Conflicts of Interest and Fiduciary Considerations

With custody and compensation rules in place, the next layer of protection focuses on preventing conflicts of interest and outright fraud. This section covers the broadest set of prohibited practices and ethical requirements.

Conflicts of Interest

Loans To and From Clients

Agents: may never borrow from or lend to any client. No exceptions.

Investment advisers and IARs: generally prohibited, with limited exceptions. An IA may borrow from a client only if the client is a broker-dealer, an affiliate of the IA, or a financial institution engaged in the business of loaning funds (e.g., a bank). An IA may lend to a client only if the IA is a financial institution or the client is an affiliate.

Affiliate: a person or entity that controls, is controlled by, or is under common control with the IA, whether directly or through one or more intermediaries, such as a corporate parent, subsidiary, or sister company under common ownership. A wealthy or trusted individual client does not qualify just because of the relationship's closeness.

The financial institution carve-out applies to IAs only. An agent whose client is a bank still may not borrow from that client.

Sharing in Profits and Losses

A broker-dealer agent may not share, directly or indirectly, in the profits or losses of a customer's account without the written authorization of both the customer and the employing broker-dealer. The cached NASAA rule states this authorization requirement plainly; it does not itself carve out a proportional-contribution test or a separate immediate-family exception.

An adviser's participation in client gains is a different topic entirely, governed by the performance-fee rules (qualified-client and fulcrum-fee exceptions), not this agent account-sharing rule.

Exam Tip: Gotchas

• The requirement is written authorization from BOTH the customer and the BD. Don't add a "proportionate contribution" test or an "immediate family is exempt" rule that isn't in the source text.
• Don't conflate agent account-sharing with an adviser's performance fee. They're governed by different rules with different conditions.

Client Confidentiality

• Client information must be kept confidential
• Cannot be disclosed without client consent
• Exceptions: Disclosure is required when compelled by law (subpoena, regulatory request)

Criminal Activities

Insider Trading (the federal antifraud authority for MNPI trading)

• Liability requires trading on the basis of material nonpublic information (MNPI) in breach of a duty of trust or confidence, not mere possession of it
• Reaches non-insiders too (not just corporate officers or directors) when that duty/breach element is met, for example a tippee who knew or should have known the tip breached a duty
• Both the person who trades and a "tipper" who breaches a duty for a personal benefit can be liable, though liability for each depends on the specific facts
• Penalties include disgorgement of profits, civil fines, and criminal prosecution

Selling Away

• An agent conducting securities transactions outside the scope of their employing broker-dealer
• Done without the firm's knowledge and approval
• Prohibited: all transactions must go through or be approved by the employing broker-dealer (BD)

Note: Selling away involves a client or third party, not the representative's own account. An agent or IAR trading their own personal account is governed by the Personal Securities Transactions and Outside Securities Accounts rules below, which require pre-clearance and/or disclosure to the firm, not by the selling-away prohibition.

Market Manipulation

Prohibited manipulative activities include:

Exam Tip: Gotchas

• Insider trading can reach non-insiders, not just corporate officers or directors, but liability still requires trading on the MNPI in breach of a duty of trust or confidence. Mere possession of a hot tip, without that breach element, is not automatically a violation.
• A tipper who breaches a duty for personal benefit, and a tippee who knew or should have known about that breach, can both be liable, but the exact facts (duty, breach, benefit, knowledge) determine each party's liability.

Personal Securities Transactions and Code of Ethics

The IA Code-of-Ethics Rule

Every SEC-registered (or SEC-registration-required) investment adviser must adopt a code of ethics that includes:

• Standards of business conduct reflecting fiduciary obligations
• Compliance with federal securities laws
• Reporting of personal securities transactions by access persons

Why this exists: access persons see client trades before the market does. Without oversight, an access person could front-run a client order in their own account, or trade ahead of a recommendation the firm is about to make to clients. Comparing an access person's personal trading against client activity over the same period is how compliance staff catch that kind of conflict.

Access Person Reporting Requirements

Access persons are supervised persons who have access to nonpublic information about client trades, who have access to nonpublic holdings of a fund the adviser manages, or who are involved in making or have access to nonpublic securities recommendations. Access to a non-fund advisory client's holdings alone does not, by itself, make someone an access person. If providing investment advice is the firm's primary business, all directors, officers, and partners are presumed to be access persons.

"Holdings" and "transactions" above mean reportable securities: nearly everything an access person could own or trade, including stocks, bonds, options, and mutual funds the adviser itself advises or underwrites. A short list is excluded because it presents little risk of the kind of trading these reports are meant to catch:

• Direct U.S. government obligations

• Bank CDs, commercial paper, and other high-quality short-term debt

• Shares of an open-end mutual fund the adviser itself doesn't advise or underwrite

• Supervised persons must promptly report violations of the code of ethics to the chief compliance officer, or to another person the code designates (the CCO must still receive violation reports periodically)

• Reports are exempt for securities held in accounts where the person has no direct or indirect influence, and for transactions under automatic investment plans

Exam Tip: Gotchas

• The 45-day currency rule applies to both holdings reports, but anchors to a different date for each. The initial report's holdings must be current as of a date no more than 45 days before the person BECAME an access person; the annual report's holdings must be current as of a date no more than 45 days before SUBMISSION. This is different from the 10-day filing deadline (when to submit the initial report) or the 30-day filing deadline (when to submit quarterly transaction reports after quarter-end).
• All directors, officers, and partners are presumed access persons if the firm's primary business is investment advice. The exam tests who qualifies.

Excessive Trading (Churning)

Churning is trading in a client's account that is excessive in frequency or size relative to the client's objectives and financial resources, done primarily to generate commissions or fees.

Factors considered:

• Turnover rate: how quickly the portfolio is being traded
• Cost-to-equity ratio: total costs relative to account equity
• Client's investment objectives
• Whether the trading was authorized

Churning is a violation of both fiduciary duty and securities laws.

Exam Tip: Gotchas

• Churning is measured by turnover rate and cost-to-equity ratio, not just the number of trades. A high number of trades alone is not sufficient to prove churning.
• Churning requires control by the adviser. If the client directed every trade, the adviser is not churning the account.

North American Securities Administrators Association (NASAA) Unethical Business Practices

For Investment Advisers and Investment Adviser Representatives (IARs)

The NASAA Unethical Business Practices Model Rule prohibits the following:

• Misrepresenting qualifications or credentials
• Guaranteeing results (promising no losses or specific returns)
• Recommending transactions without a reasonable basis
• Churning client accounts
• Borrowing money or securities from a client outside the limited exceptions covered earlier (broker-dealer, affiliate, or lending-financial-institution clients)
• Misusing client funds or securities

For Broker-Dealers and Agents (the NASAA Unethical Business Practices for BDs and Agents)

Similar prohibitions apply, plus:

• Investment company share rules: Specific obligations around breakpoint discounts and suitability of share class recommendations
• Agents must ensure clients receive applicable breakpoint discounts on mutual fund purchases

Outside Securities Accounts

Two separate requirements apply, depending on registrant type:

Agents (BD-registered persons): must obtain written consent from their employing BD before opening a new outside account. For accounts that predated employment, the agent must notify the employer within 30 calendar days of becoming associated. The employing firm may then request duplicate confirmations and statements from the other firm to monitor activity.

IA access persons: must report outside brokerage accounts as part of the holdings-reporting regime. The initial holdings report (covering all outside accounts and reportable securities) must be filed within 10 days of becoming an access person.

The adviser may instead rely on duplicate confirmations or account statements it receives within 30 days after quarter-end, in place of a separate quarterly transaction report. This is a substitute the adviser may use, not an independently mandatory delivery method.

The 30-day and 10-day deadlines are frequently confused on the exam because they cover the same general topic (outside accounts) but apply to different registrant types under different rule frameworks.

Due Diligence

• Advisers and agents must conduct a reasonable investigation before making recommendations, sufficient to avoid giving advice based on materially inaccurate or incomplete information
• Must understand the products and securities being recommended
• What counts as reasonable depends on the facts, the security, and the risks involved; it is not a categorical requirement to independently verify every issuer representation, but blind reliance on issuer claims without any inquiry falls short of the standard

Protecting Vulnerable Adults (NASAA Model Act)

The NASAA Model Act to Protect Vulnerable Adults from Financial Exploitation authorizes firms to act when financial exploitation of an eligible adult is reasonably suspected.

Key Definitions

• Eligible adult: a person age 65 or older, OR an adult who is subject to the applicable state's Adult Protective Services statute
• Qualified individual: a broker-dealer agent, investment adviser representative, OR any associated person of a broker-dealer or investment adviser who serves in a supervisory, compliance, or legal capacity. Independent contractors fulfilling any of these roles also qualify. Qualified individuals carry the mandatory reporting obligations described below

Provisions

Exam Tip: Gotchas

• Temporary HOLDS on disbursements only (not freezing the entire account). The act does not authorize a full account freeze.
• Immunity is not automatic. It requires BOTH good faith AND reasonable care. A reckless or bad-faith disclosure or delay loses the safe harbor.
• Mandatory vs. permissive: reporting to APS and the Administrator is mandatory (shall). Notifying the trusted contact is permissive (may). Many exam stems hinge on this distinction.
• The suspected exploiter is never notified. A suspected-exploiter trusted contact must not be notified of suspected exploitation, and a suspected-exploiter authorized party must not be notified that a disbursement has been delayed.
• A "qualified individual" is every BD agent and IAR, plus any other associated person acting in a supervisory, compliance, or legal capacity. Don't narrow it to just the supervisory/compliance/legal group; agents and IARs qualify regardless of role.
• The firm, not the qualified individual personally, is the actor that delays a disbursement. The qualified individual's reasonable belief triggers the mandatory report to APS and the Administrator; the broker-dealer or adviser is what places the temporary hold.

Political Contributions (pay-to-play recordkeeping)

• See the pay-to-play rules covered in the Compensation section
• An adviser that advises a government entity, or whose covered pool has a government-entity investor, must maintain records of political contributions by the adviser and its covered associates
• The 2-year solicitor look-back applies to a covered associate's contributions made before they joined the firm, only if that person later solicits clients for the adviser

What Should You Check on Exam Day?

• Can you state the loan rule for agents (never, no exceptions) versus advisers (broker-dealer, affiliate, or financial-institution clients only)?
• Do you know a BD agent needs written authorization from BOTH the customer and the broker-dealer to share in a customer's account profits or losses, and that this is separate from an adviser's performance-fee rules?
• Can you explain why insider trading liability requires trading on MNPI in breach of a duty of trust or confidence (not mere possession), and can reach non-insiders as well as corporate insiders?
• Can you distinguish selling away (client or third-party transactions outside the employing broker-dealer) from an agent's own personal trading?
• Do you know the three access-person reporting deadlines (10 days initial, 30 days quarterly, 12 months annual) and the 45-day currency rule for holdings reports?
• Can you state what proves churning (turnover rate, cost-to-equity ratio, lack of authorization) and why adviser control is required?
• Can you define an eligible adult and a qualified individual under the vulnerable-adults protection framework?
• Do you know which vulnerable-adult provisions are mandatory (reporting to APS and the Administrator, notice of a delay) versus permissive (trusted-contact disclosure, the temporary hold)?
• Can you state the vulnerable-adult hold duration (up to 15 business days initially, extendable to 25 with an APS/Administrator request, longer with a court order) and the two-part immunity test (good faith and reasonable care)?
• Do you know the different outside-account notice deadlines for agents (30 calendar days for pre-existing accounts) versus IA access persons (10 days as part of initial holdings reporting)?