Unit 2a & 2b - Obtain Necessary Suitability Information and Approvals

Reasonable-basis suitability, as used in FINRA Rule 2111 means the member or associated person making the recommendation should have a reasonable basis to believe that the recommendation A) is suitable for at least some investors. B) will result in a lower cost to the investor than comparable issues. C) has a reasonable basis for meeting the specific customer's needs. D) has a reasonable basis for believing that the security will outperform others in its industry.

The best answer is A. The reasonable-basis obligation requires a member or associated person to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors.

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

The best answer is 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.

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) Qualitative-basis suitability B) Quantitative suitability C) Reasonable-basis suitability D) Customer-specific suitability

The best answer is A. 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).

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 stock pledge agreement. C) the credit agreement. D) the loan consent agreement.

The best answer is 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.

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

The best answer is B. Prices and time of execution do not require discretionary authority.

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) Require the customer to sign a trading authorization naming the agent as the party with authority. B) Verify the account information. C) Suggest the customer buy one of the stocks the firm is currently recommending. D) Liquidate the portfolio for immediate reinvestment in stocks the firm is currently recommending.

The best answer is B. 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.

When dealing with suitable recommendations to clients, it is important to distinguish between investment objectives and investment constraints. Which of the following would be an investment objective rather than a constraint? A) Tax considerations B) Capital appreciation C) Need for liquidity D) Time horizon

The best answer is B. Capital appreication The objective is the route you wish to take. The constraints are what might keep you from getting there. The client who has capital appreciation (growth) as an objective needs to consider the potential obstacles (constraints) in the way. The longer the time horizon, the more aggressive the growth investor can be. The same is true when the need to liquidity is low. Taxes are another potential roadblock to overcome.

A customer opening a margin account must be supplied with a special margin risk disclosure. Which of the following are specific risks disclosed? I Customers are not entitled to choose which securities can be sold if a maintenance call is not met. II Customers can lose more money than initially deposited. III Customers are not entitled to an extension of time to meet a margin call. IV Firms can increase their in-house margin requirements without advance notice. A) II, III and IV B) I, II, III and IV C) I, and IV D) II and III

The best answer is B. I, II, III, and IV All of these are part of the margin risk disclosure document.

As the poet Robert Burns wrote, "The best-laid plans of mice and men often go awry." The same could be said for investment plans. The term used to describe those things that can have an impact on the ability of our plans to reach fulfillment is A) investment decisions. B) investment constraints. C) investment goals. D) investment conditions.

The best answer is B. Investment Constraints Investment constraints are those things that stand in the way of having our investment objectives reach their goals. Can bad decisions or unusual conditions do that? Yes, but those are not financial industry terms used on the exam.

An investor wants to open an account designated by number, not by name. In addition to the normal account-opening requirements, the registered representative A) can open this account with a written statement of ownership and approval from FINRA. B) cannot open the account in this manner. C) can open the account with a written statement of ownership from the customer. D) can open this account without additional documentation.

The best answer is C. For numbered accounts, there is an additional requirement that the customer must sign a document attesting to ownership.

Which the following statements regarding customer accounts is not true? A) Many states publish a legal list of securities approved for fiduciary accounts. B) The customer who opens a numbered account must sign a statement attesting to ownership. C) Margin trading in a fiduciary account does not require any special documentation. D) Stock held under joint tenants with rights of survivorship (JTWROS) goes to the survivor in the event of the death of one of the tenants.

The best answer is C. Trading on margin is prohibited in fiduciary accounts except with the appropriate documentation. Numbered accounts are permitted with a letter signed by the customer. Stock held under JTWROS passes to the survivor(s) in the event of death of one of the tenants.

A registered representative of a FINRA member broker-dealer is gathering information from a prospective customer. When the representative uses the information to prepare a financial profile, which of the following would not be included? A) Outstanding credit card balances B) Cash value in life insurance policies C) The individual's risk tolerance D) Current value of any IRAs

The best answer is C. The individual's risk tolerance The financial profile includes items with numbers. While risk tolerance is one of the most important aspects of information gathering, it cannot be quantified in the manner that debts, cash value, and IRA accounts are.

A registered representative sits down with a new customer to complete the customer account form. During this time, the customer expresses being comfortable with some risk to her initial investment in exchange for potentially higher returns. After the registered representative explains that the willingness to accept some risk may allow the account to keep pace with inflation, but that it also means the account could lose value, the customer acknowledges that she understands. This customer's risk tolerance would best be defined as A) aggressive. B) speculative. C) moderate. D) conservative.

The best answer is C. Moderate An investment risk tolerance in which the customer is willing to accept some risk to the initial principal sum invested and the potential loss of the funds in exchange for the opportunity to earn higher returns is best defined as moderate.

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 loan consent agreement. B) the stock pledge agreement. C) the credit agreement. D) the hypothecation agreement.

The best answer is D. 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.

Your customer, age 29, makes $42,000 annually and has $10,000 to invest. Although he has never invested before, he wants to invest in something exciting. Which of the following should you suggest? A) A balanced fund because when the stock market is declining, the bond market will perform well B) An aggressive growth fund because the customer is young and has many investing years ahead C) A growth and income fund because the customer has never invested before D) Customer should provide more information before you can make a suitable recommendation

The best answer is D. It is necessary to get more information about this customer and his definitions of an exciting investment opportunity before making any recommendations. A suitability and risk-tolerance analysis should be performed before a recommendation is made.

A walk-in customer completes the new account form and includes all of the information required by the customer identification program. However, the customer supplies none of the requested financial data and is unwilling to discuss objectives. Under Regulation BI of the SEC, A) opening this account could place the firm in the position of violating Regulation BI. B) the account may be opened, but all recommendations must be suitable based on the customer's situation. C) the account may be opened, but only after receiving SEC approval. D) the account may be opened, but no recommendations may be made.

The best answer is D. The account may be opened, but no recommendations may be made. Regulation BI deals with recommendations from a broker-dealers to its customers. As long as there are no recommendations, the rule does not apply. When the customer refuses to supply the necessary suitability information, the account may be opened, but trading must be limited to unsolicited orders. ** This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback.

Before making any recommendations to a client, basic client suitability information must be gathered. Many suggest beginning with a family balance sheet. Which of the following would be found on that document? A) Expenses B) Salary C) Goals D) Net worth

The best answer is D. Net Worth The balance sheet includes the client's assets and liabilities. From these, the net worth is determined. It is the income statement that contains the salary and expenses. Goals are a nonfinancial consideration.