Sample Practices that Violate Regulations

FINRA rules require you to observe high standards of commercial honor and just and equitable principles of trade. The FINRA rules also prohibit any manipulative, deceptive, or fraudulent actions (NASD Rules 2110 and 2120).

 

The following are examples of specific practices with which new representatives should be familiar since they constitute serious violations of industry regulations. These practices may harm the customer; another member firm; the integrity of the marketplace; the issuer of the securities; or the public in general; and, they could end your career in the securities business. In your training, you should learn more about these and other situations and how to avoid them.

 

  1. Rumors, knowingly false and misleading statements, incomplete information—Recommendations, analyses, and statements to customers must have a reasonable basis in fact. Withholding material information from a customer could be considered fraud. If you tell your customer to buy or sell a security based on a "hot tip," you may have committed securities fraud. If the "hot tip" is not real, or is not "hot," you have misled your customer. If it is a "hot tip," you may be violating insider-trading rules (see below). Either way, you can be subject to civil liability, disciplinary action, and even criminal charges.

  2. The SEC, FINRA, and the exchanges have developed a series of trade practice rules to ensure that traders and market makers execute orders at the best prices and exercise market discretion in the interest of their customers.

    These include:
    • Insider Trading (SEC Rule 10b-5)—It is illegal to use or pass on to others material, nonpublic information or enter into transactions while in possession of such information.

    • Backing away (NASD IM-3320)—A market maker in a given security is obliged to honor the quoted bid and ask prices for a minimum quantity.

    • Trading ahead of customer limit orders (NASD IM-2110-2)—FINRA members acting as market makers are prohibited from trading ahead of customer limit orders and must ensure that such orders are executed at the most favorable price possible under prevailing market conditions.

    • Front-running (NASD IM-2110-3)—A broker/dealer is prohibited from buying or selling a security or an option on a security while in possession of material, non-public information concerning an imminent block transaction in the security or option on the security.

    • Trading ahead of research reports (NASD IM-2110-4)—FINRA member firms are prohibited from trading activity that changes the firm's position in a Nasdaq® or exchange-listed security traded in the third market, or in any derivative security based on or related to the underlying security, in anticipation of the issuance of a research report in that security.

    • Anti-Intimidation/Coordination (NASD IM-2110-5)—A FINRA member firm may not coordinate its prices (including quotations), trades, or trade reports with any other member; direct or request another member to alter a price (including a quotation); or engage, directly or indirectly, in any conduct that threatens, harasses, coerces, intimidates, or otherwise attempts improperly to influence another member. This includes any attempt to influence another member to adjust or maintain a price or quotation and refusals to trade or other conduct that retaliates against or discourages the competitive activities of another market maker or market participan

  1. Commingling—You are not permitted to place customers' checks or money intended for transactions involving securities into your own bank account or your insurance business account, regardless of the amount of money or the length of time involved. Mishandling customer funds, such as money intended for insurance products, is a serious violation of FINRA rules and could result in prosecution by state or federal criminal agencies.

  2. Churning (NASD IM-2310-2)—Frequent trading, or trading that is not consistent with the financial goals and risk tolerance of your customer, in a discretionary account (or an account over which you exercise de facto discretion) is an abuse of your control over the customer's account. You can be found liable to your customer for damages and may be disciplined by FINRA.

  3. Suitability (NASD Rule 2310)—You must have reasonable grounds for believing each recommendation to a customer is suitable on the basis of the customer's other securities holdings and financial situation, among other factors.

  4. Free-riding and withholding (NASD Rule 2110-1)—New issues of securities that immediately begin trading at a higher price than originally offered must be distributed to the public. They may not be placed in your account under any circumstances, and only under strict guidelines may they be placed in the accounts of financial services industry personnel or their immediate families.

  5. Selling away (NASD Rule 3040)—Selling securities without processing the order through your firm and without your firm's permission or knowledge is a violation of FINRA rules. Even products that you may not consider to be securities, such as leasing arrangements or promissory notes, may be securities under federal or state law. Check with your firm before engaging in any securities transactions for any purpose.

  6. Sharing in accounts—The sharing of profits or losses in an account with a customer is generally prohibited. Before contemplating entering into such an arrangement, you should read and become familiar with the appropriate provisions of NASD Rule 2330.

  7. Conflicts of interest—Avoid even the appearance of conflict, let alone any actual conflict of interest, in transactions with your customers. For instance, if you own shares of a thinly traded stock in your personal account, one has to question your true motivation in recommending large purchases of those shares to your customers when such a recommendation is likely to drive up the price of that stock.

  8. Switching and break-point sales for mutual funds (NASD Rule 2830)—Mutual funds are typically long-term investments. Switching your customer among funds with similar investment objectives is usually a violation if it has no legitimate investment purpose and may needlessly impose another commission charge and increased tax liability on the customer. Recommending to a customer a mutual fund purchase for a quantity just beneath the point where the customer could save commission charges significantly by purchasing a few more shares may mean a bigger payment for you, but is not normally in the customer's best interests and is usually a violation.

  9. Unauthorized trades—No matter how noble your intentions may be, never enter an order without the expressed and detailed permission of the customer unless you and your firm have been granted written discretionary authority by the customer.

  10. Parking securities and maintaining fictitious accounts—Holding or hiding securities in someone else's or a fictitious account is misleading and strictly prohibited.

  11. Failure to cooperate—If the FINRA staff asks you to provide information or testify in person, you must cooperate. Failure to cooperate or respond in a full, complete, and honest manner to any such request will normally result in a fine and a suspension or bar from the industry. In addition, under FINRA regulations, you must keep FINRA informed of your home address so that you may be reached in the event of a staff investigation; failure to do so may deny you the ability to provide input to the staff and have an impact on your registration status with FINRA.

  12. Cheating on exams (NASD Rule 1080)—This rule prohibits an applicant from receiving assistance while taking a qualification examination. In instances where cheating or possession of unauthorized materials is demonstrated, the registered person or applicant found guilty of such behavior is normally barred from the securities industry.

All of FINRA's rules are listed on the FINRA Manual.