Comprehensive Securities Industry Essentials (SIE) Study Guide

Market Making, Prohibited Trading Practices, and Employee Ethics

  • Trading Ahead of Research Reports:
        * Prohibited Action: A market making desk is strictly prohibited from increasing its position in a security when it is aware that its firm is about to publish a research report on that specific stock.
        * Reasoning: Prior to publication, the information contained in a research report is considered material non-public information. Once the report is published, the firm can resume trading, but acting on it beforehand is a violation of industry rules.

  • Interpositioning and Third-Party Execution:
        * General Prohibition: Member firms are generally prohibited from using a third party to execute Over-the-Counter (OTC) agency transactions for customer orders.
        * Commission Stacking: The primary reason for this rule is to prevent "stacking commissions," where multiple brokers each charge a commission on the same trade, increasing the cost for the client.
        * Exceptions: This practice is only permitted in limited circumstances if it results in a more favorable outcome (i.e., a better price) for the customer than the firm could have achieved on its own.

  • Market Manipulation Tactics:
        * Marking the Open: Placing buy orders at the market open specifically to inflate a stock's price.
        * Marking the Close: Attempting to influence the closing price of a security by placing orders at or near the end of the trading day.
        * Painting the Tape: Creating the appearance of increased trading activity or inflating prices through multiple trades during the market day.
        * Comparison: These three practices are functionally similar; they are distinguished primarily by the timing of the manipulation.

  • Insider Trading:
        * Definition: Trading based on material non-public information.
        * Legal Threshold: It is not illegal to merely possess material non-public information; the violation occurs specifically when an individual acts upon it by trading or tipping others.
        * Liabilities: In cases of illegal tipping (e.g., a CEO telling a representative about a record quarter before it is public), both the tipper and the tippee are liable for the violation.

  • Front Running:
        * Definition: A prohibited practice where a registered representative places a personal order (such as buying a call option) with advanced knowledge of a large buy order being placed by an institutional client. This is often referred to as "trading ahead."

Settlement, Dividends, and Stock Splits

  • Regular Way Settlement:
        * Formula: T+1T + 1 (Trade Date plus one business day).
        * Business Days Definition: Settlement calculations exclude weekends and federal holidays.
        * Holiday Examples: If a trade is placed on Thursday, July 3rd, it will not settle until the next business day after the holiday, as July 4th is a market holiday.
        * Key Dates: Relevant federal holidays include July 4th, December 25th, and Juneteenth (June 19thJune \, 19^{th}).

  • Dividend Dates:
        * Ex-Date and Record Date: In the context of the exam and current rules, the Ex-Date and the Record Date are often treated as the same day for practical calculation purposes.

  • Stock Split Mechanics:
        * Example Case: A customer owns 100100 shares of XYZXYZ trading at $40\$40. The company declares a 5:45:4 forward split.
        * Impact on Price: After a forward split, the stock price must decrease because there are more shares outstanding. In a 5:45:4 split, the share price would drop to $32\$32 (\40 \times \frac{4}{5} = \3232).
        * Impact on Position: The number of shares increases. The final position would be 125125 shares (100×54=125100 \times \frac{5}{4} = 125).
        * Split Psychology: Savvy traders understand the split, but "terrestrial" or less experienced investors might erroneously view a price drop (e.g., from $60\$60 to $12\$12 following a split) as a negative development.

Options Fundamentals and Strategies

  • Key Definitions:
        * Premium: The price or amount paid by a customer to buy the option contract.
        * Strike Price: The set price at which the option holder has the right to buy or sell the underlying security.

  • "Call Up, Put Down" Rule:
        * Calls: Are "in the money" when the market price of the security goes up (above the strike price).
        * Puts: Are "in the money" when the market price of the security goes down (below the strike price).

  • Positions and Motivations:
        * Long Call (Buy a Call): Bullish. The investor wants the market to go up. Max gain is unlimited.
        * Short Call (Sell/Write a Call): Bearish or Neutral. The investor wants the market to go down or stay flat to keep the premium. Max gain is the premium.
        * Long Put (Buy a Put): Bearish. The investor wants the market to go down. Max gain is the strike price minus premium down to zero.
        * Short Put (Sell/Write a Put): Bullish or Neutral. The investor wants the market to go up or stay flat.

  • Breakeven and Profitability Calculations:
        * Example: A customer buys an XYZ May 40 callXYZ \, May \, 40 \, call at $4\$4 when the stock is trading at $42\$42.
        * Breakeven Point: Strike Price ($40\$40) + Premium ($4\$4) = $44\$44.
        * Status at $42\$42: The option is "in the money" by $2\$2, but the customer is technically losing money because the price is below the breakeven point.

  • Index Options (e.g., OEX):
        * Unlike equity options, if an index option holder decides to exercise, they receive the in-the-money amount in cash, not physical delivery of stocks.

  • Currency Options:
        * Hedging: Used to protect against adverse currency fluctuations. If a Japanese corporation must pay for German goods in Euros (EUREUR) in 6 months, they would buy calls on the Euro at today's strike price to lock in the current exchange rate.

Advanced Option Strategies and Risk Management

  • Generating Income in Flat Markets:
        * Strategy: Selling (Shorting) an option to collect a premium.
        * Covered Call Writing: The investor is Long Stock and Shorts (Writes) a Call. This is considered more conservative than simply owning stock because the premium received lowers the investor's cost basis and provides a small buffer against loss.
        * Best Market Condition: Stable or fluctuating slightly (flat).

  • Protecting Existing Positions:
        * Protecting Long Stock (Falling Market): The best strategy is to Buy a Put (Long Put). This gives the investor the right to sell the stock at the strike price if the market crashes.
        * Protecting Short Stock (Rising Market): The best strategy is to Buy a Call (Long Call). This allows the investor to buy the stock at the strike price to close their short position if the market rises unexpectedly.

  • Unlimited Gain and Loss Scenarios:
        * Unlimited Max Gain: Long Stock and Long Put. While the put protects the downside, the long stock position can gain indefinitely as the market rises.
        * Unlimited Max Loss: Short Stock and Short Put. A short stock position alone has unlimited loss potential because there is no ceiling on how high a stock price can go. Selling a put does not protect this; it only adds a small premium to the account while potentially forcing the investor to buy more stock.

Customer Accounts and Retirement Planning

  • Opening a Cash Account:
        * Required Items: Name, address, Tax ID/Social Security number, occupation, and employer.
        * Not Required: The customer's signature is not technically required to open a standard cash account.

  • Regulation SP (Privacy):
        * Firms must provide privacy notices to customers annually. They must provide it to consumers at the time of the transaction.

  • Discretionary Authority:
        * Requirements: Must be provided in writing.
        * Definition: Discretion exists if the representative chooses the Asset (security), Amount (quantity), or Action (buy/sell). Simply choosing the time or price of an execution is not necessarily discretionary.

  • Elder Abuse Protection:
        * Approximately 40%40 \%-45%45 \% of elder abuse is committed by family members or caregivers.
        * Red Flag: An elderly client (e.g., 8080 years old) coming in under pressure from a family member to grant Power of Attorney should be escalated to the compliance department or a manager for review.

  • IRA Rules and Limits:
        * Contribution Limit: The lesser of earned income or the IRS limit ($7,500\$7,500 including catch-ups for certain ages).
        * Combined Limits: The IRS views all IRAs (Roth or Traditional) as one. A person make a total contribution across all accounts up to the annual limit.
        * Prohibited Investments: IRAs cannot hold collectibles, art, antiques, or Vincent van Gogh paintings. They can hold specific gold coins.

  • Annuities:
        * Fixed Annuity: An insurance product; money goes to the insurance company's General Account. No investment risk to the client.
        * Variable Annuity: A security/hybrid product; money goes into a Separate Account and is invested in the market.
        * Accumulation Units: Units purchased during the deposit phase.
        * Annuity Units: Units used to determine the payout amount after annuitization.
        * Payout Rankings (Largest to Smallest): 1. Life Annuity (stops upon death), 2. Period Certain (guaranteed for a set time), 3. Joint and Last Survivor (covers two lifespans).

Regulatory Framework and Record Keeping

  • Exceptions to Regulation T: Regulation T (governing margin accounts) applies to most securities but does not apply to Government Securities (Treasuries).

  • Free Riding: A prohibited practice where a customer buys a security and then sells it without ever paying for the original purchase.

  • Custodial Accounts (UGMA/UTMA):
        * Minors cannot open accounts themselves. A custodian (typically a parent) must open the account for the minor.

  • Trust Accounts:
        * Grantor: The person who donates the assets into the trust.
        * Trustee: The fiduciary who administers and manages the trust. The grantor and trustee can be the same person or different entities (like a bank).
        * Beneficiary: The person who receives the benefits of the trust assets.

  • 529 Plans: These are state-sponsored education savings plans and are considered municipal securities.

  • Securities Act of 1933 Exemptions:
        * Exempt: Municipal bonds, Charitable organizations, Commercial paper (<270 days< 270 \text{ days}), and Foreign government obligations.
        * Non-Exempt: Corporate issues (e.g., industrial machinery issues) and Variable annuities must be registered with the SEC.

  • Record Retention:
        * Customer Records: Must be kept for 66 years.
        * Complaints: Must be kept for 44 years.

Question & Discussion

  • Participant: "Will the exam say it's a holiday? Like December 24th?"
  • Speaker: "The exam will usually give you a date like Thursday, July 3rd. You have to remember July 4th is a federal holiday and nothing settles that day. Same with Juneteenth if it falls on a Thursday or Friday."
  • Participant: "What if a minor is a joint owner?"
  • Speaker: "Minors cannot do anything in finance themselves. A parent would have to open a custodial account or be the primary on a joint account."
  • Participant: "If a grantor has the assets before they get insider info, is that okay?"
  • Speaker: "Yes, if you own the stock before the info becomes material non-public, you are fine to keep it. You just can't sell it or add to it until that information is made public."