Introduction
Discretionary account authorization is a critical concept for Series 7 exam candidates, focusing on the ability to trade on behalf of clients with specific permissions. Understanding the legal framework and limitations is essential for any securities representative.
Body
Understanding Discretionary Accounts
A discretionary account allows a registered representative to make trades without prior consent for each transaction. This setup provides flexibility in managing the client’s portfolio but requires robust legal documentation, notably a power of attorney (POA), to authorize these actions.
Power of Attorney
Power of attorney is a legal instrument that grants a registered representative the authority to make investment decisions on behalf of a client. For discretionary accounts, the POA must be clearly defined and documented to safeguard both parties’ interests.
Key points about POA include:
- Authorization Scope: Specifies what transactions can be made without client approval.
- Revocation Rights: Clients can revoke POA at any time, requiring the representative to cease discretionary actions immediately.
- Legal Obligations: Representatives must act in the client’s best interest, adhering to fiduciary standards.
Limits of Authority
Even with discretionary authority, there are boundaries:
- Client-Defined Limits: Clients can impose constraints on transaction types, asset classes, or investment amounts.
- Regulatory Restrictions: FINRA mandates adherence to best practices and suitability requirements for all discretionary trades.
Representatives must maintain meticulous records to demonstrate compliance with both client-imposed and regulatory limits.
Conclusion
Discretionary account authorization empowers representatives with significant responsibility. By understanding the documentation and limits associated with these accounts, candidates can ensure they’re well-prepared for the Series 7 exam.
Supplementary Materials
Glossary
- Discretionary Account: An account that allows a representative to trade without prior client consent for each transaction.
- Power of Attorney (POA): Legal authorization for one person to act on another’s behalf in financial matters.
- Fiduciary Duty: An obligation to act in the best interest of another party.
Additional Resources
- FINRA’s Guide to Discretionary Accounts
- Investment Advisor Code of Conduct
Quizzes
Test your understanding of discretionary account authorization with the following quiz:
### What document is required for a discretionary account?
- [x] Power of Attorney
- [ ] Non-Discretionary Agreement
- [ ] Service Level Agreement
- [ ] End User License Agreement
> **Explanation:** A Power of Attorney is required to grant discretionary trading authority.
### What limitation can a client impose on a discretionary account?
- [x] Asset class restrictions
- [ ] Timeline for investment returns
- [x] Transaction amount limits
- [ ] Business hours for trading
> **Explanation:** Clients can set restrictions on asset classes and transaction amounts within their discretionary account.
### How can a client revoke discretionary authority?
- [x] By submitting a written revocation notice
- [ ] By orally informing the representative
- [ ] By making no trades for a year
- [ ] By reducing account value
> **Explanation:** A written revocation notice is necessary to formally end the POA for discretionary trades.
### What is the primary concern of discretionary trading?
- [x] Acting in the client's best interest
- [ ] Maximizing firm profit
- [ ] Increasing trade volume
- [ ] Reducing client communication
> **Explanation:** Fiduciary duty ensures discretionary trades prioritize the client's best interests.
### Who monitors compliance in discretionary accounts?
- [x] FINRA
- [ ] The stock exchange
- [x] The firm’s compliance department
- [ ] Local government
> **Explanation:** FINRA and a firm's compliance department work to ensure regulatory adherence in discretionary accounts.
### Can a client limit the number of trades in a discretionary account?
- [x] Yes, with specific client directions
- [ ] No, trade volume cannot be limited
- [ ] Only through a court order
- [ ] By closing the account
> **Explanation:** Clients can set limits on trade volume as part of their discretionary account conditions.
### Why is POA revocation important?
- [x] To stop unauthorized trading
- [ ] To increase liquidity
- [ ] To open a new account type
- [x] To comply with client instructions
> **Explanation:** POA revocation is crucial to prevent unauthorized trades and adhere to client wishes.
### What term describes acting in the client’s best interest?
- [x] Fiduciary Duty
- [ ] Agency Principle
- [ ] Moral Obligation
- [ ] Legal Service
> **Explanation:** Fiduciary duty involves managing assets with the client's best interest as a priority.
### In discretionary trading, what must always be documented?
- [x] Client preferences and limitations
- [ ] Daily market predictions
- [ ] Representative's personal trades
- [ ] Press releases
> **Explanation:** Documenting client preferences and limitations helps ensure compliance and suitability of trades.
### True or False: A representative can trade in any asset class with discretionary authority.
- [ ] True
- [x] False
> **Explanation:** Representatives are bound by both client-imposed and regulatory limitations, affecting available asset classes.
Final Summary
Discretionary account authorization requires careful documentation and adherence to both regulatory and client-imposed guidelines. Mastery of these concepts ensures readiness for the Series 7 exam and effective client account management.