Quick Answer
This unit rounds out the catalog with misrepresentations and half-truths, guarantees against loss, unauthorized trading, discretionary-authority timing, fictitious accounts, commission splitting, control-relationship disclosure, and the duty to pay arbitration awards and regulatory penalties. Several rules differ by whether a broker-dealer or an investment adviser is involved, especially the discretionary-authority timing rule.
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?
| Professional | Deadline for Written Discretionary Authority |
|---|---|
| Broker-dealer/agent | Before the first discretionary trade. No grace period. |
| Investment adviser | Within 10 business days after the first transaction placed under oral discretionary authority |
- 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, 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.
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.