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.

Cash Accounts

• 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

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
• 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.

Pattern Day Trading Accounts

• 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

Requirements

• 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.

Prime Brokerage Accounts

• 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

Delivery Versus Payment / Receive Versus Payment (DVP/RVP) Accounts

• DVP (delivery versus payment): Payment for purchased securities is made simultaneously with delivery; neither party is exposed to settlement risk
• RVP (receive versus payment): The mirror of DVP from the buyer's side; securities are received simultaneously with 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.

Advisory and Fee-Based Accounts

• 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

When Each Fee Structure Is Appropriate

• 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. The exam tests whether you can identify when a fee-based account is unsuitable.