Chapter 5

Question 1

The Securities Act of 1933

Answer 1

The 1933 act defines an issuer as any person who issues or proposes to issue a security. An issuer may include a corporation, federal government, state or local government, or a church or charitable organization.

Question 2

underwriter

Answer 2

defined as a person who offers or sells securities for an issuer. An underwriter typically assists the issuer with the registration of a new security.

Question 3

Penalties under the 1933 Securities Act

Answer 3

Any person who willfully violates the Act of 1933 or SEC rules and regulations is subject to five years in prison, a $10,000 fine, or both. The Act also holds the directors, attorneys, accountants, underwriting syndicate, and all persons who signed the registration statement civilly liable for false and misleading statements contained in the registration statement and prospectus.

Question 4

Securities Exchange Act of 1934

Answer 4

governs the rules of securities that trade on the secondary markets. In an attempt to provide a fair and orderly market for investors, the Act also determines the laws that regulate the exchanges and their participating broker-dealer.
The Act of 1934 defines a broker as any person who transacts securities sales for investors while a dealer buys and sells securities for his or her own account.

Question 5

Securities and Exchange Commission (SEC)

Answer 5

One of the most significant outcomes of the Securities Exchange Act of 1934 was the creation of the Securities and Exchange Commission, more commonly known as the SEC. The SEC is responsible for enforcing securities laws in the U.S. The five commissioners of the SEC are appointed by the President of the U.S., with the advice of the Senate. Only three of the five members may be affiliated with the same political party. Members serve a five-year term during which they are full-time employees of the SEC.

Question 6

self-regulatory organization (SRO).

Answer 6

A non-governmental organization that has the power to create and enforce industry regulations and standards. The priority is to protect investors through the establishment of rules that promote ethics and equality

Question 7

Investment Advisors Act of 1940

Answer 7

was enacted to protect the public by requiring those who provide investment advice for compensation to register as advisors with the Securities and Exchange Commission (SEC).

Question 8

Investment Advisor

Answer 8

an individual or entity who for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities

Question 9

IA 1092

Answer 9

IA 1092 was issued in 1987 as a result of the increased activity in financial planning and investment advice. It essentially refined the definition of an investment advisor to include:

Pension consultants and advisors to athletes and entertainers are considered to be providers of investment advice.

Firms that recommend investment advisors may have to register themselves.

An investment advisor does not have to give advice as his/her principal business activity - simply doing so with some regularity is enough to require registration.

If a registered representative of a broker-dealer sets up a separate business entity to provide financial planning or investment advice for a fee, he/she may not rely on the broker-dealer exemption from registration; this is known as a statutory investment advisor.

Compensation does not have to be monetary to fall under the definition - receipt of products, services or discounts is also considered compensation.

Question 10

Investment Advisor Representatives

Answer 10

Employees of investment advisors must register as investment advisor representatives if they perform any of these functions:
Making investment recommendations or giving securities advice
Managing client accounts or portfolios
Soliciting or offering investment advisory services
Supervising employees who perform any of the above

Question 11

Affiliated Person

Answer 11

An individual who is in a position to influence the actions of a corporation. This includes people such as directors, executives, and owners

Question 12

Affiliated persons are prohibited from doing the following:

Answer 12

Borrowing money or any other property from a registered investment compan
Purchasing any securities or other property from a registered investment company except securities issued by the investment company
Selling any security or other property to a registered investment company except for securities issued by the investment company or securities which are part of a public distribution and for which the seller is the issuer
If an affiliated person has been convicted of any felony or misdemeanor involving the purchase or sale of securities within the past 10 years, or has been temporarily or permanently forbidden from acting as an affiliated person, it is unlawful for him or her to act in the capacity of employee, officer, director, investment advisor, advisory board member or underwriter of an investment company.

Question 13

investment company is

Answer 13

an investment company is any company who is (or proposes to be):
primarily in the business of investing, reinvesting or trading in securities;
issuing installment-type face-amount certificates.
investing, reinvesting, owning, holding, and trading securities; and holds more than 40% of their total value of assets (unconsolidated) in investment securities

Question 14

section 4 of the Investment Company Act of 1940, there are three types of investment companies:

Answer 14

Face-Amount Certificate Company- issues installment-type face face-amount certificates.

Unit Investment Trust (UIT) - created through a trust indenture, contract of custodianship or other similar structures. UITs do not have a board of directors like many companies and issue redeemable securities that do not entitle the holder to voting rights. These securities entitle the holder to a portion of a pool of investment securities. UITs are essentially mutual fund companies.

Management Company - any other companies who fit the investment company definition but are not classified as 1 or 2 above. These companies can be closed or open, diversified or non-diversified.

Question 15

Open end management companies

Answer 15

distribute and redeem securities it issues. The most common open-end management companies are mutual fund companies which sell and redeem shares at the net asset value per share.

Question 16

Closed end management companies

Answer 16

issue a fixed number of shares in an actively managed portfolio of securities. The shares are traded in the market just like common stock

Question 17

Diversified companies

Answer 17

hold a portfolio of money market, government and corporate securities with a value greater than 75% of their total assets, with no more than 5% of their total investment in any security from one issuer. Additionally, the 5% invested with a particular issuer cannot contain more than 10% of that issuers voting securities.

Question 18

Non-diversified companies

Answer 18

are like the name implies, any management company that is not diversified.

Question 19

Exemptions

Answer 19

Companies with both its principal location and place of business in Puerto Rico, the Virgin Islands. Note that this exemption is terminated should the exempt company offer securities to a resident of the US that is not located in their particular State.

Companies that have been reorganized, and at the close of these proceedings are no longer considered an investment company, all outstanding securities are owned by creditors and other individuals with a claim on company assets, and more than 50% of the company’s voting securities (over 50% of the companies net asset value (NAV)) are owned by less than 25 individuals.

Companies with written permission by the Commission by the Federal Savings and Loan Insurance Corporation.

Companies that were and are owned by a face-amount certificate company prior to March 14, 1940. These companies must be operating under State insurance laws and must be examined by the Insurance Commissioner.

Companies with 80% or more of their securities being sold to individuals within or have a large business presence within the same State.

Companies who sell securities only to accredited investors.

Companies who do not purchase securities from investment companies.

Question 20

restrictions apply to mutual fund companies

Answer 20

A mutual fund company may not purchase securities on margin.
A mutual fund company may not own a joint account that trades securities.
A mutual fund company may not effect a short sale of any security.
A mutual fund company may not purchase more than 3% of the outstanding voting stock of another investment company.

Question 21

Section 12b-1

Answer 21

of the Investment Company Act of 1940 allows the mutual fund company to pay the principal underwriter for the costs of sales literature, promotional items and other selling expenses by collecting 12b-1 fees. These fees are charged to fund shareholders and are permissible if the following conditions are met:

Payments to the principal underwriter are made according to a written plan that outlines the proposed financing and distribution agreement
The majority of shareholders and majority of non affiliated directors initially approves and continues to annually approve the plan
The board of directors reviews the payments under the plan at least quarterly
The plan and its related agreements may be terminated without penalty at any time with 60 days written notice

Question 22

Shareholder Rights

Answer 22

A mutual fund company may not borrow money, make loans, buy or sell real estate, or underwrite securities issued by other companies.
A mutual fund company may not change its investment objectives.
A mutual fund company may not change the nature of its business and cease acting as an investment company.
A mutual fund company cannot change from a diversified form to an undiversified one.

Question 23

Shareholders must also receive certain semiannual financial reports, including the following

Answer 23

A balance sheet and a statement of the fund’s total investment value
An income statement for the period covered
A list of the securities’ amounts and values on the date the balance sheet was issued
A statement of the salaries and other monies paid to the directors, advisory board and officers
Total dollar amounts of securities purchases and sales

Question 24

insider

Answer 24

affiliate or control person is defined as an officer, director or owner of more than 10% of the voting stock in a company, or the immediate family of any of these persons. This Act incorporates all of the prohibitions against the activities of insiders and the use of insider information. An insider is guilty of breaking SEC rules when using material, non-public information to trade securities, or when passing on information to another person who acts upon the information.