S.D. Admin. R. 20:08:03:06

Current through Register Vol. 51, page 67, December 16, 2024

Section 20:08:03:06 - Dishonest and unethical practices, broker-dealer, broker-dealer agents

Any broker-dealer or agent who engages in one or more of the following practices shall be deemed to have engaged in dishonest or unethical practices as used in SDCL 47-31B-412(d)(13) and such conduct may constitute grounds for denial, suspension, or revocation of registration or such other action authorized by statute.

(1) Broker-Dealers

(a) Engaging in a pattern of unreasonable and unjustifiable delays in the delivery of securities purchased by any of its customers and/or in the payment upon request of free credit balances reflecting completed transactions of any of its customers;

(b) Inducing trading in a customer's account which is excessive in size or frequency in view of the financial resources and character of the account;

(c) Recommending to a customer the purchase, sale, or exchange of any security without reasonable grounds to believe that such transaction or recommendation is suitable for the customer based upon reasonable inquiry concerning the customer's investment objectives, financial situation and needs, and any other relevant information known by the broker-dealer.

The rule in this subsection (c) may be referred hereinafter as the suitability rule;

(d) Executing a transaction on behalf of a customer without authorization to do so;

(e) Exercising any discretionary power in effecting a transaction for a customer's account without first obtaining written discretionary authority from the customer, unless the discretionary power relates solely to the time and/or price for the executing of orders;

(f) Executing any transaction in a margin account without securing from the customer a properly executed written margin agreement promptly after the initial transaction in the account;

(g) Failing to segregate customers' free securities or securities held in safekeeping;

(h) Hypothecating a customer's securities without having a lien thereon unless the broker-dealer secures from the customer a properly executed written consent promptly after the initial transaction, except as permitted by Rules of the Securities and Exchange Commission;

(i) Entering into a transaction with or for a customer at a price not reasonably related to the current market price of the security or receiving an unreasonable commission or profit;

(j) Failing to furnish to a customer purchasing securities in an offering, no later than the due date of confirmation of the transaction, either a final prospectus or a preliminary prospectus and an additional document, which together include all information set forth in the final prospectus;

(k) Charging unreasonable and inequitable fees for services performed, including miscellaneous services such as collection of monies due for principal, dividends or interest, exchange or transfer of securities, appraisals, safekeeping, or custody of securities and other services related to its securities business;

(l) Offering to buy from or sell to any person any security at a stated price unless such broker-dealer is prepared to purchase or sell, as the case may be, at such price and under such conditions as are stated at the time of such offer to buy or sell;

(m) Representing that a security is being offered to a customer "at the market" or a price relevant to the market price unless such broker-dealer knows or has reasonable grounds to believe that a market for such security exists other than that made, created, or controlled by such broker-dealer, or by any such person for whom the broker-dealer is acting or with whom the broker-dealer is associated in such distribution, or any person controlled by, controlling, or under common control with such broker-dealer;

(n) Effecting any transaction in, or inducing the purchase or sale of, any security by means of any manipulative, deceptive, or fraudulent device, practice, plan, program, design, or contrivance, which may include:

(1) Effecting any transaction in a security which involves no change in the beneficial ownerships thereof;

(2) Entering an order or orders for the purchase or sale of any security with the knowledge that an order or orders of substantially the same size, at substantially the same time and substantially the same price, for the sale of any such security, has been or will be entered by or for the same or different parties for the purpose of creating a false or misleading appearance of active trading in the security or a false or misleading appearance with respect to the market for the security. However, nothing in this subsection prohibits a broker-dealer from entering bona fide agency cross transactions for customers;

(3) Effecting, alone or with one or more other persons, a series of transactions in any security creating actual or apparent active trading in such security or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others;

(o) Guaranteeing a customer against loss in any securities account of such customer carried by the broker-dealer or in any securities transaction effected by the broker-dealer or in any securities transaction effected by the broker-dealer with or for such customer;

(p) Publishing or circulating, or causing to be published or circulated, any notice, circular, advertisement, newspaper article, investment service, or communication of any kind which purports to report any transaction as a purchase or sale of any security unless such broker-dealer believes that such transaction was a bona fide purchase or sale of such security; or which purports to quote the bid price or asked price for any security, unless such broker-dealer believes that such quotation represents a bona fide bid for, or offer of, such security;

(q) Using any advertising or sales presentation in such a fashion as to be deceptive or misleading. An example of such practice would be a distribution of any nonfactual data, material, or presentation based on conjecture, unfounded or unrealistic claims or assertions in any brochure, flyer, or display by words, pictures, graphs, or otherwise designed to supplement, detract from, supersede, or defeat the purpose or effect of any prospectus or disclosure; or

(r) Failing to disclose that the broker-dealer is controlled by, controlling, affiliated with, or under common control with the issuer of any security before entering into any contract with or for a customer for the purchase or sale of such security, the existence of such control to such customer, and if such disclosure is not made in writing, it shall be supplemented by the giving or sending of written disclosure at or before the completion of the transaction;

(s) Failing to make a bona fide public offering of all of the securities allotted to a broker-dealer for distribution, whether acquired as an underwriter, a selling group member, or from a member participating in the distribution as an underwriter or selling group member; or

(t) Failure or refusal to furnish a customer, upon reasonable request, information to which the customer is entitled, or to respond to a formal written request or complaint.

(2) Agents

(a) Engaging in the practice of lending or borrowing money or securities from a customer, or acting as a custodian for money, securities, or an executed stock power of a customer;

(b) Effecting securities transactions not recorded on the regular books or records of the broker-dealer which the agent represents, unless the transactions are authorized in writing by the broker-dealer prior to execution of the transaction;

(c) Establishing or maintaining an account containing fictitious information in order to execute transactions which would otherwise be prohibited;

(d) Sharing directly or indirectly in profits or losses in the account of any customer without the written authorization of the customer and the broker-dealer which the agent represents;

(e) Dividing or otherwise splitting the agent's commissions, profits, or other compensation from the purchase or sale of securities with any person not also registered as an agent for the same broker-dealer, or for a broker-dealer under direct or indirect common control.

(A) Notwithstanding the provisions of § 20:08:03:06(2)(e) of this rule, a broker-dealer or agent:

(i) May share a commission, discount, or other remuneration from the purchase or sale of a security with:

(a) A depository institution as defined in SDCL 47-31 B-102(5).

(b) A bank holding company approved by the board of governors of the federal reserve bank pursuant to the Bank Holding Company Act of 1956, 70 Stat. 133, 12 U.S.C. 1841, as amended; or

(c) A financial holding company approved by the board of governors of the federal reserve bank pursuant to the Bank Holding Company Act of 1956, 70 Stat. 133, 12 U.S.C. 1841, as amended;

(B) May provide to an employee of a depository institution compensation for the referral of a customer if the compensation is a nominal one-time cash fee of a fixed dollar amount and the payment of the fee is not contingent on whether the referral results in a purchase or sale of a security.

(f) Engaging in conduct specified in subsection (1)(b),(c),(d),(e),(f),(i),(j),(n),(o),(p), or (q).

The conduct set forth above is not inclusive. Engaging in other conduct such as forgery, embezzlement, nondisclosure, incomplete disclosure or misstatement of material facts, or manipulative or deceptive practices shall also be grounds for denial, suspension or revocation of registration.

(3) Broker-dealers and agents

(a) Any acts or practices enumerated in subsection (1) above.

(b) In connection with the solicitation of a sale or purchase of an OTC unlisted non-NASDAQ security, failing to promptly provide the most current prospectus or the most recently filed periodic report filed under Section 13 of the Securities Exchange Act when requested to do so by a customer.

(c) Marking any order tickets or confirmations as unsolicited when in fact the transaction was solicited.

(d) For any month in which activity has occurred in a customer's account, but in no event less than every three months, failing to provide each customer with a statement of account which with respect to all OTC non-NASDAQ equity securities in the account, contains a value for each such security based on the closing market bid on a date certain. However, this subsection applies only if the firm has been a market maker in such security at any time during the month in which the monthly or quarterly statement is issued.

(e) Failing to comply with any applicable provision of the Conduct Rules and any other Rules of Fair Practice of FINRA or any applicable fair practice, ethical standard, or fiduciary standard promulgated by the Securities and Exchange Commission or by a self-regulatory organization approved by the Securities and Exchange Commission.

(4) Sale of investment company shares by broker-dealers or agents. Any broker-dealer or agent who engages in one or more of the following practices shall be deemed to have engaged in dishonest or unethical practices as used in SDCL 47-31B-412(d)(13) and such conduct may constitute grounds for denial, suspension, or revocation of registration or such other action authorized by statute.

(a) Sales load communications:

(1) In connection with the offer or sale of investment company shares, failing to adequately disclose to a customer all sales charges, including asset based and contingent deferred sales charges, which may be imposed with respect to the purchase, retention or redemption of such shares.

(2) In connection with the solicitation of investment company shares, stating or implying to a customer, either orally or in writing, that the shares are sold without a commission, are "no load" or have "no sales charge" if there is associated with the purchase of the shares:

(i) a front-end load;

(ii) a contingent deferred sales load;

(iii) an SEC Rule 12b-1 fee or a service fee which exceeds .25 percent of average net fund assets per year; or

(iv) in the case of closed-end investment company shares, underwriting fees, commissions, or other offering expenses.

(3) In connection with the solicitation of investment company shares, failing to disclose to a customer any relevant:

(i) sales charge discount on the purchase of shares in dollar amounts at or above a breakpoint; or

(ii) letter of intent feature, if available, which will reduce the sales charges.

(4) In connection with the solicitation of investment company shares, recommending to a customer the purchase of a specific class of investment company shares in connection with a multi-class sales charge or fee arrangement without reasonable grounds to believe that the sales charge or fee arrangement associated with such class of shares is suitable and appropriate based on the customer's investment objectives, financial situation and other securities holdings, and the associated transaction or other fees.

(b) Recommendations.

(1) In connection with the solicitation of investment company shares, recommending to a customer the purchase of investment company shares which results in the customer simultaneously holding shares in different investment company portfolios having similar investment objectives and policies without reasonable grounds to believe that such recommendation is suitable and appropriate based on the customer's investment objectives, financial situation and other securities holdings, and any associated transaction charges or other fees.

(2) In connection with the solicitation of investment company shares, recommending to a customer the liquidation or redemption of investment company shares for the purpose of purchasing shares in a different investment company portfolio having similar investment objectives and policies without reasonable grounds to believe that such recommendation is suitable and appropriate based on the customer's investment objectives, financial situation and other securities holdings, and any associated transaction charges or other fees.

(c) Disclosure Statements.

(1) In connection with the solicitation of investment company shares, stating or implying to a customer the fund's current yield or income without disclosing the fund's most recent average annual total return, calculated in a manner prescribed in SEC Form N-1A, for one, five and ten year periods and fully explaining the difference between current yield and total return. However, if the fund's registration statement under the Securities Act of 1933 has been in effect for less than one, five, or ten years, the time during which the registration statement was in effect shall be substituted for the periods otherwise prescribed.

(2) In connection with the solicitation of investment company shares, stating or implying to a customer that the investment performance of an investment company portfolio is comparable to that of a savings account, certificate of deposit or other bank deposit account without disclosing to the customer that the shares are not insured or otherwise guaranteed by the FDIC or any other government agency and the relevant differences regarding risk, guarantees, fluctuation of principal and/or return, and any other factors which are necessary to ensure that such comparisons are fair, complete, and not misleading.

(3) In connection with the solicitation of investment company shares, stating or implying to a customer the existence of insurance, credit quality, guarantees or similar features regarding securities held, or proposed to be held, in the investment company's portfolio without disclosing to the customer other kinds of relevant investment risks, including interest rate, market, political, liquidity, or currency exchange risks, which may adversely affect investment performance and result in loss and/or fluctuation of principal notwithstanding the creditworthiness of such portfolio securities.

(4) In connection with the offer or sale of investment company shares, stating or implying to a customer:

(i) that the purchase of such shares shortly before an ex-dividend date is advantageous to such customer unless there are specific, clearly described tax or other advantages to the customer; or

(ii) that a distribution of long-term capital gains by an investment company is part of the income yield from an investment in such shares.

(5) In connection with the offer or sale of investment company shares, making:

(i) projections of future performance;

(ii) statements not warranted under existing circumstances; or

(iii) statements based upon nonpublic information.

(d) Prospectus.

In connection with the solicitation of investment company shares, the delivery of a prospectus is not dispositive that the broker-dealer or agent has fulfilled the duties set forth in the subsections of this rule.

(e) Definitions. For purposes of this subsection (4), the following terms mean:

(1) "Recommend": any affirmative act or statement that endorses, solicits, requests, or commends a securities transaction to a customer or any affirmative act or statement that solicits, requests, commands, importunes or intentionally aids such person to engage in such conduct.

(2) "Solicitation": any oral, written or other communication used to offer or sell investment company shares excluding any proxy statement, report to shareholders, or other disclosure document relating to a security covered under Section 18(b)(2) of the Securities Act of 1933 that is required to be and is filed with the Securities and Exchange Commission or any national securities organization registered under Section 15A of the Securities Exchange Act of 1934.

The conduct set forth above in this section is not inclusive. Engaging in other conduct such as forgery, embezzlement, nondisclosure, incomplete disclosure or misstatement of material facts, or manipulative or deceptive practices shall also be grounds for denial, suspension or revocation of registration.

(5) Variable contracts: The term, variable contract, includes variable annuities. Because owners of Variable Contracts assume certain investment risks, the contracts are also considered securities and are subject to SDCL chapter 47-31B. As securities, the sales and distribution of variable contracts are fully subject to sales practice rules. The suitability rule, as set forth in § 20:08:03:06(1)(c), applies when a variable contract is recommended and sold to a customer. Questions of suitability will arise when the investor (i) states that his or her life insurance needs are adequately met; (ii) the investor expresses preference for an investment other than an insurance product; (iii) the investor has the inability to fully appreciate how much of the purchase payment or premium is allocated to cover insurance or other costs, and the investor's ability to understand the complexity of Variable Contracts generally; (iv) the investor's willingness to invest a set amount on a yearly basis; (v) the investor's need for liquidity and short-term investment; (vi) the investor's immediate need for retirement income; and (vii) the investor's investment sophistication and whether he or she is able to monitor the investment experience of the separate account.

It shall be deemed to be a dishonest or unethical practice as used in SDCL 47-31B-412(d)(13), for a broker-dealer or agent of a broker-dealer to violate FINRA Rules 2320 and 2330 or to exclude any of the following procedures below in this subsection (5), in order to determine suitability when recommending to a customer Variable Contracts.

(a) The agent should make reasonable efforts to obtain the customer's occupation, marital status, age, number of dependents, investment objectives, risk tolerance, tax status, previous investment experience, liquid net worth, other investments and savings, and annual income;

(b) The agent should discuss all relevant facts with the customer, including liquidity issues such as potential surrender charges and the Internal Revenue Service (IRS) penalty fees, including mortality and expense charges, administrative charges, and investment advisory fees; any applicable state and local government premium taxes, inheritance taxes and market risk;

(c) The agent should seek to ensure that the variable contract application and any other information provided by the customer is complete and accurate, and promptly forwarded to a registered principal of the broker for review;

(d) The registered agent and registered principal should review the customer's investment objectives, risk tolerance, and other information to determine that the variable contract as a whole and the underlying sub-accounts recommended to the customer are suitable prior to approving the transaction;

(e) The registered agent should have a thorough knowledge of the specifications of each variable contract that is recommended, including the death benefit, fees and expenses, sub-account choices, special features, withdrawal privileges, and tax treatment;

(f) A current prospectus should be given to the customer when a variable contract is recommended and should be discussed with the customer;

(g) The registered agent should inquire about whether the customer has a long-term investment objective and typically should recommend a variable contract only if the answer to that question, with consideration of other product attributes, is affirmative. The registered agent should make sure that the customer understands the effect of surrender charges on redemptions and that a withdrawal prior to the age of 591/2 could result in a tax penalty. Customers 591/2 should be informed when surrender charges apply to withdrawals;

(h) The broker should develop procedures to screen for any customer whose age may make a long-term investment inappropriate;

(i) Brokers should establish procedures to require a principal's careful review of variable contract investments that exceed a stated percentage to the customer's net worth, and any contract in which a customer is investing more than a stated dollar amount;

(j) When a registered agent recommends the purchase of a variable contract for any tax-qualified retirement account (e.g., 401(k) plan, IRA), the registered agent should disclose to the customer that the tax deferred accrual feature is provided by the tax-qualified retirement plan and that the tax deferred accrual feature of the variable contract is unnecessary;

(k) A registered agent should conduct an especially comprehensive suitability analysis prior to approving the sale of a variable contract with surrender charges to a customer in a tax-qualified account subject to plan minimum distribution requirements;

(l) The broker should have an exchange or replacement analysis document or utilize an existing form authorized by a state insurance commission or other regulatory agency.

If such a document is used, it should be completed for all variable contract replacements and should include an explanation of the benefits of replacing one contract for another variable contract considering such matters as product enhancements and improvements, lower cost structures, and surrender charges. The document also should be signed by the customer, the registered agent, and the registered principal; and

(m) The broker should have a compliance procedure that will "red flag" registered agents who have a high rate of variable contract replacements or rollovers so that the firm can determine whether the replacements are suitable.

S.D. Admin. R. 20:08:03:06

27 SDR 5, effective 7/31/2000; 28 SDR 48, effective 10/10/2001; 30 SDR 211, effective 7/1/2004; 37 SDR 112, effective 12/9/2010.

General Authority: SDCL 47-31B-605(a)(1) and (2).

Law Implemented: SDCL 47-31B-103, 47-31B-412, 47-31B-605(a)(2).