Prohibited Business Practices: Churning, Commingling & Borrowing
Reviews major unethical practices including churning (quantitative suitability), commingling funds, borrowing from clients, and guaranteeing against loss.
- Churning: Inducing trading excessive in size or frequency to generate commissions in disregard of client objectives.
- Commingling: Unlawfully mixing client funds or securities with personal or firm funds; client assets must be strictly segregated.
- Borrowing from or lending to clients is prohibited UNLESS the client is a financial lending institution (e.g. a bank).
- Guaranteeing customers against loss or promising specific returns is strictly prohibited under all circumstances.
Under Section 101 and the NASAA Statement of Policy on Dishonest or Unethical Business Practices, certain activities are strictly prohibited:
1. Churning: Inducing excessive trading in a customer's account in light of the client's financial resources and investment objectives. Churning breaches quantitative suitability and constitutes fraud.
2. Commingling: Failing to segregate customer securities and funds from firm assets or depositing client money into an agent's personal account. Customer assets must be held in designated safekeeping.
3. Borrowing and Lending: An agent or broker-dealer may not borrow money or securities from a client, nor lend to a client, unless the client is a financial institution engaged in the business of lending funds (e.g. a bank).
4. Guaranteeing Against Loss: Promising a customer that a security will achieve a specific return or agreeing to absorb losses if a security declines in value is an illegal sales practice.
5. Sharing Commissions: Dividing securities transaction commissions with unregistered individuals is strictly prohibited. Commissions may only be split between registered agents of the same or affiliated broker-dealer.
- Borrowing money from a wealthy client who is a longtime friend is ILLEGAL under state law unless the client is a financial institution.
- Personal buyback promises ('I will buy the stock back if it drops') are illegal guarantees against loss.
An agent has full discretionary authority over an elderly widow's brokerage account. The client's sole stated investment objective is capital preservation and income. Over a four-month period, the agent executes 120 purchases and sales of growth stocks and high-yield corporate bonds, generating $14,000 in commissions while the account loses 12% in value. What prohibited and unethical practice has the agent committed?