Shingle Theory

What Is the Shingle Theory?

The shingle theory portrays the behavior of a hypothetical broker-dealer who keeps up with great ethics and high conduct while transacting securities. The shingle theory concerns the standards of professional conduct of broker-dealers and informs the regulation of financial markets in the United States. That's what the theory indicates, when they start advertising their services to the public, broker-dealers are responsible for sticking to the best practices of the financial services industry.

In particular, these best practices require broker-dealers to completely unveil all significant data to their customers with respect to the securities they sell — especially as it connects with the pricing of those securities and any special compensation received by the broker for its sale.

Grasping the Shingle Theory

"Shingle" in the term shingle theory is derived from a similarity that is pertinent to traditional retail businesses: If a retail store "hangs a shingle" to show that it is just getting started, customers of that business can expect that the store will deal reasonably with its customers and keep every fundamental regulation and regulations.

By extension, that's what broker dealer firms "hang a shingle" in the financial services marketplace are likewise expected to act in an ethical and transparent way.

The main utilization of the term emerged in a 1939 legal case including the Securities and Exchange Commission (SEC). This case included a broker-dealer that was found to have acted unethically by cheating its customers and neglecting to teach them about the overarching market prices of the securities it sold. The judge, in this case, favored the SEC, maintaining the SEC's decision to disavow the broker-dealer's license to operate.

This initial judgment has been duplicated in several subsequent court cases. Thus, the shingle theory keeps on being pertinent in the financial markets today.

To keep away from the appearance or allegation of bad behavior, broker-dealers ought to guarantee that the prices charged to their clients are inside a reasonable reach, compared to the general market price of those securities, and that their clients are aware of those general market prices.

Shingle Theory and Fiduciary Duty

Fundamentally, the key illustration of the shingle theory is that broker-dealers ought to continuously act like they have a fiduciary duty toward their customers (even in cases where they may not technically be their clients' guardians).

A fiduciary is a person or organization that acts for the benefit of someone else or persons, putting their clients' interests ahead of their own, with a duty to safeguard good faith and trust. Being a fiduciary hence requires being bound both legally and ethically to act in the other's best interests.

Finance professionals who are guardians are expected to act to the greatest advantage of their customers and furthermore give legitimate and responsible ideas connecting with securities.

Illustration of the Shingle Theory

Edward is the owner of a corrupt brokerage firm called XYZ Securities. He carefully planned his office space and professional marketing to project the presence of integrity and high professional standards. Be that as it may, he doesn't act in a professional or ethical way while dealing with customers.

In particular, Edward purposely tries to attract customers with extremely limited financial education. While citing those customers on expected securities to buy, he is careful to limit their access to data about comparable alternative products to cheat his customers for those products however much as could reasonably be expected.

Additionally, Edward consistently tries to earn special commissions, kickbacks, and other such forms of compensation without obviously or completely illuminating his clients concerning those arrangements.

Assuming Edward's firm were to be sued by one of his customers, there is a decent chance that he would be found to be in violation of the shingle theory. In light of comparable cases in the past, it appears to be possible that Edward could lose his license to operate as a broker-dealer.

Highlights

• It expects that broker-dealers operate as per industry best practices, especially as it connects with the pricing and disclosure of the products they sell.
• The shingle theory is a legal doctrine that concerns the standards of professional conduct of broker-dealers.
• The shingle theory has progressing influence in the financial services sector, as it has been over and again refered to and maintained in litigation.