SIE Exam

types of issuers

• corporations

• us treasury and government agencies

• state and local government

• banks (dual purpose; raise money and help others buy and sell securities)

• foreign government

types of securities that may be issued

equity

• used by corporations and banks (represents ownership)

• stocks

Debt

• notes and bonds (represents an issuer’s promise to pay)

  • all issuers can do debt

** when companies borrow money they can do it publicly or privately (large or small)

equity

the stock holders are owners of the business

• they may receive dividends

  • no obligation to pay dividends

debt issuers

• bonds

• creditors

• they receive interest

  • no ownership

equity disadvantage

you sold a piece of business

equity advantage

never have to pay an equity holder back

bonds advantage

didn’t dilute ownership but you have to pay them back (pay interest, repaying the principal aka par value)

brokers

• firm acts as a conduit or agent

• finds another party willing to take the other side of the trade (someone willing to find buyer and seller)

• collects commission for the service

• no risk to the firm (not using own capital)

  • ABC (agency, broker, commission)

dealer

• firm acts as a principal

• firm takes the other side of the trade

• entitled to markup/markdown

  • depending on if acting as broker or dealer

• inventory/risk (using their own money to buy and if they can not resell them they will loose money)

  • PDM (principal, dealer, markup/markdown)

front office

deals with clients

back office

deals with operations

investment banking

• issuance (underwriters)

• M & A (mergers and acquisition)

• private equity (using money to make investments)

  • debt and equity capital markets

research

provides research reports to recommend when companies should be bought or sold

private client

retail brokerage; dealing with investors

sales and trading

• secondary market

• fixed income (bonds and debt)

• equity

information barriers

certain info should not be discussed in different areas of the firm

• if a M & A was going to happen

• research shouldn’t disclose buyer recommendation to buy ahead

  • good defense

market maker

a broker-dealer that chooses to display quotes to buy or sell a specific amount of securities at specific prices

• quotes are firm for at least 100 shares (obligated to buy and sell)

  • round lot = 100 shares

  • generally applies to equity securities not debt securities

bid

represents a client’s selling (liquidation) price

• price at which the market maker will buy

ask or offer

represents a clients purchase price

• price at which the market maker will sell

• Spread = difference between the bid and ask price

  • the wider the spread the more the market maker will profit

  • the narrower the spread the less they will make

  • security that is actively traded usually has a narrower spread (Apple)

who makes spread and who makes commission?

market makers make spread and agents, dealers make commission

investment advisor

an IA is a firm that charges customers a fee for managing their securities portfolios

• the fee is based on the assets under management (AUM)

• an IA is considered a large institutional customer of a broker-dealer

** advisor earn fees, broker-dealers make commission and markups

municipal advisors (MA)

an MA is a person or firm who advises municipalities on bond offerings and must be registered with the SEC

• typically advise issuers (state, county, or city) regarding structure and timing of a new offering

• government

• advisor for mayors

institutional l investors

defined based on the amount of assets they have invested

customers with a large amount of assets are referred to as “institutional investors” such as

• banks

• insurance companies

• investment companies

• corporations, partnerships, individual investors with a certain amt of money invested

• registered investment advisers

• public and private pension plans

  • hedge funds (buy and sell on a regular basis which generate comissions)

$50 million or more

retail investors

individual investors who are not defined as institutional investors are considered retail investors

accredited investors

there are other terms used for certain investors, but they are based on regulatory definitions

• institutional investors as well as individuals who have met a financial test

  • net worth of 1 million excluding their primary residence OR

    • Annual income of 200,000 in each of the last 2 years (300,000 for married couples)

series 7, 65, or 82 registration

qualified institutional buyers (QIB)

• buyer must own and invest a minimum of 100 million of securities

• cannot be a natural person (insurance company)

primary market

• new issue market

• regulated by the 1933 securities act

  • investment bankers will help the corporation issue securities to raise money

secondary market

traded from one investor to another

• regulated by the 1934 securities exchange act

• might trade in NYSE, Nasdaq, or over the counter

• exchanges: listing requirements to be listed on the exchange

• OTCBB: over the counter bulletin board

  • Pink market: stocks that are unlisted

underwriter

• facilitates distribution

• assumes liability that varies with offering type

• signs underwriting agreement with issuer

  • buying security from issuer and selling to investor

IPO versus follow-on (Initial public offering)

equity securities only

• a company going public

  • don’t sell 100% of the company bc they want to sell securities later on

  • called a follow on: selling part of company later on

secondary market

where the trading of existing securities between investors occur

• NYSE and other traditional centralized exchanges

• provide a specific location for trade execution

• trading is normally monitored by a specialist or designated market maker (DMM)

NASDAQ

• dealer to dealer market

• non-physical: phone and computer market

• negotiated market

• unlimited number of registered “market makers”

  • company must have at least 3 market makers

• classified as a securities exchange

Non-Exchange Issues (OTC)

• dealer to dealer

• often low prices and thinly traded

• a system that offers real-time quotations

• OTC pink market

  • may be reporting or non-reporting companies

    • Nintendo: quoted in pink market (pink sheets how it got its name)

traders

• dealer to dealer

• execute trades for their firm or their firm’s clients

• do not maintain an inventory

third market

listed securities traded over the counter, trades included in NYSE volume totalsfou

fourth market

transactions between institutions, most true fourth market trades are internal crosses set up by money managers

dark pools

• provides liquidity for large institutional investors and high-frequency traders

• quotes are ANONYMOUS

• limits impacts on the market

DTCC

depository trust clearing corporation

• main subsidiaries is called DTC

• don’t hold any securities

• book entry system

• selling street name (firm) don’t have names of actual customers just firms

  • provides clearing, settlement, and information services for its members

  • parent of the NSCC

  • guarantees settlement

  • removes counterparty risk (act as a buyer for every seller and seller for every buyer (Brighthouse! Doesn’t interact with client directly)

  • transactions among its members are completed through computerized bookkeeping entries

  • EQUITY

NSCC

National Securities Clearing Corporation (equity)

FICC

fixed income clearing corporation (debt)

clearing firms

names of firms that do back office

• clear trades on omnibus or fully disclosed basis

• can clear their own stocks

introducing (correspondent) firms

lots of smaller firms, doesn’t pay for them to have their own back office

• they use services of big brokerage firms who not only clear their own trades but are the back office for the introducing firms/smaller firms

fully disclosed accounts

• specific information about each individual client is given to the clearing firm

• clearing firm is responsible for:

  • maintaining client assets

  • establishing a separate account for each client

  • sending confirmations, statements, and checks

    • contact information for introducing firm is included

• way less paperwork but more costly

• must maintain all client info for fully disclosed

omnibus accounts

• a single account is set up at the clearing firm

• specific client information is maintained by the introducing firm

• recordkeeping responsibilities rest with the introducing firm

Options Clearing Corp (OCC)

• issues and guarantees option contracts

• regulates exchange-traded options (listed options)

  • act as the 3rd party in all option transactions (the buyer for all sellers and the seller for all buyers)

  • deals directly with broker-dealers, not customers

  • trade settlement between broker-dealers and the OCC is next business day

  • BONDS

Prime Brokerage Accounts

• when a primary B/D provides a large client (hedge fund) with the ability to clear all trades through a centralized firm with executions occurring with multiple D/Bs

  • prevents a single firm from determining the client’s strategy

• the prime broker offers specialized services such as custody, securities lending, margin financing, clearing, processing, operational support, research, and customized reporting

• don’t want to deal with 10 firms just one

• hedge fund community

• consolidates all trades

transfer agent

responsible for maintaining a list of the company’s current shareholders and their contract information, and also assists in the transfer of shares

registrar

responsible for ensuring that a corporation doesn’t issue more shares than it’s authorized to issue

arbitrage

buying a stock in one exchange and simultaneously selling it on another exchange

SEC

• securities exchange commission

• government agency

• limited in budget

• how oversee securities? SRO (self regulatory) not the SEC

federal reserve board (FRB)

the “fed” is an independent agency of the US government that functions as the US central bank

• responsible for controlling monetary policy

• money supply interest rates

• goal is to create maximum employment and stable prices

• tools include

  • open market operations

  • discount rate (the only one they set)

  • reserve requirements

  • regulation T

FDIC (federal deposit insurance corporation)

• acts as a banking regulator

• insures baking depositors for up $250,000

• buying securities from bank, separate banking products from securities

State Blue Sky Regulators and North American Securities Administrators Association (NASAA)

• state administrator (sometimes called commissioner)

• enforces the uniform securities act (USA)

• the USA is a model law, not the actual law of the state

• NASAA responsible for creating the provisions and updating the USA

• focuses on protecting investors from fraud

• create the examination requirements for selling securities

pr

principal

responsible for supervising registered representatives

The securities Act of 1933

scope of the law

• to provide for “full and fair disclosure”

• prospectus must precede or accompany any solicitation of a new issue (no marking or highlighting)

• SECC “no approval clause”

Requires SEC registration of new issues

• registration exemptions are provided to issuers of certain securities and specific types of transactions

Liability

• unconditional for issuers regarding information to investors

• conditional for the underwriters that are required to perform:

  • reasonable investigation

  • “due diligence”

^{Securities Exchange Act of 1934}

scope of the law

• regulate the secondary market

• created the SEC to enforce federal securities law

• SEC utilizes self-regulatory organizations (SROs)

Provisions

• margin requirements (Regulation T)

• registration requirements for B/Ds and RRs

• trading regulations

• insider regulations

Investment Advisors Act of 1940s

An IA is defined as any person (firm) that meets the ABC test

A: advice: provides advice about securities, including asset allocation

B: Business: as a regular business

C: compensation: receives compensation for the advice

• includes firms that manage wrap accounts (they collect a single fee for providing advice and executing transactions)

Exclusions

• broker dealers that receive only commissions

• banks, saving institutions, and trust companies

• specific professionals who give incidental advice (lawyers, accountants, teachers, engineers LATE)

• publishers of newspapers and periodicals (no timed tailored advice is provided to individuals)

• not regulated by the SEC

** the SEC has power to regulate the industry and take action over civil penalties (fine) but they cannot imprison you. DOJ can go to criminal court not SEC

Securities Investors Protection Act (SIPA)

Created the Securities Investors Protection Corporation(SIPC)

• not a government agency but a non-profit membership corporation, funded through assessments of broker-dealers

• protects separate customers (not accounts) if bankruptcy occurs

• separate customers include IRAs, as well as joint and custodial accounts (one joint, my own, spouse own = 3 different customers)

• separate coverage provided for accounts that are held at different firms

coverage

• cash and street name securities (name held as broker dealer) $500,00 will only cover cash up to $250,000

• if limits are exceeded, customer becomes a; general creditor

not covered

• fraud (covered by fidelity bond), futures contracts, commodities, and fixed annuities

** securities specifically identifiable to a customer are distributed back to customer without limit

investment company act of 1940

identifies three types of investment companies

1. management companies

2. unit investment trust

3. face amount certificate companies

insider trading and securities fraud enforcement act 1988

• insiders include corporate officers and directors; owners of more than 10% of a company’s common equity

• the use of material, non-public information is prohibited

  • both tippers and tippees may be in violation

penny stock reform act of 1990

• regulates solicited sales of penny stocks (unlisted equities prices below $5.00 per share)

  • firms must establish suitability, approval, and disclosure procedures

telephone consumer protection act of 1991

• call time frame: 8 am to 9pm local time

  • firms maintain a “do not call” list

USA Patriot Act of 2001

• establishes the basis for a firm’s anti-money laundering regulations

• requires the filing of reports based on financial transactions

FINRA ( Financial Industry Regulatory Authority)

• main SROs

Conduct rules

• governs the interaction between customers and firms

Uniform Practice code

• standardizes the procedures for doing business in financial markets

Code of Procedure

• establishes the process used to discipline any person who violates FINRA rules (cannot imprison you, only DOJ)

Code of Arbitration

• provides the method for resolving disputes (typically monetary) between members, including those that involve public customers

  • cheaper than litigation

  • doesn’t have to be breaking the law, could be as simple as you thought your advisor didn’t give you the right advice and you lost money

municipal securities rulemaking board

formulates and interprets the rules that apply to

• broker dealers and salesperson engaged in municipal business and

• municipal advertising

• reactive not proactive

• MSRB rules do not apply to municipal issuers (government, towns, mayors)

• since the MSRB has no enforcement power, its rules are enforces by a separate regulatory agency

  • for broker dealers: FINRA or SEC

  • for bank dealer: comptroller of the currency, FRB, or FDIC

Chicago board options exchange (cboe)

• self-regulatory organization mainly for the options market

• a trading venue for

  • equity options

  • index options

  • yield-based options

  • ETFs

• regulated by the SEC

designated market maker

if an exchange has one entity that controls the trading in a specific stock it is called this

short sellers will profit if the stock price…

decreases

• short selling is a trading strategy which an investor sells stock that she doesn’t own

• shares are actually borrowed from a broker dealer

• belief is that the stock will decline in value (bearish) which will allow her to purchase the borrowed stock at a lower price and deliver it back to the broker dealer

WSP manual

written supervisory procedures

• compliance professionals are responsible for creating their firms house rules that form the basis of the WSP

• essentially a manual which details the rules and identifies the persons responsible for enforcing these rules

at the civil level, the SEC can sue up to

three times the profit made or loss avoided (referred to as treble damages)

corporations

file articles of incorporation

• also referred to as a certificate of incorporation or corporate charter

• solicit individuals to serve as members of the Board of Directors

  • board member responsibilities include:

  • overseeing the management team

  • corporate governance

  • declaring dividends

• Proxy: allowing someone to attend to vote on your behalf

how corporations raise money

debt financing: bondholders, senior to equities

equity: stockholders, preferred (senior) common (junior)

issuing stock

the corporate charter determines the number of shares that are authorized and can be issued

authorized: 1,000,000,000 (how many they can sell)

issued: 10,000,000 (how many are out there)

outstanding: same as issued

shares repurchased by corporation

if a corporation chooses to repurchase some of its outstanding shares, they become treasury stock (offer shares to employees)

issued - treasury = outstanding

** treasury stock does not receive dividends and has no voting rights

common stock ownership rights

inspection of book

evidence of ownership

transfer of ownership

participation in corporate earnings (entitled to dividends if declared (not guaranteed))

voting power

• election of board members

• authorization of additional authorized shares and stock splits (NOT vote for dividends)

two voting methods

statutory

• beneficial for large shareholders

• one vote her share per issue

cumulative

• beneficial for small shareholders

• allows shareholders to multiply the number of shares owned by the number of voting issues

restricted stock

when securities are purchased through a private placement, they are referred to as restricted securities or as compensation for senior executives of an issuer

stop-transfer instructions are issued and a legend on the certificates indicates that the securities are unregistered

• mandatory 6 month holding period

investment letter or lock-up agreement

• purchasers must sign the letter to acknowledge that the shares cannot be resold within a defined period

rule 144

permits the sale of restricted and control stock

• shares cannot be sold unless registered with SEC

• exemption

When intending to sell, the SEC must be notified

• form 144 field at the time the sell order is placed

• securities may be sold over 90 days through unsolicited broker’s trades or to a dealer that is acting as principal

• if any shares from this filing remain unsold and the investor wants to sell them, an updated form 144 must be filed

maximum sale allowed is the greater of:

• 1% of the outstanding shares or the average weekly trading volume over the last 4 week

FILINF FORM 144 IS NOT REQUIRED IF SELLING NO MORE THAN 5,000 SHARES AND $50,000 OF SECURITIES

control (affiliated) stock

registered stock that is part of an issuer’s public float and purchased in the open market by officers, directors, or greater than 10% shareholders of the issuer

• no minimum required holding period

American Depositary Receipts (ADRs)

priced as US dollars

pay dividends in US dollars

sponsored or unsponsored

sponsored: issued in cooperation with the foreign company, may trade on US exchanges

Unsponsored: issued without involvement of the foreign company, generally traded in OTC market

blue chip stock companies

stock of strong, well-established, dividend paying companies (blue chip is the most expensive in poker)

growth stock companies

stock of companies with sales and earnings that are expanding faster than the economy; pay little if any dividends

income stock

stock of companies that pay higher than average dividends in relation to market price

defensive stock

stock of companies that are resistant to recession (e.g. utilities, tobacco)

cyclical stocks

stock of companies whose value fluctuates with the business cycle (household appliances, automobile)

American Depositary Reciept Stocks

facilitates the trading of foreign stock in US markets

preferred stock

*no voting rights

• designed to provide returns that are comparable to bonds

• pays a stated dividend (no guaranteed)

• states as a % of par

• par value is typically $100

• dividends are paid to preferred shareholders before common shareholders

• there are multiple types of preferred stock

non-cumulative preferred stock

investor is only entitled to the current dividend; the investor is NOT entitled to unpaid dividend (dividend in arrears)

cumulative preferred stock

investor is entitled to unpaid dividends before common stock dividends may be paid

callable preferred stock

• issuer has the ability to repurchase the stock

• typically repurchased at a premium over par value

• allows issuer to remove stock from the market

participating preferred stock

investor may recieve additional dividends based on the company’s profit

convertible preferred stock

investor may convert into a predetermined number of common shares

• not as risky as common stock because you have some type of dividend paid out , hybrid

• conversion ratio = par value/conversion price

• price of convertible preferred = market value of common x conversion ratio

preemptive rights are

a shareholder’s right to maintain percentage ownership; no dilution

** only if you own shares of common stock will you receive any rights

• distributed through a rights offering

• one right for each share owned

Discounted

• shareholders exercise rights at a price that’s below the current market value prior to a public offering

• immediate intrinsic value (buy more at discounted price!) the lower the price the more value, the lower the price the less company can make

Short term

• typically must be exercised within 4-6 weeks

Tradable

*value of right determined by price

warrants

attached to bonds or stocks, acts as “sweeteners”

allows holders to purchase a specific number of the company’s common shares

• exercise price is above the current market value (premium)

• long-term

• may be exercised years after the original issuance

• attached to a new issue

may be “detached” and traded separately

rights vs warrants

FINRA Rule 2261 - Disclosure of Financial Condition

upon request, a member firm must make its balance sheet available to customers in either physical or electronic form

FINRA Rule 2262 - Disclosure of Control Relationship with Issuer

before executing a trade in the issuer’s securities, a broker-dealer must disclose to its customers if it has a control relationship with the issuer

SEC Rule 10b-18 Issuer Purchasing its Own Stock

for the issuer’s purchases to not be considered manipulative, the following conditions must be met

• only one broker-dealer used

• purchases made late in the day are prohibited

• purchase price is restricted

• single-day purchase amount is limited

“Safe harbor” you are safe if you follow the guidelines

how to calculate intrinsic value

price of common stock - warrant subscription price

how to calculate market capitalization

issued stock-treasury stock=outstanding stock

outstanding stock x stock price = market capitalization