What Is the Shingle Theory?

The shingle theory is a doctrine that informs the regulation of financial markets in the United States. In essence, it purports that, once they begin advertising their services to the public, broker-dealers are responsible for adhering to the best practices of the financial services industry.

Specifically, these best practices require broker-dealers to fully disclose all relevant information to their customers regarding the securities they sell—especially as it relates to the pricing of those securities and any special compensation received by the broker for its sale.

Key Takeaways

  • The shingle theory is a legal doctrine involving the standards of professional conduct of broker-dealers.
  • It requires that broker-dealers operate in accordance with industry best practices, particularly as it relates to the pricing and disclosure of the products they sell.
  • The shingle theory has ongoing influence in the financial services sector, as it has been repeatedly cited and upheld in litigation.

Understanding the Shingle Theory

The term "shingle theory" arises from an analogy made to traditional retail businesses: if a retail store "hangs a shingle" to show that it is open for business, the customers of that business would have reason to expect that the store would deal fairly with its customers and abide by all necessary laws and regulations. By analogy, broker-dealer firms that "hang a shingle" in the financial services marketplace are also expected to behave in an ethical and transparent manner.

The first use of the terms arose in a 1939 legal case involving the Securities and Exchange Commission (SEC). This case involved a broker-dealer that was found to have acted unethically by overcharging its customers and failing to educate them about the prevailing market prices of the securities it sold. The judge, in this case, sided with the SEC, upholding the SEC's decision to revoke the broker-dealer's license to operate.

This initial judgment has been replicated in several subsequent court cases, and for this reason, the shingle theory continues to be relevant in the financial markets today. In order to avoid the appearance or accusation of wrongdoing, broker-dealers should ensure that the prices charged to their clients are within a reasonable range as compared to the general market price of those securities and that their clients are aware of those general market prices. In essence, the key lesson of the shingle theory is that broker-dealers should act as though they have a fiduciary duty toward their customers, even if they are technically their clients' fiduciaries.

Example of the Shingle Theory

Edward is the owner of an unscrupulous brokerage firm called XYZ Securities. He carefully designed his office space and professional marketing to project the appearance of integrity and high professional standards. However, he does not act in a professional or ethical manner when dealing with customers.

Specifically, Edward deliberately seeks to attract customers with very limited financial education. When quoting those customers on potential securities to buy, he is careful to restrict their access to information about similar alternative products in order to overcharge his customers for those products as much as possible. Moreover, Edward regularly seeks to earn special commissions, kickbacks, and other such forms of compensation without clearly or fully informing his clients as to those arrangements.

If Edward's firm were to be sued by one of his customers, there is a good chance that he would be found to be in violation of the shingle theory. Based on similar cases in the past, it seems likely that Edward could lose his license to operate as a broker-dealer.