Registered persons are always obligated to act ethically in the securities industry. Some situations fall into a “grey area,” where the same action might be unethical 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. A practical way to spot churning is to compare the amount of trading to the customer’s investment objective. For example, if the objective is conservative (safe) 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 assets of the broker-dealer.
****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” securities by keeping them in inventory or allocating them to employees.
*****A complaint must be responded to only if it is provided to the broker-dealer 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 the same conduct can be 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 policies on borrowing from or lending to customers. In particular, there is no exception for family members. Agents generally cannot 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, an arrangement may be made to set the customer up with a loan through a margin account at a broker-dealer. Last, 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. That means an agent should never personally take possession of a customer’s assets.
*****Selling away occurs when a representative participates in 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 does not inform the firm.
****Agents generally may not share accounts with customers, but there is an exception. If the employing broker-dealer provides 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; it treats them as one category 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 prior to 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 professional misrepresentation involves registration designations. For example, an IAR may not imply that registration means they are successful or qualified to handle any client account. Registration only means a person may legally operate in a state; it does not measure qualifications or ability.
****If a third-party analysis or report is furnished to a client, the investment adviser or IAR must disclose that it was created by a third party. Without that disclosure, the client may incorrectly assume the adviser created it, which is misleading.
*****While an agent may be able to share an account with a customer (with written approval from the broker-dealer and a written agreement with the customer), IARs may never share accounts with clients. In all situations, it is considered unethical.
Sign up for free to take 29 quiz questions on this topic
