2.1.1 The general process
Investors utilize brokerage accounts maintained at broker-dealers to hold and trade securities. This chapter covers the general process of opening a new account, and these are the specific areas we’ll discuss:
Customers must submit certain pieces of information when opening a new brokerage account. Additionally, registered representatives are required to follow specific protocols and procedures. Gathering the “four critical pieces of information” is a legal requirement to open a financial account.
The Patriot Act, a legislation signed into law after the September 11th, 2001 attacks, was primarily created to prevent terrorism and money laundering. The law requires financial firms to verify the identities of their customers, which prevents customers from creating accounts under fake personas. To accomplish this, the firm must collect four pieces of critical information from the customer as a 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 follows one of two procedures to verify its customer’s identity. The traditional method involves comparing the provided information against a government-issued I.D., like a driver’s license, passport, or military I.D. The I.D. must be currently valid and include a picture, which is why birth certificates cannot be used for identity verification.
The modern way of verifying a customer’s identity utilizes credit bureaus. TransUnion, Experian, and Equifax, which are the three largest credit bureaus, are utilized in this process. When a customer submits their “critical information,” the broker-dealer checks data housed by the credit bureaus to confirm that the information provided matches an actual person. If one or more pieces do not match, the firm cannot do business with the customer until the mismatch is resolved. For example, if the customer mistakenly provided the wrong address, they must fix the issue before their account is opened.
The firm must obtain other items before doing business with the customer. The customer’s occupation is one of those items, as it’s the firm’s responsibility to confirm whether or not their 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.
If the customer is a registered representative in the securities industry, they’re prohibited from purchasing common stock initial public offerings (IPOs). This rule prevents securities professionals from buying up IPOs and leaving nothing for the public. The firm will know if these restrictions should be imposed by asking for the customer’s occupation.
Brokerage firms must also supervise their employees’ accounts to prevent misconduct, which includes insider trading. Insider trading occurs when a trade is executed based on material, non-public information. To prevent securities regulations or laws from being broken, firms must supervise the accounts of their registered representatives. If a registered representative wants to open an account at another brokerage firm, they must obtain written approval from their employer and notify them when the account is opened. Additionally, 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 information for a customer to provide. However, the firm must obtain this information to make suitable recommendations. “Solicited trades” (transactions based on a recommendation) may only be made if the firm can fully understand a customer’s financial situation. This provision is a part of FINRA Rule 2090, commonly known as the “know your customer” (KYC) rule. Firms must ensure they obtain all the necessary facts about a customer before performing certain actions (like making recommendations).
If the customer refuses to answer some or all suitability questions, the firm cannot recommend or suggest specific investments. 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 determine what type of account they will open. Cash accounts are standard brokerage accounts that require 100% payment for any securities purchased. Margin accounts allow the investor to borrow cash and securities from the broker-dealer for investment purposes, often leading to increased gain and risk potential (leverage). We’ll discuss margin accounts in detail later in this unit.
After the account type is determined and the new account form is completed, the firm goes through a specific process to open the account.
First, a securities principal (supervisor) reviews the new account form to ensure all required information was provided and standard account opening protocols were followed. This job is typically performed by a person holding the Series 9/10 licenses (known as a General Securities Sales Supervisor). If the form is “in good order,” the principal will sign the form, effectively approving 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 their 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), which means the investor only needs to respond if the information on file is incorrect. If the customer does not respond, the firm assumes the details on file are correct. Additionally, 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 obligated to provide customers a transparent view of their assets. At a minimum, firms must send account statements to customers quarterly (every three months). However, monthly statements must be sent if a customer holds penny stocks in their account. Additionally, statements may be sent electronically (by email) if the customer requests.
Although the firm must send consistent statements by mail (unless the investor elects for email delivery), customers may request their mail be held for short periods. For up to three months, customers may request that statements be held for any reason. For the mail to be held longer than three months, the customer must submit a request in writing and demonstrate a legitimate reason for the request (e.g., military deployment, safety, and security-related issues).
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 detail of the following:
Trade confirmations must be sent at or prior to the “completion of the transaction.” Essentially, the broker-dealer must send the trade confirmation by the time the trade settles. Like statements, trade confirmations may be distributed by mail or electronically.
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