Prohibited Practices

Section 3.2: Prohibited Practices and Customer Protection Estimated study time: 50 minutes Content: FINRA and the SEC have established a comprehensive set of rules prohibiting specific sales practices and market conduct that would harm investors or market integrity. Knowing which practices are prohibited — and why — is essential for the SIE exam and for ethical industry conduct. Churning is one of the most commonly tested prohibited practices. It occurs when a registered rep excessively trades a customer's account for the purpose of generating commissions, without regard to the customer's investment objectives. The key elements are excessive trading frequency and the motivation of generating commissions rather than serving the customer. Even if each individual trade was otherwise suitable, the overall pattern of excessive trading constitutes churning. Unauthorized trading occurs when a rep executes transactions in a customer's account without prior authorization. In a non-discretionary account, the rep must obtain specific authorization from the customer for each trade (the specific security, quantity, price, and buy/sell direction). In a discretionary account (where the customer has given written authority to the rep to make trading decisions), the rep may trade without consulting the customer each time, but must still act in the customer's best interest. Front-running occurs when a broker-dealer or registered rep executes orders for the firm's own account (or personal account) ahead of a large customer order, knowing the large order will move the market price. This is a form of market manipulation that profits at the customer's expense. Insider trading — trading on material, nonpublic information — is illegal and heavily prosecuted by the SEC. "Material" means the information would likely affect a reasonable investor's decision. "Nonpublic" means it