Series 24 - Chapter 2 Broker-Dealer Supervision

Question 1

General Supervisory Rules

WSPs

Who is responsible?
Where are they maintained?

What is required?

Answer 1

• FINRA requires members to establish, maintain and enforce written supervisory procedures (WSPs) over the activities of RRs / associated persons
• Responsiblity of General Principal in the designated OSJ to carry out procedures
• a copy of WSPs must be kept at each OSJ
• If the WSP manual is updated the old version must be retained for 3 years

Question 2

If a WSP manual is updated what is the retention requirement for the outdated version?

Answer 2

3 years

Question 3

Who is responsible for carrying out the WSPs?

Answer 3

General Principal in the OSJ

Question 4

OSJ

Answer 4

• Office of Supervisory Jurisdiction
• A office where any of the following take place:
  
  • order execution / market making
  • structuring new issue offerings
  • final approval of new accounts
  • review and approval of customer orders
  • review and approval of retail communications
  • responsiblity for supervising activities at one or more branch offices

Question 5

What are additional considerations when determining if a location is an OSJ?

Answer 5

Whether:
* the RR at the location engage in retail sales involving regular contact with customers
* a substantial number of RRs conduct securities activities at or are supervised from the location
* the location is geographically distant from other OSJs of the firm
* the members RR are geographically dispersed
* the securities activities of the location are diverse or complex

Question 6

What are the requirements of the OSJ?

Answer 6

• Series 24 Principal at each OSJ
• reviews and endorses all orders
• review of correspondence sent and received
• periodic account incspections at branches
• Review each applications registration via U4
• Obtain a copy of the U5 if registered with another firm and review within 60 days
• Perparing and delivering the Continuing Ed firm element
• Maintaining a file for customer complaints

Question 7

What is the exception for having an on-site series 24?

Answer 7

• An exception is grated if the member finds it necessary to assign an on-site registered pricipal to supevise two or more OSJs.
• The member must justify in its WSPs why it is using one principal to supervise multiple OSJs
• To do so, the member must consider:
  
  • whether the on-site principal is qualified (experience or training) to supervise the activities at both locations
  • whether the on-site principal is a producing RR (might not have time to supervise)
  • whether the on-site principal has the capicity / time to cover both locations
  • the OSJ locatios are sufficiently close in proximity to ensure the principal can be on-site regulalry
  • the nature of the activities at each location (size, scope of business, complexity of products, volume, disciplinary record)

Question 8

What should a BD consider when chosing to have one series 24 cover two or more OSJs?

5 items

Answer 8

• To do so, the member must consider:
  
  • whether the on-site principal is qualified (experience or training) to supervise the activities at both locations
  • whether the on-site principal is a producing RR (might not have time to supervise)
  • whether the on-site principal has the capicity / time to cover both locations
  • the OSJ locatios are sufficiently close in proximity to ensure the principal can be on-site regulalry
  • the nature of the activities at each location (size, scope of business, complexity of products, volume, disciplinary record)

Question 9

What is required of an OSJ as it relates to correspondence?

Answer 9

• review all incoming and outgoing correspondence of its RRs with the public relating to investment banking or secuirities business.
• Includes both written and electronic
• Includes the requirement to include procedures that identify and handle customer complaints
• Review and written apporval is required by a registered principal in advance for all outgoing correspondence of RRs (except in cases where the firm has a correspondence compliance program (procedures, training and auditing)

Question 10

What is required of an OSJ as it relates to orders?

Answer 10

• review and endorse, in writing, all transactions of RRs
• Must be performed by the Registered Principal.

Question 11

When is advance written approval of correspondence not required?

Answer 11

• If the member firm institutes a program that includes procedures to train representatives in the firm’s procedures governing correspondence, and audits these communications to ensure compliance

Question 12

What is prohibited when supervising?

Answer 12

• The member firm must have procedures to prohibit a supervisory from:
  
  • supervising their own activities
  • reporting to a person they are supervising
  • having their compensation or continued employemnet determined by the person they are supervising

Question 13

Physical Inspection of Branches

what is the requirement for non-supervisory branches?
what is the requi

Answer 13

• Non-supervisory Branches: every 3 years
  
  • if a branch does a large volume of business, large number of RRs or is complex it FINRA may require a more frequent inspection.
• Supervisory Branches: at least annually
• The inspection cycle must be set forth in the WSPs with justification.
• Completed inspections must be documented in writing and dated.
• No remote inspections of branches.

Question 14

What is included in the Branch Inspection Report

Answer 14

• At a minimum it must cover:
• safeguarding of customer funds and securities
• maintenance of books and records
• supervision of customer accounts serviced by branch managers
• transmittal of funds between RRs and cusomters, and customers and 3rd parties
• validation of customer account changes
• validation of changes in customer account information

Question 15

Who must prepare the branch inspection report?

Answer 15

• a non-resident series 24 principal
• it cannot be done by a resident branch manager or their direct supervisor
• exemptions may be granted for small firms with one office
• The person must be independent

Question 16

FINRA allows member firms to use risk-based supervision procedures to:

Answer 16

• detemrine the authenticity of customer transfer instructions
• comply with requirements that an Reg principal review all transactions relating to IB/ securities business
• Decide the extent to which additional policies and procedures are needed for the review of incoming and outgoing correspondence

Question 17

A member firm is not required to conduct a detailed review of each transaction if:

Answer 17

the member uses a reasonably desinged risk-based review system that provides the member wiht sufficient information to focus on the areas that pose the greatest numbers and risk of violation

Question 18

Heightened Supervsion

Answer 18

• Associated persons with a history of past misconduct mus receive heightened supervision
• a principal must be designated to implement an enforce a plan for heightened supervision
• The plan should include training with both the principal and associated person attesting in writing that the training occured

Question 19

What should a heightened supervision plan include?

6 items

Answer 19

• Additional training w/ written acknowledgement that the training occured.
• heightened supervision of the preson’s business activities
• proximity of the supervisor to the associated person and frequent contact with them
• frequent review of the persons communications with customers
• more frequent inspection of the associated person’s office
• expedited handling of any customer complains related to the person

Question 20

What is required for the Annual Review?

Answer 20

• annual inspection of each OSJ
• annual review of the businesses in which the firm engages, designed to detect and prevent violations
• interactive annual review with each RR and each reg principal of compliance matters relevant to their activities. (individually or collectively, in person or remote)
  • if a the session is pre-recorded it must be followed by live Q&A

Question 21

what is record of the compliance review is required?

Answer 21

• the firm must keep a record of the person conducting the annual compliance review (series 9/10 or 24)
• topics discussed - must be regulatory in nature
• names of RRs that participated

Question 22

What is required of the OSJ when hiring a new RR

Answer 22

• The OSJ (24) is responsible for reviewing the U4 and investigating and asertaining the applicants:
• good character
• business repute
• qualifications
• experience
• The series 24’s signature on the U4 serves as attestation that this occured.

Question 23

If a new RR was previously associated with another member firm, the series 24 must:

Answer 23

obtain a copy of that person’s U5 and review it within 60 days of filing for the U4 for that person

Question 24

Annual CE Firm Element

Answer 24

• the OSJ is responsible for preparing and delivering a CE progam annually to all RRs
  
  • excpetion are those individuals taht solely trade with other industry professionals
• the training plan must consider compliance issues, recent regulations and products, customer complaints and any other items deemed important.
• it must be documented in a written plan
• delivery to all participants must be documented
• should include some form of measurement of the participant’s understanding

Question 25

what is required of an OSJ as it relates to customer complaints?

Answer 25

• a seperate file of written customer complaints with actions taken by the member must be kept at each OSJ for 4 years
• this includes only complaints in writing
  *

Question 26

What is required regarding filing customer complaints

Answer 26

member firms must file statistical and summary information quarterly - on the 15th of the month following the calendar quarter in which the complaint was received

Question 27

Chief Compliance Officer

Answer 27

• member firms are required to designate a Chief Compliance Officer (must be a series 24 for BD)
• Responsible for establishing, maintaining, reviewing and testing the firm’s supervisory procedures to achieve compliance with applicable FIRNA rules, MSRB rules and fed secuirities laws and regs.
• Required to meet at least annually with the CEO

Question 28

What is required at the annual CCO / CEO meeting?

Answer 28

• discuss compliance matters, wiht the intention of ensuring the firm has policies and procedures in place to comply with all industry regs.
• this is documented in the annual compliance certification letter signed by the CEO

Question 29

What is included in the annual compliance certification letter

Answer 29

States that the member has processes in place to:
* establish, maintain and review policies and procedures designed to acheive complaince with all industry regs
* modify compliance policies and procedures as changes dictate
* test the effectiveness of its compliance Policies and procedures periodically
* the undersigned CEO has conducted one or more meeting with the CCO in the preceeding 12 months.
* The CEO has consulted with the CCO and other employees, outside consultants, lawyers etc as appropriate to attest to the statements in the certification

it must be signed by the CEO

Note: the memers processes are documented in a report and reviews by the CEO/CCO to make the certification

NOTE: FINRA is making the CEO personally liable for material failures

Question 30

When must the annual compliance certification letter be filed?

Answer 30

The final report must be filed wih the BOD the earlier of 45 days of execution or the next meeting.

Question 31

Business Continuity Plan

Answer 31

• Procedures to be followed if there is a business disruption
• FINRA requires each member firm to create BCPs in case there is an emergency or significant business disruption in order to ensure they can meet their customer obligations.
• The plan must include procedures covering existing relationships with other BDs

Question 32

Where are BCPs maintained?

Answer 32

• not required to be filed with FINRA
• must be made available to FINRA at request (promptly)
• a copy must be maintained at a secure, off-site facility
• FINRA has contracted with EVault for firms as the back-up repository for firms that dont have their own.

Question 33

BCP updates

Answer 33

• they must be updated if there are material changes in the firms operations, structure, business or location
• An annual review of the plan by a series 24 is required

Question 34

Mimimum Elements for BCP:

Answer 34

• The elements are flexible but must include:
• data back-up and recovery
• mission critical systems
• financial and operational assessments
• alternate communications between member and customers, and member and employees
• alternate physical locations of employees, critical business, bank and counter party impact
• regulatory reporting and communicaitons with regulators
• how the member will assure customers prompt access to their funds in the event they cease business
• series 24 approval
• series 24 annual review

NOTE: if a clearing firm is used the plan must still have procuedures to be followed and the clearing firms BCP may be used for this purpose

Question 35

BCP and customer disclosure

Answer 35

• The member must disclose in writing, at account opening how the member’s BCP addresses the possibility of significant business disruption and provide scenarios of severrity that detail how they will respond
• The disclosure must be provided on the firms website and mailed to clients on request
• No requirement to provide the detailed BCP

Question 36

Emergency Contact Persons

Answer 36

• Member firms must desingate two emergency contacts to FINRA
• both must be members of the firm’s senior managment
• One must be a principal
• If the firm is a sole proprietorship, the other person should be a firm employee
• If the firm has only one employee the second person should be a person familiar wiht the business (i.e. accountant, attorney, etc)
• Must be filed electronically through FINRA Contact System
• Updates should be made “promptly” - no later than 30 days
• Must be reviewed annually (within 17 business days after the end of each year)

Question 37

Requirement for Review and Updates to Emergency Contact information

Answer 37

• Updates must be made promptly, no later than 30 days after the change
• Must be reviewed annually by the firm’s executive representative or written designee within 17 business days after the end of each year

Question 38

customer account rules

Conduct of Customer Account Rules

8 items

Answer 38

• cannot guarantee against loss
• cannot share in gain / loss (excpetions)
• cannot borrow from / lend to customers (exceptions)
• cannot charge for investment advice, can charge for clerical services
• make BD financial statements available upon request
• provide FINRA manaul upon request
• cannot buy/sell unless the firm believes the customer will settle in time
• no installation sales

Question 39

What is an exemption from the rule against guaranting againts account loss?

Answer 39

• repurchase agreements where the underlying holdings are exempt
• if the repurchase agreement uses non-exempt securities (i.e. common stock) then it it prohited.

Question 40

What are the exceptions for an RR to share in gain/loss with a cilent?

Answer 40

• RRs may open a joint account wiht written approval of the employer
• Profit and loss must be shared in direct prportion to the capital invesment (with exceptions)

Question 41

What are exceptions to the “sharing in direct proportion to the capital investment” rule?

Answer 41

• Immidate family members
  -Includes parents, children, spouses, in-laws or other persons supported by the member
• ** “Hedge Fund Rule” **
  -Allows hedge fund managers to invest in their funds with clients
  -Accounts that meet the following requirements:
  a. the account is opened by a custome with a NW of at least $2.1MM with at least $1MM of customer funds
  b. prior written agreement, w/ compenstation arrangement approved by firm
  c. agreement covers gains and losses for at least 1 year
  d. pontential conflicts of interest are disclosed

Question 42

What are permitted exceptions for RR’s to lend to / borrow from clients?

Answer 42

1. Customers who are immediate family member
2. Customers who is a lending institution, lending to the associated person with typical terms
3. Customers who is another registered person at the same member (requires pre-approval)
4. the lending arrangement is based on a personal relationship with the customer (requires pre-approval)
5. the lending relationship is based on a business relationshipo outside of the BD (requires pre-approval)

Question 43

Which exceptions for an RR lending/ borrowing from a client require pre-approval?

Answer 43

1. the customer and RR are both registered at the same member
2. The lending arrangement is based on a personal relationship with the customer
3. the lending arrangement is based on a business relationship outside of the broker / customer relationship.

Question 44

Fees for Investment Advice

Answer 44

RRs cannot charge fees for investment advice.

Question 45

What may RRs charge for?

Answer 45

• fair and reasonable mark-up / commission under the 5% Policy
• clerical services (e.g. safekeeping of securities, collection of dividends, or portoflio appraisals)

Question 46

If a FINRA member charges for investment advice it must:

Answer 46

• register wiht the state (smaller IA) or register with SEC (larger IA)
• comply with all of the adviser rules in addition to FINRAs rules.

Question 47

What financial statement is a BD required to provide a client?

Answer 47

• the latest balance sheet and net capital computation
• (as perpared under the Sec Ex Act 1934)
• There is no requirement to provide an income statement
• made available upon customer request

Question 48

An order to buy or sell cannot be accepted unless:

Answer 48

• the firm has reasonable assurance that the customer will pay in 2 bus days (buys) or deliver within 2 days (sells)
• Installment sales are NOT permitted - reg T must be met

Question 49

Completion of a Purchase

Answer 49

• a security is purchased
• the customer pays in part (margin) or in full on the settlement date OR the BD makes accounting entrys on the customers account on settlement
• if payment, or entries are made before settlement, this does NOT complete the transcation

Question 50

Completion of a Sale

Answer 50

• A security is sold
• the customer delivers the security on the settlement date OR the BD makes the appropriate account entries on the customer accounts on the settlement date

NOTE: if the securities are made before the settlement date this does NOT copmplete the transactions

Question 51

Order tickets for the sale of securities being marked long and short:
Which orders should be marked and when should they be marked long?

Answer 51

• all order tickets for sales should be marked long or short EXCEPT for corporate debt securities.
• an order ticket can be marked “long” if the customer holds the security in their account or if the customer agrees to deliver the security by settlement.

Question 52

What trades must be approved by a general principal

Answer 52

• All orders effected by an RR must be reviewed and approved in writing by a general principal
• must be kept for 3 years

Question 53

Requirements Regarding Review of Correspondence

Answer 53

• Piror written principal approval is required for coorespondence (each piece / written and electronic) between an RR and customer related to invest banking and securities business
• Piror written approval **is not required IF **the firm has a communications compliance program in place and teh firm audits communications
  *

Question 54

Limits to gifts

Answer 54

• $100 per person per year
• gift limits do not apply to
  • business entertainment (cant be too extravegant or frequent)
  • gifts based on a personal relationships
  • logo gifts

e.g. an RR can take a client to a dinner costing $300 but cannot gift a $300 gift card to a clients favorite restaurant

Question 55

Requirements Regarding Entertainment

Answer 55

• The memer firm must have written policies and procedures regarding business entertainment
• This includes P&Ps, training and auditing of expenses

Question 56

Record of Gifts

Answer 56

• FINRA requires firms to keep track of all gifts and gratuities given and received related to business.
• Procedures must in place to ensure the $100 limit isnt breached within the year
• records must be retained for 3 years

Question 57

Paying for Work

Answer 57

• The $100 does not apply to paying for work
• Work can be paid for as long as:
  
  • there is a written agreement detailing the work and compenstation
  • their is prior review and approval in writing of the agreement by the principal
• Records of the agreement and payment must be kept for 3 years

Question 58

Outside Business Activities

Answer 58

• RRs must provide prompt wirtten notice to the member firm of any outside business activities and must follow the firms instructions
• The firm must assess the impact of the work on the RR’s abiltiy to do their job and on the firm
• The employer can prohibit an OBA
• OBA may be a non-compensated position of influence (i.e. unpaid board position)
• is reported on the U4 and shown on brokercheck

Question 59

Selling Away

Answer 59

• when an RR handles a securites transaction for a customer through another firm
• it is prohibited by FINRA
• All trades executed by an RR for a customer must be executed through or be known to the member firm they are with
• There can be an exception if the firm is given prior written notice of the transaction and compensation and approves of the transaction in writing (the firm must supervise the transaction)

Question 60

Exception to the Prohibition on Private Securities Trades

Answer 60

• execeptions can be granted
• the firm must recieve written note of the transaction and compensation in advance
• the firm must approve in writing
• the firm must supervise the transaction

Question 61

Information Received in a Fiduciary Capacity

Answer 61

• info received from a customer by an RR in a fiduciary capacity cannot be used to solicit purdchases or sales except with express consent from that customer
• info received by a member firm from an issuer in a fiduciary capacity cannot be used to solicit purchases or sales

Question 62

Control Relationships

Answer 62

• the firm must disclose if its in a conttrol relationship with the issuer of a security prior to its being purchased or sold (at the time the order is taken)
• must be made in writing and prior the completion of the transaction (no later than settlement)
• typicall firms give verbal disclosure at recommendation and written on the trade confirmation
• e.g. ML RR makes a recommendation to purchase BOA -there is a control relationship because BOA owns ML - it must be disclosed.

Question 63

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Disclosure of Fiduciary Relationships

Answer 63

• if a member firm acts as an underwriter they must disclose this to customers purchaing the issue

Question 64

FINRA rule 2030

Answer 64

• anti-bribery rule discouraging BDs/ covered members / covered associates from participating in pay-to-play practices by acting as intermediaries between state and local governments and investment advisers.
• associated employees include GP, Managing memer or Exec Officer of the BD

Question 65

Maximum Political Contribution

Answer 65

• Max political contribution is:
  
  • $350 per candidate per election in which the associate is entitled to vote
  • $150 per candidate, per election in which the associate is not entitled to vote
• There is a 2 year ban on contributions if a contribution exceeds $350
• The primary and general elections are considered separate elections
• Contributions can include gifts, subscriptions, loans, advances, or deposit of money or anything of value for the purposes of influcing an election for fed, state or local office. It also includes payment of election debts or inaugural expenses of a successful candidate.

Question 66

What is considered to be a political contribution?

Answer 66

Contributions can include gifts, subscriptions, loans, advances, or deposit of money or anything of value for the purposes of influcing an election for fed, state or local office. It also includes payment of election debts or inaugural expenses of a successful candidate.

Question 67

How are disputes handled ?

between RR and firm?
between clients and firms?

Answer 67

• FINRA requires that any disputes between RRs and their fims be handled by binding arbitration which can’t be appealed
• Exceptions: employment discrimination, sexual harrassment
• Customer disputes can be handled by arbitration with client consent at account opening (through Predispute arbitration Agreement)

Question 68

Proxy Materials Requirements

Answer 68

• FINRA requires that firms forward proxy materials to the beneficial owner of stocks that they hold in “street name” for margin customers.
• no charge to customers
• reimbursement is made by the issuer under a schedule prescribed FINRA
• the issue is required to:
  • furnish sufficient copies
  • assue the member firm it will be reimbursed for mailing costs

Question 69

FINRAs rule on redistribution of proxies and other corp communications states:

Answer 69

• if a stock is held by a fiduciary, the fiduciary can vote those shares
• If the fiduciary in an ERISA plan is the plan trustee, if the memer frimed has been named the plan fiduciary as the investment manager of the stock held as assets in the plan, then the investment manager votes the proxies - as long as the plan gives the manager discretion to manage, acquire or dspose of any plan assets.

Question 70

FINRA Prohibited Acts

18 items

Answer 70

1. making recommedations of highly speculative stocks
2. Account churning
3. Trading in Mutual fund shares
4. recommendations beyond a customer’s financial capacity
5. fraudulant activity with customer funds
6. payments to influence anyone in a position to influence the market price of a security
7. participants in an underwriting group to represent the POP as the prevailing market price, unless there is an independent market
8. payment to influence market prices wher they are participating in the underwriting
9. manipulative or deceptive practices with clients
10. imporoper use of customer funds and securities
11. giving concessions or discounts to the public
12. placement of orders for Mutual fund shares unless they have a customer order or they are buying for the its own account (avoid being a market maker)
13. accpeting a gift of more than $100 from an inv company or related persons.
14. Selling mutual funds just bleow the breakpoint levels
15. selling dividends (selling just before the ex-date )
16. trading mutual fund shares
17. accepting conintuing commissions, suc as annual concessions paid out of 12b-1 fees after leaving the firm (unless there is a prior written agreement)
18. sending any written communication to perspective mutual fund customers wihtout a copy of the latest fund prospectus. (exempt letters limited to the statement of the fund’s objective and its management structure)

Question 71

Speculative stocks

Answer 71

FINRA prohibits making a blanket recommendation of low priced speculative stock

Question 72

Trading in Mutual Fund Shares

Answer 72

• FINRA prohibits trading in mutual fund shares
• placement of orders for mutual fund shares are prohibited unless the firm has an existing customer order or is buying for their own account (long term investment)
• This prohibits firms from placing shares in inventory and acting as a market maker
• only the fund can act as a market maker
• Selling Mutual funds below the breakpoint is prohibted

Question 73

Breakpoint Sale

Answer 73

• prohibited by FINRA
• selling mutual fund shares just below the breakpoint

Question 74

Selling Dividends

Answer 74

• Prohibited by FINRA
• when a customer is induced to purchase a stock just before the ex-dividend date

Question 75

What is prohibited by FINRA when dealing with clients?

Answer 75

• misappropriating customer funds or trading without authorization
• manipulative or deceptive practices
• Improper use of customer funds and securities.
  
  • lending margin securities without a singed loan consent agreement
  • rehypothecation of unreasonable amounts of customer securities (in excess of 140$ of customer debit balance)

Question 76

Influencing Market Price

Answer 76

FINRA prohibits:
* payments of any designed to influence those that are in a position to influence the market price of a seucirty (i.e. newpaper, investmnent service)
* payments of any kind to influence market price wher the member is participating in the underwriting

Question 77

Concessions or Discounts

Answer 77

• FINRA prohibits giving concessions or discounts to the public
  -*does not apply to exempted securities
• Discounts and concessions can only be given to other memer firms

e.g. a member can sell a stock at the “inside” price to another member.

• member firms can compensate foreign BDs for doing trades outside the US
• member firms may compenstate exchange members for performing trades on teh exchange floor

Question 78

Anti-reciprical rule

Answer 78

• FINRA prohibits accepting a gift of more than $100 in value from an investment company or related person.
• it prohibits investment companies from giving you “extra” compensation about and beyond the sales charge for selling their shares.

Question 79

Payments of Commissions to retired RRs

Answer 79

• Payments of compensation, concessions or fees to RRs either firms or individuals.
• there is an Exception for RRRs (retiring RRs) and to non registered foreign finders
• in order to do this there needs to be a prior written agreement specifiying the compensation to be paid and the retired reprsentative must agree to do no new business or service accounts.

Question 80

Payments and commisions to foreign finders

Answer 80

• The finder must be a foreing national and not subject to US law requiring registration
• the customer must be a foreign national
• the customer must receive a disclosure document that a finder’s fee is being paid and must sign a written acknowledgement of the existence of the compensation arrangement
• the trade confirm must disclose the finders fee was paid
• records of the agreements between the firm and finder, the amounts paid must be retained

Question 81

Three major categories of communications

Answer 81

1. correspondence
2. retail communication
3. institutional communication

Question 82

Correspodence

Answer 82

• Any written or electronic communication that is distributed or made avilale to 25 or fewer retail investors within any 30 day calendar period.
• This includes both existing and propsective customers
• *Does not require prior principal approval prior to distribution

Question 83

Retail Communication

Answer 83

• Any written or electronic communication distributed to or made available to more than 25 retail investors in any 30 calendar day period
• a retail investor is anyone who not a instiutional investor (anyone with less than $50MM)
• *Does require prior principal approval prior to distribution

Question 84

Insitutional Communication

Answer 84

• Any written or electronic communication distributed/made available to institutional investors.
• Instituional investors includes banks, savings and loads, reigstered investment companies, registered invetment advisors, gov entitites, FIRNA members and any persons with $50MM or more.
  *Does not require prior principal approval prior to distribution

Question 85

Type of communications:

4 types

Answer 85

• Advertising
• Sales Literature
• Independently Prepared Reprint
• Public Appearance / Public Forum

Question 86

Advertising

Answer 86

• material intende for mass market
• Includes: newspapers, magazines, non-password protected internet websites, internet bulletin boards, TV, billboards, sings, tape recordings and motion pictures

Question 87

Sales Literature

Answer 87

• any written or electronic communication directed to a specific audience
• includes: circulars, market letters, research reports, seminar texts, password protected websites, and form letters to more than 25 investors.
• note: form letters to 25 or less investors is correspondence
• Does not include independently prepared reprints

Question 88

Independently Prepared Reprints

Answer 88

• A reprint or excerpt of an article issued by a publisher, where the publisher is not affiliated with the FINRA member and the report was not commissioned by the FINRA member
• if the report is distributed to more than 25 investors it is a retiail communication, if its distributed to less then its a correspondence

Question 89

Public Appearance / Public Forum

Answer 89

• Participation in a seminar, forum, radio or television interview, or other appearance or speaking activity
• unscripted, spontaneous talks
• subject to post use review and approval (simliar to correspondence)
• publich appearances do not require prior principal approval, the firm must maintain poilcies and procedures to supervise them for compliance with applciable standards

Question 90

Approval of Communications:
Correspondence

Answer 90

• No prior principal approval as long as the Firm has a correspondence compliance program
• If the program is in place FINRA requires “post use review and approva” by a principal
• If there is not compliance program then each item would require principal approval prior to distribution

Question 91

Approval of Communications:
Interactive Content on Websites

Answer 91

• treated similar to a website, blog and “correspondence”
• no advnace approval required by a principal
• the firm must have P&Ps to review and approve interactive content
• not required to FINRA file
• NOTE: static content on a website is treated like advertising and requires preapporval by a principal and filing with FINRA

Question 92

Approval of Communications:
Static Content on Websites

Answer 92

• Requires prior principal approval and filing
• treated like advertising
• NOTE: interactive content on a wesbsite does not require pre-approval or filing

Question 93

Approval of Retail Communications

Answer 93

• Requires prior principal approval

Question 94

Approval for Non-promotional retail communications

Answer 94

• Do not require pre-approval or FINRA filing
• treated like correspondence
• Includes:
  
  • market letters that do not make financial or investment recommendations
  • postings on onilne interactive forum (e.g. chat room)
  • communications that do not make any financial or investment recommendations or otherwise promte

Question 95

Approval of Broadly Disseminated Free-Writing Prospectus FWP

Answer 95

• Requires prior principal approval
• include items like emails, faxes, term sheets, internet sites, and recorded electronic road shows
• Broadly dissemenated: posted on an unrestricted website or released to the news media

Question 96

SEC Rule 405

Answer 96

*Automatic Shelf Registration
* Permits Well Known Seasoned Issuers (WKSIs) to automatically reister issues withiout SEC review and to use “free-writing prospectuses” (FWPs) without SEC review of the content (still needs to be filed with the SEC)
*

Question 97

Free Writing Prospectuses

Answer 97

Include:
* e-mails, faxes, term sheets, internet sites, and recorded electronic road shows

Question 98

Approval of Institutional Communications

Answer 98

• No prior principal approval if the firm has supervisory procedures
• post-review and approval by principal with procuedures in place

Question 99

Approval of Institutional Communications distributed to retail investors

Answer 99

*If an institutional communication will be redistributed to retail investors, then they become retail communications

• If an institutional communication is redistributed to retail investors and a firm finds out they must cease distrubtion until the BD has adopted the appropriate procedures to prevent redistribution.

Question 100

Required records for communications

Answer 100

• Firm must keep:
  
  • a record of the communication
  • the date of first and last use
  • the name of the principal that approved the communication
• Records must be retained for 3 years.

Question 101

Filing Communications with FINRA

Answer 101

• Only required for retail communications
• General Rules:
  
  • First year of business:
    file 10 days in advance of first use
  • After 10 years in buiness:
    No filing but retail communications are subject to spot check

       Note there are some specific retail communications that must e fileed in advance

Not required for insitutional communications or correspondence

Question 102

Retail Communications that Must be filed with FINRA 10 Days Prior to first use

Answer 102

1. Securites Futures (options) communications
- if it contains the names of spec. securities it must include the latest ODD (options disclosure doc)

2. Fund Retail Communcations with Member-Prepared performance ratings
does not apply if it includes independently prepared performance rankings

Must be filed with FINRA 10 days before first use and can’t be used utnil FIRNA approves

Question 103

Retail Communications that Must be filed with FINRA 10 After first use

Answer 103

1. CMO communications
*collatoralized mortagage obligation comms

2. Registered Structured Product Communications
*does not apply to privately placed structured products

3. Registered DPP Retail communications
*Registered Direct Participation Progams (DPP)

*Does not apply to privately placed DPPs

4. Mutual Fund Retail Communications
*dont include member-prepared performance ranking

*an Omitting Prospectus must be filed (SEC Rule 482)

5. Broadly Disseminated Free-Writing Propsectuses

*filed under Rule 405 (automatic shelf registration)

*Also if a draft storyboard for TV/Video was filed hthen the final version must be filed within 10 days after first use.

Question 104

Filing Is Not Required For

Answer 104

• Comms previously filed
• Comms that do not make a financial or investment recommendation
• Non-promotional change announcements (i.e. office addres change, employee promotion)
• Comms that only identify a member’s exchange symbol or identify a security for which the member is a market maker
• Recruitment ads
• Propsectuses, preliminary prospectuses, oferring circulars that are filed with the SEC
• Tombstone ads that comply with SEC rule 134
• Independently prepared reprints, press releases, institutional sales material, correspondence, and communications posted on an online interactive forum

Question 105

FINRA Communication Standards

Answer 105

• Must be fair and balanced
• Cannot be misleading
• Must provide a sound basis for evaluting the facts in regard to a seucirty, industry or service
• False or exaggerated claims are prohibted
• Placement of information in a legend or footnoe to inhibit an investor’s understanding is prohibited
• Predictions / projections are prohibited
• Member firm name must be included
• SIPC logo must be included on all adverisements larger than 10 square inches (not required for sales literature)
• FINRA name if used, can only state that the firm is a FINRA member, FINRA name must be smaller than firm name and must include link to FINRA site
  *

Question 106

Investment Analysis Tools

Answer 106

Firms may offer an investment analysis tool (e.g. a retirement planning calculator) so long as:

• provide FINRA with the templates for written reports
• describes the methodology and criteria used, included limitations and key assumptions
• explains that results may vary with each use and over time
• include the disclaimer that “ projections generated by the tool are hypothetical, do not reflect actual investment results and do not project investment results”

Question 107

Testimonials

Answer 107

• are permitted
• the person making the testimonial must of the knowledge and experience to form a valid opinion
• Disclosure must be included:
  
  • maker’s experience make not be indiciative of other clients
  • testimonial is not indicative of future performance or success
  • maker was paid for the testimonial (if more than $100 was paid)

Question 108

CMO Disclosures

Answer 108

• Must include within the name of the prodcut the term “Collatoralized Mortgage Obligation”
• May not compare CMO to any other investment vehicle, including bank CD
• must disclose that a gov agency backing applied only to the face value of the CMO and not to any premium paid (where applicable)
• must disclose that a CMO’s yield and avg life will fluctuate depending on the actual rate at which mortgage holders prepay the underlying mortgages and changes in current interest rates

Question 109

Mutual Fund Ads Showing Ranking-Entity Ratings

Answer 109

FINRA rule 2212 covers the use of investment company rankings in retail comms and permits the use as long as:
* the infomration was created and published by a “ranking entity - indpendent ratings firm
* prominent disclosure is made of the name of the category
* the number of investment companies in the category, the length of the time period used for the tranking and criteria on which he ranking is based
* the fact that past perfomance is no guarantee of future resutls is disclosed
* the publisher of the ranking is disclosed
* the ranking is current as of the most recent calendar quarter
* the ranking covers a period of at least 1 year
* rankings based on total return must include a comparison of 1, 5 10 year Total Returns (or life of the fund, if shorter)

Question 110

Requirements for Firm Name in retail communications

Answer 110

• Must cearly include firm name
• also required for telephone listings, usiness cards and stationary letterhead
• not required for “blind recruitment advertisements”

Question 111

SIPC logo and retail communications

Answer 111

• firms are required to place the SIPC logo on all advertisements larger than 10 square inches
• NOT required for sales literature

Question 112

Requirements for use of FINRA name in retail communications

Answer 112

• Firms may only state that they are a FINRA member
• Indviduals are not associated with FINRA ONLY the firm can be.
• The FINRA name must be small than the firm’s name
• if included on a website it must include a hyperlink to the FINRA site
• Use of the FINRA name is not required but requirements must be met if the firm choses to do so.

Question 113

Marketing Materials to Establish Expertise

Answer 113

• FINRA requires that marketing materials disclouse that it was prepared by an outside party to give to clients
• must be supervised (principal must review and approve)
• the publication must disclose that it was prepared by a thrid party for the RRs use
• the publication must prominently display the member firm’s name

Question 114

Ca

Market Letter Standards

Answer 114

• from BD to clients
• provides market commentary, may include listing of recommendations
• excluded from the definition of a “research report as long as the recommendaitons include key disclosure.
• Research reports require different disclosures
• if the market letter makes recommendations of investment cmpany or variable products they are not required to make these disclosures.

Question 115

Required Market Letter Disclosures

Answer 115

Disclosures:
* whether the firm makes a market in the recommended security or if the member/ associated person will buy or sell the security on a principal basis.
* if the member or any associated person who is involved in the preparation of the report content has a financial interest in the securities of the issuer
* if the member was a manager or co-manager of a public offering of any securities of an issuer whose securities were recommended in the past 12 months

Note:
*not required for mkt letters that make recommendations of invest. companies or variable products

*disclosures for research reports are more detailed.

Question 116

Research Report Standards

Answer 116

• Communication that makes a specific security recommendation
• The following is required:
  
  • the recommendation must have a basis in fact which can be substantiated as reasonable
  • the market price of the stock a the time must be included
  • supporting documentation to the recommendation must be furnished upon written request

Question 117

If past performance is shown in a communication then the following is required:

5 items

Answer 117

1. at least a 12 month period must be used
2. an indication of general market trends during that time must be given
3. if past performance of comparable recommendations is shown, then all of such recommendations (both good and bad) made within the prior 12 months must be shown
4. all transaction costs must be included
5. a statement that past performance does not indicate future results must be made

Question 118

Price Targets in Research Reports

4 items

Answer 118

• Can be included (not considered a projection of performance)
• Any statement of advancates must mention relevant risks
• Reports must be dated
• if information older than 6 months is used it must be noted

Question 119

Rule 134A / Rule 135A

Answer 119

• Rule 134 A: Amended Tombstone Rule
• Rule 135 B: Generic Advertising Rule
• specifies limited conditions under which an announcement regarding Mutual Fund and options securites is not considered an “offer” and therefore no prospectus is required with these announcement:

Question 120

Under Rule134A and Rule 135A
Mutual fund advertising is limited to:

Answer 120

*Mutual fund advertising is limited to:
- explanatory information about investment companies
- an explanation of the types of investment companies
- offers, descriptions, or explanations of products and services without mentioning the desirability of these investments
- an invitation to inquire for more informaiton and a copy of the prospectus, inc. the name and address of the sponsoring BD

Question 121

Under Rule134A and Rule 135A
Options advertising is limited to:

Answer 121

Options advertising is limited to:
* General description of the security being offered
* Description of the nature and functions of options markets
* Description of the Options Clearing Corporation
* Invitation to inquire for more info and obtain a copy of the options disclosures document, inc. the name and address of the sponsoring BD

Question 122

taping rule

FINRA Taping Rule

Answer 122

• If a firm’s sales force has “too many” individuals who previously worked at an expelled member firm, the firm is required to tape phone conversations with current and potential clients
• def of too many ranges form 20% to 40%
• FINRA determines which firms are subject to the rule and notifies the firm they have 60 days to comply and must write special written procedures to supervise telemarketing activity for 3 years
  *records must be retained for 3 years
  *reports must be filed quarter by the 30th of the month following quarter end

Question 123

taping rule

The FINRA Taping Rule does not apply if:

Answer 123

• for firms with 20 or more reps:
  less than 20% were associated with a disciplined firm in the past 3 years
• for firms with 10-19 reps:
  less than 4 of the reps were associated with a disciplined frim in the past 3 years
• for firms with 1-9 reps:
  less than 40% of the reps were associated with a disciplined frim in the past 3 years

Question 124

taping rule

How can a firm avoid taping if notified by FINRA

Answer 124

adjust staffing to fall below the thresholds within 30 days of first notice

Question 125

FINRA Manual Requirements

Answer 125

• FINRA requires a copy of the FINRA manual be kept in each branch office OR have internet access to the FINRA website where a copy can fe foudn
• Must be made availalbe upon customer request

Question 126

Customer Complaints

Answer 126

• Customer complaints are made to the FINRA Dept of Enforcement (DOE)
• DOE investigates, valid complaints are then sent to FINRA Office of Hearing Officers (OHO)
• The FINRA Code of Procedure dictates how the camplaint is handled.

Question 127

What sources does the does the FINRA DOE receive complaints?

Answer 127

• Customers
• FINRAs surveillance activities
• other regulators
• other member firms
• tips
• examination findings

Question 128

To investigate a complaint, FINRA has the right to:

Answer 128

• require the member to report orally or in writing on the matter
• investigate the books and records of the market
• If the firm refuses they are subject to FINRA penalties

Question 129

How should responses to information requests from FINRA be provided?

Answer 129

• Electronic reponses must be enrypted and sent separately from the Access Key

Question 130

What types of penalites could FINRA impose?

Answer 130

• Censure
• Fines
• Suspention
• Expultion
• any other fitting sanction

Question 131

What is the consequence if an individual is supsended or expelled?

Answer 131

• the person cannot remain asosciated with that firm in any capacity
• they cannot be paid a salary, commission or other renumberations resulting from any securities transacation occuring during the suspension or expulsion period
  *note: renumeration earned before the period can be paid

Question 132

Suspension from specific activities

Answer 132

• FINRA can modify a suspension to apply to specfici activies
• i.e. a principal is suspended for “failure to supervise” and remains employed as a reg rep or in a clerical role.

Question 133

FINRA notification to members and news media

Answer 133

If FINRA suspends or expels a member or person, bars a person from association or imposes a fine over $10K it will notify:

• the FINRA membership through a “notice to members” mailing
• the news media through a news release

Question 134

code of procedure

FINRA Code of Procedure

Answer 134

• Used by FINRA to pursue disciplinary action
• Internal FINRA court hearing process, with higher levels of appeal.

Process:
- An investigation is open
- DOE serves a formal complaint. Filed with the FINRA OHO
- The OHO appoints a Chief Hearing Officer
- FINRA (may) issue a cease and desist order if it believes the member firm is engaging in illegal or prohibited activities
- Complaint must be answered within 25 calendar days. answer to OHO with copy to DOE.
If they fail to repsond after 25 calendar days, second notice with 14 day response time
- CHO reviews the reponse and decides whether to go to the Hearing Panel. The resondant can request that it go to the hearing panel.
- A pre-hearing conference is held within 21 days of the respondents answer
- Two person hearing panel w/ decision within 60 days

Question 135

code of procedure

What happens if no answer is received from a respondent in when a complaint is filed.

Answer 135

It is treated as a default and the CHO (Chief Hearing Officer) issues a default decision that the firm or ind. committed the alleged violation and imposes sanctions

Question 136

code of procedure

Pre-hearing Conference

Answer 136

• A pre-hearing conference is held within 21 days of the Respondent’s answer
• Conducted prior to the Hearing Panel
• Objective to clarify issues, exchange wintess and exhibit lists, set criteria for evidence and other legal matters

Question 137

code of procedure

Hearing Panel

Answer 137

• Held in an agreed upon location
• Three person panel: Cheif Hearing Officer (FINRA employee) and two other industry panelist.
• Respondent has the opportunity to present evidenc and testimony.
• A written decision is rendered based on majortiy vote of the 3 person panel within 60 days of the hearing
• Decision is not final until 25 days after the decision (due to appeal window)
• Once a decision is final FINRA determines the appropriate penalty (can include censure, suspension, expulsion, or fines)

Question 138

code of procedure

Appeals Process

Answer 138

• Either party can appeal the Hearing Panel decision
• The first appeal goes to the FINRA National Adjudicatory Councel (NAC)
• Appeal must be filed within 25 days of decision
• NAC can appeal within 45 days and overturn the decision
• 2nd appeal - SEC
• 3rd appeal - federal appeals court

Question 139

code of procedure

Settlement Offer

Answer 139

• at any time during the hearing process the respondent can offer to settle the complaint
• every settlement offer must:
  
  • be in writing
  • state the action or practice that caused the violation
  • state the proposed sanction
  • waive all rights of appeal
• FINRA DOE decides if it will accept the settlement offer

Question 140

code of procedure

Minor Complaints

Answer 140

• if the DOE determines a complaint to be minor it may request a respondend sign a Minor Rule Violation Plan (MRVP) letter accepting a finding of violation.
• The respondent admits guidt to a minor offence and is subject to a max fine of $2500

Question 141

code of procedure

Summary Suspension

Answer 141

*FINRA can choose to suspend (wihtout a hearing process) a member that is:
- suspended or expelled form another SRO OR
- experiencing financial or operating difficulties

• the firm may request in writing a hearing within 7 calendar days of notification if this action is taken. The hearing must be held within 7 days of the request.

Question 142

FINRA Code of Arbitration

FINRA Code of Arbitration

Answer 142

• Used to settle disputes form member firm to member firm.
• Decisions are non-appealable
• less costly and quicker than litigation

Question 143

FINRA Code of Arbitration

The Code of Arbitration is use to settle disputes between:

Answer 143

1. member firm vs another member firm
2. member firm vs clearing corp (or vise-versa)
3. member firm vs associated person (or vise-versa)
4. associated person vs associated person
5. member firm versus cutomer (or vise-versa) where the customer has previously signed an arbitration agreement.

Question 144

FINRA Code of Arbitration

Disputes between two associated persons

Answer 144

• Must be settled by arbitration
• rare
• typically when two assoc. persons share a book of business and there is a dispute over income

Question 145

Code of Arbitration

Code of Arbitration Vs. Code of Procedure

Answer 145

Code of Arbitration: Disputes between members / members and clients

Code of Procedure: used by FINRA to intiate action against a member

Question 146

Code of Arbitration

National Arbitration Committee

Answer 146

• Oversees the appointment of arbitration panels for diputes in each district.
• Member firms that have disputes with other member firms AND customers who have signed a predispute arbitration agreement cannot circumvent arbitration

Question 147

Code of Arbitration

If a customer has not signed a a predispute arbitration agreement

Answer 147

They may choose to go through aribitration, file a complaint under the Code of Procedure, or simply sue the firm.

Question 148

Code of Arbitration

Selection of Arbitrators

Answer 148

• Arbitration panels are composed of individiual from inside and outside the industry
• Anyone who has relevant experiences can act as an arbitrator
• Arbitrators can be either:
  • non-public arbitrators
  • public arbitrators

Question 149

Code of Arbitration

Non-public Arbitrators

Answer 149

Any person who:
* within the past 5 years was associted with a securities BD or with a commodities firm

• is retired from engaging in any of the business activies for BD / commodities firm
• is an attorney, accountant, or other professional who has devoted 20% or more of his/her professional work in the last 2 years to clients that are BD/commodities firm
• employee of a bank or other financial institution and effects transactions in securities or monitors compliance of employees engaged in these activities

Question 150

Code of Arbitration

Public Arbitrators

Answer 150

• Any person not engaged in the acivities listed for non-public arbitrators
• Any individual who met the definition of a non-public arbitrator but has been out of the business for at least 5 years
• Anyone who has been associated wtih the industry for at least 20 years, and who has ended his or her association with the industry regardless of how long they have been out of the business

Question 151

Code of Arbitration

Arbitration Panel Composition

Answer 151

• Three individiuals, where the claim amount is $100K or more

Panel Compesition is depended on who the dispute is between:

• member / member: three non-public arbitrators
• associated person - one non-public / two public
• customer: one non-public and two public or customer can elect 3 public

Question 152

Code of Arbitration

Panel Composition
Member-Member Dispute

Answer 152

• three non-public arbitrators
• becuase the dispute is intra-industry

Question 153

Code of Arbitration

Panel Composition
Associated Person Dispute

Answer 153

• One non-public and two public

Question 154

Code of Arbitration

Panel Composition
Customer Dispute

Answer 154

• one non-public and two-public
• Customer can elect 3 public via the “optional all public panel rule”

Question 155

Code of Arbitration

Panel Compesition
Claims less than $100K

Answer 155

*Member/Member: 1 non-public arbitrator
* Associated or Customer Disputes: 1 public arbitrator

Question 156

Code of Arbitration

Simplified Arbitration Process

Answer 156

• Disputes not exceeding $50K
• claim filed with Director of Arbitration
• a copy is sent to the firm that is the object of the claims
• The resondent has 45 days to respond and can specify counterclaims
• Counterclaims must be answered within another 10 calendar days
• Decisions are rendered within 30 days from the date the record is closed

Question 157

Statute of Limitations

Answer 157

• 6 years from the event

Question 158

Code of Arbitration

When are awards from a dispute paid

Answer 158

• Paid within 30 days of the decision date
• if the firm fails to pay FINRA will give 15 days notice to the firm, after which they may suspend or revoke the firm’s registration

Question 159

Code of Mediation

FINRA Code of Mediation

Answer 159

• alternative to arbitration
• voluntary (neither party compelled to use mediation)
• both parties must agree to mediate the dispute
• It cannot be used to settle actions taken by FINRA DOE under the Code of Procedure
• generally less costly and faster than arbitration
  *either party can withdraw before a settlement is reached without consent of the other party
• private and confidential

Question 160

Code of Mediation

Mediator

Answer 160

• the mediator can from a FINRA supplied list or be an outside person acceptable to both parties
• acts as a neutral and impartial party
• has no decision making authority and cannot compel a settlement
  *

Question 161

Technical Insider
Definition Under ‘34 Act

Answer 161

• officer
• director
• 10% shareholder of the issuer’s equity securities

Question 162

SEC Rule 10b-5

Answer 162

• catch-all fraud rule
• used by the SEC to bring action against individuals who might not fit the technical insider definition but participates in insider training

Question 163

Insider Trading and Fraud Enforcement Act of 1988

Court’s Definition of an Insider

Answer 163

• Any person who haseived material non-public information that could be expected to influence the price of a company’s stock.
  *

Question 164

Insider Trading and Fraud Enforcement Act of 1988

When is insider information considered public

Answer 164

• Infomraitno is considered to be public once it has been released by the news media

Question 165

Insider Trading and Fraud Enforcement Act of 1988 Requires BDs to:

Answer 165

• have procedures to prevent misuse of material non-public information
• BDs must establish, maintain, and enforce written P&Ps designed to prevent misuse of material, non-public information by any associated person.

Question 166

What are the information barriers that shoudl be in place to prevent misuse of non public information

Answer 166

• Between Research and Inv Banking, retail sales, trading
• Between Investment banking and Research, retail sales, and trading

Question 167

Insider Trading and Fraud Enforcement Act of 1988

If an insider violates insider trading rules:

Answer 167

• civil penalites: up to 3 X the profit realized or loss avided (treble damages)
• criminal penalties: fine up to $5MM and up to 20 years in prison for each violation

Question 168

Insider Trading and Fraud Enforcement Act of 1988

If a controlling person is aware of an insider trading violotion?

Answer 168

• must prove that the person knew or recklessly disregarded the violation
• liability up to $25MM

Question 169

Insider Trading and Fraud Enforcement Act of 1988

Informer Bounty

Answer 169

Informants can be paid anywhere from 10% - 30% of the amounts recovered under civil penalties.

Question 170

Insider Trading and Fraud Enforcement Act of 1988

Who can sue the Insider that violates insider trading rules?

Answer 170

• any person who traded in the security during the time period of the insider trading
• private parties have the right to institue action against a person violating insider trading rules.
• statute of limitations is 6 years (as opposed to 5 years on other provisions of the Act of 34)

Question 171

Insider Trading and Fraud Enforcement Act of 1988

What is the statue of limitations for insider trading violations ?

Answer 171

6 years

(other provisions of the Act of ‘34 are 5 years)

Question 172

Rule 10b5-1 Pre-arranged trading plan

Answer 172

• Used by insiders to avoid insider trading violations
• safe-harbor rule that permists statutory insders to set up a written plan for trading that company’s securities.
• the plan specific the future date and amount of securites to be bought or sold, or the specifics of the algorithm to be used to determine the amount and date of future sales and purchases.
• Once the plan is in place the insider cannot influence the plan

Question 173

Pre-arranged Trading Plan cooling off period

Answer 173

• Insiders cannot start tradigin under their pre-approved trading plan for 30-60 days (“cooling off period”)

Question 174

Reg FD

Reguldation FD

Answer 174

• passed in 2000 to address specfiic issues related to insider trading rules
• designed to address 3 issues:
  - selective disclosure by issuers
  - when a trader is deemed to be an insider
  - family member trades

Question 175

Reg FD

Selective Disclosure by Issuer

Answer 175

• selective disclosure to “favored individuals” by issuers of material non-public information
• REG FD prohibits selective disclosure by individuals
• if material non-public information is made available to sec market professionals and holders of the issuer’s securities it must make public disclosure of that information.

Question 176

REG FD

If an issuer makes a disclosure of non-public information (i.e. at an analyst meeting) the issuer can avoid liabilty by:

Answer 176

1. for an intentional disclosure: simultaneously disclose the information by borad distribution to the public
2. For unintentional disclosure: promptly (within 24 hours) disclose the information by filing an 8K reort wiht the SEC or by broad distribution of the information to the public.

Question 177

REG FD

Specific defense against alleged insider trading

Answer 177

• the person, before becoming aware of the infomratino, had entered into a binding contract to buy/sell the security
• this contract must specify the amount, date and price of the trade (or the formula for this) with no futher influence by the person on the trade
• the resultant trade happened due to the contract

Question 178

REG FD

When are family members considered to be insiders?

Answer 178

• a person agrees to maintain information in confidence
• two people have a history, attern or practice of sharing confidences so that the recipient of the information should know that the person communicating the information expects the person to maintain confidentiality
• a person receives material non-public information from certain close family members, spouses, parents, childrent, and siblings

Question 179

When is there liability when a family member recieves material non-public information?

what is an affirmative defense for a family member related to insider trading?

Answer 179

• liability exists when a family member trades based on inside information
• Affirmative defense: the person that received the info demonstrates that no duty of trust or confidence existed

Question 180

SEC Act of 1934 section 9

What are the unlawful practices identified in section 9 of the Act of 1934?

Answer 180

• Wash Trades: effecting transactions in securities where there is no beneficial change of ownership in order to create misleading activitiy for the security
• placing an order for a security with the knowledge of orders that have been / will be placed, at substantially the same price
• effecting a series of transactions in a security to create an impression of falling or rising prices
• offering to buy or sell a secuirty for a customer by giving information to the effect that the price is likely to rise or fall becuase of mkt operations of certain persons.
• Including the sale of a secuirty by using false or misleading statements
• accepting payment for disseminating information that the price of the security is likely to rise or fall
• Pegging: stablizing the price of a security in the makret other than under prescribed SEC rules

Question 181

SEC Act of 1934 section 9

What is the penality and statute of limitations for violations of the prohibitions of section 9?

Answer 181

• liable for damages sustained by the investors in the security
  *2 and 5”: Suits may be brought within 2 years of discover, and no later than 5 years after the violation occured.
  *

Question 182

SEC Act of 1934 section 9

2 and 5

Answer 182

• Suits pertaining to violations of section 9
• suits may be brought within 2 years of discovery and no later than 5 years from violation

Question 183

SEC Act of 1934 section 10

Section 10 of the SEC Act of 1934

Answer 183

• Prohibited practices in section 10:
• Rule 10b-1: applies to manipulation of both exempt and non-exempt securites.
• Rule 10b-3: it is unlawful for a BD, including municipal BDs, to use or employ any deceptive or manipulatie practices

Question 184

Investment Advisors Act of 1940

Investment Advisors Act of 1940

Answer 184

Established to:
* require the registration of investment advisors with the SEC and;
* regulate the actions of invesment advisors at a federal level

Question 185

Investment Advisors Act of 1940

Who regulates Investment Advisors

Answer 185

(i* Regulation of investment advisors is split between federal and state governments

• Larger investment firms (over $100K):
  Registered at the federal level and are not required to register in each state in which they do business
• Smaller investment firms (under $100K):
  regulated at the state level and must register in each state in which they do business,
  not required to register with the SEC

Question 186

Investment Advisors Act of 1940

Invesment Advisors

Answer 186

The Investment Advisors Act of 1940 devines investment advisor as:

A person who recieves compensation for advising others about securiteis, or about the advisablity of investing in securities.

NOTE:
if a person gives advice about securities but does not charge for it they are NOT an IA

If a person gives advice about investing in commodities and charges a fee, they are NOT an IA becuase it is a security

Question 187

Investment Advisors Act of 1940

3 Prong Test for Investment Advisors

Answer 187

Informally called the ABC TEST

Test 1: Providing advice about securities?

Test 2: In the Business?

Test 3: is the person Compenstated:

Question 188

Investment Advisors Act of 1940

Who is excluded from the IA definition?

Answer 188

The following are not IAs and do not have to register with the SEC:
* banks / bank holding companies
* lawyers, accountants, engineers, or teachers whose performace of such services is solely incidental to the practice of their profession
* BDs and their RRs whose advisory services are indicental to their business and they receive no sepcial compenation for it
* publishers of bona fide newpapers, magazines or financial publications of a general and regular circulation
* any person who advises solely about U.S. Gov guaranteed obligations

Question 189

Investment Advisors Act of 1940

Who is EXEMPT from IA registration?

Answer 189

1. Intrastate Exemption:
an IA with its principal place of business in one state, who only renders advice to residents of that state on “intrastate transactions”. **securities cannot be listed on a national exchange.

Adviser to Insurance Companies
An IA whose only clients are insurance companies

Question 190

Investment Advisors Act of 1940

Federal registration with SEC is only required for:

Answer 190

*Known as “Federal Covered Advisers”
1. $100 Million of assets under management
2. Advisors to investment companies

*note: no registration is reuired at the state level

Question 191

Investment Advisors Act of 1940

Advisory Contract Rules

Answer 191

• cannot provide for compensation to the IA based on capital gains in the account
• cannot provide for a reduction in the advisory fee if the account does not reach a specific performance level
• Cannot allow for assigenment of the contract to another IA unless the customer consents

Question 192

Investment Advisors Act of 1940

If an IA is in a partnership what are specific rules regarding changes in the partnership:

Answer 192

• if the majority of the partners chagne this is in “involuntary assignment’ of the contract and required customer approval
• they must provide notification to customers of changes in compensation of the partnership

Question 193

Investment Advisors Act of 1940

Anti-Fraud Rule

Answer 193

IAs are prohibited from using the mail or an other means of interstate commerce to defraud a client.

NOTE: These provisions apply in all circumstances, so even if someone is exempt from registration as an IA these rules still apply.

Question 194

Investment Advisors Act of 1940

IA Fiduciary Standard

Answer 194

• IA must act as fiduciaries for their clients.
• Must always act in the best interest of clients.
• Cannot charge amouts greater than other Advisors offering similar services.

Question 195

Investment Advisors Act of 1940

Standard for IAs vs BDs

Answer 195

• IAs fiduciary standard: always act in the best interest of clients
• BD: suitablity standard: recommendations must be suitable, lowest cost is not neccessarily a factor

Question 196

Investment Advisors Act of 1940

Investment Adviser Principal Transaction

Answer 196

• When an IA purchases a security from a customer into their own account, or sells a security from their own account

Question 197

Investment Advisors Act of 1940

If an IA wishes to effect a principal transaction with a customer, it must:

Answer 197

• disclose, prior to the completion of the transaction, that the adviser is acting in the capacity of a broker dealer
• obtain consent of the client for the transaction

Question 198

Investment Advisors Act of 1940

Agency Cross Transaction

Answer 198

• When an IA tells one client to sell a security and another client to buy the same security at the same time

Question 199

Investment Advisors Act of 1940

If an IA wishes o effect an “agency cross” transaction it must:

Answer 199

• recommend the transaction to only one side of the cross. (if both customers have been solicited then the transaction is prohibited)
• act in the best possible interest of the client to obtain the best possible price
• obtain a written consent from the customer that discloses that the adviser will be actin ga s a broker for both buyer and seller, that a commission will be received by the adviser from both parties, and that potential conflict of interest exists.
• send to each client , at least annually, a written disclosure statement, identifying the total number of agency cross transactions and totoal commissions received from these transactions during the year.

Question 200

Investment Companies

Investment Companies

Answer 200

• collects funds from individuals and purchases securities with those funds that are consistent with the investment company’s objective.
• Three types of companies:
  1. Face Amount Certificate Company
  2. Management Compay
  3. Unit Investment Trust

Question 201

Investment Companies

Benefits of Investment Companies

Answer 201

• Diversification
• Professional investment selection

Question 202

Investment Companies

Face Amount Companies

Answer 202

• virtually obsolete
• Investors pay a fixed monthly amount to the investment company, which invests the funds in the highest quality obligations (i.e. us gov debt, AAA muni/corp debt).
• The certificate promises the investor a guaranteed rate of return and at a fixed date the certificate matures nad the investor receives the stated face value.
• These were used in conjunction with bank mortgage loans.

Question 203

Investment Companies

Management Company

Answer 203

• An investment company organized as a coporation, issuing shares of stock.
• The portfolio manager invests the portfolio and is free to manage the portoflio, buying / selling consisent with the funds objective.
• Two structures:
  
  1. open end
  2. closed end

Question 204

Investment Companies

Open-End Investment Company

Answer 204

• Mutual Fund
• Most popular investment company structure
• the number of common shares that are issues is open ended, as investors place new money in the fund, they are issued additional shares.
• The shares are non-negotiable. They cannot be traded.
• The shares are redeemable with the fund at any time.

Question 205

Investment Companies

Closed-End Investment Company

Answer 205

• Publicly Traded
• the fund has a one-time issuance of stock.
• The stock is listed on an exchange and is traded (it is negotiable)
• The funds invest in bonds with shareholders receiving income distributions from interest in addition to capital gains.
• Shares are not redeemable

Question 206

Investment Companies

Unit Investment Trust

Answer 206

• A type of investment company organized under a “trust indenture”
• Issues shares of beneficial interest,
  which represent undivided interest in a unit’ of specified securities.
• Two types of UITs
  1. Fixed Trusts
  2. Participating Trusts

Question 207

Investment Companies

Fixed UIT

Answer 207

• A trust selects a portfolio of securities (usually bonds) which are placed in trust.
• Once selected, the portfolio does not change - there is no management
• The sells units ofte fixed portfolio to investors
• interest and principal payments are passed to unit holders
• When all bonds mature, the trust self-liquidates

Question 208

Investment Companies

Participating UIT

Answer 208

• The trust invests in the shares of a management company - specifically mutual fund shares.
• Purchasers of units are indirectly buying mutual fund shares.
• Used when investors buy mutual funds within an insurance company wrapper to fund variable annuity contracts.

Question 209

Investment Companies

Variable Annuity

Answer 209

• Generally used as retirement planning vehicles.
• Investors make either a lump sum or periodic payments to buy “units”
• At retirement age the cusomter can cash out as a lump sum or periodic payments, or in the form of an annuity
• payments back to investors are dependent on the performance of the mutual fund shares purchased .

Question 210

Investment Companies

Types of Investment Companies

Answer 210

Types of Invesment Companies
1. Face Amount Certificate Company
2. Mangement Company
A. Open-End (Mutual Fund)
B. Closed-End (Publicly Traded Fund)
3. Unit Investment Trust (UIT)
A. Fixed UIT (Fixed Trust)
B. Non-Fixed UIT (Variable Annuity)

Question 211

Investment Companies

When are investment companies formed?

Answer 211

• Formed when someone conceives as an idea for an investment company objective that is needed by investors.

Question 212

Investment Companies

Fund Sponsor

Answer 212

• Establishes the fund
• Underwriter
• Can be a large invesment firm (i.e. Morgan Stanley) or a firm that specializes in running funds (i.e. Fidelity/Dreyfus)
• The sponsor must register with the SEC before the security can be sold

Question 213

Investment Companies

Prospectus

Answer 213

Details the:
* objective of the fund
* the Board of Directors
* the fees
* the track record of the sponsor
* The structure of the fund (open- or closed- ended)
*POP (public offering price) - NAV plus sales charge

Note: becuase open ended funds are continuously issues every pruchaser must recieve the latest propsectus

Question 214

Investment Companies

Open-end Fund and Prospectus Delivery

Answer 214

becuase open ended funds are continuously issues every pruchaser must recieve the latest propsectus

Question 215

Investment Companies

Public Offering Price
(POP)

Answer 215

• The Net Asset Value (NAV) per share plus a Sales Charge (the equivalent of a spread)

Question 216

Investment Companies

Selling Group

Answer 216

• Hired by the underwriter to help sell a mutual fund.
• Acts as an agent, selling the fund for the sponsor.
• The sponsor pays the sales charge as a selling concession to the selling group

Question 217

Investment Companies

How are closed end funds capitalized

Answer 217

• Capitalized like other corp stock offerings
• One time issuance of stock, and then the shares are listed and trade on an exchange
• The original offering of the stock is made under a prospectus at the offering price
• The underwriters earn a spread (disclosued in prospectus)
• Once the issue is sold out shares trade in the seconday market
• no additional prospectus is required

Question 218

Investment Companies

Investment Advisor Managmenet Fee

Answer 218

• The IA managing the fund and the fund objective is identified in the prospectus
• The management fee is based on a percentage of all assets under management.
• The IAs contract is originally set for 2 years and subject to shareholder vote every year after

Question 219

Investment Companies

How long is the IA contract for managing a fund?

Answer 219

• initially set for 2 years
• subject to shareholder vote every year thereafter

Question 220

Investment Companies

Custodian Bank

Answer 220

• A custodian bank is idenfitied to safeguard the assets of the fund
• included in the prospectus
• usually acts as a transfer agent for the fund, canceling old shares and issuing new shares
• Keeps a shareholder list for mailing, reports, proxies, distributions
• they earn a custodial fee

Question 221

Investment Management Company

Structure of an Invesment Company

Answer 221

Question 222

Investment Management Company

What is the structure of an Invesment Management Company?

Answer 222

• Fund Sponser (underwriter)
  1. Custodian Bank
  2. Investmet Adviser
  3. Selling Group

Question 223

Investment Management Company

What are the 3 key responsiblities of a Custodian Bank?

Answer 223

1. safeguards fund assets
2. act as a transfer agent & paying agent
3. receives custodial fees

Question 224

Investment Management Company

What are the key responsiblities of an Investment Adviser as part of an Investment Management Company?

Answer 224

• Manages the fund within the objective

Note: they do this for a managment fee (% of aum)
and their contracts are approved by the shareholders.

Question 225

Investment Management Company

What are the primary responsibilities of the Selling Group?

Answer 225

• sells fund at the public offering price on initial offering
• Its continuous for open-end shares and One-time offer for closed-end shares

Note: they earn a selling consession

Question 226

Investment Management Company

Diversified Fund

Answer 226

must have:
* 75% or more of its assets invested in securities
* a max of 5% of its assets invested in any one issuer
* a max holidng of 10% of the voting securities in any one issuer
* Most funds are diversified

Question 227

Investment Company Management

75/5/10 Rule

Answer 227

• Diversification Rule for mutual funds
• Fund must have:
  - 75% or more of its assets invested in securities
  - a max of 5% of its assets invested in any one issuer
  - a max holidng of 10% of the voting securities in any one issuermust have:

Question 228

Investment Company Management

Rule 35d-1

Answer 228

• States that if a fud focuses on a particular investmet, (stated in its investment policy) at least 80% of its asset must be i that investment type.

Question 229

Investment Management Company

Buying and Sellign Open-End Shares

Answer 229

• Continuously issued by the sponsor
• redeemable at any time
• do not trade in the secondary market
• non-negotiable

Question 230

Investment Management Company

Net Asset Value

Answer 230

• Computed daily
• NAV per common share
• All securities held in the fund are marked to market, the total market value is divided by the number of common shares outstanding

Question 231

Investment Management Company

No-Load

Answer 231

• there is no sales charge
• customers purchase at NAV
• sold diretly by mutual fund sponsors who do not use selling groups or salesmen
• almost all MoneyMarket funds are no-load

Question 232

Investment Management Company

Sales Charge

Answer 232

• fee on top of NAV when the fund sponsor must compensate a selling group or salesmen
• Maximum sales charge is 8 1/2 % of POP
• POP consides of NAV and sales charge

Sales Charge Percentage = (Ask-Bid)/Ask

Note: in order for a fund to charge the maximum sales charge (8 1/2 %)the fund must offer:
* breakpoints
* letter of intent
* rights of accumulation

Question 233

Investment Management Company

Forward Pricing

Answer 233

When customers buy or sell a mutual fund they dont know the exact price of the buy/sell becuase the price is computed based on that days closing.

Question 234

Investment Management Company

When a customer redeems a mutual fund share they must be paid within:

Answer 234

They must be paid within 7 CALENDAR day

*Investment Company act of 1940

Question 235

Investment Management Company

Redemption Fee

Answer 235

• A redemption fee can be charged
• Under FINRA Rules the total of all fees (up-front sales charge and the redemption fee) cannot exceed 8 1/2% of POP

Question 236

Investment Management Company

In order for a fund to charge the maximum 8 1/2% sales charge, the fund must offer?

Answer 236

• Breakpoints
• Letter of Intent
• Rights of Accumulation

Question 237

Investment Management Company

Breakpoints

Answer 237

• A reduced sales charge for large dollar purchases.
• FINRA sets brekpoint schedules that it considers to be ‘fair and reasonable’
• Mutual funds may lower the sales charge percentages in these breakpoints, but may not go higher
• Applied on a customer by customer basis

Revised Offering Price = NAV / (100% - sales charge %)

Question 238

Investment Management Company

Offering Price

formula

Answer 238

= NAV / (100% - sales charge %)

Question 239

Investment Management Company

Sales Charge Percentage

formula

Answer 239

= (Ask - Bid) /Ask

Question 240

Investment Management Company

Who does not qualify for breakpoints?

Answer 240

• Investment clubs do not qualify for breakpoints based on the group
• Breakpoints are applied on a customer-by-customer basis
• most funds will give breakpoints to a group of individuals in the same HH
• Some funds will allow breakpoints to be applied accross a fund family

Question 241

Investment Management Company

Letters of Intent

Answer 241

• If a client plans to reach a breakpoint in the future (within 13 months), he can receive the breakpoint if they sign a letter of intent
• If they dont complete the breakpoint, the purchases are recalculated based on the actual breakpoint level acchieved
• letters of intent can be backdated to include purchases in the preceeding 90 days

Question 242

Investment Management Company

How long can a letter of intent last?
What time frame can it be backdated to?

Answer 242

• Can last 13 months (inclusive of the 90 day backdating)
• Can be backdata to the preceedig 90 days

Question 243

Investment Management Company

How is the Letter of Intent Executed

Answer 243

• Additioal shares purchases uder the breakpoit are held in escrow until the breakpoint level is reached.
• If the breakpoint level is not reached, the extra shares are not released from escrow.

Question 244

Investment Management Company

Rights of Accumulation

Answer 244

• The accumulated position counts towards the breakpoint
• FINRA allows funds to use the higher of cost or market value to determine the accumulated value

e.g. Fund A has a $25,001 breakpoint

A client purchases $9K at 8 1/2%
He now buys $20K

The 9K owned +20K new purchases is above the $25K breakpoint therefor the NEW PURCHASE is at the breakpoint sales charge

Question 245

Investment Management Company

What value is the rights of accumulation based on?

Answer 245

FINRA permits fuds to use the higher of the cost or market value (use by most funds)

Question 246

Investment Management Company

Switching between funds in the same fund family

Answer 246

• Many funds allow swithing between funds in the same fund family at NAV (no sales charge on the new purchase)
• not a FINRA requirement / marketing tool
• Sale of the fund is still a taxable event

Question 247

Investment Management Company

How are purchase prices determined?

Answer 247

• The price a customer pays is the “next calculated Public Offering Price” inclusive of the appropriate sales charge and considering all of the funds purchase features (breakpoints, letter of intent, rights of accumulation)
• This is disclosed in the prospectus
• Selling groups may not discount on their own or sell them for more than POP

Question 248

Investment Management Company

The Investment Company Act of 1940 requires this to be sent to shareholders annually.

Answer 248

Annual Statement of dividend distribrutions and capital gains distributions be sent on an annual statement send to shareholders for tax purposes (form 1099)

Question 249

Investment Management Company

How are dividend and capital gains distributed to shareholders?

Answer 249

• Declarations of dividen distributions and capital gains distributions are made by the Board of Directors of the fund
• Dividends are paid periodically, and may be paid more than once a year
• Capital Gains can only be distributed annually

Question 250

Investment Management Company

Closed-End fund Ex-Date

Answer 250

*Set by FINRA

• Distributions for closed-end funds are reported to the exchange where the shares trade
• Provided by the Board of Directors
  Includes the declaration date, record date and payable date
• FINRA then sets an appropriate ex-date and the share price is reduced on that date

Question 251

Investment Management Company

Mutual Fund Ex-Date

Answer 251

• Set by the Board of Directors
• The board of directors set the declaration date, the record date, the payable date and the ex-date.
• The share price is reduced for distribution on the ex-date

Question 252

Investment Management Company

Selling Dividends

Answer 252

• Recommending the purchase of fund shares to customers just prior to the ex-date to receive a capital gain or dividend distribution
• Prohibited by FINRA
• Not prudent, as the investor mus pay tax on the distribution, then after the ex-date the sares are reduced in value by the entire before tax distribution. (i.e. receives a return of his own money on which taxes must be paid)

Question 253

Investment Company Act of 1940

Shareholder Rights

Answer 253

Each shareholder in an investment company has the right to:
1. vote for the board of directors
2. vote for changes in investment objective
3. vote anually on the investment advisor
4. receive annual and semi-annual reports from the investment company

Question 254

Investment Company Act of 1940

Shareholder rights

Board of Directors

Answer 254

• BoD must be elected by shareholders at an annual meeting
• not all board members need to be boted on annually
• directors can be divided into classes, with terms from 1-5 years
• at least one must come up for re-election each year

Question 255

Investment Company Act of 1940

What is the minimum capital required to start a fund?

Answer 255

Min Total Assets of $100K

Question 256

Investment Company Act of 1940

Fund Registration Requirements

Answer 256

• All Investment Companiese must register with the SEC within 3 months after filing the notification of registion with the SEC
• Form N-1A

Question 257

Investment Company Act of 1940

Fund Registration Information

Answer 257

1. Investment objective and policies
2. Classification and subclassification (FAC, UIT, or Mngmt Company, open/closed, div or non div)
3. Policy on borrowing money
4. Policy on Issuing Senior Securities
5. Policy on investmet concentrations
6. Policy on making loans
7. Portoflio turnover for the previous 3 years
8. ames and addresses of all affiliated persons, other companies i which the persons are officers / directors, business experience for last 5 years
9. Any other filing made with the SEC under the ‘33 and ‘34 Acts

Question 258

Investment Company Act of 1940

Borrowing Restrictions

Answer 258

• Open-end funds cannot borrow more than 1/3 of Net Assets
• Funds cannot borrow to make dividend distributions.

Question 259

Investment Company Act of 1940

Restrictions on Issuing Senior Securities

Answer 259

• Senior securities can only be issues by closed end funds
• bonds & Interest payments: asset coverage is at least 300%
• Preferred stock & dividend payments: asset coverage is at least 200%

Question 260

Investment Company Act of 1940

Change of Objective or Policies

Answer 260

• requires shareholder vote
• a majority vote of outstanding shares is required

Question 261

Investment Company Act of 1940

Prohibited Fund Actions:

Answer 261

• Purchasing shares of companies on margin
• Selling short shares of companies
• Participating in joint trading accounts in securities

Question 262

Investment Company Act of 1940

Requirements regarding Investment Advisor contracts

Answer 262

• be made in writing
• no longer than an intitial 2 year period duration and be approved by the majority vote of shareholders
• Contracts must be re-approved annually by the board of directors or by majority vote of shareholders
• Tremination at any time by the board or majority shareholder vote w/ 60 days notice
• contracts cannot be assigned to another firm (automatic termination)

Question 263

Investment Company Act of 1940

How are fund shares priced ?

Answer 263

• Priced at next computed Net Asset Value of Fund Shares
• Any applicable sales load may be added as long as it is fully disclosed in the registration satement and offering materials.
• Under Section 22 of the Investment Company Act of 1940, the SEC prohibits a underwriter from selling open-end fund shares at any price other price

Question 264

Investment Company Act of 1940

Rule 22C-1

Answer 264

• Requires management companies to compute NAV at least once daily, Monday through Friday (business days only) at a specified time set by the Board of Directors.
• Most set this as of closing of NYSE

Question 265

Rule 22d-1

Answer 265

• Permits funds to offer variatios in sales loads (breakpoints)
• must be uniformly applied to all offerees
• Chanages in sales loads must be fully disclosed in a revised prospectus, and existing shareholders must be advised of the new sales loads within 1 year of the date when it was made availalbe. (done through prospectus mailing)

Question 266

Investment Company Act of 1940

Rule 12b-1

Answer 266

• Allows for some selling and distribution expenses to be charged to fund shareholders.
• Allows investment companies to finance acctivities itended to result i the sales of shares, such as advertising, mailing of propsectuses to persons other than current shareholders, printing and mailing of sales literature and compensation of sales people.
• Must have a 12b-1 plan (needs to be approved)

*note: typically only operating expenses (not selling expenses) were able to be passed onto the shareholders

Question 267

Investment Company Act of 1940

What approvals are needed for a 12-b 1 plan?

Answer 267

• 3 levels of voting are required.
• Requires majority vote of the:
  1. Shareholders
  2. Board of Directors
  3. Uninterested Directors (neither affilitated with the
     fund or receives payments from the fund - e.g.
     outside attorney)

Question 268

Investment Company Act of 1940

Review of Fund Spending Plan

Answer 268

• A person must be appointed to direct expenditures of the funds allocated to the plan and provide quarterly updates to the Board.
• The plan must be reapproved annually.

Question 269

Investment Company Act of 1940

Termination of a 12b-1 Plan

Answer 269

• Termination of a 12-b1 plan requires 1 level of approval.
• The plan may be terminated at any time by majority vote of either:
  
  1. shareholders OR
  2. Uninterested Directors
• majority bote of the Board is NOT needed to terminate the plan.

Question 270

Investment Company Act of 1940

Amendments to a 12-b1 plan to increase funds spent

Answer 270

• Needs approval by both the shareholders and the board

Question 271

FINRA Sales Charge Rules

FINRA Conduct Rules regarding sales charges:

Answer 271

• provides for a maximum sales charge for funds that impose 12b-1 fees, and a maximum sales charge for funds that do not impose 12b-1 fees.

Question 272

FINRA Sales Charge Rules

Maximum Sales Charge Conditions for NON-12b-1 Funds

Answer 272

• 8 1/2% of the offering price
• applies to the total of the front-end and deferred sales charges
• Additional requirements must be met in order to charge the maximum (offer breakpoints and rights of accumulation)

Question 273

FINRA Sales Charge Rules

FINRA Requirements to Charge the Maximum 8 1/2% Sales Charge

Answer 273

• The fund must offer both:
  1. Rights of accumulation (cumulative quantity discount)
  2. Breakpoints (quantity discounts)

Question 274

FINRA Sales Charge Rules

FINRA Breakpoint schedules

Answer 274

• FINRA provides minimum breakpoint schedules (for both cumulative and quantity discounts apply)
• Funds can do better than these schedules
• Two alternatives are provided:

Question 275

FINRA Sales Charge Rules

Conditions where FINRA limits the maximum sales charge:

Answer 275

FINRA reduces the maximum allowable sales charge if:

1. If Rights of Accumulation does not meet schedules: max sales charge is 8%
2. If Breakpoints do not meet schedules max sales charge is 7.75%
3. If both ROA and Breakpoints do not meet schedules: Max sales charge is 7.25%
4. if an investment compnay pays a service fee (payments to 3rd parties for acct maintenance): Max Service Fee is 7/25%

Question 276

FINRA Sales Charge Rule

Maximum Sales Charge for 12b-1 Funds

Answer 276

• Maximum sales charge is 6.25% for funds that pay a service fee (fees to 3rd parties for account mainatenance)
• Max sales fee is 7.25% for funds that do not impose a sales fee

Question 277

FINRA Sales Charge Rule

Maximum 12b-1 Charge

Answer 277

• Maximum .75% (3/4 of 1% annually)
• If a fund wishes to advertise as “no-load” the maximum is .25%

Question 278

FINRA Sales Charge Rule

Share Classes

Answer 278

• Share classes impose sales charges and 12b-1 fees in varying ways
• Most common share classes:
  1. Class A shares : higher up front sales charge, no/low 12b-1 fees
  2. Class B shares: contingent deferred sales charges that declies to 0 the longer the investor is invested, higher 12b-1 fees
  3. Class C shares no upfornt sales charge, highest 12b-1 fees

Question 279

FINRA Sales Charge Rule

Class A Shares

Answer 279

• Higher Up-front sales charge & No/Low 12b-1 fees
• 12b-1 fees typically about .25%
• Suitable for long term investing
  best for clients with large amounts to invest with a long term time horizon

Question 280

FINRA Sales Charge Rule

Class B Shares

Answer 280

• Contingent deferred sales charge that declines to 0 the longer the investor stays in the fund & higher 12b1 Fees
• 12b-1 fees typically around .5%
• Most suitable for intermediate term investing

Question 281

FINRA Sales Charge Rule

Late Trading

Answer 281

• Placing orders to buy, redeem, or exchange mutual fund shares after the time as of which the fund calculates that day’s closing NAV
• Late orders should not be processed at that day’s closing NAV, they shoudl be processed at the following days NAV.
• Prohibited under the Invest Company Act of 1940

Question 282

FINRA Sales Charge Rule

Market Timing

Answer 282

• Frequently buying and selling a fund’s shares to exploit inefficiencies in how the mutual fund company computes NAV
• e.g. a hedge fund computes NAV faster than the fund and places buy orders for shares it finds to be undervalued
• to prevent this most mutual funds have placed restrictions on excessive tradig in their prospectuses and monitor accounts for excessive short term trading
• FINRA looks for market timing customers that use multiple accounts to trade just under the audit thresholds.

Question 283

FINRA Sales Charge Rule

FINRA Rules prohibit member firms from offering invesment company shares if:

Answer 283

• the service fees paid by the investment company exceeds .25% of net assets

OR

• the dividend reinvestment at NAV is not offered (reivnvestment of dividends is not made at NAV)

Question 284

FINRA Selling Agreement Rules

Written Selling Group Agreement

Answer 284

• FINRA requires any member who joins in a selling group must sign a written selling agreement.
• It must specify the cocessios to be received by the selling group member

Question 285

FINRA Selling Agreement Rule

Requirements for placing orders of mutual funds

Answer 285

• a FINRA member that takes an order to buy mutual funds must promptly sumit the order to the underwriter
• Orders must be:
• to fill a existing customer order
• for securities to be placed in the firm’s investment account

Question 286

FINRA Selling Agreement Rules

Who can make market in fund shares?

Answer 286

• Only the fund can be a market maker in mutual fund shares
• FINRA members cannot make market in fund shares, cannot hold themselves out as market makers, and canot trade fund shares
• Shares may only be purchased and redeemed through the fund

Question 287

FINRA Selling Agreement Rules

When must payment be sent to the fund sponsor?

Answer 287

*the later of :
within 3 days of receipt of the customer’s order to buy,
or
within 1 day of receitp of payment.

Question 288

FINRA Selling Agreement Rules

What occurs if a customer redeems within 7 days of purchase?

Answer 288

• the memer must forfeit the full concession to the fund underwriter.
• if the underwriter is a firm different from the fund, the underwriter must forfeit the concession the the fund
• There may be reasonable redemption fees imposed
• Redemption takes place at the next computed Net Asset Value
  *

Question 289

FINRA Selling Agreement Rules

Special Deals

Answer 289

• prohibited by FINRA
• the only compensation to be receied by a FINRA memer is the selling concession.
• There may be no toher incentives paid by the issuer or underwriter to sell shares.

Question 290

FINRA Selling Agreement Rules

Underwriter incentives

Answer 290

Underwriter incentives are prohibited. Underwriters cannot pay salesmen based on sales of a fund.

This includes:
* Commissions paid by the invesment company to the orker as a condition for selling fund shares

• Commissions paid by another FINRA member to the borker as a condition for selling fund shares
• Special incentive campaigns promoting the sale of a fund, financed by commissions directed or arranged by underwriters

Question 291

FINRA Selling Agreement Rules

Member FIRM incentives for sales of mutual funds

Answer 291

• Member firms are prohibited from offering incentives to their borkers for selling fund shares other than regular selling concessions.
• This includes:
  • placing specific mutual funds on “recommend” or “preferred” list
  • Providing sales personnel with additional compensation for the sale of shares of specific investment companies
  • giving commissions to sales personnel on fund transactions, where the commissions are directed by the investment company

Question 292

FINRA Selling Agreement Rules

Directing Trades to a BD based on Sales of a Fund

Answer 292

• FINRA prohibits underwriters from directing portoflio trades to a broker based on sales of their fund by the broker
• The only basis for a member firm to be selecting for performing portfolio trades is execution capaibilty - and not how many shares of that fund are sold by the member
• It does not prohibit a FINRA member form both receiving selling concessions from the fund and erforming portoflio trades

Question 293

FINRA Selling Agreement Rules

Directed Brokerage Arrangements

Answer 293

• Member firms are prohibited from selling the shares of a mutual fund, or acting as an underwriter for the fund if the member has a “directed brokerage arrangement that is intended to promote the sale of that investment companies securities.

*this was implemented in 2005

Question 294

FINRA Selling Agreement Rules

Prohibited Compenstation Items

Answer 294

• FINRA prohibits fund underwriters from compensating persons for retial distribution of fund shares with:
  
  • stock, warrants, or options
  • merchandise or trips
  • any compenstation not stated in the prospectus
  • any item of material value

Question 295

FINRA Selling Agreement Rules

Selling Rules for Fund Underwriters

Answer 295

• cannot hold sales contests for selling group members
• cannot compensate RRs within the selling group
• cannot direct portoflio trades to a specific selling gropu based on how much of the fund the firm sells

Question 296

FINRA Selling Agreement Rules

Selling Rules for Selling Groups

Answer 296

• Each selling group can hold a sales contest within that firm as long as it does not favor sales of one fund over another
• Each group member can compenstae RRs within that firm for fund shares sales

Question 297

FINRA Selling Agreement Rules

Allowable Gifts form Fund Underwriter
to Representative in the Selling Group

Answer 297

• gifts of no more than $100 per person per year
• Educational seminars held by the fund underwriter, provided:
  - prior firm member approval is obtained
  - the location is appropriate for the purpose of the meeting
  - the sponsor pays only for the training, education, meals, lodging and tranportation (not for entertainment, no spouses)
• Loans or guarantees to a person not controlled by the underwriter or member
• Wholesale overrides stated in the prospectus
• Occasional meals, sporting tickets, etc. paid by the sponsor as long as they are not frequent, not excessive and not based on a condition of sales.

Question 298

FINRA Selling Agreement Rules

Employees of Instiutional Customers and soliction of charitable contributions

Answer 298

• FINRA is concerned with employees of Institutional Customers soliciting charitable contributions from member BDs.
• FINRA recommneds that written Proceudres be created by the member firm require:
  • BD approval (above a threshold or frequency)
  • Approval from the Institutional customer (about a threshold/frequency)
  • cannot tie contributions to amount of directed borkerage
  • frequent review of solicited contribution activity

Question 299

FINRA Selling Agreement Rules

Soft Dollar Remuneration

Answer 299

• arrangements are contracts between investment advisers and companies with broker-dealers for research and brokerage services for their managed accounts. “Soft dollars” are client commissions that are used to pay for research and brokerage services

Question 300

FINRA Selling Agreement Rules

SEC Rules for Soft Dollar Arrangements

Answer 300

• services provided by soft dollar arrangements must directly benefit the shareholders of the mutual fund.

e.g. the BD can provide research, trading software, asset allocation software

the BD can’t pay rent subsidies because it doesn’t directly benefit shareholders.

Question 301

SEC Fund Advertising Rules

SEC Rule 153A

Answer 301

• Generic Advertising Rule
• Investment Companies can distriubute Generic fund advertising without first providing a prospectus if:
  
  • the advertisitng does not refer to the specific securities invested by the fund
  • and is limited to:
    - explanatory info about inv company secuirties, the nature of investment companies or services offered
    - explanation of differing inv objectives
    - explanation of various products / services
    - invitation to inquire more

Question 302

SEC Fund Advertising Rules

What must be included in general fund advertising provided without prrospectus?

Answer 302

• the name of the sponsoring BD
• if the sponsor is the principal underwriter or fund adviser it must be disclosed

Question 303

SEC Fund Advertising Rules

When may past performance be included in generic fund advertising provided without prospectus?

Answer 303

• if total return is shown for 1-5, and 10 year periods (or the life of the fund if shorter)
• the total return is broken down into income and capital components
• all sales charges and are reflected

Question 304

SEC Fund Advertising Rules

SEC Rule 256
Prohibited Representations In Investment
Company Sales Literature

Answer 304

• Sets requirements for investment company sales literature
• The following is prohiibited: any person to use sales literature that is materially misleading in connection witj the offer of investment company securities.
• Sales literature is materially misleading if it contains an untrue statement of material fact, or omits a fact necessary to make the material not misleading.

Question 305

Variable Annuity Overview

UIT

Answer 305

• Unit Investment Trust another type of investment company
• Issues “shares of beneficial interest”

Question 306

Variable Annuity Overview

Shares of Beneficial Interest

Answer 306

• issued by UITs
• called “units”
• represent and undivided interest in the portoflio of securities
• Redeemable with the trust sponser at any time for NAV

Question 307

Variable Annuity Overview

Two types of unit investment trusts

Answer 307

1. Fixed UIT
2. Particpating UIT

Question 308

Variable Annuity Overview

Fixed UIT

Answer 308

• the sponsor selects a fixed portoflio and puts it in a trust
• units of the portfolio are sold to investors
• once established, no buying or selling of securities takes place in the portfolio

Question 309

Variable Annuity Overview

Participating UIT

Answer 309

• The trust buys shares of a management company
• once the shares are purchases, they remain in the turst until the unit it redeemed
• shares held in trust are used to fund annuity contracts issues by insurance companies (Variable Annuities)

Question 310

Variable Annuity Overview

Fixed Annuity

Answer 310

• Issuer guarantees a rate of return
• insurance comany assumes risk
• not considered a security
• an insurance product regulated by insurance laws

Question 311

Variable Annuity Overview

Variable Annuity

Answer 311

• no guarantee of a specific rate of return
• annuity amount fluctuates based on the performance of underlying portfolio
• the investor assumes “investment risk”
• considered a security
• regulated by Securities Laws, the Investment Company Act or 1940

Question 312

Variable Annuity Overview

Structure for Variable Annuities

Answer 312

• the method used by insurance companies to structure most variable annuities is to create a trust that collects payments from investors
• The trust can only invest in investment management companies (stocks or bonds can be bought)
• The management companies are tpyically operated susidary of the insurance company

Question 313

Variable Annuity Stucture

Assumed Interest Rate
(AIR)

Answer 313

• used to provide the customer with an illustration of the annuity amount they will receive

Question 314

Variable Annuity Structure

Where are the investments held for variable annuities.

Answer 314

• investments are held in a seperate account held by the insurance company
• they sare seperate from the insurance companies other holdings and are used specificaly to fund the annuity
• portoflio operated as a management company
  with a board of managers

Question 315

Variable Annuity Structure

How are variable annuity investment accounts operated?

Answer 315

• they are operated as a management compnay
• Board of managers oversees the operating of the account
• Contract owners vote for managers and to change investment policies

Question 316

Variable Annuity Structure

Accumulation Units

Answer 316

• contract holders purchase accumulation units of a variable annuity
• Net Asset Value per unit is calculated dailly
• Each payment from a contract holder is used to accumulate more units

Question 317

Variable Annuity Structure

Mandatory Reinvestment

Answer 317

• Interest payments, dividend payments, and realized capital gains from the investments in the seperate account (annuity) are automatically reinvested to buy more accumulation units for the contract holder.
• income and capital gains cannot be distributed to the unit holders until the contract is completed.

Question 318

Variable Annuity Structure

Annuity Units

Answer 318

• When the purchase payments are completed, teh purhcased units and the additional accumulated units through reinvestment are converted into annuity units.
• Also known as “Annuitization” of the seperate account

Question 319

Variable Annuity Structure

What determines the number of annuity units received by a contract holder?

Answer 319

• the sex, age, habits (smoker/non-smoker), and annuity payment options selected by the contract holder.
• The periodic payment made to the annuitant = numer of annuity units X the annuity value
• Annuity payments may fluctuate based the performance of the investments (annuity units are fixed).

Question 320

Variable Annuity Considerations

Insurance aspects included with an Annuity

Answer 320

• mortality guarantee
• expense guarantee

Question 321

Variable Annuity Considerations

Mortality Gurantee

Answer 321

the insurance compnay guarantees to pay the annuity for one’s life (or other designated payment option).

if a person dies later than the projected mortality, the payments will continue until death

Question 322

Variable Annuity Considerations

Expense Guarantee

Answer 322

if expenses exceed a given percentage, the insurance company absorbs the excess

Question 323

Variable Annuity Considerations

Is a prosectus required with an annuity?

Answer 323

• not required for a fixed annuity (that is an insurance product)
• required for a variable annuity (it is a security)

Question 324

Variable Annuity Considerations

what is included in the prospectus for a variable annuity?

Answer 324

• investment objective
• policies of the seperate account
• management fee
• brokerage fees
• adminisitrative expense fees
• sales charges
• breakpoints
• early redemption penalties
• redemption fees
• insurance related mortatlity and expense charges

Question 327

Variable Annuity Considerations

Interest Rate Gurantee

Answer 327

• guaranteed rate of return on a fixed annuity

Note: there is no guaranteed rate of return on the investments in a variable annuity

Question 328

Variable Annuity Considerations

Surrender Charges

Answer 328

• Surrender charges imposed by an annuity on accumulation units that are liquidated before a stated time.
• Usually the longer the units are held the lower the surrender charges

Question 329

Variable Annuity Considerations

Borrowing against accumulation units

Answer 329

• can borrow against the value of accumulation units (similar to borrowing against a whole life policy
• When annuitized the account value can be taken out as a lump sum and used to purcahsed a fixed annuity (with a fixed monthly payment)

Question 330

Variable Whole Life Insurance

Variable Whole Life Insurance

Answer 330

• A type of variable annuity contract
• the holder recieves a death benefit, in addition to an investment benefit
• the investment benefit is funded by the variable annuity investments
• the death benefit is indpendently funded and guaranteed
• considered a security, must be registered
• sold under prospectus

Question 331

Variable Annuity Considerations

Qualified Variable Annuity

Answer 331

• a variable annuity purchased in a qualified account
• contributions are deductible
• earnings grow tax deferred
• distributions attriutable to growth are taxed as ordinary income

Question 332

Variable Annuity Considerations

Non-Qulified Variable Annuity

Answer 332

• purchased in a non-qualified retirement account
• contributions are not deductible
• earning grow tax deferred
• only distributions of growth are taxable at ordinary income tax rates

Question 333

FINRA and SEC Rules Regarding the Sale of Variable Annuities

FINRA requirements regarding sales charges for variable annuities

Answer 333

• FINRA requires sales charges for variable annuities be “fair and reasonable”
• not subject to the same maximum 8 1/2% sales charge as mutual funds

Question 334

FINRA and SEC Rules Regarding the Sale of Variable Annuities

Who sells Variable Annuity contracts?

At what value are variable annuity contracts sold?

When are payments received?

Answer 334

• must be sold by FINRA members at the value computed following the receipt of payment.
• payments are not recieved until they have been accepted by the insurance company
• payments must be promptly send to the insurance company by the FINRA member.

Question 335

FINRA and SEC Rules Regarding the Sale of Variable Annuities

What must be in place before orders can be placed for a variable annuity?

Answer 335

• FINRA requires that members have a written selling group agreement in force wiht the issuing insurance copmany before orders can be placed.
• The insurance company must have a registered broker-dealer with FINRA.

Question 336

FINRA and SEC Rules Regarding the Sale of Variable Annuities

What must happen if redemptions within 7 days days of acceptance?

Answer 336

The sales agreement must provide that any selling concessions will be returned to the issuer for redemptions that take place within 7 business days of contrct acceptence.

remdemption requests must be submitted promptly to the issuer.

Question 337

FINRA and SEC Rules Regarding the Sale of Variable Annuities

SEC Rule 22e-1

Answer 337

Prohibits companies form suspending redemptions for more than 7 business days after the tender of that security

exception: when the SEC declares a financial emergency

The SEC exempts variable annuity contracts from this provision during the annuity period.

note: During the annuity period there is no “formal redemption of shared. Instead the insurance company is making monthly payments so this provision cant apply.

Question 338

FINRA and SEC Rules Regarding the Sale of Variable Annuities

What is required for a variable annuity to be recommended?

Answer 338

• to recommend a varaiable annuity to a customer, the rep must have a reasonable basis to believe that:
  
  1. the customer has been informed, in general terms, of the features of the product
  2. the customer would benefit from one or more features of the product,
  3. the particular variable annuity as a whole, the underlying seperate accounts to which funds are allocated at the time of purchase, and the riders to the policy are suitable

Question 339

FINRA and SEC Rules Regarding the Sale of Variable Annuities

Variable Annuity Product Descriptions

Answer 339

FINRA requires customers must be told “clearly” that this is either a variable insurance or variable annuity.

Intended to differentiate from a mutual fund

Question 340

FINRA and SEC Rules Regarding the Sale of Variable Annuities

When making a recommendation to exchange an annuity the representive must:

Answer 340

The representative must consider whether the customer:
1. would incur a surender charge, be subject to the commencement of a new surrender period, lose existing benefits or be subject to increased fees /charges
2. would benefit from product enhancements or improvements
3. has had another variable annuity exchange within 36 months

Question 341

FINRA and SEC Rules Regarding the Sale of Variable Annuities

Section 1035 Exchange

Answer 341

exhange of annuity for another annuity

not a taxable event

Question 342

FINRA and SEC Rules Regarding the Sale of Variable Annuities

At annuity recommendation the Reg Rep must sign a statement that:

Answer 342

the appropriate detmerinations were completed

Question 343

FINRA and SEC Rules Regarding the Sale of Variable Annuities

To make a variable annuity recommendation the Representative must complete a detailed suitability questionnarie to obtain the customer’s :

Answer 343

• age
• annual income
• financial situation / needs
• investment experience
• investment objective
• intended use of the deferred annuity
• investment time horizon
• liquidity needs
• liquid net worth
• risk tolerance
• tax status and any other information that is needed to make a recommendation to the customer

Question 344

FINRA and SEC Rules Regarding the Sale of Variable Annuities

What must be done wiht the application for a variable annuity?

Answer 344

The associated person who made the recommendation must send the application for review by the principal within 7 business days.

the principal must state whether they approve or disapproves of the recommended purchase or exchange

Question 345

FINRA and SEC Rules Regarding the Sale of Variable Annuities

If an application for a variable annuity is approved by a principal what is done wiht the check from the customer?

Answer 345

• The BD must promptly forward the check to the insurance company, no later than noon the next business day

Question 346

FINRA and SEC Rules Regarding the Sale of Variable Annuities

What are valid reasons for exchanging whole life insurance policy?

Answer 346

• to get better coverage at a lower cost
• to get more desirable features or benefits
• if the customer is concerned about the solvency of the company that issued the original policy or with the service of the agent that sold the policy

Question 347

FINRA and SEC Rules Regarding the Sale of Variable Annuities

What are invalid reasons to exchange a whole life insurance policy ?

Answer 347

• to use an existing policy’s cash avlue to pay for a new policy’s first year expenses
• if the existing policy is in its early years and cashing out the policy will incur high surrender charges
• if the existing plicy is past two-year “contestability period” and a new policy could allow the insurance company to challenge a death claim that occurs in the first two years
• if there are unfavorable tax consquences

Question 348

FINRA and SEC Rules Regarding the Sale of Variable Annuities

In-Force Ledger

Answer 348

the statement of the existing whole life policy’s cash value, surrender charges, and projections of future death benefit and cash value.

used to determine if an exchange is acceptable