Quick Answer
Guaranteeing a client against loss in a securities transaction, or promising a specific return, is always unlawful, with no exception for a sophisticated or wealthy client. Calling a security "risk-free" is treated the same way. Sharing in a customer's account profits OR losses is a separate, narrower topic: it's permitted only with written authorization from both the customer and the broker-dealer. Hedge clauses that disclaim liability for negligence are suspect.
Building on the theme of what advisers cannot say, this section covers one of the clearest prohibitions in securities law: you can never guarantee results.
What Can't You Guarantee?
- It is unlawful to guarantee a client against loss in any securities transaction
- This applies to investment advisers, investment adviser representatives, broker-dealers, and agents alike
- The prohibition is absolute: there are no exceptions based on client sophistication or wealth
Exam Tip: Gotchas
- "Risk-free" claims about securities. Any claim that a security is risk-free is treated as a guarantee violation.
What Counts as a Guarantee
| Prohibited Action | Why It's a Guarantee |
|---|---|
| Promising a specific rate of return | Implies no risk of loss |
| Guaranteeing the client will not lose money | Direct guarantee against loss |
| Promising to "make the client whole" if an investment declines | Guarantee against loss |
| Stating "this investment is risk-free" (for securities) | Implies guaranteed outcome |
| Sharing in a customer's account without written authorization from both the customer and the BD | Unauthorized sharing, not itself a "guarantee" but a separate prohibited act |
Is Sharing in a Customer's Account the Same as Guaranteeing?
- Sharing in a customer's account (profits OR losses) is a narrower, separate topic from a no-loss guarantee. An agent MAY share directly or indirectly in the profits or losses of a customer's account, but only with the written authorization of both the customer and the broker-dealer the agent represents
- What's actually prohibited is (1) an absolute no-loss guarantee/promise, and (2) sharing in an account without that dual written authorization
- This authorized-sharing arrangement is different from performance-based fees (covered in the next section), which involve an adviser's compensation formula tied to gains, not a BD agent sharing directly in a customer's trading account
Exam Tip: Gotchas
- Don't teach "sharing in losses is always prohibited." With written authorization from both customer and BD, an agent may share in a customer's account profits or losses. What's prohibited is sharing without that authorization, or an outright guarantee against loss.
- Sharing in an account vs. a performance fee. Authorized profit/loss sharing in a customer's account is a BD-agent topic; a performance-based fee (allowed only for qualified clients) is an adviser-compensation topic.
What About Hedge Clauses?
- A hedge clause is language in an advisory contract that attempts to limit the adviser's liability
- Hedge clauses that limit liability for negligence may be misleading and potentially prohibited
- A clause saying "the adviser is not responsible for any losses" could discourage clients from exercising their legal rights
- The SEC views overly broad hedge clauses as potentially fraudulent because they may mislead clients about their rights
Exam Tip: Gotchas
- Hedge clauses and fiduciary duty. Hedge clauses that disclaim liability for negligence are suspect; advisers cannot contract away their fiduciary duty.
What Should You Check on Exam Day?
- Can you state the prohibition without qualifiers: guaranteeing against loss is always unlawful, for advisers, IARs, broker-dealers, and agents alike?
- Do you know there is no exception based on client sophistication or wealth?
- Can you list what counts as a guarantee (specific rate of return, no-loss promise, "make the client whole," "risk-free" claims)?
- Do you know sharing in a customer's account profits or losses is permitted with written authorization from both the customer and the broker-dealer, and that the violation is sharing WITHOUT that authorization (or an outright guarantee)?
- Can you distinguish authorized account sharing (a BD-agent topic) from performance-based fees on gains (an adviser-compensation topic, allowed only for qualified clients)?
- Do you know why an overly broad hedge clause is suspect (it can mislead a client about their legal rights and disclaim fiduciary duty)?