Chapter 11 - securities industry rules and regulations

Question 1

Securities exchange act of 1934

Answer 1

• Regulate the secondary market that consists of investor-to-investor transactions
• Created the Securities and Exchange Commission (SEC)
• Requires the registration of broker-dealers and agents
• Regulate the exchanges and FINRA
• Requires net capital for broker-dealers
• Regulates short sales
• Regulates insider transactions
• Requires public companies to solicit proxies
• Require segregation of customer and firm assets
• Authorize the federal reserve board to regulate the extension of credit for securities purchases under Regulation T
• Regulates the handling of client accounts
• Regulates interstate securities transactions

Question 2

Securities and Exchange Commission (SEC)

Answer 2

The SEC is the ultimate securities industry authority and is a direct government body.

Five commissioners are appointed to five-year terms by the president, and each must be approved by the Senate.

No more than three members may be from any one political party.

Question 3

SEC registrations requirements

Answer 3

All broker dealers, exchanges, agents, insecurities must register with the SEC. All new rules and regulations adopted by an exchange must be disclosed to the SEC as soon as they are enacted.

Issuers of securities with more than 500 shareholders and with assets exceeding $10 million or issuers with securities are traded on an exchange or NASDAQ must register and file quarterly (10-Q) and annually (10-K) reports.

Question 4

Trading suspensions

Answer 4

The SEC may impose trading suspensions and non-exempt securities or on an exchange or NASDAQ if certain emergency conditions exist.

The SEC may suspend the trading in a security for up to 10 business days, including any extension of the order.

The SEC may suspend the trading on an exchange or in a market as a whole for up to 90 days. In the case of a market-wide suspension, the SEC must notify the president and he or she must not disapprove of the suspension.

Question 5

Rule 10b-18

Answer 5

Set guidelines on how an issuer or an affiliate may re-purchase its own shares.

• May not buy on the opening print or within 30 minutes of the close of the market.
• May only enter orders through one broker-dealer or market maker on a given trading day.
• Must file Form 13e-3 with SEC when going private.

Question 6

Tender offer

Answer 6

A tender offer is made by a person or firm who is seeking to purchase all or part of the outstanding securities of an issue or at a specific price.

If the issue or, another company, or person makes a tender offer for securities, the offeror must file form TO with the SEC.

And investor may not sell short into a tender which is known as short tendering.

During a Dutch Auction the issuer will announce a range of prices at which it is willing to re-purchase it on securities.

Question 7

Form 13D / 13G / 13H

Answer 7

Requires that individuals or entities who acquire 5% or more of an issuer’s equity securities must file form 13D.

Investment companies who require 5% or more of an issue or will file a notice of their ownership on form 13G.

A large trader must file form 13H within 45 days of the end of each calendar year.

Question 8

Maloney Act of 1938

Answer 8

An amendment to the Securities Exchange Act of 1934 created the National Association of Securities Dealers (NASD) which is now part of FINRA.

NASD became the SRO for the OTC market.

NASD organized into 4 major bylaws:

• The rules of fair practice - Insurance just an equitable trade practices among members in their dealings with the public.
• The uniform practice code - sets guidelines for how FINRA members transact business with other members.
• The code of procedure - regulates how FINRA investigates complaints and violations.
• The code of arbitration - provides a form to resolve disputes.

Question 9

Becoming a member of FINRA

Answer 9

• Meat net capital requirements (solvency).
• Have at least two principles to supervise the firm
• Have an acceptable business plan detailing its propose business activities.
• Attend a pre-membership interview.

Question 10

Registration of agents/associated persons

Answer 10

All sponsoring firms are required to ascertain the applicant’s:

• Business character
• Educational background
• Professional background

Once a member has certified the above information regarding the applicant, it may formally submit the individuals application for becoming an associated person, known as a U4.

Question 11

FINRA Rule 2210

Answer 11

Streamlines member communication rules into three categories

• Retail communication - distribution or communication made to more than 25 retail investors in a 30-day period.
• Institutional communication - any written communication distributed or made available exclusively to institutional investors and marked “for institutional use only.”
• Correspondence - electronic and written communications between the member and up to 25 retail investors and a 30-day period.

Note: blind recruiting ads are the only form of advertising that does not require the member’s name to appear in the ad.

Question 12

Securities Investor Protection Corporation Act of 1970

Answer 12

Created the Securities Investor Protection Corporation (SIPC), a government-sponsored corporation that provides protection to customers in the event of a broker-dealer’s failure.

Question 13

SIPC coverage

Answer 13

Covers customer losses that result from a broker dealer failure, not for market losses.

Covers customers for up to $500,000 per separate customer, of which up to $250,000 may be in cash.

Question 14

Securities Acts Amendments of 1975

Answer 14

Gave the authority to the Municipal Securities Rulemaking Board (MSRB) to regulate the issuance and trading of municipal bonds. The MSRB has no enforcement division, its rules are enforced by other regulators.

Question 15

The Insider Trading and Securities Fraud Enforcement Act of 1988

Answer 15

Set forth guidelines and controls for the use and dissemination of non-public material information.

Trading on inside information has always been a violation of the securities exchange act of 1934, and the insider trading act prescribes penalties for violators, which include:

• A fine of the greater of 300% of the amount of the gain or 300% of the amount of the loss avoided or $1 million for the person who acts on the information.
• A fine up to $1 million for the person who divulge is the information.

Question 16

The Trust Indenture Act of 1939

Answer 16

Requires that corporate bond issues in excess of $5 million that are to be repaired during a term in excess of one year, sold interstate, issue a trust indenture for the issue.

Question 17

FINRA Rule 3230

Answer 17

Regulates how telemarketing calls are made by businesses.

Note: on the exam you may see the telemarketing rule tested under the telephone Consumer Protection Act of 1991.

• Call only between the hours of 8 AM and 9 PM in the customers time zone
• Maintain a do not call list. Individuals placed on the do not call list may not be contacted by anyone at the firm for five years.
• Caller ID must display the firm name and phone number, and caller ID blocking may not be used.

Exemptions:

• Calls to existing customers who have executed a transaction or have had an account containing cash or securities on deposit within the last 18 months.
• Calls when the color has a personal relationship with the recipient.

Question 18

SEC Rules 15g-2-15g-9

Answer 18

Collectively known as the penny stock cold calling Raul, ensures that investors do not purchase penny stocks without knowing the risks.

Question 19

FINRA Investigations into violations & complaints

Answer 19

If a FINRA staff member has received a complaint alleges a violation of securities regulations, it is up to FINRA to determine if the complaint is meritorious.

FINRA will begin an investigation of the complaint by notifying the member and/or the associated person that a complaint has been received and will request that the member or associated person respond in writing within 25 days.

If the member fails to provide the requested information within the timeframe, FINRA will send out a second request for information and provide an additional 14 days to provide the information requested.

Question 20

Simplified arbitration

Answer 20

Available for disputes involving amounts of $50,000 or less. Traditionally provides no opportunity for a hearing. Parties submit their case in writing only.

Awards under arbitration or final and binding; there is no appeal.

Question 21

MSRB Rule G-38

Answer 21

Put strict limits on the amount of political contributions that may be made by a municipal finance professional (MFP).

Question 22

National Securities Markets Involvement Act of 1996 (Coordination Act)

Answer 22

Eliminated regulatory duplication of effort and establish registration requirements for investment advisors. A covered investment advisor must registered with the SEC if:

• Manages at least $110 million
• Manages investment company portfolios
• Is not registered under state laws

Question 23

Investment adviser capital requirements

Answer 23

Must maintain a minimum level of financial solvency. For advisers with custody of customers’ cash and securities, the investment advisor must maintain minimum net capital of $35,000.

Advisers that have only limited discretionary authority over customers’ accounts need to maintain a minimum of $10,000 in net capital.

Question 24

ADV Part II

Answer 24

An investment advisor is required to provide all prospective clients with a brochure or with form ADV Part II:

• at least 48 hours prior to the signing of the contract, or
• at least at the time of the signing of the contract if the client is given a five-day grace period to withdraw without penalty.

Question 25

Uniform Securities Act (USA)

Answer 25

Laid out model legislation for all states in an effort to make each state’s rules and regulations more uniform and easier to address.

Question 26

Sarbanes-Oxley Act (Public Company Accounting Reform and Investor Protection Act) of 2002

Answer 26

Enacted to help restore confidence in the financial reports and accounting standards of publicly traded companies.

Question 27

SEC Regulation S-K & M-A

Answer 27

Set forth reporting requirements regarding transactions with an issuer’s related persons, promoters, and certain control people, as well as with their immediate family members.

Regulation M-A is a subsection of Regulation S-K. Requires that a “plain English” term sheet be filed related to any merger, acquisition, or going-private transaction.

Question 28

Hart-Scott-Rodino Act

Answer 28

Requires both parties in certain mergers and acquisition’s to file a notification of the transaction with the Federal Trade Commission (FTC) and with the Department of Justice (DOJ).

Question 29

SEC Regulation S-X

Answer 29

Sets forth guidelines for how issuers that file reports under the Securities Act of 1933 or the Securities Exchange Act of 1934 account for certain assets that appear on the balance sheet.