Series 62

Recommendations Professional Conduct And Taxation - Fair Dealings With Customers

All broker dealers are required to act in good faith in all of their dealings with customers and are required to uphold just and equitable trade practices. FINRA’s rules of fair practice, also known as the rules of conduct, regulate how business is conducted with members of the general public. The rules of conduct prohibit all of the following:

  • Churning
  • Manipulative & deceptive practices
  • Unauthorized trading
  • Fraudulent acts
  • Blanket recommendations
  • Misrepresentations
  • Omitting material facts
  • Making guarantees
  • Selling Dividends
  • Recommending speculative securities without knowing the customer can afford the risk.
  • Short term trading in mutual funds
  • Switching fund families
Churning

Most representatives are compensated when the customer makes a transaction based on their recommendation. Churning is a practice of making transactions that are excessive in size or frequency, with the intention to generate higher commissions for the representative. When determining if an account has been churned, regulators will look at the frequency of the transactions, size of the transactions, and the amount of commission earned by the representative. Customer profitability is not an issue when determining if an account has been churned.

Manipulative and Deceptive Devises

It is a violation for a firm or representative to engage in or employ any artifice or scheme that is designed to gain an unfair advantage over another party. Some examples of manipulative or deceptive devises are:

  • Capping
  • Pegging
  • Front running
  • Trading ahead
  • Painting the tape / matched purchases / matches sales
Capping: Is a manipulative act designed to keep a stock price from rising or to keep the price down

Pegging: Is a manipulative act designed to keep a stock price up or to keep the price from falling.

Front Running: Is the entering of an order for the account of an agent or firm, prior to the entering of a large customer’s order. The firm or agent is using the customer’s order to profit on the order they entered for their own account.

Trading Ahead: Is the entering of an order for a security, based on the prior knowledge of a soon to be released research report.

Painting The Tape: Is a manipulative act by two or more parties designed to create false activity in the security without any beneficial change in ownership. The increased activity is used to attract new buyers.

Unauthorized Trading

An unauthorized transaction is one, which is made for the benefit of a customer’s account at a time when the customer has no knowledge of the trade and the representative does not have discretionary power over the account.

Fraud

Fraud is defined as any act that is employed to obtain an unfair advantage over another party. Fraudulent acts include:

  • False statements
  • Deliberate omissions of material facts
  • Concealment of material facts
  • Manipulative and deceptive practices
  • Forgery
  • Material omission
  • Lying
Blanket Recommendations

It is inappropriate for a firm or a representative to make blanket recommendations in any security especially low priced speculative securities. No matter what type of investment is involved, a blanket recommendation to a large group of people will always be wrong for some investors. Different investors have different objectives and the same recommendation will not be suitable for everyone.

Example

Mr. Jones an agent with XYZ brokers has a large customer base that ranges from young investors who are just starting to save, to institutions and retirees Mr. Jones has been doing a significant amount of research on WSIA industries, a mining and materials company. Mr. Jones strongly believes that WSIA is significantly undervalued based on its assets and earning potential. Mr. Jones recommends WSIA to all his clients. In the next 6 months the share price of WSIA increases significantly as new production dramatically increases sales just as Mr. Jones’ research suggested. The clients then sell WSIA at Mr. Jones’ suggestion and realize a significant profit.

Analysis

Even though the clients who purchased WSIA based on Mr. Jones’ recommendation made a significant profit Mr. Jones has still committed a violation because he recommended it to all of his clients. Mr. Jones’ clients have a wide variety of investment objectives and the risk or income potential associated with an investment in WSIA would not be suitable for every client. Even if an investment is profitable for the client it does not mean it was suitable for the client. Blanket recommendations are never suitable

Selling Dividends

Selling dividends is a violation that occurs when a registered representative uses a pending dividend payment as the sole basis of their recommendation to purchase the stock or mutual fund. Additionally, using the pending dividend as a means to create urgency on the part of the investor to purchase the stock is a prime example of this type of violation. If the investor was to purchase the shares just prior to the ex dividend date simply to receive the dividend, the investor in many cases will end up worse off. The dividend in this case will actually be a return of the money that the investor used to purchase the stock and then the investor will have a tax liability when they receive the dividend.

Misrepresentations

A representative or a firm may not knowingly make any misrepresentations regarding:

  • A client’s account status
  • The representative
  • The firm
  • An investment
  • Fees to be charged
Omitting Material Facts

A representative of a firm may not omit any material fact either good or bad when recommending a security. A material fact is one that an investor would need to know in order to make a well-informed investment decision. The representative may, however, omit an immaterial fact.

Guarantees

No representative, broker dealer, or investment advisor may make any guarantees of any kind. A profit may not be guaranteed and a promise of no loss may not be made.


comments powered by Disqus
Trading Center