Unethical actions
Improper use of customers’ securities or funds
No registered person can make any guarantees to a customer as to a gain in the account or even against a loss. They cannot offer to buy back the investment at the purchase price later, as that would be guaranteeing against a loss.
Registered representatives may share in a customer’s account only with prior written authorization from both the employing firm and the customer (FINRA Rule 2150). The sharing must be in direct proportion to how much each contributed. If the client contributes 80% and the rep 20%, then the rep can only get 20% of the gains, and must pay 20% of the losses. The proportional requirement doesn’t apply to accounts of the rep’s immediate family: a spouse, parents, parents-in-law, children, or any relative the rep supports.
Splitting commissions
A registered representative can split commissions with another representative, as long as that representative is registered with the same firm or with a firm under common control with it. The client doesn’t have to be told about the split. Splitting commissions with anyone else, including a representative at an unaffiliated firm, is an unethical practice under state securities rules modeled on NASAA’s rule on dishonest or unethical business practices, even if the client is told about it. Separately, FINRA Rule 2040 bars paying commissions to an unregistered person who would have to be registered as a broker-dealer to receive them.
Borrowing from or lending to customers
Under FINRA Rule 3240, no associated person in any registered capacity may borrow or lend money to any customer unless they are in the borrowing/lending industry, immediate family, both registered persons of the same member, in a bona fide, close personal relationship that was formed before the broker-customer relationship and is maintained outside of it (a friendship that began only after the person became a customer doesn’t qualify), or in a bona fide business relationship outside of the broker-customer relationship - and even then, only if the member firm has written procedures permitting it. For the same-firm, personal relationship, and business relationship exceptions, the registered person must notify the firm before entering into the arrangement, and the firm must pre-approve it in writing. Broker-dealer house rules may add further restrictions, so always follow your own firm’s rules.
To be clear, the client in the business of borrowing/lending would be if your customer was a bank, or mortgage company, not an employee of the bank, or the manager of the mortgage company.
Front running of block transactions
Under FINRA Rule 5270, no member or associated person may trade a security, or a related financial instrument such as an option on it, while in possession of material, non-public market information about an imminent block transaction in that security, until the information is public or stale. An information barrier (historically called a Chinese wall) restricts the flow of material non-public information between departments of a firm, so that people who don’t need it can’t use it to trade.
Large block orders will raise or lower the price of a stock because they use up all the market maker quotes at the best prices for the purchases or sales. Trading on that information for personal gain is not allowed, which is why firms use information barriers to keep it from people who could trade on it.
Transactions related to initial public offerings
During an IPO period, no member or associated person of a member shall execute a transaction other than on an exchange, until such security has first opened for trading on the national exchange listing the security. That is indicated by the listing exchange letting the public know that the opening transaction has occurred; “dissemination of opening transaction”.
Pump and dump
Someone purchasing a lot of a cheap stock, and then likely through rumors pumping up the price and then selling it at the artificially higher price.
Promoters can use any means to create buzz - print media, online forums, or social media - including posting under multiple accounts to make a stock look more talked-about than it really is. The goal is simply to get people interested enough to buy, driving the price up before the promoter sells.
The scheme requires both the pump and the dump - simply talking up a stock you hold, without selling into the inflated price, isn’t a pump and dump.
Capping and pegging
Capping and pegging are 2 very similar forms of market manipulation. They are designed to try and prevent a stock price from crossing a certain number the person capping or pegging chooses. We will not go into how, the specific types of trades aren’t needed.
Capping is trying to prevent a stock from going above a certain value. Pegging is trying to prevent a stock from falling below a certain value. Otherwise, for exam purposes, they are the same, and often will actually be simply referred to as “capping and pegging”, not separated.
Artificial pricing
No one can execute purchases or sales at successively higher or lower prices simply to create a false sense of activity.
Trades must involve “change of beneficial ownership”
Change of beneficial ownership is a complicated phrase that basically means in plain English, that an actual, legitimate trade has taken place. If someone places an order to buy 100,000 shares and at the exact same time another order to sell 100,000 shares, of the same company, how much is that really going to cost them? Nothing but the commissions on the orders, but it looks like 100,000 shares just moved. There was no change of beneficial ownership in this case, as the person committing this violation, never really had ownership.
Why wash trades and matched orders are hard to detect
A wash trade has the same beneficial owner on both sides. Matched orders are a buy and a sell of about the same size, at about the same time and price, entered by parties who each know of the other’s order (Securities Exchange Act Section 9(a)(1)).
To catch either one, a regulator has to link the buy side to the sell side and to whoever is behind both. Manipulators make that hard by spreading their orders across different accounts, broker-dealers, and markets, so that no single firm or exchange sees the whole pattern. That’s why FINRA runs its surveillance across markets and across firms.
Inside one firm, the firm must have procedures to prevent a pattern of self-trades between its own trading desks or algorithms (FINRA Rule 5210).
Other miscellaneous prohibited practices
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No member may trade a designated security for an account in which it has an interest if the trading is excessive in view of the member’s financial resources or the market for that security.
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No member shall participate in or profit from manipulative operations or knowingly manage or finance manipulative operations.
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No one can lie about securities or spread information they know to be false, misleading, or manipulative.
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No member or AP shall hold an interest in any joint account for buying/selling a designated security, unless that joint account is reported to FINRA.
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No one can offer a transaction in a designated security that will influence the closing transaction of that security.
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Designated securities means all NMS, national market system, stocks as designated by Rule 600(b)
Improper use of assets
No broker, dealer, or municipal professional can make improper use of securities or funds held by another person, and no advisory company with custody can either.
A municipal dealer can’t guarantee a customer against loss (MSRB Rule G-25). A put option or repurchase agreement the dealer gives a customer, which commits it to buy the security back, isn’t treated as such a guarantee if its terms are given to the customer in writing with or on the confirmation and recorded in the dealer’s books. The same promise made orally, or left off the confirmation, is a prohibited guarantee.