4.4. Prime Brokerage Accounts

Because of their large size, hedge funds and other institutional investors often employ a number of brokers to execute their trades. To coordinate their trading, they sometimes open prime broker accounts. A prime broker does not engage in trading activity. Trading is done instead by executing brokers. The prime brokerage is the place where the customer’s trades are cleared and settled. The prime broker provides a number of other services as well, including taking legal custody of the customer’s assets, providing leverage financing, loaning securities for short sale, and providing back-office services, such as trade clearance and settlements, trade accounting and reporting, and IT support. Prime brokers may be brokerage firms, but are often investment banks.

When opening a prime broker account, customers must sign an agreement that names all executing brokers, and the prime broker must then enter into a written agreement with each executing broker. The agreement lays out the responsibilities of each party.

The SEC requires prime broker accounts to maintain at least $500,000 in equity in the account. If, as a result of fluctuations in the value of securities kept with the prime broker, th