Brokerage Firms

Capitalization requirements for Brokerage Firms

Based on the preliminary draft of modifications to the Unified Bulletin, a number of exercises were carried out to evaluate the impact of the brokerage firm capitalization requirements for trading risk, assuming application of the same provisions as those in effect for banks: 15% of net revenues and 36 months to come up to the total capitalization requirement for trading risk, and 12% of net revenues (as established in the Basel II accords) for investment banks, which is expected to be finalized in negotiations with the authorities in 2008.

 

Margin Account Contract

In March 2006, Banco de México published a Bulletin authorizing brokerage firms to trade on margin credit. The proposed margin account contract was released in October of that year, but even though calls for it go back several years, so far brokerage firms have not incorporated this type of trading into their catalog of services.  Among the reasons for this may be issues relating to the encumbrances on margins, and their possible execution.

As for the encumbrance of margins, the Securities Market Act allows this do be done with or without transmission of ownership.  In the first assumption--with transmission of ownership--the fiscal implications must be weighed, such as the taxability of the transaction.  This is why the proposed contract assumes only encumbrance without transmission of ownership.  If margins are encumbered without transmission of ownership, only the problem of their execution must be solved.  In this respect, Article 204, paragraph four, section I, reads:

"I. That the parties agree upon an executor for the securities collateral, and, if so agreed, an administrator of the margin assets.  These appointments may be made upon brokerage firms or banks other than the creditor.  The administrator of the margin assets may also serve as the executor."

Given the prohibition implied in this rule, it was necessary to analyze the possibility of signing reciprocity agreements between brokerage firms under which they could act as executors of margin accounts for their co-contractors; and also the possibility of a bank in the financial group acting in this role or some other equivalent.  To this end, a work group was assembled to analyze the proposed contract and avoid this and any other obstacles that may be detected, so that clients can be offered the alternative of margin credit.

On February 27, a meeting was held to analyze the implications of securities collateral without transmission of ownership of the securities; attending members agreed to compare the opinions of the group with those of their trading areas, in order to make the resulting adjustments.

 

"Poison Pill" Clauses

One of the most important principles governing the market is the free circulation of securities, which led AMIB members to take on the matter of what are called "poison pill" clauses, sometimes included in the corporate charter of publicly-traded companies under the new Securities Market Act.  These clauses are intended to restrict brokers from trading their shares in order to limit a change of control. Some of these clauses are considered excessive under the provisions of Article 48 of the Act

In general terms, it was agreed that any restriction placed on the free transmission of securities affects their market performance. Even so, the new law allows issuers to establish measures intended to prevent the acquisition of shares that would give the buyer a controlling position in the company.
It was considered necessary that brokerage firms recognize these cases and vote consistently with the interests of their clients--many times minority shareholders that may be affected by measures of this kind--and if necessary to weigh their actions as executors of securities collateral or in collateral trusts.

With these concerns in mind, a work group made up of representatives from the Compliance, Corporate Finance and Legal Affairs committees, and officers of the BMV's legal department, prepared a comparative table summing up the restrictive modifications to corporate charters, which led to meetings with some of the issuers to discuss the fine points and eliminate restrictions that might be bad for the market.
The table drawn up by the work group showed:

  1. Issuers that had included this type of clause in their corporate charter.
  2. The company's BMV marketability rating
  3. The date the general extraordinary meeting was held to approve the change in the corporate charter.
  4. A synthesis of the "poison pill" clause identifying the percentage of the capital stock considered.

Financial institutions were eliminated from the table, since they are obliged by law to include certain limits on the acquisition of their stock in their bylaws. 

In addition, the Issuers Committee discussed the practical problems these restrictions cause in the market and for brokers trading the shares of companies with these limitations. Its conclusions were:

There are three kinds of clauses intended to prevent hostile takeover:

  • Those that require Board approval to acquire a given percentage of the stock.
  • Those that require Board approval to exercise a joint vote.
  • Those that demand an obligatory IPO under stricter conditions than the law requires.

The consequences of the second type of clause imply a liability for brokerage firms, because it is almost impossible for them to know the percentage of stock held by each shareholder, particularly if the shares are traded through various brokers and the brokerage firm is unaware of the related parties. This means the rights of certain shareholders may be suspended, and they in turn might hold the broker in question liable for any losses.

The Securities Market Act specifies that clauses of this nature that violate its provisions shall be considered null and void.

There is a contingent legal risk, because issuers may incur such nullity as a matter of law.
It might reasonably be argued that regardless of the percentage, any change of control requires approval of the Board.

Restrictions may viably be placed via the control shareholders, imposing limitations on any attempt to sell off their positions.

It is also possible for shareholders acting in bad faith to argue the nullity of this clause.
Of course, the CNBV may impose sanctions for violation of the approved regulations. >>

 

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