Identify Prohibited Practices - Series 65

1. What is "tipping" in insider trading enforcement?

   Passing MNPI to another person who then trades on it. Tipping constitutes illegal dissemination of MNPI, enabling others to trade unlawfully and extending liability beyond direct insiders.

2. What is "scalping" by an investment adviser?

   Buying, recommending, then selling to profit from the price rise. Scalping exploits recommendations to generate personal gains, violating disclosure requirements and fiduciary obligations to clients.

3. What is material nonpublic information (MNPI) in the context of insider trading?

   Nonpublic info a reasonable investor would consider important. MNPI is defined as information not yet public that could significantly influence investment decisions, forming the basis for insider trading violations.

4. What is "churning" in an advisory or brokerage account context?

   Excessive trading to generate commissions or fees. Churning disregards client objectives, prioritizing adviser compensation over suitable investment strategies and breaching anti-fraud provisions.

5. What is insider trading under the federal securities laws?

   Trading while in possession of MNPI in breach of a duty. Insider trading violates securities laws by exploiting confidential information in breach of fiduciary or similar duties, undermining market fairness.

6. What is a conflict of interest in an investment advisory relationship?

   A competing interest that could bias advice unless fully disclosed. Conflicts of interest impair an adviser's ability to provide unbiased advice, necessitating full disclosure to uphold fiduciary standards and ensure client awareness.

7. What is "best execution" as it relates to trade placement conflicts?

   Duty to seek most favorable terms reasonably available. Best execution fulfills fiduciary obligations by ensuring trades are placed under optimal conditions, minimizing costs and maximizing value.

8. What is the general prohibition on an adviser guaranteeing investment results?

   Guaranteeing performance is misleading and generally prohibited. Guarantees imply certainty in uncertain markets, violating anti-fraud rules by misleading clients about investment risks.

9. What is the primary conflict of interest created by soft dollar arrangements?

   Incentive to direct trades for benefits rather than best execution. Soft dollars may bias trade routing decisions, compromising the fiduciary duty to obtain best execution for clients.

10. What is an agency cross transaction involving an investment adviser?

    Adviser acts as broker for both buyer and seller in one trade. Agency cross transactions pose conflicts by representing opposing sides, requiring safeguards to prevent favoritism and ensure fairness.

11. What is "misappropriation" theory in insider trading cases?

    Trading on MNPI stolen from a source to whom a duty is owed. Misappropriation extends insider trading liability to outsiders who breach duties by using stolen MNPI for personal gain.

12. What is an adviser's obligation regarding disclosure of conflicts of interest?

    Full and fair disclosure, in writing, before or at engagement. Disclosure ensures transparency, allowing clients to assess potential biases and make informed decisions under fiduciary standards.

13. What is "soft dollar" compensation in advisory arrangements?

    Research/services obtained with client brokerage commissions. Soft dollars use client assets indirectly for adviser benefits, derived from brokerage commissions under Section 28(e) safe harbor.

14. What is "selling away" by a registered representative?

    Selling securities not approved by the firm, outside supervision. Selling away evades firm oversight and regulatory compliance, exposing clients to unvetted risks and violating registration requirements.

15. Identify the prohibited practice: Adviser advertises "no risk" and "guaranteed returns" for a strategy.

    Fraudulent or misleading advertising. Such claims misrepresent investment realities, breaching SEC rules against false advertising and requiring accurate risk disclosure.

16. Identify the prohibited conduct: An adviser buys a stock for clients after buying it for personal account.

    Front-running (trading ahead of client orders). Front-running breaches fiduciary duty by allowing advisers to profit personally from anticipated price movements caused by client trades.

17. What must an adviser do before effecting a principal transaction with an advisory client?

    Disclose in writing and obtain client consent before the trade. Written disclosure and consent mitigate conflicts in principal trades, ensuring clients understand risks and terms per SEC regulations.

18. What is "pay-to-play" in the investment advisory context?

    Political contributions made to obtain or retain government business. Pay-to-play rules prevent undue influence on public fund allocations, promoting fair competition and protecting government clients.

19. What is a principal transaction for an investment adviser?

    Selling to or buying from a client out of the adviser's own account. Principal transactions involve inherent conflicts, as advisers may prioritize their inventory over client interests without proper safeguards.

20. What is the fiduciary duty standard for an investment adviser regarding client interests?

    Place the client's interests ahead of the adviser's at all times. Fiduciary duty requires advisers to prioritize client needs over their own to avoid self-dealing and maintain trust in advisory relationships.

21. Identify the violation: A rep makes frequent trades in a discretionary account to boost commissions.

    Churning. Churning involves unsuitable trading frequency to maximize fees, violating suitability rules and fiduciary duties in managed accounts.

22. What is the core conflict in an adviser receiving compensation from a third party for client referrals?

    Referral fee creates incentive to recommend for pay, not merit. Referral fees introduce bias, potentially leading to recommendations based on compensation rather than client suitability or merit.

23. Identify the conflict: Adviser routes trades to a broker for research despite higher costs.

    Soft dollar conflict (may impair best execution). Routing for soft dollars prioritizes adviser perks over client costs, potentially violating best execution duties under fiduciary standards.

24. Identify the prohibited practice: A rep sells a private note to clients without firm approval.

    Selling away. This practice circumvents firm supervision, potentially involving unregistered securities and breaching FINRA and SEC rules.

25. Identify the prohibited practice: Adviser recommends a security without disclosing personal ownership and intent to sell.

    Scalping (undisclosed personal trading around recommendations). This practice violates fiduciary standards by failing to disclose personal interests, potentially misleading clients about recommendation motives.

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