With the recent increase in the number of customers seeking to open self-directed brokerage accounts, FINRA reminds members of the requirements when a customer is seeking to trade options in his or her account. FINRA Rule 2360 sets forth the approval process with which members must comply when opening a customer’s brokerage account for options as well as the requirement of ongoing specific supervisory reviews for options accounts. These requirements are outlined in FINRA Rule 2360(b)(16) and FINRA Rule 2360(b)(20), respectively, which are consistent with the rules of the options exchanges (e.g., Cboe Rule 9.1 (Opening of Accounts) and 9.2(j) (Supervision of Accounts).
Account Opening & Approval. In addition, FINRA reminds members that other rules apply when opening customer accounts, including:
FINRA Rule 4512 specifying the information that a member shall maintain regarding a customer;
FINRA Rule 2090 requiring that a member use "reasonable diligence" in regard to the opening and maintenance of each account to know the "essential facts" concerning each customer; and
FINRA Rule 3310(b) and related anti-money laundering requirements, under which broker-dealers are required to establish and maintain a written Customer Identification Program to verify the identity of a customer who seeks to open a brokerage account.
FINRA rules require that each customer must be specifically approved (or disapproved) for options trading prior to the time the member accepts an options order from the customer, regardless of whether the brokerage account is self-directed or options are being recommended. The rule sets forth the steps that must be taken as part of that approval. FINRA Rule 2360(b)(16) requires a member to exercise due diligence to ascertain the essential facts relative to the customer. Specifically, the member must seek to obtain and consider detailed customer information, including, among others, the customer’s knowledge, investment experience, age, financial situation and investment objectives.
Based upon this information the member must determine whether it is appropriate to approve the customer to trade options. This approval process must consider the appropriateness of the full range of options trading being approved for the customer. As part of this approval process, members also should consider whether to approve a customer only for certain types of options transactions and not for others. A customer may, for example, be approved for one or more of the following types of options transactions: (1) purchases of puts and calls only; (2) covered call writing; (3) uncovered put and call writing; and (4) options spread transactions.
Limits & Credit Extension. In certain cases, members may require minimum dollar amounts in accounts for particular types of options transactions or may find it useful to place dollar limitations on options transactions of various types. Broker-dealers should also carefully consider the amount of credit extended to a customer for options transactions.
Approval Procedures. Broker-dealers are responsible for establishing policies and procedures for options account approval, based on the information provided by the customer and consistent with the firm’s supervisory framework. Furthermore, if a customer seeks to write uncovered short option contracts, broker-dealers must use specific criteria and standards in evaluating the suitability of the customer for writing these transactions and must deliver the special written statement.
Collection of Customer Information. It is important for members to have accurate and complete data about a customer’s financial situation and objectives, along with the other required information, to enable the member to fully review the account to determine whether to approve (or disapprove) the account for options trading. While not every customer may give all the information requested, members must note this refusal to provide information in customers’ records and consider it together with other information available as part of reviewing whether and to what extent to approve the account for options trading. The approval must be performed by a branch office manager, Registered Options Principal or a Limited Principal—General Securities Sales Supervisor.
Members must also verify the background and financial information by giving the customer the opportunity to correct any information. Unless the information is included in the customer's account agreement, the customer’s background and financial information must be sent to the customer for verification within 15 days after the customer's account has been approved for options trading. If a member becomes aware of any material change in the customer's financial situation, the current background and financial information must be sent to the customer for verification within 15 days. While the rule provides that the information is deemed verified if the customer doesn’t respond to the contrary, members should encourage customers to review the information provided and determine whether any updates or additions are necessary.
Disclosures. In addition to the requirement in FINRA Rule 2360(b)(16) to specifically approve (or disapprove) a customer’s account to trade options, the rule requires that members must furnish the customer with the document entitled Characteristics and Risks of Standardized Options, also known as the options disclosure document available on the Options Clearing Corporation’s website. The options disclosure document contains the basic information about options, including defined terms and exercise procedures, principal risks of options positions and examples of different types of options. Broker-dealers should encourage customers to read this information as well as other educational material to ensure customers understand the risks of trading options.
Other requirements:
Obligations under Regulation BI become effective once recommendations of options transactions or investment strategies involving options (including account recommendations) to retail customers are made.
Any options communications must be in conformance with the communications rules.
Options accounts records must be retained to permit timely and periodic supervisory reviews, including, among others, reviewing the compatibility of options transactions with investment objectives and with the types of transactions for which the account was approved.
Records must be retained to document the customer information, approval decisions and supervisory review materials.
Records must also be retained to permit the review of the size and frequency of options transactions, profit or loss in the account and any undue concentration in the account.
Accounts are expected to be reviewed for these areas of concern as well as ensuring their written supervisory systems policies and procedures adequately address the members’ options business.
Margin requirements. Option transactions are often required to be effected in a margin account, including transactions when an option is not paid for in full or there is a short sale of an option that is not covered by the customer. Almost all option spread transactions are required to be in a margin account. Broker-dealers are reminded that FINRA Rule 4210 sets forth the maintenance margin requirements for options transactions. In addition, the rule requires firms to have procedures to review the limits and types of credit extended to all customers, to review the need for higher margin requirements for individual securities and customers, and to formulate their own margin requirements. Further, broker-dealers are reminded that FINRA Rule 2264 requires that members furnish non-institutional customers a margin disclosure statement prior to opening a margin account that explains the risks of trading on margin.