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NASD CONDUCT
RULE 2300:TRANSACTIONS WITH CUSTOMERS
2310. Recommendations to Customers (Suitability)
(a) In recommending to a customer the purchase, sale or exchange of any
security, a member shall have reasonable grounds for believing that the
recommendation is suitable for such customer upon the basis of the facts,
if any, disclosed by such customer as to his other security holdings and
as to his financial situation and needs.
(b) Prior to the execution of a transaction
recommended to a non-institutional customer, other than transactions with
customers where investments are limited to money market mutual funds, a
member shall make reasonable efforts to obtain information concerning:
(1) the customer’s financial status;
(2) the customer’s tax status;
(3) the customer’s investment objectives; and
(4) such other information used or considered to
be reasonable by such member or registered representative in making
recommendations to the customer.
(c) For purposes of this Rule, the term “non-institutional
customer” shall mean a customer that does not qualify as an
institutional account” under Rule 3110(c)(4).
[Amended May 2, 1990 eff. for accounts opened and
recommendations made after Jan. 1, 1991; amended by SR-NASD-95-39 eff.
Aug. 20, 1996.]
NASD
Interpretive Material-2310-2. Fair Dealing with Customers
(a)
(1)
Implicit in all member and registered representative relationships with
customers and others is the fundamental responsibility for fair dealing.
Sales efforts must therefore be undertaken only on a basis that can be
judged as being within the ethical standards of the Association’s Rules,
with particular emphasis on the requirement to deal fairly with the
public.
(2) This
does not mean that legitimate sales efforts in the securities business are
to be discouraged by requirements which do not take into account the
variety of circumstances which can enter into the member-customer
relationship. It does mean, however, that sales efforts must be judged on
the basis of whether they can be reasonably said to represent fair
treatment for the persons to whom the sales efforts are directed, rather
than on the argument that they result in profits to customers.
(b)
District Business Conduct Committees and the Board of Governors have
interpreted the Rules, taken disciplinary action and imposed penalties in
many situations where members’ sales efforts have exceeded the
reasonable grounds of fair dealing. Some practices that have resulted in
disciplinary action and that clearly violate this responsibility for fair
dealing are set forth below, as a guide to members:
(1)
Recommending Speculative Low-Priced Securities
Recommending speculative low-priced securities to customers without
knowledge of or attempt to obtain information concerning the customers’
other securities holdings, their financial situation and other necessary
data. The principle here is that this practice, by its very nature,
involves a high probability that the recommendation will not be suitable
for at least some of the persons solicited. This has particular
application to high pressure telephone sales campaigns.
(2)
Excessive Trading Activity
Excessive activity in a customer’s account, often referred to as “churning”
or “overtrading.” There are no specific standards to measure
excessiveness of activity in customer accounts because this must be
related to the objectives and financial situation of the customer
involved.
(3)
Trading in Mutual Fund Shares
Trading in mutual fund shares, particularly on a short-term basis. It
is clear that normally these securities are not proper trading vehicles
and such activity on its face may raise the question of Rule violation.
(4)
Fraudulent Activity
(A) Numerous instances of fraudulent conduct have been acted upon by
the Association and have resulted in penalties against members. Among some
of these activities are:
(i)
Fictitious Accounts
Establishment of fictitious accounts in order to execute transactions
which otherwise would be prohibited, such as the purchase of hot issues,
or to disguise transactions which are against firm policy.
(ii)
Discretionary Accounts
Transactions in discretionary accounts in excess of or without actual
authority from customers.
(iii)
Unauthorized Transactions
Causing the execution of transactions which are unauthorized by
customers or the sending of confirmations in order to cause customers to
accept transactions not actually agreed upon.
(iv)
Misuse of Customers’ Funds or Securities
Unauthorized use or borrowing of customers’ funds or securities.
(B) In
addition, other fraudulent activities, such as forgery, non-disclosure or
misstatement of material facts, manipulations and various deceptions, have
been found in violation of Association Rules. These same activities are
also subject to the civil and criminal laws and sanctions of federal and
state governments.
(5)
Recommending Purchases Beyond Customer Capability
Recommending the purchase of securities or the continuing purchase of
securities in amounts which are inconsistent with the reasonable
expectation that the customer has the financial ability to meet such a
commitment.
(c)
While most members are fully aware of the fairness required in dealing
with customers, it is anticipated that the practices enumerated in
paragraph (b), which are not all inclusive, will be of future assistance
in the training and education of new personnel.
(d)
The Commission has also recognized that brokers and dealers have an
obligation of fair dealing in actions under the general anti-fraud
provisions of the federal securities laws. The Commission bases this
obligation on the principle that when a securities dealer opens his
business he is, in effect, representing that he will deal fairly with the
public. Certain of the Commission’s cases on fair dealing involve
practices not covered in the foregoing illustrations. Usually, any breach
of the obligation of fair dealing as determined by the Commission under
the anti-fraud provisions of the securities laws could be considered a
violation of the Association’s Rules.
(e)
Fair Dealing with Customers with Regard to Derivative Products or New
Financial Products
The Board
emphasizes members’ obligations for fair dealing with customers when
making recommendations or accepting orders for new financial products. As
new products are introduced from time to time, it is important that
members make every effort to familiarize themselves with each customer’s
financial situation, trading experience, and ability to meet the risks
involved with such products and to make every effort to make customers
aware of the pertinent information regarding the products. Members must
follow specific guidelines, set forth below, for qualifying the accounts
to trade the products and for supervising the accounts thereafter.
(1) Index
Warrants
Members
are obliged to comply with the Rules, regulations and procedures
applicable to index warrants and foreign currency warrants contained in
the Rule 2840 Series.
(2) Hybrid
Securities and Selected Equity-Linked Debt Securities (“SEEDS”)
Designated as Nasdaq National Market Securities Pursuant to the Rule 4400
Series
Members
are obligated to comply with any Rules, regulations, or procedures
applicable to such securities pursuant to the Rule 4420 Series, as well as
any other applicable Rule, regulation, or procedure of the Association.
[Amended eff. June 11, 1992; amended by
SR-NASD-94-49 eff. Sept. 30, 1994; amended by SR-NASD-95-37 eff. Sept. 28,
1995.]
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