Business conduct and conduct of business requirements for intermediaries
Domain 4 tests the Code of Conduct for Persons Licensed by or Registered with the SFC - the standards applied to selling, advising, executing and reporting, and the yardstick in most disciplinary cases.
General Principles
The Code opens with twelve General Principles: honesty and fairness; diligence; capabilities; information about clients; information for clients; conflicts of interest; compliance; client assets; client accounts; orders; transactions; and marketing. They are principles, not checklists, and the SFC applies them to conduct the specific paragraphs do not cover.
Know your client and suitability
Paragraph 5.2 requires that any recommendation be reasonably suitable for the client in light of the firm's knowledge of the client's financial situation, investment experience and objectives. Suitability must be assessed and recorded, not assumed. Derivative products require a risk disclosure statement and a written client agreement.
Orders and best execution
Client orders take priority over house orders, and front-running is prohibited. Where orders are aggregated, allocation must be fair and disclosed; reallocation that disadvantages clients is not permitted. Execution must be on the best available terms, considering price, speed, likelihood of execution and settlement, size and nature of the order - best execution is not simply the lowest price.
Conflicts and soft dollars
Conflicts must be avoided, or disclosed and managed. Research and other benefits received from brokers must benefit clients and relate to the execution of orders; travel, accommodation and entertainment cannot be paid for out of client commissions.
Records and marketing
Order and account records must be kept for at least seven years. Advertisements must be accurate and not misleading, must not imply guaranteed returns, and marketing of SFC-authorised schemes must follow the advertising guidelines.
Worked example
A broker receives a client buy order for a stock and a proprietary order for the same stock. The client order must be executed first. If the two are aggregated, the average price must be allocated fairly and the client must not bear the house position's loss.
Traps
Treating best execution as best price; assuming disclosure alone cures a conflict; forgetting the seven-year retention rule; believing the General Principles are unenforceable.