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?

Under the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, an agent may not divide or otherwise split the agent's commissions, profits or other compensation from the purchase or sale of securities with any person who is not also registered as an agent for the same broker-dealer (BD) or for a BD under direct or indirect common control.

• The provision sits in the statement's list of agent practices, so it binds the agent

• There is no consent route. The provision has no "unless authorized" clause, so customer consent, disclosure, or the BD's approval does not make an ineligible recipient eligible

Exam Tip: Gotchas

• Registered somewhere is not enough. An agent of an unrelated firm fails the test just as an unregistered friend does.
• The label does not matter. Paying a friend a "finder's fee" or "referral fee" out of a commission is a split, even if the friend never touched a security.

How Is Commission Splitting Different from Sharing in an Account?

• Sharing directly or indirectly in profits or losses in a customer's account is permitted with written authorization of the customer and of the BD the agent represents
• Commission splitting has no consent route: only the recipient's agent registration with the same or a commonly controlled BD permits it

Does Paying Someone to Solicit Make Them an Agent?

It can, which adds a registration problem to the split. Under the Uniform Securities Act (USA):

• An agent is any individual, other than a broker-dealer, who represents a BD or an issuer in effecting or attempting to effect purchases or sales of securities. Acting as an unregistered agent is unlawful, and so is a BD or issuer employing one
• An individual representing an issuer in transactions with its existing employees, partners or directors is excluded from the agent definition only if no commission or other remuneration is paid or given directly or indirectly for soliciting any person in this state
• An individual employed by or associated with an investment adviser who solicits, offers or negotiates for the sale of, or sells, investment advisory services is an investment adviser representative

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 (the NASAA Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers Model 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 (the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents) 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 FINRA's Rule on Payments to Unregistered Persons Prohibit?

The Financial Industry Regulatory Authority (FINRA) rule binds the member firm and its associated persons, not just the agent. Neither may, directly or indirectly, pay any compensation, fees, concessions, discounts, commissions or other allowances to:

1. A person not registered as a broker-dealer who, by reason of receiving the payments and the activities related to them, is required to be so registered under federal securities laws; or
2. An appropriately registered associated person, unless the payment complies with all applicable federal securities laws, FINRA rules, and Securities Exchange Act (SEA) rules

• The first prong's trigger is broker-dealer registration, not agent registration, though one payment to an unregistered person can violate both this rule and the USA's agent registration requirement
• The rule draws no bright line: the payments and related activities together decide it

Exam Tip: Gotchas

Calling a payment a "referral fee," "finder's fee," or "bonus" does not exempt it, and neither does switching to a flat annual amount. The question is whether the payments and related activities require broker-dealer registration.

How Does a Firm Support a Payment to an Unregistered Person?

FINRA expects the member to determine, and reasonably support, that the recipient need not register as a broker-dealer:

• An uncertain member can draw support from, among other things, reasonable reliance on applicable SEC releases, no-action letters, or interpretations; seeking its own no-action letter; or an opinion of independent, reputable U.S.-licensed counsel
• The determination must be reasonable and should be reviewed periodically if payments are ongoing
• The member must keep books and records reflecting it

Can a BD Keep Paying a Retired Representative?

Yes. A member may pay continuing commissions to a retiring registered representative, after the representative stops being associated with the member, from accounts held for that representative's continuing customers, even if customers add funds or securities during retirement, provided that:

• A bona fide contract for the payments was entered into in good faith while the person was a registered representative of the member
• The contract, among other things, prohibits soliciting new business, opening new accounts, or servicing the accounts generating the payments
• The arrangement complies with federal securities laws and SEA rules

The retiree must retire from the member (including through total disability) and leave the securities industry. On death, the beneficiary designated in the written contract, or the estate if none is designated, may be the beneficiary of the member's agreement.

Exam Tip: Gotchas

• Leaving the firm is not retiring. The retiree must leave the securities industry.

Can a BD Pay a Foreign Finder?

Yes, if all seven conditions are met. A member may pay a nonregistered foreign finder transaction-related compensation based on the business of customers the finder directs to it when:

1. The member has assured itself the finder is not required to register in the United States as a broker-dealer, is not subject to a disqualification under FINRA's By-Laws, and the arrangement does not violate applicable foreign law
2. The finder is a foreign national (not a U.S. citizen) or foreign entity domiciled abroad
3. The customers are foreign nationals (not U.S. citizens) or foreign entities domiciled abroad, trading foreign or U.S. securities
4. Customers receive a descriptive document disclosing the finder compensation
5. Customers give the member written acknowledgment of the arrangement, retained for FINRA inspection
6. Payment records sit on the member's books, and the actual agreements are available for FINRA inspection
7. Each confirmation states that a referral or finder's fee is being paid under an agreement

Exam Tip: Gotchas

• Both exceptions belong to FINRA's rule. The NASAA commission-splitting provision states no exception for retirees or foreign finders.

What Should You Check on Exam Day?

• A half-truth is still a misrepresentation, and the NASAA list is not exhaustive: forgery, embezzlement, and nondisclosure support action even where the list does not name them.
• 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.
• An agent may split commissions, profits, or other compensation only with a person also registered as an agent for the same BD or one under direct or indirect common control. No consent or firm approval cures any other split.
• FINRA's rule bars a member or associated person from paying anyone who must register as a broker-dealer and is not. Its two exceptions are a retiring representative who has left the industry and a qualifying foreign finder.
• Fictitious accounts are an independent violation; failing to pay an award and attempting to avoid one are two separate prohibited practices.