Stock Broker Ethics & Professional Standards 1 — Questions and Answers
Question 1: What does 'fiduciary duty' mean for a registered investment adviser compared to a broker-dealer's suitability standard?
- Both require the same level of care
- A fiduciary must always act in the client's best interest; a suitability standard only requires recommendations be suitable, not necessarily optimal (Correct answer)
- A fiduciary can charge higher fees; suitability advisers charge lower fees
- A fiduciary only works with institutional clients; suitability advisers work with retail clients
Correct answer: A fiduciary must always act in the client's best interest; a suitability standard only requires recommendations be suitable, not necessarily optimal
Investment advisers (RIAs) have a fiduciary duty to always act in the client's best interest, while broker-dealers under the suitability standard only need to ensure recommendations are appropriate — Reg BI has narrowed but not eliminated this distinction.
Question 2: What is 'insider trading' and why is it illegal?
- Trading in small-cap stocks; illegal due to manipulation risk
- Buying or selling securities based on material non-public information; illegal because it provides an unfair advantage and undermines market integrity (Correct answer)
- Trading after market hours; illegal due to low liquidity
- Short selling before an earnings announcement; illegal due to potential market manipulation
Correct answer: Buying or selling securities based on material non-public information; illegal because it provides an unfair advantage and undermines market integrity
Insider trading involves trading securities based on material, non-public information, giving the trader an unfair advantage over other investors and undermining the integrity and fairness of capital markets.
Question 3: Under FINRA rules, what is 'selling away' and why is it prohibited?
- Selling a client's securities without their knowledge; prohibited as unauthorized trading
- A registered representative conducting securities transactions outside the member firm without the firm's knowledge or approval; prohibited because the firm cannot supervise these activities (Correct answer)
- Selling securities at a below-market price; prohibited as market manipulation
- Selling foreign securities to US investors; prohibited without proper licensing
Correct answer: A registered representative conducting securities transactions outside the member firm without the firm's knowledge or approval; prohibited because the firm cannot supervise these activities
Selling away occurs when a registered representative conducts private securities transactions outside their member firm without the firm's knowledge or approval, bypassing the firm's supervisory system and investor protections.
Question 4: What is the 'code of conduct' that all FINRA-registered representatives must adhere to regarding conflicts of interest?
- Disclose conflicts only if they exceed $10,000 in value
- Disclose and manage all material conflicts of interest with customers fairly (Correct answer)
- Avoid all personal investing
- Never accept any gifts from clients or issuers
Correct answer: Disclose and manage all material conflicts of interest with customers fairly
FINRA rules require registered representatives to disclose material conflicts of interest to customers and handle them fairly, ensuring customers can make informed decisions despite the representative's potentially competing interests.
Question 5: What is 'misrepresentation' in securities sales and what rule prohibits it?
- Disclosing risk factors in a prospectus; prohibited by Reg D
- Making false or misleading statements about a security or omitting material facts; prohibited by SEC Rule 10b-5 (Correct answer)
- Charging undisclosed commissions; prohibited by FINRA Rule 2010
- Recommending unsuitable investments; prohibited by FINRA Rule 2111
Correct answer: Making false or misleading statements about a security or omitting material facts; prohibited by SEC Rule 10b-5
Misrepresentation involves making false or misleading statements, or omitting material facts, in connection with the purchase or sale of a security; SEC Rule 10b-5 is the primary anti-fraud rule prohibiting this.
Question 6: What ethical obligation does a broker have regarding the 'best execution' of customer orders?
- Execute all orders at exactly the ask price
- Seek the most favorable terms available for the customer considering price, speed, and likelihood of execution (Correct answer)
- Always route orders to the exchange with the lowest fees
- Execute orders only on national exchanges, never in dark pools
Correct answer: Seek the most favorable terms available for the customer considering price, speed, and likelihood of execution
Best execution requires brokers to seek the most favorable execution terms reasonably available for customer orders, considering factors like price, speed of execution, likelihood of execution, and overall quality.
Stock Broker Ethics & Professional Standards 1
What does 'fiduciary duty' mean for a registered investment adviser compared to a broker-dealer's suitability standard?