Prohibited and Unethical Business Practices Under the USA Flashcards
May an IAR and a client share in an account?
No. However, an agent may share in a client’s account.
Sam buys stock on one exchange and sells it short on another at a slightly higher price. Is this permitted?
Yes. Sam is engaging in arbitrage.
Define commingling.
The prohibited act of mixing client funds with those of the BD
__________ is a manipulative activity that is designed to keep the price of a stock from rising (and is prohibited).
Capping is a manipulative activity that is designed to keep the price of a stock from rising (and is prohibited).
Define conversion.
The prohibited act of an agent using client funds for personal use.
True or False: BDs may accept oral permission from clients to exercise discretion in their accounts.
False. The client’s prior written authorization is required
True or False: An unsolicited transaction of an unregistered, non-exempt security to a client is a violation of the USA.
False. Unsolicited transactions are exempt transactions.
True or False: Principals must approve discretionary orders prior to entry.
False. The orders must be approved promptly afterward.
Joe places an order to sell 10,000 shares of ABC whenever it’s best. Is written discretionary authority required?
No. Since discretion is limited to time and/or price, written authority is not required.
True or False: Forward-looking statements regarding mutual fund performance may be used when soliciting clients.
False. Past performance is not indicative of future results.
Are advisory fees fixed and are they subject to administrative review?
Fees are not fixed, but must be in line with other advisers. Fees are subject to administrative review.
If an agent (RR) received a power of attorney seven years ago, could she still trade that customer’s account?
Yes, powers of attorney do not need to be renewed.
Is an agent permitted to execute securities trades for compensation and not record the trades on his BD’s books and records?
No. This is referred to as “selling away.”
For any securities that are delivered to a BD, an agent must ____________ provide the customer with a receipt.
For any securities that are delivered to a BD, an agent must ____________ provide the customer with a receipt.
Define an insider.
Officers, directors, partners, greater than 10% owners, and immediate family members of all listed
True or False: An agent may trade a stock two days prior to a research report on the stock being released by his employer
False. This is an example of trading ahead and is prohibited.
What three details must a client provide for an agent to make a time and/or price decision without written authorization?
Action (buy/sell), asset, and amount. Time and/or price may remain the agent’s discretion without written authorization.
True or False: A BD may withhold shares of an IPO for the purpose of later selling them to customers at a higher price.
False
May an adviser release account information to the spouse of a client?
No, not without the client’s written authorization.
To whom are written or electronically-sent grievances (complaints) forwarded?
An immediate supervisor
Does this order require prior discretionary authorization? “Buy 300 shares of DMB this week”
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.
Define front running.
A firm/individual executing trades for its own account with knowledge of an impending large block customer order.
Next week ABC plans to announce its earnings. If ABC’s CEO wants to sell some of her shares now, is the sale restricted?
Yes. Insiders are required to wait until an earnings report is released publicly before selling shares.
An IA that is also a BD may execute agency cross trades, earning commission on both sides, if one side is ____________.
An IA that is also a BD may execute agency cross trades, earning commission on both sides, if one side is unsolicited.
_____________ is the prohibited practice of a BD trading for its own account ahead of a customer’s block order.
Front-running is the prohibited practice of a BD trading for its own account ahead of a customer’s block order.
What three items must be specified on a not held order?
Action (buy/sell), Amount (quantity), and Asset (security)
Not held order
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
what is a held order?
held order requires immediate execution
Define selling away.
The execution of transactions by an associated person outside his employment with a member firm
Define churning.
Excessive trading in a customer’s account for the primary purpose of generating commissions and other fees
Trading on material, non-public information is considered ________ ________.
insider trading
For how long may a not held order be maintained?
A not held order is considered a day order.
May an agent and a client share in an account?
Yes. However, client and firm approval is required and the sharing must be proportionate to each person’s investment.
An IAR may exercise discretion over a client’s account based on the client’s oral authorization for up to ___ days.
An IAR may exercise discretion over a client’s account based on the client’s oral authorization for up to 10 days.
For an agent to exercise discretion over a client’s account, the client must have signed a ________________________.
For an agent to exercise discretion over a client’s account, the client must have signed a power of attorney.
What is needed for a BD to exercise discretion over a client’s account?
BDs need the client’s prior written authorization
May an adviser borrow money from a client?
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.
An agent of a BD lends $5,000 to his brother, is this acceptable?
Yes, lending to immediate family members is permissible.
John and Sam are continually trading QRS stock between their accounts to cause the price to rise. Is this permitted?
No, this prohibited practice is referred to as “painting the tape.”
True or False: If an agent disagrees with a customer’s order, he may disregard the order.
False. Agents and IARs must follow all customer requests, even those with which they disagree.
May an agent share in the profits of a client’s account?
Yes, in a joint account with proportionate sharing. Permission is required from both the client and the firm.
May an agent of a BD effect personal trades in a stock two days before her firm releases a research report on the stock?
No. Employees of a broker-dealer may not trade ahead of their firm’s research report.
A firm promises a refund to all clients who invest in an IPO if shares fail to rise 20%. Is this permitted?
No. This is unethical since it is considered a guarantee against loss.
What is the annual fee levied against a fund’s assets and used to pay expenses of commissions and retail communications?
12b-1 fee
Not held orders are considered to be in effect for _____ trading day(s).
Not held orders are considered to be in effect for one trading day.
________ is the willful or intentional act of deceiving another person for gain or profit.
Fraud is the willful or intentional act of deceiving another person for gain or profit.
True or False: If a customer receives a prospectus during a solicitation, an agent has provided full and fair disclosure.
False. The agent may still have omitted material facts.
What is needed for an investment adviser to exercise discretion over a client’s funds?
An adviser may exercise discretion for 10 days with the client’s oral authorization as long as it is followed up in writing.
May an IAR solicit both sides of an agency cross transaction?
No, one side must be unsolicited.
What is needed for an investment adviser to exercise discretion over a client’s funds?
An adviser may exercise discretion for 10 days with the client’s oral authorization as long as it is followed up in writing.
True or False: A power of attorney given to an agent (RR) must be renewed.
False. Powers of attorney do not have to be renewed.
True or False: Agents of a broker-dealer must disclose material facts about a stock they are recommending.
True. Agents should make a good-faith effort to disclose all material facts to an investor.
True or False: In certain cases, fraud may be unintentional.
False. Fraud is always intentional
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?
No. This is a prohibited practice and is considered an unsuitable recommendation.
True or False: An agent of a broker-dealer may loan money to his son-in-law.
True. In-laws are considered immediate family members; therefore, the loan would be acceptable.
A corporate officer informs his son of an upcoming earnings report and the son effects trades. Is this a violation?
Yes. Both parties, the tipper (officer) and the tippee (the son), have violated the Insider Trading Act.
________ stock is the repeated practice of placing stock in the account of a person who is not the rightful owner.
Parking Stock
Churning is described as _____________________ designed to _____________________.
Churning is described as excessive trading designed to generate commissions.
When does a durable power of attorney become automatically cancelled?
At the time of death of the grantor of the POA
Does this order require prior discretionary authorization? “Buy some ABC shares today if its price begins to fall.”
Yes. This is NOT a not held order since the client did not specify the quantity of shares to be purchased.
Held orders
do not give the trader time and price discretion and will be promptly executed at the market price.
__________ is a manipulative activity that is designed to keep the price of a stock from falling (and is prohibited).
Pegging
Define the prohibited practice of shadowing.
After executing a large block order, but before the trade is reported, a BD trades for its own account.
When selling mutual fund shares, an agent must adequately disclose the ______ _______.
Sales Charge
An agent advises a client to buy stock of a company that just fired its CEO. Is disclosure to the client required?
Yes, since this is a material fact, it must be disclosed before the customer buys the stock.
An IA directs transactions to a BD who rebates 15% of the commissions to the IA for the business. Is this acceptable?
Yes, provided the IA provides written disclosure (often in Form ADV) to clients.
May an adviser or BD lend money to a client?
Yes, if the adviser or BD is in the business of lending money.
If an agent has been given time and price discretion on a client order, is written power of attorney required?
No. If the client determines the action (buy/sell), amount, and asset, power of attorney is not required.
Does an IA need written consent before executing each agency cross trade with an advisory client?
No, the client must provide written consent initially, but not for every trade.
May a wife enter trades in a husband’s account?
Yes, with written third-party authorization.
What’s a no load fund?
A mutual fund with no front-end sales charge, no deferred sales charge, and no 12b-1 fee exceeding .25% per year.
An agent encourages a customer to buy a stock due to an upcoming dividend. Is this a legal practice?
No, this is a prohibited action known as selling dividends
Does this order require prior discretionary authorization? “Buy 500 shares of DMB sometime today.”
No, this is a not held order. The customer specified the action (buy), the amount (500 shares), and the asset (DMB).
Define painting the tape.
Traders effecting transactions back and forth to create a misleading appearance of activity
Traders effecting transactions back and forth to create a misleading appearance of activity
Both oral and written disclosure of the relationship
statute of limitations for violations of the civil provisions of the USA
three years from the date of sale (or rendering of investment advice) or two years after discovering the violation, whichever occurred first
criminal penalties
5-year statute of limitations
$5,000 maximum fine
imprisonment of no more than 3 years
not included in the fee disclosure documents
1) commissions
2) markups/markdowns
3) advisory fees
discretionary rule for broker-dealers/agents
written discretionary authorization from customer and account approval by a designated supervisor
discretionary rule for IAs
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
although the rules do not prohibit testimonials for broker-dealers, they are strictly forbidden for use by
IA’s
most common forms of market manipulation
matched orders and wash trade
not included in soft-dollar safe harbor
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
a person must update the Administrator of any change to the information in his registration (e.g., firm association, name, address, etc.) when?
promptly
a personal bankruptcy within how long must be disclosed when applying for registration?
within the past 10 years
the Admin may suspend or revoke a registration based on information that was originally submitted in an application for the
first 90 days of registration
consent to service of process
limited to civil actions (lawsuits) relating to state securities law, not criminal prosecutions or unrelated civil actions (e.g. slip & fall)
FINRA
regulates BDs and agents
SEC
regulates federal covered investment advisers
registration as an agent with more than one broker-dealer is permitted only if the broker-dealers are affiliated or under
direct or indirect common control
an amended Form ADV must be filed by an IA
within 90 days following their fiscal year-end
agency cross trade
an IA (or IAR) may represent both parties to a trade and receive commissions from both sides with prior written consent from both clients
IA’s must maintain a copy of records for ?
5 years
The Administrator may require which entities that have custody of or discretionary authority over clients’ securities or funds to post a surety bond ?
BDs, agents, and IAs BUT NOT IARs
criteria for the sale of a pre-organization certificate to be an exempt transaction
1) No commissions are paid
2) The number of subscribers is 10 or less, and
3) No payment is made by the subscriber
the Admin can issue subpoenas to compel testimony but CANNOT issue an
injunction (only a court can do so)
the Uniform Prudent Investor Act provides that trustees owe a fiduciary duty to who?
the trust’s beneficiaries
IAs may charge performance fees to who?
qualified clients only? (>$1 million on account or >$2 in net worth))
soft dollars (between BDs and IAs)
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
The Administrator’s Duties
- 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)
Information required on an Agent AND IAR applications
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
It is unlawful for any person to offer or sell any security unless…
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
he administrator must hold a hearing within ____ days if the party requests a hearing in writing
15 days
Definition of a “sale”
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.
Sale or offer of a security includes:
- rights or warrants to buy another security is considered to be an offer or sale of another security
- any solicitation of an offer to buy common stock for value
- 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)
Securities sold through a private placement are
UNREGISTERED and are an EXEMPT TRANSACTION
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.
I Only
to be considered a sale, there must be some consideration or exhcange of value
What is not included in the definition of a “Sale”
- 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.
Unsolicited customer orders in the secondary market by a broker-dealer are considered to be
exempt transactions
Under the USA, disciplinary proceedings generally require the administrator to provide :
1.appropriate prior notice
2. opportunity for a hearing
3. written findings of fact and conclusions of law
De minimus exemption applies
IA firms not B/Ds or agents
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:
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
SEC Reg A
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
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 __________.
securities, transactions
Under the Uniform Securities Act, __________ companies are not specifically excluded from the definition of an investment advisor.
insurance
Surety Bond
__________ 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.
The state administrator may require a surety bond for all of the following EXCEPT:
Agents
Broker-dealers
Investment Advisors
Issuers
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.
Under the USA, the state administrator may require notice filings be made for which of the following federal covered securities?
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.
When selling non-NASDAQ OTC stocks, broker-dealers must disclose their compensation to customers:
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.
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
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
Minimum surety bond coverage
$35,000
Net capital
Liquid capital (cash and assets readily converible into cash) maintained by a broker/dealer as required by law for consumer protection
offer to sell
- gift of assessable stock
-warrants - securities offered as a bonus for buying other securities or merchandise
-rights
offer to sell
- gift of assessable stock
-warrants - securities offered as a bonus for buying other securities or merchandise
-rights
A non-exempt security must be registered in _____ _____ _____ __ ____ __ ____.
Every state it will be sold
Investment adviser brochure deliver
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.
Required net worth for investment advisers who does NOT have custody of customer funds but HAS discretionary powers
$10,000
person who only provides advice on commodities
is not a registered investment adviser; commodities do not count as a security
gift of nonassessable stock is
just a gift. accessible stock gift would be an offer or a sale
bank holding companies
securities are NOT exempt
agents may share commissions as long as
commissions from the states in which both are licensed
blanket recommendation
not allowed; cannot recommend to all clients
are investment advisers exempt from registration when making recommednationts to accredit investors on exempt sercurities
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.
investment adviser advertising what is considered unethical
testimonials, exaggerations, guarantees
if majority partners leaves
must get client consent again
if minority partner in investment advisory partnership leaves
must notify clients as soon as reasonably possible
who can file registration statement
usually issuer but BD and selling stockholders can as well
mailing direct offers
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.
ADV Part 2
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.
