Chapter 3 Flashcards
Unless the customer has given the agent discretionary authority, each transaction in a customer’s account must be approved by the client. This activity could occur when an agent is attempting to churn the customer’s account in order to generate commissions. However, unauthorized trading violations can also occur when an agent is attempting to do what is in the best interest of the client.
Unauthorized Trading
All trades in a client’s account must be authorized by the customer unless the agent has been granted discretionary authority in writing. Even with discretionary authority, agents cannot simply enter any order that they wish for the account. Orders entered on a discretionary basis must still be suitable for the account.
Discretionary Authority
If the client specifies whether the order is a buy or a sell, the security to be bought or sold, and the amount of the security to be bought or sold, the client may verbally authorize the agent to choose the price at which the order is executed and/or the time of execution. This order is only good for that business day the customer made the verbal request.
Price/Time Exception
Intentionally not disclosing a potential discount when the client is close to reaching the required dollar threshold.
Breakpoint Sales
Encouraging a client to purchase mutual fund shares just prior to the payment of a dividend, implying that the investor will receive an immediate return on his capital. The investor is, in effect, receiving their own money back as taxable income and paying an inflated sales charge.
Selling Dividends
when a broker-dealer acts in a dealer or principal capacity
it is buying or selling stock for its own account. While it must treat its clients fairly in such trades as well, it is not representing the client’s interest in the same way it does when simply acting as a broker.
A wash sale (trade)
involves the simultaneous purchase and sale of the same security with the intent to give the appearance of active trading without an actual change in beneficial ownership. This is not the same as arbitrage, which is the simultaneous buying and selling of a security at 2 different prices in 2 different markets resulting in profits without risk. Arbitrage is a lawful trading activity.
Matched Sales
When two or more parties are involved in a pattern of buying and selling a security merely to give the appearance of active trading, this is known as engaging in matched sales. Whereas there is usually only one manipulator in a wash sale, matched sales involve two or more conspirators.
Painting the Tape
When manipulative trading involves a series of purchases, or a series of sales, rather than paired buys and sells, the activity is known as painting the tape (ghosting). This is also illegal, since the intent is to give the false appearance of a trend in a stock’s price and lure other investors into the same trading activity.
Form ADV Annual Update
For state registered investment advisers, the USA requires the firm file an updated Form ADV with the state within 90 days of the investment adviser firm’s fiscal year end. Federal covered investment advisers must file an updated Form ADV with the SEC within 90 days of the investment adviser firm’s fiscal year end.
Wrap Account Brochure
When a client pays the investment adviser a flat fee for “advisory and order execution” transactions, it is called a wrap account. The wrap fee is generally calculated based upon the size of the investment portfolio (assets under management or AUM), and may factor in the number of transactions anticipated if the investor is actively trading in the client’s account.
Any material changes to the wrap fee brochure must be filed immediately, and an amendment or sticker that specifies the changes must be provided to investors. Any non-material change must be filed within 90 days of the end of the adviser’s fiscal year-end with the Administrator.
Advisers who charge wrap fees send customers “Part 2A – Appendix 1” instead of the “normal” Part 2A. Appendix 1 discloses the features and expenses specific to wrap fee arrangements.
A qualified client
is defined as a customer with a net worth of at least $2 million (not including the customer’s primary residence) or $1 million under the adviser’s management
IA
qualified custodian
◾An FDIC insured financial institution
◾A registered broker-dealer who holds client assets
◾A registered futures commission merchant who holds client assets
◾Foreign financial institution holding assets for clients
Prudent Man Rule
is the guideline that fiduciaries must observe in managing client assets, and it applies to investment advisers
The Prudent Man Rule requires a fiduciary to:
I. Make only investment decisions a prudent person without specialized knowledge would make
II. Always and only choose the most conservative investments
III. Consider the needs of the beneficiary
IV. Obtain the beneficiary’s prior permission to effect any transaction
A II & IV B I & II C I & III D II & III
C
I & III
Agency Cross Transactions
facilitates the sale of the securities from one of their clients to another of the investment advisor
Which of the following are required in order for an investment adviser to accept a blanket authorization to execute agency cross trades for a customer?
I. The consent must be renewed annually
II. The client must grant permission prior to each trade
III. The client must have the right to revoke the consent at any time
IV. The adviser must not recommend a transaction to both parties to the agency cross
A III & IV B II & III C I & IV D I & III
A
III & IV
Principal Transactions
It may sometimes be appropriate for an investment adviser to sell securities to a customer from its own account or buy securities from a customer for its own account. These are principal transactions since the IA is on one side of the trade with the customer on the other side of the trade.
Like agency cross transactions, principal transactions involve a conflict of interest. The conflict is more serious in a principal transaction than in an agency cross, so blanket authorizations to do such trades are not permitted. The IA must obtain authorization for each trade prior to the transaction.
Affinity fraud
is a tool used by criminals to gain the trust of victims by claiming to be members of the same identifiable group, such as a religious affiliation, race, national origin, or profession, or to have similar interests. While affinity fraud has always been common, social media gives con artists a rapid and largely anonymous way to identify, and identify with, target groups.
Under the Uniform Securities Act, “publicly distributed written materials” are materials which are sent to at least 35 persons, and:
A Contain a testimonial
B Provide graphs, charts, or formulas being offered to determine which securities to buy or sell
C May refer indirectly to past recommendations that were profitable to any person
D Are paid for by the recipients
D
Are paid for by the recipients
A security where the holder may have to pay something of value later in order to maintain ownership, would be a definition of: A Non-assessable stock B Futures contract C Cumulative preferred stock D Assessable stock
D
Assessable stock
The term offer or offer to sell includes which of the following?
A
When some of a corporation’s issued securities are exchanged for securities of a merged corporation or when a corporation sells a portion of its assets in exchange for receiving securities of the other corporation.
B
Gift of non-assessable stock
C
When, as a result of a court-approved reorganization, a security is issued in exchange for outstanding securities.
D
Every attempt to buy, obtain an interest in, attempt to dispose of, or offer a security for value
D
Every attempt to buy, obtain an interest in, attempt to dispose of, or offer a security for value
Nice try! The correct answer was D.
The term offer or offer to sell includes every attempt to buy, obtain an interest in, attempt to dispose of, or offer a security for value. A stock transfer as a result or mergers or reorganization is not a sale, or offer, or offer to sell. Neither is a gift of non-assessable stock.
Criminal penalties for fraudulent securities transactions that took place within a State require which one of the following to initiate criminal prosecution of the alleged offender? A NASAA B State Attorney General C FINRA D State Securities Administrator
B
State Attorney General
Which of the following statements is (are) true regarding the Uniform Securities Act?
I The maximum criminal fine for violations of the Act is $25,000
II The maximum prison sentence for a violation of the Act is three years
III In order for a violator of the Act to be imprisoned, the transgression must be willful
IV A violator of the Act can be fined and imprisoned
A
I and IV
B
I, II, III and IV
C
II
D
II, III and IV
D
II, III and IV
