Other registrations

There are several account types that don’t fit the standard retail brokerage model. This chapter covers:

• Prime brokerage accounts
• DVP / RVP accounts
• Pattern day trading accounts
• Fee-based accounts
• Numbered accounts

Prime brokerage accounts

Prime brokerage accounts designate one central broker (the prime broker) for a client, typically an institution, while other brokers may execute the client’s trades. The prime broker (always a financial firm) serves as the main point of contact. Beyond managing the relationship, the prime broker:

• Maintains custody of the client’s assets
• Handles recordkeeping for the client’s assets

Institutional clients may prefer different executing brokers for different types of trades. Hedge funds commonly use prime brokerage accounts for this reason. For example, a hedge fund might prefer TD Ameritrade for stock trades, Fidelity for bond trades, and Charles Schwab for options trades.

Even if multiple executing brokers place trades, the client’s assets remain with the prime broker. From the client’s perspective, they work with one primary firm while trades may be routed to several places.

Prime brokerage can also reduce borrowing costs. If the client uses margin loans through a single firm, the larger consolidated loan balance may qualify for lower margin interest rates.

DVP / RVP accounts

Most retail investors have the same broker-dealer both execute trades and maintain custody of their assets. For example, an investor with a Robinhood account has trades executed by the firm, and the firm also maintains the account records and safeguards the assets.

Delivery versus payment (DVP) and receive versus payment (RVP) accounts work differently. Investors (usually institutions) still use a broker-dealer to execute trades, but custody of the assets is held at a third-party financial institution, typically a bank.

Here’s how a DVP settlement works (this is used when the investor is buying a security):

• The investor contacts the broker-dealer and places a buy order.
• The investor instructs the broker-dealer to deliver the security to the investor’s bank (or other chosen financial institution).
• The broker-dealer executes the trade.
• At settlement, the broker-dealer delivers the security to the bank.
• When the security is delivered, the bank releases payment to the broker-dealer.

That’s why it’s called delivery versus payment: payment is made upon delivery.

An RVP settlement is used when the investor is selling a security:

• The investor contacts the broker-dealer and places a sell order.
• The investor instructs the broker-dealer to deliver the sale proceeds to the investor’s bank.
• The broker-dealer executes the trade.
• At settlement, the broker-dealer delivers payment to the investor’s bank.
• When the sale proceeds are delivered, the security is released to the broker-dealer.

That’s why it’s called receive versus payment: payment is received once the security is delivered.

Pattern day trading accounts

A day trade occurs when an investor buys and sells the same security on the same day. For example, an investor buys Nike stock at $125 per share in the morning and sells it at $130 per share in the afternoon. Short-term trading can be unpredictable and risky, though some investors try to make a living from it.

If an investor makes four day trades within five business days, they’re considered a pattern day trader. When that happens, the requirements for the investor’s margin account change (most pattern day traders use margin accounts).

Two key rule changes to know:

• The minimum equity requirement is $25,000 (instead of the standard $2,000 requirement).
• The investor may day trade up to four times their maintenance margin excess, which is the amount above the standard 25% equity requirement for long margin accounts*.

*Don’t get too caught up in the math of this topic. Series 7 questions usually focus on the rules rather than detailed calculations. If you know that pattern day trader accounts require $25,000 in equity and allow day trading up to four times maintenance margin excess, you’re ready for most exam questions on this concept.

Broker-dealers that promote day trading strategies must provide a risk disclosure statement to any customer who qualifies as a pattern day trader. The disclosure includes the following statements (also available on FINRA’s website):

• Day trading can be extremely risky
• Be cautious of claims of large profits from day trading
• Day trading requires knowledge of securities markets
• Day trading requires knowledge of a firm’s operations
• Day trading will generate substantial commissions, even if the per trade cost is low
• Day trading on margin or short selling may result in losses beyond your initial investment

Fee-based accounts

Investors who trade frequently and make their own decisions may want to avoid paying a commission on every trade. Fee-based accounts allow the investor to pay one annual fee for trade execution services provided by the broker-dealer.

Because the annual fee is usually high, these accounts are generally only suitable for investors who trade often.

With the rise of commission-free trading at many discount brokers, fee-based accounts may become less common. However, some broker-dealers still charge commissions and continue to offer fee-based accounts.

Don’t confuse a fee-based account with a wrap account. Wrap accounts charge one fee for transaction execution and investment management services. Fee-based accounts are directed by the investor, not managed by an investment adviser.

Numbered accounts

If an investor wants anonymity when interacting with registered representatives, they may open a numbered account. Instead of the customer’s name appearing on the account, the account is identified by a number (e.g., Customer # 1234).

Numbered accounts are often used by celebrities, athletes, politicians, and others who prefer to keep their identities private. Even so, the firm must maintain the customer’s name and identifying information somewhere in its records.