Opening a Customer Account

The account record

FINRA Rule 4512 sets out the customer account information 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 the account.

For an account with a natural person as a customer, the record must also include the customer's tax identification number, occupation and employer's name and address, and whether the customer is an associated person of another member.

And, unless the customer refuses to provide it, the record must include the customer's date of birth, annual income, net worth and investment objectives.

Two things worth noticing. The customer's signature is not required to open a cash account — the principal's approval is what is required. A signature becomes necessary for a margin account, an options account, and a discretionary account, because each involves the customer agreeing to something. And a customer who declines to give financial information may still open an account; the refusal is noted, and it constrains what can be recommended afterwards.

An employee of another member firm opening an account requires prior written notice to the employing member, and duplicate confirmations and statements must be provided to the employer on request, under FINRA Rule 3210. That is how a firm supervises its own people's trading.

Rule 4515 requires principal approval and documentation of any change in account name or designation, which exists because reassigning a trade after the fact is the mechanism by which errors and unauthorized trades are hidden.

Customer identification and anti-money laundering

The Bank Secrecy Act, as amended by the USA PATRIOT Act, requires every broker-dealer to maintain a written anti-money-laundering programme. Its four minimum elements — the four pillars — are written policies and procedures reasonably designed to achieve compliance, a designated AML compliance officer, ongoing training for appropriate personnel, and independent testing of the programme. A fifth element, risk-based customer due diligence including identification of the beneficial owners of legal entity customers, has since been added.

Within that programme sits the customer identification programme. Before opening an account, the firm must obtain, at minimum: the customer's name, date of birth for a natural person, a physical address, and an identification number — a taxpayer identification number for a US person, and for a non-US person a taxpayer identification number, passport number and country of issuance, or similar.

The firm must verify identity within a reasonable time, either documentary — a driver's licence or passport — or non-documentary, and must check the customer against government lists, including the Office of Foreign Assets Control's list of specially designated nationals. A match on the OFAC list is not a due diligence flag; it is a prohibition on doing business.

Suspicious activity reports are filed with FinCEN when a transaction of at least $5,000 is suspected of involving funds from illegal activity, being designed to evade reporting requirements, having no business purpose, or facilitating criminal activity. The report must be filed within thirty calendar days of detection, and it is confidential: a firm may not tell the customer that a SAR has been filed, and doing so is itself a violation.

Currency transaction reports are filed for cash transactions exceeding $10,000 in a day. Structuring — breaking a transaction into smaller pieces to avoid that threshold — is itself a federal offence, and a customer who asks how to avoid the report has given the representative something to escalate.

The standard of care

Two regimes sit side by side and the exam expects both.

Regulation Best Interest, SEC Rule 15l-1, requires a broker-dealer or associated person making a recommendation of any securities transaction or investment strategy to a retail customer to act in the best interest of that customer at the time the recommendation is made, without placing the firm's or the representative's interest ahead of the customer's.

It is satisfied by four component obligations.

Disclosure: full and fair written disclosure of the material facts about the scope and terms of the relationship and about material conflicts of interest — delivered in practice through Form CRS, the customer relationship summary.

Care: exercising reasonable diligence, care and skill to understand the recommendation's potential risks, rewards and costs; to have a reasonable basis to believe it is in the retail customer's best interest given their investment profile; and to have a reasonable basis to believe a series of recommended transactions is not excessive.

Conflict of interest: establishing and maintaining written policies to identify and at a minimum disclose or eliminate conflicts, with specific requirements to mitigate conflicts creating incentives for associated persons, and to eliminate sales contests, quotas, bonuses and non-cash compensation based on the sale of specific securities within a limited period.

Compliance: written policies reasonably designed to achieve compliance with the regulation as a whole.

FINRA Rule 2111, the suitability rule, sets out three obligations — reasonable-basis suitability (the product is suitable for at least some investors), customer-specific suitability (it is suitable for this customer given their profile), and quantitative suitability (a series of transactions is not excessive even if each one considered alone is suitable). Rule 2111 continues to apply to recommendations that Regulation Best Interest does not cover, notably recommendations to institutional customers.

The practical relationship: for a retail customer, Reg BI is the governing standard and it is stricter, because it adds a cost obligation and an explicit prohibition on putting the firm's interest first. A recommendation that is merely suitable is not necessarily in the customer's best interest — the clearest example being a share class or a product that does the same job at a higher cost.

FINRA Rule 2090, Know Your Customer, sits underneath both: a member must use reasonable diligence to know the essential facts concerning every customer and the authority of each person acting on the customer's behalf. Note that KYC attaches to the account, not to a recommendation, so it applies even where nothing is recommended.

Day trading and account restrictions

A pattern day trader is a customer who executes four or more day trades within five business days, where the number of day trades is more than six percent of total trades in the account over that period.

FINRA Rule 2270 requires delivery of a day-trading risk disclosure statement to a non-institutional customer before an account is approved for a day-trading strategy, and Rule 2130 requires the firm either to approve the account for day trading — having determined the strategy is appropriate — or to obtain a written agreement from the customer that they do not intend to use the account for day trading.

A pattern day trader must maintain minimum equity of $25,000 in the margin account on any day they day trade, and that equity must be in the account before day trading begins rather than deposited afterwards.

An account may be refused, restricted or closed for good reason, and the exam expects the categories: an inability to verify the customer's identity; a match against a prohibited list; suspected fraud or manipulation; the customer's failure to meet a margin call; failure to return the required agreements; or the firm's judgement that the account cannot be supervised.

FINRA Rule 2165 permits a member to place a temporary hold on a disbursement of funds or securities from the account of a specified adult — a person aged 65 or older, or aged 18 or older whom the member reasonably believes has a mental or physical impairment rendering them unable to protect their own interests — when the member reasonably believes financial exploitation has occurred, is occurring, or is attempted. The trusted contact person collected under Rule 4512 is who the firm calls. This is a rule that lets a firm do something rather than merely disclose something, and it is one of the few places where a representative's suspicion translates directly into protective action.