Compliance and Regulatory Alerts | 04-21-21
With Increase in Options Trading, FINRA Issues Alert on Options Account Approval, Supervision and Margin Requirements
On April 9, 2021, FINRA issued guidance reminding members of their obligations on customer options accounts. The new alert flows from a reported increase in the opening of self-directed brokerage accounts and a broader risk of whether broker dealers and investment advisers are collecting information and performing adequate due diligence to ensure that options trading is appropriate for their customers.
In the regulatory notice, FINRA reminded members that “regardless of whether the account is self-directed or options are being recommended, members must perform due diligence on the customer and collect information about the customer to support a determination that options trading is appropriate for the customer.” Additionally, the alert highlights compliance obligations on supervision, anti-money laundering and margin for customers seeking to trade options.
On the approval process for opening a customer’s brokerage account to options trading, FINRA reviewed rules requiring members to (i) specify and maintain information using "reasonable diligence" as to essential facts (e.g. “customer’s knowledge, investment experience, age, financial situation and investment objectives”); (ii) review the range of options trading that should be allowed (or whether there should be limits placed on the customer as to certain types of options trading); and (iii) consider the amount or type of credit that should be extended to a customer for approved options trading. As part of the approval process, FINRA also highlighted verification requirements under anti-money laundering “customer identification program” rules and emphasized the importance of keeping information up to date and documenting any material change.
On supervisory requirements, FINRA reminded members of their obligation to establish and maintain policies and procedures for the approval process, and, in particular, on the use of “specific criteria and standards” to evaluate the “suitability of the customer” when they are trading uncovered short option contracts. (These trades require that members provide a special written statement.) Only a Branch Office Manager, Registered Options Principal or a Limited Principal/General Securities Sales Supervisor may make these determinations. Further, members were urged to refer their customers to the Office of Comptroller of the Currency options disclosure document to ensure that clients were aware of the complexity of options trading and the risks associated with them.
Other Considerations: Reg BI, Communications, Records and Margin
Regulation Best Interest (“Reg BI”) comes into play when recommendations on transactions or strategies involving options are made to retail customers. In the notice, FINRA reminded members of their obligations under Reg BI, as well as on compliance with communications and records retention rules. These warnings are intended to ensure appropriate supervisory and periodic review of the customer information and to document approval decisions and materials for supervisory review.
FINRA also advised members to comply with margin requirements—most importantly, to supervise the adequacy of margin with respect to options transactions since most of these transactions are “effected” through margin accounts. (Note: FINRA updated margin requirements FAQs on April 13, 2021.) Specifically, FINRA reminded firms to establish margin policies and procedures, review the need for higher margin requirements for individual securities and customers, limit credit that can be extended to customers and provide a margin disclosure statement on trading risk.
How Bates Helps:
Bates staff and experts have been retained to assist counsel in analyzing and explaining the interplay between the use of margin, the posting of collateral, their impact on equities trading and options strategies, and to help the parties understand the potential exposure. If you or your colleagues are involved in options and margin matters, we would be happy to arrange a call to share with you our knowledge and experience.
Below, please find links to our options and margin consulting and testifying experts and their CVs for your reference:
For litigation questions, please contact Andrew Daniel, Director, at ADaniel@bategroup.com. For regulatory and compliance questions, please contact Hank Sanchez, Bates Compliance Managing Director, Bates Group at HSanchez@batesgroup.com.
If you would like more information concerning Bates Group's Practices and services, please visit:
Retail Litigation and Consulting
Institutional and Complex Litigation
Consulting and Expert Testimony
Regulatory and Internal Investigations