Registered persons are always obligated to act ethically in the securities industry. Some situations fall into an ethical “grey area,” where the same action might be inappropriate in one context but acceptable in another.
To make the expectations clear, this chapter covers:
Failure to provide the necessary documentation to customers
Failure to respond to customer complaints*****
*Excessive trading is also known as churning. One way to spot churning is to compare the amount of trading to the customer’s investment objective. For example, if the objective is conservative (safety-focused) but the account has frequent trading, churning may be occurring.
**Margin agreements must be signed and submitted promptly after the first margin trade.
***Broker-dealers must segregate fully-paid (non-margin) securities, meaning they must be kept separate from the broker-dealer’s own assets.
****A broker-dealer participating in a public offering of a new issue (e.g., an initial public offering) must offer those securities to the general public. The firm may not “hold back” the securities by keeping them in inventory or allocating them to employees.
*****A complaint must be responded to only if the broker-dealer receives it in writing (including electronic submissions). Agents must forward any complaints they receive to their supervisor (principal), who will help resolve the issue. Regardless of the outcome, the broker-dealer must respond to the customer’s complaint.
Now let’s cover unethical practices of agents. Some items repeat because they’re unethical for both broker-dealers and agents.
Borrowing from or lending to customers*
Maintaining custody of customer assets**
Failing to record securities transactions***
Establishing a fake account in order to perform prohibited transactions
Sharing an account with a customer****
Splitting commissions with agents not affiliated with the same broker-dealer
Excessive trading in a customer’s account
Making unsuitable recommendations
Executing transactions without proper authority
Executing a margin trade without the margin agreement
Executing a transaction at a price unrelated to the current market value
Failing to deliver a prospectus in a new issue offering
Engaging in any form of market manipulation
Guaranteeing a customer against loss (performance guarantee)
Advertising a security without the intention of trading it
Engaging in dishonest or manipulative marketing
*Unlike FINRA rules, NASAA applies stricter standards to borrowing from or lending to customers. In particular, there is no exception for family members. Agents generally can’t borrow from anyone, but there is one exception: if the client is in the business of lending money (e.g., banks and lending institutions), the agent may take a loan from the customer. In addition, a customer may be set up with a loan through a margin account at a broker-dealer. Finally, loans may be made to clients that are affiliates of the broker-dealer (e.g., if the client is the Marketing Director at the firm).
**Broker-dealers maintain custody, not agents. In other words, an agent should never personally take possession of a customer’s assets.
*****Selling away occurs when a representative executes a securities transaction outside their employing firm without disclosing the transaction and/or obtaining written approval from the firm. For example, an agent helps a friend sell stock in a small business on the weekend but doesn’t inform the firm.
****Agents generally may not share accounts with customers, but there is an exception. If the employing broker-dealer gives written approval and there is a written agreement with the customer, the agent may share gains and losses (e.g., participate in a joint account) with the customer.
Unethical practices of investment advisers and IARs
NASAA rules also describe unethical practices of investment advisers and IARs. Unlike the NASAA rule for broker-dealers and agents, this rule does not separate the list by role. Instead, it provides one combined list of unethical practices.
Making unsuitable recommendations
Executing transactions without proper authority*
Excessive trading in a customer’s account
Borrowing from or lending to clients**
Misrepresenting professional qualifications***
Providing a third-party analysis or report without proper disclosure****
Charging unreasonable fees
Failing to disclose conflicts of interest
Guaranteeing a customer against loss (performance guarantee)
Sharing an account with a client*****
*Investment advisers and IARs may execute discretionary transactions on 10 days of verbal authority, while broker-dealers and agents must have written authorization before any discretionary transaction.
**The same rule discussed for agents (above) applies here. An investment adviser or IAR may borrow money from a client who is in the business of lending money. Otherwise, borrowing from or lending to clients is unethical and prohibited.
***A common form of misrepresentation involves registration and designations. For example, an IAR may not imply that being registered means they are successful or qualified to handle any client account. Registration only means the person may legally operate in a state; it does not indicate skill, experience, or performance.
****If a third-party analysis or report is provided to a client, the investment adviser or IAR must disclose that it was created by a third party. Without that disclosure, the client could reasonably assume the adviser created it, which would be misleading.
*****Agents may be permitted to share an account with a customer if there is written broker-dealer approval and a written customer agreement. IARs, however, may never share accounts with clients. In all situations, it is considered unethical.
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