SIE29

Pump and Dump

A form of securities fraud commonly known as pump and dump is the act of inflating (pumping) the price of an owned stock by perpetuating false and misleading positive rumors, in order to sell the stock at a higher price later. Generally, the shares owned are first accumulated at a lower price before the misleading information is doled out to the investing public. After the stock price rises due to the frenzied buying caused by the rumors, the operators of the scheme then sell (dump) their overvalued shares to the open market. The fraudsters profit while the selling pressure associated with dumping drives the price downward, causing investors who purchased based on rumors to lose their money.

Trusted Contact Person

A reasonable effort to obtain the name and contact information for a trusted contact person must be made when -opening a customer's account, or -updating the account information for an existing account Importantly, it should be noted that the member firm is not prohibited from opening an account when the customer fails or refuses to provide the information, so long as the member firm took reasonable efforts to obtain such information. Asking the customer to provide the name and contact information for a trusted contact person constitutes a reasonable effort. When the customer has provided the name and contact information for a trusted contact person, the member firm must disclose in writing to the customer that the member or an associated person is authorized to contact the trusted contact person and disclose certain information about the customer's account. FINRA notes that the trusted contact person is intended to be a resource for the member firm in administering the customer's accounts, protecting assets, and responding to possible financial exploitation.

Trade Confirmations and delivery requirements

A trade confirmation is a printed document that confirms a trade, its settlement date, and the amount of money due from or owed to the customer. For each transaction, a customer must be sent or given a written confirmation of the trade at or before the completion of the transaction -- the settlement date. The trade confirmation includes the following information: -Trade date -- day on which the transaction is executed (the settlement date is usually the second business day after the trade date) -Account number -- branch office number followed by an account number -RR internal ID number (or AE numbers) -- account executives's identification number -BOT (bought) or SLD (sold) -- indicates a customer's role in a trade -Number (or quantity) -- number of shares of stock or the par value of bonds bought or sold for the customer. -Description -- specify security bought or sold for the customer -Yield -- indicates that the yield for callable bonds may be affected by the exercise of a call provision -CUSIP number -- applicable Committee on Uniform Securities Identification Procedures number, if any -Price -- Price per share for stock or bonds before a charge or deduction -Amount -- price paid or received before commissions and other charges; also called extended principal for municipal securities transactions -Commission -- added to buy transactions; subtracted from sell transactions completed on an agency basis. Note: Commission will not appear on the confirmation if a markup (or markdown) has been charged in a principal transaction. -Net amount -- obtained on purchases b adding expenses (commissions and postage) to the principal amount -Whether the transaction is a purchase or sale, interest is always added whenever bonds are traded with accrued interest (interest that hasn't been paid yet but will be owed to the seller up the settlement date) Finally, the confirmation must also show the capacity in which the BD acts (agency or principal) and the commission in cases where the BD acts as an agent.

All of the following are true of prohibited activities except

A) FINRA has published a list of all the prohibited activities. B) the use of manipulative devices is on FINRA's list of prohibited activities. C) the improper use of customer assets is on FINRA's list of prohibited activities. D) the use of fraudulent devices is on FINRA's list of prohibited activities. Answer is A E: There can never be a complete list of all the ways to cheat people. If it looks like lying, cheating, or stealing, don't do it.

The penalties for trading on insider information include civil penalties up to treble damages. up to $1 million for registered representatives or broker-dealers. criminal penalties up to $25 million for broker-dealers. jail time up to 30 years.

A) I, II, and III B) III and IV C) I and IV D) I and II Answer is A E: The penalties are stiff. Regulators really don't want people trading on inside information. However, the maximum prison sentence is 20 years, not 30

A restricted person in the issuing of new securities under Rule 5130 would include all of the following except

A) a roommate of a registered representative. B) a portfolio manager buying for a portfolio she manages. C) a registered representative buying for his own account. D) a broker-dealer buying for its own account. Answer is B E: Portfolio managers buying for portfolios they manage is ok but not their own account. Other people in the industry and those supported by or under the support of those in the industry would be prohibited. Because roommates of a registered representative would be codependent, they would also be prohibited.

A form of market manipulation that attempts to hold the price of the security down is called

A) churning. B) free riding. C) capping. D) supporting. Answer is C E: This can be done by shorting the stock to push the price down. It is illegal if it is used to manipulate the market.

There are a number of prohibited actions that can be considered market manipulation. One of them that is primarily used by investors who have written call option contracts is

A) supporting. B) pegging. C) front running. D) capping. Answer is D E: Capping is the act of entering sell orders in a stock for the purpose of keeping the stock from rising. This would be an attempt to keep calls one is short from being in the money and exercised.

Account Statements and delivery requirements

Account statements provided to customers give a general accounting of securities and cash held in the account. A statement shows: all activity in the account since the previous statements; securities positions, long or short; and account balances, debit or credit If a customer's account has a cash balance (known as a free credit balance), the firm may hold it in the account. However, the statement must advise the customer that these funds are available on request. Under FINRA fules, members are required to send statements to customer at least quarterly. If penny stocks are held in the account, a statement must be sent that month. ***ACTIVITY is defined as purchases, sales, interest, or dividends received, or any funds flowing in our out of the account. Penny stocks are any stocks under $5.*** Finally, account statements must include a statement advising customers to promptly report any discrepancy or inaccuracy to their brokerage firms and clearing firms.

Restricted person - Rule 5130 continued

Any immediate family member of any natural person of those listed above are also restricted. Finally, there is a de minimis exemption. If the beneficial interests of restricted persons do not exceed 10% of an account, the account may purchase a new equity issue. In other words, restricted persons will be able to have an interest in an account that purchases new equity issues as long as no ore than 10% of the account's beneficial owners are restricted.

Problematic Activities

Anytime that funds or securities of a customer are used in a way other than was intended by the customer, improper use has occurred. All such uses are prohibited. FINRA expects member firms to detect or investigate "red flags" that alert the firm to improper use of customer funds. Exception reports may be generated to indicate red flags, such as conflicting information in new account applications and suspicious transfers of funds between unrelated accounts. The BD is expected to implement reasonable systems and controls regarding the supervisory review of customer accounts to thwart, among other things, the falsification of new account applications and other records to take advantage of vulnerable customers. There is no end to the number of red flags and combinations of red flags, but a very small sampling might include: -suspicious activity involving transfers and disbursements in customer accounts. -activity in the account of a deceased person -excessive customer complaints -exception reports showing discrepancies regarding more than one address or a street address not matching a city or ZIP code provided or a telephone area code not matching an address provided.

Account Statements and Trade Confirmations

BDs communicate and verify activity in a customer's account via account statements and trade confirmations. While they may appear different from one BD to the next, there is uniformity required regarding the information provided and the time frames for delivery.

Guarantees and sharing in customer accounts

BDs, investment advisers, and RRs may not guarantee any customer against a loss or guarantee a gain. All such guarantees or anything intended to convey a guarantee is prohibited. Member firms and reps are prohibited from sharing in profits or losses in a customer's account. Unless a joint account has received the member firm's prior written approval and the RR shares in the profits and losses only to the extent of his proportionate financial contribution to the joint account. Can only be measured in dollars. The firm, however may share in a loss if the loss was due to an error made by the firm. Exceptions to the proportion rule are made when sharing in a joint account with immediate family members. In these instances, directly proportionate sharing of profits and losses is not mandatory. Immediate family members include parents, mother/father in law, spouses, children, and any relative to whom the officer or employee in question contributes financial support. Financial support is broadly defined to include anyone who is living in the same residence. **Firms can't have joint accounts with customers.***

Marking the close and marking the open

Entering trades before the opening (or at or near the close) solely to manipulate the reported price of a where a stock will open or close is prohibited. Marking the open -- Entering orders before the opening for a stock or falsely reporting trades that never occurred to influence the opening price of a stock is called marking the open. Marking the close -- Effecting trades at or near the close of the trading day or falsely reporting trades that never occurred to influence the closing price of a stock is called marking the close.

Excessive Trading (Churning)

Excessive trading in a customer's account to generate commissions rather than to help achieve the customer's stated investment objective is an abuse of fiduciary responsibility known as churning. Excessive frequency or excessive size of transactions not in keeping with the client's trading history or financial ability are often signs of churning. To prevent such abuses, SROs require that a principal of the member firm review all accounts especially those for which an RR or an investment Adviser has discretionary authority.

Electronic Delivery

FINRA allows members to electronically send documents, such as confirmations and account statements, to customers as long as certain conditions are met. To do so, the firm must have procedures in place to show that the information sent has been delivered as intended and that the confidentiality and security of personal information are protected. Further, customers must provide written consent to electronic delivery. In addition, a customer who consents to receive information and documents electronically must be provided with the information in paper form, upon request.

Name the special concerns and expectations when serving senior clients

FINRA, along with other regulators, specifically addresses the financial exploitation of seniors and other specified adult customers. FINRA defines the impacted accounts as those for individuals: age 65 and older or age 18 and older, whom the member reasonably believes has a mental or physical impairment that renders the individual unable to protect her own interests FINRA notes financial exploitation to be -the wrongful or unauthorized taking, withholding, appropriation, or use of funds or securities -any act or omission of an act taken by a person to obtain control, through deception, intimidation or undue influence, over the specified adult's money, assets or property; or convert the specified adult's money, assets, or property This includes any act aligning with the previous, done through the use of a power of attorney, guardianship, or any other authority. Essentially, to prevent potential exploitation, the rules regarding the accounts of seniors and other specified adult customers do two things: 1. Member firms and associated persons must make "reasonable efforts" to obtain the name and contact information for a trusted contact person. 2. Member firms will be permitted to, but not required to, place temporary holds on customer accounts when there is a reasonable belief of financial exploitation.

Nontrade Confirmations/Third-Party activity notices

Firms are required to send confirmations of activity in accounts even when the activity is not trade related or initiated by a third party. The following are three examples of such instances where a confirmation of third-party activity would be generated. Example 1) Customers with a foreign bank account may from time to time wire money from the foreign country back to a brokerage account in the United States (or the reverse). When the funds are credited (or debited) to and from the account, a confirmation of the deposit/withdrawal is sent. Example 2) When a deposit (or withdrawal) of a stock certificate is made, this is an activity that is not trade related. The customer receives a confirmation of activity. Example 3) A customer with an outside money manager handling some of the customer's money may execute through a BD where the customer has an account and the manager withdraws his fee quarterly in advance. Each time a fee is taken, a confirmation is sent from the BD indicating that specific "third-party activity" occurred and was logged.

Freeriding

Freeriding is a term used when securities are purchased and then sold before making payment for the purchase. Freeriding is generally prohibited in both cash and margin accounts. As a penalty, the account will be frozen for 90 days, and no new transactions can occur unless there is cash or marginable securities in the account before the purchase is made.

Front Running

Front running is the act of placing orders for one's own account ahead of other orders that are known to be entering the market in an attempt to gain from the price movement that is likely to occur.

Temporary holds on disbursements and review

If the member firm reasonably believes that financial exploitation has occurred, is occurring, has been attempted, or will be attempted, it can place a temporary hold on disbursements of funds or securities. Note that the rule does not require the member firm to take this action, but allows it to do so at its discretion. The hold can be no longer than 15 business days under the rule. A state regulator or agency of jurisdiction, however, can terminate the hold sooner, or extend the hold longer. If a member firm places a temporary hold on disbursements, it must immediately initiate an internal review of the facts and circumstances that caused the member to initiate the temporary hold on the disbursements. In addition, the rule requires the member to provide notification of the hold and the reason for the hold to the trusted contact person and all parties authorized to transact business in the account, no later than 2 business days after the date the hold was initiated. However, a member firm is not required to provide notification to the trusted contact person or a party authorized to transact business in the account, if the trusted contact person or party is unavailable or the member reasonably believes that the trusted contact person or party is the perpetrator of the financial exploitation.

Matched Orders

Matching orders is a manipulation that involves one party selling stock to another with the understanding that the stock will be repurchased later (usually same day) at virtually the same price. The intent of such transactions is to make it appear that far more activity in a stock (share volume) exists than it actually does. This is sometimes called PAINTING THE TAPE.

Market Rumors

Misleading information or rumors can be used for the sole purpose of manipulating the price of a stock up or down. The spreading of false information and market rumors by industry personnel is expressly prohibited. Regulators have issued alerts to warn investors about fraudsters who may or may not be securities industry persons, attempting to manipulate share prices by spreading false or misleading information about stocks. For example, while social media can provide many benefits for investigators who want to research potential investments, it also presents opportunities for fraudsters. Through SM, fraudsters can spread false or misleading information about a stock to large numbers of people with minimal effort and at a relatively low cost. They can also conceal their identities or even impersonate credible sources of market information. SM platforms that might be used in this way would include online bulletin boards, email blasts, and internet chat rooms.

Market Manipulation

No security is exempt from the industry's antifraud provisions. This means that fraud or market manipulation cannot be involved in the trading of any security. The following are a number of prohibited trading practices, because they are all meant to manipulate the markets and deceive the market participants.

Rule 5130 - restricted persons

Rule 5130 ensures that Members make a bona fide public offering of securities at the public offering price (POP) Members do not withold securities in a public offering for their own benefit or use such securities to reward persons who are in a position to direct future business to the member and Industry insiders, such as members and their associated persons do not take advantage of their insider status to gain access to new issues for their own benefit at the expense of public customers. The rules apply to IPOs of common stock. The rules prohibit member firms from selling a new issue to any account where restricted persons are beneficial owners. Before selling an IPO to any account, representatives are required to obtain a written representation from the account owner/s that the account is eligible to purchase a new common stock issue at the POP. Restricted persons, those not allowed to purchase shares at POP, are defined as: -member firms (whether or not they are involved in the IPO) -employee of member firms -finders and fiduciaries acting on behalf of the managing underwriter, including attorneys, accountants, financial consultants and so on. -portfolio managers, including any person who has the authority to buy or sell securities for a bank, savings and loan association, insurance company, or investment company -any person owning 10% or more of a member firm.

Insider Trading

Securities Exchange Act of 1934 prohibited the use of insider information in making trades. Under the act, the penalties for insider trading were up to $5,000 in fines. The Insider Trading and Securities Fraud Enforcement Act of 1988 (Insider Trading Act) amended its provisions and specified significant penalties for insider trader and securities fraud. All BDs must establish written supervisory procedures specifically prohibiting the misuse of inside information.Additionally, they must establish policies that restrict the passing of potentially material nonpublic information between a firm's departments. This barrier against the free flow of sensitive information is known as a firewall or an information barrier. The Insider Trading Act defines an insider as any person who has access to material nonpublic information about a company. Material information is information that would most likely influence the price of the company's stock. Utilizing that information for the purpose of gain, or to avoid a loss, constitutes insider trading. Possession of inside information is illegal. It is the use of such information to make a gain or avoid a loss that constitutes insider trading. ***Inside information, by definition, is any material nonpublic information -- that is, any information that has not been disseminated to, or is not readily available to the general public.

The Insider Trading Act

The Act prohibits insiders from trading on or communicating nonpublic information. Both the TIPPER and the TIPPEE are liable, as is anyone who trades on information that they know or should know is not public or who has control over the misuse of this information. The key elements of tipper and tippee liability under insider trading rules are as follows: Is the information material and nonpublic? Does the tipper owe a fiduciary duty to a company or its stockholders? Has he breached it? Does the tipper meet the personal benefits test? does the tippee know or should the tippee have known that the information was inside or confidential?

Bounties

The Insider Trading Act specifically allowed for payment to informers. However, amended under the Dodd-Frank legislation, awards may now be paid in connection with original information concerning any violation of securities law, including insider trading. The information bounty or award can range from 10% to 30% of amounts recovered, based on the information received.

Penalties for Insider Trading

The SEC can investigate any person suspected of violating any of the provisions of the insider trading act. If the SEC determines that a violation has occurred, civil penalties of up to 3 times the profits made or losses avoided may be levied. A controlling person. such as an RR or BD, could be fined $1 million or three times the profit made or loss avoided, whichever is greater. Violators may also face criminal penalties of up to $5 million and up to 20 years in jail. If the violator is an employee of a BD, the firm (which is supposed to have procedures in place to prevent this) could be fined up to 3 times damages or $25 million, whichever is greater. ***Persons who enter trades at or near the same time (but on the other side of the market) in the same security as a person who has inside information are known as contemporaneous traders. These traders may sue persons that have violated insider trading regulations, and suits may be initiated up to five years after the violation has occurred.***

Borrowing from or lending to customers

The most common examples of misuse might be in the form of borrowing or lending even with consent. Note that borrowing without consent is indistinguishable from stealing. Taking (borrowing) a customer's funds for either the firm's or the representative's own use is prohibited. Lending a customer's securities for the purpose of short sales when no loan consent agreement has been signed by the customer is another way in which improper use might occur. Borrowing and lending arrangements can be permitted under certain circumstances. Firms that permit lending arrangements between reps and customers must have written procedures in place to monitor such activity. Registered persons who wish to borrow from or lend money to customers are, in most cases, required to provide prior written notice of the proposed arrangement to the firm, and the firm must approve the arrangement in writing. The Conduct Rules permit the following 5 types of lending arrangements: 1. There is an immediate family relationship between the rep and the customer (no notice or approval is needed) 2. The customer is in the business of lending money (a bank, no approval is needed) 3. The customer and the reps are both registered persons with the same firm (firm approval required) 4. The customer and the rep have a personal relationship outside the broker-customer relationship (firm approval required) 5. The customer and the rep have a business relationship outside the broker-customer relationship (firm approval required.) ***A reps BD must have procedures in place allowing for borrowing or lending arrangements with customers. If the firm does not allow for such arrangements, then a representative may not enter into such an arrangement.***

Updating customer account records

To ensure that the information obtained from each new customer is accurate, firms must furnish to each customer, within 30 days of opening the account, a copy of the account record. The firm must include a statement that the customer should mark any corrections on the record and return it along with a statement that the customer should notify the firm of any future changes to information in the account record so that accurate and current records can be maintained. If the customer should ever contact the firm with any changes, the firm must furnish the customer with an updated account record within 30 days of receipt of the notice to change. Further, this account updating must occur at least every 36 months thereafter.