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Global Securities Markets: Navigating the World's Exchanges and OTC Markets by George W. Arnett

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Chapter 11

Prime Brokerage

In its most generic sense, prime brokerage refers to an investment firm acting as custodian and lender where the investment firm is not the sole place where the customer executes his securities transactions. In exchange, the prime broker secures the right to lend the customer's securities. As we have seen, the lending of securities by brokerage firms in the United States is a matter of tight credit regulation pursuant to Regulation T. In other countries, most notably the United Kingdom, firms are free to extend credit as they see fit as long as they are prudent. This more relaxed standard is one of the reasons for the phenomenal growth of the hedge fund industry in the United Kingdom. In the United States, prime brokerage has a much more specific meaning and regulatory framework because prime brokers must fit within the dictates of Regulation T and specific dictates of the SEC. A short history will help explain the U.S. model, which can be contrasted with prime brokerages around the world.

In the past, when hedge funds wanted research from wire houses, the funds could pay directly for the information (which they generally did not want to do) or they could establish accounts at the wire houses and transact purchases and sales with these providers. The wire houses would make a commission or a mark-up on the trades in lieu of a direct payment and thereby get paid (in soft dollars) for the research they provided. This resulted in hedge funds having accounts ...

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