The USA also states that the above definition "applies to any securities offer, sale or purchase, including offers, sales or purchases involving registered, exempt or federal covered securities."

► Communications with Clients and Prospects

Fiduciary Duty

A fiduciary is a person legally appointed and authorized to hold assets in trust for another person. The fiduciary manages the assets for the benefit of the other person, rather than for his or her own profits.

All securities professionals must handle client funds and offer advice in a professional, ethical and responsible manner. Because of such, they have a higher standard of ethical responsibility than the average person.

If the professorial has a fiduciary duty to the client as in the case of an investment adviser the adviser, must put the interest of their clients above their own.

Disclosure

Investment advisers MUST disclose the nature of the relationship between the client and the investment adviser. Investment advisers CANNOT participate in, or be compensated (unless there is a specific exemption) by any percentage of gains of a client's portfolio, and the basis of all compensation must be disclosed in the investment advisory contract.

Furthermore, if any change within an Investment Adviser's partnership firm is made (e.g. a change in partners or ownership); clients must be made aware of the change in a reasonable time. It is important to note that this act of notification only applies to partnerships, and not corporations.

Unlawful Representations

The USA cites "prohibited conduct" as:

Fraudulent investment advice:

"It is unlawful for a person to provide any type of investment advice (for compensation) either directly or indirectly or through publications or writings, to the value of securities or the advisability of investing in, purchasing, or selling securities that:

Attempts to employ a device, scheme or artifice to defraud.

Engage in any act, or course of business that would operate as fraud."

Advertising materials

Distribution of any unregulated or fraudulent prospectuses, pamphlets, circulars, sales literature or advertising communications, including any/all hard copy and electronic materials.

Misleading Filings

Misleading filings are prohibited under the USA. Such items include any filings that make false or misleading statements, or omit material facts concerning investment advice or an offering.

Other activities considered fraudulent include:

Informing a client that registration of a security means that the SEC or state Administrator has approved (likes) an offering, or a security is a "good offering".

Deliberately misquoting a security to effect a securities transaction.

Untrue or inaccurate statements regarding commissions, including both markups and markdowns.

Inaccurate statements regarding registration status. If you tell a client that a security will be approved for a NASDAQ listing, when in fact, the company has only submitted an application, you have committed fraud.

Any deliberate and/or misleading statements regarding financial statements, dividends, earnings or future expectations.

Telling a client anything about their account that is untrue - including returns.

Promising services that you, your firm or your associates cannot (or simply will not) fulfill - with the intention of promising such to gain securities related business. This includes anything from analyzing an investment to obtaining shares of an IPO.

The bottom line here is that if you state anything to your clients that is even REMOTELY untrue, (a lie) you are
committing fraud. If you tell your client that a bulletin board stock is going to be huge, since it is soon to be listed on the NASDAQ National Market, and "he should buy it now", though you have no evidence that the stock will actually be listed, you have committed fraud. What's more, if you tell your client something misleading because you actually are trying to protect him/her from a loss, even if your intentions are sound, you have committed fraud.

Example: Johnny Fast talker is an Agent for Big Blue Brokerage, which has recently come out with an analyst's report regarding the OTC BB oil/gas stock: Gassed Up. The firm's analysts believe the stock is a good buy, indicating a promising future with attractive growth potential. While getting doughnuts one morning, Johnny Fasttalker notices an article in a newspaper mentioning that Gassed Up officers are anticipating that the stock will soon be quoted on the NASDAQ National Markets system (NNM). Johnny is very excited about the news, since it reaffirms how brilliant his firm's analysts are. In turn, he immediately calls his best client to tell them about the stock. While chatting with his most risk-tolerant client, Johnny mentions that he noticed Gassed Up in the morning paper, which mentioned the possible NNM listing. Johnny feels that when the papers pick up such news, the upgrade in the stock's quotation generally is inevitable, and his client would be wise to get in before the listing is actually approved. Has Johnny committed any fraudulent activity?

Answer : Yes, though the morning paper reported that Gassed Up company officials anticipate the quotation in the
NNM, Johnny has no specific (or public) information as to any official confirmation of NASDAQNM's approval. Thus, he has fraudulently misled his client, and can be liable for both civil and criminal penalties.

► Trade Practices

Suitability

Suitability comes in many forms, a few of which we will discuss here. If at any time, you knowingly recommend an investment to a client that is unsuitable, with the intention to defraud, you are liable for both civil and criminal penalties.

According to the USA, in a court of law, suitability comes down to:

"Reasonable basis for recommending a security or investment strategy: where brokers "conduct themselves in a fair and equitable manner with their customers, have a reasonable basis for recommending a particular security or strategy to a particular customer and have reasonable grounds for believing that the customer understands the investment or strategy, and the risks involved in the investment."

Excessive trading

Any time an agent trades either on a discretionary basis or recommends trading excessively in, or for, a client's account for the sake of generating commissions, the agent is committing fraud. Legally, the term associated with this action is known as churning.

*Exam Tips and Tricks The SEC defines churning as follows: Churning refers to excessive buying and selling in your account by your broker. For churning to occur, your broker must exercise control over the investment decisions in your account, either through a formal written discretionary agreement or otherwise, and must engage in excessive trading in light of the financial resources and character of the account for the purpose of generating commissions.

Insider Trading

As the SEC site informs, there are actually two types of insider trading, the legal kind and the illegal kind. The reason for this clarification is that many people simply associate the term with illegal activities. According to the SEC, legal insider trading occurs when insiders (officers, directors and certain other employees) trade their own firm's securities based on material, public information and report any/all transactions to the SEC.

The SEC lists examples of insider trading, such as:

Corporate officers, directors and employees who traded the corporation's securities after learning of significant, confidential corporate developments;

Friends, business associates, family members and other "tippees" of such officers, directors and employees, who traded the securities after receiving such information;

Employees of law, banking, and brokerage and printing firms, who were given such information to provide services to the corporation whose securities they traded;

Government employees who learned of such information because of their employment by the government; and

Other persons who misappropriated, and took advantage of, confidential information from their employers.

Selling Away

Selling away is a violation that occurs when an agent attempts to sell securities not held or offered by his or her brokerage firm, or that they not able to immediately gain possession of at the time of the offer. As a rule, such activities are a violation of securities regulations.

► Other Trade Practices

Discretion

If an agent is managing a discretionary account, there is an added fiduciary responsibility. He/she may make the choice of whether to buy or sell, the quantity and the security on behalf of the client. While the discretion portion of the exam can mean several things, please think: use common sense. By this, terms like "pump and dump", (i.e. create or spread false rumors) are fraudulent. Misusing client funds or accounts, soliciting orders that are in direct violation of the USA, failing to disclose commissions, or capacity of commission structure and/or disclosing that certain transactions will require different commission structures - are FRAUDULENT practices!

Conflict of interest

This term should be self-explanatory, simply don't do something in one client's account, with the intention of doing/trading something different in another, in an attempt to defraud.

Another rule is that any potential conflict of interest must be disclosed to the client. For example if the broker dealer or its officers are owners or market makers in the security.

Compliance

If a customer files a formal complaint, the agent involved must bring the complaint to the attention of his/her supervising principal, the firm's compliance officer and/or broker-dealer officials.

Guarantees

It is considered fraudulent to guarantee any returns to any client. It is also considered fraudulent to guarantee a client's account against loss.

Commingling funds

Commingling funds is when customer and agent funds are mixed together. By law, an agent is required to use a
separate trust or escrow fund to temporarily hold a client's funds. Basically, an agent cannot deposit a customer's funds that are intended for securities transactions in their own personal account. This activity is considered fraudulent, and violation could result in state or federal prosecution. An agent may share in a client's account profits, if:

The agent's participation has been approved by a principal, and

The agent's participation is directly proportional to his/her contributions to the account.

Trading Ahead

The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients have been given the information.

Painting the tape

An illegal action by a group of market manipulators buying and/or selling a security among themselves to create
artificial trading activity, which, when reported on the ticker tape, lures in unsuspecting investors as they perceive unusual volume. This is similar to matching orders. Simply: this is cheating.

Borrowing money from clients

It is considered fraudulent to borrow money from clients for personal use, unless the person loaning the money (or securities) is specifically in the legitimate business of lending. Simply, this would be considered theft.

Anti-Money Laundering

Money laundering is the process of creating the appearance that large sums of money obtained from fraudulent
sources, originated from a legitimate source. This is achieved through a series of three steps (that can often occur simultaneously):

Placement

Where the money enters the financial system, often through several small currency deposits, or commingled deposits from several legal and illegal enterprises.

Layering

This money is then moved throughout the financial system through a process of several complex transactions to
confuse the paper trail.

Integration

The funds are made to appear legal through additional transactions, such as the purchase and resale of real estate,
stocks or other assets.

USA PATRIOT Act

Under the USA PATRIOT Act, (enacted in 2001 in response to terrorist attacks around the world), an Anti-Money Laundering Program was established and requires all broker/dealers to comply. FINRA has listed this requirement under Rule 3011, and requires firms to:

Establish and implement policies and procedures that will detect and report suspicious transactions.

Establish and implement policy procedures, and internal controls that comply with the Bank Secrecy Act.

Provide for independent testing for compliance by an outside party or member personnel.

Provide FINRA with identification of individual(s) responsible for monitoring day-to-day operations and internal controls. (Providing immediate updates should anything change.)

Provide training for the appropriate personnel regularly.

► Bank Secrecy Act (BSA) and Compensation

Currency Transaction Reports (CTRs)

Under the Bank Secrecy Act (BSA), (enacted to aid in identifying the source, volume, and movement of currency in
and/or out of the United States or deposited in financial institutions), firms are required to file a CTR for any cash
transactions over $10,000.

In order to identify potentially fraudulent activity, banks are also required to maintain records of any funds transferred in the amount of $3,000 and above. Many banks will use software that aids in discovering suspicious activity, especially in larger banks where thousands of transactions are performed daily.

In addition, these reports include structured transactions, where a number of small transactions totaling $10,000 or
more have been made over a short period of time. This activity often occurs when an individual is attempting to avoid the $10,000 reporting requirement.

This information is reported on FinCEN Form 104. FinCEN itself is a bureau of the U.S Treasury and is the delegated administrator of the BSA.

Suspicious Activity Reporting

These reports, as required by the BSA, should be filed for:

Criminal violations involving insider abuse.

Criminal violations for $5,000+, when suspect is identified.

Criminal violations for $25,000+, even when no suspect is identified.

Transactions for $5,000+, if the bank or affiliate knows, suspects or has reason to suspect the transaction:

May involve potential money laundering, terrorism financing or other illegal activity,

Is designed to evade the BSA,

Has no apparent business or lawful purpose or seems odd when compared to the customer's normal activities, and
there is no reasonable explanation after examining the facts.

Suspicious activities are often difficult to detect since they are designed to avoid detection. Some examples of
suspicious activities include:

Customers who are uninterested in investment products that offer lower fees and higher returns,

Customers who supply inaccurate, false or suspicious information,

Customers with known criminal backgrounds, who begin to conduct numerous transactions or

Customers who wire funds into an account, then immediately request to redirect funds to another institution, city or country.

Compensation

As stated already, agents and/or advisers may not participate in percentage gains of an account except under certain circumstances:

Agents may participate in gains of an account, if the account is equally (dually) owned by the agent and client, and is approved by the broker-dealer. What's more, the agent must equally participate in any losses that occur.

Investment Advisers may not participate in "performance-based fees" unless the client is:

An institutional investor,

A private client with a minimum net worth of $2. Million or

A private client with a minimum of $1,000,000 invested with the adviser.

► Compliance and Custody of Client Funds

Margin

Any time a client is an owner of a cash account, an agent cannot open a margin account for that client without written authorization from the client. Without the client having signed a margin account agreement, an agent would NOT be in compliance if he/she were to effect any transactions on margin.

As a standard part of the margin account agreement, a broker-dealer usually has a client sign a hypothecation agreement, which allows the broker dealer to hold the margined securities in the street name (that is, in the name
of the broker-dealer) and use the securities held as collateral for the loan from the broker-dealer to the customer. This is very much like a bank's name appearing on the title to an automobile for which it has made a loan. The car is held as collateral for the loan. Additionally, the client's stock may be used as collateral, by the broker-dealer, to borrow money from a bank - the primary source for the money loaned to the client.

Complaints

Any time a customer files a complaint with or broker-dealer, the complaint must immediately be reported to the firm's compliance department. In addition, the broker-dealer must promptly respond to the customer's complaint.

Custody of Client Funds

Investment advisers have different rules than broker-dealers. They must notify their Administrator if they will have
direct possession of client funds (custody). If an investment adviser does have direct possession (custody) of a client's funds, an administrator may require that a surety bond be posted, or may completely disallow custody.

Because of the rules governing investment advisers, many firms choose to have a broker-dealer hold client's funds,
while the investment adviser merely maintains discretionary authority over the accounts.

Discretionary (Managed) Accounts

A discretionary (managed) account allows a broker to buy and sell securities without the client's direct consent for each transaction.

There are two types of discretionary accounts:

Limited accounts merely allow an investment adviser or broker to place orders, but DO NOT provide any authority to withdraw money.

Full access accounts DO allow a broker or investment adviser access to the client's funds. This is analogous to an unlimited power of attorney.

In most situations, investment advisers ONLY have limited discretionary authority.