Study guide
13.2 Prohibited and Unethical Practices
Series 66 Uniform Combined State Law
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1 Introduction
About the Series 66 How to Use This Guide
2 Chapter 1: Economic Factors and Business Information
1.1 Financial Ratios and Valuation 1.2 Time Value of Money 1.3 Descriptive Statistics and Risk Measures
3 Chapter 2: Cash and Fixed Income Securities
2.1 Cash and Cash Equivalents 2.2 Fixed Income Securities Basics 2.3 Types of Bonds 2.4 Bond Risks and Duration
4 Chapter 3: Equity Securities
3.1 Common Stock 3.2 Preferred Stock 3.3 Equity Valuation Methods 3.4 Public Offerings and IPOs
5 Chapter 4: Pooled Investments
4.1 Mutual Funds 4.2 ETFs and Unit Investment Trusts 4.3 REITs and Direct Participation Programs
6 Chapter 5: Insurance Products and Annuities
5.1 Life Insurance Products 5.2 Annuities
7 Chapter 6: Alternative Investments and Derivatives
6.1 Alternative Investments 6.2 Options Basics 6.3 Structured Products and Complex Investments
8 Chapter 7: Client Types and Profiles
7.1 Types of Clients 7.2 Building Client Profiles
9 Chapter 8: Portfolio Theory and Management
8.1 Modern Portfolio Theory 8.2 Asset Allocation Strategies 8.3 Measuring Portfolio Performance
10 Chapter 9: Retirement Plans
9.1 Qualified Retirement Plans 9.2 Individual Retirement Accounts 9.3 ERISA and Fiduciary Obligations
11 Chapter 10: Tax Considerations and Estate Planning
10.1 Investment Taxation 10.2 Estate Planning Basics 10.3 Special Accounts (Education and Health)
12 Chapter 11: Investment Adviser Regulation
11.1 Investment Adviser Definition 11.2 Investment Adviser Registration 11.3 Investment Adviser Representative Registration
13 Chapter 12: Broker-Dealer and Securities Regulation
12.1 Broker-Dealer Definition and Registration 12.2 Securities Registration 12.3 Administrative Provisions and Remedies
14 Chapter 13: Ethical Practices and Fiduciary Obligations
13.1 Fiduciary Duty 13.2 Prohibited and Unethical Practices 13.3 Custody and Safeguarding Client Assets
15 Chapter 14: Client Communication and Business Practices
14.1 Advertising and Client Communications 14.2 Advisory Contracts 14.3 Cybersecurity and Privacy
16 Chapter 15: Suitability and Best Interest Standards
15.1 Suitability Obligations 15.2 Best Execution 15.3 Account Management and Supervision
13.2 Prohibited and Unethical Practices
Key Takeaways Explain This Topic AI
Churning is excessive trading to generate commissions, measured by turnover ratio and cost-equity ratio.
A turnover ratio of 6 or cost-equity ratio above 20% is generally indicative of churning.
Front-running (trading ahead of client orders) is strictly prohibited.
Scalping (recommending securities then selling own position) is prohibited.
Guaranteeing against loss is ALWAYS prohibited, regardless of circumstances.
Sharing in client profits/losses requires written consent AND proportionate sharing.
Unauthorized trading and selling away are serious violations.
Material misrepresentation and omission are forms of fraud.
Last updated: January 2026
Both investment advisers and broker-dealers must avoid prohibited practices that harm clients and violate securities laws.
Churning (Excessive Trading)
Churning is trading that is excessive in light of the account's objectives, conducted primarily to generate commissions rather than benefit the client.
Elements of Churning
To prove churning, three elements must be established:
- Element Description
- Control Broker had control over the account (actual or de facto)
- Excessive trading Trading was excessive given account objectives
- Scienter Broker acted with intent or reckless disregard for client
- Quantitative Indicators
FINRA Rule 2111 (Quantitative Suitability) identifies these key metrics:
- Metric Calculation Warning Levels
- Turnover Ratio Total purchases ÷ Average equity (annualized) 2 = suggestive, 4 = presumptive, 6+ = conclusive
- Cost-Equity Ratio Total annual costs ÷ Average equity Above 20% indicative of excessive trading
- In-and-Out Trading Frequent buy/sell of same securities "Hallmark" of churning
- Turnover Ratio Examples
- Account Type Turnover Ratio Interpretation
- Conservative 2 Suggestive of churning
- Moderate 4 Presumptive of churning
- Any account 6+ Generally conclusive
- De Facto Control
Even in non-discretionary accounts, churning can occur if:
- Client routinely accepts all broker recommendations
- Client never makes independent decisions
- Broker dominates decision-making
- Fraudulent Practices
- Practice Description
- Material Misrepresentation Making false statements of material fact
- Omission Failing to disclose material information
- Manipulation Artificially affecting security prices
- Front-Running Trading ahead of known client orders
- Scalping Recommending securities then selling own position
- Front-Running
Trading in a security ahead of a client's order to profit from the expected price movement:
- Applies to advisers, BDs, and their employees
- Violates fiduciary duty
- Criminal penalties may apply
- Scalping
Recommending securities to clients while secretly selling the adviser's own position:
- Deceives clients about adviser's true opinion
- Violates disclosure requirements
- May cause client losses while adviser profits
- Trading Violations
- Unauthorized Trading
Making trades without client consent:
- Even one unauthorized trade is a violation
- Discretionary authority requires written authorization
- Time/price discretion ≠ full discretion
- Selling Away
Selling securities NOT approved by the employing firm:
- Private securities transactions
- Violates firm supervision requirements
- May involve undisclosed compensation
- Best Execution
Advisers must seek the most favorable terms reasonably available:
- Factor Consideration
- Price Best available price for the security
- Commission Reasonable commission rate
- Speed Timeliness of execution
- Reliability Broker's track record
- Total cost All-in cost to the client
- Sharing in Client Accounts
- General Rule
Sharing in profits or losses is prohibited unless:
- Requirement Details
- Written consent Client must agree in writing
- Firm approval Employing firm must approve
- Proportionate sharing Based on capital contribution
- Exception for Family Members
When sharing with immediate family members :
- Proportionate sharing NOT required
- Written consent still required
- Relationship must be genuine
- Guarantees
- Absolutely Prohibited
- Prohibited Practice Example
- Guaranteeing against loss "I'll cover any losses you have"
- Promising specific returns "You'll definitely make 10%"
- Making up losses Reimbursing client from personal funds
- Allowed Practices
- Allowed Example
- Historical performance "This fund returned 8% last year" (with disclosures)
- Investment objectives "We seek 7-9% annual returns"
- Risk discussions "Higher risk may mean higher returns"
- Other Prohibited Practices
- Practice Description
- Borrowing from clients Unless client is a lending institution
- Lending to clients Generally prohibited
- Excessive markups Unreasonable profit on principal trades
- Backdating documents Falsifying dates on trades or contracts
- Forging signatures Creating or altering client signatures
- Commingling Mixing client and firm assets
- Misappropriation Using client assets for other purposes
- False statements to regulators Providing false information in exams
Exam Tip : Churning indicators - turnover ratio of 6+ and cost-equity ratio above 20%. Guarantees against loss are ALWAYS prohibited. Sharing requires WRITTEN consent AND proportionate sharing (except family).