OPENING A NEW ACCOUNT

The new account form serves two purposes. It helps establish trust between the registered representative and the client. It also satisfies several regulatory requirements. Each firm has its own new account form, but the basic information that is collected is always the same. A lack of proper documentation could result in disciplinary action (i.e. fines, restrictions against performing securities transactions, dismissal of guilty parties).

The NYSE Rule 405 states that a registered representative should have a basic understanding of a client's risk tolerance, financial needs and investment objectives, current income level and tax status, and his other investment holdings and net worth. Aside from knowing these factors, FINRA requires a registered representative to obtain the following information from a client when opening a new account:

• Name and residence
• Citizenship status
• If client is of legal age
• Occupation plus the name and address of his employer
• Signature of the registered representative opening the account
• Signature of the principal approving the account
• Whether or not the customer is affiliated with another FINRA member
• Whether distributions should be reinvested or paid-out as cash
• Name of any person(s) authorized to make transactions in the account

Upon setting up his new account, a client must also establish service instructions. These instructions specify how the account should be serviced (how securities will be paid for, how securities will be delivered, etc). The client has several options to choose from, such as the following:

Transfer and Ship-- The securities are transferred to the client's name and then delivered to the him. Securities are not recorded on the firm's records. The client assumes full responsibility for the securities and for communicating with the issuers of those securities. This option might also be referred to as "mailing securities to a client."

Transfer and Hold-- The securities are transferred to the client's name, but are held separately by the broker-dealer for safekeeping. However, the client's name is held on all the issuers' records. Since each security issuer will have the client's name, all dividends, proxies, and reports will go directly to the client. This option might also be referred to as "holding securities in a client's name."

Hold in Street Name-- The securities are registered in the broker-dealer's name and are also held by him. However, the client is still listed as the beneficial owner. This is the most common form of delivery. Most new account forms do not even list this as an option, because it is assumed that this is how the securities will be handled unless a client requests otherwise!

Hold or Mail Payments-- Once dividends (or interest) are paid, the payments are either credited to the client's account or they are sent to the address held on record. The client chooses which method he prefers.

Forward to Another Address-- The securities or checks are forwarded to another address. The client chooses whether he wants this arrangement to be temporary or permanent.

Delivery versus Payment (DVP)-- This is an agreement between a buy and a seller of a security. It promises that the delivery and payment of the security will occur simultaneously. This reduces the risk of theft for both parties. This option is primarily used for institutional accounts (i.e. a bank acting as agent for a client). This option might also be referred to as "cash on delivery."


A new account might also contain a binding agreement known as an arbitration clause. By signing this arbitration agreement, the client states that any disputes he has with his representative or with the firm will be settled outside of court. The client must at least acknowledge that he has received a copy of this clause when he opens up his new account. Although the details of each clause might differ, most clauses disclose the following general information:

• Involved parties are waving the right to seek remedies in court.
• The panel of arbitrators will be familiar with the securities industry.
• Arbitration is final and binding for all parties involved.
• Awards must be paid within 30 days.
• Awards and amounts are not based on legal reasoning or facts, and if a party is dissatisfied with them, his right to appeal or modify the ruling is very limited.
• Simplified arbitration is available for claims that do not exceed $25,000.

TYPES OF CLIENT ACCOUNTS

An account can be individually or jointly owned. Several different types of accounts fall under the joint ownership category. Two or more individuals can open up a joint account (tenants in common, tenants by entirety, joint tenants with rights of survivorship). Businesses can also open joint accounts (corporate account, partnership account, etc). Custodial accounts require an individual (or group) to manage the account on the owner's behalf (accounts for minors, accounts for incompetent persons, etc).

Individual Account--- This type of account is owned by one person. This person is the only one who can control all the investments in the account. He is also the only one who can request distributions from the account.

Per its name, a joint account has two or more owners (individuals and in some cases, entities). Each owner has some form of control over the account. The following are common types of joint accounts:

Joint Tenants with Right of Survivorship (JTWROS) Account-- Assets are jointly owned by each tenant. This account is characterized by rights of survivorship, meaning that upon death of a tenant, the assets are equally distributed to the surviving tenant(s).

Tenants in Common (TIC) Account-- Each tenant owns a portion of the assets (equal or unequal). This account has no rights of survivorship, meaning that upon death, assets are directed to the deceased's estate instead of to the surviving tenant(s).

Tenants by Entirety (TBE) Account-- Typically, married couples open up this type of account (sometimes business partners). Like a JTWROS account, this account is also characterized by rights of survivorship.

Businesses can also open up joint accounts.

Corporate Account-- With this type of account, the corporation decides which of its officers can make the transactions. If a margin account is opened, certified copies of the company's bylaws and its corporate charter must be on file.

Partnership Account-- This type of account is an unincorporated association of two or more individuals. They must form an agreement as to which partner(s) can make account transactions. Cash, margin, or retirement accounts can also be opened, as long as all investment limitations are disclosed.

If an account owner needs someone to make account decisions and act on his behalf, a custodial account is opened.

Custodial ("Fiduciary") Account-- Recall that a fiduciary is a legally appointed person who acts on behalf of a beneficiary. A fiduciary cannot be an owner of the account. He should also provide documentation proving that he has been authorized to conduct transactions in the account. The fiduciary makes all the decisions that are necessary to properly manage and maintain the account (i.e. initiating trades, approving distributions, etc). Although the account owner does not have legal control over the investments, the fiduciary must make all decisions in the account owner's best interest, not his own. The Prudent Man Rule is the law that require this. These rules also state that a fiduciary cannot share in a client's profits, but is permitted to charge a reasonable fee for the services he provides.

A fiduciary can be a trustee, custodian, conservator, guardian, executor, administrator, or receiver. The roles of these fiduciaries are as follows:

• Trustee: Administers a trust
• Custodian: Manages a UGMA or UTMA account
• Conservator: Acts on behalf of an incompetent person
• Guardian: Handles the affairs of an incompetent person or a minor (until that minor reaches a certain age)
• Executor: Manages the affairs of an estate
• Administrator: Liquidates the estate of a person who died without a will
• Receiver: Handles the details of a bankruptcy

Custodial accounts are mainly used to describe accounts for minors. A member firm does not allow a minor to open an account in his own name. If a minor wants to open an account, he must open up a UGMA or UTMA Account or a Trust Account. These accounts for minors are opened under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). The UTMA is just a more recent version of the UGMA.

The following information describes these custodial accounts for minors:

• The account is registered in the custodian's name, but under the minor's social security number.

• Each account can only have one minor and one custodian.

• The account is opened for savings purposes for the minor's future.

• The minor is responsible for the taxes on any interest, gains, and dividends.

• An adult (usually a parent or grandparent) donates ("gifts") money to the minor's account. This person can act as the custodian for the account, if he prefers. The amount that this person donates has no monetary limit and cannot be taken back.

• The custodian quits his duties and puts the account in the minor's name once that minor reaches the age of majority (an age determined by each individual state that allows the minor to take full control of his account).

• As with any custodial account, the Prudent Man Rules apply.

Remember, a custodial account is characterized by a fiduciary acting on behalf of an account owner. Therefore, by its very definition, the fiduciary is given a "built-in authority" over the account. The same is also true for other types of accounts, and it is usually easy to see which ones this is true for by just reading the title and definition of each type of account. For example, the account owner of an individual account is clearly the only one who is allowed to make the decisions. With joint accounts, both parties are permitted to make account decisions unless otherwise stated. For instance, a corporate account is technically a joint account, but the corporation chooses which employees are allowed to make the decisions. Even though these types of accounts subtly state (in their definitions) who has the control, a "non-owner" (person or entity not named on the account) can still be named as a decision-maker in the event the responsible party is unable to make the decisions. For example, the owner of an individual account likely wants someone to be allowed to exercise control over his account in the event that he cannot. The account owner must give written permission to a non-owner so that the non-owner has the authority to make decisions regarding the account and its activity. This is called power of attorney.

The owner must file this authorization with the broker-dealer who is handling the account. The owner must also specify how much control he wants to give to the non-owner. Full power of attorney allows the non-owner to make investment decisions, make deposits, and make withdrawals. This maximum control is usually given to trustees, guardians, and custodians. Limited power of attorney means that the owner only gives the non-owner some control over the account. The exact details regarding what the non-owner is allowed to do is specified in the written permission form that the owner gives to the broker-dealer.

Discretion is similar to power of attorney. If an account owner gives discretionary authority to a broker-dealer, the broker-dealer can make trades in the owner's account without consulting the account owner. The owner must give written documentation to allow this, and must also specify the parameters within which the broker-dealer is allowed to act (i.e. which security to buy or sell, the amount, the time, the price, etc). The owner might not want the broker-dealer to do all of these things, which is why he must document all of his orders. Upon documentation, the owner is legally bound to all trading decisions the broker-dealer makes on his behalf. Even though the broker-dealer holds this power, the account owner can still make decisions too. Therefore, this form of custodial account is often referred to as a discretionary account. If an account is considered to be discretionary, the following rules apply:

• The broker-dealer can only decide which securities to buy or sell, and how many sharesto buy or sell.
• As with any custodial account, the Prudent Man Rules apply.
• All discretionary orders must be identified at the time a trade is executed.
• Each trade must be approved in writing by an officer of the broker-dealer.
• Churning (excessive trading) is prohibited, and a supervisor must review the broker-dealer's trading activity to ensure this is not occurring.

Cash Accounts-- Almost any investor will qualify to open up a cash account. Once the account has been set up, the investor deposits cash into it, and then uses that cash to buy stocks, bonds, mutual funds, or other investments. Cash accounts are the most basic, simple types of accounts. With cash accounts, the securities that are purchased must be paid in full.

Margin Accounts-- This type of account is offered by brokerages and allows investors to borrow money so that they can buy more securities if they do not have the full amount of cash needed. This increases an investor's purchasing power. With this type of account, the assets (securities) in an investor's account are used as collateral for the line of credit that is needed to buy more stock. Even though the broker charges a low interest rate for this, the investor will still need to earn a very high return on his investments in order to pay the broker and still "earn" a substantial amount for himself. Additionally, if the price of the margined security decreases, significant losses can occur extremely quickly. This is because the investor would lose a portion (or all) of what he invested and borrowed, plus he will still have to come up with the interest he owes on the loan. For these reasons, margin accounts are considered quite risky and can only be opened if an investor is approved.

If an investor wants to open a margin account, he must fill out an application with his broker. The investor's annual income, net worth, estimated liquid net worth, and possibly even credit history will be reviewed. Upon approval, the account is subject to the rules of the Federal Reserve Board, FINRA, the NYSE and other securities exchanges, and the brokerage firm that approved the account. The rules of the brokerage firm are usually the most stringent of all the organizations.

In addition to be approved to open a margin account, the investor must also sign a margin agreement. A margin agreement is a contract between a client and a brokerage and consists of the following three parts:

• Credit Agreement-- This part of the margin agreement explains the terms of the contract (i.e. how the broker-dealer will finance the investor's purchase, how interested is calculated, how that interest is charged to the investor's account, etc).

• Hypothecation Agreement-- If an investor signs this part of the margin agreement, he is giving the broker-dealer permission to use his securities as collateral. All securities must be listed by their "street name."

• Loan Consent Agreement-- If an investor signs this part of the margin agreement, he is giving the firm permission to loan his securities to other investors who want to borrow them or sell them short. This is an optional part of the margin agreement.

Margin accounts may not be opened for the following types of accounts:

• Individual Retirement Accounts (IRAs)
• Corporate Retirement Accounts
• Custodial Accounts
• Keogh Plans
• Tax-sheltered Annuities (TSAs)

Before an investor can even start trading on margin, he must first deposit $2,000 with his brokerage firm. This is the minimum margin. Then, anytime the investor wants to purchase securities on margin for his account, he must always meet an initial margin requirement. This is the amount (%) that an investor must pay for the securities he wants to purchase. As long as he has this minimum amount, he can borrow the rest from the brokerage firm. The initial margin requirement for new purchases is 50% of the total amount that the investor wants to purchase.

The Federal Reserve Board created a rule called Regulation T to list these specific margin requirements! Even though the Fed created this rule, the SEC is the entity that actually enforces it. This rule was made to ensure that a certain amount of equity was present for margin transactions. Government agency securities, non-convertible corporate debt, municipal securities, and T-bills/notes/bonds are exempt from Regulation T! Regulation T also specified which securities were marginable and which ones were not. If a security is "marginable," it is capable of being purchased on margin. The marginable (eligible) securities are as follows:

• Stocks and bonds that are listed on an exchange
• Stocks that are quoted on the NASDAQ National Market
• Certain OTC securities
• Warrants for any listed securities; warrants for some non-listed securities (there are only a few exceptions for non-listed securities)

Not all securities are marginable! This means that they cannot be purchased using margin, but must be paid in full instead! These non-eligible securities include options, rights, insurance contracts, certain common and preferred OTC stocks, and any "new issues" (securities that are being sold on the market for the first time). Since mutual funds are considered to be new issues, they cannot be purchased using margin either!

MAINTAINING CLIENT ACCOUNTS

Financial Background-- A registered representative must periodically verify (and update) a client's financial status.

Objectives-- A client changes his investment objectives as he ages. Risk tolerance and time horizon are key factors in determining investment objectives.

Change of Address-- If a client moves to a state where his broker-dealer is not registered, the broker-dealer might not be able to service that client anymore. Therefore, an up-to-date address must always be on record in order to keep everyone informed.

Transferring Accounts-- If a client wants to transfer his account to another broker-dealer, the client must first complete a Transfer Initiation Form (TIF) with his current firm. The current firm will submit the TIF to the new firm. The new firm will respond within three business days by either validating or rejecting the request. Rejection will occur if the client's information between the old and new firm does not match (name, social security number, account info, etc). Rejection could also occur as a result of the new firm's credit policies (if the client's account does not meet the new firm's minimum equity requirements, if the quality of securities that are supporting a margin loan is not ideal, etc). However, if the new firm decides to accept the transfer amount and if the client's info matches, the request will be approved. As a result, the old firm will move the client's assets to the new firm within four business days. All open orders must be canceled and new orders cannot be accepted at this time. The account's balance, a list of all securities, and the positions of all securities must be included in the transfer instructions. Since firms are obligated to make these transfers as quickly as possible, most use an automated service called ACATS (Automated Customer Account Transfer Service).

Account Statements-- Broker-dealers must provide their clients with quarterly account statements. However, most broker-dealers give their clients an account statement for any month wherein activity has occurred (trades, deposits, earnings, withdrawals, etc). The account balance must contain any activity since the last statement, the positions of all securities, and any cash balances.


DEATH OR INCOMPETENCE OF AN ACCOUNT OWNER

If a client passes away or is rendered incompetent, certain procedures will be followed to handle the client's account. Procedures vary according to the type of account the client has. The following protocols will be followed upon death or incompetence:

Individual Accounts-- All account activity must cease until someone provides proof that he is legally authorized to take control of the account. The registered representative will obtain the legal documentation necessary to help this person dissolve the account. Then, a new account will be set up for the authorized person, but the account will be titled as "The Estate of [full name of the deceased]."

Any securities registered to the deceased person will be transferred to the deceased's estate. In accordance with each state's law, certain documents might be required before this transfer can be made. Some of these documents include the death certificate, affidavit of domicile, state inheritance tax waiver, and a copy of the will or court appointment. The day of the person's death is used to determine the value of each security (how much each security was worth on the day the person died). This is important in determining estate taxes.

If the account was set up as Transferable on Death (TOD), it is named to the beneficiary and bypasses probate.

Joint Tenants with Right of Survivorship-- Ownership is passed to the survivor(s). The account assets of the deceased are evenly distributed to each surviving account owner.

Tenants in Common-- Ownership is not passed to the surviving account owner(s). The account assets of the deceased owner go directly to his estate.

Tenants by Entirety-- Ownership is passed to the surviving spouse.

Partnership Accounts-- In the event of death or incompetence of one of the partners, all pending transactions and orders will be cancelled and the account will be frozen. The executor of the deceased's estate will instruct the registered representative as to how to dissolve the account.

Custodial Accounts-- Recall that the custodian's name is on the account on behalf of someone else (usually a minor). However, the minor's social security number is used to open the account (even though the custodian's name is on it. If the minor dies, the account's assets are transferred to the minor's estate. If the custodian dies, a new custodian must be appointment to manage the account.

RULES AND REGULATIONS

Many federal laws have been designed and implemented to prevent money laundering and other criminal activity involving large sums of money.

The Bank Secrecy Act of 1970 requires a financial institution to report any cash transaction that exceeds $10,000 and any wire transaction that exceeds $3,000 to the government. The broker-dealer must include information on who is transferring the funds, as well as who is receiving the funds.

The Patriot Act was passed to monitor transactions that could possibly be related to terrorism. It requires broker-dealers to file Suspicious Activity Reports (SARs) for any transaction of at least $5,000 in cash or securities, especially if they know (or even suspect) the following:

• the transaction involves funds derived from illegal activity
• the transaction is structured to evade the Bank Secrecy Act requirements
• the transaction appears to serve no lawful purpose and is not the type of transaction the client would usually engage in
• the client is using the broker-dealer to facilitate criminal activity

The Patriot Act also requires financial institutions to implement a Customer Identification Program (CIP) with any individuals who want to conduct business with them. The CIP (also called "Know Your Customer") is a collection of information regarding a client, such as the type of account the client is qualified to open, how he opened his account, and other information that would help identify the type of client the financial institution is working with.

Regulation S-P restricts a financial institution's ability to disclose a client's personal information. In other words, it cannot give out a client's personal information to the public or to a non-affiliated third party. If a company plans to disclose a client's personal information, it must let the client know this in its notice of privacy policies and practices. If a client is provided with the notice but fails to opt out, the company is allowed to give out some of the client's personal information. The company must also keep the client informed on any updates ("annual notices") regarding its financial privacy practices. Finally, a broker-dealer, mutual fund, or registered investment adviser is permitted to share client information if required by federal, state, or local law. For example, client information may be shared when certain services are performed (i.e. transacting securities).


There are several FINRA Rules (previously known as NASD Rules) that state which actions registered representatives are permitted to take regarding client accounts. These rules are as follows:

Rule 2330: Customer Securities and Funds

This rule details improper uses of customer funds, including performance guarantees and sharing in investment performance. The only exceptions apply to accounts owned by members of the representative's family or to registered investment advisers who receive written authorization from an advisory client.

Rule 3240: Borrowing From or Lending to Customers

This is strictly forbidden between registered representatives and clients. However, if a broker-dealer has a written policy that allows this and if the client is a member of the representative's immediate family, then this is permitted. This is also permitted if the broker-dealer is in the business of borrowing and lending funds. In other words, as long as he offers these services to the general public and from a business standpoint, his actions are permitted. For example, when a broker-dealer loans to a certain type of client, he must be ready to provide loans to every other person of the same financial and credit status that request this of him.

Note: "Immediate family" is defined as a child, husband or wife, brother or sister, parent, grandparent, grandchild, cousin, aunt or uncle, niece or nephew, mother or father-in-law, brother or sister-in-law, son or daughter-in-law, or any other person the representative supports.

Rule 2040: Dealing with Non-Members

This rule pertains to people who are not clients (a "non-member" is any person who is not affiliated with a broker-dealer). A registered representative must treat non-members and the general public the same. In other words, he cannot offer special discounts or share commissions with any non-members.

Rule 3210: Transactions For or By Associated Persons

If a registered representative wants to start an investment account for a spouse or child, he must obtain permission from another broker-dealer. The NYSE, FINRA, and the Municipal Securities Rulemaking Board (MSRB) all require this. However, not all of these self-regulatory organizations (SROs) are as strict when it comes to documenting this process. FINRA is the most lax and the NYSE is the most stringent. Each SRO requires the following:

• FINRA: notification that the account is being opened; duplicate confirmations only if the employer requests
• MSRB: notification that the account is being opened; duplicate confirmations
• NYSE: permission before opening the account; duplicate confirmations

Rule 11860: Prompt Receipt and Delivery of Securities

This rule discusses a client selling a security and how he will be payed. It states that a registered representative cannot accept a client's order unless the client has agreed to accept securities as his form of payment. This especially pertains to short sales. Before the representative can accept a client's order to sell a security "short," he must first be sure that the security will be delivered before the settlement date.

Rule 8210: Complaints

Broker-dealers must maintain a record of all written complaints. The record must contain a description of the action he took in handling the complaint. It must also contain any correspondence (between client, broker-dealer, etc) that pertains to the complaint.

The following rules were created under the Securities Exchange Act of 1934 and pertain to fraudulent activity and foreign transactions:

SEC Rule 10b-10: Confirmation of Transactions

This rule deals with documentation and is designed to prevent a registered representative from fraudulent activity. It requires a broker-dealer to submit written confirmation for any transaction made in a client's account. The documentation must include the following details:

• the date and time of the transaction
• which security was bought or sold
• the price of the security that was bought or sold
• the number of shares that were bought or sold

SEC Rule 17a-8: Accounts and Records

This rule pertains to the financial reporting and recordkeeping of currency and foreign transactions. It states that all records of foreign transactions must be kept for at least five years. In general, records must be kept in an easily accessible place for the first two years, but this does not apply to foreign transactions.