There are various account types that fall outside the norms of typical retail brokerage accounts. We’ll discuss the following in this chapter:
Prime brokerage accounts appoint one central broker for a client (typically an institution), with many other brokers actually executing trades. The prime broker, which is always a financial firm, acts as the main point of contact. In addition to managing the relationship, the prime broker maintains custody and all recordkeeping of the client’s assets.
When an institutional client wants to perform a transaction, they utilize the services of various brokers. Hedge funds commonly utilize prime brokerage accounts because they notoriously prefer certain firms for specific transactions. For example, a hedge fund may prefer TD Ameritrade to do its stock trades, Fidelity to do its bond trades, and Charles Schwab to do its options trades.
Regardless of how many executing brokers actually end up executing trades for the client, all assets are maintained by the prime broker. The client only deals with one financial firm, although their trades are going to various places. Additionally, the client usually saves on interest if utilizing margin loans all through one firm as financial firms charge lower margin interest rates for larger loans.
Most retail investors have the broker-dealers doing their trades additionally maintain custody of their assets. For example, an investor with a Robinhood account not only has their trades executed by the brokerage firm, but also have their accounts maintained, recordkept, and safeguarded by them as well.
Delivery versus payment (DVP) and receive versus payment (RVP) accounts work differently. Investors (usually institutions) utilizing these accounts continue to employ the transaction execution services of broker-dealers. However, their assets are held at a third-party financial firm, typically a bank.
Let’s walk through how a DVP settlement would occur, which involves the investor purchasing a security. The investor contacts their broker-dealer, requests to buy an investment, and informs the firm of their desire for the security to be delivered to the bank (or financial institution) of their choice. The broker-dealer executes the trade and subsequently delivers the security to the investor’s bank upon settlement. When the security is delivered, the bank releases payment to the broker-dealer. This is what gives DVP accounts their name - payment is made to the broker-dealer on delivery!
Accounts utilizing RVP settlement involve the investor selling a security. The investor contacts their broker-dealer, requests a sale of an investment they own, and informs the firm of their desire for the sales proceeds to be delivered to the bank of their choice. The broker-dealer executes the trade and subsequently makes payment to the investor’s bank upon settlement. When the sales proceeds are delivered to the bank, the security being sold is released to the broker-dealer. This is what gives RVP accounts their name - payment is received from the broker-dealer once the security is delivered!
A day trade occurs when an investor buys and sells the same security on the same day. For example, an investor purchases Nike stock at $125/share in the morning and sells it at $130/share in the afternoon. While short-term trading is unpredictable and risky, some investors make a living off this type of trading.
When an investor performs four-day trades within a five business day period, they are considered pattern day traders. If this occurs, the investor’s margin account requirements change (the vast majority of pattern day traders utilize margin accounts). While you’ll learn more about them later in this chapter, there are two primary changes to be aware of.
First, the minimum equity for these accounts is $25,000 (instead of the normal $2,000 requirement). Second, the investor may only day trade four times their maintenance margin excess, which is any amount above the normal 25% equity requirement for long margin accounts*.
*Don’t get too caught up in the math of this topic. Series 7 questions tend to focus on the rules without going terribly deep into calculations or concepts. If you know pattern day trader accounts require $25,000 equity and may only trade four times their maintenance margin excess, you’re well prepared for questions on this concept.
Broker-dealers that promote day trading strategies must provide a risk disclosure statement to any customer qualifying as a pattern day trader. The following statements are included in this disclosure (and are also available on FINRA’s website):
Self-driven investors that trade often may want to avoid paying commissions on each trade. Fee-based accounts allow investors to pay one annual fee for all trade execution services provided by their broker-dealer. The annual fee tends to be fairly steep, so these accounts are only suitable for investors that trade often in their accounts.
With the recent offering of commission-free trading by numerous discount brokers, these accounts may become obsolete in the future. However, a number of broker-dealers still charge commissions and offer fee-based accounts.
You should not confuse this type of account with a wrap account. As a reminder, wrap accounts charge one single fee for transaction execution and investment management services. Fee-based accounts are managed by the investor, not an investment adviser.
If an investor prefers to be anonymous when interacting with registered representatives, they may open a numbered account. Instead of their name appearing on their account, a number appears (e.g. Customer # 1234). Numbered accounts are often used by celebrities, athletes, politicians, and other individuals that would prefer for their identities to be kept secret. Regardless, the firm must keep the customer’s name and identifiable information on file somewhere within its system.
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