Chapter 07: Prohibited and Ethical Business Practices Under the USA

Define front running.

A firm/individual executing trades for its own account with knowledge of an impending large block customer order.

Are advisory fees fixed and are they subject to administrative review?

Fees are not fixed, but must be in line with other advisers. Fees are subject to administrative review.

True or False: Charging an unreasonably high commission is acceptable if disclosure is made to the client.

False

When does a durable power of attorney become automatically cancelled?

At the time of death of the grantor of the POA

Is an agent allowed to recommend the sale of a fund's shares in order to buy another fund's shares with the same objective?

No. This is a prohibited practice and is considered an unsuitable recommendation.

For any securities that are delivered to a BD, an agent must provide the customer with a receipt.

For any securities that are delivered to a BD, an agent must immediately provide the customer with a receipt.

An IA directs transactions to a BD who rebates 15% of the commissions to the IA for the business. Is this acceptable?

Yes, provided the IA provides written disclosure (often in Form ADV) to clients.

An agent makes this statement to a client: "Go with us; we're approved by the Administrator and SEC." Is it acceptable?

No. Neither the SEC nor the Administrator provide approval for securities or securities professionals.

__ is a manipulative activity that is designed to keep the price of a stock from falling (and is prohibited).

Pegging is a manipulative activity that is designed to keep the price of a stock from falling (and is prohibited).

A corporate officer informs his son of an upcoming earnings report and the son effects trades. Is this a violation?

Yes. Both parties, the tipper (officer) and the tippee (the son), have violated the Insider Trading Act.

True or False: BDs may accept oral permission from clients to exercise discretion in their accounts.

False. The client's prior written authorization is required.

Define commingling.

The prohibited act of mixing client funds with those of the BD

It is a violation of the USA for an IA to act as a broker-dealer for a buyer of securities without ____.

It is a violation of the USA for an IA to act as a broker-dealer for a buyer of securities without written disclosure.

stock is the repeated practice of placing stock in the account of a person who is not the rightful owner.

Parking stock is the repeated practice of placing stock in the account of a person who is not the rightful owner.

Churning is described as designed to .

Churning is described as excessive trading designed to generate commissions.

BD securities and client securities must be segregated; in other words, they may not be .

BD securities and client securities must be segregated; in other words, they may not be commingled.

A holdings report filed by an access person must be current as of ___ days prior to the date the report is submitted.

A holdings report filed by an access person must be current as of 45 days prior to the date the report is submitted.

May an agent of a BD effect personal trades in a stock two days before her firm releases a research report on the stock?

No. Employees of a broker-dealer may not trade ahead of their firm's research report.

May an adviser release account information to the spouse of a client?

No, not without the client's written authorization.

For how long may a not held order be maintained?

A not held order is considered a day order.

True or False: Agents of a broker-dealer must disclose all facts about a stock they are recommending.

False. Agents only need disclose material facts, not all facts.

What is required for an agent to open a joint account with a customer?

Written approval of the client and the BD and any sharing must be proportionate to each person's contribution.

What is required of a BD controlled by/affiliated with an issuer of a security being sold to/purchased by a customer?

Both oral and written disclosure of the relationship

Define conversion.

The prohibited act of an agent using client funds for personal use.

True or False: To provide full and fair disclosure during a solicitation, an agent only needs to offer a prospectus.

False. The agent must also disclose any material facts of which he may be aware.

May an adviser borrow money from a client?

Yes, if the client is in the business of lending money, or if the client is an affiliate of the adviser, or is a BD.

True or False: It is an unethical practice for a BD to delay the delivery of securities purchased by a customer.

True

What are the two reports that an access person of an investment adviser must file?

The transaction report and the holding report

Joe places an order to sell 10,000 shares of ABC whenever it's best. Is written discretionary authority required?

No. Since discretion is limited to time and/or price, written authority is not required.

True or False: Principals must approve discretionary orders prior to entry.

False. The orders must be approved promptly afterward.

When does a standard power of attorney become automatically cancelled?

At the time of either the grantor's death or declaration of grantor's incompetence

When must an access person file a transaction report?

Within 30 days of the end of each calendar quarter

What three items must be specified on a not held order?

Action (buy/sell), Amount (quantity), and Asset (security)

A firm promises a refund to all clients who invest in an IPO if shares fail to rise 20%. Is this permitted?

No. This is unethical since it is considered a guarantee against loss.

Define churning.

Excessive trading in a customer's account for the primary purpose of generating commissions and other fees

John and Sam are continually trading QRS stock between their accounts to cause the price to rise. Is this permitted?

No, this prohibited practice is referred to as "painting the tape."

Is an agent permitted to execute securities trades for compensation and not record the trades on his BD's books and records?

No. This is referred to as "selling away."

Is discretionary authorization required to enter a not held order?

No, since discretion is limited to time and/or price for not held orders.

Not held orders are considered to be in effect for _ trading day(s).

Not held orders are considered to be in effect for one trading day.

Firms must keep client information confidential unless disclosure is authorized by the or a _ _.

Firms must keep client information confidential unless disclosure is authorized by the client or a regulatory authority.

What restrictions exist in describing a fund as no-load?

It may have no front-end or deferred sales charge, and a 12b-1 fee may not exceed .25%.

Transactions should be executed at a price that is reasonably related to the _ price.

Transactions should be executed at a price that is reasonably related to the current market price.

True or False: Agents of a broker-dealer must disclose material facts about a stock they are recommending.

True. Agents should make a good-faith effort to disclose all material facts to an investor.

An agent of a BD lends $5,000 to his brother, is this acceptable?

Yes, lending to immediate family members is permissible.

What is required of an IA that uses third-party research?

The IA must disclose the source of the research to its client.

An IAR may exercise discretion over a client's account based on the client's oral authorization for up to ___ days.

An IAR may exercise discretion over a client's account based on the client's oral authorization for up to 10 days.

Define selling away.

The execution of transactions by an associated person outside his employment with a member firm

An agent encourages a customer to buy a stock due to an upcoming dividend. Is this a legal practice?

No, this is a prohibited action known as selling dividends.

Define an insider.

Officers, directors, partners, greater than 10% owners, and immediate family members of all listed

True or False: If an agent disagrees with a customer's order, he may disregard the order.

False. Agents and IARs must follow all customer requests, even those with which they disagree.

For an agent to exercise discretion over a client's account, the client must have signed a __.

For an agent to exercise discretion over a client's account, the client must have signed a power of attorney.

True or False: Access persons must file holdings reports annually.

True

_ is the prohibited practice of a BD trading for its own account ahead of a customer's block order.

Front-running is the prohibited practice of a BD trading for its own account ahead of a customer's block order.

Define the prohibited practice of shadowing.

After executing a large block order, but before the trade is reported, a BD trades for its own account.

True or False: Promoting the purchase of certain fund shares due to an impending dividend payment is acceptable.

False. Selling dividends is prohibited. Since the dividend is imbedded in the share price, there is no monetary benefit.

List the access persons of an investment adviser.

Officers, directors, partners, or persons with access to client investment positions or investment company holdings

__ is a manipulative activity that is designed to keep the price of a stock from rising (and is prohibited).

Capping is a manipulative activity that is designed to keep the price of a stock from rising (and is prohibited).

May an agent use a new issue prospectus to create a marketing piece and only include positive details about the issue?

No. Material provided to clients must include all facts about the issue, not just the positive ones.

An IA that is also a BD may execute agency cross trades, earning commission on both sides, if one side is .

An IA that is also a BD may execute agency cross trades, earning commission on both sides, if one side is unsolicited.

May an agent and a client share in an account?

Yes. However, client and firm approval is required and the sharing must be proportionate to each person's investment.

Does this order require prior discretionary authorization? "Buy some ABC shares today if its price begins to fall."

Yes. This is NOT a not held order since the client did not specify the quantity of shares to be purchased.

When must an access person file a holding report?

Within 10 days of becoming an access person and at least once every 12 months thereafter

True or False: All illegal activities are intentional.

False. Some accidental or unintentional actions are considered unethical and, therefore, illegal.

Define painting the tape.

Traders effecting transactions back and forth to create a misleading appearance of activity

When selling mutual fund shares, an agent must adequately disclose the _.

When selling mutual fund shares, an agent must adequately disclose the sales charge.

Identify the acronym: POA

Power of Attorney

To whom are written or electronically-sent grievances (complaints) forwarded?

An immediate supervisor

May an adviser or BD lend money to a client?

Yes, if the adviser or BD is in the business of lending money.

Is an adviser required to disclose the source of raw data that is used to determine the recommendations to its customers?

No. Disclosure is not required if the IA's recommendations are based on its own independent conclusions.

May a wife enter trades in a husband's account?

Yes, with written third-party authorization.

True or False: If churning in a client's account generates large profits, it is not considered a violation.

False

True or False: Forward-looking statements regarding mutual fund performance may be used when soliciting clients.

False. Past performance is not indicative of future results.

True or False: In certain cases, fraud may be unintentional.

False

Does this order require prior discretionary authorization? "Buy 500 shares of DMB sometime today."

No, this is a not held order. The customer specified the action (buy), the amount (500 shares), and the asset (DMB).

May an IAR and a client share in an account?

No. However, an agent may share in a client's account.

True or False: An agent may trade a stock two days prior to a research report on the stock being released by his employer.

False. This is an example of trading ahead and is prohibited.

May an agent share in the profits of a client's account?

Yes, in a joint account with proportionate sharing. Permission is required from both the client and the firm.

True or False: A power of attorney given to an agent (RR) must be renewed.

False. Powers of attorney do not have to be renewed.

What step must an IA complete when faced with a conflict of interest?

The conflict must be disclosed to the client. If disclosure is insufficient, the IA must abstain from the action.

Sam buys stock on one exchange and sells it short on another at a slightly higher price. Is this permitted?

Yes. Sam is engaging in arbitrage.

May an agent and a client share in an account?

Yes, if both the firm and customer provide approval and all sharing is proportionate to each party's investment.

What is a not held order?

An order giving agents discretion as to execution time/price. Clients must specify buy/sell, security, and quantity.

Define an agency cross transaction.

A trade executed by a financial firm that is acting as a broker for both the buyer and seller.

What is selling away?

An agent executing securities transactions for compensation and not recording the trades on the BD's books and records.

Trading on material, non-public information is considered .

Trading on material, non-public information is considered insider trading.

What is needed for a BD to exercise discretion over a client's account?

BDs need the client's prior written authorization.

Does this order require prior discretionary authorization? "Buy 300 shares of DMB this week"

Yes, since it is NOT a not held order. Not held orders are only good for a trading day, and this order is for the week.

If an agent has been given time and price discretion on a client order, is written power of attorney required?

No. If the client determines the action (buy/sell), amount, and asset, power of attorney is not required.

What's a no load fund?

A mutual fund with no front-end sales charge, no deferred sales charge, and no 12b-1 fee exceeding .25% per year.

An agent advises a client to buy stock of a company that just fired its CEO. Is disclosure to the client required?

Yes, since this is a material fact, it must be disclosed before the customer buys the stock.

What is the annual fee levied against a fund's assets and used to pay expenses of commissions and retail communications?

12b-1 fee

True or False: A BD may withhold shares of an IPO for the purpose of later selling them to customers at a higher price.

False

True or False: Access persons must file transactions reports annually.

False. Transactions reports are filed within 30 days of the end of each calendar quarter.

Next week ABC plans to announce its earnings. If ABC's CEO wants to sell some of her shares now, is the sale restricted?

Yes. Insiders are required to wait until an earnings report is released publicly before selling shares.

If an agent (RR) received a power of attorney seven years ago, could she still trade that customer's account?

Yes, powers of attorney do not need to be renewed.

True or False: An agent of a broker-dealer may loan money to his son-in-law.

True. In-laws are considered immediate family members; therefore, the loan would be acceptable.

True or False: If a BD receives a written complaint from a client, it may be ignored if the complaint seems baseless.

False. Failing to respond to a formal written complaint is prohibited.

What three details must a client provide for an agent to make a time and/or price decision without written authorization?

Action (buy/sell), asset, and amount. Time and/or price may remain the agent's discretion without written authorization.

is the willful or intentional act of deceiving another person for gain or profit.

Fraud is the willful or intentional act of deceiving another person for gain or profit.

Does an IA need written consent before executing each agency cross trade with an advisory client?

No, the client must provide written consent initially, but not for every trade.