Stock Broker Ethics & Professional Standards 2 — Questions and Answers
Question 1: What is 'unauthorized trading' and what are its consequences for a registered representative?
- Trading in currencies without a Forex license; results in a fine
- Executing trades in a customer's account without the customer's prior knowledge or approval; can result in termination, FINRA sanctions, and civil liability (Correct answer)
- Trading after hours on foreign exchanges; results in exchange penalties
- Trading below the NBBO price; results in regulatory review
Correct answer: Executing trades in a customer's account without the customer's prior knowledge or approval; can result in termination, FINRA sanctions, and civil liability
Unauthorized trading involves executing transactions in a customer's account without their knowledge or prior approval, violating the customer's rights and trust, and can result in termination, FINRA disciplinary action, fines, and customer restitution.
Question 2: What is the FINRA arbitration process and what types of disputes is it designed to resolve?
- A court proceeding for criminal securities fraud; resolves only felony cases
- An industry dispute resolution forum for resolving securities-related disputes between investors and broker-dealers or between industry members, outside of court (Correct answer)
- A mediation process for regulatory violations; resolves only minor rule violations
- An internal broker-dealer process for handling employee complaints only
Correct answer: An industry dispute resolution forum for resolving securities-related disputes between investors and broker-dealers or between industry members, outside of court
FINRA arbitration is a binding dispute resolution process for securities-related claims between customers and broker-dealers, or between industry professionals, providing a faster and less expensive alternative to court litigation.
Question 3: What does it mean for a registered representative to 'guarantee' a customer against investment losses, and why is it prohibited?
- Offering a money-back guarantee; prohibited because it conflicts with SIPC coverage
- Promising that an investment will not lose money or will achieve a certain return; prohibited because all investments carry risk and such promises are fraudulent misrepresentations (Correct answer)
- Offering to cover losses from margin calls; prohibited due to leverage regulations
- Insuring an account against broker-dealer failure; prohibited because that is SIPC's role
Correct answer: Promising that an investment will not lose money or will achieve a certain return; prohibited because all investments carry risk and such promises are fraudulent misrepresentations
Guaranteeing an investment against losses is prohibited because it involves making false promises — all investments carry inherent risk, and such guarantees violate anti-fraud provisions and FINRA rules.
Question 4: What is 'market manipulation' and which behavior is an example of the prohibited practice of 'painting the tape'?
- Using fundamental analysis to value stocks; an example is discounted cash flow analysis
- Artificially influencing a security's price or trading volume through deceptive practices; an example is executing a series of trades to create the appearance of active trading with no economic purpose (Correct answer)
- Trading large block orders; an example is institutional portfolio rebalancing
- Providing research coverage of a stock; an example is issuing a buy recommendation
Correct answer: Artificially influencing a security's price or trading volume through deceptive practices; an example is executing a series of trades to create the appearance of active trading with no economic purpose
Market manipulation involves artificial or deceptive acts to distort a security's price or volume; 'painting the tape' means executing a series of transactions between colluding parties to create the illusion of active trading and interest in the security.
Question 5: What is a 'Chinese wall' (information barrier) in broker-dealer firms, and why is it important?
- A physical barrier between trading floors in different countries
- An internal information barrier separating departments that possess material non-public information (e.g., investment banking) from those that trade securities (e.g., sales and trading), to prevent insider trading (Correct answer)
- A firewall between the firm's computer systems and the internet
- A compliance procedure separating equity and fixed income trading desks
Correct answer: An internal information barrier separating departments that possess material non-public information (e.g., investment banking) from those that trade securities (e.g., sales and trading), to prevent insider trading
A Chinese wall (information barrier) is a set of policies and procedures separating investment banking (which handles MNPI) from trading and research departments, preventing the misuse of material non-public information in trades.
Question 6: What ethical standard requires brokers to treat all customers fairly regarding the timeliness of executing customer orders?
- The anti-front-running rule
- The priority of customers' orders over proprietary trading or the representative's personal account (Correct answer)
- The best execution rule requiring speed over price
- The payment for order flow disclosure requirement
Correct answer: The priority of customers' orders over proprietary trading or the representative's personal account
Brokers must prioritize customer orders over trading for the firm's own account or the representative's personal account in the same security, ensuring customers are not disadvantaged by self-interested trading.
Stock Broker Ethics & Professional Standards 2
What is 'unauthorized trading' and what are its consequences for a registered representative?