Federal Regs & FINRA

Question 1

Decisions of FINRA arbitration panels:

a. May be appealed
b. Are not binding if either party contests the decision
c. Are binding upon all parties to the arbitration
d. Are not binding if both parties agree not to accept the decision

Answer 1

c. Are binding upon all parties to the arbitration

Decisions of FINRA arbitration panels are binding upon all parties to the arbitration. The parties must agree to accept the findings of the arbitration panel before submitting to arbitration.

Question 2

Which of the following may NOT occur during the waiting period of the securities registration process?

a. The underwriter publishes a tombstone ad.
b. An underwriter sends a red herring to a potential customer.
c. An RR accepts a cash deposit for the offering from an interested customer.
d. An RR discusses the offering with a customer over the phone.

Answer 2

c. An RR accepts a cash deposit for the offering from an interested customer.

During the waiting period (cooling-off-period), RRs may send customers the preliminary prospectus (red herring), discuss the issue with them, and accept (nonbinding) indications of interest. However, no part of the purchase price can be accepted until on or after the effective date.

Question 3

Which of the following communications would most likely contain the legend “This material must be preceded by or accompanied by a prospectus”?

a. Tombstone ad
b. Omitting prospectus ad
c. Generic advertising
d. Supplemental sales literature

Answer 3

d. Supplemental sales literature

Supplemental sales literature for a mutual fund must be preceded by or accompanied by a prospectus for that fund. This requirement does not apply to the other communications mentioned in the question.

Question 4

A customer has just mailed a check to a mutual fund to purchase some shares. The customer is expecting to receive a confirmation of the transaction. The fund may send the confirmation to the customer by any one of the following deadlines EXCEPT:

a. By the settlement date
b. By the seventh calendar day after the trade date
c. Within five business days of the end of the quarter, for non-money-market funds
d. Within five business days of the end of the month, for money-market funds

Answer 4

b. By the seventh calendar day after the trade date

The Securities Exchange Act of 1934 generally requires confirmations for securities transactions to be sent to customers by the settlement date for the trade. This is usually three business days after the transaction. However, mutual funds may use special rules as long as they inform their customers. For non-money-market funds, a statement may be sent within five business days of the end of each quarter describing the activity in the account during the period. For money-market funds, a similar statement may be sent within five business days of the end of the month.

Question 5

Under what conditions can mutual fund shares be used as collateral in a margin account?

I. If the shares have been paid in full for at least 30 days
II. If the shares were purchased through a dividend reinvestment plan
III. If all of the securities in the mutual fund’s portfolio are considered marginable by the Federal Reserve Board

a. I and II only 
b. I and III only 
a. II and III only 
b. I, II, and III

Answer 5

a. I and II only

Newly issued securities are usually not permitted as collateral in margin accounts. Since mutual fund shares are always considered new shares when purchased, this rule applies to them. However, the SEC will permit newly issued shares to be transferred to a margin account after they have been owned for 30 days. In addition, shares that have been purchased as part of a plan for the automatic reinvestment of dividends may be used as margin collateral immediately.

Question 6

Which of the following documents need NOT be submitted to FINRA?

I. Tombstone ads
II. Interoffice correspondence
III. Mutual fund performance reports created by an independent publisher
IV. Form letters to be used to prospect for mutual fund customers

a. I and II only
b. I and IV only
c. II and III only
d. I, II, and IV only

Answer 6

a. I and II only

Any communication used to induce the purchase of investment company shares must be filed with FINRA within ten days after initial use. Prospectuses and tombstone ads are excepted from this requirement. Moreover, a dealer does not have to file sales literature that has been filed by a sponsor. Of the choices given, tombstone ads and interoffice correspondence need not be filed with FINRA.

Question 7

When a broker-dealer is acting in the capacity of a dealer, the firm is acting as:

a. An agent 
b. An intermediary 
c. A principal 
d. A broker

Answer 7

c. A principal

When a broker-dealer (brokerage firm) is acting in the capacity of a dealer, the firm is acting as a principal. A dealer buys and sells for its own account and risk. A broker, who is an agent or intermediary for the customer, does not assume the risks of ownership as a dealer and receives a commission. A broker-dealer can choose in which capacity it wishes to act in a transaction but cannot act as both a broker and a dealer in the same transaction.

Question 8

A FINRA member firm commits a number of violations of the Conduct Rules. All of the following actions may be taken EXCEPT:

a. Registered personnel can be suspended from FINRA
b. The firm can be suspended from FINRA
c. A prison sentence of two years
d. Registered persons can be barred from association with any member of FINRA in any capacity

Answer 8

c. A prison sentence of two years

FINRA does not have the authority to imprison violators of the Conduct Rules.

Question 9

A customer’s account is frozen for 90 days under Regulation T. Which of the following statements is CORRECT?

a. The customer cannot make any transactions under any circumstances.
b. The customer can make purchase transactions only if the full purchase price is in the account before the order is executed.
c. The customer can make sales but not purchases.
d. The customer can make purchases but not sales.

Answer 9

b. The customer can make purchase transactions only if the full purchase price is in the account before the order is executed.

When a customer’s account is frozen for 90 days under Regulation T, the customer can make purchase transactions only if the full purchase price is in the account before the order is executed.

Question 10

After a routine audit of a broker-dealer’s branch office, FINRA has decided to bring disciplinary action against an RR for breakpoint sales. This action would be brought under the:

a. FINRA’s Code of Procedure
b. FINRA’s Code of Arbitration
c. Uniform Commercial Code
d. Investment Company Act of 1940

Answer 10

a. FINRA’s Code of Procedure

Disciplinary procedures against member firms and their RRs are covered under FINRA’s Code of Procedure.

Question 11

The only form of price manipulation permitted by the SEC would be:

a. Creating the appearance of active trading in a stock
b. Effecting transactions for the purpose of raising or depressing the price of a security to induce purchases or sales
c. Making statements in order to raise or depress the price of a security when the statements are knowingly false or misleading in regard to material fact
d. Stabilizing new issues at or below the public offering price by the managing underwriter

Answer 11

d. Stabilizing new issues at or below the public offering price by the managing underwriter

The managing underwriter of a new issue can effect stabilizing transactions to prevent or retard a price decline in a public offering of stock. Stabilization is considered a form of manipulation and transactions must be effected at or below the public offering price in order to be legal.

Question 12

Under FINRA’s Conduct Rules, an RR may NOT accept which of the following gifts or awards?

a. A gift certificate for $75 from another broker-dealer
b. A trip to Hawaii from the RR’s broker-dealer for the biggest increase in total mutual fund sales
c. With permission of the RR’s employer, a dinner at a popular restaurant paid for by a mutual fund distributor, followed by a slide show reviewing the features and benefits of some of the distributor’s new funds
d. With permission of the RR’s employer, two round-trip tickets to Paris from a mutual fund group for meeting the goal of selling over $1,000,000 of that group’s funds

Answer 12

d. With permission of the RR’s employer, two round-trip tickets to Paris from a mutual fund group for meeting the goal of selling over $1,000,000 of that group’s funds

FINRA members are permitted to give gifts of up to $100 per person per year to persons associated with another member firm (choice a). However, gifts or awards in excess of this amount is not acceptable, even with the member firm’s permission (unless an employment contract is involved). In particular, receiving cash or noncash compensation from a mutual fund or its distributor is not permitted (choice d). An exception is made for reasonable expenses related to training and education, with the employing firm’s permission (choice c). The compensation cannot be conditioned on meeting a specific sales target, as in choice (d), but a member firm may hold a sales contest for its own RRs as long as the awards are based on total sales of a particular type of product, such as all mutual funds sold by the firm (choice b).

Question 13

Which of the following statements is NOT TRUE regarding SEC insider trading rules?

a. Possession of material, nonpublic information is a violation of insider trading rules if the information was obtained fraudulently.
b. Persons who profit from insider trading violations can be fined up to three times the profit in an SEC civil proceeding.
c. If a person with inside information passes that information on to another person who then trades based on the information, both persons have violated insider trading rules.
d. It is not only a violation to earn a profit from trading on inside information, it is also a violation to avoid a loss by trading on material, nonpublic information.

Answer 13

a. Possession of material, nonpublic information is a violation of insider trading rules if the information was obtained fraudulently.

Mere possession of inside information does not violate SEC insider trading rules. Trading while in possession of such information is the violation. In addition, if a person (the tipper) passes along inside information to another person (the tippee), who then trades on the information, both the tipper and the tippee are guilty of insider trading violations.

Question 14

An RR is talking to a mutual fund prospect who seems almost ready to purchase a large amount of a specific fund. To clinch the sale, the RR mentions the fact that the fund is about to pay a large dividend and that the client can get the dividend by making the purchase today. This type of appeal is:

a. Acceptable, if it is based on the truth about the fund’s upcoming dividend
b. Acceptable only if the client is in a low tax bracket
c. Not acceptable, since it is considered selling a dividend
d. Not acceptable, since the rep would not have access to such information

Answer 14

c. Not acceptable, since it is considered selling a dividend

It is a violation of industry Conduct Rules to induce the purchase of a mutual fund based on the fact that the fund is paying an upcoming dividend. This implies that receiving the dividend is an advantage to the investor, which is generally not the case. This practice is called selling dividends

Question 15

Which of the following may NOT be accepted by a Series 6 representative?

a. An application to purchase a variable universal life insurance policy
b. An order to sell 100 shares of a closed-end investment company on Nasdaq
c. An order to redeem $10,000 worth of a mortgage-backed securities fund
d. An order to buy a new issue of a closed-end municipal bond fund

Answer 15

b. An order to sell 100 shares of a closed-end investment company on Nasdaq

Series 6 registered representatives may accept orders only for redeemable shares of investment companies and shares of closed-end funds during the distribution period only. Series 6 RRs may not buy or sell securities in the secondary market.

Question 16

Before being sent to customers, FINRA rules require approval by a principal of all of the following EXCEPT:

a. An article from a newspaper about a mutual fund the broker-dealer sells
b. The script for a seminar on mutual fund investing to be presented by an RR
c. A form letter that includes the names of all mutual funds sold by the broker-dealer
d. A prospectus for a mutual fund for which the RR’s firm acts as a dealer

Answer 16

d. A prospectus for a mutual fund for which the RR’s firm acts as a dealer

Under FINRA rules regarding communications with the public, advertising and/or sales literature must be approved by a principal before being sent to the public. A prospectus is not covered by these rules.

Question 17

Which of the following statements regarding telephone solicitations is TRUE?

a. RRs may not make telephone solicitations between 9 a.m. and 8 p.m. local time.
b. If an RR calls a potential client and the prospect asks to be placed on the do-not-call list, their number must remain on the list for two years.
c. Time-of-day restrictions on telephone calls by RRs do not apply to calls to an existing customer for the purposes of servicing the account.
d. Each RR must set up and maintain a separate do-not-call list.

Answer 17

c. Time-of-day restrictions on telephone calls by RRs do not apply to calls to an existing customer for the purposes of servicing the account.

According to industry rules regarding telephone solicitations, prospective customers can be contacted between 8:00 a.m. and 9:00 p.m. local time of the party called. This restriction does not apply to existing customers. In addition, persons must remain on the do-not-call list indefinitely and each RR does not maintain his own list.

Question 18

A corporation has filed a registration statement with the SEC. The underwriters, before the effective date, can:

I. Send a preliminary prospectus (red herring) to potential investors
II. Send a research report to potential investors
III. Publish a tombstone ad

a. III only
b. I and II only
c. I and III only
d. I, II, and III

Answer 18

c. I and III only

During the period after filing but before the effective date (the waiting or cooling-off period), underwriters may offer the securities to customers by means of the preliminary prospectus (red herring). However, they may not complete a sale before the effective date. Advertising, including research reports, cannot be sent to potential investors when an issue is in registration. One exception is a tombstone ad. Tombstones can be published during the cooling-off period.

Question 19

A type of offering in which the issuing corporation is assured of receiving the full amount of the offering and anything unsold is retained by the underwriter is a:

a. Firm commitment
b. Best efforts
c. All-or-none
d. Contingency offering

Answer 19

a. Firm commitment

A type of offering in which the issuing corporation is assured of receiving the full amount of the offering and anything unsold is retained by the underwriter is a firm commitment.

Question 20

An RR receives a letter from a client complaining about the performance of a mutual fund that the RR’s firm has recommended. The RR should:

a. Send a copy to the mutual fund, since it is really a complaint about the fund
b. Return the letter to the customer with the statement that the customer must provide written evidence to support the grievance
c. Forward the complaint to a supervisor, who must place a copy in the complaint file
d. Attempt to satisfy the customer before taking any other action

Answer 20

c. Forward the complaint to a supervisor, who must place a copy in the complaint file

FINRA rules require customer complaints to be given to a principal. The firm is then required to keep a copy in a complaint file.

Question 21

Which of the following can an RR do when selling shares of a mutual fund?

I. Tell a customer to concentrate their investments in one family of funds to take advantage of breakpoints
II. Offer discounts on sales charges beyond those mentioned in the prospectus
III. Explain that the exact value of shares being redeemed is determined after the redemption order is submitted
IV. Allow a customer to sign a letter of intent two months after the client’s initial investment

a. I and III only 
b. II and IV only 
c. I, III, and IV only 
d. I, II, III, and IV

Answer 21

c. I, III, and IV only

RRs may not offer sales charge breakpoints to customers that are more generous than those described in the prospectus. Any sales charge discounts must be made available on the same terms to all clients and must be described in the prospectus. A letter of intent may be backdated 90 days. When redeeming mutual fund shares, the price is based on the next NAV calculated, so it is not known at the time the redemption notice is submitted. A family of funds allows an investor to take advantage of breakpoints even when the client is investing in more than one fund in the complex.

Question 22

A corporation that is planning an offering of common stock has not yet filed a registration statement. Which of the following actions on the part of an RR working for an underwriter would be a violation of the Securities Act of 1933?

a. Informing a customer about the advantages of buying this offering
b. Accepting orders for the shares to be offered
c. Attempting to obtain indications of interest for the shares to be offered
d. All of the above

Answer 22

d. All of the above

All of the actions listed would be violations of the Securities Act of 1933 if a registration statement has not yet been filed. During the preregistration period, an RR cannot discuss the new issue with customers, let alone accept orders or even indications of interest for the offering.

Question 23

If an investor asks a registered representative to underline the most important facts in a mutual fund prospectus, the RR:

a. May not do this since it violates federal securities laws
b. May do this if a principal of the broker-dealer approves the change
c. May do this if the change is filed with FINRA
d. May do this without restriction since it was at the customer’s request

Answer 23

a. May not do this since it violates federal securities laws

A prospectus may not be amended or altered in any way even with a highlighter unless the changes are filed with the SEC. An RR may discuss portions of the prospectus with the client, but should not make any marks on the document.

Question 24

A customer makes an initial $3,000 contribution into a variable annuity with his application, but decides five days later that he does not want the investment. The client surrenders the annuity. Under FINRA rules, the member firm must:

a. Return the full amount of the initial payment to the client
b. Return any commissions it earned to the client within seven business days
c. Return any commissions it earned to the insurance company within seven business days
d. Obtain a signed statement from the customer that he understands he will lose part of his investment

Answer 24

c. Return any commissions it earned to the insurance company within seven business days

Under FINRA’s Conduct Rules, dealer agreements must include a provision stating that commissions on variable products are to be returned by the broker-dealer to the insurance company if the variable contract is tendered for redemption within seven business days after the application is accepted. Some variable contracts may contain a free-look provision, but these clauses are typically included because of state insurance laws, not because they are mandated by FINRA.

Question 25

A registered representative has learned that his broker-dealer is now able to offer a popular family of mutual funds in which one of his clients had recently expressed an interest. The RR would like to send an e-mail to the client notifying her that the funds are now available through his firm. Which of the following statements is TRUE regarding this e-mail?

a. It is not covered by FINRA rules since it is electronic rather than hard-copy
b. It must be handled under the firm’s procedures for RR correspondence
c. It must be approved by a principal of the firm
d. This type of communication with customers is not permitted under any circumstances since it might be considered a prospectus

Answer 25

b. It must be handled under the firm’s procedures for RR correspondence

Under industry rules, electronic communications sent to 25 or fewer retail investors, such as text messaging and e-mail, are considered correspondence. FINRA does not require principal approval of correspondence prior to use, but firms are allowed to implement their own rules. FINRA merely requires a broker-dealer to create policies and procedures for handling both incoming and outgoing correspondence that is appropriate based on the nature of the firm’s business. Every RR must be familiar with their own firm’s policies regarding correspondence.