Discretionary vs Non-Discretionary Accounts: Is Your Stockbroker Following the Rules?

Discretionary accounts give the stockbroker the authority to execute trades without first obtaining authorization from the investor. Non-discretionary accounts require investors to authorize each transaction prior to the execution of a trade. Even in a non-discretionary account, stockbrokers still make investment recommendations; however, they are not permitted to act on those recommendations without obtaining approval from their investors.

No matter what type of account you choose, you should regularly review your account statements. Both discretionary and non-discretionary accounts are subject to fraud and misconduct.

• If a stockbroker executes trades in an account without customer approval in an account that has not been approved for discretionary trading, they are engaging in unauthorized trading. Unauthorized trading violates FINRA Rule 2010.
• If a stockbroker executes trades in a discretionary account or a non-discretionary account that do not suit the investor’s financial goals, they may have executed unsuitable trades, in violation of FINRA Rule 2111.

Is a Discretionary Account Right for Me?

If you want to open a discretionary account, you should carefully evaluate how much trust you feel you can place in your stockbroker. The Financial Industry Regulatory Authority (FINRA) urges investors to first review their stockbroker’s BrokerCheck profile before moving forward with a discretionary account. Look for any disclosures that mention unauthorized or excessive trading. And even if you trust your stockbroker, you should still review your account statements to make sure your stockbroker is not abusing their power.

With a discretionary account, you are running the risk that your stockbroker may execute excessive trades. Excessive trades incur too many fees for the investing strategy to offer any financial benefit to the investor. The losses could stack up before you catch the unsuitable strategy.

FINRA Rule 3260: Discretionary Account Rules

FINRA outlines the rules for discretionary accounts in Rule 3260, which states that an account cannot be approved for discretionary trading unless the customer gives their written authorization and the firm approves.

Your account must be approved for discretionary trading in writing. Verbal authorization is not sufficient.

• FINRA recently fined a broker $5,000 and suspended him for 30 days following allegations that he exercised discretion in accounts without authorization—even though the investors knew the stockbroker was exercising discretion in their accounts and approved.
• Brokers have been known to use deception to make it look like they have written authorization. FINRA noted in an Investor Insight that two brokers had been fined and suspended after they exercised discretion in 80 accounts without written authorization. The stockbrokers had back-dated certain conversations with investors to make it look as though they had authorization. 

According to FINRA Rule 3110, firms must review discretionary accounts as part of their supervisory duties. Firms must have supervisory systems in place designed to catch unauthorized trading as well as suspicious transactions in discretionary accounts. Stockbrokers must state in their compliance questionnaires if they have exercised discretion in any customer accounts. If they answer inaccurately, they may face a FINRA fine and suspension.

Time-and-Price Discretion

FINRA Rule 3260 offers one exception: Investors can give their stockbrokers short-term time-and-price discretion, a type of temporary discretion that only lasts until the end of the trading day. This type of discretion specifies that if a certain stock reaches a certain price before the end of the day, the stockbroker can execute the trade without the investor’s express permission.

Standards for Discretionary Trading

Even if an account is approved for discretionary trading, stockbrokers cannot execute transactions that do not fit the approved investment strategy or the investor’s stated financial goals, investment objectives, and risk tolerance. Investors might still have a case for a securities lawyer if their broker did not follow their instructions and over-concentrated their portfolio or executed excessive transactions in their discretionary account.

If you believe your broker did not act in your best interest in your discretionary account, you will likely have to show a FINRA arbitration panel how the stockbroker’s trades did not fit your agreed-upon strategy. Speaking with a securities lawyer is the first step toward successfully arguing your case.

• FINRA defines excessive transactions as a number of transactions that generate too many fees for the investor to profit. Brokers trade excessively—also known as churning—to generate a profit for themselves.
• Over-concentration occurs when stockbrokers do not properly diversify their accounts. Accounts that only have a single type of stock suffer unnecessarily when a particular stock loses money.

Can I Sue My Broker?

Brokers who notice unauthorized trading in a non-discretionary account, or excessive, unsuitable trading in a discretionary account should speak with a securities lawyer. Our securities attorneys have dealt with many cases involving discretionary accounts and know what steps you need to take to document your claim. Contact us today for a free case evaluation.