Types of Accounts

Before you can evaluate suitability or make recommendations, you need to understand the different account structures available to customers. Each account type has distinct rules for payment, leverage, custody, and fee arrangements.

What Is a Cash Account?

• Cash account: The customer pays in full for all securities purchased by the settlement date
• No borrowing from the broker-dealer: no margin, no leverage
• The simplest and most common account type

What Is a Free-Riding Violation?

• Free-riding: Buying securities in a cash account, selling them before paying in full, and using the sale proceeds to cover the original purchase
• Why it's possible: the trade executes on the trade date but payment is not due until the settlement date (T+1). That gap between executing the trade and delivering funds is what the free-rider exploits.
• This violates Regulation T (the Federal Reserve Board's credit regulation)
• Consequence: A 90-day freeze on the account
• During the freeze, the customer can still trade but must have sufficient settled cash in the account before placing any purchase

Exam Tip: Gotchas

• Free-riding is about the sequence: buying, then selling before paying, then using sale proceeds to pay. The 90-day freeze doesn't prevent all trading; it just requires cash up front for every purchase.

What Is a Pattern Day Trader?

• Day trade: Buying and selling (or selling short and covering) the same security on the same day in a margin account
• Pattern day trader: A customer who executes 4 or more day trades within 5 business days, provided day trades represent more than 6% of total trades in the margin account during that period

What Does the Legacy Framework Require?

• The $25,000 minimum can be a combination of cash and eligible securities
• If equity falls below $25,000, the customer cannot day trade until it is restored

Exam Tip: Gotchas

• Pattern day trader requires BOTH conditions: 4+ day trades in 5 business days AND more than 6% of total trades. Missing either one means the customer is not a pattern day trader.
• Day-trading buying power is 4x, not the standard 2x for regular margin accounts.

Rule change: FINRA replaced this day-trading margin framework with a real-time intraday margin standard. The pattern day trader designation, the $25,000 minimum equity, and the 4x day-trading buying power no longer apply. Instead, a margin customer must maintain adequate maintenance margin (25% of long market value) throughout the trading day, subject to the usual $2,000 general margin minimum. The prior framework above remains on the current exam content outline, so it may still be tested during the transition.

What Is a Prime Brokerage Account?

• Prime brokerage: A customer (typically an institution or hedge fund) selects one member firm as the prime broker to provide:
  • Custody and clearing
  • Financing
  • Consolidated reporting
  • Securities lending
• Trades are executed through other firms (executing brokers) but settled and held at the prime broker
• Key benefit: reduced borrowing costs through a single margin relationship

What Are DVP and RVP Accounts?

• DVP (delivery versus payment): The settlement convention for an institutional buyer; payment is released only against simultaneous delivery of the purchased securities, so neither party is exposed to settlement risk
• RVP (receive versus payment): The counterpart convention for an institutional seller; the securities are delivered only against simultaneous receipt of payment
• Typically used by institutional investors (banks, pension funds, insurance companies)
• Custody of assets is held at a third-party institution (usually a bank), not the broker-dealer
• Settlement occurs on a trade-by-trade basis rather than through a standard brokerage account

Exam Tip: Gotchas

• DVP/RVP accounts eliminate principal risk (the risk that one side delivers but the other doesn't pay).
• Assets are custodied at a third-party bank, not the broker-dealer. Account statements typically show no cash balance or security positions because everything settles individually.

When Is a Fee-Based Account Appropriate?

• Fee-based account: Customer pays a flat fee or percentage of assets under management (AUM) instead of per-trade commissions
• Advisory account: A fee-based account where the broker-dealer or investment adviser provides ongoing investment advice and portfolio management

Which Fee Structure Fits Which Customer?

• Firms must evaluate whether a fee-based arrangement is in the customer's best interest under Regulation Best Interest (Reg BI)

Exam Tip: Gotchas

• A fee-based account is NOT always better for the customer. If a customer rarely trades, paying a percentage of AUM every year can cost far more than occasional commissions. For a low-activity customer, a fee-based account can be unsuitable.

What Should You Check on Exam Day?

• Cash accounts require full payment by settlement date; violating that with free-riding triggers a 90-day freeze, not a trading ban
• The legacy pattern-day-trader numbers ($25,000 equity, 4x buying power, 6% trigger) still appear on the outline even though FINRA replaced the framework with a real-time intraday margin standard; know both
• DVP/RVP accounts settle trade-by-trade with custody at a third party, eliminating principal risk
• A fee-based account can be unsuitable for a low-activity customer under Reg BI, even though it looks like the "premium" option