SECURITIES LAW

 STATE SECURITIES LAWS

FINRA Series 63

The Series 63 is a securities exam and license entitling the holder to solicit orders for any type of security in a particular state. To obtain a Series 63 license, the applicant must pass an exam and possess knowledge of ethical practices and fiduciary obligations. In most states, individuals who want to become licensed to sell securities must pass the Series 63 or Series 66 examination, depending on the level of other registration the individual has. The Series 63 exam allows individuals to become securities agents and to solicit orders for any type of security in a particular state. Securities Agent is the term used by the Uniform Securities Act (‘USA’) for a FINRA ‘Registered Representative’ (‘RR’). The Uniform Securities Act is at the heart of the Series 63 exam. The act is not a federal law, it's a set of state laws based on a model created by an organization of people who administer securities laws within the states. Series 63 exam is based on the Uniform Securities Act, as well as Statements of Policy and Model Rules adopted by NASAA.  Uniform Securities Act came to be known as the Blue-Sky Laws.  The Uniform Securities Act is oriented toward the protection of the average investor than the protection of institutions.  Applicable to the Series 63 exam, is the registration of investment advisors. Under NSMIA, an investment advisor (or a firm) registers either with the Securities and Exchange Commission (SEC) (as a federal covered advisor) or with the state under the USA. The assets the firm manages, along with other considerations, are factors that specify the exact registration requirements. Although not as critical to an understanding of how the USA functions, the GLBA of 1999 changed the nature of registration for broker-dealers and in certain cases, allowed banks to register as broker-dealers. Thus far, banks have continued the practice of creating broker-dealer subsidiaries rather than registering as such themselves. Under the USA, banks still enjoy a wide range of exemptions. Policy Statements, Memoranda of Understanding and Model Rules of NASAA," this law is the source material for the exam NASAA's Adopted Model Rules and Adopted Statements of Policy Although there are three versions of the Uniform Securities Act, as mentioned above, only one of them, the 1956 Uniform Securities Act is relevant to the Series 63 exam.  NASAA was organized in 1919, the North American Securities Administrators Association (NASAA) is the oldest international regulatory organization devoted to investor protection. NASAA is a voluntary association whose membership consists of 67 state, provincial, and territorial securities administrators in the 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Canada, and Mexico. It works to protect customers of investment advice and securities as part of a complementary regulatory system that works at the federal, state/provincial, and industry levels. NASAA seeks to help investors identify and avoid fraud by educating the public, investigating violations of state and provincial law, and filing enforcement actions. The North American Securities Administrators Association (NASAA) is an organization of securities regulators whose aim is to protect investors from fraud. A registered representative (RR) is a person who works for a brokerage company and serves as a representative for clients trading investment products such as stocks, bonds and mutual funds.

EXAM TOPICS AND NUMBER OF QUESTION WEIGHTING

Series 63 Exam format: rules and regulations: 75% ethics: 25% 

Fiduciary obligations refer to the expectations of trust between securities agents and their clients with regard to making investment decisions that are always in the clients’ best interest.

THERE ARE 1) BD FIRMS, 2) BD INDIVIDUALS, 3) IA FIRMS AND 4) IA INDIVIDUALS.

Broker Dealers and Investment Advisers are business entities, firms. Agents and Investment Adviser Representatives (RR’s) are always natural persons/individuals.  Broker-Dealers: Must be registered with the state.  Investment Advisors: Must be registered with the state (unless they are federal covered" advisors - these are firms). Investment Advisory Representatives (RR’s): Must be registered with the state - these are the people who work for investment advisors.  If a broker-dealer (BD FIRM) is located in a state, they register in that state. If a broker-dealer is out-of-state, they only register in the other state if their clients are non-institutional/non-accredited. If their clients are institutional, they don’t have to register in that other state. If an investment adviser (IA FIRM) is out-of-state, they only register in the other state if they have more than 5 non-institutional clients. If their clients are institutional, they don’t have to register in that other state. If an investment adviser is in the state, they register in the state unless they are “federal covered,” which means they:  Manage > $30 million in assets  Advise mutual funds  Advise insurance companies. Investment advisers (IA FIRMS) may be federal covered, but the IA reps (IA INDIVIDUALS) still register in the state. 

Regulation of Investment Advisers (IA firms), both state-registered advisors and those registered with the Securities and Exchange Commission (SEC): Investment advisers are firms that offer advice about securities in exchange for a fee. (3 Questions); Definitions of professional titles, duties, and roles; Registration process; Post-registration requirements; Termination protocol.  IA FIRMS: Definitions of an Investment Adviser (e.g., activities requiring registration) 3 - An investment advisor (also known as a stockbroker) is any person or group that makes investment recommendations or conducts securities analysis in return for a fee, whether through direct management of clients' assets or by way of written publications. The precise definition of the term was established through the Investment Advisers Act of 1940. An investment advisor with sufficient assets to be registered with the Securities and Exchange Commission (SEC) is known as a Registered Investment Advisor (RIA). Investment advisors are also referred to as “financial advisors” and can alternatively be spelled as “investment advisers” or “financial advisers.” In the U.S., investment advisors are required to register at the state level, and they also need to register with the SEC if they manage $100 million or more in client assets. Investment advisors often have discretionary authority over their clients’ assets and are required to uphold standards of fiduciary responsibility. IA has fiduciary responsibility to put clients’ interest ahead of their own.  investment advisors must ensure that clients’ transactions are given priority over their own and that any recommendations made to clients are well tailored to those clients’ needs, preferences, and financial circumstances. Investment advisors must also be careful to avoid any real or perceived conflicts of interest. One way in which investment advisors seek to minimize real or perceived conflicts of interest is through their compensation structure. Investment advisors are paid through fees which cause their own success to be linked to that of the client. For example, an investment advisor might charge a management fee based on the size or performance of the client’s assets. That way, the investment advisor has a clear financial motive to work toward the client’s success. Investment advisors often have a level of discretionary authority which allows them to act on behalf of their clients without having to obtain formal permission prior to executing a transaction. However, this authority must be formally provided by the client, generally as part of the client onboarding process. As of 2018, investment advisors operating within the U.S. must register with the SEC if they manage assets totaling $100 million or more. Investment advisors with lesser amounts of assets are still eligible to register, but they are only required to register at the state level. Additionally, records regarding investment advisors and their associated firms must also be kept, to enable oversight of the industry. Real World Example of an Investment Advisor: Suppose you are a 65-year-old retiree that has just hired an investment advisor to manage your retirement funds. The advisor you chose was recommended for her close adherence to the best practices of the investment management industry. You recently downsized your home and have $1 million in combined retirement savings. You have some experience investing and are comfortable buying blue-chip stocks. However, given your age and risk tolerance you are mostly interested in preserving your principal and ensuring you have adequate money to fund your lifestyle for the next 20 or more years.  At your first meeting, your investment advisor began by asking you a series of questions designed to thoroughly understand your retirement plans, financial circumstances, risk tolerance, investment objectives, and other factors relevant for assessing your needs. She carefully explained her compensation structure (a mixture of flat fees and performance fees) and addressed the measures she takes to minimize real or perceived conflicts of interest. She explained that as part of the onboarding process she would obtain discretionary authority over your investment accounts and that she would have a fiduciary responsibility toward you as her client. Lastly, she directed you toward resources where you can verify and monitor her registration status. After thoroughly answering your questions, your adviser suggested various potential investment strategies designed to best meet your needs given your budget and preferences. After careful discussion, you agreed on a course of action and completed the ongoing process. In the months and years ahead, you would continue to have scheduled communication with your adviser where she would update you on the status of your investments and address your concerns.

Regulation of Investment Adviser Representatives (IARs): Investment Adviser Representatives are the individuals associated with an investment adviser firm. (3 Questions); Definitions of professional titles, duties, and roles; Registration process.  IA INDIVIDUALS (REPS): definition of an Investment Adviser Representative (e.g., activities requiring registration) 3 – 

BD INDIVIDUALS, aka Registered Representatives - What Is a Registered Representative (RR). A registered representative (RR) is a person who works for a brokerage company and serves as a representative for clients trading investment products such as stocks, bonds, and mutual funds. Registered representatives are also known as brokers. Understanding Registered Representatives (RR). Registered representatives can buy and sell securities for clients. They are primarily known as transaction-based service providers. To carry out these transactions a registered representative must be licensed to sell the designated securities. They must also be sponsored by a firm registered with the Financial Industry Regulatory Authority (FINRA). To become licensed as a registered representative for a sponsoring firm, a person must pass the Series 7 and Series 63 securities examinations. These exams are administered by FINRA. The Series 7 license allows the registered representative to buy and sell stocks, mutual funds, options, municipal securities and some variable contracts for their clients. The Series 63 license allows the representative to trade variable annuities and unit investment trusts. A substantial portion of the Series 63 exam is focused on state securities requirements across the U.S. Other licenses may also apply for various other types of transactions. Compare and contrast with Series 66 licenses. Standards for Registered Representatives: Investors seek registered representatives to carry out financial market transactions on their behalf. Registered representatives typically have access to a full range of market trading capabilities which fit the needs of their investors. They may also be able to execute thinly traded securities or have access to new securities launches. Registered representatives differ from registered investment advisors. Registered representatives are governed by suitability standards while registered investment advisors are governed by fiduciary standards. Registered representatives are transaction-based service providers. U.S. regulators require that registered representatives ensure an investment is suitable for an investor given their investment profile. They also ensure that trades are executed efficiently. Investors will incur sales charges determined by securities issuers when dealing with a registered representative. Registered investment advisors seek to offer more holistic financial plans and investing services. They offer very different fee schedules and are typically fee-based by assets under management. Registered investment advisors are regulated by fiduciary standards which go beyond standard suitability. Registered investment advisors develop comprehensive financial plans and must ensure the best interest of the client.

BD INDIVIDUALS (AGENTS): (NOT A DIRECT EXAM TOPIC) CHOOSING A BROKER: FINRA also offers a service called BrokerCheck. Through BrokerCheck an investor can research the experience of brokers and brokerage firms. There are over 3,700 broker-dealers to choose from, according to the Financial Industry Regulatory Authority (FINRA).  By definition, broker-dealers are buyers and sellers of securities, and they are also distributors of other investment products. As the name implies, they perform a dual role in carrying out their responsibilities. As dealers, they act on behalf of the brokerage firm, initiating transactions for the firm’s own account. As brokers, they handle transactions, buying and selling securities on behalf of their clients. In their dual roles, they perform a couple of vital functions; they facilitate the free flow of securities on the open market, and they buy or sell securities in their own accounts to ensure there is a market in those securities for their clients. In this regard, broker-dealers are essential, and they are also well-compensated, earning a fee on either or both sides of a securities transaction. Special Considerations: Broker-dealers that are tied directly to investment banking operations also engage in the underwriting of securities offerings. When a broker-dealer acts as an agent of the issuing company, either as a principal underwriter of the stock or bond offering, or as a member of the underwriting syndicate, they enter into a contractual arrangement, acting on a “firm commitment” with the issuer that obligates them to distribute a certain amount of the securities offered to the public in exchange for an underwriting fee. They may also acquire a piece of the securities offering for their own accounts and may be required to do so if they are unable to sell all of the securities. Once the underwriting process is completed and the securities are issued, the broker-dealers then become distributors, and their clients are typically the target of their distribution efforts. In that effort, the financial advisors of the firms then act as brokers to solicit their clients and recommend the purchase of the security for their accounts. In this regard, the broker-dealers are facilitating the interests of the issuer, themselves (in the collection of a distribution fee), and their clients, although their only contractual obligation is to the issuer.

Regulation of broker-dealers and of the agents of broker-dealer: The SEC defines a broker as any person in the business of making securities transactions for accounts belonging to other people, and dealers as anyone in the business of buying and selling securities for their own account. (12 Questions on BD/6 Questions on BD Agents): Definitions of professional titles, duties, and roles; Registration process; Post-registration requirements; Termination protocol.  BD FIRMS: definition of a Broker-Dealer 3 – registration/post-registration, e.g., books and records; registration maintenance requirements 3 - A broker-dealer (B-D) is a person or firm in the business of buying and selling securities for its own account or on behalf of its customers. The term broker-dealer is used in U.S. securities regulation parlance to describe stock brokerages because most of them act as both agents and principals. A brokerage acts as a broker (or agent) when it executes orders on behalf of its clients, whereas it acts as a dealer, or principal when it trades for its own account. here are thousands of broker-dealers comprising two broad categories: a wirehouse, which sells its own products, or an independent broker-dealer, which sells products from outside sources.  Supervisory Actions to be Taken by BD: need training before social media use, need annual training at a minimum, policies should be: clear, written, concise, define responsibilities of parties, clearly describe monitoring tools. Know the B-D supervision of agents.

BD FIRMS VS IA FIRMS: DIFFERENCES BETWEEN FIN ADVISOR (IA) AND BROKER:  Investment advisers (aka financial advisors) are paid a flat fee or percentage of AUM to advise clients on securities and/or manage portfolios. Brokers are paid commissions to execute trades or buy and sell assets for clients. Brokers and investment advisers are regulated by different bodies and require different qualifications for practice (e.g., FINRA regulates brokers and the SEC regulates investment advisers). Both professionals are legally prohibited from giving advice that conflicts with their clients’ needs. These days, it’s not uncommon to see brokers dual-registered as investment advisers. Brokers may also be involved heavily as part of a sales team in private placements, initial public offerings (IPOs), or secondary issuances. Working alongside their firm's corporate finance departments, brokers may work to sell their clients on a hot new issuance or private deal to help a company raise capital. In return, the broker may receive a commission, shares, or warrants in the issuing company. On the other hand, work on a fee-based system of dispensing investment advice catered towards individual client needs and oftentimes, manage investment accounts. For example, an investment adviser may work with a client to create an entire wealth management framework, including assisting the clients through tax, estate, and mortgage planning. Not to be confused with a financial adviser, investment advisers are registered with and regulated by the Securities and Exchange Commission (SEC) and or a state regulatory body. Investment advisers are also known as asset managers, investment managers, and wealth managers. Key Differences in Regulations: Investment advisers are also held to a higher legal standard than brokers. In the United States, investment advisers must adhere to the Investment Advisers Act of 1940, which calls on advisers to perform fiduciary duties with regards to their clients’ accounts. Fiduciary duty, which is legally enforceable under the Advisers Act Sections 206 (1)/(2), prohibits advisers from “employ[ing] any device, scheme or artifice to defraud any client or prospective client.” The standard also imposes upon the adviser the “affirmative duty of ‘utmost good faith’ and full and fair disclosure of material facts” as part of the adviser’s duty to exercise loyalty and care. This includes “an obligation not to subordinate the clients’ interests to its own.” Due to the importance of this fiduciary conduct, most investment advisers can make investment decisions for their clients without first getting the client's permission. Prior to 2011, all investment advisers with $30 million or more assets under management (AUM) had to register with the U.S. Securities and Exchange Commission (SEC), while advisers with less than $25 million needed only to register with their state regulatory body. In 2011, the Dodd-Frank Act increased the minimum assets under management for SEC registration to $110 million. Brokers, as defined broadly by the SEC as “any person engaged in the business of effecting transactions in securities for the account of others” (which may also include investment advisers), must register with the SEC and a self-regulatory organization. The most well-known broker self-regulatory organization is the Financial Industry Regulatory Authority (FINRA). Key Differences in Testing and Licensing: Investment advisers and brokers also have different training and licensing requirements. Brokers have to pass the Series 7, otherwise known as the General Securities Representative Exam; the Series 7 also acts as a precursor to further exams in the securities industry. On the other hand, future investment advisers must pass the Series 65 exam, which is a requirement before they can dispense financial advice for a fee. An additional distinction between the Series 7 and the Series 65 is that only the Series 7 requires an individual to be sponsored by a firm prior to enrolling for the test. The Series 65 is also often used by certified public accountants (CPAs) to enter the investment advisory business. Unlike chartered financial analysts (CFAs) and certified financial planners (CFPs), the CPA designation does not meet the prerequisites to have the Series 65 exam waived.

BD INDIVIDUALS (AGENTS): Broker-Dealer Agent supervision 3  - definition of an Agent of a Broker-Dealer 4 - Agents: What most people call "registered representatives" will be referred to as "agents" for the Series 63 exam. They must be registered with the state. An agent is a  person who has been legally empowered to act on behalf of another person or an entity. An agent may be employed to represent a client in negotiations and other dealings with third parties. The agent may be given decision-making authority. An agent may be authorized to represent a client in negotiations and other dealings with third parties or may have decision-making authority. Two common types of agents are attorneys, who represent their clients in legal matters, and stockbrokers, who are hired by investors to make investment decisions for them. The person represented by the agent in these scenarios is called the principal. In finance, it refers to a fiduciary relationship, in which an agent is authorized to perform transactions on behalf of the client. Legally, there are three classes of agents: Universal agents have a broad mandate to act on behalf of their clients. Often these agents have been given power of attorney.  General agents are contracted to represent their clients in specific types of transactions or proceedings over a set period.  Special agents are authorized to make a single transaction or a series of transactions within a limited period. A securities agent is an example of a special agent. Generally, people hire agents to perform tasks that they lack the time or expertise to do for themselves.

BD INDIVIDUALS (AGENTS): registration/post-registration, e.g., books and records; registration maintenance requirements 5 - BD INDIVIDUALS: An agent is always a natural person and always represents somebody else. If he represents a broker-dealer, he’s an agent, regardless of what he sells. If he represents an issuer, he usually is not an agent. If he represents an issuer, he’s not an agent if:  The issuer is exempt  The security is exempt  The transactions are exempt.  Exempt means “excused.” Non-exempt means “not excused.” “Federal covered” securities are covered at the federal level. If they’re exempt at the federal level, they are “federal covered.” If they register only at the federal level, they are “federal covered.” So “exempt” and “federal covered” are not exactly the same. All exempt securities are “federal covered,” but not all federal covered securities are exempt. GE commercial paper is exempt and federal covered. GE common stock is federal covered, but it does have to register with the SEC because it is non-exempt. It doesn’t have to register with the states, though, which is ultimately what “federal covered” means. A “federal covered” adviser registers with the SEC. They also may provide the states with:  Filing fees.  Notice filing Consent to service of process. And, they are still subject to anti-fraud rules at the state level. A legal person is anyone who is NOT:  Dead  Minor  Mentally incompetent. A natural person is an individual and just one example of a legal person. An agent properly registered in Arizona may offer securities to an existing client vacationing in Colorado without registering in the state of Colorado. However, if the offer violates securities laws, the Administrator in Colorado definitely has authority to take action, because the Uniform Securities Act gives jurisdiction to the Administrator in any state where the offer to sell or solicitation of any offer to buy:  Originates  Is directed into  Is accepted. Think “DOA” for “directed into,” “originates,” “accepted.” The state where a check is written is not material. 2 A security is an investment of money into something that can be traded for value and which fluctuates. An insured CD or fixed annuity is NOT a security. Maximum criminal penalties are 3 years, $5,000. Statute of limitations is 5 years. Testimony can be required over 5th Amendment objections—but it can’t be used to incriminate the one forced to squeal. Ignorance of the law can keep someone out of prison. Civil liabilities to someone sold a security/advice in violation of the law include:  Original price paid, plus interest, less any income received  Court costs, reasonable attorney’s fees  NO “pain and suffering” The statute of limitations is 2 years from discovery, 3 years from violation.

Remedies and administrative provisions (6 Questions): Administrator’s authority: Administrative actions: Liabilities and penalties: Other provisions such as advertising materials and filing sales. State antifraud authority 1 authority of state securities Administrator 2 -administrative actions 2 other penalties and liabilities 2 - Fraud, misrepresentation, dishonesty, manipulative and deceptive business practices are prohibited. Administrator: The state administrator is vested with considerable power for enforcing the USA and the rules.  The securities Administrator has broad powers to investigate, hold hearings, issue rules and orders, grant and take away licenses, and enforce anti-fraud regulations. The Administrator may NOT:  Sentence people to prison  Issue injunctions  Issue orders to deny, suspend, or revoke without prior notice, opportunity for hearing, and written findings of fact/law. The Administrator has the power to grant licenses but also to deny, suspend, or revoke licenses. A denial, suspension, or revocation implies that somebody done somebody wrong. These orders are issued when they’re in the public interest, provide needed protection to investors, and the applicant/registrant lies, misleads, deceives, or has already been in trouble with other regulators. An order to cancel is non-punitive, meaning “no punishment.” A license is canceled simply because the party no longer exists or can’t be located. An order to withdraw is non-punitive. It means that the applicant/registrant has decided to withdraw the application or license. It is effective within 30 days (if not sooner) provided that there are no orders or proceedings against the party submitting the withdrawal. 

Regulation of securities and issuers (6 Questions):  Issuers are defined as governments, corporations, or investment trusts that register and sell securities to finance their own business operations. Definitions of professional titles, duties, and roles; Registration process; Post-registration requirements; Exemptions. State authority over federally covered securities definition of securities and issuers 1 registration/post-registration (e.g., state registration requirements) 1 exemptions 1 - Securities: Must be registered with the state (unless exempt).   All securities that are sold to a state residence must either be: 1) duly registered 2) exempt from registration or 3) sold through an exemption transaction.  Exempt securities are exempt from the registration requirements if the Securities Act of 1933 but are not exempt from the antifraud provisions of the USA.  Exempt securities are 1) issued by exempt issuers, such as governments or 2) short term debt instruments with less than 270 days to maturity. Securities registration:  Non-exempt securities become federally registered by submitting a registration statement to the Securities Exchange Commission (SEC). Non-exempt securities must also register in the states in which the securities will be sold.  The 3 methods of registering securities in a state are: 1) coordination 2) filing/notification 3) qualification. It is important to understand how the 3 security types of securities registration differ and under what circumstances the different registration methods are used.  Registration of IPO’s thorough coordination. When a company first sells stock to the public during an IPO, the company must file a registration statement with the SEC.  The company must also file a registration statement with the state securities administrator in the states where the issue will be sold.  Most IPO’s will register with the state securities administrator at the same time that they are becoming registered with the SEC.  The they are becoming registered with the SEC.  This process of simultaneous registration is known as coordination.  The following must be submitted to the administrator: 1) 3 copies of the prospectus. 2) any amendments to the prospectus.  3) the amount of securities to be offered within the state. 4) a list of other states where the securities will be offered.  5) other info as required by the state securities administrator, including corporate bylaws, articles of incorporation, specimen of the security, and indenture of any kind.  If an amendment has been made to the federal registration, it must also be made to the state registration.  A security’s state registration will become effective after 10 days as long as no stop order has been issued; or at the same time as the security’s federal registration becomes effective.  It is important to note that a state registration may not become effective prior to the security’s federal registration be on file with the administrator for at least 20 days.  A question may ask you to remember either the 10-day rule or 20-day requirement.  It Is unlikely that a question will have both answers in the same answer key.  What about 2) filing/notification 3) qualification methods of registering?

Communications with clients and prospects (8 Questions): Disclosures; Unlawfully representing registrations; Guarantees of performance.  Contractual agreements with clients disclosures re Communication with Customers and Prospects 2 - FINRA requires communications with the public (eg advertisements, market letters, emails) to make specific disclosures and obtain appropriate approvals from supervisors and, in some cases, FINRA. The amended FINRA Rule 2210 changes the definitions of the different types of communications (eg retail communications, correspondences) and amends the circumstances under which they must be filed with FINRA for approval. Registered reps are required to abide by these rules in all communications with clients. FINRA rule 2210 – Communications with the Public - governs three categories of “communications” by FINRA member firms: • Institutional communications; • Retail communications (more than 25 public individuals); and • Correspondence (less than 25 public individuals). The rule sets forth requirements relating to approval, review and recordkeeping of communications; filing requirements and review procedures; and content standards.  Firms should have policies and procedures in place reasonably designed to prevent institutional communications from being forwarded to retail investors and make appropriate efforts to implement such policies and procedures.  Members generally must have a registered principal approve all advertisements, sales literature and independently prepared reprints prior to use.   The recordkeeping requirements apply to retail and institutional communications. Members must retain retail or institutional communications for three years from the date of last use.  IA current clients must be delivered a brochure within 120 days of the advisor's fiscal year (every year).

unlawful representations concerning registrations 2 - Misrepresenting a Securities Professional's Registration - can't say registration makes you more qualified.  Misrepresenting a Security's Registration - prohibited imply that registration of a security means that the Administrator has approved of the issue.

performance guarantees 2 - Guaranteed Security - where a party other than the issuer guarantees the payment of principal and interest (on a debt security) or dividend (on an equity security).  Guarantee Against Loss - simply CAN'T guarantee against loss or that you will personally "buy back" if they lose money - certain circumstances, IA can receive performance-based compensation -BD can correct bona fide error.

customer agreements (e.g., new account, margin, options) 2 - Contract Non-Requirement: NO requirement that advisory contracts be renewed on an annual basis, can be written for any length agreed upon. Opening an account with questions about the investor's investing experience and knowledge...Options account (question on new options account form).   New Account Agreement.  Information needed: - does client have legal capacity to enter into agreement -employment information -CIP notice (name, DOB, address, identification #) -citizenship or visa details -financial information about the client. NASAA's Statement of Policy on Dishonest/Unethical Business Practices of BD and Agents.  it is prohibited to execute any transaction in a margin account without securing from the customer a properly executed, written margin agreement promptly after the initial transaction in the account.  Margin Account: need: credit agreement, hypothecation agreement. optional: loan consent form.  Hypothecation Agreement: gives permission to the BD to pledge customer margin securities as collateral. Loan Consent Form (optional): gives permission to the firm to loan customer margin securities to other customers or BD, for short sales.  Credit Agreement - discloses the terms of the credit extended by the BD.  Margin Account Risk Disclosure Document: must provide FINRA risk disclosure for margin accounts; must be provided ANNUALLY.  Options Accounts: supervisor must approve ODD; must ask about financial situation and investment objectives.  Receipt of the Options Agreement: Within 15 days after account has been approved for options trading, BD must obtain the written agreement that customer is aware and is bound to FINRA rules.  Margin Calls: client is NOT entitled to choose which securities can be sold if a call for additional funds is not met.  Credit Agreement: contains all the terms of the loan, explains how the interest is charged, contains the terminology which authorizes the BD to use the value of the account as collateral for the margin loan made by the BD.  Hypothecation Agreement: permits the BD to pledge the client's margin securities as collateral for a loan that the BD takes out.  ODD must be received within 15 days of account approval.

correspondence and advertising (e.g., social media, email, website) 2 - Regulatory Concerns about Social Media:  All media included in FINRA guidance, same rules apply as face-to-face communication, must also abide by internal (firm) rules, bound by rules during own time (weekend party pictures might not be suitable).   Investment Adviser Advertising: Prohibited items: -untrue statement, referring to any testimonial, refer to specific past recommendations, statements that it will be free (testimonials = forbidden for IAs, not for BDs) - a FB "like" on a post could be considered a testimonial.  Issues Related to Agents: - covers personal cell phones - Twitter doesn’t need approval, LinkedIn does - content not the device.  Advertising: cannot leave out any information or highlight the "best" performance date, any distribution of nonfactual data, unrealistic claims, CANNOT highlight on prospectus to draw attention to key points.  Unethical advertising campaigns: exaggerating the capabilities of the firm and personnel, guaranteeing performance, using testimonials, CAN OFFER FREE SERVICES.  Advertising charting or graphing system disclosure/statement must be made as to the limitations and difficulties involved in using the system.  Affinity Fraud: type of fraud using social media where the fraudsters pretend to be member of a group, sometimes using respected leaders of the group to spread the word about the scheme. Form ADV Part 2: must be delivered annually to clients (within 120 days of the end of adviser's fiscal year); if not delivered 48 hours in advance of the initial contract, the client has a 5-day penalty-free termination clause.

Compensation of securities agents and firms (4 Questions): Fees; Commissions; Fees based on meeting specific performance metrics; Soft dollars (payments that mutual funds or other money managers make to their service providers). Disclosure of Compensation: e.g. fees; commissions; markups; soft dollars; disclosure of compensation 4 - Larger Accounts: tend to have many of the smaller fees waived; if client moving account to another firm, LIKELY the transfer fee will be charged. Disclosure of Fees - disclosed when account is open, minimize fine print, use standardized/uncomplicated terms. Typical Broker-Dealer Fees - issuance of stock certificate, transferring an account, wiring funds, margin account interest, account maintenance fees, safekeeping funds, late settlement fee, postage/handling.  NOT included in FEE DISCLOSURE - commissions, markups/markdowns, advisory fees.  Compensation: BD (Agent) = commissions; Dealer (Principal) = markup/markdown.  In order to act as a principal (agent) in trade:  client must receive full written disclosure as to the capacity in which the advisor proposed to act, consent of the client.  Could charge fees based on: commissions, hourly rate, % of aggregate value of funds under management (assume performance-based compensation is not permitted; flat fees and fees based on portfolio value are).  Fees NOT included in fee disclosure:  commissions, markups/markdowns, advisory fees for those registered as IA’s.  Obtaining fee schedule: should be a simple process for customers/prospects; made on website without requiring log-in. Free Offer:  must not only be free of financial cost, must be free of any other burden or commitment.

Client funds and securities (8 Questions): Custody of client financial assets; Discretion over client accounts; Authorization to trade; Sensible investing standards. Suitability and reasonable basis for making a recommendation based on age, risk tolerance, and financial standing customer funds and securities e.g. custody; discretion; trading authorization; prudent investor standards; suitability 4 - Investment Advisory Contracts: can't enter into a contract without consent; Waivers are NOT permitted.  Discretionary Accounts: Before BD can exercise discretion, written authorization must be received from firm; oral authorization may be relied upon for first 10 business days. Not a Recommendation: -website available to customers or groups that has research pages or electronic libraries, news, quotes, that can be requested -search engine on website enabling customers to sort through data about performance of stocks/mutual funds -provides research tools to screen universe of stocks -allows members to subscribe to emails or other communication to alert news about a security. Recommendations: -send customer-specific communication -tell customer to buy or sell a stock, use data mining technology to analyze a customer's financial or online activity. Adoption: a firm's endorsement of the content of a third-party site.  Entanglement: adoption taken one step further, when the firm contributes to the third-party information and then posts it.

Conflicts of interest and other issues concerning fiduciary responsibility (4 Questions): Client confidentiality; Excessive trading; Loans to and from clients; Insider trading; Selling away (the offering of securities not available from the representative’s firm). Market manipulation conflicts of interest, criminal activities, and other ethical issues e.g. excessive trading; loans to and from customers; sharing in profits and losses in a customer account insider trading; selling away; market manipulation; due diligence; outside securities accounts 6 - Acting as Agent with advisory client.  Requirements: - client receives full written disclosure as to the capacity in which the adviser proposes to act - consent of the client. Disclosure of Conflicts of Interest - Any doubt in transparency? Make sure to disclose.  Fiduciary Responsibility of IA - act in best interests of clients, not self.  Consent of the client before completion of a trade made between the firm and client must be made when an IA will be acting in the capacity of a principal. Discretionary Authority: IA is not the ONLY person allowed to make decisions in the account, can also be client. Disclosure of Capacity - must indicate capacity on trade confirmation which is sent no later than settlement date.  Disclosure of Capacity by IA - IA might buy from advisory client in capacity of principal, permitted if: client receives full disclosures, client consent is obtained.   When BD in the capacity of principal in trade, firm has acted as: contra-party to the trade (one of the principals - buyer or seller).  Account time receipts for customer information: Discretionary authorization - before exercising discretion.  Margin account agreement - promptly after first trade: Discretionary authorization - received by IA within 10 days after initial trade.  Options account agreement: received within 15 days after the customer's account has been approved. Know rules re outside securities accounts.

cyber security and data protection 4 – What exactly are cyber security and data protection? Cyber Security is the practice of defending computers, servers, mobile devices, electronic systems, networks, and data from malicious attacks. It is also known as 'information security' or 'electronic information security'. There is a direct correlation between technology advancements and the sophistication level of cyber attacks. Specifically, as technology advancements are made to prevent/reduce cyber attacks, cyber criminals must evolve and develop new strategies to overcome the advancements. Data Protection refers to the processes used to safeguard sensitive customer information. Several regulatory agencies, including FINRA, have made cyber security and data protection a key focus.  In an effort to hold members accountable, FINRA requires its member firms to have an established program to prevent cyber attacks and protect customers’ data.  Firms need to establish a cybersecurity program to: - Identify and assess cybersecurity threats; - Protect assets from cyber intrusions; - Detect when their systems and assets have been compromised; - Plan for the response when a compromise occurs; and - Implement a plan to recover lost, stolen or unavailable assets. This checklist is primarily derived from the National Institute of Standards and Technology (NIST) Cybersecurity Framework and FINRA’s Report on Cybersecurity Practices. Use of this checklist does not create a "safe harbor" with respect to FINRA rules, federal or state securities laws, or other applicable federal or state regulatory requirements. ………. There is more on this………..

NEW CLIENTS: Online Red Flags for Investors: promises of high returns with no risk, offshore operations, e-currency sites, recruit friends, professional websites with little to no information, no written information, testimonials from other group members.  Patriot Act: concerned about validating identity, not suitability, through CIP.

Know these:  Hypothecation definition - Hypothecation agreement is the agreement that pledges the customer's securities that were purchased on margin as collateral for the loan. It also allows the brokerage firm to take the same securities and re-pledge or re-hypothecate them as collateral for a loan at a bank to obtain a loan for the customer.

remuneration definition -  think this include any compensation, fees, concessions, discounts, commissions, etc.

indemnification definition - indemnification clause serves to compensate a party for harm or loss arising in connection with the other party's actions or failure to act. The intent is to shift liability away from one party, and on to the indemnifying party. 

If you see a question that begins, "The administrator may...," the answer is frequently "all of the above." On the other hand, if you encounter a question that begins with the phrase, "The administrator must..." the answer is a short list. Again, the administrator has tremendous power under the USA.

CONCEPT CHECK:

Prospectus delivery requirements – see under Offerings below in SIE exam section.

Due diligence for B-Ds – see under SIE exam section below

Regulation A amendment. - https://www.sec.gov/rules/final/2015/33-9741.pdf - this new SEC rule issued in 2012 is an amendment to the 1933 Securities Act.  It is known as the JOBS ACT or Jumpstart Our Business Startups Act of 2012.  Exempting from the registration requirements of the Securities Act offerings of up to $75 million of securities annually (tier two) and offerings of publicly issued securities are up to $20 million (tier one).  Both are for 12 months at a time only and is normally only for accredited investors (but that’s not an actual rule?).   The issuer must still file an offering statement with the SEC on EDGAR?  Each offeree and purchaser must receive an offering circular containing concise narrative disclosure, and the issuer must file two years of financial statements.  Advantages of a Tier 1 offering are ongoing reporting doesn’t apply and the nature and number of investors are limited.   No investor sophistication requirement for Tier 1, so NOT limited to accredited investors only.   The Tier 1 rules do not restrict resale, nor do they limit the number of buyers.  Reg A gives certain exemptions under 1933 and 1934 Act, e.g. not having to file proxy statements.  For a Tier 1 offering (maximum $20 million), aside for two years of financials there is NO ongoing reporting requirement. But, for a Tier 2 offering (maximum $50 million), annual, semiannual, and current events filings are required. Tier 2 issuers ONLY are exempt from registration and qualification under state securities (blue-sky) laws (tie 1 are not exempt and must therefore register under state blue-sky laws. Can ‘test the waters’ under tier 1 and 2 by sending advertisements to both accredit and non-accredited investors(?).  For TIER TWO each offeree and purchaser must receive an offering circular with concise narrative disclosures, and sales must not be made until the SEC approves the offering statement.  Does this apply to Tier 1 too?  Persons (bad actors) who are convicted of (or subject to sanctions for) securities fraud or other offenses involving transactions in securities or SEC filings cannot use the exemption. Under Tier 2 (maximum $50 million), a nonaccredited investor in unlisted securities cannot purchase an amount exceeding 10% of the greater of the investor’s net worth or annual income.     

Regulation D amendment - Reserve Requirements of Depository Institutions – this is a six-per-month limit on transfers from the "savings deposit".(?)  Rule 506 of Regulation D applies to securities sold under the private placement exemption created by section 4(2) of the 1933 Act. Securities sold under this exemption are restricted securities and may be resold only by registration or in a transaction exempt from registration. The securities’ certificates bear a legend that the shares of stock are restricted and purchased for personal investment.

Types of customer account

Exceptions for foreign B-Ds - ???

 

 

FEDERAL SECURITIES LAWS (1933/1934) AND INVESTMENT COMPANY LAWS (1940)

 

FINRA SIE and Series 7

Products/risks 44%

Customer accounts 31%

Capital markets 16%

Regulations 9%

 

The Investment Company Act of 1940 - This Act regulates the organization of companies, including mutual funds, that engage primarily in investing, reinvesting, and trading in securities, and whose own securities are offered to the investing public. The Securities and Exchange Commission (“SEC” or “Commission”) is the primary regulator of investment companies and investment advisers. Specifically, the Division of Investment Management of the SEC does this.  This is the primary law that governs investment companies.  Investment companies are also subject to other federal securities laws (e.g., the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934). The SEC has also adopted various regulations generally applicable to investment companies under these laws. The Investment Adviser Act of 1940 - Generally, persons who manage the portfolios of registered investment companies must register with the Commission as investment advisers under the Investment Advisers Act of 1940 (the “Advisers Act”).   

 

PRIMARY MARKETS: The Securities Act of 1933 – regulates primary issuances of securities.  Also known as the 1933 Act, the Securities Act, the Truth in Securities Act, the Federal Securities Act, and the '33 Act, was enacted by the United States Congress on May 27, 1933, during the Great Depression and after the stock market crash of 1929. The federal Securities Act of 1933 regulates the initial offering of securities by requiring that a registration statement be filed with the SEC prior to sale or an offer to sell. Its objectives are to (1) disclose to potential investors all material information and (2) prevent fraud. Its objective is not the regulation of securities already outstanding or enforcing blue sky laws. 

Public companies need to register with SEC under 1933 Act any public sale of debt or equity.   The elements necessary to recover damages if there has been a material misstatement by AN ISSUER in a registration statement filed under the Securities Act of 1933: 1) the plaintiff must prove that (s)he was an acquirer of a security covered by a registration statement, 2) (s)he suffered a loss, and 3) the statement misstated or omitted a material fact.

 

THERE ARE CERTAIN S133 EXEMPTIONS FROM REGISTRATION OF SECURITY ISSUANCES: 

·       INTRASTATE EXEMPTION FOR OFFERINGS ONLY IN HOME STATE:  One exemption from registration under the Securities Act of 1933 is an intrastate issue of securities. Under SEC Rule 147, an issue qualifies as intrastate if (1) the issuer is incorporated in the state in which the issue is made, (2) 80% of the proceeds are to be used in that state, (3) 80% of its assets are located in the state of incorporation, (4) the issuer does at least 80% of its business (gross revenues) within that state, (5) all the purchasers and offerees are residents of the state, (6) no resales to nonresidents occur for at least 6 months from the date of the sale of the security by the issuer, and (7) steps are taken to prevent interstate distribution.

·       Some securities issued by insurance companies are regulated under S133 but not insurance policy contracts or annuity contracts.  

·       Offer by fund manager to sell $6 million worth of securities with intent to purchase municipal securities (all business done in state).  Rules 504 and 506 of Regulation D are two exemptions from registration otherwise required by the 1933 act. Rule 504 (limit $5 million) cannot be used. However, Rule 506 exempts qualifying transactions without regard to the dollar amount of the offering. Moreover, offers and sales may be made to an unlimited number of accredited investors. But up to 35 purchasers need not be accredited investors. These purchasers must have sufficient knowledge and experience to evaluate the risks and merits of the investment. If sales are made to purchasers who are not accredited investors, general solicitation and advertising are not permitted.

·       Same as previous except apply Rule 147, the intrastate registration exception under the Securities Act of 1933. Under this safe harbor provision of SEC Rule 147, an issue qualifies as intrastate if (1) the issuer is organized or incorporated in the state in which the issue is made, (2) 80% of the proceeds are to be used in that state, (3) 80% of its assets are located there, (4) the issuer does at least 80% of its business (gross revenues) within that state, (5) all the purchasers and offerees are residents of the state, (6) no resales to nonresidents occur for at least 6 months from the date of the sale of the security by the issuer, and (7) steps are taken to prevent interstate distribution.

·       A company that plans to offer a new issue of voting stock to the investing public and properly uses an exemption from registration under the Securities Act of 1933 must still adhere to both federal antifraud laws and state laws.  An exemption from federal registration will almost never have any effect on the need to register with states where a security is to be sold. Neither will an exemption from registration excuse a seller from obeying any antifraud rules.

·       The SEC is authorized by the 1934 act to impose sanctions to enforce its provisions. The SEC may deny, suspend, or revoke registration or it may order a suspension of trading of the securities. These sanctions are in addition to civil and criminal liability imposed by the federal securities laws.

·       ISSUER REPORTING: A covered corporation under the 1934 act is not required to provide copies of Forms 10-K, 10-Q, or 8-K to its shareholders. However, the annual report required to be sent to shareholders is comparable to the Form 10-K.

o    Reporting requirements under the 1934 act do not substitute for those under the 1933 act.  Must submit Form 10-K to the SEC EVEN IN those years in which the corporation has made a public offering.

 

LIABILITY OF A CPA FOR ERRORS OR OMMISSIONS IN FINANCIALS INCLUDED IN A PROSPECTUS DURING PRIMARY LISTING

Under the liability provisions of the Securities Act of 1933, a CPA may be liable to any purchaser of a security for certifying materially misstated financial statements that are included in the security’s registration statement.  A purchaser must only prove only that the accountant prepared and certified the financial statements, the statements contained a misstatement or omission of material fact, and (s)he incurred a loss. A purchaser does not need to prove FRAUD/NEGLIGENCE or RELIANCE. (Criminal liability under Section 24 of the 1933 act and civil liability under Sections 18 and 10(b) of the 1934 act require proof of fraud).  The statute of limitations on an action by a purchaser of securities relying on the Securities Act of 1933 is 1 year after the false statements or omissions of material fact were discovered or should have been discovered. The latest the suit may be brought is within 3 years after the security was first offered to the public.  BECAUSE THE PLAINTIFF DOESN’T HAVE TO SHOW FRAUD OR NEGLIGENCE ON THE PART OF THE CPA, THE ONUS IS ON THE CPA TO SHOW THAT IT EXERCISED DUE DILIGENCE. 

 

***

SECONDARY MARKETS: Securities Exchange Act of 1934 - regulates the secondary trading of those securities between persons often unrelated to the issuer, frequently through brokers or dealers.  The Securities Exchange Act of 1934 - An act to provide for the regulation of securities exchanges and of over-the-counter markets operating in interstate and foreign commerce and through the mails, to prevent inequitable and unfair practices on such exchanges and markets, and for other purposes.  

The 1934 act requires all regulated, publicly held corporations to register with the SEC. Covered corporations either (1) list shares on a national securities exchange or (2) have at least 500 shareholders of equity securities and total gross assets exceeding $10 million.  EXEMPTIONS FROM HAVING TO REGISTER WITH THE SEC:  Excludes share splits and stock dividends.  Public org’s and 501c3’s are exempt from registration requirements.  But only municipal government securities that are issued where the funds are used for governmental purposes (do agencies count?).   Securities Act of 1933 includes notes, equities sold at a discount and those sold pre-incorporation.  How does securities registration affect an investor – it requires that each prospective investor receive a prospectus disclosing pertinent financial and other information, e.g. what the funds will be used for.   

 The 1934 act requires all publicly held companies to make a one-time registration with the SEC. Following registration, an issuer must file specific up-to-date and accurate reports with the SEC to ensure fair trading practices for investors. An issuer may terminate its registration if it has fewer than 500 shareholders and less than $10 million in assets; but NOT IF the securities in question are listed on a National Securities Exchange.  A corporation with only one class of stock must comply with the proxy filing and distribution requirements of the 1934 act (what does this mean?).  Further REPORTING REQUIREMENTS under 1934 Act so must file periodic reports: (1) national securities exchanges, (2) an issuer with more than $10 million in total gross assets and a class of equity securities with (a) at least 2,000 shareholders or (b) 500 who are not accredited investors, (3) an issuer whose securities are listed on a national exchange, and (4) an issuer that has registered under the 1933 act. These issuers must file annual (10-K), quarterly (10-Q), and material events (8-K) reports and send similar reports to shareholders. A covered corporation (ie covered by the 1934 Act) is required to file annual (10-K), quarterly (10-Q), and material events (8-K) reports with the SEC. Similar reports are sent to shareholders. The 10-K report contains information about 

1.      the entity’s business activities, 

2.      securities, 

3.      management, 

4.      related parties, 

5.      disagreements about accounting and disclosure, 

6.      audited financial statements, 

7.      etc. 

The 10-K report is intended to bring the information in the registration statement up to date. Any newly appointed officers are listed in this 10-K.  Company does not have to report shareholder “short-swing” profits (small public shareholders only), or that a competitor made a tender offer to Integral’s shareholders, unless the tender offer is hostile (unsolicited), then need to file a statement with the SEC.  Also required to disclose: Insiders that may be liable to the corporation for short-swing profits. Insiders include directors, officers, and owners of more than 10% of the corporation’s stock. Form 10-K also requires disclosure of the market price of the common stock of the registrant, including the high and low sales prices, for each quarter of the last 2 fiscal years and any subsequent interim periods, not every change in the market price of its stock need be reported.  Ten days prior to mailing a proxy statement to shareholders, a company reporting under the Securities Exchange Act of 1934 must file its proxy statements with the SEC.  All shareholder proposals don’t have to be included in the proxy statement.  And only need to include financials in the proxy statement if issuing new shares, contemplating a merger, or electing new directors.  

 

INSIDER TRADING

Governed by Securities Exchange Act of 1934.  . Specifically, insiders must turn over to the corporation any profits earned on purchases and sales of their company’s stock that fall within 6 months of each other. They also are prohibited from buying or selling stock based on inside information not available to the public.

 

TENDER OFFERS

A tender offer is an offer to shareholders to buy their stock to gain control of a corporation. Under the Securities Exchange Act of 1934, anyone who makes a tender offer that may result in the purchase of more than 5% of a class of registered equity securities must file the tender offer with the SEC. Because the acquiree is listed on a national stock exchange, its shares must be registered and the tender offer must be filed prior to acquisition. 

 

ONGOING INVESTOR REPORTING TO SEC:

·       Any person or group of persons who acquire beneficial ownership of more than 5% of a class of registered equity securities of certain issuers must file Schedule 13D

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UNDERSTANDING PRODUCTS AND THEIR RISKS 44%

 

2.1 Products 

 

2.1.1 Equity Securities 

• Ownership (e.g., order of liquidation, limited liability) 
• Control and restrictions (e.g., SEC Rule 144) 

 

2.1.2 Debt Instruments 

• Municipal securities 
• °  General obligation (GO) bonds 
• °  Revenue bonds 
• °  Others (e.g., special type bonds, taxable municipal securities, short-term obligations) 

• ·  Negotiated vs. competitive offerings via underwriters and syndicates 
• ·  Auction 

 

2.1.3         Options

o   Special disclosures (e.g., Options Disclosure Document (ODD)) 

o   Options Clearing Corporation (OCC) for listed options 

 

2.1.4 Packaged Products
· Investment companies 

° Types of investment companies 

• -  Closed-end funds 
• -  Open-end funds 
• -  Unit investment trusts (UITs) 
• -  Variable contracts/annuities 

• ·  Loads 
• ·  Breakpoints 
• ·  Right of accumulation (ROA) 
• ·  Letter of intent (LOI) 
• ·  Net transactions 
• ·  Surrender charges 
• ·  Sales charges 

 

2.1.5 Municipal Fund Securities 

• ·  529 Plans 
• °  Prepaid tuition 
• °  Savings plans

§  A s529 plan is an investment account that offers tax-free earnings growth and tax-free withdrawals when the funds are used to pay for qualified education expenses.  Because 529 plans have no income limits for owners, even high earners can contribute and receive available tax breaks. 4. The account must be held in your child's name. "Usually it's best to have the account with the parent listed as the owner or the trustee with the child as beneficiary. In 2020, many families are trying to make the most of their tax-advantaged savings accounts. Those saving for retirement may deposit up to $6,000 to an IRA or Roth IRA ($7,000 if you're over age 50) and up to $19,000 to an employer-sponsored 401(k). But what about college funds? That's where it can get tricky, since the IRS doesn't specify an annual contribution limit for 529 plans and many 529 plans offer high total contribution limits.  There are no time or age limits on using a state 529 college savings plan. Money can be kept in a 529 plan indefinitely. 529 plans can be used for graduate school, not just undergraduate school, and can be passed on to one's children. There is also no age limit on contributions to a 529 plan.  To avoid federal gift tax consequences, federal law allows single taxpayers to contribute up to $14,000 in one year or make a lump-sum contribution of $70,000 to cover five years. Married couples may contribute as much as $28,000 per year or $140,000 as a lump sum.  All education savings plans are sponsored by state government.  A saver may typically choose among a range of investment portfolio options, which often include various mutual fund and exchange-traded fund (ETF) portfolios and a principal-protected bank product.

·       ·  Local government investment pools (LGIPs) 

·       ·  ABLE accounts 

·       ·  Municipal fund securities 

·       ·  Owner vs. beneficiary 

·       ·  Restricted use of plan assets 

·       ·  Tax advantages 

·       ·  Direct or adviser sold 

 

2.1.6         Direct Participation Programs (DPPs) 

·       Types of DPPs 

·       Limited partnerships 

·       Tenants in common (TIC) 

·       ·  Pass-through tax treatment 

·       ·  Unlisted 

·       ·  Generally illiquid 

 

2.1.7 Real Estate Investment Trusts (REITs) · Types of REITs 

• °  Private 
• °  Registered, non-listed 
• °  Listed 

• ·  Real estate equity or debt 
• ·  Tax-advantaged income without double taxation 

 

2.1.8 Hedge Funds 

• ·  Minimum investment 
• ·  Partnership structure 
• ·  Private equity 
• ·  Generally illiquid 

 

2.1.9         Exchange-traded Products (ETPs) 

·       Types of ETPs 

·       Exchange-traded funds (ETFs) 

·       Exchange-traded notes (ETNs) 

• ·  Alternative investments to mutual funds 
• ·  Fee considerations 
• ·  Active vs. passive 

 

2.2 Investment Risks 

• ·  Definition and Identification of Risk Types 
• °  Market/systematic 
• °  Non-systematic  

 

Rules

 

FINRA Rules
2261 – Disclosure of Financial Condition
2262 – Disclosure of Financial Relationship with Issuer
2310 – Direct Participation Programs
2330 – Members’ Responsibilities Regarding Deferred Variable Annuities 2342 – “Breakpoint” Sales
2360 – Options 

 

MSRB Rules
D-12 – Definition of Municipal Fund Securities
G-17 – Conduct of Municipal Securities and Municipal Advisory Activities G-30 – Pricing and Commissions
G-45 – Reporting of Information on Municipal Fund Securities 

 

CBOE Rule
Rule 1.1 – Definitions 

 

SEC Rules and Regulations Securities Exchange Act of 1934 

3a11-1 – Definition of the Term "Equity Security" 

10b-18 – Purchases of Certain Equity Securities by the Issuer and Others Investment Company Act of 1940 

Section 3(a) – Definitions - “Investment Company”
Section 4 – Classification of Investment Companies
Section 5 – Subclassification of Management Companies
12b-1 – Distribution of Shares by Registered Open-end Management Investment Company 

 

 

UNDERSTANDING TRADING, CUSTOMER ACCOUNTS, AND PROHIBITED ACTIVITIES 31%

 

Some rules and regulations most applicable are summarized here; more are included in the content below.

 

REG T:  

Federal Reserve Board Regulation T governs cash accounts and the amount of credit that broker-dealers can extend to investors for the purchase of securities. Investors who want to purchase securities using broker-dealer credit need to apply for a margin account. Reg T mandates that investors can borrow no more than 50% of the purchase price while the remaining balance must be paid in cash.

 

FINRA Rules:
2010 – Standards of Commercial Honor and Principles of Trade - This is FINRA’s ‘catch all’ provision and is the single most important securities industry regulation. The rule requires that all industry members conduct business with high standards of commercial honor and that they maintain just and equitable principles of trade. Selection of detailed rules included in content below.

 

MSRB Regulations - Selection of detailed rues included in content below.

 

SEC rules and Regulations – SEC Registration requirements. Selection of detailed rues included in content below.

 

Patriot Act:

USA PATRIOT Act requires U.S. financial institutions to perform due diligence and, in some cases, enhanced due diligence, with regard to correspondent accounts established or maintained for foreign financial institutions and private banking accounts established or maintained for non-U.S. persons. Requires all potential money laundering to be reported.  See AML programs below.  Requires verification of identification of account holders and special due diligence procedures. See KYC section below.  Requires filing of Suspicious activity reports (SARs).

 

Federal Trade Commission Telemarketing Sales Rule: Same as FINRA rule 3230 – Telemarketing:

Telemarketing Sales Rule helps protect consumers from fraudulent telemarketing calls and gives them certain protections under the National Do Not Call Registry. Companies also need to be familiar with rules banning most forms of robocalling.  The Telemarketing Sales Rule, which requires telemarketers to make specific disclosures of material information; prohibits misrepresentations; sets limits on the times telemarketers may call consumers; prohibits calls to a consumer who has asked not to be called again.

 

Section (1): Trading, Settlement and Corporate Actions 

 

Orders and Strategies 

o   ·  Types of orders (e.g., market, stop, limit, good-til-canceled (GTC), discretionary vs. non-discretionary, solicited vs. unsolicited) 

o   ·  Buy and sell, bid-ask

o   ·  Trade capacity (e.g., principal, agency) 

o   ·  Long and short, naked and covered 

o   ·  Bearish and bullish 

 

Investment Returns 

o   ·  Components of return (e.g., interest, dividends, realized/unrealized gains, return on capital) 

o   ·  Different types of dividends (e.g., cash, stock) 

o   ·  Dividend payment dates (e.g., record date, ex-date, payable date) 

o   ·  Concepts of measurement (e.g., yield, yield to maturity (YTM), yield to call (YTC), total return, basis points) 

o   ·  Cost basis requirements 

o   ·  Benchmarks and indices 

 

Trade Settlement 

o   ·  Settlement time frames for various products (e.g., T, T + 1, T + 2) 

o   ·  Physical vs. book entry (e.g., delivery and settlement) 

o   FINRA rule 2232 – Customer Confirmations - Customer Confirmations. (a) A member shall, at or before the completion of any transaction in any security effected for or with an account of a customer, give or send to such customer written notification (i.e. always send trade confirmations).

o   MSRB rule G-15 – Confirmation, Clearance, Settlement and Other Uniform Practice Requirements with Respect to Transactions with Customers - Requires municipal securities brokers and municipal securities dealers to provide customers with written confirmations of transactions, containing specified information; prescribes certain uniform practice procedures for dealers that transact municipal securities business with customers.
MSRB rule G-21 – Advertising - Prohibits false or misleading advertising concerning the facilities, services or skills of any dealer and establishes standards for advertisements of municipal fund securities; requires a municipal securities or general securities principal to approve in writing all advertisements prior to first use.

Corporate Actions 

o   ·  Types of corporate actions e.g., splits, reverse splits, buybacks, tender offers, exchange offers, and rights offers.

 

Mergers and acquisitions (M&A)) 

o   ·  Impact of stock splits and reverse stock splits on market price and cost basis 

o   ·  Adjustments to securities subject to corporate actions 

o   ·  Delivery of notices and corporate action deadlines 

o   ·  Proxies and proxy voting 

 

Section (2): Customer Accounts and Compliance Considerations 

 

Account Types and Characteristics 

o   ·  Cash 

o   ·  Margin – FINRA rule 2264 – Margin Disclosure Statement – required to be disclosed to anyone that opens a margin account.

o   SEC Act of 1934 Section 11(d) – Prohibition on Extension of Credit by Broker-Dealer - The guiding principle with regard to the arranging limitation in Section 11(d)(1) is that a broker-dealer cannot arrange for its customer to obtain financing to purchase a new issue if it could not have extended the credit directly.

o   FINRA rule 4210 – Margin Requirements - FINRA Rule 4210 (Margin Requirements) describes the margin requirements that determine the amount of collateral customers are expected to maintain in their margin accounts, including both strategy-based margin accounts and portfolio margin accounts.  The rule explains the margin requirements for equity and fixed income securities, along with options, warrants and security futures.

o   Maintenance margin - Maintenance margin is the minimum amount of equity that an investor must maintain in the margin account after the purchase has been made.  Maintenance margin is currently set at 25% of the total value of the securities in a margin account as per FINRA requirements. The investor may be hit with a margin call if the account equity falls below the maintenance margin threshold.

o   ·  Options 

o   ·  Discretionary vs. non-discretionary 

o   ·  Fee-based vs. commission 

o   ·  Educational accounts 

 

Customer Account Registrations 

o   ·  Individual 

o   ·  Joint 

o   ·  Corporate/institutional 

o   ·  Trust (e.g., revocable, irrevocable) 

o   ·  Custodial (e.g., UTMA)  - The Uniform Transfers to Minors Act (UTMA) allows a minor to receive gifts—such as money, patents, royalties, real estate, and fine art—without the aid of a guardian or trustee. A UTMA account allows the gift giver or an appointed custodian to manage the minor's account until the latter is of age. In the name of minor until 18.  Shields minor from tax consequences of gifts.

o   ·  Partnerships 

o   ·  Retirement (e.g., individual retirement account (IRA), qualified plans) 

o   Types and characteristics

o   Required minimum distributions 

o   Contributions

 

Anti-money Laundering (AML) 

o   ·  Definition of money laundering 

o   ·  Stages of money laundering (e.g., structuring, layering, placement) 

o   ·  AML compliance program – A set of regulations and procedures that financial institutions follow to prevent and detect money laundering or terrorist financing activities. What does a business have to do to stay AML compliant? The aims of an anti-money laundering compliance program are to expose fraud, money laundering, tax evasion, and terrorist financing within a company. To reach this goal, there are three most important must-dos. Sophisticated reporting -  A powerful reporting system helps to immediately inform money-laundering activity to the relevant authorities. Detecting risky customers - Businesses must evaluate their client's risk profiles and process them accordingly (enhanced due diligence, customer due diligence, etc.). Compliance officer - The whole process is not easy to manage and requires a special person in the company who would have the experience and the knowledge to keep the business in close compliance with what is demanded.  Compliance must be the moral responsibility of every team member across all organizational levels, they must be trained to recognize and report their suspicions.

o   ·  Suspicious Activity Report (SAR) – SAR is a document that financial institutions, and those associated with their business, must file with the Financial Crimes Enforcement Network (FinCEN) whenever there is a suspected case of money laundering or fraud.

o   ·  Currency Transaction Report (CTR)  - A currency transaction report (CTR) is a bank form used in the United States to help prevent instances of money laundering. This form must be filled out by a bank representative who has a customer requesting to deposit or withdraw a currency transaction greater than $10,000. 

o   ·  FinCEN - The Financial Crimes Enforcement Network (FinCEN). FINECN mission is to safeguard the financial system from illicit use, combat money laundering and its related crimes including terrorism, and promote national security through the strategic use of financial authorities and the collection, analysis, and dissemination of financial intelligence.

o   Office of Foreign Asset Control (OFAC) and the Specially Designated Nationals and Blocked Persons (SDNs) List - The Office of Foreign Assets Control ("OFAC") of the US Department of the Treasury administers and enforces economic and trade sanctions based on US foreign policy and national security goals against targeted foreign countries and regimes, terrorists, international narcotics traffickers.  An OFAC check can help you confirm if a candidate is a potential threat to national security and if they are allowed to do business in the United States.  See also KYC below.

o   FINRA rule 3310 and MSRB rule G-41 – Anti-money Laundering Compliance Program - Each member shall develop and implement a written anti-money laundering program reasonably designed to achieve and monitor the member's compliance with the requirements of the Bank Secrecy Act (31 U.S.C. 5311, et seq.), and the implementing regulations promulgated thereunder by the Department of the Treasury. Each member's anti-money laundering program must be approved, in writing, by a member of senior management. The anti-money laundering programs required by this Rule shall, at a minimum, (a) Establish and implement policies and procedures that can be reasonably expected to detect and cause the reporting of transactions required under 31 U.S.C. 5318(g) and the implementing regulations thereunder; (b) Establish and implement policies, procedures, and internal controls reasonably designed to achieve compliance with the Bank Secrecy Act and the implementing regulations thereunder; (c) Provide for annual (on a calendar-year basis) independent testing for compliance to be conducted by member personnel or by a qualified outside party, unless the member does not execute transactions for customers or otherwise hold customer accounts or act as an introducing broker with respect to customer accounts (e.g., engages solely in proprietary trading or conducts business only with other broker-dealers), in which case such "independent testing" is required every two years (on a calendar-year basis); (d) Designate and identify to FINRA (by name, title, mailing address, e-mail address, telephone number, and facsimile number) an individual or individuals responsible for implementing and monitoring the day-to-day operations and internal controls of the program (such individual or individuals must be an associated person of the member) and provide prompt notification to FINRA regarding any change in such designation(s); (e) Provide ongoing training for appropriate personnel; and (f) Include appropriate risk-based procedures for conducting ongoing customer due diligence.

o   USA Patriot Act Section 314 – Cooperative Efforts to Deter Money Laundering Section 326 – Verification of Identification - Section 314 helps law enforcement identify, disrupt, and prevent terrorist acts and money laundering activities by encouraging further cooperation among law enforcement, regulators, and financial institutions to share information regarding those suspected of being involved in terrorism or money laundering.

o   USA Patriot Act Section 352 – Anti-Money Laundering Programs – this section required all financial institutions, as defined by the Bank Secrecy Act, to establish an anti-money laundering program within six months of the passage of the PATRIOT Act.

 

Books and Records and Privacy Requirements 

o   ·  Books and records retention requirements 

o   MSRB rule G-8 – Books and Records to be Made by Brokers, Dealers, Municipal Securities Dealers, and Municipal Advisors  - Requires municipal securities brokers, municipal securities dealers and municipal advisors to make and keep current certain specified records concerning their municipal securities activities.

o   MSRB rule G-9 – Preservation of Records - Prescribes periods of time records must be preserved; requires that records be accessible for inspection by appropriate regulatory agencies.

o   ·  Confirmations and account statements 

o   FINRA rule 2231 – Customer Account Statements – Every quarter need to send a statement of account ("account statement") containing a description of any securities positions, money balances, or account activity to each customer whose account had a security position, money balance, or account activity during the period since the last such statement was sent to the customer.

o   FINRA rule 2251 – Forwarding of Proxy and Other Issuer-related Materials (e.g. annual reports etc.) to the actual beneficiaries is required.

o   ·  Holding of customer mail 

o   ·  Business continuity plans (BCP) 

o   ·  Customer protection and custody of assets 

o   ·  Privacy requirements (e.g., Regulation) 

o   Nonpublic personal information 

o   Confidentiality of information 

o   Privacy notifications 

o   Safeguard requirements 

o   Regulation S-P – Privacy of Consumer Financial Information and Safeguarding Personal Information Securities Exchange Act of 1934 requires broker-dealers, investment advisers, and investment companies to notify customers of their privacy policies and establish sufficient safeguards for their personal and financial information.  Regulation S-P – Privacy of Consumer Financial Information and Safeguarding Personal Information Securities Exchange Act of 1934. 

 

Communications with the Public and General Best Interest Obligations and Suitability Requirements 

o   ·  Communications with the public and telemarketing 

o   Classifications and general requirements 

o   Do-not-call list 

o   FINRA rule 2210 – Communications with the Public - governs three categories of “communications” by FINRA member firms: • Institutional communications; • Retail communications (more than 25 public individuals); and • Correspondence (less than 25 public individuals). The rule sets forth requirements relating to approval, review and recordkeeping of communications; filing requirements and review procedures; and content standards.  Firms should have policies and procedures in place reasonably designed to prevent institutional communications from being forwarded to retail investors and make appropriate efforts to implement such policies and procedures.  Members generally must have a registered principal approve all advertisements, sales literature and independently prepared reprints prior to use.   The recordkeeping requirements apply to retail and institutional communications. Members must retain retail or institutional communications for three years from the date of last use.

o   ·  Best interest obligations and suitability requirements 

o   Know-your-customer (KYC) 

o   FINRA rule 2090 re KYC - Every member shall use reasonable diligence, in regard to the opening and maintenance of every account, to know (and retain) the essential facts concerning every customer and concerning the authority of each person acting on behalf of such customer. See also OFAC above under AML.

o   General requirements (e.g., what constitutes a recommendation) 

o   FINRA rule 2090 – Know Your Customer AND FINRA 2111 – Suitability Rule - Know Your Customer is a standard in the investment industry that ensures investment advisors know detailed information about their clients' risk tolerance, investment knowledge, and financial position. Protects clients and advisors.  KYC means having policies for risk management, customer acceptance policies, and transaction monitoring. Reasonable effort when opening and maintaining client accounts.  KYC rule is important at the beginning of a customer-broker relationship to establish the essential facts of each customer before any recommendations are made. The essential facts are those required to service the customer’s account effectively and to be aware of any special handling instructions for the account. Also, the broker-dealer needs to be familiar with each person who has authority to act on behalf of the customer.  The 2111 Suitability Rule goes hand in hand with KYC.  Broker-dealer must have reasonable grounds when making a recommendation that is suitable for a customer based on current review of existing portfolio, new facts and risk profile.  To this end the SEC requires that a new customer provide detailed financial information that includes name, date of birth, address, employment status, annual income, net worth, investment objectives, and identification numbers before opening an account.

 

Prohibited Activities 

 

Market Manipulation 

o   FINRA rule 2120 – Commissions, Mark Ups and Charges – Requires that a BD trade with customers at a ‘fair’ price, and a ‘fair’ commission’, and a fair mark-up based on reasonable expenses, when considering prevailing market levels and all other relevant factors.

o   Definition of market manipulation 

o   Types of market manipulation 

o   market rumors 

o   pump and dump   

o   front running – FINRA rule 5270 – Front Running of Block Transactions - brokers may not deal in securities-related transactions to benefit themselves if they possess private knowledge that a block transaction is about to take place. A “block transaction” would continue to include a transaction involving at least 10,000 shares but would also include a transaction involving any related financial instrument overlying such number of shares. 

o   FINRA rule 5320 – Prohibition Against Trading Ahead of Customer Orders - Rule 5320 generally prohibits a member firm that accepts and holds a customer order from trading a security on the same side of the market for its own account at a price that would satisfy the customer order, unless it immediately executes the customer order up to the size of and at an equal or better price.

o   excessive trading 

o   marking the close – (aka window dressing )occurs when a trader holds a significant position in a thinly traded symbol and enters orders crossing the spread at or near the close of normal trading hours, in an attempt to cause the session to close at a price favoring the held position.

o   marking the open -  the practice of making multiple trades minutes after the opening of the market in order to manipulate the price of a traded instrument.

o   backing away – FINRA rule for market makers only.  The term backing away refers to the failure by a market maker in a security to honor the quoted bid and ask prices for a minimum quantity. Backing away constitutes a serious violation of industry regulations.

o   freeriding - In a cash account, an investor must pay for the purchase of a security before selling it.  If an investor buys and sells a security before paying for it, the investor is “freeriding” which is not permitted under the Federal Reserve Board’s Regulation T and may require the investor’s broker to “freeze” the investor’s cash account for 90 days.  During this 90-day period, an investor may still purchase securities with the cash account, but the investor must fully pay for any purchase on the date of the trade.

o   FINRA rule 5280 – Trading Ahead of Research Reports - Most investment firms employ researchers to conduct reports to determine where money should go. Of course, many brokers control two different categories of money: Their own money and their clients’ money. When this is the case, these two departments at the firm must be reasonably separated; otherwise, the firm could easily manipulate the market for its own benefit.  Rule 5280 puts an affirmative duty on firms to put proper safeguards in place to protect client centered research knowledge from getting to their own trading department. Firms must restrict access to information regarding both the timing of the reports and the content of these reports. The lack of safeguards has been a big problem over the last several years and investors have been financially damaged as a result. NEED CHINESE WALLS. This is not technically market manipulation or insider trading.

o   Selling away - Selling away is when a broker solicits a client to purchase securities not held or offered by the executing brokerage firm. Brokerage firms generally have lists of approved products that can be offered by their brokers to clients of the firm. These approved products have usually undergone due diligence screenings and have been identified by the firm's screening personnel as solid products.

 

Insider Trading 

o   ·  Definition of insider trading 

o   ·  Definition of material nonpublic information 

o   ·  Identifying involved parties 

o   ·  Penalties (e.g., fines, expulsion, incarceration)

o   SEC Section 10 covers Regulation of the Use of Manipulative and Deceptive Devices – include, among other things, the purchase or sale of a security of any issuer, on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence that is owed. Rule 10b5-1 Trading "on the Basis of" Material Nonpublic Information ie Insider Trading. 

o   Section 20A – Liability to Contemporaneous Traders for Insider Trading

o   Section 21A – Civil Penalties for Insider Trading

o   10b-1 – Prohibition of Use of Manipulative or Deceptive Devices or Contrivances with Respect to Certain Securities Exempted from Registration
10b-3 – Employment of Manipulative and Deceptive Devices by Brokers or Dealers
10b-5 – Employment of Manipulative and Deceptive Devices
10b5-1 – Trading on Material Nonpublic Information in Insider Trading Cases
10b5-2 – Duties of Trust or Confidence in Misappropriation Insider Trading Cases
10b-10 – Confirmation of Transactions

o   Insider Trading & Securities Fraud Enforcement Act of 1988 (ITSFEA) - increased the liability penalties to all involved parties, increased fines and sentences for all who commit insider trading - The act allows the SEC to impose stiff monetary penalties, usually in multiples of the profit generated from insider trades, and the guilty parties may serve significant jail time, up to five years, according to the extent of their crime. The actual maximum of the fines imposed was capped at either 300% of the amount of money made on the trades or $1 million, whichever amount was larger. 

 

Other Prohibited Activities 

o   ·  Restrictions preventing associated persons from purchasing initial public offerings (IPOs) –

o   FINRA rule 5130 – Restrictions on the Purchase and Sale of Initial Equity Public Offerings - A member or a person associated with a member may not sell, or cause to be sold, a new issue to any account in which a restricted person has a beneficial interest, except as otherwise permitted herein.

o   ·  Use of manipulative, deceptive or other fraudulent devices 

o   FINRA rule 2020 – Use of Manipulative, Deceptive or Other Fraudulent Devices - Use of Manipulative, Deceptive or Other Fraudulent Devices. No member shall effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive or other fraudulent device or contrivance.

o   ·  Improper use of customers’ securities or funds 

o   Borrowing from customers - FINRA rue 3240 – Borrowing from or Lending to Customers - FINRA Rule 3240 mandates that brokers cannot borrow money from customers or lend money to customers unless the situation meets one of the following criteria: The broker-dealer has written procedures that allow customers and brokers to freely borrow money from and lend money to one another. The customer is a member of the broker’s immediate family (which FINRA defines as parents, grandparents, mother-in-law or father-in-law, husband or wife, brother or sister, brother-in-law or sister-in-law, son-in law or daughter-in-law, children, grandchildren, cousin, aunt or uncle, or niece or nephew, or any person the broker materially supports). The customer is a financial institution that regularly extends lines of credit as part of its business operations.  The customer is also a registered representative at the same broker-dealer as the broker. The broker and customer have a personal relationship such that they would not have engaged in the lending or borrowing relationship if they had not had a personal relationship. The broker and customer are engaged in a business relationship outside of the broker-customer relationship. Even when these criteria are met, as part of FINRA Rule 3240, registered representatives must inform their broker-dealer that they would like to enter into a lending relationship, and the broker-dealer must approve it in writing before it goes through. What does this approval process look like? The broker should seek the brokerage firm’s approval in writing. Once approved, if the broker wants to modify the arrangement in any way (such as extending the timeframe of the lending arrangement), this must also be approved.

o   Sharing in customer accounts - FINRA rule 2150 – Improper Use of Customers’ Securities or Funds; Prohibition Against Guarantees and Sharing in Accounts - No member or person associated with a member shall guarantee a customer against loss in connection with any securities transaction or in any securities account of such customer. BD or their registered reps may share in the profits or losses in a customer account if: (i prior written authorization from the member (the BD) employing the associated person; (ii) prior written authorization from the customer; and (iii) such member or person associated with a member shares in the profits or losses in any account of such customer only in direct proportion to the financial contributions made to such account by either the member or person associated with a member. Excluded from this rule are immediate relatives.

· Financial exploitation of seniors -  FINRA rule 2165 – Financial Exploitation of Specified Adults AND 4512 – Customer Account Information –Option to put Temporary Hold (15 days max) on Disbursements.  This is not mandatory it is a Safe Harbor provision covering natural person age 65 and older, or a natural person age 18 and older who, based on facts and circumstances observed in the member’s business relationship with the customer, has a mental or physical impairment that renders the individual unable to protect his or her own interests (specified adult), in certain circumstances where the member reasonably believes that financial exploitation of the specified adult has occurred, is occurring, has been attempted or will be attempted.   Need to report orally and in writing to all concerned and conduct internal reviews. A trusted contact person is designated under Rule 4512 and needs to be contacted.

·       FINRA rule 5240 – Anti-intimidation/Coordination - one in a series of regulations that helps to protect investors from fraud and other types of market manipulation. More specifically, rule 5240 prohibits FINRA registered firms from engaging with one another in a manner that manipulates market prices or the free flow of information. 

 

• ·  Activities of unregistered persons
• Prohibition against paying commissions to unregistered persons  - FINRA rule 2040 – Payments to Unregistered Persons - prohibits FINRA member firms from making payments to persons who are not registered as broker-dealers. One exception for foreigners under certain conditions.
• Prohibition against solicitation of customers and taking orders 
• ·  Falsifying or withholding documents 
• Signatures of convenience 
• Responding to regulatory requests 
• ·  Prohibited activities related to maintenance of books and records (e.g., falsifying records and improper maintenance/retention of records).  

 

Municipal securities rules:

 

MSRB rule G-13 – Quotations - Requires quotations distributed or published by a dealer to represent bona fide bids or offers of municipal securities, based upon the dealer’s best judgment of the fair market value of the securities; prohibits misrepresentation of another broker or dealer’s quotations.

MSRB rule G-14 – Reports of Sales or Purchases - Prohibits municipal securities brokers and municipal securities dealers and their associated persons from distributing or publishing reports of purchases or sales of municipal securities unless the report is made with knowledge or reason to believe that the transaction was effected, and without any reason to believe that the reported transaction is fictitious, or in furtherance of any fraudulent, deceptive or manipulative purpose; requires dealers to report information to the MSRB or its designee regarding all transactions in municipal securities; states that such information will be made available under the Act to agencies charged with inspection for compliance with and enforcement of MSRB rules; places upon the dealer the obligation to provide transaction information promptly, accurately and completely; requires each dealer to obtain from FINRA a unique symbol to identify its transactions for reporting purposes; establishes Transaction Reporting Procedures with which dealers must comply regarding formats and methods for reporting.

MSRB rule G-25 – Improper Use of Assets - Prohibits the improper use of municipal securities or funds held on behalf of another person, guarantees against loss in customer accounts and transactions and sharing in profits and losses of customer accounts and transactions by any broker, dealer or municipal securities dealer.

MSRB rule G-47 – Time of Trade Disclosure - Requires dealers to disclose to customers at or prior to the time of trade all material information known or available publicly through established industry sources.

 

Trade execution rules:

FINRA 5290 – Order Entry and Execution Practices and FINRA 5310 – Best Execution and Inter-positioning.  MSRB rule G-18 – Best Execution - Requires municipal securities brokers and municipal securities dealers to use reasonable diligence to ascertain the best market for the subject security and buy or sell in that market so that the resultant price to the customer is as favorable as possible under prevailing market conditions.

SEC Rules and Regulations 

Regulation M - The SEC's Regulation M is designed to prevent manipulation by individuals with an interest in the outcome of an offering and prohibits activities and conduct that could artificially influence the market for an offered security. As part of its program to monitor firms for compliance with Regulation M, FINRA's Market Regulation Department reviews over-the-counter trading and quoting activity for prohibited purchases, bids or attempts to induce bids or purchases during the applicable restricted period, and for prohibited short sales during the five-day period prior to pricing the offering. BD supervisors do electronic filings to FINRA.

SEC Act of 1934 Section 14 – Proxies - A proxy is a person who is designated by another to represent that individual at a meeting or before a public body. It also refers to the written authorization allowing one person to act on behalf of another. In corporate law, a proxy is the authority to vote stock.  SEC requires that shareholders of a company whose securities are registered under Section 12 of the Securities Exchange Act of 1934 receive a proxy statement prior to a shareholder meeting, whether an annual or special meeting. The information contained in the statement must be filed with the SEC before soliciting a shareholder vote on the election of directors and the approval of other corporate action. Solicitations, whether by management or shareholders, must disclose all important facts about the issues on which shareholders are asked to vote. SEC’s proxy rules are in schedule 14A and are numerous.  Two examples: (f) The term “proxy” includes every proxy, consent or authorization within the meaning of section 14(a) of the Act. The consent or authorization may take the form of failure to object or to dissent. (g) Proxy statement. The term “proxy statement” means the statement required by §240.14a-3(a) whether or not contained in a single document.

 
SEC Act of 1934 Section 15 – Rules Relating to Over-the-Counter Markets - OTC Markets Group Inc. does not regulate the OTCQX, OTCQB and Pink markets. The company is neither a stock exchange nor self-regulatory organization (SRO) and is not itself regulated by the FINRA or the SEC. ... In addition, companies with SEC-registered securities are regulated by the SEC.  The SEC holds primary responsibility for enforcing the federal securities laws, proposing securities rules, and regulating the securities industry, which is the nation's stock and options exchanges, and other activities and organizations, including the electronic securities markets in the United States.  What Is the Securities Exchange Act of 1934? The Securities Exchange Act of 1934 (SEA) was created to govern securities transactions on the secondary market, after issue, ensuring greater financial transparency and accuracy and less fraud or manipulation.  The Financial Industry Regulatory Authority (FINRA) regulates broker-dealers that operate in the over-the-counter (OTC) market. Many equity securities, corporate bonds, government securities, and certain derivative products are traded in the OTC market. The OTC Bulletin Board (which is a facility of FINRA), and OTC Link LLC (which is owned by OTC Markets Group, Inc., formerly known as Pink OTC Markets Inc.), for example, operate within the OTC market, particularly with respect to OTC equity securities. OTC Link LLC (OTC Link) is an electronic inter-dealer quotation system that displays quotes, last-sale prices, and volume information in exchange-listed securities, OTC equity securities, foreign equity securities and certain corporate debt securities. In addition to publishing quotes, OTC Link provides, among other things, subscribers the ability to send and receive trade messages, allowing them to communicate for the purpose of negotiating trades.  All subscribers to OTC Link are broker-dealers that are members of FINRA. Subscribers are permitted to quote any OTC equity security eligible for quoting under Exchange Act Rule 15c2-11 or the applicable exemptions to Rule 15c2-11. OTC Link does not require companies whose securities are quoted on its system to meet any eligibility requirements. With the exception of some foreign issuers, the companies quoted on OTC Link tend to be closely held, very small and/or thinly traded. Most issuers do not meet the minimum listing requirements for trading on a national securities exchange. Many of these companies do not file periodic reports or audited financial statements with the SEC, making it difficult for the public to find current, reliable information about those companies. OTC Link is registered with the SEC as a broker-dealer and as an alternative trading system and is a member of FINRA.

SEC Act of 1934 15c1-2 – Fraud and Misrepresentation - (a) The term manipulative, deceptive, or other fraudulent device or contrivance, as used in section 15(c)(1) of the Act (section 2, 52 Stat. 1075; 15 U.S.C. 78o(c)(1), is hereby defined to include any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person. (b) The term manipulative, deceptive, or other fraudulent device or contrivance, as used in section 15(c)(1) of the Act, is hereby defined to include any untrue statement of a material fact and any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, which statement or omission is made with knowledge or reasonable grounds to believe that it is untrue or misleading. (c) The scope of this section shall not be limited by any specific definitions of the term “manipulative, deceptive, or other fraudulent device or contrivance” contained in other rules adopted pursuant to section 15(c)(1) of the act.

SEC Act of 1934 15c1-3 – Misrepresentation by Brokers, Dealers and Municipal Securities Dealers as to registration - The term manipulative, deceptive, or other fraudulent device or contrivance, as used in section 15(c)(1) of the Act, is hereby defined to include any representation by a broker, dealer or municipal securities dealer that the registration of a broker or dealer, pursuant to section 15(b) of the Act, or the registration of a municipal securities dealer pursuant to section 15B(a) of the Act, or the failure of the Commission to deny or revoke such registration, indicates in any way that the Commission has passed upon or approved the financial standing, business, or conduct of such registered broker, dealer or municipal securities dealer or the merits of any security or any transaction or transactions therein.  

 

SEC Registration
SEC Act of 1934 15c2-12 – Municipal Securities Disclosure - (a) General. As a means reasonably designed to prevent fraudulent, deceptive, or manipulative acts or practices, it shall be unlawful for any broker, dealer, or municipal securities dealer (a “Participating Underwriter” when used in connection with an Offering) to act as an underwriter in a primary offering of municipal securities with an aggregate principal amount of $1,000,000 or more (an “Offering”) unless the Participating Underwriter complies with the requirements of this section or is exempted from the provisions of this section.  There are many provisions in this section of the Securities Act of 1934.

SEC Act of 1934 15l-1 – Regulation Best Interest - Broker-Dealers to Act in the “Best Interest” of Retail Customers.  There are Disclosure Obligations, Care Obligations, Conflict of Interest Obligations and Compliance Obligations.  Regulation Best Interest enhances the broker- dealer standard of conduct beyond existing suitability obligations, and aligns the standard of conduct with retail customers’ reasonable expectations by requiring broker-dealers, among other things, to: act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker-dealer ahead of the interests of the retail customer; and address conflicts of interest by establishing, maintaining, and enforcing policies and procedures reasonably designed to identify and fully and fairly disclose material facts about conflicts of interest, and in instances where we have determined that disclosure is insufficient to reasonably address the conflict, to mitigate or, in certain instances, eliminate the conflict.  

 

 

KNOWLEDGE OF CAPITAL MARKETS 16%

Regulatory Entities, Agencies and Market Participants 

 

The Securities and Exchange Commission (SEC) 

o   The high-level purpose and mission of securities regulation.  SEC purpose is protecting investors and capital, overseeing the stock market and proposing and enforcing federal securities laws. The mission of the SEC is to 1) protect investors; 2) maintain fair, orderly, and efficient markets; and 3) facilitate capital formation.

o   Definition, jurisdiction and authority of the SEC.  SEC is an independent federal government regulatory agency that was created by Congress in 1934 as the first federal regulator of the securities markets. The SEC promotes full public disclosure, protects investors against fraudulent and manipulative practices in the market, and monitors corporate takeover actions in the United States. It also approves registration statements for bookrunners among underwriting firms.

 

Self-regulatory Organizations (SROs) 

o   Purpose and mission of an SRO.  A self-regulatory organization (SRO) is an entity such as a non-governmental organization, which has the power to create and enforce stand-alone industry and professional regulations and standards on its own. In the case of financial SROs, such as a stock exchange, the priority is to protect investors by establishing rules, regulations, and set standards of procedures which promote ethics, equality, and professionalism.

o   Jurisdiction and authority of SROs (e.g. CBOE FINRA and MSRB).  

o   The Chicago Board Options Exchange started primarily to provide a market for the trading of options as options became a larger investment market and therefore more attractive to investors. However, the creation of the holding company, CBOE Global Markets, in 2010 was the center of its focus to be a world leader in creating investment products and markets. The CBOE has research staff analyzing the direction of the investment markets and creating new products for an evolving investment landscape. It defines its mission to create more value for its marketplace, customers, investors, and employees.

o   FINRA  is an independent, nongovernmental organization that writes and enforces the rules governing registered brokers and broker-dealer firms in the United States.  The mission is to protect investors by making sure the United States securities industry operates fairly and honestly. FINRA oversees about over 5,000 brokerage firms, and 660,000 registered securities representatives.

o   The Municipal Securities Rulemaking Board (MSRB) establishes rules that securities firms, banks and municipal advisors must follow when engaging in municipal securities transactions and advising investors and state and local governments. The mission of the MSRB is to protect investors, state and local governments, and the public interest, by promoting a fair and efficient municipal securities market.  The MSRB’s General or “G” Rules, are classified into various subcategories that define fair practice, uniform practice, market transparency, professional qualifications and regulated entity rules. 

 

Other Regulators and Agencies 

o   Department of the Treasury operates and maintains systems that are critical to the nation's financial infrastructure, such as the production of coin and currency, the disbursement of payments to the American public, revenue collection, and the borrowing of funds necessary to run the federal government.

o   Internal Revenue Service (IRS) administers the federal tax laws that Congress enacts. The IRS performs three main functions—tax return processing, taxpayer service, and enforcement. In addition, the IRS conducts criminal investigations and oversees tax-exempt organizations and qualified retirement plans.

o   The North American Securities Administrators Association (NASAA) is an organization of securities regulators whose aim is to protect investors from fraud.  Organized in 1919, NASAA is the oldest international regulatory organization devoted to investor protection. It is a voluntary association whose membership consists of 67 state, provincial, and territorial securities administrators.  It works to protect customers of investment advice and securities as part of a complementary regulatory system that works at the federal, state/provincial, and industry levels.  NASAA seeks to help investors identify and avoid fraud by educating the public, investigating violations of state and provincial law, and filing enforcement actions.

 

The Federal Reserve - influencing the supply of money and credit; regulating and supervising financial institutions; serving as a banking and fiscal agent for the United States government; and supplying payments services to the public through depository institutions like banks, etc.

 

Securities Investor Protection Corporation (SIPC)  - is a nonprofit corporation created by an act of Congress to protect the clients of brokerage firms that are forced into bankruptcy.  SIPC protects against the loss of cash and securities – such as stocks and bonds – held by a customer at a financially-troubled SIPC-member brokerage firm. The limit of SIPC protection is $500,000, which includes a $250,000 limit for cash. Most customers of failed brokerage firms are protected when assets are missing from customer accounts. There is no requirement that a customer reside in or be a citizen of the United States. A non-U.S. citizen with an account at a brokerage firm that is a member of SIPC is treated the same as a resident or citizen of the United States with an account at a SIPC member brokerage firm. SIPC protection is limited. SIPC only protects the custody function of the broker dealer, which means that SIPC works to restore to customers their securities and cash that are in their accounts when the brokerage firm liquidation begins. SIPC does not protect against the decline in value of your securities. SIPC does not protect individuals who are sold worthless stocks and other securities. SIPC does not protect claims against a broker for bad investment advice, or for recommending inappropriate investments. It is important to recognize that SIPC protection is not the same as protection for your cash at a Federal Deposit Insurance Corporation (FDIC) insured banking institution because SIPC does not protect the value of any security.

 

Federal Deposit Insurance Corporation (FDIC)  - The Federal Deposit Insurance Corporation (FDIC) is an independent agency created by the Congress to maintain stability and public confidence in the nation's financial system.  primary purpose of the FDIC is to prevent "run on the bank" scenario. hen a bank fails, FDIC steps in and first attempts to get another bank to take over, for example when JP Morgan took over Washington Mutual. Otherwise, the FDIC cuts checks to depositors in a matter of days. The standard insurance amount is $250,000 per depositor, per insured bank, for each account ownership category. ... The FDIC insures deposits only. It does not insure securities, mutual funds, or similar types of investments that banks and thrift institutions may offer.

 

Market Participants and their Roles 

o   ·  Investors (e.g., accredited, institutional, retail) 

o   ACCREDITED INVESTORS - MSRB Rule 215 covers Accredited Investors - In the U.S, the definition of an accredited investor is in SEC in Rule 501 of Regulation D. To be an accredited investor, a person must have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year.

o   ·  Broker-Dealers (e.g., introducing, clearing, prime brokers) 

o   Registered representatives of a broker dealer - In the case of a broker dealer;  registered reps, principals, officers and directors are all considered associated persons. As such, they are required to be registered. Clerical and secretarial staff are not considered associates, and therefore are not required to be registered.

o   ·  Investment advisers 

o   ·  Municipal advisors

o   ·  Issuers and underwriters 

o   ·  Traders and market makers

o   FINRA rule 5250 – Payments for Market Making - No member or person associated with a member shall accept any payment or other consideration, directly or indirectly, from an issuer of a security, or any affiliate or promoter thereof, for publishing a quotation, acting as market maker in a security.

o   ·  Custodians and trustees 

o   ·  Transfer agents - Transfer agents keep records of who owns a company's stocks and bonds and how those stocks and bonds are held—whether by the owner in certificate form, by the company in book-entry form, or by the investor's brokerage firm in street name. They also keep records of how many shares or bonds each investor owns.

o   ·  Depositories and clearing corporations (e.g., Depository Trust & Clearing Corporation (DTCC), Options Clearing Corporation (OCC)) 

o   Auditors/Accountants – Section 10(b) prohibits fraud in connection with the purchase and sale of any security. Any party directly connected to the sale of securities is potentially liable; though there may be limits on the liability of certain professionals, such as auditors, bankers, accountants, etc. Rule 10(b)(5) allows for a cause of action by the SEC as well as private actions.  This provision applies whether or not the security is registered under the 34 Act. The SEC adopted Rule 10(b)(5) to implement section 10(b). Together, these anti-fraud provisions are the basis for most litigation under the 34 Act. Generally, Rule 10(b)(5) prohibits the following conduct in connection with the sale of a security:

·       Using any device, scheme, or other artifice to defraud purchasers; Example: A device or scheme includes any sales or investment program, whether done in person or via distant communication, to defraud participants. 

·       Making any untrue statement or failing to disclose any material fact that make the statement misleading; or Example: This includes making false statements or failing to disclose relevant information in the process of selling or transferring a security. INCLUDES MATERIAL OMMISSIONS OR MISSTATEMENTS.  AND INCLUDES ‘SCIENTER’ – KNOWLING MANIPULATED/DEFRAUDED. (compliance with GAAS can be argued as evidence that the auditor lacked scienter and hence cannot be guilty).

·       Employing any practice that would deceive or defraud.  Note: This is a very broad, catch-all provision. 

·       Rule 10(b)(5): A plaintiff must demonstrate deceit through the misrepresentation or omission of information. This must be done either intentionally or recklessly. Simple negligence is not enough to establish liability. DOES NOT INCLUDE NEGLIGENCE. 

 

Market Structure 

1.2.1 Types of Markets 

• ·  The primary market 

·       MSRB G-11 – Primary Offering Practices - Any change in the priority provisions or pricing information shall be promptly furnished in writing by the senior syndicate manager to the other members of the syndicate and the selling group.

·       MSRB G-32 – Disclosures in Connection with Primary Offerings – electronically send advance refunding documents and applicable Form G-32 information be submitted to EMMA Dataport, no later than five business days after the closing date for the primary offering.

·       MSRB rule G-34 – CUSIP Numbers, New Issue and Market Information Requirements - Apply for the assignment of a CUSIP number or numbers with respect to such issue within a specified time frame.

• ·  The secondary market (e.g., electronic, over-the-counter (OTC), physical) - The secondary market, also called the aftermarket and follow on public offering, is the financial market in which previously issued financial instruments such as stock, bonds, options, and futures are bought and sold. The secondary market is where securities are traded after the company has sold its offering on the primary market. It is also referred to as the stock market. The New York Stock Exchange (NYSE), London Stock Exchange, and Nasdaq are secondary markets. 
• ·  The third market - A third market consists of trading conducted by non-exchange member broker-dealers and institutional investors of exchange-listed stocks. In other words, the third market involves exchange-listed securities that are being traded over-the-counter between broker-dealers and large institutional investors.
• ·  The fourth market - The over-the-counter market for the sale of listed securities between institutional investors. For example, if a mutual fund sells stock in Google to a hedge fund without going through an exchange, the transaction is said to occur on the fourth market.

 

Offerings 

• ·  Roles of participants (e.g., investment bankers, underwriting syndicate, municipal advisors) 
• ·  Types of offerings 
• °  Public vs. private securities offering 

o   Registration of public initial offerings. SEC Rules and Regulations Securities Act of 1933 - Section 7 – Information Required in a Registration Statement - A legal document filed with the SEC to register securities for public offering that details the purpose of the proposed public offering. The statement outlines financial details, a history of the company's operations and management, and other facts of importance to potential buyers.  SEC Act of 1933 Section 8 – Taking Effect of Registration Statements - The term "registration statement" means the statement provided for in section 6, and includes any amendment thereto and any report, document, or memorandum filed as part of such statement or incorporated therein by reference.  "Prospectus" means any prospectus, notice, circular, advertisement, letter, or communication, written or by radio or television, which offers any security for sale or confirms the sale of any security.  Section 10 – Information Required in Prospectus - identify the security, state the price thereof, state by whom orders will be executed, and contain such other information as the Commission, by rules or regulations deemed necessary or appropriate in the public interest and for the protection of investors, and subject to such terms and conditions as may be prescribed therein.

• °  Initial public offering (IPO), secondary offering and follow-on offering 

o   FINRA Rule 2269 – Disclosure of Participation or Interest in Primary or Secondary Distribution - A member who is acting as a broker for a customer or for both such customer and some other person, or a member who is acting as a dealer and who receives or has promise of receiving a fee from a customer for advising such customer with respect to securities, shall, at or before the completion of any transaction for or with such customer in any security in the primary or secondary distribution of which such member is participating or is otherwise financially interested, give such customer written notification of the existence of such participation or interest.

• °  Methods of distribution (e.g., best efforts, firm commitment) 
• SHELF REGISTRATIONS: Shelf registrations and distributions (e.g., definition, purpose) – known as SEC Section 3 filing.  Shelf registration is a procedure, included in the regulation that a corporation can evoke to comply with U.S. Securities and Exchange Commission (SEC) registration requirements for a new stock offering up to two years before doing the actual public offering. ... Shelf registration is formally known as SEC Rule 415. Shelf offerings give the company the flexibility to get the paperwork out of the way now and then offer the shares only when it needs the cash or only when the market conditions are good. ... Shelf offerings can dilute existing shares considerably if the offering comes from the company because new shares are being created.  SEC Rule 415 allows corporations that are seasoned or well-known seasoned issuers to file registration statements covering an unlimited amount of securities that may be issued within 3 years of the effective date of the registration. The securities then are issued without (1) filing a new registration statement, (2) observing a 20-day waiting period, or (3) preparing a new prospectus. The issuer must (1) update the information so that it is accurate and current or (2) refer investors to quarterly and annual statements filed with the SEC. Shelf registration benefits large corporations that frequently offer securities to the public.
• Types and purpose of offering documents and delivery requirements (e.g., official statement, program disclosure document, prospectus) - An offering memorandum or offering circular (‘OC’) is a type of prospectus for a bond or other security. Sometimes, this is also referred to as a prospectus, offering memorandum, or short OC.  Contains information relating to the nature, character and risk of the offering through a written disclosure document.  
• A summary prospectus is the disclosure document provided to investors by mutual fund companies prior to or at the time of sale. The written document is a truncated version of the final prospectus that allows investors to see pertinent information regarding the fund's investment objectives and goals, sales charges and expense ratio, focused investment strategy, and data on the fund's management team.
• Offering memo - Securities, such as private placement transactions that are exempt from full registration under federal securities law, provide investors disclosure information through an offering memorandum. This disclosure document, often referred to as a private placement memorandum, includes a summary of the offering terms, risks associated with the investment and a full description of the issuing company. An offering memorandum also details how the funds raised will be used, information on the company's management team and previous financial performance as available. The disclosure document for private placement transactions is substantially longer than a summary prospectus and must be given to prospective investors prior to completing a sale.
• ·  Regulatory filing requirements and EXEMPTIONS (e.g., SEC, blue-sky laws)  - The SEC filing is a financial statement or other formal document submitted to the U.S. Securities and Exchange Commission (SEC). Public companies, certain insiders, and broker-dealers are required to make regular SEC filings. SEC rules require your company to file annual reports on Form 10-K and quarterly reports on Form 10-Q with the SEC on an ongoing basis. These reports require much of the same information about the company as is required in a registration statement for a public offering. 
• A public company with a class of securities registered under either Section 12 or which is subject to Section 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”) must file reports with the SEC (“Reporting Requirements”).The underlying basis of the Reporting Requirements is to keep shareholders and the markets informed on a regular basis in a transparent manner. Reports filed with the SEC can be viewed by the public on the SEC EDGAR website. The required reports include an annual Form 10-K, quarterly Form 10Q’s and current periodic Form 8-K as well as proxy reports and certain shareholder and affiliate reporting requirements. Form 10-K is an annual report filed with the SEC, and Form 10-Q is a quarterly report filed with the SEC. A reporting entity files Form 10-Q only for the first three quarters of the fiscal year, and Form 10-Q for the first quarter of the next year will report only that quarter’s results. All large fourth-quarter expenses are reported in Form 10-K (because there is no 10Q for a fourth quarter).
• Form 10-K must include audited financial statements (comparative balance sheets and statements of income, cash flows, and changes in equity).
• A company becomes subject to the Reporting Requirements by filing an Exchange Act Section 12 registration statement on either Form 10 or Form 8-A. A Section 12 registration statement may be filed voluntarily or per statutory requirement if the issuer’s securities are held by either (i) 2,000 persons or (ii) 500 persons who are not accredited investors and where the issuer’s total assets exceed $10 million. In addition, companies that file a Form S-1 registration statement under the Securities Act of 1933, as amended (“Securities Act”) become subject to Reporting Requirement; however, such obligation becomes voluntary in any fiscal year at the beginning of which the company has fewer than 300 shareholders. 
• Under 1933 Act  any public offering or sale of securities not subject to an exemption must be registered.
• A reporting company also has record keeping requirements, must implement internal accounting controls and is subject to the Sarbanes-Oxley Act of 2002, including the CEO/CFO certifications requirements, prohibition on officer and director loans, and independent auditor requirements. Under the CEO/CFO certification requirement, the CEO and CFO must personally certify the content of the reports filed with the SEC and the procedures established by the issuer to report disclosures and prepare financial statements.
• ISSUER COMMUNICATIONS RE PROSPECTIVE OFFERINGS. EXAMPLE: “Apogee Co. has filed with the SEC for many years, and its market capitalization is $10 billion. Perigee Co. has filed continuously with the SEC for 3 years, and its market capitalization is $75 million. Which of the following is most likely a true statement about communications prior to and during a registered offering of securities?  Apogee is a well-known seasoned issuer because it has filed for at least 1 year under the Securities Exchange Act of 1934 and has a market capitalization of at least $700 million. Perigee is a seasoned issuer (having filed for at least 1 year and a market capitalization of at least $75 million). Thus, only Apogee may make oral communications at any time if certain conditions are met. In specified circumstances, a well-known seasoned issuer (Apogee) may make oral and written communications at any time. These may include a free-writing prospectus, a written offer (including one by electronic means) that is not a statutory prospectus.”
• A well-known seasoned issuer may make oral and written communications re a public offering of securities at any time (there is no ten day or other limit).  
• An unseasoned issuer, in general, may continue to issue  fact-based information that is routinely published even when they are soon to be registering new securities offering with the SEC.  For example, if a reporting issuer regularly issues fact-based business information and/or forward-looking information it may continue to do that during a registration and new offering.
• In general, any issuer (seasoned, non-seasoned or neither) may communicate a free-writing prospectus after a registration statement is filed with the SEC in contemplation of a new securities offering.
• Issuers CANNOT FILE HARD-COPY DOCS – have to file all registration statements, prospectuses, periodic reports, etc., on EDGAR.  These electronic filings are available to the public on the SEC’s website within 24 hours.
•  

 

Securities Investor Protection Act of 1970 (SIPA) 

Another Capital market rule is the Securities Investor Protection Corporation (SPIC).  FINRA Rule 2266 references it – SIPC Information - All members (with some exceptions) that are excluded from membership in the Securities Investor Protection Corporation (SIPC) and that are not SIPC members; or whose business consists exclusively of the sale of investments that are ineligible for SIPC protection, shall advise all new customers, in writing, at the opening of an account, that they may obtain information about SIPC, including the SIPC brochure, by contacting SIPC, and also shall provide the Web site address and telephone number of SIPC. In addition, such members shall provide all customers with the same information, in writing, at least once each year. In cases where both an introducing firm and clearing firm service an account, the firms may assign these requirements to one of the firms.  

Section 23 – Unlawful Representations

431 – Summary Prospectuses

Schedule A – Schedule of Information Required in Registration Statement Schedule B – Schedule of Information Required in Registration Statement 

 

Securities Exchange Act of 1934
Section 3(a) – Definitions and Application of Title
Section 12 — Registration Requirements for Securities
Section 15 – Registration and Regulation of Brokers and Dealers
Section 15A – Registered Securities Associations

SEC Regulation D 

Rules Governing the Limited Offer and Sale of Securities Without Registration - Regulation D (Reg D) is a Securities and Exchange Commission (SEC) regulation governing private placement exemptions. It should not be confused with Federal Reserve Board Regulation D, which limits withdrawals from savings accounts. Reg D offerings are advantageous to private companies or entrepreneurs that meet the requirements because funding can be obtained faster and at a lower cost than with a public offering. It is usually used by smaller companies. The regulation allows capital to be raised through the sale of equity or debt securities without the need to register those securities with the SEC. However, many other state and federal regulatory requirements still apply.  

 

Securities Act of 1933 

144 – Persons Deemed Not to Be Engaged in a Distribution and Therefore Not Underwriters
144A – Private Resales of Securities to Institutions
145 – Reclassification of Securities, Mergers, Consolidations and Acquisitions of Assets
147 – "Part of an Issue," "Person Resident," and "Doing Business Within" for Purposes of Section 3(a)(11) 164 – Post-filing Free Writing Prospectuses in Connection with Certain Registered Offerings.  In specified circumstances, a well-known seasoned issuer (not every issuer) may make oral and written communications at any time. These may include a free-writing prospectus, a written offer (including one by electronic means) that is not a statutory prospectus. Subject to certain limitations, any issuer may communicate a free-writing prospectus after the registration statement is filed.

 

 

OVERVIEW OF REGULATORY FRAMEWORK  9%

SRO Regulatory Requirements for Associated Persons - SRO qualification and registration requirements 

• A self-regulatory organization (SRO) is an entity such as a non-governmental organization, which has the power to create and enforce stand-alone industry and professional regulations and standards on its own. In the case of financial SROs, such as a stock exchange, the priority is to protect investors by establishing rules, regulations, and set standards of procedures which promote ethics, equality, and professionalism. Examples of Self-Regulatory Organizations Include:
• The New York Stock Exchange (NYSE)
• The Financial Planning Association (FPA)
• Chicago Board of Trade (CBOT)
• American Council of Life Insurers (ACLI)
• Financial Industry Regulatory Authority, Inc. (FINRA)
• Fixed Income Clearing Corporation (FICC)
• Options Clearing Corporation (OCC)
• American Institute of Certified Public Accounts (AICPA)
• Definition of registered vs. non-registered person - Both firms and individuals must be registered with FINRA to conduct securities transactions and business with the investing public. Registered representatives differ from registered investment advisors. Registered representatives are governed by suitability standards while registered investment advisors are governed by fiduciary standards. ... Registered investment advisors are regulated by fiduciary standards which go beyond standard suitability.  RIAs are fiduciaries, while broker-dealers aren't. RIAs are registered with the Securities and Exchange Commission (SEC) or their state securities regulator, depending on their size. ... In addition to the fiduciary obligation, the other main difference between an RIA and a broker-dealer is in the way they are compensated.

o   Permitted activities of registered and non-registered persons -  Gen Sec Rep has passed the Series 7 exam and is qualified for the solicitation, purchase and/or sale of all securities products, including corporate securities, municipal fund securities, options, direct participation programs, investment company products and variable contracts. 

• Ineligibility for membership or association – Cannot be FINRA member if Misdemeanors that must be disclosed are those involving investments or an investment-related business, fraud, false statements or omissions, wrongful taking of property, bribery, perjury, forgery, counterfeiting, extortion or a conspiracy to commit any of these offenses.
• Background checks - The Form U4 contains detailed information on past employment and disclosure history, including bankruptcy, liens/judgments, criminal history, and civil litigation. Within 30 days of filing Form U4, a “reasonably available public records” search for information contained in U4 must be conducted.
• Fingerprinting 
• Statutory disqualification - FINRA By-Laws - FINRA's By-Laws provides that no member shall be continued in membership if it becomes subject to disqualification; and that no person shall be associated with a member, continue to be associated with a member, or transfer association to another member if such person is or becomes subject to disqualification. FINRA's authority to deny the registration and/or membership of disqualified persons or members is set forth in Section 15A(g)(2) of the Securities Exchange Act of 1934 (“Exchange Act”).
• The list of disqualifying events according to Section 3(a)(39) of the Exchange Act are as follows:
• certain misdemeanor and all felony criminal convictions for a period of ten years from the date of conviction.
• temporary and permanent injunctions (regardless of their age) issued by a court of competent jurisdiction involving a broad range of unlawful investment activities.
• expulsions or bars (and current suspensions) from membership or participation in a self-regulatory organization (SRO). Includes bars with a right to re-apply.
• bars (and current suspensions) ordered by the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC) or other appropriate regulatory agency or authority. Includes bars with a right to re-apply.
• denials or revocations of registration by the SEC, CFTC or other appropriate regulatory agency or authority.
• findings that a member or person has made certain false statements in applications or reports made to, or in proceedings before, SROs, the SEC on other appropriate regulatory agency or authority.
• any final order of a State securities commission (or any agency or officer performing like functions), State authority that supervises or examines banks, savings associations, or credit unions, State insurance commission (or any agency or office performing like functions), an appropriate Federal banking agency (as defined in Section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813(q)), or the National Credit Union Administration, that
• bars such person from association with an entity regulated by such commission, authority, agency, or officer, or from engaging in the business of securities, insurance, banking, savings association activities, or credit union activities; or
• constitutes a final order based on violations of any laws or regulations that prohibit fraudulent, manipulative, or deceptive conduct.
• findings by the SEC, CFTC or an SRO that a person: 1) "willfully" violated the federal securities or commodities laws, or the Municipal Securities Rulemaking Board (MSRB) rules; 2) "willfully" aided, abetted, counseled, commanded, induced or procured such violations; or 3) failed to supervise another who commits violations of such laws or rules.
• Certain associations with disqualified persons. In determining "association" for purposes of Exchange Act Section 3(a)(39)(E), FINRA uses the definition of "associated person" set forth in Exchange Act Section 3(a)(21).
• Misdemeanors that must be disclosed are those involving investments or an investment-related business, fraud, false statements or omissions, wrongful taking of property, bribery, perjury, forgery, counterfeiting, extortion or a conspiracy to commit any of these offenses.
• Failing to register an associated person 
• State registration requirements (e.g., blue-sky laws) - Blue sky laws are state-level, anti-fraud regulations that require issuers of securities to be registered and to disclose details of their offerings. Blue sky laws create liability for issuers, allowing legal authorities and investors to bring action against them for failing to live up to the laws' provisions.  

Continuing Education (CE) requirement 

o   Firm Element – this is the second portion of the Continuing Education program is custom developed by each FINRA Member Firm and is known as the "Firm Element". The Firm Element requires individual firms to provide ongoing training programs to keep certain registered employees current on job and product-related subjects.

• Regulatory Element - Regulatory Element requires all registered individuals to complete a computer-based training session within 120 days of the second anniversary of their initial registration date, and every three years thereafter.

Employee Conduct 

o   ·  Form U4 and Form U5 (e.g., purpose, when to update forms) - applicants must disclose information about certain criminal charges and convictions, including disclosure of all felony convictions and certain misdemeanor convictions

o   SEC form U4 – contains questions that relate to bankruptcy, criminal convictions, criminal charges, and regulatory/disciplinary actions and arbitrations. What most people don’t realize is that the federal securities laws impose rather draconian sanctions for violations of rules relating to a Form U4, and while the report may appear to show only a short or mid-range suspension as a sanction, in many cases the reality is that the financial advisor has effectively been barred from the industry. Section 15(b)(4)(A) of the Securities Exchange Act of 1934 provides that a person who willfully fails to disclose material information (and to the regulators, all questions on the Form U4 are material) on a Form U4 is subject to a statutory disqualification from association with any securities broker-dealer. What does that mean? In a nutshell, if you don’t answer the U4 questions truthfully, and you did so willfully, you are essentially barred from association with any broker-dealer, forever.

o   ·  Consequences of filing misleading information or omitting information – FINRA’s Sanction Guideline recommends consideration of a monetary fine of $5,000 to $146,000 against the responsible principal and/or firm, and suspension of the responsible principal in all supervisory capacities for 10 to 30 business days.

o   Customer complaints - Rather than keep and preserve the customer complaint records required under this Rule at the office of supervisory jurisdiction, the member may choose to make them promptly available at that office, upon request of FINRA. Customer complaint records shall be preserved for a period of at least four years.

o   ·  Potential red flags – e.g. Report if an applicant claims to have a degree that cannot be confirmed by the educational institution.

Reportable Events 

o   ·  Outside business activities - Outside Business Activities means any activities that a Supervised Person may be engaged in outside of their employment with the Firm, including, but not limited to, service as an officer, director, partner, employee, consultant or independent contractor with any for profit or non-profit organization

o   ·  Private securities transactions – FINRA rule 3280 - shall mean any securities transaction outside the regular course or scope of an associated person's employment with a member, including, though not limited to, new offerings of securities which are not registered with the SEC.

o   ·  Reporting of political contributions and consequences for exceeding dollar contribution thresholds  - Rule 206(4)-5 has a de minimis exception that permits covered associates to make aggregate contributions of up to $350 per election (primary and general elections are counted separately) to an elected official or candidate for whom the covered associate is entitled to vote, and up to $150 per election to an elected official or candidate for whom the covered associate is not entitled to vote.  For investment advisers, failure to comply with the terms of the SEC Pay-to-Play Rule can have very serious consequences, including fines and, more importantly, being unable to receive advisory fees from applicable clients for periods of up to two years from the date of a triggering political contribution.

o   ·  Dollar and value limits for gifts and gratuities and non-cash compensation - FINRA Rule 3220 (Influencing or Rewarding Employees of Others)2 (the Gifts Rule) prohibits any member or person associated with a member, directly or indirectly, from giving anything of value in excess of $100 per year to any person where such payment is in relation to the business of the recipient's employer.

o   ·  Business entertainment  (?)

o   ·  Felony, financial-related misdemeanors, liens, bankruptcy 

1.      Bankruptcy must be reported to FINRA but will probably not cause you to lose your registration or have your application denied, unless: You lied on your bankruptcy papers.

2.      Questions 14K and 14M on form U4 require a registered person to disclose the existence of any tax liens, unsatisfied judgments, bankruptcies.

FINRA RULE 1122 – Filing of Misleading Information as to Membership or Registration - No member or person associated with a member shall file with FINRA information with respect to membership or registration which is incomplete or inaccurate so as to be misleading, or which could in any way tend to mislead, or fail to correct such filing after notice thereof.

FINRA RULE 2060 – Use of Information Obtained in Fiduciary Capacity - member who in the capacity of paying agent, transfer agent, trustee, or in any other similar capacity, has received information as to the ownership of securities, shall under no circumstances make use of such information for the purpose of soliciting purchases, sales or exchanges.

FINRA RULE 2263 – Arbitration Disclosure to Associated Persons Signing or Acknowledging Form U4 - This means you are giving up the right to sue a member, customer, or another associated person in court, including the right to a trial by jury, except as provided by the rules of the arbitration forum.

FINRA RULE 2267 – Investor Education and Protection - require all firms to include a prominent description of and link to BrokerCheck on their websites, social media pages and any comparable Internet presence (the initial proposal).

FINRA RULE 5110(h) – Non-cash Compensation and FINRA RULE 2310(c) – Non-cash Compensation - FINRA Rules 5110 and 2310 do not require internal firm non-cash compensation arrangements in connection with public offerings of securities or direct participation programs to be based on total production and equal weighting of product sales.

FINRA RULE 2341(l)(5) – Non-cash Compensation - shall mean any form of compensation received in connection with the sale and distribution of investment company securities that is not cash compensation, including but not limited to merchandise, gifts and prizes, travel expenses, meals and lodging. 

FINRA Gifts Rule 3220 prohibits any member or person associated with a member, directly or indirectly, from giving anything of value in excess of $100 per year to any person where such payment is in relation to the business of the recipient’s employer.

FINRA RULE 3110(e) – Responsibility of Member to Investigate Applicants for Registration 3220 – Influencing or Rewarding the Employees of Others - Each member shall establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules. Final responsibility for proper supervision shall rest with the member. 

FINRA rule 3270 – Outside Business Activities of Registered Persons - No registered person may be an employee, independent contractor, sole proprietor, officer, director or partner of another person, or be compensated, or have the reasonable expectation of compensation, from any other person as a result of any business activity outside the scope of the relationship with his or her member firm, unless he or she has provided prior written notice to the member, in such form as specified by the member. Passive investments and activities subject to the requirements of Rule 3280 shall be exempted from this requirement.

3280 – Private Securities Transactions of an Associated Person - Prior to participating in any private securities transaction, an associated person shall provide written notice to the member with which he is associated describing in detail the proposed transaction and the person's proposed role therein and stating whether he has received or may receive selling compensation in connection with the transaction.  
FINRA RULE 4513 – Written Customer Complaints - FINRA Rule 4513 requires firms to preserve records of written customer complaints at each office of supervisory jurisdiction. 

FINRA RULE 4330 – Customer Protection – Permissible Use of Customers' Securities 4530 – Reporting Requirements - No member shall lend securities that are held on margin for a customer and that are eligible to be pledged or loaned, unless such member shall first have obtained a written authorization from such customer permitting the lending of such securities.

FINRA RULE 8312 – FINRA’s BrokerCheck Disclosure - FINRA may release information already publicly disseminated through the Investment Adviser Public Disclosure database about a BrokerCheck Associated Person currently associated with a BrokerCheck Firm who is, or was, licensed as an investment adviser representative.

MSRB Rules
G-2 – Standards of Professional Qualifications - No broker, dealer or municipal securities dealer shall effect any transaction in, or induce or attempt to induce the purchase or sale of, any municipal security, and no municipal advisor shall engage in municipal advisory activities, unless such broker, dealer, municipal securities dealer or municipal advisor and every natural person associated with such broker, dealer, municipal securities dealer or municipal advisor is qualified in accordance with the rules of the Board.

G-3 – Professional Qualification Requirements – No broker, dealer, municipal securities dealer, municipal advisor or person who is a municipal securities representative, municipal securities sales limited representative, limited representative - investment company and variable contracts products, municipal securities principal, municipal fund securities limited principal, municipal securities sales principal, municipal advisor representative or municipal advisor principal (as hereafter defined) shall be qualified for purposes of Rule G-2 unless such broker, dealer, municipal securities dealer, municipal advisor or person meets the requirements of this rule.

G-7 – Information Concerning Associated Persons – Requires dealers to obtain information from their associated personnel concerning their qualifications to engage in municipal securities business and contemplates that this information will be filed with the appropriate regulatory agency. 

G-10 – Delivery of Investment Brochure – Each broker, dealer and municipal securities dealer (collectively, a “dealer”) shall, once every calendar year, provide in writing (which may be electronic) to each customer the following items of information: (i) a statement that it is registered with the U.S. Securities and Exchange Commission and the Municipal Securities Rulemaking Board; (ii) the website address for the Municipal Securities Rulemaking Board; and (iii) a statement as to the availability to the customer of an investor brochure that is posted on the website of the Municipal Securities Rulemaking Board that describes the protections that may be provided by the Municipal Securities Rulemaking Board rules and how to file a complaint with an appropriate regulatory authority.

G-20 – Gifts, Gratuities and Non-cash Compensations – Prohibits dealers and municipal advisors from giving gifts or providing services in excess of $100 to another person in relation to the municipal securities activities of such person’s employer and limits the giving and acceptance of non-cash compensation by dealers, subject to exceptions. 

G-37 – Political Contributions and Prohibitions on Municipal Securities Business – Prohibits dealers from engaging in municipal securities business and municipal advisors from engaging in municipal advisory business with municipal entities if certain contributions have been made to officials of such municipal entities within the preceding two-year period and requires dealers and municipal advisors to disclose certain political contributions and other information.