Chapters 3/4 Flashcards
Rules governing the use of advertising and promoting:
- Providing a basis for evaluating investments and being fair/balanced
- Not containing false, exaggerated, or misleading claims
- Being clear about risks/benefits
- Being mindful of the audience that’s being targeted
- Not projecting performance or implying that past performance will be repeated.
Each SRO has specific rules for this
3 categories FINRA divides communications with the public into
- Correspondence
- Institutional communication
- Retail communication
Correspondence
Any written or electronic message sent by a member firm to 25 or fewer retail investors within a 30-day calendar period. Subject to FINRA review and spot check but NOT approval.
Includes existing and prospective retail investors.
Institutional communications
Any type of written or electronic communications that’s distributed ONLY to institutional investors, but doesn’t include a member firm’s internal communications. Subject to FINRA review and spot check but not pre-approval.
Institutional investor (according to FINRA)
- Banks, S&L, insurance, BDs, or RIAs
- Government entities
- Employee benefit plans and other qualified plans w/ at least 100 participants.
- Individuals or entities w/ >= $50mm
- People acting solely on behalf of these institutional investors.
- There is no FINRA defintion of retail customer. Any customer who is not an institutional customer is a retail customer
True or false: FINRA requires that member firms have policies/procedures to avoid institutional communications being sent to retail investors?
True. One acceptable method is placing a legend that says “For Use by Institutional Investors Only”. If a member firm becomes aware that institutional communications are becoming available to retail investors, the firm must treat all future communications to that institutional investor as retail communications
- Internal communication that will not be sent to either institutional or retail
investors should be marked “For internal use only.”
Retail communications
Written or electronic commuinications distributed to > 25 retail investors within a 30-day calendar period. Often subject to preapproval and filing w/ FINRA.
True or false: All materials prepared for public media where the ultimate audiance is unknown should be considered retail communications?
True
How does FINRA view social media?
FINRA considers social media usage as advertising. Content must be preapproved by a principal of the member firm. Recordkeeping rules apply to social media posts.
Posts by employees are NOT subject to preapproval by the firm but should be monitored. Personal posts not related to business are obviously not governed by FINRA.
Interactive content vs static content
Interactive content is content on social media that is posted/disseminated for real-time interation (ex: instant messaging on LinkedIn). This is supervised in a manner that’s similar to correspondence if it’s in the context of business (not personal use) and is supervised and monitored but not pre-approved.
Static content is posted for an extended period of time on social media. This is considered retail communication and may be subject to pre-approval.
How does FINRA view hyperlinks?
BDs are allowed to include hyperlinks on their website to an independent 3rd party’s content. If the hyperlink is to content that the BD was involved with preparing then it’s considered advertising. If the hyperlink is to a generic article about securities and doesn’t mention specific securities, it’s considered educational material and not advertising.
3rd party posts
Posts by customers or any other 3rd partry. These are not considered advertising unless the member firm has ADOPTED the 3rd party content (ex: the BD pays the 3rd party to post or shares the 3rd party post to their own page). In this case of paying, soliciting, or sharing/liking the 3rd party post, it’s considered advertising. It’s also considered advertising (and thus retail communication) when the member firm is involved in preparation of the content (i.e. ENTANGLEMENT)
- 3rd party posts still must be retained in recordkeeping.
Policies/Procedures that member firms SHOULD develop related to social media:
- Usage restrictions
- Training and education
- Recordkeeping and retention
- Monitoring
- Approval
True or false: Correspondence, institutional communications, and retail communications must be pre-approved by a principal of the member firm?
False, correspondence and institutional communications must be monitored by the member firm but do NOT need to be pre-approved.
Retail communications must be approved by a principal either before it’s released or before it’s filed w/ FINRA, whichever comes first.
Recordkeeping requirements for communications
All communications w/ investors must be kept for 3 years after the last date of use and kept in an easily accessible location for the first 2 years. The records must contain copies of these communications, the dates of first/last use, the name of the approving principal, and the date of approval.
Who can pre-approve retail communications?
Someone with a Series 24 or Series 9/10.
A Supervisory Analyst, with a Series 16, can approve research reports surrounding debt and equity securities.
Certain types of retail communications require approval from principals w/ specific registrations.
Blind recruitment ads
Typically, all retail communication and correspondence must explicitly state the name of the firm that created it. However, an exception exists for companies to publish recruitment advertisements anonymously.
True or false: Institutional communications and correspondence are required to be filed w/ FINRA?
False. However, they are subject to spot checking w/ FINRA.
When must retail communications be filed w/ FINRA?
It depends on the content. Some must be filed 10 business days prior to the first use, others within 10 business days of their first use.
- During a firm’s first year under FINRA, all retail communications must be filed 10 days prior to the first use. This may also be required for firms who have had disciplinary violations.
Retail communications that always MUST be filed at least 10 days prior to the first use:
- Communications surrounding registered investment company communications that include self-created rankings or comparisons
- Bond funds including volatility rankings
- Communications surrounding security futures
Retail communications that always MUST be filed within 10 days of the first use:
- Communications surrounding registered investment companies (mutual funds, closed-end funds, ETFs, unit investment trusts, and variable products)
- Communications surrounding publicly traded direct participation programs
- Communications surrounding SEC-registered CMOs
- Any security that’s registered w/ the SEC and derived from or based on a single security, basket of securities, index, commodity, debt issuance, or foreign currency.
- A previoulsy filed draft version of a television or video retail communication.
What is required to be provided when filing w/ FINRA
The name, title, and central registration depository of the registered principal, and the date approval was given.
Retail communications that do not need to be filed w/ FINRA:
- Another firm has previously filed the communications w/ FINRA and the material is NOT being altered.
- The communication was posted on social media
- The communication doesn’t make any recommendations, isn’t a research report, and doesn’t promote the firm’s products/services.
- Communications that only identify a firm’s ticker, identify a security for which the firm is a market maker, or identify the price of a security.
- Tombstone advertisements, mutual fund profiles, and prospectuses that have been filed w/ the SEC.
- Press releases only available to the media.
- Communications that only refer to investments as part of a listing of products offered by the firm
- Any reprint of an article issued by a publisher that’s not a member firm and neither the member firm nor issuer of security is commissioning the reprint.
- If retail communications aren’t required to be pre-approved they’re not required to be filed w/ FINRA
- Retail communications and correspondence must disclose the name of the BD
Omitting prospectuses (SEC Rule 482)
Investment company advertisements that meet the definition of a prospectus. This may not contain an application to invest.
Required disclosures of an omitting prospectus
- That investors must consider risks before investing
- The propsectus contains details about the mutual fund
- The prospectus should be read carefully before investing
- The source where an investor can obtain the full prospectus
- That performance data is of past performance and doesn’t guarentee future success
- The performance will fluctuate
- A toll free # where an investor can obtain performance data
- Whether a non-recurring fee (ex: sales load) is charged
- Standardized performance information must be presented in a font size that’s at least as
large as that which is used for non-standardized performance information.
Can fund advertisements show average annual return?
Yes, as long as it presents:
- 1 year returns for a fund that’s been around for at least a year
- 1 a 5 year returns for a fund that’s been around for at least 5 years
- 1, 5, and 10 year returns for a fund that’s been around for at least 10 years. Or for the life of the fund if it’s shorter than 10 years.
- Omitting prospectuses and supplemental sales literature can show fund performance but tombstone ads CANNOT.
SEC Rule 156
This rule governs any sales literature. Sales literature cannot be misleading by being untrue or omitting material facts. An easy way to mislead investors is through past performance numbers.
Since fund names can be misleading, a registered investment firm whose name suggests it focuses on a particular security/industry must invest >= 80% of its assets in that security/industry. This goes for geography as well.
- A fund name that uses the words guaranteed or insured, or anything similar in
conjunction with United States or U.S. government, is considered misleading and deceptive.
Sales literature
Any communcation that offers to sell or induces the sale of shares in an investment company.
- Communications between issuers, underwriters, and dealers may also be
considered sales literature if there’s a reasonable expectation that the materials may be directed to prospective investors, or that the information contained in these communications may be given to investors in the course of selling the fund’s shares.
True or false: Performance figures are always reported after fees are deducted, but before taxes are paid?
True
Use of investment companies’ rankings in retail communications
Member firms may NOT use rankings in retail communications other than (1) rankings created by ranking entities (2) rankings created by an investment company/affiliate, but based on performance metrics of a ranking entity.
If a firm uses a ranking symbol instead of number, the symbol must be explained. Again, rules surrounding rankings don’t apply to a reprint or excert of an article as long as the publisher is not affilliated w/ the member firm or the issuer of securities
Ranking entity
An organization that provides general info on investment companies and is independent of that investment company and its affiliates. The ranking entity must not be hired by the investment company or its affiliates to create the ranking.
SEC Standardized Yields
For rankings based on yield, the SEC says that money market funds are required to use a 7 day standardized yield, whereas bond funds are required to use a 30 day standardized yield.
Any rankings based on total return must be accompanied by these yield rankings.
Required disclosures for retail communications containing an investment company ranking
- The name of the category (growth, balanced, etc.)
- The # of investment companies in that category
- The name of the ranking entity
- The length of the period
- The criteria (total return, yield, etc.)
- The fact that past performance is no guarentee of future performance
- The funds that assess front-end non-recurring sales loads, whether the rankings takes those loads into account.
- Whether the ranking is based on total return or the current SEC standardized yield.
- The publisher of the ranking data
- Whether the ranking consists of a symbol vs a number, and an explanation of the symbol.
- If investment company rankings are being used for more than one
class of investment with the same portfolio (Class A and B shares), the retail communication must provide a prominent disclosure of this fact.
Bond mutual fund volatility ratings
Measures the sensitivity of a bond fund’s NAV to changes in economic and market conditions. Published by a 3rd party.
A member firm may only use bond volatility ratings in its supplemental sales literature, not in ads intended for public dissemination. However, the supplemental sales literature may only be used if a propsectus for the fund has or will be sent to the customer and if:
* The rating cannot identify or describe volatility as a RISK rating
* The supplemental sales literature must include the most recently available ratings.
* The criteria and methodology used to determine the rating must be based on quantifiable factors.
* Ratings methodology is disclosed.
* The name of the rating entity and current rating are disclosed.
- Bond funds must disclose if they paid the ratings entity
- The disclosure statement should also indicate that there’s no uniform method for determining bond fund volatility, the fund’s rating may have changed since the last update, and there’s no guarentee that ratings will stay the same going forward.
FINRA rules for variable products
All communications w/ clients must clearly identify the product is a variable annuity of variable life insurance policy (cannot use a misleading name). These products should never be described as short-term or liquid since there’s often surrender charges and tax penalties. Variable life insurance policies must disclose that loans and withdrawls may have an impact on the policy’s cash value and death benefit.
Insurance firms often guarentee some of its products’ features. These guarentees shouldn’t be overemphasized. With the exception of a fixed-account option offered by some companies, neither the principal
value of the separate account nor its investment returns are ever guaranteed.
- Clients also shouldn’t be told that ratings given to the insurance company (ex: BBB+) apply to the separate account.
FINRA rules surrounding hypothetical returns on variable life insurance policies
Life insurance companies usually provide clients w/ hypothetical rates of return. FINRA and the SEC have these guidelines:
* An assumed rate of return cannot exceed 12%
* One of the assumed rates of return must be 0%
* The assumed rates of return must be reasonable based on current market conditions.
* The cash values and death benefits must reflect the policy’s maximum mortality and expense charges for each of the assumed rates of return.
* Must disclose that these hypothetical scenarios show how performance of underlying accounts COULD affect the policy’s cash values and death benefits, that everything is hypothetical, and these aren’t projections.
Options Disclosure Document (ODD)
A brochure that offers investment a description of the options market. Investors MUST be given an ODD before an options account is opened.
Regulation of communications regarding options
All options-related retail communication must be pre-approved by a principal. This does NOT apply to correspondence- options correspondence is subject to the same requirements as correspondence for other products.
All options-related communications made prior to the delivery of the ODD must be submitted for approval to an options exchange OR to FINRA at least 10 calendar days prior to use.
- If a firm issues sales material that’s only being sent to existing clients, it will not need to be filed since all existing clients would have already received the options disclosure document.
Regulation of communications regarding municipals
Any advertisements related to municipal securities and municipal fund securities (529 plans) must be approved by a principal prior to its use.
Official statement
A document prepared by or on behalf of a state or local government in connection with a new issue of municipal securities.
- Official statements (whether final or preliminary) are not advertisements but summaries of official statements are advertisements and must be approved by a principal.
SEC Rule 15c2-12
This rule mandates that an underwriter have a reasonable basis when recommending a muni security. Underwriters:
* Must obtain and review an official statement prior to bidding for or purchasing the securities.
* Must send customers the most recent copy of the preliminary official statement within one business date of request.
* Must contract w/ the issuer to receive sufficient quantities of the final official statement within 7 business days.
What additional disclosure is required after the issuance of muni bonds and the official statement is sent to the customer?
An underwriter is required to disclose to the MSRB whether the issuer or other obligated persons have agreed to provide continuing disclosure info under SEC Rule 15c2-12
Rules for municipal fund security (529 plan) advertisements
- Advise investors to consider risks
- Point investors to the official statement for more info
- Identify the firm as an underwriter
- The official statement should be carefully read before investing.
- If there’s a sales load charge or other nonrecurring fee, that should be stated.
- Generic advertisements that don’t refer to a specific fund but rather the general nature of 529 plans are fine. An invitation for further info is fine as long as an official statement is provided.
True or false: If the advertisement doesn’t include total return quotations, calculated to the most recent month and ending within seven business days prior to the date of the advertisement, the firm must include either a
toll-free (or collect) telephone number or a website from which an investor can obtain total return quotations for the most recent month-end?
True
Blind advertisement
An advertisement that doesn’t identify a municipal securities broker or dealer, but may include the issuer of the muni security and their contact info and how to obtain an official statement.
W/ these, just using the logo of the broker or dealer is fine.
True or false: Customers who purchase municipal securities are required to receive a confirmation at or before the completion of the transaction (which is typically the settlement date). For 529 plans—which
are classified as municipal fund securities—the confirmation must provide the portfolio allocation or fund designation for these securities?
True
Rules regarding CMOs
All retail communications and correspondence must include the term “collateralized mortgage obligation” within the name of the product and disclose any applicable gvt. agency backing relates only to the face value and not a premium.
A disclosure must be made to indicate that a CMOs yield and avg. life will fluctuate.
All CMO advertisements must be submited to FINRA.
- CMOs may not be compared to any other type of investment.
What must educational materials about CMOs that B/Ds are required to offer retail investors include:
- Questions that a CMO investor should ask prior to investing
- An explanation of the structure of a CMO
- An explanation of characteristics and risks of a CMO
- An explanation of the relationship between mtg. loans and mtg. securities
- A glossary of terms related to MBSs
True or false: Retail communications related to CMOs must be approved before initial use by a principal and filed with FINRA within 7 business days of first use?
False, retail communications related to CMOs must be approved before initial use by a principal and filed with FINRA within 10 business days of first use
True or false: At times, RRs can prepare reports that are considered research reports that must be reviewed by SAs even though these RRs are not considered Research Analysts?
True
Mandatory research report disclosures:
- Whether the analyst (or member of their household) has a financial interest in the subject company(ies).
- Whether the member firm has ownership of the subject company and if so if the ownership is >=1% of the outstanding stock of the subject company.
- Whether the firm makes a market in the subject security.
- Any material conflict of interest
- Whether the member firm has been involved in IB activity w/ the subject company in the last 12 months.
- Whether the analyst of a member of their household is employed w/ the subject company in any capacity.
- These are also the same disclosures for public appearances
Public appearance
A conference call, seminar, or public speaking engagement being delivered to 15 or more persons or one or more representatives of the media.
What must be documented when RRs do seminars
- Date
- Topic
- Sponsor of the seminar
Quiet period for IPOs where research analysts cannot publish
10 days regardless of whether the BD is a manager, syndicate member, or selling group member.
Quiet period for secondary offerings where research analysts cannot publish
3 days for managers and co-managers of the offering and no restriction for all other participating firms.
True or false: Under the hot news exception, research may be published during the quiet period if the issuer is subject to
certain unexpected news events?
True
Disclosures for 3rd party research used by BDs
- Whether the BD has received compensation from the subject company within the preceeding 12 months and whether it expects to receive comp. in the followings 3 months for IB services
- Whether the BD makes a market for a security
- Whether the BD owns 1% of more of the subject company’s equity securities.
- Any other material conflicts of interest.
3rd party research vs independent 3rd party research
3rd party research= Research that is prepared by an affiliate of the BD. Must be approved by an SA.
Independent 3rd party research= Research that is prepared by a person who has no affiliation w/ the BD, makes determinations w/o any input from the member firm. The member firm has NO EDITORIAL CONTROL, and thus does not need to be approved by an SA.
Procedures surrounding public appearances of RRs (not RAs)
- If making a recommendation, any conflict of interest must be disclosed
- Written procedures must be established to supervise the public appearances
- Any scripts, slides, handouts, etc. are considered communications
- Unscripted public appearances are their own category- they’re not considered retail communications, institutional communications, or correspondence.
- Anything handed out during a public appearance is considered retail communication and must be pre-approved.
True or false: BDs must disclose if more than $500 is paid for a testimonial?
False, $100
S Corp. vs C Corp.
S Corp. is a business that’s taxed separately from its owners and has unlimited owners.
C corp. income is taxed twice- first at the corporate level and then dividends to shareholders are taxed.
Afilliated directors vs non-afilliated directors
Afilliated directors= Members of the BOD who are also senior executives
Non-afilliated directors= Members of the BOD who are not employees of the firm
Authorized shares
In the articles of incorporation, there are a set # of shares that can be issued. This can only be modified by a majority vote from the shareholders, thereby revising the corporate charter. Most firms issue fewer shares than authorized.
Outstanding stock
Stock the has been issued to the public less treasury stock
Rights of shareholders
- Right to evidence of ownership: to have stock certificates as proof of ownership.
- Right to transfer
- Right of inspection
- Right to vote
- Right to receive dividends
- The # of votes a shareholder gets is dependent on the # of shares they own
Restricted shares
Restricted shares do not have the right to transfer. These often have a legend on the face of the certificate that indicate they’re ineligable to transfer.
True or false: Shareholders vote on cash and stock dividends?
False, these decisions are made by the BOD.
Super voting shares
Shares that have more than one vote per share. The issuance of super voting shares must be approved by shareholders.
Statutory vs cumulative voting methods
Statutory voting= A shareholder is given one vote per share owned per voting issue. More beneficial the larger # of shares you own.
Cumulative voting= Investors can multiply the # of shares they own by the # of voting issues.
Example: 3 new people are being added to the BOD and there is a shareholder vote for 5 candidates. In statutory voting, if a shareholder has 3 total shares, they can cast 1 vote per open seat on the BOD. W/ cumulative, the shareholder can divy up the votes how they like- 3 votes going to one candidate, 2 to one and 1 to another, etc.
- In statutory voting, the shareholder wouldn’t have to use all 3 votes. For example, if he didn’t like 3/5 candidates, he could’ve chosen just to use 2 of his votes and forego his 3rd vote.
Spin-off transactions
When a parent company sells a subsidiary to effectively create a new standalone company. Each shareholder of the parent company retains their original shares in the company, but also is given shares in the newly created entity.
- There are no immediate tax consequences to the recipient of the new shares.
- Spinoffs are used in hopes that separating the entities will result in a higher valuation than if combined.
Securities that are a result of a reclassification
- An issuer that substitutes one security for another
- M&A
- A transfer of assets from one company to another
- Stock splits and reverse stock splits are NOT considered reclassification
Tender offer
When someone offers to buy a corporation’s shares to acquire control of the firm. These are typically offered at a premium to market value.
Leveraged buyout (LBO)
When a private equity company primarily uses debt to finance the purchase of a publicly-traded company.
- Since a large amount of borrowed funds are used to make the purchase, they’re usually non-investment grade.
True or false: Preferred stockholders have voting rights?
False
Cumulative vs non-cumulative preferred stock
Cumulative preferred stock= Pays dividends in arrears if necessary. If a firm misses expected dividend payments to preferred shareholders one year, they will make up for that payment the next year they are profitable enough before paying out common dividends.
Non-cumulative preferred stock= Does not pay dividends in arrears.
Participating preferred stock
For preferred stock, the stated return is typically the maximum amount they expect to receive. However, participating preferred stock shareholders may receive more dividends if the company has a good year.
Callable preferred stock
Stock that the company can call back at a specified price (usually higher than the stock’s par value (what it’s issued at)) at some point in the future.
Variable/adjustable rate preferred stock
Preferred stock where the dividend rate adjusts under a predetermined formula- often benchmarked to T-bills.
- The market prices of variable rate preferred stock is typically more stable than that of fixed rate preferred stock.
Series K Preferred Stock
Preferred stock that starts w/ a fixed rate but then after a certain amount of time switches to a variable/adjustable rate. Series K shares have the following features:
* They’re depository shares and represent a larger basket of an issuer’s preferred stock.
* Wide range of par values.
* No voting rights.
* Divideds are non-cumulative.
* Dividends are taxed at a max. rate of 20%.
Penny stock
An unlisted equity security that has a bid price lower than $5 per share
Exceptions to the definition of a penny stock
- Any equity traded on an exchange.
- Investment company securities
- OCC-listed puts and calls
- Securities whose issuer has net tangible assets exceeding $2mm if it’s been in continuous operation for at least 3 years; net tangible assets exceeding $5mm if it’s been in continuous operation for less than 3 years or avg. revenue of $6mm for the last 3 years.
Penny stock risk disclosures
- BDs must provide clients w/ a risk disclosure document prior to executing penny stock transactions for them.
- The current quote for the security
- The compensation that the BD will receive for the transaction
- The copmensation that the RR will receive for the transaction
- During the last trading day of each month, BDs must send clients holding penny stocks a monthly statement of the # of penny shares owned and the estimated market value.
Situtations where penny stock risk disclosures aren’t required
- Transactions w/ institutional accredited investors.
- Private placements
- Transactions w/ the issuer, officers of the company, BOD, general partners, or any owner who owns 5% or more of the firm’s stock
- Any transaction that the BD has not recommended to the client
- Transactions that are executed by a BD whose commissions/markups from penny stocks don’t exceed 5% of its total commissions/markups and the BD has not been a market maker.
SEC Rule 15g-9
Prior to the client purchasing a penny stock, the BD must approve the person’s account for penny stock transactions and obtain written consent from the customer that indicates the identity and quantity of the penny stock to be purchased.
BDs must (1) make sure that customers are suitable for penny stock transactions, (2) deliver a WRITTEN statement regarding this suitability determination, (3) obtain from the customer a MANUALLY signed and dated copy of this statement.
Transactions w/ established customers where that customer has executed a securities transaction or deposited funds in their account more than 1 year prior to the penny stock transaction are exempt. Also, customers are exempt from this rule if they made 3 purchases of penny stocks on 3 separate days and involved 3 separate issues.
- Anyone who is exempt from the penny stock disclosure is also exempt from this rule.
Preemptive rights
When a company does a secondary offering, existing shareholders have the ability to buy additional shares before the public does so that their share count won’t be diluted. All existing shareholders have an equal # of rights to buy new shares as the amount they currently hold.
Ex: Company A has 1mm shares outstanding and is issuing 1mm new shares. Shareholder A has 1,000 shares so they will have preemptive rights to buy an additional 1,000 shares before the public has the option.
- Stock rights are not taxable at time of receipt, but instead are treated the same as stock dividends. If a shareholder sells their rights in the open market, the proceeds are taxable as ordinary income.
Warrants
A derivative that give the right, but not the obligation, to buy or sell a security—most commonly an equity—at a certain price before expiration. Warrants typically have a maturity set over a period of years.
- Options are traded on an exchange and between investors, whereas warrants are issued by the company itself.
- Warrants’ strike price is usually higher than the current market price.
American depository receipt (ADR)
A claim to a foreign security w/ the actual shares being held by a U.S. bank abroad. ADRs are traded on exchanges or OTC and are priced and pay dividends in USD.
- Dividends that are received by a U.S. investor on foreign securities (e.g., an ADR) may be subject to a withholding tax by the country from which they were paid. If the investor has securities that paid dividends which were subject to a foreign tax, the broker-dealer will send the investor a form that will report the gross amount of the dividends or interest and the amount of tax withheld by the foreign government. The fact that the company earns income in the U.S. is irrelevant.
Sponsored vs unsponsored ADRs
Sponsored ADR= The company whose stock underlies the ADR pays the depository bank to issue ADR shares in the U.S. These can trade on U.S. exchanges.
Unsponsored ADR= The company doesn’t pay for the cost associated w/ trading in the U.S. These are traded OTC.
- Sponsored ADR companies are permitted to raise capital in the U.S.
True or false: The NYSE and NASDAQ have multiple market makers for each securities?
False, NYSE has one designated person per company while NASDAQ has multiple.
Electronic communication networks (ECNs)
Market centers that bring buyers and sellers together
Dark pools
A system that provides liquidity for large institutional investors and high-frequency traders but does not disseminate quotes. The objective is to allow these investors to trade with the least amount of market impact and with low transaction costs.
How individuals’ dividends are taxed
Cash dividends are taxable in the year that they’re received. Non-qualified dividends are taxed at the investor’s ordinary tax rate. Qualified dividends are taxed as LT capital gains (max. of 20%).
- In order for a dividend to be qualified, an investor must hold the shares for more than 60 days and these shares must be unhedged.
How corporations’ dividends are taxed
If a corporation owns less than 20% of the distributing corporation, 50% of the dividend income will be excluded from corporate income. If the corporation owns 20% or more of the distributing corporation, the exclusion is 65% of the total dividends received.
Ex: Firm A owns 1k shares of Firm B (15% of firm B) and recevied $2k in dividends from Firm B. $1k of these dividends will be tax free. If firm B owned 70% of firm B and received a $2k dividend, $1.3k would be tax-free.
- Dividends from REITs don’t qualify for this exclusion. Mutual funds may or may not qualify for this exclusion.
True or false: Stock splits are taxable at the time of receipt?
False, stock splits are treated the same as stock dividends
Cost basis of securities
The total price paid to acquire a security including any transaction costs.
True or false: Capital gains/losses are recognized in the year the asset is sold?
True
True or false: Netting capital losses against capital gains does NOT reduce the tax liability on the capital gains?
False, it does
True or false: If an investor has both LT capital gains and ST capital losses, these two figures must be netted before the 20% tax rate applies?
True
Wash sale
The IRS does NOT allow investors to claim deductions for capital loss if they purchase substantially the same security within 30 days of the sale.
Short sales are also covered by this rule. If a short seller closes their position by buying the security and then subsequently shorts the security within a 30 day period, this is not allowed for tax purposes.
Ex: Investor A buys stock A at $24 per share and later sells the stock at $21 claiming a $3 loss. If 10 days after the sale (within 30 days), the investor buys the same stock for $25, the $3 loss will be disallowed.
- Substantially the same means the stock itself, rights, warrants, convertible bonds, convertible preferred stock, or call options of the company.
- For debt securities, bonds of a different issuer, w/ a different coupon OR different maturity will NOT be considered substantially the same.
True or false: The gain or loss on a short sale is typically treated as a short-term capital gain or loss since a holding period for the security is never established?
True
True or false: Options are created by the issuer of the underlying security?
False, options are created by the Options Clearing Corporation (OCC).
What 2 methods for calculating the cost basis for capital gains/losses on stock transactions does the IRS allow?
- FIFO
- Specific Identification
True or false: Stock dividends requires a shareholder vote?
False, the BOD makes decisions regarding stock dividends and cash dividends. A stock SPLIT requires a shareholder vote.
