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The Ethics and Professionalism Requirements of NASD Rule 2110
ule 2110, formerly Article III, Section 1 of the Rules of Fair Practice, commands that, "A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade". The basis of this rule is nothing less than Section 15A of the Securities Exchange Act of 1934, which requires the NASD, as a registered securities association, to have and enforce rules that "promote just and equitable principles of trade".
One court has suggested that Rule 2110 is to ensure "professionalism". Another court has suggested that the rule "states a broad ethical principle". The SEC has commented that the rule gives the NASD authority to impose sanctions for "moral standards" even if there is no "unlawful" conduct. The NASD itself has stated that the rule applies when there is "bad faith".
But what does all that really mean? Undeniably, the scope of such a rule could be far-reaching, perhaps even a regulatory "blank check".
To answer that question, we examined years of decisions by courts, state regulators and the NASD. We found, first, that Rule 2110 is applied not only to securities related conduct but also to any unethical business conduct. For example, Rule 2110 was violated when the broker:
Passed bad checks to his firm;
Cheated his firm to increase commissions;
Improperly obtained reimbursement for country club initiation fees from his firm; and
Improperly obtained a donation for his daughter's private school tuition from his firm's matching gift program by misrepresenting that he had contributed personal funds.
Second, we found that Rule 2110 is applied to numerous types of securities related activities, whether or not there is a violation of a more specific, companion provision of the NASD rules.
For example, in one decision, Alaska securities regulators found that the broker had violated the rule by 1) having a customer sign and date a blank new account form; 2) delaying (for three weeks) the execution of the investment program to which the customers had agreed; 3) altering the date on the new account form to mask the delay in program execution; 4) failing to return telephone calls of the customer promptly to discuss concerns of the customer; and 5) failing to promptly notify the firm's compliance department and keep it informed.
Brokers also have violated Rule 2110 when they have:
Sold securities that were neither registered nor exempt from registration;
Sold securities pursuant to private placement memoranda that contained material misrepresentations and omissions;
Improperly withheld customer funds and "deliberately" took advantage of an unsophisticated customer;
Induced an elderly customer to make a large, unsecured loan;
Delayed refunding customer funds to customers;
Forged signatures on documents;
Used customer funds for personal benefit rather than the customer's benefit;
Shared commissions from securities sales with an unlicensed individual;
Made unauthorized transactions in customer's account;
Recommended purchase of speculative warrants;
Failed to cooperate with NASD staff by not providing requested information;
Failed to disclose solicitation of outside business; and
Failed to honor arbitration award (as well as failed to produce documents in arbitration and failed to submit a dispute to arbitration as required by the NASD Code of Arbitration Procedure).
As one can see, while not a regulatory "blank check", Rule 2110 does have a significant reach. Brokers, therefore, need to be mindful of their obligation to act ethically and professionally, in all of their business activities.
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Sponsored by James J. Eccleston, an attorney representing stockbrokers, financial planners and
investors nationwide in arbitration, litigation and regulatory matters, and a shareholder with the law firm
Shaheen, Novoselsky, Staat, Filipowski & Eccleston
P.C.(www.snsfe-law.com). This Web site contains material
of general interest. It is neither intended to, nor constitutes, either legal advice or investment advice.
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