chapter 16 prohibited activities Flashcards
Rule 10b-5
The 1934 Act prohibits manipulative and deceptive practices in the sale of securities. Rule 10b-5 includes specific anti-manipulation provisions
To employ any device, scheme, or artifice to defraud,
b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
Rule 10b-1
Rule 10b-1 – Stipulates that antifraud rules also apply to exempt securities
Rule 10b-3
Rule 10b-3 – Stipulates that broker-dealers are prohibited from engaging in fraudulent practices
Market rumors
Spreading false or misleading information to influence the price of stocks and bonds.
Front-running
Executing an order for a proprietary account or one in which you have discretion ahead of a customer block order.
The order may not be executed until information regarding the entire block trade has been publicly disseminated.
• Block trades are generally 10,000 or more shares.
Marking the Close/Marking the Opening
Affecting trades near the opening or close of trading in an attempt to influence a stock’s closing price up or down.
Churning:
Excessive trading in a client’s account for the purpose of generating additional fees and commissions
Interpositioning:
Refers to the insertion of a third party between a customer and the best market. It is prohibited if detrimental to the customer and acceptable if execution is advantageous to the customer.
Trading Ahead of Customer Orders
Occurs when, after accepting and while holding a customer order, the dealer executes an order for the same security, same price, on the same side of the market for its own account.
Under the Limit Order Protection Rule:
The obligation is to fill the customer’s order first.
An exception exists if executed by a different department at the same firm if information barriers exist.
Quoting a Security in Multiple Mediums
Refers to displaying quotes on the same security in multiple markets. This is permitted if quoted at the same price.
Regulation M (or Reg. M)
Limits bids and purchases by distribution participants (underwriters and selling group members)
Prevents conditioning the market by restricting trading for a specific period of time
Allows for passive market making
Permits distribution participants to execute unsolicited trades to maintain marketability of the security
Permits stabilization of the new issue to protect its price from falling substantially
Trading Ahead of a Research Report
If a firm has knowledge of material, non-public information regarding the contents of a research report, it may NOT establish, increase, decrease, or liquidate an inventory position in a security or its derivative.
backing away
A market maker that publishes a quote is obligated to buy or sell up to the size quoted at its stated bid or offer.
Failure to do so is deemed backing away.
For example, if the bid is 10.00, the ask is 10.05, the market maker must buy at 10.00 and sell at 10.05.
Regulation T Payment Date
The Reg. T payment must be obtained for purchases that are made in cash or margin accounts within 2 business days of settlement (T+4 or S+2)
Before settlement, a customer can request that the broker-dealer transfer a trade from a cash account to a margin account
If no payment is made, the position is closed out (securities sold) on the third business day following settlement
The result of non-payment is that the account is frozen for 90 days (all payments must be made in advance)
freeriding
An investor who buys a stock and subsequently sells it, but fails to meet the Regulation T requirement, is guilty of freeriding
Anti-Intimidation/Coordination Interpretation
The following actions are prohibited:
Coordinating price quotes, transactions, or trade reports with other market makers
Threatening, harassing, or intimidating other market makers
Retaliating against or discouraging the competitive activities of another market maker
Best Execution
FINRA and MSRB rules require a dealer to use reasonable diligence in obtaining best execution for their customers. Factors include:
The character of the market for the security
The size and type of the transaction and number of markets checked
The ease of obtaining a quote and the terms of the order
MSRB Time of Trade Disclosure
According to the MSRB, dealers are required to provide customers with all material information that is known or reasonably available at or prior to time of trade
requirements apply for both solicited and unsolicited trades, trades that occur in the primary or secondary market, or for agency or principal trades.
Insider Trading
Insider trading involves the purchase or sale of securities using material, non-public information about an issuer to make a profit or avoid a loss.
Insider Trading Penalties
Civil – The SEC may demand disgorgement of profits and the payment of treble damages
Criminal – An individual may be subject to a maximum fine of $5 million, and/or up to 20 years in prison
Bounties
The SEC can award bounties of up to 10% of the penalty for information leading to those responsible for the violation
New Issue Rule
The New Issue Rule prohibits member firms from selling equity IPOs to accounts in which a restricted person has a beneficial interest (more than 10%).
Restricted Persons
Member firms and any member firm employees
Immediate family members of member firm employees if:
• There is material support (25% of the person’s income), or
• Sharing of a household, or
• The purchase is made through the family member’s firm
Finders and fiduciaries
Portfolio managers purchasing for their own account
General Exemptions to restricted person
Issuer-directed sales that allow restricted persons to purchase if the associated person or associated person’s immediate family is an employee or director of the issuer
An account that includes restricted persons, provided their combined ownership does not exceed 10% (de minimis)
Portfolio managers purchasing for the mutual fund
A B/D purchasing for its own account after making a bona fide public offering
The general or separate account of an insurance company
Foreign investment companies ERISA accounts, state and local benefit plans, and other 501(c)(3) plans
Sharing in Accounts
Sharing in profits and losses in a client’s account is prohibited unless a joint account is established with the client and:
The employee has the written permission of both the client and the broker-dealer, and
The sharing is proportionate to the employee’s investment
• An arrangement with a family member is exempt from the proportionate sharing requirement.
Investment advisory accounts permit sharing in profits and losses if:
Prior written consent between the firm and customer
Firm is in compliance with SEC regulations
Guarantees
employees may neither guarantee against losses nor reimburse a customer for losses in any way
RRs borrowing from or lending to customers is acceptable without firm notification if the customer
Is an immediate family member, or
• Is a financial institution regularly engaged in the business of providing loans
RRs must provide written notification to their firms and obtain prior written approval i
The customer and RR are both registered with the same firm, or
• A personal relationship exists, or
• A business relationship exists outside of the brokerage firm.
Financial exploitation rules apply to specified adults who are most likely to be exploited including
Persons age 65 or older
Any persons 18 or older believed to have a mental or physical impairment jeopardizing their ability to protect their own interests
Outside Brokerage Accounts
Employee Requirements
Before a member firm employee can open an account with another firm, the employee must:
Obtain the employer’s prior written consent
Provide written notification of his association to the executing firm
Satisfy the previous two provisions within 30 days
Outside Brokerage Accounts Executing Broker-Dealer Requirements
The executing firm must send duplicate confirmations and statements if requested by the employing firm.
This applies to accounts for the employee’s spouse, dependent children, or an account in which the person controls or has a beneficial interest.
Payments to unregistered persons
Generally, firms and RRs are prohibited from paying compensation to any individual or firm who is not FINRA registered.
• This includes paying referral fees.
• Retiring representatives may continue to receive commissions on existing accounts if a bona fide contract is created
Prior to utilizing any form of electronic storage media
Prior to utilizing any form of electronic storage media, a B/D must notify its self-regulatory organization (SRO).
If the electronic storage media to be used is other than CD-ROM
If the electronic storage media to be used is other than CD-ROM, the B/D must give its SRO 90-days’ advance notice.
