Customer Funds and Securities

Review custody, discretion, authority, and care standards.

What Counts as Custody?

• Custody is the authority to obtain client funds or securities, not just physical possession. Fee-deduction authority alone is custody, and a related person's authority gives the adviser custody too.
• Narrow exceptions cover inadvertent receipt and forwarding a third-party check, each within 3 business days with records kept.
• Qualified custodians include qualifying banks, broker-dealers, futures commission merchants, and foreign financial institutions. Custody also requires Form ADV, client notice, and quarterly statements.
• An adviser with custody generally needs an unannounced annual surprise examination by an independent CPA.
• The fee-deduction-only exception removes only independent verification. It requires written authorization, the deduction amount to the custodian, an itemized client invoice, and Form ADV notice.

What Are the Safekeeping and Commingling Rules?

• Broker-dealer securities: segregate free or safekeeping securities and maintain possession or control of fully paid and excess-margin securities. Customer and proprietary securities may not share a firm-loan lien. Qualifying central aggregation alone is not commingling; cash follows the SEC reserve formula.
• Conversion generally is an intentional, unauthorized taking or exercise of ownership, with no exception for a later repayment. A genuine loan is distinct and is also prohibited for an agent.
• An adviser may borrow only from a broker-dealer, an affiliate, or a lending institution, and may lend only as a lending institution or to an affiliate. An agent has no such exceptions.
• Misuse creates antifraud exposure only when it also involves a fraudulent scheme, material misstatement or omission, or fraudulent or deceitful practice. No exemption shields qualifying fraud.

How Do Discretion and Trading Authorization Work?

• Investment discretion means choosing the security, amount, or action without the client's prior approval.
• Discretion alone is not custody; either status can trigger a bond.
• A broker-dealer or agent needs prior written authority and FINRA written firm acceptance. FINRA requires named associated persons' dated signatures. For discretionary accounts with a natural-person customer or owner, the SEC requires dated customer/owner and natural-person grantee signatures. An adviser needs writing within ten business days after the first orally authorized trade.
• In common forms, full trading authorization adds withdrawals and limited trading does not. The actual grant and applicable law control.
• Estate fiduciary: executors and administrators are personal representatives for the estate and persons entitled under the will or law, not only heirs.
• Guardian-type financial authority: a guardian of the person has no automatic financial power. A court-authorized financial guardian, conservator, or comparable fiduciary follows applicable law and the actual order and may not use that authority for unauthorized personal gain.

Which Numbers Matter Most?

What Is the Memory Aid for Spotting Discretion?

Memory Aid: AAA

Written investment-discretion authority is required if the customer omits:

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

Time-and-price-only authority is execution discretion exempt from written authority.

Which Standard of Care Applies to Each Role?

• Broker-dealer agent, retail customer: NASAA suitability plus Regulation Best Interest, with Disclosure, Care, Conflict of Interest, and Compliance. FINRA's separate suitability rule excludes recommendations covered by Reg BI. Care weighs costs; a separate rule requires Form CRS.
• Broker-dealer agent, non-retail customer: suitability. The customer-specific prong relaxes for institutional accounts that independently evaluate risk. Neither standard is waivable; both reach only recommendations.
• Investment adviser: an ongoing fiduciary duty of loyalty and care across the whole relationship, not just at the moment of a recommendation.
• Trustee: the prudent investor standard. Assess the portfolio, diversify absent special circumstances, balance risk and return, oversee delegation, and keep costs reasonable. Judge decisions when made.

Which Gotchas Trip Students Up?

• Custody is about authority, not possession. An adviser that can only deduct its own fee still has custody, and the fee-deduction exception removes independent verification only.
• BD written-first versus IA oral-then-10-days is the common mix-up, and a discretionary grant covers only trades within its stated scope.
• Reg BI is not a fiduciary standard. It carries no ongoing duty of loyalty, and neither it nor suitability reaches an unsolicited, unrecommended trade.

One-Breath Recap

Broker-dealers segregate free or safekeeping securities, maintain possession or control of fully paid and excess-margin securities, and keep customer and proprietary securities out of firm-loan liens; cash follows the SEC reserve formula. Conversion has no exception for a later repayment. Advisers with custody need qualified custodians and generally surprise exams. Investment discretion means choosing security, amount, or action. Broker-dealers 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 require dated customer/owner and natural-person grantee signatures. Advisers need writing within ten business days after the first orally authorized trade. Time-and-price is execution discretion exempt from written discretionary authority. NASAA requires suitability and retail best interest; advisers owe fiduciary duty and trustees use the prudent investor standard.

Need more than the recap? Read the full Customer Funds and Securities unit.