter will also result in a one sided trade. A Non-CNS or T-f-T compared trade will generate a balance order. A balance order will generate a fail record. If a fail is generated without a matching trade the transaction is no longer a balanced entry.

Generally, two types of differences will result:

  1. Stock Record Break
  2. Bookkeeping Break

A Stock Record Break indicates that the firm’s total long position does not equal its total short position in a particular security.

A money break is the result when the dollar amount debited does not equal the dollar amount credited.

All post settlement date exceptions resulting from unmatched trades – both Stock Record and Bookkeeping Breaks – must be resolved on S+1.

Ex-Clearing Trades

Trades in securities that are not eligible for the NSCC trade comparison process are booked on an Ex-Clearing Trade Blotter and are compared manually by the P&S Department.

Prior to settlement date, a "Fail Record" is automatically generated for all Ex-Clearing trades. A Fail Record is an entry to the firm’s Receive and Deliver (R&D) File. The R&D File is an accounting sub-ledger which contains settlement details such as the security traded, the quantity bought or sold, the net amount to be settled, and the contra broker with which to settle the trade. In basic accounting terminology, the "Fail" is either an open deliverable (securities are sold) or an open receivable (securities are purchased).

When the firm sells securities to another brokerage firm for Ex-Clearing settlement, a Fail-to-Deliver is automatically generated prior to settlement date. For accounting purposes, the actual sell trade is a credit entry. The Fail-to-Deliver is a debit entry.

 

 

The reconciliation of a firm’s trading activity is generally divided into specific processing groups based on the type of security traded, the exchange or market on which the trade was executed, and the method of settlement for that particular security.

Although the division of product lines may differ from one firm to another, reconciliation is generally separated based on the following product types:

    1. Equities
    2. Fixed Income Securities
    3. Options
    4. Commodities
    5. Mutual Funds

The daily reconciliation is further delineated based on the exchange or market of execution.

Equity trades are reconciled based on the Exchange or Market on which the trades were executed.

Equity Securities are either traded on a Stock Exchange or on the NASDAQ Over-the-Counter Market. Exchange traded securities are sometimes refered to as "Listed" securities. The term listed security is derived from the fact that the security must be "Listed" with a particular exchange in order to be traded on that exchange.

The Primary Domestic Stock Exchanges are:

    1. The New York Stock Exchange
    2. The American Stock Exchange
    3. The Pacific Stock Exchange
    4. The Boston Stock Exchange
    5. The Midwest Stock Exchange
    6. The Philadelphia Stock Exchange

The NASDAQ Over-the-Counter Market is an electronic Securities Dealer Network.





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