The Corner

by Bart Ward

Before you open a new account at a brokerage firm, the broker-dealer and registered representative (stockbroker) must evaluate you as to character and credit references, financial reliability and specific financial goals and objectives.

According to New York Stock Exchange Rule 405 (“Diligence as to Accounts”) and Financial Industry Regulatory Authority (FINRA) rule 2090 (“Know Your Customer”) exchange members and registered representatives must exercise due diligence to learn essential facts about every customer that opens an account. General guidelines suggest the registered representative interview the client in order to obtain an inventory of the client’s present securities’ holdings and discover the client’s financial situation, needs and risk posture.

According to FINRA, “rule 2090 requires firms to ‘use reasonable diligence, in regard to the opening and maintenance of every account, to know (and retain) the essential facts concerning every customer….’ The rule explains that essential facts are ‘those required to (a) effectively service the customer’s account, (b) act in accordance with any special handling instructions for the account, (c) understand the authority of each person acting on behalf of the customer, and (d) comply with applicable laws, regulations, and rules.”

Generally, any competent person may open an account. Any person declared legally incompetent may not open an account. Fiduciary or custodial accounts may be opened for minors or legally incompetent individuals.

After opening an account, the client and the registered representative establish payment and delivery instructions. These instructions may be changed for individual transactions. For a purchase or a buy order, the customer must stipulate whose name is to be on the security and who will keep the security certificate. For buy orders, customers may select any of the following payment and deliver instructions:

• Transfer and ship. Securities are transferred into the name of the customer and shipped to them.

• Hold in street name. Securities are transferred into the brokers-dealer’s name and held by the broker-dealer. Although the broker-dealer is the nominal owner of the securities, the customer is still the beneficial owner. “Street” here refers to Wall Street and is shorthand for the world in which the firms operate.

• Delivery vs. payment. In delivery vs. payment (DVP), securities are delivered to a bank or depository against payment. In other words, this is cash on deliver (COD) settlement. The broker-dealer must verify the arrangement between customer and bank or depository, and the customer must notify the bank or depository of each purchase or sale.

Account ownership. Procedures and relevant regulations vary according to the type of person, group or business that owns the account. The principal types of ownership are:

• individual

• joint (for example, a husband and wife or two business associates)

• corporate, limited liability or partnership

• trust

• ira

Trading authorization. The primary types of trading authorization are:

• Discretionary. After receiving authority from the customer, the registered representative enters trades without having to consult the customer before each trade.

• Fiduciary. The individual given fiduciary responsibility enters the trades for the account.

• Custodial. The custodian for the beneficial owner enters all trades.

A new account form’s basic sections are: Primary Account Holder, Entity Account Information, Suitability, Investment Product Knowledge, Account Characteristics, Beneficiary Information and Customer Agreement.

While much of this sounds technical and is not very exciting, there is much more going on here than meets the eye for the brokerage firm, registered representative and client. This column for years has run a theme about how important is to understand your attitudes, objectives and risk posture before investing—in anything. Wall Street has throughout the ages been enamored with what is today called “product.” That is investments of all types and the creation of them. Clients themselves get caught up in the game, often motivated by fear and greed.

However, there is the starting point to make investing less like gambling. This for the client is to understand what their attitude is toward investing, what objectives they are trying to accomplish and what the risks are when making those investments. You must have a plan if things don’t go as anticipated and what you will do if your investment goes south instead of north. While it is crucial that the investment professional “knows the customer,” you as a client must know yourself.

Quote of the Week: “A poor stock market will discourage both consumer and business outlays.  Also a decline in the value of stocks reduces their value as collateral, a further depressant.”—George Soros

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