A new agent at a broker-dealer hears "do whatever you think is best" and places the trade. It is profitable. The client thanks her. The state still writes it up, because a BD agent needs written discretionary authority on file BEFORE the trade. An IAR doing the identical thing gets ten business days to paper it. Discretion rules don't care that you made money, and they don't run the same way on both sides of the license.
Fees, commissions, and markups all count as compensation. The form doesn't matter. The disclosure does.
Fees. Investment advisers typically charge a percentage of assets under management (AUM), a flat fee, or hourly. Whatever the structure, the fee schedule must be disclosed in Form ADV Part 2 (the brochure) and delivered to the client at or before the contract is signed.
Commissions. Agents of broker-dealers earn commissions on agency trades. Commissions must be disclosed on the trade confirmation: amount, capacity (agency vs principal), and any concession received from third parties.
Common mistakes
- Flipping the discretion asymmetry between IARs and BD agents. The 10-business-day oral window belongs to IARs. BD agents need written authorization on file BEFORE the first discretionary trade. Assuming the fiduciary must carry the stricter rule is exactly how this one gets missed.
- Thinking time/price discretion needs written authority. It doesn't, IF the client specified security, action, and amount, AND the order expires same day. Picking when and at what price within the day is not discretion.
- Assuming markups equal commissions. Markups are built into the price in principal trades; commissions are added separately in agency trades. Confirmation must show capacity, but markups are not labeled as commissions.
Bottom line
- Compensation must be disclosed in writing at or before the advisory contract; "compensation" includes any economic benefit (cash, soft dollars, third-party payments).
- IA custody triggers a qualified custodian, surprise audit, client notice, and minimum net worth or bond (typically $35,000).
- BD agent discretion = written authority plus firm acceptance BEFORE the first trade. IAR discretion = oral authority OK at the trade, written authority within 10 business days after it.
- Time/price discretion is NOT full discretion if client specified security, amount, and action, AND the order expires same day.
Exam shortcut
"Before the first trade" equals BD agent discretion. If the question shows an agent of a broker-dealer placing a discretionary trade on oral-only consent, it's a violation no matter how fast the paperwork follows. If the rep is an IAR, check the calendar instead: written authority is due within 10 business days of that first trade. 3 business days is the custody safe harbor for inadvertently received funds.
The full lesson (about 2,730 words, 18 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- H19
- H20
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