Series 65: 10.11.4. Sharing Profits And Losses In A Customer Account

10.11.4. Sharing Profits and Losses in a Customer Account

One of the most important characteristics of a good securities professional is that her advice is objective and free from personal bias. To ensure that this is the case, federal and state regulators generally prohibit investment advisers and their registered employees from linking their compensation to the profits and losses of their clients. In other words, aside from a few exceptions, IAs and IARs are prohibited from directly sharing in the profits or losses in a client account.

When this ethical standard is violated, it usually looks like one of two things. Most commonly, it occurs when a securities professional agrees to work for a percentage of any gains he earns for his client in a specified period (e.g., 20% of the profits earned during each calendar year). The other instance is when a professional promises to limit a client’s losses by reimbursing the client in the event that the account heads south.

In both of these cases, the reason behind this prohibition against performance-based compensation has to do with the belief that it’s difficult for securities professionals to focus on a client’s investment objectives when they have a huge amount to gain or lose personally. If there is an incentive for them to take an above average risk in order to increase the potential for their personal gain, it might be hard for them to work in the best interest of the client.

There are a few notable exceptions to this rule that may show up on the exam