Supervising the Delivery of Products and Services Offered by the BD Flashcards
What are three categories of investment companies under the Investment Company Act of 1940?
1) management companies — open-end (mutual fund); closed-end (CEF)
2) Unit investment trusts (UITs)
3) Face-amount certificates (FAC) companies - these are rare
In what circumstances does the 34 Act allow for “soft dollars” or non-cash compensation from an investment advisor to a BD?
Soft dollar bundles can include:
1) research services provided by the BD
2) educational or research seminars and meetings (EXCLUDING T&E)
3) Information systems or computer software that assists with investment and market analysis
NOTE - soft dollars cannot be redeemed for items that don’t DIRECTLY benefit the investment advisor’s clients (i.e. marketing assistance, office equipment etc)
In context of open ended fund, how is NAV calculated?
(Total fund assets - total fund liabilities) / number of outstanding shares
True / false: a mutual fund sponsor (underwriter) buys shares from mutual funds at the NAV and resells to end customer or BDs at a higher price, the public offering price
true
Note if BDs acquire from sponsors it’s at a discount to POP and they then resell at POP to end customer
What is the 75-5-10 rule (mutual funds)?
It’s a rule that…
75% of the total assets must be invested in securities issued by THIRD PARTY companies (relative to the investment company);
Within the 75%, no more than 5% of the funds total assets can be invested in ONLY ONE ISSUER; and
Within the 75%, the fund can own no more than 10% of the outstanding voting securities of ANY ONE ISSUER
NOTE - the remaining 25% is free from restriction / concentration rules
How often must open ended funds calculate their NAV?
daily
When investors purchase mutual fund shares OR UITs from a BD of the investment advisory firm, what is the maximum sales charge (sales load) they can charge?
a maximum of 8.5% of the Public Offer Price
In context of mutual funds, what are the annual fees called that are charged in addition to sales charge that covers the marketing and distribution expenses?
What is the maximum amount of this fee that can be charged?
12b-1 fees
The maximum 12b-1 fee that can be charged is 1% of a Fund’s NAV (if a load fund) or 0.25% (if a no-load fund)
What are the four classes of shares that a mutual fund can sell?
What are the features of each class?
Class A = shares have front-end sales charges (loads) paid at the time the shares are purchased; can offer breakpoints (bulk discounts); typically lower 12b-1 fees / lowest expense ratio
Class B = have back end deferred sales charges paid that is paid when investor redeem inside a certain number of years; NO breakpoints; typically higher 12b-1 fees
Class C = do not impose an upfront sales charge but instead charges a flat ongoing fee (level load) in addition to high 12b-1 fees; NO breakpoints
No Load = mutual fund shares sold at their NAV (NAV and POP are the same) - NO sales charge added but are bought directly from the investment company vs. BD
What type of investor are Class A mutual fund shares most suitable?
investors who intend to hold their shares for the long term (7+ years) as well as those making large purchases and want to take advantage of breakpoints
What type of investor are Class C mutual fund shares most suitable?
Investors who want to make short term mutual fund investors (btwn 1 - 3 years)
If a fund charges the maximum sales charge / load - what three features must they offer?
if they charge a 8.5% sales charge they must offer…
1) Breakpoints - bulk discounts based on amount of money invested in the funds; investors are allowed to sign LOIs and invest over 13 month pd (and can be backdated 90 days)
2) Rights of accumulation - sales charge on NEW investment is determined by adding the new investment to the account balance (including any benefit from accumulation); no need for LOI / no time limit
3) automatic reinvestment of dividends at NAV (no additional sales charge)
NOTE - Without these features the maximum sales charge is 6.25%
True / false: all of open ended, closed ended an UITs are actively managed
false - only open ended (mutual) and closed ended funds are actively managed; unit investment trusts are NOT actively managed
True / false: both mutual funds and UITs are non traded in secondary market and must be redeemed by trust
true - both can be bought back at NAV
Must buy / sell from the trust vs. other investors
What are certain benefits of UITs over mutual funds?
1) cost is lower (given passive management / fixed investment strategy)
2) tax efficiency (given not actively traded)
True / false: UITs have fixed termination dates
true - trust terminations range from 13 mos to 30 years
True / false: ETFs are traded based on their NAV
False - the shares can trade at a premium or discount to NAV driven by supply / demand (which fluctuates throughout the day)
Between ETFs and CEFs, which are likely to trade at a wider premium / discount to NAV
CEFs - often trade at prices 10 - 20% higher or lower than NAV vs. ETDs which traded within narrow range of NAV
Unlike mutual funds, with CEFs or ETFs when are sales charges applied?
investors pay commissions at time of each buy / sell transaction
What are two types of ETFs?
1) leveraged ETFs - seek to generate a multiple of the return of the related benchmark index (negative returns are also magnified)
2) inverse ETFs - designed to move in the opposite direction of the benchmark it follows (using derivatives)
True / false: Open ended funds have unlimited shares where as CEFs, UITs and ETFs have a fixed amount of shares
true
True / false: UITs and mutual funds do NOT trade on exchanges whereas ETFs and CEFs do trade on exchanges
true
This investment vehicle includes S-Corps and LPs and give investors a share in cash flows and tax benefits of an underlying entity without holding an active management role in the business
Direct participation programs or DPPs, which proportionally share both their losses and income with investors
Losses flow through and can be used to offset PASSIVE gains to reduce taxable income and reduce taxes (NOTE - ordinary income and capital gains cannot be offset by passive losses, only passive income from other sources)
What type of investor would be suitable for a DPP?
high tax bracket investors who don’t have a high need for liquidity or high visibility into management
True / false: most DPPs do not trade in the secondary market and are designed to be held to a specific termination date
true
Firms that make public offers of DPPs must disclose
1) an annual per share estimated value of the DPP (based on reliable valuation)
2) explanation of the valuation methodology and the date of the valuation
Note that this valuation method is also disclosed on a customer’s account statement and the fact that distributions may include return of capital (reducing per share value) and investments may be illiquid, and if sole, price received may be lower than what’s indicated
true / false: with variable whole life insurance products both a minimum cash and death value are guaranteed
false - minimum cash value is not guaranteed, and the actual amount of cash value in the policy is based on the performance of the sub accounts chosen by the investor
A minimum death value IS guaranteed
True / false: with universal life insurance (variable or fixed), the premiums are flexible in amount and due date but if sufficient premium is not paid the policy will lapse
true
What is the maximum interest rate assumption allowed by FINRA for illustrations for both variable life insurance and variable annuities?
12%
And if a 12% column is shown, a column must be shown with 0% return as well
Illustrations must always reflect the maximum mortality, expense and admin fees the insurer can impose
What are the two phases of a variable annuity?
the accumulation phase - time during which an annuity owner is paying into the contract (there is a death benefit of getting max of amount contributed or value of accounts)
The annuitization phase - where distributions can begin without penalties at age 59.5 (early withdrawals subject to 10% penalty on earnings)
What are four annuity payout options?
1) straight life - gurantees payments for life of annuitant regardless of how long lives (no payment to beneficiaries upon death)
2) life w certain period - guarantees a minimum timeframe for payments to be made (i.e. for 10 to 15 years - beneficiary only protected during the guaranteed minimum period)
3) joint w last survivor - ensures that income will continue through death of a SECOND annuitant, regardless of who dies first (ie. For married couples); can be full or partial payment to survivor
4) unit refund - provides a residual benefit to named beneficiary of annuitant should death occur during annuity payout phase IF teh amount paid prior to death is less than account value
True / false: all applications for VARIABLE annuities must be forwarded to an OSJ for suitability review by a S24 RP before application is submitted to insurance company
true
Review must occur no later than 7 BUSINESS days after receipt of as complete application
NOTE - a member can forward funds / check to the insurance company prior to principal approval (and pending such approval)
True / false: a 1035 exchange allows an owner of an annuity to exchange an existing annuity or life insurance contract for a new annuity contract without paying any tax at time of the exchange
true
The contract exchange must take place directly btwn teh insurance companies
NOTE - 1) an annuity can be exchanged for another annuity; 2) a life insurance policy can be exchanged for another life insurance policy; 3) a life insurance policy can be exchanged for an annuity; BUT 4) an annuity CANNOT be exchanged for a life insurance contract
The trust indenture act of 1939 requires corporate issuers of bonds to assign trustee if this amount of debt is issued
$50mm of non-exempt debt securities
What are the two suitability standards that must be met for new products?
1) reasonable basis suitability - the security is suitable for at least SOME of the firm’s customers
2) customer specific suitability - that the product can be recommended to specific individuals based on their profile
What is a key focus on suitability of offering DDPs to customers?
1) whether they have a tax profile that can take full advantage of the product’s features
2) does customer have high enough net worth to be able to sustain total capital loss
True / false: a rep with discretionary authority to execute a DPP in a customer’s account must still receive prior written consent nws discretionary authority
true
Yes, they are that risky
Prior to a sale of a CMO product what much a RR offer to investors?
1) a glossary of terms
2) a set of questions an investor should ask the rep prior to investing (and then answering those questions)
What is a DPP roll-up?
A transaction that combines multiple DPPs into one larger single entity
What is required before a BD is able to solicit votes / tenders for a DPP roll-up?
A BD’s compensation (MAXIMUM 2%) is paid REGARDLESS of whether the LPs vote affirmatively or negatively in the proposed transaction (i.e. comps is not contingent upon a successful roll-up)
NOTE - the general partners / sponsors must pay all solicitation expenses in event the transaction is rejected
Qualified REITs can deduct dividend distributions paid (avoiding corporate double tax) if what is true?
1) the REIT must generate 75% of its income from real estate; AND
2) must maintain at least 75% of its assets in real estate; AND
3) must distribute at least 90% of its taxable income to shareholders annually
By when must a non-traded REIT given an estimated value?
within 150 days of the second anniversary of the deal breaking escrow
Open ended ICs (mutual funds) must disclose their average annual total return and after tax returns over what periods?
one year, five tear and ten year periods
NOTE - if fund has not been existence for 1, 5 or 10 years, the time period during which the registration statement was in effect (how long it’s be in existence) is substituted for the final period
True / false: a rep who tells a client who wants to make a large purchase of mutual funds to “buy into several mutual fund families” in order to assure diversification is engaging in a PROHIBITED breakpoint sale
true
Single fund families offer numerous choices for diversification within their brand name and this is an attempt to prevent the client from aggregating purchases —> prohibited “breakpoint sale”
HOWEVER a rep might reasonably place a client into 4 - 6 different mutual funds if the goal is to create a diversified portfolio across ASSET CLASSES
True / false: would it be suitable for a rep to recommend to the owner of a company to fund the company’s 401k with a deferred variable annuity
false
What is a reverse convertible bond?
a debt instrument that allows the issuer (not the investor) to convert the bond’s principal into shares of common stock
True / false: a reverse convertible bond is likely suitable only for HNW retail investors or other sophisticated investors
true
A reverse convertible bond might make sense for an investor who wants higher coupons / yield but subject to additional risk in addition to credit risk of issuer
Are hedge funds subject to the 1940 Act?
No and are only sold to accredited investors
