Standards of care and Code of Ethics

What "best interest" actually means

"Best interest of the client" sounds like one idea. It's three — the phrase appears in three different regulatory regimes that apply to different professionals at different moments, and the Series 63 expects you to keep them surgically distinct.

An investment adviser owes a fiduciary duty — the highest standard, and the one with no off switch. It is continuous, not point-of-sale. It survives the recommendation. It requires not just acting in the client's best interest but proving it: disclosure of all material conflicts, full transparency of compensation, and loyalty that places the client's interests ahead of the firm's.

A broker-dealer agent is subject to Regulation Best Interest (Reg BI) under SEC Rule 15l-1. Reg BI attaches at the time of recommendation — not before, not after — and requires the agent to act in the customer's best interest without placing the firm's financial interests ahead of the customer's. It runs on four named obligations: Care, Disclosure (including Form CRS), Conflict of Interest, and Compliance.

FINRA Rule 2111 is the suitability standard for recommendations outside Reg BI's scope; it does not apply to recommendations subject to Reg BI — a recommendation must fit the customer's profile. Rule 2111 does not apply to a recommendation subject to Reg BI — for a covered retail recommendation, analyze the broker-dealer's conduct under Reg BI, not as a layer on top of suitability. Know suitability's three components cold, because they resurface all over this module: reasonable-basis (the product works for someone), customer-specific (it fits this customer), and quantitative (the pattern of recommendations is appropriate).

Compensation

• Fees: Assets under management (AUM) fees, flat fees, hourly fees. Must be fully disclosed.
• Commissions: Transaction-based compensation. Creates potential conflict of interest (incentive to trade more).
• Performance-based fees: Only permitted with qualified clients (generally $1.1M+ AUM or $2.2M+ net worth; rising to $1.4M / $2.7M for advisory contracts entered on or after June 29, 2026 under the SEC Rule 205-3 inflation adjustment). The qualified-client and fulcrum-fee methods are separate performance-fee pathways — a qualified-client contract need not use a fulcrum fee.
• Soft dollars: Using client commissions to pay for research and services. Permitted under Section 28(e) safe harbor if used for eligible research that benefits clients.
• All compensation must be disclosed to clients

Compensation and the duty to disclose it

Follow the money — the exam does. How an adviser or agent is paid is itself a conflict of interest, and the duty to disclose compensation is one of the most heavily tested topics in this chapter.

• AUM, flat, and hourly fees — the standard adviser compensation models. All must be disclosed in Form ADV Part 2A (the brochure) and in the advisory contract.
• Commissions — transaction-based compensation creates an incentive to recommend more trades. The Reg BI Care Obligation requires BDs to consider whether commission-based recommendations remain in the customer's best interest.
• Performance-based fees — permitted only with qualified clients: $1.1M+ AUM with the adviser or $2.2M+ net worth (rising to $1.4M / $2.7M for advisory contracts entered on or after June 29, 2026 under the SEC Rule 205-3 inflation adjustment). The NASAA Performance-Based Compensation Exemption Model Rule 102(f)-3 mirrors the federal threshold.
• Referral fees and solicitor arrangements — permitted with written disclosure under SEC Rule 206(4)-3 (the Cash Solicitation Rule) and equivalent NASAA rules. The conflict must be disclosed before the client engages, not after.
• Markups, markdowns, and commissions — governed by FINRA Rule 2121 (Fair Prices and Commissions). Compensation must be fair and reasonable considering the type of security, availability in the market, price, the amount of money involved, the firm's overall pattern of charges, and disclosure to the customer. The historical 5% guideline is a starting reference, not a safe harbor. The rule applies whether the firm acts as principal (markup/markdown) or agent (commission), and excessive markups are a violation regardless of how the charge is labeled.

Conflicts of Interest and Prohibited Activities

• Loans to/from clients: Advisers should not borrow from or lend to clients
• Sharing in profits/losses: Generally prohibited unless the adviser contributes proportionally
• Client confidentiality: Must protect non-public personal information (Regulation S-P)
• Insider trading: Strictly prohibited. Trading on material non-public information (MNPI) violates Section 10b-5
• Selling away: Engaging in securities transactions outside the scope of employment with the firm — prohibited
• Market manipulation: Any scheme to artificially influence the price of a security
• Personal securities transactions: Must be reported and monitored. Access persons must submit holdings and transaction reports.
• Outside securities accounts: Must be disclosed and approved
• Political contributions (pay-to-play): Restrictions under SEC Rule 206(4)-5 to prevent advisers from winning government contracts through political donations

Conflicts of interest — the framework

Here's the honest premise the rules are built on: a fiduciary cannot eliminate every conflict of interest. What the law demands instead is a discipline — identify, mitigate, and disclose each one. The Series 63 tests two lists: the conduct no disclosure can cure, and the conduct disclosure makes permissible.

Prohibitions (no disclosure cures these):

• Borrowing from or lending to clients (outside approved channels — e.g., margin from the firm's clearing broker)
• Sharing in profits and losses of a client's account (limited exception for proportional contributions in joint accounts)
• Trading on or tipping material nonpublic information (insider trading)
• Misappropriating client assets

Permitted with full written disclosure:

• Soft dollar arrangements within the Section 28(e) safe harbor
• Principal trades by an adviser (with prior written client consent per trade under SEC Rule 206(3))
• Agency cross transactions (NASAA Model Rule 102(f)-1 — covered in Section 3)
• Outside business activities and outside brokerage accounts (notice to firm)

One more name to recognize: the Uniform Prudent Investor Act, adopted by most states, supplies the background standard for trustees and advisers managing client assets — diversify, balance risk and return, consider beneficiary circumstances, delegate prudently. The Series 63 doesn't require every UPIA provision, but it does expect the central premise on sight: prudence is evaluated at the portfolio level, not investment-by-investment.

Pay-to-play — SEC Rule 206(4)-5 and MSRB Rule G-37

Winning government business with campaign checks is its own regulated hazard. The pay-to-play rules restrict political contributions by financial professionals who solicit business from government entities — two parallel regimes, and the Series 63 tests both by their numbers.

SEC Rule 206(4)-5 (investment advisers): an adviser that makes a political contribution to an official with influence over advisory contracts must wait 2 years before receiving compensation from that government entity. De minimis exceptions: $350 per election for officials the contributor can vote for; $150 for those they cannot.

MSRB Rule G-37 (municipal securities professionals): substantively similar — a 2-year ban on municipal securities business with an issuer following a triggering political contribution by a covered associate, with parallel de minimis thresholds ($250 per election for officials the contributor can vote for, $0 otherwise).

Three traps to internalize: both rules apply to the firm, not just the individual — one covered associate's check can bench the entire firm. Both require ongoing record-keeping of covered contributions even when no government business is being sought. And refunding the contribution does not cure the violation once it's discovered — there's no undo button on a triggered time-out.

Code of Ethics — SEC Rule 204A-1

Every registered investment adviser must adopt, distribute, and enforce a written Code of Ethics under SEC Rule 204A-1. The Code polices the personal securities trading of supervised persons — and, more strictly, access persons, the supervised persons with access to nonpublic information about client transactions or recommendations. The Series 63 cares most about the paperwork rhythm.

Three reporting clocks, tested directly:

• Initial holdings report — due within 10 days of becoming an access person, with data current within 45 days.
• Quarterly transaction reports — due within 30 days of each quarter-end, listing every reportable personal securities transaction.
• Annual holdings report — due at least once per 12-month period, again with data current within 45 days.

Pre-clearance is required for IPOs and limited offerings (private placements) — not for routine trading in publicly available securities. The Code must also require prompt internal reporting of violations to the chief compliance officer and must prohibit fraud against clients in any personal trading activity. And note the meta-rule: failing to maintain or enforce an effective Code of Ethics is itself a violation, independent of any underlying trading misconduct. The paperwork failure is the offense.