Selecting New Accounts and the Series 7 Exam
Investors can open many different types of accounts through a broker-dealer. Besides knowing a customer’s investment profile, for the Series 7 exam you need a basic understanding of the types of accounts. Fortunately, most of them are pretty straightforward.
Single and joint accounts
Some investors prefer to share; others like to go it alone. Whatever their preference, adults can open up accounts that fit their needs:
Single (individual) accounts: Naturally, this account is in the name of one person. The key thing for you to remember is that individuals may not open accounts in other people’s names without written permission (power of attorney).
Joint accounts: This account is in the name of more than one person. All individuals named on the account have equal trading authority for the account. For Series 7 exam purposes, you need to be familiar with two types of joint accounts:
Joint tenants with rights of survivorship (JTWROS): With this type of joint account, when a joint tenant named on the account dies, his or her portion of the account passes on to the surviving joint tenant. These accounts are usually set up almost exclusively for husbands and wives. In states where community property laws exist (currently Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), investments acquired during the marriage are automatically presumed to be jointly owned by the husband and wife.
Joint with tenants in common (JTIC): With this type of account, when one tenant of the account dies, his or her portion of the account becomes part of his or her estate. JTICs are usually set up for individuals who aren’t related.
A registered representative may open a joint account with a client provided that a proportionate sharing agreement between the two parties is on file.
The following question tests your knowledge of account types.
All of the following people may open a joint account EXCEPT
(A) Two friends
(B) A husband and wife
(C) A parent and minor son
(D) Three strangers
The right choice here is (C). A joint account is an account in the name of more than one adult. Choices (A), (B), and (D) are all possible for joint accounts; however, an account opened for a minor must be a custodial account, which I discuss in the next section.
Trust accounts are ones that are managed by one party for the benefit of another party. A specific type of trust account that you’re most likely to see on the Series 7 exam is a custodial account. A custodial account is set up for a child who’s too young to have his own account. A custodian (adult) makes the investment decisions for the account. Any adult can open a custodial account for a minor, so the people named on the account don’t have to be related.
Custodial accounts are trust accounts and may be referred to on the Series 7 exam as UGMA or UTMA accounts because they fall under the Uniform Gifts to Minors Act or Uniform Transfer to Minors Act. A UTMA account is an extension of the UGMA account that allows gifts in addition to cash and securities to be transferred to the minor. The additional gifts allowed are art, real estate, patents, and royalties.
Additionally, because the minor is too young to make investment decisions for himself, some rules are specific to custodian accounts:
There can only be one custodian and one minor per account.
The minor is responsible for the taxes (the minor’s Social Security number is registered for the account).
The account is registered in the name of the custodian for the benefit of the minor (the custodian is responsible for endorsing all certificates).
The account can’t be held in street name (in the name of the broker-dealer with an ID number).
Securities can’t be traded on margin or sold short.
Anyone may give a gift of cash or securities to the minor. The gift is irrevocable (can’t be refused by the custodian).
If an account receives rights, the custodian can’t let the rights expire. Because rights have value, a custodian can exercise or sell the rights.
Custodial accounts are for minors, so as soon as a minor reaches the age of majority, which is determined by the minor’s state of residence, the custodial account is terminated and the account is transferred to a single account in the name of the (former) minor.
Decision making can be stressful, and some investors don’t want to deal with it. With a discretionary account, an investor can give you (the registered rep) the right to make trading decisions for the account. All discretionary accounts need a written power of attorney signed by the investor, which gives trading authorization to the registered rep.
If a customer places an order but doesn’t specify the security, the number of shares or units, and/or whether the customer wants to buy or sell, you need a written power of attorney. If you don’t have a written power of attorney, you can’t do anything but decide when to place the order (timing).
For example, suppose one of your customers calls you and says that he wants to sell 100 shares of ABC common stock and you believe you can get a better price later in the day. The customer can give you verbal permission to place the order at your discretion. This type of order is called a market not held order and is usually good only for the rest of the day.
Here are some specific rules for discretionary orders that you’re likely to see on the Series 7 exam:
Each discretionary order must be marked as discretionary on the order ticket.
As with other orders, principals must sign each order ticket.
A principal needs to review discretionary accounts regularly to make sure reps don’t trade excessively to generate commissions, which is called churning.
A fiduciary is anyone who can legally make decisions for another investor. Examples of fiduciaries are custodians (UGMA accounts), a registered rep having power of attorney, an executor of an estate, a trustee, and so on. Fiduciaries are subject to the Prudent Man or Prudent Investor Rule, which means that they must invest the fund’s money in securities designated by their state’s legal list. If their state does not have a legal list, fiduciaries should invest in securities that only a prudent person who’s seeking reasonable income and preservation of capital would invest in.
Only incorporated businesses can open corporate accounts. If you’re opening a corporate account, you need to obtain the tax ID number of the corporation, which is similar to an individual’s Social Security number. Additionally, you need to obtain a copy of the corporate resolution, which lets you know who you should be taking trading instructions from (so you don’t get a call like, “Hi, I’m Joe Blow, the janitor for XYZ Corporation, and I’d like to purchase 1,000 shares of ABC for our company”).
If a corporation wants to open a margin account (accounts where they’re borrowing some money from the broker-dealer to purchase securities), you also need a copy of the corporate charter (bylaws). The corporate charter has to allow the corporation to purchase securities on margin.
An unincorporated association is sometimes called a voluntary organization. An unincorporated association is a group of two or more individuals who form an organization for a specific purpose (in this case, investing). If an unincorporated association has too many characteristics of a corporation, such as having a board of directors, limited liability, and so on, it may be treated and taxed at a higher rate, as if it were a corporation.
Accounts set by institutions such as banks, mutual funds, insurance companies, pension funds, hedge funds, and investment advisers are considered institutional accounts. Their role is to act as specialized investors on behalf of others.
Two or more individual owners of a business that’s not set up as a corporation may set up a partnership account. All partnerships must complete a partnership agreement, which the broker-dealer has to keep on file. The partnership agreement, like a corporate resolution, states who has trading authorization for the account so you know who you’re supposed to be taking orders from.
No matter which type of account you open, portfolio diversification is key.