Other Prohibited Activities

Several additional prohibited practices round out the ethical obligations of securities professionals. Many of these overlap between broker-dealer (BD) and investment adviser (IA) rules but have important distinctions.

What Counts as a Misrepresentation, Omission, or Half-Truth?

Misleading a customer is prohibited under the antifraud provisions of the Uniform Securities Act. These provisions have the broadest reach of any part of the Act: they apply to the offer, sale, or purchase of any security, including exempt securities and exempt transactions, and they apply to registered and unregistered persons alike.

Three forms of misrepresentation are prohibited:

• Affirmative misstatement of a material fact: stating something false that a reasonable investor would consider important (for example, claiming a stock "has consistently generated positive returns" when it has not)
• Material omission: leaving out a fact needed to keep a statement from being misleading (for example, quoting a bond's yield but not disclosing that the issuer is under investigation)
• Half-truth: a statement that is technically true but misleading without its full context (for example, "this fund returned 12% last year" while omitting that it lost money in each of the prior four years)

A fact is material if a reasonable investor would consider it important in making an investment decision.

Exam Tip: Gotchas

• A half-truth is still a violation even though every word is literally true. If accurate information is presented in a way that creates a false impression, it is a prohibited misrepresentation.

Can a Professional Guarantee Against Loss?

• Broker-dealers (BDs) may not guarantee a customer against loss in any securities account or transaction
• Investment advisers (IAs) may not guarantee a client that a specific result (gain or no loss) will be achieved
• This prohibition applies regardless of form - written, oral, or implied
• Saying "I guarantee you won't lose money" or "this investment is guaranteed to go up" both violate the rule

When Is Trading Unauthorized?

• Broker-dealers (BDs) may not execute a transaction without customer authorization
• Investment advisers (IAs) may not place an order without authority
• Every transaction must fall into one of three categories:
  • (1) Specifically authorized by the customer
  • (2) Authorized under a valid written discretionary agreement
  • (3) An unsolicited order initiated by the customer

When Must Discretionary Authority Be in Writing?

• The time/price exception applies regardless of whether the professional is a broker-dealer or an investment adviser: if a customer says "buy 100 shares of XYZ at the best price today," the professional may decide when during the day and at what price to execute without needing written discretionary authority

Exam Tip: Gotchas

• The time/price exception needs no written authority. If a customer specifies what to buy but leaves the timing and price to the professional, no written discretionary authority is required.
• Choosing the security itself always needs written authority. If the professional decides what to buy or sell, written discretionary authority is required, and the deadline depends on who is trading.
• The 10-business-day grace period belongs to investment advisers only. A broker-dealer or agent gets no grace period at all; written authority must exist before the very first discretionary trade. The exam tests whether the IA grace period bleeds over onto BDs (it does not).

What Are Fictitious Accounts?

• An agent may not establish or maintain an account containing fictitious information to execute transactions that would otherwise be prohibited
• Creating a fictitious account is an independent violation separate from whatever prohibited transaction the account facilitates
• Penalties apply for both the fictitious account and the underlying prohibited conduct

When Is Commission Splitting Allowed?

• An agent may not divide commissions, profits, or other compensation with any person not registered as an agent for the same broker-dealer (BD) or a BD under direct or indirect common control
• This prevents paying referral fees or kickbacks to unregistered persons
• Reinforces the broader prohibition on paying securities-related compensation to unregistered persons

Exam Tip: Gotchas

• Commission splitting with unregistered persons is prohibited even for legitimate referrals. An agent who pays a friend a "finder's fee" for sending over a client has violated the rule, even if the friend never touched a security.

When Must a BD Disclose a Control Relationship?

• A broker-dealer (BD) must disclose to the customer, before entering into any contract, that the BD is controlled by, controlling, affiliated with, or under common control with the issuer
• If oral disclosure is made, it must be supplemented by written disclosure at or before completion of the transaction

What Happens if a Firm Won't Pay an Award or Penalty?

Broker-dealers (BDs) and agents must:

• Pay and fully satisfy final judgments and arbitration awards (customer-initiated, investment-related)
• Pay regulatory penalties (fines, restitution, and disgorgement imposed by the SEC, state regulators, or self-regulatory organizations (SROs))
• Not attempt to avoid payment; attempting to evade an award is itself a separate prohibited practice
• Alternative written payment arrangements are permissible if agreed to and honored

Exam Tip: Gotchas

• This provision is written for broker-dealers and agents. NASAA's adviser unethical-practices rule does not contain a parallel arbitration-award or regulatory-penalty payment provision. Do not extend this specific duty to investment advisers or IARs on a Series 63 question that asks what the adviser rule itself requires.

Can a Firm Publish a Transaction or Quote It Does Not Believe Is Real?

No. It is a prohibited practice to:

• Publish or circulate any communication that reports a transaction as a purchase or sale unless the firm believes it was a bona fide transaction
• Publish a bid or asked price unless the firm believes it represents a bona fide bid or offer

This stops firms from creating false market data that misleads investors about a security's real trading activity or pricing.

Is the NASAA List of Prohibited Practices Complete?

No, and this matters. The NASAA dishonest-practices statement says expressly that the conduct it enumerates is "not inclusive." Conduct that never appears on the list can still be grounds for denial, suspension, or revocation of a registration, including:

• Forgery
• Embezzlement
• Nondisclosure or incomplete disclosure of material facts
• Misstatement of material facts
• Manipulative or deceptive practices, broadly defined

Exam Tip: Gotchas

• The enumerated list is a floor, not a ceiling. A question may describe conduct that appears nowhere in the NASAA list and ask whether it can support disciplinary action. The answer is yes, if the conduct is fraudulent or dishonest. Do not pick an answer choice that says the Administrator is powerless because the conduct is not specifically named.

What Does the Rule Prohibit?

A member firm (BD) and its associated persons may not pay any compensation, fees, commissions, concessions, discounts, or other allowances, directly or indirectly, to any person who is required to register as a broker-dealer under federal law but is not so registered.

• The rule's trigger is broker-dealer registration, not agent registration. In practice the two overlap heavily: a person paid transaction-based compensation for securities activity is frequently also functioning as an unregistered agent under the USA, so paying that person can violate both this rule and the USA's registration requirements at once
• A BD cannot split commissions with, or pay a referral fee to, a person who should be registered as a broker-dealer but is not
• A BD also cannot pay even a properly registered associated person unless that specific payment itself complies with applicable federal securities laws, FINRA rules, and SEA rules
• Before paying an unregistered person, a member must reasonably determine, and document, that the payment does not require the recipient to register as a broker-dealer, and revisit that determination periodically if the payments continue

Exam Tip: Gotchas

Labeling a payment a "referral fee," "finder's fee," or "bonus" does not exempt it. If the payment is tied to a securities transaction and the recipient should be a registered broker-dealer, the payment is prohibited regardless of what it is called.

Can a BD Keep Paying a Retired Representative?

Yes, under a narrow exception. A "retiring registered representative" is someone who retires from the member and leaves the securities industry, including through total disability. A BD may continue paying commissions to that person, for accounts held by the representative's continuing customers, regardless of whether those customers add funds or securities to the accounts during retirement, provided:

• A bona fide, written contract for the continuing payments was entered into in good faith while the person was still registered with the member
• The contract prohibits the retired representative from soliciting new business, opening new accounts, or servicing the accounts that generate the continuing commissions
• The arrangement otherwise complies with applicable federal securities laws

This exception also extends to the beneficiary the retiring representative named in the written contract, or to the representative's estate if no beneficiary was named, in the event of the representative's death.

Exam Tip: Gotchas

The contract has to exist before the person stops being registered. A new payment arrangement negotiated after the person has already left the industry does not qualify, no matter how the parties describe it.

Can a BD Pay a Foreign Finder?

Yes, subject to conditions. A BD may compensate a nonregistered foreign finder for directing foreign customer business, provided:

• The member has assured itself that the finder need not register as a U.S. broker-dealer, is not subject to a FINRA disqualification, and that the compensation arrangement does not violate foreign law
• The finder is a foreign national (not a U.S. citizen) or a foreign entity domiciled abroad
• The customers are foreign nationals or foreign entities domiciled abroad, transacting in either foreign or U.S. securities
• Customers receive a disclosure document describing the compensation being paid to the finder
• Customers provide written acknowledgment of the compensation arrangement, retained and available for FINRA inspection
• Records of payments and the underlying agreement are maintained and available for FINRA inspection
• Each transaction confirmation indicates that a referral or finder's fee is being paid under an agreement

What Should You Check on Exam Day?

• A half-truth is still a misrepresentation even when every individual word is accurate.
• The discretionary-authority deadline depends on who is trading: no grace period for BDs/agents, a 10-business-day grace period for IAs. The time/price exception is the only way to avoid needing written authority at all.
• Fictitious accounts and commission splitting with unregistered persons are independent violations, separate from whatever underlying transaction they facilitate.
• Failing to pay an award and attempting to avoid paying one are two separate prohibited practices.
• The NASAA list is explicitly not exhaustive. Forgery, embezzlement, and nondisclosure are grounds for action even though the enumerated list does not name every one of them.
• The rule bars paying transaction-based compensation to anyone required to register as a broker-dealer who is not registered; that is a different legal hook than agent registration, even though the two usually travel together
• A member must reasonably determine, and periodically re-check, that an unregistered payee's activity does not require broker-dealer registration
• The retiring-representative exception requires a person who has left the industry entirely, a written contract that predates the departure, and a bar on soliciting new business
• The foreign-finder exception requires the member's own due-diligence assurance, foreign nationals on both sides, disclosure, written customer acknowledgment, and FINRA-inspectable records