Customer Agreements and Accounts

The new account record

FINRA Rule 4512 sets out what a member must maintain for each account: the customer's name and residence, whether the customer is of legal age, the names of the associated persons responsible for the account, and the signature of the partner, officer or manager who accepted it.

For an account with a natural person as customer, the record must also include the tax identification number, occupation and employer, and whether the customer is an associated person of another member. And unless the customer declines, the date of birth, annual income, net worth and investment objectives.

Two timing points the exam asks about. The customer's signature is not required to open a cash account — the principal's approval is. And a customer who declines to give financial information may still open an account, with the refusal noted, though the omission constrains what may afterwards be recommended.

Rule 4512 also provides for a trusted contact person, whom the firm may contact to confirm the customer's whereabouts and health or to raise a suspicion of financial exploitation. A trusted contact has no authority to trade, withdraw or instruct.

An associated person of another member opening an account must give prior written notice to their employing member under FINRA Rule 3210, and duplicate confirmations and statements may be required.

Margin

A margin account lets a customer borrow from the firm against the securities as collateral. Two written agreements are required and the exam tests both by name.

The credit agreement discloses the terms of the loan — the interest rate, how it is computed and when it is charged.

The hypothecation agreement pledges the customer's securities as collateral and permits the firm to repledge them to obtain a bank loan.

A third, the loan consent agreement, permits the firm to lend the customer's securities to others and is optional; the customer may decline it.

The NASAA statement of policy makes it an unethical practice to execute any transaction in a margin account without securing from the customer a properly executed written margin agreement promptly after the initial transaction in the account, and to hypothecate a customer's securities without a lien unless a properly executed written consent is obtained promptly after the initial transaction. Note the timing: promptly after the first transaction, not necessarily before it.

The Federal Reserve Board's Regulation T sets initial margin at 50 percent of the current market value of a margin equity security, or the higher percentage set by the regulatory authority where the trade occurs. The payment period is the settlement cycle plus two business days — three business days after the trade date under T+1 settlement.

FINRA Rule 4210 adds a minimum initial equity of $2,000, except that cash need not be deposited in excess of the cost of the securities purchased, and maintenance requirements of 25 percent of market value for long positions and, for short positions, the greater of $5.00 per share or 30 percent of market value at $5.00 and above, or the greater of $2.50 per share or 100 percent below $5.00.

A margin disclosure statement must be provided at or before opening and annually thereafter, stating that the customer can lose more than they deposited, that the firm may sell without contacting them, and that the customer does not choose which securities are sold.

The statement of policy separately makes it unethical to fail to segregate customers' free securities or securities held in safekeeping.

Options accounts and option valuation

An options account requires a specific sequence, and the exam asks for the order.

The firm learns the essential facts about the customer — objectives, employment, income, net worth and liquid net worth, marital status and dependants, age, and investment experience and knowledge.

The options disclosure document must be furnished at or prior to the time the account is approved. Delivery comes before approval.

A Registered Options Principal approves the account in writing, specifying which transaction types are permitted.

Within fifteen days after approval, the firm sends the background and financial information to the customer for verification and obtains a signed options agreement in which the customer undertakes to abide by exchange and clearing corporation rules and not to exceed position or exercise limits.

Option valuation appears on the study guide's testable list, and the level required is the basics. A call is in the money when the market price exceeds the strike; a put is in the money when the strike exceeds the market. Intrinsic value is the in-the-money amount and is never negative; time value is the premium minus intrinsic value, and the whole premium of an out-of-the-money option is time value. One contract covers 100 shares, so a premium quoted at 3.50 is $350.

For a long position the maximum loss is the premium; breakeven is the strike plus the premium for a call and the strike minus the premium for a put. An uncovered short call carries unlimited loss, which is why uncovered writing requires specific approval, minimum equity standards and a separate written description of the risk.

Records and privacy

NASAA has issued no model rule on broker-dealer books and records, because federal law limits state authority in that area — so the exam tests the SEC rules here.

SEC Rule 17a-3 specifies the records that must be made, including the order memorandum with the account identifier, the security, buy or sell, quantity, terms and conditions, time of entry and execution, whether the order was solicited or unsolicited, and the associated person who took it. Note that the customer's name is not required on the ticket; the account number identifies the account.

SEC Rule 17a-4 sets the retention periods: six years for blotters, ledgers, stock records and customer account records; three years for order tickets, confirmations, communications, advertising and sales literature, complaints and trading authorizations; and lifetime of the firm plus three years for the organizational documents. Records must be readily accessible for the first two years.

Regulation S-P requires an initial privacy notice no later than when the customer relationship is established and an annual notice thereafter, an opt-out notice and a reasonable opportunity to opt out before disclosing non-public personal information to a non-affiliated third party, and written administrative, technical and physical safeguards for customer records.

Section 403 of the Act adds the state layer, giving the Administrator authority over the records a registrant must keep and the sales literature it distributes.

A practical rule that follows from all of it: customer information belongs to the firm and to the customer, not to the representative. Taking a client list to a new firm is a privacy violation and usually a contractual one.