Discretionary Trade Restrictions
As we have seen, broker-dealers are not allowed to make discretionary trades unless the customer clearly permits it in writing ahead of time and unless the trade has been determined to be suitable for the customer’s needs. Typically, a customer will provide written discretionary authorization to the firm’s registered representative, often when opening the account, so that written permission is not required before each transaction.
However, a broker-dealer has other disclosures to make prior to executing a discretionary trade.
A broker-dealer generally cannot execute a transaction for a customer with a discretionary account unless it first determines that the transaction is suitable for that customer. Transactions must be suitable in size and frequency to the customer’s financial background, tax status, and investment objectives. However, if the transaction is specifically directed by the customer and has not been recommended by the broker-dealer, determining the customer’s suitability will not be required.
Excessive trading in a discretionary account to earn additional commissions is considered churning (see below) and is also prohibited.
Similarly, broker-dealers may not execute a transaction for a customer with a discretionary account if it has a control relationship with the issuer of that security, unless the customer has specifically authorized the transaction. This means that the broker-dea