9.5 Fiduciary and Institutional Accounts

What a Fiduciary Is

A fiduciary manages assets for someone else under a legal duty to act in that person's best interest. Fiduciaries include trustees, custodians of minor accounts, executors and administrators of estates, guardians, agents holding a power of attorney, and investment advisers. The exam tests both their duties and the limits on a registered representative's authority to trade for a customer.

Fiduciary Duties and the Prudent Investor Rule

The Prudent Investor Rule (from the Uniform Prudent Investor Act) modernized the old "legal list" approach. It requires the fiduciary to judge each investment in the context of the whole portfolio, balance risk and return for the account's purpose, diversify unless imprudent, and may delegate investment functions prudently. A single risky holding can be appropriate if it improves the portfolio's overall risk-return profile.

Discretionary vs. Non-Discretionary Accounts

Discretion is authority for the representative to decide any of the "three A's": the Asset (what security), the Amount (how many shares/dollars), or the Action (buy or sell) without contacting the customer first.

Requirements before any discretionary trade:

• A written discretionary authorization (trading authorization) signed by the customer
• Acceptance/approval by a principal
• Each discretionary order marked as discretionary and subject to principal review; the account must be monitored for churning

Time and price are NOT discretion. If the customer names the security and quantity and only lets the rep choose when or at what price within the day, no written authority is needed and the order is non-discretionary. That authority is good only for the day unless the customer says otherwise.

In a non-discretionary account, the rep may recommend, but the customer approves each trade.

Trading Authorization (Power of Attorney)

A power of attorney (POA) lets a third party trade an account.

Every POA — durable or not — terminates at the principal's death; the account then becomes an estate matter. When the authorized party is an outside third party, both the owner and the third party must provide identifying documentation.

Institutional Accounts

Institutional investors include banks, insurance companies, registered investment companies, pension and retirement plans, registered investment advisers, broker-dealers, and (per FINRA) any entity or person with at least $50 million in total assets.

Institutional Suitability — FINRA Rule 2111

A firm does not escape suitability with institutions, but it may satisfy customer-specific suitability differently when both conditions hold: the firm reasonably believes the institution is capable of independently evaluating investment risk, and the institution affirmatively indicates it is exercising independent judgment. The firm still needs a reasonable-basis suitability for any recommended product.

Prime Brokerage, DVP, and RVP

Prime brokerage lets an institution (often a hedge fund) execute through several executing brokers while one prime broker clears, settles, custodies, finances, and lends securities for short sales, and provides consolidated reporting.

Institutions also settle via Delivery vs. Payment (DVP) — securities delivered only against payment — or Receive vs. Payment (RVP) — payment made only against receipt of securities. Both ensure a simultaneous exchange that cuts settlement risk.

Custodian, Trustee, and Guardian Distinctions

The exam likes to blur fiduciary roles, so keep them straight. A custodian under UGMA/UTMA manages assets for one minor and the relationship ends at the age of majority. A trustee acts under a trust document that can outlast the grantor and may bind multiple beneficiaries. An executor or administrator winds down an estate temporarily. A guardian or conservator is appointed by a court to manage the affairs of an incapacitated adult or a minor without a custodial arrangement.

In each case the registered representative must collect documentation proving the fiduciary's authority before accepting orders, and the fiduciary's powers — including any use of margin or options — flow only from that governing instrument or court order.

Discretion: Procedures and Prohibitions

Once a discretionary account is opened, ongoing supervision is heavy because discretion invites abuse. A principal must approve the account in writing, review activity frequently (not just at month-end), and watch for churning — excessive trading that generates commissions without serving the customer. Discretion does not authorize the rep to withdraw funds; moving cash or securities to a third party still requires separate written authorization. A rep may never exercise discretion before the signed authorization is on file, even if the customer gave verbal permission.

Suitability Layers Recap

FINRA Rule 2111 imposes three suitability components that apply to all customers:

1. Reasonable-basis suitability — the rep must understand the product and believe it is suitable for at least some investors. This applies even to institutions.
2. Customer-specific suitability — the recommendation fits this customer's profile; this is the layer an institution can satisfy through an independent-judgment representation.
3. Quantitative suitability — a series of recommended transactions is not excessive given the customer's profile.

Numbered Comparison: Discretion vs. POA vs. Suitability

1. Discretionary authority lets the firm's rep choose the trade; it needs written customer consent plus principal approval.
2. Trading authorization (POA) lets a non-firm third party trade; it can be limited or full, durable or non-durable.
3. Suitability governs the quality of recommendations regardless of who places the order.

On the Exam

Know that time and price authority alone is NOT discretion, that every discretionary trade needs prior written authority plus principal review, that durable powers of attorney survive incapacity while every power of attorney terminates at the principal's death, and that institutional suitability turns on the customer's affirmative representation that it is exercising independent judgment.