Unit 1 - Seeking Business

Question 1

Who may approve investment related communications?

Answer 1

General Securities Principals (Series 24) may review and/or approve communications for all securities except options. Limited Securities Principals (Series 26) may only review and/or approve communications for investment company products.

Question 2

What are the 3 different categories of communication defied by FINRA?

Answer 2

• Institutional Communication
• Retail Communication
• Correspondence

Question 3

Define Institutional Communication

Answer 3

Any written communication that is distributed or made available only to institutional investors but does not include a member firm’s internal communications.

Question 4

Define Retail Communication.

Answer 4

FINRA Rule 2210. Any written communication that is distributed or made available to more than 25 retail investors within any 30 calendar day period.

Question 5

What is the approval process for Retail Communication?

Answer 5

Approval by qualified registered principal at member firm before the earlier of its use or filing with FINRA’s Advertising Regulation Department. Requirement does not apply if at time a member intends to use it:

1) . another member has filed with FINRA and has received letter saying it is consistent with applicable standards
2) the member using it has not materially altered it and will use it in a manner consistent with conditions of FINRA’s letter.

Question 6

What are the exceptions to approval rules on FINRA Rule 2210 (retail communications)?

Answer 6

Approval generally will not apply to any retail communication that does not make any financial or investment recommendation or otherwise promote a product or service of the member.

Question 7

Define Retail Customer

Answer 7

Any customer, existing or prospective, that does not fit the definition of institutional client.

Question 8

Define Correspondence

Answer 8

written or electronic communication that is distributed or made available to 25 or fewer retail investors within any 30 calendar-day period. Member firms must establish written procedures to review and address any issues.

Question 9

Which of the 3 types of communication typically requires prior approval?

Answer 9

Retail Communication.

Question 10

Define “public appearance” and it’s approval guidelines.

Answer 10

Public Appearance is participation in a seminar, webinar, forum (including chat rooms), radio, TV or other public appearance or public-speaking activity.
Members must establish written procedures. Pre-approval may be required but is not mandatory.
If an associated person recommends a security in a public appearance, the associated person must have a reasonable basis for the recommendation. And associated person must disclose

Question 11

List 5 categories that fall outside the definition of a research report (and hence FINRA’s guidelines on research reports).

Answer 11

1. discussions of broad-based indices
2. commentaries on economic, political or market conditions
3. technical analysis concerning the demand and supply for a sector, index or industry based on trading vol or price.
4. Statistical summaries of multiple companies’ financial data, including listings of currentnges ratings
5. Notices of ratings or target cha

Question 12

What is the FINRA filing requirement for retail communiction?

Answer 12

10 days before first use if Member is in 1st year of operation and 10 days from first use if member firm is an established firm.

Question 13

What is the filing requirement with FINRA for any retail communication around Options?

Answer 13

10 days pre filing

Question 14

How long must retail communication be kept on file?

Answer 14

3 years from last use.

Question 15

What approval is necessary for Institutional Communication?

Answer 15

No preapproval of a principal is required. When such procedures do not require review of all institutional communications prior to first use or distribution, they must include provision for the education and training of associated persons as to the firm’s procedures governing institutional communications.

Question 16

What approval is necessary for Retail Communication

Answer 16

Preapproval of a principal is required (prior to use).

Question 17

What approval is necessary for Correspondence?

Answer 17

Preapproval of a principal may be required but is not mandated.

Question 18

What approval is necessary for Independently Prepared Reprints (IPR)?

Answer 18

IPRs must be preapproved by a principal if the communication meets the definition of a retail communication.

Question 19

What approval is necessary for Research Reports?

Answer 19

Approval requirements are based on how they are defined (institutional, retail). Research reports must be preapproved by a principal if the communication meets the definition of a retail communication.

Question 20

What approval is necessary for Website communications?

Answer 20

Preapproval of a principal is required.

Question 21

What approval is necessary for Social Media?

Answer 21

Use of an online interactive forum by a RR must be approved by a principal, although each post does not require principal approval.

Question 22

What approval is necessary for emails and instant messaging?

Answer 22

Approval requirements are based on how they are defined (institutional, retail or correspondence).

Question 23

What approval is necessary for Generic Advertising?

Answer 23

Preapproval of a principal is required.

Question 24

How may Members use rankings in retail communications?

Answer 24

1. if rankings are created and published by a Ranking Entity

2. a ranking created by an investment company that is based on standard performance measurements.

Question 25

Bond Mutual Fund Volatility Rating

Answer 25

Is a description issued by an independent third-part, relating to the sensitivity of the net asset value of a portfolio of an open-end management company that invests in debt securities to changes in market conditions and the general economy.

Question 26

Securities Act of 33.

Answer 26

Requires issuers of new securities to file registration statements with the SEC in order to provide investors with complete and accurate information in the form of a prospectus when soliciting sales. Think of the Securities Act of 33 as the Paper Act because of the registration statement and prospectus.

Question 27

Which entities are exempt of the Act of 33?

Answer 27

• US Government
• US municipalities
• Nonprofit religious, educational, and charitable organizations
• Banks and savings and loans
• Public Utilities and common carriers whose activities are regulated as to rates and other items by a state or federal regulatory body.

Question 28

What types of securities are exempt from the Act of 33?

Answer 28

• commercial paper - maturity less than 270 days
• bankers acceptance - maturity less than 270 days
• securities acquired in private placements - restricted stock.

Question 29

What are the ways an issuer or investment banker may “blue sky” an issue?

Answer 29

• Qualification: Issuer files with the state, independent of federal registration, and must meet all state requirements.
• Coordination: The issuer registers simultaneously with the state and SEC. Both registrations become effectivve on the same date.
• Notice filing: Securities listed on a major stock exchange and on NASDAQ, as well as investment companies registered under the Investment Company Act of 1940 are known as federally covered securities. State registration is not required, but most states require the filing of a notice that the issuer intends to offer its securities for sale in that state and the state may assess a fee.

Question 30

Firm Commitment offering.

Answer 30

Most commonly used type of underwriting contract. Under its terms, the underwriter investment bank commits to buy the securities from the issuer and resell to the public. Underwriters assume the financial risk if unable to distribute all shares to the public. Firm commitment = principal capacity, underwriter has the risk.

Question 31

Negotiated vs. Competitive bid underwriting.

Answer 31

• negotiated: the issuer and the investment banker negotiate the offering terms, including amount of securities to be offered, offering price, etc. Standard in underwriting corporate securities
• Competitive bid: standard for underwriting most muni securities and are often required by state law. Investment bankers bid and the issuer awards the securities to the underwriter(s) whose bid results in the lowest net interest cost to the issuer.

Question 32

Standby agreement

Answer 32

Firm commitment when a company’s current stockholders do not exercise their preemptive rights in an additional offering. Corporation has underwriters standing by to purchase unsold shares. A standby offering is a firm commitment offering involving unexercised preemptive rights.

Question 33

best efforts arrangement

Answer 33

The underwriter acts as an agent for the issuing corporation. The deal is contingent on the Underwriter’s ability to sell the shares. Underwriter sells as much as possible with no financial liability. Best efforts = agent capacity, underwriter has no risk.

Question 34

All-or-none underwriting

Answer 34

The issuing corporation has determined that it wants an agreement outlining that the underwriter must either sell all of the shares or cancel the underwriting. Because of uncertainty, any funds collected must be held in escrow.

Question 35

Mini-max offering

Answer 35

Best efforts underwriting setting a floor or minimum which is the least amount the issuer needs to raise in order to move forward with the underwriting and a ceiling or maximum on the dollar amount of the securities the issuer is willing to sell. Most frequently found in limited partnership offerings.

Question 36

What are the 3 phases of the underwriting process

Answer 36

1. Issuer files registration statement with the SEC. Before the filing, no sales may be solicited and no prospectus may circulate.
2. Cooling off period (20 days). No one may solicit sales but indications of interest may be solicited with a red herring.
3. Effective date - offering period may begin. Sales may now be solicited but the firm must use a final prospectus.

Question 37

Red Herring

Answer 37

Red Herring or preliminary prospectus is used to gauge investor reactions and gather indications of interest for corporate securities. Final offering price and underwriting spread are not included. SEC rules prohibit the sale of public offering securities without a prospectus, which means that no sales are allowed until the final prospectus is available.

Question 38

Information found in a tombstone ad:

Answer 38

• name of issuer
• type of security
• underwriter
• price
• effective date of sale

Question 39

Stabilizing bids

Answer 39

When demand is lower than supply the underwriter can stabilize the price. Stabilizing bids must not be made at a price higher than the public offering price (POP). If the stabilizing bid is made at a price higher than the POP, it is called pegging or fixing and is strictly prohibited.

Question 40

Components of Underwriting Compensation

Answer 40

-Underwriting proceeds: price the issuer receives from underwriter
-public offering price: price investors pay
-underwriting spread: composed of manager’s fee, underwriting fee, selling concession.
A member can only grant discounts and concessions to other FINRA-member firms. Exception is foreign nonmember that is ineligible for FINRA membership.

Question 41

Typical underwriting spread allocation

Answer 41

Syndicate manager’s fee: 10-20%
Underwriting syndicate fee: 20-30%
Selling concession: 50-60%

Question 42

Final Prospectus

Answer 42

• includes final offering price and underwriting spread
• a copy of the final prospectus must precede or accompany all sales confirmations. But “access” on the SEC website equals delivery.

Question 43

Summary Prospectus

Answer 43

SEC Rule 498. A mutual fund can provide a summary prospectus to investors that may include an application investors can use to buy the fund’s shares. Full prospectus must be made available if investor purchases shares.

Question 44

Statement of Additional Information

Answer 44

Investors may request without charge. Includes additional information such as fund’s consolidated financial statements.

Question 45

Trust Indenture Act of 1939

Answer 45

Applies to corporate bonds (nonexempt) with the following characteristics:
-Issue size of more than $50M within 12 months
-Maturity of 9 months or more
-offered interstate.
Protects bondholders by requiring the issuers of these bonds to appoint a trustee to ensure that promises (covenants) between the issuer and the trustee who acts solely for the benefit of the bondholders are carried out.

Question 46

Municipal Securities

Answer 46

• 2nd in safety only to US gov’t and agency securities.
• exempt from the filing requirements of 33 but like all other securities they are subject to the anti-fraud provisions of the Securities Exchange Act of 34.
• Full and fair disclosure of material facts is required. Sometimes called the Official Statement. No prospectus or prelim prospectus but there is a preliminary official statement.
• Notice of sale published in Daily Bond Buyer. This notice is used to obtain an underwriter.

Question 47

List 4 provisions that allow for exemption from the registration statement and prospectus requirements of the Act of 33.

Answer 47

Reg A+: small and medium corporate offerings
Reg D: private placements
Rule 147: securities offered and sold exclusively intrastate
Reg S: offers and sales made outside the US by US issuers
and other exempt transactions including Rule 144, 144A and Rule 145.

Question 48

Regulation A+:

Answer 48

provides two offering tiers for small and medium size companies that will allow the companies to raise money without the registration and prospectus requirement of Act of 33.
Tier 1: offerings up to $20M in a 12-month period. Of the $20M, no more than $6M can be sold on behalf of existing shareholders. Subject to coordinated review by individual states and SEC.
Tier 2: offerings up to $50M in a 12 month period. Of the $50M no more than $15M can be sold on behalf of existing selling shareholders. Subject to SEC review only and none at state level. Still subject to rigorous disclosure requiremetns.
-general solicitation is allowed for both h/ever tier 2 must be qualified investors (either be an “accredited” investor or limit investment to 10% of investor’s net worth.
-Investment companies are specifically excluded.

Question 49

Reg D

Answer 49

Private Placements. SEC does not require registration if it is privately place with accredited investors or a maximum of 35 non-accredited investors.

Question 50

Define “accredited” investor

Answer 50

Has net worth in excess of $1M or annual income of $200 in each of the two most recent years ($300K jointly with spouse.

Question 51

Rule 147

Answer 51

Offerings that take place entirely in one state are exempt from registration when:
-issuer has principal office and receives 80%+ of its income in the state
-at least 80% of the issuer’s assets are located within the state
-at least 80% of proceeds are used within the state
-a majority of the issuers’ employees are based within the state
-all purchasers are residents of the state
Purchasers of an intrastate issue may not resell the stock to any resident of another state for at least 6 months.

Question 52

Rule 144

Answer 52

Regulates the sale of control and restricted securities, stipulating the holding period, quantity limitations, manner of sale and filing procedures. Restricted securities are those acquired through some means other than a registered public offering.

• Restricted Stock held by a nonaffiliate: 6 month hold, sell freely thereafter
• Restricted Stock held by an affiliate: 6 month hold, volume limits (1% limit of total shares outstanding at time of sale or average weekly trading vol over past 4 weeks)
• Control Stock (registered) held by an affiliate: no hold, vol limits always apply.

When encountering a Rule 144 question, always look for 2 things: what kind of stock is being sold (restricted or control) and who is selling it (insider or noninsider). Only restricted stock has a holding period. Control stock unless it is restricted can be sold immediately, but vol limits always apply.

Question 53

Rule 144 A

Answer 53

Allows nonregistered foreign and domestic securities to be sold to certain institutional investors in the US without holding period requirements. To qualify the buyer must be a qualified institutional buyer (QIB). A QIB must have a minimum of $100M invested on a discretionary basis and cannot have any affiliation with the entity selling the security.