Customer Accounts

Types of Customer Accounts

Opening and maintaining customer accounts is a fundamental responsibility of a registered representative. The Series 7 exam tests your understanding of the various account types, the documentation required to open them, and the rules governing their use. Every investor has unique needs, and selecting the appropriate account structure is the first step in providing quality service.

Individual Accounts

An individual account is owned by a single person who has sole authority over all transactions and decisions in the account. Only the account owner can authorize trades, request withdrawals, or make changes to the account. Upon the death of the account owner, the account becomes part of the owner's estate and is subject to probate proceedings. The account is frozen upon notice of death, and no transactions may be executed until the estate's legal representative provides proper documentation.

Joint Accounts

A joint account is owned by two or more individuals. All parties must sign the new account agreement. There are two primary types of joint ownership:

Joint Tenants with Right of Survivorship (JTWROS): Each tenant has an equal, undivided interest in the account. Upon the death of one tenant, the surviving tenant(s) automatically inherit the deceased's share — the account bypasses probate. This is the most common form of joint ownership between spouses. All tenants can conduct transactions independently.

Tenants in Common (TIC): Each tenant owns a specified percentage of the account, which may be unequal (e.g., 60/40). Upon the death of one tenant, that tenant's share passes to their estate (not automatically to the surviving tenant). The deceased tenant's share is subject to probate. All tenants can transact independently.

Corporate Accounts

A corporate account is opened on behalf of a corporation. Opening one requires a corporate resolution — a document from the corporation's board of directors authorizing the account and designating who may trade on behalf of the corporation. The corporate charter or articles of incorporation may also be needed. Corporate accounts may trade in securities of other companies, but buying and selling the corporation's own stock is subject to insider trading rules (SEC Rule 10b-5) and Section 16 requirements for officers and directors.

Partnership Accounts

A partnership account requires a partnership agreement that specifies which partners are authorized to transact. Under the Uniform Partnership Act, any general partner can bind the partnership; however, broker-dealers typically require specific documentation authorizing named partners to trade. Limited partners generally have no trading authority.

Trust Accounts

A trust account is managed by a trustee for the benefit of one or more beneficiaries. The trust document (trust agreement or trust indenture) governs the trustee's authority, investment powers, and distribution requirements. Trustees have a fiduciary duty to act in the best interests of the beneficiaries and must comply with the prudent investor rule — investing with the care, skill, and caution that a prudent person would exercise. The account is opened in the name of the trust (e.g., "Jane Smith, Trustee of the Smith Family Trust").

Estate Accounts

An estate account is opened by the executor or administrator of a deceased person's estate. A court-issued document (Letters Testamentary or Letters of Administration) is required to authorize the executor to manage the assets. Estate accounts are temporary — they exist only until the estate is settled and assets are distributed to heirs.

Custodial Accounts (UGMA/UTMA)

Custodial accounts are opened for the benefit of minors under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). An adult custodian manages the account until the minor reaches the age of majority (18 under UGMA, 18 or 21 under UTMA depending on the state).

Key rules for custodial accounts:

• One custodian, one minor per account
• The custodian may not be the same person as the donor (in some states)
• Gifts to the account are irrevocable — once assets are donated, they cannot be taken back
• The account is registered in the minor's Social Security number and income is taxed to the minor (the "kiddie tax" may apply)
• No margin trading, options, or short selling in custodial accounts
• UGMA allows gifts of cash, securities, and insurance policies; UTMA allows any type of property including real estate

Omnibus Accounts

An omnibus account is maintained by one broker-dealer at another broker-dealer on behalf of the first firm's customers. The customers' individual identities are not disclosed to the carrying firm. The introducing firm is responsible for maintaining individual customer records and ensuring compliance. This arrangement is common in prime brokerage and introducing/clearing relationships.

New Account Documentation and KYC

FINRA Rule 4512 — Customer Account Information

FINRA Rule 4512 specifies the information that must be obtained when opening a new customer account. At a minimum, the following information is required:

• Customer's name and residence (physical address, not just a P.O. Box)
• Whether the customer is of legal age
• Occupation and name and address of employer (for employed individuals)
• Tax identification number (SSN or EIN) — though the account can be opened before it is received, it must be obtained within a reasonable time
• Whether the customer is an associated person of another FINRA member firm
• Whether the person opening the account has discretionary authority over any other account

While not required by Rule 4512, broker-dealers routinely collect additional information to fulfill suitability obligations, including income, net worth, investment experience, investment objectives, risk tolerance, time horizon, and liquidity needs.

Customer Identification Program (CIP)

Under the USA PATRIOT Act, every broker-dealer must implement a Customer Identification Program (CIP). The CIP requires the firm to obtain and verify the identity of each customer who opens an account. Required information includes:

• Name
• Date of birth (for individuals)
• Physical address
• Government-issued identification number (SSN for U.S. persons; passport number and country of issuance for non-U.S. persons)

The firm must verify the customer's identity within a reasonable time of account opening using either documentary methods (government-issued ID) or non-documentary methods (credit report verification, database checks). The firm must also check the customer's name against government lists of known or suspected terrorists (OFAC lists).

Suitability and Regulation Best Interest

FINRA Rule 2111 — Suitability

FINRA Rule 2111 requires that a broker-dealer or registered representative have a reasonable basis for believing that a recommended transaction or investment strategy is suitable for the customer. The rule encompasses three suitability obligations:

1. Reasonable-basis suitability: The representative must understand the investment product and have a reasonable basis to believe it is suitable for at least some investors. This requires due diligence on the product's risks, rewards, and costs.
2. Customer-specific suitability: Based on the customer's investment profile (age, financial situation, objectives, experience, risk tolerance, time horizon, liquidity needs, tax status), the recommendation must be appropriate for that specific individual.
3. Quantitative suitability: A series of recommended transactions, even if individually suitable, must not be excessive in frequency or size when viewed in the aggregate. This addresses the issue of churning — excessive trading to generate commissions.

Regulation Best Interest (Reg BI)

Regulation Best Interest (Reg BI), adopted by the SEC in 2019 and effective June 30, 2020, establishes a higher standard than traditional suitability for broker-dealers when making recommendations to retail customers. Reg BI requires that broker-dealers act in the best interest of the retail customer at the time a recommendation is made, without placing the financial interests of the firm or representative ahead of the customer's interests.

Reg BI has four component obligations:

1. Disclosure Obligation: The firm must provide, before or at the time of the recommendation, all material facts about the scope of the relationship, including fees, costs, conflicts of interest, and the type of services provided. This is accomplished through the Form CRS (Customer Relationship Summary).
2. Care Obligation: The firm must exercise reasonable diligence, care, and skill. It must understand the potential risks, rewards, and costs of the recommendation; have a reasonable basis to believe the recommendation is in the customer's best interest; and consider reasonably available alternatives.
3. Conflict of Interest Obligation: The firm must establish policies and procedures to identify, disclose, and mitigate or eliminate conflicts of interest. Sales contests, quotas, and other incentives tied to selling specific products must be eliminated or carefully managed.
4. Compliance Obligation: The firm must establish and maintain written policies and procedures reasonably designed to achieve compliance with Reg BI.

Investment Profile Factors

A customer's investment profile includes all information used to assess suitability and best interest. The key factors are:

• Age: Younger investors typically have longer time horizons and can tolerate more risk; older investors nearing retirement may need capital preservation
• Annual income and net worth: Determines the customer's financial capacity to sustain investment losses
• Investment objectives: Capital preservation, income, growth, speculation
• Investment experience: Novice investors may not understand complex products
• Risk tolerance: The amount of volatility and potential loss the customer can and is willing to accept
• Time horizon: The expected period until the customer needs to access the invested funds
• Liquidity needs: Whether the customer may need to access funds quickly
• Tax status: Tax bracket affects whether tax-advantaged investments (munis, retirement accounts) are appropriate
• Other investments: Existing holdings and overall financial picture

Margin Accounts

A margin account allows a customer to borrow money from the broker-dealer to purchase securities. The securities in the account serve as collateral for the loan. Margin trading amplifies both gains and losses, making it a powerful but risky tool. The Series 7 exam extensively tests margin account rules and calculations.

Opening a Margin Account

To open a margin account, the customer must sign a margin agreement consisting of three components:

• Credit Agreement: Outlines the terms of the loan, including the interest rate (based on the broker call rate plus a spread) and how interest is calculated
• Hypothecation Agreement: Gives the broker-dealer the right to pledge the customer's securities as collateral for the margin loan
• Loan Consent Agreement (optional): Allows the broker-dealer to lend the customer's securities to other parties (for short sales). This is NOT required to open a margin account

Regulation T (Reg T) — Initial Margin

Regulation T, established by the Federal Reserve Board, sets the initial margin requirement at 50%. This means a customer must deposit at least 50% of the purchase price when buying securities on margin. The broker-dealer lends the remaining 50%. For example, if a customer wants to buy $20,000 worth of stock on margin, they must deposit at least $10,000 (the Reg T requirement), and the broker-dealer lends the other $10,000.

The minimum initial deposit to open a margin account is $2,000 (or 100% of the purchase price if less than $2,000). This is set by FINRA rules, not Reg T.

Maintenance Margin

FINRA Rule 4210 sets the minimum maintenance margin at 25% of the current market value for long positions. This means the customer's equity must remain at least 25% of the account's market value. Most broker-dealers set their "house maintenance" requirement higher, often at 30-35%.

If the customer's equity falls below the maintenance requirement, the broker-dealer issues a margin call (maintenance call). The customer must deposit additional cash or securities to bring the equity back to the required level. If the customer fails to meet the margin call, the broker-dealer may sell securities in the account — without the customer's consent — to restore the required equity level.

Margin Calculations

Understanding margin math is critical for the Series 7. Here are the key formulas:

• Long Market Value (LMV): The current value of securities held
• Debit Balance (DR): The amount owed to the broker-dealer
• Equity = LMV - DR
• Equity % = Equity / LMV
• Margin call trigger: When Equity % falls below 25% (FINRA minimum)

Special Memorandum Account (SMA)

The Special Memorandum Account (SMA) is a bookkeeping line of credit that tracks excess equity in a margin account above the Reg T requirement. SMA increases when the market value of securities rises, when the customer deposits additional cash or securities, or when dividends and interest are credited. SMA can be used to purchase additional securities or can be withdrawn as cash.

Important: SMA does not decrease when the market value of securities falls (it only increases, never decreases due to market action). However, a customer can only use SMA if the account remains above the maintenance requirement after the withdrawal or purchase.

Restricted Accounts

An account becomes restricted when the equity falls below the Reg T initial margin requirement (50%) but remains above the maintenance margin requirement (25%). In a restricted account, the customer cannot make new margin purchases without depositing additional funds. However, the customer is not required to add funds simply because the account is restricted — a margin call is only issued if the equity falls below the maintenance requirement.

Pattern Day Trader (PDT) Rules

A pattern day trader (PDT) is someone who executes 4 or more day trades within 5 business days, provided that day trades represent more than 6% of total trading activity in the margin account during that period. PDTs face stricter requirements:

• Must maintain a minimum equity of $25,000 in the margin account
• Have 4:1 intraday buying power (instead of the standard 2:1 margin)
• If the account falls below $25,000, the customer cannot day trade until the balance is restored

Discretionary Accounts, Power of Attorney, and Fiduciary Accounts

Discretionary Accounts

A discretionary account grants the registered representative authority to make investment decisions on behalf of the customer without obtaining prior approval for each trade. To establish discretion, the customer must provide written authorization (a limited power of attorney or trading authorization) that is accepted by the firm.

Key rules for discretionary accounts:

• Each discretionary order must be approved by a principal promptly after execution
• The firm must review discretionary accounts for excessive trading (churning)
• The representative cannot exercise discretion until the written authorization is on file
• Discretion involves the representative choosing the asset (what security to buy/sell), the action (buy or sell), or the amount (how many shares). If the customer specifies all three and leaves only the time and/or price to the representative, this is NOT considered discretion — it is a "not held" or "market/time" order

Power of Attorney

A power of attorney (POA) is a legal document granting one person (the agent or attorney-in-fact) authority to act on behalf of another (the principal).

• Limited (special) power of attorney: Grants authority over specific actions, such as trading in the account. Does NOT allow withdrawals or changes of beneficiary.
• Full (general) power of attorney: Grants broad authority, including trading, withdrawals, and other account changes.
• Durable power of attorney: Remains in effect if the principal becomes mentally incapacitated. A non-durable POA terminates upon incapacitation of the principal. All POAs terminate upon the death of the principal.

Fiduciary Accounts

A fiduciary is a person who has been entrusted with the management of another person's assets and must act in the best interests of that person. Fiduciary accounts include trust accounts, estate accounts, custodial accounts (UGMA/UTMA), and accounts managed under a power of attorney. Fiduciaries must adhere to the prudent investor standard, which requires diversification, consideration of the portfolio as a whole, and investment decisions that serve the beneficiaries' interests.

Prime Brokerage

A prime brokerage arrangement allows institutional clients (typically hedge funds) to use one broker-dealer (the prime broker) for custody, clearing, and financing while executing trades through multiple other broker-dealers (executing brokers). The prime broker consolidates all activity into a single account, provides leverage, and handles settlement. Prime brokerage requires a written agreement among all parties, and the prime broker must receive trade confirmations from executing brokers on a timely basis.