What is a discretionary account?
As a general rule, there are two types of brokerage accounts: discretionary and nondiscretionary. The legal duties that a brokerage firm owes to its client often depend upon which type of account is held by the client.
In a discretionary account, the client has given his or her broker the power and authority to make trading decisions without first consulting with the client on a trade-by-trade basis. In other words, the broker has discretion to trade the account, as he or she sees fit, in accordance with the investment objectives and other information provided by the client. The broker does not need to call the client before placing each and every trade.
In a nondiscretionary account, in contrast, the broker must consult with his or her client before placing every trade. The broker does not have authority to make trading decisions without the client’s express permission. The broker must mark each trade as either “solicited,” which means the trade was the broker’s idea, or “unsolicited,” which means the trade was the client’s idea.
As a general rule, a broker who handles a discretionary account owes a higher level of fiduciary duty to his or her client. This is because the client places more trust and control in the hands of the broker. In a discretionary account, a broker must not only recommend suitable and proper trades, the broker must also monitor the account and sell positions that become unsuitable due to changing market conditions.
In nondiscretionary accounts, courts have held that brokers owe a lower level of duty. The broker must recommend suitable and appropriate trades on a trade-by-trade basis, but generally has no ongoing duty to monitor the account once the trade is made. This duty can change based on the facts and circumstances of the case however. For example, if a broker develops a relationship of high trust and confidence with the client, such that the client never rejects the broker’s advice and the broker begins to make trades without the client’s prior permission, courts have found that a de facto nondiscretionary account can exist, thus giving rise to higher level of fiduciary duty.
Please Note: Rabin Kammerer Johnson provides these FAQs for informational purposes only, and you should not interpret this information as legal advice. If you want advice as to how the law might apply to the specific facts and circumstances of your case, please contact one of our attorneys.