Ch. 4 - Regulatory Framework

Question 1

National Adjudicatory Counsel

Answer 1

establishes rules, regulations, and FINRA membership eligibility standards.

Question 2

Who may apply for membership to FINRA?

Answer 2

• Any BD registered with the SEC
• Any person who affects transactions in securities as a broker, a dealer, or an investment banker,
• municipal bond firms

Question 3

What do FINRA members agree to do?

Answer 3

■ comply with the association’s rules and regulations;
■ comply with federal securities laws; and
■ pay dues, assessments, and other charges in the manner and amounts fixed by the association.

Question 4

Who must be registered with FINRA?

Answer 4

Any person associated with a member firm who intends to engage in the investment banking or securities business. Must be sponsored by a member firm. Member firm must ascertain the person’s business reputation, character, education, qualifications, and experience. As part of the application process, the member firm must certify that it has made an investigation (background check) and that the candidate’s credentials are in order.

Question 5

What Firm employees need fingerprint records?

Answer 5

• all directors, officers, and partners must submit those fingerprint cards to the U.S. attorney general for identification and processing.
• those involved in sales and those who handle cash or customer securities.

Question 6

Who is exempt from fingerprinting?

Answer 6

-Those selling only mutual funds, variable annuities, or direct participation programs (DPP)
-Certain BD employees (clerical or ministerial) if they:
■ are not involved in securities sales;
■ do not handle or have access to cash or securities or to the books and
records of original entry relating to money and securities; and
■ do not supervise other employees engaged in these activities.

Question 7

Who is considered a registered representative?

Answer 7

All associated persons engaged in the investment banking and securities business including any:
■ assistant officer who does not function as a principal;
■ individual who supervises, solicits, or conducts business in securities; and
■ individual who trains people to supervise, solicit, or conduct business in securities.

Question 8

What is a principal?

Answer 8

Anyone who manages or supervises any part of a member’s investment banking or securi- ties business must be registered as a principal with FINRA (including people involved solely in training associated persons). Unless the member firm is a sole proprietorship, it must employ at least two registered principals.

Question 9

When will a member be disqualified or ineligible for FINRA membership?

Answer 9

-Must meet FINRA’s eligibility standards regarding training, experience, and competence
-May be statutorily disqualified if disciplinary sanctions by the SEC, another SRO, a foreign financial regulator, or a foreign equivalent of an SRO
-An individual applying for registration as an associated person will be rejected if he:
■ has been or is expelled or suspended from membership or participation in any other SRO or from the foreign equivalent of an SRO;
■ is under an SEC order or an order of a foreign financial regulator denying, suspending, or revoking his registration or barring him from association with a BD; or
■ has been found to be the cause of another BD or associated person being expelled or sus- pended by another SRO, the SEC, or a foreign equivalent of an SRO.
The following also can automatically disqualify an applicant for registration:
■ Misstatements willfully made in an application for membership or registration as an associated person
■ A felony conviction, either domestic or foreign, or a misdemeanor conviction involving securities or money within the past 10 years
■ Court injunctions prohibiting the individual from acting as an investment adviser, an underwriter, or a BD or in other capacities aligned with the securities and financial services industry

Question 10

Where is disciplinary history kept?

Answer 10

• The Central Registration Depository (CRD) maintains.
• customer can access this information toll free through the CRD’s BrokerCheck.
• hyperlink to BrokerCheck is required on all FINRA member firm websites.

Question 11

When will FINRA membership be denied?

Answer 11

if the applicant or any associated person:
■ has been expelled or suspended by another SRO or from the foreign equivalent of an SRO;
■ is subject to an SEC order denying, suspending, or revoking registration as a BD; or
■ has willfully filed a false or misleading application or has failed to disclose material facts.
■ a bankruptcy or unsatisfied lien does not disqualify one from registering, but failure to disclose does

Question 12

What Continuing education is required for FINRA registered persons?

Answer 12

1. Firm Element: requires member firms to prepare an annual training plan taking into account such factors as recent regulatory developments, the scope of the member’s business activities, the performance of its personnel in the regulatory element, and its supervisory needs. This annual in-house training must be given to all registered persons who have direct contact with the public.
2. Regulatory Element: requires that all registered persons complete a computer-based training session within 120 days of the person’s second registration anniversary and every three years thereafter (i.e., within 120 days of the person’s 5th, 8th, 11th registration anniversary, and so on). The content of the regulatory element is determined by FINRA, and is appropriate to either the RR or principal status of the person.
   If a person fails to complete the regulatory element within the prescribed period, FINRA will deactivate that person’s registration until the requirements of the program are met.

Question 13

What are rules regarding RRs working out of home office?

Answer 13

-approval of the member firm’s SRO is required as it would be for any office associated with the BD.
-All normal business activities, including taking customer orders for the purchase and sale of securities, would be permitted.
-subject to a premise visit and review by principals of the firm and FINRA examiners, as any BD office would be.
home office address and telephone number may be advertised in any normal manner, such as on business cards or through various public media venues like newspapers and websites.

Question 14

What are the four steps of rules and codes in the FINRA manual?

Answer 14

1. Conduct Rules—set out fair and ethical trade practices that member firms and their representatives must follow when dealing with the public. Included are events that must be reported.
2. Uniform Practice Code (UPC)— established the uniform trade practices, including settlement, good delivery, ex-dates, confirmations, don’t know (DK) procedures, and other guidelines for BDs to follow when they do business with other member firms.
3. Code of Procedure (COP)—describes how member violations of the Conduct Rules will be heard and handled.
4. Code of Arbitration (COA) Procedure—governs the resolution of disagreements and claims between members, RRs, and the public; it addresses monetary claims

Question 15

What is Form U4?

Answer 15

Required to be filed by sponsoring firm when hiring a registered representative

registration is not effective until the person passes the appropriate qualification exam(s). If a person fails the exam, 30 days must elapse before a second attempt can be made. If a person fails an exam three straight times, the person must wait six months (180 days) before making a fourth attempt.
Information required is extensive and includes:
■ name, address, and any aliases;
■ 5-year residency history;
■ 10-year employment history (this includes full-time education); and
■ information on any charges, arrests, or convictions relating to the investment business. An affirmative answer (Yes) to any of the questions regarding charges, arrests, or convictions requires a detailed explanation. This information must be provided on the Disclosure
Reporting Pages (DRP).
Any changes to this information require filing an amended form with the CRD no later
than 30 days after the member becomes aware of these changes. If the amendment involved a statutory disqualification, an amended form must be filed within 10 business days.
In addition to registering with FINRA, a representative must satisfy the registration requirements of each state she does business in. The Form U4 must be check-marked for each state and the accompanying fee and qualification exam if any must be satisfied. If a representative’s firm is also a member of an exchange, such as the NYSE or the CBOE, this must be noted, and once again, applicable fees must be paid and qualification exams

Question 16

What is Form U5?

Answer 16

Required to be filed with FINRA by a sponsoring firm when a registered representative terminates.
-must file with the CRD within 30 days of termination date.
-must also provide a copy of the form to their former employee within the same time frame.
-Failure to do so within 30 days will result in a late filing fee being assessed against the member. -The form requires the member to indicate the reason for termination and provide an explanation where appropriate. Failure to provide accurate information could lead to severe disciplinary action.
If the member checks the Discharged box or Permitted to Resign box, all of the details surrounding the termination must be disclosed.
-In the event that the member, after filing the form, learns of facts or circumstances that would cause the information filed to be inaccurate or incomplete, the member must file an amended Form U5 within 30 days of learning of facts giving rise to the amendment. A copy of the amended filing must be sent to the former employee. There is no time limit on how long after termination an amended Form U5 is required.
-If a registered person leaves one member to join another, the new employer, in addition to filing Form U4, must get a copy of Form U5 filed by the former employer within 60 days of the U4 filing. A copy is obtained either from the new employee or the CRD.

Question 17

What is the two-year rule for RRs?

Answer 17

If a registered person leaves the industry and reaffiliates with a member firm within two years, that person’s license remains valid. If reaffiliation occurs after two years, that person must requalify by passing the appropriate exam.
Similarly, when a registered person leaves the business, FINRA retains jurisdiction over that person for two years. If that person becomes subject to a customer complaint or charges are brought against that person by FINRA, that person is still subject to FINRA rules for the two-year period following termination.
To avoid having a securities registration lapse, it may be tempting for former RRs to park their registrations with a member firm as the end of the two-year period nears. However, parking a securities license will subject the RR and the member firm to FINRA sanctions.

Question 18

What are examples of statements or claims that might be considered misleading or omitting and subject the RR or Firm to sanctions and disqualification?

Answer 18

1. Recruitment advertising—A BD advertises for new RRs and includes this statement: “RRs with our firm make more than RRs with any other firm in the securities industry in both com- missions and advisory fees.” (Potential commission or fee claims may never be exaggerated.)
2. Brochures—A chart within a brochure shows that long call option contracts have unlimited maximum gain potential, but neglects to reflect in any way that maximum loss can be the entire premium paid. (Graphs, charts, and other tools may never show opportunity for gain without also showing loss potential.)
3. Professional or educational designations—An RR implies in a recommendation to clients that his bachelor of science degree makes him uniquely qualified to recommend a certain tech stock. (Use of degrees or designations may never be used in a misleading fashion, nor can reference to nonexistent designations be made.)
4. FINRA mandates that members must consider the nature of the audience to which the communication will be directed and should provide details and explanations appropriate to the audience.

Question 19

What must be done when a customer complaint is received or a red flag identified?

Answer 19

-proper personnel must be notified—e.g., account’s representative, the account’s principal, the branch manager, or a member of the compliance department.
-principal may need to address these concerns.
-If resolved to the satisfaction of both the member firm and the customer, no
further action is needed.
-if a dispute cannot be resolved, it may be referred to FINRA’s director of arbitration

Question 20

What is the definition of a “complaint”?

Answer 20

written statement by a customer (or a person acting on behalf of a customer) alleging a grievance arising out of, or in connection with, a securities transaction.

Question 21

What is the COA?

Answer 21

• covers monetary disputes between FINRA members and/ or customers. If the dispute is between a member and an associated person, both parties are compelled to arbitrate. If the dispute is between a client and a member, the dispute would go to arbitration only if an arbitration agreement (predispute clause) has been signed by the customer.
• if the dispute involves a public customer, most of the arbitration panel members must be public arbitrators, which means that most arbitrators are not affiliated with the securities business.
• If the dispute is between members, the panel may comprise whatever mix of arbitrators both parties agree to.

Question 22

Can new account forms have an arbitration agreement?

Answer 22

Yes. This is a common industry practice and binds the client to submitting all disputes to arbitration if they cannot be resolved. Without such an agreement, disputes between members and public customers can only go to arbitration at the insistence of the customer.

Question 23

Where and how long must customer complaints be maintained

Answer 23

• a file at the office of supervisory jurisdiction (OSJ).
• each complaint in the file must be accompanied by a statement of its resolution and be endorsed by a principal.
• Member firms must electronically file information on all customer complaints with FINRA.
• These filings must be made within 15 days of the end of each calendar quarter.
• complaints and quarterly filings must be retained for four years

Question 24

What reportable event is related to outside business activity of an associated person?

Answer 24

• An associated person cannot work for any business other than his member firm (inde- pendent activity) without his employing BD’s knowledge.
• If a registered person wants to be employed by or accept compensation from an entity other than the member firm, that person must provide prior written notice to the member.
• permission is not required, but firm does have the right to reject or restrict any outside affiliation if it feels a conflict of interest exists. These affiliations would also include serving as an officer or director of a company or owning any interest in another financial services company.
• A passive investment, such as the purchase of a limited partnership unit, is not considered an outside business activity. An associated person may make a passive investment for his own account without providing written notice to the employing BD.

Question 25

What is a private securities transaction?

Answer 25

Any sale of securities outside an associated person’s regular business and her employing member. Also known as selling away.

Question 26

What must an associated person wish to enter into a private securities transaction?

Answer 26

■ provide prior written notice to her employer;
■ describe in detail the proposed transaction;
■ describe in detail her proposed role in the transaction; and
■ disclose whether she has or may receive compensation for the transaction.

With compensation—If the transaction involves compensation, the employing member may approve or disapprove the associated person’s participation. If the member approves the participation, it must treat the transaction as if it is being done on its own behalf by entering the transaction on its own books and supervising the associated person during the transaction. If the member disapproves the transaction, the associated person may not participate in it.

Without compensation—If the associated person has not received or will not receive compensation for the private securities transaction, the employing member must acknowledge that it has received written notification and may require the associated person to adhere to specified conditions during participation.
Transactions that the associated person enters into on behalf of immediate family members and for which the associated person receives no compensation are excluded from the definition of private securities transactions.

Question 27

When a BD give other firms’ employees gratuities?

Answer 27

■ the compensation is not conditional on sales or promises of sales;
■ it has the employing member’s prior approval; and
■ the compensation’s total value does not exceed the annual limit set by the regulatory bodies (currently $100 per year).
**may not distribute business-related compensation
** permit occasional noncash expenditures that exceed the $100 limit, such as dinners, seminars, or tickets to entertainment events. These are considered allowable business entertainment items. In addition, reminder advertising items such as pens, mouse pads, and similar inexpensive items are also permitted. However, vacations or season tickets to cultural or sporting events are always violations.

Question 28

When is payment or reimbursement by sponsors in connection with meetings to train or educate representatives acceptable?

Answer 28

■ the representative obtains the member firm’s prior permission to attend;
■ the location of the meeting is appropriate to the purpose of the meeting (e.g., an office of the sponsor or the member would be appropriate, but a meeting held at a posh hotel in the Bahamas would not);
■ there is no payment or reimbursement for a guest (e.g., a spouse) of the representative attending the meeting;
■ payment or reimbursement is not conditioned on the achievement of a sales target;
■ there is no payment or reimbursement for certain expenses incurred in connection with
meetings, such as golf outings, cruises, tours, and similar types of entertainment; and
■ the member firm creates a record of all noncash compensation received by its representatives as well as the details of the meeting.