PROPRIETARY TRADING
TRADERS
AGREEMENTS

Take a close look at the firms' agreements:

When you take a "job" or "position" with a proprietary trading firm (which allows you to trade the firm's capital), it's very important to read the fine print of their agreements and policies and understand what you are signing onto.

Many firms ask you to deposit money up front, to be responsible for your trading losses and some even ask you to indemnify the firm for losses in excess of your deposit amount. Most firms have a laundry list of expenses they will charge your account and very restrictive policies for how you may trade (no overnight positions and much more). Take careful note of their margin and lending policies.

Yes, this prop trading opportunity may suit your needs; predominantly you need to have access to much greater trading capital then you have available or are prepared to risk in your own trading business. Pattern day traders with direct-access customer accounts may only have margin up to 4 to 1, whereas prop traders may have margin of 10 or 20 to 1. Your margin is not supposed to be directly connected to your deposit, but it often is - in an unofficial manner.

A day trading business is a high risk activity to begin with and proprietary trading with far greater leverage is even more risky. Prop trading firms advertise the point that they are on the hook for losses, but they control your trading and risk and usually make sure to limit your losses to the extent of your deposit, which they ask you to replenish after a draw down.

Before you go further with a prop trading firm offer, start your education with the SEC report on the day tading business, which includes significant coverage of prop trading firms. Click here to find this report and our observations in our Resources section.

Proprietary trading firms (PTFs) offer the following types of agreements. We cover the tax aspects of these agreements on our Tax page. Click here.

Employment contracts or deals without signed contracts. Click here to learn more about taxes and the agreements.

Independent contractor agreements or deals without signed agreements. Click here to learn more about the agreements (taxes covered on the Tax page).

LLC Operating Agreements for proprietary trading firms organized as Limited Liability Companies (LLC). Click here to learn more the agreements (taxes covered on the Tax page).

Due to all these complexities, nuances and pitfalls, we recommend that most prop traders consider a consultation with one of our attorneys. We can review your agreements and consult you on the legal and business matters.

You can sign up for a tax and legal consultation below. Prop trading can be an excellent way to trade more capital then you have on hand, but with that added leverage, there are added risks and pitfalls. Learn how to take advantages of the pluses and avoid and limit the risks and pitfalls.

If you have a question or just want to see how we can help you, please call us or e-mail us at info@greencompany.com. If you need help evaluating a proprietary trading firm agreement and figuring out your tax matters with this firm, purchase one of the following offers:

All consultations are done by phone and/or e-mail. Consultations may be split over several sessions.

Employment contracts or deals without signed contracts.

Some PTFs offer employment – they hire you to trade their firm's capital and you get paid a salary, which is reported on a W-2. As a legal employee, you are eligible to participate in the firm's employee benefit programs including health insurance plans, retirement plans and other fringe benefit programs. Because you get these benefits and a guaranteed salary, employment prop trading deals offer significantly lower "payouts" from the trading gains you generate. Some employment deals require deposits, while others do not. Most offset future payouts with prior losses, so you are responsible for losses in a sense. Few employment deals require you indemnify the firm for losses.

For tax purposes, you have employment tax status. You have the following taxes withheld from your paycheck: payroll taxes (social security and Medicare taxes) and federal and state income taxes, based on your number of W-4 allowances. The firm pays 50% of the payroll taxes. Employee tax status is far inferior to trader tax status, independent contractor tax status, or LLC member (partner) tax status. All these other statuses have business treatment, which means they can deduct all possible business expenses from gross income without limitation. Employees don't have business tax breaks, but may deduct "non-reimbursed employee business expenses" on Form 2106. These are "miscellaneous" itemized deductions which are only deductible in excess of 2% of your adjusted gross income. Plus, these deductions are added back when computing AMT. Home office expenses are not allowed unless your home office is required by your employer under strict conditions which are rarely the case.

For legal purposes, don't just rest on the laurels of figuring you are an employee and therefore have no risk. Read the fine print of your agreement. The firm may require you to indemnify them for losses, which is rare, but possible. It's always wise to consult with an attorney before signing any important agreement.

See our message board forum: "Are some prop trading firms violating Reg T margin rules?" Click here. The firm making this case argues it does things right because it does not require deposits from their employees. But if you take their logic to the final degree, if they also charge traders for losses over time, then isn't that also a factor which can lead to customer treatment. So even employees should follow this continuing story.

The PTFs maintain a sub-trading account for your trading activity, and your W-2 compensation is calculated as a percentage of your net trader profits (after the PTF charges you for various fees and expenses). Compensation percentages vary by firm, but 60 percent is probably average.

Independent contractor agreements or deals without signed agreements.

Many firms that offer employment deals (see above) also offer independent contractor (IC) deals as well.

Independent contractors are similar to employees in that they perform work for a company, but they are very different in tax and legal ways. A company is responsible for its employees, but not for it's ICs.

Many large companies try to save on employee benefit costs by using ICs. But the IRS and state unemployment divisions challenge companies on the "20 part test" to determine if the IC's really are not disguised employees.

Ask your prop trading firm if your IC terms and conditions and actual fact pattern will pass these tests. If you don't have any other trading accounts outside of the firm, or any other work besides this job trading for the firm, and you report to work at the firm's office, and they supervise and direct your trading efforts closely, you may fail the independent contractor tests. To learn more, see "Employees vs. Independent Contractors" on www.irs.gov. .

Independent contractors are responsible to pay their own taxes and all of their own business risks. Read the fine print in your IC agreements.

IC agreements are very similar to employment agreements; except you may be asked to deposit higher amounts of money and you will be granted higher payouts versus employees.

IC agreements usually don't provide for advances or guaranteed payments and you are just paid from your trading gains generated. Many firms will hold back reserves.

IC agreements will provide for full loss responsibility with the firm recouping your losses and expenses before they pay out new high net profit gains.

Watch out, some firms may require indemnification for losses even if you don't generate future gains. The buzzword for this is the replenishment of deposits to cover losses. Or a note to pay back losses over your deposit amounts.

As an IC, you are engaged to trade the firm's capital, which is really connected to your deposit if you make one, and you are paid for your work. See the tax page. You have earned income from management services, not a share of trading gains. So you owe SE taxes and you can contribute to tax deductible retirement plans and deduct your health insurance premiums.

LLC Operating Agreements for proprietary trading firms organized as Limited Liability Companies (LLC).

Many PTF are organized as limited liability companies (LLCs).

Some of these firms previously hired traders and provided their tax information on a Form 1099-Misc., but the SEC forced them to change their business model to become LLCs. The SEC also required that all proprietary trader members of these LLCs be registered with the SEC (Series 7 or other).

These PTF LLCs usually require LLC members to contribute a minimum of $25,000 to the LLC member capital. This $25,000 is probably related to the $25,000 required for the Pattern Day Trader rules.

When you read the fine print of the LLC Operating Agreement, you see similar provisions to those mentioned above on "deposit" accounts. The LLC member proprietary trader must maintain his or her deposit or capital account at $25,000. All the losses and expenses earned by the trader are charged against this capital account. All distributions (advances or compensation, whatever you want to call them) are also charged against the trader’s capital account.

The proprietary traders are usually a different type of LLC member from the "member-managers." Those are the real owners that manage the company and share in a portion of the LLC proprietary traders gains.

Most LLC Operating Agreements are written completely in favor of the Class A true owner/managing members. These agreements are very one-sided in their favor. Much of what these firms say you are entitled to are actually stated as "at the managing members discretion" in the agreement. That is a buzzword for 'they can change it however they like at year-end or otherwise."

With a LLC Operating Agreement, you are signing up and committing yourself in connection with your capital. This is a very serious legal agreement and you need to consult with a lawyer, who represents you alone and not the company - otherwise that would be a conflict of interest.

We have excellent attorneys who can help with all these types of agreements or terms and conditions when agreements are not presented. We can also help you do due diligence on the firm you are considering and help you stay out of trouble if it's not a good deal.