NASAA Dishonest Practices: Compensation Provisions
FINRA Rule 2121 sets the federal standard for fair pricing. At the state level, NASAA's Statement of Policy on Dishonest or Unethical Business Practices reinforces and expands on these rules.
Unfair Pricing (NASAA 1983 Statement, Section 1.k)
- It is a dishonest or unethical business practice for a broker-dealer to enter into a transaction with or for a customer at a price not reasonably related to the current market price of the security
- It is also dishonest to receive an unreasonable commission or profit
- This mirrors FINRA Rule 2121 at the state level, meaning violations can trigger both federal and state enforcement
Exam Tip: Gotchas
- Unfair pricing or excessive fees count as a NASAA dishonest practice violation, which can trigger state enforcement action on top of any federal FINRA action.
Unreasonable Service Fees (NASAA 1983 Statement, Section 1.m)
- Charging unreasonable and inequitable fees for services performed is a dishonest practice
- This covers miscellaneous services such as:
- Collection of principal, dividends, or interest
- Exchange or transfer of securities
- Appraisals
- Safekeeping and custody
- Other services related to the securities business
Think of it this way: Even non-transaction fees are subject to a reasonableness standard. Charging $500 to transfer an account when industry norms are $75 could be a violation.
Exam Tip: Gotchas
- Unreasonable fees for non-transaction services (transfers, custody, appraisals) are also NASAA violations, not just unfair trade prices.
Excessive Trading / Churning (NASAA 1983 Statement, Section 1.b)
- Inducing trading in a customer's account that is excessive in size or frequency in view of the financial resources and character of the account is a dishonest practice
- Churning generates excessive commissions for the broker-dealer/agent at the customer's expense
Three elements of churning:
| Element | Description |
|---|---|
| Excessive trading | High turnover rate, high cost-equity ratio, patterns of in-and-out trading |
| Control | The broker-dealer must have control over the account, either discretionary authority or de facto control through the customer's reliance on the agent's recommendations |
| Intent | The trading is motivated by generating commissions, not by serving the customer's interest |
Exam Tip: Gotchas
- Churning requires control over the account. If a customer independently decides to trade frequently, it is not churning, even if the turnover is high. The broker must have either discretionary authority or de facto control (the customer rubber-stamps everything the agent suggests).
Agent Commission Splitting (NASAA 1983 Statement, Section 2.e)
- An agent may not divide or split commissions, profits, or other compensation with any person who is not also registered as an agent for:
- The same broker-dealer, OR
- A broker-dealer under direct or indirect common control
- This prevents payments to unregistered persons for securities-related activities
Why this matters: If an agent pays a referral fee to an unregistered friend for bringing in a client, that is a commission-splitting violation, even if the friend never touches a security.
Exam Tip: Gotchas
- Commission splitting is only allowed with other registered agents at the same firm (or an affiliated firm under common control).