chapter 16 prohibited activities

Question 1

Rule 10b-5

Answer 1

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,

Question 2

Rule 10b-1

Answer 2

Rule 10b-1 – Stipulates that antifraud rules also apply to exempt securities

Question 3

Rule 10b-3

Answer 3

Rule 10b-3 – Stipulates that broker-dealers are prohibited from engaging in fraudulent practices

Question 4

Market rumors

Answer 4

Spreading false or misleading information to influence the price of stocks and bonds.

Question 5

Front-running

Answer 5

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.

Question 6

Marking the Close/Marking the Opening

Answer 6

Affecting trades near the opening or close of trading in an attempt to influence a stock’s closing price up or down.

Question 7

Churning:

Answer 7

Excessive trading in a client’s account for the purpose of generating additional fees and commissions

Question 8

Interpositioning:

Answer 8

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.

Question 9

Trading Ahead of Customer Orders

Answer 9

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.

Question 10

Quoting a Security in Multiple Mediums

Answer 10

Refers to displaying quotes on the same security in multiple markets. This is permitted if quoted at the same price.

Question 11

Regulation M (or Reg. M)

Answer 11

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

Question 12

Trading Ahead of a Research Report

Answer 12

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.

Question 13

backing away

Answer 13

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.

Question 14

Regulation T Payment Date

Answer 14

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)

Question 15

freeriding

Answer 15

An investor who buys a stock and subsequently sells it, but fails to meet the Regulation T requirement, is guilty of freeriding

Question 16

Anti-Intimidation/Coordination Interpretation

Answer 16

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

Question 17

Best Execution

Answer 17

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

Question 18

MSRB Time of Trade Disclosure

Answer 18

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.

Question 19

Insider Trading

Answer 19

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.

Question 20

Insider Trading Penalties

Answer 20

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

Question 21

New Issue Rule

Answer 21

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%).

Question 22

Restricted Persons

Answer 22

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

Question 23

General Exemptions to restricted person

Answer 23

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

Question 24

Sharing in Accounts

Answer 24

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

Question 25

Guarantees

Answer 25

employees may neither guarantee against losses nor reimburse a customer for losses in any way

Question 26

RRs borrowing from or lending to customers is acceptable without firm notification if the customer

Answer 26

Is an immediate family member, or

• Is a financial institution regularly engaged in the business of providing loans

Question 27

RRs must provide written notification to their firms and obtain prior written approval i

Answer 27

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.

Question 28

Financial exploitation rules apply to specified adults who are most likely to be exploited including

Answer 28

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

Question 29

Outside Brokerage Accounts

Employee Requirements

Answer 29

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

Question 30

Outside Brokerage Accounts Executing Broker-Dealer Requirements

Answer 30

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.

Question 31

Payments to unregistered persons

Answer 31

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

Question 32

Prior to utilizing any form of electronic storage media

Answer 32

Prior to utilizing any form of electronic storage media, a B/D must notify its self-regulatory organization (SRO).

Question 33

If the electronic storage media to be used is other than CD-ROM

Answer 33

If the electronic storage media to be used is other than CD-ROM, the B/D must give its SRO 90-days’ advance notice.