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 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.

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

An order is discretionary if any of these is missing:

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

Time and price-only direction is NOT discretion.

Think of it this way: If the professional is deciding what to buy or sell, or how much, that's discretion. If they're only deciding when and at what price to execute a trade the client already chose, that's not discretion.

Written Authorization Required

Under the NASAA Statement of Policy on Dishonest or Unethical Business Practices, 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.

Investment Adviser Exception: Oral Authority for the First Trade

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:

• Place the first discretionary trade based on the client's oral discretionary authority, then
• Obtain the client's written discretionary authority within 10 business days after the date of that first transaction

This is a narrow, one-time grace period tied to the first trade under oral authority. It does not extend to a broker-dealer or agent, and it does not excuse the adviser from eventually obtaining written authority.

Exam Tip: Gotchas

• BD/agent vs. IA are different rules. A broker-dealer or agent must have written authorization before the first discretionary trade, no exceptions. An investment adviser may act on oral authority for the first trade only, then has 10 business days to get it in writing. Mixing up which professional the grace period applies to is a common trap.

Time and Price Discretion: When Written Authorization Is Not Required

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

This is sometimes called a "not held" order. The customer gives the agent flexibility on timing and price but has already made the investment decision.

Key rule: The NASAA rule excludes time-and-price discretion from the definition of discretionary authority based on what the client already specified (security, amount, action), not on how quickly the agent acts. This is different from FINRA's broker-dealer rule, which limits time-and-price discretion to the business day it was granted unless the customer provides a written, signed, and dated extension, or the account is an institutional account acting on valid Good-Til-Cancelled, "not held" instructions; the NASAA rule tested here has no stated same-day deadline.

Exam Tip: Gotchas

• The key test for discretion is who decides what to buy or sell and how much.
• "Buy 100 shares of XYZ when you think the price is right" = time-and-price discretion (no written authorization needed, regardless of which day the agent executes).
• "Invest $10,000 in something appropriate" = the agent is choosing the security, which is discretion requiring written authorization.

Prohibition on 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
  • The USA antifraud provision if done in connection with the purchase or sale of a security
  • Potentially criminal penalties under state law if willful

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.

Supervision of Discretionary Accounts

A broker-dealer that permits discretionary accounts has heightened supervisory obligations:

• A principal or supervisor must review discretionary accounts regularly for:
  • Excessive trading (churning), the hallmark violation in discretionary accounts
  • Trades that are unsuitable for the client
  • Activity that exceeds the scope of the discretionary authorization
• The firm must have written supervisory procedures governing discretionary accounts

What Should You Check on Exam Day?

• Discretion = choosing the security, the amount, or the action (buy/sell) without the client's prior approval. Time and price alone are not discretion.
• A broker-dealer or agent needs written authorization before the first discretionary trade, with no grace period.
• An investment adviser may act on oral authority for the first trade, then must get written authority within 10 business days of that trade.
• FINRA separately requires the firm to accept the account as discretionary in writing.
• Trading outside the scope of a discretionary grant is unauthorized trading, even in a discretionary account.
• Discretionary accounts require heightened supervision, watching especially for churning.