Chapter 12: Other Account Types

Section 1: Margin Accounts

A margin account allows a customer to borrow either money or securities from a broker-dealer. By borrowing, the investor uses leverage—which can amplify returns but also amplify losses. In a cash account, risks and returns are lower because the customer pays 100% of the purchase price. Leverage changes the math entirely.

Due to the risky nature of margin, not all account types are permitted to use leverage. Custodial, fiduciary, and retirement accounts are generally ineligible for margin.

Topic 1: Regulation T — Buying on Margin

Initial Margin Requirements

Regulation T (Reg T) is a Federal Reserve Board regulation that covers lending from broker-dealers to customers. It sets initial margin requirements for marginable securities.

• In a cash account, the initial margin requirement is 100% (you pay for everything)
• In a margin account, the broker-dealer may lend a customer up to 50% of the purchase price of a marginable security

Exempt Securities

Not all securities fall under Reg T's jurisdiction. Exempt securities are not covered by Reg T's initial margin rules. The major exempt securities are:

• U.S. government securities
• Agency issues
• Municipal issues
• Commercial paper

The Fed has no power to set initial margins for these securities. However, they are still marginable, subject to minimum maintenance requirements set by FINRA.

While corporate bonds are nonexempt, the Fed does not set specific margins for them either, because their prices tend to be fairly stable. Only FINRA minimum maintenance margins apply to corporate bonds.

Deposit Requirements

Reg T deposits must be made within 2 business days of settlement. Since a corporate security settles in 1 business day (T+1), the Reg T deposit must be made by T+3.

The deposit can be made in securities instead of cash. A customer may deposit fully paid marginable securities worth twice the amount of the call.

Marginable vs. Non-Marginable Securities

Topic 2: Regulation T — Selling Short on Margin

Short Selling Basics

Short selling is when an investor borrows securities from a broker-dealer and then sells them. This can only be done in a margin account.

The strategy works like this: a bearish investor sells borrowed securities at the current (high) price, hoping to repurchase them later at a lower price. After buying back the shares, they return them to the broker-dealer—this is called covering the short position. The difference between the sale price and the repurchase price is the customer's profit or loss.

• Bullish investors hope to buy low and sell high
• Bearish investors hope to sell high and buy low

Fiduciary and retirement accounts are typically not permitted to sell short due to the strategy's unlimited loss potential.

Initial Margin for Short Sales

The Reg T initial margin requirement for short sales is the same as for long purchases—50%.

Minimum Deposit Requirements

Margin accounts have a minimum equity requirement of $2,000. But the rules differ depending on whether you're long or short:

Topic 3: Regulation T for Cash Accounts

Payment Requirements

In a cash account, Reg T requires the broker-dealer to collect payment from the customer promptly—no later than 2 business days after the settlement date.

Reg T Extensions

If payment is not collected by S+2, under exceptional circumstances, the firm may request a Reg T extension from FINRA. If granted, the customer gets another 2 business days (or longer if a special request is made) to pay.

If the customer does not pay by either S+2 or the extension date (if one is granted), the firm is obligated to sell out that position and freeze the account for 90 days.

Frozen Accounts

When an account is frozen, the customer can still trade—but they can no longer borrow. They must have 100% of the required cash to pay for any transaction before placing it. After 90 days of compliance, the freeze is removed.

Free-Riding

Free-riding is the prohibited practice of buying securities without intending to pay for them, then selling them on or before the settlement date to generate the cash needed to pay for the original purchase.

Topic 4: Restricted Margin Accounts and Minimum Maintenance

Restricted Margin Accounts

A restricted margin account is one where the equity has fallen below 50% of the market value but remains above the minimum maintenance requirement.

Short Account Equity

In a short margin account, equity is calculated differently:

Minimum Maintenance Requirements

While a restricted account doesn't trigger any immediate action, there are limits to how far equity can fall. These limits are the minimum maintenance requirements established by FINRA.

Margin Maintenance Call — Long Stock Example

Short Account Margin Call

In a short margin account, a margin call is issued when equity drops below 30%. A useful shortcut for finding the trigger point:

For example, a customer with a short margin account that has a credit balance of $130,000 will receive a margin call if the SMV rises above $130,000 / 1.3 = $100,000.

Long Account Margin Call Trigger

The same convention works for long accounts:

An account with a $50,000 debit balance will receive a margin call if its LMV falls below $50,000 / 0.75 = $66,666.67.

Meeting a Margin Call

When a margin call occurs, it must be met promptly—typically within 3 business days, though depending on circumstances it could be anywhere from the same day to 5 business days. If the customer fails to provide the required equity, the broker-dealer will sell the customer out: liquidating enough stock to bring the account back to the required 25% minimum. The customer has no control over which securities are sold.

Summary of Key Margin Requirements

Special Memorandum Account (SMA)

When a security purchased on margin increases in value, the equity in the account increases as well. Equity above 50% of the market value is considered excess equity.

SMA and Buying Power

Excess equity creates buying power of 2 x SMA (since the initial margin requirement is 50%).

The Special Memorandum Account (SMA) amount can also be withdrawn from the account in cash. However, this withdrawal would be considered a loan and added to the amount the customer owes the broker-dealer.

Topic 5: Other Types of Margin Accounts

Pattern Day Traders

Customers who engage in day-trading strategies take on a higher level of risk. Because day traders execute rapid "in and out" transactions on the same day, they typically end the day with no position—and therefore would have no margin requirement under standard Reg T rules. Due to this elevated risk, these accounts require special client disclosures.

Pattern Day Trader Definition

FINRA defines a pattern day trader (PDT) as anyone who executes four or more day trades within five business days. A day trade is a purchase and sale of the same security (or vice versa) on the same day. A purchase on one day followed by a sale the next day is not defined as a day trade.

$25,000 Minimum Equity

Instead of the standard $2,000 minimum equity, the minimum equity for a day-trading account is $25,000—a 12.5x premium over regular margin accounts.

Minimum Margin: 25% of Highest Intraday Market Value

Day traders must maintain a minimum margin of 25%, the same as regular accounts. The critical difference is how it's computed: because a day-trading account has no end-of-day market value, the 25% minimum is applied to the account's highest intraday market value, but in no case less than $25,000.

Buying Power in Day-Trading Accounts

Pattern day-trading accounts are subject to FINRA's minimum margin rules (not Reg T) since they typically don't carry securities positions into the next day. If the account is "flat" at the end of the day, buying power is simply four times the cash balance.

However, if the account has an unsatisfied margin call outstanding, buying power is reduced to twice the maintenance margin excess.

Portfolio Margin

Everything discussed so far uses the standard strategy-based margin method, where a prescribed percentage is applied regardless of actual risk. This approach is conservative and doesn't account for hedging strategies or offsetting positions.

Portfolio margin takes a different approach: it assesses the risk of the entire account, considering variables such as hedging strategies, protective options, and offsetting long and short positions.

Key facts about portfolio margin:

• The most dramatic effect is reducing margin for stock positions hedged by options—since the margin becomes the maximum potential loss
• Portfolio margin provides no benefit for long options positions or spread positions, where the margin already equals the maximum potential loss
• Portfolio margin can only be used for equities, options, or derivatives positions used as hedges—it cannot be used for bond positions
• The basis for the margin requirement is "stress testing" securities positions using probability-based loss percentages based on historical volatility
• For most equities, the maximum portfolio margin is 15% (vs. 50% under Reg T). If the position is "concentrated" (too large a percentage of the portfolio in a single security), the margin doubles to 30%

Only Sophisticated Investors Qualify

Additional portfolio margin requirements:

• The brokerage firm must get prior approval from FINRA and demonstrate it has sophisticated computer systems capable of computing and monitoring margin requirements on a real-time, intraday basis
• If a portfolio margin account has a margin deficiency at end of day, payment must be received within 3 business days
• The account must be approved for uncovered options writing by a Registered Options Principal (ROP)—either Series 4 or Series 9 licensed
• The customer must receive a Portfolio Margin Risk Disclosure Statement at or before the first transaction and must sign an acknowledgment that they have read and understand it

Topic 6: Margin on Options and Leveraged ETFs

Margin on Long Options

Long options require 100% deposit of the premium. No loans are permitted against long options—which makes sense since the contract expires at a set date within the coming months. Minimum maintenance requirements do not apply since the positions are fully paid.

This treatment is the same whether a long call, long put, interest rate option, or foreign currency option is purchased.

LEAPS

LEAPS (Long-term Equity Anticipation Securities) have initial expirations from 28–36 months in the future. Reg T requires that 75% of the premium be deposited. This is also the minimum requirement. When LEAPS are within 9 months of expiration (the same as a regular option), 100% of the premium must be deposited.

Margin on Covered Stock Options

Short Call Covered by Stock Ownership

If a stock call is "covered" by owning the underlying stock, there is no margin on the call itself—only on the long stock position (100% in a cash account, 50% in a margin account). If the customer is exercised, they simply deliver the stock they own.

Short Put Covered by Short Stock Position

A short put is considered covered if the customer has a short stock position in the same stock. The customer cannot lose on the short put: if the market falls, the short stock position generates an offsetting profit. (However, the customer still faces unlimited loss potential on the short stock itself.)

Once the short stock position is properly margined, there is no additional margin requirement on the short put.

Margin on Straddles and Spreads

Straddles

If a customer buys a straddle (buying an identical call and put on the same stock), they must deposit 100% of the combined premiums because they are buying both contracts.

Spreads

Spreads are gain-limiting and risk-limiting positions where the customer buys and sells a contract on the same security with different strike prices or expirations. The key margin principle: a customer cannot be required to put up more than they can lose.

Leveraged ETFs

Leveraged exchange-traded funds (ETFs) are designed to generate multiples (e.g., 200%, 300%) of the performance of the underlying index or sector. Some are "short" or "inverse" leveraged ETFs, seeking to deliver performance opposite to the index. They use options, futures, and swaps to multiply returns—which also means price swings can be dramatic.

FINRA's concern is that increased volatility means traditional strategy-based margin won't sufficiently account for the expected risk. As a result, the FINRA Board of Governors can require leveraged ETFs to maintain more than normal margin.

Topic 7: Opening a Margin Account

Cash vs. Margin Account Opening

To open a cash account, only the new account form is required—the customer agrees to pay in full for all purchases. To open a margin account, additional documentation is required. A principal must approve all accounts.

The Margin Agreement

Before opening a margin account, the customer must sign a margin agreement, which sets the terms and conditions between the customer and the broker-dealer. The agreement has three parts:

Rehypothecation

The firm also has the right to repledge (rehypothecate) the securities to a bank to raise funds. The Federal Reserve controls lending by banks to broker-dealers under Regulation U (Reg U). Funds are borrowed from the bank at the broker's call rate (also called the call loan rate)—the rate at which banks lend money to broker-dealers to fund margin loans.

Special Disclosures for Pattern Day-Trading Accounts

Before opening a day-trading account, the firm must provide a disclosure statement covering:

• Day trading can be extremely risky
• Be wary of exaggerated claims about potential profits
• Day trading requires knowledge of securities markets and firm operations
• Day trading will generate substantial commissions for the firm
• Day trading on margin can result in losses greater than one's investment
• Persons who day trade for others must be registered as an investment adviser or broker-dealer

Credit and Risk Disclosure Statements

Noninstitutional customers opening a margin account must also receive a credit disclosure statement and a margin risk disclosure statement explaining the risks of margin trading. This disclosure must be redelivered annually.

Customer Signature

The customer must sign the margin agreement at or before the settlement of the first trade in the account.

Section 2: Fiduciary Accounts

A fiduciary account is one where a third party acts for, and in the best interest of, the account owner. The fiduciary standard is the highest duty of care in the financial world—it means putting someone else's interests ahead of your own, every single time. Types of fiduciary accounts include custodial accounts, guardian accounts, and trust accounts.

Topic 1: Requirements for Fiduciary Accounts

Documentation

Fiduciary accounts generally cannot be opened unless the proper documentation appointing the fiduciary is received by the firm. Since the fiduciary is a third party, only they are permitted to trade in the account. The fiduciary cannot give trading authorization to another person (unless the account documentation specifically permits this, such as allowing an outside registered investment adviser to manage the account).

Cash Accounts Only

Fiduciary accounts are generally prohibited from margin transactions—only cash accounts are permitted. To open a margin account for a fiduciary, the documents appointing the fiduciary must specifically authorize margin transactions.

The Prudent Person Rule and Legal List

Each state often limits fiduciaries in the types of investments they can make. State law requires fiduciaries to follow either:

• The prudent person rule: only investments that a prudent individual would make are permitted
• A legal list: a specific list of permissible investments provided by the state

Under these standards:

• Aggressive options strategies (e.g., naked call writing) are prohibited
• Conservative options strategies (e.g., covered call writing, buying protective puts) are permissible

Power of Attorney

A power of attorney (POA) is not a type of account but a mechanism for granting authorization to a third party.

Topic 2: Types of Fiduciary Accounts (Custodial Accounts)

Custodial Accounts

Custodial accounts are accounts where a third party manages the account on behalf of a beneficiary, most often a minor. The third party must manage the account in the best interest of the beneficiary.

UGMA and UTMA

Two custodial account types appear on the exam: the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA).

Key rules:

• An adult must open and manage the account on behalf of a minor
• One custodian, one minor—the minor and custodian do not need to be related, but the custodian must be an adult
• The minor is the official owner of the account and its assets; the custodian manages the account
• These are NOT joint accounts—all assets are the property of the minor
• Custodians have third-party trading authorization; minors cannot trade in the account
• Dividends, interest, and capital gains are considered unearned income

Tax Treatment (Kiddie Tax)

The account must be opened under the minor's Social Security number. A portion of earnings is taxable at the minor's rate; above a certain threshold, the parent's/guardian's tax rate applies. Regardless of the rate, the taxes are the child's responsibility. These rules are called the kiddie tax.

Irrevocable Gifts

Gifts can be made to the account by other adults, but all gifts are irrevocable—they cannot be withdrawn or reversed once given. Gifts can be either cash or fully paid securities.

Death of Minor

In the event of the minor's death, the account assets transfer to the minor's estate—not directly to the parents.

Fiduciary Duties of the Custodian

UGMA Accounts

Under UGMA, full rights to account assets transfer to the minor upon reaching the age of majority in their state of residence. The minor is always the legal owner, and the account uses the minor's Social Security or tax ID number.

UGMA investments are limited to financial assets—stocks, bonds, mutual funds, etc. Investments cannot include real estate, collectibles, or uncovered derivative products.

UTMA Accounts

UTMA accounts are similar to UGMA but with two important differences:

1. Broader asset range—UTMA accounts can include real estate and other non-financial assets
2. Delayed transfer—The custodian can delay the transfer of assets beyond the age of majority, but no later than age 25 (actual age limits vary by state)

ABLE Accounts

Do not confuse UGMA/UTMA accounts with Achieving a Better Life Experience (ABLE) accounts, which are designed to allow people with disabilities and their families to save for the future. An ABLE account can be established for either a child or an adult, provided they have a disability that began before the age of 46.

Guardian Accounts

A legal guardian is a person appointed by a court to protect the assets of a minor or an incompetent adult. To open a guardian account, the firm must obtain a copy of the court order appointing the guardian. The account cannot be opened only in the name of a minor or incompetent adult.

Topic 3: Trust Accounts

Overview

Trust accounts are most commonly used to ensure the smooth passing of assets to heirs upon death. They may also minimize estate and inheritance taxes, or provide for a minor child or a loved one with a disability.

Key Parties

Like estate accounts, trust accounts are custodial accounts because the trustee manages the account on behalf of the beneficiaries. The trustee has trading authority, but a third party can also have trading authority if listed in the trust agreement.

Trust Agreement

When opening a trust account, the firm must obtain a copy of the trust agreement. The agreement specifies what transactions the trustee is authorized to perform. These accounts cannot be margin accounts unless specifically authorized by the trust agreement.

Revocable vs. Irrevocable Trusts

A revocable living trust can be revoked (eliminated) at any time before death by the person who owns the assets (the trustor). If revoked, ownership reverts back to the original owner. The grantor may appoint themselves as trustee.

An irrevocable trust, once set up, cannot be undone or revoked. Irrevocable trusts are typically given their own tax identification numbers and treated as separate taxpayers. Any income earned within the trust is subject to annual taxation.

(If you're wondering why anyone would choose a revocable trust given the tax disadvantage, the answer is flexibility. Some people value the ability to change their mind more than the estate tax savings—a very human impulse that no regulation can account for.)

Living vs. Testamentary Trusts

• Living trusts: Created while a person is living
• Testamentary trusts: Initiated upon a person's death, according to the terms of a will. The instructions are carried out by a trustee

Charitable Trusts

A charitable trust is for customers who want to leave part of or all their estate to a charity.

A charitable remainder trust (CRT) works as follows: assets are given to the charity before the donor's death, but the donor receives a fixed amount of income from the assets periodically until death. After death, the remainder of the assets belong to the charity. A CRT is irrevocable.

Section 3: Joint, Business, and Options Accounts

Several additional account types appear on the Series 7. Joint accounts involve more than one owner. Business accounts serve partnerships, corporations, or investment advisers managing accounts on behalf of clients. Options accounts follow specific rules established by the Chicago Board Options Exchange (Cboe) and the Options Clearing Corporation (OCC).

Topic 1: Joint Accounts

General Rules

When more than one party is named on an account:

• New account information must be obtained for each party
• All parties are allowed access and may make trades independently
• Checks issued must be payable to all parties on the account
• Social Security numbers are collected from each owner, but joint accounts report taxable events under a primary tax identification number belonging to one owner
• Each owner is responsible for their respective tax bill (in many cases, each party claims half of gains or losses)

Two Types of Joint Account Ownership

Transfer-on-Death (TOD)

Transfer-on-death (TOD) is not an account type but a designation that allows the owner to pass an account to a beneficiary upon death. The owner keeps complete control of the account during their lifetime. Similar to JTWROS, a TOD designation avoids probate.

Topic 2: Business Accounts

Corporate Accounts

To open a corporate account, the firm must receive a copy of the corporate resolution, which must permit accounts to be opened and designate individuals with trading authorization. A corporate tax identification number is required. Firms may also request a copy of the corporate charter.

Limited Liability Company (LLC) Accounts

An LLC combines the benefits of a sole proprietorship or partnership with those of a corporation. Starting an LLC requires filing articles of organization with the secretary of state, including a statement of purpose and expected duration (an LLC may exist perpetually or have a specific termination date).

To open an account, an LLC must provide a copy of their articles or certificate of organization. If the LLC has only one member, that member's Social Security number can be used in place of an employer identification number.

Partnership Accounts

To open a partnership account, the firm must obtain a copy of the partnership agreement. Like a corporate resolution, it must allow for opening the account and name the partners authorized to trade.

Investment Adviser Accounts

An investment adviser provides investment advice for a fee and is considered a fiduciary. An investment adviser account is typically held in the customer's name, but the adviser has discretionary authority.

When an adviser has many customers, they might open an omnibus account—an account held in the adviser's name containing all its customers' securities. To open an omnibus account, the investment adviser must fill out individual new account forms for each customer, along with a third-party trading authorization (since the customer is granting POA to the adviser).

Wrap Accounts

A wrap account provides investment advice and a certain number of brokerage transactions in a single package. The investment adviser trades accounts for clients, charging an annual management fee. Confirmations and statements go to both the customer and the adviser.

Wrap accounts are defined as an advisory product because they charge either a flat fee or a percentage of assets. To offer advisory products, a representative must be dually registered as a FINRA broker-dealer representative and a registered investment adviser (RIA) representative.

Institutional Accounts

An institutional account is held by a bank, investment company, registered investment adviser, or any other business or individual with total assets of at least $50 million.

Institutional accounts are considered sophisticated investors who do not need retail-level protections. The suitability obligation is fulfilled if:

• The broker-dealer reasonably believes the institutional customer can evaluate risk independently
• The customer affirms it is exercising independent judgment when evaluating the broker-dealer's recommendations

Topic 3: Options Accounts

Cboe Requirements

The Chicago Board Options Exchange (Cboe) has its own requirements for opening options accounts, similar to FINRA's but with specific additions.

Required Information

To open an options account, the customer must be asked specifically about:

• Investment objective
• Investment experience
• Financial situation
• Financial needs
• Marital status
• Net worth
• Liquid net worth
• Estimated annual income

If the customer refuses to disclose any of this information, the representative must note "not disclosed" for each such item. The Cboe states it is then up to the approving manager to decide whether the account should be opened.

Options Agreement

Cboe requires the customer be sent a copy of the options agreement. By signing, the customer agrees to abide by trading restrictions imposed by the member firm and to comply with OCC rules (e.g., position limits, exercise limits). If the customer's financial situation changes materially, the options agreement must be amended.

Account Approval

Options Disclosure Document (ODD)

The customer must also receive an Options Disclosure Document (ODD) created by the OCC. This must be delivered by the date of the principal's approval.

The 15-Day Rule

Options Accounts for Associated Persons

If a representative of another firm wishes to open an options account at another member firm, they must first receive written approval from their employer. If approved, all statements and confirmations will be automatically sent to the employing broker-dealer.

Chapter Summary

Key Terms Glossary

Margin accounts generate revenue for broker-dealers, fiduciary accounts protect the vulnerable, and options accounts require their own approval chain. Understanding these structures isn't just exam material—it's the difference between knowing what a brokerage firm does and understanding how it makes money doing it.