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 under the federal definition 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 any one of the security, the action (buy or sell), or the quantity without getting the customer's approval for each individual trade? If yes, it is discretionary.

If the customer approves each trade before it is entered (naming the security, action, and quantity), the account is not discretionary, even when no discretionary paperwork is on file. The customer, not the representative, is making each decision. Discretion exists only when the representative acts without the customer's approval for each trade.

What Must Be in Place Before Discretion Is Exercised?

No member or registered representative may exercise discretionary power in a customer's account unless both of these are in place:

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), as evidenced in writing by the member or by a duly designated partner, officer, or manager

Separately, SEC recordkeeping rules require every order entered under discretionary authority to be designated as discretionary on the order ticket. That is a per-order record duty rather than a third precondition of the discretionary account rule, but exam questions often test all three together as the package a representative needs.

How Are Discretionary Accounts Supervised on an Ongoing Basis?

• 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 and character
• This review is specifically designed to detect churning (excessive trading to generate commissions)
• There is no fixed numeric trade-count threshold for churning. Whether activity is excessive is judged relative to the account's financial resources and character, not by a set number of trades. The review targets excessive trading only: there is no minimum-activity requirement, so a quiet or inactive account is not itself a violation

Exam Tip: Gotchas

• Before any discretion is exercised, the discretionary account rule requires two things: prior written authorization + written firm acceptance. Missing either one means the account is not properly authorized. Each discretionary order must then be marked discretionary on the order ticket and promptly approved in writing.
• Churning detection is a primary reason for the frequent review requirement. If you see "excessive trading" in a question, think discretionary account supervision.

What Are the Exceptions to the Discretionary Account Rule?

Not every decision by a representative qualifies as "discretion." The discretionary account rule carves out two exceptions:

• 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, unless the customer gives a specific, signed, and dated instruction extending it
• The same-day limit does not apply to an institutional account (as defined for customer-account-information purposes) acting on valid Good-Till-Cancelled, not-held instructions
• Every exercise of time-and-price discretion must be reflected on the order ticket
• This exception does NOT require written authorization or principal approval
• A second, narrower exception covers bulk exchanges of money market fund shares at net asset value using a negative-response letter, limited to fund mergers, clearing-member changes, or sweep-account fund changes; the letter must compare fees and investment objectives and include a prospectus, and the negative-response feature cannot activate until 30 days after mailing

How Do You Tell Full Discretion from Time-and-Price Only?

Exam Tip: Gotchas

• The critical question is always: did the customer specify the security, the action (buy/sell), and the quantity? If yes to all three, the rep only has time-and-price discretion (no written auth needed, expires end of day). If the customer left any one of those to the rep, it is full discretion (written auth required, written firm acceptance required).
• Time-and-price discretion expires at the end of the business day it was granted unless the customer gives a specific, signed, and dated written instruction extending it. Not end of week, not "until canceled."

How Are Options Discretionary Accounts Different?

• Options discretionary accounts are subject to additional oversight under FINRA's options rules
• A registered options principal (ROP) or a Limited Principal-General Securities Sales Supervisor must accept the account in writing, a different ROP must review that acceptance, and an ROP who is not exercising the discretion must review the discretionary activity
• Because options carry additional risk, supervision requirements are stricter than for equity discretionary accounts

How Long Must Discretionary Account Records Be Kept?

Exam Tip: Gotchas

• Note the 6-year vs. 3-year split, and note where the line actually falls. Only account acceptance documentation runs 6 years, and its clock starts when the account closes, not when the record is updated. The written authorization, the written agreements, and individual order approvals all run 3 years from the date the record is made. The trap is assuming every account-level document gets the 6-year period.

What Should You Check on Exam Day?

• Before discretion: written customer authorization + written firm acceptance (missing either means no valid authority); each order is then marked discretionary (an SEC recordkeeping duty) and promptly approved in writing
• Time-and-price discretion is the narrow exception: no written authorization or principal acceptance needed (though it still must be marked on the order ticket), and it expires end of business day (absent a signed, dated extension)
• Watch the 6-year vs. 3-year recordkeeping split, and remember frequent review targets excessive trading, not a fixed trade count