Chapter One Knowledge of Capital Markets 12 Questions - 16% of the - - PDF document

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Chapter One

Knowledge of Capital Markets 12 Questions - 16% of the exam

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Types of Markets

 First/Primary Market

Issuer Transaction, Issuer Benefits. Centralized Location, requires Prospectus

 Second/Secondary Market

Transactions between investors. Centralized Location. Auction Style.

 Third Market

Transaction between investors, non-centralized. Negotiated Format

 Fourth Market

Instinet, large block trades between institutions.

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Broker Dealers

 Introducing/Fully‐Disclosed Firms

Introduce clients to the clearing firm who actually handles the transactions

 Carrying/Clearing firms

Holds the customer firms (carrying), and actually helps clear/settle the transactions. Full back office.

 Prime Broker Dealers

Special broker dealers for certain special clients; Hedge fund, money managers, etc.

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Securities Offerings

 Public Offering – Securities sold to general public. Usually large number of investors, large amounts of money  Private Offering – Securities sold to smaller groups of private

• investors. Usually small number of investors, small amounts of money

 Initial Public Offering – First time securities are brought to market. Primary Market.  Subsequent/Additional Public Offering – Any time after first time securities are brought to market. Primary Market.  Secondary Market – Large blocks with proceeds going to existing stockholders.

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Monetary Policy

 Controlled by the Federal Reserve Board  Primary focus to control inflation  Supervises and regulates banks  Maintains stable financial system  Tighten/Loosen money policy  Regulation T

Margin Requirements Currently 50% must be down payment ($2,000 minimum) Must pay BD within 4 business days or account frozen for 90 days

Only cash trades, no borrowing

No mutual funds on margin 13 14

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Monetary Policy

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Fiscal Policy

 Controlled by President and Congress  Taxes and Expenditures of Federal Dollars.

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Economic Theories

 Keynesian – (Demand Side), government expenditures, in short term, influences economic growth.  Monetarist – Controlling money supply, influences economic growth.  Supply‐side – Lowering taxes and regulations (helping suppliers), influences economic growth.

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Interest Rates

 Discount Rate: Rate set by the FRB, and charged for loans to member banks  Federal Funds Rate: The rate members banks charge each other for overnight loans  Prime Rate: The rate large US banks charge their best corporate customers  Broker Call Loan: Rate BDs charged by banks on Margin Accounts.

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Chapter Two

Understanding Products and Their Risks 33 Questions - 44% of the exam

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Common Stock

 Objective

A customer would buy common stock for growth and for potential dividends (income)

 The # 1 security for a hedge against inflation  Purchaser is hoping the price will go up  Always more risky than debt of the same issuer  Voting rights  Pre‐emptive rights

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Common Stock

 Risks

Stock price could go down Can only lose the money you put in (limited liability) Dividends are not guaranteed

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Preferred Stock

 Objective

Purchased for INCOME Stated interest rate on certificate, representing annual income as a percentage of par Par Value is $100 Higher liquidation claims in bankruptcy than common stock No voting and No preemptive rights Can be Cumulative, Participating, Convertible, or Callable Dividends are not guaranteed

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Equity Securities

 Preferred Stock  Types (Attachments)  Straight Preferred:

Nothing other than stated rate if BOD declares dividend

 Convertible:

Investor can convert the security into common shares Lower stated return than straight.

$ = (Number of Common Stock Shares)

Benefit to investor

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Control and Restricted Stock (SEC)

 Control Stock

Owned by officer, directors and persons who own 10% or more of outstanding shares

 Restricted Stock (Letter Stock or Legend Stock)

Unregistered stock owned by a control person (affiliate) or a non-control person

 Control Person aka Affiliate  Non‐control Person aka non‐affiliate

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Debt Securities (Bonds)

 Bought for INCOME  You are loaning your money to the issuer, you are a creditor  They agree to pay your money back plus interest, semi‐ annually  Terms associated with bonds

Par value, face value Premium/Discount

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Debt Securities (Bonds)

 Yields  Nominal (coupon rate)

Stated interest rate, or nominal yield printed on the Certificate Interest paid every six months (semiannually). Annual income is the coupon times par, or coupon percentage times $1000. Example: Take percentage and multiply by 10. 5% coupon pays $50 a year, 7.5% coupon pays $75 a year

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Debt Securities (Bonds)

 Current Yield  Yield to maturity (basis)

total yield anticipated if the bond is held until it matures

 Yield to Call

Exists if the bond is callable. Bond may be redeemed prior to maturity Callable bond only, and only matters if premium

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Mortgage Bond (Secured Bond)

 Secured Bonds  These are bonds backed by Collateral, something the person loaning the money will get, if the issuer doesn’t pay them back. Mortgage Bonds, most common type. Backed by real property

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Equipment Trust Certificate (Secured Bond)

 Equipment Trust Certificate  Backed by specific piece of equipment  Example: Airplanes or Railroad cars (rolling stock)  Not backed by issuer

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Collateral Trust Certificate (Secured Bond)

 Issued by corporations that own subsidiaries companies  Stock of the subsidiary company pledged as collateral for their bond issue  Backed by stocks and bonds that are owned by the corporation and are held in trust for the bondholder

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Municipal Bonds

 Debt security issued by a state, municipality or county  Federally tax exempt  Most suitable for people in high income tax brackets  Two types

General Obligation

Backed by taxes (full faith and credit of the issuer) Court house, fire station, etc

Revenue Bond

backed by revenue from a project backed by user fees, not taxes (toll road/bridges, stadiums, etc) 35 36

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Money Market Securities

 Cash equivalents Securities market that deals in short-term debt (one year or less) All Treasuries maturing within 1 year  Treasury Bills Matures in less than a year  Commercial Paper  Bankers Acceptance  Jumbo CDs Minimum of $100,000, exchange trading

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Rights & Warrants

 Warrants are Long term; 3‐5 years or perpetual (forever)  Rights are Short term (max 60 days)  Warrants Issued with purchase price above current market value.  Rights Issues with purchase price below current market value  Warrants are generally attached as sweetener to bond or other security issue.  Rights are issued with additional offering for current shareholders to maintain proportional ownership.

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Options

 Derivatives derives value from underlying security, i.e. stock  Contract between two parties  Buyer (owner) Long Rights they can exercise Force the writer to either buy (if put) or sell (if call) the underlying security  Seller (writer) Short The one with the obligation in the contract

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50 100 150 1 6 11 16

Down

100 200 1 6 11 16

Up

50 100 1 6 11 16

Flat

Option contracts

 Calls

The buyer bets the price will go above the strike price The seller believes the price will down or stay the same The buyer of a call is bullish

Bulls attack up

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50 100 150 1 6 11 16

Down

50 100 1 6 11 16

Flat

Option contracts

 Puts

They buyer bets stock will go down below strike price The seller believes the price will stay the same or go up The buyer of a put is bearish

Bears attack down

50 100 150 200 1 6 11 16

Up

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Sample Option Quote

Long 1 XYZ Jan 60 Cal l at 3

Long The investor has bought the call and has the right to exercise the contract XYZ The single contract represents 100 shares of XYZ stock Jan The contract expires on the third Friday of January at 11:59 pm ET 60 The strike price of the contract is 60 Cal l The type of option is a call, and the investor has the right to buy the stock at 60 since he is long the call 3 The premium of the contract is $3 per share. Contracts are issued with100 shares, so the total premium is $300. The investor pad the premium to buy the call

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“In The Money” (ITM)

 Buyers want the contract in the money  Call ITM when CMV above Strike  Put ITM when CMV below Strike  If the contract is “In The Money”, it has intrinsic value equal to the difference between the CMV and the Strike.  The contact has intrinsic value when in the money

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“Out of the Money”

 Seller wants contract out of the money  A call is out of the money when the underlying security is below the strike price  A put is out of the money when the underlying security is above the strike price.

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“At The Money”

 The current market price of the security is equal to the strike price  Sellers also like the contract to be at the money because the buyer will not exercise their right

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Options Contracts Terms

 Hedging

Hedging is insurance Buying a negatively correlated investment Buying puts as insurance against a long (buying) position in a stock

“Correlation does not imply Causation”. Just because things move together (positive correlation) or move opposite (negative correlation), does not mean that one is causing the other to do that, or even that something else is causing both of the movements.

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Covered and Uncovered Calls

 Covered Call

Covered Calls are when someone writes a call, but also owns the same number of shares they are writing. Worst case they only lose the shares they already owned when the call gets exercised.

 Uncovered Call (Naked)

When someone writes a call but doesn’t own the same number of shares Worst case, if the stock price goes extremely high, they would have to purchase at the extremely high price. They would have to then sell at the strike price, losing a lot of money. Very very dangerous. Unlimited loss potential

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Investment Companies

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Unit Investment Trust

 A redeemable, fixed portfolio of securities, that is unmanaged, and has a definite specific life span  No board of Directors but has a board of managers or trustees.  Many times it contains bonds, a bunch of different 20‐year bonds, the UIT then has a 20‐year fixed life. When the bonds pay interest, the UIT pays the owners, when the bonds finally mature, the UIT pays the owners, and dissolves.

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Open-End (Mutual Fund)

 Issuer must always sell and redeem shares, number of shares outstanding changes daily.  Forward Pricing

NAV is calculated once every business day at 4:00 pm EST Client receives next calculated NAV from when their funds post at the fund company Example: Clientʹs funds post 2 pm Thursday, so the client will receive Thursday’s close of business NAV. If instead the Clientʹs funds post 5 pm Friday, the client receives Monday close of business NAV Redemption of shares works the same way

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Advantages to investing in MFs

 Guaranteed liquidity  Professional management  Ability to diversify with small initial or periodic investments  Automatic reinvestment of dividends and capital gains at NAV (no sales charge)  Exchange within the same family at NAV (no sales charge)  Reduced sales charges (breakpoints, A shares only)

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Am ount

• f

Pur c has e at O f f er i ng Pr i c e ( $) Sal es Char ge as %

• f

O f f er i ng Pr i c e

L es s s s t ha han n $2 $25, 5, 000 000

5. 00%

$2 $25, 5, 000 000 t

• l

es s s s t ha han n $50, $50, 000 000

4. 25%

$50, $50, 000 000 t

• l

es s s s t ha han n $1 $100, 00, 000 000

3. 75%

$1 $100, 00, 000 000 t

• l

es s s s t ha han n $2 $250, 50, 000 000

3. 50%

$2 $250, 50, 000 000 t

• l

es s s s t ha han n $500, $500, 000 000

2. 00%

$500, $500, 000 000 t

• l

es s s s t ha han n $1 $1, 000, 000, 000 000

0. 50%

$1 $1, 000, 000, 000 000 an and d abov above

0. 00%

Break Points

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Letters of Intent, and Rights of Accumulation

 Letters of Intent

Allows investor to reach breakpoint and get discount, over short period of time. Has 13 months to reach breakpoint and can back date it 90 days. Only includes New Money.

 Rights of Accumulation

Allows investor to get discount on future purchases, once breakpoint is reached in account. Includes Accumulation and Growth.

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Annuities

 An annuity is a contract with an insurance company designed to provide retirement income  Types

Fixed Annuities (not a security) General account of the insurance company with a guaranteed fixed return. Suffers from Inflation Risk. Fixed Indexed Annuities (not a security) General account of the insurance company, where an index is used to calculate credited return. Caps and participation rates are used. Variable Annuities Separate account of the insurance company, where the investor has the investment risk as they choose where the separate account is invested. Requires Insurance and Securities Licenses.

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Real Estate Investment Funds (REITs)

 Undivided interest in real estate  Types

Equity REIT: Acquire, Manage, Build, Renovate, and Sell real

• estate. Generate income usually from rent or similar income.

Mortgage REIT: Lend money to real estate buyers, or purchase

• mortgages. Generate income from mortgage loan interest.

Hybrid REIT: Combination of Equity and Mortgage REITs.

 Gains and income pass through to investors

Losses and deductions do not

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Registrations/Listing of REITS

 Private

Exempt from SEC registration, and don’t trade on national stock exchanges. Generally sold to institutional investors

 Registered, non‐listed

Do not trade on exchanges, but are registered and have more disclosure requirements than Private REITs

Can be sold to institutional and some accredited investors

 Listed

The REIT is listed on exchanges. Will not have the same liquidity risks

• f other, unlisted securities.

Can be sold to accredited and some retail investors 69 70

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Limited Partnerships

 General Partner

Manage partnership Unlimited liability responsible for all debts Fiduciary responsibility to investors

 Limited partner (the investor)

Limited liability Tax benefits No “day to day” management role

Can Inspect records Can vote

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Direct Participation Programs (DPP)

 Limited Partnerships

General Partner manages (managed by someone other than LP) Limited Partner has Limited Liability (can only lose what you invest) Flow through of income/losses to investors aka “pass- through” DPP not directly taxable (taxes paid by owners the LPs and GPs) High liquidity risk (sale may require GP approval) Can be organized as Limited Partnerships, Subchapter S

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Hedge Funds

 Very high risk  Invests in advanced and complicated strategies (short selling, margin trading, options, Commodities and currency)  Tries to make profit in all market conditions  Generally illiquid, lock in, limited trading opportunities

May need partners permission to sell sometimes, partners can lock the fund (no withdrawals)

 Usually high fees and high minimum Investments  Usually structured as a Partnership  Suitable for high net worth individuals who are not risk‐adverse  Not usually registered, but manager is usually an IA.

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Exchange Traded Funds (ETFs)

 Exchange‐traded funds

Represent ownership in the underlying portfolio of stocks, bonds, or commodities. Similar to a mutual fund that tracks an index fund (e.g. S&P 500)

ETFs trade like stocks on exchanges (very similar to a Closed End Fund)

Advantages over mutual funds

Priced intraday (all throughout the day, not just 4pm) Lower fees, both sales and management Can be easily bought and sold on margin Tax efficient typically, no capital gains distributed

Disadvantages over mutual funds

Potential overtrading by investor Commissions paid to buy and sell (like trading stock) Price based on supply and demand

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Systematic Risks

 Risks that cannot easily be diversified away. Market

The market as a whole falls in value

Interest rate risk

The risk that changes in interest rates will affect the secuirty

Inflation (purchasing power)

The risk in fixed income securities that over time the value of the principal is losing purchasing power.

• Bonds, Fixed annuities

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Non-Systematic risks

 Risks that can be easily diversified away, generally by simply purchasing more issuers

Capital

The risk of loss of principal.

Business/Credit

The risk the issuer will go out of business, or default on debt. Business Risk relate to stock. Credit Risk relates to bonds.

Reinvestment

The risk at maturity that you won’t be able to put your money back and get as good an investment. Callable securities are common examples that have this risk.

Call

The risk that a security’s issuer will call the security; returning principal and ending income. Only on callable preferred stock or bonds Does come with higher income on the bonds though Only get called during falling interest rates.

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Non-Systematic risks continued

Liquidity

The risk that the investment can’t be turned to cash at CMV quickly. Minimal/nonexistent in exchange listed securities, government securities, mutual funds and similar. Certain specialty investments have major liquidity problems; Real estate, hedge funds, and similar.

Regulatory

The risk that a regulation, “rule”, from a federal agency will negatively impact the investment;

• FDA, FCC, EPA, etc

Legislative

Risk that laws will change

Political/Sovereign

The risk in foreign investments that the political climate, changes. Also called sovereign risk.

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Retirement Plans (Individual)

 Traditional IRA

Tax deductible contributions Has RMDs (70 ½)

 Roth IRA

Non-deductible contributions No RMDs (70 ½)

 Both grow tax deferred  Both Premature withdrawal penalty (59 ½)  Tax Free Withdrawals;

Open for 5 years and withdrawal after 59 ½ (Roth Only) 1st time homebuyer, qualified education, disability, death (both) 77 78

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Retirement Plans (ERISA)

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Retirement Plans (Corporate)

 401(k)

Corporate employee plan Money eventually vests

 403(b)

Tax Sheltered Annuity (TSA) For Public School Employees, Non-profit Hospitals, and Churches

 SEP

Self-employed people and employees Employer contributions only

 SIMPLE

Small business plan, no more than 100 eligible employees

 Keogh

Straight simple qualified ERISA plan. No corporations, only sole proprietorship

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Understanding Trading, Customer Accounts & Prohibited Activities 23 Questions - 31% of the exam

Chapter Three

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Transaction Dates

 Trade Date (T)– The recorded date of the transaction, when the price is agreed and set, and both parties become responsible to fulfill the transaction.  Settlement Date (Regular Way)

Corporate & municipal securities (T+2) Equity Options (T+1) Government Securities (T+1) Cash Trades (Mutual Funds) same day Reg T (Gives 2 days after settlement) = 4 business days to pay

T + 2 + 2 = Reg T 81 82

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Types of Orders

 Market

An order to buy or sell at the next available market price

 Stop

An order to buy or sell once a given price has been reached. Once that price is hit, the order “Triggers”, and becomes a market order. Could be bought or sold at prices better or worse than the Triggered price. “Stop Loss”, designed to stop a loss, or to lock in a gain.

 Limit

An order to buy or sell at a given price or better. Will never be bought or sold at a price ‘worse’ than the limit price Buy Limit Order Buy 100 shares BMK @ 40

This order will be executed only at $40 or better (when buying, lower price is better)

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Types of Orders

 Stop Limit

Like a stop order, but instead of becoming a market order at Trigger, it becomes a limit order. A stop price, and limit price are given.

 Good‐til‐Cancelled (GTC)

Orders are good until executed or cancelled All GTC orders cancel automatically last business day of April and October Most orders are “Day Orders”, and cancel at end of the day unless they are marked GTC

 Fill or Kill (FOK)

If entire order is not filled immediately, he order is cancelled Buy 100 BMK @ 50

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Types of Orders

 Immediate or Cancel (IOC)

IOC orders are like FOK orders except partial execution is acceptable

 All or None (AON)

Fill the entire order over a period of time. If entire order not filled, then order is cancelled

AON Day order

• Fill order by end of day or cancel order

AON GTC order

• Fill in one week or cancel order

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Taxes on Investment Returns

 Components

Interest – Taxed as ordinary income Dividends – Taxed as ordinary income Cost Basis – All the after-tax dollars you place into your investment Capital Gains – The gain that is received from selling an asset

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Types of Dividends

 Cash Dividends

Given in the form of cash. Can be reinvested (at no sales charge) or can be received in cash. Either way, Ordinary Income Tax will be paid that year.

Increases cost basis

 Stock Dividends

A stated percentage of stock will be given, so number of shares will increase.

A 10% stock dividend, with someone owning 1,500 shares, means they get 10% more,

• r 150 shares more, so after the dividend they have 1,650 shares.

Not directly taxable but will effect cost basis for capital gains calculations if portions of the portfolio are sold.

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Dividend Payment Dates

 Declaration Date (set by BOD)

The day the Board of Directors authorizes the dividend

 Payment Date (set by BOD)

The date on which the declared dividend will be paid

 Record Date (set by BOD)

The day the shareholder must officially own shares to receive the dividend

 Ex‐Dividend Date (Set by Regular Way Settlement Rules)

First day you purchase the security, and will NOT get the upcoming dividend ONE business days prior to the Record Date Must purchase shares before EX-date if you want to receive the

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Ex-Date (A) Record Date (A) Ex-Date (B) Record Date (B) Ex-Date (C) Record Date (C) Last Day To Buy (A) Last Day To Buy (B) Last Day To Buy (C)

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Capital Gains

 The type of income from selling securities.  Holding periods

Long Term over 1-year, Short Term 1 year or less

 Capital Losses go against Capital Gains Dollar for Dollar  Excess Long‐Term Capital Losses can be written off against Ordinary Income $3,000 a year until used up

I make $50K, I lost $10K. I can write-off 3 years @$3,000 and 1 year @ $1,000

 Unrealized Gains/Losses are those that exist before a sale has occurred. No taxes are owed until they are realized  Realized Gains/Losses are those once a sale has occurred

Short-Term realized gains charged Ordinary Income Long-Term realized gains charged Capital Gains rate

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Benchmarks and Indices

 Index

Statistical tool designed to measure performance of something over time. Dow Jones Index measures performance of 30 big companies. Consumer price index measures inflation.

 Benchmark

Something that serves as a standard by which others are measured or judged, point

• f reference. Almost all benchmarks are indexes, but not all indexes are

benchmarks.

 Beta

Measure of of a stock’s volatility in relation to the market

Beta of 1.0 has the same volatility of the market

 Alpha

Difference between what you expect and what you actually got

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Types of Corporate Actions

 Most requires Votes of both Board and Shareholders  Splits

Requires shareholder approval Designed to decrease an expensive security to get more people interested and able to purchase

 Reverse Splits

Requires shareholder approval Designed to increase a cheap securities price to get the price into a more attractive price area, and to potentially keep it from getting delisted if there are minimum prices to be listed on certain exchanges.

 Buybacks

Only the board approves (no shareholder approval) The company purchases its shares on the open market to turn them into Treasury Stock. 91 92

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Types of Corporate Actions (Cont…)

 Tender Offers

Requires shareholder approval Type of public takeover bid Offer to all stockholder of a publicly traded company to tender their stock for a specified price during a specific time, subject to tendering of a minimum and maximum number. Usually at a premium

 Exchange Offers

Requires shareholder approval Like a Tender Offer, but securities are offered instead of cash; trading.

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Types of Corporate Actions (Cont…)

 Rights Offers

Requires shareholder approval An issue of Rights to existing shareholders that entitle them to buy additional shares from the issue in proportion to their existing holdings, within limited period of time.

 Mergers and Acquisitions

Requires shareholder approval When two companies combine into 1 (Exxon and Mobil), or when one company takes over another company (AT&T and Cingular Wireless)

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Stock Splits

 Remember: The total value never changes.  Example: 3 to 2 split. Start with 200 shares at $60 a share.  With a split, the number of shares INCREASES, the value

• f each individual share DECREASES.

 Multiply the SHARES by the larger number  Shares increase to 300 𝟑𝟏𝟏 𝟒

𝟑 𝟑𝟏𝟏 𝟒 𝟑)

 So Cost decreases to $40 (𝟕𝟏

𝟑 𝟒 𝟕𝟏 𝟑 𝟒

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Reverse Splits

 Remember: The total value never changes.  Example: 5 for 2 reverse split. Start with 8,000 shares at $5.  With a reverse split, the number of shares DECREASES, the value of each individual share INCREASES.  Multiply the PRICE by the larger number  Cost increases to $12.50 (𝟔

𝟔 𝟑 𝟔 𝟔 𝟑)

 So Shares decrease to 3,200 shares (𝟗𝟏𝟏𝟏

𝟑 𝟔 𝟗𝟏𝟏𝟏 𝟑 𝟔) 95 96

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Account Types

 Cash Account

Trades must be paid in full, no borrowing allowed custodial accounts (for minors) must be opened as cash accounts Retirement accounts must be opened as cash accounts

 Margin Accounts

Accounts not fully paid, borrowing allowed

 Discretionary Accounts

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Margin Account Details

 Margin Account

Client borrows money from broker Regulation T (set by FRB) determines how much equity client must

• deposit. Currently 50% (or $2,000, whichever is greater)

 Margin account agreement

Credit agreement Hypothecation agreement Loan consent agreement (Broker/Call loan rate)

 Corporate, partnership, and fiduciary accounts ok if permitted

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Discretionary Accounts

 Rep can make purchase and sales decisions without needing to talk to client.  Discretionary if any of the 3 A’s are missing

Action: Buy or Sell Asset: The specific asset Amount: The number of shares or dollar value to buy or sell

 Price and Time are NOT discretionary!

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Account Statement & Trade Confirmations

 Account Statements

Provided at least quarterly

Monthly if there’s activity (deposits, dividends paid)

 Trade confirmations

Printed document with trade details

Provide electronically if written approval

Provided no later than completion of trade (settlement date)

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Public Communication (written)

 Retail Communications

More than 25 in 30 calendar days (26 or more)

 Correspondence

25 or fewer in 30 calendar days (less than 26)

 Institutional

Non-retail investor, does not need principal approval

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Suitability Requirements and Recommendations

 Know Your Customer Rule (KYC)

Financial

Balance sheet or income statement

• Annual income, Home value, Mortgage payment, How much pay in taxes

Non-financial considerations

Information not included on balance sheet or income statement

• How much do you need to save for retirement?
• Tax bracket

Risk Tolerance (more detailed in S6) Investment Objectives (more detailed in S6)

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Unethical Practices

 Front Running

Someone who knows a large order is going to be processed, and puts an order in before specifically to benefit from the change in price when the larger order executes. Agent is “running in front” of the large order

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Rumors

 Spreading false gossip about a security for personal benefit.  Generally connected with Pump and Dump schemes.  Pump and Dump;

Buying a large amount of a cheap stock, artificially increasing the price of the stock, and when it is higher sell all you have at a profit. Buy 10million shares of a stock for $0.02, cost of $200k. Spread rumors, get people to buy it, stock goes up to $0.05 on the news, sell your stock for a cool $500k, so $300k profit. Then stock plummets as it isn’t worth anything.

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Marking the Close/Open

 Marking the Close

Buying a security at very end of trading day at higher price than current market price to artificially raise the closing price to make it appear higher valued.

 Marking the Open

Placing orders at a slightly higher price, or sale orders at a lower price to drive up or suppress the price of securities when the market just opened.

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Backing Away

 Failure of a Market Maker to honor their quoted bid and ask prices.

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Freeriding/Withholding

 A practice where an underwriter does not make a legitimate public offering of a hot issue, but instead holds back shares for its own use  The underwriter is “withholding” shares.

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Churning

 Agent doing transactions purely for commissions  Depends on client’s objectives and goals, if it is churning, not just number  Switching

Churning in mutual funds

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Selling Dividends

 Trying to convince a client to buy a security just to receive an upcoming dividend.  Selling the stock BECAUSE of dividends

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Breakpoint Sale

 Selling an investment just below a breakpoint.  Must always notify clients of breakpoints.  Can’t recommend borrowing beyond their means, but Letters Of Intent could be suggested

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Am ount

• f

Pur c has e at O f f er i ng Pr i c e ( $) Sal es Char ge as %

• f

O f f er i ng Pr i c e

L es s s s t ha han $2 $25, 000 000

5. 00%

$2 $25, 000 000 t

• l

es s s s t ha han $50, $50, 000 000

4. 25%

$50, $50, 000 000 t

• l

es s s s t ha han $1 $100, 00, 000 000

3. 75%

$1 $100, 00, 000 000 t

• l

es s s s t ha han $2 $250, 50, 000 000

3. 50%

$2 $250, 50, 000 000 t

• l

es s s s t ha han $500, $500, 000 000

2. 00%

$500, $500, 000 000 t

• l

es s s s t ha han $1 $1, 000, 000, 000 000

0. 50%

$1 $1, 000, 000, 000 000 an and d abov abov e

0. 00%

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Restrictions on certain APs purchasing IPOs

 Certain full Broker Dealer employees are not allowed to participate in IPOs.  No account in which those individuals have any

• wnership claim may purchase IPOs that that individual

is prohibited from purchasing (unless there is an exception).

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Fraud

 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.

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Unethical Practices

 Borrowing/Lending to a Client

You cannot borrow from clients who are not in the lending/borrowing business, except;

Immediate Family, Outside long‐term friends (best friend since childhood who become a client a couple years ago), outside business partners requiring lending between you, and other reps registered with the same member firm

 Be careful of confusing HOUSE rules with FINRA rules.

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Unethical Practices

 Guarantees

Registered Reps cannot, in any way, guarantee a profit to the customer

 Sharing in customer accounts

Registered Reps can’t share in clients accounts, unless there is a written procedure in place and they share in direct proportion to the amounts contributed by all parties.

Except in the case of accounts being shared with immediate family.

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Unethical Practices

 Influencing Employees of Other Members

B/Ds may not pay compensation to employees of other members except:

The employing firm gives written permission Gifts less than $100

 Be careful about the difference between a “gift” and a “marketing expense”

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Financial exploitation of seniors and other persons

 Permit members to place temporary holds on disbursements of funds or securities from the accounts of specified customers where there is a reasonable belief of financial exploitation of these customers (65 years old or

• lder), mentally incapacitated, or similar.

 Require members to make reasonable efforts to obtain the name of and contact information for a trusted contact person for a customer’s account.

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Activities of unregistered persons

 Prohibition against paying commissions to unregistered person

Must be natural person, can’t receive commission income through separate entity.

 Unregistered persons can’t solicitate customers or take

• rders

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Falsifying or Withholding Documents

 Signatures of convenience

Blank forms/dates with signatures to allow easy filling and filing. Very unethical and not allowed.

 Respond to regulatory requests Promptly

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FINRA Sanctions

 Censure  Fine  Suspend  Expel member  Barr associated person  Any other sanction deemed appropriate

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Chapter Four

Overview of Regulatory Framework 7 Questions - 9% of the exam

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Securities Act of 1933

 Also known as the paper act  Regulates new issues, the actual securities  Regulates the Primary Market  Requires Prospectus  20‐day cooling off period

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Securities Exchange Act of 1934

 Regulates the People and Places, the Trading/Exchanging

• f Securities

 Regulates Broker Dealers, Associated Persons, Created the SEC

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Investment Company Act of 1940

 Regulates Investment Companies;

Face Amount Certificate Companies Unit Investment Trusts Management Companies

Open‐End Management Company (Mutual Fund) Closed‐End Management Company

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Investment Advisor Act of 1940

 Regulates Investment Advisors, and the Investment Advisor Representatives  And Investment Advisor meets the following 3 points;

They are in the business, of Giving Investment Advice on Securities, and Gets paid specifically for that advice

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Insider Trading

 Using Material Non‐Public information to make a gain or prevent a loss in a securities transaction.  Illegal in all cases, no exceptions.  $1mil (indexed) or 3 times profit gained/loss avoided, whichever greater (‘treble damages’)  Cotemporaneous Traders‐ The ‘contra party’ (other side

• f trade) to someone using inside information. They can

recoup only their loss, no treble damage. Includes legal fees, and ‘modest’ interest.

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Telemarketing

 Calling people you donʹt know to try to get them to buy something  No private residence can be called before 8:00am their time or after 9:00pm in their local time zone  Check the Do‐Not‐Call List (DNC)

If not expected to call, must check DNC list. If client request to never be called again, must add them to company DNC list.

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Telemarketing Continued…

 Established business relationship exemption

Telemarketer has made a financial transaction within 18 months of call The telemarketer is the Broker/Dealer of record on the client's account The person contacted the telemarketer within 3 months of the call

 Personal Relationship

Family, friends, and acquaintances are exempt

 Telephone Consumer Protection Act of 1991

When making cold calls, rep must record names and put on DNC if uninterested (within 30 days). Must tell prospect firm’s name.

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Suitability requirements

 Know‐your‐customer (KYC)

Bank and AML regulations. Requires proof of identity, make sure the client is who they say they are.

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Now What? Review the material take more qbank. Replay will be up tomorrow. TEST WITHIN 7‐10 DAYS FOR BEST RESULTS!!!

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Concept Cards

 We sell packs of Concept Cards (Flash Cards) for each of the Exams  Combine and save!  www.TSG.mx/Cards

SI E

• $35 S6
• $25 S63
• $20

S26

• $30

S65

• $30

SI E & S6 $55 ( Save $5! ) SI E, S6, & S63 $70 ( Save $10! ) Al l 5 $120 ( Save $20)

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Contact us with questions! Brian Kolins

(610) 348-1966 Brian@TheSecuritiesGuys.guru

Jeff Tharp

(210) 325-6302 Jeff@TheSecuritiesGuys.guru

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