NASAA Series 63Ethical Practices and ObligationsMedium
An investment adviser representative (IAR) manages a client's discretionary account. Over the past year, the IAR has executed numerous trades in the account, generating substantial commissions for the firm but resulting in only marginal gains for the client, and in some cases, net losses after accounting for transaction costs. The client's investment objectives are long-term growth with moderate risk. This activity raises concerns about which unethical practice?
- ASelling away.
- BChurning.
- CCommingling of funds.
- DMarket manipulation.
Show answer & explanationAnswer & explanation
Correct answer: B. Churning.
The description of excessive trading that generates high commissions for the firm but results in marginal or negative returns for the client, contrary to their long-term growth objective, is a clear indication of churning.
Why the other options are wrong
- A. Selling away involves transactions outside the scope of the firm, not excessive trading within the account.
- C. Commingling is mixing client funds with an agent's own funds, which is not described here.
- D. Market manipulation involves artificially influencing security prices, not excessive trading within a single account.
Churning
The unethical practice of an agent or IAR engaging in excessive trading in a client's account primarily to generate commissions, without regard for the client's investment objectives or financial benefit.
- Involves discretionary accounts.
- Focus is on generating commissions, not client returns.
- Often results in high transaction costs and poor client performance.
- Violates suitability and fiduciary duties.
Memory trick: Turn and churn, clients burn.