Discretionary accounts

A discretionary account provides a financial professional with trading authority over an account. If you didn’t have the time or knowledge necessary to manage your own brokerage account, you could give your broker power of attorney (POA), which allows them to make investment decisions on your behalf. When a firm has POA over a customer’s account, they make investment decisions for them without prior customer approval.

In order for the firm and/or broker to make suitable decisions, customers must answer all suitability questions posed by the firm. If you recall, suitability questions (like net worth and annual income) are voluntary for customers to answer. However, if they are unanswered, the customer cannot be provided with recommendations. The same rule applies to discretionary accounts.

A discretionary account is a type of fiduciary account. A fiduciary is a third party overseeing another person’s assets. Fiduciaries must put their client’s interests before their own and act in their best interest.

Discretionary accounts come with added supervision due to the power they give financial professionals. If your broker has POA on your account, they have a lot of control over your financial assets. Therefore, all trades made on behalf of customers must be marked as ‘discretionary’ and must be reviewed more often by principals (supervisors). All discretionary trades must be reviewed promptly after being submitted.

A discretionary order is defined as one where the financial professional is making a decision on behalf of the customer pertaining to any of the following:

• Asset: what security is being bought or sold

• Action: if the security is being bought or sold

• Amount: how many shares or units are being bought or sold

Many people remember this as the “AAA” rule. If the financial professional chooses the asset, action, or amount for a trade, the order is considered discretionary and requires a POA to be submitted.

Sometimes, financial professionals can make certain choices for customers and avoid the trade being considered discretionary. Both of the following can be decided without POA or discretionary status:

• Price of the security

• Time of the trade

Financial professionals can choose the price and/or time of a transaction without the trade being considered discretionary. Regardless, the trade must be completed within one day in order to maintain its non-discretionary status. If it takes more than one day to complete, the order reverts back to discretionary status and requires a POA.

Discretionary accounts are usually marketed to customers as “wrap” accounts. These accounts come with a list of services, which typically include asset management and general account maintenance. Instead of paying the firm for separate services and trade commissions, wrap accounts have all of their services “wrapped” up into one fee.

Wrap account fees are usually charged as asset under management (AUM) fees. For example, a customer with a $100,000 account would pay an annual fee of $1,000 if their wrap account fee was 1% of AUM.

Wrap accounts are considered investment advisory products and require financial professionals to be properly licensed as investment adviser representatives in order to sell them. This typically involves passing the Series 65 or Series 66 exams.