NASAA Series 65, Uniform Investment Adviser Law ExaminationLaws, Regulations, and Guidelines, including Prohibition on Unethical Business PracticesHard
An investment adviser representative (IAR) is engaged in a practice known as 'cherry-picking,' where profitable trades are allocated to the IAR's personal account and unprofitable trades are allocated to client accounts. This practice is a clear violation of which of the following principles?
- AThe duty of loyalty.
- BThe principle of suitability.
- CThe duty of best execution.
- DThe prudent man rule.
Show answer & explanationAnswer & explanation
Correct answer: A. The duty of loyalty.
Cherry-picking is a blatant violation of an IAR's duty of loyalty, which requires placing the client's interests before one's own. By allocating profitable trades to personal accounts and unprofitable ones to client accounts, the IAR is directly benefiting at the expense of the client.
Why the other options are wrong
- B. Suitability concerns whether an investment is appropriate for a client's profile, not the fairness of trade allocation.
- C. Best execution refers to achieving the most favorable terms for client trades, not the allocation of profitable vs. unprofitable trades.
- D. The prudent man rule relates to the standard of care in managing investments, not necessarily allocation fairness.
Duty of Loyalty - Cherry-Picking
The duty of loyalty requires an IAR to always act in the client's best interest and avoid conflicts of interest. 'Cherry-picking,' where an IAR allocates profitable trades to their own account and unprofitable trades to client accounts, is a direct violation of this duty.
- Core fiduciary principle.
- Requires placing client interests above personal interests.
- Prohibits self-dealing and undisclosed conflicts.
- Cherry-picking is a severe breach of this duty.
Memory trick: Conflicts of Interest: Loyalty's Rule, No Self-Serving Fool!