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 Three Conditions Must Be Met to Exercise Discretion?

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

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

• 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.

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, 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."

How Are Options Discretionary Accounts Different?

• Options discretionary accounts are subject to additional oversight under the Chicago Board Options Exchange (Cboe) options-supervision rules
• 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

How Long Must Discretionary Account Records Be Kept?

Exam Tip: Gotchas

• Note the 6-year vs. 3-year split: account-level documents (the written authorization, account acceptance, and written agreements, since these count as customer account information) = 6 years; individual order approvals = 3 years.

What Should You Check on Exam Day?

• The discretionary trio is written customer authorization + written firm acceptance + order marked discretionary; missing any one voids the authority
• 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