Chapter 5: Ethical Practices and Obligations - F. Other Prohibited Practices

Question 1

Prohibited Practices

Answer 1

• Borrowing money or securities from a client or from a client’s account;
• Effecting discretionary trades in a customer’s account without written authorization from the customer. (One way to remember what constitutes a discretionary trade is “AAA: - Action, which would be buy or sell; Amount either in the number of shares or the dollar amount; or Asset, which is a type of security.” If any of the AAAs is missing, it is considered a discretionary account);
• Commingling customer funds with agent funds or funds of the broker/dealer;
• Sharing in the profits or losses in a customer’s account, unless the agent has written consent from the customer and the broker/dealer and the sharing of profits and losses is directly proportionate to the funds invested by each party involved (note that this type of sharing in a customer account is only allowed for agents and never for broker/dealers, investment advisers or investment adviser representatives);
• Knowingly or deliberately failing to follow a customer’s instructions;
• Effecting trades in a customer’s account without specific authorization from the customer, or accepting orders from a third party without having a written third party trading authorization from the customer;
• Guaranteeing a customer’s account against a loss, or guaranteeing a minimum rate of return or specific dollar profit on any investment;
• Effecting private transactions with customers not recorded on the books of the broker/dealer, known as selling away;
• Soliciting orders for nonexempt unregistered securities (these are securities that should be registered);
• Participating in manipulative market activities, which give the misleading appearance of trading activity in a security, such as wash trades and matched orders;
• Participating in securities transactions only to give the appearance of increased trading activity known as painting the tape;
• Failing to notify a customer of larger than ordinary commissions or costs (notifying the customer is not enough; the extra cost must be justified);
• Failing to notify a supervisor of written customer complaints; and
• Disclosing information about an account to someone other than the customer without the customer’s authorization.

Question 2

Arbitrage

Answer 2

Note that the practice of buying a security on one exchange and simultaneously selling it on another exchange, thus taking advantage of price differentials for a profit, is a legitimate practice known as arbitrage. However, such simultaneous buying and selling of securities when there is no beneficial ownership change, in order to create the misleading appearance of heavy trading volume, is a prohibited practice.