5.7.3 Sharing Profits and Losses in a Customer Account
One of the most important characteristics of a good securities professional is that her advice is objective and free from personal bias. To ensure that, federal and state regulators generally prohibit investment advisers and their registered employees from linking their compensation to the profits or losses of their clients. In other words, aside from a few exceptions, IAs and IARs are prohibited from directly sharing in the profits or losses in a client account.
When this ethical standard is violated, it usually looks like one of two things. Most commonly, it occurs when a securities professional agrees to work for a percentage of any gains they earn for their client in a specified period (e.g., 20% of the profits earned during each calendar year). The other instance is when a professional promises to limit a client’s losses by reimbursing the client in the event that the account heads south.
In both of these common cases, the reason behind the prohibition against performance-based compensation has to do with the belief that it’s difficult for securities professionals to focus on a client’s investment objectives when they have a huge amount to gain or lose personally. If there is an incentive for them to take an above average risk in order to increase the potential for their personal gain, it might be hard for them to work in the best interest of their client.
There are a few notable exceptions to this