Stock Broker Ethics
Ultimately, the decision is yours. You decide how and when to invest your money in stocks. However, many people rely on the advice of their stock broker when they make decisions about which stocks to buy or sell. Is that reliance ill advised or do stock brokers have obligations to their clients?
While stock brokers are not typically responsible for any investment losses incurred by their clients, stock brokers do have ethical and professional responsibilities to their clients which, if honored, may minimize losses.
The National Association of Securities Dealers (NASD) Rule 2310 which is currently implemented by the Financial Industry Regulatory Authority (FINRA) requires the stock brokers and other financial professionals who work under its auspices to follow certain rules when they make recommendations to customers. Specifically, the rule requires a stock broker to make recommendations about buying or selling securities based on the stock broker’s “reasonable grounds for believing that the recommendation is suitable for the customer.” The rule requires that the stock broker take reasonable steps to base his or her recommendations on:
· The client’s financial status;
· The client’s tax status;
· The client’s investment objectives which may include the client’s time horizon for needing the money, the purpose for which the money will be used and the client’s risk tolerance; and
· Any other reasonable information as provided by the client or deemed important by the stock broker.
At a minimum, this rule requires stock brokers to understand their clients’ current financial circumstances and future financial objectives. Therefore, potential investors should be cautious about any stock broker or other financial professional who calls and advises them to buy or sell a certain stock prior to understanding their financial situation and investment goals. What might be a good investment for some clients may be a bad investment for other clients. Therefore, stock brokers must get to know their clients before advising them on what to buy or sell.
The Due Diligence Rule
The New York Stock Exchange (NYSE) has a similar rule to the NASD rule described above. Stock brokers who are recommending that a client buy or sell a security that is traded on the New York Stock Exchange must comply with NYSE Rule 405. Rule 405 requires stock brokers to “use due diligence to learn the essential facts relative to every customer, every order….”
Rule 405 does not explain when is “essential”, however other guidance from the New York Stock Exchange suggests that information such as age, financial status and investment objectives are essential pieces of information.
Some stock brokers are paid a commission for every product that they sell. The commissions vary from product to product and can create a conflict of interest between the stock broker’s own interests and those of the client.
Therefore, it is important to make sure that your investment advisor or stock broker understands your financial status and investment objectives and tries to further your objectives every single time a transaction is made on your behalf. Otherwise, you may be making unwise investments and your stock broker may be violating important ethical rules.
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