Chapter 7 - Recordkeepers and Reporting Requirements

Question 1

SEC Rule 17a-3

Answer 1

Requires BDs to create specific records

Question 2

SEC Rule 17a-4

Answer 2

Requires records be kept for a certain number of years (either life, 6 years or 3 years). All records must be kept in an easily accessible place for first 2 years.

Question 3

17a-4 Lifetime records

Answer 3

Partnership articles/articles of incorporation, minute books, stock certificate books

Question 4

17a-4 6-year records

Answer 4

1. Blotters
2. General ledger
3. Customer account ledgers (from date of last update or date account was closed)
4. Stock record
5. Records listing each office
6. Records listing each principal
7. Account records (T&C)

Question 5

Blotter

Answer 5

Daily records of itemized sales/purchases/receipts/deliveries of securities and cash and any other debits/credits

AKA diary, journal, day book

Question 6

17a-4 3-year records

Answer 6

Securities in transfer
Dividends/interest received
Securities/money borrowed and loaned
FTD and FTR
Stock record differences
Agency and principal order tickets
Confirmations and comparisons
Options records
Trial balances
Subsidiary ledgers
All communications relating to business
Form U4 employment application (3 years after termination)

Question 7

Posting requirements

Answer 7

Table in book

Question 8

Exceptions to Rule 17a-3

Answer 8

A BD is not required to prepare 17a-3 records if it clears trades through a bank who prepares the records, with an agreement stating the records are BD property and notification to the SEC that the records are available for inspection

If BD clears (on fully disclosed basis) through a clearing BD, responsibility for records is with the clearing BD

Omnibus account – introducing BD is responsible for record keeping

Question 9

SEC Rule 17a-5

Answer 9

Requires BDs to file certain reports with the SEC on a regular basis

FOCUS report – monthly
Annual financial report

Oath and affirmation must be attached to these reports stating information is true and correct (from a general partner or authorized officer)

Question 10

FOCUS report

Answer 10

For BDs which clear transactions and carry customer accounts:
Part I monthly within 10 BDs
Part II quarterly within 17 BDs

For BDs which don’t clear transactions or carry customer accounts:
Only Part IIA quarterly within 17 BDs

If a BD’s fiscal year =/= calendar year, must file an additional FOCUS report (fifth FOCUS report)

Must be signed by principal executive officer, principal financial officer, and principal operations officer

Question 11

17a-5 annual report

Answer 11

• Must be audited by an independent accountant (must notify SEC when hired or fired)
• Must be filed as of the same fixed or determinable date each year (if year-end changes, must notify SEC)
• Must contain stmt of fin condition, stmt of income/loss, stmt of changes in fin position, stmt of equity (or partners capital), and stmt of changes in subordinated liabilities
• Supporting schedules, including computation of net capital and computation of reserve requirement
• Auditor SIPC opinion
• Must be filed no later than 60 calendar days after YE
• An extension (typically up to 10 BDs) must be requested from FINRA at least 3 BDs prior to due date, must include letter from auditor
• Must be filed with SEC, SEC regional office, and exchanges which it’s a member (considered filed when received by SEC)
• Not required to send physical statements if it provides disclosure with instructions to obtain statements on website or phone

Question 12

17a-5 requirements regarding auditors

Answer 12

When an auditor is retained or terminated, must file a report with the SEC containing:
- Name, address, phone, reg number of BD
- Name, address, phone of auditor
- Date of fiscal year of annual reports covered
- Whether engagement is for single year or ongoing

If change in relationship between BD and auditor, must notify SEC

Upon termination of auditor, notify SEC within 15 BDs

Question 13

SIPC filings

Answer 13

• SIPC-6 General Assessment Payment Form – filed for first half of year, due 30 days after period end
• SIPC-7 General Assessment Reconciliation Form – Filed at year-end, less any SIPC-6 payment. Due 60 days after year-end

Question 14

17a-5 rules re: Statements to customers

Answer 14

Must send customers audited annual F/S within 105 days of YE. For purposes of this rule, only BDs holding client funds or securities are considered to have customers. Get an extra 30 days if BD sends with next mailing of customer statements. Statement must contain a balance sheet, net capital, and required net capital and must direct customers to the SEC for the full financial report and whether auditor found any material inadequacies.

Question 15

17a-5 mid-year F/S

Answer 15

Customers must also be sent unaudited mid-year statements, within 65 days of date

Not required to send physical statements if it provides disclosure with instructions to obtain statements on website or phone

Question 16

Exception to 17a-5 F/S

Answer 16

BDs which only deal with other BDs that are members of an exchange are not required to prepare audited F/S

Question 17

Report filed upon termination of membership interest

Answer 17

If a BD holds membership in and ceases to be a member in good standing with national securities exchange/association, the firm must file Part II or Part IIA of Form X-17a-5 with the SEC within 2 BDs

Question 18

PCAOB

Answer 18

Created by SOX Act to oversee accounting professionals. Auditor of 17a-5 report must be registered with PCAOB

Question 19

SEC Rule 17H-1T and 2T

Answer 19

BD must maintain an org chart with firm and all associated persons, and must designate MAPs

Question 20

MAP designation

Answer 20

Material associated person

Consider:
- Overall financing requirement of BD and the associated person
- Level of risk present in person’s activities
- Level of operational support and services provided by the person
- Extent to which person has authority to cause a withdrawal of capital from the BD

Question 21

Form 17H

Answer 21

“Risk Assessment report for BDs”

Quarterly within 60 days

Question 22

FINRA audit requirement

Answer 22

If FINRA is concerned with accuracy of books and records, it can require a BD to do an independent audit

Question 23

SEC Rule 17a-11

Answer 23

BDs must notify regulators in the case of deteriorating financial conditions or operational events

All filings must be filed with SEC DC office, SEC regional office, and DEA and may be emailed

Question 24

17a-11 net capital violation (notice requirements)

Answer 24

If net capital falls below minimum requirements, BD must notify on the day it occurs. Notice must state BDs net capital and requirement.

Same requirement applies if outstanding amount of subordinated debt >70% of debt-equity total for a period exceeding 90 days.

This must be filed even if BD is notified by SEC/DEA that it is below requirement and the BD disagrees. BD may include basis for disagreement.

Question 25

Early warning notice

Answer 25

If BD has AI:NC ratio > 12:1, or if dollar amount of net capital is <120% of minimum, must notify SEC/DEA within 24 hours

Question 26

Other requirements to file notice under 17a-11

Answer 26

- Non current books and records (must notify that day and file a report within 48 hours on how they will remedy) - Material inadequacies (notify within 24 hours and file a report within 48 hours on how they will remedy) - Highly leveraged BDs (if total amount of money payable against all securities loaned or subject to repo agreement, or total contract value of all securities borrowed or reverse repo agreement, excluding govt securities, exceeds 2500% TNC)

Question 27

SIC

Answer 27

Securities Information Center SIC acts as clearinghouse for information regarding these securities.

Question 28

SEC Rule 17f-1

Answer 28

Deals with missing, lost, counterfeit, or stolen securities BD is required to make inquiry of SIC for all securities except: 1. Received from issuer or issuer’s agent 2. Received from another reporting institution or Fed 3. Registered in the name of seller 4. Was previously sold to customer, verified by internal records 5. Received as part of a transaction which has a face/market value of $10k or less If security is registered in BD’s name, is delivered by a non-customer, or are bearer bonds >$10k, inquiry is required

Question 29

Reporting to SIC

Answer 29

If securities are missing/criminal activity suspected, BD must report it to SIC, as well as FBI and transfer agent within one BD If securities are missing but no criminal activity suspected, must report to SIC and transfer agent if BD isn’t able to resolve it within 2 BDs If security certificates are not received, delivering BD must provide certificate numbers within 2 BDs of request, and receiving BD must report to SIC within 1 BD of receipt of certificate numbers If security certificates are lost, stolen or missing while in transit, delivering BD must report to SIC within 2 BDs of notice of non-receipt If securities are discovered missing as a result of a count or internal audit and criminal activity is not suspected, must file a report within 10 BDs or as soon as verification of certificate numbers can be completed If lost/stolen securities are later recovered, must notify applicable agencies within 1 BD

Question 30

Form X-17f-1A

Answer 30

Used when filing reports with SIC Requires the following: - Issuer - Type of security/series - Date of issue/maturity date - Denomination - Interest rate - Certificate number - Registered name - Distinguishing characteristics (for counterfeiting) - Date of discovery of loss/recovery - Type of loss - CUSIP - FINS number

Question 31

FINS

Answer 31

Financial Industry Numbering System

Question 32

FINRA required information when opening a new customer account

Answer 32

- Customer name and address (residence address may not be a PO box) - Whether legal age - Name of RR (N/A for institutional accounts) - If account is for non-individual, names of authorized individuals - Signature of approving principal Must obtain this info/approval prior to entering any order Before settlement of initial transaction, RR must make reasonable effort to obtain: - TIN/SSN - Occupation/employer - Whether customer is associated with another member firm This requirement doesn’t apply to instituational accounts or accounts limited to non-recommended investment company shares

Question 33

Institutional account

Answer 33

Account established for a bank, savings and loan institution, insurance company, registered investment company, RIA, or person with assets at least $50m

Question 34

Trusted contact person

Answer 34

Requires BD to make reasonable effort to obtain name and contact info for contact person at time of opening of non-institutional account and for existing customers Intended to be resource for BD in administering customer’s account and protecting assets Contact person doesn’t have authority in the account but is a resource for questions on financial exploitation, health status, or information on executor/legal guardian, etc.

Question 35

Financial exploitation of customers

Answer 35

If BD believes financial exploitation has occurred, it may place a temporary hold on the account and notify trusted contact person and all authorized individuals

Question 36

Discretionary accounts

Answer 36

Account in which an RR is the authorized third party Some BDs don’t allow discretionary accounts A principal must have a discretionary authorization in writing before it’s effective and must get a signed power of attorney which grants trading authorization Firms are required to maintain manual signatures of each authorized person on an account (Any other new account signatures may be electronic) Each discretionary order must be approved promptly by a principal and accounts must be reviewed frequently to ensure transactions are appropriate

Question 37

SEC recordkeeping rules for discretionary accounts

Answer 37

1. Copy of POA – must be kept for 3 years 2. Customer’s signature and date (6 years after termination)

Question 38

Time/price exception for discretionary accounts

Answer 38

RR may accept verbal authorization if customer specifies: 1. Buy/sell 2. Which security 3. Number of shares/units i.e. if RR’s discretion is limited to time and price, not considered a discretionary order

Question 39

Required signatures for opening a new account

Answer 39

Approving principal must sign each new account form Customers opening margin or options accounts Industry rules don’t require a customer signature for a cash account (though many BDs require it)

Question 40

SEC required information for customer accounts (17a-3)

Answer 40

BDs must maintain: - Name - TIN/SSN - Address - Phone - DOB - Employment status/occupation and whether customer is associated with a BD - Annual income and net worth (excluding principal residence) - Investment objectives In practice, this is all obtained prior to opening account. Not required: - Educational background Customers may refuse to provide some info, but RRs should document the attempt to obtain (put “refused” on the form). However principals may deny an application if there is insufficient information to determine investment objectives.

Question 41

Customer account information requirements after opening

Answer 41

- Must send copy of account record within 30 days of opening or with customer’s next stmt (same requirement for updates to customer information) - Then, periodic updates of account information are required every 36 months - Change in address – must notify previous address and registered personnel within 30 days If any specific terms are used to describe investment objectives, must include definitions.

Question 42

Tax information requirements for customer accounts

Answer 42

BDs must request TIN/SSN. Customers may be subject to backup withholding if they don’t provide it. Many firms require this number to open an account. Customer is also typically required to fill out a W-9 (attest TIN is accurate and customer not subject to backup withholding) (W-8 for foreign entities/non-residents) Customers subject to backup withholding are required by the IRS to notify the BD

Question 43

Numbered account

Answer 43

Number instead of name, but not anonymous – normal required info still required BD should have customer sign a written acknowledgment of ownership to keep on file

Question 44

Customer account statement requirements

Answer 44

At least quarterly (typically monthly for accounts with activity) Must include: - Description of security positions - Money balances - Account activity since last stmt Account activity = sales, purchases, interest credits or debits, charges or credits, dividends, transfer activity, securities receipts/deliveries, and JEs relating to securities in BD possession

Question 45

Account stmt valuation

Answer 45

FINRA requires firms to estimate value of non-traded or unlisted REITs

Question 46

Permitted valuation methods for REITs

Answer 46

1. Net investment – for 2 years + 150 days, must use information from prospectus (offering price less commissions, dealer fees, org expenses) 2. Appraised value – based on assets and liabilities, performed at least annually, conducted by third party expert, derived from standard methodology

Question 47

AML

Answer 47

Anti money laundering

Question 48

USA PATRIOT Act

Answer 48

Passed after 9/11 to prevent money laundering relating to terrorist activity

Question 49

3 stages of money laundering

Answer 49

1. Placement – purchase securities with illegal cash 2. Layering – execute transactions in stages to avoid detection and triggering reporting requirements 3. Integration – take out proceeds from transactions and using them legitimately

Question 50

Types of layering

Answer 50

Structuring = A form of layering involves purchase of several blocks of securities all with cashier’s checks from different banks and all under $10k Another form of layering involves taking opposite positions of the same security short/long in different customer accounts

Question 51

Required reports relating to AML

Answer 51

1. BCTR: Bank Secrecy Act Currency Transaction Reports are required to be filed with FinCEN for all cash (or CE) transactions executed by a single customer during one BD that exceed $10k in the aggregate 2. CMIR: Currency and Monetary Instrument Report must be filed when a person physically transports or receives cash (or CE) or monetary instruments in an amount of $10k or more into or out of the US. Applies to wire transfers. BDs must collect information about transactions >$3k including names of both customers and must verify identity of recipient if not a customer. 3. SAR: Suspicious Activity Reports must be filed whenever a transaction or group of transactions >$5k and the firm suspects criminal violation, illegal funds, structured transactions, or transactions with no apparent legitimate purpose. SARs are confidential and may not be disclosed to customer in question.

Question 52

FinCEN

Answer 52

Financial Crime Enforcement Network. Part of Dept of US Treasury

Question 53

Mandatory AML compliance programs

Answer 53

BDs are required to, at a minimum: 1. Policies and procedures that can be reasonably expected to detect/report suspicious transactions and deter money laundering 2. Designation of compliance officer responsible for AML 3. Ongoing employee training 4. Independent audit function to test effectiveness of AML program FINRA requires this program to be in writing and approved by a member of senior mgmt

Question 54

Customer Identification Procedures

Answer 54

BDs must create CIPs and use reasonable measures to verify identity of anyone who opens an account, and must maintain records of information used to verify and determine whether that person is listed as a known or suspected terrorist Minimum info: - Name - DOB - Address - TIN/SSN (or copy of application for TIN) BD can verify identity after account is opened/transactions begin

Question 55

Customer verification procedures

Answer 55

A BD may use documentary (inspecting a form of govt ID) or non-documentary (contacting the individual) forms of verification

Question 56

Records retention for customer verification

Answer 56

5 years following closing of account

Question 57

SDN List

Answer 57

SDN = Specially designated nationals and blocked persons list Identifies known/suspected terrorists, other criminals, and pariah nations like Syria/Iran BD must ensure they don’t do business with anyone on this list. If it discovers a customer is on the list, must block transactions immediately and inform LI. Special due diligence is required when opening accounts for foreign individuals. BDs are also prohibited from maintaining accounts for foreign shell banks (no physical presence).

Question 58

Penalties for violating AML laws

Answer 58

RR guilty of facilitating ML can face 20 years in prison/fines of greater of $500k per transaction or twice the amount of funds involved Can face civil penalties as well Can be liable even if they were just willfully blind to the activity

Question 59

Regulation S-P

Answer 59

S-P = Safeguard procedures Created after laws were abolished which now allowed banks/brokerages/insurance companies to merge, so SEC wanted to protect clients’ privacy Requires all BDs, insurance companies, and investment advisers registered with the SEC to adopt policies and procedures that are reasonably designed to protect client privacy, which must be provided to clients

Question 60

Customers vs consumers for purposes of Reg S-P

Answer 60

Customer = person with ongoing relationship with the firm Consumer = Person who provides info to firm in connection with potential transaction

Question 61

Requirements for transferring accounts

Answer 61

Must be done with written instructions and must be clear of liens If both firms are members of ACATS, must use that system for the transfer Receiving firm must submit transfer request to carrying firm immediately upon receipt from the customer, and the carrying firm must either validate the instructions or take exception within one business day. Any exceptions must be resolved rapidly by the two member firms.

Question 62

Protesting a transfer

Answer 62

Carrying firm may take exception to a transfer if: - No record of account on its books - Transfer instructions are incomplete - Transfer instructions contain an invalid signature If a transfer is protested, both firms must resolve differences promptly

Question 63

Validating a transfer

Answer 63

Account must be frozen while validating transfer instructions (all orders must be canceled, with the exception of options positions expiring within 7 BDs, and no new orders) Transfer instructions must include a listing of all positions, money balances, and market values Within 3 calendar days of validation, transfer must be completed

Question 64

Rules regarding non-transferable assets

Answer 64

Customer must be informed, either in writing on the transfer instructions or on a separate document, whether any assets cannot be readily (or within required time frame) transferred. Receiving firm is not required to accept delivery of those assets. Carrying firm must notify customer in writing and await instructions regarding disposition (liquidation, retention, transfer to customer or third party) If customer instructs the firm to liquidate a non-transferable asset, distribution must be made within 5 business days of receiving the customer’s instructions

Question 65

Non-transferable assets examples

Answer 65

- Proprietary to carrying firm - Third party product with whom receiving firm doesn’t have a relationship - Asset of bankrupt issuer - Asset is limited partnership interest

Question 66

Interfering with transfer of customer accounts

Answer 66

Under FINRA rules, member firms and their employees are prohibited from interfering with a customer’s account transfer request. Often relates to change in employment of an RR from one firm to another. Firms are prohibited from seeking court orders to restrict movement of customer assets once customer has given written consent to transfer (unless there’s a lien on the account).

Question 67

Bulk transfers of client accounts

Answer 67

Allowed through use of a negative consent letter if: - There’s been a merger/acquisition - BD seeks to enter a clearing arrangement - BD is no longer in business - BD is experiencing financial/operational difficulties - A financial institution has terminated its networking arrangement with a BD Not allowed in the case of a RR who is changing firms to facilitate transfer of individual customer accounts

Question 68

Negative consent letter

Answer 68

Notification to customer that there’s been an underlying change in the business of the firm. If client doesn’t respond within certain timeframe, client is deemed to have consented.

Question 69

Reg S-P notices - timing and content

Answer 69

Timing depends on client’s relationship, either customers or consumers. Customers must get privacy notice when relationship is first established + updated version annually. Consumers must get privacy notice before the BD discloses any non-public personal information to any non-affiliated 3rd party. (Aggregated/blind data is not considered non-public) Privacy notices must state the types of personal info that the firm collects and categories of both affiliated and unaffiliated 3rd parties to whom the information may be disclosed + option to opt out and how