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Series 7 > Unit 2 Obtain Necessary Suitability Information & Approvals > Flashcards

Unit 2 Obtain Necessary Suitability Information & Approvals Flashcards

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Series 7 Top-off Exam flashcards
1
Q

Getting to Know a Client - Financial Information

A
  • Financial investment consideration can be express as a sum of money
  • Financial questions have answers that show up on a customer’s personal balance sheet or income statement
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2
Q

Customer Balance Sheet

A
  • Snapshot of the individual’s financial condition @ a point in time
  • Ask questions like - value of CDs, savings accounts, home, car, collectibles, securities you own; have you established long-term investment accounts; what are your liabilities - owe on mortgage and how large is your credit card debt
  • From this info it can determine the net worth and how much of it is liquid
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3
Q

Customer’s Net Worth

A
  • ASSETS minus LIABILITIES
  • Assets do not include income
  • Liabilities do not include expenses
  • Net worth is relevant in determining an individual’s investment objective (for example - have credit card debt - objective could be debt reduction)
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4
Q

Customer Income Statement

A
  • Info about customer’s marital status, financial responsibilities, projected inheritances & pending job changes
  • Ask questions like - total gross income/family income; pay in monthly expenses; net spendable income after expenses; secure is your employment
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5
Q

Using Customer Balance Sheet & Customer Income Statement

A
  • Client is able to make a lump-sum investment (balance sheet shows a large amount of net assets available)
  • Client is able to make periodic investments (income statement reveals a positive cash flow - there is money at the end of the month)
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6
Q

Noninvestment Considerations

A
  • Cannot be expressed as a sum of money or a numerical cash flow
  • Often carry more weight than the financial considerations
  • Include - age, marital status, # and ages of dependents, employment of you and family members, current & future education and health needs for you & family, risk tolerance, tax status & attitudes towards investing
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7
Q

Customer’s Attitude for Investments

A
  • No matter how much an analysis of a customer’s financial status tells the registered rep about the ability to invest, it is the customer’s emotional acceptance of investing & motivation to invest, which molds the portfolio
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8
Q

Customer Attitude Questions

A
  • What kind of risk can you afford to take?
  • How liquid must your investments be?
  • Are you seeking long-term or short-term investments?
  • Can you tolerate market fluctuations?
  • How stable is your income?
  • How would you react to a loss of 5% or your principal? 10%? 50%
  • What level of return do you consider good? Poor? Excellent?
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9
Q

Customer Risk Tolerance

A
  • Certainly shades of gray when defining
  • Makes it even more critical that the rep and customer are on the same page when it come to the risk tolerance
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10
Q

If you see low risk …

A
  • Conservative
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11
Q

If you see some risk …

A
  • Moderate
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12
Q

If you see more than average risk …

A
  • Moderately agressive
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13
Q

If you see high risk …

A
  • Aggressive
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14
Q

Client contacts rep wanting to purchase securities the rep feels is not suitable for the client …

A
  • Rep has a responsibility to tell the customer that the trade is not suitable
  • If customer insists, rep should place the order & mark the trade unsolicited
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15
Q

How is all the info necessary to complete the customer profile obtained?

A
  • No universal method
  • Client completes a detail questionnaire
  • Personal interview b/t prospect & registered rep
  • Data gathering techniques involve asking prospects to bring in account statements, insurance policies, 401k plan options & maybe tax returns
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16
Q

Why collect statements and/or financial documents?

A
  • Obtaining the info is critical when one needs to measure the sophistication of the investor
  • Viewing the types of securities currently or previously owned can provide a clue
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17
Q

Who is an accredited investor?

A
  • Any individual with a net worth in excess of $1M, not including their primary residence OR
  • Any individual who had an income in excess of $200K in each of the 2 most recent years or joint income with that person’s spouse in excess of $300K in each of those years & has a reasonable expectation of reaching the same income level in the current year
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18
Q

FINRA believes that each member should take reasonable steps to verify accredited investor status by …

A
  • Tax returns or W2s for the previous 2 years
  • Obtaining written representation from the purchaser/investor that he has a reasonable expectation of reaching the income level necessary
  • Bank or brokerage account statements
  • A credit report
  • Obtain written confirmation from: registered BD, investment advisor registered with SEC, a licensed attorney in good standing in client’s jurisdiction or a certified public accountant
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19
Q

Investment Goals

A
  • A goal is where you want to be (end game)
  • Common examples: planning for college, retirement, saving for future purchase, philanthropy, capital to start a biz, leaving a legacy
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20
Q

Investment Objectives

A
  • Are the tools used to reach the investment goals
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21
Q

Three Primary Investment Objectives

A
  • Growth
  • Income
  • Stability (capital preservation)
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22
Q

Three Broad Classes of Investment Objectives with Many Shades In-between

A
  • Growth (can be aggressive, moderate and even conservative)
  • Income (can be current, future, or high risk)
  • Preservation of Capital (safety)
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23
Q

Concept of Investment Objectives

A
  • Picture an equilateral triangle with 3 equal sides (leg) and each point being an objective - Growth, Income & Safety
  • It is true that the closer you move on the leg to one of these points (objective), the farther you move from the others
  • For example if you wish to maximize your growth, you go all the way to the G and move farther away from the I and the S
  • The role of the rep is determine where the customer’s objectives lie
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24
Q

It is important to to understand with investment objectives …

A
  • You can’t maximize all three (growth, income & safety) - something has to give
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25
Q

Investment Constraints

A
  • Limitations or restrictions that are specific to your client
  • “We’d like to buy this, but we can’t.”
  • Examples: liquidity needs, time horizon & personal ethical choices
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26
Q

Preservation of Capital Objective

A
  • Many people want to avoid any drop in value of their investment but these investors are specifically seeking SAFETY
  • There is a trade-off with reducing risk, the investor is sacrificing the opportunity for higher income
  • Exposed to inflation (purchasing power) risk
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27
Q

Income Objective

A
  • Primary factor is the amount of risk the investor is willing and/or able to take
  • The risk/reward principle is quite clear - the more risk, the greater the potential reward and vice versa
  • Example of income & safety would be US Treasury securities
  • Example of income & growth would be investing in high-yield (junk) bonds
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28
Q

Growth (Capital Appreciation) Objective

A
  • The term growth refers to a broad spectrum of objectives
  • Some are very high risk tolerance and want their portfolio to be solidly on G while others are quite conservative and are closer to S while still on the “leg” of G
29
Q

Speculation Objective

A
  • Although a subcategory of growth, speculation is often listed as specific objective
  • Try to earn much higher-than-average returns in exchange for higher-than-average risks
  • Use margin, sell short & trade in options or penny stocks
30
Q

Time Horizon

A
  • Investment constraint
  • Time horizon & liquidity needs will determine the level of volatility the client should assume
  • 20 to 30 year time frame, dramatic volatility (changes in prices of a security/commodity) is acceptable
  • 3 to 5 year time frame should be invested for safety & liquidity
  • Particularly important constraint when planning for college or retirement
31
Q

Liquidity

A
  • Investment constraint
  • A need for a certain sum or might just like the idea that they can get their money literally at a moments notice
  • Product is liquid if a customer can sell it quickly at face amount (or very close to it) or at fair market price
  • Liquid investments does NOT mean you won’t lose money on your investment
32
Q

Liquid Investment Examples

A
  • Securities listed on an exchange or Nasdaq
  • Mutual funds
  • Exchange-traded funds
  • Most real estate investment trusts
33
Q

Illiquid Investment Examples

A
  • Annuities (when initially purchased and/or when the annuitant is under age 59 1/2)
  • Real estate
  • Securities purchased in a private placement
  • DPPs
  • Hedge funds
34
Q

Two Ways to Reduce Taxes

A
  • Tax deferral
  • Tax-free income
  • Taxes are an investment constraint
35
Q

Tax Deferral

A
  • Certain contributions (IRA or TSA) may be tax deductible & and are not taxed until withdrawn
  • Two benefits to investor: investments made with pretax money and no taxes on the income & growth UNTIL the money is paid out
36
Q

Tax-free Income

A
  • Municipal bonds pay interest that is free from federal taxation (some cases where it is taxed at state level)
  • Depending on the investor’s tax bracket, tax-free income may result in higher returns on an after-tax basis
37
Q

Laws & Regulations Investment Constraints

A
  • Example would be the case of the accredited investor - perfect security to meet objective but can’t make the purchase bc of lack of accredited status
  • Example is the desired security is not registered for sale in the client’s state of residence
  • Certain investments that are illegal or inappropriate for an IRA
38
Q

Unique Circumstances and/or Preference Investment Constraints

A
  • Some of the same goals keep coming up so it is important to understand that these are all unique individuals with their own needs & wants
  • Desire to avoid investing in certain industries like ESG (Environment, Social & Governance) Investing - strong feeling about environmental issues and won’t invest in companies considered polluters or create health issues or investor has parent die of lung cancer won’t invest in tobacco companies
  • Unique cases like receiving a large inheritance or multi-million dollar lottery win could change objectives pretty quickly
39
Q

Suitability

A
  • FINRA’s suitability rules have always been based on a fundamental requirement to deal fairly with customers
  • Firms and their associated persons must have a reasonable basis to believe that recommended transaction or investment strategy involving securities is suitable for the customer
  • The more info a registered rep has about a customer’s income, current investment portfolio, retirement plan, net worth, customer’s financial situation the better the recommendation
  • The more a customer knows about the risks & rewards of each type of investment, the better the decisions
40
Q

Rule 2111

A
  • Effective in 2011 (proposed in 2009 by FINRA)
  • Three main obligations: reasonable-basis, customer-specific and quantitative suitability
41
Q

Reasonable-Basis Suitability

A
  • Registered rep has a reasonable basis to believe that a recommendation is suitable for at least SOME investors
  • Rep must recognize the potential risks & rewards associated
  • If the rep can’t explain risks, they are violating the rule
42
Q

Customer-Specific Suitability

A
  • Registered rep has a reasonable basis to believe that the recommendation is suitable for a SPECIFIC customer
  • Recommendations would be based on that customer’s investment profile
43
Q

Quantitative Suitability

A
  • Registered rep has a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, are NOT excessive & UNsuitable for the customer when taken together
  • Commissions generated, profits-to-cost ratio & the use of in-and-out trading in a customer’s account may provide a basis for a finding that there’s been a violation
44
Q

An investor opens an account but only provides minimum info. What are the responsibilities of the rep?

A
  • The rep is limited to what can be recommended to the customer based on the info that was provided
  • The rep is making recommendations that they believe are suitable based on the info they have
    • It is when a customer insists on making a trade that is considered unsuitable that the order be marked unsolicited
45
Q

Options Accounts

A
  • Trading options generally involves a higher degree of risk than stocks, bonds or mutual funds
  • Higher risk requires that a designated supervisory person w/ knowledge about options must approve the account opening
  • Special options disclosure document (ODD) that must be provided to any prospective options customer
46
Q

To get a customer’s account approved for options trading …

A
  • Member firm or registered rep with the BD must exercise due dilligence
  • Learn the essential facts relative to the customer such as investment experience and knowledge - # of years of trading & the size of the trade, frequency & type of transactions for options, stocks and bonds, commodities
  • Designated supervisor uses this info to approve or disapprove the account
47
Q

Options Account Approval Will Indicate

A
  • Date the ODD is furnished to customer
  • Nature & types of transactions for which the account is approved (buying, covered writing, uncovered writing, spreading, discretionary transactions)
  • Name of the registered rep assigned
  • Name of the supervisor approving
  • Date of approval
  • Dates of verification of currency of account info
48
Q

Special Options Account Agreement

A
  • Describes the risks of options trading & the rules the customer must follow
  • Must be signed & returned to the firm/rep within 15 days after the account has been approved
  • Customer agrees to advise the firm of any changes that occur to their financial situation, investment objectives, etc
49
Q

Order of Steps in Opening An Options Account

A
  • Obtain essential facts about the customer
  • Give the customer an options disclosure document (ODD)
  • Have the manager approve the account
  • Enter the initial order
  • Have the customer sign & return the options agreement within 15 days
50
Q

Margin Accounts

A
  • Requires more documentation than opening a regular cash account
  • Includes 3 documents: credit agreement (mandatory), the hypothecation agreement (mandatory), a loan consent (optional)
  • FINRA rules require that the client sign the margin documents no later than the first trade in the account
51
Q

Margin Credit Agreement

A
  • Discloses the terms of the credit extended by the BD
  • Includes the method of interest computation & situations under which interest rates may change
  • Must be signed
52
Q

Margin Hypothecation Agreement

A
  • In a margin account, the collateral is the security purchased on margin
  • This gives the BD a lien on the customer’s margin securities
  • Must be signed
53
Q

Margin Loan Consent Form

A
  • Gives permission to the firm to loan the customer’s margin securities to other customers or BDs - usually for short sales
  • Optional
54
Q

Margin Risk Disclosure

A
  • BD must provide to margin customers on an annual basis
  • Discusses the risks associated with margin trading like:
    • Customer are not entitled to choose which securities can be sold if a maintenance call is not met
    • Customers can lose more money than initially deposited
    • Customers are not entitled to an extension of time to meet a margin call
    • Firms can increase their in-house margin requirements w/o advance notice
55
Q

Discretionary Accounts

A
  • Customer has authorized the BD or RR to make the investment decisions in the account
  • Normally an order to buy or sell a security is at the direction of the client but many clients prefer the convenience of letting their securities professional “call the shots”
  • Being able to determine the trading activity presents a potential conflict of interest as BDs/agent’s compensation is transaction-based (the more trading in the account = more income)
56
Q

Discretion

A
  • Is defined as the authority to decide: which security, the # of shares or units OR whether to buy or sell
57
Q

An order is discretionary if any one of the three A’s are missing …

A
  • Activity/action
  • Amount
  • Asset
58
Q

FINRA rules prohibit the exercise of any discretionary power by a BD/agent in a customer’s account unless …

A
  • Customer has given PRIOR WRITTEN authorization (power of attorney) to a stated individual(s)
  • Account has been accepted by the brokerage firm, as evidenced in writing by the firm and until the document is on file, no discretionary transactions can take place
    • Customers may also continue to enter orders on their own if they wish
59
Q

Discretion - Time or Place

A
  • Exception to the discretionary rule
  • An oral grant of time or price discretion is limited to the end of the biz day on which the customer grants it
  • If the order is to be good longer, the customer must state it in writing
  • Any exercise of time or price discretion must be reflected on the order ticket (as is the case w/ regular discretion)
    • FOR EXAMPLE: “Buy 100 shares of ABC for my account whenever you think the price is right.” is not a discretionary order bc the client has specified the action (buy), the amount (100 shares) and the asset (ABC) - time or price are not considered discretion
60
Q

Discretionary Account Are Subject to Rules

A
  • Each discretionary order must be identified as such when entered
  • An officer or partner of the brokerage house must approve each order promptly and in writing (not necessarily before order entry)
  • Record must be kept of all transactions
  • No excessive trading or churning may occur
  • Account must be checked regularly
61
Q

Fiduciary Accounts

A
  • Requires evidence of the individual’s appointment & authority which usually comes from the court
  • No documentation is required for an individual to open an UGMA or UTMA
  • Discretion authority usually makes one a fiduciary
62
Q

Fiduciary

A
  • One who has the legal power to act on behalf of another person
  • Examples: trustee named on a trust, executor designated in a decedent’s will, admin appointed by the court to liquidate the estate of a person who died (w/o a will), guardian designated by the courts to handle a minor’s affairs, receiver of a bankruptcy or a conservator
63
Q

Corporate Accounts

A
  • Must establish:
  • The biz’s legal rights to pen an investment account
  • Indication of any limitations that the owners, the stockholders, a court or any other entity has placed on the securities in which the biz can invest
  • Who will represent the biz in transactions
  • Must obtain a copy of the corporate charter & corporate resolution
64
Q

Corporate Charter

A
  • Is proof that the corporation does exist
65
Q

Corporate Resolution

A
  • Authorizes both the opening of the account & the officers designated to enter orders
66
Q

Partnership Accounts

A
  • Partnerships frequently open cash, margin, retirement & other types of investment accounts for biz purposes
  • Must complete a partnership agreement stating which of the partners can make transactions and well as any investment limitations (if any)
  • Amended partnership agreement must be obtained each year if changes have been made
67
Q

Sole Prop Accounts

A
  • Is opened like an individual account
68
Q

Numbered Accounts

A
  • Customer’s account may only be identified by only a multi-digit number or symbol
  • Customer must sign a form certifying the they own the account(s) identified by the number or symbols
  • Tax reporting is done the same as any other account
  • Example: celebrities for privacy

Series 7 (4 decks)

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