Supervision - General B/D Activities

Question 1

What are the characteristics of an Equity Linked Note?

Answer 1

Debt instrument where the final payout at maturity is based, in part, on the the return of the underlying equity, which can be a single stock, a basket of stocks, or an index.

A typical ELN is principal protected - investor is guaranteed 100% of original amount invested. No interest during maturity. Final payout, in cash, is the amount of invested capital plus a portion of the the gain in the underlying equity.

Question 2

Distressed debt

Answer 2

Defined as a corporate bond where the issue has filed for bankruptcy or appears likely to do so in the near future.

Question 3

How often are members required to review fee-based accounts?

Answer 3

Periodically to determine whether they remain appropriate. Generally they are unsuitable unless the customer engages in at least a moderate amount of trading.

Question 4

Customer Account Guarantees

Answer 4

A customer’s account may be guaranteed by another customer of the B/D

The account guarantee must be in writing

Guarantees of this nature are prohibited for pattern day traders

Question 5

What is a pattern day trader?

Answer 5

A trader who executed 4 or more trades in a 5 business day period

Question 6

What is the minimum equity requirement for a pattern day trader?

Answer 6

$25,000

Question 7

Prime Brokerage Account characteristics

Answer 7

Customer selects one member firm (prime broker) to provide custody and financing of securities while other firms (executing brokers) handle all trades place by the customer

Prime brokerage customer must maintain a minimum of $500,000 of equity. The minimum net capital requirement is $1,500,000

The customer receives trade confirmations and customer account statements from the prime broker.

Research is not a reason or advantage to customer with prime brokerage accounts

Question 8

FINRA - Monitoring Extension Requests - Clearing and Introducing Firms

Answer 8

FINRA requires clearing firms to file monthly reports within five business days of month end, indicating which of its introducing firms requested extensions that exceeded 2% of their total transactions for the month.

Question 9

What happens when a customer buys and sells a stock in a cash account without fully paying for the buy side?

Answer 9

Account is automatically frozen - no additional purchases without cash on hand - meaning client can deposit full purchase price - and no sales of securities without prior deposit of the certificates.

The account will be unfrozen if funds to pay for the purchase arrive on or before the 5th business day following the trade date

Question 10

How old can a list of borrowable securities be to remain valid?

Answer 10

24 hours

Question 11

SEC Rule 15c 2-1 - Commingling of customers accounts and pledging

Answer 11

Customer’s securities can be commingled with those of other customers if all customers express their consent in writing.

The broker dealer can pledge these securities to a bank to obtain a loan, provided the loan does not exceed the amount the b/d loans to customer.

Customer securities may never be commingled with firm position. The firm may loan out customer margin securities if the customer has signed a loan consent agreement.

Question 12

Minimum Capital Requirement - Market Maker - Stock Price > $5

Answer 12

$2,500 per security in which you make a market.

$100,000 minimum with a ceiling of $1 million

Question 13

Minimum Capital Requirement - Market Maker - Stock Price < $5

Answer 13

$1,000 per security

$100,000 with a ceiling of $1 million

Question 14

Minimum Capital Requirement - Firms Dealing Exclusively in Investment Company Securities

Answer 14

$5,000 for subscription orders only

$25,000 wire orders

Question 15

Minimum Capital Requirement - Introducing Firms

Answer 15

$5,000 if the customer does not accept customer securities

$50,000 if a firm accepts customer securities

Question 16

Allowable capital for minimum capital requirement calculation

Answer 16

net worth (common stock + retained earnings) and subordinated loans, including secured demand notes

Question 17

Maximum aggregate indebtedness ratio for a first year firm

Answer 17

8:1

Question 18

SIPC Coverage

Answer 18

Coverage under SIPC is up to $500,000 per separate customer. Of that total, SIPC covers no more than $250,000 in cash.

SIPC assessments are based on gross volume of securities business and will not be affected by how a member clears its business

Any customer claims that SIPC does not cover will result in the customer becoming a general (unsecured) creditor of the company.

Commodity futures contracts are not covered by SIPC.

Question 19

Minimum capital requirements and definition - Dealer

Answer 19

If an introducing member or a firm engaged solely in the sale of investment company products executives more than 10 trades per year in its investment account, it is considered a dealer for net capital purposes. The minimum net capital requirement for a dealer is $100,000.

Question 20

If a member reduces SIPC coverage, customers must be advised ____ days in advance

Answer 20

30 days

Question 21

Subordinated loan agreements

Answer 21

All subordinated loan agreement must be filed with FINRA 10 business pays prior to the effective date of the cash loans. It may be longer if standard forms are not used.

Question 22

Maximum AI : NC ratio - established firm.

Answer 22

An established firm cannot let its AI:NC ratio exceed 15:1. Otherwise it is in violation of the net capital rule.

Question 23

SEC Rule 10b-17 - Record Date for Dividends

The SEC requires issues to notify the exchange or FINRA at least ____ blank days prior to the record date to have sufficient time to set and publish the ex date for cash dividends, stock dividends and stock splits.

Answer 23

10 days.

This notification is required for symbol or name changes, mergers, acquisitions and bankruptcy.

Question 24

Prepayment of a subordinated loan.

Answer 24

To prepay a subordinated loan

• A firm needs prior approval from its designated enforcement agency
• The subordinate loan must have been outstanding for at least one year
• Prepayment causes it AI:NC ratio to exceed 10:1 or net capital falls below 120% of minimum

Question 25

Introducing Firms - Acceptance of Checks

Answer 25

Both $5,000 and $50,000 introducing firms may accept checks made out to the clearing firm for prompt forwarding

NEITHER may accept checks made out in their name

Question 26

Insider Trading Fines

Answer 26

Insider trading fines are payable to the U.S. Treasury

Member firms can be penalized up to $25 million for the misdeeds of its employees. Natural persons can be fined up to $5 million and 20 years in prison in a criminal proceeding.

Question 27

Temporary Subordinated Loans - Capital Treatment & Use

Answer 27

Temporary subordinated loans are short term an may not be used as a source of long term capital or to correct capital deficiency.

These are normally used in connection with firm commitment underwritings to restore capital reduces by the haircut in the firm’s underwriting commitment.

Question 28

If securities are lost and subsequently recovered, a report must be made in ____ business days

Answer 28

1 day

Question 29

When securities are discovered missing after a B/D conducts a physical securities, the B/D has how many days to resolve the difference before reporting it?

Answer 29

10 days

Question 30

How frequently must a B/D perform a physical securities count?

Answer 30

Quarterly

Question 31

At what frequency must mutual funds provide reports to shareholders?

Answer 31

Mutual funds must provide semiannual and annual reports to shareholders

Question 32

How long must customer statements be retained?

Answer 32

Six years

Question 33

What are the five main records that B/Ds must retain for 6 years?

Answer 33

Blotters
General Ledger
Customer ledger
Stock Records
Customer Account Records

Question 34

Focus IIA reports are filed by introductions firms ___________ within ________ days of the end of the _________.

Answer 34

Quarterly; 17; Quarter

Question 35

All records, whether required to be maintain for 3 or 6 years, must be readily accessible for the most recent _____ years

Answer 35

2

Question 36

A debt-to-equity ratio of more than ______ for a period of more than _____ days is a violation of the net capital rule requiring immediate notification to the regulatory authorities.

Answer 36

70%, 90 days

Question 37

If a B/D’s capital falls below _____% of minimum the firm is in early warning, which requires notification within ________

Answer 37

120%

24 hours

Question 38

A member is in early warning if:

Answer 38

It’s capital fall below 120% of its minimum requirement; or
It’s AI:NC ratio exceeds 12:1

Once a firm discovers that it is in early warning, notification must be made to the regulatory authority within 24 hours. This notice must be made electronically.

An inability to clear trades is an indication that the firms is having significant operational problems, but not an early warning

Question 39

Rule 17a-5 requires that if a accountant or the B/D terminates the associate, the SEC and FINRA must be notified within ____ days

Answer 39

15

The notification must include reasons for the termination and a summary of all disputes the member and its former accountant had over the past 2 years.

A statement from the former accounting firm declaring whether the firm agrees or disagrees with the members interpretation is also included

Question 40

Blotter posting requirement

Answer 40

Most blotters maintained by the B/D must be posted no later than the business day after the transaction.

For receipts and delivery of transactions, the business day after the securities have been received is the deadline.

For cash receipts and disbursements, the blotter must be posted by the business day after the cash we received or disbursed

Question 41

Verification of Ownership

Answer 41

A B/D must inquire as to the validity of ownership of securities delivered by a new customer or by an existing customer that are NOT registered in the customers name.

Question 42

Document Retention - Life of the Firm

Answer 42

Stock Certificate Book

Articles of incorporation or partnership agreement

Minutes of the directors’ meeting

Question 43

The SEC requires trial balances to be prepared ________

Answer 43

Monthly

Question 44

All BDs registered with the SEC must file audited financial statements within _____ of the fiscal year end date

Answer 44

60 days

Question 45

Carrying firms must provide customers with what by when?

Answer 45

Semiannual statement - unaudited balance sheet and net capital computation

Annual statement - audited balance sheet and net capital computation

Question 46

If securities are stolen, the BD should notify

Answer 46

SIC and the transfer agent within 1 business day

The FBI must be notified immediately

Question 47

When a BD suspects that securities are lost or missing, but not stolen, it has ____ business days to find the securities.

Answer 47

2 - if not found the BD must report the loss to SIC and the transfer agent on the next business day

Question 48

If a member is required to record telephone conversation of all its RRs because it has too many representatives were previously associated with disciplined firms, it must do so for a period of ______ years and make ______ reports to FINRA

Answer 48

3 years

Quarterly reports

Question 49

The Trust Indenture Act of 1939 applies to corporate bond issues of ______ or more sold ______.

Answer 49

$50 million

Interstate

The act requires the issuer to appoint a trustee to protect the rights of future bondholders

Question 50

Fidelity Bonds

Answer 50

FINRA rule 5360 requires all member firms to join SIPC and to secure fidelity bonding insurance to insure against employee theft or embezzlement, fraudulent trading, and forgery of securities or checks.

If a members fidelity bond coverage is substantially modified, cancelled or terminated, FINRA must be notified immediately.

Fidelity bonds must be reviewed and renewed annually, within 60 days of the bond’s expiration date (anniversary date)

In determining the fidelity bonding requirement, firms must use their highest net capital requirement over the last 12 months preceding the computing.

Question 51

FINRA Enforcement of Capital Deficiencies

Answer 51

If a firm has computed capital of less than 150% of its minimum requirement for 15 consecutive business days, FINRA can prohibit the firm from expanding it business

If a firm has computed capital of less than 125% of its minimum requirement for 15 consecutive business days, FINRA can require the firm to reduce its business.

Question 52

SEC reserve computation requirements for carrying firms

Answer 52

Carrying firms must perform a reserve computation weekly.

Monthly computation is available if customer credits are no greater than $1 million, the firm’s AI:NC ratio does not exceed 8:1, and the deposit amount, if any, must be 105% of the excess customer credits.

Question 53

Under the Investment Advisors Act of 1930, persons managing more than _____ amount of assets must register with the SEC.

Answer 53

$100 million

Question 54

Investment Manager Diversification

Answer 54

To be diversified, an investment company must have 75% or more of its assets invested in securities.

In addition, the investment company can have no more than 5% of its assets invested in any one security and can own no more than 10% of voting securities of one issuer

Question 55

Th initial contract for an investment advisor or underwriter of a registered investment company can cover a period no longer than ________

Answer 55

2 years

Question 56

Rule 15c3-3 - Customer Protection Rule - Special Reserve Bank Account

Answer 56

• Requires carrying firms to establish a special reserve bank account for the exclusive benefit of client.
• Firms must determine weekly if credits, the amount firms owe customers, exceed debits, the amount customers owe firms.
• If credits exceed debits, the balance must be deposited into the special reserve account.

Question 57

Rule 15c3-3 - Customer Protection Rule - k(1) and k(2) exceptions

Answer 57

K(1) exception is available for broker dealers whole line of business is limited to the sale and redemption of redeemable securities of registered investment companies and insurance company separate accounts.

K(2)I exception is for introducing firms that do not carry margin accounts, and all transaction are processed through a special bank account for the exclusive benefits of clients

K(2)ii is for introducing firms who clear on a fully disclosed basis and who promptly transmit all customer funds and securities to the clearing firm which carries all customer accounts.

Question 58

FINRA Rule 2330

Answer 58

Applies to recommended purchases and exchanges of deferred variable annuities and initial sub account allocations.

Question 59

12b-1 fees

Answer 59

Must be reviewed quarterly by the board of directors

Question 60

Closed End Fund - Delivery of a Prospectus

Answer 60

As a new issue, the sale of a closed end fund requires the delivery of a prospectus. Secondary market trades do not.

Question 61

Mutual Funds - Capital Gains

Answer 61

The investment company act of 1940 specifies that capital gains are to be distributed no more than once per year

Question 62

FINRA Rule 4311

Answer 62

Requires clearing members to notify, in writing, introducing firms chief compliance and chief executive officers of the exception reports offered to introducing members by July 1 of each year

Question 63

Customer Confirmations

Answer 63

Customer confirmations must be given or sent at, or before, completion of the transaction. Completion of the transaction typically occurs on settlement date.