Learn What Types of Accounts Brokers Have Authority To Trade On Your Behalf
Generally speaking, there are two kinds of accounts when it comes to differentiating between who has authority to trade in a customer account at a brokerage firm. These accounts are called non-discretionary and discretionary accounts. FINRA Rule 3260, formerly NASD Rule 2510, governs what a broker may or may not do when it comes to entering orders in a customer’s account.
Most accounts are non-discretionary, meaning that a broker may only enter an order for a client after he discussed the trade with the client and obtained client approval with one exception, which is a broker may exercise “time and price” discretion on when to enter the order on only that day, but only if granted by the client. A broker acting any other way in entering an order in a non-discretionary account is often accused of engaging in “unauthorized trading.” We receive many telephone calls from investors complaining about “unauthorized trading,” and when we ask questions, we find out what really happened is the broker engaged in unlawful “discretionary” trading. This is an important distinction that many lawyers and customers do not appreciate, so we will explain the difference and why it may have been critical to your case at the end of this article.
The other category is the discretionary account, which can only lawfully exist if the customer has granted the broker or advisor the authority in writing to buy and sell securities in the account without contacting him/her. There are two levels of discretionary accounts: one where the broker or advisor only has limited discretionary authority to enter buy and sell orders, and the other where full discretion is granted to not only trade but also to transfer funds and securities as if the broker or advisor were the owner of the account. Customers should never grant a broker or advisor full discretionary authority over the assets in their accounts. Many brokerage firms expressly prohibit employees from accepting full discretionary authority and frown on employees accepting limited trading authority. This is because FINRA requires an additional level of supervision of these types of accounts to avoid misconduct, including the prohibited activity of excessive trading. This extra layer of supervision is one reason why unscrupulous brokers avoid opening discretionary accounts.
Unfortunately, many clients expect their brokers and advisors to manage their accounts and accept the fact that orders are entered without discussing them beforehand (without regard to the type of account they opened). Most customers do not know that when brokers and advisors act this way in non-discretionary accounts, they violate FINRA Rule 3260.
Attorneys who defend brokerage firms are not afraid of unauthorized trading cases because they are generally the easiest type of cases to defend. These defense attorneys argue the customer’s receipt of confirmations and monthly statements disclosing the transactions demand timely complaints (usually within 10 days) of unauthorized trading. And they argue that if the customer waits too long, he has ratified the trade as his/her own and cannot complain or recover any losses.
We generally counsel clients not to bring unauthorized trading claims unless they complained immediately, and did so in writing, to management who then ignored their complaints. We believe, if the facts support the claim, it is better to claim the broker or advisor was given verbal discretion and traded the account without written discretionary authority in violation of FINRA Rule 3260. These claims are less defensible because customers, unlike FINRA registered brokers and advisors, are not required to know the rules prohibit that activity.
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