Part 1 Lesson 1: Supervision of Options Accts

Question 1

Account Types

Answer 1

Customer and Institutional Accounts
• Types of customers
• Retail
• Institutional
• Fiduciary
• Discretionary

Question 2

Retail Accounts

Answer 2

Retail account—an account opened by any natural person with a broker-dealer
• Customers’ classifications
- Ownership and trading authorization
- Payment method and types of securities traded
• Any entity that is not an institution must be treated as retail customer

Question 3

Institutional Accts

Answer 3

An institutional account is defined as the following:
- Bank or savings and loan association (S&L)
- Registered investment company (mutual fund)
- Insurance company
- An investment adviser registered either with the SEC or with a state securities commission
- Any other person (whether a natural person, corporation, partnership, trust, or otherwise) with total assets of at least $50 million.

Question 4

Fiduciary Accts

Answer 4

Fiduciary accounts
- A person who is legally appointed and authorized to represent another person, act on that person’s behalf, and make prudent decisions, include the following:
Trustee. Executor. Conservator. Court administrator. Guardian. UGMA custodian. Receiver in a bankruptcy.

Question 5

Discretionary accounts

Answer 5

Discretionary options accounts:
- The customer gives the broker authority to enter transactions at the broker’s discretion.
- The order tickets must be marked discretionary.
- All trades must be reviewed frequently by an ROP.
- Before discretion can be exercised, the following must occur:
• Authorization in writing
• Sign the account form
• Limited/full power of attorney
• Approved in writing by an ROP or General Sales Supervisor (Series 9)

Question 6

Suitability standards for retail customers

Answer 6

Suitability standards for retail customers
- Reasonable-basis suitability
- Customer-specific suitability
- Quantitative suitability

Question 7

Suitability for institutional accounts

Answer 7

Suitability obligations for institutional customers are fulfilled by
• the institution’s capability to independently evaluate investment risk, and
• the institution’s ability to make sophisticated and independent investment decisions.

• TAKE NOTE
- A person with $50 million in assets is considered an institutional account.

Question 8

New account form requirements for options

Answer 8

In an option new account form, the required information must be complete. Also, the broker-dealer must obtain the following information:
• Investment objective(s)
• Employment status
• Estimated annual income from all sources
- Estimated net worth
- Estimated liquid net worth
- Marital status and number of dependents
- Legal age
- Investment experience and knowledge
- Date the ODD was furnished to the customer

Question 9

Options levels and tiers

Answer 9

Levels of approval may differ from member firm to member firm:
- Level I - covered options (calls and puts) only
- Level II-long calls, puts, straddles, combinations, strangles
- Level III—spreads (calls and puts), including ratio spreads
- Level IV - uncovered calls and puts, short positions

Question 10

Opening an approval levels for uncovered calls or put

Answer 10

The firm must have written procedures concerning the following:
- Specific criteria used in approving accounts
- Specific minimum equity requirements for accounts
- Special statement for uncovered options writers
• Customer must receive the statement before initial trade describing the risks involved in uncovered writing

Question 11

Discretionary accounts and orders

Answer 11

Discretionary order is only if firm chooses more than the price and/or time of execution
• Before any trading occurs, the firm must have the following:
- Limited or full power of attorney or affidavit
- Account approval in writing
- All order tickets marked discretionary
• ROP must review all trading activity frequently

Question 12

Discretionary, orders, test topic alert

Answer 12

TEST TOPIC ALERT
An ROP, who is not exercising the discretionary authority, must frequently review any accounts trading activity to guard against prohibited activities.
Each order ticket must be marked discretionary.

Question 13

Guaranteed account

Answer 13

Guaranteed account
Must have an account agreement stating the following:
• Will cross guaranteed any deficit between accounts
• No one else has any interest in the accounts
• A cash account and a margin account are one account.

Question 14

Uncovered option accounts, approval requirements

Answer 14

Uncovered options account approval requirements:

These are different for every broker-dealer:
• Proper investment objective
• Profile to have options trading experience
• In-depth knowledge of option procedures
• Appropriate risk tolerance

Documentation on suitability will be required

Question 15

Anti-money laundering standard compliance

Answer 15

Anti-money laundering standard compliance
- Detect and report transactions that raise suspicion
- Designate an individual responsible for controls
- Training for appropriate personnel
- Provide for annual independent testing for compliance

Question 16

The bank secrecy act

Answer 16

The Bank Secrecy Act
- Currency received more than $10,000 in a single day
- Form 112 must be filed within 15 days of receipt
• The two federal agencies empowered are the Federal Reserve and the U.S. Treasury Department.

Question 17

The three stages of money laundering

Answer 17

There are three stages of money laundering:
1. The placement stage is when funds enter the system.
2. The layering stage involves the movement of funds.
3. The integration stage occurs when funds are commingled.

Question 18

USA patriot act and account verification

Answer 18

The USA PATRIOT Act requires broker-dealers to do the following:
• Verify the identity
• Maintain the records
• Check any list of known or suspected terrorists
• These rules are designed to prevent, detect, and prosecute money laundering and the financing of terrorism.

Question 19

Customer identification program, CIP

Answer 19

Customer identification program (CIP)
- Customer name
- Date of birth
- Address
- Identification number (e.g., SSN)
• The firm also must verify the identity of each new customer by obtaining a copy of an unexpired drivers license, valid passport, or military ID.

Question 20

CIP

Answer 20

Anti-Money Laundering Standards
• CIP
- Office of Foreign Asset Control (OFAC) is an agency of the U.S.
Treasury Department
• The firm must do the following:
- Check the name on the OFAC list of known or suspected terrorists
- Print out the time-stamped report clearing the customer
- Maintain the report with the account records

Question 21

Suspicious activity reports SAR

Answer 21

Suspicious activity report (SAR)
• Financial Crimes Enforcement Network (FinCEN)
• An event, transaction, or series of transactions that involve
$5,000
- Funds derived from illegal activity
- Evadethe requirements of the BSA
- Serves no business or lawful purpose
- The use of the firm to facilitate criminal activity
• File FinCEN Form 111 SAR within 30 calendar days—kept five years
• Subject of the report must not be notified

Question 22

AML verification by customer

Answer 22

Verification by the customer
• Either part of the option agreement signed, or sent within 15 days after the account is approved
• The customer need not send back positive verification

Question 23

They know your customer KYC requirement

Answer 23

The know your customer (KYC) requirement
- For each customer, a member must
• use reasonable due diligence to know the essential facts;
• know the authority acting on behalf of the customer; and
• comply with applicable laws, regulations, and rules.

Question 24

Red flags for money laundering

Answer 24

Red flags for money laundering can include the following:
- Customer transactions lack business sense
- Customer has multiple accounts under a single name
- Customer requests many transfers to third parties
- Excessive journal entries between unrelated accounts
- Lack of concern regarding risks and commissions