Investor Alert – Examples of Account Executive Prohibited Activities

FINRA rules require that account executives observe high standards of commercial honor and just and equitable principles of trade in dealing with you, the customer. FINRA rules also prohibit any manipulative, deceptive, or fraudulent actions (NASD Rules 2110 and 2120).

However, sometimes an investor will run into an unscrupulous account executive who will lie, cheat or steal to take advantage of the naive or trusting investor. The following are examples of specific practices to which you may be exposed and with which should should be familiar. If you are exposed to any of these situations, you should immediately contact qualified legal counsel.

1. Rumors – an account executive who knowingly provides false and misleading statements, incomplete information or statements to customer’s that have no reasonable basis in fact. Withholding material information from a customer could be considered fraud. If an account executive tells you to buy or sell a security based on a “hot tip,” the account executive may have committed securities fraud. If the “hot tip” is not real, or is not “hot,” the account executive will have misled you. If it is a “hot tip,” the account executive may be violating insider-trading rules (see below). Either way, the account executive 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 participant

3. Commingling: Account Executives are not permitted to place customers’ checks or money intended for transactions involving securities into their own bank account or their 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.

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

5. Suitability: (NASD Rule 2310)- The account executive must have reasonable grounds for believing each recommendation to you is suitable on the basis of your other securities holdings and financial situation, among other factors.

6. 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 the account executive’s 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.

7. Selling away: (NASD Rule 3040)-Selling securities without processing the order through the account executive’s firm and without the broker/dealer’s permission or knowledge is a violation of FINRA rules. Even products that the account executive may not consider to be securities, such as leasing arrangements or promissory notes, may be securities under federal or state law.

8. Sharing in accounts: The sharing of profits or losses in an account with a customer is generally prohibited.

9. Conflicts of interest: You account executive should avoid even the appearance of conflict, with you, let alone any actual conflict of interest, in transactions with you.

10. Switching and break-point sales for mutual funds: (NASD Rule 2830)-Mutual funds are typically long-term investments. Switching 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 you, 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 the account executive, but is not normally in your best interests and is usually a violation.

11. Unauthorized trades: No account executive may never enter an order without the expressed and detailed permission of your the customer unless you have granted written discretionary authority.