Series 65

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.

Unethical Business Practices of Investment Advisers

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:
  1. 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.

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


    • 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.
Client Loans
    • 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

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

  1. Other Prohibited Behaviors

    • Misrepresentations, third-party research, noncompliant ads, lack of material facts, front running and untrue statements are prohibited.
    • Agency cross transactions: With respect to an IA's own account, IA security sales to a client (or purchases from a client) are prohibited unless the client is given prior written notification and the client consents.
    • IAs must maintain policies and procedures to prevent illegal insider trading.

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