sales-practices

What this skill does

# Sales Practices

## Purpose
Provides comprehensive guidance on FINRA and SEC rules governing the conduct of broker-dealers and their associated persons in securities sales activities. Covers ethical standards, prohibited practices, supervision requirements, and specialized rules for vulnerable investors and complex products. This skill enables identification of sales practice violations and the regulatory framework for enforcement.

## Layer
9 — Compliance & Regulatory Guidance

## Direction
prospective

## When to Use
- Evaluating whether a broker's trading activity constitutes churning or excessive trading
- Assessing whether mutual fund breakpoint discounts were properly applied
- Determining if an associated person engaged in selling away or unapproved private securities transactions
- Reviewing outside business activity disclosures and firm obligations
- Evaluating supervisory procedures and whether a firm met its supervision obligations
- Analyzing potential market manipulation, marking the close, or other deceptive practices
- Investigating unauthorized trading in customer accounts
- Applying senior investor protection rules including trusted contact persons and temporary holds
- Assessing suitability and disclosure requirements for variable annuity sales or 1035 exchanges
- Reviewing options account approval, risk disclosure, and suitability for options strategies
- Determining whether conduct violates FINRA's broad ethical standards under Rule 2010

## Core Concepts

### FINRA Rule 2010 — Standards of Commercial Honor
FINRA Rule 2010 is the catch-all ethical standard for all member firms and associated persons. It requires adherence to "high standards of commercial honor and just and equitable principles of trade." This rule is intentionally broad and serves as the basis for disciplinary action even when no other specific rule is violated. Conduct that is unethical, dishonest, or in bad faith — even if technically legal — can be sanctioned under Rule 2010. FINRA enforcement frequently pairs Rule 2010 with more specific rule violations as a supplementary charge. Examples of standalone Rule 2010 violations include forgery, misrepresentation of credentials, conversion of client funds, and failure to disclose material information.

### FINRA Rule 2020 — Use of Manipulative, Deceptive, or Other Fraudulent Devices
FINRA Rule 2020 prohibits any member or associated person from effecting any transaction in, or inducing the purchase or sale of, any security by means of any manipulative, deceptive, or other fraudulent device or contrivance. This rule mirrors the antifraud provisions of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. It covers a broad range of manipulative schemes including pump-and-dump, marking the close, wash trading, matched orders, and any scheme to defraud customers or the market.

### Churning and Excessive Trading
Churning occurs when a broker exercises control over a customer's account and engages in excessive trading to generate commissions rather than to benefit the customer. Three elements must be established:

- **Control:** The broker exercised de facto or de jure control over trading decisions. De facto control exists when the customer routinely follows the broker's recommendations without independent judgment.
- **Excessive activity:** Trading frequency and volume are inconsistent with the customer's investment objectives. Quantitative metrics include:
  - **Turnover ratio:** The aggregate cost of purchases divided by the average account equity over the period. A turnover ratio exceeding 6 is generally considered presumptive evidence of churning. Ratios of 4-6 may indicate excessive trading depending on account type and objectives.
  - **Cost-to-equity ratio (break-even return):** The total costs (commissions, markups, fees) as a percentage of average account equity on an annualized basis. A cost-to-equity ratio exceeding 20% is generally considered excessive because the account must earn more than 20% annually just to break even after costs.
  - **In-and-out trading:** A pattern of purchasing securities and selling them within a short period, generating commissions on both sides without meaningful investment rationale.
- **Scienter:** The broker acted with intent to defraud or with reckless disregard for the customer's interests.

FINRA Rule 2111 (Suitability) includes a quantitative suitability obligation (the third prong) that specifically addresses excessive trading. A broker who has actual or de facto control over an account must have a reasonable basis for believing that the number of recommended transactions within a given period is not excessive and is consistent with the customer's investment profile. The SEC has also brought churning cases under Section 10(b) and Rule 10b-5, which require scienter, and under Section 15(c) of the Exchange Act.

### Breakpoint Abuse
Mutual funds offer volume discounts called breakpoints — reduced sales charges for larger purchases. Breakpoint abuse occurs when a broker fails to inform customers of available discounts or structures transactions to avoid breakpoints (e.g., splitting a single purchase into multiple smaller transactions across fund families). Key obligations:

- **Rights of accumulation:** Customers are entitled to count existing holdings in the same fund family toward breakpoint thresholds. Brokers must aggregate qualifying holdings when calculating applicable sales charges.
- **Letters of intent (LOI):** A customer may sign an LOI committing to purchase a specified amount within 13 months, thereby qualifying for a reduced sales charge on each purchase during that period. Brokers must inform customers of this option when a planned purchase schedule would qualify.
- **Household aggregation:** Many fund families allow aggregation of purchases across accounts within the same household for breakpoint purposes. Brokers should inquire about related accounts.

FINRA has brought numerous Letters of Acceptance, Waiver and Consent (AWC) actions against firms and individuals for breakpoint failures. In 2003, FINRA (then NASD) conducted an industrywide sweep that resulted in approximately $43 million in restitution for breakpoint overcharges. Firms must maintain systems to identify breakpoint-eligible transactions and train registered representatives on breakpoint obligations.

### Selling Away — Private Securities Transactions (FINRA Rule 3280)
FINRA Rule 3280 governs private securities transactions — any securities transaction outside the regular course or scope of an associated person's employment with a member firm. An associated person who wishes to participate in a private securities transaction must:

1. **Provide prior written notice** to the employing member firm describing the proposed transaction in detail, the person's proposed role, and whether they have received or may receive selling compensation.
2. **If compensation is involved:** The firm must evaluate the transaction, and if it approves, must record the transaction on its books and supervise the person's participation as if the transaction were executed through the firm. If the firm disapproves, the person must not participate.
3. **If no compensation is involved:** The firm must acknowledge the notice and may impose conditions or restrictions.

Selling away is one of the most common violations leading to FINRA disciplinary action and customer arbitration claims. Associated persons who sell unregistered securities, promissory notes, or interests in private companies without firm approval expose both themselves and investors to significant risk. Common selling away scenarios include private placements, real estate investments, cryptocurrency ventures, and personal loans from customers.

### Outside Business Activities (FINRA Rule 3270)
FINRA Rule 3270 requires associated persons to provide prior written notice to their employing member firm before engaging in any business activit