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.
Guaranteeing 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
Unauthorized Trading
- 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
Discretionary Authority Without Written Authorization
- A broker-dealer/agent must obtain written discretionary authority before the first discretionary trade. There is no grace period.
- 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
- Time/price exception: if a customer specifies what to buy but leaves the timing and price to the professional, no written discretionary authority is needed.
- Written authority required: if the professional decides what to buy or sell, written discretionary authority is required (for a broker-dealer/agent, before the trade).
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
Commission Splitting with Unregistered Persons
- 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.
Failure to Disclose Control Relationships
- 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
Failing to Pay Arbitration Awards or Regulatory Penalties
Both broker-dealers (BDs)/agents and investment advisers (IAs)/investment adviser representatives (IARs) 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