Discretionary Accounts

The final topic in this unit brings together authorization and supervision. When a customer gives a representative the power to make investment decisions without getting approval for each trade, the account is discretionary, and FINRA imposes strict requirements to protect the customer.

What Makes an Account Discretionary?

A person exercises investment discretion (SEC Exchange Act Section 3(a)(35)) if they are:

• Authorized to determine what securities shall be purchased or sold for the account, OR
• Making decisions about what securities to purchase or sell, even if someone else shares responsibility, OR
• Exercising influence over purchase and sale decisions as determined by the SEC

The key test: can the representative choose the security, the action (buy or sell), and the quantity without getting the customer's approval for each individual trade? If yes, it is discretionary.

FINRA Rule 3260 - Discretionary Account Requirements

No member or registered representative may exercise discretionary power unless all three conditions are met:

1. The customer has given prior written authorization to a stated individual or individuals
2. The account has been accepted by the member (the firm) in writing by a duly designated partner, officer, or manager
3. Every discretionary order is identified as discretionary on the order ticket at the time of entry

Ongoing Supervision

• A designated person must promptly approve in writing each discretionary order entered
• Discretionary accounts must be reviewed at frequent intervals to detect transactions that are excessive in size or frequency relative to the account's financial resources
• This review is specifically designed to detect churning (excessive trading to generate commissions)

Exam Tip: Gotchas

• Full discretion requires three things: written authorization + firm acceptance + order marking. Missing any one means the account is not properly authorized.
• Churning detection is a primary reason for the frequent review requirement. If you see "excessive trading" in a question, think discretionary account supervision.

The Time-and-Price Exception

Not every decision by a representative qualifies as "discretion." There is one key exception:

• If a customer specifies the security, the action (buy or sell), and the quantity, the representative may exercise discretion over time (when to execute) and price (at what price) without triggering full discretionary account requirements
• Time-and-price discretion is valid only until the end of the business day on which it was granted
• This exception does NOT require written authorization or principal approval

How to Tell the Difference

Exam Tip: Gotchas

• The critical question is always: did the customer choose the security and the action (buy/sell)? If yes, the rep only has time-and-price discretion (no written auth needed, expires end of day). If no, it is full discretion (written auth required, principal acceptance required).
• Time-and-price discretion expires at the end of the business day it was granted. Not end of week, not "until canceled."

Options Discretionary Accounts

• Options discretionary accounts are subject to additional oversight under Cboe (Chicago Board Options Exchange) Rule 9.4
• A registered options principal (ROP) must approve the account and review discretionary activity
• Because options carry additional risk, supervision requirements are stricter than for equity discretionary accounts

Recordkeeping for Discretionary Accounts

Note: Account-level documents are kept for 6 years, but individual order approvals are kept for 3 years.

Exam Tip: Gotchas

• The 6-year vs. 3-year recordkeeping split is frequently tested. Account-level documents = 6 years; individual order approvals = 3 years.