Section 4
Function 4: Transaction Processing and Compliance
Prohibited practices, regulatory compliance, and dispute resolution
47 min read
· Lesson 4 of 4
About This Lesson
The last chapter is the rulebook's sharp edge: the practices that end careers, the forms that follow you between firms, and the forum where disputes get settled. The exam treats this material as free points if you memorized the numbers, $500,000 SIPC, 30 days for a U5, 6 years for arbitration eligibility, and as a minefield for everyone else.
What you'll cover
- prohibited practices: manipulation, insider trading and its penalty structure, OBA versus selling away, and the absolute ban on guarantees
- SIPC coverage and its limits, plus Form U4 and Form U5 mechanics
- dispute resolution: arbitration versus mediation, the six-year window, predispute clauses, and the process flow
This is the thirtieth and final chapter of the course. Finish it, run the practice exams, and the Series 7 is yours to take.
In this chapter
47 min · 13 concept checks
Section 1 of 3
~12 min · 3 concept checks
Prohibited Practices & Conduct Violations
Prohibited Practices: What Registered Reps Cannot Do
FINRA rules and securities law define a set of practices that are explicitly prohibited regardless of customer consent. The exam presents scenarios and asks whether conduct is permitted — know these cold.
Churning
Excessive trading in a customer's account primarily to generate commissions rather than to benefit the customer. Violates FINRA Rule 2111 quantitative suitability. In discretionary accounts, even individually suitable trades can constitute churning if frequency is excessive.
Unauthorized trading
Entering trades in a customer's account without the customer's prior authorization. This includes discretionary trades without a written discretionary agreement on file. Even if the trade is profitable, it is unauthorized trading.
Front-running
Trading a security in a personal account ahead of a large customer order that the rep knows will move the market. Uses material non-public information about the pending order. Violates FINRA rules and anti-fraud provisions.
Commingling
Mixing customer securities or funds with the firm's own assets. Customer assets must be segregated at all times. This protects customers in the event of firm insolvency.
Insider trading
Trading on material, non-public information (MNPI) or tipping others who then trade. MNPI = information that would likely affect an investor's decision to buy or sell, not yet available to the general public. Both tipper and tippee may be liable.
Selling away
Conducting securities business outside of the employing firm without the firm's written approval. Even if the outside investment is legitimate, failure to notify and receive approval from the firm is a violation.
Misrepresentation
Making false or misleading statements about a security, including omissions of material facts. Guaranteeing returns is a specific form of misrepresentation — all investments carry risk and no returns can be guaranteed.
Market manipulation
Artificially inflating or depressing a security's price through wash trades (buying and selling the same security to create false volume), matched orders, or spreading false rumors. Violates SEC Rule 10b-5.
Insider Trading: The Legal Framework
Insider trading runs on SEC Rule 10b-5 and the Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA), and the exam tests the framework in pieces:
Who counts as an insider? Officers, directors, and 10%+ shareholders are the traditional list, but liability reaches anyone holding MNPI through a relationship of trust or confidence, the "temporary insiders": attorneys, accountants, investment bankers, and anyone tipped by a true insider.
Civil penalties: up to 3 times the profit gained or loss avoided (treble damages), plus disgorgement of profits.
Criminal penalties: up to 20 years imprisonment and $5 million in fines for individuals; up to $25 million for firms.
Section 20A: investors who traded contemporaneously with the insider get a private right of action; they can sue for damages.
Chinese wall (information barrier): the required separation between investment banking, which may hold MNPI, and the trading and research desks that could misuse it.
Outside Business Activities (OBA) and Private Securities Transactions
Two disclosure regimes govern what a registered person does outside the firm, and the exam tests whether you know the line between them:
Outside business activities (FINRA Rule 3270): any outside employment or third-party compensation gets disclosed to the firm in writing, and the firm may limit or prohibit the activity.
Private securities transactions (FINRA Rule 3280, "selling away"): any securities transaction outside the regular course of employment needs written approval before participating. A legitimate investment without the disclosure-and-approval step is still a violation.
The line: a non-securities OBA (teaching a class, working a restaurant shift) requires disclosure; anything touching securities compensation requires the full Rule 3280 treatment.
Two disclosure regimes govern what a registered person does outside the firm, and the exam tests whether you know the line between them:
Outside business activities (FINRA Rule 3270): any outside employment or third-party compensation gets disclosed to the firm in writing, and the firm may limit or prohibit the activity.
Private securities transactions (FINRA Rule 3280, "selling away"): any securities transaction outside the regular course of employment needs written approval before participating. A legitimate investment without the disclosure-and-approval step is still a violation.
The line: a non-securities OBA (teaching a class, working a restaurant shift) requires disclosure; anything touching securities compensation requires the full Rule 3280 treatment.
Guarantees Are Always Wrong
The most direct prohibition in the chapter: a registered representative may never guarantee a customer against loss or promise a specific return. No exception survives, even if:
• the customer requests the guarantee in writing
• the rep is confident in the recommendation
• the guarantee is informal or verbal
• the rep personally reimburses the customer for a loss
Guarantees misrepresent investment risk, create a conflict of interest, and violate FINRA Rule 2150. When a question asks you whether a rep can promise a minimum return or make a customer whole for a loss, the answer is always no.
The most direct prohibition in the chapter: a registered representative may never guarantee a customer against loss or promise a specific return. No exception survives, even if:
• the customer requests the guarantee in writing
• the rep is confident in the recommendation
• the guarantee is informal or verbal
• the rep personally reimburses the customer for a loss
Guarantees misrepresent investment risk, create a conflict of interest, and violate FINRA Rule 2150. When a question asks you whether a rep can promise a minimum return or make a customer whole for a loss, the answer is always no.
🏛️
You Are The Compliance Officer
Four situations land on your desk. Identify the violation and the applicable rule in each case.
Progress:
Case File 1 — The Gift
A registered representative at your firm plays golf with the portfolio manager of a large pension fund that directs significant brokerage business to you. At the end of the round, the rep hands the PM a $400 gift card to a luxury restaurant "to thank him for the relationship." The rep reports the gift accurately on their quarterly gifts and entertainment log.
What action should you take as compliance officer?
✓ Correct. FINRA Rule 3220 limits gifts to $300 per person per year. Disclosure does not cure the violation — the cap is absolute, not a disclosure threshold. A $400 gift exceeds the limit by $100 regardless of reporting. The rep must return the excess value (or have it applied as a credit) and should receive a formal written reminder of the policy. This is not a criminal matter, but it is a reportable FINRA rule violation that must be addressed.
✗ Disclosure does not cure a Rule 3220 violation. The $300 per person per year limit is absolute — exceeding it is a violation regardless of how accurately it was reported. The excess must be addressed (returned, credited, or otherwise remedied). The rep needs formal counseling and documentation. Escalation to FINRA is appropriate for material or repeated violations, but a single first-time overage is typically handled internally first.
Case File 2 — Outside Business Activity
You receive a tip that one of your brokers has been conducting financial planning seminars on weekends, charging attendees $500 for personalized investment advice. The broker never notified the firm. The advice given at these seminars is unrelated to any securities transactions executed at your firm — no orders were placed through the firm as a result.
Which FINRA rule is at issue, and how should you classify this activity?
✓ Correct. The key distinction: OBA (Rule 3270) covers non-securities outside activities (working at a restaurant, teaching a fitness class). Selling Away (Rule 3280) applies when a registered person participates in securities transactions outside the firm — and providing compensated investment advice is a securities activity. Since the broker is receiving compensation for investment advice without the firm's knowledge or approval, this is a Rule 3280 violation requiring written notice (and potentially written permission since compensation is involved). The firm must conduct an investigation and determine whether to allow, restrict, or terminate the activity.
✗ The critical distinction: OBA (Rule 3270) covers non-securities outside work. When the outside activity involves securities activities — like investment advice — it falls under Selling Away (Rule 3280) instead. Compensated investment advice is a securities activity even without order execution. Rule 3280 requires prior written notice; if compensation is received, it also requires prior written approval. This is more serious than a simple OBA disclosure issue.
Case File 3 — The Guarantee
A rep's client is nervous about a volatile market. To reassure her, the rep says: "I personally guarantee this portfolio won't lose more than 5% this year. If it does, I'll make up the difference myself." The client agrees to keep the funds invested based on this assurance. The rep did not share this arrangement in writing with the firm.
How do you classify this situation and what must happen?
✓ Correct. FINRA Rule 2150 (improper use of customer funds and securities) and general antifraud provisions make guarantees against loss absolutely prohibited — no exceptions. A representative cannot guarantee a customer against loss, promise a specific return, or personally agree to make up losses. This applies even if: the rep is wealthy enough to honor it, the customer requested it, the guarantee is in writing, or the firm is informed. The rep must be instructed to immediately retract the statement to the client, and the client must understand no guarantee exists. Disciplinary action is warranted.
✗ Guarantees against loss are unconditionally prohibited under FINRA rules. No disclosure, no wealth threshold, no written agreement makes this permissible. The prohibition is absolute. The rep must retract the guarantee immediately (with compliance oversight), and the client must be informed that no guarantee exists. This is a serious violation requiring formal disciplinary review regardless of whether any loss actually occurred.
Case File 4 — The Recommendation
A broker calls 40 clients in a single afternoon to recommend purchasing shares of a micro-cap biotech stock. He tells each client: "This is a sure thing — phase 3 trials look great based on what I've been hearing." Three clients ask where he got this information. He says he has a "contact at the company." The clients purchase $280,000 in total. The stock rises 60% before the FDA announcement.
What is the primary regulatory concern?
✓ Correct. "Phase 3 trials look great based on what I've been hearing" from "a contact at the company" is a textbook description of trading on material non-public information (MNPI) — insider trading. Section 10(b) of the Exchange Act and Rule 10b-5 prohibit trading on MNPI obtained through a breach of fiduciary duty. Both the tipper (the company contact) and the tippee (the broker and his clients) face liability. Civil penalties: up to three times the profit gained or loss avoided (treble damages). Criminal penalties: up to $5 million and 20 years imprisonment. The firm must immediately halt trading, notify legal counsel, and preserve all communications. A SAR filing may be required.
✗ The phrase "phase 3 trials look great based on what I've been hearing" from "a contact at the company" describes insider trading — trading on material non-public information. This is the primary concern, and it is far more serious than the other issues present (though "sure thing" is also a prohibited guarantee). Both the broker and the clients who traded on the MNPI face civil and criminal liability under Section 10(b) and Rule 10b-5. Treble damages and up to 20 years imprisonment apply. This is an emergency escalation to legal and senior compliance leadership.
Concept Check
A registered representative enters several trades in a discretionary account over three months, each of which is individually suitable for the customer's profile. However, the cumulative trading activity is far in excess of what is consistent with the customer's investment objectives. Which prohibited practice has most likely occurred?
Churning is defined as excessive trading in a customer's account, primarily to generate commissions. The key insight is that individual trade suitability does not prevent a churning violation — the overall pattern of trading must be consistent with the customer's investment objectives and profile. In a discretionary account, the rep has greater responsibility because the customer relies on the rep's judgment entirely. Churning violates FINRA Rule 2111 (quantitative suitability) and Rule 2010 (standards of commercial honor).
Concept Check
A registered representative learns from a friend who works at a pharmaceutical company that the company's new drug just failed FDA approval — information that has not yet been publicly announced. The rep tells a customer to sell the stock immediately. This situation most directly involves:
This is insider trading. Material, non-public information (MNPI) is information that: (1) is not yet available to the general public, and (2) would likely influence an investor's decision to buy or sell. A failed FDA approval is clearly material and non-public. Both the tipper (the pharmaceutical employee) and the tippee (the rep) and the customer who acts on the tip can face liability. The rep does not need to trade personally to violate insider trading rules — passing the information to a customer who trades is also a violation.
Concept Check
A registered representative at Firm A learns that a friend is forming a startup and needs investors. Without informing Firm A, the rep raises $500,000 from several clients by selling them unregistered interests in the startup. Which violations have most likely occurred?
This fact pattern involves two violations. First, selling away (FINRA Rule 3280) — conducting private securities transactions outside the employing firm without prior written approval. Second, selling unregistered securities to investors who may not qualify for exemptions under Reg D — which has strict rules on accredited investors and prohibits general solicitation. The rep's personal relationship with the startup founder does not create an exemption from securities laws.
Section 2 of 3
~10 min · 4 concept checks
SIPC & Registration (Form U4/U5)
SIPC and Customer Protection
The Securities Investor Protection Corporation (SIPC) protects customers of failed broker-dealers, against the firm's insolvency, never against the market:
- Coverage limit: Up to $500,000 per customer, of which no more than $250,000 may be cash. Securities are covered at market value.
- What SIPC covers: Securities and cash held at the broker-dealer in the customer's account. Covers losses arising from broker-dealer insolvency only.
- What SIPC does NOT cover: Investment losses from market declines, fraud by the broker (only insolvency), commodity futures, fixed annuity contracts, or currency.
- Separate coverage: Each separate account type (individual, joint, IRA) is covered separately by SIPC — an investor with $500,000 in an individual account and $500,000 in an IRA at the same firm gets full SIPC coverage on both.
SIPC vs. FDIC: SIPC covers securities
customers of failed broker-dealers ($500,000 limit). FDIC covers bank deposit customers
($250,000 per depositor per institution). These are separate programs covering
separate industries. Money market mutual fund shares held at a broker-dealer are
covered by SIPC, not FDIC.
Form U4 and Form U5: Registration and Termination
Form U4: Uniform Application for Securities Industry Registration
Form U4 opens a registered career; the form captures the background FINRA and the firm use to judge fitness for the industry:
Required disclosures on Form U4:
• Personal information (name, date of birth, address)
• Residency for the previous 5 years
• Employment history for the previous 10 years
• Educational background
• Disciplinary history (criminal, civil, regulatory)
• Customer complaints
• Bankruptcy filings within the previous 10 years
• Liens, judgments, and other financial events
• Personal information (name, date of birth, address)
• Residency for the previous 5 years
• Employment history for the previous 10 years
• Educational background
• Disciplinary history (criminal, civil, regulatory)
• Customer complaints
• Bankruptcy filings within the previous 10 years
• Liens, judgments, and other financial events
5-year residency vs 10-year
employment: The two periods are different. Residency goes back
5 years; employment history goes back 10 years. The member firm must
verify the applicant’s representations on Form U4 before the
individual is permitted to engage in registered activity.
Form U5: Uniform Termination Notice
Form U5 closes the chapter at a firm, filed within 30 days of termination, and it carries:
- Reason for termination (voluntary, involuntary, deceased)
- Whether the termination was for cause (regulatory or compliance violation)
- Any open customer complaints, regulatory matters, or pending investigations at termination
- Updated information that occurred since the last U4 amendment
The departing rep receives a copy, and disagreements over the firm's stated reason are a steady source of disputes.
Concept Check
SIPC coverage protects a customer's account at a broker-dealer that becomes insolvent. What is the maximum SIPC coverage per customer for cash?
SIPC covers up to $500,000 per customer at a failed broker-dealer, of which no more than $250,000 may be cash. Securities are covered at market value up to the $500,000 total limit. This protects against broker-dealer insolvency only — not investment losses from market declines. Different account types (individual, joint, IRA) are each covered separately. SIPC does not protect commodity futures, currencies, or fixed annuities.
Concept Check
An applicant for registration as a registered representative of a FINRA member firm must disclose extensive personal background information. The member firm is responsible for verifying which specific aspect of the applicant’s recent personal history?
Form U4 requires disclosure of the applicant’s previous 5 years of residency. The member firm is responsible for verifying this representation as part of its hiring and registration due diligence. Note that employment history disclosure on Form U4 covers a different period — 10 years rather than 5. The two windows are often confused on the exam. Residency is shorter (5 years) and employment is longer (10 years). The 3-year residency and 3-year employment distractors understate both required disclosure periods. Member firm verification of these representations is mandatory before registration becomes effective.
Concept Check
When completing Form U4 to register as an associated person of a FINRA member broker-dealer firm, which of the following items must be disclosed by the applicant during the registration filing?
Form U4 requires residency disclosure for the previous 5 years. Employment history requires the previous 10 years — a different and longer period. The two windows are commonly confused; candidates should remember that residency (5 years) is shorter than employment (10 years). Three-year periods do not match either Form U4 disclosure requirement. The five-year employment distractor understates the actual employment disclosure period. The longer employment window allows FINRA and the firm to identify compliance, regulatory, or termination issues from the applicant’s extended professional history.
Concept Check
A registered representative leaves a FINRA member firm. Under FINRA rules, the member firm must file Form U5 within what time period after the representative’s termination from the firm?
Form U5 must be filed by the member firm within 30 days of the representative’s termination. The 30-day window allows the firm to gather necessary information about the termination reason, any open complaints or regulatory matters, and other disclosures required on the form. The terminated representative receives a copy of the U5 from the former firm and may dispute statements characterized in ways the representative believes are inaccurate. 10-day and 15-day distractors understate the filing window. The 60-day distractor overstates it. The 30-day filing requirement applies regardless of the reason for termination.
Section 3 of 3
~14 min · 6 concept checks
Dispute Resolution: Arbitration & Mediation
Dispute Resolution: Arbitration and Mediation
FINRA runs the largest securities dispute forum in the country, and most customer agreements point disputes there instead of court. This block is the working summary; the next two go deep on the comparison and the procedure.
Arbitration
- Customer arbitration: Customers may always bring claims against broker-dealers in FINRA arbitration. They are not required to arbitrate but may choose to. Customer arbitration agreements are generally valid and enforceable.
- Industry arbitration: Disputes between registered persons and member firms, or between member firms, must be arbitrated (mandatory).
- Panel size: Claims ≤ $100,000: one arbitrator. Claims > $100,000: three arbitrators (unless parties agree to one).
- Time limit (statute of limitations): Claims must be filed within 6 years of the event giving rise to the dispute.
- Finality: Arbitration awards are final and binding; very limited grounds for appeal (fraud, evident partiality, or arbitrator misconduct).
Mediation
Mediation is the voluntary cousin: a neutral mediator helps the parties find a settlement, either side can walk away at any time, and nothing binds unless they agree.
Arbitration vs Mediation: FINRA Dispute Resolution
The exam tests the arbitration-mediation line with precision, and the table holds every tested distinction:
| Feature | Arbitration | Mediation |
|---|---|---|
| Mandatory or voluntary? | Mandatory for industry disputes (member-vs-member, member-vs-RR). Mandatory for customer disputes if a predispute agreement exists. | Voluntary for both parties. Either party can decline. |
| Binding decision? | Always binding. Arbitration results in a final award. | Not binding unless the parties agree to a settlement during mediation. |
| Decision authority | Arbitrator(s) issue an award. | Mediator facilitates negotiation; parties decide whether to settle. |
| If unsuccessful? | Award is final (subject to limited appeal grounds). | Dispute may proceed to arbitration if no settlement is reached. |
Mediator cannot be
arbitrator in same dispute. If mediation does not resolve the
matter and the dispute moves to arbitration, the mediator who heard
confidential settlement positions cannot serve as the arbitrator. The
mediator’s neutrality could be compromised by exposure to the
parties’ settlement strategies.
Common Sequencing Misconception
One misconception to clear: mediation does NOT automatically come first. Parties may mediate first or go straight to arbitration; arbitration is mandatory for many disputes, mediation never is, and the two run independently.
Code of Arbitration: Eligibility and Procedure
The Six-Year Eligibility Window
Under FINRA’s Code of Arbitration Procedure, a claim is no longer
eligible for arbitration once 6 years have elapsed from the
occurrence or event giving rise to the claim. The six-year
window is a procedural eligibility cutoff, separate from but related
to substantive statutes of limitations under state or federal law.
Customer complaints arising more than six years after the underlying events cannot be brought in FINRA arbitration. Any state-law statute of limitations may also apply and could be shorter than six years depending on the jurisdiction and claim type.
Customer complaints arising more than six years after the underlying events cannot be brought in FINRA arbitration. Any state-law statute of limitations may also apply and could be shorter than six years depending on the jurisdiction and claim type.
Predispute Arbitration Agreement
Most customer account agreements carry a predispute arbitration clause sending disputes to FINRA instead of court, and the clause comes with its own rules:
- The agreement must be highlighted and the customer must acknowledge it.
- The customer must receive a copy of the predispute agreement at account opening.
- If a customer requests to see the predispute arbitration agreement she has signed, the member firm must supply a copy within 10 business days of the request.
- Class actions are typically excluded from arbitration; customers may pursue class claims in court despite the predispute clause.
Arbitration Process Flow
- Claimant files a Statement of Claim with FINRA Dispute Resolution Services and pays a filing fee.
- Respondent files an Answer (typically within 45 days).
- FINRA appoints arbitrator(s) — single arbitrator for smaller claims, three-arbitrator panels for larger claims.
- Discovery, motions, and hearing scheduling proceed.
- Hearing is held; arbitrators issue a final, binding award.
- Award is filed with court for enforcement; appeal is limited to specific procedural grounds.
Concept Check
A customer's dispute with a broker-dealer involves a claim of $150,000. The case is submitted to FINRA arbitration. How many arbitrators will hear the case?
FINRA arbitration panel size depends on claim size. For claims of $100,000 or less, one arbitrator hears the case. For claims exceeding $100,000, a three-arbitrator panel is required (unless the parties mutually agree to a single arbitrator). The $150,000 claim exceeds the $100,000 threshold, so three arbitrators are required. FINRA arbitration awards are final and binding, with very limited grounds for appeal. Claims must be filed within 6 years of the event.
Concept Check
A customer files a complaint with FINRA that a broker-dealer defrauded him in a transaction 8 years ago. FINRA arbitration has a 6-year statute of limitations. Which of the following is most accurate?
FINRA's arbitration rules impose a 6-year eligibility limit — claims must be filed within 6 years of the event giving rise to the dispute. At 8 years, the claim is time-barred under FINRA's rules and will be dismissed. Note that this is separate from state court statutes of limitations, which may have different timeframes. However, the question specifically asks about FINRA arbitration. The 6-year rule applies uniformly, including to fraud claims.
Concept Check
A customer of a FINRA member firm wishes to file a claim under the Code of Arbitration Procedure. The customer’s claim is no longer eligible for arbitration once how much time has elapsed from the occurrence giving rise to the claim?
Under FINRA’s Code of Arbitration Procedure, a claim is no longer eligible once 6 years have elapsed from the occurrence or event giving rise to the claim. The six-year window is a procedural eligibility cutoff specific to FINRA arbitration. State or federal substantive statutes of limitations may apply separately and could be shorter or longer for specific claim types. The 2-year and 4-year distractors understate the FINRA window. The 10-year distractor overstates it. Beyond six years, customers cannot bring claims in FINRA arbitration regardless of the merits.
Concept Check
A customer requests to see the predispute arbitration agreement she signed when opening her account at a FINRA member firm. The firm must supply a copy of the agreement within how many days?
When a customer requests a copy of the predispute arbitration agreement she signed, the member firm must supply the copy within 10 business days of the request. The 10-business-day requirement gives the customer prompt access to the document she may need to review for understanding her arbitration rights and obligations. The customer is contractually bound by the agreement she signed, so reasonable access to that document is essential. Shorter periods (5 business days) understate the FINRA standard. Longer periods (15 or 30 business days) overstate it. The 10-business-day window is fixed in FINRA rules.
Concept Check
Regarding FINRA-administered arbitration and mediation services, which statement is accurate?
Mediation is a voluntary settlement process in which a neutral mediator helps the parties try to resolve the dispute. Arbitration is a formal dispute-resolution process that can produce a final and binding award. Arbitration does not automatically move to mediation if a party dislikes the result. A mediator in a dispute generally may not later serve as an arbitrator in that same dispute because of neutrality concerns.
Concept Check
A customer and a FINRA member broker-dealer have completed a FINRA arbitration proceeding regarding a disputed transaction. The arbitration panel has issued an award favoring the customer. Regarding the arbitration outcome, the award is
FINRA arbitration awards are binding on both parties. Limited appeal grounds exist — such as arbitrator misconduct, fraud, or substantial procedural irregularities — but courts do not review arbitration awards on the merits. The arbitration panel’s decision on the substantive issues is final once issued. There is no cooling-off period after award issuance permitting withdrawal from the arbitration process. The award is not advisory; it has the force of a final judgment once confirmed by a court for enforcement purposes. Automatic merits review by courts would undermine the purpose of arbitration as binding dispute resolution.
Summary
Exam Essentials — high-yield review
Chapter Summary
Ch 30 Exam Essentials — Prohibited Practices, Compliance, and Dispute Resolution
- Core prohibited practices (memorize all 8): Churning, unauthorized trading, front-running, commingling, insider trading, selling away, misrepresentation/guarantees, market manipulation (wash trades, matched orders).
- Insider trading liability: Both tipper AND tippee can face liability. Civil: up to 3x the profit/loss avoided (treble damages). Criminal: up to 20 years imprisonment, $5M individual fines. Information barrier (Chinese wall) required at broker-dealers.
- SIPC coverage: $500,000 per customer ($250,000 maximum for cash). Protects against broker-dealer insolvency — NOT market losses, NOT commodity futures, NOT fixed annuities. Each account type (individual, IRA, joint) covered separately.
- FINRA arbitration rules: Claims must be filed within 6 years of the event. Claims ≤$100,000 = 1 arbitrator. Claims >$100,000 = 3 arbitrators. Awards are final and binding; very limited appeal grounds.
- Guarantees are always prohibited: No rep may guarantee a customer against a loss or promise a specific return — regardless of whether the customer requests it, agrees to it in writing, or the rep is confident in the recommendation.
Ethics and Compliance Exam Traps — Consolidated
Twelve compliance traps the exam recycles. One pass before test day; each line settles a recurring question:
1. Form U4 = registration; Form U5 = termination. U4 filed when an associated person joins a firm; U5 filed within 30 days of leaving.
2. Form U4 residency = 5 years; employment = 10 years. The two disclosure periods are different. Residency is shorter (5), employment is longer (10).
3. Member firm verifies U4 disclosures before registration is permitted. The firm bears responsibility for confirming applicant representations are accurate.
4. Arbitration is mandatory and binding. Mediation is voluntary and only binding if the parties agree to settle.
5. Arbitration always results in a final award. Mediation may not resolve the dispute; if not, arbitration follows.
6. Mediator cannot serve as arbitrator in the same dispute. The mediator’s exposure to confidential settlement positions disqualifies them from later neutral adjudication.
7. Code of Arbitration eligibility expires after 6 years. From the occurrence giving rise to the claim. Older claims cannot be brought in FINRA arbitration regardless of merit.
8. Predispute arbitration agreement must be supplied within 10 business days of customer request. The customer is entitled to review the document she signed.
9. Class action claims are typically excluded from FINRA arbitration. Customers can pursue class claims in court despite predispute clauses.
10. Predispute arbitration clauses must be highlighted in account agreements. Customer must acknowledge the clause and receive a copy at account opening.
11. Arbitration awards are subject to limited appeal grounds. Procedural irregularity or arbitrator misconduct, not disagreement with the merits decision.
12. Single arbitrator for smaller claims; three-arbitrator panels for larger claims. The threshold separating the two panel sizes is currently around $100,000 in dispute amount.
Twelve compliance traps the exam recycles. One pass before test day; each line settles a recurring question:
1. Form U4 = registration; Form U5 = termination. U4 filed when an associated person joins a firm; U5 filed within 30 days of leaving.
2. Form U4 residency = 5 years; employment = 10 years. The two disclosure periods are different. Residency is shorter (5), employment is longer (10).
3. Member firm verifies U4 disclosures before registration is permitted. The firm bears responsibility for confirming applicant representations are accurate.
4. Arbitration is mandatory and binding. Mediation is voluntary and only binding if the parties agree to settle.
5. Arbitration always results in a final award. Mediation may not resolve the dispute; if not, arbitration follows.
6. Mediator cannot serve as arbitrator in the same dispute. The mediator’s exposure to confidential settlement positions disqualifies them from later neutral adjudication.
7. Code of Arbitration eligibility expires after 6 years. From the occurrence giving rise to the claim. Older claims cannot be brought in FINRA arbitration regardless of merit.
8. Predispute arbitration agreement must be supplied within 10 business days of customer request. The customer is entitled to review the document she signed.
9. Class action claims are typically excluded from FINRA arbitration. Customers can pursue class claims in court despite predispute clauses.
10. Predispute arbitration clauses must be highlighted in account agreements. Customer must acknowledge the clause and receive a copy at account opening.
11. Arbitration awards are subject to limited appeal grounds. Procedural irregularity or arbitrator misconduct, not disagreement with the merits decision.
12. Single arbitrator for smaller claims; three-arbitrator panels for larger claims. The threshold separating the two panel sizes is currently around $100,000 in dispute amount.
Practice what you just learned
Practice Questions
Test yourself with exam-style questions on this topic.