3.4 Account Types

Understanding different brokerage account types is essential for the SIE exam. Each account type has specific characteristics, requirements, and appropriate uses.

Cash Accounts vs. Margin Accounts

The two fundamental account types are governed by Regulation T of the Federal Reserve Board.

Cash Accounts

In a cash account, the customer pays 100% of the purchase price for securities.

Payment Required: 100% of purchase price

Borrowing: Not permitted

Short Selling: Not permitted

Interest Charges: None

Risk Level: Limited to investment amount

Key Cash Account Rules

Securities must be fully paid before sale (no free-riding)

Fully paid securities are segregated and held for the customer

Cannot engage in strategies with unlimited loss potential

Simplest account type with lowest risk

Free-Riding Violation: Selling securities before paying for them in a cash account is prohibited.

Margin Accounts

In a margin account, customers can borrow money from the broker to purchase securities.

Initial Payment: 50% minimum (Reg T)

Borrowing: Up to 50% of purchase price

Short Selling: Permitted

Interest Charges: On borrowed funds

Risk Level: Can exceed investment (leverage)

Margin Requirements

Initial Margin: 50%, Regulation T

Minimum to Open: $2,000 or 100% (whichever less), FINRA

Maintenance Margin (Long): 25% minimum, FINRA Rule 4210

Maintenance Margin (Short): 30% minimum, FINRA Rule 4210

Margin Example

Buying $10,000 of stock on margin:

Purchase Price: $10,000

Customer Pays (50%): $5,000

Broker Loans (50%): $5,000

Interest Charged On: $5,000

Leverage Effect

Stock rises 20%: Cash account +20% return, margin account +40% return

Stock falls 20%: Cash account -20% return, margin account -40% return

Warning: Leverage amplifies both gains AND losses. Margin accounts carry significantly higher risk.

Margin Calls

When equity falls below maintenance requirements, the firm can issue a margin call and/or sell securities in the account:

The customer may be asked to deposit additional funds or securities

The firm can sell securities without contacting the customer first; most firms try to notify customers, but they are not required to

The firm, not the customer, chooses which securities to sell, and the customer is not entitled to an extension of time

Joint Accounts

Joint accounts have two or more owners. Two main types exist:

Joint Tenants with Rights of Survivorship (JTWROS)

Ownership: Equal among all owners

Death of Owner: Assets pass to surviving owner(s)

Probate: Avoided

Common Use: Spouses

Tenants in Common (TIC)

Ownership: Can be unequal (specified percentages)

Death of Owner: Deceased's share goes to their estate

Probate: Required for deceased's share

Common Use: Business partners, relatives

Joint Account Rules

Both types share these characteristics while all owners are alive:

Any owner can trade without others' permission

Any owner can deposit funds

Any owner can request information

Checks must be made payable to all owners

Key Difference: JTWROS passes assets to survivors; TIC passes to the deceased's estate.

Individual Accounts

Individual accounts have a single owner with full control:

One person owns and controls the account

Can grant trading authority to others (POA)

Assets pass to estate upon death

Custodial Accounts (UGMA/UTMA)

Custodial accounts hold assets for minors under:

UGMA - Uniform Gifts to Minors Act

UTMA - Uniform Transfers to Minors Act

Beneficial Owner: The minor

Control: Custodian (adult)

Transfers at: Age of majority (18-21, varies by state)

Tax Reporting: Minor's SSN

Margin Trading: Not permitted

Key Custodial Account Rules

One custodian, one minor per account

Gifts are irrevocable (cannot be taken back)

Custodian manages for minor's benefit

Assets transfer to minor at majority

Cannot use margin or engage in speculative strategies

Corporate and Institutional Accounts

Corporate accounts require additional documentation:

Corporate Resolution: Authorizes account opening

Articles of Incorporation: Proves existence

List of Authorized Traders: Who can trade

Tax ID (EIN): For tax reporting

Institutional Account Definition

An institutional account (per FINRA rules) is:

Bank, savings institution, insurance company

Registered investment company

Registered investment adviser

Entity with $50 million+ in assets

Trust Accounts

Trust accounts hold assets for beneficiaries according to trust terms:

Grantor: Creates the trust

Trustee: Manages assets per trust terms

Beneficiary: Receives benefits

Trust Document: Legal terms and instructions

Types include:

Revocable Living Trust - Can be modified

Irrevocable Trust - Cannot be changed

Testamentary Trust - Created by will

Fiduciary Accounts

Fiduciary accounts are managed by someone other than the owner:

Trust: Fiduciary is Trustee

Estate: Fiduciary is Executor/Administrator

Custodial: Fiduciary is Custodian

Conservatorship: Fiduciary is Conservator

Fiduciary Duty: The fiduciary must act in the best interest of the beneficial owner.

Summary: Account Type Comparison

Cash: Owners 1+, key feature is full payment required

Margin: Owners 1+, key feature is borrowing permitted

JTWROS: Owners 2+, key feature is survivorship rights

TIC: Owners 2+, key feature is specified ownership

UGMA/UTMA: Owner is minor (custodian controls), key feature is irrevocable gift

Corporate: Owner is entity, key feature is resolution required

Trust: Owners per terms, key feature is trustee manages