Conflicts of Interest - Other Prohibited Behaviors

Actions that are considered either unethical or conflicts of interest include the following:

  • Misrepresentations - IA cannot misrepresent his/her qualifications, services, or fees to clients or potential clients

  • Third-party research - IA cannot use or rely on third-party research for investment recommendations or reports without disclosing this fact to the client

  • Advertisements - IA cannot use an advertisement that does not comply with the guidelines of the Investment Advisers Act of 1940

  • Failure to state important facts - such as failing to state the tax implication of a transaction

  • Trading equities based on information from the analyst department before his or her clients have been given the information (also known as front running).

  • Failing to follow a client's instructions

  • Making misleading or untrue statements, including:
    • Stating or implying that either the state administrator or the SEC approves or endorses the IA
    • Making exaggerated claims about investment performance
    • Stating or implying that either the administrator or the SEC approves of a specific investment
    • Making inaccurate statements regarding commissions or markups
    • Giving inaccurate market quotations
    • Misrepresenting the client's account status

The North American Securities Administrators Association (NASAA) lists fraudulent and unethical business practices for investment advisers, agents and broker-dealers in statements of policy and model rules it publishes.

Agency cross transactions
The Investment Advisers Act of 1940 sets strict standards for IA transactions with a client. Investment advisers are prohibited from to selling any security from its own account to a client without notifying the client in writing and obtaining the client's consent before completion of the transaction. The same prohibition applies to purchasing securities from a client.


STOP
Unethical Business Practices of Investment Advisers

http://www.nasaa.org/content/Files/IAUnethical091105.pdf



Exam Tips and Tricks
The exam is likely to contain a number of questions on prohibited behaviors, such as misleading statements and misrepresentations. Consider this sample question:

All of the following are unethical behaviors prohibited under the Uniform Securities Act EXCEPT:

  1. Deliberately failing to follow a client's instructions
  2. Executing a trade, upon the client's orders, that the IA believes to be unsuitable
  3. Telling a client that the IA is a registered investment adviser and has therefore been approved by the state administrator
  4. Failing to tell a client that making trades recommended by the IA will subject the client to a large tax liability

The correct answer is "b" - the IA must follow client orders. It would be unethical only if the IA recommended the inappropriate trade.

Insider Trading
Investment advisers are required to establish, maintain and enforce written policies and procedures to prevent insider trading. It is illegal to make securities trades based on material information not made available to the public. This ban applies not only to company insiders or employees but to anyone with access to nonpublic information. An amendment to the Securities Exchange Act of 1934 -- the Insider Trading Act of 1984 --increased penalties that could be levied and clarified who could be held responsible for illegal insider trading. The amendment applies not only to those who trade based on nonpublic information but also to those who pass on such information or aid those who engage in such trading.

Conclusion
Within this section we have examined activities that investment advisers are prohibited from, such as churning, loaning money to (or borrowing from) clients and front running, among others. In addition, we've looked at how IAs must uphold the highest level of confidentiality with clients.

  1. Conflicts of Interest

    Churning

    • Misrepresentations - IA cannot misrepresent his/her qualifications, services, or fees to clients or potential clients

    • Third-party research - IA cannot use or rely on third-party research for investment recommendations or reports without disclosing this fact to the client

    • Advertisements - IA cannot use an advertisement that does not comply with the guidelines of the Investment Advisers Act of 1940

    • Failure to state important facts - such as failing to state the tax implication of a transaction

    • Trading equities based on information from the analyst department before his or her clients have been given the information (also known as front running).

    • Failing to follow a client's instructions

    • Making misleading or untrue statements, including:
      • Stating or implying that either the state administrator or the SEC approves or endorses the IA
      • Making exaggerated claims about investment performance
      • Stating or implying that either the administrator or the SEC approves of a specific investment
      • Making inaccurate statements regarding commissions or markups
      • Giving inaccurate market quotations
      • Misrepresenting the client's account status

Client Loans

    • Making more trades than necessary for the purpose of increasing commissions is unethical, since IAs must make trades in the best interests of their clients.
  1. Investment Adviser Duties

    Confidentiality

    • Borrowing money from a client is prohibited unless the client is a broker-dealer or an affiliate of the investment adviser or is in the business of lending money
    • Lending money to a client is prohibited unless the IA is a lending financial institution or the client is an affiliate or employee of the IA

  2. Fiduciary Duties

      • All client information must be held with the strictest confidence, unless the client has authorized its release in writing or the SEC, IRS or other governmental authority requires the information by law.
    1. Other Prohibited Behaviors

      • All IAs must be loyal, provide objective recommendations that are appropriate for each client and ensure best execution for securities transactions.

    2. Introduction


      Related Articles
      1. Professionals

        What To Do When Your Client Behaves Badly

        As a financial advisor managing your client's assets is only part of the job; sometimes you have to manage your client, as well.
      2. Professionals

        Manage Your Clients' Expectations

        You can't control how they react to the market, but you can help them understand the reality of the situation.
      3. Financial Advisors

        Losing a Client Is Not Always The End of The World

        Losing a client is never pleasant for a financial advisor, but sometimes this is a better outcome than continuing the relationship.
      4. Professionals

        How Often Should You Contact Clients?

        Figuring out how often an investment advisor should contact clients is not easy.
      5. Professionals

        5 Traits the Best Financial Advisors Share

        Discover what the best financial advisers share in terms of the traits they possess, and learn what clients value most in their advisers.
      6. Retirement

        Helping Your Clients Face The Financial Reality Of Retirement

        Altering retirement plans is tough, but when the retiree is unprepared, it's very necessary.
      7. Financial Advisors

        How Client Behavior Impacts Retirement Planning

        While many clients know they should save for retirement, they don't. Here's how advisors can help modify their bad financial behavior.
      8. Brokers

        Deal Effectively With Difficult Clients

        Learn how to tame the most shrewish clients with these simple methods.
      9. Professionals

        Private Banking Vs. Wealth Management: Not Quite the Same

        Discover the various ways in which private banking and wealth management services coincide, as well as the significant differences between them.
      10. Financial Advisors

        Tips for Assessing a Client's Risk Tolerance

        Determining a client’s risk tolerance is a critical piece of the puzzle in designing and appropriate asset allocation.
      RELATED TERMS
      1. International Accounting Standards ...

        An older set of standards stating how particular types of transactions ...
      2. Agency Cross

        A transaction in which an investment adviser acts as the broker ...
      3. Investment Manager

        A person or organization that makes investments in portfolios ...
      4. Agency Broker

        A broker that acts as an agent to its clients. When acting as ...
      5. Limited Discretionary Account

        A type of account in which a client allows a broker to act on ...
      6. Churning

        Excessive trading by a broker in a client's account largely to ...
      RELATED FAQS
      1. An advisor has all client advisory fees automatically deducted from their accounts ...

        The correct answer is c) An advisor is not deemed to have custody of client funds when debiting management fees from the ... Read Answer >>
      2. What is the difference between fee-based advisors and commission-based advisors?

        Understand the difference between fee-based advisers and commission-based advisers. Learn what types of duties each type ... Read Answer >>
      3. What is the difference between fee-only advisors and fee-based advisors?

        Better manage your retirement account by understanding the important differences between fee-only and fee-based financial ... Read Answer >>
      4. The de Minimis clause for investment advisers means:

        A. An investment adviser must register with the state if it holds less than $25 million in assets.B. An investment adviser ... Read Answer >>
      5. Why are fee-based accounts preferred by many high net worth individuals (HNWI)?

        Learn why many high-net-worth individuals prefer fee-based financial advisers, and learn how commission based advisers may ... Read Answer >>
      6. Does agency theory apply to brokers and clients?

        Learn how the existence of incentives that encourage moral hazard impacts broker-client relationships. Understand how agency ... Read Answer >>
      Hot Definitions
      1. MACD Technical Indicator

        Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
      2. Over-The-Counter - OTC

        Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
      3. Quarter - Q1, Q2, Q3, Q4

        A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
      4. Weighted Average Cost Of Capital - WACC

        Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
      5. Basis Point (BPS)

        A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
      6. Sharing Economy

        An economic model in which individuals are able to borrow or rent assets owned by someone else.
      Trading Center