Series 7 - Rules and Regulations

3 Stages of Money Laundering

1. Placement - In the initial stage, the funds derived from illegal activities are transferred into the financial system (banks or BDs). 2. Layering - Disguising the source of the funds by moving the funds from one place to another through a series of transactions. 3. Integration - Final state when illegal funds are mixed with legitimate funds usually via businesses that operate using cash.

Order Ticket Information

1. Registered Reps ID number 2. Customer Account Number 3. Number of shares or bonds being bought or sold 4. Discretionary authority or not 5. Whether buying, selling long, or selling short 6. For options, whether buying or selling, is covered or uncovered, and is opening or closing. 7. Market order, good till cancelled (GTC) order, or day order, etc... 8. Whether trade is executed in cash or on margin 9. Whether the trade is solicited or unsolicited 10. Time of the order 11. The execution price

Payment and Delivery Instructions

1. Transfer and Ship - securities are registered to and shipped to the customer. 2. Transfer and Hold - securities are registered to the customer but held by the broker/dealer. 3. Held in Street Name - securities are registered to and held by the broker/dealer.

Unsolicited Order

Check this on the order ticket if the customer requests a trade that you think is unsuitable, you advise them of that, and they still want to proceed.

Violation for Commingling Funds

Combining a customers fully paid and margined securities or combining a firms securities with customer securities.

Violation for Painting the Tape

Creating the illusion of trading activity due to misleading reports on the consolidated tape (ie. can't report a trade of 10,000 shares as two trades of 5,000).

Regulation S-P

Enacted by the SEC to protect the privacy of customer information, specifically the nonpublic personal information such as SSN, account balances and info collected from internet cookies. Notice of privacy policy must be given to customers when new accounts are opened and annually. If your firm reserves the right to disclose info to unaffiliated third parties, a reasonable opt out means must be provided.

MSRB (Municipal Securities Rulemaking Board)

Established to develop rules that banks and securities firms must follow when underwriting, selling, buying, and recommending municipal securities. Subject to SEC oversight, but does not enforce SEC rules. MSRB rules are enforced by FINRA. Does not approve or guarantee securities.

Bank Secrecy Act

Establishes the US Treasury Dept as the regulator for anti-money laundering programs. BD must have programs to detect money laundering and may not do business with organizations on a list of launderers. Must review the Office of Foreign Asset Controls (OFAC) list of Specially Designated Nationals (SDN).

Violation for Marking the Close/Marking the Open

Executing a series of trades within minutes of the open or close of the market to manipulate the price of a security.

Violation for Backing Away

Failure on the part of the securities dealer to honor a firm quote.

Limited vs. Full Power of Attorney

Full allows someone who is not the owner of an account to deposit and withdrawal cash or securities and make investment decisions for the account owner. Limited power allows trading but no withdrawal of assets. A durable power of attorney survives a declaration of mental incompetence.

Violation for Giving or Receiving Gifts

Giving or receiving gifts > $100 per customer per year. Business expenses are exempt (dinner, hotel, etc).

5 Percent Markup Policy

Guideline, not a rule, to ensure investors receive fair treatment and aren't charged excessively in the OTC market. Following trades subject to the 5% rule: - Principal Dealer Transactions- securities bought or sold out of the BD inventory. - Agency/Broker Transactions - firm acts as middle man and charges a commission. - Riskless Simultaneous Transactions - Firm buys a security for its inventory for immediate resale to the customer. - Proceeds Transactions - firm sells a security and uses the money to immediately buy another security. Treated as one transaction, can't charge on both. *Does not cover securities exempt from SEC rules

Violation for Interpositioning

Having two securities dealers act as agents for the same exact trade so that two commissions are earned on one trade.

Holding Customers Mail

Holding customer statements and confirmations is permitted for up to 2 months if the customer is travelling domestically and 3 months if travelling abroad. Firm is not required to do this, just a courtesy.

Trade Confirmations Include

Must be given to the customer at or before the settlement date and include: 1. Customer Account Number 2. Registered Reps ID number 3. The Trade Date 3. Whether the customer bought (BOT) or sold (SLD) 4. Discretionary authority or not 5. The Number of shares of stock or the par value of bonds purchased or sold. 6. The yield (if bonds)-the lower of YTM or YTC 7. The Committee on Uniform Security Identification Procedures (CUSIP) number, a security ID number 8. The price of the security 9. The total amount paid or received, not including commissions 10. The commission (added on purchases, subtracted on sales) if the member acted as an agent 11. The net amount, the amount the customer paid after adding or subtracting the commission (if the investor purchased or sold bonds, the accrued interest is added or subtracted during this calculation). 12. Whether the member acted in an agency or principal capacity * Markups and markdowns (if acting as principal) must only be shown for Nasdaq securities, not other transactions.

The New York Stock Exchange

Oldest and larges in the US. Responsible for listing securities, setting exchange policies, and supervising the exchange and member firms. Has the power to take action against member firms. Does not approve or guarantee securities.

Death of an Account Holder

Once aware, firm must cancel all open orders, mark the account 'Deceased', and freeze the assets in the account until instructions and documentation are received from the executor. Third party powers of attorney on the account are revoked and any discretionary authority ends.

Corporate Accounts

Only for incorporated businesses. Need the Tax ID number and the corporate resolution (to tell you who to take trading instructions from). If they want a margin account you need the corporate charter because the charter must allow for it.

Violation for Making Political Contributions

Prohibited from providing investment advisory services for a fee for two years after a contribution is made. Cannot solicit contributions for them either.

Securities Investor Protection Corp (SIPC)

Protects the customer against broker dealer bankruptcy up to $500K for each separate customer asset (securities and cash) of which no more can than $250K can be cash. A private, non profit organization created by the gov. The investor becomes a general creditor of the form for the amount owed over these limits.

Federal Deposit Insurance Corp (FDIC)

Provides deposit insurance, protecting accounts from bank failure (bankruptcy) up to $250K per depositor.

T+5

Reg T settlement timing

FINRA (Financial Industry Regulatory Authority)

Self regulatory organization responsible for the operation and regulation or the NASDAQ stock market, the NYSE, the International Securities Exchange and the OTC market. Formed in 2007. Responsible for making sure members follow FINRA and SEC rules, handling complaints against member firms, and administering securities exams. Does not approve or guarantee securities.

T+3

Settlement timing for: Equity (Stock) Corporate Bonds Municipal Bonds US Gov Agency Securities (ie. Fannie Mae) Mutual Funds (ie. Tuesday trade would settle on Friday, Thursday trade would settle on Tuesday). Customer confirmations must be sent no later than the settlement date (T+3). *Cash settlements are same day.

T+1

Settlement timing for: Equity Options Index Options T-Bills T-Notes T-Bonds Broker to Broker Confirmations must be sent T+1. *Cash settlements are same day.

Transfer on Death (TOD)

This is an account that allows the registered owner of the account to pass all or a portion of it, upon death, to a named beneficiary. This account avoids probate but the assets do not avoid tax.

Requirements for Good Delivery

Transfer agent is responsible: - must be in good physical condition (not mutilated). - must be endorsed. - exact number of shares or bonds must be delivered. - correct denomination of the certificates must be delivered. - Bearer (coupon) bonds must be in $1K and $5K denominations with all unpaid coupons attached. - Registered bonds must be in multiples of $1K par value with max par value of $100K. - Stock certificates must be in multiples of 100 shares or divisors of 100 shares or units that add up to 100 shares. * Single Odd lot trades (less than 100 shares) are exempt from the good delivery rule. A trade with 2 oor more odd lots that don't meet the other rules above are not allowed.

Other Types of Account

Unincorporated Associations - group of two or more people that form an organization for a specific purpose (investing) but is not a corp or partnership. Institutional Accounts - banks, mutual funds, ins. co., pension funds and investment advisors. Partnership Accounts - two or more owners of a business, must have a partnership agreement to tell who is authorized to give trading instructions.

Rejection and Reclamation

When a broker/dealer realizes after accepting securities as a good delivery, that the certificate is not in good delivery form, they can return the securities back to the selling broker/dealer with a Reclamation form within 15 days if irregularities are minor, within 30 days if refused by the transfer agent or the certificates are counterfeit or stolen.

Transferring Customer Accounts

When a customer wants to transfer from one BD to another BD, they fill out an account transfer form, listing the securities held. Transfer instructions are then sent. Transfers are executed through ACAT. Old BD has 3 days to validate or take exception (if some info is wrong). After its validated, the old BD has 3 business days to transfer the account to the new BD.

Violation for Churning

When a registered rep excessively trades a customers account for the sole purpose of generating commissions.

Frozen Accounts

When an account is being transferred to a new broker/dealer, the old broker/dealer has one day to validate or take exception to the transfer instructions. The old firm then returns the instructions to the new firm with the a detailing of the clients securities positions. At this point the account is frozen and the transfer must be completed within three business days of the validation. After validation, any transactions must be completed by the new firm. If a customer buys securities in a cash account and sells them before paying for the buy side by the fifth business day, the account is frozen. Any additional buy transactions require full payment in the account before the order is executed. And sell transactions require securities on deposit. Frozen account status lasts 90 days, but is lifted if payment is received by the fifth business day.

Cancels and Rebills

When an order contained the wrong account number the registered rep must report it to the manager immediately. Changing the account number on an order ticket requireds manager approval.

Telephone Act of 1991

When dealing with potential customers: - no calls before 8am - no calls after 9pm local time - must give your name, company name, company address and phone number - place on a do not call list if asked -do not send unsolicited ads by fax machine. *Does not apply to existing customers.

OPMC

"Other People Might Care" Acronym for remembering the path of an new securities order: Order dept, Purchasing and Sales dept, Margin and Credit dept, then the Cashiering dept.

Justifications for Charging More Than 5%

- Experiencing difficulty buying or selling the security because the market price is too low or too high. - Handling small trades - Encountering difficulties in locating and purchasing a specific security. - Incurring additional expense involved in executing the trade. - Dealing with odd lot trades. Trading non liquid securities. - Executing transactions on foreign markets.

New Account Form Information

- Name and address of individuals who will have access to the account. - Customers DOB (must be of age). - Type of account being opened. - SSN or Tax ID if a business. - Customers occupation, employer and type of business. - Domestic or foreign residency and/or citizenship. - Bank references and the customer's net worth and annual income. - Whether the investor is the insider of a company. - Investment objectives. - Signatures of the principal. (Not the customer or registered rep!) * Account records must be updated when changes occur. * Only legally competent individuals can open accounts.

Laundering Red Flags on New Accounts

- Over concern with US gov reporting requirements. - Reluctance to reveal info about business activities. - Suspect or fake looking IDs. - Irrational transactions that are inconsistent with stated objectives. - A fiduciary who is reluctant to give info about the customer. - An individuals general lack of knowledge about his own industry.

Violation for Paying for Referrals

Members are prohibited from paying cash or non cash compensation to any person for locating, introducing or referring a client; except those registered with the member firm or other FINRA members

Violation for Spreading Market Rumors

Members may not spread false market rumors that may prompt others to buy or sell a security.

Principals Responsibilities

- Approve all new accounts. - Approve all trades in accounts (on the same day). Orders must be approved after execution, but do not have to be before they are entered. - Sign all new account and trade order tickets. - Approve all advertisements and sales literature. - Handle all complaints. *They do not have to approve a prospectus or your recommendations to your customers.

Custodial Account Rules

- Can only be one custodian and one minor per account. - The minor is responsible for the taxes (minors SSN is registered to the account). - The account is registered in the name of the custodian for the benefit of the minor. - Custodian endorses all certificates. - Account can's be held in street name. - Securities can't be traded on margin or sold short. - Anyone may give a gift of cash or securities to the minor, cannot be refused by the custodian and is irrevocable. - If an account receives rights, the custodian can't let the rights expire, because rights have value, the custodian can exercise or sell the rights. - Age of majority determined by State of residence. - At majority, the custodial account is terminated and a single account is opened in the name of the minor.

Laundering Red Flags on Existing Accounts

- Deposits of large amounts of cash or money orders. - Structuring - making deposits just under $10,000 to avoid having them reported. - Wire transfers to noncooperative countries. - Sudden and unexplained wire activity. - Making a deposit and transferring it to another party without any business purpose. - Buying a long term investment and liquidating it in the short term. - Transfers between multiple accounts for no apparent reason. - Depositing bearer bonds and requesting the money immediately. - A total lack of concern about risks and commissions.

Violation for Frontrunning

A violation in which a registered rep executes a trade for himself, his firm or a discretionary account based on knowledge of a block trade (10,000 shares or more) before the trade is reported on the ticker tape.

Stock or Bond Power and Power of Substitution

A form used in lieu of signing the back of the stock or bond certificate.

Timing of Account Statements

AIM: 1. Active Accounts - if any trading occurs in a month, or the account holds penny stocks, the customer must receive a statement for that month. 2. Inactive Accounts - statements sent quarterly. 3. Mutual Funds - statements sent semi annually. *Customers may request a copy of the broker/dealers most recent BS.

Trust Accounts

Account managed by one party for the benefit of another party. Example is a Custodial Account set up for a child too young to have his own account.

Don't Eat Rubber Pickles

Acronym for remembering dividend dates: 1. Declaration 2. Ex dividend 3. Record 4. Payment

Violation for Freeriding

Allowing a customer to buy or sell securities without paying for the purchase.

Street Name Accounts

Also called numbered account, is registered in the name of the broker dealer with an ID number. - Must have a written statement from the customer attesting to the ownership of the account. - May be changed into a regular account an any time by the customer, except for margin accounts. - All margin accounts must be in street name.

UTMA Account (Uniform Transfers to Minors Act)

Also known as UGMA (Uniform Gifts to Minors). A custodial trust account that allows gifts in addition to cash and securities (like real estate, art, patents, etc....)to be transferred to the minor.

Mediation

An even more informal way for investors and broker dealers to resolve disputes. Entered into voluntarily, heard by a third party, are nonbinding.

Violation for Prearranging Trades

An illegal agreement between a registered rep and a customer to buy back a security at a fixed price.

Code of Arbitration

An informal hearing (heard by 2 or 3 arbiters) that's primarily conducted for disputes between members of FINRA, but public customers can also choose this route. Arbitration decisions are binding and nonappealable so are lest costly than court action.

Discretionary Accounts

An investor can give a registered rep. the right to make trading decisions for the account. Require a written power of attorney signed by the investor. - Each order must be marked as discretionary on the order ticket. - Principals must sign each order ticket. - A principal must review these accounts regularly to make sure reps don't trade excessively to generate commissions (called churning).

Fiduciary

Anyone who can legally make a decision for another investor. Examples: custodian, rep with power of attorney, executor of an estate. Subject to the 'Prudent Investor Rule' - can only invest in the State's legal list, or if the state doesn't have a list, only investments a prudent person seeking reasonable income and preservation of capital would invest in.

Currency Transaction Report

BDs and financial institutions must report any cash or cash equivalent deposits, withdrawals or transfers of $10,000 or more. Or, they must report suspicious activity of $5,000 or more by filing a SAR (suspicious activity report).

Patriot Act (2001)

Broker dealers are required to keep records of the information used to identify the customer via CIPS (the customer identification program used to verify the identity of customers who wish to conduct financial transactions). Must also verify that a customer doesn't appear on any list of known terrorists or terrorist organizations. Must review the Office of Foreign Asset Controls (OFAC) list of Specially Designated Nationals (SDN).

Violation for Paying the Media

Brokerage firm or affiliated person pays an employee of the media to affect the price of a security.

Violation for Matching Orders

Illegally manipulating the price of a security to make the trading volume appear larger than it really is (ie. when two firms trade a stock back and forth).

Don't Know Notice

In iterdealer trades, each side electronically enters its version of the trade, if the details on either side don't match the system will "DK" the trade.

Single Account

In one persons name. Individuals cannot open accounts in other peoples names without power of attorney.

Joint Accounts

In the name of more than one person. All individuals on the account have equal trading authority. 2 Types: 1. Joint Tenants with Rights of Survivorship (JTWROS) - when a joint tenant on the account dies, his portion of the account passes to the surviving joint tenant. Usually set up for husbands and wives. In state where community property law exists, investments acquired during marriage are automatically presumed to be jointly owned by husband and wife. 2. Joint with Tenants in Common (JTIC) - when a joint tenant on the account dies, his portion of the account becomes part of his estate. Usually for people who aren't related.

Delivery versus Payment (DVP)

Instead of delivering the securities to a customer (transfer and ship) or to the broker/dealer (transfer and hold or hold in street name), they are delivered to a bank and their is a cash on delivery settlement.

Code of Procedure

Litigation. FINRAs formal procedure for handling securities related complaints between public customers and members of the securities industry. Appealable all the way to the supreme court.

Ex Dividend Date

The first day that the stock trades without dividends. If you purchase the stock on this date you are not entitled to a dividend. Stock transactions take 3 days to settle so the ex dividend date is automatically two business days before the record date. Board of Directors announce the other three dates. The price of the stock is reduced by the amount of the dividend on this date. Due Bill used to show that a dividend is owed to the seller of a stock.

Dividend Record Date

The day the corp inspects its records to see who gets the dividend. Investor must be listed as a stockholder in the company records to receive the dividend.

Dividend Declaration Date

The day the corp officially announces that a dividend will be paid to shareholders.

Settlement Date

The day the issuer updates its records and the certificates are delivered to the buyers brokerage firm. Regular Way: - 3 Days for Stocks, Corp Bonds and Municipal Bonds - 1 Day for US Gov Bonds and Options * Cash trades require same day settlement, payment for and delivery of the securities on the same day as the trade. * Delayed Deliveries are possible if mutually agreed on.

Trade Date

The day the trade is executed. The investor owns a security as soon as the buy trade is executed, whether or not they have paid for the trade.

Dividend Payment Date

The day that the corporation pays the dividend.

Payment Date

The day the buyer of the securities must pay for the trade. Regular Way: - 5 Days for Stocks, Corp Bonds and Options - 3 Days for Municipal Bonds - 1 Day for US Gov Bonds