Communication with Customers and Prospects

Required disclosures

Some things must be affirmatively disclosed rather than merely not misrepresented.

Material facts about the security and the transaction. The anti-fraud provision in section 101 of the Act prohibits omitting a material fact necessary to make statements not misleading, which converts a great many silences into violations. A yield presented without its risk, a tax exemption presented without the alternative minimum tax consequence, and a distribution rate presented without the fact that it is funded from capital are all omissions of this kind.

Control relationships. The NASAA statement of policy makes it a dishonest or unethical practice for a broker-dealer to fail to disclose, before entering into a contract with or for a customer, that it is controlled by, controlling, affiliated with or under common control with the issuer of the security. Where that disclosure is not made in writing, it must be supplemented in writing at or before completion of the transaction.

Capacity and compensation. The confirmation must disclose whether the firm acted as agent or principal and what it earned, which is a federal requirement under SEC Rule 10b-10 and is testable here.

A prospectus. Failing to furnish a customer purchasing securities in an offering, no later than the due date of the confirmation, with either a final prospectus or a preliminary prospectus plus a document containing the remaining information, is itself an enumerated unethical practice.

And where securities are sold at a financial institution — a bank branch, for example — NASAA's Rules for Sales of Securities at Financial Institutions require disclosure that the securities are not insured by the FDIC, are not deposits or obligations of the institution and are not guaranteed by it, and are subject to investment risk including possible loss of principal. Setting and signage must distinguish the securities activity from the deposit-taking activity.

Unlawful representations

Section 403 of the Act states the rule plainly, and the exam tests it in several disguises: neither registration nor the filing of a sales literature document with the Administrator constitutes a finding by the Administrator that the document is true, complete or not misleading — and it is unlawful to make any representation to a prospective purchaser that any of those things means the Administrator has passed on the merits of, recommended, or approved the security or the transaction.

So an agent may say they are registered. An agent may not say that registration means the state approved them, endorsed them, found them qualified, or vouched for anything they sell. The parallel federal rule about the SEC works the same way.

A related prohibition from the statement of policy, added in the 2022 amendments and heavily relevant now: using a title, purported credential or professional designation containing any variant of the terms adviser or advisor without being licensed as an investment adviser or investment adviser representative, unless otherwise permitted by law. A registered representative who calls themselves a financial advisor on a business card may be making an unlawful representation about the capacity in which they act.

And two more, from the same statement of policy. Representing that a security is offered at the market, or at a price relevant to the market price, unless the firm knows or has reasonable grounds to believe a market exists other than one it makes, creates or controls itself. And publishing anything reporting a transaction as a purchase or sale, or quoting a bid or asked price, unless the firm believes the transaction or quotation was bona fide.

The guarantee prohibition

It is a dishonest or unethical practice for a broker-dealer or agent to guarantee a customer against loss in any securities account or in any securities transaction.

There is no exception and no dollar threshold. It does not matter that the representative could afford it, that they meant well, or that the customer suggested it. Offering to make a customer whole out of your own pocket after a bad recommendation is the most common way this rule is broken, and it is understandable and prohibited.

Note what the word guaranteed actually means under the Act: guaranteed as to payment of principal, interest or dividends. So describing a security as guaranteed is a factual claim about a third party's undertaking to pay, not a promise about performance. A GNMA security is guaranteed as to timely payment of principal and interest; describing it as guaranteed against loss of market value is false.

The federal counterpart, FINRA Rule 2150, prohibits the same thing and adds the sharing prohibition covered in lesson 3.3.

Related prohibitions on promises: representing that a specific result will be achieved, that a return is assured, or that a customer cannot lose. And the newer clauses of the statement of policy address the other end of a dispute — failing to pay or attempting to avoid paying a final judgment or arbitration award from a customer-initiated proceeding, and failing to pay a fine, civil penalty, restitution or disgorgement order imposed by the SEC, a state or an SRO, are themselves dishonest or unethical practices.

Advertising, sales literature and electronic media

The standard: using any advertising or sales presentation in a way that is deceptive or misleading. The statement of policy gives the example — distributing non-factual data, material or presentation based on conjecture, or unfounded or unrealistic claims, in a brochure, flyer or display, by words, pictures or graphs, designed to supplement, detract from, supersede or defeat the purpose or effect of any prospectus or disclosure.

That last clause is the useful one. Sales material that undercuts the prospectus is prohibited even when every individual statement in it is true.

Section 403 gives the Administrator authority to require the filing of any prospectus, pamphlet, circular, form letter, advertisement or other sales literature addressed to prospective investors, unless the security or transaction is exempt or the security is federal covered.

Federal rules apply alongside. FINRA Rule 2210 classifies communications by audience size: 25 or fewer retail investors in any 30 calendar-day period is correspondence; more than 25 is a retail communication requiring principal approval before the earlier of use or filing; institutional-only communications are a third category. Retail communications concerning investment companies, direct participation programs, collateralized mortgage obligations and derivative products are filed with FINRA within 10 business days of first use; a new member's retail communications and certain rankings are filed 10 business days before use.

The content standards apply regardless of medium. Email, text messages, websites, blog posts and social media used to discuss the firm's business are communications, subject to the same standards, the same approval requirements and the same retention obligations. Two distinctions the exam draws in this area: static content on a firm's website or a profile page is generally treated as a retail communication requiring prior principal approval, while interactive real-time content is generally supervised rather than pre-approved. And a representative who shares or endorses third-party content may adopt it, making it their own communication.

A tombstone advertisement is the narrow exception during a registered offering: it may name the issuer, the security, the amount, the price, the underwriters and where a prospectus may be obtained, and it must state that it is not an offer to sell. Anything more is a prospectus.