Prohibited and Unethical Business Practices Under the USA

Question 1

May an IAR and a client share in an account?

Answer 1

No. However, an agent may share in a client’s account.

Question 2

Sam buys stock on one exchange and sells it short on another at a slightly higher price. Is this permitted?

Answer 2

Yes. Sam is engaging in arbitrage.

Question 3

Define commingling.

Answer 3

The prohibited act of mixing client funds with those of the BD

Question 4

__________ is a manipulative activity that is designed to keep the price of a stock from rising (and is prohibited).

Answer 4

Capping is a manipulative activity that is designed to keep the price of a stock from rising (and is prohibited).

Question 5

Define conversion.

Answer 5

The prohibited act of an agent using client funds for personal use.

Question 6

True or False: BDs may accept oral permission from clients to exercise discretion in their accounts.

Answer 6

False. The client’s prior written authorization is required

Question 7

True or False: An unsolicited transaction of an unregistered, non-exempt security to a client is a violation of the USA.

Answer 7

False. Unsolicited transactions are exempt transactions.

Question 8

True or False: Principals must approve discretionary orders prior to entry.

Answer 8

False. The orders must be approved promptly afterward.

Question 9

Joe places an order to sell 10,000 shares of ABC whenever it’s best. Is written discretionary authority required?

Answer 9

No. Since discretion is limited to time and/or price, written authority is not required.

Question 10

True or False: Forward-looking statements regarding mutual fund performance may be used when soliciting clients.

Answer 10

False. Past performance is not indicative of future results.

Question 11

Are advisory fees fixed and are they subject to administrative review?

Answer 11

Fees are not fixed, but must be in line with other advisers. Fees are subject to administrative review.

Question 12

If an agent (RR) received a power of attorney seven years ago, could she still trade that customer’s account?

Answer 12

Yes, powers of attorney do not need to be renewed.

Question 13

Is an agent permitted to execute securities trades for compensation and not record the trades on his BD’s books and records?

Answer 13

No. This is referred to as “selling away.”

Question 14

For any securities that are delivered to a BD, an agent must ____________ provide the customer with a receipt.

Answer 14

For any securities that are delivered to a BD, an agent must ____________ provide the customer with a receipt.

Question 15

Define an insider.

Answer 15

Officers, directors, partners, greater than 10% owners, and immediate family members of all listed

Question 16

True or False: An agent may trade a stock two days prior to a research report on the stock being released by his employer

Answer 16

False. This is an example of trading ahead and is prohibited.

Question 17

What three details must a client provide for an agent to make a time and/or price decision without written authorization?

Answer 17

Action (buy/sell), asset, and amount. Time and/or price may remain the agent’s discretion without written authorization.

Question 18

True or False: A BD may withhold shares of an IPO for the purpose of later selling them to customers at a higher price.

Answer 18

False

Question 19

May an adviser release account information to the spouse of a client?

Answer 19

No, not without the client’s written authorization.

Question 20

To whom are written or electronically-sent grievances (complaints) forwarded?

Answer 20

An immediate supervisor

Question 21

Does this order require prior discretionary authorization? “Buy 300 shares of DMB this week”

Answer 21

Yes, since it is NOT a not held order. Not held orders are only good for a trading day, and this order is for the week.

Question 22

Define front running.

Answer 22

A firm/individual executing trades for its own account with knowledge of an impending large block customer order.

Question 23

Next week ABC plans to announce its earnings. If ABC’s CEO wants to sell some of her shares now, is the sale restricted?

Answer 23

Yes. Insiders are required to wait until an earnings report is released publicly before selling shares.

Question 24

An IA that is also a BD may execute agency cross trades, earning commission on both sides, if one side is ____________.

Answer 24

An IA that is also a BD may execute agency cross trades, earning commission on both sides, if one side is unsolicited.

Question 25

_____________ is the prohibited practice of a BD trading for its own account ahead of a customer’s block order.

Answer 25

Front-running is the prohibited practice of a BD trading for its own account ahead of a customer’s block order.

Question 26

What three items must be specified on a not held order?

Answer 26

Action (buy/sell), Amount (quantity), and Asset (security)

Question 27

Not held order

Answer 27

gives a broker the time and price discretion to seek the best price available. Broker is not held responsible for potential losses or missed opportunities

Question 28

what is a held order?

Answer 28

held order requires immediate execution

Question 29

Define selling away.

Answer 29

The execution of transactions by an associated person outside his employment with a member firm

Question 30

Define churning.

Answer 30

Excessive trading in a customer’s account for the primary purpose of generating commissions and other fees

Question 31

Trading on material, non-public information is considered ________ ________.

Answer 31

insider trading

Question 32

For how long may a not held order be maintained?

Answer 32

A not held order is considered a day order.

Question 33

May an agent and a client share in an account?

Answer 33

Yes. However, client and firm approval is required and the sharing must be proportionate to each person’s investment.

Question 34

An IAR may exercise discretion over a client’s account based on the client’s oral authorization for up to ___ days.

Answer 34

An IAR may exercise discretion over a client’s account based on the client’s oral authorization for up to 10 days.

Question 35

For an agent to exercise discretion over a client’s account, the client must have signed a ________________________.

Answer 35

For an agent to exercise discretion over a client’s account, the client must have signed a power of attorney.

Question 36

What is needed for a BD to exercise discretion over a client’s account?

Answer 36

BDs need the client’s prior written authorization

Question 37

May an adviser borrow money from a client?

Answer 37

Yes, if the client is in the business of lending money, or if the client is an affiliate of the adviser, or is a BD.

Question 38

An agent of a BD lends $5,000 to his brother, is this acceptable?

Answer 38

Yes, lending to immediate family members is permissible.

Question 39

John and Sam are continually trading QRS stock between their accounts to cause the price to rise. Is this permitted?

Answer 39

No, this prohibited practice is referred to as “painting the tape.”

Question 40

True or False: If an agent disagrees with a customer’s order, he may disregard the order.

Answer 40

False. Agents and IARs must follow all customer requests, even those with which they disagree.

Question 41

May an agent share in the profits of a client’s account?

Answer 41

Yes, in a joint account with proportionate sharing. Permission is required from both the client and the firm.

Question 42

May an agent of a BD effect personal trades in a stock two days before her firm releases a research report on the stock?

Answer 42

No. Employees of a broker-dealer may not trade ahead of their firm’s research report.

Question 43

A firm promises a refund to all clients who invest in an IPO if shares fail to rise 20%. Is this permitted?

Answer 43

No. This is unethical since it is considered a guarantee against loss.

Question 44

What is the annual fee levied against a fund’s assets and used to pay expenses of commissions and retail communications?

Answer 44

12b-1 fee

Question 45

Not held orders are considered to be in effect for _____ trading day(s).

Answer 45

Not held orders are considered to be in effect for one trading day.

Question 46

________ is the willful or intentional act of deceiving another person for gain or profit.

Answer 46

Fraud is the willful or intentional act of deceiving another person for gain or profit.

Question 47

True or False: If a customer receives a prospectus during a solicitation, an agent has provided full and fair disclosure.

Answer 47

False. The agent may still have omitted material facts.

Question 48

What is needed for an investment adviser to exercise discretion over a client’s funds?

Answer 48

An adviser may exercise discretion for 10 days with the client’s oral authorization as long as it is followed up in writing.

Question 49

May an IAR solicit both sides of an agency cross transaction?

Answer 49

No, one side must be unsolicited.

Question 50

What is needed for an investment adviser to exercise discretion over a client’s funds?

Answer 50

An adviser may exercise discretion for 10 days with the client’s oral authorization as long as it is followed up in writing.

Question 51

True or False: A power of attorney given to an agent (RR) must be renewed.

Answer 51

False. Powers of attorney do not have to be renewed.

Question 52

True or False: Agents of a broker-dealer must disclose material facts about a stock they are recommending.

Answer 52

True. Agents should make a good-faith effort to disclose all material facts to an investor.

Question 53

True or False: In certain cases, fraud may be unintentional.

Answer 53

False. Fraud is always intentional

Question 54

Is an agent allowed to recommend the sale of a fund’s shares in order to buy another fund’s shares with the same objective?

Answer 54

No. This is a prohibited practice and is considered an unsuitable recommendation.

Question 55

True or False: An agent of a broker-dealer may loan money to his son-in-law.

Answer 55

True. In-laws are considered immediate family members; therefore, the loan would be acceptable.

Question 56

A corporate officer informs his son of an upcoming earnings report and the son effects trades. Is this a violation?

Answer 56

Yes. Both parties, the tipper (officer) and the tippee (the son), have violated the Insider Trading Act.

Question 57

________ stock is the repeated practice of placing stock in the account of a person who is not the rightful owner.

Answer 57

Parking Stock

Question 58

Churning is described as _____________________ designed to _____________________.

Answer 58

Churning is described as excessive trading designed to generate commissions.

Question 59

When does a durable power of attorney become automatically cancelled?

Answer 59

At the time of death of the grantor of the POA

Question 60

Does this order require prior discretionary authorization? “Buy some ABC shares today if its price begins to fall.”

Answer 60

Yes. This is NOT a not held order since the client did not specify the quantity of shares to be purchased.

Question 61

Held orders

Answer 61

do not give the trader time and price discretion and will be promptly executed at the market price.

Question 62

__________ is a manipulative activity that is designed to keep the price of a stock from falling (and is prohibited).

Answer 62

Pegging

Question 63

Define the prohibited practice of shadowing.

Answer 63

After executing a large block order, but before the trade is reported, a BD trades for its own account.

Question 64

When selling mutual fund shares, an agent must adequately disclose the ______ _______.

Answer 64

Sales Charge

Question 65

An agent advises a client to buy stock of a company that just fired its CEO. Is disclosure to the client required?

Answer 65

Yes, since this is a material fact, it must be disclosed before the customer buys the stock.

Question 66

An IA directs transactions to a BD who rebates 15% of the commissions to the IA for the business. Is this acceptable?

Answer 66

Yes, provided the IA provides written disclosure (often in Form ADV) to clients.

Question 67

May an adviser or BD lend money to a client?

Answer 67

Yes, if the adviser or BD is in the business of lending money.

Question 68

If an agent has been given time and price discretion on a client order, is written power of attorney required?

Answer 68

No. If the client determines the action (buy/sell), amount, and asset, power of attorney is not required.

Question 69

Does an IA need written consent before executing each agency cross trade with an advisory client?

Answer 69

No, the client must provide written consent initially, but not for every trade.

Question 70

May a wife enter trades in a husband’s account?

Answer 70

Yes, with written third-party authorization.

Question 71

What’s a no load fund?

Answer 71

A mutual fund with no front-end sales charge, no deferred sales charge, and no 12b-1 fee exceeding .25% per year.

Question 72

An agent encourages a customer to buy a stock due to an upcoming dividend. Is this a legal practice?

Answer 72

No, this is a prohibited action known as selling dividends

Question 73

Does this order require prior discretionary authorization? “Buy 500 shares of DMB sometime today.”

Answer 73

No, this is a not held order. The customer specified the action (buy), the amount (500 shares), and the asset (DMB).

Question 74

Define painting the tape.

Answer 74

Traders effecting transactions back and forth to create a misleading appearance of activity

Question 75

Traders effecting transactions back and forth to create a misleading appearance of activity

Answer 75

Both oral and written disclosure of the relationship

Question 76

statute of limitations for violations of the civil provisions of the USA

Answer 76

three years from the date of sale (or rendering of investment advice) or two years after discovering the violation, whichever occurred first

Question 77

criminal penalties

Answer 77

5-year statute of limitations
$5,000 maximum fine
imprisonment of no more than 3 years

Question 78

not included in the fee disclosure documents

Answer 78

1) commissions
2) markups/markdowns
3) advisory fees

Question 79

discretionary rule for broker-dealers/agents

Answer 79

written discretionary authorization from customer and account approval by a designated supervisor

Question 80

discretionary rule for IAs

Answer 80

oral authorization may be relied upon for the first 10 days after the initial discretionary trade in the account; after that time, however, without a written authorization, no further discretion may be exercise

Question 81

although the rules do not prohibit testimonials for broker-dealers, they are strictly forbidden for use by

Answer 81

IA’s

Question 82

most common forms of market manipulation

Answer 82

matched orders and wash trade

Question 83

not included in soft-dollar safe harbor

Answer 83

Office space/computers/office supplies (e.g. BD cannot seek more trades from a hedge fund by offering them below market price office space); Advertising; Mass-marketed publications (WSJ, NY Times); travel expenses; Rent; Salary reimbursements

Question 84

a person must update the Administrator of any change to the information in his registration (e.g., firm association, name, address, etc.) when?

Answer 84

promptly

Question 85

a personal bankruptcy within how long must be disclosed when applying for registration?

Answer 85

within the past 10 years

Question 86

the Admin may suspend or revoke a registration based on information that was originally submitted in an application for the

Answer 86

first 90 days of registration

Question 87

consent to service of process

Answer 87

limited to civil actions (lawsuits) relating to state securities law, not criminal prosecutions or unrelated civil actions (e.g. slip & fall)

Question 88

FINRA

Answer 88

regulates BDs and agents

Question 89

SEC

Answer 89

regulates federal covered investment advisers

Question 90

registration as an agent with more than one broker-dealer is permitted only if the broker-dealers are affiliated or under

Answer 90

direct or indirect common control

Question 91

an amended Form ADV must be filed by an IA

Answer 91

within 90 days following their fiscal year-end

Question 92

agency cross trade

Answer 92

an IA (or IAR) may represent both parties to a trade and receive commissions from both sides with prior written consent from both clients

Question 93

IA’s must maintain a copy of records for ?

Answer 93

5 years

Question 94

The Administrator may require which entities that have custody of or discretionary authority over clients’ securities or funds to post a surety bond ?

Answer 94

BDs, agents, and IAs BUT NOT IARs

Question 95

criteria for the sale of a pre-organization certificate to be an exempt transaction

Answer 95

1) No commissions are paid
2) The number of subscribers is 10 or less, and
3) No payment is made by the subscriber

Question 96

the Admin can issue subpoenas to compel testimony but CANNOT issue an

Answer 96

injunction (only a court can do so)

Question 97

the Uniform Prudent Investor Act provides that trustees owe a fiduciary duty to who?

Answer 97

the trust’s beneficiaries

Question 98

IAs may charge performance fees to who?

Answer 98

qualified clients only? (>$1 million on account or >$2 in net worth))

Question 99

soft dollars (between BDs and IAs)

Answer 99

arrangements under which products or services other than execution of securities transactions are obtained by an investment adviser from a broker dealer in exchange for client brokerage transactions being directed to the broker

Question 100

The Administrator’s Duties

Answer 100

• Person in the state that is responsible for enforcing the status securities laws and rules.
• Has the power to create certain rules and regulations
• Does NOT write the law itself (law is created by the State Legislature)

Question 101

Information required on an Agent AND IAR applications

Answer 101

1.) Applicant’s qualifications and business history

2.) Any injunctions or administrative orders involving a security

3.) Any convictions for misdemeanors involving securities

4.) Any felony convictions

5.) The applicant’s financial condition and history

6.) Consent to Service of Process

***All securities-related misdemeanor convictions and all felony convictions must be disclosed on the application regardless of time frame

Question 102

It is unlawful for any person to offer or sell any security unless…

Answer 102

1.) It is registered under the USA

OR

2.) The security or transaction is exempted under the USA

OR

3.) It is a federal covered security

Question 103

he administrator must hold a hearing within ____ days if the party requests a hearing in writing

Answer 103

15 days

Question 104

Definition of a “sale”

Answer 104

every contract of sale, contract to sell or disposition of a security or interest in a security for value. The definition of an “offer to sell” is every attempt or offer to dispose of or solicitation of an offer to buy a security.

Question 105

Sale or offer of a security includes:

Answer 105

1. rights or warrants to buy another security is considered to be an offer or sale of another security
2. any solicitation of an offer to buy common stock for value
3. any offer to sell common stock for value
   - gift of security is NOT considered to be a sale unless the security is assessable. (Common stock is non-assessable)

Question 106

Securities sold through a private placement are

Answer 106

UNREGISTERED and are an EXEMPT TRANSACTION

Question 107

Under the USA, the term ‘sale’ or ‘sell’ includes which of the following:
I. a disposition of a security for consideration
II. a stock dividend given to stockholders in lieu of a cash dividend.
III. An exchange of stock in a merger transaction which is approved by stockholders.

Answer 107

I Only
to be considered a sale, there must be some consideration or exhcange of value

Question 108

What is not included in the definition of a “Sale”

Answer 108

• Bona fide pledges of securities as collateral for loans
• stock dividends
  -corporate mergers approved by stockholders
• the exchange of corp assets in consideration of stock of another corporation
• acts incidental to judicially-approved reorganization (bankruptcy) in which securities are issued in exchange for other outstanding securities.

Question 109

Unsolicited customer orders in the secondary market by a broker-dealer are considered to be

Answer 109

exempt transactions

Question 110

Under the USA, disciplinary proceedings generally require the administrator to provide :

Answer 110

1.appropriate prior notice
2. opportunity for a hearing
3. written findings of fact and conclusions of law

Question 111

De minimus exemption applies

Answer 111

IA firms not B/Ds or agents

Question 112

a canadian broker dealer that has no office in this state may effect transactions in securities with or for a person from canada who temporarily resides in this state with whom the canadian broker dealer had a bona fide broker-dealer client relationship before the person entered the US:

Answer 112

Only if he or she is registered with the state

canadian broker-dealers cannot do business in a state without first registering in that state, even if their canadian client is only a temporary resident in the state

Question 113

SEC Reg A

Answer 113

is a federal exemption, not a state exemption.
Reg A allows issuers to sell relatively small issues of securities to the public by filing a shorter, simplified registration statement with the SEC rather than a full registration statement

Question 114

Securities issued in connection with employee benefit plans, such as employee stock purchase plans, saving plans, pension plans, and/or profit sharing plans, are considered to be exempt __________ under the USA, not exempt __________.

Answer 114

securities, transactions

Question 115

Under the Uniform Securities Act, __________ companies are not specifically excluded from the definition of an investment advisor.

Answer 115

insurance

Question 116

Surety Bond

Answer 116

__________ are a type of casualty insurance and are often required by government agencies as a condition to licensing or registration. If an IA firm has discretionary authority over customer accounts or has custody of customer securities or monies, the Administrator may require the firm to post a surety bond or an equivalent amount of cash and/or marketable securities in order to protect customers against losses due to check forgery, lost securities, or fraudulent trading.

Question 117

The state administrator may require a surety bond for all of the following EXCEPT:
Agents
Broker-dealers
Investment Advisors
Issuers

Answer 117

Issuers

Although the state administrator may require agents, broker-dealers, and investment advisors to post surety bonds as a condition of state registration, there are no bond requirements for issuers.

Question 118

Under the USA, the state administrator may require notice filings be made for which of the following federal covered securities?

Answer 118

Investment company securities

Federal covered securities need not be registered with the state administrator. Although investment company securities (open-end and closed-end mutual funds and units investment trusts) are federally covered, the Administrator may require them to make a notice filing at the state level. This consists of the payment of fees, filing copies of the documents filed with the SEC, and filing a consent to service of process form.

Question 119

When selling non-NASDAQ OTC stocks, broker-dealers must disclose their compensation to customers:

Answer 119

When selling non-NASDAQ OTC stocks, broker-dealers must disclose their compensation to customers both at the time of the sale and again on the confirmation. Confirmations are usually sent to customers the next business day after the trade date.

Question 120

Under NASAA’s Statement of Policy regarding Dishonest or Unethical Business Practices by Broker-Dealers and Agents in Connection with Investment Company Shares, when selling investment company shares, broker-dealers and agents may not state or imply to a customer that shares sold without a commission are no-load or have no sales charge if there is ______ associated with the purchase.
I. A front-end load
II. A contingent-deferred sale load
III. A 12b-1 fee that exceeds 0.25% of average net fund assets per year
IV. In the case of closed-end funds, commissions or other offering expenses

Answer 120

Under NASAA’s Statement of Policy regarding Dishonest or Unethical Business Practices by Broker-Dealers and Agents in Connection with Investment Company Shares, when selling investment company shares, broker-dealers and agents may not state or imply to a customer that shares sold without a commission are no-load or have no sales charge if there is ______ associated with the purchase.
I. A front-end load
II. A contingent-deferred sale load
III. A 12b-1 fee that exceeds 0.25% of average net fund assets per year
IV. In the case of closed-end funds, commissions or other offering expenses

Question 121

Minimum surety bond coverage

Answer 121

$35,000

Question 122

Net capital

Answer 122

Liquid capital (cash and assets readily converible into cash) maintained by a broker/dealer as required by law for consumer protection

Question 123

offer to sell

Answer 123

• gift of assessable stock
  -warrants
• securities offered as a bonus for buying other securities or merchandise
  -rights

Question 124

offer to sell

Answer 124

• gift of assessable stock
  -warrants
• securities offered as a bonus for buying other securities or merchandise
  -rights

Question 125

A non-exempt security must be registered in _____ _____ _____ __ ____ __ ____.

Answer 125

Every state it will be sold

Question 126

Investment adviser brochure deliver

Answer 126

annually whether or not the adviser has custody or discretion; Unless there have been no material changes, a copy of the adviser’s brochure or brochure supplement must be delivered to all current clients,(except those who are exempt from the brochure delivery requirements {impersonal advise costing less than $500 per year and investment companies registered under the Investment Company Act of 1940}), within 120 days of the end of the adviser’s fiscal year. Custody or discretion is irrelevant to this question. Under the USA, all advisory contracts, both initial and renewal, must be in writing.

Question 127

Required net worth for investment advisers who does NOT have custody of customer funds but HAS discretionary powers

Answer 127

$10,000

Question 128

person who only provides advice on commodities

Answer 128

is not a registered investment adviser; commodities do not count as a security

Question 129

gift of nonassessable stock is

Answer 129

just a gift. accessible stock gift would be an offer or a sale

Question 130

bank holding companies

Answer 130

securities are NOT exempt

Question 131

agents may share commissions as long as

Answer 131

commissions from the states in which both are licensed

Question 132

blanket recommendation

Answer 132

not allowed; cannot recommend to all clients

Question 133

are investment advisers exempt from registration when making recommednationts to accredit investors on exempt sercurities

Answer 133

The Uniform Securities Act exempts investment advisers with no place of business in the state who deal with certain institutional customers such as banks, insurance companies, investment management companies, and employee benefit plans with assets of $1 million or more.

Question 134

investment adviser advertising what is considered unethical

Answer 134

testimonials, exaggerations, guarantees

Question 135

if majority partners leaves

Answer 135

must get client consent again

Question 136

if minority partner in investment advisory partnership leaves

Answer 136

must notify clients as soon as reasonably possible

Question 137

who can file registration statement

Answer 137

usually issuer but BD and selling stockholders can as well

Question 138

mailing direct offers

Answer 138

Anyone who offers to sell or buy a security in the state is subject to the statutes of the state to which the offer is directed, even if the sale is not completed. Offers by mail directed to persons in other states are considered to have been made in the other state (state it was sent from), if received where originally addressed. Under the USA, the address that is critical is the one to which the mailing is directed. If it is forwarded to another state, it is not considered an offer in that state.

Question 139

ADV Part 2

Answer 139

ADV Part 2 is the brochure that investment advisers must deliver to clients; it describes the investment adviser’s fees, educational background, investment policies, and types of investments made. The states in which the adviser is registered or intends to be registered in are not contained in ADV Part 2.