Unauthorized Trading
1
Definition
 Executing
a buy or sell transaction in a
customer account without their knowledge
and not agreed to by the customer (either
expressly or implicitly).
 Motive
is usually to generate commissions
or to conceal other activities.
2
Prohibitions Against
Unauthorized Transactions
 FINRA
Rules 2010 and 2020 and IM2310-2(a)(4)(A)(iii)
 Section
10(b) of the Securities Exchange
Act of 1934 and Rule 10b-5
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Prohibitions Against Unauthorized
Transactions

Beginning July 9, 2012, Unauthorized Transactions will
violate the provisions of FINRA Rule 2010. Specifically,
Endnote 8 of FINRA Regulatory Notice 11-02 states:
“Former NASD Rule 2310 contained interpretative
material (IMs) discussing a variety of types of
misconduct. Although FINRA eliminated those IMs, most
of the types of misconduct that the IMs discussed were
either explicitly covered by other rules or incorporated in
some form into the new suitability rule. The exception
was unauthorized trading, which had been discussed in
IM-2310- 2. However, it is well-settled that unauthorized
trading violates just and equitable principles of trade
under FINRA Rule 2010 (previously NASD Rule 2110).”
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Time and Price Discretion



NASD Rule 2510(d) states that the written discretionary
agreement requirement shall not apply to discretion as to
the price at which or the time when an order given by a
customer for purchase or sale of a definite amount of a
specified security shall be executed.
The authority to exercise time and price discretion will be
considered to be in effect until the end of the business
day on which it was granted.
Any exercise of time and price discretion must be
reflected on the order ticket.
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Time and Price Discretion-cont.

An exception to having to obtain prior written
authorization is time and price discretion. Time and
price discretion can be defined as verbal permission as
to the exact time and exact price in which a broker
executes the order for the customer. (good until the end
of the day)

State rules and NASD Conduct Rule 2510 prohibits
brokers from exercising discretionary authority in a
customer’s account without first obtaining written
discretionary authority from the customer.
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Examination Steps to detect
Unauthorized Trading
 Review


Inquire as to the merits of each disputed claim of
unauthorized trading
Timing of complaint in relationship to the date of the
disputed transaction
 Choose


customer complaints
a sampling of cancelled trades
Include accounts alleging unauthorized trading
Review documentation describing reason for
cancellation
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Examination Steps (cont’d)
 Look


for patterns of frequent cancellations
One particular security
One salesperson
 Determine
whether a significant number of
accounts with a cancelled trade had no
subsequent transactions
8
Examination Steps (cont’d)

Review customer accounts for suspicious trades
involving the same security or salesperson

Prepare chronological schedule

Review order tickets and confirmations
 Review client file/information to determine if
there is a current trading authorization which
grants another individual the authority to trade in
the account
9
Examination Steps (cont’d)

Review account activity to determine if there was
any unsuitable trading in the account
 Account activity should be reviewed to
determine if the transaction(s) is/are consistent
with the customer’s investment objectives and if
required, a customer’s risk tolerance (i.e., Low,
Medium or High)
10
Examination Steps (cont’d)
 Interview
salesperson(s) involved
 Interview customer(s)
 Interview branch manager and/or
supervisor of salesperson
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Examination Steps (cont’d)
Interview 3rd parties (sales assistants, operations
personnel, client’s spouse, etc…) who may have
first hand information relating to the
transaction(s)
 Review Supervisory Procedures Manual of
broker-dealer
 Determine if and what type of exception reports
are used by the broker-dealer to monitor trading
activity


Review firm’s exception reports for cancelled trades
and excessive trading activity
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Proof Checklist

Element of Violation


Salesperson executed the disputed trade(s) in
customer account(s)
Proof





Order tickets
Confirmations
Account statements
Salesperson’s commission records
Admission by salesperson that trades were executed
in customer’s account
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Proof Checklist

Element of Violation


Customer(s) did not authorize the transaction(s)
expressly or implicitly
Proof

Customer’s testimony
• Denial of expressed or implied authorization
• Realized or unrealized loss(es) were not the sole motivation
for filing the complaint

Documentation showing absence of customer
availability (i.e., travel itinerary, medical emergencies)
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Proof Checklist

Proof – (cont’d)





Absence of oral discretion including time and price
Trade(s) inconsistent with investment history
Account Statements
Firm’s records regarding disposition of complaint
Similar complaints from other customers of
salesperson
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Proof Checklist
 Element

of Violation
Customer promptly complained to firm or
salesperson
 Proof



Complaint letter to firm, state regulatory
agency, SEC, FINRA, etc.
Customer’s testimony
Firm’s records regarding disposition of
complaint
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