Series License/General Securities Principal

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Series 24

Chapter 1

Preregistration Period

Prepares statements ( no discussion w/ customers)

Filing date ends the Preregistration Period

Waiting Period (cooling off)

Sec reviews the statement

Lasts around 20 days from last amendment. If filing is not correct SEC will send deficiency letter

Not Permitted to : Sell new issue or accept payment for new issue

Can: Discuss the issue, Provide Red-Herring and Record the names of potential purchasers

Ended by the effective date

Post Effective Period

Issuing of final prospectus (no later than the time a sale is confirmed)

If the firm has not filed before they need to supply a preliminary prospectus at least 48 hours before and then a final prospectus


Reporting status at time for filing: Exchange or Nasdaq Listing Status: After the offering, dealers must provide prospectus for:

Non Reporting Will be Listed 25 days Non Reporting Will not be listed and is not an IPO 40 days Non Reporting Will not be listed and is an IPO 90 days Reporting Aftermarket prospectus requirement does not apply


Unlawful representation • Failing to file the registration statement • Making a material misstatement and/or material omission • Selling security publicly before registration is effective • Failing to give a copy of final prospectus to purchaser

Small businesses (Less than $25 million) (become effective 20 calendar days after filing)

• Form SB-1: enables issuer to raise $10 million or less within any 12 months

• Form SB-2: enables issuer to raise capital in an unlimited amount for unspecified time period. (as long as it falls under the definition of small business issuer.


Trust indenture Act of 1939

• Bonds must register under the Securities act of 1933

• If issuing more than $10 million dollars must provide a indenture (agreement) between the issuer and a trustee who acts on behalf of the bondholders interest


Series 24 CH1 8-15

Well- Known Seasoned Issuer (issuer is required to file reports under section 13(a) or 15(d) With in 60m days of determination of eligibility must have - Worldwide market value of common equity by non-affiliates of $700 million or more. - Or in last 3 years have at least $1 billion aggregated principal amount of nonconvertible securities. - Eligible to register on From S-3 (short form) or F-3(foreign private issuers)

Majority-owned subsidiary- (subsidiary of a well-known seasoned issuer)

Securities are nonconvertible, and the parent company guarantees the securities fully and unconditionally

Seasoned issuer- Eligible to use form S-3 or F-3

Unseasoned issuer- reports under section 13 or 15(d) but does not meet requirements to file on from S-3 or F-3

Non-Reporting issuer- does not require filing of reports under section 13 or 15(D)

Ineligible issuer-

- Issuer that has not filed reports - Blank Check Company - Shell Company - Issuer offering penny stock - Using a form of selling other than firm commitment underwriting - Has filed for bankruptcy or issuer insolvent in past 3 years - Issuer of entity of issuer have been convicted of a felony or misdemeanor with securities or anti-fraud in the last 3 years - Has been is of a refusal or stop order

Free writing prospectus- Well-known seasoned issuers that will be subject of registration statement. It is an offer to sell or a solicitation of an offer to buy securities in the form of a written communication. (issuer free writing prospectus must be retained for 3 years)

New Issue Communications Examples of illegal communication

1. Research reports- if it contains info about the new offering 2. Advertising- ad campaign related to the new off 3. Oral Communication- discussions between registered reps and customers regarding new offers, Permitted after filing date 4. Internal syndicate memoranda- not allowed to be distributed to customers

Cooling off period- Generally underwriters may discuss new offer but may not offer in writing except with preliminary prospectus. Also applies to research reports

Exceptions to communication rules:

Gun- Jumping Provisions:

Rule 134: Communication not deemed a prospectus

Tombstone ads may include- o The name of the issuer o The full title of the security o The amount being offered o A brief description of type of business o Price o Date of sale o Identify of underwriters

Other ok info - Contact info of organization sending communication ( name, address, phone number and email) - Anticipated schedule for the offering (approximate commencement date) and a description of marketing events - Exchanges where securities will be listed - Name of selling securities holders

Rule 135a: Generic Advertising

Does not mention specific investment company, but provided general info about investing or generic types of funds

Can also contain request for further info with name and address of broker-dealers

Rule 137: Persons not participating in an offering

In order to be allowed to have a research report the issuer cannot have had a blank check, shell or penny stock offer within last 3 years

Research reports can be distributed by non-affiliated dealers who receive no direct compensation

Rule 138: Nonequivalent Securities (nonconvertible debt or preferred stock)

The broker dealers can distribute and publish research reports. If the report covers common stock, convertible debt or convertible preferred stock of an issuer, the report maybe published if it is regarding the nonconvertible debt or preferred stock.

Rule 139: Research Reports Are allowed to publish and distribute if the issuer is subject to 1934 act or is a well-known seasoned issuer.

If certain criteria are met

Cannot be initiation or re- initiation coverage of the issuer or security

Industry specific reports cannot display one security with more prominence

Rule 144a offering are also not considered offering or advertising

Reg S is not considered a selling effort


Rule 168: allows the issuer to continue to publish or disseminate regularly released factual business and forward looking information at any time.

Factual info includes: o Information about the issuer o Information about the business or financial development of the issuer o Ads of info about the issuer’s products or services o Dividend notices o Info in reports filed with eh SEC under Securities Exchange Act of 1934

Forward –looking info: o Earning Forecasts o Future management operation plans o Statement about future economic performance o Information in reports filed with the SEC This does not include info about a registered offer or activities in the registered offering does not quality as factual business info.

Rule 169 : allows a Non-reporting issuer to continue to publish or disseminate regularly released factual business information.

Electronic Road Show Road show conducted over the Internet (a graphic communication) considered a free writing prospectus

Live shows (oral) Taped (Graphic communication)

If the issuer is non-reporting (equity or convertible securities) then the issuer must file the road show with the SEC at time of registration. Unless it is a Bona Fide electronic road show (discussed shortly used for IPOs only)

Rule 415:

Reforms: if meets the requirement can be used 3 years after initial effective date other wise should be sold with 2 years

§ An offer that begins immediately and last greater than 30 days § Registered on Forms S-3 or F-3 and is sold immediately and in the future on a continuous basis

Rule 145: Reclassifications

Subject to 145: § Reclassifications § Mergers/Consolidations § Transfer of assets

Not subject: § Stock Splits § Reverse Stock splits § Change in Pas value

ADR’s (American Depositary Receipts)

Carry voting rights, Priced in $’s , pay $ dividends but ADRs are sensitive to currency risk Series 24 CH1 21-24

Exemptions (No matter what are still subject to Anti-fraud provisions of Securities act of 1933)

Exempt Securities:

• US Government and agency securities • Municipal Securities • Securities issued by Nonprofit orgs • Short-term corporate debt (less than 270 days) • Securities issued by domestic banks and trusts (but not bank holding companies) • Securities issued by small business investment companies (exempted by federal legislation)

Rule 147: Intrastate sales exemption

1. Issuer derives 80% of its gross revenues within the state 2. 80% of issuers assets are within the state 3. 80% of proceeds of the sale must be used for business within the state

100% of the securities sold pursuant to Rule 147 must be to residence of the state

Must wait 9 month before selling to someone outside the state Before the 9 months must sell to someone in the state

Regulation A:

Aggregate offering price: max of $5 million with in 12 months may be sold. No more than $1.5 million by selling shareholders

Offering Statement: Cannot make a written or oral offer unless Form 1-A offering statement has been filed with SEC. Considered qualified on 20th calendar day after filing

Preliminary and final offering circular: must be furnished to prospective buyers at least 48 hours prior to mailing of confirmation statements (with final prospectus)

Exempt Transactions:

Private Placements or REG D

Regulation D • Must file Form D with SEC no later than 15 days after first sale • Under $1 Million can sell to any one accredited and 35 non accredited investors (needs offering memorandum) • Over $1 Million allows an unlimited number of accredited investors to purchase must sign a investment letter which states that the securities are unregistered and can only be resold if registered. • Cannot advertise within the general public or open investment seminars • Over $5 million non accredited investors but have ability to gauge the risk • Securities are Restricted because they need to be registered in order to Resell • Must disclose relationship between issuer and purchase rep

Accredited investors • Financial institutions • Any director, executive office, or general partner of issuer • Individuals who meet financial tests (Net worth greater than $1 million) or Income over $200,000 (w/ spouse $300,000) Purchaser Representative- a person who represents potential purchasers who are solicited to buy securities pursuant to REG D and Cannot own 10% or more of company, nor be affiliated with issuer unless a close relative to the offeree.

Offering Memo- issued only if nonaccredited investors are offered securities it in tales detailed financial information of issuer

Series 24 CH1 27-30

Rule 144: permits the resale of restricted stock under certain conditions

Control Stock: stock acquired by an affiliated person of the issuer in the open market

Holding Period: 1 yr holding period for restricted stock, begins with purchase and must be fully paid at time of purchase.

Holding period applied to:

• Individuals who purchases and wished to sell • Individual who acquires stock as a gift • Securities acquired by a trust from a beneficiary • Securities acquired by a pledged from a pledgor

If person is deceased then it can be sold but estates are subject to rule 144

Control Stock does not have a holding period

Exception- Person has not been affiliated for 3 months prior to sale and has held the stock for at least 2 years.

Broker transaction- transactions not involving solicitation Exception: • A broker may make inquiry of a customer who has indicated an unsolicited interest in the securities with in preceding 10 days • The broker may make inquiry of another broker that has indicated an interest in the security within the last 60 days.

Notice of Sale : must file a Form 144 unless it is less than 500 shares or $10,000

Limitation of Amount: 3 month time period, IF exchange listed cannot exceed 1% of total shares outstanding or the average weekly volume of the past 4 weeks. IF over the counter the limit is 1% total shares outstanding

Rule 144a- Permits the sales of restricted stock ( except for the sales by the issuer) to Qualified Institutional Buyers QIBS with out conditions of rule 144 (seller does not need to be QIB)

QIBS (three part test)

1) Insurance companies 2) Registered investment companies 3) Small business development companies 4) Private and public pension plans 5) Certain bank trust funds 6) Corporations, partnerships, business trusts, nonforprofits 7) Registered investment advisers

Second: must buy for its own account or other QIBS

Third: Buyer must own $100 million of securities of issuers not affiliated with the buyer

Regulation S: Sale of U.S. company stock issued outside the U.S.

Transaction must be offshore. (no offer is make to a person in the US or the transaction is not facilitated in the US

Reg S may not be resold to US investors because of the Distribution compliance period. Usually 40 days for debt securities and 1 year for equity

CH2 1-4

Underwriting securities

TYPE Liab for unsold shares

Firm Commitment YES Syndicate must absorb losses in unsold shares Best Effort NO Unsold shares are returned to issuer Best Effort: All or None NO Offer is canceled if all shares are not sold Best Effort: Mini-Maxi NO Offering is canceled if set minimum is not sold, but sale may continue up to preset maximum Stand-by YES Syndicate agrees to buy any shares not purchased by shareholders in rights offering

Distribution of Securities

Syndicate- Broker-dealer forms a syndicate and takes the role of syndicate manager (managing underwriter)

They then create an agreement among underwriters or syndicate agreement. The role of the syndicate is to guarantee (underwrite) the sale

Selling Group- the syndicate will sometimes recruit other broker dealer to assist in the sale. Must sign a selling group agreement, which describes the relationship. Selling group does not assume financial liability.

Syndicate Practices

Underwriting Spread- difference between investing public and issuing company

Typical Spread Manager's fee 0.1 Underwriting fee-earned by syndicate 0.2 Concession (selling group) 0.5


CH2 8-12

REG M Rule 101- Helped to prevent manipulation

Restricted period – can range from 1-5 days before pricing or when ever the broker-dealer becomes a participant.

Exception: • Transactions involving government and muni bond, investment grade nonconvertible and preferred stocks and RICS (2-9) • Actively traded securities , which are those with ADTV of at least $1 million , where public float is $150 million • Odd-lot transactions • Exercise of any options, warrant, right, or similar instrument • Unsolicited brokerage transactions and unsolicited purchases when acting as a principal

Research- Referring to covered securities reports they my be distributed during the restricted period if they meet the conditions of rules 138 and139 of securities act of 1933

Rule 102: Activities of issuers

Issuing insiders are prohibited from supporting or raising the price of stock before an IPO

Exception- • Issuers may not bid for or purchase the following: • Actively traded securities of the issuer or an affiliate • Basket transactions involving a covered security • Inadvertent transactions

Rule 103:Passive Market Making

Permits distribution participants to continue making markets in a Nasdaq stock that is the subject of an offering during the rule 101 restricted periods but only on a passive basis.


Rule 104: Stabilizing- is the placing of any bid or effecting of any purchase, for the purpose of pegging, fixing , or other wise maintaining the price. Although it is manipulation the SEC has considered it benefits

The max price a stabilizing bid can be initiated is the public offering price.


Stabilizing

Stabilizing when the Principal market is open-

The bid must be initiated in any market at a price no higher than the last independent transaction price for the principal market.

IF: 1) security traded in principal market, when day stabilizing is initiated or the preceding business day

    2) Current ask price is equal to or greater than the last independent transaction price

Closed-

The price stabilization may be initiated is generally limited to the lower of the price at which stabilization could be initiated in the principal market at its previous close or the last independent transaction or bid in the market.

Can be raised to match independent bids of the market

Disclosure: If stabilization occurs, the market must disclose the purpose of the stabilizing bid


Rule 105: Short Sales in Connection with an offering

Securities from an offering may not be used to cover short sales affected during a period beginning five business days prior to the pricing of the offering and ending with the pricing of the issue Does not apply if not conducted on a firm-commitment basis

Underwriters cannot make all- or none unless 1) all the securities being offered are sold at a specific price and time 2) issuer receives the total amount it is due by a specific date

Disclose of interest- broker/ dealer must give or send the customer written notice disclosing its participation in the distribution before the completed transaction


CH 2 16-18

Selling syndicate- is a group distributing securities under an agreement that imposes a financial commitment on its members.

Selling group-is a group distributing securities under an agreement that does not impose a financial commitment on its members.

Nonmembers: (suspended nasd members) : nonmembers cannot join in syndicate or selling groups.

This does not apply to foreign broker-dealers. Although they must follow the same rules

If issuer if selling to public and has hired agent, then no nasd member firm can participate.

Review of Underwriting Agreements Usually submitted by managing underwrite (to nasd for review)

• Estimated max public offering price • Estimated max underwriting discount • Estimated max reimbursement for underwriting expense

Filing is required for most offers including REG A and intrastate offerings

Filing must be no later than one day after filing of any registration

Exempt: U.S. government sec, Municipal sec, redeemable share investment companies, variable contract and private placements.

Exempt from filing requirement: Investment grade debt and preferred stock, other securities of issuer outstanding (debt and preferred stock)

Fairness of compensation

Nasd Reviews all that a member firm participates, but will not pass judgment on merits of issue of public offer price.

Factors: # of shares purchased by the underwriter, time when shares are purchased, cost of stock in relation to public off price.

Shares received from the issuer by the underwriters that exceed 10% of the total offering will be considered unreasonable.

Option or warranty are considered unfair if they exceed 5 years duration or can be exercised on more favorable terms.

Compensation- in addition to the underwriting discount, any payments to underwriters for costs not usually borne by issuer are included in compensation

Examples of expense not considered compensation: blue-sky fees, printing costs, accountant fees

Restrictions- the sale of securities acquired in connection with an offering is restricted for a period of 6 months following the effective date

Selling Concessions: Can only be given to bona fide service providers who are broker-dealers in investment banking.

Must sign a written agreement that is will comply with the NASd rules on selling concessions

Settlement of syndicate accounts: syndicate manager of a firm-commitment must no later than 90 days following the settlement date, provide each syndicate member with an itemized statement of syndicate expenses.


CH2 22-27

Rule 2790 (The New Issue Rule)

NASD member firms should make a bona fide offering of new issues and not withhold any shares for its own account, any employees or industry insiders. Also restricts the sale to accounts with restricted persons have beneficial interest.

Exception: personal of Limited broker dealers

New Issues are ALL IPOs of equity securities that are sold under a registration statement or offering circular.

NOT NEW Issues: • Secondary offering • All debt offerings, (convertible and non-investment grade) • Private offerings • Preferred stock and rights offerings • Investment company offerings • Exempt securities as defined under the securities act of 1933

Preconditions fro sale

Affirmative statement- a form that positively declares that an account is eligible

Firms using electronic communication may not rely on oral statements

Selling firms must re-verify eligibility every 12 months and retain copies of all information and records for a minimum of 3 years

Prohibited Sales: Cannot sell to a restricted person and a member firm cannot buy new issues unless it is exempt

Restricted Persons Is not permitted to purchase any shares of a new issue unless an exemption applies.

Nasd member firms an any associated person of the member firm Immediate family of an employee of a member firm (spouse, children, parents, siblings, In-laws)

Immediate family is considered restricted if all 3 condition apply 1. The employee gives/receives material support to immediate family. Material support is 25% or more of the persons income 2. The employee is employed by the member firm that is selling new issues 3. Employee has the ability to control the allocation of the new issue

Other restricted persons: Finders and fiduciaries, Portfolio managers, person who owns a broker-dealer


General Exemptions:

New issues can be sold to the following accounts

• Investment companies registered under the investment company act of 1940 • The general or separate account of an insurance company • A common trust fund • Account were beneficial interest is less than 10% • Public traded entities other than broker-dealer or its affiliates that engage in the public offering of new issues • Foreign investment companies • Erisa accounts, state and local benefit plans

Broker-dealer can purchase shares of new issues if the offer is undersubscribed

Restricted persons can purchase shares of new issues in order to keep the their equity at the same level (Anti-Dilution). Must have owned the shares at least 1 year prior and new shares must be held for three months following the effective date

Issuer-Directed Securities Entites that control or are controlled by an issuer may purchase shares of a new issue if the issuer specifically directs them to.

EX. The parent company of an issuer, the subsidiary of an issuer, employees and director of an issuer

Allows registered representative to purchase shares of equity IPO if the issuer is the employing broker-dealer


Securities taken in trade: Can exchange owned shares and trade for securities being distributed. Principal capacity (must be purchased at fair market) , Agent capacity (member charged a normal commission for securities that are sold)


Affiliate- an entity that controls, is controlled by, or is under control with member. Assuming that corporation owns 10% or more of stock member or partnership where any partner owns 10% or more.

Employee purchases- Employees can purchase if the sold being sold is: • The member company • A parent company of the member • An entity, which wholly owns the member • An entity, which owns at least 51% of the stock of the member • An entity that would become a member or parent of a member as a result of the transaction

Qualified independent underwriter (needed when underwriter is selling its own stock) • Participates in the preparation of any offering documents and would exercise the same due diligence as any underwriter, even if not actively selling the securities • Unless the security is investment grade, then the underwriter must provide a pricing option for the new issue and the new issue can not be sold at a price. • Must have engaged in investment or securities business for 5 years and has seen offers of similar size • Cannot have been convicted of fraud in the past 5 years

Disclosures (Registration statement, offer circular, or similar docs) • Must disclose that the offer is made under the provisions of the NASD • Must include a date by which the offer is expected to be complete • Include the name and responsibilities of any qualified independent underwriters

Recommendations- Member firms are required to maintain on file the basis for its recommendation to its customers. (On discretionary power , must obtain the clients written consent, even though it holds discretionary power)

Filing • Underwriting agreements for member proprietary offers must be filed under the corporate financing rule. • When firm is issuer, it is responsible for filing the required docs and fees • In case of affiliated, the managing underwriter is responsible for filing • If no manager then the member affiliated with issue must file

Direct Participation Programs (DPP) A direct participation program is an investment that provides for the flow-through tax consequences to the investors in this security. Types: Limited partnership, joint venture, subchapter S corporation and similar programs

NOT DPP’s Real Estate Investment Trust(REITS), Pension plans, investment company securities, and tax-sheltered annuities

Disclosure:

Full disclosure must be made on this areas: Compensation, Physical properties, tax aspects, the financial condition and experience of the sponsor, risk factors and appraisals on properties.

Must also believe that the client: • Will be in a financial position to realize the tax benefits of the program • Has the financial resources to assume the risks and lack of liquidity • Meets all suitability standards

Members must maintain records showing the basis for determining suitability. Need written approval on discretionary accounts for transaction

Limits to DDP Compensation Max compensation is 10% gross dollar amount of securities plus .5% of the proceeds for the reimbursement of bona fide due diligence expenses. If firm is an NASD member then the total cap is 15%

Rollups- a limited partnership rollup transaction is one that involves the combination or reorganization of one or more limited partnership. NASD Compensation on Rollups • No more than 2% of the exchange value of the newly created securities • Paid regardless of whether or not the partners reject the proposal

CH3 1-3

Exchange Markets

NYSE RULES

Distribution and size- Public shares of at least 1,100,000 with market value of $100,000,000 ($60,000,000 for IPO/Spin-off)

Financial criteria- • Pretax income over three years of $10,000,000 • Operating cash flow of $25,000,000 over last 3 years, with positive amounts each year • Average Global Market Capitalization of $750,000,000 with revenues of $75,000,000 for last fiscal yr

Unlisted Trading Privileges- in some cases the securities are not listed because of inability to meet exchange requirement. Yet these can still trade on other exchanges such securities are said to have Unlisted Trading Privileges.


The Role of the Specialist

Specialist- must be approved by NYSE for each stock in which they specialize. In addition to maintaining the book of orders, they are responsible for balancing buy and sell orders to arrange an equitable opening price.

Can act as an AGENT OR PRINCIPAL

Agent- matching the customer with counterparty when market conditions allow

Principal- Trading from their own account. This trading must be down in order to maintain a fair and orderly market. They are prohibited from make a transaction other wise

Fair and orderly- means one in which there is price continuity and reasonable depth. This also covers the idea of Trade imbalances. which is where the specialist act to create liquidity. The specialist also cannot compete with public orders


Stopping Stock- is a guarantee given by a specialist to a floor broker that the broker’s order will be executed at a specific price unless a better price can be obtained in the crowd. (only for public accounts)

Automated Trading Systems-

NYSE- uses SUPERDOT (designed order turnaround) It can take market and limit and takes round and odd lots

Orders are entered at the branch and are routed directly to the specialist


CH2 7-9

Types of Orders

Market order- Executes at whatever price the market is when it reaches the floor. Will always be executed

Limit order- Wanting to buy or sell at a specific price. It can only execute at a specific price or better.

Buy limit- executes at limit or lower Sell limit- executed at limit or higher

Usually it is given to a specialist to hold until he can execute.

It is possible that the order will not be executed if the limit is never met or there might be stock ahead (other orders at the same price with a higher priority)

Stop Order- a stop order becomes a market order to buy or sell once a stock trades to or thought a specific price. The Stop price is the specific price that activates the market order. Thus the order will execute but there is no guarantee of the execution price.


Sell Stop Order- A sell Stop order is always placed below the current market price. It is used to limit a loss and protect profits

Buy Stop Order- - A order that is always placed above the current market price. It is typically used to limit a loss or protect a short sale

Stop Limit Order: a stop- limit order is similar to a stop order except that it becomes a limit order when the stop price causes the activation. It is a combination of a stop order and a limit order. But exposes the risk that the investor misses the market

Sell Stop- Limit Order- is always placed below the market price and once activated it become a sell limit order.

Buy Stop-Limit order- Always placed above the market price and once activated it becomes a buy limit order

ORDER QUALIFIERS

Day-Order= If not executed in the days trading it is canceled

Good-Till-Canceled(GTC) or Open Order= remains in effect until executed or canceled

At-the-Open= order to buy or sell at opening price. If not executed it is canceled

At the Close= order executed at the Closing Price. If closing price cannot be obtained to the order must be canceled.

MOC- Market on close LOC- Limit on Close

Not-Held(NH) = this gives the broker discretion as to the time and price on and order. If the broker cannot execute or find the best price the order is canceled and the broker is not held responsible.

Immediate- or- cancel (IOC)- State execute as much of the order as possible immediately and cancel the rest

Priority

1) Price 2) Time 3) Size

CH2 12-15

NYSE RULES

Bids and offers NYSE Brokers- must communicate promptly their bid and offer(size) to a reporter for dissemination to the public If a bid or offer is revised or canceled it must be reported Reporting can be suspended if accurate reporting is not possible

Rule 61- All bids and offers in the NYSE trading crowd be for round lost or multiples of round lots. Thus if I am selling 500 and 41 but someone is buying 200 at 41 I would be left with 300 shares with 200 sold at 41

NYSE Rules 91- A member(acting as a specialist) is prohibited from filling an order to purchase securities by selling the securities from any account in which it or for any account that an approved person of the firm

NYSE Rule 92- A firm member is prohibited from entering a proprietary order for a listed security if the person entering the order has knowledge of an existing customer order on the same side of the market that may be executed at the same price.

Also prohibits members from trading along with a customer who is an individual investor trading in his own name.

In order to trade along a customer must be an institutional investor and must provide permission to the firm on a case-by-case basis.


Circuit Breakers- Are periods of high volatility

Rules 80a- restricts index arbitrage strategies if the NYSE composite changes by at least the ( 2% value) at the beginning of each calendar quarter

Rule 80B- Dow Jones Industrial Average (DJIA)

Cause Level 1 10% Before 2pm- 1 Hour 2-3PM: 30 Minutes 2:30+: trading continues Level 2 Level 2 20% Before 1pm- 2 Hour 1-2 PM: 1 hour 2:00: trading is halted for the remainder of the day Level 3 30% Suspended for the day Pending and open customer- turn into GTC

NYSE Rule 97- Block positioned- min net capital- $1,000,000, A block of stock is considered to have a value of $ 500,000 or more. Prohibits a member firm, that has purchased stock as a principal from a customer in a block sale, from purchasing additional shares of subject security on a plus tick during the last 20 min of trading day

Exceptions: • Has information barrier procedures that would limit knowledge of customer orders throughout the firm • Is effecting a transaction to hedge a position that is economically equivalent to a short position acquired in the course of facilitating a customer order • Makes a transaction for bona fide arbitrage reasons or to participate in the trading of securities of a company that is part of publicly announced reorganizations (merger, acquisition, consolidation) • Is trading to offset another transaction that was made in error • Is facilitating the conversion of options • Has a specialist that is trading stocks in which he is registered • Is facilitating a block sale or basket of stocks by a customer • Is facilitating a customer’s existing order to purchase a block, or specific stock within a basket, or a stock that is being added to reweighed in an index at or after the close of trading. Must record transaction and show that the # of shares does not exceed the number needed to fill the customer order • Is enacting a transaction because of a stock’s addition to an index or an increase in stocks weight to an index. Cannot exceed the number of shares required to rebalance.


NYSE RULE 127- Crossing a Block: (block of at least 10,000 shares or $200,000 market value which ever is less)

If a member firm receives a large block order of stock that might not be absorbed by the market .the firm should explore the market. If the firm intend to cross the block at a set price , they will need to follow certain procedures.

Proxies- rule 450: member firm cannot vote on proxies of securities that it hold in street name for customers. Proxy should be forwarded to the customer at issuing corporation expense. If the customer fails to respond then the member firm may vote.

Except if it is a investment manager of stock held by an ERISA plan which reserve the right to vote the proxies itself

Erroneous Reporting: Rule 411- the price at which an order is executed is binding even if an erroneous report is rendered to a customer. An Erroneous report of a transaction that was not in fact executed is not binding on the member firm. Conversely, if an order is transacted and an erroneous report is sent indicating that the order was not transacted, the execution will be binding on the person entering the order

Prohibited Activities-

Manipulative activities- this includes a series of purchases at successively higher prices, or a series of sales at successively lower prices. If the purpose was to improperly influence the price of the security.

Circulation of rumors- a sensational nature designed to influence the price of a security is prohibited.

Prearranged trades- are not permitted. An offer to sell coupled with offer to buy at a higher price

Prohibited from publicly offering to: • Buy or sell dividends • Bet on the course of the market • Buy or sell privileges to receive or deliver securities

NYSE 409: for every account that there was money or securities in the preceding quarter. A member firm must send an account statement showing securities and money positions and entries. Can hold mail for 2 months if traveling domestically and 3 months if it is a broad.


CH4 1-5

Securities Exchange Act 1934 Focus is on the registration and sale of new issues

Covers: • Regulation of transactions in the secondary market, including antimanipulation rules and regulation of the extension of credit in securities transactions • Registration and regulation of broker-dealers • Oversight of industry self-regulatory organizations (SRO) • Registration and regulation of companies with securities trading in the secondary market, including regular financial disclosure, proxy rules, and insider reporting

Exempt: US Government securities and municipal securities

SEC: The Act of 1934 created the Securities and Exchange Commission. It is in charge of enforcing the securities laws and with creating rules to implement. Members are appointed by the president with consent with the Senate. 5 total commissioner, with 3 or less of one party affiliation. Members are appointed for five years


Interstate Commerce: “trade, commerce, transportation, or communication among the several states, or between any foreign country and state”

Does not cover: Foreign stock exchanges

Violations of the Exchange Act Max fine of $1,000,000, imprisonment for ten years, or both, for individuals. For business entities the max fine is $2,500,000. If violators can prove they were not aware of the rule, can opt to not be imprisoned

Registration and Reporting Requirements

• Stock exchanges must register with the SEC • If a Public Company has more than $10,000,000 in assets or 500 shareholders or is traded on an exchange it must be registered with the SEC (in addition to 1933 securities act) • Rules 13a-11 and 13a-13 require issuers of securities to file an annual 10-K and quarterly reports 10Q (except foreign governments, foreign private issuers, ADRS) • 8-K forms are needed to report material events • Nasdaq interdealer quotation system- File reports on 10-C under certain circumstances. 5% of greater change in amount of securities outstanding or changes in the corporate name

Insiders- is a director, officer or owner of 10% or more of the stock of a corporation. Have ability to control the corporation. Must report becoming an insider with in 10 days to the SEC. Must report changes in positions within 2 business days. Form 3 is initial filing form and Form 4 is beneficial ownership changes.


Short Swing Profits- are profits earned within six months of purchase.

• Insiders are prohibited from selling affiliated stock short. • Also applies if insider sells stock held over 6months is sold and the bought back for less within 6 months

Disgorgement- when a corporation sues for recovery of profits

5% owners- anyone who acquires 5% or more of issuers securities should notify the issuer, the exchange and the SEC.

Proxies- Sec does not require proxies but does require certain rules on them

• Must be filed with SEC

Purchases of Equity Securities by issuer

• If a registered company purchases its own stock or a tender offer then it must file a report with the SEC • Schedule 13e-3: is used to report repurchases to cause any class of equity securities that effect the listing of a stock or that would cause less than 300 shareholders • Requires financial statements for the last 2 fiscal years and latest ytd period

Rule 10b-18: was created to control how and issuer, or its affiliate, may buy its own stock in the secondary market.

If the following conditions are met the SEC will assume it is not manipulation • One broker-dealer to place bids and makes purchases on any trading session • Avoid making purchases at certain times of the day. If the securities are actively traded it is prohibited to trade in the last 10 min of trading. For most securities cannot be first transaction or during the last 30 mins. • Limit the bids or purchases of at certain prices. May not be higher than the last highest independent bid or last transaction. For all others no higher than highest independent bid obtained from three independent dealer • Limit the amount of stock purchased on any single day. Total single day volume cannot exceed 25% of the ADTV. If trading under 25% then the issuer may effect one block purchase a week if not other 10b-18 purchases were made

Block Purchase- quantity has a purchase price of over $200,000 or is at least 5,000 shares w/purchase price of at least $50,000 or is at least 20 round lots that total 150% or more of trading volume

After market wide trading suspension is relaxed provided • The reopening of trading to the close of trading on the same day as the imposition of the market-wide trading suspended or • At the next day’s opening, if the market-wide trading suspension was in effect at the scheduled close of trade

In either event volume of purchase cannot exceed 100% of ADTV


Ch 4 9-14

Antimanipulation Rules- prohibits (a) short sales of listed securities and (b) manipulative or deceptive device or contrivance” employed on an exchange or over-the counter

Short Sales: (regulated by SEC rule 10a-1 and SHO)

May be made only on a plus or zero-plus tick. Ex. Plus tick 49 49.1 (+) 49.2 (+) 49.1 (-)

Ex. Plus zero 49 49.1(+) 49.1( + zero)

Can not trade on minus ticks or minus zero ticks

All Sell orders are marked Long or Short: if the broker believe the stock is in possession can be marked long but if it is not held should be a short sale

Position is Long for purpose of short sale if • Has time to security • Has entered into an unconditional contract to purchase the security but has not yet received delivery • Owns a security convertible into the one sold and has tendered it for conversion • Is long an option or warranty and has exercised the option or warrant

If you hold a convertible security but has not been tendered it is not considered long Also if warrants or options are held but not exercised the position is not long

Selling short against the box: owns the stock that is being sold but intends to effect the delivery by borrowing the same number of share, retaining the stock held in the long account. Same up-tick requirements as short sale

Senior officers cannot sell the securities of there own company short!

Dividends: if a dividend is declared on a stock, the price of the stock will be reduced by the amount of the dividend. This is not considered a down tick and the price will be adjusted at close

Exceptions- some short sales are beneficial to the market or carry little risk of manipulation. • Arbitrage activities • Hedging activities of block positioners • Odd-lot offsets by odd-lot dealer • Overallotment in a new issue • Activities of exchange specialists exchange market makers and third market makers

Short Sales and Recommendations: If a customer accepts a purchase recommendation from a broker-dealer that supplies the stock to the customer by selling it short, the brokers is required to make a covered purchase promptly in order to effect delivery to the customer

Insider Trading- the purchase or sale of securities using material, nonpublic information about those securities in a fraudulent manner.

If a corporation has material information, it must release it to the public before anyone may use the information to do a transaction

Unlawful with the purchase or sale of security • Employ and device, scheme, or artifice to defraud • Make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statement made , in light of the circumstances under which they were made , not misleading • Engage in any act, practice or course of business that operated or would operated as a fraud or deceit upon any person

A sales of a security based upon untruthful statements or omissions of material fact can be held liable to the purchaser unless the sell was not aware of the untruthful statement or omission

Tippers/ Tippees If a tipper tells a tippee confidential info, then both are in violation of insider trading rules.

The Insider Trading and Securities Fraud Enforcement Act of 1988 ( and ITSA insider trading sanctions act)

Broker/dealers are required to establish, maintain, and enforce written policies and procedures reasonably designed. Key Procedures • A system for monitoring employees’ personal trading and trading in firm proprietary accounts • Restriction or monitoring of trading in securities when the firm has access to inside information • Procedures to restrict access to file containing confidential information, including the establishment of information barriers • Education of employees regarding insider-trading issues

Information barrier procedures- a set of procedures for preventing the transmission of confidential information from one department to another within the broker-dealer (Chinese walls)

The burden is on the dealer to be able to show that they are adequate

Consequences of insider trading violation

Civil Penalties- up to 3 times the amount of the gain, or loss avoided. SEC can also ask for disgorgement of profits

Criminal Penalties- ITSFEA states: fines up to $5million and imprisonment up to 20 years, for each violation. Corporation and other non-natural persons may be fined up to $25 million per violation

Bounties- the acts allows for granting of bounties for information leading to payment of penalties not greater than 10% of the penalty.

Manipulation: consists of wash sales, matched orders and poll activities

Wash sales- represents the purchase and sale of securities by an individual without an beneficial change of ownership for the purpose of raising or depressing the price of the security .

Matched orders are similar to wash sales, they are when two persons acting together to buy and sell a security for the purpose of raising or lowering the price of a security

Manipulator can be sued but the suit must be within 3 years of the activity or 1 year of the discovery

Trading Suspensions and Emergency Authority

The Sec may: • Suspend trading in any security(except exempt) for a period not exceeding 10 business days • Suspend all trading on any national securities exchange or otherwise (except exempt) for a period not exceeding 90 days. Can be overturned if the president disapproves of the suspension

Emergency authority- the sec must determine that the order is in the publics interest and for the protection of investors: • Maintain or Restore fair and orderly securities markets (except exempt) • Ensure prompt, accurate and safe clearance and settlement of transactions in securities (other than exempt)

Emergency order must be less than 10 days

Emergency- means a major market disturbance characterized by a) sudden and excessive fluctuation of securities prices generally, or a substantial threat of such fluctuations, that threaten fair and orderly markets b) substantial disruptions of the safe or efficient operations of the national system for clearance and settlement of securities


Ch 4 20-23

SEC rule 11Ac1-5

Requires market centers to disclose order execution information.

Market center- is any national securities exchange, alternative trading system, OTC market maker, national securities association, or a member firm that internalizes order.

Required to produce monthly electronic reports that include uniform statistical measures of execution quality for covered orders.

Covered securities- are defined as any Global market system security and any other security for which transactions repost, last sale data or quotation information is disseminated

Covered order- is any market or limit order received and executed during normal business hours. This includes immediate or cancel, but exclude any order in which the client provides special instructions. (Must be made public)


SEC Rule 11Ac1-6

Requires that broker/dealers disclose non-direct customer order-routing information through quarterly reports.

Directed order- designates where the customer want the order to be executed

Non-direct order- has no market center designation, the broker-dealer chooses the place of execution

Report must disclose • Market center that non-direct orders were routed • Payment for order flow • Internalization • Profit-sharing arrangements • Info is also posted on the internet website, free of charge and accessible to the public Upon request: The market center to which a person’s order was routed can only be done within 6 months at no charge to the customer.

Exemptions:

De Minimus level of orders- firms that route less than 500 orders a quarter are exempt from quarterly reporting. But upon request must prove to customers and notify them of this annually

Insignificant Execution Venues- broker/dealers must disclose only the execution centers to which the most orders are route. Less than 5% of non-directed order is not mandatory for report inclusion.

Tender Offers- is an offer to buy stock of a company at a specific price. Often done to gain control. A person who is making a tender for stock may not buy the stock or a convertible bond of the same issue during the period of tender is open.

Tender offer practices: • The offer must be made public no later than 9am(eastern) on the business day after the scheduled expiration date (the offer must state the approximate # of shares tendered to date.

• Shareholder must be notified of tender no later than 10 business days from date tender was made

• Management of the subject company must advise shareholders of whether they recommend or decline the tender offer

• Tender offers must generally be held open for at least 20 business days from the time they are announced to holders

• If the person making the offer increased or decreased the % of the class of securities being sought, the consideration offered, or the dealer’s soliciting fee, the offer must remain open for at least 10 business days from the date that notice of the change is given to holder

• It is considered fraudulent for a person making a tender offer to fail to pay the consideration offered, or to return securities tendered, promptly after the offer is terminated or withdrawn.


Inside information and tender offers: associated person with knowledge of material nonpublic information that has been obtained through the offeror, the company subject to the offer, are prohibited from trading in securities on the target company. Associated persons of the company attempting a tender include: • Officer • Director • Partner • Employee • As well as anyone acting on behalf of the offeror

Partial tender offers- the exact number of shares that will be accepted from any person tendering stock is unknown until the tenders are accepted. Once the tendered securities are accepted, the investor must convert the equivalent securities into the tendered security and make delivery

It is illegal to short tender(tender when one does not own)

Partial tender offer (long owner) • Has title to stock • Has entered into an unconditional contract to buy the stock but has yet to receive it • Owns a call option and has exercised the option

When determine a investors net long position- long puts are not obligated to sell thus are not considered in the position

Ch4 26-31

Registration of Broker-Dealer

Firms must file Form BD with the SEC

They are then subject to Exchange Rules covering: • Minimum financial standards • Protection of customer funds and securities • Books and records to be created and maintained • Disclosures to customers • Manipulative, deceptive, or fraudulent practices

Foreign Broker-Dealer

If a foreign broker/ dealer operates an office in the U.S. generally must register with the SEC. Unless it is a subsidiary that is not engaged in the securities industry. Also exempts foreign brokers that don’t have U.S. home offices from registration under certain circumstances • If the foreign dealer only effect unsolicited transactions. § Solicitation- includes phone calls encouraging to use the dealer, ads on broadcast or publications, investment seminars for US person. • Research reports are considered solicitation under this rule unless. • 1)the repots are distributed by a U.S. Registered broker-dealer • 2) U.S. Broker accepts responsibility for the content • 3) report directs all orders to the U.S. Broker • 4) all orders are in fact executed by registered broker-dealer • Foreign broker-dealers may contact U.S. institutional investors if trades are booked through U.S. Registered dealer, with in person visits must have a U.S. Broker dealer present (unless assets exceed $100 million or a major institutional investor) • Foreign broker-dealers may directly contact and execute transactions for select groups • Banks • Registered broker-dealers • Supranational agencies (world bank) • Foreign persons in the U.S. • U.S. Persons outside the U.S NASD allows member firms to pay non-registered foreign persons a transaction related fee. Must provide the document to the ‘Referred” client

NASD- the power to manage and administer the affairs of the NASD and to promote the welfare, objectives and purpose of the NASD is vest in the Board of Governors

NASD administrative districts, which is headed by a district committee, which is an agent of the board of governors .

Membership- A broker or dealer that is authorized to transact investment banking or securities business in the United States is eligible for membership in the NASD. Except: • Individuals trading for their own accounts, but not as part of a regular business would not be a dealer thus not eligible • Broker or dealers that have been suspended or expelled from NSA or NSE • Brokers or dealers that are barred or suspended from association w NSA or NSE for conduct inconsistent with just and equitable principle of trade • Broker or dealer enjoined by a court from engaging as investment advisor, underwrite of broker, dealers, or another capacity in the securities industry • Broker or dealer that are deemed unsuitable for membership by NASD Board of Governors

Membership is dependant on compliance with the Board if Governors requirements on training, experience, and financial responsibility.

NASD members pay an annual assessment based on annual gross revenues from muni’s, OTC securities, U.S. government securities and exchange transactions.

Department of Member Regulation decides on applications, if the application is denied, Can appeal National Adjudicatory Council. Can further appeal to the SEC

Failure to Pay Fees Failure to pay can result in suspended or cancellation upon 15 days written notice from the NASD

Executive Representative- is an associated person appointed by a member firm who is authorized to act on behalf of the firm in all official business between the firm and the NASD

Dealing with Nonmembers- Nonmembers must be treated in the same manner as members of the public. This limits the ability for nonmember firms to transact business by not allowing them price concessions and discounts

Suspended Members- become a nonmember on the effective date of the expulsion. All admission fees, dues, assessments and other charges paid to the NASD cannot be recovered

Broker-dealer membership is terminated if there registration is revoked by the SEC or if they resign from the NASD

Restrictions of dealing w/nonmembers • Securities issues or guaranteed by the United States • Securities issued by municipalities • Transactions on an exchange • Commission for execution of an order on an exchange even if the exchange member is not a member of the NASD

Member firms may not pay commission to a nonmember for execution of an order in the over the counter market

Foreign Broker-Dealers: are not treated like nonmembers, but must comply with the restriction of the rule as though it were a member of the NASD. The Foreign Broker-dealer should treat non-members like the general public

Continuing Commissions- prior to retirement if there is a contract with member firms to receive such compensation. Thus they would be a former member of the NASD and would not be allowed to solicit new order or accounts.

Penny Stock Regulations-

Penny stock- Low-priced OTC stocks, often quoted in pink sheets or NASD OTC bulletin An Equity that is priced less than $5 not included on any exchange or Nasdaq and whose issuer has not met financial standards of listed equity companies

Disclosure- Prior to effecting any transaction the broker-dealer must furnish the customer with a Risk Disclosure Document on penny stocks

For each penny stock transaction, the broker-dealer must disclose to the customers • Current Quotation for the security • Compensation the Broker-dealer will receive for the transaction • Compensation the registered rep will receive for the transaction

Monthly statement are required if the customer has a penny stock in his account for the month. It must include: 1) the identity and number of shares of each penny stock 2) Estimated maker value of the security.

Exemptions: to penny stock disclosure rules

• Transactions with an institutional accredited investor • Private placements • Transactions with issuer, officer, director , general partners, of 5% owners • Transaction that are not recommended by the broker-dealer • Transactions by a broker-dealer whose commission and marker ups from penny stock do not exceed 5% of its total commissions and markups

Sales Practice required for penny stocks Prior to purchase must: Approve the person’s account for penny stock transactions Obtain from the customer a written agreement to the transaction w/identity and quantity of purchase

Account Approval Procedure: • Determine that the customer is suitable for penny stock transactions based on info about financials and investment objectives • Deliver to customer a written statement regarding the suitability determination • Obtain from the customer a manually signed and dated copy of the statement

Exempt from the cold call rule: 1. Transactions w/ an Institutional accredited investor 2. Private Placements 3. Transactions with the issuer, officer, directors, general partners, or 5% owners 4. Transactions that are not recommended by the broker dealer 5. Transactions by a broker-dealer whose commission and markup from penny stocks do not exceed 5% of its total commission 6. Transactions with established customers

Established customer- is one for whom the broker-dealer carries an account and who Has effected a securities transaction or made deposit more than one pervious year Has made three purchases of penny stocks (3 different issuers on 3 different days) Being established does not exempt it from Penny Stock Disclosure Rules



CH5 1-4

OTC Markets:

Most are unlisted securities • OTC has a wider range of capitalization • OTC is really a collection of markets developed to suit the trading characteristic of various issues • OTC is a Negotiated dealer market, Market makers competing with each other.

Broker-dealers in OTC • Don’t have to purchase a seat • Can act as an Agent or a Principal (or counter party • In the Agent or Broker transactions receive commissions • Where are Principal transactions profit are made by bid ask spread • Cannot act as both at the same time • Some Firms only conduct broker transactions in the OTC these firms rely on commissions and rarely act as principals • Riskless principal- Acts as a pass threw from another broker-dealer to customer account • Dealers are at the core of the OTC, help to provide liquidity

Market makers- a dealer that stands ready to buy and sell a specific security and is willing to take the other side of a customer transaction and helps provide liquidity

Market-Maker Quotes

Bid- willing to pay for security Ask- what you are willing to sell for

Size: it is assumed that the stock is sold in round lots of 100 thus if you are willing to buy 2000 and sell 3000 it would be 20by30

Retail customers orders are usually down(for the bid) or up(of the offer)

Mark up- The price the retail customer pays compared to what the broker bought it for

The inside market: Each security has on average 11 market makers at most 50 Lowest offer and highest bid is called the inside market Backing away- market maker fails to honor it quote and is a violating if NASD and SEC Rules This can result in $ fines or suspension of the firm

CH5 8-11

Pink Sheets: • Traditional OTC trading- • Paper version- from Pink Sheets, LLC • Electronic: EQS (electronic quotation services) • Pink sheets list, Market makers and their phone numbers (sometimes give bid ask) • Pink Sheet are Subject (static)- which means it’s not a quote and should be verified • There is uncertainty with companies traded and with making sure best price was obtained


NASD (best execution)- In any transaction for or with a customer, a member and persons associated with a member shall use reasonable diligence to ascertain the best interdealer market for the security and buy or sell in such market so that the resultant price it the customer is as favorable as possible under the prevailing market conditions

Should contact at least 3 dealer to get a real-time quote for customers. Problem is the offer is only good when you are on the phone with the broker

NASDAQ- began Automated quotation system in 1971

Nasdaq helps to collect and disseminate real-time, firm quotes in selected OTC stocks. OTC Bulletin Board (otcbb)-is and automated version of pink sheets

The Third market- Over the counter sales of exchange-list securities or (The Nasdaq Intermarket)

Restrictions on IPOs : Cannot trade an IPO on a third market before the IPO is traded on the primary exchange. (consolidated tape is proof)

Consolidated Quotation System- (CQS): attempts to reduce this problem by collecting quotes for all markets in which a listed stock trades and displaying them on one screen. This includes common stocks, preferred stock, warrants and right that are registered or allowed unlisted trading privileges. CQS operates between 9:30am-6:30 pm

ITS- Intermarket Trading System: links national and regional exchanges. I allows for one exchange to send and execute on another floor.

NASD members who are registered as market makers are permitted to participate in ITS thought Supermontage. NASD members not registered third market makers may not use ITS


The Fourth Market: Direct institution-to-institution trading, with out services of a broker dealer.

PTS- Propriety trading system- is set up to facilitate institution-to-institutional accounts.

The true fourth market activity is impossible to estimate, since there is no reporting requirement


Ch6 1-5

The NASDAQ stock market:

Corporate governance standards include • Keeping a min of 2 independent directors on the board • Maintaining an audit committee with majority independent directors • Provide shareholder with annual reports and make quarterly and other reports available • Solicit proxies and provide statements for all meeting • Refrain from taking certain actions or issues securities that would disparately reduce or restrict the voting right or existing shareholders

Issuers must amend registration statements if there is a material change

Although not technically a exchange it still has listing requirements, apply of listing , and be accepted by NASDAQ.

Securities not registered with the SEC like Eurobonds are not eligible

If an issuer is delisted, the issuer must reapply for listing as other non-listed companies and must meet initial listing standards

initial listing standards 1. $15 million of stockholder equity 2. $1 million of pretax income (latest fiscal year or 2 of last 3) 3. Public float of at least 1,100,000 shares w/ MKV of $8million 4. $5 minimum bid price 5. 400 round-lot shareholders 6. at least 3 market makers

Initial Listing alternative 2 1. $30 million of stockholder’s equity 2. Public float of at least 1,100,000 shares with market value of $18 million 3. 2-year operating history 4. $5 min bid price 5. 400 round-lot shareholders 6. at least 3 market makers

Initial List Alternative 3 1. Either $75 million market cap or $75 million total assets, or $75 million total revenue 2. Public Float of at least 1,100,000 shares w/MV $20 million 3. $5 min bid price 4. 400 round-lot shareholders 5. At least 4 market makers

Once list it must meet one of the 2 alternative standards

Continued listing alternative 1 1. $10 million of stockholders equity 2. public float of a least 750,000 share w/MV of $5million 3. $1 min bid price 4. 400 round-lot shareholders 5. at least 2 market makers

Continued listing alternative 2 1. Either $50 million market Cap, or $50 million total assets, or $50 million total revenue 2. Public float of at least 1,100,000 shares w/ MV $15 million 3. $3 min bid price 4. 400 round-lot shareholder 5. A least 4 market makers

NASDAQ Capital Market Standards:

Capital Market Initial Listing Standards: 1. Either $5 million of stockholders equity, or $50 million market cap, $750,000 net income 2. public float at least 1,000,000 shares w MKV $5million 3. $4 min bid price 4. at least 3 market makers 5. 300 round-lot shareholders 6. either 1 yr operating history or $50 million market Cap

Alternative 1 1. Either $2.5 million equity, or $35 million market cap, of $500,000 of net income(latest fiscal year or 2 of last 3) 2. Public float of at least 500,000 shares with MV of $1million 3. $ 1 min bid 4. at least 2 market makers 5. 300 round-lot shareholders


Nasdaq Service and Systems

Level 1- provides subscribers with inside market for each Nasdaq security was well as last sale and volume. Used mostly by individuals and registered reps

Level 2 Service- provides subscribers w/names and quotes of all registered market makers in each Nasdaq security

• Also shows the inside market • Displays Current total volume for the day, the last sale, high low price for the day and net change • From the screen can easily determine which market maker has the best price • All NASDAQ quotes are firm

Level 3- is only available to registered market makers in a particular security. The info is interactive and quotes can be updated through level 3


Normal business hours 9:30 am eastern and closes no earlier than 4pm eastern. Business can stay open past 4:00pm eastern voluntarily remain open but must notify Nasdaq operations. Can close no later than 6:30 pm. Between 4:00pm and 6:30 pm is called extended hours

Registration as a NASDAQ market maker:

A broker dealer may enter quotes into Nasdaq only if it is registered as a Nasdaq market maker. Must file an application with NASD It is effective when notified by the NASD Must also register in specific issues it wished to make market

Payments

• No NASD member or associated person may accept, direct or indirect for: § Publishing a quote § Acting as a market maker § Submitting an application in connection with market-making activity

Consideration- granting or offering securities on terms more favorable than those granted or offered to the general public.

Promoter- all persons other than the issuer or its affiliates who would have an interest in influencing a broker-dealer to makes a market in a security.

Ex. Advisor, accountant, attorney, someone who owns restricted securities of an issuer or who owns 5% or more of public float

The rule does not prohibit a member from accepting Payment for bona fide services Reimbursement for registration fees paid to the SEC

Primary market makers- is those that provide liquidity to market, as measured by specific performance standard however due to SEC order handling rules all NASDAQ market makers in securities are considered primary market makers


Ch6 9-12

Nasdaq Market Center (SuperMontage)

Supermontage: Is an order display, quotation, and execution system. It allows for trading on Nasdaq Global Market, Nasdaq Capital market, and exchange listed securities and acts as the only system to access the quotes of Nasdaq market maker.

• Supermontage: displays 5 price levels for each security. o Including inside market and four best levels beneath


Order-entry firm: is a firm that enters an order into SuperMontage. Orders can be for customers and broker-dealers thus they may be market makers or non-market makers

Supermontage: accepts= market orders, marketable limits order and limit orders. Order of up to 999,999

Will accept short sales but will only execute if they comply w/ NASD short sale rules


NASDAQ market velocity- measures order activity within NASDAQ. Including quotes, orders, updates and cancellations.

Quote types: 1. Market participant Entered- The market participant maintains its quote 2. Summary quote- allows several quotes at different price levels. 3. System Generated- When market participant quote is exhausted, Supermontage will generate a quote based on the market price

Automatic Quote Refresh (AQR) – Refreshes quotes when previous quote size falls below one round lot. With price and size preselected by market participant. If participant has multiple quotes that might be better priced than the quote that would not be created by the AQR, then better-priced quote will be displayed

EX. MM#1 has 2 quotes 15.40 and 15.45 and AQR is set at $.1 and MM1# best offer is (15.40) but is decremented down to zero. Then MM1# quote will increase to 15.45 not 15.50 because it is better-priced quote.


If there are no other participants quoting in the stock, the price will be refreshed by no lower than one tick inferior from the last valid inside market or no lower than one tick inferior from the market participant’s last displayed quote before the 30 seconds expired, which is less.

Reserve- Allows firms to maintain an additional amount of securities to trade unknown to market participants. In order to maintain must have at least 100 share (one round lot)

Once a Market Maker displayed and reserve size is exhausted then the market maker: • Manually enter new quote • Use automatic quote refresh

If a quote is not entered or automatic quote refresh is not used them Nasdaq will enter a quote on its behalf

New types of orders:

Non-Directed Orders- Liability orders are orders that create an obligation to buy or sell a security. They are delivered to or executed against a market maker’s display, or reserve size or delivered to ECN. If orders are not sent non-directed may either be market orders or marketable limit order.

Preferenced order: are orders that are sent to a specific market participant that is at the inside market. Perferenced orders are entered into the non-directed order process previously described and considered liability orders. If the market participant who receives the order is not at the inside market, the order will be rejected. IF partial fill then unexecuted portion will be returned to the sending firm


Trades on Supermontage- occur automatically(locked-in), except with manual executions. Nasdaq market makers and UTP exchanges must accept automatic executions. Upon trade both parties are notified of the transaction and report is sent to NASDAQ and Clearing agency.


Ch6 16-19

Nasd operates: SuperMontage, CQS and the OTC Bulletin Board

ECN (not NASD operated)- an electronic system that widely disseminates to third parties orders entered by market makers and permits such orders to be executed against in whole or in part. (doesn’t include- Crossing systems: such as ITG/Posit or internal broker-dealer order routing system

Can include institutional investors as well as broker-dealers ECNS are either operated by a broker-dealer, are registered as broker-dealer themselves or are registered with SEC Orders from ECN’s are included in NASDAQ quote montage.

ECN Interaction w/ SuperMontage ECN are not required to maintain two sided quote and act only in an agency capacity to execute order. Since ECN quotes can access internally by subscribers to the system. Plus they would be able to execute on SuperMontage creating double jeopardy making them take a principal position or (proprietary positions)

2 types of participation in Supermontage as Order Delivery ECN or Full Participation ECN.

Order Delivery ECN: has the ability to post aggregate subscribers order and enter non-directed orders into SuperMontage to access other market participant quotes.

Market participates can interact with order delivery ECN’s by sending non-directed SuperMontage orders to them. Supermontage will decrement the ECN’s displayed size by the amount for which the order is sent.

An order delivery ECN can accept, decline, partially fill, price improve, or allow an order to time-out. If an order times-out after being sent to an ECN, it is canceled by SuperMontage and sent to the next market participant at the inside market.

If the ECN’s displayed quote is partially decremented, the remaining interest will be canceled or set to the next price provided to SuperMontage by the ECN. If no price level is set by the ECN, SuperMontage will be set to zero


Full Participation ECNs: an ECN that has agreed to accept automatic executions by SuperMontage participants. The can also send order to other market participant for execution. Full participation ECNs have 5 character identifier ex ECNA+

UTP Exchanges: • Can participate in SuperMontage • Must accept automatic executions • Can enter directed and non-directed order • National securities exchanges that trade unlisted securities only enter multiple quotes if they are agency orders, designated as non-attributable orders • UTP that do not accept automatic executions and are not part of SuperMontage can submit quotes to SIP (securities information processor) or the NASDAQ Stock Market. • The UTP Exchange must be accessible by telephone or a self-created alternative link

Advanced Computerized Execution System (ACES) Pass-Thru

• Aces Pass-thru is a customizable order-routing systems • Allows order-entry firms with granted access to market maker’s internal trading systems to route orders to the system via ACEs. • Execution reports back through ACES • Market makers can add, delete or restore order-entry firm routing their orders. o Order entry firms send orders through ACES Pass-Tru to market makers with whom they have arrangements • Fees for the use of ACEs are paid for by the Market maker

Nasdaq international services

Supports European trading sessions from 3:30 am to 9am eastern Coincided with the London market


European market maker – operating only during the European session International market maker- operating during both European and regular domestic session.

Securities qualified for NASDAQ international: • Nasdaq Global Market Securities • Any non- Canadian foreign security or ADR that is included in Nasdaq but is not an NGM security • Any Equity security listed on a U.S. Exchange Plus • Market making commitment by at least one broker-dealer • If affiliated with NASD members but not part of the NASD are limited to European status only. • Quotes must be two-sided and firm and trading reports similar to U.S. Nasdaq

Transactions in NASDAQ international service require • Securitys symbol • Volume • Type of transaction (buy,sell, or short sale) • Date of Transaction • Account Number • Market Center were the trade was executed • Price (exclusive of commission and markup or down)

The Alternative Display Facility (ADF)

It is the Alternative choice of Nasdaq equities instead of SuperMontage, it operated 8 am. EST to 6:30 pm Gives the ability for participants to post quotes and reports and compare trade executions ADF Quotes are not accessible over SuperMontage but are included in the inside market ADF does not provide order delivery or execution capabilities

Thus there is NASD rule 4300(A): The Order Access Rule- ADF market participants must provide direct electronic access to other market participants and all other NASD Members and allow for indirect electronic access to its quote. Under the rule, market participants are either ADF, ECNS, ATS

Direct Electronic Access: ability to deliver an order fro execution directly against another ADF market participant without the need for voice communication. The Access must have: equivalent speed, reliability, availability, and costs

Indirect Electronic Access: is the ability to route an order through a market participant’s customer broker-dealer for execution against the market participant’s best bid and offer without the need for voice communication. The Access must have: equivalent speed, reliability, availability, and costs available to the market participant customer broker-dealer providing access to the market participant’s quote.

Performance Standards:

Minimum standards for ADF Linkages: 2 Second turnaround for an order that will be accepted or declined 3 or fewer second turnaround for communication between market participants

must be meet in order to ensure adequate technology to send and receive executions in a timely manner. Must be able to meet peak standards before any authorization is given to post quotes

Multiple Market Center Quotations- if a Non-Nasdaq member is posting 2 or more venues the posted quotes must be the same

Same as for ADF’s except posting different size quotations in different venues is not prohibited although the price must be the same

Ch6 22-30

OTC Bulletin Board (OTCBB) 7:30 am-6:30pm- is an electronic quotation service for OTC equity securities. Displays real-time quotes, last-sale prices and volume information.

• OTC Equity security- is generally any equity that is not listed or traded on Nasdaq or a national securities exchange. Including Domestic and foreign equity issues, warrants, units, ADRS and direct participation programs. • Does not have listing requirements • But must file periodic financial information with the SEC or other regulators and must remain current. If not filed with in the 30-60 days grace period will be delinquent

Quotes included in OTCBB • 2-sided quote (bid and off) • Bid only • Offer price only • Un priced indications of interest (such as bid wanted or offer wanted • Bids or offers accompanied by a modifier reflecting unsolicited customer interest

During normal business hours quotes must be firm except for (DPPS) direct participation programs securities

Minimum quote size: 5,000 shares @ prices up to $.5 To 50 shares @ process above $200

OTCBB is a real time system- quotes may be updated by market makers at anytime. DPPs are updated twice a day between 8:30-9:30 and 12-12:30

With at least 2 market makers showing 2 sided quotes for any OTCBB security, the system will then display the inside market based on all quotes in the system for the given security. Including 1 sided price quotes. Like all Non-Nasdaq equities, trades must report within 90 seconds of execution.

When referring to OTCBB Securities. Reps must be careful because OTCBB securities should not be mislead to allow investors to believe that it is the NASDAQ market. Since bulletin board stocks do not meet listing standards. For instance the NASD is concerned that because the equity has a ticker symbol then it will be seen as a NASDAQ equity.

Initiation of Quotes for Non-NASDQ OTC securities

Rules 15c2-11- requires that broker –dealers who wish to publish quotes for a non-Nasdaq OTC equity security must collect and review certain information about the issuer. Meaning to initiate or resume quotes in an inter-dealer quote medium.

Information to be collected (must have one unless exception) 1. A prospectus that’s effect for less than 90 days 2. An offer circular effective within the preceding 40 days 3. The issuers latest form 10-k and subsequent forms 10-Q’s and forms 8-ks 4. For certain foreign securities, financial filing under rules 12g3-2(b) during the last fiscal year 5. Sixteen specific items of information about the issuer similar to the aforementioned items

The dealer is to review the information and reasonable believe that all the material aspects and sources from which the information was obtained are reliable

Must also have the following information: • A record of the circumstances involved in the publication of the quote, including the identity of the person for whom it is being published and any information regarding the transaction provided to the dealer by those persons • A copy of any SEC trading suspension order for any security if the issuer during the proceeding 12 months, or a copy of the SEC public releases announcing the suspension • A copy or written record of any other material information about the issuer that comes into the dealer’s knowledge or possession before the publication of the quote

Submission of Information to the NASD The Form 211 must be completed within at least 3 business days to prior to enter a quote The firm must specify: • The issuer • The issuer’s predecessor in the event of a merger or reorganization within 12 months • The type of security to be used • The member’s initial or resumed quote • The particular subsection of Rule 15c2-11 with which the dealer is demonstrating compliance

Any filing must be signed by a principal of the member firm

The NASD will review the material and within 2 business days, and notify the dealer if the application has been cleared.

SEC-Imposed Trading Suspension-

If the SEC imposes a trading suspension it should alert the broker-dealer to information in its possession could be inaccurate. The broker-dealer should update the information and or receive reassurances of additional information about the suspension

Exception to Rule 15c2-11

• If the security is listed on an exchange or Nasdaq, the rule does not apply • Compliance wit 15c2-11 is not required if a dealer is publishing a quotation on behalf of a customer where it represents Unsolicited customer interest in buying or selling the security.

The piggyback Exception: • The quotation must have appeared on at least 12 of those 30 day • And there can be no more than four business days in succession during the 30-days period without quotation

If the dealer qualifies for piggybacking exception and begins publishing quotes, it can continue to publish without complying with 15c2-11. If it ceases publishing then it must comply before resuming quotations.

A Stock that has been delisted from NASDAQ may be quoted on the OTCBB without filing form 211 if • The market maker has quoted the stock on NASDAQ during the 30-days period prior to its removal • The security has been quoted continuously on Nasdaq during the 30 calendar days preceding its delisting, exclusive of any trade halt • The issuer must not be the subject of bankruptcy proceedings • The issuer must be current in the filing with the SEC

The Piggyback exception does not transfer from one quotation medium to another. But if the security is eligible for piggybacking in another quotation medium (pink sheets) then dealer can if it meets the regular and continuous conditions initiate or resume quotations in the OTCBB with out 15c2-11

Characteristics of Non-Nasdaq securities • Lack of liquidity • Thinly traded and prone to manipulation • Now requires transactions involving member firms to be reports • Most Non-Nasdaq issues are domestic companies


Third-Market Trading

OTC transactions in listed securities (Nasdaq Intermarket transaction)

Consolidated Quotation System (CQS)- the avenue by which third market quotes in exchange-list securities

A Market maker must apply to the NASD to function as a CQS market maker

Market maker must enter quotes into CQS within 5 business days or lose its registration

Market- maker obligation: Quotes must be firm at the price and size displayed If no size assume normal lot (100) If multiple exchange quotes must be identical

Withdrawals: if a Market maker withdrawals its quotes of a security, it terminates its registration. Cannot register until 2 business days.

Excused withdrawals: are available upon application to NASD Market Operations, for illness, vacation, physical circumstance (up to 5 days) , for legal and regulatory ( up to 60)

Trading Practices- Specific guidelines to cover transactions by members in the third market.

1) Members may not execute transactions that are fraudulent, manipulative, or deceptive. Such as wash sales or painting the tape 2) Circulating information that the members know or has reason to believe is false or misleading is prohibited 3) Members may not engage in third-market transactions in order to influence the closing price 4) NASD members may not execute third-market transactions in a security that is subject of an IPO until the security has opened for trading in the primary exchange. 5) Members may not trade ahead of customer orders that they are holding. EX: if a customer has a unexecuted customer order to buy a listed stock in the third market, it may not sell stock from its own account. Likewise can’t execute a trade that would suffice the buy price of the unexecuted order


CH7

1-7

Market-Maker Obligation Regarding Quotes:

Firm quote rule-The member is obligated to execute an order presented to it at a price at least as favorable as its published quote.

The obligation to fill the order begins when the order is presented regardless of how it was transmitted

Except: • The market maker communicated to NASDAQ a revised price or size prior to the presentation of the order. • The market maker just effected or is in the process of effecting a transaction at the time the order is presented and immediately upon completion of the transaction, communicates a revised quote to NASDAQ (Trading Ahead exception)

Backing away- failing to buy or sell a normal unit of trading


NASD Rules on Quotations:

If one member firm disseminates a quote on behalf of another firm, it must have reason to believe the quote was bona fide. Quotes include indications such as Bid wanted or offer wanted not just priced quotes

If a member give a priced bid or offer the member must be prepared to honor it at the price and under the conditions stated. (NASD version of the Firm quote rule)

If a member published a subject quote but will not update firm quote it is considered backing away

Nasdaq Quote rules: Must be two sided and firm. (Except when the market maker is publishing a stabilizing bid.)

If a market maker updates its quote, but does not specify a size for the update, a new quote will assume the previous quote size


Trade- or Fade:

If a market maker is required to honor its quoted size, failure to honor a larger size order would force the market maker to change its quote. The rule requires that NASDAQ market makers to publish an inferior quote anytime they fail to execute the full size of an incoming order that is at least one normal unit of trading greater than the market maker’s published quotation size.


Anticompetitive activities regarding quotations: • A market maker moves an offer down at the request of another market maker • A market maker provided information to another member firm’s trader regarding an institutional customer strategies • A market maker reveals to another member firms trader a larger net long or short position

Locked or Crossed Markets:

Crossed- occurs when a market maker enters a bid quote that is higher than the ask quote of another market maker or the ask quote is lower than the bid quote of another market maker.

A situation arising when the bid price of a security exceeds the ask price.

Contrary to normal markets where the bid-ask spread is positive; in a cross-market the spread is negative. This scenario occurs mainly in volatile and high volume

Locked- occurs when the highest bid and lowest offer are equal

A short-term situation occurring within a market where both the bid and ask are identical, resulting in no bid-ask spread.

Locked markets are typically corrected immediately through subsequent trades. This abnormal market condition occurs mainly on the Nasdaq exchange for orders entered before the opening bell.

Opening Quotes:

Opening Nasdaq- 9:25 am EST. At this point quoting is firm and becomes auto-executable.

Any quotes that order or carry a price that would lock the market are placed in Queue.

Queue- is a holding state in which the order are placed until they can be executed

The quotes and orders are executed in time priority against the best bid (for sell orders) and best ask (for buy orders). If a quote or order is reached for execution, but is not executable at the time is added to the book

Inside Market: Bid 19.95 ask 15.97

Would lock or cross the book: MM1 Bid for 100 shares 16.25 LLCL bid 500 shares 16.00 MM2 ask 100 shares 15.44 MM1 ask for 200 shares at 15.40

Anti-internalization qualifier will prevent the automated system from executing a market participant’s order with its own quote and will send the order to the next market participant.

When an order is entered after 9:25 am it is added to the In Queue Based quotes and orders in time priority.

If a Nasdaq market maker enters a quote after 9:25 that would lock or cross the market, an execution occurs at the inside market


Opening Cross:

Begins 9:28 am orders in the NASDAQ market center are automatically executed. At this time orders cannot be canceled but can be changed to be more aggressive (order that is better in price or size)

All ordered executed in the Opening Cross are automatically reported in to ACT with a .T modifier

Order imbalance indicator: is an electronic messaging that provides information about orders involved in the opening process. Messages are sent out every 15 seconds until 9:28:20 am and then increases to every 5 seconds until the market opens.

Info provided on the Order Imbalance Indicator • The inside match price • The number of shares represented by each order type paired at the inside match price • The size of an imbalance • The buy or sell direction of any imbalance • The indicative prices at which the opening cross would take place if executed at the time of the dissemination and the percent outside the current inside market on the Nasdaq Market center

Often indicative prices are termed Near Clearing Price and Far Clearing Price

Near Clearing price is the price at which all quotes and orders during the opening cross would execute

Far Clearing price- is the price at which MOO,LOO,IO and early regular hours orders only would execute


How is the official Opening price determined ? (one of the 3) 1. A price that maximizes the volume of MOO,LOO,IO and early regular hours orders and executable quotes executed- if more than one price exists, the system would check for the next price 2. A price that minimizes imbalances –if more than one price exists, the system would check for the next price 3. A price that minimizes the distance from the bid-ask midpoint of the inside quote


The Nasdaq Official Opening price- is based on the orders that are in queue what NASDAQ opens for trading at 9:30 am. It is the price of the first trade executed and reported within Nasdaq market center, if at 9:30:15am there is no opening match then the NOOP is based on the last eligible sale reported in the Market Center.

NASDAQ Closing Cross-the process begins at 3:50 pm

This is when an order imbalance indicator begins dissemination. The indicators provides info on Market-on close(MOC), Limit- On-close (LOC) and imbalance only orders (IOO)

Imbalance indicator is sent at the following times

3:50- 3:55- every 30 seconds 3:55-3:59- 15s 3:59-3:59:59-5s

at 4:00pm est SuperMontage executes the max number of shares at a single price, this represents the NASDAQ official closing price .

Voluntary and Excused Withdrawals

Nasdaq market maker may terminate its registration in a security by withdrawing its quotes on a voluntary (unexcused) basis. May not register as a market maker in the security for 20 business days.

Excused circumstances 1. An excused withdrawal for up to 5 business days may be granted for circumstance beyond the market maker control 2. Withdrawals of up to 60 days may be granted for legal or regulatory reasons, if supporting documentation is provided and the conditions are not permanent in nature. 3. Excused withdrawal status for religious holidays may be granted, application must be made one business day in advance and must be approved by the NASD 4. Small firms (defined as market maker with 3 or fewer Level 3 firms) may have difficulty because of vacations by key personal. Excused withdrawals because of vacations may be granted if the application is made one business day in advance and included a list of securities for which withdrawal is requested 5. Market makers that are participants in a securities distribution are covered by special rules. (Passive Market Making) 6. If a firm fails to maintain a clearing relationship with a registered clearing agency or a member of a clearing agency. It may reenter quotes after reestablishing a clearing relationship. If a market makers’ failure to maintain a clearing relationship is voluntary, its withdrawal is considered voluntary, not excused 7. If a firm has a fail to deliver in a threshold security at its clearing firm for a period of 13 continuous settlement days and the security cannot be borrowed in order to effect a short sale transaction as part of a bona-fide market making, the firm qualifies for an excused withdrawal

Passive Market Making:

• Market makers involved in distribution may not enter a bid or effect a purchase at a price that exceeds the highest independent bid on NASDAQ • In a falling market, when the last independent bid drops below the passive market maker, the passive maker can maintain its bid until § Its purchases have reached or exceeded the lesser of 2 time the minimum quotation size for the security or the maker remaining daily limit. • At that point ,the passive market maker must drop its bid to below the independent bid. • In a rising market the passive makers do not have to raise the bid when the independent bid rises. • If there is no independent market maker then passive market making is not allowed

Daily Purchase Limit: a passive market makers limit is the greater of 30% of its ADTV in the stock or 200 shares. Once a passive maker’s net purchases for the day are more than its purchase limit ,it must then withdrawal from the market for the rest of the day. If close to the limit can execute one more trade that would put them over the limit.

If execution of a buy and sell order are within 30seconds then the order will only count as a net purchase

CH7 13-15

Stabilizing Bids on Nasdaq

A market maker must submit to the requirements of Regulation M by entering a request to Nasdaq Market Operations to enter a one-sided bid. SYND is the abbreviation for stabilizing bid.

Additional conditions: • Only one market maker may enter a stabilizing bid in a security • In order to enter a stabilizing bid, there must be one independent market maker entering quotes in the security • A stabilizing bid must be available for all freely tradable outstanding securities of the same class as the security being offered.

The request doesn’t need to be in writing, but the market maker must confirm its request in writing no later than the close of business on the day the stabilizing bid is entered. this can be accomplished by: • Sending a request to Nasdaq Market Operations and Underwriting Activity Report • Or a written conformation that included: i. The identity of the security and its Nasdaq symbol ii. Contemplated effective date and pricing date of the offering iii. The date and time that an identifier should be included on Nasdaq iv. A copy of the cover page of the preliminary or final prospectus.

Market-Maker Status:

A Market maker may need to be granted excused withdrawal status or passive market-maker status by the NASD. The syndicate manager must apply for this status on behalf of any affected syndicate member no later than the business day prior to the first entire trading session of the one or 5 day restricted period under rule 101.

This can be accomplished by submitting a Regulation M Restricted Period Commencement Form.

The manager then notifies each affected syndicate member that it will have a passive market-maker status or that its quote will be withdrawn on an excused basis, unless that market –market directly notifies the NASD otherwise.

PSMM- identifies passive market makers

Penalty Bids and Syndicate Covering Transactions

Written notice must be provided for prior to the start of: • Syndicate covering transactions • Penalty bid • Reference security under rule 101


The notice must include: • Identity of the security and its Nasdaq symbol • The date the member intends to impose the penalty bid or conduct the transaction • (A Reg M Trading notification from can be used) • The manager must do so with in 30 days of the effective date of the offer. • Maintain info in its files about the amount of the syndicate short position

Penalty bid- is an arrangement that permits the managing underwriter to reclaim a selling concession from a syndicate member in connection with an offer when the securities originally sold by the syndicate member are purchased in syndicate covering transactions. Abbrevated as PBID


Syndicate Covering Transactions- is the placing of any bid or the effecting of any purchase on behalf of the sold distributor or the underwriting syndicate or group to reduce a short position created in connection with the offering.

Syndicate short positions can arise from Overallotment, in which a syndicate member sells more than the number of shares being offered. In some cases the short position can be covered buy a syndicate stabilizing purchase. Green shoes option- this is a provision that may be included in the registration statement that allows the syndicate to purchase up to 15% more shares than originally registered to cover Overallotment.

Trading Halts: NASD members may not execute any type of order in a NASDAQ security, or exchange-traded securities for which the NASD has imposed a trading halt pending a material information release.

Nasdaq issuers must notify the NASD of pending material releases. Then the NASD will determine whether a halt is needed.

The purpose of the halt is to allow the information to disseminate to the public.

The NASD will also halt trading during period of extreme market volatility if the SEC requests it to do so

Nasdaq can halt trading in Nasdaq issues and third market but has limited authority in non-nasdaq stocks

Circumstance, which Nasdaq can halt: OTCBB security is dually listed on foreign market or registered with a foreign regulatory authority. The foreign market or authority halts trading in stock for regulatory reasons OTCBB security is derivative or component of a Nasdaq or listed security and Nasdaq or the listing exchange halts trading in the underlying security OTCBB issuer does not provide timely information to the NASD regarding dividends or other distributions as required by the SEC Rule 10b-17

If Nasdaq issues a trading and quotation halt, all NASD member firms may not trade the halted security. NASDAQ has a limit of 5 days to lift the halt

Where as if the SEC halts trade it can be in any security


CH7 19-24

Short Sales

Under Rule 3350 members may not effect a short sale of a Nasdaq Global Market (NGM) security at or below the current inside bid, when this bid is below the preceding best bid. (does not apply to capital market issues)

NASD’s short sale rule is in effect during regular trading hours. The restriction applies to both transactions for customers and members.

Nasdaq screens will indicate bid that fail the Tick-test with a downward-pointing red arrow., while bids that pas the test will carry an upward green arrow

Exceptions: • Sales by a qualified market maker registered in the security on Nasdaq, in connection with bona fide market-making activity. • Sales in which the seller owns the security being sold and intends to deliver the security promptly without undue inconvenience • Sales by a member firm, for an account in which it has no interest, executing an order to sell that is market long when the member does not know that the account owners have or would have as a result of the sale, a short position in the security. • Sales by a member firm to offset odd-lot customer orders • Sales by a member to liquidate a long position of less than a round lot, as long as the sale does not change the member’s position by more than one unit of trading • Arbitrage transactions, such as shorting stock when the seller owns a convertible bond or international arbitrage transactions, where the seller is profiting from the price difference between US and off-shore markets • Sales by a syndicate or selling group member in connection with an Overallotment

Short sales on a down bid are permitted for accounts of options market maker registered w/ an exchange in NGM options or an index with an NGM security component.

Exempt hedge transactions- are short sales that offset options positions taken as part of the option market makers normal market-function (doesn’t include arbitrage)

Bona Fide Market Making- if a market maker anticipates heavy activity in a particular stock, it could affect short sales at down bids to prepare for customer selling interest. (but can’t rely on of speculative short selling in own account)

Can’t – use Qualified market maker status to buy on a downtick for a customer short sale


Orders Market Long-

Bid test rules exempts sales by a broker-dealer for accounts in which it has no interest and are marked long.

Also exempt are sales buy any person for an account in which that person has an interest, if the person owns the security and intends to deliver it as soon as possible with out inconvenience.

To consider a sale long when the member is not in possession of the security or the account is not long, the firm must make an Affirmative determination- that the customer owns and will deliver in 3 days.

If the customer does not deliver the NGM stock then the member did not exercise due diligence in making affirmative determination the member would have violated the Short Sale rule if it was executed on a down tick

Short-Interest Reporting

NASD Members must maintain a record of total short positions in NASDAQ stocks in all customer and proprietary accounts.

All short interest reports must be made as of the close of designated settlement date , which is the 15th or preceding business day

The report must be received by the NASD within 2 business days of the settlement date

Short interest must also be collected and reported about listed securities and must be reported to the designated examining authority

SEC Regulation SHO: applies to equity securities and any security that is convertible into an equity security

3 rules: Rules 200, Rule 200T, Rule 203

Rule200: updates regulations regarding a person who is determined to own a security and when a broker-dealer is determined to own a security although it may not be net long.

DEF: (Security owner): is a person who is considered an owner of a security if he has purchased the security or entered into an unconditional and binding contract to make the purchase but has not yet received the security.

Also if the person holds a future in a security contract to the security and has received notification that the position will be physically settled.

A Broker-Dealer must aggregate all of its positions in a security to determine its net position, except in instance where the broker-dealer qualifies for independent trading unit aggregation.

Each independent trading unit must aggregate all of its positions.

Except: § The broker-dealer has a documented organization plan that identifies each aggregation unit with specific trading objectives and supports it independent identity. § At the time of each sale, each aggregation unit of the firm determines its net position for every security trades. § All traders in an aggregation unit must follow the trading objectives or strategy of that unit and may not coordinate the strategy with another aggregation unit § Individual traders may be assigned to one aggregation unit at any time.

Order marking requirements:

Long- seller owns the security being sold and it is either in the possession or control of the broker-dealer or will e delivered by settlement date.

Short- The seller own the security being sold but does not reasonably believe that it will be in possession or control of the broker-dealer prior to settlement day or the seller does not own the security being sold.

Short Exempt- The seller qualifies for an exception from the tick test or price test of an exchange or NSA


Rule 202T –Temporary short sale rule suspension

This is a pilot program that the SEC is using to test the effects of removing the (tick test and bid test) on short selling. In order to gain insight on its effect on liquidity, market volatility, price efficiency

Rule 203- Borrowing and Delivery Requirements

In instances where the broker-dealer knows or should have known that the sale of an equity security is marked long and must make delivery by settlement date. They cannot borrow securities for delivery

Except: can use borrowed securities

• That broker-dealer is lending a security to another broker or dealer • Broker dealer believes that seller owns the security but fails to deliver • Good faith mistake, with not seller delivery, dealer can either borrow securities or close-out within 35 days after trade date.

Locate Requirements: Prior to effecting a short sale, broker-dealer must locate securities that can be used for delivery by settlement date.

Broker-dealer may not accept an order to sell short an equity for a person, or for its own account

§ The broker-dealer has borrowed the security or entered into an arrangement to borrow the security § The broker-dealer reasonably believes that is can borrow the security for delivery on the date of delivery is due

Easy to borrow list: must be less than 24 hours old and provide a reasonable grounds that a security on the list is available.

Exceptions that allow a broker-dealer to forgo requirements regarding short sales for its account or the account of another person

• When Broker-dealer A, ahs accepted a short sale from broker dealer B. Broker-dealer B must meet the requirement regarding the acceptance of short sales for its account or account of another person. • To the sale of security on behalf of or by a person has been determined the owner. If the person does not deliver the security within 35 days after the trade date. The broker dealer must borrow the security or buy a link in kind and quantity order • To short sale transactions by a market maker in a connection with a bona-fide market making activities in the security for which this exception will be claimed (including Specialist acting as a dealer, dealer acting as a block positioners, or dealer that buy and sells on a regular basis) • Transaction in security futures


Fail to deliver positions:

If a broker-dealer has a fail to deliver position at a clearing firm in a threshold security for a continuous period of 13 settlement days. The broker-dealer must immediately close out the fail to deliver by purchasing securities of a like kind and quantity. Must be no later than 13 settlement day

Threshold security- is any equity security that is registered in accordance with Securities exchange act of 1934 or issuer must file reports and

• There is an aggregate fail to deliver position for 5 consecutive settlement days at a clearing firm for 10,000 shares or more and equal to at least .5% of the total outstanding shares of the issuer • A self-regulatory organization (SRO) has included the security on a threshold securities list sent to its members.


CH7 27-29

Handling Customer Orders

The limit order display rule-If a customer limit order is accepted by a market maker and the price on the order would improve that market makers quote, the market maker must immediately change its quote to reflect the customers interest

SEC defines immediately to means 30 seconds in normal market.

Abnormal conditions: Market open, trading resumes after a halt and IPO begins trading

If a market maker is not required to accept a customer limit order. The display rule applies only if the limit order is accepted

Size: In some circumstance, it also change their quotes to reflect the size of a client’ order. If the market maker is at the inside market and accepts a customer limit order a the inside, it must change its size to reflect the customer’s interest, unless the order is de minimis (10% or less of the market maker’s size)

Exceptions: Customer can request to have an order not be displayed. Documents of this request are not required but are recommended. Other exceptions: § Block-size order (at least 10,000 shares or $200,000 in market value) § Odd-lot orders § All-or-none order § Orders sent to another market or broker-dealer that comply with the ECN Alternative § Orders that are executed immediately upon receipts

A market maker would not display orders that would lock or cross the market without making a reasonable effort to execute the quote that would be locked or crossed. Also applies to ECN’s whose quotes appear on Nasdaq

Then ECN Amendment:

If a market maker quotes a better price in an ECN than on Nasdaq, it must update its Nasdaq quote to reflect the improved price. But doesn’t have to display the full size of the superior priced order.

The ECN Display Alternative:

Qualifying ECN- (linked or eligible ECN) Must meet 2 conditions: • The best market-maker prices in the ECN must be communicated by the ECN to Nasdaq • The ECN must permit access to such orders by other market makers and dealers who are not subscribers to the ECN

ECN Display Alternative: permits market makers to anonymously enter better quotes in an ECN while the same time informing the entire market that these better prices are available. Must use the full size of the ECN order

CH 8 1-5

Opening Customer Accounts

New Account Documentation- one of the most important documents. Info is collected for regulators and to help the reps

A registered Rep who wished to open accounts for a customer is required to obtain information for the new account form prior to entering the order. The account must be approved by a principal promptly.

NASD Requires the following new account info

• Customer Name and Residence (not a B.O. Box) • Whether the customer is of legal age • Signature of the registered representative opening the account • Signature of the partner, officer, or manager (principal) approving the account

If the customer is a business or organization rather than a person, then the RR must obtain the names of the people authorized to transact business in the account.

The rep must made a reasonable effort to obtain the following: • Taxpayer ID number (TIN) such as a social security # • Customer’s citizenship • Customer’s occupation as well as the employer’s name and address • Whether the customer is associated with another NASD member • Information used to make recommendations to the customer, including financial background, tax status, and investment objectives

Investment knowledge and experience is required but Educational background is not needed.

If the client refuses to fill this we can write ‘refused’

If it’s a broker account the persons authorized to transact business in the account must be obtained. Signature is not needed for cash accounts but is for Margin and Options

Account information: Copies of account records or documents of the information collected about the account-holder must be sent to the customer within 30 days of opening or with the next statement. Periodic updates must be sent to the customer no later than 36 months

Change of information: • A notification to the customer to alert the member or member firm of any changes or corrections must be included in the account-change related mailings. • Any changes to investment objectives within 30 days or with next statement. • Any change to the account name or address listed for the account-holder, that change must be sent to the old address on file and to the registered rep within 30 days

Tax Information • Must request the client’s social security or tax id number. Most firms will not open an account without the tax id. • Typically is asked to sign a w-9 certification states that the tax info is accurate and is not subject to back with holdings • Nonresident aliens and foreign entities not subject to backup should complete a W-8

Other New Account Information

Predispute Arbitration Clause:

Industry rules require arbitration clauses to be presented on the form in a certain format and with specific wording. If a firm elects to include a predispute arbitration clause in its new account for, it must be highlighted and preceded by the following.

• Arbitration is final and binding on the parties • The parties are waiving their right to seek remedies in court, including the right to a jury trial • Prearbitration discovery generally is more limited than, and different from, court proceedings. • It is not required that the arbitrator’s award include factual findings or legal reasoning and any parties right to appeal or seek modification of ruling by the arbitrators is strictly limited. • Typically the panel of arbitrator will include a minority of arbitrators who were or are affiliated with the securities industry • Immediately before the signature line there must be a highlighted statement that the agreement contains a predispute arbitration clause • A copy of the agreement must be given to the customer, who must acknowledge its receipt on the agreement or on a separate document

Trading Authorizations- If another person will be permitted to trade an account. Additional information and documentation are required. Trading authority (not withdrawals)

• Family members, such as spouses • Attorney • Investment advisers • The customer’s registered representative

Full trading authorization- permits the authorized person to withdraw money and securities from the account in addition to placing buy and sell orders.

In both cases , the broker-dealer must receive a written trading authorization signed by the account owner prior to permitting the authorized person to trade the account. Firms should also obtain signatures of authorized persons and date of trading authority

Discretionary Accounts: when a registered rep is authorized third party • Some do not allow this, other give only limited authority • If a firm permits, then a principal must accept the discretionary authority in writing before it becomes effective • Each discretionary order must be approved promptly by a principal and must be reviewed frequently to insure that transactions are not excessive in size or frequency • Churning- excessive trading, the way to test is to examine the investment objectives, followed by the number of trades and size. Frequent trades might be ok for daytraders but not most investors • If a member firm is selling its own stock to the public and wants to place some of the stock in a customer account for whom the member hold discretionary authority, need prior consent

Time/Price Exception: Verbal authorization to make certain decisions without it being considered a discretionary account. • Specific security • Whether to buy or sell the security • The number of shares or other units to be bought or sold • If only discretions as to time and or price (then it is not considered discretionary order and written authorization is not required

Service Instructions

Hold Securities in Street Name: • Most are now held in the such centralized depositories as DTC (Depository Trust Company) • Securities are then transferred on a book-entry basis • Most customer stock is held in street and this makes it difficult to send them information • Issuers may request such information from the broker-dealer

Depository Trust Company (DTC) – is a securities depository and national clearinghouse for the settlement of trades in corporate, municipal and mortgage-backed securities

DTC- eligible securities include: • Corporate equities • Corporate bonds • Municipal bonds • Money-market instruments • Mortgage-backed bonds • U.S. treasuries and agencies

Settlement: DTC provides for book-entry settlement of eligible securities. Brokerage firms that participate in partial transfer use DTC to settle transfers


Hold Securities in Customer Name: (Transfer and Hold)

Securities are transferred into the customer’s name and are then held in segregation in the firms vault. Customer name appears in the stockholder records of the issuer. All issuer information is sent directly to the customer.

Mail Securities in customer name (transfer and ship): Issuer communicates directly with the customer. Securities are transferred into the customer’s name and delivered to the customer, the firm has no record.

Hold or mail dividends/ Interest payments: customer can choose between being mailed the dividends or having the account credited

Guaranteeing a Customers Account: This is used to guarantee in writing for the purpose of securing margin.

Forward to another address: The customer may instruct the firm to have securities and or checks forwards to another address

CH 8 9-12

Individual account: opened by and for 1 person, only other person who could be in charge would be a third party

Joint Account: More than one owner of record, Any owner can initiate activity. When signatures are required then all signature are required.

New account information should be obtained about each owner

Joint Tenancy with Rights of Survivorship (JTWROS or JT TEN) (most common) Tenancy in Common (TEN COM) (most common) Tenants by Entirety (TEN ENT) Life Tenancy (LIFE TEN)

JTWROS- if one tenant dies, ownership passes to the next tenant with out probate

TOD (transfer on Death): allows the account assets to be transferred to a beneficiary at death without passing through probate


Corporate Accounts: Reps need to make sure person-opening account has the power to do so. This is done by a corporate resolution- (board of directors- appoints person to open the account)

If they want a margin, must provide a corporate charter to show authorization


Partnership Account: To open a partnership account: • Each partner should provide § Name, address, citizenship and tax id § Should also sign and copy of the partnership agreement should be put on file

Accounts for Employees of other member firms: NASD states that a member firm (executing) transacting business for any employee, partner, or officer of member firm must use due diligence to determine that such transactions will not adversely affect the interest.

When a executing member knows that a person associated with an employee member has a financial interest or discretionary authority. Executing member must: • Notify the employer member in writing of the intention to open the account • Send duplicate confirmations and statements to the employer member, if requested • Notify the person opening the account that these procedures will be followed

Employee must give notice to both employer firm and executing firm A person opening an account must tell if they are NASD member firms

If a NASD member opens an account with a non-member firm then the member must notify the employer in writing prior to opening the account.

The employer may request to have the employee request in writing duplicate confirmations, statements and other information to the employing member

The employing firm is not required to grant approval

Does not apply to investment company shares, variable contracts, or UIT


Fiduciary Account:

Fiduciary- is someone who acts on behalf of and for the benefit of someone else

Should provide documentation of their authority and make investment choices based on a prudent man standard.

Prudentman standard- their investment decisions should be consistent with what a prudent man of discretion and intelligence would choose for income and preservation of capital.

Accounts for Incompetents; (A person who has been declared by a court unable to handle his own affairs

The court appoints one or more persons as fiduciaries to handle the person’ affairs. Guardianship is a legal arrangement based on the statues of the state of domicile under which the affairs of an individual are handled by a guardian. To open an account should provide court certified copy of certificate of appointment.

Evidence of appointment of incumbency, this document certifies that the person listed therein is the fiduciary for another person. Evidence of appointment must be dated no more than 60 days prior to presentation other wise needs to be recertified. Unless it is a will and testament.

Accounts for Minors: Member firms will not allow minors to open accounts in their own name as they are not legally responsible and could repudiate transactions when they reach their age of majority

Uniform Gifts to Minors (UGMA) and Uniform Transfers to Minors (UTMA)

UGMA, as irrevocable gift of cash or securities is given to a minor by an adult (minor cannot gift minor under UGMA but can with UTMA) • The donor appoints an adult to act as custodian (can be same as donor) • Limit of 1 custodian per 1 minor account • No limit to amount of gift • Would be registered like Mary Smith as Custodian for Kenneth Schmitz under the Missouri uniform Gifts of Minors Act. But the Account is open under the beneficiaries social security # • Minor must pay taxes on income generated • A custodian is not permitted to sign a power of attorney granting a rep or advisor trading authority. • Custodian may receive a fee for managing the custodial account, except if it the donor • Cannot have a margin account. Thus can’t buy futures • Stock may not be registered in street name (unless UTMA)

• If a custodian dies without appointing successor then the court will appoint one • Custodial relationship is terminated when the minor reaches age of majority, should then transfer into beneficial owners individual name.

Invest Adviser Accounts

Investment advisor- is a business or person who receives compensation for providing investment advice to others. Most are registered with the SEC or state and are often RIA (registered investment advisers) RIA can open one account that contains all advisory clients asset or each client might set up a separate account and provide advisor with third party In both accounts there must be written authorization for the adviser to transact business in the account

Report by Institutional Investment Manager-if a institutional investment manager exercises discretion over an account it must file reports with the SEC . If the market value of equity securities under the advisors control exceeds $100 million on the last trading day of any month, form 13f must be filed with the SEC

Reports are required only for securities on the NASDAQ and Sec publishes a list of subject securities. SEC requires reports be filled within 45 days of each calendar quarter


CH 8 16-19

Types of Accounts

Cash account- client will pay for any transaction in full by settlement date, for most securities 3 business days after transaction date

Margin Accounts- Transactions in a Margin account require some type of deposited by a customer

2 choices: Long positions and Short positions (while both would be executed in one margin account)

When purchasing stock in a long margin account, a customer will pay part of a the purchase price by the settlement date (generally 50%) and the broker dealer will finance the balance of the purchase.

To open such an account a margin agreement or customer agreement must be signed

Key provisions Credit agreement- discloses the terms under which the broker-dealer will finance the customer’s purchase, including both how interest is calculated and how it is charged to the account

Hypothecation agreement- provides that the securities purchased by the customer will collateralize the debt. The Broker-dealer can rehypothecation the securities (use securities to get a loan)

Loan Consent agreement- give broker-dealer the right to lend the customer securities to other clients or broker-dealer (short-sales purpose). Loses the right to vote the loaned stock

Options Account- A new options account form must be completed for customer who wish to begin trading options. Since options are more risky should make sure to have complete and accurate info on accounts

DVP/RVP Accounts DVP –delivery vs. payment RVP- receive vs. payment These transactions are refers to as POD (payment on delivery) and COD (collect on delivery) Usually deposit, withdrawal and transfer or securities is by Integrated Delivery Systems (IDS) IDS- is an industry-wide system, linked through a computer network, which expedites the movement of securities and funds between brokerage firms and agent banks

Rules Before accepting a DVP/RVP order, the broker should obtain the name and address of the customer’s agent, as well as the customer’s account number with the agent Order tickets must be marked to indicate these types of orders The customer must provide the broker with an agreement that the customer will promptly furnish its agent with settlement instructions for each transactions DVP/RVP trades must be settled through a securities depositor by book-entry procedures for all transactions involving depository –eligible securities, except for trades settled outside the U.S.

Depending on the firm, customer accounts that specify these instructions either on the new account form or on a separate form.

Duplicate conformations and account statements are sent to the agent and all pertinent info about the third –party

This data: Tax ID number Clearing number Agent internal account number for the customer

Internal account number is very important, since it is the agent’s mean of identifying the customer

Day-Trading: (Special requirements apply to account opening procedures for broker-dealers who promote the use of day-trading strategy

Day-trading strategy: an overall trading strategy characterized by the regular transmission by customer of intra-day orders to effect both purchase and sale transactions in the same security or securities. Transmitting one or more ‘round trip’ transactions in a single day

The NASD’s day trading rules apply if a broker-dealer affirmatively promotes day-trading activities or strategies through advertising, training seminars, or direct outreach programs.

A broker dealer is also considered to promote day trading if it uses a third party to advertise.


A firm will not be considered to be promoting day trading solely by:

• Promoting efficient execution services or lower execution costs based on multiple trades • Providing general investment research or advertising the high quality or prompt availability of its general research • Having a Web site that provide general financial information or new or that allows the multiple entry of intra-day purchase and sales of the same security

If a Broker-dealer does not itself advertise day-trading strategies, it will be considered to be promoting day trading if one of its principals or officials is aware that any of the firm’s individual registered rep is promoting the practice.

Consequences of Promoting day trading: if a firm is considered to be promoting day trading o Provide a risk disclosure statement on day trading prior to opening an account for a non-institutional customer o Either (A) approve the customer’s account for a day-trading strategy; (B) obtain from a customer a written agreement that the customer does not intend to use the account for day-trading purposes

A firm may not rely on the written statement from the customer if it know the customer intends to day trade the account. IF a firm later discovers a customer is using an account for day trading the firm must approve the account for day trading as soon as practicable , but no than 10 days after discovery


SEC Regulation SP

Privacy of Consumer Financial Information

REG SP is the SEC response to the Graham-Leach-Bliley Act in 1999.

States: all broker-dealers, investment companies, and investment advisers registered with the SEC to adopt policies and procedures reasonably designed to protect the privacy of the confidential information

The Timing of the notice depends on the client’s relationship with the firm. REG SP divides clients into Customers- someone who has an ongoing relationship with the firm Consumers- someone who provides information to the firm in connection with a potential transaction

Firms must provide notice when the relationship is initiated and annually

If a firm must give every consumer a privacy notice before it discloses any nonpublic information to any nonaffiliated third party. Must state: Type of personal info the firm collects Categories of third parties to whom info is disclosed Give client a way to opt out of the disclosing. Must be reasonable (writing a letter to indicate this desire is not reasonable)

Publicly available information- is info that may be obtained from federal, state, or local government records or distributed media such as telephone directories or newspaper.

Non-Publicly available information- includes info obtained from the customer or customer lists put together from personally identifiable information (I.E. Account number)


CH 9 1-5

Updating Account Information

It is important because if a client’s situation has changed, transactions might be executed that are inappropriate. Several items are more important

• Address Changes: If client address change, it is important to note whether they now live in a different state. Because both the rep and firm must be registered in that state • Financial Background: It is important to verify that the information on file is accurate. Changes in patterns of purchases and sales might indicate a different financial situation. • Objectives: in the long run all clients will change or modify their investment objectives. This is especially true as client’s age.

Death of the Account owner:

If an individual account owner dies, any open orders for the account should be canceled and no other activity should take place until legal authority has been proven.

The new account is usually set up “ The Estate of (deceased’s name)”

Then the account is transferred by the executor or administrator of the estate to the name of the estate The documents required for this are: Death certificate Copy of the will or court appointment (letter testamentary) Affidavit of domicile State inheritance tax waiver

If a person who has granted power of attorney dies, the power is automatically terminated

Securities are generally valued for these purposes as of the date of death or an alternative date six months after the date of death. Approximately 2/3 of the states have adopted the Uniform Transfer on Death Registration Act- allowed account owners to designate beneficiaries, helps avoid probate but not estate taxes

Transferring Accounts

If a customer wants to transfer an account from one member firm to another member fir , the customer must give written instructions to the receiving firm. Both member firms are required to coordinate their activities in order to expedite the transfer.

Receiving firm must submit the transfer request to carrying firm immediately upon receipt from the customer. Carrying firm must validate instructions or take exception within 3 business days.

Nontransferables- the customer must be informed in writing on the transfer document or separate document. That the assets cannot be readily transferred. For all nontransferable assets the carrying firm must request customer instructions as to liquidate or retention.

If the customer requests liquidation , the proceeds must be forwarded to the customer within 5 days of liquidation.

If the account has credit or debt cards should be destroyed upon transfer

Once a carrying firm receives transfer instruction, it must cancel all open order( except options which expire in 7 business days), freeze the account, and not accept new orders.

Exceptions: • No record of account • Transfer instructions incomplete or improperly signed

Not Exceptions • Dispute over security positions • Money balance in the account

In such cases the carrying member must still transfer the securities position and money position reflected for the account.

Upon validation of transfer instructions, the carrying member must return the transfer instructions to the reviving member. With attached • Records of Security positions • Any safe keeping positions • Money balance

Within 3 business day following validation, the carrying member must complete the transfer of the account to the receiving member

For any position not delivered or received, the carrying and receiving firms must establish fail-to-deliver and fail-to-receiver positions at CMV (current market value)

Each firm must also debit/credit the related money account

If both firms have ACATS (automated customer account transfer service) they must use such a system

Order Tickets:

Order ticket- (order memorandum), is a record of a customer’s instructions about the execution of a buy or sell order.

Register rep will fill out the info on the ticket and pass it to the wire room, which transmits it to the appropriate market for execution.

All orders that are entered by customers must be approved by a principal of the member firm on the day they are entered.

At each step additional info is added to the ticket to compile a record of how the order was handled. Regardless of trade outcome the broker dealer must retain a copy of the order ticket or the information it contains

Components of an order ticket:

Entries on an order ticket include:

Buy or Sell- Sell orders must be market Long or Short

SEC Def: Short Sale: any sale of a security that the seller does not won or any sale that is consummated by the delivery of a security borrowed by or for the account of the seller.

A person owns a security if any of the following is true: • The customer or customer’s agent has the title to the security • The customer has purchased, or has entered into an unconditional contract, binding on both parties, to purchase, but as not received • The customer owns a security convertible into or exchangeable for it and ahs tendered the offer • The customer has an option to purchase or acquire it and has exercised such option • The customer has rights or warrants to subscribe to it and has exercised such rights and warrants

Broker-dealer and customers are considered to own securities only to the extend they have a net long position in a security.


Account Number/ Name: The name of the customer is not always sufficient. If the person entering the order is not the person whose name is on the account, that persons name should also be entered on the ticket.

Time Stamps: order tickets must contain 2 time stamps, one that records the time the order is entered and one that records executions.

Account Type: Identifying the type on the ticket can facilitate processing and review of the order.

Security name or symbol: Care should be taken to identify the security correctly. It is important for instances where there maybe several issues or classes

Terms and conditions: if no price or other terms are indicated, the order is a market order Other qualifications include: Price(limit) Stop Stop Limit GTC (other wise assumed a day order) At-the close/ At-the open Not Held All-or-none (not permitted for some types of order/market Fill-or-kill Immediate-or-cancel Do-not-reduce/ Do-not-increase Special settlement (cash, seller’s option)

Discretionary order/ Discretion not exercised: If a client has issued discretionary authority it should be indicated on each order. Thus if the customer consented to the trade should be market “discretion not exercised

Solicited/ Unsolicited: If a transaction was completely initiated by the customer, it should be marker ‘unsolicited’


Cancel Trade (CXL) Checking this box cancels an order previously entered on another ticket. The form usually required the identification of the previous ticket # and date. Some firms require the approval of a supervisor before a cancellation. When a customer cancels an agency order: must record § Date § Conditions § Extent feasible § Time of cancellation

Special Instructions: When an account is client provides instructions on how to dispose of security’s. if the standing orders are to be overridden then the new instructions should be included on the ticket.

Adjustment of Open Orders: NASD member holding open orders for customer or other broker-dealers must adjust those orders on any Ex-dividend date for that security in a manner similar to the adjustment made by exchange specialists. If the member is holding a buy limit, sell stop or sell stop- limit order, it must be reduced the order by subtracting the $ amount of the dividend from the price.

If the dividend is declared in a fractional amount, the adjustment is rounded down to the next whole amount

Fractional Stock split: would create and odd lot, would then be reduced to the next lowest round-lot

Open orders are also adjusted proportionately for stock dividends or splits.

Reverse split, all open orders are canceled on the Ex-date

Broker dealer must contact its customers who placed orders affected by reverse splits. Does not apply for:

Orders governed by exchange rules Orders market ‘do-not reduce’ or do-not-increase’ Sell limit, buy stop, or buy stop-limit orders


Ch 9 8-10

Customer Limit Order Protection

NASD considers it a violation of just and equitable business principles for member firms to trade ahead of customers. Manning rule

Basic requirements: (manning rule) • Must protect a customer limit order. • This means the executing broker-dealer cannot complete the order in a propriety basis by virtue of its position within the market. • Simply: the market maker must execute the customer limit order immediately upon executing an order for its own account that would fill the customer order. • Immediately- means within 60 seconds of an execution for the firm’s account • It also applies to other firms that are accepted by market makers for execution • A member firm may not accept and hold customer limit orders in NASDAQ securities, whether those orders come from its own customers or customer from another firm, and trade those securities for its own account at prices that satisfy the limit orders • Orders that are sent away to another member or ECN must be protected as well

Exception:

• Orders from institutional accounts- defined as an account for 1) a bank, insurance company, S&L or registered Investment Company 2) a registered investment adviser 3) entity with total asset of $50million • Large orders, including those from retail customers: defined as orders over 10,000 shares, unless it is less than $100,000 in value

For the exception to apply the terms and conditions must be clearly disclosed at the time the order is accepted

Application of the Manning rule

• The customer Limit Order Protection Rule applies only during the hours Nasdaq is open, normally 9:30 am to 6:30 pm • If a customer gives a broker-dealer a not-held or working order, the rule does not apply, since the firm is being given the authority to exercise its brokerage judgment. However the firm should clearly document that is has received such authority for the customer. • The interpretation does not apply to odd-lot orders • If the market-marking desk of a firm is holding a customer limit order, no other trading desk in that firm (such as risk-arbitrage desk) may knowing trade ahead of the customer’s order • If another desk executes an order for the firm’s account that would have filled the customer order, the market maker may owe the customer an immediate execution. • As long as information barriers are present it prevents the nonmarket-making desk from obtaining knowledge of customer limit orders • Executions through SuperMontage can trigger a manning obligation

Partial Executions- If a firm triggers a Manning obligation, it is required to fill only as much of the customer orders as it has executed for its own account

Price Improvement: If a market maker holds an undisplayed limit order priced better than its quote and subsequently receives a market order on the opposite side of the market, it is not appropriate for the firm to execute the market order at its published quote and the limit order at its limit price. The broker must price-improve the market order to the limit order price

A market maker has the option of pricing-improving the market order in such a way that its Manning Obligation is not triggers. This could be done by executing the market order at a minimum increment above the order price.

The Min price improvement required is $.01, the Min quote increment

Market Order Protection- NASD RULE 2111 protects market orders received by a member firms. A member is prohibited from trading ahead of a customer market order in its won account without, immediately thereafter, executing the market order at the same price or better.


Ch 9 14-17

Conformations and other Disclosures

SEC rule 10b-10: requires that broker-dealer provide customers with a detailed confirmation of any purchase or sale. A broker-dealer must give or send a confirmation to the customer at or before the completion of the transaction.

The following info is usually included • The identity, CUSIP, and price of the security bought or sold, along with the number of shares, units, or principal amount • The date of the transaction, as well as the time of execution or a statement that the time will be furnished upon written requests. • The capacity in which the broker-dealer acted, which could be as • Agent for the customer • Agent for some other person • Agent for some other person • Agent for both the customer and some other person (Cross) • Principal for its own account • The dollar price and yield information • Whether a debt security or common stock is callable (statement that further information will be provided upon request) • The settlement date


Commission/ Markups:

Commission- is the charge that a broker-dealer assesses for executing an agency trade for the customer.

Markup- is the difference, in a principal transaction, between the price charged to the customer and the prevailing inter-dealer price.


All Remuneration (commissions) must be disclosed on the confirmation and must be disclosed on the confirmations.

Principal transactions- report only the net price (including the markup)

Currently 2 situations were markups are disclosed: • Riskless principal transitions, in which the broker-dealer purchase the security for the resale to the customer only when the customer’s order is already in hand • Principal transactions in Nasdaq stock or in list stocks traded OTC. Markups on listed stocks and Nasdaq Global Market securities are required to be disclosed by Rule 10-10 because they are “Reported Securities’ under Sec rules. NASDAQ mark ups must be disclosed on confirmations

A broker-dealer must disclose the amount of commission it charged on a transaction if it acted in an agency capacity.

If a broker-dealer acted as both buy and seller in a single transaction, it must disclose this fact to both the buyer and seller. (Must also offer to disclose the time when transaction occurred and name of the other party to the transaction.)

A broker-dealer CAN NOT act as a broker (agent) and dealer (principal) on the same transaction

Payment for Order Flow: Many firms automatically route certain types of small retail customer trades to a specific broker-dealer for execution. Executing broker will pay a per-share fee to the originating broker for this arrangement

Confirms under this must disclose this practice and offer to provide additional info on request.

A broker-dealer must provide written info about its payment-for-order-flow practices when opening a new account and annually thereafter.

Requests for Further Information

A firm has 5 business days after the request to provide the additional data , unless the transaction occurred more than 30 days prior to the request, the firm may take 15 business days to supply the info

Errors: should be brought to the attention of a supervisor

Additional disclosure: The broker-dealer may have to make other disclosures to the customer on certain trades.

Control Relationships- additional disclosure is needed for a customer, which the firm is “controlled by, controlling, or under common control with the issuer” Ex broker is owned by a publicly traded company

This must be done prior to the trade for the customer

Disclosure of interest in Distribution- A firm is obligated to disclose, in writing, its interest in the distribution at or before the completion of the transaction. Ex (a dealer participates in a distribution of securities and receives an investment advisory fee, this created conflict of interest)

Completion of a Transaction- Sec rules say something needs to be done “at or before the completion of the transactions.” • In a purchase by a customer, completion normally occurs when the customer makes payment of any part of the purchase price to the broker-dealer, If the payment is made by a bookkeeping entry, completion occurs when the broker-dealer makes a bookkeeping entry for any part of the purchase price • However, in a purchase, if the customer pays prior to the time the payment is due, competition occurs when the security is transferred out of the customer’s account • However in a sale if the customer delivers the security prior to the time of delivery is due the completing occurs when the broker-dealer makes payment into the account of the customer

Account Statement- should be sent at least quarterly, but usually its monthly Must include: • Description of any security position • Any money balances • Any account activity since the last statement

Complaints- any written statement of a customer or any person acting on behalf of a customer alleging a grievance involving the activity of those persons under the control of the member in connection with the solicitation or execution of any transaction or the disposition of securities or fund of that customer

Members are required to maintain a separate file of all written complaints Must include: • Description of action taken by the member • Any correspondence regarding the complaint • Principal must review the complaint • No mandatory deadline for resolution • If no complaints must still maintain file

Quarterly reports- NASD members are required to provide NASD with statistical and summary information about customer complaints on a quarterly basis. Report is due 15th day of the month following the quarter. If no complaint no report needed


CH 9 20-22

Anti- Money Laundering and USA PATRIOT ACT

Money laundering generally takes place in 3 stages Placement- the money launderers place illegal cash into the flow of the broker –dealer business most often through the purchase of securities Layering – the launderers execute transactions in several layers in order to avoid detection or trigger reporting requirements. Ex. The purchase of several block securities in amounts less than $10,000 with checks drawn from different institutions. Or taking opposite positions on the same security and using different accounts for each purchase. Integration- putting the illegal money back in the stream of commerce, making them appears it is the legitimate source. Ex buying security then selling and depositing the money in bank account


Required Reports-

Broker-dealers are required to file Currency Transaction Reports or CTRs for all cash transactions by a single customer during one business day that exceeds $10,000. Including cash and coins. This includes the Aggregate total of all smaller transactions

Reps should be alert for clients who execute a number of transactions in amount that’s are just below $10,000 reporting level or deposit instruments that are sequentially numbers


Currency and Monetary Instrument Transportation Report (CMIR) must be filed when one send or receives, physically transports, cash, monetary instrument in amounts greater than $10,000 into or out of the US

Broker-dealers who transfer or transmit funds must collect info over $3,000 including Names of transmitter and recipient. Must also verify identify if not customers.

Suspicious Activity Reports (SARS) A firm must file an SAR whenever a transaction equals or exceeds $5,000 and the firm suspects The client is violating the federal criminal laws The transaction involves funds related to illegal activities The transaction is designed to evade the reporting requirements The transaction has no apparent business or other legitimate purpose and the broker-dealer cannot determine any reasonable explanation after examining all the available facts and circumstances

The fact that a SAR has been filed is confidential, cannot inform the subject that the SAR has been reported

Mandatory AML Compliance Programs:

At minimum: § Policies and procedures that can be reasonably expected to detect and report suspicious transactions and deter money laundering § The designation of a compliance officer who is responsible for the firms AML programs § An ongoing employee training program § An independent audit function to test the effectiveness of the firm’s AML program § AML programs must be in writing and approved by senior management

Customer Identification Procedures (CIP): broker-dealers need to create customer identification procedures and use reasonable measures to verify the person’s identity. It must also keep records of the information used as well as check the terrorist watch list.

Must verify a customers identity with in a reasonable time.

At minimum the following should be obtained: § Name § Date of birth § Address (individual must be residential or street address, other supply principal place § Identification number (tax ID Number, passport # for non-US and country of issuance, alien ID card


Taxpayer ID Exception- A broker-dealer who receives an application to open an account may forgo obtaining taxpayer ID number if that person has applied fir but not yet received the number. However, in lieu of the number, dealer must retain a copy of the person’s application

Customer Verification- broker/dealer can use documents or non-documentary methods in verifying customer identity. And must keep records of methods used to verify for 5 years following account closure.

Individuals on Government watch lists: must make certain that they are not doing business with anyone on the list maintained by the Treasury Department Office or Foreign Assets Control (OFAC). Which is a list of suspected terrorists and criminals. If a firm finds out one of its client is on the list it must block all transactions and inform authorities.

Penalties:

AML laws: A registered rep found guilty of facilitating money laundering can face up to 20 years in prison and fines up to $500,000 per transaction or twice the amount of the fund involved

Reps do not have to know about activity and can be prosecuted for being willfully blind to the activity


CH 10 1-4

Securities Exchange Act of 1934 grants the power to regulate credit purchases of securities to the Federal Reserve Board (FED).

Regulation T, governs the extension of credit by broker-dealer Regulation U, govern extension of credit by lenders other than broker-dealers Regulation X , governs those who borrow to buy securities

Regulation U pertains to lender making loans to investors who use securities as collateral for the loan and would apply to partners of member firms who are buying for their own account as well as customers.

Limits that apply under U are not applicable if the transactions are by a market maker or underwriter. The ability of these dealers to use credit is only limited by the lender’s credit standards

REG X: pertains to borrowers within or outside the United States who intend to purchase or transfer U.S. securities that are regulated under the Boards T and U. Borrowers who are subject to REG X must ensure the source is legitimate


A borrow is subject to REG X IF • Is with the U.S. and causes credit to be granted unlawfully without adhering to REG T or U. • Is considered a U.S. person who is outside the U.S. and acquires credit or purchase or transfer U.S. Securities • Or a non-U.S. person who is directed by or acting on behalf of a U.S. person


Regulation T: determines which securities may be purchased on credit (margin) through a broker-dealer, when payment must be made and the amount of credit that may be extended.

Marginable Securities- include • Exchange Listed Securities • Nasdaq Securities

Not Marginable- Stocks on OTC Bulletin Board (OTCBB) or in pink sheets

Investment Company Securities-

Open-end investment company securities, (mutual funds) and UIT (unit investment trust) are Marginable securities under REG T and may be used as collateral in margin account.

SEA act of 1934 prevents the extension of credit on a new issue by a participant in distribution for 30 days.

Thus a dealer cannot extend credit on initial purchases but once held for 30 days it can be used as collateral for a loan in a margin account a the dealer

Payment Deadlines- Reg T requires payment for purchases in cash and margin accounts be made promptly. In cash account its 100% but in margin it is a lower %.

If the payment is not received within 2 business days following settlement date (REG T payment date) broker-dealer is required to sell out of the securities, unless valid extension reason.

Liquidation in both cash and margin accounts occur the day after the REG T payment date or the third business day following settlement.

If an account is liquidated the account is on freeze for 90 days. Thus the customer must pay in advance for all purchases.

After 90 days the customers credit is reestablished and can be extended normal credit terms

Freeriding- customer makes a purchase and then meets the payment through liquidation. Meaning customer could not purchase a stock and then sell the same stock in order to pay the purchase price.

For trading purposes: customers own the security as of the trade date. They may sell the securities at any time after the trade has been executed. Whether or not it has been paid for yet.

If a customer sells the securities prior to settlement date but does not withdraw the proceeds and pays the original purchase by the Reg T payment date there is no REG T violation and member account is not put on freeze.

Free-riding applies if the customer sells the security and does not pay for the purchase by the payment date.

Broker-dealers are not required to collect funds by the REG T payment date if the amount is less than $1000

Extensions- In exceptional circumstances, a member firm may apply to the NASD or exchange for an extension of time for the payment amount due. For example if there was a delay in the mail. The extension is granted by the NASD or exchange and must apply for the REG T deadline.

COD Transactions- Normal payment period does not apply. In a COD account, where securities are delivered to the customer’s custodian bank and a paid upon delivery, the broker has 35 calendar days in which to deliver and receive payment. If the unable to deliver in 35 must apply to NASD for an extension

Opening a Margin Account- Margin department keeps records of all customer accounts and insures that payment is made in accordance with Reg T requirements

When a new margin account is opened for a customer, the member firm must send the customer a statement of the amount of interest they will be charged and the method by which interest will be computed.

A broker-dealer that extends credit to a customer must disclose: Condition under which interest charges will be imposed Percentage interest charge Method of computing interest Method of deterring the debit balance on which interest will be charged

Written statement must be sent to all customers to whom credit is extended at least quarterly. Customer must sign a margin agreement

Hypothecation Practices prohibited: § Commingling of securities for the account of a customer with those of another customer without obtaining the written consent of each customer § Commingling the securities of a customer with those of any person who is not a customer of the broker-dealer ,including securities owned by broker-dealer § Hypothecating customer securities for a sum that exceeds the total indebtedness of all customers

With permission, broker-dealer are to use their customer’s securities as collateral for bank loans under a process can Rehypohecation. The dealer must obtain the consent of each customer in order to rehypothecate the stock of the customer at a bank in a single loan account.

Amount that may be rehypothecated: The customer protection rule, permits broker-dealers to use stock with a value of 140% of the customers debit balance as collateral for a bank loan. They may borrow only the amount that it lent the customer, but may collateralize the borrowing with stock valued at 140% of the debit balance

Check book example!

Stock loans- in order for broker-dealers to loan a customers stock to another dealer it may do so only if a consent agreement is signed.

• Loan consent agreement is an optional provision

• Borrower has the right to recall borrowed stock at any time

• Lender of the stock retains all rights except the right to vote


CH 10 7-11

Initial Margin

Reg T established the min amount of margin a customer must deposit when establishing a position.

Initial margin is the % of the purchase price, including commission that the customer must deposit with the broker-dealer.

The balance of the total purchase price is called the Loan Value: is the amount that the broker-dealer may finance. It is the complement of margin requirements

EX. Margin requirement is 70% thus loan value is 30%

Since 1974 initial margin requirements is set at 50%.

Meeting a Call: Once the initial margin is deposited, Reg T does not require additional money if the price of stock declines

NASD will require the deposit of additional margin (a maintenance margin call) if the account equity declines beyond certain levels

A customer may deposit stock that is fully paid and borrow against the stock. But it must be a Marginable stock

Excess Equity and SMA

Excess equity- refers to equity in a margin account that is greater than REG T multiplied by the market value

EX. MV $12,000 Debt balance - $5,000 thus Equity is $7,000

Reg T Req on $12,000 of stock is $6,000 (50% of $12,000).

Thus $7,000 Equity - $6,000 (Reg T) thus there is $1,000 of excess equity


SMA- Special Memorandum Account.- the amount of cash that may be withdrawn from a margin account.

Excess equity is created by the appreciation of securities, cash dividends, the sale of securities, and voluntary deposits of cash or fully paid, Marginable securities by the account holder. When excess equity is created a SMA notation is created showing how much can be borrowed

Usually closing prices of preceding day are used to indicate equity and SMA

SMA increases with an increase in equity yet SMA does not decrease when excess equity declines.

Restricted account: if the debt balance of an account is greater than the loan value the account is restricted. How ever additional purchases can be made as long as the customer deposits the amount required by REG T

If an account is restricted, but it has SMA balance then as long as the min maintenance requirement is not violated. Since Reg T is an initial requirement, additional cash is not required to eliminate restriction.


Sale in a Restricted Account: A customer who sells stock in restricted account may withdraw 50% of the amount sold. The balance of the amount sold must be maintained in the account as per the retention requirement. If 100% of amount sold is left in the account then that will be applied toward the debt balance


Buying power: If a customer has SMA in a Margin Account it may be withdrawn as a loan or used to purchase additional securities on margin. Buying power is the ability to buy securities on credit and only applicable in margin accounts.

LMV -DR = EQ

$30,000          $10,000                  = $20,000      SMA= 5000

Buying power thus is 5000/.5 = $10,000

Minimum Maintenance Requirement

NASD requires that customer maintain a certain minimum equity in margin accounts after the initial requirements are met.

Margin call or maintenance call- is when equity drops below the min equity, the member firm must call for additional margin

Minimum Maintenance requirement for a long account is 25% Thus equity must be at least 25% of the CMV.

LMV - DR = EQ $25,000 -$10,000 = $15,000

LMV * Min Equity $25,000 .25 = $6,250 (well under the $15,000 equity in the account)

To determine the point at which the market value would have to decline before a long account is at the 25% minimum equity level, multiple the debit balance by 4/3


In-house maintenance margin requirement: a broker-dealer may have an in-house maintenance margin requirements that are greater than regulatory requirement, These requirement may be increased at any time without advanced notice. A broker –dealer is required to provide 30-days advance written notice of changes to be made to the terms and conditions under which credit charges will be made, excluding changes required by law

Guarantees: The account of a customer may be guaranteed by another customer. This means that if a customer’s account balance is undermargined, the equity if anther account may be used as collateral


Minimum Initial Equity Requirement

There is a minimum dollar requirement on a purchase in a margin account. The minimum initial margin deposit must be $2,00 unless the amount of the purchase is less than $2,000, which calls for the customer to deposit the full purchase price.

Once the initial equity requirement has been met, no maintenance call is required if the dollar amount of equity subsequently drops below $2,000.


CH 10 14-15

Short Accounts:

A short sale is a transaction completed by the delivery of stock the customer does not own. In order to effect delivery ,the broker-dealer handling the account will borrow stock.


Credit Balance (CR)- The customer’s account will be credited with the sale proceeds plus the cash margin deposited required.


(SMV) short market value - is what the customer owes the broker at the current market value


CR- SMV = EQ (equity)

Short sale initial deposit is 50% margin. The broker will borrow the stock and the customer, who must eventually replace the stock borrowed, owes the broker the value of the stock.

Minimum Maintenance Requirement: usually it is around 30% of the market value.

Ex. Short sell $25,000 the MMR would be $7,500

To determine how high the market value can go before a maintenance call multiple Credit Balance by 10/13 (.769)

$2.50 per share or 100% of current market value, which ever is great if the short stock is less than $5.00 per share $5.00 per share or 30% of the current market value, whichever is greater, if the short stock is valued at $5.00 per share or above

Day Trading Margin:

Special rules apply to accounts of pattern day traders. A pattern day trader is any customer who day trades 4 or more times in 5 business day period.

If a customer meets the definition of a pattern day trader, but the # of day trades is 6% or less of total trades for the five-business day period, the customer will not be considered a pattern day trader

Day trading: the purchasing and selling or selling and purchasing of the same security on the same day in a margin account.

Except- a long position held overnight and sold the next prior to any new purchase of the same security. A short position held overnight and purchased the next day prior to and new sale of the same security


If the broker-deal has a reasonable basis that the customer opening an account or resuming day trading will engage in a pattern of day trading, the firm can impose special day trading margin requirements

Minimum Equity requirement: Pattern day traders have a minimum equity requirement of $25,000 rather than the normal minimum requirement of $2,000. This must be deposited in the account before any day-trading can begin


Margin Calls- Day trading buying power is limited to 4X the traders maintenance margin excess, determined at the close of the pervious day.

If a day-trader exceeds buying power then must make a margin call within 5 business days.

During restricted times: the buying power is only 2x the traders maintenance margin

If the margin call is not met in 5 days, trading is restricted for 90 days or until call is met

Funds deposited to meet min equity requirement or day-trading margin call must remain on deposit in the account for at least 2 business days

Cross-Guarantees Prohibited: Pattern day trading are not permitted to meet day-trading margin requirements through the use of cross-guarantees. Each- day trading account much meet the requirements independently, based only on the resources in the account. This prohibits cross-guarantees not only between accounts of different customers, it also prohibits cross-guarantess between different account of the same customer


Ch11 1-9

Trade Reporting

ACT:

NASD Rules require the reporting of most over-the-counter- equity transactions. Usually are covered through Nasdaq’s Automated Confirmation Transaction service (ACT)

ACT’s: the system facilitates the reporting and clearing of Nasdaq and OTC transactions by allowing the order-entry and market-making firm to enter price trades. This info is used to report, match and clear transactions.

ACTS is NOT an order-execution system ,trades entered have been executed in another system

Market-Maker Obligations Report trades in Nasdaq National Market securities, Nasdaq Small Cap securities, CQS issues, OTC equity securities, Nasdaq-listed convertible bonds within 90 seconds (during normal hours), enter trade details for all clearable and internalized transactions using the Nasdaq workstation 2 Correct, decline, or cancel trades, when necessary

Order-Entry Firm Obligations: Act rules require that order-entry side must do one of the following: • Enter a version of the trade within 20 mins of execution using the OE function on Nasdaq 2 • Accept the market-maker trade entry on ACT trade scan within 20 mins of executions • Decline an incorrect market-maker trade entry on ACT Trade Scan or cancel the trade entry

Once a trade has been matched, either because the order-entry side accepted the trade on ACT. ACT matches the trade details entered by the market-maker and order-entry sides, the transaction is considered locked-in for clearing purpose.

ACT Trade Scan: ACT Trade Scan can be used by both market-makers and order-entry firms

• View trades entered into the system • Accept, decline, or cancel open trades (market makers can correct trades) • Break a matched or accepted trade (both sides must agree) • Change an entry from principal (P) to agent (A) or Riskless principal (R) or from A to P or R

Reporting Transactions in Nasdaq Securities: • Nasdaq National Market securities and Nasdaq Small Cap securities are virtually the same. Except that NNM securities are reported because of SEC rules where as SmallCap are reported to the NASD

Normal Trading Hours: (9:30 –4 eastern)

Transactions in Nasdaq securities must be reported to ACT within 90 second of execution If the ACT is not available, trade must reported by phone to the Market Operations Department. Trades not reported within 90 seconds must be reported ASAP and will carry the ‘.SLD’ along with time of transaction

Transactions Outside of Normal Market Hours

• 12am- 8am : trades are reported through ACT on trade date between 8:00am and 9:30am. Should be identified “.T” and accompanied by execution

• 8am-9:30 am: Trades are reported to ACT within 90 seconds of execution . If not in 90 seconds then should be “.T”

• 9:30-4: Normal requirements Transactions in Nasdaq securities must be reported to ACT within 90 second of execution. Trades not reported within 90 seconds must be reported ASAP and will carry the ‘.SLD’ along with time of transaction

• 4-6:30 pm : Trades are reported through ACT within 90 seconds of execution. Identifier “.T”

• 6:30 pm to Midnight: Trades are to be reported through ACT on the next business day (T+1) between 8am –6:30 . Trades should be designated as “as/of” trades and the time of execution should be reported.

Form T: Transactions were not reported to ACT according to the preceding rules must be reported to the Market Regulation Department weekly on form T. Should be used as a back up only if Trade data cannot be entered electronically. Excessive or unjustified use of this reporting procedure could lead to disciplinary action

Who Reports: To avoid double counting, the transaction is reported by only one side of the trade • In a transaction between 2 registered market makers, only the seller reports • In a transaction between a market maker and a member firm who is not a market maker reports • In a transaction between 2 members, neither of whom are market makers, only the seller reports • In a transaction between a member firm and a customer, only the member firm reports.

Riskless Principal Transactions- is defined as a trade in which a member firm • After having received an order to buy • After having received an order to sell a security, sells the security at the same price, as principal, in order to satisfy the order to sell

This definition applies to firms that make a market in the security involved as well as non-market makers.

When determining whether two trades are done at the same price, commission, markups, and markdowns are excluded

EX: MM1 has customer order to sell 1000 shares of xyz. MM1 sells xyz 1000 shares to MM2 as principal @21

      MM1 then fills customer order as principal 20.80 net (.20 mark down). Since the price of both trades is 21 when the markdown is excluded, this is considered a Riskless principal transaction.

As the seller MM1 has the reporting obligation. Method 1: MM1 would report the transaction with MM2 to ACT and would mark the report “Riskless principal” Method 2: MM1 would report the transaction with MM2 to ACT and would mark the report “principal” MM! Would also submit one of the following two reports of the trade with the customer as a “Riskless principal”

1. Clearing-only report if necessary to clear the transaction with the customer. 2. Non-tape, non-clearing report (if a clearing entry is not necessary because for example, the trade is internalized)

In some cases, a trade will be reported as part Riskless principal and part principal.

What is reported? Nasdaq symbol Number of shares (round lots only) Price (usually does not include commission, markup, markdowns or services) Whether the trade is a buy, sell, or cross (a cross (or dual agency) is a transaction in which the broker-dealer is acting as agent for both the buyer and the seller. Time of execution, if the trade is being reported more than 90 seconds after execution

ACT rules require additional information above and beyond the minimum NASDAQ requirements. For example a sort sale must be reported in ACT as sell short or Sell short exempt


Aggregate Reports: Under certain conditions, traders may aggregate reports for Nasdaq securities rather than report each trade separately. In all cases, must be same price, security and side of the market (buy/sell)

Openings- Orders received prior to the opening and executing at opening can be reported as one transaction. This also applies to orders received during a trading halt and executed together when trading resumes

Simultaneous transactions- When a number of orders are executed at the same time, such as when several orders with the same limit price are all executed, one trade report can be given Block execution of several orders are handled in the same way

Consecutive orders- If several individuals orders are executed in quick succession at the same price, making it impractical to report each separately, one report can be given. The orders must be executed within 60 sec on each other and reported within 90sec on the first execution in the group. Orders of 10,000 shares must be reported individually. But does not apply to trades effected on the first day of secondary market trading following and IPO

Trade modifiers

.SLD - Late Trade Report- trades not reported within 90 seconds of execution, actual time of the execution must be appended .T - After hours execution- time of execution must be included if not reported within 90 sec .O – Price Override- used when the inside market changes within the 90-second reporting .B – Bunched Trade- used for several trades aggregated into one report .SB – Late Bunched – used for a bunched trade not reported within 90 seconds .C – Cash Trade- trade settle the same day as the trade date .ND- Next Day Trade – trade will settle on T+1 .SNN – Extended Settlement- used for trades that will settle after regular way. The “NN” represents the extended settlement date, from 4 to 60 days later .W – Weighted Average – trades executed and reported on a weight average basis .PRP – Prior Reference Price – trade that should have been effected at an earlier time, but was not actually effected until now

.PRP is last execution, while .SLD is late trade report

Exceptions • Transactions reported automatically by another (CAES) • Transactions that are part of a primary or secondary distribution • Private placements • Transactions in which the buyer and seller have agreed to a price substantially unrelated to the current market for the security • Purchases or sales related to the exercise of an option or convertible at a preestablished price not related to the current market value

OATS (Order Audit Trail System): Is a system that enables the NASD to effectively review market activity in regard to customer orders within a member firm, conduct surveillance, and enforce rules. OATS records the life of an order from receipt, to routing, to modification if applicable, and cancellation or execution. OATS also helps with time synchronization and is done on a daily basis being recorded on HH:MM:SS format. OATS must be reported the same day or when the info first becomes available, OATS must be reported daily.

Info that must be reported to NASD from OATS:

• From whom the order was received • Order identifier • Date and time of receipt • How the order was received (manually or electronic) • Terms of the order § Buy § Sell § Long § Short § Stock § Shares § Price § Order type § Time in force § Special handling requests § Account type

• Where the order was routed for execution • How it was routed • Whether the order was modified § Cancelled § Changed § Date § Time

• Execution § Price § Full or partial § Date § Time § Capacity § Exchange where trade reported • Whether there is a separate reporting agent for OATS

Reporting Transactions in Non-Nasdaq Equity Securities: OTC Equity Securities- equity securities for which real-time reporting is not otherwise required. This is any security not listed on Nasdaq or a national exchange. The rule encompasses transactions in OTC bulletin Board issues as well as Pink Sheet stocks. However any transaction in an OTC Equity Security must be reported, regardless of it appearing in particular quotation mediums.

Foreign OTC Equities- are reported through ACT similar to Nasdaq securities.

OTC Market Maker- is a broker-dealer that holds itself out as a market maker by entering proprietary quotations or indications of interest for a particular OTC in any interdealer quotation medium, such as pink sheets or OTCBB

Foreign OTC transactions equities outside of 8-6:30pm are reported on T+1

Exceptions- • Transactions that are part of a primary or secondary distribution Private placements • Transactions in which the buyer and seller have agreed to a price substantially unrelated to the current market for the security • Purchases or sales related to the exercise of an option or convertible at a preestablished price not related to the current market value


Reporting Third-Market Transactions:

NASD Members who execute OTC transactions in listed securities must report through ACT.

Transactions Outside of Normal Market Hours: Third market

• 12am- 8am : trades are reported through ACT on trade date between 8:00am and 9:30am. Should be identified “.T” and accompanied by execution

• 8am-9:30 am: Trades are reported to ACT within 90 seconds of execution . If not in 90 seconds then should be “.T”

• 9:30-4: Normal requirements Transactions in Nasdaq securities must be reported to ACT within 90 second of execution. Trades not reported within 90 seconds must be reported ASAP and will carry the ‘.SLD’ along with time of transaction

• 4-6:30 pm : Trades are reported through ACT within 90 seconds of execution. Identifier “.T”

• 6:30 pm to Midnight: Trades are to be reported through ACT on the next business day (T+1) between 8am –6:30 . Trades should be designated as “as/of” trades and the time of execution should be reported.

Who Reports: • In a transaction between 2 registered market makers, only the seller reports • In a transaction between a market maker and a member firm who is not a market maker, only the market maker reports. • In a transaction between 2 members, neither of whom are market makers, only the seller reports • Transactions executed on an exchange are reported by the exchange, not the member firm

What is Reported? • Stock symbol • # of Shares (round lot only) • Price (doesn’t include commission, markups or service charges • Whether the trade is a buy, sell or cross • Time of execution , if not in 90sec window

Exceptions: • Transactions reported automatically by ITS/CAES • Transaction executed on an exchange • Transactions that are part of a primary or secondary distribution • Private placements • Odd-lot-transactions • Transactions in which the buyer and seller agreed to price substantially unrelated to the current market for the security • Purchases by a member as a principal in anticipation of making an immediate exchange distribution or exchange offering on the floor of an exchange. • Purchases of securities off the floor of an exchange pursuant to a tender offer • Purchase or sales related to the exercise of an option or convertible at a preestablished price not related to the current market value

Ch11 15-17

Trade Reporting and Compliance Engine (TRACE)

Fixed income-reporting system that provides a greater transparency in the corporate bond market.

TRACE is an NASD created system that members must use to report transactions in eligible fixed- income securities and continuous bond sales info. Eligible fixed-income securities: • Depository-eligible U.S. dollar-denominated debt securities • Investment and non-investment grade securities • Split Rated- Securities considered investment grade by one national statistical rating organization (NSRO) and non-investment grade by another NSRO • Sec Register debt securities of corporations that are in the U.S. or foreign countries • Securities issued under the Securities Act of 1933 and purchased or sold according to rule 144A

Securities that are not required to be reported: • Mortgage-back securities • Asset-backed securities • Collateralized mortgage obligations (CMO’s) • Money market instruments • Sovereign (government) debt • Development band debt • Municipal securities • Debt securities in physical form • Repurchase agreements (REPOS)

Reporting Requirements: Each NASD Member that is party in a TRACE-eligible security transaction must report its side of the transaction to the NASD. If it is just one NASD member then it must report the entire transaction

TRACE reports must be submitted to the NASD within 15 mins Committee on Uniform Securities and Identification Procedures (CUSIP) number or NASD symbol • Number of Bonds • Price or contract amount and accrued interest • Buy, Sell, or cross transactions • Date of execution (for as of trades • Contra- party identifier • Agent or Principal • Time of execution • Give-up for executing broker (if any) • Give- up for introducing broker (if any) • Commission/ markup or markdown • Trade modifiers • Yield to call or yield to maturity


Reporting Times

Trade executed between: Report to TRACE

8:00- 6:29:59pm Within 15 mins 6:30-11:59:59pm Next business day within 15 mins after TRACE opens. Must indicate as of and transaction date 12:00 a.m - 7:59:59am Same business day within 15 min after TRACE opens Non-business day executions (TRACE system is closed) including Saturdays, Sunday and federal or religious holidays Next business day within 15 mins after TRACE opens. Must be reported as executed same day of the report. Execution time must be 12:01:00am modifier must be 'special price' allowing for time/date to be entered

Bond Dissemination:

Non-investment grade securities that are included in information dissemination are base on the following:

• Volume • Price • Name recognition • Research • A minimum # of bonds outstanding • At least 2 dealers trading the security • A contribution to representing diverse groups in the entire group of securities designated for dissemination

Non-investment-grade securities may be withdrawn or not designated for dissemination if:

• It has matured • It has been called • It has been upgraded to investment grade • It has been downgraded to a state with which trading characteristics do not warrant designation for dissemination


NASD disseminates from TRACE

• The NASD symbol • A CUSIP • The transaction date and time • The price • The yield • The # of bonds

Ch11 20-23

Uniform Practice Code- sets the standards for clearing and settlement procedures to be used by members when dealing with each other.

These standards enhance the efficiency of the intermember dealings regarding such things as settlement of contracts, deliveries, ex-dividends, due bills and marks to the market.

Settlement:

Regular-Way Settlement: in a regular-way transaction, a trade settles in 3 business days

Cash Contracts: Cash trades are transactions that settle on the same business day that the trade is executed. The seller must deliver the securities to the buyer on the trade date and the buyer must pay for the securities when it receives them. Same day settlement is complete when the customer is recorded as owner of the stock, not when confirmations is sent as often is the case.

Seller’s Options: occurs when a seller does not wish to deliver the securities within three business days. Seller must specify the date on which the stock is delivered but cannot be less than 4 business days. The seller can deliver early if it notifies one day before it intends to deliver.

National Securities Clearing Corporation- is used by NASD members involving OTC securities, if the security has been qualified and both member firms are qualified as clearing members by the NSCC.

Each participant submits data at the end of the day. NSCC attempts to match buying and selling side of each trade.

The next day, participants receive from the NSCC contract sheet, describing § The trades that compared correctly and are not ready to settlement § Uncompared trades which participants must reconcile


Continuous Net Settlement (CNS): The process is possible when broker-dealers employ a clearing agency, EX NSCC and securities depository, EX. DTC )depository trust corporation to settle and clear trades

For each security the member firm buys and sells, positions are netted out so that the firm owes or is credited with one securities or money balance each day for that issue. Fail to receive and deliver are taken into account in the netting process


Confirmations: UPC code: requires written confirms from NASD members be sent on the first business day. (normal Way) and must contain adequate descriptions of the security and transactions.

Cash transactions- confirms must be sent on the business day of the transaction.

If the broker sends the Contra-broker (other side of the trade) a confirm but does not receive one in return. The broker must then send the contra-broker a DK (don’t know) notice, which questions the trade. The contra-broker should review its records and if its an error it may be canceled with notification and approval of the NASD

Note: these are for physical confirms, not those compared electronically

Delivery of Securities: purpose is to make sure that securities will be acceptable to the transfer agent. The transfer agent will make the final determination as to whether a security is a good delivery and may be transferred to the new owner.

Endorsements and Assignments:

1) A customer who sells a security is required to sign the certificate. Usual method is to sign the stock certificate on the back and then mail the certificate to the broker.

2) Can send the certificate, unsigned, in one envelope and to send a signed stock power in a separate envelope

3) Enter a third party (broker) name on the back, then the broker-dealer would sign a power of substitution when it sends the stock to the transfer agent.

Assignments on a security must be exactly as the name appears on the certificate. In addition the assignment must be guaranteed (a signature guarantee) by a member firm of the NYSE or commercial bank. The transfer agent will not accept a security for transfer without a proper assignment and guarantee.

Ex. Certificate is made out to Ken s. Schmitz would need to sign the back Ken s. Schmitz- Ken C. Schmitz and have both guarantee by a NYSE member firm or bank. This is generally referred to as an erasure guarantee

Additional Documentation:

If an account is register in the name of an executor or guardian and the security is signed by the executor or guardian, the transfer agent will accept the stock without requiring additional documents.

Will not accept a dead person signature, but will accept if it is signed by a duly designated executor and accompanied by the necessary legal documents. (death certificate , appointment of executor, state tax waivers, and affidavit of domicile.)

Certificates made out in the name of a company must be signed exactly as the name appears, without alterations or enlargements of any kind. A NASD member cannot accept unless the person signing is assured that the properly designated by the board of directors.

Corporations can submit a corporate resolution and have the broker keep a copy of their resolution with all the transfer agents in advance.


Units of Delivery: Certificates must be in certain units. If not the buying broker does not need to accept the certificates.

Stock Transactions: On stock transactions, deliveries may be for multiples of 100 shares.

Cannot be in non round lots thus 300 share can be broken up by 200 shares and 100 shares but not 150 and 150.

Were as smaller units can be used if they can total 1000 shares. Ex 25, 50, 25

Odd lots shares can be delivered in single certificates or multiple

In partial stock delivery the remainder must be in a round lot


Bond Transactions- Bonds are good delivery in $1,000 denominations, or denominations of $100 or multiples aggregating to $1,000 (registered cannot be more than $100,000)

Drafts that accompany the shipment of securities must be accepted only if presented during normal business hours. The acceptance of a draft prior to the settlement date, or the acceptance of a draft with irregularities, is at the option of the broker0dealer to whom the draft is delivered


Ch11 26-29

Dividends

UPC- covers Ex-dividend, ex-right and ex-distribution procedures.

To determine an Ex-dividend date, count back 2 business days before the record date. Any individual who purchased the stock are the Ex-dividend date would not receive the dividend.

In the event that a trade occurs in time for a buyer to receive a dividend. (before the ex-date) but the sender fails to deliver the securities by the record date, a due bill will accompany the security when it is delivered.

A due bill occurs when a dividend is due to the buyer, but is paid to the seller because delivery was not made in time to change the issuer’s records.

Bond interest:

UPC covers accrual of bond interest – On all bond transactions (other than for bonds trading flat- without accrued interest), the buyer of the bond will pay the seller the interest that has accrued from the last payment date to the day prior to the settlement date.

Government bonds- computed on the basis of actual days elapsed for last payment

Corporate and muni- each month is considered 30 days, the first day is counted is the last date that interest was paid.


Reclamation- The right to return or the right to demand the return of a security that is previously delivered and accepted

Requires the use of the Uniform Reclamation Form

Reason: • Wrong security delivered • Required due bill not attached • Signature issues • Mutilated securities is delivered without authentication by the transfer agent • If the transfer agent refuses delivery

Bonds- reclamation is permitted if the bearer bond is deliverered without all necessary coupons attached.

If the bond has been called prior to delivery, unless the entire issue has been called for redemption or was traded as a called bond.

Close-Outs: UPC deals with Close-out procedures for failed trades, or trades that were not completed as agreed.

Buy-in: occurs when a selling broker has failed to make proper deliver to a buying broker. The broker will then purchase the securities in the open market, charging the difference to the selling broker. A buy in may not be done sooner than the third business day following settlement date. The broker whom delivery is due must send a buy-in notice to contra-broker no later than 12 noon two business day before execution of the proposed buyin

Selling broker has right to notify that securities are in transit, the buyer must defer the close-out for 7 days

Sell-out: if a selling broker makes good delivery to a buying broker. And the buying broker refuses the accept ,the selling broker has the right to sell securities immediately, with out notice, and charge the buying broker with the loss

Notice of Close-out: NASD member that buys in or sells out another member must notify the other members of such action on the same day

Marks to the Market: a mark to the market occurs when a member firm is partially unsecured on an open contract with another member firm. The mark to the market is sent when there is a difference between the contract prices.

B lends A $50,000; stock goes to $60,000 then B can request A to send $10,000 because of stock rise

B lends A $50,000; Stock goes to $30,000 then A can Request B to send $20,000 in collateral

IF a member firm sends another member firm a mark to the market demanding the deposit of additional cash.


When-Issued Securities:

The UPC covers when, as and if issued and when, as and if distributed transactions These are transactions in securities, which are not yet available for delivery.

One the securities are issued or distributed, then the NASD Operations committee will determine if the final form is essentially the same as original announcements. If they are then it will determine the settlement date, if not all transactions are canceled.

If the NASD does not determine settlement date then it will be on the business day following the seller giving the buyer written notice of its intention to deliver.

Clearing Agreements- It is an agreement between the introducing firm and the clearing firm. Where the clearing firm provides back office support for a fee. The clearing firms actually holds the funds and securities and receive statement and confirms.

If the Clearing firm is responsible for all record keeping, the introducing firm will provide the clearing member with complete details about customer accounts. Known a fully disclosed basis.

When entering into a Clearing agreement then the introducing member should provide a list or description to assist the supervising member to help with supervising activities, monitoring its customer accounts and carrying out its functions and responsibilities under the clearing agreement.

The clearing firm must notify the introducing firm annually (no later than July 31) of the reports it offers to the introducing firm.

Review of Agreements: When a clearing firm enters into a new agreement or revise an existing agreement. It must submit to the NASD for review and approval.

Customer notice: Each customer must be notified in writing ,upon opening an account, of the existence of the clearing agreement


Ch11 32-34

Clearly Erroneous Trades

NASD rule 11890 was created as the result of a complaint from a member that a trade was executed 10 points away from the inside market but the counterparty refused to cancel the trade. Prior to this rule NASD did not have the authority to adjust such transactions

Filing a Complaint:

A member firm or member of UTP exchange that believes a transaction was in error and wants it reviewed must submit a written complaint. • For transactions occurring between 9:30 am and 10 am complaints must be filed by 10:30am • For transactions occurring before 9:30 am or after 10 am. Complaints must be submitted within 30 mins of the transaction.

Once submitted the complainant has up to 30 additional mins to submit supporting documentation.

Including: • Security symbol • Execution time • Share amount • Prices • Contra party • System used during trade execution • Reason for filing

Inside market price Min threshold $0 - $.99 $.02+ (.10* Inside Price) $1.00 - $4.99 $.02+ (.07* Inside Price) $5- $14.99 $.02+ (.06* Inside Price) $15 or more $1.00

For a buy order, the inside market is the best off. For a sell order, inside market is the best bid

If a Nasdaq officer finds that it meets the requirements for adjudication. The counterparty will be notified verbally by Market Watch and must be 30 mins to submit documents supporting its position

Once all the info has been received the Nasdaq officer has the power to allow • The trade to stand • Void the trade • Modify one or more of its terms Both parties will receive a verbal report, followed by a written report

Once a complaint has been filed it may not unilaterally be withdrawn. Both parties must agree to withdrawal.


System Disruptions or Malfunctions: If Nasdaq becomes aware of such errors, it may correct them without waiting for a complaint to be filled. Nasdaq offer must make corrections within 30mins of detection, but in no event later than 3pm on the next trading day

Review: A Nasdaq officer decision can be appealed to the Market Operations Review Committee (MORC) if the appeal is filed within 30mins of verbal notification Unless verbal notification is given after 4pm , then either party has until 9:30 am of the next trading day. The decision of the MORC does not affect the right to dispute to NASD arbitration.


SEC rule 15c6-1 The Settlement Cycle:

A broker-dealer cannot enter into a contract for the purchase or sale of a security that provides for the payment of funds and delivery of securities later than the third business day after the trade date unless otherwise expressly agreed to by the parties at the time of the transaction. This condition does not apply for exempt securities including • Government bonds • Muni bonds • Commercial paper • Bankers acceptances in exempt securities • Limited partnership interests (nonlisted)

Prime Brokerage: is a service that has been developed for institutional and large retail customers who are active traders. Often using several broker-dealers, prior to prime brokerage they would need to open a separate account at each executing broker-dealer.

Where as in Prime brokerage arrangement, the client chooses one firm as its prime broker. Client still uses multiple brokers but all trades are ultimately handled by the prime broker.

Conditions that must be satisfied in order to establish a prime brokerage account: • Must maintain net equity of $500,000 unless the account is managed by a registered investment advisor, in which case the min equity is $100,000 • The customer must sign agreements between the prime broker and executing broker, which detail the responsibilities of each party as well as a contract • A broker-dealer cannot engage in activity with any broker-dealer that it knows or believes is in violation of SEC conditions regarding prime-brokerage

Orders place with the executing broker are made through an account with the executing broker in the prime broker name, for the benefit of the customer.

Transactions are recorded in the customers account at the prime broker

To confirm the trades the Depository Trust company (DTC) Intuitional Delivery (ID) system is used. The prime broker will affirm the trade if the info on IDS is correct

Benefits: • Enables clients to centralize their clearing and custodial services • Allows them to receive on set of comprehensive reports regarding their portfolios. • Helps with margin accounts to lower the cost of funds


CH12 1-11

Supervisory Responsibilities:

All broker-dealers are required to diligently supervise their business ,including the registered reps. Not just required by NASD but SEC

Failure to Supervise- is a charge that can be raised against broker-dealers or supervisors who do not carry their responsibility to prevent violation of federal securities acts, SRO regulations, state securities laws, or the firm’s own written supervisory procedures.

It is also enforced against supervisors who fail to detect or fail to take action after detecting, violations of these regulations by the employees they supervise. These charges can be brought not only by the SEC, NASD and other SRO’s

Basic SEC requirements:

The Securites Exchange Act of 1934: gives the SEC the power to sanction broker-dealer

Failed reasonably to supervise, with a view to preventing violations (of federal securities laws) another person who commits such a violation, if such person is subject to his supervision.

Not considered to be failure to supervise if: • There are established supervisory procedures and a system for applying those procedures which would be reasonable expected to prevent and detect violations of relevant rules • The supervisor has reasonably discharged those duties under the system and has no reason to believe that the system is not operating properly

This protects supervisors whose employee’s hides wrongdoing, but does require due diligence.


NASD Requirement for Supervision:

A member organization of the NASD must establish and maintain supervisory procedures to ensure compliance by member organization personnel with securities laws and regulations and with NASD rules. One or more principals must be designated to review this policy and must notify the NASD as to this person identity


Registered Options Principal (series 4) Municipal securities principal (series 53) Financial and Operations Principal (series 27 or 28)


Written Supervisory Procedure:

All broker-dealers must have written supervisory procedures manual and must cover the scope of the business activity. As well as procedures so that supervisors can implement the plan and be able to detect and prevent violations and must be kept at the office.

Must explain and include: Methods by which supervisory reviews are documented Titles, registration status and location of the supervisory personnel. Record of the names of supervisory personnel must be maintained for 3 years, two of which must be easily located. NASD member firms must have a copy of the NASD manual in an accessible place


Office of Supervisory Jurisdiction (OSJ) NASD rules state that a member firm must appoint a principal to supervise any location and is defined as a office of supervisory jurisdiction

OSJ includes any location where one or more occur: • Market-making and or order execution • Structuring of public offering or private placement • Maintaining custody of customers’ funds and or securities • Final acceptance (approval) of new accounts • Review approval of advertising or sales literature • Responsibility for supervising other branch offices

OJS must have a general securities principal who is responsible for: • Approve and review of accounts • Transactions • Correspondence • Advertising • Sale literature • Response to customer complaints

If principal has jurisdiction over satellite offices, he must approve accounts and order and make frequent visit of those sites

A General Securities Principal may not approve options related communications nor options accounts and may not be responsible for financial reporting to regulators.

A non-OSJ branch may be supervised either by a principal or a competent registered selling representative.

Branch Office: is considered to be where one or more of the firm’s associated personnel regularly conduct the business of effecting transactions in, or attempting to in due the purchase or sale of any security, or any location represented as such.

Locations not required to be registered as branch offices:

A non-sales offices A location of convenience used occasionally and by appointment only The floor of an exchange A temporary location used in business continuity A location primarily used for non- securities business and from which less than 25 securities transactions are effected annually A Representative’s primary residence that is not used as an office for the public A temporary location used for securities business (excluding primary residence) for less than 30 business days in any calendar year

A Location of convenience may be a situated in a bank. It is permitted to display only signs that comply with federal, state and SRO rules.

Primary residence Limitations: the exemption for branch office registration for primary residence apply only if the following conditions are met:

• Only one associated person or all associated persons who reside at the same place, who are members of the same family may conduct business at the residence. • The residence may not be represented as an office of the firm nor can customers meet at residence • Neither customer fund nor security may be handled at the residence • The associated person must be assigned to a branch office and the address for that branch must be listed on the persons business cards, stationary, advertisements and other public communications • Correspondence and communication with the public from the associated person must be subject to supervisions • Electronic communication, including email, must be made through the firm system • All orders must be entered through the branch of the associated persons or through an electronic system established and review able at the branch by the firm • Written procedures regarding the supervision of sales activities conducted at an associated person’s residence must be maintained by the firm • The firm must maintain a list of all residence locations

Inspections: Member organization must review each office, which include periodic exams of customer accounts. Each OSJ must be inspected annually. Offices must be reviewed periodically and the cycle of inspection must be included in the firms written supervisory procedures and must keep record of when each inspection was conducted.

Supervision of each business line

A broker-dealer must appoint a supervisor to oversee each type of business. Ex

• Retails sales • Investment banking • Trading departments, such as equity and fixed income • Research • Clearing


Written Approvals: A sales supervisor’s responsibilities must include approving new accounts as well as reviewing correspondence, transactions and customer accounts. Each must be documented in writing.

Some firms review each trade ticket where as others review the trade blotter

Supervision of Registered Representatives:

Each registered rep must be assigned a specific supervisor.

Registration of Representatives: All person engaged in the investment banking or securities business of a member firm must be registered, except for those whose activities are solely clerical or ministerial. Member firms must investigate: Good character Business repute Qualifications Experience

A U-4 from is used apply for registration, If a person was previously registered with the NASD the firm should review the latest U-5. If an applicant who receives a request for a copy of their U-5 must provide the copy within 2 business day. If held at pervious firm then firm has 2 business days to provide a copy.

Form U-4:

Each individual who is to be licensed under SRO rules must complete Form U-4. The form is filed with the Central Registration Depository (CRD)

CRD- is a computerized information system maintained by the NASD, which provides registration information regarding broker-dealers and registered reps to state regulators other SRO’s and the SEC

A broker-dealer must notify its customers annually that is its registered personnel’s disciplinary history is available

Statutory disqualification can occur solely on past transgressions, including: • Being expelled or suspended for a self-regulatory organization • Having a registration denied, suspended, or revoked by the SEC or another regulatory agency • Violating or assisting in the violation of any securities or commodities law or the rules of the MSRB • Failing as a principal or supervisor, to reasonably supervise a subordinate who violates rules (unless) there was a supervisory system in place which would reasonably be expected to detect the violation and the supervisor reasonably discharges supervisory duties under the system • Being convicted ,within the last 10 years, of a felony of misdemeanor involving false reports, bribery, perjury, crimes related to funds or securities or any other felony

By signing the U-4 registered reps also agree to file a timely amendment if any info changes

Fingerprinting Requirements: any employee of a broker-dealer must be fingerprinted: • Is engaged in the sale of securities • Regularly comes in contact with money or securities • Has access to the keeping, handling, or processing of securities, or the records of original entry of the broker-dealer

When a person is submitting a U-4 form , a finger print card is also required for identification purposes


Form U-5: After a register rep resigns or is terminated from a NASD member firm, the firm must notify the NASD within 30 days on Form U-5. It must also provide the individual with a copy of the form

Qualification Examinations:

The inclusive registered rep license is the Series 7: it allows a rep to sell any security product

Series 6: Investment Company Products/Variable Contracts Representative: NASD license that permits a rep to sell open-end investment companies (mutual funds), closed –end funds during distribution period, variable annuities, and variable life insurance

Series 11: Assistant Rep- Order Processing: an NASD license for sales assistants that permits the representative to accept unsolicited orders from customers. Persons with this license cannot: Solicit transactions New accounts Give investment advice Effect transactions for a firm Receive compensation based on the size or number of transaction Cannot hold any other NASD license at the same time

Series 22: Direct Participation Programs Limited Representative: Am NASD license that permits a rep to sell direct participation program

Series 42: Registered Option Limited Rep: An NASD license that permits the sale of options if the representative also has a series 62 license.

Series 52: Municipal Securities Rep: An MSRB license that permits a rep to open accounts for and execute transaction in muni securities

Series 55: Limited Rep- Equity trade: an NASD license that must be obtained by individuals who trade equity and or convertible securities on a principal or agency basis in the over-the counter market, as well as persons who supervise traders. This category of registration also requires a series 7 or series 62

Series 62- Corporate securities limited rep: an NASD license that permits reps to sell exchange-traded and OTC corporate securities but does not allow the sale of investment company securities , variable contracts, municipal securities, options or limited partnerships.

Series 72- Government Securities Rep: permits a rep to conduct business in U.S. Tresury, government agency and mortgage backed securities. Also need a series 42

Series 86- Research analyst Part 1: Analysis module: NASD registration that permits an analyst to prepare analysis, modeling, and valuations for companies that are subject of research reports

Series 87- Research analyst part 2: regulation module: NASD registration that permits an analyst to prepare research reports or supervise research analysts.

EXAM confidentially: It is a violation of NASD rules to: Remove an exam of a portion of an exam Reproduce parts of the exam Disclose parts of the exam to anyone Receive parts of an exam from anyone Compromise the contents of a past or present exam in anyway

State Registration:

Most states require passing the series 63 exam. But a rep still needs to the proper application and fees must be submitted and registration must be granted by the state administrator

The taping rule: a broker-dealer must use special written procedures and begin the taping of conversations between its registered personnel and customer for a period of 3 years. When a firm hires a personnel from a member firm that has been disciplined.

They must meet the following criteria:

• Employees at least 5, but fewer than 10 registered reps ,where 40% or more have been employed by one or more disciplined firms within the last 3 years. • Employs at least 10 but fewer than 20 reps where 4 or more have been with disciplined firms within the last 3 years • Employs at least 20 reps, where 20% or more have been employed by one or more disciplined firms within the last 3 years

A broker that has been notified by the NASD is subject to the taping rule has 60 days to comply and begin taping. The broker then must create procedures fro reviewing, retaining, and classifying the recordings and send a report to the NASD every quarter.

Except: The firm has a one time opportunity ti reduce its staff levels below the thresholds to avoid the taping rule. Employees fired cannot be rehired by the same firm for 180 days

Activities of Nonregistered Persons: may: • Extend invitations to firm sponsored events • Inquire whether a prospective customer wishes to discuss investment with a registered rep • Inquire whether a prospective customer wishes to receive investment literature from the firm If it is an associated person of a foreign broker-dealer it is permitted to make sales calls in the U.S. if accompanies by a registered rep

Annual Compliance Meeting or Interview: all registered person must be part of an annual compliance review. The emphasis of the meeting should be compliance issues and product knowledge.

Continuing Education: CE requirement are divided into 2 parts

• The regulatory element, which is created and administered by regulators • The firm element, which is the responsibility of each broker-dealer

Regulatory element: RR are to participate in Regulatory Element training on the second anniversary of their initial securities registration and every 3 years for the remainder of the career.

Regulatory element: Written by the Securities Industry/ Regulatory Council on Continuing Education is computer based and includes questions/ scenarios

NASD will notify a RR 30 days in advance of the anniversary date. 120 days from anniversary date to complete the regulatory element training, if not complete RR become inactive.

Firm Element:

Covered person- is any registered person who has direct contact with customers in the conduct of a member firm’s securities sales, trading or investment banking activities and their immediate supervisor.

Each firm must demonstrate that once a year they analyze the training needs of their covered personnel and develop a written training plan.

Min requirement of firm element plan include: enhance broker’s securities knowledge, skill set, and professionalism.

Such training must cover securities products, services and strategies offered by the firm emphasizing on:

• General investment features and associated risks • Suitability and sales practice consideration • Applicable regulatory requirements


CH12 16-20

Business Conduct of Members

Supervisors are responsible for ensuring that the firm and its registered reps comply with all relevant rules and regulation in the conduct of day-to-day business of the firm.

Recommendations: must be made based upon the facts disclosed by the customers regarding other securities holdings and current financial situation. Should not be based on profit but on fair dealings. Recommendations can then be made without the advance approval of the firm (unless policy dictates differently)


The following would violate fair dealing:

• Recommending low-priced securities without obtaining information about the customer’s other securities holdings and financial situation. Thus making blanket recommendations of low priced securities is a violation because they are risky and not for everyone • Recommendation for purchases that are beyond the customers ability to pay. • Excessive activity in customer accounts (churning) • Trading in mutual fund shares which by their nature are not suitable trading vehicles or to buy hot issues • Use of discretion without authorization for the customer • Misuse of customer’ securities and funds • Unauthorized transactions by RR that are concealed from employer • Making guarantees as to future performance • The use of promissory language by member firms • Paying someone to make a favorable comment about the security

Recommendations must have reasonable basis and must include:

• The price at the time of the original recommendation • If the member firm makes the market of the member firm intended to buy or sell the security in its own account • If the member firm and its officers or partners own warrants, rights or options to acquire the security • Whether the member was the manger or comanager of any of the issuer’s securities offerings within the past 12 months • Information supporting the recommendation must be provided or offered • Reference to past recommendations for a particular type of security must include all the recommendations for that type for the past year. • Each recommendation must be shown with date and the price at time of recommendation, as well as price range to be acted upon. • Reference to past recommendations may not imply that they were profitable

Seminars and presentations: Fall under the NASD Conduct rules. Examples of these activities include:

• Seminar conducted by a RR or principal that is open to customers • Principal appearing on TV discussing investments


Institutional customers: have at least $10 million invested in securities in its portfolio

Suitability obligations to institutional customers: RR cannot ignore suitability issues just because the customer is an institutional investor. There are 2 primary considerations in determining the scope of a member’s suitability in making recommendations.

1) The customer’s ability to evaluate investment risk independently. Factors should be considered include: • Use of 1 or more consultants, investment advisers, or bank trust departments • General level of experience of the institutional customer in financial market and experience with instruments under consideration. • Customer’s ability to understand the economic features of the security • Customer’s ability to independently evaluate how market development would affect the security • The complexity of the security


2) The extent to which the customer is exercising independent judgment:

Any written or oral understanding that exists between the member and the customer regarding the nature of the relationship The presence of absence of a pattern of acceptance of the member’s recommendations The use by the customer of ideas, suggestions, market views and information obtained from other member or market professions. The extent to which the member has received from the customer current comprehensive portfolio information in connection with discussing recommended transactions or the extent to which it has not been provided info regarding its portfolio or investment objectives


Regulation FD- Fair Disclosure

Concern that the selective disclosure of inside information to research analysts and large investors was unfair prompted the SEC to adopt Regulation FD. Regulation FD bars issuers from selectively disclosing nonpublic, material information to securities professionals, or it shareholder if it is ‘reasonably foreseeable” that they will trade on the information

REG FD applies to: • Senior company officials • Those who regularly communicate with research analysts and investors • Company’s investment relations • Public relations

If any of the preceding people disclose nonpublic, material information to analysts or investors it must be disclosed to the public at large

Intentional disclosure- then the company must simultaneously disclose the info to the public

Unintentional the company has 24 hours to publicly disseminate the information or until NYSE opening which ever is later.

The company may file a Form 8-k with the SEC or by using some other method designed to reach a broad spectrum of the investing public

REG FD does not apply to disclosures in normal course of business such as disclosure to company accountants, lawyers and investment bankers

Best Execution: Failure of member firms to use reasonable diligence to enable customers to obtain the best price on purchases and sales is inconsistent with just and equitable principles of trade. Factors that are considered: • Price, volatility, and relative liquidity of the security • General character of the market for the security • Size and type of the transaction • # of markets checked • Accessibility of the quotation • Terms to conditions of the order as communicated to the members

Interpositioning (prohibited) – is the insertion of a third party between the customer and the best market price to the detriment of the customer.

Prohibition would not apply is member firm could prove that interpositioning helped provide the best price.

Lack of sufficient personnel to effectively execute an order would not be a reasonable basis for not obtaining the best price for a customer.

Front – Running (prohibited)

NASD member firms or associated persons cannot execute an order for which the firm has interest of discretionary authority with knowledge of material nonpublic info about an imminent block transaction in the security.

The ban is lifted once the block transaction is made public. Unless it is a partial execution which the ban is still in effect until the entire block is traded

Block is considered 10,000 or more shares

Does not apply to: SuperMontage (automatic execution)

Nasdaq, Consolidated tape, or options price reporting service

Another example is a rep who holds a security and trys to build retail interest in the stock. Thus causing the price to rise

Trading in Anticipation of a Research Report

The NASD prohibits a member from establishing, increasing, decreasing or liquidating an inventory position in a particular security in anticipation of the firm’s issuance of a research report in that security.

However unsolicited order flow from retail customer or other broker-dealer are not covered

The restriction is also lifted for in-house use only research reports, not for external publication.

Applies to NASD members in listed stocks in the third market and All Nasdaq stocks. As well as there derivatives. But does not address OTC securities although the NASD considers trading ahead as a violation of just and equitable principles of trade.

Extended hours:

NASDAQ permits but does not require, market makers to remain open during extended trading hours 4pm-6:30 p. Broker-dealers must disclose the risks of extended hours trading before permitting clients to engage. The risk include: Lower liquidity Higher volatility Changing prices Unlinked markets News announcements Wider spreads



CH12 26-33

Communication with the public: Broker-dealers are responsible for the content of the communications between its registered reps and customers.

Research Analysts and Research Reports

An associated person(analyst) is an employee of a member firm who makes recommendations in research reports and public appearances as to whether a equity security should be bought, sold, or held. Including employees who report to analysts.

Supervisory procedures should be revised accordingly as should general practices related to research reports preparation and approval and are required to affirm annually that the member’s written supervisory procedures comply with new and existing rules.


Investment banking and Research Department control issues

The information barriers separating research and investment banking must be reinforced through the supervision of these areas, including written supervisory procedures.

A member’s investment banking department is restricted from exercising any control over its research department, particularly research reports. Supervisory analysts must supervise and approve reports. Can contact if for the reason of review of information contained in reports for accuracy or conflict of interest.

Written communication must be routed through the member’s legal or compliance department or copied. Oral communication must be transmitted through legal or compliance personnel or conducted in the presence of a rep from one of these 2 departments

Members May not submit research reports to the subject company except for the purpose of fact verification and then only the relevant section may be transmitted, but this must be okayed with legal or compliance departments prior to transmitting.

A subject company must be notified of a change in rating the trading day before a public announcement.

Communications not related to verification or conflict avoidance are prohibited

Solicitation of investment banking business: Research analysts are prohibited from participating in the solicitation of investment banking business. As well as participate in road shows in connection with investment banking.

A research analyst is prohibited from communicating with a customer regarding an investment banking services transaction. In the presence of issuing company or investment banking personal.

Tree-way communications also aim to prevent customers, prospects from identifying a research analyst as a part of the investment banking department and their solicitation of business for investment banking service transactions.

Investment banking department personnel is prohibited from, directly or indirectly , directing a research analyst to participate in the sales or marketing efforts for an investment banking service transaction or to communicate with a customer or prospective.

A research analyst’s job is to provide accurate and unbiased information regarding an issuer and the issuer’s securities. Information must be fair, balanced and not misleading

Analysts are prohibited- to invest in Private Investment in Public Equity (PIPE) transactions , which are private financing arrangements made for public companies where institutional investors purchase securities registered after the offering is complete.

Exception: In smaller firms, personnel may act in a dual capacity as both investment adviser and research analyst.

This exception is given to member firms that over the pervious 3 years “have participated in 10 or fewer investment banking transactions or underwriting as manager or comanager have generated $5 million or less in gross investment banking service revenue for those transactions.”

Firms must keep records of any communication that would normally be subject to review and monitoring.

This exception does not effect the relationship between issuer and analyst. They should always have a separation.

Anti-Retaliation- prohibits a member firm from, directly or indirectly, retaliating or threatening to retaliate against an analyst who publishes a research report or makes a public appearance that may have negative affect on the member’s investment banking relationship.


Terminations: The termination of an analyst may take place provided it is unrelated to issuing or distributing negative research findings or making an unfavorable public appearance.


Restrictions on Issuing Research Reports:

The quiet period for initial public offerings is 40 calendar days, for secondary offerings, the quiet period is 10 calendar days. The quiet period for secondary offering does not apply to issuers whose securities are actively traded as defined under REG M

There is also a 25- day quiet period after the date oft eh offering for a broker-dealer (other than a manager or comanager) that has agreed to participate as an underwriter or dealer in an initial public offering. During this quiet period , the participant broker-dealers may not publish research reports for the subject security nor would its analysts be permitted to make public appearances regarding the issuer security.

Booster Shot: research reports published shortly before or after the end of a lock –up agreement. Lock-ups prevent insiders from selling the stock of his company for a specified period. Booster shots are usually positive and reiterates a buy recommendation that stabilizes the security when the lock up agreement ends. Booster shot research reports are prohibited form being published by a manager or comanager of a securities offering for 15 days prior to and after the expiration of lock-up agreements.

Booster shots prohibitions do not affect actively traded securities (average daily trading value (ADTV) of at least $1 million, where public float is at least $150 million

Significant News Exception to Quiet Periods: Significant news or events allow for research reports to be published or public appearances to be made during quiet periods.

Significant news or events are things that have a material impact or material change in a companies financial condition, operations, or earnings would require a 8-k.

Research Reports-

Research report disclosure must appear on the first page of the publication or must refer to the page on which they appear (cannot be in reduced typeface)

If a member publishes a report that makes recommendations on 6 or more subject companies, the report must disclose where the disclosures can be found.

Mandatory disclosures: • Whether the analyst has a financial interest in the securities of the subject company • Whether the firm has ownership of the subject security if such ownership is 1% or greater of the outstanding stock of the subject company • Disclosure of whether the firm makes a market in the subject security • Any material conflict of interest about which the analyst or member knows or has reason to know • Whether the member has received compensation for investment banking activity from the subject company during the twelve months preceding publication, or expects to receive or seek compensation in the 3 months following publication • Whether the analyst or any member of the analysts’ household is an officer, director or advisory board member of the subject company.

Disclosure Specifics: Members must disclose the following:

• The % of all securities the firm has rated in each category • The % of subject companies within each rating category that are investment banking clients of the firm or have been within the past 12 months • A price chart of actual performance for the last 3 years • Firm’s recommendation on the security including indication of instance where the member’s ratings or price target has changed for any subject security the member has rated for one year or longer • A clear and complete explanation of the rating system it uses, and what each particular rating means • A rational basis for the recommendation and supporting analytical data • The current market price of the subject security at the time of the recommendation • Possible risk that may impede the security achieving the target pricing

Public Appearances:

The disclosures required during public appearances, including television and radio interviews, during which predictions may be made include:

• Whether the subject company is an investment banking client of the member • Whether the analyst has a financial interest in the security that is subject of the report • Whether the member firm has ownership of the subject security if such ownership is 1% or greater of the outstanding stock of the subject company • Any material conflict of interest about which the analyst or member firm knows or has reason to know • Whether the analyst or any member of the analyst’s household is an officer, director, or advisory board member of the subject company.

Each member whose analyst engages in such public appearances must address eh disclosure requirements in its written supervisory procedures.


Compensation and Personal Trading

Analyst Compensation- Compensation based on specific investment banking deals is strictly prohibited.

Compensation- should be based on an analyst’s overall contribution to the firm. Member and supervisory personnel should be able to document a “totality of performance’” based compensation schedule to avoid the appearance of impropriety or a charge or rule breaking. If an analyst’s compensation is in any way based on contributions to the member’s investment banking business, this fact must be disclosed in research reports authored by the analyst.

Firm Compensation- A firm engaging in investment banking business with a subject company in the 12 months prior to publication of a research report must disclose this relationship and any compensation received from the subject company.

Similarly, a firm must disclose any investment banking relationship with a subject company for which it intends to seek compensation in the 2 months following publication.

Personal Trading:

An analyst is not permitted to trade against her won recommendations or her member’s recommendations.

Analysts are prohibited from purchasing or selling securities in a company regularly covered by the member’s analysts in the 30 days before or 5 days following the publication of a report. (unless shares were purchased prior to commencement of coverage)

Cannot purchase shares in a company in the same sector covered by the analyst prior to its IPO

Exceptions- Passive investor- the analysts is not making decisions or directing trades for particular securities. Unless the analysts owns more than 1% beneficial ownership or 20% of its assets in the analyst’s sector.

Sales by an analysts would be permitted within 30 days of issuing a research report if the subject was not previously covered by the analyst.

Research Analyst Supervisors: - Personnel of an NASD member firm that oversee the activities and approve the research reports of research analysts must also obtain approval for certain securities transactions These transactions are in equity securities of companies upon which the research analyst, who they oversee, writes the research reports. EX the director of research, members of the committee and supervisory analysts.



CH12 36-45

Advertisements and Sales Literature: must be truthful and may not omit material facts. Dissemination of advertisements or sales literature that contain untruthful statements or that are otherwise misleading may bot be used.

Advertisements- as any published material or material used in electronic or other public media such as websites, newspapers, magazine, radio, television, telephone recordings, and motion pictures ,among other sources. (doesn’t include independently prepared reprints

Sales literature- includes marketing letters, notices, circulars, research reports, form letters and reprints of published articles (except independently prepared reprints) and seminar texts.

All are subject to NASD requirements if it involves an offer or recommendation or any security analysis or investment advice.

Excluding- Tombstone ad’s, Routing ad’s discussing member firm personnel changes, prospectus or reports interpreting changes in tax laws.

Internal Review: Ad’s , Sale Lit and independent reprints must be approved in writing prior to use by a registered principal of the firm, either before its use or filing with the NASD. Firms must maintain a file containing all Ad’s , Sale Lit and independent reprints for 3 years after last date of use, (2 years readily acceptable). Must contain the name of approving principal and date approval was given.

Also need to keep a file with all source material for any chart, table, graph or other illustration.

NASD Review:

Initial Advertisements: if firm has never filed ads with NASD or exchange, it must file with the NASD 10 days before use for a year.

Other ads that need to be filed with the NASD: • Advertisements for collateralized mortgage obligations • Advertisement for securities futures • Ad’s and sale literature for registered investment companies that include or use performance ranking or comparison of investment companies that are not published or have been created by the investment company

Bond Fund Volatility Ratings: Sales literature regarding bond mutual funds or sales literature that uses bond mutual fund volatility ratings must be filed with the NASD at least 10 business day before use and indicate date of intent for use. Cannot use until it has been approved. The NASD may require further information, this will not require a resubmission like you would need in a Denial by the NASD.

Subsequent Advertisements and Sale Literature: after the 1 year period is over, firms may file certain items and include:

• Ads and sales literature for registered investment companies that do not refer to bond mutual funs or bond mutual fund volatility ratings • Ads and sales literature for public direct participation programs • Ads for government securities • Any ads or sales literature that includes performance rankings or comparisons of investment companies and the ranking or comparison used.

Television or video: can be filed as storyboards but the final must be filed with the NASD within 10 business days of first use or broadcast.


Violation of Standards: If the NASD finds the a firm has not been following the standards for ads and sales literature, it may require that the firm file all ads and sales literature at least 10 business days before use.

Exceptions- • Press releases for the media only • Ads and sale literature that only mentions the exchange symbol for a member firm or a security in which the member is registered market maker • Ads and sales literature that only mentions the member firm or states a security at a specific price • Documents that have been filed with the SEC • Ads and Sales literature regarding recruitment, member firm name changes, member postal and electronic address, offices, mergers or acquisitions or business structure • Ads and sales literature that has been previously field and not been changed

General Standards: All communication with the public must be fair, balanced and based on principals of fair dealing.


Specific standards: must contain • Name of member firm that is sponsoring the material • Any comparisons must have described the differences between them • Testimonials- must clearly indicate results achieved by the maker may not have been obtained by anyone else and past results are not indicative of future results • If the testimonial is paid for it must be disclosed.

Advertising For CMO’s (collateralized mortgages obligations)

All CMO ads must be filed with the NASD 10 business days in advance of use

Communication : CMO’s must be described as (collateralized mortgages obligations) and may not compared to any other types of investment. Members must offer customers educational info about CMO’s and all claims about safety, guarantees, product simplicity and predictability must be accurate and not misleading

The following disclosure must appear in the ad:

The yield and average life shown above consider prepayment assumptions that may or may not be met. Changes in payments may significantly affect yield and average life. Please contact your REP for information on CMOs and how they react to different market conditions.

NASD has prepared a standardized CMO print ad. Members that use the format must still submit to the NASD. All CMO ads must contain the standardized info. Radio and TV ads must meet the same standards as print ads.


Accrual Tranche Bonds: is a deferred coupon Tranche of a CMO. Do not receive regular interest, nor amortized principal payments. Ads for Tranches must contain

Accrued interest is calculated on a 360-day year The security may not be principal or interest of the CMO Your representative should be contacted for information on CMO’s and how they react to market conditions A CMO may consist of private, whole loan mortgages

Exemptions: • Ads and sale literature solely related to changes in a member’s name ,personnel, location • Tombstone ads • Prospectus, offering circulars and similar documents • Material for internal use only

Investment companies:

Must disclose that there is a sales charge involved in the purchase of mutual fund shares. IF it does not list the charge must refer to the prospectus (which contains the charge)

Time periods- Except for money-market funds, ranking employed in advertising or sales lit may not be based on a period less than 1 year. Current rankings must be for most recent calendar quarter.

Switching: warning must be included that investors should weight the cost of switching investment companies. Must be in a separate paragraph in type-face as large as the rest of the literature.

Institutional sales Material and Correspondence:

Institutional sales material- is any communication which is provided to institutional investors

Institutional investors: • A bank • A savings and loan association • An insurance company • Registered Investment Company • An investment advisor registered under SEC section 203 • Any other entity with total assets of at least $50 million • A 403b employee benefit plan • An NASD member or an associated person of that member, or a person acting on behalf of an institutional investor

Institutional sale material is not filed with the NASD but is subject to spot check. Does not need approval by a principal.

Rule 2211 member firm may not distribute communications to an institutional investor if it thinks that a non institutional investor might get it

Correspondence: - is a written or electronic messages sent by a member to one or more of its existing retail customers and to fewer than 25 prospective retail customers within any 30 calendar day period.

The member firm must establish written procedures for the review of correspondence regarding its securities business or investment banking business. A registered principal must review all electronic correspondence with the public.

If a firm does not require all correspondence be reviewed it must educate and train its personnel regarding correspondence and must keep a record of the training. After it must maintain surveillance to make sure procedures have been implemented.

Incoming Correspondence- the concern is with customer checks and complaints. The NASD requires that firms have adequate handling of complaints and funds

Approval: Approval of most correspondence, and institutional sale material is not required. But a principal must review both prior. Firms must create a policy that allows principals to review institutional sale material. Procedure must be designed for supervision, education, and training of registered reps who work on institutional sales. Must keep records of training. If correspondence is sent to 25 or more existing clients within 30 calendar-days period and either promotes a product or service of the broker-dealer or makes a financial or investment recommendation then it must be approved by a principal.

Record keeping- Institutional sales material and the name of the person who prepared it must be kept on file for 3 years after the last date of use, source material must also be maintained.


Electronic Communications:


Communication Category Chat room discussion Public Appearance WEBSITE Public Advertisement Password protected Sales literature

E-Mail 25 or more prospective retail customers Sales literature <25 prospective retail customer within 30 days Correspondence To one (prospective or existing customer Correspondence Unlimited existing retail customers Correspondence Instant messaging 25 > Sales literature <25 prospective retail customer within 30 days Correspondence To one (prospective or existing customer Correspondence Unlimited existing retail customers Correspondence


Chat Room Discussions: a chat room allows a group of people to converse or chat over the Internet about a given topic. NASD registered person, whether at the office of a broker-dealer or at home, is held accountable for what she says regarding securities or industry services in an electronic chat room.

Web Sites: All web sites must be approved by a registered principal prior to use and adhere to the rules of Communications with the Public.

E-mail and Instant Messaging: They are considered to be similar and are required to be supervised, reviewed, and maintained in books and records alike. Communications that are considered sales literature must be approved by a registered principal prior to use.

All records of all electronic communications to be maintained for 3 years (2 years easily access)

Instant messaging may only be used by a firm if it has the ability to monitor, archive, and retrieve message that have been sent.


Telephone Solicitations: Federal Telephone Consumer Protection Act of 1991 protects consumers from cold calls. Main provisions: • Telephone solicitations may only be place between 8am-9pm local time, unless the person has given prior consent • When calling prospective, caller must provide their name, entity or person whose behalf the call is made., and telephone number or address where the entity or person can be reached. • Each broker-dealer is responsible for creating a do-not-call list. If a person asks not, to be called then the dealer must place him on the do not call list for 5 years. Dealers must also train its registered personnel to use the list properly.

• Registered reps may not make calls that harass or abuse the person called. EX use of language that can be seen as a threat or intimidating, use of profanity.

• The ACT bans the use of fax machine to send unsolicited ads.

The time-of-day and disclosure requirements do not apply to existing customers if the purpose of the call is to maintain or service an existing account of the RR.

An existing customer is someone for whom a broker-dealer carries an account and: • Within the past 18 months, the customer has effected a securities transaction, or made a deposit into, an account under the control of , or assigned to the rep • Within the past 18 months, the customer earned dividend of interest income in an account controlled by or assigned to the rep.

Use of Stockholder information for Solicitation: NASD rules do not allow the use of stockholder information for the solicitation purposes by a trustee unless the member firm is directed to do so by the firm.

Broker-Dealer Conduct on the Premises of Financial institutions

If a NASD member conducts business on the premises of financial institution where retail deposits are take it must comply with special provisions to ensure customers can distinguish between the bank and the broker dealer

Setting: the broker should be conducted in a location that is physically distinct from the area in which deposits are taken. The broker must clearly display its name in the area in which it conducts business.

Agreement: any networking arrangement or affiliation between financial institution and the broker-dealer must be in writing. • Should arrange parties responsibilities and compensations • Also should state that supervisory personnel can be examined any location the broker-dealer conducts business by the SEC and NASD.


Customer Disclosures: must disclose orally and in writing when opening a customer account on premises of a financial institution. 1. Not insured by the Federal Deposit Insurance Corporation (FDIC) 2. Not deposits or other obligations of and are not guaranteed 3. Subject to investment risks , including loss of principal

Should attempt to get customers written acknowledgment of disclosures.

Communications: Confirmations and account statements sent by the broker-dealer must clearly indicate that it provides the brokerage services. Ads and sales literature that include the location of a financial institution or are distributed on its premises must include disclosures 1,2,3 above. Where this is not practical, such as radio spot the following may be used:

• Not FDIC Insured • No Bank Guarantee • May Lose Value

Disclosures are not required in radio broadcasts 30 seconds or less, electronic billboard type signs.

Terminations: the broker-dealer must promptly notify the financial institution if it terminates for cause an associated person who is also employed by the institution


CH12 51-54

Regulation of Investment Advisers

-wrap account is a brokerage account in which a client is charged a single fee for all services, including investment advice, execution services and administration. Usually based on a percentage of assets under management. Most broker-dealers who offer wrap account are considered investment advisors and thus are regulated under Investment Adviser Act 1940.

What is an Investment Adviser? • Providing advice about securities • Being in the business of giving advice and • Being compensated for the advice

Exclusions from the definition of an IA

1. Banks or bank holding companies: not including S&L’s or investment adviser subsidiary of the bank

2. Certain Professionals: Lawyers, Accountants, engineers and teachers

3. Broker-dealers: a broker-dealer is exempt if the investment advice is solely incidental to its normal business and receives no special compensations. The RR must provide advice within the control and knowledge of the broker-dealer. The exclusion is not available to any representative providing advice outside the scope of the broker-dealer’s business

4. Publishers of bona fide newspapers, magazines or financial publications of general and regular circulation. The publication cannot i. Contain promotional material ii. Be tailored to the specific needs of an individual iii. Be timed to specific events affecting the securities industry

5. Government securities advisers. 6. Any other person exempted by the SEC. To date no other persons have been excluded

Registration:

If a firm does meet the definition of an investment adviser, then it usually must register with t e SEC if it is a large adviser ($25 million or more under management) or an advisor to a registered investment company. Smaller firms register with the STATES and are called RIA’s

Exempt advisors: • An investment advisor whose clients are all residents of the state in which the adviser maintains its principal office and who does not furnish advice about exchange traded securities. • An investment adviser whose only client are insurance companies • An adviser who qualifies for the private adviser exemption. Have fewer than 15 clients in 12 months , do not hold themselves out to the public as investment advisor and don’t advise Registered investment companies.

Investment Advisory Contracts: Contracts between IA’s and their clients are subject to certain conditions under SEC rules. (contracts are not required by the SEC)

• Contracts must contain a provision that prohibits the adviser from assigning the contract without the consent of the client • If the investment adviser is a partnership, the contract must provide that the adviser will notify the client within a reasonable period of time after any change in the partnership • Performance-based fees are generally not permitted. These are fees that are based on a share of the capital gains or capital appreciation in the account.

Qualified Client: investment advisors may enter into performance-based fee relationships with qualified clients. (a person or company with at least $75,000 under management of an advisor or $1.5 million net worth

The Brochure Rule: an investment adviser is required to provide clients with a written disclosure statement, or brochure, containing information about its background and business practices. Such as a copy of Part II of SEC from ADV

Warp account clients receive a special brochure.

Written disclosure must be delivered to clients and prospective no less than 48 hours prior to entering into a written or oral advisory contract. It may be delivered no later than the time of entering into the contract if the prospective client has the right to terminate the contract without penalty within 5 business days. IA’s must also annually deliverer or offer in writing to deliver its disclosure document to its clients.

Except: the brochure rule does not apply to investment company clients or contracts for impersonal advisory services requiring payment of less than $200


Antifraud Provisions of the Investment Advisers ACT: An investment adviser is a fiduciary who owes clients good faith and full and fair disclosure of all material facts. Thus it is an IA’s duty to disclose all material facts to clients, where if failure to do so would defraud or deceive a client or prospective.

Conflict of interest- must disclose all potential conflicts of interest, including all relevant facts so that the client can make an informed decision about the specific conflict involved.

The investment Adviser who is an RR- An investment advisor who is also a registered representative of a broker-dealer and provides investment advisory services outside the scope of employment with the broker-dealer must disclose to his advisory clients that the advisory activities are independent from his employment with the broker-dealer.

Broker-dealer is receiving or is going to receive a fee from a customer for investment advice, and wishes to sell that customer a security, which it is underwriting. The broker-dealer is required to disclose to the customer.

Soft dollar Compensation: some IA’s receive research and other services from broker-dealer in return for executing transactions for their advisory clients through the broker-dealer. Advisers are not permitted to receive reimbursements for travel expenses, furniture or equipment, since it would benefit the IA not the client.

Step-Outs – transactions to fulfill their soft-dollar commitments. EX: Advisor might with to use BD 1 for execution but wants research from BD 2 the adviser could send an order for execution by 1 but directs 1 to step put a portion of the commissions in favor of BD2, who provides the adviser with research

Conflict of interest: the use of step-outs by mutual fund advisers to compensate broker-dealers for the sale of fund shares. If the adviser asked executing broker to step out of private client trades to compensate other broker-dealers for fund distribution.

Confirmations: Both the executing broker-dealer and the broker dealer providing soft-dollar services to send a written confirmation containing all of the information required by the rule








CH13 1-3

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.

Marking the close/ Marketing the opening: is a series of transactions, at or near the close of trading, which either up tick or downtick a security. This is a concern because it is not part of the normal forces of supply and demand.


Motivation: for marking the close

1) Brokerage firms use a securities closing price in determining what their margin requirement s will be for their customers 2) A security’s closing price is the price shown in the newspapers as the final price for the security for that trading session

Marking the open might occur when options expire, (contracts settle on opening prices) and certain trade strategies are executed as the market opens

Fair prices and Commissions

Members are not permitted to charge prices or commissions that are unfair or excessive. Thus developed the 5% markup policy

2 major questions: When is a markup of about 5% acceptable when may it be more, or when must it be less? How is the markup calculated when the prevailing inter dealer price is not obvious.

Factors that influence the level of markups:

• The type of security involved- Common stock is usually higher than bonds

• The availability of the security in the market- if more effort is required to locate a particular security and execute a transaction , a higher mark up is justified

• The price of the security- % markups increase as price decreases

• The amount of money involved in a transaction-

• Disclosure- disclosure to the customer that the circumstance may warrant a higher-than normal markup helps to make the dealers case

• The pattern of markups- mark ups in each transaction must be justified on its own merit. Patterns of persistent markups are treated most severely by the NASD

• The nature of the broker-dealer’s business- firms that offer services to customers, such as research.

Calculating Markups-

Difference between interdealer ask and sales prices to customers

Mark down Difference between interdealer bid price and purchases from customers

EX: MNOP inside market is 19.5-20. Dealer X sells the stock fro $21 per share markup is $1 or 5%

This is acceptable only if the market for MNOP is active and competitive (it is not if one market maker dominates and controls the market.


Policy Enforcement: When calculating markups, a broker-dealer must determine:

• Whether it is acting as a market maker or not in the transaction • Whether the market for the stock is dominated and controlled rather than active and competitive • Whether actual transactions or validated quotes may be used as the best evidence of the prevailing price


Prevailing Price-

A quote is considered validated when:

• A competitive market for the security exists. • Interdealer sales occur with some frequency, although not necessarily contemporaneously • On the days when interdealer sales occur, they are consistently affected at prices at or around the quoted offers.


Suppose that a stock is being quoted at 24.50 –25 yet most interdealer trades are being negotiated through SuperMontage at 24.75. When calculation markups on sales, 24.75 should be used as the prevailing price, not 25

Proceeds Transactions: are those in which the customer directs the member firm to sell a security and use the proceeds of the sale to buy another security. The member firm should computer the markup in the same manner as if the customer had purchased for cash, for both the sale and purchase.

Exemptions: • Securities sold under a prospectus or an offering circular at a fixed offer price. • Registered secondaries • Mutual funds • Transactions on an exchange • Government securities • Municipal bonds

Charges for services: members are allowed to charge for services such as collection of dividends or safekeeping of securities, but the charges must be reasonable and may not unfairly discriminate between customers


CH13 8-9

Information obtained as a fiduciary:

Member firms acting as agents are prohibited from using information obtained about holders of the companies securities in order to solicit purchase, sales, or exchanges except at the request of and on behalf of the issuing company.

Prohibited Activities

Payments to Influence Market Prices: a member firm may not pay anything to an employee of a news media, investment service, or similar service for publishing anything designed to affect the market price of a security. This prohibition does not apply to bona fide advertisements paid for by the member firm, subject to the rules regarding ads


Offering’ At the Market”: a Member firm that is part of a primary or secondary distribution of a security which is not approved on a national exchange may not be represented as being a “at the market” unless such there is a reasonable grounds to believe that an independent market for the security exists

Sharing in Accounts- NASD members may not share in profits or losses in a customer’s account unless the employee has made a financial contribution into the account and shares in the profits and losses in direct proportion to the employee’s financial contribution. The written authorization of the employee’s member firm must be obtained prior to engaging in this activity.


Gifts to Employees of others-

Member firms personnel may not give a gift exceeding $100 per recipient per year to personnel employed by someone else, if the gift is in relation to the business of the recipient’s employer. Written records of all gifts and compensation must be retained by the member firm giving the gift or compensation.

Guarantees- Employees of member firms may not guarantee against losses in customer accounts or transactions within customer accounts, nor reimburse a customer for losses.


Outside Business Activities

RR must provide written notice to their employing broker dealer before participating in any business activities outside the scope of that person’s. this is a guard against conflicts of interest.

Even part-time employment by a registered rep must be reported.

Need permission first before working at any outside employment.


Private Securities transactions:

Private securities transactions are transaction outside the regular scope of an associated person’s employment with a member firm. This practice is some times called selling away. Selling away may include the participation in private placements, traditional IPO and arranging loans. Associated persons engaging in the following transaction must provide written notice to the employing member.

If the person is receiving commission for the transaction. The member must approve and keep record on the members books

If the person will not be compensated for the transaction, the member may nevertheless require the associated person to adhere to specific conditions in order to participate in the transaction.

Personal transactions in investment company and variable annuity securities are not covered by the rule





CH13 12-15


Municipal Securities Rulemaking Board (MSRB) is a self- regulatory organization that governs broker-dealers and bank dealers that buy, sell, underwrite and provide advice about municipal securities; NASD acts as the enforcement agency for the MSRB for any NASD member that is also in the MSRB.

Political Contributions (rule G-37)

Pay-to-play: - the practice of municipal securities dealers making political contributions in order to curry favor with politicians who might in return steer municipal securities underwriting business their way.

A municipal finance professional (MFP) is defined as:

• Any associated person primarily engaged in the activities of a municipal securities representative. In a diversified broker-dealer where municipal securities are only part of its business, there might be many reps that are not MFPs since those activities are not primary aspect of their business

• Any associated person who solicits Municipal securities business. (negotiated underwriting activities, negotiated remarketing services, providing financial or consultant services to or for an issuer.

• Direct supervisors of these associated persons

• Any member of the executive or management committee of a dealer or of a separate identifiable department of a dealer bank.

A MFP is considered to be any gift , subscription ,loan, or deposit of money of anything of value for:

• Influencing any election for federal, state, or local office • Payment of debt incurred in connection with any such election • Transition or inaugural expenses incurred by the successful candidate for state or local office.

Violations : a violation occurs if the MFP is not entitled to vote for the official and the MFP makes a political contribution. Also would be a violation if contribution to exceed $250 per election.

If a violation occurs, the muni dealer is prohibited from engaging in municipal securities business with the issuer for 2 years.

MPF employed by a dealer is not allowed to solicit or coordinate contributions for an official of an issuer with which the dealer is or is intending to do business.


Reported Related to Political Contributions

Firms must report on contributions to officials of issuers and on payments to political parties of states and political subdivision. 2 copies of these reports must be sent to the Board on form G-37/G-38 by the last day of the month following the end of each calendar quarter and must include:

• The name and title of each official of an issuer and political party receiving contributions or payments

• The amount of the contribution or payment made and the contributor category of the persons and entities involved.

• A list of issuers with which the dealer has engaged in municipal securities business, along with the type of municipal securities

MFP or executive offices whom contribute is entitled to vote that do not exceed $250 do not need to be reported.

Contributes made by executive officers that exceed $250 must be reported on Form G-37/G-38 although these contributions would not trigger the 2 year ban.

Dealers are not required to list the names of municipal finance professionals and exec offices on form G-37/G-38

Solicitation of Municipal Securities Business

A broker,dealer or municipal securities dealer may not agree to pay, either directly or indirectly any person who is no affiliated with the firm for soliciting municipal securities business on behalf of the firm

What is solicitation? Any direct or indirect communication by any person with an issuer for the purpose of obtaining or maintaining muni securities business.

Who is an affiliated person? Any person who is a partner, director, officer, employee, or registered person of the firm. Also considered are other companies that directly control, are controlled by or under common control of muni securities firm.

What is municipal securities business? A Muni securities business includes:

The purchase of a primary offering form an issuer on a negotiated basis. Competitive bid allocations are excluded from the def.

The offer or sale of a primary offering of Muni securities on behalf of any issuer, including public offerings as well as private placements.

If a municipal securities firm provides financial or advisory service to an issuer, or on behalf of the issuer, in a primary offering, the firm is engaged in municipal securities business.

Muni securities firms are allowed to pay compensation to consultants under a transitional payment provision provided the solicitation occurred prior to the rule change of AUG 29,2005. The consulting agreement must have been written and include the name, company, role and compensation arrangements of the consultant


CH13 18-23

Resolving Problems:

Code of Procedure: describes the Association’s disciplinary process. These rules cover disciplinary actions by the NASD against member firms and their associated persons. Disciplinary actions may be taken by the NASD for violations of NASD rules, violations of SEC rules or failure to pay dues or assessments.

Disciplinary Proceedings: If the NASD’s Department of Enforcement believes that a member firm or associated person has violated a rule or law under its jurisdiction, the department will request authorization from the office of disciplinary affairs to issue a complaint.

The respondent ( the firm or person named in the complaint). The response to the complaint within 25 days of receiving it.

If the respondent fails to respond within 25 days, a second notice will be sent. After 14 more day’s failure to answer will be treated as an admission by the respondent.

The respondent may request a hearing.

Hearing is held before a Hearing Panel consisting of a Hearing Officer and 2 panelists, who are appointed by the NASD Chief Hearing Officer (an attorney employed by the NASD). The hearing officer must provide 28 days notice of hearing to the respondent.

The other members of the panel are persons associated with or retired from, member firms that have an expertise in the area in dispute and have server on local NASD committees.

The Hearing officer may call a prehearing conference to prepare the parties for the hearing or to otherwise make the process more efficient. Documentary evidence is summated prior to the hearing. The hearing provides an opportunity for witness to testify under oath. Within 60 days after the Hearing Panel has stopped accepting evidence, it must render a written decision arrived at by majority vote.

Anytime before hearing respondent can offer a settlement. If accepted, the respondent waives the right to appeal. If rejected, the hearing would proceed to a conclusion.

Sanctions: hearing panel may impose the following penalties:

• Censure a member firm or an associated person • Fine a member firm or associated person • Suspend the membership of a firm or suspend the registration of an associated person, either for a definite period or until specified conditions are met. • Expel a member firm or cancel its membership, revoke or cancel the registration of an associated person • Suspend or bar an associated person from association with any member firm • Impose any other fitting sanction

Note: if the registration of an associated person is suspended, canceled, of revoked, that person may not be associated with a member firm in any capacity (including clerical or ministerial positions)

Other than a bar expulsion, as sanction is effective 30 days after the respondent has received notice of a final disciplinary action. A bar or expulsion is effective as soon as soon as the decision is served on the respondent. If a broker-dealer is suspended must be treated as non-members.

Appeals- Once a decision has been rendered by the Hearing Panel, the respondent has 25 days to file an appeal with the NASD National Adjudicatory Council (NAC)

If the respondent wins the Department of Enforcement has the right to appeal to NAC.

The process of appeal places the decision in limbo

Appeals

Hearing Panelà NACà SEC à Fed Courts

Acceptance, Waiver, and Consent: (AWC)

Letter of Acceptance- The respondent signs a letter accepting a finding of violation, consenting to the imposition of sanctions and waiving the right to appeal. Letter would describe the rules violated and the sanctions to be imposed. If the respondent rejects the letter, disciplinary process would proceed as normal.


Minor Rule Violation: fine of $2,500 or less.

Violations include: • Failure to have advertising approved by a principal • Failure to properly maintain advertising and or sales literature files • Failure to file advertisement on time with the NASD • Failure to file timely reports of short positions • Violations of SEC or NASD books and records rules • Failure to submit trading data as requested

Release of Disciplinary Information: Info about the disciplinary history of a member firm or registered rep is available to the public through the NASD’s Public Disclosure Program (PDP). This information is on file at the Central Registration Depository (CRD) and can be accessed online or a toll free #

Information provided about individuals includes the following:

• Current employing firm, 10 years of employment history and all approved registration • Certain legal and regulatory charges and action brought against RR such as felonies, certain misdemeanors and civil proceedings and investment –related violations. • Pending customer initiated arbitrage and civil proceeding involving investment-related activities, any arbitration or civil proceedings that resulted in an award to a customer, and settlement of $10,000 or more in an arbitration, civil proceeding or complaint involving investment-related activities. • Written customer complaints alleging sales practice violations and compensatory damages of $5,000 or more that were filed within the last 24 months • Formal investigations involving criminal or regulatory matters • Terminations of employment after allegations involving violations of investment-related statues or rules, fraud, theft, or failure to supervise investment-related activities

If an associated person is subject to action taken by a member and the fine is greater than $2,500, the member is obligated to promptly notify the appropriate SRO

Investor Education: The NASD’s Investor Education and Protection Rules requires member firms, at least once every calendar year, to provide each customer, in writing, the following:

• NASD Regulation public Disclosure Program Hotline # • NASD regulation Website Address • A statement as to the availability to the customer of an investor brochure that includes the info describing the public disclosure program

Code of Arbitration: The NASD Code of Arbitration is concerned with the settlement of disputes through arbitration. It is not concerned with discipline for violation of rules and regulations (covered by the CODE OF PROCEDURE)

Code of Arbitration:

Requires disputes be settled by arbitration including associated persons

Except in the case of statutory discrimination claims, including sexual harassment.

When a Rep signs a U4 they are agreeing with this statement “ I agree to arbitrate any dispute, claim or controversy that may arise between me and my firm, or customer or any other person ,that is required to be arbitrated under the rules, constitutions or by-laws of the SRO indicated”

A public customer can bring a claim against a member but a member cannot bring a claim against a customer, unless the customer agrees.

A customer may initiate arbitration by filing a Submission Agreement of Claim, and paying the deposit fee. Respondents may file a counter claim against the person initiating the arbitration

Does not apply to disputes between the NASD and member firms.

The NAC will appoint a panel of 1-3 arbitrators, depending on the $ amount.

If a customer is involved a majority of the arbitrators will be public arbitrators (not affiliated with the securities industry.

Once notified of the composition of the panel, the customer has the right to reject the selection of an arbitrator on a peremptory basis and has the right to unlimited challenges for cause.

Simplified arbitration is used if dispute does not exceed $25,000, a single arbitrator decides the case. Unless a public customer demands or consent to a hearing, or the arbitrator calls for a hearing.

Any awards granted by the arbitrator must be paid within 30 days of determination or penalties may be assessed on late payments.

Mediation: is an informal process in which 2 parties to a dispute attempt to reach a settlement without resorting to arbitration or litigation, as well as a 3rd party a mediator. The mediator is a neutral person, knowledgeable about the securities industry., who attempts to facilitate the discussions and help the parties reach an agreement

Once 2 parties agree to mediation, they select a mediator (fee is split). NASD will suggest a mediator but it can be any mediator if the parties agree. Both parties then provide the mediator with information they think is necessary to understand the dispute.

Then parties meet with mediator in a joint session. Each party presents its case then meet individually with the mediator in sessions called caucuses.

Caucuses: is to help each party examine the strengths and weakness of the case, look at the risks involved, and consider possible settlements or resolutions. It is confidential

The mediation process will continue until: • The parties resolve the dispute through a written settlement • The mediator declares an impasse in the belief that continuing would be futile • Either party or the mediator withdraws, in writing the process

Partial Success Possible: Even if parties do not reach settlement, but often the 2 sides have a better understanding of the dispute. Sometime part of the issue will be settled leaving the rest for arbitration.

The parties can be in mediation and arbitration at the same time. This way if mediation fails arbitration is ready to go. Mediation can even be started when arbitration has begun if the decision has not been rendered.

Mediation vs. Arbitration

Mediation Arbitration A negotiation process between the 2 parties A hearing process at which the 2 parties present their cases Mediator attempts to facilitate a resolution-does not impose a settlement Arbitrator imposes a binding settlement Either part can withdraw if it chooses Parties cannot unilaterally withdraw Informal discussion process- parties may consider feeling and look for creative solutions in addition to evidence More formal process- testimony under oath Settlement must be mutually agreeable- compromise may be possible Arbitrator decides the outcome- is more of a 'win or lose' decision Parties must be willing to see strengths of the other sides' position Useful where position of one or both parties is inflexible Can be less costly and quicker than arbitration Often more expensive and time consuming than mediation, but usually cheaper and quick than litigation Process is private and any settlement is confidential Hearing are private but the decision is public


CH14 1-10

The Net Capital Rule: It prevents a broker-dealer from becoming over leveraged by requiring a specific type of a aggregate indebtedness (AI)/ Net capital (NC) ratio at or below a certain value. A broker-dealer may not continue in business if this ratio becomes too large.

A broker-dealer’s AI/NC ratio is calculated from a trail balance. The trial balance is a listing of all accounts in affirms’s general ledger, divided into 2 groups: debit and credits. From the trail balance, the broker-dealer can construct an income statement, balance sheet as well as net capital. (trail balance must be prepared monthly)

In calculating the AI/NC ratio, not all debts or liabilities are included, only those that fit the def of aggregate indebtedness.

Not all broker-dealer’s equity or net worth is counted, only liquid net worth.

Aggregate Indebtedness: AI- includes liabilities that are not secured by a specific asset of the broker-dealer. Other liabilities that would be included in aggregate indebtedness are:

• Customer credit balances, which represent money owed to customers, available to them on demand • Accounts payable, such as bills owed to vendors.

A broker-dealer may reduce its AI by the amount that is on deposit in the Special reserve Bank account. However if the firm has more deposited then required only the required amount may be subtracted


Determining the NET Capital Requirement:

A broker-dealer’s Net Capital (NC) msut in general be at least 1/15th the aggregate indebtedness. (AI/NC<15 to1).

Ex AI= $1,200,000 it must have a net capital of at least $80,000 (1,200,00* 1/15= 80,000)

First Year Requirement: Broker-dealers in first year of operations must meet more stringent requirements of 1/8th AI.

Minimum Dollar Requirement- In addition to meeting AI to net capital test. Firms must also maintain a minimum dollar amount of net capital.


Type of broker-dealer MIN $ amount of net capital Carries customer accounts and receives or hold funds and securities 250000 Performs centralized clearing and account maintenance functions for customers who execute transactions through several other broker-dealers (prime broker) 1500000 Carries accounts but does not hold customer funds or securities 100000 Acts as a dealer (firm that executes more than ten transactions per year for their own investment account) 100000 introduces accounts on a fully disclosed basis to another firm and does not receive customer funds or securities 5000 Introducing broker-dealer that receives customer securities for immediate delivery to a clearing firm 50000 Engages solely in the sale of redeemable shares of investment company securities (mutual funds) and operates on a subscription basis (does not accept customer funds- customer checks made out to the distributor) 5000 All other broker-dealers (including mergers and acquisitions firms and those doing business only in direct participation 5000


Which ever of the requirement is higher should be met.

Limitations on Introducing Firms Introducing broker-dealer may engage in a best-efforts or all –or- none underwriting only.

The broker-dealer may accept checks made payable to the issuer only, and must forward such checks to the issuer promptly.

In order to participate in a firm- commitment underwriting, an introducing broker-dealers needs at least $100,000 of net capital, which would permit it to act as a dealer.

Introducing broker-dealers may only do occasional trades for their own accounts (no more than 10 a year). They may not act as dealers or market makers.

Market makers- is required to maintain a minimum dollar amount of net capital for each stock in which it makes a market. The amount required is $2,500 for each stock selling above $5 a share, and $1,000 for each stock selling for $5 per share or less not to exceed $1,000,000

Summary of Net Capital Requirements- must meet 3 basic requirements

1. Net capital of at least 1/15 of AI (1/8 of AI in the first year of operation) 2. The minimum dollar requirement, depending on the type of business 3. The market-maker requirement, depending on the # of stocks in which market are made

Alternative Net Capital Requirement: Large broker-dealers may elect to be governed by an alternative net capital requirement. Under this approach a broker-dealer is required to maintain net capital of $250,000 of 2% of the aggregate debit items, which ever is greater

Computation of Net Capital

Net Capital is computed by starting with net worth (equity) and making certain deductions based on the liquidity of the broker-dealers assets


Haircut: is the reduction of market value of securities is reduced because of possible liquidity should large amounts be sold at one time.

A haircut is applied to the net long or short position in each category of security held

The standard haircut for common stock held in a broker-dealer inventory is 15%. The standard 15% haircut can be considered an adjustment for average liquidity. If the broker-dealer owns securities that are more liquid than average, such as treasuries, the haircut is less than 15%. If securities are less liquid than normal, the haircut is larger than 15%

If it is a limited market then the haircut is 40%.

Open contractual commitments, such as underwriter commitments, require special deductions as well.

Undue Concentration Deduction: If a broker-dealers inventory contains 1 security that accounts for a significant % of the market value of its total inventory. This puts the firm at undue risk if the security declines.

If any long or short is more than 10% of the broker-dealers net capital before the application of haircuts.

The undue concentration rule requires an additional deducting on the amount in excess of the 10% threshold

If the securities falls under the general rule for haircuts, the percent applied is 15%

Otherwise the amount is ½ the normal amount.

Undue concentration applies to the portion of an equity position in excess of $10,000 or the market value of 500 shares. In the case of debt securities, it only applies to the value of the position in excess of $25,000

EX peak holding inc is a broker-dealer

20,000 shares of MXI at $15 a share = $300,000 value 5,000 share of PRV at $8 a share =$40,000 6,000 shares of COL at $20 a share = $120,000

Peak holdings inc has a tentative net capital of $2,500,000. 10% of 2,500,000 is $250,000. Which are valued at $300,000 create and undue concentration.


Fail to Deliver: A fail to deliver occurs when a broker-dealer has sold stock to counter party, but has not delivered the stock by the settlement date. The fail to deliver is an asset (an account receivable) since the firm will be paid the contract price once delivery is made.

At first a Fail to deliver is treated as a ‘Good’ receivable, that is, no deduction is required.

After 4 business days (following the original settlement date) have passed, the fail to deliver is considered aged and a haircut is required.

The broker-dealer is required to treat the aged fail to deliver like stock that is in its trading account, which usually means a 15% haircut.

The haircut is applied to the current market value of the stock, and additional adjustment is made for any unrealized profit or loss on the stock.

Securities Differences: is a discrepancy between the amount of the securities recorded on a broker-dealer’s books and the amount actually counted during periodic audits. If the amount is less than the amount on the books it is short securities difference. If the amount is greater than long securities difference.

To Resolve: a broker-dealer would check the stock record, which would reflect the amount and location of stock, to make certain there are no errors in the entries. It would also check the receive and deliver blotter and delivery ticket.

A short securities difference is subject to a deduction if it has not been resolved within 7 business days/ Long securities difference involves securities that have not been resold they do not have any effect on net capital.


Subordination Agreement:

Normally a loan does not increase a broker-dealers net capital, since liabilities (the loan) and assets (cash) increase by the same amount, leaving net worth and net capital unaffected.

Under certain conditions (RULE 15c3-1) they are called Satisfactory Subordination Agreements

2 types:

Subordinated loan agreement: (borrows cash only)

Secured demand note: (some of the assets provided are securities)

If the loan includes securities subject to special haircut (ex OTC stocks w/ less than 3 market makers) the securities will usually be subject to the same haircut that applies to securities owned by the broker dealer. Securities normally subject to a 15% haircut (such as common stock) are subject to a deduction of 30% when used to back a secured demand note.

In order to be satisfactory for net capital, the subordination agreement must meet several conditions:

The agreement must be in writing, must indicate the duration of the loan, must be for a specific amount, and must acknowledge that the proceeds of the loan will be used in the conduct of the broker-dealers business and are subject to the risks of the business. The lender must agree to subordinate its claim for repayment to the claims of all other creditors. The loan must have a minimum duration of 1 year The subordination agreement must be filed with the SEC 10 days prior to its effective date and with the broker-dealer’s examining authority (NYSE OR NASD) 30 days prior to its effective date.

If a subordinated loan is made for a period longer than 1 year, a provision for prepayment may be written into agreement ,but no prepayments may be made during the 1st year of the loan.

Prepayment is no permitted if it would cause the broker-dealers ratio of aggregate indebtedness to net capital to exceed 10 to 1 or the firm’s net capital to fall below 120% of the minimum dollar amount required.


Temporary Subordination Agreement: a member firm may enter into a temporary subordination agreement. The broker-dealer is limited to no more than 3 such agreements in any 12 month period and the duration may not exceed 45 days. Usually permitted for underwriting purposes only

Debt-Equity Requirement:

A broker-dealers equity must be at least 30% of its debt-equity total.

Debt to equity total is equal to its net worth plus the amount of its satisfactory subordination agreements. Preventing to much of its net capital for subordinated loans or secured demand notes. If the equity falls below 30% and remain below 30% for a period exceeding 90 days the dealer would be in violation of the net capital rule.

In order for a subordinated loan to be treated as equity:

The lender must be a partner or stockholder The loan must have had an initial term of at least 3 years and must have at least 12 months remaining before it is due The loan may not have any provisions for accelerated maturity (provisions that allow the lender to call in the loan early under certain conditions.)

Customer Funds and Securities:

The customer Protection Rule- Contains provisions to ensure the safekeeping of both customer securities and customer funds. The rule defines a customer as any person for whom the broker-dealer holds funds or securities, but does not include another broker-dealer, a partner, officer, or director of the broker-dealer, or a subordinated lender.


Customer Securities: A broker-dealer is required to promptly obtain and thereafter maintain physical possession or control of all fully paid and excess margin securities that belong to its customers.

Control of securities- means that the securities are under the direct control of the broker-dealer, good site locations include the office of the broker-dealer, in transit between offices and SEC approved depository.

Excess Margin Securities: are defined as those securities whose value exceeds 140% of the debit balance of a customer. EX customer owns $10,000 and has a debit balance of $5,000 would have excess margin worth $3,000 {10,000- (140%*5000}

A broker-dealer is required to computer daily as of the close of the preceding business day, the quantity of fully paid and excess margin securities that are in its possession or control and those that are not in possession or control.

If a customer sells securities and fails to deliver the securities within 10 business days of settlement date, the broker-dealer must buy0in the customer.


Customer Funds- Broker-dealers are required to maintain a Special Reserve Bank Account for the Exclusive benefit of Customers at a bank. The reserve bank account must contain cash or qualified securities (issued or guaranteed by the U.S. government) that are set aside for the benefit of customers. This account must be separate from other bank accounts of the broker-dealer and must be maintained solely as a reserve account for the protection of customers. The amounts on deposit in the Reserve Bank Account may not be used by the broker-dealer for any purpose.

The amount that must be on deposit is the difference between customer-related credits and debits.

Timing of the Deposit: Computations must be made weekly, as of the close of the last business day of the week, to determine the amount of cash or qualified securities that must be on deposit.

The required deposit must be made no later than 1 hour after the open of banking business on the second business day following the determination.

If a broker dealer fails to meet this: it must notify the SEC by telegram immediately and follow up the telegram by notification in writing. Notice must also be sent to the broker-dealer’s examining authority.

Under certain condition can be computed monthly but the broker-dealer must maintain a deposit equal to at least 105% of the amount otherwise required (only available to brokers whose ratio of aggregate indebtedness to net capital does not exceed 8 to1 and do not carry customer free credits exceeding $1,000,000

NOTICE: The broker-dealer must obtain written notification from the bank that the reserve bank account is for the exclusive benefit of customers of the broker-dealer and that the cash and qualified securities may not be used as collateral for a loan to the broker-dealer and is not subject to any charge, lien, or claim of any kind by the bank or any other person

Exception: • Broker-dealers that restrict their activities to the sale of mutual funds and that promptly transmit all funds and deliver all securities when received. • Broker-dealers that clear their trades through another firm on a fully disclosed basis are not covered by the rule. • Firms that carry no margin accounts, promptly transit all customer funds and deliver securities, do not hold funds or securities, or owe money or securities to, customers and effect all transaction for customers through one or more bank accounts maintained for that purpose.

If a broker is exempt but wants to trade non-exempt it would need to obtain written approval of the NASD.

The NASD will base its decision on • Experience • Qualifications • Firms, procedures for customer safeguarding • Financial condition of Firm


Customer Free Credit Balance:

Requires a broker-dealer to advise customers regarding their free credit balance quarterly. Customers must receive written notice of the amount due to them along with a statement that the funds are payable to them upon demand.

The notice must also state that the funds are not segregated and can be used in the conduct of the broker-dealers business.

If a broker-dealer sent statements more than quarterly, notification of the free credit balances must be sent with each statement.

Exceptions: If the dealer segregates customer free credit balance so that the broker dealer cannot use the balance.

Securities Investor Protection Act

SIPA- establishes procedures for the protection of customer funds and securities in the event a broker-dealer becomes insolvent. Brokers that use the mail or other instruments of interstate commerce are required to be members of SIPC.


SIPC provided coverage for each separate customer (retail and institutional) to a max of $500,000 of which no more than $100,000 may be in cash. If a customer has a cash and margin account the combined amount would be $500,000.

Joint Accounts would have separate coverage.

SIPC coverage applies to customer only. Does not apply if the customer hold the securities themselves. It does not cover commodities accounts

SIPC Procedures: If a broker fails, a trustee will be appointed by a federal court to distribute funds and securities to customers. The trustee is required to notify the broker-dealer’s customers of the insolvency and handle the orderly liquidation of the broker-dealer

Securities that can be specifically identified as belonging to a customer will be distributed to the customer without regard to the $ limits.

If a customer has a claim for securities than cannot be specifically identified as being in the possession of the broker-dealer. The $ amount of the customer’s claim will be based upon the market value of the securities on the day a court is petitioned by SIPC to appoint a trustee.

If there are insufficient securities in the possession of the failed broker-dealer , the securities on hand will be distributed to the claimants on a proportionate basis.

Customers who have claims that exceed the maximum dollar limits of SIPC coverage will rank with other general creditors for the balance of their claim. What ever is left over after $500,000 protection would be a general claim.




Ch15 1-9

Record-Keeping and Reporting Requirements

Sec and SRO’s rely on broker-dealer records and reports to monitor compliance with industry rules.

Books and Records

Records may be divided into those that must be retained for the life of the firm, those that must be retained for 6 years and those that must be retained for 3 years. Note that all records must in an easily accessible place for the first 2 years of their existence.

Lifetime Records: Partnership articles, (in the case of a broker-dealer organized as a partnership), articles of incorporation, minute books and stock certificate books.

Posting Requirements: Each required record must be created (posted) within a certain time frame.


6 year Records and Posting requirements:

• Blotters- reflects transactions as of trade date and prepared no later than the next business day • General Ledger- as frequently as necessary to determine compliance with Net Capital Rules, but not less than one a month • Customer account ledgers- No later than settlement date • Position Record- no later than the business day after settlement date or the date of securities movement • Cash and margin account records- Prepared before the execution of transaction

3 year Records and Posting Requirements-

• Fail to receive : fail to deliver: no later than 2 business days after settlement • Long and short stock record differences- no later than 7 business days after discovery • Securities in transfer, dividends and interest received, securities borrowed and loaned, monies borrowed and loaned: No later than 2 business days after the date of the securities or money movement • Order tickets: Prepared before the execution of a transaction • Confirmations, comparisons: No later than the business days after the transactions • Option records: No later than the business day after the options is written • Trail Balance: Prepared no later than 10 business days after the end of an accounting period • Associated person’s application and fingerprint cards: Prepared at, or prior to commencement of employment • Termination notice: prepared after the conclusion of employment • Written supervisory procedures and manuals: must be current and following any change or update, the former procedure or manual must be keep for 3 years • Supervisory Personnel Designations: Prepared at time of designation until no longer effective

Life time Records

For BDS organized as partnerships: • Partnership articles: Created prior to inception

For BDS organized as corporations: • Articles of Incorporation • Minutes Books • Stock Certificate Books: Created prior to inception


Exceptions: A broker-dealer need not prepare the records if it clears its trades through a bank and the bank prepares the records required by Rule 17a-3. The bank must provide the broker-dealer with a written agreement that the records are the property of the broker-dealer. The bank must provide the SEC with a written notification that the records are available for inspection.

If a broker-dealer clears its on a fully disclosed basis through another broker-dealer, the obligation to maintain records rests with the clearing firm. A fully disclosed account is one in which the introducing broker-dealer turns over full responsibility for the maintenance of the account to the clearing broker-dealer. The introducing broker-dealer will be open the account and solicit orders but will not be involved in maintaining the account records.

Another type of clearing account is an OMNIBUS account, in which the clearing broker-dealer will transact the order and clear the trades, but the introducing broker-dealer will maintain the account in all other respects. In this case, the introducing broker-dealer will be responsible for record maintenance.

IF a broker-dealer intends to use electronic storage for record keeping or retention, it must notify its DEA at least 90 days prior to use.

Record Keeping Formats:

If a firm decides to use electronic storage media, it must notify its DEA prior to beginning. If the firm chooses to use optical disk technology (CD-ROM) it must notify its DEA at least 90 days prior to using the other method:

Electronic storage media must also have the following capabilities:

• Maintain records in non-rewritable and non-erasable format • Automatically confirm the quality and accuracy of the media recording process • Maintain records in serial form with time and date information that documents the required retention period for the information stored. • Be able to download indexes and records maintained to any medium accepted by the Commission or other SRO of which the firm is a member. • Must place the files where the SEC and SRO can immediately review stored files and must have duplicates • All duplicates must be kept separate from the original records and must be organized and indexed. • The index must be duplicated and kept separate from originals and made available for review • Must have an auditing system in place that shows accountability for the input of records

Reporting Requirements

• Monthly SEC financial reports • Quarterly SEC (FOCUS) Reports • Annual Report • Oath or affirmation (made by a general partner or authorized officer) that Annual report is true and correct

Focus Reports-

Part 1- for broker-dealers that clear transactions and carry customer accounts, must be filed monthly within 1- business days of the end of the month

Part 2- for broker-dealers that do not clear transactions or carry customer accounts, must be filed quarterly, within 17-business day of the quarter end.

Annual Report: of financial conditions, and must be certified by an independent public accountant.

Repost must be filed on the same, fixed or determinable date each year, unless approved by the designated examining authority (DEA) Notification must be sent to SEC as well if there is a change.

If the accountant is retained the firm or if the accountant was terminated must file with the SEC. The SEC should also be notified of new auditors or disputes between member firm and auditors.

Annual report must contain • Statement of financial condition • Statement of income or loss • Statement of changes in financial position • Statement of changes in stockholders equity or partners • Statement of change in liabilities subordinated to claims of general creditors • Must also include supporting schedules including (net capital and reserve requirement) • Supplemental statement report stating the opinion of the independent public account regarding SIPC membership status

The annual report must be filed no later than 60 days after the date of the financial statements. The report must be filed with: • SEC in Washington • SEC regional office • Each national securities exchange • Each national securities association (if it is member)

Statements to customers-

Audited annual statements must be sent within 45 days after filed with SEC. Must contain a balance sheet which contains net capital and required net capital.

If auditors commented on any material inadequacies during audit, a statement must indicate that the audited report is available for inspection at SEC in Washington or at the Regional office.

Other Filings

Net Capital Violation-

If a broker-dealer’s net capital falls below the minimum requirements of Rule 15c3-1, The broker-dealer must file a notice on the day the violation occurs. The notice must state the broker-dealer’s net capital and net capital requirement.

The same reporting requirement applies if the outstanding amount of subordinated debt exceeds 70% of the debt-equity total for period exceeding 90 days.

The filling must be with SEC Washington, SEC regional office (where principle place of business) and with Brokers-dealer’s DEA

A broker-dealer must also file a notice of net capital deficiency if it is informed by its DEA or SEC that its capital is below the amount required. It can include a basis for disagreement.

Net Capital of $60,000 and AI of $960,000 ($960,000/$60,000)= 1/16 which is in excess of the 1/15 ratio.

A broker-dealer may not continue to do business with less than the required amount of net capital.

Early Warning Notice- If a broker-dealer has a ratio of aggregate indebtedness to net capital exceeding 12 to 1, or if the dollar amount of Net capital is less than 120% of its minimum net capital requirement. It must notify the SEC and DEA with in 24 hours

Example: Net capital of $290,000 and AI of $2,500,000. The ratio of aggregate indebtedness to net capital is 8.6 to 1. Which is satisfactory. However, the broker dealer has a minimum net capital requirement of $250,000, since that dollar minimum is greater than 1/15 of its AI (1/15*$250,000)= $166,667). 120% times its minimum is $300,000. since the firm actually has only $290,000 of net capital, it would file an Early Warning notice with its DEA and the SEC within 24 hours.

Noncurrent Books and Records- If a broker-dealer fails to maintain books and records as required by SEC rules, it must give notice to the SEC and its DEA that day. The broker-dealer must file a report within 48 hours detailing the steps being taken to correct the situation. The report must be transmitted by overnight delivery.

Material Inadequacies- If a broker-dealer discovers, or is notified by an independent public account , of the existence of any material inadequacy in the broker-dealer’s accounting system, internal controls, or procedure for safeguarding securities, the CFO must send telegraphic of fax notice tot eh SEC within 24 hours and file a report within 48 hours stating what steps that are being taken to correct the situation. Must also notify the DEA

Securities Information Center

Deals with missing, lost, counterfeit, or stolen securities. The Securities Information Center (SIC) acts as a clearinghouse for information about these securities.

Making Inquiries of SIC- Under the rule, a reporting institution (exchanges, self regulatory associations, and broker dealers) is required to make inquiry of the Securities Information Center with respect to every security which comes into possession unless the security:

1. Is received from the issuer or issuer’s agent 2. Is received from another report institution or Federal Reserve Bank 3. Is registered in the name of the existing customer or that person’s nominee 4. Was previously sold to the customer by the firm, as verified by the firm’s internal records 5. Is received as part of a transaction, which has an aggregate face value of $10,000 or less in the case of bonds, or market value of $10,000 or less in the case of stocks.

If a stock delivered by a customer is registered in street name rather than the customer’s name, inquiry is required. If stock is delivered by a party who is not currently a customer of the broker-dealer, inquiry is required.


Reporting to SIC- If securities are discovered to be missing and criminal activity is suspected, of if securities are suspected of being counterfeit, a report must be sent to the SIC. Also the transfer agent and the Federal Bureau of Investigation must be notified. It must be made within 1 business day of discovery.

If securities are missing but no criminal activity is suspected, reports must be submitted to the SIC and the transfer agent if the broker-dealer is unable to resolve the loss within 2 business days of discovery

If securities are missing, no criminal act, found as a result of an audit. A report must be filed no later than 10 business days after discovery or as soon after a count or verification of the certificate numbers can be determined

If securities were reported lost or stolen are subsequently recovered, notice must be sent to the SIC, the transfer agent and, if applicable ,to the FBI within 1 business day of discovery

Other Financial Responsibility Rules:

Securities counts-

Requires a broker-dealer to make a physical examination and count of all securities in its possession at least once in each calendar quarter.

The broker dealer must account for: • All securities in transfer • Securities in transit • Securities pledged or loaned • Securities failed to receive • Failed to deliver • Or otherwise subject to the broker-dealers control but not its possession

The broker-dealer must verify the status of all securities subject to its control but not in physical possession, where the situation has existed from more than 30 days.

Exempt: brokers who deal in only redeemable shares or investment companies and promptly transmit all funds

Broker-dealers must record on its books and records all security differences that are unresolved not later than 7 business days after the security count.

The Security count must be made at intervals not less than 2 months but no more than 4 months apart.

The examination must be done by or supervised by someone whose regular duty does not require then to have direct responsibility of the securities or related records.

NASD Rules

Members Experiencing Financial and or Operational Difficulties: the NASD must take action and it may be in the form of restrictions or a reduction in business. The following are considered reasons to take actions By the NASD:

• There has been a reduction in excess net capital by 25% in the preceding 2 months or 30% or more in the preceding 3 months prior to a computation. • The broker-dealer cannot show or is not in compliance with Customer Protection rules • The broker-dealer is unable to clear and settle transactions in a timely manner • Books and records have not been maintained under SEC regulations • The broker-dealer cannot show or is not in compliance with Net Capital Requirement

If a broker-dealer is found to be experiencing financial or operational difficulties, the NASD may require the broker-dealer perform one or more of the following actions:

• Return all free-credit balances to customers promptly • Deliver all fully paid customer securities to account-holders • Decreased or change the holdings in its inventory • Close existing branch offices or delay the opening of new offices • Do not open new customer accounts • Restrict the payment of salaries to officers, partners, directors, shareholders, or other associated personnel • Arrange for an audit by an independent public accountant • Discontinue all unsecured loans and collect all where practical • Accept unsolicited customer orders only • Effect liquidating transaction only • File special financial operating reports

The NASD may subject the firm to take any action that they deem applicable in order to protect the public or member firm

Disclosure of Financial Condition: NASD requires member firms to send balance sheets to customer every 6 months and make available to customer upon request.

Fidelity bonds:

NASD members that are not member of an exchange are required to carry a blanket fidelity bond covering officers and employees that protects against Loss, misplacement, forgery, alteration, securities loss and fraudulent trading.

Do not cover losses due to errors and omissions.

The bond has a provision that carrier will notify the NASD if the bond is canceled, terminated, or substantially modified. Minimum coverage for each section of the bonds must be $25,000

The minimum coverage for fidelity, misplacement and forgery and alterations must be at least 120% of member firms required net capital for whose net capital requirement is less than $600,000

Net Capital Requirement Minimum Coverage Under Rule 15c3-1

$600,000-$1,000,000         $        750,000.00 
$1,000,000-$2,000,000   $1,000,000 
$2,000,001-$3,000,000   $1,500,000 
$3,000,001-$4,000,000   $2,000,000 
$4,000,001-$6,000,000   $3,000,000 
$6,000,001-$12,000,000  $4,000,000 
$12,000,001 and above   $5,000,000 

Review of coverage:

Member firms must review their fidelity bond coverage annually, as of the anniversary date of the issuance and must be made within 60 days. For firms in business for more than 1 year then amount of coverage is for the succeeding 12 months and must be based on the highest required net capital for the preceding 12 months.

Notice of Cancellation: member firms must notify the NASD within 10 business days if any bond is canceled, terminated, or substantially modified.

Securities failed to Receive and Failed to deliver: Member firms may not sell a security for their own account or purchase a security as broker for customers (except exempt securities) if the member firm has a fail to deliver that is 60 days or older in the case of domestic securities, Canadian securities and ADR or a fail to deliver that is 90 days older in the case of foreign securities.


Ch16 1-8

Packaged Products and Retirement Plans:


Packaged Product- is a security that allows customers to participate in various investments indirectly, usually thought a pool in which many investors participate.


Investment Company Act 1940: The purpose of the act is to protect the interests of small investors who are pooling their resources through investment companies. It is also concerned with conflicts of interest that the managers and distributors of these companies might have.


Investment Company: is a corporation or trust in which investors pool their funds to obtain diversification and professional management. Usually organized as corporations in the same manner as a business but some have been developed as trusts.

Requires that all investment companies register with the SEC. Except: those that do not made a public offering and:

• Issuer have no more than 100 shareholders • Issuers whose shareholders are all qualified purchasers (qualified- individuals with at least $5million in investments and institutions with at least $25 million in investments.)


Form N-1A is used for registration. The registration statement and prospectus must clearly state the fundamental objective of the fund. The objective can only change with a majority of outstanding shares.

Annual Reports must be sent to the SEC and semiannual to shareholders. Must include: • Balance sheet • Income statement • List of securities owned • Statement of recent changes in portfolio


Classification of Investment Companies:

Face-Amount Certificate Company- issue certificates of the installment type that pay a stated amount at the completion of the plan. Not an important product today.

Unit Investment Trust (UIT) – is established under an indenture or similar instrument. UITs issue only redeemable securities ,each of which represents an undivided interest in a specific portfolio of securities. The portfolio remains fixed for the life of the fund. Has aboard of trustees.

Management company- holds securities on behalf of investors. The portfolio is managed by a investment adviser that follows an investment strategy that is defined by the investment company. Two subclasses: closed-end investment companies and open-ended investment companies (mutual funds) (can’t purchase on margin)

How mutual funds are organized:

A mutual fund owns a portfolio of securities and in turn is owned by its shareholders. The fund represents a portfolio of securities that it holds for its owners, whose interest are protected by the funds directors or trustee

Board of directors- supervises the overall operations of the fund Custodian- holds the cash and securities of the fund and may perform clerical functions, including acting as transfer agent, registrar, or dividend disbursing agent Distributors and Dealers- Manages the sales effort and recruits other broker-dealers to help sell fund shares (may receive a discount on customer orders). Also sets the public offering price Investment adviser or manager- manages the fund’s portfolio of securities. The contract between the investment company and the investment adviser must detail compensation paid to the adviser and approved bi-annually by either the BOD(board of director) or shareholders. Contract can be cancelled without penalty with 60 day notice.

Affiliates-includes a corporation that owns 10% or more of the stock of the member firm, or a partnership in which any partner owns 10% or more of the stock of the member firm. REITS and an investment company register under the Investment company act of 1940 are specifically exempt fro the def of affiliate.


Misleading Names- often have names that indicate their objective, frequently contains the name of the sponsor. The SEC sale names cannot be misleading.

EX- Recommended, sponsored. 

Buying and Selling Mutual Fund Shares- mutual funds continuously issue new shares and will sell as many new shares as an investor wishes to purchase. Some mutual funds sell their shares directly to investors without using services of a broker-dealer. These funds do not need to assess a sales change and are called no load.

The price charged when purchasing a mutual fund share is the public offering price (POP).

It consists of the next net asset value )NAV) per share calculated after receipt of the order, plus in some cases a sales charge.

Appropriate Recommendations:

Sales Charges: The distributor and dealer for a mutual fund are its sales force. The sales charge is the way that they are compensated.

Traditional Front-End Load: Mutual funds that levy a sales charge (also called a load) often add that charge onto the price paid by the investor at the time of purchase.

Investors pay the next NAV calculated after their order is entered (forward pricing). Then the sales charge is added. EX NAV is $9.50 and Sales charge is .5 thus POP is $10.00


Percentage Sales Charge- the sales charge is described as a percentage of the total price.

Reduced Sales Charge- most mutual funds offer breakpoints, where if the customer purchase a larger $ amount the sales charge is lowered

Letter of Intent: enables an investor to qualify for the discount made available by breakpoints without depositing the entire amount up front. The letter states the investor intents to invest the money needed over the next 13months. The letter may be backdated 90 days and is not binding to the investor. A portion of the investors holdings will be held in escrow in the event that he does not meet the requirement of the letter of intent and this will be used to pay for the increased sales charge


Dividend Reinvestment: Most mutual funds pay dividends and capital gains distributions to shareholders. Some mutual funds allow investors to reinvest dividends and distributions, without paying a sales charge (at NAV). Some funds, however do charge sales loads on reinvestment amounts. (New funds registered with Sec after April1,2000 are prohibited from assessing sales charges on reinvested dividends.

Redeeming shares: 

Redemption- when an investor sells the shares back to the fund on any business day. Each share is redeemed at its NET Asset Value (NAV)

NAV- to calculate NAV, the adviser adds up the value of all the securities in the portfolio (assets) and then subtracts any money owed by the fund (liabilities). That figure is then divided by the number of shares owned by investors at that time. Under the Investment company act of 1940 to pay proceeds of redemption within 7 days.

A funds NAV must calculate its NAV at least daily, but may be priced more frequently.

Redemption Fees: Most mutual funds redeem shares at NAV. However, some funds deduct a small redemption fee from this account. Such fees range from ½% to about 1% and is returned to the mutual fund portfolio. It is designed to discourage redemption to quickly. Some funds waive redemption fees after the shares have been held for a specific period.

Deferred sales charges- Some mutual funds allow investors to buy shares at the NAV, they impose a sale charge when the investor redeems the shares, also called a back-end loaded fund.

Often a contingent deferred sales charge is in effect when means that the longer you hold the fund the fee decreases


12b-1 Charges- deductions investors pay for distribution expense. (such as commissions and advertising)

Must has a 12b-1 plan in place which permits the board to enter into contracts with the principal underwriter that involves payments to the underwriter. The plan must be approved by shareholders and the funds board, as well as by the directs who are not affiliated with the fund, the adviser, or underwriter.

The board must make quarterly reviews of the expenditures made under the plan.

12b-1 charges are based on an annual rate, but the charges may be accrued and paid over shorter periods, such as monthly.

Service Fees- Service fees are charges deducted under a 12b-1 plan that pay for personal service or the maintenance of shareholder accounts. EX trailing commissions: RR who have sold fund shares to customers, receive these payments in years following the original sale.


Asset Based Sales Charges- charges deducted from the net asset of an investment company to pay distribution expenses other than service fees. Such expenses might include ads, printing and mailing sales literature and prospectuses to those who are not current shareholders. It also includes the compensation of the underwriter, dealers and sales personnel


NASD Rules Regarding Investment Companies

Selling Fund Shares: A written sales agreement must be in effect between an underwriter and an NASD member before the member may receive a discount on the sale of mutual fund shares.

The selling agreement must set forth the amount of the discount and must include the condition that if the customer redeems shares within 7 business days after the purchase, the dealer must refund to the underwriter the full concession received on the original sale. The underwriter must then turn over to the fund both its share and dealer’s share of the sales charge.

Nasd members may not purchase fund shares at a discount from an underwriter unless the underwriter is an NASD member.

If a broker-dealer wishes to sell shares of open-end investment company, it must have a signed selling agreement. Then it can buy for its own investment account or filling a customer. The broker-dealer may not buy the shares for inventory with intention to resell later.

Selling Dividends- Selling dividends refers to the practice of inducing an investor to purchase a mutual fund on the basis of an impending dividend.


Breakpoint Sales- The Nasd also prohibits breakpoint sales- which occurs when a registered rep sells mutual funds shares for an amount just below the point at which a sales charge discount would be earned without informing the client about the client about the availability of a sales breakpoint.

Also can occur if funds are spread between mutual funds so that the amount is below breakpoints.

Sales Charges- NASD members may not sell mutual funds to customers if the sales charges are excessive.

Funds without an Asset-Based Sales Charge:

The maximum sales charge that may be assessed for the sale of shares of a fund that does not charge an asset-based sales charge is8.5% of the offering price. In order to charge the maximum, the fund must offer:

1) Quantity discounts (breakpoints) 2) Rights of accumulation

For each of the preceding features that a fund omits, the maximum sales charge is reduced to a specified level. EX. If a fund does not offer dividend reinvestment at NAV, but does offer the other 2 features, the maximum sales charge is 7.25%

Funds With an Asset-Based Sales Charge: The max sales charge that may be assessed by a fund with an asset based charge depends on whether the fund pays a service fee.

• If a fund pays a service fee, the max front-end or deferred sales charge resulting from and transaction is 6.25% of the amount invested.

• If the fund does not pay a service fee, the Maximum front-end or deferred sales charge resulting from any transaction is 7.25% of the amount invested.

Limits on Asset-Based Charges: NASD members may not sell shares of investment companies that have asset-based sales charges in excess of .75% of average annual net asset value. Members are also prohibited from selling mutual funds that pay service fees of more than .25%


Use of the Term No-load: RR may not refer to mutual fund as no-load or as having no sales charge if it has a front-end, deferred, of 12b-1 charge greater than .25% of average annual assets.

Disclosure: Broker-dealers may not sell a mutual fund with an asset-based sales charge unless the prospectus discloses that long-term shareholders may pay more than the economic equivalent of a maximum front-end load permitted by NASD rules. This disclosure is not required in the case of money-market funds with asset-based charges of .25 of 1% or less.

Execution of Investment Company Portfolio Transactions:

Anti-Reciprocal Rule- NASD prohibits member firms from selling open-end investment company shares because of commissions received or to be received from the investment company. The member firm may not pay additional compensation for the sale of certain investment companies, or prepare a preferred or recommended list of certain investment companies, in order to generate additional sales for the purpose of benefiting commissions.

This prohibition does not in any way limit member firms from preparing a list of recommended investment companies if the purpose is to provide their employees and customer with information that will enable them to make decisions regarding purchase based on investment merit. The prohibition does not apply to paying extra compensation for the sale of investment companies in general if the purpose is to generate additional sales through bona fide sales contest that do not favor one investment company over another.

Member Compensation:

Mutual fund underwriters may not pay dealers a discount or concession in the form of a security, such as a warrant or stock.

RR’s are prohibited, with certain exceptions, from receiving any compensation for the sales of investment company or variable contract products, either in cash or otherwise from anyone other than the NASD member they are associated.

Cash compensation- includes any discount, concession, commission, service or other fee, asset-based sales charge, loan, override, or cash employee benefit received in connection with the sale and distribution of investment company or variable contract securities.

Noncash compensation- any compensation that is not cash compensation, including meals, gifts, prizes, lodging.

De minimis Exception-

RR may accept gifts up to $100 per person per year from someone affiliated with the issuer or distributor. 

Other gift are acceptable as long as not excessive, for instance gifts, sports tickets, occasional means

Both assume that the gift is not based on selling or performance.


Training and Education Exception:

The NASD recognized that issuers and distributors (which it refers to as offerors) perform a valuable service when they provide training to member firms and their RR’s regarding the products and services they offer.

Therefore, NASD rules permit offerors to pay or reimburse for meetings that serve and educational function. However, there are several conditions

• RRs must have their broker-dealer’s permission to attend the meeting • Attendance may not be tied to the achievement of a sales target • The location of the meeting must be appropriate • Payments or reimbursements for guests of RR’s such as spouses are not permitted.

In House Incentive Programs: a broker-dealer is free to create its own internal sales programs with noncash incentives such as merchandise and vacation trips. A firm may even accept contributions by offerors to its noncash. One restrictions requires that a noncash incentive program for variable contract or investment company securities must be based on RR’s total production for all variable contracts or investment company products distributed by the broker-dealer. The credit earned by an RR toward the incentives offered must be equally weighted among the products in the program.


CH16 13-21

Retirement Plans:

Qualified Plan Accounts: are those that receive favorable tax treatment. To be considered qualified, the plan must meet the provisions set forth in the Employee Retirement and Income Security Act of 1974 (ERISA)

ERISA Sets IRS standards on: • Percentage of employees covered • Method of distributing benefits • Amount of contributions for each employee • Vesting of benefits • How the plan is funded

If established properly, a qualified plan will provide: • The employer will be allowed to deduct from income all contributions made into the plan • The fund established to provide the retirement benefits will be exempt from taxes

Funding- A Qualified retirement plan may be established as either a defined contribution or defined benefit plan.

Defined Contribution- requires that a specific annual percentage of contributions be made into the plan by the employer on behalf of each employee. Total Dollar contribution is based on the employee’s annual compensation.

Defined benefit plan: promises to pay the employee a specific amount each year once the employee retires. The benefit payment is usually based upon age, years of service, and salary history. Actuarial calculations are used to determine the amount that an employer must deposit each year to provide fro the retirement benefit specified by the plan.

Defined benefit plans allow for larger max contributions than defined contribution plans.

Vesting: specific amount an employee is entitles to keep when withdrawing from a plan. The employer may choose one of the vesting schedules put forth by the IRS. One schedule provides for full vesting after five years of service, the other provides for full vesting after 7th years and at least 20% by the 3rd year.

Participation- 21 years old and at least 1 year of service. Part-time worker (less than 1,000 hours). A plan may set a waiting period if there is 100% immediate vesting after 2 years

Plan Administration-

• All qualified plans must be in writing and communicated to employees. • Plan assets must be held in a trust or custodial account. • A trustee, who has exclusive authority and discretion to manage and control assets (must be named in writing) • General principles such as diversification, liquidity of investments, obtaining a reasonable return

Tax Treatment of Employees- The contribution made on behalf of the employee is not included in the employee’s income. The employee will recognize these contributions as income when the money is distributed to the individual. Income earned while fund is accumulating the plan is tax-deferred until distributed to the employee.

Corporate Pension Plans- may be established as defined benefit or defined contribution. For all employees who are 21 years old and have worked for at least 1 year.

Contributions made into the plan are not contingent upon the employer’s profits.

Pension plans are often noncontributory, meaning the employees may not make contributions into the plan. (those that do allow employee participation are normally after-tax dollars.


Profit-sharing plans- Defined contribution plan, fund must be allocated to participants in a nondiscriminatory fashion based upon a predetermined formula. An employee is not required to contribute if they are not profitable

401(k) plans: an employee makes contributions to an employee trust. Contributions are not included in the income of the employee and accumulate on a tax-deferred basis. Employees may elect to contribute part of their salary into the plan on a pretax basis. As with all ERISA plans, early withdrawals from a 401(k) plan (before age 59 ½) are subject to a 10% penalty tax

403(b) Plan: are deferred retirement plans that may only be established by certain tax-exempt, nonprofit organizations covered under section 501(c) (3) ,such as churches and public school systems. They can also be referred to as Tax-deferred annuity (TDA) ,Tax-sheltered annuity (TSA) or qualified annuity.

Employees may exclude contributions from their taxable income provided they do not exceed certain limits. Employers may match employee contributions.

Employee Stock Ownership Plan (ESOP) –Provides similar benefits similar to those of a profit-sharing plan except that employer contributions are invest in the stock of the employer. Advantages: • Employer is the ability to receive a tax deduction based on the FMV of the stock without making a cash outlay. • Can increase employee morale and motivation, but still has risk of decline in share value

Keogh (HR-10) Plans: is restricted to self-employed. An individual who is employed by a corporation , but who has additional income from self-employment. Can set up a Keogh plan for the amount earned from self-employment.


If a Keogh Plan is set up it must include employees in the plan that meet certain requirements. (1 year or longer of work, 21 years of age, if they work a total of 1,000 hours or more during the year. Contributions fro employees must be at the same rate as fro the employer.

In order to claim a deduction for a contribution into a Keogh plan, the plan must be started prior to the end of the tax year (DEC 31) Contributions may be made up until the tax return is due.

Contributions (including employees) may be claimed as a deduction on the self-employed individual’s tax return.

The contribution, plus any investment gains, accumulate on a tax-deferred basis until the money is withdrawn from the account. Distributions are taxed as ordinary income

An early withdrawal from a Keogh Plan would occur before the age of 59 ½. This would result in a penalty of 10% of the amount withdrawn, as well as ordinary income tax but are allowed for death and disability.

The Keogh plan allows a max contribution of 100% of compensation or $45,000 which ever is less. The amount deductible is limited to the lessor of 20% of the compensation or $45,000.

Individual Retirement Account (IRA)

Anyone who receives compensation for working during any year (including wages, salaries, commissions, and professional fees) is eligible to establish an IRA. (DOESN’T include interest, dividends, or capital gains made from investments.

An individual may establish an IRA even if covered under an employer’s retirement plan.

A husband and wife, if both are employed, may each set up their own IRA.

The Max individual contributions to and IRA is the less or 100% annual compensation:

$4000 in 2005-2007 $5000 in 2008 and thereafter

If an IRA is funded in excess, a 6% penalty is assessed on the contribution. (excess contribution is not tax-deductible and income earned on the excess contribution)

Additional individuals over 50 years old, there is catch up provision that allows extra money to be contributed towards an IRA.

$500 in 2004-2005 $1000 in 2006- thereafter

For individuals covered by an employee’s qualified plan, limits are placed on the deductibility of contributions once income reaches a certain threshold. As income rises about this level ,the amount that may be deducted is reduced (phased out) until contributions cease to be deductible above a specified income level.

IRAs for Married Couples- If a husband and wife are both employed, each may make contributions into each one’s own IRA according to the contribution limits previously discussed. Therefore, if they file a joint tax return, a MAX deduction of $8,000. If either spouse is cover by an employer’s plan, deductibility of the contribution may be limited or prohibited.

If an individual has a nonworking spouse, the individual may contribute an additional $4,000 into plan on the spouse’s behalf. This would raise the max to $8,000 for a couple The contribution would have to be in separate accounts. The extra account is called a Spousal IRA.

Maintaining and Liquidating an IRA- an individual may establish an IRA up until the time the person’s tax return is due (April 15th) for the given tax year.

Contributions made into an IRA must be made in cash. Contribution may be invested in various instruments such as stocks, bonds, annuities, mutual funds, or U.S. gold coins.

IRA’s cannot be invested in life insurance polices, collectibles such as art, antiques, stamps

An IRA may be maintained at a brokerage firm or bank, which acts as a custodian for the account. The IRA decides how the funds will be invested. The brokerage firm or bank acts only as trustee

Contributes and investment gain in an IRA accumulate on a tax-deferred basis until the money is withdrawn from the account. Distributions are allocated between pretax and after-tax monies and can be withdrawn in lump sums or periodically.

The funds in an IRA maybe withdrawn without penalty once the owner of the account reaches the age of 59 ½. Prior to 59 ½ are Premature and subject to a 10% penalty in addition to the taxes on the income.

• Circumstance for early withdrawal (no penalty) • Death • Disability or mental incompetence of account owner • Payment of certain medical expenses • Payment of first-time home buyers expenses

It would still be considered for income taxes

Withdrawal of funds from an IRA must begin by April 1st following the year the person attains the age of 70 ½. If not a penalty of 50% can be assessed if the person is not following an actuarial life expectancy table.

Rollovers

An individual is permitted to move an investment from 1 type of retirement plan to another without incurring any tax liability. Once a distribution check is reinvests but must be within 60 days. And can only be done once every 12 months. (applies to Ira and voluntary deductible contributions made to an employer

If a roller is initiated by a distribution from a qualified plan, the distributing firm must withhold 20% for tax purposes.

If it is from IRA to Ira withholding is not needed

Direct rollover- is from one trustee to another, no 60 day time limit and rollover limit are not in effect. Or withholdings

Roth Ira

Contributions are not deductible- but certain withdrawals are tax free. Withdrawals are not included in an individuals gross income and are not subject to the 10% withdrawal penalty (both earning and contributions)

Qualified Distributions: • After 59 ½ • To beneficiary of investors estate after death • Because the taxpayer is disabled • To purchase a principal residence as a first-time home buyer (subject to a $10,000 limit)

However it is not qualified if the distribution is within 5 years of establishing the account.

Contribution Limits :

Same as traditional. But after and individual reaches age 70 1/2 , the minimum distribution requirement at 70 ½ does not apply


Not Eligibility:

Single: $99,00- $114,000 and greater

Joint $156,000-$166,000 and greater

Coverdell Education IRA’s: This is a way of saving money for a child’s college education. Anyone with a gross income is within certain limits, may contribute a maximum of $2,000 per years into an account established for the benefit of a child under the age of 18. Same income limits are those for a Roth IRA. Total of all contributions from various people to one child’s account may not exceed $2,000.

• Contribution is not tax-deductible. • Grows tax-free if used to pay for child’s educational expenses. • If not used for education subject to a 10% tax penalty and ordinary income tax • If not used by beneficiary’s 30th b-day it must be distributed and is subject to penalty

Section 529 Plans:

Contributions are made with after-tax dollars Earnings are tax-deferred. Qualified withdrawals, however that are used for educational purposes are tax-free States determine the specific plan rules

Nonqualified Plan Accounts: (do not have to meet ERISA requirements regarding employee coverage, contributions limits and vesting.

Payroll Deduction plans:

Most payroll deductions involve the purchase of life insurance through payroll deductions. These voluntary plans may also be funded thought purchase of mutual funds and variable annuities. (often are given a group discount on sale charges)


Deferred Compensation:

These are contractual arrangements under which select individuals agree to defer receipt of part of their compensation until retirement, disability, termination, and death. Deferred compensation is discriminatory and has been used to shift income from a high tax bracket to one where tax rate was lower.

Do not require the approval of the IRA. The employer selects who is eligible for inclusion in the plan (not required to follow ERISA)

BAD BOY clause is a provision in most deferred compensation agreements that restricts the rights of employee from receiving deferred monies. This is to protect the employer from paying employees who violate company policy or trust. Violations of such clauses result in the forfeiture of some or all benefits payable from that date on. Also if the firm fails chances are deferred compensation is lost because its is unsecured.

Employer’s contribution is no tax-deductible during the deferred period, but can be claimed on payout. The employee has no right to the contributions and pays no tax during the deferral period.


NASD Rules Regarding Variable Products:

Variable products include: variable annuities and variable life insurance. These products are funded through separate accounts that are subject to many of the provisions of the Investment Company Act of 1940.

Selling Agreements: NASD members that are principal underwriters may not sell variable contracts through another broker-dealer unless that firm is also an NASD member and has a sales agreement.

The sales agreement must provide that commissions will be returned to issuing insurance company if a variable contract is tendered fro redemption within 7 business days after the acceptance of the contract application


Redemptions: If an insurance company does not promptly make payments to contract owners who properly tender requests for partial or total redemptions, NASD members are not allowed to participate in the sale of variable contracts of that company.

Other Important facts about variable Contracts: The percentage of the sales charge on variable contracts is computed on the amount deposited in the separate account, plus the sales charge. The issuer must be paid promptly and the NASD must be notified if payment is not received within 10 business days. Also NASD members may not sell the contract at a price that is lower than the price paid by customer.


Communications With the Public about variable life insurance and variable annuities.

Variable a products have special standard regarding advertising and sales literature.

Identification: To prevent misunderstanding communications about variable annuities or variable life insurance must clearly identify the product. If a proprietary name is used, there must also be a general description of the product.

Liquidity: Withdrawals from variable products can sometimes involve substantial charges or tax penalties. Therefore, communications about these products may not represent or imply that they are short-term, liquid investments. Any information presented about liquidity of access to investment values must be balanced by information about negative impact of early redemption. In case of variable life insurance, discussions of loans and withdrawals must include an explanation of their impact on cash values and death benefits.

Guarantees: Some aspects of variable products are guaranteed while other aspects are not. When guarantees, their safety cannot be over-emphasized, sine they depend on the claim-paying ability of insurance.

Communications may not represent or imply that a guarantee applies to the investment return or principal value of the separate account, or that the insurance company’s ratings apply to separate


Hypothetical Illustrations for Variable Life Insurance: NASD rules regarding communications with customers strictly forbid any discussions of performance that might be interpreted as projections or predictions. The SEC and NASD allow the use of hypothetical illustrations in presentations concerning variable life insurance, but have established guidelines for their use.

An illustration may use an combination of assumed investment returns up to and including a gross rate of 12%, provided that one of the return is a 0% gross rate. The 12% must be within a reasonable area given market conditions. The return in the illustration must reflect the maximum mortality and expense charges. The Illustration must include an explanation that it is hypothetical and does not project or predict actual results.


Other Content Restrictions: Comparisons between variable products and other types of investments may be made as long as they are clear, fair, and balanced. Material for variable life insurance that discusses its investment features must balance that presentation with a discussion of its insurance features. However, communications for single premium variable life insurance may emphasize its investment features as long as it also includes an adequate explanation of its life insurance aspects.