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.

What Conflicts of Interest Are Prohibited?

Can Agents and Advisers Loan or Borrow 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.

Can an Agent Share in a Customer's Account Profits or 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.

Who Can an Agent Split a Commission With?

The same NASAA rule places this prohibition directly beside the account-sharing rule above. An agent may not divide or split commissions, profits, or other compensation from a securities purchase or sale with any person not also registered as an agent for one of two employers: the same broker-dealer, or a broker-dealer under direct or indirect common control.

The test is registration status plus employer. It is not the referrer's licensing in another field and not the size of their contribution. The prohibition also covers profits or other compensation, so relabeling the payment a referral fee does not move it outside the rule.

Exam Tip: Gotchas

• Disclosure does not cure it. Unlike many conflict rules, this one has no consent or disclosure exception. Telling the customer, or getting their written agreement, does not make a prohibited split lawful.
• Common control is the exception students forget. A split with an agent at a different BD is permitted when the two firms sit under direct or indirect common control.
• Do not import the account-sharing test. Sharing in a customer's account needs written authorization from both the customer and the BD. Commission splitting has no authorization path at all; either the recipient qualifies or the split is prohibited.

When Can Client Information Be Disclosed?

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

What Criminal Activities Are Prohibited?

What Is Insider Trading Under Federal Antifraud Law?

• 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

What Is Selling Away?

• An agent effecting securities transactions that are not recorded on the regular books or records of the employing broker-dealer
• Prohibited unless the broker-dealer authorizes the transaction in writing before it is executed
• Covers any unrecorded transaction, including the agent's own personal transactions; the NASAA rule does not carve out a client or third-party requirement

Note: Oral or verbal approval, even from a branch manager or other supervisor, does not satisfy the writing requirement. An agent who gets a verbal go-ahead and executes the trade has sold away, even though the firm was informally aware of it. Holding a personal account at another firm is a related but separate issue, covered by the Outside Securities Accounts rule below (consent/disclosure for the account itself, not written pre-approval for each transaction in it).

What Manipulative Practices Are Prohibited?

Prohibited manipulative activities include:

Exam Tip: Gotchas

• The number of transactions never distinguishes wash trades, matched orders, and painting the tape. A wash trade requires the same person as buyer and seller, even across many trades in different accounts; what matters is that beneficial ownership never actually changes hands. A matched order requires a second, separate party. Painting the tape can be one person or several.
• Marking the close is about timing, not volume. A single small trade placed in the closing seconds to set the print is manipulation, while the same trade at midday is not. Look for the clock in the question, not the size.
• Manipulation does not require a profit or even a price move. Spreading a rumor known to be false violates the rule whether or not the person trades and whether or not the market reacts.
• 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.
• Insider trading carries civil penalties (disgorgement plus additional civil fines) that are separate from any criminal case or regulatory bar. The civil penalty is measured against the trading advantage, not against the client's account or the firm's revenue.
• 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.

What Does the Code of Ethics Require for Personal Trading?

What Must an IA's Code of Ethics Include?

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.

What Must Access Persons Report?

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 certificates of deposit (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.
• Do not confuse currency with filing deadlines. The 10-day deadline is when to submit the initial report. The 30-day deadline is 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.

What Is 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.

What Are the NASAA Unethical Business Practices?

What Unethical Practices Apply to IAs and 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

What Unethical Practices Apply to Broker-Dealers and Agents?

The NASAA Dishonest or Unethical Business Practices of Broker-Dealers and Agents Model Rule adds practices specific to BDs and agents, on top of prohibitions similar to the IA/IAR list above:

• Trading on margin without a written agreement: executing a transaction in a margin account without securing a properly executed written margin agreement from the customer, promptly after the initial transaction in the account
• Hypothecation without a lien or consent: hypothecating (pledging as loan collateral) a customer's securities without having a lien on them, unless the broker-dealer secures a properly executed written consent from the customer promptly after the initial transaction, except as permitted by SEC rules
• 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

Exam Tip: Gotchas

The written margin agreement and the written hypothecation consent do not have to exist before the first trade. Both may be secured promptly after the initial transaction in the account.

What Are the Rules for Outside Securities Accounts?

Two separate requirements apply, depending on registrant type:

Agents (BD-registered persons):

• Must obtain written consent from the employing BD before opening a new outside account
• For an account that predated employment, within 30 calendar days of becoming associated the agent must obtain the employer's written consent to keep it, and must notify the firm carrying the account in writing of the association
• 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.

What Due Diligence Is Required Before Recommending?

• 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

How Does the NASAA Model Act Protect Vulnerable Adults?

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.

What Are the Key Definitions Under the Vulnerable Adults Act?

• 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

What Are the Act's Key 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.
• The mandatory and permissive duties split cleanly. 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.

What Recordkeeping Applies to Political Contributions?

• 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 (agents never; advisers only with broker-dealer, affiliate, or financial-institution clients), and that sharing in account profits or losses needs written authorization from both the customer and the broker-dealer?
• Can you name the manipulative practices (wash trades, matched orders, painting the tape, marking the open or close, pump and dump, false rumors) and state that insider trading carries civil penalties separate from any criminal case?
• 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 state that selling away covers any transaction not recorded on the employing broker-dealer's regular books or records, including the agent's own personal trades, unless the firm authorized it in writing before execution?
• Do you know which vulnerable-adult provisions are mandatory (reporting to APS and the Administrator) versus permissive (trusted-contact disclosure, the temporary hold), and the hold duration (15 business days, extendable to 25)?