03-Aug-2005
By Amy B. Crane
When it comes to finding a new broker, most investors focus on commission rates, fees and research. The brokerage agreement usually gets short shrift as a necessary formality in the new account process. However, ignoring the terms of your brokerage agreement isn’t a good idea because this document sets out the framework of the relationship between you and broker.
“Brokerage agreements from National Association of Security Dealer (NASD) member firms are usually similar, but investors should read and understand what they are signing,” says Bruce Fenton, president of Atlantic Financial. NASD rules govern brokerages and brokers under federal law; nearly all brokerages are members of the NASD.
The agreement provides details regarding matters such as how disputes are resolved, how you will pay for securities you buy, how dividends are credited and margin calls. In addition, most brokerages can amend the agreement without your explicit knowledge or with a brief notification included in one of your statements.
What to Look Out For
Most agreements are four or five pages long. Here are the most important clauses to watch out for:
Credit Reports. When you sign most brokerage agreements, you give permission for the brokerage to pull your credit report and your spouse’s credit report if it is a joint account and/or if you live in a community property state. In some cases, the account agreement allows the brokerage to obtain other information about you as well as supplying your account information to credit bureaus. Virtually all brokerages reserve the right to reject your application for any reason.
Debit Balances. Many investors have multiple accounts at one brokerage firm. But what investors don’t realize is that a number of brokerages reserve the right in their agreements to take money from one account to pay the debts in another account. “In the agreements that I looked at, this was pretty uniform,” says Dr. Don Taylor, an associate professor of finance at the American College in Bryn Mawr, Pa. “If you have a cash balance in one account they could raid another and the broker is the one who chooses which account. They could even take money out of your IRA, triggering taxes and penalties.”
Margin Calls. For investors who buy stock on margin, many brokers can change the margin requirements without notice and can also liquidate any of your other investments to meet margin calls at any time. Buying stock on margin involves borrowing money against the securities you already own to buy more stock. A margin call occurs when the value of the stock that you bought on margin decreased in value and your broker requires that you put up more funds to bring the balance up to a minimum requirement.
Dividend and Interest Payments. While most investors assume that they receive credit for all dividends and interest immediately, this isn’t always the case. Many brokerages note in your account agreement that they reserve the right to lend out your securities to other customers who are selling stock short. If you receive a dividend during that time, you don’t get the actual dividend, but a payment in lieu of the dividend, which won’t receive the same tax treatment as the dividend, Taylor says. Also, brokerages can calculate interest on cash balances however they like.
Binding Arbitration. If you have a conflict with your broker that you can’t resolve, you can’t sue in court. Virtually all brokerage agreements stipulate that disagreements must be settled through binding arbitration, which is very different from going to court. While arbitration is generally quicker than going to court, there is limited discovery and very narrow grounds for appeal if the investor loses, says Andrew Stoltmann, a securities attorney in Chicago, Ill. Discovery is the process under which parties in a dispute gather information and background on the dispute.
Other Clauses. Other important clauses to be aware of include:
• Right of joint account holders: if you have a joint account with your spouse or another party, either person can remove any or all of the money in the account without the others’ permission.
• Agreement to be bound by future revisions: if this provision is in your agreement, it means that your brokerage can totally change the terms of your agreement without notifying you, but you will still be bound by the provisions in the new agreement, Taylor says.
• Notice period: this clause states the amount of time you have to notify the brokerage if there is a mistake in a trade or on your statement. “This is a pretty big deal, especially with online trading, because you may only have a day or two to dispute a trade confirmation if a mistake is made,” Taylor says.
