Section 3 Understanding Trading, Customer Accounts and Prohibited Activities

Other Prohibited Activities

18 min read · Lesson 10 of 10

About This Lesson

This chapter collects the prohibited activities that don't fall under manipulation or insider trading. It's a grab-bag FINRA expects you to recognize on sight, so treat it as a recognition lesson built for speed.

What you'll cover

  • Improper use of customer funds: borrowing and lending, guarantees against loss, and commingling
  • Sharing in customer accounts, and unauthorized trading
  • Selling away (private securities transactions) and other rep misconduct
  • Protecting senior investors under Rule 2165
  • IPO allocation restrictions

None of these is deep on its own. The challenge is breadth, the SIE can pull a scenario from any of them, so the goal here is fast, confident recognition of what is allowed and what is not.

In this chapter ~18 min · 9 concept checks
Section 1 of 5 ~5 min · 4 concept checks

Improper Use of Customer Funds

The most basic rule about handling a customer's money is that it is the customer's money: a rep cannot pledge it away or mix it with their own.

Guaranteeing against loss

A rep may never guarantee a customer against loss or promise a specific result. This holds no matter how it is framed, in writing, with supervisory approval, or for an institutional client, and no matter whose money backs the promise. An offer to buy a customer's shares back at a set price if they fall is just a guarantee in disguise, and it is prohibited.

Commingling

A rep must never commingle customer funds with their own or the firm's proprietary assets. Customer money and securities stay segregated at all times. Depositing a customer's check into a personal account, even briefly and even with good intentions, is a violation; the funds go directly to the proper firm account.

Borrowing money from, or lending money to, a customer is generally prohibited under FINRA Rule 3240, because of the obvious conflict of interest. The rule carves out five narrow exceptions where it may be allowed, and every one of them still requires the firm's approval under its written procedures:

  1. The customer is an immediate family member of the rep.
  2. The customer is a financial institution regularly in the business of lending (a bank, for example).
  3. The customer is another registered person at the same firm.
  4. There is a personal relationship outside the broker-customer relationship.
  5. There is a business relationship outside the broker-customer relationship.

The exception removes the flat ban, but it never removes the need for the firm to know about and approve the arrangement in advance.

Concept Check

Under FINRA rules, guaranteeing a customer against losses in their account is:

Guaranteeing customers against losses is always prohibited under FINRA Rule 2150. No exception exists regardless of the circumstances or approval level.
Concept Check

A registered representative recommends a stock to a client. To help close the sale, the representative offers to personally repurchase the shares if they drop below $90. This offer is:

Offering to repurchase shares at a set price is functionally a guarantee against loss, the RR is promising the client will not lose beyond a certain point. Guarantees are prohibited under all circumstances regardless of funding source, documentation, or customer type. It does not matter whether the RR uses personal funds or firm funds, whether the offer is verbal or written, or whether the client is retail or institutional. There are no exceptions to this rule.
Concept Check

A registered representative deposits a customer's check into the representative's personal bank account, intending to transfer the funds to the customer's brokerage account the next business day. This practice is:

Commingling customer funds with personal assets is always prohibited, regardless of intent or timing. Customer funds must be segregated from both personal and firm proprietary assets at all times. Separate record-keeping does not cure the violation, and principal approval cannot authorize commingling. The funds should be deposited directly into the appropriate firm account.
Concept Check

A registered representative borrows $5,000 from a customer who is also a close personal friend and business partner outside the broker-customer relationship. Under FINRA Rule 3240:

FINRA Rule 3240 generally prohibits borrowing from customers, but permits it under five narrow exceptions with firm approval. One exception is a personal relationship outside the business relationship (e.g., a longstanding friend). However, this still requires prior written firm approval, the exception does not mean it can happen without oversight.
Section 2 of 5 ~4 min · 2 concept checks

Sharing and Trading in Customer Accounts

A customer's account belongs to the customer, which limits two things a rep might be tempted to do: share in it, and trade in it without being asked.

Sharing in a customer's account

Under FINRA Rule 2150, a rep may share in the profits and losses of a customer's account only if all three of these are true:

  1. The customer gives written authorization.
  2. The rep's firm gives written approval.
  3. The rep shares only in proportion to their own financial contribution.

Verbal sign-off is not enough; the firm's approval must be in writing. One exception: if the customer is an immediate family member, the rep may share disproportionately (more than their contribution).

Unauthorized trading

Placing a trade in a customer's account without the customer's authorization, or without written discretionary authority, is always prohibited. It does not matter that the trade was profitable or made in good faith, and a customer's later silence does not turn an unauthorized trade into an authorized one.

Churning, The Three-Element Test

Churning (excessive trading in a customer account to generate commissions) requires proving three elements:

1. The broker had control over the account (discretionary authority or de facto control through the customer's reliance on the broker's recommendations)
2. Trading was excessive relative to the customer's objectives and financial situation
3. The broker acted with intent to defraud or with willful disregard for the customer's interests

Key: a broker cannot be found guilty of churning for an account over which they have no discretion, the customer must authorize each trade.
Concept Check

A registered representative may share in the profits and losses of a customer's account if all of the following conditions are met EXCEPT:

Sharing in accounts requires: (1) written customer authorization, (2) written firm approval, and (3) proportional sharing based on financial contribution. Verbal supervisor approval is NOT sufficient, the firm must provide written approval.
Concept Check

A registered representative believes a particular stock is an excellent opportunity for a client. Without contacting the client, the representative purchases 500 shares in the client's account. The stock rises 20% over the next month. Which of the following is TRUE?

Unauthorized trading, executing transactions without customer knowledge or authorization, is always prohibited. Neither profitability nor good faith cures the violation. The RR must have customer authorization or written discretionary authority before placing any trade. Client silence or failure to object does not constitute after-the-fact authorization.
Section 3 of 5 ~4 min · 2 concept checks

Selling Away and Other Misconduct

A few further violations round out the chapter, all of them about a rep stepping outside the rules of honesty and firm oversight.

Selling away (private securities transactions)

Selling away is participating in a securities transaction outside your firm without giving the firm prior written notice. It is prohibited under FINRA Rule 3280. If the rep will be compensated, the firm must not only receive notice but also approve the transaction and supervise it as though it were the firm's own business. Doing private deals on the side, unreported, is a classic enforcement trigger.

Misrepresentation

Knowingly making an untrue statement of a material fact to a customer is a violation in itself. It does not matter how it turns out, even if the customer happens to profit, the misrepresentation still exposes the rep to civil liability and regulatory sanction. The conduct is what is prohibited, not the outcome.

Unregistered persons and falsified records

An unregistered person may not solicit customers, take orders, or receive transaction-based compensation, and a firm may not pay commissions to one. Separately, falsifying records, including signing a customer's name (a "signature of convenience") or improperly maintaining books and records, is a serious violation on its own.

Concept Check

Which of the following activities is considered "selling away"?

"Selling away" refers to a registered person participating in a private securities transaction outside their firm without providing prior written notice. It is a serious violation of FINRA Rule 3280. If compensation is involved, the firm must receive prior written notice AND must approve the transaction and supervise it as if it were the firm's own. Failure to notify is a significant enforcement action trigger.
Concept Check

A registered representative makes a presentation to a client and knowingly includes an untrue statement about a security's historical returns. The client accepts the recommendation and earns above-average returns over the next several years. Which statement is TRUE?

Making a knowingly false statement of material fact is a violation regardless of the outcome. The fact that the client profited does not cure the misrepresentation. The RR is subject to civil liabilities and FINRA sanctions because the conduct itself was prohibited, outcomes do not determine whether a rule was broken. A formal complaint is not required for regulatory action.
Section 4 of 5 ~3 min · 1 concept check

Protecting Senior Investors

Older and vulnerable customers get extra protection, and FINRA Rule 2165 gives firms two specific tools.

Trusted contact person

When opening or updating an account, a firm must make reasonable efforts to get the name of a trusted contact person, someone it can reach out to if it suspects exploitation or diminished capacity. Note that the trusted contact has no trading authority; they are a point of contact, not an agent on the account.

Temporary hold on disbursements

If a firm reasonably suspects financial exploitation of a customer who is 65 or older (or has a mental or physical impairment), it may place a temporary hold on disbursements, not on trades, from the account. The hold can run up to 15 business days, extendable by another 10 (25 total) with senior firm approval. Red flags include sudden changes in financial patterns, unexplained withdrawals, an unfamiliar new person directing activity, and abrupt beneficiary changes.

Concept Check

Under FINRA Rule 2165, the maximum initial hold period on a disbursement from a senior investor's account when financial exploitation is suspected is:

Under Rule 2165, the initial hold is up to 15 business days. This can be extended by an additional 10 business days (25 total) with senior firm principal approval. The hold applies to disbursements, not to trading activity.
Section 5 of 5 ~2 min

IPO Allocation Restrictions

To keep new-issue (IPO) shares from being funneled to industry insiders, FINRA Rules 5130 and 5131 bar certain restricted persons from buying them.

Restricted persons (Rule 5130)

  • Broker-dealer employees and their immediate family members.
  • Finders and fiduciaries acting on behalf of the offering.
  • Portfolio managers buying for their own accounts.
  • Owners of 10% or more of a broker-dealer.

Spinning (Rule 5131)

Underwriters may not hand IPO allocations to executives and directors of public companies in exchange for that company's investment-banking business. That quid pro quo is called spinning.

Before selling a new issue, a firm must obtain a representation from the buyer that they are not a restricted person, and it must refresh that confirmation annually.

Summary Recap & exam traps

Chapter Essentials

This chapter is a recognition checklist. With customer funds, three lines are bright: a rep may never guarantee against loss (an offer to buy shares back at a set price is a guarantee in disguise), may never commingle customer money with personal or firm assets, and may not borrow from or lend to a customer except under the five narrow Rule 3240 exceptions, each of which still needs firm approval. Inside a customer's account, a rep may share only with written customer and firm approval and in proportion to their contribution (immediate family is the exception), and may never trade without authorization, profitability and good faith do not excuse an unauthorized trade.

Beyond the account, selling away (a private securities transaction without prior written notice to the firm) violates Rule 3280, and a knowing misrepresentation is a violation regardless of how the trade turns out. Unregistered persons cannot receive transaction-based compensation. Rule 2165 lets a firm take a trusted contact and place a hold on disbursements (not trades) for a customer 65+, up to 15 business days plus a 10-day extension. And Rules 5130/5131 keep IPO shares away from restricted persons and bar spinning.

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Exam Traps to Watch

The reliable gotchas in this chapter:

• Guaranteeing against loss is never allowed. Not in writing, not with approval, not for institutions. An offer to repurchase a customer's shares at a set price is a guarantee in disguise, and just as prohibited.

• The outcome never cures the violation. An unauthorized trade or a knowing misrepresentation is a violation even if the customer made money. Watch for answer choices that say "acceptable because it was profitable."

• Borrowing exceptions still need firm approval. Even an immediate-family or personal-relationship loan under Rule 3240 requires prior written firm approval, the exception removes the ban, not the oversight.

• Sharing needs written approval and proportionality. Verbal sign-off is not enough, and the rep shares only in proportion to their contribution, unless the customer is immediate family, who may share disproportionately.

• Selling away is about prior written notice. A private securities transaction outside the firm requires notice; if the rep is paid, the firm must also approve and supervise it. Rule 3280.

• Rule 2165 holds disbursements, not trades, for ages 65+. The temporary hold is 15 business days, extendable by 10 (25 total), and the trusted contact has no trading authority.
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