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What Is a Special Memorandum Account (SMA)?

What Is a Special Memorandum Account (SMA)?

All You Need to Know About Special Memorandum Account (SMA)

Definition of the Special Memorandum Account (SMA): The Special Memorandum Account is a line of credit where the excess equity in the margin account is deposited, increasing the buying power of the shares on margin. 

Understanding Special Memorandum Account

For traders, experts, and investors, the Special Memorandum Account is the one that confuses, and the term Special Managed Account (SMA) is frequently used equally with the Special Memorandum Account. The Special Memorandum Account is a separate account owned by the broker that functions similarly to a credit account.

The Special Memorandum Account account has two operating signals: a positive SMA and a negative SMA. A negative SMA is never a good sign for accounts. An investor must be aware of SMA to avoid a negative SMA account. Besides that, investors must also understand what happens in case of a negative SMA.

The Special Memorandum Account works:

  • Whenever investors deposit cash, the value of the stocks or options they hold increases.
  • When a percentage of the proceeds, including dividends, are deposited into their Special Memorandum Account.

The SMA is like credits. An investor can withdraw these credits from the SMA as cash to access more stocks (buy more of them), which will improve their purchasing power by allowing them to buy more stocks.

Follow SMA Closely

The Special Memorandum Account is crucial to observe, as well as its value because if it is negative, the broker will issue traders a margin call. A margin call is when a broker requests additional funds or assets from a client to cover losses and satisfy margin requirements.

The traders will be forced to sell some of their securities to meet the margin requirements, which is never a good thing in the investment world. Traders must also have a positive Special Memorandum Account in the amounts required to buy something new.

Here is an SMA account example, if traders want to buy some stock and the margin requirement is $100 or more, they need to have $100 or more in their account to make that trade happen. If traders do not have that in their Special Memorandum Account, they cannot make any more trades until they deposit more money or what has already been held value increases.

Purpose of Special Memorandum Account

Many traders also frequently misunderstand Special Memorandum Account existence purposes.

The primary purpose of the Special Memorandum Account existence is to give extra buying power to the client’s margin account (brokerage account).

Things You Need To Know About Special Memorandum Account

  • The Special Memorandum Account is maintained together with the margin account.
  • The value of the securities held in the margin account changes frequently.
  • Excess equity is created when an account has more equity than needed, i.e., 50%(under Regulation T). Here, the Special Memorandum Account refers to this extra equity.
  • The Special Memorandum Account increases when the value of the security increases but does not decrease with a decrease in security value.
  • When a calculation shows extra equity, a broker can automatically transfer excess equity from the margin account to the Special Memorandum Account. 
  • While calculating the equity in the margin account, the broker treats a single entry amount as a debit in the margin account. 
  • After the transfer from the margin account to the Special Memorandum Account, the reduced value of the securities in the margin account does not affect the amount transferred.
  • The Special Memorandum Account and margin account can be credited and debited using the same amount. A simple increase or decrease in an entry can affect these two accounts. 
  • Payments made by the broker to the client (investor) or on their behalf, as well as transfers made from the Special Memorandum Account to their client (investor) other accounts, can reduce the amount of a single entry.

The entries in the above points refer to the Special Memorandum Account and include the following:

  1. Payments of only dividends and interests.
  2. Cash deposited to meet a maintenance margin call or any other condition imposed by a self-regulatory entity that is not mandated by this section.
  3. Any lapsed or liquidated security positions eligible for withdrawal under the margin account no longer need the selling proceeds of any stocks or cash.
  4. Excess margin transferred under section 220(4)(e)(2) from the margin account.

Take Aways

  • The Special Memorandum Account denotes purchasing power.
  • Brokerage firms hold Special Memorandum Accounts.
  • The Special Memorandum Account is also an investment account where the excess margin is held in the account.

Understanding the Special Memorandum Account With An Example

Jackson is a trader who purchases 1000 shares of SDF company at $50 per share on margin. In this example, what is SMA if the SDF company trades at $70 per share? Let us find out.

Jackson purchased $50,000 value shares (1000 * $50), and Jackson has to deposit Reg. (Regulation) T amount–50% of the purchase. Therefore $25,000 (50% * $50,000) goes under the customer equity (EQ) $25,000 (50% * $50,000) and Jackson has to borrow $25,000 on margin from the broker. 

Now $70,000 ($70 * 1,000) implies the long market value (LMV). The borrowed amount from the broker does not change, and the $25,000—margin amount does not change.

Therefore, the EQ increases to $45,000 ($70,000 - $25,000 because the amount borrowed from the broker remains the same. When the new Regulation T margin requirement is multiplied by the LMV, we get the EQ value as ($70,000 * 50%) $35,000.


What affects the balance in the Special Memorandum Account?

Two majorly affect the Special Memorandum Account balance—the purchase of securities and cash withdrawals from the brokerage accounts.

Can investors withdraw cash from the SMA account?

The investors can use the funds in the account to buy additional securities. Also, the Special Memorandum Account balance is maintained to meet margin requirements and does not represent real funds that an investor can withdraw.

Does market value affect SMA?

Only an increase in the current market value can affect the Special Memorandum Account. Another fact about the SMA accounts balance is that the account increases as the securities value increases but does not depreciate as the securities value decreases in the account.

This happens because the goal of this account is to maintain the buying power generated by the unrealized gains created for future purchases. Without the Special Memorandum Account, investors would have to take out the extra equity from the bank and deposit it for future purchases.

Why do we need to understand the Special Memorandum Account?

The Special Memorandum Account primarily reflects the excess margin generated, and the SMA account multiplied by 2 represents the buying power of the margin account. The purpose of the SMA is also to provide additional buying power of margin accounts of the clients by the broker.

Investors also have to understand that the Special Memorandum Account exists when a margin of equity in the account surpasses the 50% threshold set by the federal Reg T requirements.

When do the brokerage firms calculate the Special Memorandum Account balance?

After each trading day, the brokerage companies determine the Special Memorandum Account balance of the investors to ensure the balance is more than or equal to zero. Brokers calculate the change simply by considering the SMA account’s previous day's changes to the current day cash.