Series 6 - Unit 4 - Secondary Markets

4.1 secondary markets

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Securities Exchange act of 1934 - (2) things to know

1. established the SEC

2. secondary market is regulated by the exchanges themselves under SEC oversight

(3) SROs

1. FINRA (largest

2. MSRB

3. CBOE

when you hear Exchange/Secondary Market, think of pricing determined by…

auction

when you hear OTC/Third Market, think of pricing determined by…

negotiation

Market Makers buy at the ___, sell at the ___

bid, ask

Customers buy at the ___, sell at the ___

ask, bid

Broker

agent - individual or firm, charges commission

Dealer

Principal - always a firm, buys and sells from own account, earns a markup or markdown

Double-Auction Market

in exchanges, buyers compete against buyers, sellers compete against sellers, to get the best price

OTC Market

unlisted securities traded between securities dealers

“Interdealer market”

OTC market are only deals between BDs - one acting as an agent (for a retail investor), the other acting as the dealer

Third Market

exchange listed securities dealt OTC

Fourth Market

institutional investors make large trades, dark pools, ECNs

in the secondary market, what is the “size” that stocks are traded called, and how many shares does it consist of

Round Lots, 100 shares

if stock price is above $250,

round lot size is different

4.2 customer orders

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what must be completed by the rep every time a customer submits an order

order ticket

Order Ticket Shows (10)

1. Name of rep taking the order

2. Solicited/unsolicited

3. Discretionary or non discretionary

4. The time the BD received the order

5. Buy/sell

6. Name of security

7. Number of shares

8. Account name and number

9. Cash or margin account type

10. Price and time limits, if any

if there is a mistake on an order ticket - what must happen next, and how long is this documented and kept on record

must receive principal/branch manager approval. 3 years

when must a trade confirmation be sent to a customer, and how long are they kept on record

on or before settlement date, 3 years

Report of Execution

double checked against the order ticket to make sure it’s accurate, then sent to customer

Incorrect Trade Reports - when are they binding on the customer?

binding if the trade was simply REPORTED incorrectly, non-binding if the order was EXECUTED incorrectly

statements must be sent by BD’s at LEAST how frequently?

quarterly

how frequent for penny stocks?

monthly

Uniform Practice Code (UPC)

Set by FINRA to create uniform trading practices

regular way settlement

T+2

Mutual Fund Settlement

whenever NAV is calculated next - remember, it’s a primary market transaction!

Cash Settlement

• Same day

• Cash trades must settle before 2:30 PM EST

• If trade happens before 2:00 PM, must be settled by 2:30 PM

• If trade happens after 2:00 PM, settlement is due within 30 minutes

Regulation T settlement

T+3, S+2

what if customer can’t pay in time for regulation T?

BD can request extension

who do they request the extension with?

the Designated Examining Authority (DEA) for wherever the trade took place:

Exchanges - the exchange themselves. They’re an SRO

OTC - FINRA

if extension is denied or passes with no payment?

BD must close the trade and freeze account for 90 days

*if amount owed is less than $1k, BD isn’t required to freeze account

FINRA conduct rules are for…

advisers making recommendations

what do the Conduct Rules require from the advisor?

they must understand customers financial situation before recommending

Financial professional can only share in profits/losses on the account only if (2)

1. Written approval from firm

2. Rep's gains and losses are proportional to their financial contributions

*proportional sharing doesn’t apply to accts shared with immediate family (parents, siblings, spouses, in-laws, kids)

FINRA rule 3170 requires…

firms that hire reps from a disciplined firm must tape record the phone conversations of ALL registered reps

Rule 3170 - Level A

5-9 reps employed

40% or more from disciplined firms

Rule 3170 - Level B

10-19 reps employed

4 or more from disciplined firms

Rule 3170 - Level C

20 or more reps employed

20% or more from disciplined firms

how long does firm have to implement the recording after FINRA notice, and how long does it need to be maintained

60 days, 3 years

FINRA rule 5310

best execution. Must use reasonable care to find best possible terms for a customer on a trade

Interpositioning - what is it, and is it allowed?

adding an extra BD to a trade without benefitting the buyer or seller

allowed if customer still gets best possible deal. Not allowed if just to increase commissions/fees

FINRA Rule 2273

when transferring accounts to a new firm, requires disclosure of compensation to brokers or dealers AND all moving fees/expenses

also protects customers right to move — as long as no liens (debts) on account

2273 - what must a broker provide when soliciting former customers to move accounts

education materials

Educational Materials may include (4)

• Whether broker incentives create a conflict of interest

• Whether some assets are not transferrable

• Cost of transferring assets

• Differences in products/services old vs new firm

Educational materials can be sent via hyperlink if contacted electronically, but must be mailed within 3 days if…

contacted by phone or in person

how long does rule 2273 apply for

3 months after broker joins new firm

does rule 2273 apply to institutional investors?

no

Ex-dividend stocks

on the first day a new stock buyer doesn’t qualify for the dividend (the ex-date), the price drops by the amount of the dividend

DNR

do not reduce - if marked DNR, order will not be adjusted

Stock Dividends / Split adjustments

open orders that haven’t been executed are adjusted to match the new price/quantity

Painting the tape

making a stock look like it has more trading activity than it really does by selling a stock to somebody knowing you will buy it back at nearly the same price

Marking the close

making trades/falsely reporting them at or near EOD to inflate the closing price

Payments to Influence Stock Prices

firms cannot pay for positive reviews or articles to raise stock prices. They are allowed to advertise as long as they are clearly marked as ads

Front Running

 placing a trade before a large block order they know is coming

Insider Trading

material, nonpublic info used to make a profit/avoid a loss

Insider Trading and Securities Fraud Enforcement Act of 1988

Increased penalties for insider trading. SEA act of 1934 banned insider trading, but people still did it and were only assessed $5k fees.

BD firms must do (2) to prevent insider trading:

1. Have written rules against using inside info

2. Set up firewalls between departments to block flow of info

are both the tipper and tippee both responsible?

yup

(2) things to think about regarding the tipper:

1. do they have a duty to keep the info private?

2. are they receiving a personal benefit (even a freindship boost)?

1 thing to think about regarding the tippee

should they have known the information was confidential

Civil Penalties for Insider Trading (2)

1. Treble fines for profits made or losses avoided

2. Firm fined the greater of treble or ~$2.5m

Criminal Penalties for Insider Trading (2)

1. Up to $5m in fines

2. Up to 20 years in jail