So far, every investment product we’ve discussed is traded in brokerage accounts. Investors use these accounts, which are maintained at broker-dealers, to hold and trade securities.
This chapter explains the general process of opening a new brokerage account. Here are the specific areas covered:
Customers must provide certain information when opening a new brokerage account. Registered representatives also must follow specific protocols and procedures.
Collecting the four critical pieces of information is a legal requirement for opening a financial account.
The Patriot Act, legislation signed into law after the September 11th, 2001 attacks, was primarily designed to help prevent terrorism and money laundering. One key requirement is that financial firms verify customer identities, which helps prevent accounts from being opened under false identities.
To meet this requirement, the firm collects four pieces of critical information as part of a Customer Identification Program (CIP):
*While a customer may request mail to be sent to a P.O. box, a physical mailing address must be on file.
**If a customer is a non-resident alien, they must provide their foreign passport and U.S. tax identification number (TIN).
After collecting this information, the firm uses one of two methods to verify the customer’s identity:
If one or more items don’t match, the firm can’t do business with the customer until the mismatch is resolved. For example, if the customer accidentally provides the wrong address, the address must be corrected before the account can be opened.
The firm must also obtain other information before doing business with the customer. One key item is the customer’s occupation. The firm uses this to determine whether the customer is an affiliate (insider) of a publicly traded company or works in the securities industry.
If the customer is an affiliate of a publicly traded company, the brokerage firm must enforce the provisions of Rule 144. As a reminder, Rule 144 prohibits affiliates from quickly selling significant amounts of their control stock. It limits sales to the greater of the last four week’s trading average, or 1% of the outstanding shares, up to four times a year.
If the customer is a registered representative in the securities industry, they’re prohibited from purchasing common stock initial public offerings (IPOs). As we learned in the primary market chapter, this rule helps prevent securities professionals from buying up IPO shares and leaving none for the public.
Brokerage firms must also supervise their employees’ accounts to help prevent misconduct, including insider trading. Insider trading occurs when a trade is executed based on material, non-public information.
To help ensure securities regulations and laws aren’t violated, firms must supervise the accounts of their registered representatives. If a registered representative wants to open an account at another brokerage firm, they must:
In addition, the firm maintaining the account for the representative must provide the employing firm with duplicate statements and trade confirmations if requested.
Firms must ask for many pieces of information when an account is opened, but some items are voluntarily provided. In particular, suitability questions are always optional for a customer to answer.
Suitability questions include:
Items like annual income or net worth may be sensitive for a customer to share. However, the firm needs this information to make suitable recommendations.
“Solicited trades” (transactions based on a recommendation) may only be made if the firm can understand the customer’s financial situation. This requirement is part of FINRA Rule 2090, commonly known as the “know your customer” (KYC) rule. Firms must ensure they obtain the necessary facts about a customer before taking certain actions (such as making recommendations).
If the customer refuses to answer some or all suitability questions, the firm can’t recommend or suggest specific investments. In that case, all of the customer’s trades must be “unsolicited” (transactions not based on a recommendation) and submitted without the firm’s guidance.
When a customer completes a new account form, they must choose what type of account to open.
We’ll discuss margin accounts in detail later in this unit.
After the account type is selected and the new account form is completed, the firm follows a specific process to open the account.
First, a securities principal (supervisor) reviews the new account form to confirm that:
This review is typically performed by someone holding the Series 9/10 licenses (a General Securities Sales Supervisor). If the form is “in good order,” the principal signs it, which approves the account.
There’s no legal or regulatory requirement for the customer to sign the new account form, which allows firms to open accounts over the phone. However, many financial institutions require customers to sign agreements to firm policies, which may include terms of service and an arbitration agreement.
Within 30 days of account approval, the firm must send the customer a confirmation of the information provided on the new account form. The customer verifies the information on file by negative confirmation (affirmation), meaning the investor only needs to respond if the information is incorrect. If the customer doesn’t respond, the firm assumes the information on file is correct.
In addition, the firm must follow up with the customer and verify the information on file every 36 months (three years).
Account statements provide a historical view of account activity, security values, and overall balances. Broker-dealers are required to give customers a clear view of their assets.
At a minimum, firms must send account statements quarterly (every three months). However, monthly statements must be sent if a customer holds penny stocks in their account. Statements may also be sent electronically (by email) if the customer requests.
Although firms must send statements consistently by mail (unless the investor elects email delivery), customers may request that their mail be held for short periods.
FINRA’s rule on holding mail does not explicitly state how often mail can be held. For example, there is no rule against a customer requesting mail be held for three months, then taking a month break, then requesting another hold for three months. All that is required is for the firm to determine “reasonable intervals” for the mail hold instructions to apply. Additionally, firms must educate their customers on other ways to obtain their mail securely (e.g., by email).
In addition to statements, customers receive trade confirmations when a transaction occurs. Trade confirmations provide the following details:
Trade confirmations must be sent at or prior to the “completion of the transaction.” In practice, this means the broker-dealer must send the trade confirmation by the time the trade settles. Like statements, trade confirmations may be delivered by mail or electronically.
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