Suitability responsibilities of a discount broker/dealer when a customer is trading in options contracts (under former Article III, Section 2, now Rule 2310).


 

May 18, 1993

 

Thank you for your recent letter to Ms. Rothwell of this office regarding the trading of options by customers through a discount broker/dealer. Your letter indicated concern with certain arbitration cases which apparently have assessed discount broker/dealers with responsibility for protecting customers from incurring excessive losses in option accounts.

 

Please be advised that although many arbitration cases are conducted under the auspices of the NASD, matters which are heard in arbitration, and the decisions rendered, do not represent the position of the NASD on any particular matter and should not be equated with a disciplinary action initiated by the NASD.

 

Generally, Article III, Section 2 of the NASD's Rules of Fair Practice (copy attached) governs the suitability requirements of broker/dealers when effecting securities transactions for public customers. As Section 2 indicates, the various requirements and information needed from customers are in the context of recommendations to customers by a broker/dealer. Although Section 2 does not directly address suitability requirements, if any, which must be met by a discount broker/dealer, the policy of the Board of Governors following Section 2 indicates that implicit in all member and registered representative relationships with customers and others is a fundamental responsibility for fair dealing. The policy indicates that sales efforts must therefore be undertaken only on a basis that can be judged as being within the ethical standards of the Association's Rules, with particular emphasis on a requirement to deal fairly with the public.

With regard to the trading of options, the Board of Governors policy references Section 33 and Appendix E of the Rules of Fair Practice. Pursuant to Section 33(a), a member or a person associated with a member shall not effect any transaction in an option contract except in accordance with the provision of the rules, regulations and procedures adopted by the Board of Governors. In addition, Section 33(c) incorporates Appendix E (copy attached) which has specific requirements for all broker/dealers who effect transactions in option contracts for customers. Specifically, Section 16(a) of Appendix E requires that no member or person associated with a member shall accept an order from a customer to purchase or write an option contract unless the broker/dealer furnishes or has furnished to the customer the appropriate options disclosure documents and the customer's account has been approved for options trading in accordance with the provisions of Subsections (b) through (d) of Section 16. Subsection (b) of Section 16 delineates the due diligence requirements for broker/dealers when approving a customer's account for options trading. The interpretation of the Board of Governors following Section 16 lists the specific information which the member shall seek to obtain from customers with respect to their trading in options. In addition, Section 21 of the Rules of Fair Practice list the specific records which are required to be maintained on each customer of an NASD member.

 

While the NASD has no specific position as to the suitability and monitoring of options accounts by a discount broker/dealer, the NASD's Rules of Fair Practice reflect the recognition by the Association that options accounts require a heightened degree of review and records specificity, notwithstanding that an account is opened at a discount broker/dealer. The determination of whether a broker/dealer is going to be responsible for the suitability of the options traded in any customer's account is necessarily going to depend on the facts and circumstances of the account, including whether the securities in the account were recommended and/or the amount of discretion that the broker/dealer exercised over the account. The fact that an options account is opened through a discount broker/dealer on an unsolicited basis would not necessarily be an absolute protection against responsibility for the suitability of the securities in the account, without an analysis of the surrounding facts and circumstances.

 

Thank you for your inquiry. I hope this response proves useful and addresses your concerns. Please do not hesitate to contact me at the above telephone number if I can be of any further assistance.

 

Very truly yours,

 

Lewis E. Antone, Jr.