NASAA Series 63Ethical Practices and ObligationsMedium
An investment adviser representative (IAR) manages a client's portfolio and frequently receives research reports from a brokerage firm for free, in exchange for directing client trades to that firm. This arrangement is not disclosed to the client. This scenario primarily represents a violation of the IAR's duty to:
- APrevent selling away.
- BAvoid churning.
- CDisclose conflicts of interest.
- DMaintain client confidentiality.
Show answer & explanationAnswer & explanation
Correct answer: C. Disclose conflicts of interest.
Receiving free research in exchange for directing client trades (soft dollar arrangements) creates a potential conflict of interest. The IAR might be incentivized to direct trades to the firm providing the research, even if another firm offers better execution or lower costs, potentially not acting in the client's best interest. This conflict must be disclosed to the client.
Why the other options are wrong
- A. Selling away involves unauthorized transactions outside the firm, not soft dollar arrangements.
- B. Churning is excessive trading, which isn't explicitly described as the primary issue here, though it could be a consequence.
- D. Client confidentiality is about protecting client data, not about trade direction incentives.
Soft Dollar Disclosure
Investment advisers must disclose soft dollar arrangements (receiving research or other services from a broker in exchange for directing client commissions to that broker) to clients, as these arrangements can create a conflict of interest.
- Exchange of client commissions for research/services.
- Creates potential conflict of interest for the adviser.
- Must be fully disclosed to clients.
- Adviser must ensure commissions are reasonable for value received.
Memory trick: Transparent dealings, trusted feelings.