Sharing in Profits and Losses in a Customer Account

Lesson

Investment advisers and their representatives must adhere to strict guidelines when sharing profits and losses in a customer account to avoid conflicts of interest and ensure the client's best interests are always prioritized.

Practice Question #1

Which of the following is required for an investment adviser to share in the profits and losses of a customer's account?

A) Written consent from the client

B) Approval from the custodian

C) A discretionary account

D) A fee-based account

Select an option above to see an explanation here.

A) Written consent from the client is required for an adviser to share in profits and losses. B) Approval from the custodian is not required, but the arrangement should be disclosed. C) A discretionary account is not required to share profits and losses. D) A fee-based account is not required to share profits and losses.

Terms

Sharing in Profits and Losses:: An arrangement where an investment adviser or representative participates in the gains and losses of a customer's account.
Written Consent:: A formal agreement between parties, often required to share profits and losses in a customer account.
Proportionality:: The concept that sharing in profits and losses should be based on the adviser's or representative's financial contribution to the account.

Practice Question #2

What is the primary concern when an investment adviser shares in the profits and losses of a customer's account?

A) Churning

B) Unauthorized trading

C) Conflict of interest

D) Suitability

Select an option above to see an explanation here.

A) Churning is a concern in any client account but is not specific to sharing in profits and losses. B) Unauthorized trading is a concern in any client account but is not specific to sharing in profits and losses. C) The primary concern when sharing in profits and losses is the potential for a conflict of interest. D) Suitability is a concern in any client account but is not specific to sharing in profits and losses.

Historical Example

In the late 1990s, a prominent investment adviser was found to have engaged in sharing in profits and losses in customer accounts without obtaining proper written consent. This led to regulatory fines, penalties, and significant reputational damage for the adviser and their firm.

Practice Question #3

Which of the following is NOT an ethical practice when sharing in profits and losses in a customer account?

A) Obtaining written consent from the client

B) Disclosing the arrangement to the custodian

C) Basing the sharing arrangement on the adviser's financial contribution to the account

D) Engaging in excessive trading to generate commissions

Select an option above to see an explanation here.

A) Obtaining written consent from the client is an ethical practice. B) Disclosing the arrangement to the custodian is an ethical practice. C) Basing the sharing arrangement on the adviser's financial contribution to the account is ethical. D) Engaging in excessive trading to generate commissions or churning is an unethical practice.

Real-World Example

An investment adviser and their client agree to share in the profits and losses of the client's account. The adviser contributes 25% of the initial investment and receives 25% of the gains and losses. Both parties sign a written consent form, and the arrangement is disclosed to the custodian and the adviser's firm.