Series 7 Study Guide Navigation

Communications with customers covering their accounts, the processing of customer requests, and document retention

There’s no denying that keeping accurate records in just about every aspect is a critical part of the daily workings of a broker-dealer.

Of course, we immediately think of the details of the transactions they make but just as important is information pertaining to customer account records.

What about records covering the daily operations?

Yes, they are just as important as well.

In fact, all the necessary retention requirements of records are outlined by the SEC in rules 17a-3 and 17a-4.

Account records and customer confirmations

As a way to help protect investors, customer confirmations are essential according to FINRA.

That’s because:

  • Transaction terms can be verified
  • Conflicts of interest (if any) can be identified
  • It provides safety from fraud
  • It allows customers to see transaction costs and assess them
  • It allows customers to see the quality of work (or lack thereof) carried out by their broker-dealer

Customer confirmations

The Series 7 exam covers two specific things regarding customer confirmations.

First, is the information that you will find on a customer confirmation.

Second, when should a customer confirmation be sent out to a customer.

Let’s start with the contents of a customer confirmation.

When securities are traded, a document called a trade confirmation will confirm that the trade has been made.

The first thing this shows (and it will appear on the face of the confirmation) is the amount of money that either must be paid by the customer (if they bought the securities) or is owed to them (if they sold the securities).

The second critical piece of information that you’ll find is the date on which the exchange of money for the purchase or sale of the security must take place and which is commonly referred to as the settlement date.

Make sure that you check out SEC Rule 10b-10 and FINRA Rule 2232 where all the basic requirements for a customer confirmation can be found.

Depending on the type of securities trade, according to those rules, the confirmation should contain the following:

  • What capacity the member acted in, for example, agent or principal
  • Was the member acting as a dual agent (in other words, were they working with the customer who bought the security as well as the one who sold it?)
  • If it was an agency trade, the confirmation must include the source as well as the number of commissions made
  • If the issuer and member are in a control relationship
  • If there was a deferred sales load, there must be a description of it
  • If acting in a principal capacity, the markdown or markup charged to retail customers
  • Share information including their identity, the number involved in the transaction, and the price
  • The traded debt securities’ total par value
  • When a debt security transaction is carried out on a yield or dollar basis, the confirmation must contain whichever is lower out of the yield to call or yield to maturity

Now that we’ve covered the contents, let’s move on to the confirmation delivery.

This is also detailed in SEC Rule 10b-10.

So before the settlement date for each transaction, which singles its completion, customers must be sent a written confirmation of that trade.

That’s all you will need to know when it comes to confirmation delivery.

Let’s move on to When-Issued trades.

Even before new municipal bonds are issued, many of them would already be accounted for.

By that, we mean that they have already been bought by investors.

In that situation, a when-issued confirmation will be sent to the investor buying the bonds.

This document will describe the bonds that they have purchased.

What you won’t find, however, is either the settlement date or the total dollar amount of the purchased securities.

That’s because those are unknown at that point.

Remember, the total dollar amount is calculated using accrued interest and that can only happen when the settlement date is known.

The investor will receive a new confirmation once the bonds are issued.

This will include the settlement date and the purchase price.

The confirmation of a when-issued transaction must have the following in it:

  • The securities description
  • For a dollar bond, the purchase price. For a serial bond, the yield
  • The date the trade will take place.

It won’t include the accrued interest, as we’ve mentioned because the settlement date is not known.

As systems have modernized, information, as mentioned above, can be delivered electronically.

This includes any confirmations as well as account statements.

Note, however, that there are certain conditions that need to be met to do so.

To start, systems must be put in place that shows that the information has been sent and delivered to each specific customer.

It goes without saying that this information is highly confidential, so the necessary cyber security systems must be in operation as well to ensure that the information is protected at all times.

But before any of this information can be sent electronically, a customer must consent to that method of delivery.

Even if they have done so, should they request a paper copy at any point, this too must be made available to them.

Note that all customer confirmations must be kept for a period of three years.

Customer account statements

Regulations require that customers of FINRA member firms receive account statements at least four times a year (quarterly, in other words).

For penny stocks, however, even if an account has no activity, these statements must be sent out monthly as per regulations that guide this type of security.

When speaking of account activity, it includes any:

  • Purchases
  • Sales
  • Interest credits
  • Interest debits
  • Account charges
  • Account credits
  • Payment of dividends
  • Transfers
  • Security receipts
  • Security delivery

Positions are generally at current market value.

While that’s true for most securities that are very liquid, what about those investments that aren’t.

Well, FINRA rules specifically cover unlisted REITs and DDPs in this regard, and customer account statements must include a per share estimated value should an investor hold these types of securities.

How can those values be estimated?

Well, there are a few methods that we will cover now.

These are unlikely to appear on the exam, but it’s useful to know and understand them just in case things change in that regard.

The first method in which to estimate value is by net investment.

From the offering prospectus and in the Estimated Use of Proceeds section, a net investment figure can be derived from the percentage shown in the “amount available for investment” record.

If there is a range of amounts available for investment as indicated by the issuer, a FINRA member firm is allowed to take the maximum offering percentage and use that.

If they believe that this percentage isn’t an accurate figure, then the minimum offering percentage must be used instead.

The next method is by using appraised values.

A per share estimated value that shows an appraised value can be used by a member firm at any time.

However, this must:

  • Be derived from the valuation of the DDP or REIT’s assets and liabilities which is carried at least once a year either by a third-party valuation expert or with their help
  • Uses recognized industry practice methodology in doing so

Disclosures can be used as a method as well.

FINRA Rule 2231 states the following regarding disclosures: “Any account statement that provides a per share estimated value for a DPP or REIT security shall disclose that the DPP or REIT securities are not listed on a national securities exchange, are generally illiquid and that, even if a customer is able to sell the securities, the price received may be less than the per share estimated value provided in the account statement.”

The gross proceeds of sales in the year prior as well as all interest and dividends credited to a customer account must be sent in statements to customers and the IRS (on a Form 1099) at the beginning of each year in January.

Should the account be considered a joint account, the statement only needs to be sent to the account holder who has their social security number linked to it.

When these account statements are sent, each must also stipulate that if the customer finds any inaccuracy or discrepancy, this must be reported to the broker straight away.

If applicable, it should also be reported to the clearing firm.

Customer records together with account transfers

In this section, we specifically look at those recordkeeping requirements that broker-dealers and other financial institutions must have in place when it comes to their customers.

These are exam-specific.

Customer account information updating

As we already know, within 30 days of opening their account, all customers must receive a copy of their account record.

The main reason behind this is that the information recorded is accurate and allows the customer to alert the firm to any mistakes that they may have come across.

This is particularly critical when it comes to suitability information.

This isn’t the first and last time that a copy of the account must be sent to the customer.

In fact, every three years, regulations state that they should receive a copy and notify the member firm of any changes that need to be made.

The member firms too, especially supervisors, need to constantly scan customer accounts to pick up any anomalies that might indicate that the circumstances of a customer have changed.

This can significantly affect how the member firm places investments for customers should this be the case.

What happens when there are changes to make, for example, when a customer alerts the member firm that they have to update certain sections of the account record?

Well, their customer record needs to be updated and within a period of 30 days of first receiving the changes, a new record should be sent to them.

When a customer’s employment changes, another important update must occur in their records.

That’s because of two main reasons:

  • Their suitability may be affected. For example, should they receive a promotion and are earning more, perhaps they have more to put towards investing, or the firm can be a little more aggressive with their investment options for that client. When it comes to a demotion, or changing to a job that pays less, then the opposite is true.
  • If a customer starts a new job with a publicly traded company, there are significant implications, most notably reducing the chances of them acquiring MNPI. If that client makes a trade in stock, for example, that will raise a red flag.

When it comes to keeping records that verify a customer’s identity, well they only have to be kept for five years from the point that these details were first recorded.

Transferring customer accounts between broker-dealers

Customers move between broker-dealer firms all the time.

For example, the registered representative who handles their account might change employment and move to another broker firm.

Because they have built up a relationship with them, the customer may choose to move too.

That’s just one example.

In this section, we are going to cover the regulations that you should know when this happens.

And when it does, it’s all carried out through the Automated Customer Account Transfer Service (ACATs).

Let’s start with some terminology first.

When a securities account belonging to a customer moves from one member firm to another, the original firm where the account is held is known as the carrying member.

The firm that will be receiving the account of the customer as they move over is known as the receiving member.

To initiate this movement, customers must sign a Transfer Initiation Form (TIF) which essentially acts as an account transfer form.

The Automated Customer Account Transfer Service (ACATs) then carries out the transfer through a standardized automated process.

This starts with the receiving firm sending the TIF to ACATS.

Note that customer authorization is needed and will mean either an electronic or original signature from them.

There is only one business day for the carrying member to confirm the securities as per the TIF.

They can take exception to the instructions, however.

If they don’t, within three business days, the transfer of the account must be completed by the carrying member.

When an account is not subjected to any claims (for example, a lien for owed monies), no member firm can hamper the transfer of the account because the customer’s registered representative has changed employment.

We’ve talked about it, but let’s focus a little more on when a customer follows a registered representative to another broker-dealer as it’s pretty important to understand the procedures involved.

This is outlined in FINRA Rule 2273, which covers the type of disclosures that need to be carried out should this occur.

It is particularly important that the customer is furnished with educational material regarding things that they must consider should this situation play out.

This includes financial incentives for the representative should the move take place, something that actually could lead to a conflict of interests.

Other information that this educational communication requires from FINRA includes:

  • Costs to liquidate some assets which aren’t transferable from one firm to the next will be borne by the customers
  • Account maintenance fees might be charged should these assets be left with the current firm
  • Other costs that could result from the transfer of assets from one firm to the next. This could be as a result of the two broker-dealers using different pricing structures, for example.
  • Differing services offered from the current customer firm to the recruiting firm
  • Differing products offered from the current customer firm to the recruiting firm

When member firms hire a registered representative, the regulations state that former customers (only natural persons, not entities) must receive educational communications, either orally, electronically, or in paper form in the following situations:

  • If they contact a former customer to transfer assets. This contact can be either directly or through the registered representative
  • If assets of the former customer, even without individual contact with them, are transferred to an account overseen by the registered representative working for that member firm

It is for a period of three months from the date of employment of the registered representative with the new member firm that the delivery of this communication applies.

When a customer who is contacted and asked if they want to transfer assets states they are not interested, FINRA Rule 2273 does not apply.

Should they change their mind within a period of three months that the registered representative is employed with the new member firm (as mentioned above), then educational material must be sent to them.

Remember, this rule only comes into play for natural persons, not institutional accounts.

Dealing with customer accounts as well as retention requirements for these accounts

When it comes to record-keeping, all the regulations that need to be adhered to are found under SEC Rules 17a-3, 17a-4 as well as FINRA Rule 4511.

Let’s start by looking at SEC Rules 17a-3 and 17a-4 that cover lifetime records, those kept for six-year periods or those kept for three-year periods.

These cover:

  • The records that member firms need to prepare
  • The circumstances in which these records are prepared
  • The retention period of these records

While we’ve mentioned the record types above (lifetime, six-year and three-year), note that all customer complaints must be kept for four years.

Let’s carry out a quick breakdown of the types of documents you would find in these various record periods.

Lifetime records include:

  • Stock certificate books
  • Articles of Incorporation or Partnership Agreements
  • Minutes of board or partnership meetings

Six-year records include:

Six-year records must include the following:

  • Records of original entry as well as receipts and deliveries (or blotters)
  • General ledger including assets, liabilities as well as net worth. These are prepared every month
  • Stock ledger: Firm owned stock
  • Customer ledgers: Customer held cash and margin account held statements that are posted by the settlement dates
  • Customer account records including account forms for new customers, other customer information, and any agreements, for example, margin agreements
  • Principal designation record including an office listing of all individuals at a member firm that understands and is able to explain the various records that the firm holds as well as the type of information within.

Three-year records include:

  • Monthly prepared trial balances
  • FOCUS reports
  • U4 and U5 forms
  • Fingerprint identification cards
  • Trade confirmations
  • Order tickets
  • Records of security and cash loans
  • Failed-to-receive and failed-to-deliver records
  • Long and short securities differences

While we’ve covered the various lengths that records must be kept, for all of these categories, records for the past two years must be in a location that is readily accessible.

The Series 7 exam might include questions regarding trade blotters.

Remember that these are a method of record-keeping that covers all daily activity.

This includes cash received and paid out, securities received, securities delivered as well as which securities were bought or sold during the trading day.

What a blotter won’t include is information about a client or settlement dates.

The first business day following whichever action we’ve highlighted above is when blotters will need to be posted according to regulations.

Account holder death

When a member firm is informed that an account holder dies, there are certain procedures that will need to be put in place.

Perhaps the most important is that any open orders for that account should be immediately canceled.

The account must also be marked deceased.

Any assets in the account should be frozen too.

From then on, the member firm will wait on instructions from the executor of the deceased estate as well as filling in all the necessary documentation that they need.

Note that authorization for third-party power of attorney will be revoked on any accounts that have this stipulation.

The death of an account holder also means that any discretionary authority also comes to an end.

When it comes to the documents that are required to release assets these include:

  • Death certificate (a certified copy is necessary)
  • Inheritance tax waivers
  • Letters testamentary

What happens with an account where there is more than one person involved, for example, joint tenants with rights of survivorship (JTWROS) accounts?

Well, in a JTWROS account, when one party passes away, a certified copy of a death certificate is needed by the member firm before the account is allowed to be transferred into the new owner’s name.

None of the other documents we’ve mentioned for accounts where single ownership is found are necessary for JTWROS accounts, other than the certified death certificate.

For a tenants in common account (TIC), should one party pass away, their interest in the account is transferred to their estate.

For the assets that belonged to the deceased to be passed on to their descendants, the executor will need to provide a range of documents.

This can include an affidavit of domicile in some states.

This means that the executor will handle the estate under the laws of that particular state.

The account will also need to be frozen in the event of the death of a tenant as well as acceptance of orders.

The account can then be unfrozen as soon as the member firm receives all the correct documentation.

The major difference here with a JTWROS account is that the other tenant may not place any orders until the documentation is sorted out as the account is frozen.

With a JTWROS account, this is not the case.

What about partnership accounts?

Well, should a partner die, if the member firm wants to execute any further orders on the account, the remaining partners will need to give written authority to do so.

Usually, an amended partnership agreement is the document that will need to be signed by the remaining partners for this to happen.

For the Series 7 exam, there are three steps to remember when a customer dies:

  • All open orders need to be canceled
  • The account needs to be marked as deceased and must be frozen
  • From that point on, the executor will provide instructions to the member firm as to how the account should be dealt with

Procedures for holding the mail of a customer

When opening a new account with the member firm, part of the process will see a customer give specified mailing instructions.

In some cases, someone else may hold power of attorney for a customer and then statements and confirmations might need to be sent to them with duplicates sent to the customers.

Member firms may hold mail for customers under FINRA rules as long as:

  • Written instructions regarding the holding of mail with the time period that the member firm needs to do so are received from the customer. The default time period for this is three months but customers can request for a longer period of time, providing they provide an acceptable reason which is not convenience sake. For example, an acceptable reason could be that they are out of the country for six months.
  • The customer is informed by the member firm of other methods that they can receive information about their account or monitor it, for example, by email or through a website. Customers must provide confirmation that they have received information about and understood these alternate methods.
  • At certain periods, the member firm must confirm that instructions as set out by the customer still apply

During the period in which the customer has asked the member firm to hold mail for them, there must be an effective communication channel open between the parties at all times.

This is so the member firm can provide the customer with account information when they need to.

Also, processes must be in place to ensure that FINRA rules, as well as federal securities laws, are not violated in any way in relation to the mail of a customer being tampered with.

Last, it is important to note that while member firms often do hold customer mail, under no circumstances do they have to.

There is no rule forcing a member firm to do so if they do not wish to and those that do are simply extending a courtesy to their customers.

Anti-Money Laundering (AML) compliance

FINRA Rule 3310 specifically deals with AML programs that member firms must come up with, install and then monitor so they meet requirements as set out by various regulations including the Bank Secrecy Act.

Any AML program that member firms draw up will need to be given full approval from a senior management member.

This approval must be in written form and should the manager who provided it move to another firm, the approval process must be carried out again with another senior management member.

According to AML compliance rules, member firms must:

  • Have procedures and policies in place that detect and report any transactions where money laundering is suspected
  • Have procedures, policies, and internal controls in operation that provide that confirmation to the Bank Secrecy Act
  • Select an individual(s) that monitors the AML program and is responsible for day-to-day operations as well as the internal controls thereof. FINRA needs to be informed who this individual(s) is as they will act as the go-between between the member firm and FINRA.
  • Institute regular ongoing training for personnel

Part of the Bank Secrecy Act rules and regulations include various documents the member firm will have to keep track of, like the currency transaction report (CTR) for example.

Whenever a currency is deposited or received into an account that is more than $10,000 on a single day, member firms must report this on Form 112 as per regulations set out by the Bank Secrecy Act.

This must be adhered to for:

  • Cash transactions that are paying off loans
  • Funds transferred electronically
  • Purchase of certificates for either mutual funds, bonds, stocks, and other investments

When wire transfers amount to more than $3,000, the Bank Secrecy Act says they must be reported as well.

It’s not against the law to pay for purchased securities using currency but in many cases, member firms simply do not allow investors to do this.

If member firms do not use a Form 112 to report the various transactions as highlighted above, they can face significant fines.

These can be up to $500,000.

But that’s not all, as 10-year prison sentences or in some cases, both of these outcomes could result if Form 112 requirements are not met.

Note that for record-retention purposes, Form 112s must be kept for five years.

So how long after a currency has been received into an account, must a Form 112 be filed?

Well, member firms have to do so within 15 days.

From the government side, when it comes to dealing with money laundering attempts through buying stock with currency, for example, two federal agencies are involved: the Federal Reserve and the Department of Treasury.

Finally, for this section, let’s talk about some of the red flags that the AML compliance program that member firms institute should be able to pick up.

These are all based on a customer:

  • Who doesn’t seem to be perturbed when it comes to risks, the cost of transactions, or how much commission they have to pay
  • Who is either using a cashier’s check or currency to make large deposits often
  • Who makes lots of wire transfers to third parties that seem unrelated
  • Who often makes large transfers between unrelated accounts
  • Who either makes currency deposits or withdrawals that just fall under the reporting figure of $10,000. This is known as structuring.

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