Series 6 Study Guide
Post 12 of 13
- 1.1 Reaching out to current and potential customers
- 1.2 Describing to potential and current customers
- 2.1 Provides information about the different account types
- 2.2 Secures customer information/documentation and looks out for suspicious activity
- 2.3 Tries to secure investment profile information regarding the customer
- 2.4 Opening accounts and the supervisory approval
- 3.1 Give customers details regarding strategies for investment
- 3.2 Studies and scrutinizes the investment profiles of customers
- 3.3 Highlights various disclosures to customers about investment products
- 3.4 Keeps customer records
- 4.1 Gives current quotes
- 4.2 Confirmation for customer transactions in line with all regulatory requirements
- 4.3 Tell relevant superior and help with the solution to any customer complaints
Post 12 of 13 in the Series 6 Study Guide
Order tickets: Required information
When it comes to order tickets, there’s certain information that needs to be present.
This is filled in each time that a representative takes on a buy or sell order from a customer.
If it’s a sale, the representative has to make sure that the customer can either deliver the securities or pay for the purchase before they are allowed to process the order.
The associated person that is taking the trade will need to be marked on the brokerage order ticket as well.
Whether the trade is unsolicited, solicited, or made under discretionary authority must also appear on the ticket as well as the time the customer places the order with the broker-dealer.
Execution is the next step that’s carried out.
This sees the order placed with the trading department.
In doing so, the representative must make sure that the following information is found on the order ticket:
- Buy or sell
- The securities name
- The number of shares or bonds to be traded
- Account name
- Account number
- The type of account (is it a cash or margin account, for example)
- Price and time limits that are in play (if there are any)
- If the trade is solicited or unsolicited
- Was there any discretionary authority on the trade or not
- Times stamps for when the trade was entered, executed, changed, or canceled
An execution report will also need to be filled out when the trade is completed.
It’s critical to note that the account name and number are always on an order ticket.
Mistakes can be made here and if they are, only a principal or branch manager’s approval can allow for a correction to be made, for example, changing a digit on the account number to reflect the right number.
Records of any changes that do take place must be kept for a three-year period.
Dates and terms for transaction settlement
Let’s talk a little about the settlement date.
This is when the security moves from the seller to the buyer.
In other words, the ownership of the security will change hands on the settlement date.
The relevant exchange of the securities (and funds) involved in the transaction is exchanged by the broker-dealers involved.
The customer is involved too.
They either have to deliver the securities someone has bought from them, or pay to ensure those that they bought are then delivered to their account.
No matter what the settlement type, you can find all the standardized dates and times for them laid out in FINRA’s Uniform Practice Code (UPC).
This provides explanations, rules as well as interpretations that attempt to make settlements uniform in nature, wherever possible.
The idea behind it was to ensure that transactions are simplified and ensure that there is a method by which they can be facilitated easily on a day-to-day basis.
Also, in doing so, the UPC aims to eliminate misunderstandings and business disputes that may arise regarding settlements in the transactions of securities while free and open market mechanisms are improved where necessary.
Now let’s talk about various settlement options beginning with regular way settlement.
This is a method of settlement that occurs extremely often in the world of securities and it’s just assumed that most people know what it means.
Let’s just recap what a regular way settlement for a transaction entails.
When securities are traded under a regular way settlement, following the trade, that settlement will take place T+2.
That means it’s on the second business day after the trade has taken place that settlement will occur.
In a situation where two parties have never carried out a transaction between each other, they will know the procedures to follow and their responsibilities thanks to the fact that it is outlined in the UPC.
Of course, transactions take place outside of this method.
When that happens, there are elements that always need to be considered.
These include the type of security as well as time, delivery, place, and other factors.
At the time of the trade, if any nonregular aspects will be part of the transaction, this must always be disclosed.
What happens if a regular way delivery was expected, but that’s not how the transaction turned out?
Well, there are options.
The delivery can be accepted as is, which is the decision of the buyer alone or it can be rejected.
This happens when it has turned into a losing proposition before delivery has taken place and the process is commonly called rejection.
If we compare U.S. government securities to agency or corporate securities, a regular way settlement is a little different and this is something you should note.
Instead of the settlement being T+2, it now is T+1.
That means it’s on the first business day after the trade has taken place that settlement will occur.
There’s no settlement when it comes to mutual funds, that’s because the settlement for these takes place whenever their next net asset value (NAV) is calculated.
Also, remember that mutual funds are primary market transactions.
Next, we look at cash settlements.
When a trade has a cash settlement, the time frame is a little shorter.
On the same day the trade is executed, the seller must deliver the securities and the buyer must make the payment.
Should the trade be carried out before 2.00 pm ET, the settlement takes place no later than 2.30 pm ET.
The settlement will be due 30 mins after the trade occurs for any time a trade takes place after 2.00 pm ET.
Cash settlements are not the norm and so if a client would prefer one, they must make a request at the broker-dealer.
For the exam, trades are always regular way settlements unless the question states otherwise.
The date customers must pay for any securities that they purchase is specified in Regulation T of the Federal Reserve Board.
This specifies that two business days after settlement, the payment for the transaction will be due.
That means that four business days after the trade date, a customer payment will be due if the trade was a regular way trade.
When a Regulation T payment is in effect, it is sometimes called a settlement plus two (S+2).
This can be a bit confusing, so let’s look at an example.
Let’s say that Frank has bought 100 shares of ABC Company stock.
He did this on a Monday and it was a regular way settlement.
That means that T+2 would see settlement due on Wednesday.
Frank, however, doesn’t settle on Wednesday and this means that the broker-dealer can step in and take action.
Should Frank still not have paid on Friday, which takes in the Regulation T aspect of S+2 (or T+4), the broker-dealer is required to take action according to regulations.
Extensions are possible should the time limit as outlined by Regulation T come and go.
This extension must be asked for from the designated examining authority (DEA) by the broker-dealer.
The request will also have to be made before the deadline is reached.
Should the extension not be given, or if it is given and the customer still doesn’t pay, a closeout transaction, in which the broker-dealer will sell the relevant securities, takes place.
Following that, a freeze is placed on the account for a 90-day period.
That means for a buy transaction to be executed, the frozen account will have to have enough cash in it.
The account won’t be frozen by the broker-dealer should the payment required be $1,000 or less.
Essentially, if a regular way settlement is in place, customers are expected to settle by the second day.
All Regulation T does is provide a two-day grace period.
This allows the broker-dealer to sort out any hassles a customer might be having in terms of payment, or, as we have seen, request an extension.
Should you see a question in the exam that mentions settlement date duration, it will always be a regular way or cash settlement (it should be specified in exam question).
If there are Regulation T aspects involved when it comes to the settlement, this will be mentioned in the question as well.
Open order adjustments
When a stock goes ex-dividend, some orders that are found on the order book will be reduced.
Determined by the amount of the distribution, the stock price will open lower on the ex-date.
That means that all orders entered on the ex-date below the market are reduced.
Remember that when the new owner of the stock does not qualify to receive the current dividend, that’s known as the ex-date.
Buy limits, sell stops and sell stop limits are all the orders that will be reduced by the dividend amount.
Do not reduce instructions (DNR)
Sell stop order prices as well as those of open buy limits must first be reduced by the dollar amount of the dividend.
This won’t happen, however, if they have a do not reduce (DNR) instructions attached to them.
If they do have a DNR order, it’s on the morning of the ex-date that these orders would then be executed
Stock split and stock dividend adjustments
In the case of a stock dividend or stock split, there will be an adjustment in those orders that have not yet been executed.
This will ensure that from the point it was placed, the integrity of said order is maintained.
Here is an example.
Let’s say that a customer wants to buy 100 shares of Mignel Corporation shares.
These are priced at $40 per share.
Before the order goes through, Mignel Corporation opts to split its stock at 2:1.
This means that the order needs to be adjusted and will now see 200 shares purchased at $20 per share.
For a stock dividend, the same would be true.
For example, should a 20% stock dividend be declared by Mignel Corporation, the initial buy order (100 shares of stock at $40 per share) would be adjusted.
It would now be 120 shares of Mignel stock costing $33.33. per order.
We reached this figure by taking the initial 100 shares and multiplying them by 1.2 (an increase of 20%). which resulted in 120 shares being purchased.
Divide $4,000 by 120 to get the share price of $33.33.
$4,000 is the constant value in all the transactions and adjustments carried out, it should be noted.
Report of execution
When a trade is executed, the registered representative will receive a report that it has been carried out.
The first step after this is to take the order ticket and check it against this report of execution to see that the customer’s requests for each specific trade were carried out to the letter.
Should that be the case, it is the duty of the registered representative to then report to the customer that the trade has been executed as they requested.
But what happens if there is an error when they check the execution report against the order ticket.
Trade reports that are incorrect
If an error is picked up on the execution report as opposed to the orders from the customer on the order ticket, this should immediately be reported by the registered representative.
To do this, the principal or the branch office manager of the member firm must be alerted as soon as possible.
That’s because many changes that may need to be made – for example, if the account number on the ticket needs to be changed – will require specific approval from a manager.
In some cases, it’s the trade details that might be incorrectly reported to a customer.
The actual trade in this situation, however, will remain binding on the customer.
The trade won’t be binding if it is executed outside of the instructions of the customer, however.
What’s the exact process for reporting an error?
Well, the member firm will have someone whose role it is to receive all error reports.
So they should be informed of all errors that a registered representative might come across.
Note that for the member firm, the person in this position will either hold a principal’s license or be in a manager position.
Reports cannot just be made verbally either.
That’s because there are strict record-keeping requirements that FINRA has for these reports.
So, for a start, they have to be in writing.
Also, there is a specific period of time for which they will need to be kept and that period is three years.
This falls under FINRA’s general record retention rules.
Firms often assign their own generic names to these error reports and thats’ fine as FINRA doesn’t require a specific name.
So depending on who the registered representative works for, you will find that these reports are called anything from error reports to trade correction reports (as an example).
Trading practices that are considered unethical
When an artificial market for a stock is portrayed in transactions, you’ve reached a point where the trading practices followed are unethical.
In this section, we are going to look at various types of trading practices that regulatory authorities do not allow.
We will start with painting the tape.
This occurs in a situation where stock is traded between two parties.
The intention, however, is that later in that trading day, the original seller will buy the stock back from the party that bought it at around the same price.
The main idea behind painting the tape is to show that the stock is active when in reality, it’s not as active as portrayed by the buying and selling back and forth.
Next, we have marking the close.
In an effort to influence the closing price of a stock, when a member firm either effects trade or falsely reports them, this is known as marking the close.
Again, this is strictly prohibited.
Here’s an example that involves a proprietary trader at a member firm.
Each quarter, they will receive bonuses based on the firm’s trading account profits.
So let’s say that at the end of the second quarter of the year (June), at 3.55 pm ET, numerous small buy orders are entered in the securities where long positions are already held.
This can be seen as a marking the close attempt so that the prices of the securities go up slightly as the trading day comes to an end.
This will then reflect in paper profits on the account and because it is at the end of the quarter, the proprietary trader will receive extra compensation because of it.
The next prohibited activity is payments used to influence market prices.
This relates to a member firm paying for mentions, articles, or favorable reviews in financial publications as a way to try and influence the price of any securities they deal with.
When it comes to paid advertisements that are placed by the member firm, these will not be considered as a prohibited activity but must be marked accordingly.
Then we have the spreading of false information.
No misleading information can be spread by member firms or any of the representatives that work for them, particularly when it will influence the price of a certain stock.
Another prohibited activity is front running.
This happens when a registered representative has knowledge that the general public won’t have regarding a large block order that will see stock either bought or sold.
Front running is the act of placing a buy or sell order in front of the block order, usually from a personal account.
For example, when a large block order to sell will see the price of shares drop, the representative first sells their shares in the stock before the block order goes through.
Or if they don’t own any shares in the stock and a large buy block order will see the stock price rise, they place their own buy order first.
In that way, they can purchase the stock at a cheaper price, and when the block order goes through and the price rises, sell the stock they’ve purchased to make a profit.
But how many shares would a block order constitute?
Well, according to the regulations, it is 10,000 or above.
Insider trading is perhaps the most well-known of all the activities prohibited by regulatory authorities.
There’s even an Insider Trading Act that outlines various penalties for this prohibited activity.
But what is insider trading?
Well, it’s when a profit is made or a loss avoided thanks to a person having material nonpublic information at their fingertips.
And an insider has a specific definition under the law.
When someone has material nonpublic information access about a company, they are considered to be an insider.
More often than not, this is someone that works for the company.
When information can influence the stock price of that company, it is considered to be material information.
Under the Securities Exchange Act (1934), no trades may be carried out as a result of the insider information on hand.
Initially, fines for carrying out insider trades were very low but all this changed in the 1980s when millions could be made by those trading having knowledge of material nonpublic information.
In fact, before the changes occurred, these fines were simply seen as a relevant business cost to those carrying out insider trading.
In 1988, this all changed, however, specifically through the Insider trading and Securities Fraud Enforcement Act, also known as the Insider Trading Act which amended certain provisions and changed penalties when it came to securities fraud as well as insider trading.
Broker-dealers are tasked with having specific written supervisory procedures when it comes to insider trading and the misuse thereof.
That’s not all, however.
There must be policies in place when it comes to material nonpublic information to ensure that it cannot be passed between various departments in a member firm.
These procedures that stop this are commonly known as an information barrier or sometimes a firewall (but don’t get confused with the firewall that’s associated with information technology, although they both do protect information).
Those that have inside information are not doing anything illegal.
It’s illegal when they act on it to either avoid a loss or make a gain.
That’s considered to be insider trading.
When it comes to trading on or communicating nonpublic information, there are two parties that the Insider Trading Act covers.
The first is the tipper.
This is the person that has the nonpublic information and relays it to other parties.
Those parties, it could be one person or more, are known as the tipee.
Both are liable should the regulations regarding insider trading as set out in the Insider Trading Act be broken.
The liability of these two parties under the rules governing insider trading relate to the following key elements:
- Is the information that was shared considered to be material and nonpublic?
- Is there a fiduciary duty by the tipper to the company and the stockholders pertaining to the information? Has that fiduciary duty been broken as a result of sharing said information
- Are the requirements of the personal benefit test met by the tipper?
- If the information was confidential and considered to be nonpublic material information, should the tipee know or have known that?
What are the penalties that are associated with insider trading?
When any person is suspected of insider trading, the SEC has the authority to investigate them.
Should a violation have occurred, there are various punishments at their disposal.
For example, civilian penalties may be levied and these are up to three times the losses avoided or profits made.
When it comes to the registered representative or other controlling persons, the fine – as of 2020 – is $2.14 million but this is adjusted with inflation each year.
Or it is three times the profit made or loss avoided if that is higher than the $2.14 million fine.
It’s not only fines that are handed out either.
While criminal penalties will include additional fines of up to $5 million, those convicted of insider trading can also face up to 20 years behind bars.
The member firm too, can be fined.
This can be either $25 million or three times the damages as a result of the insider trading, with the greater of the two the fine handed out.