Chapter 2 — Customer Accounts, Profiles & Recommendations
Before a representative can recommend anything, an account has to exist — properly identified, properly authorized, and properly understood. This chapter is the decision framework that sits underneath every suitability and best-interest question you'll see later: who owns the account, who's allowed to act on it, what the firm knows about the customer, and who has to sign off before money moves.
2.1Account Types and Registration
- Functional account types: pattern day trading, prime brokerage, DVP/RVP, advisory/fee-based
- Registration types: tenants in common, community property, sole proprietorship, partnership, unincorporated association
- Requirements for opening a customer account
- Retirement plans and tax-advantaged accounts: contributions, rollovers, distributions, taxation, age rules
- Employer-sponsored plans and ERISA
- Wealth events, account registration changes, and internal transfers
Two separate questions get asked about every account: what is it for (a functional account type) and who legally owns it (a registration type). Keep those questions apart — a single account can be, for example, a margin account (function) registered as tenants in common (ownership) held for a retirement purpose that isn't tax-advantaged at all. The exam mixes and matches these freely.
Functional account types
| Type | What it is | Key requirement |
|---|---|---|
| Pattern day trader (PDT) | A margin account flagged once a customer executes four or more day trades within five business days, where those trades exceed 6% of the account's total trading activity in that window | Minimum equity of $25,000 must be maintained in the account; the firm must obtain approval under FINRA Rule 2130 and furnish the day-trading risk disclosure statement required by Rule 2270 before the account can day-trade |
| Prime brokerage | A large institutional client executes trades away, across multiple broker-dealers, but consolidates clearing, custody, and reporting through one "prime" broker | Executing brokers "give up" the trade to the prime broker under a give-up agreement; the prime broker handles margin, custody, and reporting centrally |
| DVP / RVP | An institutional settlement arrangement where securities and cash move simultaneously through the customer's own custodian bank, rather than being held at the broker-dealer | The broker-dealer never holds the customer's free credit balance or securities — settlement instructions route to the custodian instead |
| Advisory / fee-based | The customer pays an asset-based fee for ongoing advice and trading rather than per-transaction commissions | Requires its own advisory agreement (and, if the firm is acting as an investment adviser, Form ADV disclosure); the conflict-of-interest profile differs from a commission account, since the fee doesn't change based on trading activity |
Account registration types
Registration answers a narrower question: when more than one party (or a non-individual entity) owns the account, who has legal title, and what happens to that title if an owner dies, leaves, or is added?
| Registration | Ownership pattern | What happens on an owner's death or exit |
|---|---|---|
| Tenants in common (TIC) | Two or more owners, each holding a specified (possibly unequal) undivided percentage interest | A deceased owner's share passes to their estate, not automatically to the surviving co-owner(s) — TIC carries no automatic right of survivorship |
| Community property | Applies to married couples in community-property states; property acquired during the marriage is generally deemed owned 50/50 regardless of whose name is on the account | Governed by the applicable state's community-property and probate rules |
| Sole proprietorship | An unincorporated business with a single owner — legally, the business and the owner are the same person | The account may need to be re-registered in the individual's name alone if the business ceases |
| Partnership | Two or more owners operating under a partnership agreement that specifies who may direct trading in the account | Requires an updated partnership agreement/resolution on file whenever trading authority changes |
| Unincorporated association | A club, committee, or similar group with no separate corporate legal identity | Requires a resolution or governing document naming who is authorized to sign and trade for the group |
Students often assume tenants in common works like joint accounts with survivorship. It doesn't. TIC is defined precisely by the absence of automatic survivorship — if the exam describes two unrelated business partners who each want their own share to go to their own heirs (not to the other partner), TIC is the answer; an arrangement built around automatic survivorship between the co-owners is a different registration entirely.
Opening a customer account
Every new account starts with a new account form capturing the customer's identity, contact information, employment, and an initial snapshot of investment objectives — details that feed directly into the suitability profile built out in Module 2.3. The form requires the registered representative's signature and, before the account can be used, a registered principal's approval.
Retirement and tax-advantaged accounts
Traditional IRA vs. Roth IRA
| Feature | Traditional IRA | Roth IRA |
|---|---|---|
| Contributions | Pre-tax (deductible, subject to income/coverage limits) or non-deductible after-tax | Always after-tax |
| Growth | Tax-deferred | Tax-free if the distribution is qualified |
| Qualified withdrawal | Ordinary income tax on withdrawal after age 59½ | Tax-free once the account has been open 5 years and the owner is 59½ (or another qualifying event applies) |
| Early withdrawal (before 59½) | 10% additional tax plus ordinary income tax, unless an exception applies (first-time home purchase up to a lifetime cap, higher education, certain medical expenses, disability, death, and others) | Contributions (not earnings) can be withdrawn anytime without tax or penalty, since they were already taxed; early withdrawal of earnings follows similar exceptions to a Traditional IRA |
| Required minimum distributions (RMDs) | Required starting at the IRS's current RMD age (73, rising to 75 later this decade) | None for the original owner during their lifetime |
SEP IRA
A Simplified Employee Pension is funded entirely by employer contributions (typically self-employed individuals or small business owners), calculated as a percentage of compensation, with the employee immediately 100% vested. It uses the same withdrawal and RMD framework as a Traditional IRA once funds are in the account.
Employer-sponsored plans and ERISA
| Plan | Typical employer | ERISA-covered? | Defining feature |
|---|---|---|---|
| 401(k) | Private-sector employer | Yes | Employee salary-deferral contributions, often with an employer match; a defined-contribution plan |
| 403(b) | Public schools, nonprofits | Often, though church/government-affiliated plans may be exempt | Tax-sheltered annuity structure; functions similarly to a 401(k) for its sector |
| 457(b) | State/local government and certain tax-exempt employers | Governmental 457(b) plans are generally exempt from ERISA | No 10% early-withdrawal penalty upon separation from service, regardless of age — a key contrast with 401(k)/403(b) |
| Defined benefit | Traditional pension sponsors | Yes | Employer promises a specific future benefit (formula-based on salary/service); the employer bears the investment risk |
| Profit-sharing | Any employer | Yes | Employer contributions (often discretionary, tied to profits) go into individual employee accounts; the employee bears the investment risk |
Stock compensation and non-qualified deferred compensation
Incentive stock options (ISOs) can qualify for favorable capital-gains treatment if specific holding-period requirements are met, but may trigger alternative minimum tax exposure; non-qualified stock options (NQSOs) are taxed as ordinary income at exercise. An employee stock purchase plan (ESPP) lets employees buy employer stock, often at a discount. A non-qualified deferred compensation (NQDC) plan, by contrast, is not ERISA-protected — it can be offered selectively to executives rather than all employees, and because the deferred amounts remain a general, unsecured obligation of the employer, they're exposed to the employer's own creditors if the company becomes insolvent.
Education savings: 529 plans vs. Coverdell ESAs
| Feature | 529 plan | Coverdell ESA |
|---|---|---|
| Contribution limit | Very high lifetime limits set by the state plan; large contributions can be spread over five years for gift-tax purposes | Fixed, comparatively low annual limit per beneficiary |
| Contributor income limit | Generally none | Phases out for higher-income contributors |
| Qualified use | Broad — K-12 tuition (subject to limits) through college and certain apprenticeship/student-loan uses | K-12 and higher-education expenses |
| Age/timing rule | No age limit on the beneficiary | Funds generally must be used by the beneficiary's 30th birthday (disability exception applies) or rolled to another family member |
Wealth events and account registration changes
An inheritance is an operational event as much as a tax event: the account has to be legally re-registered before anything else happens. A beneficiary typically must provide a death certificate and any required estate documentation before an inherited (beneficiary) IRA can be established in their name. For most non-spouse beneficiaries who don't qualify as an "eligible designated beneficiary", current law generally requires the inherited account to be fully distributed within 10 years.
Any registration change on an existing account — adding or removing an owner, converting an individual account to a trust account, or similar — requires review, approval, and documentation by a principal under FINRA Rule 4515.
2.2Customer Identification, Documentation, Privacy & Authority
- Customer screening: CIP, KYC, residency/citizenship status, corporate insiders, and employees of other broker-dealers or SROs
- Information security and privacy: initial disclosures, opt-out notices, exceptions
- Account authorizations: power of attorney, trust documents, corporate resolutions, trading authority, discretionary account documentation
This module is best understood as a customer file, built one document at a time. Each piece of paper in that file exists to answer one question: who is this customer, and who — if anyone besides the customer — is allowed to act on this account?
Customer screening
| Screening element | What it verifies | Why it matters |
|---|---|---|
| CIP (Customer Identification Program) | The customer's true identity — name, date of birth, address, and an identification number | Prevents the firm from opening an account for someone whose identity can't be confirmed, a core anti-money-laundering safeguard |
| KYC (Know Your Customer) | The essential facts about the customer and who has authority to act on their behalf | Ties directly into the suitability obligations covered in Module 2.3 — you can't assess suitability for a customer you don't actually know |
| Residency / citizenship | Whether the customer is a U.S. person or a non-resident alien | Determines tax withholding and reporting (a U.S. person certifies with Form W-9; a non-resident alien certifies foreign status with Form W-8BEN) |
| Corporate insiders | Whether the customer is an officer, director, or other affiliate/control person of a public company | Triggers heightened monitoring — sales by an affiliate are subject to Rule 144's control-person volume limitations and filing requirements |
| Employees of another broker-dealer or SRO | Whether the prospective customer works for a different member firm | The representative's firm must be notified before such a person opens or maintains a brokerage account elsewhere, and the executing firm must be able to furnish duplicate statements/confirmations to the employer firm on request |
Privacy: Regulation S-P
Every new customer must receive an initial privacy notice describing what nonpublic personal information (NPI) the firm collects and who it may be shared with. If the firm intends to share NPI with nonaffiliated third parties outside specific exceptions, the customer must be given an opt-out right and a reasonable opportunity to exercise it before that sharing begins. Sharing with affiliates, and sharing that falls under specific carve-outs does not require an opt-out.
Account authorizations
Trading authority over an account is granted, in writing, through one of a small set of standard documents — and the exam consistently tests whether you can match the situation to the correct document.
| Document | Grants authority to | Scope |
|---|---|---|
| Power of attorney (POA) | A named agent to act for the account owner | Can be limited (trading only) or full/durable; does not itself change who owns the account |
| Trust documents | The named trustee, per the terms of the trust agreement | The account is titled in the name of the trust; the trustee's authority is limited to what the trust instrument permits |
| Corporate resolution | The specific officers/signers the corporation's board authorizes | Required before a corporate account can be opened or before signing authority changes |
| Discretionary trading authorization | The representative (or another named party) to enter orders without the customer's prior approval of each transaction | Must be in writing, signed and dated by the customer, and approved by a principal before discretion is exercised |
Situation: A representative wants to enter orders for a customer without checking in on each individual trade.
Governing rule: FINRA Rule 3260 (and Rule 408T where applicable) — Discretionary Accounts.
What's required: Written authorization signed and dated by the customer, prompt written approval by a principal for each discretionary order, and frequent principal review of the account.
Exception: Time-or-price discretion on an order the customer already placed that day isn't "discretion" in this sense — only discretion over the asset, the action (buy/sell), or the amount triggers the rule.
2.3Investment Profile, Suitability & Best Interest
- Financial and personal factors that make up a customer's investment profile
- Investment objectives: preservation of capital, income, growth, speculation
- Reasonable-basis, customer-specific, and quantitative suitability
- Investment strategies and recommendations to hold
- Verification of investor accreditation and sophistication
- Regulation Best Interest and MSRB Rule G-19
This module is best learned through profiles, not definitions — so before the frameworks, start with the raw material every suitability analysis is built from.
Building the investment profile
| Financial factors | Personal / other factors |
|---|---|
| Current securities holdings | Age |
| Other assets and liabilities | Marital status and dependents |
| Annual income | Employment status and occupation |
| Net worth (and liquid net worth specifically) | Investment experience and knowledge |
| Tax bracket / tax considerations | Home ownership and financing situation |
| Employee stock options held | |
| Insurance coverage in place | |
| Liquidity needs and time horizon |
Investment objectives
| Objective | What the customer is prioritizing | Products that typically fit |
|---|---|---|
| Preservation of capital | Not losing principal, even at the cost of return | Money market funds, short-term Treasuries, high-grade short-term bonds |
| Income | Steady cash flow from the portfolio | Investment-grade bonds, dividend-paying stocks, income-focused funds |
| Growth | Increasing the value of the portfolio over time, generally accepting more volatility | Common stock, growth-oriented equity funds |
| Speculation | Higher risk pursued for higher potential (and less certain) return | Options strategies, low-rated bonds, concentrated or leveraged positions |
The three suitability obligations — FINRA Rule 2111
| Obligation | Definition |
|---|---|
| Reasonable-basis suitability | The representative must understand the product well enough to believe it could be suitable for at least some investors before recommending it to anyone. |
| Customer-specific suitability | The recommendation must fit this particular customer's investment profile — not just be a generally reasonable product. |
| Quantitative suitability | A series of individually suitable transactions can still be unsuitable in the aggregate if their frequency, size, or cost is excessive given the customer's profile (churning). |
"Suitable product" and "suitable recommendation" are not the same claim. A well-diversified, investment-grade bond fund can pass reasonable-basis suitability easily and still fail customer-specific suitability for a client whose stated objective is short-term liquidity for a home down payment next quarter. The exam will describe a perfectly reasonable product and ask you to reject the recommendation anyway, because it doesn't fit the customer in front of you.
Rule 2111 also reaches beyond buy recommendations: an explicit recommendation to hold a position, and a recommended investment strategy (not just a specific security), both fall within the suitability obligation the same way a purchase recommendation would.
Regulation Best Interest
Reg BI (Exchange Act Rule 15l-1) applies when a broker-dealer recommends a securities transaction or investment strategy to a retail customer — a natural person using the recommendation primarily for personal, family, or household purposes. It layers four obligations on top of, and in places beyond, Rule 2111's suitability framework:
- Disclosure obligation — disclose material facts about the recommendation and the relationship, including conflicts of interest.
- Care obligation — exercise reasonable diligence, care, and skill to act in the retail customer's best interest, without placing the firm's or the representative's own financial interest ahead of the customer's.
- Conflict of interest obligation — establish policies to identify and address (through disclosure, mitigation, or elimination) conflicts, including those created by compensation.
- Compliance obligation — maintain written policies and procedures reasonably designed to achieve compliance with Reg BI as a whole.
For municipal securities recommendations specifically, MSRB Rule G-19 imposes a parallel suitability obligation, built on the same reasonable-basis / customer-specific / quantitative structure.
Verifying accreditation and using analysis tools
When a recommendation involves an offering limited to accredited investors (Regulation D, Chapter 1), the representative's obligation doesn't stop at asking the customer to self-certify — for a 506(c) offering in particular, the issuer (and, in practice, the firm facilitating it) must take reasonable steps to actually verify accredited status. Separately, whenever a representative uses an investment analysis tool — a retirement calculator or return projection, for example — with a customer, FINRA 2214 requires disclosing the tool's criteria and methodology, its limitations, and a statement that actual results will vary.
2.4Supervisory Approval, Restrictions & Account Maintenance
- Supervisory review and approval (Rules 3110 and 3120)
- Handling customer funds and securities
- Restricting, freezing, or closing an account
A broker-dealer isn't just a collection of representatives; it's a regulated entity with an obligation to supervise its people and safeguard its customers' assets. The exam tests this conceptually: given a specific situation at a branch, can you recognize what requires supervisory sign-off, and why?
Supervisory review and approval
| Rule | What it requires |
|---|---|
| FINRA 3110 Supervision | Written supervisory procedures (WSPs) covering account opening, transaction review, and correspondence; a registered principal must review and approve new accounts and supervise the activity in them |
| FINRA 3120 Supervisory Control System | An independent test-and-verify layer on top of Rule 3110 — the firm must periodically confirm its WSPs are actually being followed in practice, with annual CEO/CCO certification of the process |
| Cboe 9.2 Options accounts | A Registered Options Principal must approve an options account before, or promptly after, the customer's first options transaction |
| MSRB G-27 Municipal supervision | Parallel supervisory structure for municipal securities activity, including designation of a qualified municipal securities principal |
Handling customer funds and securities
A registered representative generally should not personally accept and hold a customer's cash or physically retain a customer's securities certificates. Checks must be made payable to the firm, never to the individual representative, and forwarded promptly and unopened to the appropriate operations area for processing and safekeeping. Third-party checks and unusual payment instructions are red flags that call for extra scrutiny and, often, principal escalation before the funds are accepted.
Restricting, freezing, or closing an account
| Situation | What typically happens |
|---|---|
| Nonpayment / freeriding in a cash account | Under Regulation T, the account is frozen for 90 days, requiring the customer to have funds on deposit before placing a new purchase |
| Suspected unauthorized trading | Activity in the account is restricted pending an internal investigation |
| AML / source-of-funds red flags | The firm may restrict activity while it resolves the concern, and may be obligated to file a Suspicious Activity Report |
| Legitimate business reasons | A firm may close an account it no longer wishes to service, generally with appropriate advance notice to the customer |
Function 3 — Learn the math and mechanics behind Reg T.