12. Customer Recommendations and Disclosures

Question 1

All retail customers opening margin accounts must receive a margin risk disclosure ________

Answer 1

prior to / at time of account opening AND

Annually thereafter

Question 2

True / false: the margin risk disclosure can be in paper or electronic form and in a separate document (or contained by itself on a separate page as part of another document)

Answer 2

true

Question 3

True / false: if retail customers can open accounts or trade online, the margin risk disclosure statement must be posted on the firm’s website

Answer 3

true

Question 4

True / false: the margin risk disclosure document also addresses the risk of trading low priced stocks

Answer 4

false

That risk is separated and covered in a penny stock risk disclosure document

Question 5

IPOs are not marginable for at least ____ following pricing

Answer 5

at least 30 days

Question 6

True / false: initial margin requirements (50%) are the same for listed and OTC securities

Answer 6

true

Question 7

The initial margin requirement for penny stocks is the greater of ________

Answer 7

Reg T’s 50% or FINRA’s initial $2k requirement

Ie there is no higher requirement for margin trades in penny stocks

Question 8

A customer with a long margin account will receive a margin maintenance call (i.e. customer must provide additional capital) if the long market value of the securities fall to an amount equal to the _____ divided by ____

Answer 8

loan size

0.75

Example: client buys $90k in stock with $45k loan amount (Reg T’s 50%) - how low can the stock fall before a client receives a margin maintenance call?

A - stock can fall to $45k / 0.75 = $60k (if the stock position falls to this amount, the client will need to contribute additional capital into the account or be sold out

Question 9

True / false: a BD must receive permission from FINRA prior to implementing a PORTFOLIO margin program for its customers

Answer 9

true bc these programs offer greater leverage and risk taking

Note - FINRA permission is NOT required for standard margin accounts

Question 10

A margin call in a portfolio margin account (PMA) must be satisfied in _______ days

Answer 10

3 business days

Question 11

BDs must provide ____ days advanced written notice to customers when revising margin credit policies

Answer 11

30 days

Question 12

True / false: proxy expenses (inc expenses associated w forwarding of proxies to BOs of securities) are paid by the issuer

Answer 12

true and can be paid via any reasonable mean so long as the expenses are fully covered

Question 13

True / false: a municipal utility company is considered a retail investor and NOT an institutional investor

Answer 13

true

Question 14

A _________ occurs when a market maker acting in a principal capital, receives an order to buy an equity security, purchases the equity security at one price and then sells to the customer at a different price

Answer 14

a “net” transaction

Question 15

Following the execution of a trade, a confirmation must be provided by _____

Answer 15

at or prior to completion of the transaction (settlement date)

Question 16

True / false: if a BD is selling securities of one of its own affiliate companies (i.e. a subsidiary of the firm) into a discretionary account, it must receive client permission prior to execution

Answer 16

true

Question 17

What are the three types of suitability that must be cleared under FINRA for recommendations?

Answer 17

1) reasonable basis - the recommendation is suitable for at least SOME investors (requires the RR to understand the risks and rewards of product)

2) customer specific - the recommendation is suitable for a specific customer based on that customer’s investment profile

3) quantitative - that a SERIES of recommended transactions (even if suitably individually) are NOT excessive or unsuitable when considered together (e.g. to avoid
“Churning” for fees)

Question 18

________ establishes a “best interest” standard when BDs or RRs make any securties or investment strategy recommendation to RETAIL customers

Answer 18

Regulation BI

Stricter than FINRA suitability rules

Applies to not only types of investments but also type of account (brokerage vs. advisory vs. IRA)

Question 19

_____ is provided to clients at account opening and helps clients to learn about a BD or advisor to make informed decisions regarding firm’s services, fees, costs and conflicts

Answer 19

Form CRS (Customer Relationship Summary)

Note the form CRS is filed w FINRA and stored in the CRD

Records of Form CRS must be retained for 6 years from date of last delivery

Question 20

FINRA’s 5% compensation guideline applies to transaction involving these securities (4 types)

Answer 20

1) trades on national exchanges

2) OTC equity transactions

3) Corporate bond trades

4) Treasury bond trades

Question 21

FINRA’s 5% compensation guideline DO NOT apply to transaction involving these securities (4 types)

Answer 21

1) municipal bond trades (exempt securities)

2) mutual fund sales (new securities sold w a prospectus)

3) New issues - IPOs (new securities sold w a prospectus)

4) New issues - follow-ons (sold w a prospectus)

Question 22

A __________ is where one customer sells securities and uses the proceeds to pay for other securities purchased AT OR ABOUT the same time

Answer 22

a “proceeds transaction”

Note “at or about” does not mean same day reinvestment necessarily

Question 23

For Proceeds Transactions the FINRA 5% policy dictates that…

Answer 23

AGGREGATE commissions for a proceeds transaction should not exceed 5% of the amount reinvested (both legs - selling and buying together)

Question 24

Mark-ups and mark-downs should be based on….

Answer 24

The inside market (NBBO - national best bid and offer - the highest displayed buy and lowest sell prices among various trading exchanges)

Question 25

A _________ is where a BD having received an order to buy or sell, purchases or sells the securities as principal, and then fills the existing customer order at the SAME price

Answer 25

A “Riskless Principal Transaction” Riskless because there is no risk that the transaction will be completed

Question 26

True / false: a mark-up of less than 5% can still be considered unfair and excessive

Answer 26

true The 5% is a guideline not a rule Facts / circumstances may dictate that a fee of less than 5% could still be excessive

Question 27

A _________ is were the BD, acting in a principal capacity (dealer), receives a customer order in an equity security (buy or sell) and buys / sells at one price and then sells / buys the securities to another customer at a different price

Answer 27

A “Net Transaction” The fee is EMBEDDED in the higher price leg

Question 28

For net transactions with ______ customers, WRITTEN trade by trade consent is required

Answer 28

Retail customers This makes these types of transactions uncommon

Question 29

For net transactions with institutional clients, net trades may be authorized by….(two methods)

Answer 29

1) order by order with written OR verbal consent 2) negative consent - blanket consent but reserves right to object to any one net transactions trade

Question 30

For Riskless Principal Transactions both legs of transactions ______ and the fee is ______

Answer 30

1) are the same price 2) pay up to 5% on each leg (total is 10%)

Question 31

The ___________ protects against losses of cash and securities held by a BD in the event of the firm’s failure (bankruptcy / liquidation)

Answer 31

Securities Investor Protection Corporation NOTE - Not a gov’t entity, but one funded by BDs so customers feel comfortable putting securities in street name of firm (no nominal ownership but beneficial ownership)

Question 32

The SIPC does not cover… (7 areas)

Answer 32

1) against market losses 2) inappropriate recommendations 3) fraud by issuers (eg Ponzi schemes) 4) Accounts held at FOREIGN BDs 5) Currency and commodities (not securities) 6) Investment contracts (such as limited partnerships) 7) Fixed annuity contracts

Question 33

SIPC coverage ($500k securities up to $250k univested cash) is per ___________

Answer 33

Customer / account Examples of separate customers (each with its own protection)…. 1) individual account 2) joint account 3) individual retirement account 4) Roth IRA 5) Minor’s account NOTE - if an individual has a cash account and a margin account at the same firm, it’s only ONE account

Question 34

Which of the following firms need be a SIPC member… 1) BD that exclusively provides M&A advisory services ______ 2) BDs whose principal business is conducted outside the US _____ 3) BD that exclusively distribute open-end mutual funds and Unit Investment Trusts (UITs) _____ 4) BDs that exclusively distribute and sell closed-end funds _____ 5) BDs that are exclusively in the business of insurance and the sale of variable annuities _____

Answer 34

1) BD that exclusively provides M&A advisory services …YES 2) BDs whose principal business is conducted outside the US …NO 3) BD that exclusively distribute open-end mutual funds and Unit Investment Trusts (UITs) …NO 4) BDs that exclusively distribute and sell closed-end funds ….YES 5) BDs that are exclusively in the business of insurance and the sale of variable annuities ….NO

Question 35

When must a Disclosure of Financial Condition be disclosed and what should be disclosed?

Answer 35

When: Upon request by bona fide customer What: most recent balance sheet & net capital computation

Question 36

When must a Margin Disclosure Statement be disclosed? If online trading offered where must the document be posted?

Answer 36

When: at or before account opening AND annually thereafter If BD offers online trading risk document must be posted online

Question 37

When must a Day Trading Risk Disclosure Statement (in margin accounts) be disclosed? What if firm promotes a Day Trading Strategy?

Answer 37

When: Prior to opening a day-trading account (retail only) If promoting a day trading strategy, post disclosure statement on BD’s website

Question 38

When must an Extended Hours Trading Risk Disclosure be disclosed? If online trading offered where must the document be posted?

Answer 38

When: Prior to extended hours trades If BD offers online trading post risk document online

Question 39

When must a SIPC Disclosure be disclosed? What must be included?

Answer 39

When: At account opening AND annually thereafter What: SIPC Website; SIPC Telephone #; Availability of SIPC brochure

Question 40

How is the maximum purchasing power calculated for Pattern Day Trader margin accounts?

Answer 40

calculated as 4x the “maximum purchasing power” “Maximum purchasing power” is defined as difference between the equity in the account and the minimum maintenance requirement (greater of 25% of total value or $25k)