Chapter 6 - Prohibited and Unethical Business Practices Under the USA

Question 1

Fraud typically has three parts:

Answer 1

1. Misrepresentation of a material fact
2. Reliance on the misrepresentation
3. Injury or harm occurring as a result of the misrepresentation

Question 2

True or False: Fraud is almost always unethical (i.e., against the law), but not all unethical activities are fraudulent (e.g., accidentally breaking the law).

Answer 2

True

Question 3

True or False: Fraud is not intentional

Answer 3

False. Fraud is intentional.

Question 4

True or False: Prohibited activities include making false or misleading statements, as well as failing to provide adequate disclosure.

Answer 4

True

Question 5

Claiming that securities are approved by a regulator is permissible.

Answer 5

False. It is prohibited.

Question 6

Stating that a security is to be listed without justification is prohibited.

Answer 6

True

Question 7

Inducing the purchase of a security (stock or mutual fund shares) based on an impending dividend (“selling dividends”) is prohibited.

Answer 7

True

Question 8

Referring to a mutual fund as “no load” if it has a 12b-1 fee that exceeds .25% of average net fund assets (can’t have a front-end or back-end load) is prohibited.

Answer 8

True

Question 9

Failing to disclose sales charges when soliciting investment company shares is not prohibited.

Answer 9

False. It is prohibited.

Question 10

Failing to disclose mutual fund breakpoints and letter of intent features is prohibited.

Answer 10

True

Question 11

What is the rule regarding soliciting orders for unregistered, non-exempt securities?

Answer 11

Soliciting orders for unregistered, non-exempt securities is generally not allowed. However, it is acceptable if the order is unsolicited, and the client acknowledges this through a signed statement.

Question 12

_________________ is placing a client in a fee-based account where there is little to no trading, resulting in the client paying unnecessary fees.

Answer 12

Reverse Churning

Question 13

Excessive trading by a broker in a client’s account primarily to generate commissions is called what?

Answer 13

Churning

Question 14

What is the rule for exercising discretion without written authorization for Broker-Dealers (B/Ds)?

Answer 14

Without written authorization, B/Ds may only accept “not held” orders.

Question 15

What is the rule for exercising discretion without written authorization for Investment Advisers (IAs)?

Answer 15

IAs may exercise oral discretion for up to 10 days.

Question 16

What is the rule regarding borrowing from or lending to a client?

Answer 16

Borrowing from or lending to a client is allowed if the client or firm is in the business of lending cash or securities.

Question 17

Prohibited and Unethical Practices? Omitting Material Facts.

Answer 17

Yes

Question 18

Prohibited and Unethical Practices? Failing to deliver a final prospectus when selling a new issue.

Answer 18

Yes

Question 19

Prohibited and Unethical Practices? Failing to disclose conflicts of interest.

Answer 19

Yes

Question 20

Prohibited and Unethical Practices? Failing to maintain client confidentiality

Answer 20

Yes

Question 21

Prohibited and Unethical Practices? Syndicate members withholding sales of IPO shares.

Answer 21

Yes

Question 22

Prohibited and Unethical Practices? Unnecessarily delaying payment or delivery of securities.

Answer 22

Yes

Question 23

Prohibited and Unethical Practices? Splitting commissions with another agent

Answer 23

Yes.
*Permitted if both agents are registered with the same B/D or related B/Ds and registered in the B/D’s state.

Question 24

Commingling clients’ and firm’s securities (must be segregated)?

Answer 24

• B/Ds are not required to segregate client cash
• IAs must segregate both client cash and securities

Question 25

Can Agents share in profits or losses in a client’s account?

Answer 25

Yes, if: * Agent has written permission from both his B/D and client * Agent shares in direct proportion to his contribution

Question 26

Are recommending variable annuities to senior investors or investors with short-term objectives considered a prohibited and unethical practice?

Answer 26

Yes. Recommending variable annuities to senior investors or investors with short-term objectives is generally considered a prohibited and unethical practice. Variable annuities are designed for long-term investment goals, such as retirement, due to their complex structure, fees, and potential surrender charges. For senior investors, the long-term nature and potential penalties for early withdrawal may not align with their financial needs. Similarly, for investors with short-term objectives, the high fees and surrender charges associated with variable annuities make them unsuitable.

Question 27

True or False: If a client’s objective is capital appreciation and/or inflation protection, equity securities (stocks) should be recommended.

Answer 27

True. If a client’s objective is capital appreciation and/or inflation protection, equity securities (stocks) are generally recommended. Stocks have the potential for higher returns compared to other investment options, which can help achieve capital growth and protect against inflation over the long term.

Question 28

True or False: If a client’s objective is income, bonds should not be recommended.

Answer 28

False. If a client’s objective is income, bonds are typically recommended. Bonds provide regular interest payments, which can be a reliable source of income for investors.

Question 29

True or False: If a client’s objective is tax-free income, municipal bonds should be recommended.

Answer 29

True. If a client’s objective is tax-free income, municipal bonds are typically recommended. Municipal bonds often provide interest payments that are exempt from federal income tax, and sometimes state and local taxes as well, making them a suitable choice for investors seeking tax-free income.

Question 30

True or False: Treasuries are not suitable for all investors; zero-coupon bonds are not suitable for investors in their 70s.

Answer 30

True. Treasuries, while generally considered safe investments, may not be suitable for all investors due to their lower yields compared to other investment options. Zero-coupon bonds are not typically suitable for investors in their 70s because they do not provide regular interest payments and may have significant price volatility. Older investors often prefer investments that provide steady income and lower risk.

Question 31

If a client purchases securities in her margin account, an agent is prohibited from helping the client pay off her margin account balance?

Answer 31

Yes, an agent is generally prohibited from helping a client pay off her margin account balance. This includes actions such as lending the client funds or arranging loans on behalf of the client to meet margin calls. These practices are considered unethical and can lead to conflicts of interest and regulatory issues.

Question 32

True or False: Cold calling prospective clients outside of the acceptable time frame (Telemarketing calls are only allowed between 8:00 a.m. and 9:00 p.m. local time of the person being called) is a prohibited and unethical practice.

Answer 32

True

Question 33

True or False: Advisers must disclose all potential conflicts of interest to clients, such as effecting agency cross or principal transactions for its advisory clients.

Answer 33

True. Advisers must disclose all potential conflicts of interest to clients, including effecting agency cross or principal transactions for their advisory clients. This transparency helps ensure that clients are fully informed about any potential conflicts that could affect their investment decisions.

Question 34

True or False: Advisers must disclose all potential conflicts of interest to clients, such as Adviser receives any compensation that’s related to the securities it recommends to its clients.

Answer 34

True. Advisers must disclose all potential conflicts of interest to clients, including any compensation they receive that is related to the securities they recommend.

Question 35

True or False: Advisers do not need to disclose all potential conflicts of interest to clients, such as Adviser is paid to solicit for, or refer clients to, another adviser or B/D.

Answer 35

False. Advisers must disclose all potential conflicts of interest to clients, including if the adviser is paid to solicit for, or refer clients to, another adviser or broker-dealer. Full disclosure ensures that clients are aware of any potential biases or incentives that might influence the adviser’s recommendations.

Question 36

True or False: Advisers must disclose all potential conflicts of interest to clients, such as Adviser receives rebates (cash or noncash), fees, or soft dollar arrangements from B/Ds (e.g., access to B/D’s research).

Answer 36

True. Advisers must disclose all potential conflicts of interest to clients, including if the adviser receives rebates (cash or noncash), fees, or soft dollar arrangements from broker-dealers (e.g., access to the broker-dealer’s research). This transparency helps clients understand any incentives that might influence the adviser’s recommendations.

Question 37

Investment advisers must create compliance programs and consider these factors before using social media:

Answer 37

*Usage guidelines *Content standards, *Monitoring *Approval of content *Training of IARs *Third-Party content *Information security *Record Keeping

Question 38

True or False: Investment Adviser Representatives (IARs) that comment, like, or share posts made on their Investment Adviser’s (IA) website or social media pages are generally considered to have adopted the third-party post. This means they are responsible for the content and must ensure it complies with regulatory requirements.

Answer 38

True

Question 39

An ____________________ refers to a situation where an investment adviser is involved in the creation or dissemination of a testimonial, such as paying for social media posts or directly influencing the content. In such cases, the adviser is responsible for ensuring the accuracy and compliance of the testimonial with regulatory standards. This includes disclosing any compensation arrangements and potential conflicts of interest to maintain transparency with clients.

Answer 39

entangled testimonial

Question 40

___ and ___ cannot be used in email signatures or social media profiles.

Answer 40

IAR and RIA

Question 41

For Broker-Dealers Social media posts are considered communication with the public and subject to filing and recordkeeping requirements.

Answer 41

True

Question 42

True or False: Broker-dealers do not need to approve the social media site(s) before an agent may use it for business purposes.

Answer 42

False. Broker-dealers must approve the social media site(s) before an agent may use it for business purposes. A registered principal of the firm must review and approve the site to ensure that its use complies with all applicable rules and regulations.

Question 43

Social media sites must be designed in a way that allows broker-dealers to comply with regulatory requirements, including supervision, recordkeeping, content approval, suitability, disclosure, and overall compliance with FINRA and SEC rules.

Answer 43

True

Question 44

A person who violates insider trading regulations is potentially subject to both civil and criminal penalties. The maximum civil penalties are up to _____ times the amount gained, or loss avoided. For individuals, criminal penalties are a fine of up to $___ million and/or ____ years' imprisonment. Corporations can be fined up to $__ million for insider trading violations.

Answer 44

three (treble damages), 5, 20, 25

Question 45

Violations of the Uniform Securities Act are punishable with a maximum fine of $_____ and/or ______ years in prison. Violations of federal law can be punished with fines of up to $_______ and/or _____ years in prison.

Answer 45

5,000, three, 10,000, five

Question 46

For exchange-listed initial public offerings (IPO), broker-dealers must provide a prospectus to customers who buy shares on the exchange for up to__ days after the IPO.

Answer 46

25

Question 47

For non-listed IPOs, a prospectus must be provided for up to __ days.

Answer 47

90

Question 48

Investors who buy shares of non-listed companies in the secondary market must receive a prospectus for up to __ days after a follow-on.

Answer 48

40

Question 49

True or False: investors who buy shares of an exchange-listed company are not required to be provided with a prospectus even if the company has recently sold additional shares in a follow-on offering.

Answer 49

True

Question 50

A registered representative who wants to sell securities outside of her normal course of employment must first notify her firm in _________ about the proposed transactions and must receive her firm's _________ permission.

Answer 50

writing; written