Unit #4: Regulation of Securities and Issuers

As defined in the Uniform Securities Act, the term "security" would include 1. debentures 2. Keogh plans 3. a preorganization subscription 4. whole life insurance policies that pay dividends to their policyholders A) I and III B) II and III C) II and IV D) I and IV

A) 1 & 3 *It is always easier to remember the things that are not a security—retirement plans, nonvariable insurance policies, collectibles, commodities, condominiums, and currencies.

Each of the following persons is able to issue securities EXCEPT A) an individual B) a credit union C) a corporation D) a partnership

A)An individual *Individuals, (non-natural persons), cannot issue securities. You can't sell stock in yourself.

The USA defines all of the following as securities EXCEPT A) unlisted stock B) debentures C) commodity futures D) U.S. Treasury bills

C) *The term security encompasses a wide range of investments. The best thing is to remember the 6 items that are not securities. Included in that list are commodity futures.

As a federal covered security, the KAPCO Growth Fund is required to notice file under the laws of State A. State A's Administrator can require the issuer to provide copies of A) a report of the amount of the federal covered security sold in the state B) a listing of the officers and directors of the issuer C) the schedule of compensation to the fund manager D) proxy statements

A) A report of the amount of the federal covered security sold in the state. *Because those companies that are required to notice file are levied a fee based on the amount of securities sold in the state, information relating to the amount of sales in the state must be reported.

Which of the following can issue stock? A) A corporation B) The U.S. Treasury C) A city D) A state

A)Corporation *Corporations issue stock. Federal and state governments, including municipalities can issue debt securities, but not equity securities. Even though the Savings Bonds advertisements read, "Take stock in America, buy U.S. Savings Bonds," that is a fiction because you can't buy stock in a government and, of course, buying bonds is lending money.

The U.S. Supreme Court case resulting in the decision than an investment contract is a security is the A) Howey case B) Golub case C) Muller case D) Steiner case

A)Howey case *It was the Howey case in 1946 where the decision ruled that an investment contract meeting the 4 prongs: (1) an investment of money, (2) into a common enterprise, (3) with the expectation of profit, and (4) due to the managerial efforts of others, is a security.

Which of the following is an example of a nonissuer transaction? A) Private placement by an issuer B) Secondary offering by an institutional seller C) Primary issue of corporate stock D) Preemptive rights offering

B) Secondary offering by an institutional seller *Explanation Investors or shareholders routinely receive the proceeds from a secondary transaction. About the only time a secondary offering is an issuer transaction is if the issuer were reselling treasury stock because the proceeds go to the issuer.

Although certain common stocks, known as federal covered securities, are exempt from state registration, the Administrator has the power to request from the issuer all of the following EXCEPT A) copies of the registration statement filed with the SEC B) a copy of the issuer's articles of incorporation C) a contact person located within the state for purposes of legal service D) a consent to service of process

C) Contact person located within the state for purposes of legal service. *The consent to service of process eliminates the need for any local representation for legal purposes.

A securities transaction where there is no benefit to the issuer is called A) a primary transaction B) an issuer transaction C) a nonissuer transaction D) a nonprofit transaction

C) non-issuer transaction. *In a nonissuer transaction, the proceeds do not benefit or go to the issuer directly. In a primary transaction, the proceeds of an underwriting go to the issuing corporation directly.

Fearing loss of a potential sale, an agent omits facts that a prudent investor requires to make informed decisions. Under the Uniform Securities Act, this action is A) fraudulent for nonexempt securities only B) fraudulent for exempt securities only C) not fraudulent if there was willful intent to omit the information D) fraudulent for both exempt and nonexempt securities

D)Fraudulent for both exempt and nonexempt securities. *Material facts are facts that an investor relies on to make investment decisions. The willful omission of a material fact in the sale, purchase, or offer of a security is fraudulent. This applies whether the security offered is exempt or nonexempt.

The Uniform Securities Act would consider which of the following insurance products to be a security? A) Mortgage life insurance B) Modified endowment life insurance C) Fixed annuity D) Variable life insurance

D) *The key is the word variable. Insurance products are excluded from the definition of a security unless the word variable is part of the description. So, variable life and variable annuities are securities—the rest are not.

Under the registration provisions of the Uniform Securities Act, it is unlawful for an agent in the state to sell XYZ securities unless A) XYZ is a federal covered security B) the agent is a nonregistered, nonexempt person C) XYZ is a nonregistered, nonexempt security D) both the agent and XYZ are nonexempt and nonregistered

A) XYZ is a federal covered security. *If XYZ is a federal covered security, it is not required to register with the state. Nonexempt securities and nonexempt persons must be registered to be sold (securities) or to do business (persons).

All of the following may be required of a federal covered security EXCEPT 1. paying a filing fee 2. providing a consent to service of process 3. submitting copies of any information filed with the SEC 4. using a state-sanctioned legend on the offering documents A) I, II, and III B) IV only C) I and II D) II and III

B) 4 only. *Federal covered securities may be required to pay a filing fee, provide a consent to service of process, and if requested, submit copies of any and all documentation filed with the SEC. However, requiring a legend or other similar statement is beyond the jurisdiction of the state on a federal covered security.

A transactional exemption would be available under the Uniform Securities Act when an agent for a broker-dealer A) receives an unsolicited order from a client to purchase heating oil contracts B) sells a large block of an unregistered nonexempt security to an insurance company that is not authorized to do business in this state C) sells a retail client $10,000 of U.S. Treasury bonds D) sells a large block of an unregistered nonexempt security to an individual who meets the definition of an accredited investor

B) Sells a large block of unregistered nonexempt security to an insurance company that is not authorized to do business in this state. *The sale of a security to an institution, such as an insurance company, is considered an exempt transaction. The fact that the company is not authorized to do business in the state only means that its securities would not be exempt, but that does not change the fact that this is a sale to an institution and is, therefore, exempt. The term accredited investor is meaningless here, only institutions qualify for exempt treatment, not rich people. The T-bonds are an exempt security, but the sale to a retail client is not an exempt transaction. Heating oil contracts are a commodity, not a security.

All of the following must be specified in the state registration statement of the security EXCEPT A) the total amount of security that will be offered in this state B) the total amount of the security that will be offered in each state C) a stop order from any other state that affects the offering of the security within that state D) all other states where the security is currently registered or will be registered

B)the total amount of the security that will be offered in each state. *It is not necessary to list the total amount of the security to be offered in all states. However, for filing fee purposes the amount to be sold in this state must be disclosed.

An investment adviser who trades on material nonpublic information is A) generally going to increase the returns in client accounts. B) straddling a commingled arbitrage. C) in violation of the antifraud provisions of the Uniform Securities Act. D) engaging in the unethical business practice known as front running.

C) In violation of the antifraud provisions of the Uniform Securities Act. *Using inside information is a fraudulent act under both state and federal law. Front running, an unethical business practice, is when a securities professional "runs in front" of a client order to take advantage of the impact that client order will have on the security's price. Even if the use of the material nonpublic information increases client returns, the ends don't justify the means.

XYZ Corp. will issue a new security and distribute it through a public offering. Under the Securities Act of 1933, which of the following is NOT required to be included in XYZ's registration statement? A) The name and address of an individual who owns 11% of XYZ's stock B) An estimate of the proceeds that will be raised through the offering and how that money will be used C) The name and address of XYZ's personnel manager D) The identity of the underwriter

C) The name and address of XYZ's personal manager. *A registration statement must contain the identity of owners of more than 10% of the issuer's stock, an estimate of the proceeds and a description of the use to which they will be put, and the identity of the underwriter, among many other things. It must also identify all the issuer's officers and directors, their holdings of the issuer's securities, and their salaries. Because the description of the personnel manager does not use the term officer or director, this employee need not be identified in the registration statement.

Which of the following is NOT an accredited investor? A) Any organization not formed for the purpose of purchasing securities with a net worth in excess of $5 million. B) An individual whose income was greater than $200,000 in each of the 2 most recent years with a reasonable expectation of reaching that level again this year. C) An individual with a net worth, including the value of her primary residence, that is greater than $1 million. D) A registered open-end investment company with net assets of $600,000.

C)An individual with a net worth, including the value of her primary residence, that is greater than $1 million. *An accredited investor can take different forms: an individual with a net worth, excluding the value of the principal residence, greater than $1 million (the $1 million can be joint with spouse); an individual whose yearly income for the past 2 years exceeded $200,000 ($300,000 joint with spouse) with a reasonable expectation of earning that amount this year; and any organization not formed for the purpose of purchasing the securities being offered with a net worth in excess of $5 million. In addition, any registered investment company, bank or insurance company, regardless of size, is included in the definition of accredited investor in SEC's Rule 501.

Which of the following are defined as securities under the Uniform Securities Act? 1. Real estate investment trust certificates 2. Preorganization subscription agreements 3. Shares of treasury stock 4. Voting-trust certificates issued by a corporation undergoing a reorganization A) I and IV B) I, II, and III C) I only D) I, II, III, and IV

D) 1, 2, 3 & 4 *All the choices listed are defined as securities under state law. We believe the best thing for you to do is remember those few things that are not securities.

An agent can sell an unregistered security to one of the firm's retail customers under each of the following circumstances EXCEPT A) if the security being purchased is an exempt security B) if the security being purchased is a warrant to purchase stock that is NYSE listed C) if the agent is not registered in the client's state D) if the transaction is initiated at the request of the customer

C)if the agent is not registered in the client's state. *When engaging in securities transactions with retail clients, agents must always be registered in the state of residence of that client. As long as the agent is properly licensed, if the security being purchased is exempt or it is being purchased in an exempt transaction (such as an unsolicited trade), registration of the security is not required. Federal covered securities, such as those listed on the NYSE, are also exempt from registration. That exemption carries over to warrants and rights issued by that company.

Under the Uniform Securities Act, which of the following would be considered an exempt transaction? 1. An existing client calls his agent with an order to purchase 1,000 shares of a common stock that is not registered in this state 2. At the suggestion of the agent handling her account, a client purchases some U.S. Treasury bonds for inclusion in her IRA 3. Shares of a technology company's IPO are sold to an institutional client 4. Shares of an insurance company's IPO are sold to an individual client A) II and IV B) I, II, III, and IV C) I, III, and IV D) I and III

D) 1 & 3 *A client calling to purchase stock is an unsolicited transaction, probably the most common of the exempt transactions. Any sale to an institutional client is an exempt transaction, whereas those to individuals, unless unsolicited, generally are not. Please note, even though the Treasury bonds are an exempt security, because the transaction was solicited by an agent to an individual client, it is not an exempt transaction.

Which of the following statements made by an investment adviser would violate the anti-fraud provisions of the Uniform Securities Act? A) "We require any associated person determining general investment advice to be a CFA." B) "We believe that fundamental analysis is the best way to select stocks for our clients." C) "We have over $40 billion in assets under management representing both institutional and retail clients." D) "Our fees are nonnegotiable." (when Form ADV Part 2A clearly indicates otherwise)

D)"Our fees are nonnegotiable." (when Form ADV Part 2A clearly indicates otherwise) *Stating an untruth would be considered fraud. If the Form ADV Part 2 says that the fees are negotiable, you can't state that they are not. An adviser may certainly state which method of analysis he thinks is best. A firm can also set whatever standards it wishes, even though none are required by the regulatory bodies. As far as bragging about the amount of AUM, if you've got them, it is okay to flaunt them.

Securities issued by which of the following are exempt from the registration and disclosure requirements of the Uniform Securities Act (USA)? 1. The United States or any territory 2. A state or political subdivision of a state 3. A common carrier (e.g., a railroad) regulated in respect to its rates and charges by the United States or a state 4. Banks and savings institutions A) I and II B) I, II, III, and IV C) II and IV D) II and III

B) 1, 2, 3, & 4. *The Uniform Securities Act exempts all of the securities listed from registration and disclosure requirements. Banks and common carriers are under the regulatory supervision of other government agencies.

All of the following are nonissuer transactions EXCEPT A) Joe Smith sold 100 shares of Apple Computer to his neighbor, Kevin Jones, in a private transaction B) Intel sold 10 million shares of its preferred stock in a private placement transaction to a syndicate of five pension funds C) broker-dealer A sold 5,000 shares of Dell Computer from inventory to broker-dealer B D) Monster Insurance Company sold 10,000 shares of IBM to KLM Investment Bankers, Inc., through INSTINET

B) Intel sold 10 million shares of its preferred stock in a private placement transaction to a syndicate of five pension funds. *When an issuer sells its own securities, it is an issuer transaction. When someone other than the issuer sells securities, it is a nonissuer transaction.

A customer requests information on a new mutual fund and asks her agent to circle the important information in the prospectus and information he thinks will be of special interest to her. This is permitted A) if accompanied by an unmarked prospectus B) under no circumstances C) without restriction D) if approved by a principal

B)under no circumstances *The prospectus is a legal document and may not be altered.

ABC Furniture Company wishes to raise capital by issuing some securities in its home state. The CEO of the company feels that registration with the Administrator is unnecessary because the issue is exempt. Should ABC be ordered to appear at a hearing, the burden of proving its issue is exempt is on A) the hearing panel B) the CEO C) the Administrator D) the company

D) the company In any case where there is a question as to the legality of a specific exemption, the burden of proof is always on the party requesting the exemption.

The primary purpose of the securities registration requirements of the Uniform Securities Act is to ensure that proper disclosure is made available to potential investors. However, not all securities are required to register. Which of the following qualify for an exemption from registration under the act? A) Common stock issued by life insurance companies authorized to conduct insurance sales in that state B) Commercial paper with no more than 9 months to maturity that is in 1 of the 3 highest ratings by a nationally recognized rating agency and in a minimum denomination of $10,000 C) Equipment trust certificates issued by railroads whose rates are not subject to regulation by a state or federal agency D) Bonds that are obligations of the People's Republic of North Korea

A) *A security issued by a life insurance company issuing stock in a state in which the company is authorized to conduct its insurance business is exempt from registration. Railroads under the jurisdiction of other state or federal regulators carry an exemption from state securities registration for their equipment trust certificates, but if the railroad is not regulated (the case here), the exemption does not apply. The commercial paper would qualify if the denomination was $50,000 instead of $10,000. The exemption for foreign government securities only applies to those countries with which the United States maintains diplomatic relations. At the time of this writing, North Korea is on a very short list of countries who do not qualify.

The Uniform Securities Act grants exemptions to the securities of a number of issuers. If you were the Administrator, which of the following securities would NOT be eligible for an exemption in your state? A) Debt securities issued by the ABC Savings and Loan Association, organized under the laws of a neighboring state, but not authorized to do business in your state B) Equipment trust certificates issued by a regulated common carrier C) Bonds issued by the Province of Alberta D) Common stock issued by the XYZ Trust Company, organized under the laws of a neighboring state, but not authorized to do business in this state

A) Debt securities issued by the ABC Savings & Loan Association, organized under the laws of a neighboring state, but not authorized to do business in your state. *Any issue from a state or Canadian province is always exempt. Equipment trust certificates issued by any regulated common carrier are always exempt. Banks, savings institutions, and trust company securities are also exempt as long as they are organized under the laws of the United States or any state. However, securities issued by a savings and loan or building and loan are only exempt if the issuer is authorized to do business in this state.

Under the Uniform Securities Act, all of the following conditions must exist in order for a private placement to be considered an exempt transaction EXCEPT A) noninstitutional clients must not make payment for their purchases B) broker-dealers and their agents must reasonably believe that noninstitutional clients are buying the securities for investment purposes and not for resale C) commissions may not be paid to sales agents of the broker-dealer offering the securities to noninstitutional clients D) the offer must be directed to no more than 10 individuals during any 12-month period

A) Noninstitutional clients must not make payment for their purchases. *For a private placement to remain an exempt transaction under the Uniform Securities Act, the offer may be directed to no more than 10 individuals during any 12-month period. Additionally, no commissions may be paid to agents of the offering broker on sales to noninstitutional buyers, and there must be reasonable belief that the purpose in buying the securities by noninstitutional clients is for investment rather than resale purposes. However, just as with any other securities purchase, payment must be made in accordance with industry standards.

Under the Uniform Securities Act, a nonissuer transaction is A) an initial public offering of common or preferred stock B) the issuance of mutual fund shares C) a Regulation D private placement sale of limited partnership interests D) the purchase and sale of shares of common stock on the CHX

D) The purchase and sale of shares of common stock on the CHX. *Explanation In a nonissuer transaction, the proceeds do not flow to the issuer; rather, the proceeds are credited to selling shareholders. A secondary market trade, such as a transaction executed on the floor of an exchange, is a nonissuer transaction. An IPO, the purchase of mutual fund shares, and the purchase of limited partnership interests all benefit the issuer and are called issuer transactions.

Which of the following would NOT be included in the definition of a security under the Uniform Securities Act? A) Debentures issued by the XYZ Retirement Planning Company B) Preferred stock in the Colonel Corn Processing Corporation C) Common stock in the Shining Silver Mining Company D) Whole life insurance policies issued by the Dividend Mutual Life Insurance Association of America

D) Whole life insurance policies issued by the Dividend Mutual Life Insurance Association of America. *Nonvariable contracts issued by insurance companies are not securities.

Which of the following would be considered an issuer transaction as defined in the Uniform Securities Act? A) In its capacity as a market maker, LMN Securities Co. sells 200 shares of GEMCO common stock to the corporate treasurer of GEMCO, buying for the company's investment account. B) Barb, the largest shareholder in XYZ Corporation, purchases an additional 50,000 shares on the NYSE. C) Ken, the largest shareholder in ABC Corporation, sells 100,000 shares in a registered secondary transaction. D) GEMCO, traded on the Nasdaq Stock Market, sells 5,000 shares of its stock to LMN Securities Co., a registered market maker in GEMCO stock. The stock was donated to GEMCO by a former officer of the firm.

D)GEMCO, traded on the Nasdaq Stock Market, sells 5,000 shares of its stock to LMN Securities Co., a registered market maker in GEMCO stock. The stock was donated to GEMCO by a former officer of the firm. *An issuer transaction is one in which the issuer receives the proceeds of the sale. When GEMCO sold those donated shares to the market maker, the proceeds were received by the issuer (GEMCO). When stockholders sell their shares, they are the ones who receive the money, not the issuer. Purchases are never considered issuer transactions because the money is going out, not coming in.