Unit 2

Which of the following statements regarding discretionary accounts is not true? A) The customer must approve each order before or after it is executed. B) The account may not be accepted unless approved, in writing, by a principal of the member firm. C) The customer must grant written authorization to the broker-dealer or a designated individual to exercise discretion in the account. D) Each discretionary order must be reviewed promptly by a principal.

A) The customer must approve each order before or after it is executed. To establish a discretionary account, a customer must grant trading authority in writing. Furthermore, the firm must indicate its willingness to handle the account on a discretionary basis through the signature of a principal of the firm. All orders, including those for discretionary accounts, must be reviewed and endorsed promptly but not before execution. LO 2.g

An arrangement in which the registered representative has the authority, or power of attorney, to make trades from funds in the account without prior approval from the investor is known as A) a discretionary account. B) a stop-loss account. C) a power-of-attorney account. D) a nonapproval account.

A) a discretionary account. Discretionary accounts are arrangements in which the registered representative has the authority, or power of attorney, to make trades from funds in the account without prior approval from the investor. LO 2.g

A registered representative's recommendations to a customer A) must be approved in advance by a principal. B) must be reviewed by a principal whether or not they result in a trade. C) must match the customer's risk tolerance and investment objectives. D) are not covered by FINRA rules.

C) must match the customer's risk tolerance and investment objectives. Recommendations made to a customer must be suitable for that customer. Individual recommendations do not require advance approval or review by a principal, though the resulting trade, if one occurs, must be reviewed by a principal. LO 2.d

SEC Regulation Best Interest (BI) focuses on A) customer transaction costs. B) ensuring that customers receive the highest possible interest on their cash balances. C) recommendations to customers. D) ensuring broker-dealer profitability.

C) recommendations to customers. Regulation BI became effective on June 30, 2020, and states, "When making such a recommendation to a retail customer, you must act in the best interest of the retail customer at the time the recommendation is made, without placing your financial or other interest ahead of the retail customer's interests." **This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback. LO 2.f

Each of the following can create activity in a customer's account except A) the registered representative granted discretionary authorization. B) the holder of a full power of attorney. C) the trusted contact person. D) the holder of a limited power of attorney.

C) the trusted contact person. The trusted contact person has no trading authority over the account. The purpose of this person being named is to assist the member firm when there is suspicion of possible senior exploitation. A registered representative who has been granted discretionary power is able to make buy and sell decisions without contacting the client. The only difference between a limited and a full POA is that the person with a full POA can access funds as well as make trades. LO 2.g

A registered representative has a client who wants to save for college for her child. The child will be entering college in five years. This would be an example of A) planning too late. B) tactical asset allocation. C) an investment objective. D) an investment constraint.

D) an investment constraint. Time constraints include such conditions as liquidity and time horizon, both of which are in play here. It may be true that the client has started too late, but that is not what the exam would be looking for as the correct answer. This is an investment goal, not an investment objective. LO 2.e

Which of the following circumstances would not cause a registered representative to be identified as a fiduciary? A) A registered representative names one of his customers the executor of his estate B) A registered representative becomes a member of the board of directors of a charitable foundation. C) A registered representative receives discretionary authorization from a client D) A registered representative holds himself out as a fiduciary for ERISA plans and pensions.

A) A registered representative names one of his customers the executor of his estate Executors of an estate are included in the definition of a fiduciary. However, in this choice, the customer is the executor, not the registered representative. That customer has a fiduciary responsibility to the representative's heirs (when that time comes). The granting of discretionary authority over the account of a client is a form of having fiduciary responsibilitythe registered representative is in control of the customer's money. Being a board member of a foundation, or holding oneself out as a fiduciary for an ERISA plan, will generally find themselves being defined as a fiduciary. LO 2.g

A registered representative is opening both cash and margin accounts for a corporation. Which of the following documents will he need? The corporation's charter and bylaws A copy of the corporation's most recent balance sheet The corporation's last three profit and loss statements The name(s) of natural persons authorized to trade the account A) I and IV B) II and IV C) II and III D) I and III

A) I and IV Corporate accounts are generally those established by the officers of a corporation. Such accounts require a copy of the corporate resolution naming the authorized person(s) and account trading limits (if any). If it is to be a margin account, a copy of the corporate charter and a signed margin agreement are also required. LO 2.g

In recommending securities to customers, a FINRA member firm must do which of the following? I. Guarantee that future performance will match or exceed past performance II. Have a suitable basis for recommendations III. Disclose or offer to disclose supporting documentation IV. Offer to reimburse execution costs associated with recommendations A) II and III B) I and IV C) I and III D) II and IV

A) II and III Under the Conduct Rules, a FINRA member firm recommending securities to customers must not make future performance or reimbursement guarantees, must have a suitable basis for its recommendation, and must disclose or offer to disclose supporting documentation. LO 2.f

A person legally responsible for the handling of the financial assets of another, such as an executor or guardian, is usually called A) a fiduciary. B) an investment adviser. C) a trustee. D) a custodian.

A) a fiduciary. Fiduciary is the term that describes the legal position of trustees, custodians, and most investment advisers. This is a case where you choose the most complete response. LO 2.g

In a margin account, the broker-dealer lends money to the customer to assist in the purchase of a marginable security. Instead of delivering the security to the purchaser, the broker-dealer holds it as collateral for the loan. The form signed by the customer agreeing to this is A) the hypothecation agreement. B) the credit agreement. C) the stock pledge agreement. D) the loan consent agreement.

A) the hypothecation agreement. There are three special margin account agreement forms. The hypothecation agreement is the one in which the customer agrees to allow the broker-dealer to keep the securities purchased as collateral for the margin loan. The credit agreement contains the terms of the loan, such as interest to be charged, and the loan consent agreement is an optional form agreeing to let the broker-dealer lend out those securities. LO 2.g

All of the following are financial considerations in a customer profile except A) wanting to learn a new language. B) the equity in the vacation home. C) the balance in the Roth IRA. D) an expected inheritance.

A) wanting to learn a new language. Wanting to learn a new language is a goal and a nonfinancial consideration. Financial investment considerations can be expressed as a sum of money (total liabilities, for example) or as a numerical cash flow (gross income of $160,000 per year, for example). LO 2.b

FINRA Rule 2111 places three obligations on members when determining if a specific recommendation to a customer is suitable. Which of the following is not one of those three? A) Reasonable-basis suitability B) Qualitative-basis suitability C) Customer-specific suitability D) Quantitative suitability

B) Qualitative-basis suitability The rule does not refer to qualitative-basis suitability. It does say that a recommendation may be suitable if at least some investors would benefit from it (reasonable-basis suitability). The recommendation should also take the specific customer's profile into consideration (customer-specific suitability). Finally, although a specific recommendation may be suitable, when looking at the quantity of trading, there could be a churning violation (quantitative suitability). LO 2.f

One of your customers would like to begin an investment program calling for regular monthly contributions of $200. Which of the following would be the best source for determining if this plan is reasonable? A) The investor's savings account B) The investor's income statement C) The investor's balance sheet D) The investor's objectives

B) The investor's income statement When it comes to the ability to make ongoing contributions to an investment program, the income statement is usually going to be the most reliable tool for verification. It is from the income statement that discretionary income (the amount left over after paying expenses) is determined. The balance sheet indicates any lump sum availability. The savings account is a part of the balance sheet. Objectives are important, but they are not a financial measurement. LO 2.a

Which of the following documents must an existing customer sign to establish a discretionary account? A) New account application B) Trading authorization C) Options agreement D) Customer's agreement

B) Trading authorization To establish a discretionary account, the agent must receive written authorization from the customer(s) in whose name(s) the account has been established. An existing customer has already completed the new account application and signed any required customer agreements. LO 2.g

If an agent is assigned to an account previously handled by an agent who has since left the firm, which of the following actions should the agent take first? A) Suggest the customer buy one of the stocks the firm is currently recommending. B) Verify the account information. C) Liquidate the portfolio for immediate reinvestment in stocks the firm is currently recommending. D) Require the customer to sign a trading authorization naming the agent as the party with authority.

B) Verify the account information. The agent must verify and update client information before recommending trades. Without knowledge of the client's needs and financial profile, the agent cannot make suitable recommendations. LO 2.c

If a registered representative receives a call from a custodian wishing to buy shares of a new issue security, she should A) refuse to accept an order. B) discuss and review suitability. C) talk the investor into buying another stock. D) accept the order only if it is placed in a margin account.

B) discuss and review suitability. There are no restrictions that specifically apply to the purchase of new issues in a custodial account, provided the registered representative has discussed and reviewed the suitability of the investment. LO 2.f

A charge of churning would likely be brought against a registered representative who was found to have disregarded the FINRA rule on A) customer-specific suitability. B) quantitative suitability. C) investment goal suitability. D) reasonable-basis suitability.

B) quantitative suitability. FINRA Rule 2111 places three obligations on members when determining if a specific recommendation to a customer is suitable. One of those obligations is quantitative suitability. Churning is generally defined as excessive trading in a customer's account. The registered representative, having control over a customer account, has to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together. LO 2.f

In constructing a profile for your customer, you wish to assemble information on both financial and nonfinancial investment considerations that affect your customer. Which of the following qualify as financial investment considerations? I. Your customer's tolerance of various forms of risk II. Your customer's dependents and their ages III. Your customer's liquid net worth IV. Your customer's monthly credit card payments A) I and III B) II and IV C) III and IV D) I and II

C) III and IV Liquid net worth and expenses such as credit card payments involve concrete sums of money and cash flow, and thus, they are financial. The number of dependents and risk tolerance should be considered regarding suitability and making appropriate recommendations, but they are nonfinancial considerations. LO 2.a

As a registered representative, if you are assigned to an existing account that was previously handled by another registered representative who has since left your firm, which of the following actions should you take first? A) Liquidate the portfolio for immediate reinvestment in stocks you are currently recommending B) Require the customer to sign a trading authorization, naming you as the party with authority C) Verify the account information D) Suggest the customer buy one of the stocks you are currently recommending

C) Verify the account information The first action to take would be to verify and update the customer's information to make suitable investment recommendations. LO 2.c

customer wishing to open a numbered account must be informed that A) he must supply proof of U.S. citizenship and reside permanently in the United States. B) the account may only be opened with prior permission from the SEC. C) he must supply a written statement attesting to his ownership of the account. D) numbered accounts are restricted to cash accounts.

C) he must supply a written statement attesting to his ownership of the account. Numbered—or symbol—accounts require that a written statement, which is signed by the client and acknowledges ownership, be kept on file. LO 2.g

Which of the following oral orders can be accepted from a customer without additional documentation? A) Buy $20,000 of quality bank stocks B) Increase my position in ABC C) Buy 200 shares of computer stock D) Buy 100 shares of ABC when the price is right

D) Buy 100 shares of ABC when the price is right Prices and time of execution do not require discretionary authority. LO 2.g

A wealthy individual has established a trust and named you as the trustee. If you wish to establish an account that permits the trust to engage in margin transactions, which of the following statements regarding margin trading is true? A) It is permitted if the fiduciary observes the prudent investor rule. B) It is not permitted. C) It is permitted if the fiduciary shares in the profits or losses. D) It is permitted if provided for in the underlying documentation.

D) It is permitted if provided for in the underlying documentation. Margin trading in a trust account is permitted only if it is specifically provided for in the trust agreement. LO 2.g

A new client indicates the desire to invest in a highly speculative venture suitable only for those with significant net worth. The client assures you that he has the financial ability to sustain the loss of the entire investment. You believe it is necessary to verify that is the case. What documentation would help you? A) A letter from the client's best friend assuring you that the individual is a qualified risk taker B) A note from the client's doctor attesting to his excellent health C) The client's membership card to an exclusive country club D) The client's tax returns for the past three years

D) The client's tax returns for the past three years There are several acceptable sources of information that can be used to verify an individual's financial capabilities. One of these is copies of tax returns for at least the previous two years. Verification from the client's attorney, bank statements, and brokerage statements not more than 3 months old can also be used. LO 2.c

A new client would like to invest in an offering restricted to accredited investors. Any of the following could be used to verify accredited investor status except A) written confirmation from the client's CPA. B) tax returns for the past two years. C) a bank account statement not more than three months old. D) a letter from a duly licensed life insurance agent.

D) a letter from a duly licensed life insurance agent. Although it is possible that the insurance agent has sufficient information, the regulators do not include them in the list of verifiable sources, such as the CPA or the client's attorney. LO 2.c

Tamika is a registered representative with Financial Engineers, LLC, a FINRA member broker-dealer. The firm uses an investment policy statement (IPS) to help design financial plans for their clients. One of Tamika's current clients plans to purchase a new boat seven months from now. When using the IPS, this would be considered A) an investment objective. B) a financial objective. C) a long-term goal. D) an investment constraint.

D) an investment constraint. Investment constraints are obstacles or restrictions that must be met in order to meet goals. In this case, we are dealing with a liquidity constraint—in seven months, cash will be necessary to make the purchase. LO 2.e

Your client informs you that a signed discretionary account form is in the mail. Before receiving the form, and unable to contact the client, you notice that one of her stocks is dropping sharply on adverse news. You A) can enter a discretionary order with written permission of a principal of the broker-dealer. B) can enter a discretionary order with written documentation of the situation. C) can enter a discretionary order with instructions that the order is not held. D) cannot enter a discretionary order.

D) cannot enter a discretionary order. A discretionary order cannot be entered until the signed discretionary account form has been received. LO 2.g

All of the following are investment constraints except A) liquidity. B) investor preferences. C) time horizon. D) growth of capital.

D) growth of capital. Growth of capital is an investment objective. The other choices represent obstacles (constraints) that might keep the investor from fulfilling that objective. LO 2.e

A customer asks her registered representative to exercise discretion over her account. To do so, the representative must do each of the following except A) obtain written authorization from the customer. B) obtain evidence of written acceptance of the account by a registered principal of the firm. C) have a principal initial each order promptly, which may be before or after execution. D) obtain approval from FINRA.

D) obtain approval from FINRA. The requirements for a discretionary account include a written authorization from the customer, a written acceptance by a principal of the firm, and close supervision of each transaction to ensure suitable transactions in light of the customer's objectives and financial situation. No approval from FINRA is required. LO 2.g

FINRA Rule 2111 places three obligations on members when determining if a specific recommendation to a customer is suitable. FINRA's suitability rules would likely find a registered representative is not in violation of complying with those three if A) proper disclosures were made of the representative's compensation received. B) control relationships were disclosed. C) the recommendation was profitable for the investors. D) the recommendation made would be suitable for at least some customers.

D) the recommendation made would be suitable for at least some customers. This question refers to the three specific obligations under Rule 2111. Those three are reasonable-basis suitability, customer-specific suitability, and quantitative suitability. Complying with the first of the three means the registered representative has to have a reasonable basis to believe that a recommendation is suitable for at least some investors. Control relationships must always be disclosed, but that is not part of the three obligations. Compensation may have to be disclosed, but, once again, that is not part of the three obligations. Be sure to focus on answering the question being asked. LO 2.f