Customer Accounts

Question 1

Transfer and Ship

Answer 1

Securities that are to be transferred and shipped will be registered in the customer’s name and will be sent to the customer’s address of record.

Question 2

Transfer and Hold in Safekeeping

Answer 2

Securities will be registered in the customer’s name and will be held by the brokerage firm. The broker dealer may charge a fee for the safekeeping of the securities. Customers may now elect to hold securities registered in their name electronically in the book entry form through the Direct Registration System (DRS). The DRS offered through the depository trust corporation will allow investors to hold their securities on the books of the issuer or the transfer agent. Investors who hold securities with the DRS will receive a statement from the issuer or transfer agent.

Question 3

Hold in Street Name

Answer 3

Securities that are held in street name are registered in the name of the brokerage firm as the nominal owner of the securities, and the customer is the beneficial owner. Most securities are held in this manner to make transfer of ownership easier.

Question 4

Receipt VS. Payment (RVP) / Delivery VS. Payment (DVP)

Answer 4

These account are normally reserved for trusts and other institutional accounts that require that securities be delivered prior to releasing payment for the securities. These account are set up as cash-on-delivery (COD) accounts. At the time the customer opens the account, the customer will also decide what to do with the distributions from the account. Investors may have distributions sent directly to them or they may have them reinvested or swept into a money market account.

Question 5

Mailing Instructions

Answer 5

All confirmations and statements will be sent to the customer’s address of record. Statements and confirmations may be sent to an individual with power of attorney if the duplicates are requested in writing. A customer’s mail may be held by a brokerage firm for up to two months if the customer is traveling within the United States and for up to three months if the customer is traveling outside the United States. If a customer provides a valid reason and submits a written request, the broker-dealer may hold the customer’s mail for up to six months. Customer who are on active duty with the military and have no fixed address should be advised to open a military P.O. Box where statements may be sent.

Question 6

Individual Account

Answer 6

An individual account is an account that is owned by one person. That person makes the determination as to what securities are purchased and sold. In addition, that person receives all of the distributions from the account.

Question 7

Joint Account

Answer 7

A joint account is an account that is owned by two or more adults. Each party to the account may enter orders and request distributions. The registered representative does not need to confirm instructions with both parties. Joint accounts require the owners to sign a joint account agreement prior to the opening of the account. All parties must endorse all securities and all parties must be alive. Checks drawn from the account must be made out in the names of all of the parties.

Question 8

Joint Tenants with Rights of Survivorship (JTWROS)

Answer 8

In a JTWROS account, all the assets are transferred into the name of the surviving party in the event of one tenant’s death. The surviving party becomes the sole owner of all of the assets in the account. Both parties on the account have an equal and undivided interest in the assets in the account.

Question 9

Joint Tenants in Common (JTIC)

Answer 9

In a JTIC account, if one party dies all the assets of the tenant who has died become the property of the decedent’s estate. They do not become the property of the surviving tenant. An account registered as JTIC allows the assets in the account to be divided unequally. One party on the account could own 60% of the account’s assets.

Question 10

Transfer on Death (TOD)

Answer 10

An account that has been registered as a TOD account allows the account owner to stipulate to whom the account is to go to in the event of his or her death. TOD accounts are sometimes referred to as pay on death or POD accounts. The party who will become the owner of the account in the event of the account holder’s death is known as the beneficiary. The beneficiary may only enter orders for the account if he or she has power of attorney for the account. Unlike an account that is registered as JTWROS, the assets in the account will not be at risk should the beneficiary be the subject of a lawsuit, such as in a divorce proceeding.

Question 11

Death of a Customer

Answer 11

If an agent is notified of the death of a customer the agent must immediately cancel all open orders and mark the account deceased. The representative must await instructions from the executor or administrator of the estate. In order to sell or transfer the assets, the agent must receive: letters of testamentary, inheritance tax waivers, certified copy of the death certificate. The death of a customer with a discretionary account automatically terminates the discretionary authority.

Question 12

Corporate Accounts

Answer 12

Corporations, like individuals, will purchase and sell securities. In order to open a corporate account, the registered representative must obtain a corporate resolution that states which individuals have the power to enter orders for the corporation. If a corporation wants to purchase securities on margin, then the registered representative must obtain a corporate charter and the bylaws that state that the corporation may purchase securities on margin. Finally, a certificate of incumbency must be obtained for the officers who are authorized to transact business for the corporation, within 60 days of the account opening.

Question 13

Revocable vs. Irrevocable Trusts

Answer 13

Trusts may be revocable or irrevocable. With a revocable trust, the individual who established the trust and contributes assets to the trust, known as the grantor or settlor, may, revoke the trust and take the assets back. The income generated by a revocable trust is generally taxed as income to the grantor. If the trust is irrevocable, the grantor may not revoke the trust and take the assets back. With an irrevocable trust, the trust usually pays the taxes as its own entity or the beneficiaries of the trust are taxed on the income they receive.

Question 14

Trusts

Answer 14

If the trust is established as a simple trust, all income generated by the trust must be distributed to the beneficiaries in the year the income is earned. If the trust is established as a complex trust, the trust may retain some or all of the income earned and the trust will pay taxes on the income that is not distributed to the beneficiaries. The grantor of an irrevocable trust is generally not taxed on the income generated by the trust unless the assets in the trust are held for the benefit of the grantor, the grantor’s spouse, or if the grantor has an interest in the income of the trust greater than 5 percent. A trust may also be established to hold or to distribute assets after a person’s death under the terms of their Will. Trusts that are established under the terms of a Will are known as Testamentary trusts. All assets placed into a Testamentary trust are subject to both estate taxes and probate. A representative who opens a trust account must obtain documentation of the trustees’ investment powers over the trust’s assets.

Question 15

Partnership Accounts

Answer 15

When a professional organization, such as a law partnership, opens an account, the registered representative must obtain a copy of the partnership agreement. The partnership agreement will state who may enter orders for the account of the partnership. If the partnership wishes to purchase securities on margin, it must not be prohibited by the partnership agreement. A family limited partnership is often used for estate planning. Parents may place significant assets into a family limited partnership as a way to transfer their ownership. Usually, the parents will act as the general partners and will transfer limited partnership interests to their children. As the interests are transferred to the children, the parents may become subject to gift taxes. However, the gift taxes usually will be lower than they would have suffered without the partnership.

Question 16

Trading Authorization

Answer 16

From time to time, people other than the beneficial owner of the account may be authorized to enter orders for the account. All discretionary authority must be evidenced in writing for the following accounts: discretionary accounts, custodial accounts, fiduciary accounts.

Question 17

Operating a Discretionary Account

Answer 17

A discretionary account allows the registered representative to determine the following, without consulting the client first: the asset to be purchased or sold, the amount of the securities to be purchased or sold, the action to be taken in the account (whether to buy or sell). The principal of the firm must accept the account and review it more frequently to ensure against abuses. The customer is required to sign a limited power of attorney that awards discretion to the registered representative. The limited power of attorney is good for up to three years; the customer is bound by the decisions of the representative, but may still enter orders. Once discretion is given to the representative, the representative may not, in turn, give discretion to anther party. If the representative leaves the firm or stops managing the customer’s account, the discretionary authority is automatically terminated. If a FINRA or MSRB broker dealer has a control relationship with an issuer of securities, the customer must be informed of the relationship and must give specific authorization for the purchase of the securities.

Question 18

Limitations of Power of Attorney

Answer 18

A standard power of attorney will also terminate upon the death or incapacitation of the account owner. A durable power of attorney will continue in full effect in the case of incapacitation and will only terminate upon the account owner’s death. A full power of attorney allows an individual to deposit and withdraw cash and securities from the account. A full power of attorney is more appropriate for fiduciaries such as a trustee, custodian, or a guardian.

Question 19

Managing Discretionary Accounts

Answer 19

All discretionary accounts must have the proper paperwork kept in the account file and must have: every order entered marketed discretionary (if discretion was exercised by the representative), every order approved promptly by a principal, a designated principal to review the account, a record of all transactions. Discretion may not be exercised by a representative until the discretionary papers have been received by the firm and approved by the principal.

Question 20

Third Party and Fiduciary Accounts

Answer 20

A fiduciary account is one that is managed by a third party for the benefit of the account holder. The party managing the account has responsibility for making all of the investments and other decisions relating to the account. The individual with this responsibility must do as a prudent person would do for his or her self and may not speculate. This is known as the prudent man rule. Many states have an approved list of securities, known as the legal list, that may be purchased by fiduciaries. The authority to transact business for the account must be evidenced in writing by a power of attorney. The fiduciary may have full power of attorney, also known as full discretion, under which the fiduciary may purchase and sell securities, as well as withdraw cash and securities from the account. Under a limited power of attorney or limited discretion, the fiduciary may only buy and sell securities; assets may not be withdrawn. The fiduciary has been legally appointed to represent the account holder and may not use the assets in the account for his or her own benefit. The fiduciary may, however, be reimbursed for expenses incurred in connection with the management of the account. Examples of fiduciaries include: administrators, custodians, receivers, trustees, conservators, executors, guardians, sheriffs/marshals.

Question 21

Opening Third Party and Fiduciary Accounts

Answer 21

When opening a third party or fiduciary account, the registered representative is required to obtain documentation of the individual’s appointment and authority to act on behalf of the account holder. Trust accounts require that the representative obtain a copy of the trust agreement. The trust agreement will state who has been appointed as the trustee and any limitations on the trust’s operation. Most trusts may only open cash accounts and may not purchase securities on margin, unless specifically authorized to do so in the agreement. When opening an account for a guardian, the representative must obtain a copy of the court order appointing the guardian. The court order must be dated within 60 days of the opening of the account. If the court order is more than 60 days old, the representative may not open the account until a new court order is obtained. Guardians are usually appointed in cases of mentally incompetent adults and orphaned children.

Question 22

Uniform Gift to Minors Account (UGMA)

Answer 22

Minors are not allowed to own securities in their own name because they are not old enough to enter into legally binding contracts. The decision to purchase or sell a security creates a legally binding contract between two parties. The Uniform Gift to Minors Act (UGMA) regulates how accounts are operated for the benefit of minors. All UGMA accounts must have: one custodian, one minor, UGMA and the state in the account title, assets registered to the child’s name after he or she reaches the age of majority. All securities in a UGMA account will be registered in the custodian’s name as the nominal owner for the benefit of the minor who is the beneficial owner of the account. For example, the account should be titled: Mr. Jones as custodian for Billy Jones under New Jersey Uniform Gift to Minors Act.

Question 23

Custodians on UGMA Accounts

Answer 23

Only one custodian and one minor are allowed on each account. A husband and wife could not be joint custodians for their minor child. If there is more than one child, a separate account must be opened for each one. The same person may serve as custodian on several accounts for several minors, and the minor may have more than one account established by different custodians. The donor of the security does not have to be the custodian for the account. If the parents are not the custodians of the accounts, they have no authority over the accounts.

Question 24

Responsibilities of the Custodian

Answer 24

The custodian has a fiduciary duty to manage the account prudently for the benefit of the minor child within certain guidelines, such as: no margin accounts, no high-risk securities (i.e. penny stocks), the custodian may not borrow from the account, no commodities, no speculative option strategies, the custodian may not give discretion to a third party, all distributions must be reinvested within a reasonable time, the custodian may not let rights or warrants expire; they must be exercised or sold, the custodian must provide support for all withdrawals from the account, withdrawals may only be made to reimburse the custodian for expenses incurred in connection with the operation of the account or for the benefit of the minor.

Question 25

Contributions of a UGMA Account

Answer 25

Gifts of cash and securities or other property may be given to the minor. There is no dollar limit as to the size of the gift that may be given. The limit on the size of the tax-free gift is $15,000 per year. An individual may give gifts valued at up to $15,000 to any number of people each year without incurring a tax liability. Once a gift has been given, it is irrevocable. Gifts to a UGMA account carry an indefeasible title and may not be taken back for any reason whatsoever. The custodian may, however, use the assets for the minor’s welfare and educational needs.

Question 26

UGMA Taxation

Answer 26

The minor is responsible for the taxes on the account. However, any unearned income that exceeds $2,200 per year will be taxed at the parent’s marginal tax rate if the child is younger than 14 years old. For gifts that exceed $15,000 per year, the tax liability is on the donor of the gift, not on the minor.

Question 27

Death of a Minor or Custodian

Answer 27

If the minor dies, the account becomes part of the child’s estate. it does not automatically go to the parents. If the custodian dies, a court or the donor may appoint a new custodian.

Question 28

Uniform Transfer to Minors Act

Answer 28

Some states have adopted the Uniform Transfer to Minors Act rather than the Uniform Gifts to Minors Act. The main difference is that with a UTMA account the custodian may determine when the assets become the property of the child. The maximum age is 25 years old.

Question 29

Accounts for Employees of Other Broker Dealers

Answer 29

FINRA Rule 3210 governs the opening of accounts for employees of broker dealers. This rule requires that an employee of a broker dealer who wishes to open an account at another broker dealer to obtain the employer’s written permission prior to opening the account. The employee must present written notification to the broker dealer opening the account that he/she is employed by a FINRA member firm at the time the account is opened. This rule is in effect for the employee or any of the employees immediate family members. This rule will also require the employee to obtain the employer’s written permission for accounts that were opened within 30 days of the start of employment. Excluded from this rule are accounts opened by the employee where no transactions may take place in individual securities such as accounts opened to purchase open end mutual funds, variable annuities, and UITs.

Question 30

Numbered Accounts

Answer 30

A broker dealer, at the request of the customer, may open an account that is simply identified by a number or a symbol, so long as there is a statement signed by the customer attesting to the ownership of the account.

Question 31

Account Transfer

Answer 31

Clients from time to time will wish to have their accounts transferred from one brokerage firm to another. This is usually accomplished through an Automated Client Account Transfer (ACAT). The ACAT provides transfer and delivery instructions to the firm, which will be required to deliver the account to the client’s new firm. The firm that receives the transfer instructions is required to validate the instructions and freeze the account or take exception to them within one business day. No new orders may be accepted and all open orders will be canceled. However, orders may be taken for options positions that expire in 7 days or less. Once the account and positions have been validated, the firm has three additional business days to complete the transfer.

Question 32

Account Transfer Exceptions

Answer 32

A firm may only take exception to the instructions for the following reasons: the customer’s signature is missing or invalid, the account title does not match the carrying firm’s account number, the social security number does not match, the account number is wrong. From time to time certain investment positions will not be able to be transferred from the old firm to the new firm. A customer is required to give specific instructions as to what should be done with that investment. The customer may elect to: leave the investment at the old firm, have it liquidated, have it shipped. Any disputes between the two firms must be resolved within 5 business days. A registered rep who changes firms may utilize a bulk account transfer process for his clients’ account so long as the client have provided affirmative consent. FINRA does not allow customer accounts to be transferred or the broker of record to be changed through a negative consent letter.

Question 33

Option Accounts

Answer 33

A customer wishing to trade options must be given a copy of the OCC’s risk disclosure document and sign the firm’s option agreement. The customer’s account may be initially approved by a branch manager who is not a registered option and security futures principal (ROSFP), so long as the account is approved by a ROSFP within a reasonable amount of time. A branch manager with more than three representatives conducting options business is required to qualify as a registered option and security futures principal.

Question 34

Margin Accounts

Answer 34

A margin account allows the investor to purchase securities without paying for the securities in full. The investor is required to deposit a portion of the securities’ purchase price and may borrow the rest from the broker dealer. The portion of the securities’ purchase price that an investor must deposit is called margin. The amount of the required deposit or margin is controlled by the Federal Reserve Board under Regulation T of the Securities Exchange Act of 1934. Regulation T gave the Federal Reserve Board the authority to regulate the extension of credit for securities purchases. The Federal Reserve Board controls: which securities may be purchased on margin, the amount of the initial required deposit, payment dates. Customers who purchase securities on margin must receive a separate margin disclosure statement at the time the account is opened and annually thereafter detailing the risks of purchasing securities on margin. If the broker-dealer allows customers to open account online, the margin disclosure statement must be clearly displayed on the firm’s website.

Question 35

Margin Signing Requirements

Answer 35

Unlike when opening a cash account, when a customer opens a margin account he or she will be required to sign certain account documents. The customer will be asked to sign the following: credit agreement, hypothecation agreement, loan consent.

Question 36

The Credit Agreement

Answer 36

The credit agreement states the terms and conditions under which credit will be extended to the customer. It will include information about how interest is charged as well as information about the rates that will be charged. A margin loan does not amortize, meaning that the principal is not paid down on a regular schedule. The brokerage firm simply charges interest to the account.

Question 37

The Hypothecation Agreement

Answer 37

The hypothecation agreement pledges the customer’s securities that were purchased on margin as collateral for the loan. It also allows the brokerage firm to take the same securities and repledge or rehypothecate them as collateral for a loan at a bank to obtain a loan for the customer.

Question 38

Loan Consent

Answer 38

By signing a loan consent agreement, the customer allows the brokerage firm to lend out the securities to customers who wish to sell the securities short. This is the only part of the margin agreement that the customer is not required to sign. The credit and hypothecation agreements must be signed prior to the account being approved to purchase securities on margin. All securities purchased in a margin account will be held in street name, the name of the brokerage firm, so that the broker dealer may sell the securities to protect itself if the value of the securities falls significantly.

Question 39

Day Trading

Answer 39

Day trading is an investment strategy defined by the entering of round-trip orders, consisting of both a buy and sell order, on the same day for the same security. Firms that promote the use of day trading strategies to individual investors must adhere to special account opening requirements. A broker dealer will be considered to be promoting day trading strategies if it holds seminars, advertises, or uses another company to promote its services. If the firm promotes day trading, it must provide the customer with a risk disclosure document and approve the account for day trading. If the customer is not approved for day trading, the customer may still open an account so long as the firm obtains a written statement from the customer stating that he or she will not be engaging in day trading strategies. A firm will be considered to be promoting day trading if the registered representative promote day trading strategies with the knowledge of the firm’s principal.

Question 40

The Operation of Margin Accounts

Answer 40

Customers who want to establish a new margin account must have at least $2,500 in equity prior to the broker dealer loaning the customer any funds. Customers who have established margin accounts and who purchase securities on margin are required to maintain equity equal to 25% of the long market value. When the equity in an account is below the initial requirement of 50% and above the minimum equity requirement, the account is said to be a restricted margin account. The term restricted only refers to the relationship of the equity to the market value. No limitations are placed on the account and the investor is free to increase his/her positions at will by depositing 50% of the price of the new securities. Special rules apply for customers who sell low-priced stocks short. A customer who sells a stock short worth $5 or less is subject to a marginal requirement of the greater of $2.50 per share or 100% of the value of the stock sold short. For example, a customer who sold 1,000 shares of stock short at $3 per share would be required to deposit $3,000.

Question 41

Commingling Customers’ Pledged Securities

Answer 41

A broker dealer may not commingle a customer’s pledged securities with another customer’s pledged securities as joint collateral to obtain a loan from a bank without both customers’ written authorization. This authorization is required by SEC Rule 15c2-1 and is part of most margin agreements. A customer’s securities may never be commingled with the firm’s securities.

Question 42

Wrap Accounts

Answer 42

A wrap account is an account that charges the customer a set annual fee for both advice and execution costs. The fee is based on the assets in the account. Wrap account holders must be given Schedule H, which details how fees are to be charged, prior to opening the account. A firm that offers wrap accounts to its clients must be registered as investment advisors. Agents who service wrap accounts must have passed the Series 65 or 66 exams. Wrap accounts and other asset based fee accounts are usually not appropriate for clients who trade infrequently and use a buy and hold strategy. The practice of placing these types of accounts into fee based programs constitutes a violation known as reverse churning.

Question 43

Regulation S-P

Answer 43

Regulation S-P requires that the firm maintain adequate procedures to protect the financial information of its customers. Firms must guard against unauthorized access to customer financial information and must employ policies to ensure its safety. Special concerns arise over the ability for a person to hack into a firm’s customer data base by gaining unauthorized access. Firms must develop and maintain specific safeguards for its computer systems and WiFi access. Regulation S-P was derived from the privacy rules of the Gramm-Leach-Bliley Act. A firm must deliver: an initial privacy notice to customers, no later than when the account was opened, an annual privacy notice to all customers. The annual privacy notice may be delivered electronically via the firm’s website, so long as the customer has agreed to receive it in writing and it is clearly displayed.

Question 44

Regulation S-P Opting Out

Answer 44

Regulation S-P also states that a firm may not disclose nonpublic personal information to nonaffiliated companies for clients who have opted out of the list. The method by which a client may opt out may not be unreasonable. It is considered unreasonable to require a customer to write a letter to opt out. Reasonable methods are emails or a toll-free number. The rule also differentiates between who is a customer and who is a consumer. A customer is anyone who has an ongoing relationship with the firm. A consumer is someone who is providing information to the firm and is considering becoming a customer or who has purchased a product from the firm and has no other contact with the firm. The firm must give the privacy notice to consumers prior to sharing any nonpublic information with a nonaffiliated company. Regulation S-AM prohibits broker dealers from soliciting business based on information received from affiliated third parties unless the potential marketing had been clearly disclosed to the potential customer, the potential customer was provided an opportunity to opt out, but did not opt out.

Question 45

Identity Theft

Answer 45

The fraudulent practice of identity theft may be used by criminals in an attempt to obtain access to the assets or credit of another person. The Federal Trade Commission (FTC) requires banks and broker dealers to establish and maintain written identity theft prevention programs. A broker dealer’s written supervisory procedures manual must be designed to detect red flags relating to the known suspicious activity employed during an attempt at identity theft. The identity theft prevention program should be designed to allow the firm to respond quickly to any attempted identity theft to mitigate any potential damage.

Question 46

Day Trading Accounts

Answer 46

Day trading is an investment strategy defined by the entering of round-trip orders, consisting of both a buy and sell order, on the same day for the same security. Firms that promote the use of day trading strategies to individual investors must adhere to special account opening requirements. A broker dealer will be considered to be promoting day trading strategies if it holds seminars, advertises, or uses another company to promote its services. If the firm promotes day trading, it must provide the customer with a risk disclosure document and approve the account for day trading. If the customer is not for day trading, it must provide the customer with a risk disclosure document and approve the account for day trading. If the customer is not approved for day trading, the customer may still open an account so long as the firm obtains a written statement from the customer stating that he or she will not be engaging in day trading strategies. A firm will be considered to be promoting day trading if the registered representative promote day trading strategies with the knowledge of the firm’s principal. A pattern day trader is defined as anyone who enters 4 or more round trip orders in a 5 day period. The minimum equity for a day trading account is $25,000.

Question 47

ABLE Accounts

Answer 47

An ABLE account, sometimes referred to as a 529 ABLE account, may be established as a tax-advantaged savings account to provide for the care of individuals with disabilities. The Achieving a Better Life Experience (ABLE) account regulations were passed in order to recognize the unique financial burdens inherent in caring for a disabled person. Individuals with disabilities may have only one ABLE account at a time and the individual with the disability is deemed to be both the account owner and the designated beneficiary. ABLE accounts may be transferred or rolled over into new ABLE accounts for the same beneficiary. Contributions to the account are made with after-tax dollars and are allowed to grow tax deferred. The contributions and growth may be used tax free by the beneficiary for qualified care and quality-of-life expenses. Tax-free withdrawals may be made by the beneficiary to cover qualified expenses incurred or in anticipation of paying expenses to be incurred. Qualified expenses would include things such as: medical care, wellness care, transportation, housing expenses (including mortgage, tax, rent, insurance, and utility payments), transportation, assistive technology, education, job training.

Question 48

ABLE Withdrawals and Eligibility

Answer 48

Withdrawals from an ABLE account for expenses that do not meet the definition of qualified expenses will be seen as part of the beneficiary’s resources if retained past the month the distribution occurred. In order to qualify for an ABLE account, the individual must have been disabled by the time he or she reached their 26th birthday. The maximum annual contribution to an ABLE account is equal to the annual tax-free gift limit of $15,000 and is subject to change each year. Anyone may make contributions to an ABLE account and the account may be rolled over to another family member if that person meets the eligibility guidelines. The assets in the ABLE account will not impact the disabled person’s eligibility for many assistance programs. When calculating eligibility for assistance, the first $100,000 in assets in the ABLE account are excluded when estimating the amount of resources available. However, ABLE account balances which exceed $100,000 can cause the beneficiary fo the account to be placed in a suspended status for receiving supplemental security income (SSI) until all resources in the ABLE and other accounts owned by the individual fall to $100,000 or lower. Upon the death of the beneficiary of an ABLE account, the remaining assets will be used to repay Medicaid for any payments made to the beneficiary.