NASAA Series 65, Uniform Investment Adviser Law ExaminationLaws, Regulations, and Guidelines, including Prohibition on Unethical Business PracticesMedium
An investment adviser representative (IAR) with a fiduciary duty to clients discovers that a new, high-growth tech stock, "QuantumLeap Inc.", is about to be added to a major market index. This information is not yet public. The IAR buys 500 shares of QuantumLeap for their personal account before recommending it to clients. Which of the following best describes this IAR's action?
- AThis is acceptable as long as the IAR's personal purchase is small relative to the client recommendations.
- BThis is a conflict of interest, but not necessarily a prohibited practice if disclosed to clients beforehand.
- CThis constitutes front-running, a prohibited practice under the Uniform Securities Act.
- DThis is permissible if the IAR can demonstrate the personal purchase did not negatively impact client orders.
Show answer & explanationAnswer & explanation
Correct answer: C. This constitutes front-running, a prohibited practice under the Uniform Securities Act.
Front-running occurs when an investment professional uses material non-public information about an impending client transaction to trade for their own account ahead of the client. This is a clear breach of fiduciary duty and a prohibited practice.
Why the other options are wrong
- A. The size of the personal purchase does not negate the fact that the IAR traded on material non-public information before clients.
- B. While it is a conflict, front-running is a specific type of prohibited practice that cannot be cured by disclosure after the fact, especially when it involves trading on non-public information about an impending client transaction.
- D. The impact on client orders is secondary; the act of trading ahead of clients based on non-public information for personal gain is inherently prohibited.
Front-Running
The unethical and illegal practice of an investment professional using material non-public information about an impending client transaction to trade for their own account ahead of the client.
- Involves trading on advance knowledge of client orders.
- Done for personal gain.
- Breaches fiduciary duty.
- Prohibited under the Uniform Securities Act.
Memory trick: Fiduciaries Follow Rules, Front-Running Fails.