Account features
Many Series 63 test questions involve scenarios registered persons encounter with investors. Some of those circumstances will include mentions of account features and registrations. This chapter covers those topics to equip you with the knowledge necessary to understand those scenarios. If you’ve already prepared for the SIE, Series 6, 7, 65, or 66 exams, this chapter will likely feel like a review.
Account features
Investment accounts can have numerous features, including check writing, option trading abilities, margin, and cash management. The primary feature we’ll discuss in this section relates to trading authorization. If an account owner wants to provide a third party the power to act on their behalf, they can obtain a power of attorney (POA).
Limited POA allows the third party to perform account transactions, allowing the authorized person to buy and sell securities on behalf of the account owner. However, they cannot request withdrawals from the account. Full POA allows the third party to buy and sell securities as well as request withdrawals.
If the POA is non-durable, it ceases to exist if the account owner becomes incapacitated. Incapacitation includes medical comas and mental incompetency. Regardless of the reason, non-durable POA is revoked if this occurs. Durable POA survives incapacitation and remains in effect.
POA always ceases to exist if the account owner were to pass away. At that point, the executor of the estate would take over control of the decedent’s (deceased person’s) assets. Also, POA can be revoked at any time by the account owner.
Account registrations
We’ll discuss the following account registrations in this section:
- Individual accounts
- Joint accounts
Individual accounts
An individual account is owned by one person (obviously). This account type can also be registered as transfer on death (TOD), which is a designation that adds a listed beneficiary (or beneficiaries). TOD designations avoid probate and are directly transferred to the beneficiaries upon the death of the account owner.
Probate court involves distributing assets to surviving family and friends after a person dies. When an account lacks a beneficiary, it comes under the jurisdiction of the probate courts. Whether the decedent had a will or not, the court determines the estate distribution process and who runs it. Probate can be a complicated and difficult process to go through, and many investors plan to minimize the number of accounts and assets that become part of the process. TOD accounts are excluded from probate and only require a death certificate to be submitted in order for the account to be claimed.
If an individual account lacks a TOD designation, it is included in probate. In order to claim control of the account, the executor or administrator of the estate must submit court documents that prove their status. Executors and administrators are granted power by the probate court to act on behalf of the estate. This is the person who is responsible for paying off the debts of the decedent and distributing estate assets to beneficiaries.
Whether a person is named as the executor in a will or not, the probate courts must officially appoint them. Once the executor receives their court appointment document, they submit it to the financial firm to gain control of the decedent’s account.
Joint accounts
Accounts with more than one owner are joint accounts. There are two primary types of joint accounts: with rights of survivorship and tenants in common.
Joint with rights of survivorship (WROS) accounts provide equal ownership rights to all owners. If one of the owners passes away, the remaining owners fully own the account. For example, assume John and Stacey own a joint WROS account together. If John passes away, Stacey now owns the entire account. As long as there’s a surviving owner on the account, joint WROS accounts avoid probate.
Joint WROS accounts may also have a transfer on death (TOD) designation, which only applies if all owners on the account pass away. If that were to occur, the assets become the property of the account beneficiaries. If TOD does not exist, the account becomes property of the estate of the last living account owner (subject to probate).
Joint accounts may also be set up as tenants in common (TIC) accounts. TIC accounts provide specific ownership allotments to their owners. If one of the owners passes away, their allotment goes to their estate and is handled in probate court. For example, assume Jim owns 40% of a TIC account and Jada owns 60%. If Jada were to pass away, her 60% becomes property of her estate and is handled in probate court. Jim keeps his 40% and moves it to an individual account in his name.
Regardless of the type of joint account, both WROS and TIC accounts work the same when all account owners are alive. Even if there are 15 account owners on the joint account, any one owner can submit trading instructions, receive all the mail, manage the account, and request withdrawals from the account without the permission of the other owners. However, all of the account owners’ names must appear on any check being issued, regardless of who requested the check.
Fiduciary accounts
We first learned of the fiduciary duty when we discussed the disclosures investment advisers make to their clients. Fiduciaries must put their client’s interests before their own and act in their best interest. All of the accounts in this section share this characteristic in common.
Fiduciary accounts are governed by the Uniform Prudent Investor Act (UPIA), which requires fiduciaries to invest assets primarily in a safe manner from a holistic (big picture) perspective. The UPIA does not forbid fiduciaries from investing in any particular asset class. For example, assume you’re managing an account for a risk-averse investor. A few aggressive investments could exist in the portfolio as long as the overall structure reflected a conservative outlook. A fiduciary’s performance is not based on one or a few investments, but on the comprehensive output of the portfolios they construct.
Additionally, the UPIA explicitly calls for fiduciaries to prioritize diversification. This involves investing in multiple asset classes (e.g., stocks, bonds, real estate) and individual securities. Diversification greatly reduces non-systematic risk, which is a risk that applies to a single investment or a small portion of the market.
We’ll discuss these fiduciary registrations in this section:
- Discretionary
- Custodial
- Guardianship
- Trusts
Discretionary accounts
A discretionary account provides a financial professional with trading authority. Investment advisers and investment adviser representatives (IARs) consistently utilize these account types when actively managing their clients’ money. When a firm has discretionary authority over a customer’s account, they proactively make investment decisions for them. POA is required for discretionary accounts, and advisers typically obtain limited POA (a.k.a. limited trading authorization) to avoid taking custody. Remember, a person is considered to maintain custody if they can withdraw funds out of a client’s account, which comes with a number of added requirements.
A discretionary order is defined as one where the financial professional is making a decision on behalf of the customer pertaining to any of the following:
Asset - What security is being bought or sold
Action - If the security is being bought or sold
Amount- How many shares or units are being bought or sold
Many test takers remember this as the “AAA” rule. If the financial professional chooses the asset, action, and/or amount for a trade, the order is considered discretionary and requires a POA to be submitted.
Financial professionals can make some choices for customers and avoid the trade being considered discretionary. Both of the following can be decided without POA or discretionary status:
- Price of the security
- Time of the trade
Financial professionals can choose the price and/or time of a transaction without the trade being considered discretionary. Regardless, the trade must be completed within one day in order to maintain its non-discretionary status. If it takes more than one day to complete, the order reverts back to discretionary status and requires a POA.
Discretionary accounts are usually marketed to customers as wrap accounts. As we discussed in a previous chapter, these accounts provide a number of services, typically including asset management, trade execution, and general account maintenance. Instead of paying the firm for each separate service, wrap accounts have all of their fees “wrapped” up into one charge.
Wrap accounts are considered investment advisory products, which may only be offered by investment advisers and IARs. If a broker-dealer or agent wanted to offer them, the broker-dealer would be required to be dual-registered as an investment adviser, and the agent would be required to be dual-registered as an IAR.
Custodial accounts
Custodial accounts are opened for minors under the age of 18. A custodian must open the account and manage the assets on behalf of the minor, but the assets in the account are the property of the minor. Custodians are typically parents, but technically can be any adult. Only one custodian and minor are allowed per custodial account.
Guardianship accounts
When a person cannot manage their own finances, a court-mandated guardian may be appointed to oversee that person’s assets. Typically involving mental incapacitation or the inability to manage money, guardianship accounts are opened by financial firms when they receive proper court appointments. At that point, the account owner’s assets are placed into a guardianship account and can only be managed by the court-appointed guardian.
Trust accounts
A trust account is created for the benefit of a specific beneficiary. Trusts are legal entities involving these three distinct parties with varying responsibilities:
- Grantor(s)
- Trustee(s)
- Beneficiary or beneficiaries
The grantor is responsible for creating and funding the trust. The first step to creating a trust involves the grantor utilizing legal services to construct a trust agreement. Within this agreement, the grantor specifies the objectives, management styles, and the trust’s beneficiary or beneficiaries. Trust objectives vary widely, including funding a child’s college education, supporting an elderly family member, or managing assets on behalf of a charity.
The grantor also names trustees in the trust agreement. Trustees manage the trust according to the instructions provided by the grantor. When a trust account is opened with a brokerage firm, trustees manage trust assets by trading securities and performing general transactions (e.g., distributing funds to beneficiaries).
A trust is managed for the sole benefit of its beneficiaries, which could be a person, persons, or an organization. Beneficiaries don’t have any legitimate power over the trust, as the trustees are in control. However, the trustees serve the trust and its beneficiaries. The role of a beneficiary is minimal - they exist to receive the “benefits” of the trust (e.g., cash distributions, assets).
Trust accounts are fiduciary accounts, but are not subject to the typical “safe” fiduciary standards (e.g., investing in low-risk securities). Trustees could pursue more risky investment strategies if the grantor mandates or allows riskier strategies in the trust agreement. Additionally, trust accounts can be opened as margin accounts (allowing the trust to invest borrowed funds) as long as the trust agreement specifically allows it. When a trust account application is submitted, the brokerage firm requests the trust agreement to determine if the account is eligible for margin.
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