Customer Funds and Securities

The whole unit on one sheet: how professionals hold client assets, when they may trade with discretion, and which standard of care applies to each role.

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.
• NASAA's custody rule requires a qualified custodian (bank, savings association, broker-dealer, futures commission merchant, or qualifying foreign institution), notice to the Administrator on Form ADV, notice to the client at account opening, and a reasonable basis that the custodian sends quarterly statements.
• An adviser with custody generally needs an unannounced annual surprise examination by an independent CPA.
• The fee-deduction-only exception removes independent verification alone, and only with written client authorization, itemized invoices to custodian and client, and Form ADV notice.

What Are the Safekeeping and Commingling Rules?

• Commingling, mixing client assets with the firm's own, is prohibited for broker-dealers and advisers even if nothing is stolen. Client assets stay segregated and identifiable in records; a client-only pooled account is fine, and free credit balances must be available on demand.
• Conversion, taking client assets for personal use, is theft and the more severe violation. Unauthorized borrowing from a client account, even temporarily, is also a violation for an agent, with no exception.
• 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.
• The antifraud provisions cover misuse of customer funds, and no exemption shields the conduct.

How Do Discretion and Trading Authorization Work?

• Discretion means the professional decides which security, how much, or whether to buy or sell without the client's prior approval on each trade.
• Discretion alone is NOT custody. An adviser trading an account at a qualified custodian, with no power to withdraw, owes none of the custody safeguards. Either can trigger a bond, but they are separate determinations.
• A broker-dealer or agent needs written authorization before the first discretionary trade; an adviser may accept oral discretion for the first trade and obtain written authorization shortly after. Separately, the firm must accept the account as discretionary in writing.
• Full trading authorization lets a third party trade and withdraw; limited authorization allows trading only. The firm keeps a copy and may refuse or restrict any authorization.
• Trust, estate, custodial, and guardian accounts are fiduciary: the person in control must act in the beneficiary's best interest.

Which Numbers Matter Most?

What Is the Memory Aid for Spotting Discretion?

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.

Which Standard of Care Applies to Each Role?

• Broker-dealer agent, retail customer: best interest under Regulation Best Interest, adding disclosure, care, conflict of interest, and compliance obligations and, unlike suitability, weighing costs. A separate rule requires Form CRS.
• Broker-dealer agent, non-retail customer: suitability, built on the investment profile and three components (reasonable-basis, customer-specific, quantitative). The customer-specific prong relaxes for institutional accounts that can evaluate risk independently. Neither standard can be waived, and 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, owed only to beneficiaries. Judge each investment in the overall portfolio, diversify absent special circumstances, balance risk and return, delegate with oversight, and keep costs reasonable. No category is barred outright, and decisions are judged 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

Client assets must stay separate from the firm's: commingling and conversion are always prohibited, and an adviser with custody needs a qualified custodian and generally a surprise exam. Discretion means the professional picks the security, the amount, or the action. A broker-dealer or agent needs written authorization before the first discretionary trade, while an investment adviser may act on oral discretion but must obtain written authorization within 10 business days of that trade. Time-and-price direction is not discretion. Full trading authorization adds withdrawal rights; limited does not. Broker-dealers owe best interest or suitability at recommendation, advisers owe an ongoing fiduciary duty, and trustees owe the prudent investor standard.

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