There are several important things you need to consider before assigning someone discretionary authority over your account
When Carl was overseas, he called his uncle, Bill, a retired stockbroker, to ask Kate to sell shares on his account. However, Kate refused to take Bill's order as she said Carl hadn't given him the proper authority. Carl was angry at Kate's inflexibility, as he had missed a good selling opportunity - his shares didn't hit the same high price for a long time!
How can I make third party authorisation?
If you want to authorise a third party (not your brokerage or its staff) to operate your account, it is best to give the authority in writing (such as a power of attorney) and spell out the extent of the authority.
As the account owner, you are responsible for all the consequences of transactions the authorised third party conducts in your account, even if they result in losses.
In Carl's case, Kate was right not to take Bill's instruction, as Carl had not given Bill any authorization. Instead, Carl should have told his brokerage, preferably in writing, that Bill was an authorised person who could place orders on his account.
How can I authorise the brokerage or account executive?
If you want to authorise your brokerage or its staff to trade for you, you must open a discretionary account instead.
- Your discretionary authority must be granted or revoked in writing. This should include a clear explanation of your investment objectives and risk profile. The discretionary authority has to be reconfirmed in writing each year.
- Your client agreement should designate your account as a discretionary one.
Important features of discretionary accounts
- Once discretionary authority is granted, your brokerage will be able to act on its own initiative without asking you. To stop anyone overtrading your account to earn more commission (this known as churning), make sure that you get regular statements showing your position in money and investment holdings. Review every transaction promptly to ensure it reflects your investment objectives. And remember that the combination of a discretionary account and a hold mail arrangement could expose you to unnecessary risk.
- All investments carry a degree of risk. Trades made under a discretionary arrangement may not always yield profits. Note that making a loss on an investment does not necessarily mean that your brokerage's conduct is wrong or that it has committed a crime.
- You cannot give a third party authorisation to a staff member of your brokerage, even though he may be your friend or relative. You have to open a discretionary account.
Can trades be unauthorised in a discretionary arrangement?
Yes, if the account holder has not given his authority in writing, but a verbal agreement has been reached. Allegations of unauthorised trades arise when the investor disputes transactions saying they are not authorised but the account executive says that authorisation was given.
Very often, the dispute becomes a case of one person's words against another's. To avoid this type of situation, you're recommended to give clear written authorisation to set up a discretionary arrangement.
SFC rules on discretionary accounts
Discretionary account openings should be approved by the brokerage's senior management, who must make sure there are adequate internal control procedures for proper supervision of the accounts. These procedures include a proper order audit trail, timely transaction reports and regular performance reviews.
A discretionary account agreement must be executed, setting out clearly the client's investment objectives and strategies, and the extent of the discretion. The client agreement and the brokerage's records must show that the account is a discretionary one. Discretionary authority needs to be reconfirmed annually.