Discretionary Authority

With the rules on custody and safekeeping established, this section covers discretionary authority: when a securities professional can make investment decisions on behalf of a client without getting approval for each trade.

What Constitutes Discretion?

An agent or adviser exercises investment discretion when they make investment decisions on behalf of a client (choosing the security, the amount, or whether to buy or sell) without obtaining the client's prior approval for each specific transaction.

Investment discretion covers decisions about:

• Which security to buy or sell
• How many shares or the dollar amount
• Whether to buy or sell (the action itself)

Memory Aid: AAA

Written investment-discretion authority is required if any of these is missing from the customer's order:

• Asset (which security)
• Action (buy or sell)
• Amount (number of shares)

Time-and-price-only authority is still discretionary power, but it is exempt from written discretionary authority.

Think of it this way: If the professional decides what to buy or sell, or how much, that is investment discretion. If they decide only when and at what price to execute a trade the client already chose, they have execution discretion that is exempt from the written investment-discretion requirement.

When Is Written Authorization Required?

Under the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, a broker-dealer or agent exercising discretion must have:

• Written discretionary authorization from the customer (a signed power of attorney or trading authorization), obtained before the first discretionary trade is executed
• No oral authorization: for a BD or agent, an oral authorization is never sufficient, and there is no grace period

Separately, under Financial Industry Regulatory Authority (FINRA) rules, a member firm must also accept the account as discretionary, evidenced in writing by the firm or by a partner, officer, or manager the firm designates. The customer's written authorization is the state-law requirement; firm acceptance is FINRA's addition.

For a discretionary account with a natural-person customer or owner, the SEC requires an account record containing dated signatures from each customer or owner granting authority and each natural person granted it. FINRA separately requires the dated signature of each named associated person authorized to exercise discretion. These are record duties, not a universal requirement to sign one particular authorization form.

When Must an Investment Adviser Replace Oral Authority with Written Authority?

An investment adviser or investment adviser representative is not held to the same before-the-first-trade rule. Under NASAA's rule on unethical adviser practices, an adviser may:

• Begin placing discretionary trades based on the client's oral discretionary authority
• Obtain the client's written discretionary authority within 10 business days after the date of the first transaction placed under that oral authority

The first transaction starts the deadline. The interval does not limit the adviser to one trade, although every trade must remain within the oral grant and written authority still must arrive by the deadline. This rule does not extend to a broker-dealer or agent.

Exam Tip: Gotchas

• BD/agent vs. IA are different rules. A broker-dealer or agent needs prior written discretionary authority. An investment adviser must obtain written authority within ten business days after the first orally authorized transaction. That first transaction starts a deadline, not a one-trade limit.

When Is Written Authorization Not Required for Time and Price Discretion?

A broker-dealer agent may exercise time and price discretion without written authorization if both of the following conditions are met:

1. The customer has directed a specific trade, naming the security, the amount, and the action (e.g., "buy 100 shares of XYZ")
2. The agent's discretion is limited to deciding when to execute the trade and at what price

The NASAA policy describes this as discretionary power that relates solely to the time and/or price for the executing of orders. The customer gives the agent flexibility on timing and price but has already made the investment decision.

NASAA's adviser rule has the same exception. An investment adviser needs no written discretionary authority when its discretion relates solely to the price at which, or the time when, an order for a definite amount of a specified security is executed.

Key rule: The NASAA rule calls time-and-price authority discretionary power but exempts it from the written-authorization requirement when the client already specified the security, amount, and action. The NASAA rule sets no same-day deadline, so under that rule the agent may keep working an unexpired order in a later session. Any deadline the customer gives still controls.

FINRA adds a day limit that NASAA does not state. Under FINRA's discretionary accounts rule, time-and-price discretion lasts only until the end of the business day on which the customer granted it, unless the customer gives a specific written indication, signed and dated, that says otherwise. That day limit does not apply to time-and-price discretion in an institutional account exercised under valid good-till-canceled instructions issued on a not-held basis. A firm and its agents follow both rules. A question that names only the NASAA rule tests the NASAA text, which has no day limit.

Exam Tip: Gotchas

• The key test for investment discretion requiring written authority is who decides the security, amount, and action.
• "Buy 100 shares of XYZ when you think the price is right" = execution discretion over time and price (no written authorization needed under the NASAA rule, which sets no day limit; FINRA's separate end-of-day rule and its exceptions apply when a question names FINRA).
• "Invest $10,000 in something appropriate" = the agent is choosing the security, which is discretion requiring written authorization.

What Counts as Unauthorized Trading?

Effecting a securities transaction in a customer's account without the customer's prior authorization is an unauthorized trade and constitutes a dishonest or unethical business practice.

• Even in a discretionary account, the agent must act within the scope of the discretionary authorization; exceeding the authority granted is unauthorized trading
• Unauthorized trading violates the NASAA Statement of Policy on Dishonest Practices. It also creates:
  • Antifraud exposure if the facts establish a fraudulent scheme, a material misstatement or omission, or a practice operating as fraud or deceit in connection with a securities transaction
  • Potential criminal exposure under state law if the conduct is a willful violation

Exam Tip: Gotchas

• "Within scope" matters. A discretionary authorization for low-risk investments does NOT cover speculative options trades. Trading outside the granted scope is unauthorized trading even if the account is generally discretionary.

How Must a Firm Supervise Discretionary Accounts?

FINRA's discretionary accounts rule sets two supervisory duties for the member or the person it duly designates:

• Approve promptly in writing each discretionary order entered
• Review all discretionary accounts at frequent intervals to detect and prevent transactions that are excessive in size or frequency in view of the account's financial resources and character

The same rule bars a member from effecting excessive transactions in any account in which it or its agent holds discretionary power.

What Should You Check on Exam Day?

• Investment discretion = choosing the security, the amount, or the action (buy/sell) without the client's prior approval. Time and price alone are execution discretion exempt from written discretionary authority.
• Broker-dealers/agents need prior written authority and firm acceptance. FINRA requires named associated persons' dated signatures; for discretionary accounts with a natural-person customer or owner, SEC records also need dated customer/owner and natural-person grantee signatures.
• An investment adviser may begin on oral authority but must get written authority within ten business days after the first trade; the rule sets a deadline, not a one-trade limit.
• Trading outside the scope of a discretionary grant is unauthorized trading, even in a discretionary account.
• Under FINRA's rule, the member or its designee approves each discretionary order promptly in writing and reviews discretionary accounts at frequent intervals for excessive trading.