Discretionary Accounts: Does your Broker have too much Authority?
A discretionary account is a type of investment account in which you (the account holder) give the broker the authority to make investment decisions on your behalf. In other words, the broker has the discretion to buy and sell securities in your account without obtaining your prior approval for each transaction.
If your broker or financial advisor abuses their discretion by making trades that are not in your best interest or if they engage in fraudulent activity, this can lead to broker fraud. For example, the broker may make trades that generate high commissions for themselves but are not suitable for your investment objectives or risk tolerance. Alternatively, the broker may engage in unauthorized trading or churning, where they make excessive trades to generate commissions.
To prevent broker fraud in discretionary accounts, it is essential to establish clear guidelines and controls, including setting investment objectives and risk tolerance levels, regular monitoring and review of account activity, and ensuring that the broker is acting in the client’s best interest. It’s also important to choose a reputable broker or financial advisor with a track record of ethical behavior and avoid giving them too much discretion without proper oversight.
This type of account is typically used by investors who prefer to delegate the investment decisions to a broker or financial advisor, either because they lack the time or expertise to manage their own investments, or because they prefer a hands-off approach to investing.
In a discretionary account, your broker has a fiduciary duty to act in your best interest, and to make investment decisions that are consistent with your investment objectives and risk tolerance. The broker may take into account factors such as market trends, economic data, and company financials to make investment decisions.
Discretionary accounts, also called managed accounts, may have higher fees than non-discretionary accounts, as the broker assumes more responsibility for managing the account. However, the potential benefits include potentially higher returns and a more hands-off approach to investing.
You should carefully consider the risks and benefits of a discretionary account and ensure that you fully understand the terms and conditions of the account before opening one. Additionally, you should choose a reputable broker or financial advisor with a track record of ethical behavior and ensure that you regularly monitor your account to ensure that the broker is acting in your best interest.
Discretionary vs Nondiscretionary
Discretionary accounts and nondiscretionary accounts differ in terms of who makes investment decisions.
In a nondiscretionary account the account holder retains full control over the investment decisions. In this type of account, the investment advisor provides recommendations and advice to the account holder, but the account holder must make the final investment decisions.
FINRA Rules for Discretionary Accounts
FINRA (Financial Industry Regulatory Authority), the self –regulator who oversees the securities industry, has rules regarding discretionary brokerage accounts. FINRA Rule 3260 governs discretionary accounts and imposes specific requirements on broker-dealers and registered representatives who exercise discretion in customer accounts.
Under FINRA Rule 3260, brokers and dealers must obtain written authorization from the account holder before making any discretionary trades. The written authorization must specify the scope of the discretion granted and be approved by a designated principal of the broker-dealer.
In addition, brokers and dealers must exercise discretion in a manner consistent with the customer’s investment objectives, risk tolerance, and other guidelines provided by the customer. The broker must also regularly review the account to ensure that the discretionary trades are suitable for the customer’s investment profile and objectives.
FINRA also requires that brokers and dealers maintain records of discretionary trades, including the terms and conditions of the authorization, and the time and price of each trade.
These rules are designed to protect investors from fraudulent or unsuitable trading practices in discretionary accounts and to ensure that brokers and dealers act in their clients’ best interests when exercising discretion.
While it is less common, unauthorized trading can potentially occur in a discretionary brokerage account if the broker or financial advisor exceeds the scope of their discretion or acts outside of the account holder’s investment objectives and risk tolerance.
For example, if the broker makes trades that are not consistent with your stated investment goals, or if they exceed the agreed-upon level of risk, this could be considered unauthorized trading. Similarly, if the broker engages in churning, or excessive trading in the account to generate commissions, this could also be considered unauthorized trading.
If you suspect that unauthorized trading has occurred in your discretionary brokerage account, you should contact your broker or financial advisor immediately and file a complaint with FINRA. You may also want to consult with a securities attorney to discuss potential legal options, such as filing a FINRA arbitration claim.
Unauthorized trading in a nondiscretionary account can occur if the broker or financial advisor executes trades without your prior approval. For example, the broker may make trades in your account without your knowledge or consent, or they may misrepresent the nature or risks of the investment to obtain your approval.
Further, some brokers or financial advisors may engage in churning or excessive trading to generate commissions, make unsuitable investment recommendations, or engage in other fraudulent activities.
It is important for you to closely monitor your account activity and review trade confirmations and account statements regularly. If you notice any unauthorized trading activity or suspicious behavior, you should contact their broker or financial advisor immediately and report the incident to the brokerage firm’s compliance department.
In addition, you can take steps to protect yourself by carefully reviewing and understanding the terms and conditions of their account agreement, setting clear investment objectives and risk tolerance levels, and only approving trades that are consistent with their investment goals. You can also choose a reputable broker or financial advisor with a track record of ethical behavior and report any suspicious behavior or fraudulent activity to the appropriate regulatory authorities.
What are FINRA’s rules regarding unauthorized trading?
FINRA has strict rules and regulations regarding unauthorized trading in brokerage accounts. FINRA Rule 3260 specifically addresses the issue of discretionary accounts and the requirements for brokers and dealers to obtain written authorization from customers before exercising discretion in their accounts.
In addition to Rule 3260, FINRA has several other rules that apply to unauthorized trading, including:
- FINRA Rule 2150 – Prohibited Use of Customers’ Securities or Funds: FINRA prohibits broker-dealers from using customers’ securities or funds for their own benefit or making unauthorized withdrawals from customer accounts.
- FINRA Rule 4512 – Customer Account Information: FINRA requires broker-dealers to maintain accurate and up-to-date customer account information, including the customer’s investment objectives, financial situation, and risk tolerance.
- FINRA Rule 4513 – Records of Written Customer Complaints: FINRA requires broker-dealers to maintain records of all written customer complaints, including those related to unauthorized trading.
- FINRA Rule 5330 – Adjustment of Orders: FINRA prohibits broker-dealers from adjusting or canceling a customer order without the customer’s consent.
If a broker engages in unauthorized trading, they may be subject to disciplinary action by FINRA, including fines, suspension, or even permanent expulsion from the securities industry. Customers who believe that unauthorized trading has occurred in their account may file a complaint with FINRA, which will investigate the matter and take appropriate action if necessary.
If you have a securities related dispute, the securities attorneys at the White Law Group may be able to help you. The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm dedicated to helping investors in claims in all 50 states against their financial professional or brokerage firm. Since the firm launched in 2010, it has handled over 700 FINRA arbitration cases.
For a free consultation with a national securities attorney, please call the offices at 888-637-5510. For more information on The White Law Group, and its representation of investors, please visit WhiteSecuritiesLaw.com.
Tags: discretionary v nondiscretionary, FINRA 3260, managed accounts, unauthorized trading Last modified: March 31, 2023