According to its website, the Financial Industry Regulatory Authority, Inc. better known as FINRA, serves as “the largest independent regulator for all securities firms doing business in the United States.” FINRA’s primary role is investor protection through ensuring fairness in the capital markets. FINRA’s Rules of Fair Practice, also referred to as the Rules of Conduct, regulate how brokers, dealers and other security industry personnel interact with the investing public.
FINRA grew from a set of regulations originated by the National Association Of Securities Dealers, Inc., or NASD. To better fulfill its purpose FINRA separated from NASD to become a self-regulating body that enforces its guidelines among the NASD’s stockbroker members. According to its website, FINRA presides over the brokerage industry which includes 4,275 brokerage firms and 630,650 stockbrokers. [FINRA website, About Us page]
Rules of Fair Practice
FINRA enacted the Rules of Fair Practice to provide specific guidelines to stockbrokers as to how to comply with its mission of protecting investors and maintaining market integrity. These rules exist alongside any legal requirements mandated by securities laws and seek to promote ethical, not just legal, compliance. The Rules of Fair Practice requires brokers and dealers to act fairly and equitably when dealing with customers. The rules specify prohibited actions, disclosure obligations and loyalty behaviors.
FINRA champions loyalty and fair dealing through its Rules of Fair Practice by placing restrictions on brokers acting as transfer or paying agents or as trustees. These restrictions limit a broker from using information garnered from the seller to solicit sales except when specifically requested. The Rules prohibit several actions deemed unethical by FINRA, for example, churning, which involves an excessive volume or frequency of transactions solely to generate commissions for the broker.
In addition to churning, the Rules of Fair Practice prohibit fraudulent acts and deceptive practices including trading ahead. These rules also ban unauthorized trading, which involves trading without the customer’s knowledge. Brokers cannot sell dividends, misrepresent products, omit facts that could impact a client’s decision or make blanket recommendations. Brokers cannot recommend options, derivatives and other high risk securities unless they first confirm a customer can afford the consequences of a loss. The rules also prohibit brokers and dealers from guaranteeing performance, engaging in short-term mutual fund trading or personally borrowing from or lending money to a client.
Brokers and dealers who violate the Rules of Fair Practice can suffer serious consequences as a result of their actions. Sanctions include penalties and fines, public censure of the broker’s behavior or restriction of activities the dealer can engage in for a period of time. More serious sanctions include NASD membership suspension or revocation. FINRA’s board of governors can also bar a member from associating with other members.
- Securities and Exchange Commission: Release No. 34-60850; File No. SR-FINRA-2009-067 [http://www.sec.gov/rules/sro/finra/2009/34-60850.pdf]
- 360training: Understanding the Rules of FINRA [http://icourseplayer.360training.com/courses/course1789/pdf/Rules%20of%20FINRA_PDF.pdf]
- FINRA: Investor Protection. Market Integrity. [http://www.finra.org/]