Robinhood was at the center of the unprecedented and monumental Reddit trading mania that saw shares of GameStop (GME) and other companies, including headphone maker Koss (KOSS) and cinema operator AMC (AMC) soar to extreme levels as amateur traders piled into the stocks earlier this year.

However, the popular trading app was accused of selling off the Reddit stocks without customers’ permission.

Selling stocks out of a client’s brokerage account without authorization in order to maximize the broker’s commissions is generally considered unauthorized and illegal trading.

The circumstances under which a broker is authorized or unauthorized to sell your position depends on the broker agreement the trader has signed and the type of brokerage account.

However, unauthorized selling of positions is very rare in an online discount stock brokerage account.

That said, your first resource should be your client agreement that you signed when the brokerage account was established. This document outlines all of the permissions and authority given to your broker to execute on your behalf.

Discretionary vs non-discretionary accounts

According to the Financial Industry Regulatory Authority (FINRA) unauthorized trading is one of the most common problems that traders and investors should watch out for.

Generally, if a broker sells your position without your consent and knowledge, they could be liable for unauthorized trading. In situations like these, the main issue is determining what kind of account you had with that broker.

There are various types of brokerage accounts and some of them are subject to unauthorized trading rules while some are not. In this blog post, we’re going to focus on discretionary and non-discretionary accounts, as well as margin accounts.

Discretionary accounts

A discretionary account is an account that gives a brokerage firm the right to make individual trades without the permission of their client.

If the terms of the client agreement you signed with the broker give the firm the right to use its own discretion to make trades in your account, you have given prior consent and the broker will probably not be liable for unauthorized trading.

Non-discretionary accounts

A non-discretionary account, on the other hand, is an account that gives the client the authority to always decide whether or not to make a trade.

Therefore, an account must have to be non-discretionary in order to qualify as an unauthorized trade. Basically, a non-discretionary account means that the broker must get prior consent before carrying out any transactions in securities.

If your account was non-discretionary and the broker sold some securities without your consent, he likely broke several securities laws.

What if you have a margin account?

While the laws regarding unauthorized trading vary from state to state, there is an exception when a broker may make a trade in a non-discretionary without the broker getting prior permission from the client for the said position.

For instance, if you have a margin account and the value of the account drops below the broker’s requirements, they may be able to sell your positions without seeking your approval beforehand.

Basically, a margin account is a type of brokerage account that allows you to buy securities on margin by borrowing money through your broker.

Buying on margin allows you to buy more shares than what you could otherwise be able to buy with just the money in your cash account (buying power).

There is a $2,000 minimum requirement for margin accounts, but you will be given 2:1 leverage, which means if you have $2,500 in the account you will have up to $5,000 in buying power.

Consider a scenario where you buy a stock for $200, and the stock price goes up to $250. If you purchased the stock using a cash account, then you will receive a 25% return on your trade.

But if you purchased the stock on margin, paying $100 in cash and borrowing $100 from your brokerage firm, then you will earn a 50% return on the money that you used.

However, not all stocks bought on margin will rise in value. If the price of the stock goes down, then your loss will be amplified in the same way.

Using our example, a $200 stock that falls to $100 represents a 50% loss in a cash account, as well as a 100% loss in a margin account (plus interest on the $100 loan).

If the value of the collateral in your trading account dips below the required margin threshold, then the broker may issue a margin call.

Basically, this is a request by your broker to repay the money you borrowed by immediately depositing additional securities or cash to raise the account value above the maintenance margin.

If you fail to pay the margin call, the broker has the right to seize your positions and begin liquidating them to recover them loan.

Bottom Line

For many stock traders, the brokerage industry is a mysterious and strange place filled with a language all on its own. Before diving into the stock market, it is a good idea to spend some time learning the basics of how to responsibly pick stocks.

It’s also worth keeping in mind that a stock broker can be your best friend or worst foe. The actions of your stock broker can be the difference between enjoying better sleep at night knowing your money is in safe hands or having sleepless nights with anger and worry.

When you open up a new account with a brokerage firm, make sure to know whether your account is discretionary or non-discretionary. Many traders don’t bother to know the status of their account because most brokers rarely explain the key differences between these two types of accounts.

Make sure to review your account on a regular basis to stay up-to-date with activities. Examine your broker’s terms and conditions, and always ask questions for clarity of information that you may not comprehend.

These simple steps can help you avoid many types of broker misconduct, including unauthorized transactions.