A secured demand note (SDN) is a promissory note in which the investor agrees to lend cash to the brokerage firm on demand, often without prior notice, at any time during the term of the note. The investor must deposit either cash or securities as collateral for the SDN. This cash or collateral is what is used by the broker-dealer to draw upon if they need cash on demand. While the investor retains most of their beneficial rights to the securities that have been deposited as collateral for the SDN, such as the appreciation of the value of the securities, and the right to vote the securities, but the securities must be registered in the firm’s name or in bearer form. An SDN is treated as an asset on the broker-dealer’s books, because it is a receivable. Once the loan has been made, the broker-dealer must issue a subordinated loan agreement to the investor (the lender) in the amount of the payment.
The broker-dealer then has the right to pledge, re-pledge, hypothecate and re-hypothecate any of the securities in the deposit account without notice. The broker-dealer also may lend to itself or others any or all of the securities and cash pledged as collateral to secure the SDN. The investor retains their beneficial rights to the securities, but there are restrictions on these rights. For instance, once securities have been pledged, the investor cannot sell or use the securities in any way unless they substitute securities of equal value to the deposited securities. The broker-dealer also has the right to receive and hold dividends from the collateralized securities.
Collateralized securities are generally included in the net capital formula as an asset, discounted to account for the volatility of their market value. The amount of the discount varies with each type of security. For most securities, th