Ethical Practices and Obligations practice questions

Answer: B) Permitted only with written authorization from the customer and the agent's broker-dealer

Under the NASAA model rule, an agent may share in a customer account's profits or losses only with written authorization from both the customer and the agent's broker-dealer. A verbal agreement or the customer's consent alone does not satisfy the rule.

• AIncorrect. A proportionate share and the customer's verbal agreement are not enough. The model rule requires written authorization from both the customer and the broker-dealer the agent represents.
• BCorrect. Under the NASAA model rule, it is a dishonest or unethical practice for an agent to share directly or indirectly in the profits or losses of a customer's account without written authorization from both the customer and the broker-dealer the agent represents.
• CIncorrect. The customer's written consent covers only half of the requirement. The broker-dealer the agent represents must also authorize the arrangement in writing.
• DIncorrect. Agents are not barred outright from sharing in a customer's account. They may do so when the customer and the broker-dealer have both authorized it in writing.

Answer: C) Choose when and at what price to buy those shares that day

• AIncorrect. The amount was set.
• BIncorrect. That requires written discretion.
• CCorrect. That doesn't require written authority.
• DIncorrect. Time and price discretion is generally for that day.

Answer: A) Front running, an unethical practice that puts the IAR's interests ahead of clients'

Buying for a personal account while knowing about an imminent large client order is front running. It is an unethical practice that puts the IAR's interests ahead of clients' interests, and reporting the trade doesn't cure it.

• ACorrect. Front running means trading for one's own account while knowing about an imminent large client order, to profit from the expected price move. It breaches the duty to put clients' interests first.
• BIncorrect. Churning is excessive trading in a client's account to generate commissions or fees. Here the IAR traded in his own account ahead of client orders.
• CIncorrect. Reporting personal trades doesn't make it acceptable to trade on knowledge of pending client orders. The conduct is prohibited no matter how it is reported.
• DIncorrect. Marking the close means placing trades near the market close to influence the closing price. The issue here is trading ahead of known client orders.

Answer: B) Prohibited, because settling a complaint away from the firm hides it from supervision

An agent may not privately pay off a customer to settle a complaint without the firm's knowledge or approval. This conceals the complaint from supervision and required records and is treated as unethical conduct.

• AIncorrect. Whose money is used doesn't matter. The violation is settling a complaint away from the firm and keeping it from supervision.
• BCorrect. Settling or trying to settle a customer complaint without the firm's knowledge or approval is treated as unethical conduct. It hides the problem from supervisors and keeps the complaint out of the records the firm must maintain.
• CIncorrect. A private release doesn't cure the problem. The firm still doesn't know about the complaint or the settlement and can't supervise, record, or report it.
• DIncorrect. There's no dollar threshold. Even a small payment made without the firm's knowledge to resolve a complaint is improper.

Answer: A) A customer that is a bank regularly engaged in making loans in the ordinary course of its business

Borrowing from customers is generally prohibited. A recognized exception is a customer that is a financial institution regularly engaged in lending, acting in its ordinary course of business. A customer's wealth, investor status or length of relationship does not qualify.

• ACorrect. A financial institution regularly engaged in providing credit, lending in the ordinary course of its business, is a recognized exception to the ban on borrowing from customers.
• BIncorrect. A customer's wealth does not create an exception. A below-market rate from an individual customer also suggests the agent is using the client relationship for personal benefit.
• CIncorrect. Accredited-investor status and loan paperwork do not make a customer an acceptable lender. The concern is the conflict of interest, not how the loan is documented.
• DIncorrect. A long-standing brokerage relationship is not a permitted category. A loan that arises from the broker-customer relationship is exactly the conflict the restriction targets.

Answer: B) Promptly forward it to the supervisor or compliance department for handling

An agent who receives a written customer complaint should promptly forward it to a supervisor or compliance. The firm must record and keep written complaints and the action taken, and it handles the response.

• AIncorrect. The firm has to know about every written complaint so it can supervise, record it, and respond. The agent can't decide alone whether the firm hears about it.
• BCorrect. Written complaints go to the firm, which must keep a record of each one and of any action taken (FINRA Rule 4513) and handle the response under supervision.
• CIncorrect. The complaint record must be kept by the firm at its office of supervisory jurisdiction. Filing it privately keeps it away from the supervisor.
• DIncorrect. The agent's duty is to bring the complaint to the employing firm. The firm handles it and any regulatory reporting that may be required.

Answer: A) It is unsuitable, because the recommendation must fit this particular customer's investment profile

Suitability has two layers. A product approved as suitable for some investors must still fit the specific customer's investment profile, and neither firm approval, a signed risk acknowledgment nor diversification replaces that check.

• ACorrect. Even if a product is suitable for some investors (reasonable-basis suitability), the agent must have a reasonable basis to believe it fits this particular customer's profile. An aggressive-growth portfolio doesn't fit a low-risk, income-focused retiree.
• BIncorrect. Firm approval addresses only whether the product suits some investors. The agent still has a separate duty to check whether it suits this customer.
• CIncorrect. A signed risk acknowledgment doesn't make an unsuitable recommendation suitable or waive the agent's obligation.
• DIncorrect. Diversification lowers issuer-specific risk, but it doesn't make an aggressive strategy fit a customer with low risk tolerance and income needs.

Answer: A) It is unsuitable because the leverage does not fit her objectives, finances and risk tolerance

A recommendation, including one to use margin, must fit the client's investment profile. Disclosing risks or getting signed account documents doesn't cure a recommendation that conflicts with a principal-preservation goal on a fixed income.

• ACorrect. Whether a recommendation is suitable, or in her best interest, depends on her investment profile: financial situation, needs, objectives, liquidity needs and risk tolerance. Borrowing the maximum on margin conflicts with a goal of preserving principal on a fixed income.
• BIncorrect. Telling a client about the risks doesn't satisfy the separate duty to recommend only what fits her profile. A disclosed but unsuitable recommendation is still unsuitable.
• CIncorrect. Account paperwork such as a margin agreement is an operational requirement. It doesn't turn an unsuitable recommendation into a suitable one.
• DIncorrect. Suitability is judged when the recommendation is made, based on the client's profile, not on how the investment later performs.

Answer: A) A best execution concern

• ACorrect. Customers should get favorable terms.
• BIncorrect. Best execution still applies.
• CIncorrect. It isn't required.
• DIncorrect. It's still a concern.

Answer: C) Conversion

• AIncorrect. It is conversion.
• BIncorrect. It is conversion.
• CCorrect. Using client funds for oneself is theft.
• DIncorrect. It is conversion.