Fiduciary and Institutional Accounts

Fiduciary and institutional accounts involve special responsibilities and rules that differ from standard retail accounts. Understanding these distinctions is critical for Series 7 representatives.

Fiduciary Accounts Overview

A fiduciary is a person or institution that manages assets on behalf of another, with a legal obligation to act in the beneficiary's best interest. Fiduciary relationships include:

• Trustees managing trust assets
• Custodians managing accounts for minors
• Executors/administrators managing estates
• Agents with power of attorney
• Investment advisers

Fiduciary Duties

All fiduciaries share common legal obligations:

The Prudent Investor Rule

The Prudent Investor Rule (derived from the Uniform Prudent Investor Act) requires fiduciaries to:

1. Invest with care, skill, and caution
2. Diversify investments unless imprudent to do so
3. Consider the portfolio as a whole, not individual investments
4. Act with prudence in delegating investment functions
5. Balance risk and return based on the trust's purposes

Modern Interpretation: Fiduciaries may use modern portfolio theory and consider total return, not just income vs. principal.

Discretionary vs. Non-Discretionary Accounts

Discretionary Accounts

A discretionary account gives the representative authority to make investment decisions without obtaining prior approval for each trade.

Requirements for Discretion:

• Written discretionary authorization signed by customer
• Principal approval of the authorization
• Each discretionary trade must be marked as such
• Principal review of discretionary activity

Discretionary Authority Covers:

• What to buy or sell (asset selection)
• How much to buy or sell (quantity)
• When to execute (timing)

Not Discretionary (Time and Price): If the customer specifies the security and quantity, but gives the representative flexibility on timing or price, this is NOT discretionary. Only asset selection and/or quantity authority constitutes discretion.

Example:

• Discretionary: "Buy some tech stocks for my account"
• NOT discretionary: "Buy 100 shares of AAPL when you think the price is right"

Non-Discretionary Accounts

In non-discretionary accounts, the representative must obtain customer approval before executing each transaction. The rep may recommend investments, but the customer makes all final decisions.

Trading Authorization

Trading authorization (power of attorney) allows someone other than the account owner to trade on the account.

Types of Trading Authorization

Third-Party Trading: When authorizing a third party (not an employee of the firm), both the account owner and the authorized party must provide identification and documentation.

Institutional Accounts

Institutional investors include:

• Banks and insurance companies
• Registered investment companies (mutual funds)
• Pension and retirement plans
• Investment advisers
• Broker-dealers
• Entities with $50+ million in assets

Institutional Account Benefits

Institutional accounts have certain regulatory advantages:

Institutional Suitability

Under FINRA Rule 2111, broker-dealers have different obligations for institutional customers:

• Must still have a reasonable basis for recommendations
• May rely on the institution's capability to evaluate investment risks
• Must have reasonable basis to believe the institution can evaluate risks independently
• Customer must affirmatively indicate it is exercising independent judgment

Key Point: Firms cannot completely avoid suitability obligations just because a customer is institutional. The institution must genuinely be capable of independent evaluation.

Prime Brokerage

Prime brokerage services allow institutional customers (especially hedge funds) to:

• Execute trades through multiple brokers
• Clear and settle all trades through one prime broker
• Borrow securities for short selling
• Access leverage and financing
• Receive consolidated reporting

The prime broker provides custody, clearing, and financing while the client trades with various executing brokers.

Delivery vs. Payment (DVP) and Receive vs. Payment (RVP)

Institutional accounts often use special settlement arrangements:

These methods reduce settlement risk by ensuring simultaneous exchange of securities and payment.

On the Exam

The Series 7 exam frequently tests:

• Distinguishing discretionary from non-discretionary authority
• Understanding fiduciary duties (loyalty, prudence, diversification)
• Knowing when time and price authority is NOT discretionary
• Recognizing institutional customer suitability differences
• Understanding POA types and their scope