Other registrations | Account registrations | Brokerage accounts

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
DVP / RVP accounts
Pattern day trading accounts
Fee-based accounts
Numbered accounts

Prime brokerage accounts

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.

Definitions

Retail investor: An individual investing for themselves or their family
Institutional investor: A single entity investing on behalf of a group of clients

Examples: hedge funds, mutual funds, insurance companies, banks

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.

DVP / RVP accounts

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!

Sidenote

How securities are held

With the digital capabilities we are accustomed to in the modern age, securities issued in book entry form are capable of being held in multiple ways. As a reminder, book entry means ownership of securities is tracked digitally, without any physical certificates. Most securities issued and trading in this form are held in street name.

When a broker-dealer buys securities on behalf of the customers it maintains accounts for, the investor is usually not reflected as the shareholder or bondholder. From the perspective of the transfer agent (the entity responsible for tracking the ownership of securities), the investor’s broker-dealer is the official owner of the security. If you were to purchase a security through an E-Trade account, E-Trade would be viewed as the owner of the stock on the transfer agent’s books. Regardless, you would still be the ultimate and true owner of the security. No need to worry about losing ownership - this is completely normal in the industry. The street name system allows for trades to occur smoothly, without the need for extra paperwork or investor signatures to facilitate a trade.

A common alternative to holding securities in street name is known as direct registration (or sometimes the Direct Registration System). Instead of a broker-dealer maintaining custody of the security in their name, the issuer or its transfer agent holds the security on behalf of the investor. The investor receives a statement of ownership directly from the issuer or its transfer agent, but may not be provided the same level of service many broker-dealers offer (e.g. 24/7 online access, beneficiary designations, sophisticated trading tools, etc.).

When securities are not held in street name or through direct registration, the process of trading securities typically becomes more difficult. While bearer bonds do not exist anymore, investors may still purchase stocks and maintain their ownership through physical certificates. To buy securities in this manner, the investor still must obtain the services of a broker-dealer. Once bought, the security’s ownership will be transferred into the investor’s name (on the books of the transfer agent), then the security will be sent to the customer. This process is referred to as transfer and ship in the industry.

Holding a security in this manner can be a headache. While there’s a record of ownership, the investor must protect and safekeep the certificate from theft or damage. As quoted by Dr. Ben Branch, professor of finance at the Isenberg School of Management at the University of Massachusetts-Amherst:

“If you hold your stock certificate in a safe deposit box, when you want to sell, you have to go down to the bank and get it out and take it physically to a broker. You have to sign the certificate and the broker then has to transmit that certificate to Depository Trust Corp*. This process is supposed to take no more than three days but there is always the risk that you will lose the certificate.”

*As a reminder, the Depository Trust & Clearing Corporation (DTCC) is the primary clearinghouse used by the industry. The DTCC is a non-profit, industry-owned organization that clears the vast majority of trades in the financial markets. You may remember the DTCC from your SIE exam studies, but it’s generally not tested on the Series 7.

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 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):

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

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.

Numbered accounts

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.

Key points

Prime brokers

Provide services to institutional customers:
- Maintain custody
- Record keeping
- Send trades to various firms

DVP accounts

Delivery vs. payment
The investor maintains custody of assets at the bank
Broker-dealer executes purchase of security
Payment made to broker-dealer upon delivery to the bank

RVP accounts

Receive vs. payment
The investor maintains custody of assets at the bank
Broker-dealer executes the sale of the security
Payment made to bank upon delivery of security to broker-dealer

Street name

Securities held in the custody of broker-dealer
Broker-dealer considered owner on transfer agent’s book
Investor is the “true” owner of the security

Direct Registration System

Issuer or transfer agent holds security on behalf of the investor

Transfer and ship

Securities purchased through broker-dealer
Registered in name of the investor
Physical certificates shipped to the investor

Day trade

Purchase and sale of same security intraday

Pattern day trader

Investor performing 4 day trades in a 5 business day period

Pattern day trader accounts

Minimum $25,000 equity
May trade 4x minimum maintenance excess
May require risk disclosure

Fee-based accounts

Charge one annual fee for all trades performed
Suitable for self-driven investors trading frequently

Numbered accounts

Customer’s name is hidden from representatives
Account owner referred to by a number (e.g. Customer # 1234)
Firm must maintain a record of the actual owner