Series 63 Terms

Uniform Securities Act (USA)

model law used to create state securities laws; applicable for any state; regulator is the state Administrator / Commissioner

State Administrator (Commissioner)

uses rules, orders and laws to enforce the USA

NASAA

responsible for updating the USA through NASAA Model Rules and Statements of Policy; write the Series 63 Exam

NSMIA

reduce duplication of federal and state regulation; defined Federal Covered Securities and Federal Covered Advisers that are now exempt from state regulation (defines where the federal regulations stop and state regulations start)

Person

individual, corporation, partnership, unincorporated organization, government or political subdivision of a government, and certain trusts (any legal entity); excludes minors, mentally incompetent people, and deceased people

state

any state, territory, possession of the US including DC and PR

BD

registered with the state, FINRA, and the SEC (employees must register with the state administrator and FINRA)

IA

registered with either the states OR the SEC (employees must register with the State Administrator)

security

defined by the Howey test as (1) investment of money in (2) common enterprise with an (3) expectation of profits (4) derived from the efforts of others; regulated by USA via registration

included in definition of a security

stocks, treasury stock, notes, bonds, debentures, rights and warrants, investment contract, preorganization certificate, certificate of participation in any profit sharing agreement or oil, gas, or mining lease, investment company shares, LPs, variable contracts, options, viatical investments

NOT included in definition of a security

life insurance, endowment policies, fixed annuities, and the four C’s (commodities, collectibles, currencies, condominiums as a place of business or residence)

viatical investment

purchase of interest in an insurance policy covering another individual’s life; illiquid since you don’t know when the insured will die

suitability standards for viatical investments

accredited investors OR meet one of the following standards: (1) minimum net worth of $150k excluding primary residence and $100k annual income or (2) minimum net worth of $250k excluding primary residence

Considered very speculative and risky (great likelihood of fraud)

general registration provisions

o    Issuers must pay a filing fee, disclose the amount of securities being offered in a state, and disclose the other states in which a registration statement has been filed

o    State administrator may require a prospectus to be sent to any person to whom an offer is made

o    Effective date is granted by the Administrator and represents the date on which securities can be sold publicly

Security’s registration expires one year after its effective date

methods of securities registration

filing (notification), coordination, qualification

filing (notification)

for larger issuers conducting follow-on interstate offerings; issuers must meet stringent requirements and conditions (e.g., registration statement previously filed under 1933 Act, minimum of 36 months of continuous business, minimum 4 market makers); becomes effective at the same time as the federal registration

coordination

for smaller issuers conducting interstate offerings like IPOs; state registration is coordinated with the federal registration under the ’33 Act (though it doesn’t need to be filed at the same time); becomes effective at the same time as the federal registration 

qualification

for issuers only wanting to sell within one state; requirements determined by the individual state; no federal registration requirement; becomes effective when determined by the Administrator

actions against registration

the state Administrator can deny, suspend, or revoke any registration statement if it’s in the public interest AND

o    Registration is incomplete or contains false or misleading information

o    Issuer, a partner, officer, or director of the issuer, or an underwriter has willfully violated any provision of the USA

o    Issuer’s enterprise is illegal

o    Underwriter’s compensation is unreasonable (~10% is usually cap)

o    Offering is or may be fraudulent

o    Proper fee hasn’t been paid

o    A stop order can’t be issued against an effective registration based on facts the Administrator knew when the registration became effective unless proceedings are instituted within 30 days

exempt securities

typically, because the issuer is trustworthy

o    US government

o    Municipal governments

o    Canadian government / provinces

o    Foreign governments recognized by US

o    Banks, savings institutions, or trust companies; including federal savings and loan associations

o    Insurance companies, but not annuity contracts

o    Common carriers (e.g., railroads)  

o    Public utilities regulated by the Public Utility Holding Company Act of 1935

o    Non-profit organizations (e.g., religious organizations) aka Church bonds

o    Short-term corporate debt (commercial paper) with the following characteristics: nine-month maximum maturity, minimum denomination of $50k, rated in one of 3 highest categories by NRSRO

Exempt transactions

Typically based on the limited purchasers (i.e., non-public); examples include private placements and trades between institutions (e.g., between issuer and underwriter)

Ex: non-issuer transactions, private placement, institutional transactions, fiduciary transactions, mortgage-backed

non-issuer transactions

Refers to secondary market trades (key words: isolated, non-recurring, or unsolicited trades); trades in securities are s.t. ’34 Act and trades in securities that are listed on the Toronto Stock Exchange

Private placements

limited to <10 non-institutional investors; purchases must be made for investment purposes only; no commission paid for soliciting non-institutional investors (not used because this was made before Reg. D)

Institutional transactions

Those with banks, BDs, or other financial institutions; insurance, trust, or investment companies; between issuer and underwriter  

fiduciary transactions

those involving a trustee, administrator, executor, or sheriff

mortgage-backed

transactions in bonds that are secured by real estate mortgages (if sold as a unit)

federally covered securities

Given state-specific registration exemption

Include securities listed on an exchange, issued by an investment company (e.g., mutual funds), issued under Reg D Rule 506 (double exemption), sold to qualified purchasers (any person that owns >$5M of securities – invested in the markets, not net worth and assets like real estate)

o    Even if exempt from registration, securities remain s.t. anti-fraud provisions of both federal law and USA

o    Administrator can’t cancel the registration of these securities or prohibit its sale in the state, but can investigate fraud in the sale

notice filing

although exempt from state registration, issuers of investment company shares and private placements under Reg D (506) are s.t. notice filing with the Administrator, which involves:

o    Filing copies of any offering documents (prospectuses) that have been filed with the SEC

o    Filing a consent to service of process

o    Payment of a fee

o    Notice filing is NOT a method od registration which can be denied by the Administrator

2 types of Agents

agent of a B/D, agent of an issuer

Agent of a B/D

refers to a B/D employee who represents the B/D in effecting securities transactions; always subject to registration

Includes all officers, partners, or directors of a B/D who are involved in the sale of securities; excludes clerical jobs

issuer

any person that issues or proposes to issue any security for the purpose of raising capital

issuer transaction

sale by an issuer

Agent of an issuer

employee of an issuer in the sale of certain securities; not required to register as an agent if the sale involves an exempt security, an exempt transaction, a federally covered security, or a transaction with existing employees, partners, or directors of the issuer and no commission or renumeration is paid for soliciting a person in the state (but have to register if the securities aren’t exempt)

Excluded from B/D definition

Agents (they register as an agent, not a BD), issuers, banks, savings institutions, trust companies, a person with no place of business in a state and who ONLY transacts business there with

o issuers involved in the transaction

o Other BDs

o Financial institutions

o Existing clients who aren’t residents of the state like students or vacationers

Agent exemptions

agents can engage in securities transactions in a state in which they are not registered if

o Existing customer is temporarily visiting another state (students, vacationers)

o Existing customer moves to a new state AND

Agent’s registration is pending in a new state

Agent is registered in at least one other state

Agent is registered with a national securities association like FINRA

Agent’s B/D is registered in the new state

Canadian B/Ds

USA allows for the limited registration of BDs and agents that are residents in Canada and have no place of business in a state provided:

o They only transact business with a Canadian person who is temporarily in the state

o They don’t solicit new clients in the state

o The BD is a member of an SRO or Canadian stock exchange

o They file an application with the Administrator along with a consent service of process

o Renewal applications are filed prior to December 1 each year

Registration requirements

B/Ds file form BD with the CRD, Agents file form U4 with the CRD

Form BD

filled out by Broker-Dealers with the Central Registration Depository (CRD) to register

Form U4

filled out by Agents with the Central Registration Depository (CRD) to register; an agent’s registration is only effective when employed with a BD  

Central Registration Depository (CRD)

where Form BD and Form U4 are filed

Form U5

filed by regulators, states, or legal jurisdictions to report disciplinary actions against BDs and associated persons (these convictions also go on U4)

Registration procedures

application, consent to service process, pay filing fee

Application

step 1 of the registration procedure; application becomes effective 30 days after filing and expires annually on 12/31; updated annually at time of renewal; Amendments for material changes are filed promptly (usually within 30 days)

Consent to Service of Process

required in the registration process; document that is filed once and is never renewed because it’s irreversible; grants the Administrator power of attorney to receive and process non-criminal legal complaints

Filing fee

paid upon registration and annually thereafter; for successor firms (firm ownership changes), a new application must be filed and there will be no additional filing fee for the remainder of the fee (relevant for bankruptcies and M&A because you update all the registrations)

Bonding requirements

posted as a part of the registration process to cover the costs of lawsuits (to prevent theft)

o Required for B/Ds, agents, and IAs that have custody of, or discretionary control over, client funds and securities

o Not required if B/Ds net capital or IA’s net worth exceeds the minimum set by the Administrator

o Must be maintained for as long as B/D or IA is in business, plus three years thereafter

o In lieu of bond, cash or securities may be deposited (amount and type of securities determined by Administrator); no other personal property

Minimum financial requirements

a minimum net capital amount that a B/D must maintain; set by the SEC and depends on a B/Ds activity (active MMs have to post more); must report to SEC / FINRA deficiencies within one business day along with submitting a statement of financial condition by the next business day and obtain surety bond to make up the deficiency

Minimum financial requirements deficiency

BD must report within 1 business day, submit a statement of financial condition by the next business day, and obtain a surety bond to make up the deficiency

B/D recordkeeping requirements

·        records may be maintained in physical form, on microfilm, or electronically; all records are subject to examination by the Administrator at any time, both inside and outside the state

o    3 years: maintain books, records, and correspondence (easily accessible for the first 2)

o    Records required to be filed with administrator: any advertising, sales literature, or other communication that’s disseminated to existing or prospective clients (unless it deals with exempt securities), any required financial reports with amendments for material changes filed promptly (within 30 days)

o    Order tickets: must reflect customer name/account number, trade details (buy/sell description, number of shares, order type), capacity of firm, and whether discretion is being utilized

3 years

maintain books, records, and correspondence (easily accessible for the first 2)

Records required to be filed with administrator

any advertising, sales literature, or other communication that’s disseminated to existing or prospective clients (unless it deals with exempt securities), any required financial reports with amendments for material changes filed promptly (within 30 days)

Order tickets

must reflect customer name/account number, trade details (buy/sell description, number of shares, order type), capacity of firm, and whether discretion is being utilized

Required new account info

name, address, whether of legal age, RR (agent), principal signature

Requested new account info (beyond required)

SSN, occupation and address of employer, whether they’re associated with a BD, name of trusted contact person for eligible adults (agents must notify Adult Protective Services and the commissioner of the state if an eligible adult is being exploited)

Form CRS

document given to new customers when they open a brokerage account; must be under 2 pages and have easy to understand language; must be received no later than the time a customer opens the account, places an order, or receives a recommendation for account type / securities transaction / investment strategy (regulated under Reg BI)

TOD / POD account

transfer on death / pay on death – can leave money to someone after you die (either cash or the portfolio)

Power of attorney

required to open a discretionary account (for IAs, oral discretion is permitted for 10 days. For BDs, time and price discretion are permitted if Not Held without POA)

Securities Investors Protection Act (SIPA)

created SIPC; non-profit membership corporation that protects Separate Customers (not accounts) if a B/D bankruptcy occurs (separate customers include IRAs, joint and custodial accounts); separate coverage is granted for accounts held at different firms

SIPC coverage

cash and street name securities up to 500k of which 250k is cash; don’t cover fraud (covered by fidelity bond), futures contracts, commodities, and fixed annuities

o Securities specifically identifiable to a customer are distributed back to a customer without limit

investment advisers

always registered EITHER with the states OR the SEC

ABC test for IAs

Investment adviser defined as any person that provides Advice as part of their regular Business and receives Compensation for it

IAR

provides and determines investment advice; manages accounts and solicits advisory services; manages those who perform these functions (but not managers of accounting, HR, etc.)

Under USA, 3P solicitors may be considered IARs and may be s.t. registration in most states

IARs employed by FCA

only required to register in a state in which he has an office (NY or NJ); if he has no office in a state, no registration is required in the state regardless of how many clients he has there

excluded from IA definition

IARs, banks, savings institutions, and trust companies, Lawyers, Accountants, Teachers, Engineers, BDs and their agents, publishers (e.g., newspapers and magazines) and Federal Covered Advisers (since they’re under NSMIA)

exemptions for IAs

adviser with no place of business in a state and if all their clients there are financial institutions or have no more than 5 non-institutional clients in the state within the last 12 months

Federal Covered Adviser

AUM of $110M+; IA must register with SEC; may still be s.t. Notice Filing in the state(s) in which it has an office

Register either with SEC or states

AUM between $100M and $110M

mid and small sized advisers

Both must register with states

Mid-Sized Adviser: AUM between $25-$100M

Small Adviser: AUM below $25

must register as FCA

o    Advisers to investment companies

o    Advisers to BDCs

o    Advisers not regulated by the state in which they have their principal office

o    Pension consultants that provide advice to employee benefit plans with $200M+

o    Internet advisers that give advice through an interactive website based on client provided info

o    Advisers to private funds with assets of $150M+

o    New advisers believing they’ll be eligible for SEC registration within 120 days of registering (usually occurs via M&A)

o    Multi-state advisers that would otherwise be required to register in 15+ states

solicitors

a person who directly or indirectly solicits any client for, or refers any client, to an IA

o    If affiliated (partner, officer, director, employee of adviser), then relationship must be disclosed

o    IA Act of 1940 doesn’t require solicitors to register but state registration may be required

3P solicitors

adviser must be registered and have a written contract with the adviser to receive a cash referral fee from the adviser

Form ADV Part 1

filed to register as an IA; provides specific disclosure info for SEC and state use including:

o IA name, # employees, nature of business

o Name, address, education and 10-year business history of each partner, officer and director

o How firm maintains custody of client assets

o If principal business consists of investment supervisory service

o Number and size of discretionary and non discretionary accounts

Form ADV Part 2

information more for client disclosures; may be used as the firm’s brochure; includes:

o    All actual and potential conflicts of interest and affiliations

o    Services provided and related fees

o    Soft dollar arrangements

o    Types of securities on which advice is given

o    Types of analyses used

o    Education and business background of those rendering investment advice

o    IA’s B/S if it has custody of client funds or securities or collects prepaid fees of more than $1,200, 6 months or more in advance (if federally covered – if regulated at the state level, the prepaid trigger fee is $500)

the brochure rule

IA’s written disclosure document (brochure) must be delivered to clients no later than the signing of the contract (and must be delivered annually thereafter); excludes contracts with registered investment companies and contracts for impersonal advisory services costing less than $500/year

o According to USA, brochures must be delivered 48 hours prior to signing a contract OR at the time the contract is signed, provided the client is allowed to cancel within 5 business days without penalty

Advisory contracts

o    Must be in writing

o    can’t contain exculpatory provisions (hedge clauses) or mandatory arbitration clauses

o    Generally prohibit performance fees (% of profit)

§   Compensation is typically expressed as a % of the total value of the account averaged over a given period (AUM)

§   Performance fees may be charged to qualified clients (those with $1.4M+ AUM with adviser or $2.7M net worth)

o    May only be assigned to another adviser with client consent

o    Must state that, if the IA is a partnership, all clients will be notified of any change in partners

Custody by investment advisers

holding client funds or securities, directly or indirectly, or having authority to obtain possession of them (ex: full discretion over an account held at a separate B/D, check writing privileges in a client’s account)

Not considered custody

if adviser inadvertently held or obtained a client’s securities or funds and returned them to the client within 3 business days or forwards 3P checks within 3 business days

Required steps if granted custody

notify Administrator in writing, appoint a qualified custodian, notify clients of the custodian, ensure clients get quarterly statements (either sent by IA or custodian)

o If quarterly statements are sent by the IA, they must arrange for an unannounced annual audit by independent CPA who reports the results to the Administrator and provide form ADV-E within 120 days of completion

Minimum financial requirements (IAs)

determined by state Administrator; $35k for custody and $10k for discretion only; report deficiency within 1 business day via statement of financial condition and obtain surety bond to make up the deficiency

IA recordkeeping requirements

maintain books and records for 5 years (and within the appropriate office for 2 years); file any advertising and sales literature with Administrator along with financial reports (within 30 days); Federal Covered Adviser records are also s.t. inspection by the Administrator

Docs maintained by IA

checkbooks and bank statements, written agreements, ledgers and trial balances, power of attorneys and code of ethics, copies of any circular/advertisement sent to 2+ people, any political contributions, written complaints

Fiduciary duties

only required for IAs (not BDs who only have a duty to provide suitable recommendations); include having reasonable and objective basis for the investment advice being provided, suitability, best execution, disclosure of conflicts of interest, consulting with other professionals when appropriate

Uniform Prudent Investor Act (UPIA)

used by advisors as a guide when implementing financial plans; based on Modern Portfolio theory – doesn’t prohibit any specific investments but examines trade off between risk and reward holistically and recognizes need for diversification within a portfolio

Soft dollar arrangements

IA may pay higher commissions for trade execution in return for “soft dollars” if used to acquire services that will benefit its advisory clients (incl. research reports, analysis, market data, seminars, software used to provide analysis because they make the advice betters; excludes things like office supplies, computer hardware, rent, travel/entertainment/meals, salaries, etc.) – must be disclosed either in brochure or Form ADV part 2

Fraud

includes (1) misrepresentation of material fact, (2) reliance on the misrepresentation, and (3) injury or harm occurring because of the misrepresentation; almost always unethical (aka against the law)

Unethical activities

prohibited by law or regulation but not always fraudulent (ex: accidentally breaking the law)

Prohibited and unethical activities

making false or misleading statements, failing to provide adequate disclosure (ex: claiming securities are approved by a regulator, stating that a security is to be listed without justification, inducing the purchase of a security – stock or mutual fund shares – based on impending dividends, referring to a MF as no load if 12b-1 fees exceed 0.25%, not disclosing sales charges, not disclosing breakpoints and LOI features)

selling away

prohibited and unethical activity that involves executing trades not recorded on BDs books (like private placement for a relative, etc.)

painting the tape

prohibited and unethical activity and a form of market manipulation where two BDs agree to pre-arrange trades

front-running

prohibited and unethical activity where BD places a trade for its own account before placing a trade for a customer order

conflicts of interest

if an adviser also acts as B/D (including agency cross), adviser receives compensation for the securities they recommend, adviser paid to solicit or refer clients to another adviser or BD, adviser receives compensation of any form from BDs (ex: access to BDs research, etc.)

o must be disclosed

agency cross

where agent acts as a broker for its advisory client and the person on the other side of the trade

selling securities on a financial institution’s premises

NASAA had a model rule requiring agents who sell investment products on the premises of a bank to disclose that the products aren’t FDIC-insured, are not bank deposits or guaranteed by the bank, are s.t. investment risks including the loss of principal

o    activities of BDs and their agents should be physically segregated from areas engaged in retail banking

o    BDs must notify the bank if any agents are terminated

Social media policy for IAs

compliance program must exist addressing usage guidelines, content standards, monitoring, approval, training of IARs, and information security

3p posts

IAs are responsible for the accuracy of 3P posts if used in marketing – they effectively “adopt” any post they comment, like, or share

Entangled testimonial

IAs must disclose if they paid for social media posts and are responsible for accuracy

Email signatures

IAR and RIA can’t be used in email signatures or social media profiles

Social media policy for BDs

social media posts are considered communication with the public and subject to filing and recordkeeping requirements; agents can’t spread false info or use inflated credentials; BDs must approve social media sites before an agent may use for business program (social media sites must be designated in a way so that BDs can comply with regulatory requirements) – not every individual post

Offer

any attempt to dispose of a security for value

sale

any agreement or contract to sell a security