A stockbroker has a fundamental responsibility for fair dealing. The rules and regulations of the securities industry require a stockbroker to treat his customer in a fair manner characterized by high standards of honesty and integrity.
Besides being governed by securities laws and commercial regulations, stockbrokers are subject to the rules of self-regulatory organizations such as the Financial Industry Regulatory Authority (FINRA). FINRA Rules of Fair Practice impose the following standard upon members of the securities industry: "A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade." This standard (along with other FINRA rules) is enforceable as the standard to which public customers are entitled to depend.
Since stockbrokers are compensated through commissions on the transactions which they execute, there is some inherent tension between the broker's interests and the interests of the customer. It is the broker's responsibility to always place the interests of the customer first. The broker's obligations and duty to the customer must be paramount, and for a broker conducting himself properly this will not present a conflict.
A prime example of the broker's obligation to keep the customers interests first is the question of trading frequency in the account. The broker is obligated to recommend trades which meet the needs of the customer, not merely to generate commissions for himself. Excessive trading by a broker involving purchasing and selling securities for the purpose of increasing commissions, is known as "churning", and it is prohibited.
A broker also has a duty to disclose all material information in connection with an investment recommendation. In general, the broker has an obligation to disclose all information which may be reasonably relevant to an investor to take into consideration in making an informed investment decision. In particular, a broker has an obligation to disclose the various risks and level of risk of an investment recommendation.
Brokers have a duty to be truthful in all communications with customers. Brokers are held to a standard that their communications should provide a sound basis for evaluating any securities being recommended. In particular, exaggerated, false or misleading statements are prohibited in a stockbroker's communications with the public.
A broker may not execute trades in a customer's account unless the customer has approved and authorized the trade in advance, or has given the broker discretionary trading authority (the power for the broker to make trading decisions in the account). A broker may not engage in unauthorized trading. On the other hand, a broker has an obligation to carry out the instructions of the customer.
Perhaps one of the most important and least known obligations of a stockbroker is the requirement for all investment recommendations to be consistent with the customer's financial status, investment objectives, level of understanding and risk tolerance. According to this suitability rule and the requirement of the "know your customer" rule, a broker must have reasonable grounds for believing that the recommendation is suitable and appropriate for that particular customer based upon his individual financial situation, understanding and needs.
It is the responsibility of the stockbroker to make reasonable efforts to obtain the relevant information regarding the customer and recommended investments. The "know your customer" rule requires that the broker obtain a customer profile so that the broker will be able to properly match the needs of the customer with appropriate investments. The broker is also required to use care in connection with knowing the investments which are recommended.
Certain forms of investments pose particular problems, and therefore, brokers have additional duties in connection with such activity. For example, trading with money borrowed from the brokerage firm, known as trading on margin, is a carefully regulated activity. Brokers also have special responsibilities in connection with options trading and private placement limited partnerships among other forms of investments.
A brokerage firm has a responsibility to supervise the activities of its brokers. The firm must maintain a system to enforce compliance with rules and to prevent violations of securities laws and regulations. The responsibility of the brokerage firm to supervise its agents is especially important since many customers maintain their account with a particular firm and follow the advice of their broker based upon the name of the firm standing behind the broker.
A stockbroker and brokerage firm have the responsibility to conduct themselves with good faith in their interaction with customers. Customers place their trust and reliance in the broker and brokerage firm to treat them in accordance with the high standards imposed upon the securities profession. The fact that many customers place their total faith and reliance in the broker viewing him as a trusted advisor and putting their financial affairs in his hands, certainly should heighten the broker's responsibilities and duty of good faith.