In April 2016, the Department of Labor issued a fiduciary rule requiring anyone giving retirement advice to act solely in the client's best interest. The financial services industry sued almost immediately. In March 2018, the Fifth Circuit vacated the rule in Chamber of Commerce v. U.S. Department of Labor. The fiduciary standard for brokers died in a Louisiana federal courtroom.
The Securities and Exchange Commission stepped into the vacuum a year later. In June 2019, the SEC adopted Regulation Best Interest, a new federal standard that sits somewhere between suitability and fiduciary duty. Today, Reg BI is the rule that governs how a broker-dealer agent is allowed to talk to a retail customer. It is also, along with the NASAA Statement of Policy on Dishonest Practices, the Vulnerable Adults Model Act, and a handful of FINRA rules, the reason one in every four questions on the Series 63 lives in this chapter.
Section 1: NASAA Broker-Dealer Dishonest Practices
This is the single biggest rule document for Chapter 3. It is called the Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents. NASAA adopted it on May 23, 1983 and has amended it several times since, most recently on April 7, 2025. Most of the ethics questions on the Series 63 trace back to this document. It lists 25 prohibited practices for broker-dealers and 6 prohibited practices for agents.
State securities regulators spend most of their time on two things: stopping fraud, and stopping conduct that is not fraud but is still wrong. The NASAA Statement of Policy is the second bucket. It is the list that regulators built after decades of watching the same bad conduct repeat itself. Every item on the list is there because a broker somewhere tried it and got away with it once.
The Opening Standard
"Each broker-dealer and agent shall observe high standards of commercial honor and just and equitable principles of trade in the conduct of their business."
Source: NASAA BD Dishonest Practices SoP, adopted 5/23/1983, amended 5/16/2022 and 4/7/2025.
Churning, Suitability, and Best Interest [§§1.b, 1.c, 1.d]
Churning is defined in §1.b as "inducing trading in a customer's account which is excessive in size or frequency in view of the financial resources and character of the account." The test is not a hard count. The test is whether the activity level is out of proportion with the customer's situation. A retired widow with $50,000 in assets does not need 40 trades a month.
Suitability (§1.c) prohibits recommending a security without reasonable grounds based on the customer's investment objectives, financial situation, needs, and other known information. Best Interest (§1.d) is the Reg BI cross-reference for retail customers, discussed in detail in Section 6 below.
The Brand-New "Adviser" Title Rule [§1.e]
On April 7, 2025, NASAA added a new prohibition: a broker-dealer agent may not use a title, a purported credential, or a professional designation containing any variant of "adviser" or "advisor" unless the agent is actually licensed as an investment adviser or investment adviser representative. The rule was a response to a decade of "Senior Financial Advisor" business cards on brokers who were legally salespeople. Customers kept assuming the word meant something. NASAA decided it should.
This item is brand new as of April 2025, and many older prep materials have not caught up to it yet. If a question describes a broker-dealer agent handing out a card that reads "Senior Financial Adviser" and the agent is not separately IAR-licensed, the conduct is prohibited under §1.e.
Unauthorized Trading and Discretion [§§1.f, 1.g]
Unauthorized trading (§1.f) is executing a transaction on behalf of a customer without authorization. Discretionary authority (§1.g) for a broker-dealer cannot be exercised "without first obtaining written discretionary authority from the customer, unless the discretionary power relates solely to the time and/or price for the executing of orders."
A broker-dealer agent needs written discretionary authority before the first discretionary trade. An investment adviser gets ten business days of oral discretion before needing written authority. These two rules are different on purpose, and the exam tests the difference relentlessly.
Margin, Segregation, Hypothecation, Markups [§§1.h to 1.k]
A margin agreement (§1.h) must be obtained "promptly after" the initial transaction in the account. The key word is "after," not "before." The first trade can happen, but the signed agreement has to follow soon. Segregation (§1.i) requires customer securities to be kept separate from firm property. Hypothecation (§1.j) prohibits pledging a customer's securities without written consent. Markup restrictions (§1.k) prohibit transacting at a price not reasonably related to the current market price.
Prospectus Delivery and Market Manipulation [§§1.l, 1.p, 1.q]
A final prospectus (or a preliminary prospectus plus additional document) must be furnished no later than the confirmation date (§1.l). Market manipulation (§1.p) covers wash sales (no change in beneficial ownership), matched orders (false appearance of active trading), and series of transactions designed to raise or depress price. Guaranteeing a customer against loss (§1.q) is absolutely prohibited. No exceptions.
Agent-Specific Prohibited Practices [§§2.a to 2.e]
Six practices in the NASAA SoP apply specifically to agents rather than to firms. These are the ones most frequently tested.
| Section | Prohibited Practice | Key Nuance |
|---|---|---|
| §2.a | Borrowing or lending money or securities with customers | Flat prohibition, no exceptions |
| §2.b | Selling away (off-firm transactions) | Requires written firm authorization before execution |
| §2.c | Fictitious accounts | Even if no loss to customer, still prohibited |
| §2.d | Sharing in customer profits or losses | Requires written authorization from customer AND firm |
| §2.e | Commission splitting with outsiders | Allowed only among agents at same firm or affiliates |
The borrowing rule at §2.a is a flat prohibition for broker-dealer agents. No exceptions. This is one of the three rules most likely to be tested as a trap against the investment adviser rule in Section 3, which does allow narrow carve-outs. If the fact pattern gives you a broker-dealer agent borrowing from a customer "because the customer is a bank," that is the investment adviser rule leaking into a broker-dealer question. The broker-dealer agent is still in violation.
Selling away (§2.b) is "effecting securities transactions not recorded on the regular books or records of the broker-dealer which the agent represents, unless the transactions are authorized in writing by the broker-dealer prior to execution of the transaction." The test is whether the agent did a side deal the firm did not know about. Even if the customer got a good outcome, it is still selling away unless the firm authorized it in writing first.
Sharing in a customer's account (§2.d) requires written authorization from both the customer AND the firm. Notice what the NASAA rule does not say: it does not require the agent's share to be proportional to the agent's contribution. Proportionality is a FINRA Rule 2150 requirement, not a NASAA one. Many prep providers mix the two. If you see "proportional to contribution" in a NASAA answer choice, that is a trap.
Test tip: The list is explicitly "not inclusive." Forgery, embezzlement, nondisclosure, incomplete disclosure, and material misstatements are grounds for discipline even if not specifically listed in §§1 or 2.
Section 2: NASAA Investment Company Shares Dishonest Practices
NASAA adopted a separate Statement of Policy for investment company shares in 1997. It is shorter than the main BD document, but it contains the single most-tested specific number in the entire ethics domain.
The "No Load" 0.25% Rule [§A.2]
A mutual fund cannot be described as "no load" or having "no sales charge" if any of the following are present:
- A front-end load
- A contingent deferred sales load
- A Rule 12b-1 fee or service fee that, in total, exceeds 0.25% of average net fund assets per year
- For closed-end shares: underwriting fees, commissions, or other offering expenses
Lock in 0.25%. One quarter of one percent. Not 0.50%. Not 1%. If a fund's 12b-1 fees and service fees combine to anything above 0.25%, calling it "no load" is a prohibited practice under NASAA policy.
Other Key IC Shares Rules
| Section | Rule |
|---|---|
| §A.3 | Must disclose breakpoint discounts and letter of intent features |
| §A.4 | Multi-class share recommendations require suitability analysis based on sales charge arrangement |
| §§B.1, B.2 | Cannot recommend simultaneous holdings in funds with similar objectives or switching between similar funds without reasonable grounds (anti-switching rule) |
| §C.1 | When stating yield, must disclose 1, 5, and 10 year average annual total return per SEC Form N-1A |
| §C.2 | Cannot compare fund performance to savings accounts or CDs without disclosing the fund is not FDIC-insured |
| §C.5 | Cannot project future fund performance |
Section 3: NASAA Investment Adviser Unethical Practices
NASAA Model Rule 102(a)(4)-1 is the investment adviser version of the dishonest practices rule. It overlaps with the broker-dealer rule in many places, but it has a handful of important differences that the Series 63 tests specifically because they are different.
The Ten-Business-Day Oral Discretion Rule [§(b)]
An investment adviser may exercise discretionary authority based on a client's oral instruction, but must obtain written discretionary authority within ten business days after the date of the first transaction placed pursuant to that oral authority.
This is the single biggest structural difference between the broker-dealer rule and the investment adviser rule. A broker-dealer agent cannot exercise any discretion without prior written authorization. An investment adviser gets a ten-business-day grace period. (Why ten business days and not five or fifteen? The NASAA drafting committee declined to explain, which is the drafting committee's prerogative.)
Borrowing and Lending With Clients [§§(e), (f)]
Here is the second structural difference. For an investment adviser, borrowing from a client is prohibited UNLESS the client is:
- A broker-dealer
- An affiliate of the adviser, or
- A financial institution in the business of loaning funds
Loaning to a client is prohibited unless the investment adviser itself is a financial institution in the lending business, or the client is an affiliate. Compare these narrow carve-outs to the broker-dealer rule, where the prohibition is flat and has no exceptions at all.
Test tip: If a question says "a broker-dealer agent may borrow from a customer if the customer is a bank," the answer is wrong. That is the investment adviser rule, not the broker-dealer rule. The broker-dealer rule has no bank carve-out.
Other Notable IA Prohibited Practices
| Section | Practice |
|---|---|
| §(a) | Unsuitable recommendations |
| §(c) | Excessive trading (churning) |
| §(g) | Misrepresenting qualifications, services, or fees |
| §(j) | Failing to disclose material conflicts of interest in writing before advice is rendered |
| §(k) | Guaranteeing a specific result |
| §(m) | Disclosing client identity or affairs without consent |
| §(p) | Failing to establish written insider trading policies under IAA §204A |
| §(u) | Accessing a client account using the client's own username or password (added 2019) |
| §§(w), (x), (y) | Failing to pay or attempting to avoid final judgments, arbitration awards, or regulatory fines (added 2022) |
Section 4: NASAA Vulnerable Adults Model Act
NASAA adopted the Model Act to Protect Vulnerable Adults from Financial Exploitation on January 22, 2016. The act was drafted after state regulators spent years watching the same pattern repeat: a caregiver, a relative, or sometimes a legitimate-seeming "financial consultant" would gain control over a senior's account and drain it. By the time a regulator found out, the money was gone. The model act gave securities firms a legal framework to pause, report, and (in some cases) delay suspicious disbursements before the money left the account.
Core Definitions
An eligible adult is a person who is 65 years of age or older, or a person subject to the state's Adult Protective Services statute. The number is 65, not 60 and not 70. A qualified individual is any agent, IAR, or person in a supervisory, compliance, or legal capacity at a broker-dealer or investment adviser. "Financial exploitation" means the wrongful or unauthorized taking, withholding, appropriation, or use of money, assets, or property of an eligible adult, including conduct using a power of attorney, guardianship, or conservatorship obtained through deception, intimidation, or undue influence.
Mandatory Reporting [§3]
If a qualified individual reasonably believes financial exploitation may have occurred, may have been attempted, or is being attempted, the qualified individual shall promptly notify both:
- Adult Protective Services, AND
- The state securities commissioner
Reporting is mandatory. The statute uses "shall." Good-faith reports carry immunity from administrative and civil liability under §4.
Permissive Disbursement Delay [§7]
A broker-dealer or investment adviser may delay a requested disbursement if the firm reasonably believes, after internal review, that the disbursement may result in financial exploitation. The statute uses "may," not "shall." Delay is optional. Reporting is not.
| Timing | Action required |
|---|---|
| Within 2 business days | Written notification to all authorized parties (unless a party is suspected) AND notify APS and the commissioner |
| Within 7 business days | Report internal investigation results to the Agencies |
| 15 business days | Maximum initial disbursement delay |
| 25 business days | Maximum delay with Agency-requested extension (15 plus 10) |
The memory hook is "2, 7, 15, 25." Two days to notify. Seven days to report results. Fifteen initial. Twenty-five maximum. Every exam that tests this section tests at least one of those four numbers.
Test tip: Reporting is mandatory ("shall"). Delay is permissive ("may"). If a question asks what the firm is required to do, the answer is reporting. If it asks what the firm may do, the answer could be delay.
Section 5: Sales at Financial Institutions
NASAA adopted the Sales at Financial Institutions Rule in 1998. It applies when a broker-dealer conducts broker-dealer services on the premises of a financial institution (bank, savings and loan, savings bank, credit union) where retail deposits are taken.
The Required Disclosures [§C.3]
Before or at account opening, the broker-dealer must disclose orally AND in writing that securities products:
- (A) Are NOT insured by the FDIC
- (B) Are NOT deposits or obligations of the financial institution and are not guaranteed by the institution
- (C) Are subject to investment risks, including possible loss of principal
The firm must also obtain a written acknowledgment of these disclosures from the customer.
The Short-Form Logo Disclosure [§C.4(b)(i)]
- Not FDIC Insured
- No Bank Guarantee
- May Lose Value
Permitted on advertisements and sales literature. Three lines. Memorize the exact wording.
The logo disclosure is not required for radio broadcasts of 30 seconds or less, for electronic signs, or for banners used only as location indicators.
Section 6: SEC Regulation Best Interest
Regulation Best Interest is the SEC's answer to a decade of fights over what broker-dealers owe their retail customers. In 2016, the Department of Labor tried to impose a strict fiduciary standard on anyone giving retirement advice. The financial services industry sued. In March 2018 the Fifth Circuit Court of Appeals vacated the DOL rule in Chamber of Commerce v. U.S. Department of Labor. The SEC stepped in with Reg BI (Rule 15l-1) in June 2019. It sits somewhere between the old suitability standard and a true fiduciary duty, and it is the rule that controls what a broker-dealer agent can say to a retail customer today.
The General Obligation
When a broker-dealer recommends any securities transaction or investment strategy to a retail customer, the broker-dealer must "act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer, or natural person who is an associated person making the recommendation ahead of the interest of the retail customer."
Retail Customer Definition
A retail customer is a natural person (or a legal representative of one) who (1) receives a recommendation and (2) uses the recommendation primarily for personal, family, or household purposes. This definition matters because Reg BI applies only to retail customers. Recommendations to institutional customers are still governed by FINRA Rule 2111.
The Four Component Obligations
Reg BI has four component obligations. The memory hook is D-C-C-C: Disclosure, Care, Conflict, Compliance.
1. Disclosure Obligation. Before or at the time of the recommendation, the broker-dealer must disclose in writing all material facts about (a) the scope and terms of the relationship, (b) material fees and costs, (c) the services offered and any limitations on them, and (d) all material conflicts of interest.
2. Care Obligation. The broker-dealer must exercise reasonable diligence, care, and skill. The firm must understand the risks, rewards, and costs of the recommendation. It must have a reasonable basis to believe the recommendation is in the retail customer's best interest based on the customer's investment profile. It must consider reasonable alternatives. This is evaluated as of the time the recommendation is made, not in hindsight.
3. Conflict of Interest Obligation. The firm must establish, maintain, and enforce written policies and procedures reasonably designed to identify all conflicts and, at minimum, disclose or eliminate them. Conflicts that incentivize associated persons to place their own interests ahead of the customer's must be mitigated. And the firm must identify and eliminate (not just disclose) sales contests, sales quotas, bonuses, and non-cash compensation based on the sale of specific securities or specific types of securities within a limited period.
4. Compliance Obligation. The firm must establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI as a whole.
How Reg BI Interacts With FINRA Rule 2111
FINRA amended Rule 2111 in 2020 to add Supplementary Material .08, which says: "This Rule shall not apply to recommendations subject to SEA Rule 15l-1 (Regulation Best Interest)." The practical effect is a clean split.
| Customer type | Governing standard |
|---|---|
| Retail customer | SEC Regulation Best Interest (Rule 15l-1) |
| Institutional customer | FINRA Rule 2111 (three-prong suitability) |
(The institutional cutoff is $50 million in total assets under FINRA Rule 4512(c). See Chapter 4 for more.)
Section 7: FINRA Rule 2111 and Rule 2121
FINRA Rule 2111: Suitability (Institutional Only, Post-2020)
Since the 2020 amendment, FINRA Rule 2111 applies only to institutional customers. For retail customers, Reg BI controls. But the three-prong suitability framework is still testable because it still applies to institutional recommendations, and because the Series 63 item writers like the symmetry between the old rule and the new one.
- Reasonable-basis suitability. The recommendation must be suitable for at least some investors. The firm must understand the product's risks and rewards.
- Customer-specific suitability. The recommendation must suit the particular customer based on that customer's investment profile.
- Quantitative suitability. A series of recommended transactions must not be excessive and unsuitable when taken together.
The investment profile elements are age, other investments, financial situation and needs, tax status, investment objectives, experience, time horizon, liquidity needs, and risk tolerance. For institutional accounts ($50 million or more in assets under FINRA Rule 4512(c)), customer-specific suitability is satisfied if the member reasonably believes the customer can evaluate risks independently and the customer affirmatively indicates it is exercising independent judgment.
FINRA Rule 2121: Fair Prices and Commissions
The 5% Policy was adopted by the NASD in 1943 as a guideline for evaluating markups on principal transactions. It has survived eight decades because nobody has come up with a better way to express "a reasonable markup." It has also survived eight decades of prep providers misreading it as a hard ceiling. It is not a hard ceiling. It never was.
The 5% Policy is "a guide, not a rule." A markup pattern of 5% or even less may be unfair or unreasonable depending on the circumstances. The seven factors for determining a fair markup are:
| # | Factor |
|---|---|
| 1 | Type of security (stocks warrant higher markups than bonds) |
| 2 | Availability of the security (effort and cost of obtaining it) |
| 3 | Price of the security (lower prices may justify higher percentages) |
| 4 | Amount of money involved (small transactions may warrant higher percentages) |
| 5 | Disclosure (does NOT cure an excessive markup) |
| 6 | Pattern of markups (consistent practice matters) |
| 7 | Nature of the member's business (cost of services considered) |
Test tip: A 3% markup can still be excessive. A 5% markup can still be reasonable. Disclosure does not justify an otherwise unfair markup. If a question treats 5% as a bright-line ceiling, that is a wrong answer.
Section 8: Soft Dollars and the Uniform Prudent Investor Act
Soft Dollars Under SEA §28(e)
A soft dollar arrangement is a practice in which an investment adviser pays higher commissions to an executing broker-dealer in exchange for research or brokerage services. SEA §28(e) creates a safe harbor for the practice so long as the services received are of the right kind.
| Acceptable soft dollar uses | Unacceptable soft dollar uses |
|---|---|
| Research reports | Computer hardware |
| Analysis | Telephone lines |
| Market data | Hiring personnel (salaries) |
| Seminars | Rent |
| Software used to provide analysis | Travel, entertainment, or meals |
The distinction is "research that informs investment decisions" on one side versus "general overhead that keeps the adviser in business" on the other. Soft dollar arrangements must be disclosed in the adviser's Form ADV Part 2 or brochure.
Uniform Prudent Investor Act (1994)
For 164 years, American trustees operated under the "prudent man rule" announced in Harvard College v. Amory in 1830. The rule, which was a genuine step forward at the time, told trustees to observe how "men of prudence, discretion and intelligence manage their own affairs." Over time courts read the rule as a categorical prohibition on anything that looked speculative, which came to mean almost anything other than government bonds and blue-chip stocks. By the 1980s, Harry Markowitz had already won a Nobel Prize for showing that a diversified portfolio of so-called speculative assets was often less risky than a concentrated portfolio of so-called safe ones. The Uniform Law Commission finally caught up in 1994 with the Uniform Prudent Investor Act, which formally adopted Modern Portfolio Theory into American trust law.
The Uniform Prudent Investor Act applies to trustees and fiduciaries investing trust assets, which includes investment advisers acting in a fiduciary capacity. Its core principles:
- Portfolio-level evaluation. Investment decisions are evaluated in the context of the portfolio as a whole, not individual securities in isolation.
- Risk and return are managed together. Trustees manage risk, not avoid it.
- No categoric restrictions. No investment type is per se imprudent. Options and futures are not specifically prohibited.
- Diversification is required unless special circumstances make it counterproductive.
- Delegation is permitted with reasonable care in selecting the agent, setting terms, and monitoring performance.
- Duty of loyalty. Investments must be made solely in the beneficiaries' interest. Social investing is inconsistent with the duty if it sacrifices returns.
- Ex ante measurement. Compliance is judged at the time of the decision, not in hindsight.
The UPIA shows up on Series 63 because NASAA has listed it as testable, and because it provides the conceptual foundation for what "prudent" investment advice means under state fiduciary standards.
Section 9: Thresholds, Traps, and Memory Tactics
Quantitative Thresholds for Chapter 3
| Threshold | What it governs | Source |
|---|---|---|
| 0.25% | Max 12b-1 / service fee to call a fund "no load" | NASAA IC Shares §A.2(iii) |
| 10 business days | Investment adviser oral discretion window | NASAA Rule 102(a)(4)-1(b) |
| 65 years | "Eligible adult" definition for vulnerable adult protections | NASAA Model Act §2(3)(a) |
| 2 business days | Notify authorized parties and Agencies after starting delay | NASAA Model Act §7(1)(b) |
| 7 business days | Report investigation results to Agencies | NASAA Model Act §7(1)(b)(iii) |
| 15 business days | Maximum initial vulnerable adult disbursement delay | NASAA Model Act §7(2)(b) |
| 25 business days | Maximum total delay with Agency extension | NASAA Model Act §7(2)(b) |
| 30 seconds | Radio broadcast exception for financial institution logo disclosure | NASAA Fin Inst Sales §C.4(b)(ii)(a) |
| 1, 5, 10 years | Average annual total return disclosure periods for fund yields | NASAA IC Shares §C.1 |
| 5% "Policy" | Markup guideline (NOT a hard rule) | FINRA Rule 2121 Supplementary Material .01 |
Common Traps
Trap 1: BD discretion vs. IA discretion. Broker-dealers need written authority before the first discretionary trade. Investment advisers get ten business days of oral discretion. If "10 days" appears in a broker-dealer discretion question, that is a trap.
Trap 2: Agent borrowing from customers. For broker-dealer agents, the prohibition is flat. No exceptions. A question may offer "unless the customer is a bank" as a distractor. That carve-out is the investment adviser rule, not the broker-dealer rule.
Trap 3: Sharing in profits or losses. The NASAA rule requires written authorization from both the customer and the firm. It does not require the agent's share to be proportional to the agent's contribution. Proportionality is a FINRA Rule 2150 rule that prep providers sometimes inject into the NASAA rule by mistake.
Trap 4: Vulnerable Adults, mandatory vs. permissive. Reporting is mandatory ("shall"). Delay is permissive ("may"). Read the verb in the question.
Trap 5: Eligible adult age. 65, not 60 and not 70. The number is the same as Medicare eligibility.
Trap 6: "No load" ceiling. 0.25%, not 0.50% and not 1%. One quarter of one percent.
Trap 7: Reg BI vs. Rule 2111. Reg BI applies to retail customers. Rule 2111 applies to institutional customers. If the fact pattern names a retail customer and the answer says Rule 2111, that is wrong post-2020.
Trap 8: The 5% Policy is a guide, not a rule. A 3% markup can be excessive. Disclosure does not cure it.
Trap 9: The "Adviser" title rule is new. The April 7, 2025 NASAA amendment prohibits broker-dealer agents from using "adviser" or "advisor" titles without investment adviser licensure. Older prep materials have not caught up.
Trap 10: Soft dollars. Research and analysis software are acceptable. Hardware, salaries, rent, travel, and meals are not. The SEC reads §28(e) narrowly.
Memory Tactics
- D-C-C-C. Reg BI obligations: Disclosure, Care, Conflict, Compliance.
- 2, 7, 15, 25. Vulnerable Adults timing: notify, report, initial delay, maximum delay.
- 65 = Medicare age. Eligible adult threshold.
- 10-day oral for IA, written-before for BD. Discretion rules differ by design.
- 0.25 = no load ceiling. One quarter of one percent.
- "Not FDIC / No Bank Guarantee / May Lose Value." Three lines of logo disclosure at financial institutions.
Domain 3 is 25% of the exam, and it is the domain where one additional hour of study translates most directly into additional points on test day. If the material in this chapter is still fuzzy, come back before attempting the next chapter. Chapter 4 (Communications) layers more specific numbers on top of the framework here.