Suitability and Prohibited Activities Flashcards
A registered representative is out to lunch with a college friend, during which the friend says, “I heard that ABC Fund has taken a large position in XYZ stock”. Based on this conversation, the representative calls clients and recommends they immediately purchase XYZ stock. This would be:
A
Prohibited and fraudulent as this recommendation is based on inside information
B
Permitted because it is not inside information
C
Prohibited and unethical as this recommendation is based on a rumor
D
Permitted without restriction
C
Prohibited and unethical as this recommendation is based on a rumor
This representative is making recommendations based on a rumor, which is unethical and prohibited.
A registered representative has facilitated the withdrawal of funds from an insurance client’s variable life insurance contract without the knowledge or consent of the customer. The RR then endorsed the disbursement check and deposited the proceeds into their personal bank account. In what prohibited activity has the RR engaged?
A
Backing away
B
Commingling
C
Trading ahead
D
Front running
B
Commingling
Commingling is a term often used by FINRA to describe a RR mixing a client’s assets with his own. Often, as is the case in this question, the RR first steals the assets prior to combining them with their personal holdings. Front-running and trading ahead refer to placing trades ahead of your customer to get a favorable trade execution either on the buy or sell side. Backing away typically refers to failure to honor a firm quote.
A registered representative with XLR Securities has a 57-year-old client who has only recently started to invest in a retirement account. The client feels they need to make up for lost time and asks the registered representative what they should do. The registered representative recommends investing primarily in quality, proven energy stocks. One year later, the account has increased 30% in value. How would you characterize the recommendation?
A
The advice would be unsuitable because the selection of investments was concentrated in one industry
B
The advice would be unsuitable because it does not contain any bonds
C
The selection of investments is proper because the client gave instructions to make up for lost time
D
The selection of investments is appropriate because only quality, proven energy stocks were chosen
A
The advice would be unsuitable because the selection of investments was concentrated in one industry
All recommendations must be suitable given the circumstances of each client. Regulators look at suitability, not profitability. Investments concentrated in one industry would be speculative (high risk) and not suitable for most investors. Retirement accounts usually consist of a combination of equities (stocks) and bonds, with a higher percentage of the account invested in stocks if the client wants growth, or a higher percentage invested in bonds if the client is near retirement or does not want a lot of risk.
When price levels are decreasing at 5% and the amount of investment income decreases at 5%, the purchasing power of investment income will:
A
Remain the same
If the amount of money you have drops 5%, but the value of what you want to buy also drops 5%, then your purchasing power remains the same.
Which of the following securities would have the greatest taxation risk?
A
Municipal bonds
B
Common stock
C
Preferred stock
D
U.S. government bonds
A
Municipal bonds
A taxation risk exists when income tax laws change, causing unfavorable tax consequences to securities investors. Currently municipal bonds are not subject to federal (and in some cases state and local) taxation. A change in tax laws would have the greatest impact on municipal bonds.
Investors that seek high returns must be willing to accept:
A
Higher fees
B
Higher risk
C
Higher taxes
D
Lower risk
B
Higher risk
Investors are often willing to take on more risk for the possibility of greater rewards. Taking on less risk could greatly reduce an investors potential return. There is always a trade-off between risk and reward.
Which of the following is not an argument for portfolio diversification?
A
There will be less market risk
B
There are securities in the portfolio with varying grades of risk
C
There is a potential for winners to offset losers in the portfolio
D
Not all securities decrease in value in an adverse market
A
There will be less market risk
Market risk is the possibility that the value of an investment will fall due to a decline in the market as a whole and is unrelated to any adverse conditions of an issuer. A systematic risk is inherent to investing in the market. Diversification does not protect from systematic risks. The other choices all validate diversification.
Which of the following statements is true?
A
Unintentional violations of law are punishable at the civil level
B
It is lawful to omit to state a material fact
C
Unintentional violations of law are considered fraudulent
D
Market manipulation is punishable at only the criminal level
A
Unintentional violations of law are punishable at the civil level
Market manipulation is illegal and is punishable at both civil and criminal levels depending upon the offense and if the behavior was intentional. Intentional violations of the law are considered fraudulent and usually punishable at the criminal level. Unintentional violations are usually punishable at the civil level. Criminal penalties are higher than civil penalties.
When do large-cap stocks tend to outperform mid- and small-cap stocks?
A
When the economy is in the trough
B
When the economy is expanding
C
When the economy has peaked
D
When the economy is contracting
D
When the economy is contracting
Markets can favor a specific capitalization category at different times. Large-cap stocks tend to outperform the other 2 categories when the economy is contracting due to their size and established profile. When the economy is growing, small-cap stocks can outperform the other 2. Therefore, a diverse portfolio will include these various classifications of stock in consideration of market fluctuations.
If an investor places a high percentage of their investable assets in bonds, cash equivalents, and stocks that are less volatile than average they are:
A
Knowledgeable
B
Aggressive
C
Sophisticated
D
Defensive
D
Defensive
This is a method of portfolio allocation and management aimed at minimizing loss of principal. Defensive investors place a high percentage of their investable assets in bonds, cash equivalents, and stocks that are less volatile than average.
A registered representative does not want the employing broker-dealer to know about securities holdings and decides to open a fictitious account at another firm, under another name. Under what circumstance would this be acceptable?
A
If the assumed name is a legal name
B
If the name cannot be tied to the registered representative
C
If the name is the individuals’ surname
D
Under no circumstances
D
Under no circumstances
Establishment of fictitious accounts to execute transactions that otherwise would be prohibited, such as the purchase of new issues by prohibited persons, or to disguise transactions that are against firm policy.
According to the Insider Trading Act, which of the following is not considered an insider?
A
A corporate officer of the company
B
An owner of 10% of the issuer’s convertible bonds
C
Shareholders with more than a 10% ownership
D
A member of a company’s board of directors
B
An owner of 10% of the issuer’s convertible bonds
According to the Insider Trading Act, officers, directors, and anyone owning more than 10% of any class of equity securities are considered insiders. Those that meet this definition are subject to the short-swing profit rule. They cannot not keep profits made from sales of stock they held for less than 6-months. Bondholders are generally not considered insiders, as they are lenders and not owners of the company.
A registered representative can promise a client that the security being recommended for purchase will be resold at a price higher than paid by the client:
A
If approved by the supervising principal
B
If the arrangement is documented in writing
C
Under no circumstances
D
If the customer signs a waiver
C
Under no circumstances
No member firm or associated person can guarantee a customer against loss in connection with any securities transaction or in any securities account.
The risk that an investment’s value will change inversely to changes in the interest rates in the general economy is what type of risk?
A
Interest rate
B
Credit
C
Reinvestment
D
Legislative
A
Interest rate
The risk that an investment’s value will change inversely to changes in the interest rates in the general economy (as interest rates rise, bond prices fall, and vice versa) is interest-rate risk. Interest-rate risk affects the value of bonds more directly than stocks, and it is a major risk to all bondholders.
What type of investment risk relates to the ability of the issuer to remain a profitable organization?
A
Market risk
B
Business risk
C
Interest-rate risk
D
Economic risk
B
Business risk
Business risk occurs when the issuer is unprofitable or fails and the investor loses their money. Interest-rate risk applies to outstanding fixed-income security prices versus interest rates. Market risk is the risk that the entire market declines.
