Chapter 3 SIE Flashcards
Market order
buy or sell, executed immediately at the best available market price
The fastest way to get an execution since the investor is not price sensitive.
These at market orders should not be used if the security in question is illiquid. In that case limit orders might be the better choice.
limit order
buy or sell, limits the acceptable purchase or selling price paid or received for the securities.
Come with inherent risk. The risk is that the market may never go as low as the buy limit designated on the order, or as high as the sell limit designated on the order. As a consequence it is possible that the order will never be executed.
stand in time priority. There may be multiple orders to buy stock at a particular price. Once the stock begins trading at that price, those limit orders that were entered first will be filled first.
for a buy limit order, or better means at the limit price or
lower
for a sell limit order, or better means at the limit price or
higher
buy limit order buy 1000 shares of xyz at 32
this order could only be executed to purchase xyz at 32 or better. because this is an instruction to buy, or better would be lower. therefore it would need to be executed at 32 or lower
sell limit order sell 1000 shares of xyz at 32
this order could only be executed to sell xyz at 32 or better. Because this is an instruction to sell, or better would be higher. therefore it would need to be executed at 32 or higher.
stop order
buy or sell a stop order does not become a “live” working order in the marketplace until the stock trades at or through a specified stop price, the order becomes a market order, and like any other market order, it should be executed immediately at the best available price.
xyz cmv = 12
Order: buy 2000 shares xyz at 15 stop
as soon as xyz trades at or through the stop price of 15, this order will become a live working market order, and like all market orders, will be executed at the next available price.
Stop limit order
Buy or sell, this order type also has a stop price and does not become a “live” working order until the stock trades at or through the stop price. However it also has a limit price, so once the order is triggered by the stock reach the specified stop price, the order becomes a limit order to buy or sell at a specified limit. Like any other limit order, it may or may not be executed depending on where the price of the stock is.
day order
Unless marked to the contrary, an order is assumed to be a day order, valid only until the close of trading on the day it is entered. If the order has not been filled(executed in full), it is canceled at the close of the day’s trading. Keep in mind that while market orders should be filled immediately, this is of more importance with limit orders.
good till canceled order
are valid until executed or canceled. However, all gtc orders are automatically canceled if unexecuted on the last business day of April and the last business day of October. If the customer wishes to have the order remain working beyond those specific days, the customer must reenter the order.
market at open or market on close order
these are market orders designed to be executed at the opening of the day or at the close of the day. Depending on the market (exchange or otc) the order is being sent to, the customer is not guaranteed the exact opening or closing price but instead a price at, or close to, the first or last price of the day.
Fill or kill order
Applicable to limit orders, this is an instruction to fill(execute in its entirety) the order immediately or kill(cancel) the order completely. In this light there can’t ever be a partial execution
all or none order
must be executed in their entirety or not at all. AON orders can be day orders or good till canceled orders. They differ from Fill or Kill in that they do not have to be filled immediately. In other words, they can be held until the end of the day(for day orders) or beyond for gtc orders until they can be filled in their entirety.
bid price and ask(offer) price
the current bid price for a security is the highest price anyone is willing to pay for the securities at that moment in time. The current ask( offer) price is the lowest price that anyone is willing to accept to sell the securities at that moment in time.
all quotes maintained in active markets, like the stock exchange are
dynamic and change constantly throughout the trading day.
spread
difference between the bid and the ask price.
agent
if the firm acts as an agent, it is a broker acting on behalf of its customer to buy or sell securities in the market. The rm is paid a commission when acting as an agent.
agent=broker=commission
principal
If the firm is acting as a principal, the firm is buying into or selling out of, its own inventory to accommodate its customer. In this capacity, the firm is a dealer and will mark up the securities it is selling out of its inventory or mark down the securities it is buying into its inventory, rather than charge the customer a commission.
principal=dealer=markup or markdown
buy in an open position=
long= bullish
sell to open a position=
short= bearish
naked short selling
Selling a stock short without first borrowing the shares or confirming a location where the shares can be borrowed from
this is a violation
By contrast, if the shares have been properly borrowed or they have been located (and therefore, it is known they can be borrowed), the short seller can now move forward and sell short. These shares, because they have already been borrowed or located to be borrowed, are known to be covered.
whats a discretionary account
discretion is defined as the authority to decide
what security
An account set up with preapproved authority for an RR to make transactions without having to ask for speci c approval is a discretionary account.
the number of shares or units
whether to buy or sell
Discretion does not apply to decisions regarding the timing of an investment or the price at which it is acquired only.
A customer can give discretionary power over his account(s) only by filing a
trading authorization or a limited power of attorney with the bd
solicited order
A transaction initiated by an agent or RR is known as a solicited transaction.
unsolicited order
those initiated by the customer.
order tickets should be marked ether
solicited or unsolicited
ordinary income
Ordinary income can be de fined as the income earned from interest, wages, rents, royalties, and similar income streams. Ordinary income is taxed at different rates depending on the amount of income received by a taxpayer in a given tax year. The IRS divides ordinary income into tax brackets.
capital gains
Capital gains are usually associated with the sale or exchange of property, including securities. The category of capital gain taxation is further broken down into long-term and short-term capital gains. If an asset is sold within one year (12 months or less) of its purchase, the gain is considered to be a short-term gain, and it will be taxed at the same rate as the taxpayer’s other ordinary income. Therefore, for short-term capital gains, the tax rates are the same as the taxpayer’s ordinary income. However, if the asset is held for more than one year, the gain is considered to be a long-term capital gain, and is taxed at a favorable long-term rate.
dividends
are distributions of a company’s profits to its shareholders. Investors who buy stock or mutual funds, for example, are entitled to dividends if and when the board of directors (BOD) votes to make such distributions. Shareholders are automatically sent any dividends to which their shares entitle them.
cash dividends
Cash dividends are normally distributed by check if an investor holds the stock certi cate, or they are automatically deposited to a brokerage account if the shares are held in street name (held in a brokerage account in the rm’s name to facilitate payments and delivery). When declared, cash dividends are typically paid quarterly and are taxed in the year they are distributed.
stock dividends
If a company wishes to reinvest its pro ts for business purposes rather than to pay cash dividends, its BOD may declare a stock dividend. This is typical of many growth companies that invest their cash resources in research and development. Under these circumstances, the company issues additional shares of its common stock as a divi- dend to its current stockholders instead of cash. The net result is that the shareholder now owns more shares after the distribution. but the cost per share is adjusted downward. The stock dividend itself is not taxable, but the adjusted cost per share (new cost basis) will impact the tax consequences when the shares are sold.
There are four dates to remember that are associated with the dividend disbursing process:
derp
declaration date
ex-dividend date
record date
payable date
declaration date
When a company’s BOD approves a dividend payment, it is recognized as the date the dividend was declared. At this time, the BOD would also designate the payment date and the dividend record date, discussed as follows.
ex-dividend date
on the basis of the dividend record date, FINRA or the exchange (if the stock is listed) posts an ex-date. The ex-date is one business day before the record date. Because most trades settle the regular way—two business days after the trade date—a customer must purchase the stock two business days before the record date to qualify for
the dividend. Or said another way, to receive the dividend, the stock must be purchased
before the ex-dividend date.
— Conversely, if the stock is purchased on or after the ex-date, the new owner has pur- chased the stock “ex” without the dividend, and is therefore not entitled to receive it.
record date
The stockholders of record (those who own the stock) on the record date receive the dividend distribution.
payable date
On the payable date, the dividend disbursing agent sends dividend checks to all stockholders whose names appear on the books as owners as of the record date.
declaration, record and payment are determined by
the BOD
the ex dividend dat is determined by
finer
interest
is the income paid to those who purchase debt securities—bondholders. It is generally stated as a percentage of face value (a.k.a. par value) on an annual basis. Interest is taxed as ordinary income.
capital gain
occurs when a security is sold for a price higher than the cost basis.
capital loss
If the selling price is lower than the cost basis
upon liquidation, cost basis represents
the cost basis is not taxed
a return on capital
as a gain, but any sales proceeds above cost basis would be
index funds
Some mutual funds are created to track a particular index. These types of funds do not attempt to beat the market, but simply try to match the performance of a given index. Index funds are usually a lower cost for investors and have far less portfolio turnover when compared to actively managed funds.
trade settlement
The date a transaction occurs is known as the trade date. Settlement date, on the other hand, is the date on which ownership actually changes between the buyer and seller. It is the date on which BDs are required to exchange the securities and funds involved in a transaction and customers are requested to pay for securities bought and to deliver securities sold.
regular way settlement
In the securities industry, it is FINRA’s Uniform Practice Code (UPC) that standardizes the dates and times for each type of settlement. Regular way, as its name suggests, is the regular way that securities transactions settle after the securities trade. Regular way settlement for most corporate securities (equity and debt) transactions is the second business day (holidays and weekends are not settlement days) following the trade date, known as T + 2.
t+2 for
corporate securities, municipal bonds, government agency securities
t+1
federal government securities
like T bills notes and bonds, and options
same day as trade for
money market securities
cash settlement
Cash settlement, or same-day settlement, requires delivery of securities from the seller and payment from the buyer on the same day a trade is executed. Stocks or bonds sold for cash settlement must be available on the spot for delivery to the buyer. Both parties to the transac- tion would have to agree for cash settlement to occur.
sellers option
A seller’s option contract lets a customer lock in a selling price for securities without having to make delivery on the second business day. Instead, the seller can settle the trade as speci ed in the contract. Or, if the seller elects to settle earlier than originally speci ed, the trade can be settled on any date from the fourth business day through the contract date, provided the buyer is given a one-day written notice. A buyer’s option contract works the same way, with the buyer specifying when settlement will take place.
Seller’s or buyer’s settlement option cannot take place any sooner than
the trade date plus three business days (T + 3)
physical certificate
When securities are issued with physical paper certi cates (bonds or shares), it is those certi cates that would be required for physical delivery. Certi cates must be endorsed by all owners to constitute a good delivery.
book entry
some securities are sold without a physical certi cate. In those instances, evidence of ownership is kept on record at a central agency. For example, earlier, we noted that government securities issued by the U.S. Treasury are all issued in book-entry form, meaning that no physical securities (paper certi cates) exist. Transfer of ownership is recorded by entering the change on the books or electronic les.
forward split
A forward stock split increases the number of shares and reduces the price without affect- ing the total market value of shares outstanding; an investor will receive more shares, but the value of each share is reduced. The total market value of the ownership interest is the same before and after the split.
even split
the investor will always be given a certain number of shares for each share owned: 2 for 1, or 3 for 1, for example.
uneven split
n an uneven split, the split can be designated in any ratio: 3 for 2, or 5 for 4, for example.
reverse split
Sometimes, a stock price becomes so low that it attains an undesirable aura about it. In some cases, a low stock price might not meet the listing criteria of a stock exchange that it is listed on and delisting can occur. To combat these issues, one corporate action that can be taken, strictly related to the price of the stock, is a reverse stock split. Unlike a forward split where the number of shares is increased and the price per share is decreased, a reverse split has the opposite effect on the number and price of shares. After a reverse split, investors own fewer shares worth more per share.
there are more or fewer shares at lower or greater value as a result of
the corporate action split depending on if its a forward or reverse split .
preemptive rights
entitle existing common stock- holders to maintain their proportionate ownership shares in a company by buying newly issued shares before the company offers them to the general public.
rights
short term, given to existing shareholders, allows one to purchase shares below current market value
warrants
long term, bundled with other securities, allows someone to purchase shares at a price that is above the current market value at the time the warrants were issued
mergers and acquisitions
hese are transactions in which the ownership of companies or their operating units are transferred as in the case of an acquisition, or combined as in the case of a merger. M&A can allow enterprises to grow, shrink, or change the nature of their business.
takeover
A takeover is the purchase of one company, known as the target company, by another company, known as the bidder or buyer. A hostile takeover is accomplished when the buyer goes directly to the target company’s shareholders, bypassing the BOD or management.
spin-off
This is a type of divestiture where a parent company sells all of the shares of a subsidiary or distributes new shares of a company or division it owns to create a new company.
tender offer
This is an offer to buy securities for cash or for cash plus securities.
buyback
A buyback, sometimes referred to as a repurchase, is when a company buys its own outstanding shares in the open market from existing shareholders. Companies might buy back shares for numerous reasons. For example, doing so reduces the number of shares available (supply) and therefore can increase the value of shares still available (demand). Sometimes, by removing available shares from the market, a company might be trying to eliminate any threats of takeover.
a notice is not required for
an ordinary interest payment on a corporate debt security
proxy solicitation
Stockholders can receive multiple proxy solicitations for controversial company proposals. If proxies are solicited, the SEC requires a company to give stockholders information about the items to be voted on and allow the SEC to review this information before it sends the proxies to stockholders. In a proxy contest, everyone who participates must register with the SEC. Also, anyone who is not a direct participant but who provides stockholders with unsolicited advice must register as a participant.
member firms are reimbursed
by issuers for all costs relating to the forwarding of proxy materials. such costs include postage and related clerical expenses
cash account
is the basic type of investment account. Anyone eligible to open an investment account can open a cash account. In a cash account, a customer pays in full for any securities purchased. Payment in full as de ned by the SEC under Regulation T must occur not later than two business days after the standard settlement period. in other words T +4
long margin account
customers purchase securities and pay interest on the money borrowed until the loan is repaid.(borrow money)
short margin
stock is borrowed and then sold short, enabling the customer to pro t if its value declines. (borrow securities)
hypothecation
is the pledging of customer securities as collateral for margin loans. A hypothecation agreement must be signed by a customer who wants to open a margin account. This agreement is generally contained within the margin agreement, and thus, customers are giving permission for this process to occur when they sign the margin agreement.
rehypothecates
After customers pledge their securities to the BD by signing the margin agreement, the BD rehypothecates (repledges) them as collateral for a loan from a bank. In this light, you can see that a BD is not lending its own funds to customers purchasing securities on margin but instead is borrowing money from a bank for that purpose. Regulation U oversees the process of a bank lending money to BDs based on customer securities having been pledged as collateral for the loan.
individual and joint accounts about margin
those with more than one party to the account) can utilize margin.
corporate accounts about margin
may utilize margin only if it is not restricted in the corporation’s char- ter or bylaws. In other words, trading on margin may be listed as being prohibited, and if so, would not be allowed.
partnership accounts about margin
may utilize margin only if it is not restricted in the partnership reso- lution. Like a corporate account, a partnership agreement might list trading on margin as being prohibited, and if so, would not be allowed.
fiduciary accounts about margin
could only utilize margin if it is specifically per- mitted within the trust or custodial agreement. Note the difference here. In this instance, margin must be specifically listed as being permitted.
IRA can use margin?
and other qualified plans prohibit the use of margin.
margin and approval
Like all accounts, margin accounts would need to be approved by a principal of the rm before the rst trade. The approval would need to be in accordance with whether or not mar- gin is permissible for the type of account being set up, as outlined in the previous section.
margin account
margin
it allows customers to increase their trading capital by borrowing either cash or securities via their BDs.
the amount of equity that must be deposited to buy securities in a margin account
marginable
refers to securities that can be used as collateral in a margin account
the frb can change regulation t __
at any time , but the current requirement(50%) has been in place since 1974. assume regulation t equals 50% in a test question unless it is specified different.
credit agreement
nt form.
Credit agreement—The credit agreement discloses the terms of the credit extended by the BD, including the method of interest computation and situations under which interest rates may change.
hypothecation agreement
As noted earlier in this unit, the hypothecation agreement allows the securities to be pledged for the loan and gives permission to the BD to repledge customer margin securities as collateral. The rm rehypothecates customer securities to the bank, and the bank loans money to the BD on the basis of the loan value of these securities. All customer securities must be held in street name (registered in the name of the BD) to facilitate this process. When customer securities are held in street name, the BD is known as the nominal, or named, owner. The customer is the bene cial owner because he retains all rights of ownership.
loan consent form
If signed, the loan consent form gives permission to the rm to loan the customers margin securities to other customers or BDs, usually to facilitate short sales where securities need to be borrowed.
to open a margin account
it is mandatory that the customer signs the credit agreement and hypothecation agreement. the loan consent form is optional
the initial deposit and maintenance requirement in a short account is a minimum of
2000 regardless of how small the initial transaction is
A firm’s designated examining authority (DEA) could be
a U.S. exchange or FINRA. This would be the designated authority tasked with monitoring and auditing the firm for industry rule compliance.
in a non discretionary account
no order can be entered without the customer’s prior approval.
commission based accounts- vs fee based accounts
Accounts can be set up as commission based, where a commission is billed for each trans- action, or as fee based. Firms can offer investors fee-based accounts that charge a single fee (either xed or a percentage of assets in the account) instead of commission-based charges for brokerage services.
Fee-based accounts are appropriate only for investors who engage in at least a moderate level of trading activity. Accounts with a low level of trading activity may be better off with commission-based charges. Rules require that, before opening a fee-based account, investors be given a disclosure document describing the services to be provided and the cost.
wrap accounts
Wrap accounts are accounts for which rms provide a group of services, such as asset allo- cation, portfolio management, executions, and administration, for a single fee. Wrap accounts are generally investment advisory accounts.
section 529 plans
Section 529 plans (as previously discussed in section 2.1.2.5.5) are some of the most popu- lar methods of saving for education. Remember, these state-sponsored plans are eligible for tax-free distributions for quali ed withdrawals. Ownership of a 529 plan does not preclude the opening of a Coverdell account.
coverdell(education IRA)
Coverdell Education IRAs allow after-tax contributions of up to $2,000 per student per year for children younger than age 18. Contribution limits may be reduced or eliminated for higher-income tax payers. Distributions are tax free as long as the funds are used for qualified education expenses. These expenses include those for college, secondary, or elementary school. If a student’s account is not depleted by age 30, the funds must be distributed to the individual subject to income tax and 10% penalty or rolled into an education IRA for another family member bene ciary.
single account
has one bene cial owner. The account holder is the only person who can control the investments within the account and request distributions of cash or securities from the account.
If a person not named on an account will have any authority over the account, the customer must
le written authorization with the BD giving that person access to the account. This trading authorization usually takes the form of a power of attorney. Two basic types of trading authorizations are full powers of attorney and limited pow- ers of attorney. Both would be canceled upon the death of either party.
full power of attorney
A full power of attorney allows someone who is not the owner of an account to deposit or withdraw cash or securities and make investment decisions for the account owner. Custodians, trustees, guardians, and other people lling similar legal duties are often given full powers of attorney.
limited power of attorney
A limited power of attorney allows an individual to have some, but not total, control over an account. The document speci es the level of access the person may exercise. Limited power of attorney, also called limited trading authorization, allows the entering of buy and sell orders but no withdrawal of assets. Entry of orders and withdrawal of assets is allowed if full power of attorney is granted.
numbered accounts
Customers are permitted to open numbered accounts, which use a number, a symbol, or a nominee name in lieu of their real name. These accounts are subject to all customer identi cation procedures and other associated anti-money laundering rules. The rm must maintain a written statement signed by the client attesting to the ownership of the account.
transfer on death
Transfer on death (TOD) is a type of individual account that allows the registered owner of the account to pass all or a portion of it, upon death, to a named bene ciary or bene ciaries. This account avoids probate (i.e., having the decedent’s will declared genuine by a court of law) because the estate is bypassed. However, the assets in the account do not avoid estate tax, if applicable.
joint account
two or more adults are named on the account as co-owners, with each allowed some form of control over the account. The account forms for joint accounts require the signatures of all owners.
tenants in common
ownership provides that a deceased tenant’s fractional interest in the account is retained by that tenant’s estate and is not passed to the surviving tenant(s).
each party must specific a percentage interest in the account*
joint tenants with right to survivorship
ownership stipulates that a deceased tenant’s interest in the account passes to the surviving tenant(s).
all parties have an undivided interest in the account *
corporate accounts
Corporations, like individuals, will invest in securities. When opening an account for a corporation, a rm must obtain a copy of the corporate charter as well as a corporate resolution.
partnership accounts
A partnership is an unincorporated association of two or more individuals. Partnerships frequently open accounts necessary for business purposes.
The partnership must complete a partnership agreement stating which of the partners can make transactions for the account.
fiduciary account
When securities are placed in a duciary account, a person other than the owner initiates trades. The most familiar example of a duciary account is a trust account. Money or securities are placed in trust for one person, often a minor, but someone else manages the account. The manager or trustee is a duciary.
uniform gift to minors
Accounts set up for minors can be established under either the Uniform Gift to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). These accounts require an adult to act as custodian for a minor (the bene cial owner). Any kind of security or cash may be given to the account without limitation.
When a person makes a gift of securities to a minor under the UGMA or UTMA laws,
that person is the donor of the securities. A gift under these acts conveys an indefeasible title; that is, the donor may not take back the gift, nor may the minor return the gift. Once the gift is donated, the donor gives up all rights to the property.
when opening a custodial account
representative must ensure that the account appli- cation contains the custodian’s name, the minor’s name and Social Security number, and the state in which the account is registered.
beneficial owner
account contains the minors social security number
If the bene ciary of a custodial account (minor) dies,
the securities in the account pass to the minor’s estate, not to the parents’ or custodian’s estate.
contributions for ira
An eligible individual may make contributions up to a maximum dollar amount that can change from year to year (as determined by the IRS tax code), provided that the contribution does not exceed earned income (normally compensation and income from self-employment) for the year. The dollar cap is increased by a catch-up amount for individuals age 50 and older.
current ira contribution limits and catch up contributions limit for those age
50 and older may be tested
these limits may change, sometimes annually. current contribution limits can be found on www. irs.gov/retirement -plans
funding for ira
Within an IRA, investments can be made in stocks, bonds, investment com- pany securities, U.S.-minted gold and silver coins, and many other securities.
are life insurance allowed in iras
no but other life insurance products like annuities are.
rollovers and transfers or iras
Individuals may take possession of the funds and investments in a quali ed plan to move them to another quali ed plan, but may do so no more than once every 12 months. This is known as a rollover and it must be completed within 60 calendar days of withdrawal.
distributions/withdrawals for ira
Distributions may begin without penalty after age 591⁄2 and must begin by April 1 of the year after the individual turns 701⁄2. Distributions before age 591⁄2 are subject to a 10% penalty as well as regular income tax, except in the event of:
■ death;
■ disability;
■ first-time homebuyer for purchase of a principal residence;
■ education expenses for the taxpayer, spouse, child, or grandchild;
■ medical premiums for unemployed individuals; and
■ medical expenses in excess of de ned AGI limits.
roth iras
Roth IRAs allow after-tax con- tributions up to a maximum annual allowable limit per individual per year. Contributions to other (traditional) IRAs when combined with contributions to a Roth IRA may not exceed the maximum annual allowable limit.
Contributions to Roth IRAs are not deductible on one’s tax return. Note the difference here between a traditional IRA and a Roth IRA.
RMDS at age 70 ½ do not apply to
roth iras. the 10% penalty for distributions before 591/2 is waived for first time homebuyers if they use the funds to purchase a principal residence
a simple ira
is an employer-sponsored retirement plan offered by small businesses that employ 100 or fewer people. SIMPLE is an acronym for savings incentive match for employees. These plans are typically a less expensive and less complicated alternative to 401(k) plans, which are often favored by larger companies [401(k)s are discussed next]. Plan participants are typically given a menu of investment choices, such as stock and bond mutual funds.
401 k
is a type of retirement contribution plan that allows an employee to elect to contribute a percentage of salary up to a maximum dollar limit to a retirement account each year (a de ned contribution). Just like with IRAs, catch-up contributions for those age 50 and older are also allowed. Contributions are excluded from the employee’s gross income and accumulate tax deferred, as do any earnings in the account. Employers are permitted to make matching contributions up to a speci ed percentage of the employee’s contributions. In addition, 401(k) plans permit hardship withdrawals for situations such as unemployment or rst-time homebuyers and can also allow loans against any vested balance.
403 b plans
is a type of quali ed retirement plan available to employees of public edu- cational institutions. In general, employees of colleges, universities, elementary schools, and secondary schools are eligible to participate if they are at least 21 years old and have completed one year of service.
besides 403 b plans for employees of educational institutions , tax sheltered annuities are also available for
employees of tax exempt organizations and religious organizations
anti money laundering
The Bank Secrecy Act establishes the U.S. Treasury Department as the lead agency for developing regulations in connection with anti-money laundering (AML) programs.
3 stages of money laundering
placement
layering
integration
placement
This first stage of laundering is when funds or assets are moved into the laundering system. This stage is recognized as the time when illegal funds are the most susceptible to detection.
layering
The goal of money launderers during this stage is to conceal the source of the funds or assets. This is done through a series of layers of transactions that are generally numerous and can vary in form and complexity.
integration
In the final stage, illegal funds are commingled with legitimate funds in what appear to be viable legitimate business concerns. This can be accomplished using front companies operating on a cash basis, import and export companies, and many other types of businesses.
aml compliance program
BDs are required to establish internal compliance procedures to detect abuses. There are signs or red ags that might suggest the possibility of money laundering. If a red ag is detected, it should be reported to the principal designated to receive such reports immediately.
Examples of red ags include:
■ a customer exhibiting a lack of concern regarding risks, commissions, or other transaction costs;
■ a customer attempting to make frequent or large deposits of currency or cashier’s checks;
■ a customer making a large number of wire transfers to unrelated third parties;
■ a customer engaging in excessive journal entries between unrelated accounts; and
■ a customer who designs currency deposits or withdrawals to fall under the $10,000 cash transaction report (CTR) ling threshold, a practice known as structuring.
suspicious activity report
The USA PATRIOT Act requires rms to report to the Financial Crimes Enforcement Network (FinCEN) when there is an event, transaction, or series of events or transactions that appear to be questionable.
FinCEN
FinCEN is a bureau of the U.S. Treasury Department that collects and analyzes information about financial transactions to combat money laundering, domestic and international terrorist financing, and other financial crimes.
current transaction report
The Bank Secrecy Act requires BDs to report any currency received in the amount of more than $10,000 on a single day. Though paying for purchased securities with currency is not pro- hibited, many firms do not permit this. Failure to report can result in fines of up to $500,000, 10 years in prison, or both. Records relating to filed reports must be retained for five years.
use patriot act
requires financial institutions to maintain Customer Identi cation Programs (CIPs) to prevent nancing of terrorist operations and money laun- dering. Financial institutions, such as banks and BDs, must keep records of identi cation information and check customer names against the Specially Designated Nationals (SDN) list maintained by the Of ce of Foreign Assets Control (OFAC).
office of foreign assets control
publishes and maintains a list of indi- viduals and companies owned or controlled by, or who are acting for, or on behalf of, targeted countries and individuals, groups, or entities that are designated under programs that are not country speci c, such as terrorists and those traf cking in narcotics.
lifetime records
Records that must be kept for the life of the rm are partnership articles if a partnership, articles of incorporation if a corporation, minute books (records of directors’ or partners’ meetings), stock certi cate books, and organizational documents such as Form BD and amendments.
six year records
There are ve primary records that must be retained for six years.
blotters general ledger stock record customer ledgers customer account records
blotters
A blotter is a record of original entry. A member generally maintains blotters relating to the purchase and sale of securities, the receipt and delivery of securities, and the receipt and disbursement of cash. Blotters must re ect transactions as of trade date (or event date) and must be prepared no later than the following business day.
general ledger
The general ledger contains accounting records of the rm’s assets, lia- bilities, and net worth accounts. From the general ledger, a rm prepares its nancial statements. The general ledger must be prepared as frequently as necessary to determine compliance with the net capital rule, but in no event less frequently than monthly.
stock record
The stock record shows all securities held by the rm, the ownership of those securities, and where the securities are held. The stock record must be posted no later than the business day after the settlement date.
customer ledger
ustomer ledgers are customer statements. Cash accounts and margin accounts are shown on separate ledgers. These ledgers must be posted no later than the settlement date.
customer account records
Customer account records might include the new account form and margin agreement, if appropriate.
3 year records
Most other records are three-year records. Examples of these records include the following:
■ Advertising
■ Trial balances
■ Form U4, U5, and ngerprint cards for terminated personnel
■ Customer con rmations
■ Order tickets
■ Subsidiary ledgers such as securities borrowed and securities loaned, monies borrowed and monies loaned, and dividends and interest received
■ A list of every of ce where each associated person regularly conducts business
Unit 3 Understanding Trading, Customer Accounts, and Prohibited Activities 155
■ Associated persons’ compensation records
■ The rm’s Compliance and Procedures Manual
One exception to the lifetime, six-year, and three-year retention is the
requirement for written customer complaints. Customer complaint records must be retained
electronic delivery
FINRA allows members to electronically send documents, such as con rmations and account statements, to customers as long as certain conditions are met. To do so, the rm must have procedures in place to show that the information sent has been delivered as intended and that the con dentiality and security of personal information are protected. Further, customers must provide written consent to electronic delivery.
updating customer account records
To ensure that the information obtained from each new customer is accurate, rms must furnish to each customer, within 30 days of opening the account, a copy of the account record. The rm must include a statement that the customer should mark any corrections on the record and return it along with a statement that the customer should notify the rm of any future changes to information in the account record so that accurate and current records can be maintained.
account statements provided to customers give
give a general accounting of securities and cash held in the account.
activity is defined as
Activity is de ned as purchases, sales, interest, or dividends received, or any funds flowing in or out of the account. Penny stocks are defined as those price under $5 per share.
trade confirmation
is a printed document that confirms a trade, its settlement date, and the amount of money due from or owed to the customer. For each transaction, a customer must be sent or given a written confirmation of the trade at or before the completion of the transaction—the settlement date.
nontrade confirmations/ third party activity
Firms are required to send con rmations of activity in accounts even when the activity is not trade related or initiated by a third party.
business continuity plans
INRA requires member rms to create and maintain a business continuity plan (BCP) to deal with the possibility of a signi cant business disruption. The plan must address certain points having to do with the consequences of the event, including but not limited to the following:
■ Data backup and recovery (hard copy and electronic)
■ Alternate communications between the rm and its customers
■ Alternate communications between the rm and its employees
■ Alternate physical location of employees
■ Communications with regulators
■ Prompt customer access to funds and securities in the event the rm is unable to continue its business
privacy requirements-regulation SP
This regulation was enacted by the SEC to protect the privacy of customer information. In particular, the regulation deals with nonpublic personal information.
nonpublic personal information
The SEC, in Regulation SP, notes examples of nonpublic personal information. This type of information would include a customer’s Social Security number, account balances, transac- tion history, and any information collected through an internet cookie.
confidentiality of information
If your rm reserves the right to disclose to unaf liated third parties nonpublic personal information, the notice must provide customers a reasonable means to opt out of this disclo- sure. Reasonable opt-out means providing customers with a form with check-off boxes along with a prepaid return envelope, providing an electronic means to opt out for customers who have agreed to the electronic delivery of information, and providing a toll-free telephone number. Asking customers to write a letter to express their disclosure preferences or to opt out would not be considered reasonable under Regulation SP.
privacy of consumer financial information
Regulation SP is designed to pro- tect a customer’s nonpublic, personal information. Under Regulation SP, rms must provide their customers with a description of their privacy policies (a privacy notice). The notice must state the types of personal information that the rm collects and who the rm shares this infor- mation with. Firms must initially provide every customer with a privacy notice at the time the relationship is rst established. Once the relationship is established, the firm must provide with an updated version of this notice annually.
safeguard requirements
In addition, the regulation embodies the obligation of nancial institutions to safeguard customer information as related to all forms of existing and developing technology. For exam- ple, this would include, but not be limited to, securing desktop and laptop computers and encrypting email.
retail communication
means any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30-calendar-day period. A retail investor is any person other than an institutional investor, regardless of whether the person has an account with the member.
correspondence
means any written (including electronic) communication that is distributed or made available to 25 or fewer retail investors within any 30-calendar-day period.
institutional communication
means any written (including electronic) communication that is distributed or made available only to institutional investors, but does not include a member’s internal communications (e.g., internal memos).
if an entity does not fall under any of the designated categories for institutional investor
then it must be considered and treated as a retail customer.
do not call list
The TCPA requires an organization that does telemarketing (cold-calling in particular)
suitability requirements
Whether or not an investment strategy or security is suitable for a customer is a determina- tion made by an RR as to whether the strategy or security matches the customer’s investment objectives and nancial capability. The representative must have enough information about the customer to make this judgment.
know your customer
FINRA and other SROs require brokers to know their customers. This implies under- standing a customer’s nancial status (net worth and net income), investment objectives, and all facts essential in making suitable recommendations. It is an RR’s responsibility to perform due diligence to determine the validity of a customer’s information.
pump and dump
is the act of in ating (pumping) the price of an owned stock by perpetrating false and misleading positive rumors, in order to sell the stock at a higher price later.
front running
is the act of placing orders for one’s own account ahead of other orders that are known to be entering the market in an attempt to gain from the price movement that is likely to occur.
excessive trading
in a customer’s account to generate commissions rather than to help achieve the customer’s stated investment objectives is an abuse of duciary responsibility known as churning.
marking the open
Entering orders before the opening for a stock or falsely reporting trades that never occurred to in uence the opening price of a stock is called marking the open.
marking the close
Effecting trades at or near the close of the trading day or falsely reporting trades that never occurred to in uence the closing price of a stock is called mark- ing the close. For example, putting in buy orders at the close for the purpose of pushing up the price of a stock so that it is valued higher in one’s portfolio or account at the end of the day is marking the close.
backing away
A market maker can revise a rm quote in response to market conditions and trading activity, but a market maker who refuses to do business at the price(s) quoted is backing away from the quote. Backing away is a violation of trading rules.
free riding
Freeriding is a term used when securities are purchased and then sold before making pay- ment for the purchase. Freeriding is generally prohibited in both cash and margin accounts. As a penalty, the account will be frozen for 90 days, and no new transactions can occur unless there is cash or marginable securities in the account before the purchase is made.
capping
Capping is usually associated with those who are short option call contracts. This is the act of entering sell orders in a stock for the purpose of keeping it from rising above the strike price of calls someone is short; this is done so the calls won’t be in the money and thus likely to be exercised.
supporting
Supporting is usually associated with those who are short put option contracts.
This is the act of entering purchase orders in a stock for the purpose of keeping the price from falling below the strike price of put contracts that an investor has written. This arti cial price support is done to prevent the puts from moving in the money and being exercised.
pegging
Pegging is a generic term that applies to any activity intended to keep the price of a stock from moving. This can involve entering either buy or sell orders, or both.
wash sales
A wash sale viola- tion is an attempt to create a loss for tax purposes (sell at a loss) when one’s intent is to still maintain ownership of the securities.
the rules of wash sales
do not prohibit the initial sale (for a loss) or the recreation of the position. These are permissible actions. The rule does, however, prohibit taking the loss on one’s tax return if the position was recreated within the 30 days before or after the sale window.
matched orders
s a manipulation that involves one party selling stock to another with the understanding that the stock will be repurchased later (usually the same day) at virtually the same price. The intent of such transactions is to make it appear that far more activity in a stock (share volume) exists than actually does. This is sometimes referred to as painting the tape.
breakpoint sales
To understand a breakpoint sale, one must rst know what a breakpoint is.
Breakpoints are quantity discounts on open-end management company shares (mutual funds)—the greater the dollar amount of a purchase, the lower the sales charge. There is no industry standardized breakpoint schedule, so they can vary across mutual fund families.
insider and insider trading
The Insider Trading Act de nes an insider as any person who has access to nonpublic information about a company that would most likely in uence the price of the company’s stock. Utilizing that information for the purpose of gain, or to avoid a loss, constitutes insider trading.
material nonpublic information
Inside information, by de nition, is any material nonpublic information—that is, any information that has not been disseminated to, or is not readily available to, the general public.
identifying involved parties
The Insider Trading Act prohibits insiders from trading on or communicating nonpublic information. Both the tipper (the person who relays the information) and the tippee (the person who receives the information) are liable, as is anyone who trades on information that they know or should know is not public or who has control over the misuse of this information.
insider trading pentacles
The SEC can investigate any person suspected of violating any of the provisions of the Insider Trading Act. If the SEC determines that a violation has occurred, civil penalties of up to three times pro ts made or losses avoided may be levied. A controlling person such as an RR or BD could be ned $1 million or three times the pro t made or loss avoided, whichever is greater.
Violators may also face criminal penalties of up to $5 million and up to 20 years in jail. If the violator is an employee of a BD, a rm (which is supposed to have procedures in place to prevent this) could be ned up to three times damages or $25 million, whichever is greater.
contemporaneous traders.
Persons who enter trades at or near the same time in the same security as a person who has inside information
may sue persons that have violated insider trading regulations, and suits may be initiated up to ve years after the violation has occurred.
informal bounties
The Insider Trading Act speci cally allowed for payment to informers. However, amended under the Dodd-Frank legislation, awards may now be paid in connection with original infor- mation concerning any violation of securities law, including insider trading. The information bounty or award can range from 10% to 30% of amounts recovered based on the information received.
Generally, before borrowing from or lending to a customer, a representative must
advise his rm in writing and receive written permission. However, notice and ap- proval are not needed if the loan is between immediate family members, and approv- al is not needed if the customer is a lending institution and the loan is on standard commercial terms.
firms cannot have joint accounts with
customers
representatives may have joint accounts with customers only if the arrangement has been approved by the principal and account proceeds are shared in proportion to each party’s contribution
financial exploitation of seniors
FINRA, along with other regulators, speci cally addresses the nancial exploitation of seniors and other speci ed adult customers. FINRA de nes the impacted accounts as those for individuals:
■ age 65 and older, or
■ age 18 and older who the member reasonably believes has a mental or physical impairment
that renders the individual unable to protect her own interests. FINRA notes nancial exploitation to be:
■ the wrongful or unauthorized taking, withholding, appropriation, or use of funds or securi- ties; or
■ any act or omission of an act taken by a person to obtain control, through deception, intimidation or undue in uence, over the speci ed adult’s money, assets or property; or convert the speci ed adult’s money, assets, or property.
unregistered persons are prohibited against
oliciting customers and taking orders to buy or sell securities.
only registered persons can be paid
commissions
continuing commissions may never be paid
on business referred or introduced by
an employee after that person ceases to be registered with the member.
