Special Account Types
Investment advisers work with various account types that have unique features, risks, and regulatory requirements. Understanding these distinctions is critical for both suitability and compliance.
Margin Accounts
A margin account allows investors to borrow money from their broker-dealer to purchase securities. The securities in the account serve as collateral for the loan.
Regulation T (Federal Reserve Board)
Regulation T governs the extension of credit by broker-dealers to customers for securities purchases:
| Requirement | Amount |
|---|---|
| Initial Margin | 50% of purchase price |
| Minimum Account Equity | $2,000 |
| Pattern Day Trader Minimum | $25,000 |
Example: To purchase $10,000 of stock on margin, an investor must deposit at least $5,000 (50%) and can borrow the remaining $5,000.
FINRA Maintenance Requirements
After the initial purchase, FINRA requires ongoing minimum equity:
| Requirement | Minimum |
|---|---|
| Long Positions | 25% of market value |
| Short Positions | 30% of market value (FINRA) |
| Firm Requirements | Often 30-40% (higher than FINRA minimum) |
Margin Calls
When account equity falls below the maintenance requirement:
- Margin Call Issued - Broker demands additional funds or securities
- Meeting the Call - Investor must deposit cash or marginable securities
- Forced Liquidation - If not met, broker can sell securities without consent
On the Exam: Know that Regulation T sets the 50% initial margin, while FINRA sets the 25% maintenance minimum. Firms can require higher amounts but never lower.
Margin Account Risks
| Risk | Description |
|---|---|
| Amplified Losses | Losses magnified beyond original investment |
| Interest Costs | Ongoing charges on borrowed funds |
| Forced Liquidation | Securities sold without consent |
| No Time Extension | Firms can demand immediate payment |
Fee-Based vs. Commission-Based Accounts
Fee-Based Accounts
An asset-based fee is charged as a percentage of assets under management (AUM):
| Feature | Description |
|---|---|
| Fee Structure | Typically 0.5% - 2% of AUM annually |
| Alignment | Adviser benefits when assets grow |
| Best For | Active traders, ongoing advice |
| Conflicts | May incentivize keeping assets invested |
Commission-Based Accounts
Compensation is transaction-based:
| Feature | Description |
|---|---|
| Fee Structure | Per-trade commissions |
| Best For | Buy-and-hold investors, infrequent trades |
| Conflicts | May incentivize excessive trading (churning) |
| Advantage | No ongoing fees if account is inactive |
Suitability Considerations
| Account Type | Suitable When |
|---|---|
| Fee-Based | Frequent trading, ongoing advice needed |
| Commission-Based | Infrequent trading, self-directed investors |
Discretionary vs. Non-Discretionary Accounts
Discretionary Accounts
The adviser has written authorization to make investment decisions without prior client approval for each transaction:
| Requirement | Details |
|---|---|
| Written Authorization | Must be signed by client |
| Trading Authority | Can determine what, when, and how much to buy/sell |
| Fiduciary Duty | Higher level of responsibility |
| Cannot Determine | Adviser cannot authorize withdrawals |
Non-Discretionary Accounts
The adviser must obtain client approval before each transaction:
| Aspect | Non-Discretionary |
|---|---|
| Authority | Recommendations only |
| Execution | Client must approve each trade |
| Control | Client maintains full control |
| Suitability | Still must be suitable |
On the Exam: Discretionary authority covers investment decisions (what to buy/sell). It does NOT give authority to withdraw money or change beneficiaries—those require separate authorization.
Wrap Fee Programs
A wrap fee program bundles multiple services for a single, all-inclusive fee.
What's Included in Wrap Fees
| Service | Typically Included |
|---|---|
| Investment Advice | Yes |
| Trade Execution | Yes |
| Custody Services | Yes |
| Administrative Fees | Yes |
| Manager Selection | Often included |
Wrap Fee Ranges
Typical wrap fees range from 1% to 3% of assets, depending on services and account size.
Form ADV Part 2A Appendix 1
SEC rules require wrap fee programs to provide a separate disclosure brochure (Appendix 1) that includes:
- Description of services provided
- Fees and how they are calculated
- Conflicts of interest
- Information about participating managers
Wrap Fee Suitability
| Appropriate For | Not Appropriate For |
|---|---|
| Active traders | Buy-and-hold investors |
| Those wanting bundled services | Those needing minimal service |
| Clients needing ongoing advice | Self-directed investors |
| Those preferring fee predictability | Cost-sensitive inactive accounts |
Options Accounts
Options accounts require additional disclosures and suitability determinations:
Account Requirements
- Options Agreement - Client must sign
- Options Disclosure Document (ODD) - Must be delivered
- Suitability Review - Assess experience and risk tolerance
- Approval Levels - Increasing levels for more complex strategies
Approval Levels (Typical Structure)
| Level | Permitted Strategies |
|---|---|
| Level 1 | Covered calls, protective puts |
| Level 2 | Long calls and puts |
| Level 3 | Spreads |
| Level 4 | Uncovered (naked) writing |
| Level 5 | Uncovered index options |
Key Takeaways
- Reg T requires 50% initial margin; FINRA requires 25% maintenance minimum
- Fee-based accounts charge AUM percentage; commission accounts charge per trade
- Discretionary authority requires written authorization and covers investment decisions only
- Wrap fees bundle services for 1-3% of assets—appropriate for active traders
- Options accounts require tiered approval based on experience and strategy complexity
The Federal Reserve's Regulation T requires an initial margin of:
A wrap fee account would be MOST suitable for:
Discretionary authority in an investment account allows the adviser to:
12.3 Performance Measures & Reporting
Continue learning