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SEC Regulations for Sharing Client Profits & Losses

Instructor: Yusuf Abdullah

Yusuf has taught Science and Mathematics at school level and Finance and Economics at University level. He has recently earned his Ph.D in Financial Econometrics.

The lesson deals with SEC and FINRA regulations that provide a framework for sharing in the clients' profit and losses. You'll learn about SEC Rule 9.1(f). and FINRA Rule 2150 and the conditions required.

Fiduciary Duty

Sam is a new investor and has been using the financial planning services of Liberty Funds in New York. His point of contact is Sarah who is a financial planner and a good investment advisor. As a part of the disclosure policy, Sam gets to know that the firm (Liberty Funds) has a number of clients who are related to the employees of the fund. While not worried, but curious, he asks how the firm would remove conflicts of interest in such cases. Sarah informs him that the firm follows SEC and FINRA rules related to conflicts of interest and treats each client equally. Fiduciary duty is the obligation of the investment advisor to work in the best interest of the client.

Relevant SEC and FINRA Regulations

Sarah goes on to state that the regulations related to investment advisors aim to prohibit the conflicts of interest related to a company insider, blood relations, investment in customer and client shared accounts, etc. As a result, a number of rules have been formulated by FINRA. While securities markets are regulated by SEC, FINRA regulates the professional in the securities industry. Both entities work together to provide a level playing ground for each investor. While FINRA is an independent and self-regulatory body, it is overseen by SEC.

SEC Rule 9.1(f). prohibits an investment professional or a registered member to partake in profits or losses of the clients. This means that the result of client accounts should not determine gain or losses for the advisor. The rationale behind this is that it may lead to favoring one client over another. Moreover, in cases where profits are shared asymmetrically, i.e., losses are not shared, the advisor may take excessive risk at the expense of the client.

FINRA Rule 2150 is similar to SEC Rule 9.1(f). but allows an investment professional or a registered member to partake in profits or losses of the clients if:

  • a prior written authorization is obtained from the investment firm
  • a prior written authorization is obtained from the client
  • share in profit and losses is pro-rated on the basis of the investment

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