Series 63 Unethical Practices: Broker-Dealers and Agents Practice Questions
Question 1
An agent repeatedly buys and sells securities in an account over which the agent exercises control, generating commissions but little client benefit. What element is most relevant in evaluating churning?
- A. Whether the client's net worth is large enough to absorb losses from the trading without changing the client's standard of living.
- B. Whether the individual trades were executed through an electronic platform rather than by telephone with the representative.
- C. Whether the securities traded paid dividends during the period, since income-producing positions are exempt from excessive-trading analysis.
- D. Control, excessive activity relative to the client's objectives, and scienter or deceptive intent as applicable.
Show answer and explanation
Correct answer: D. Control, excessive activity relative to the client's objectives, and scienter or deceptive intent as applicable.
Churning requires control over the account, trading excessive in light of the client's objectives, and intent to benefit the representative through commissions.
- A. Client wealth does not make excessive trading acceptable.
- B. The execution method is irrelevant to whether trading is excessive.
- C. Dividend payment does not shield trading from a churning analysis.
- D. Control, excessiveness and deceptive intent are the core elements.
Question 2
A registered agent shares a portion of his commission on a securities transaction with a friend who referred the client but who is not registered as an agent. Is this arrangement permissible?
- A. Permissible, as long as the unregistered individual's share of the commission is less than 25%
- B. Permissible, as long as the arrangement is disclosed to the client in advance
- C. An unethical practice, because compensation for effecting securities transactions may not be shared with an unregistered person
- D. An unethical practice only if the unregistered individual resides outside the state where the transaction occurs
Show answer and explanation
Correct answer: C. An unethical practice, because compensation for effecting securities transactions may not be shared with an unregistered person
Sharing commissions or other transaction-based compensation with a person who is not registered as an agent is a dishonest and unethical business practice under the NASAA model rule. The prohibition is not scaled by the percentage shared, cured by client disclosure, or affected by the referring individual's state of residence; the defect is the unregistered person's receipt of transaction-based compensation at all.
- A. There's no percentage safe harbor — sharing any portion of transaction-based compensation with an unregistered person is prohibited outright.
- B. Disclosing the arrangement to the client doesn't cure the problem; the issue is that an unregistered person cannot receive compensation tied to effecting securities transactions.
- C. Sharing commissions with someone who isn't registered as an agent is an unethical practice because only registered persons may be compensated for effecting securities transactions.
- D. The unregistered friend's state of residence is irrelevant — the violation is sharing transaction-based compensation with an unregistered person, period.
Question 3
An agent tells a customer, 'Buy this stock now -- next quarter's dividend increase will push the price up before the ex-dividend date,' even though no such increase has been announced or approved by the issuer. This practice is best described as:
- A. 'Selling dividends' -- an unethical and fraudulent practice of using an unannounced or speculative future distribution as an inducement to purchase
- B. A legitimate technical-analysis-based recommendation
- C. Permitted, because the agent genuinely believes the increase is likely to occur
- D. Permitted only if the speculative nature of the statement is disclosed on the trade confirmation after the sale
Show answer and explanation
Correct answer: A. 'Selling dividends' -- an unethical and fraudulent practice of using an unannounced or speculative future distribution as an inducement to purchase
'Selling dividends' refers to inducing a purchase by emphasizing an upcoming (often unannounced, unconfirmed, or purely speculative) dividend or distribution, misleading the customer about the certainty of that benefit. It is a recognized unethical/fraudulent sales practice regardless of the agent's personal belief in the likelihood of the increase.
- A. Correct -- this is the textbook description of the 'selling dividends' unethical practice.
- B. Incorrect -- this isn't a technical analysis claim; it's a specific, false factual assertion about a company action that hasn't happened.
- C. Incorrect -- the agent's belief doesn't make an unconfirmed, unannounced claim into a true or permissible statement.
- D. Incorrect -- after-the-fact disclosure on a confirmation doesn't cure a misrepresentation made to induce the purchase.
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Explore careers at ParsonexQuestion 4
An agent sells $200,000 of promissory notes issued by a company owned by his brother-in-law to several of his brokerage clients, without providing prior written notice to, or receiving prior approval from, his broker-dealer. Three months later, after a client complains, the agent informs his branch manager about the sales for the first time. Does the after-the-fact disclosure cure the violation?
- A. No, selling away occurs at the time of the unauthorized, undisclosed sales; disclosing after the fact does not retroactively cure the violation, though it may be a mitigating factor
- B. Yes, disclosure to the firm at any point, including after the sales were made, remedies a selling-away violation by allowing the firm to ratify the transactions retroactively and avoid a regulatory sanction
- C. Yes, because the notes were sold to existing brokerage clients rather than to the general public, so the prior notice and approval requirement did not apply to the transactions
- D. No, because the client complaint triggered a regulatory inquiry; had the agent disclosed to the firm before any complaint, the earlier disclosure would have cured the violation
Show answer and explanation
Correct answer: A. No, selling away occurs at the time of the unauthorized, undisclosed sales; disclosing after the fact does not retroactively cure the violation, though it may be a mitigating factor
Selling away is defined by engaging in securities transactions outside the scope of one's employment without prior written notice to and approval from the broker-dealer; the violation is complete once the sales occur without that prior notice/approval. Coming forward later may be considered in any disciplinary response but does not undo the fact that unauthorized, unsupervised sales already took place — supervision exists precisely to catch problems before they harm clients, not after.
- A. Correct. Selling away occurs at the moment of the unauthorized, undisclosed sales; disclosing it after the fact doesn't cure the violation, though it may mitigate the resulting sanction.
- B. Disclosure at any later point doesn't retroactively cure a violation that already occurred at the time of the unauthorized sales, and firm ratification does not prevent regulatory sanction.
- C. Selling to existing brokerage clients rather than the general public doesn't exempt the transactions from the prior-notice requirement.
- D. The violation exists independent of any complaint or regulatory inquiry, and later disclosure — whenever made — cannot cure a sale that already occurred without prior notice and approval.